SEVERN BANCORP The Company
The Company is a savings and loan holding company chartered as a corporation in the state ofMaryland in 1990. It conducts business primarily through four subsidiaries, the Bank, SBI, theTitle Company , and Hyatt Commercial (see "Subsequent Events" later in this Item for information on subsequent sale of certain Hyatt Commercial assets). Hyatt Commercial conducts business as a commercial real estate brokerage and property management company. SBI holds mortgages that do not meet the underwriting criteria of the Bank and is the parent company ofCrownsville , which does business asAnnapolis Equity Group and acquires real estate for syndication and investment purposes.The Title Company engages in title work related to real estate transactions. The Bank has seven branches inAnne Arundel County, Maryland , which offer a full range of deposit products and originate mortgages in its primary market ofAnne Arundel County, Maryland and, to a lesser extent, in other parts ofMaryland ,Delaware , andVirginia .
Significant Developments - COVID-19
OnMarch 11, 2020 , theWorld Health Organization declared the outbreak of COVID-19 as a global pandemic, which continues to spread throughout theU.S. and around the world. The declaration of a global pandemic indicates that almost all public commerce and related business activities must be, to varying degrees, curtailed with the goal of decreasing the rate of new infections. The COVID-19 pandemic in theU.S. has had and is expected to continue to have a complex and significant adverse impact on the economy, the banking industry, and the Company in future fiscal periods, all subject to a high degree of uncertainty.
Effects on Our Market Areas
Our commercial and consumer banking products and services are offered primarily inMaryland , where individual and governmental responses to the COVID-19 pandemic have led to a broad curtailment of economic activity sinceMarch 2020 . InMaryland , the Governor issued a series of orders, including ordering schools to close for an indefinite period of time and an order that, subject to limited exceptions, all individuals stay at home and non-essential businesses cease all activities for an indeterminate amount of time. SinceJune 2020 , many of these restrictions have been removed and some non-essential businesses were allowed to re-open in a limited capacity, adhering to social distancing and disinfection guidelines. The Bank has remained open during these orders because banks have been identified as essential services. The Bank has been serving its customers through its drive-ups, ATMs, and in all of its branch offices by appointment only. Locally, as well as nationally, we have experienced an increase in unemployment levels in our market area as a result of the curtailment of business activities, the levels of which are expected to remain elevated for the near future.
Policy and Regulatory Developments
Federal, state and local governments and regulatory authorities have enacted and issued a range of policy responses to the COVID-19 pandemic, including the following:
? The FRB decreased the range for the federal funds target rate by 0.5%
on March 3, 2020 , and by another 1.0% on March 16, 2020 , reaching the
current range of 0.0% - 0.25%.
? On March 27, 2020 , the President of the U.S. signed the CARES Act,
which established a
cash payments to individuals, supplemental unemployment insurance
benefits and a $659.0 billion loan program (revised by subsequent
legislation) administered through the SBA, referred to as the PPP.
Under the PPP, small businesses, sole proprietorships, independent
contractors and self-employed individuals were able to apply forforgivable loans from existing SBA lenders and other approved regulated
lenders that enroll in the program, subject to numerous limitations and
eligibility criteria. PPP loans have an interest rate of 1.0%, a
two-year or five-year loan term to maturity, and principal and
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interest payments deferred until the lender receives the applicable
forgiven amount or the end of the borrower's loan forgiveness. The Bank
participates as a lender in the PPP. In addition, the CARES Act
provides financial institutions the option to temporarily suspendcertain requirements under accounting principles generally accepted in
the
account for the effects of COVID-19. The Consolidated Appropriations
Act of 2021 extended the period established by the CARES Act for
consideration of TDR identification to January 1, 2022 or 60 days after
the date the national COVID-19 pandemic emergency terminates.
? On April 7, 2020 , federal banking regulators issued a revisedInteragency Statement on Loan Modifications and Reporting for Financial
Institutions, which, among other things, encouraged financial
institutions to work prudently with borrowers who are or may be unable
to meet their contractual payment obligations because of the effects of
COVID-19, and stated that institutions generally do not need to
categorize COVID-19-related modifications as TDRs and that the agencies
will not direct supervised institutions to automatically categorize all
COVID-19 related loan modifications as TDRs. On August 3, 2020 ,
Interagency Statement on Additional Loan Accommodations Related to
COVID-19 was issued that addresses loans nearing the end of their
original relief period and provides guidance for extension of such
relief period.
? On April 9, 2020 , the FRB announced additional measures aimed at
supporting small and mid-sized businesses, as well as state and local
governments impacted by COVID-19. The FRB announced the Main Street Business Lending Program, which established two new loan facilities
intended to facilitate lending to small and mid-sized businesses: (1)
the Main Street New Loan Facility ("MSNLF") and (2) the Main Street
Expanded Loan Facility ("MSELF"). MSNLF loans were unsecured term loans
originated on or after
as upsized tranches of existing loans originated before April 8, 2020 .
The combined size of the program was $600.0 billion . The program was
designed for businesses with up to 10,000 employees or
2019 revenues. To obtain a loan, borrowers had to confirm that they
were seeking financial support because of COVID-19 and that they would
not use proceeds from the loan to pay off debt. The FRB also stated
that it would provide additional funding to banks offering PPP loans to
help struggling small businesses. The PPP Loan Facility ("PPPLF") was
created by the FRB on April 9, 2020 to facilitate lending by
participating financial institutions to small businesses under the PPPof the CARES Act. Under the facility, the FRB lent to participating
financial institutions on a non-recourse basis, taking PPP loans as
collateral. Lenders participating in the PPP were able to exclude loans
financed by the facility from their leverage ratio. Due to our high
liquidity levels, we did not participate in the PPPLF.
The FRB also created a Municipal Liquidity Facility to support state
and local governments with up to $500.0 billion in lending, with the
Treasury Department backing $35.0 billion for the facility using fundsappropriated by the CARES Act. The facility made short-term financing
available to cities with a population of more than one million or
counties with a population of greater than two million. The FRB
expanded both the size and scope of its Primary and Secondary Market
Corporate Credit Facilities to support up to $750.0 billion in creditto corporate debt issuers. This allowed companies that were investment
grade before the onset of COVID-19 but then subsequently downgraded
after
announced that its Term Asset-Backed Securities Loan Facility would be
scaled up in scope to include the triple A-rated tranche of commercial
mortgage-backed securities and newly issued collateralized loan
obligations. The size of the facility was $100.0 billion .
Effects on Our Business
The COVID-19 pandemic and the specific developments referred to above could have
and are expected to continue to have a significant impact on our business. The
outbreak of COVID-19 could continue to adversely impact a broad range of
industries in which the Company's customers operate and impair their ability to
fulfill their financial obligations to the Company. In particular, we anticipate
that a significant portion of the Bank's borrowers in the hotel, restaurant, and
retail industries will continue to endure significant economic distress, which
has caused, and may continue to cause, them to draw on their existing lines of
credit and adversely affect their ability to repay existing indebtedness, and is
expected to adversely impact the value of collateral. These developments,
together with economic conditions generally, are also expected to impact our
commercial real estate portfolio, particularly with respect to real estate
with
exposure to
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these industries, and the value of certain collateral securing our loans. As a
result, we anticipate that our financial condition, capital levels, and results
of operations could be adversely affected. As of December 31, 2020 , we held $4.1
million , $14.7 million , and $48.9 million in hotel, restaurant, and retailindustry loans, respectively. Our Response
We have taken numerous steps in response to the COVID-19 pandemic, including the following:
? actively working with loan customers to evaluate prudent loan
modification terms;
? continuing to promote our digital banking options through our website.
Customers are encouraged to utilize online and mobile banking tools,
and our customer service and retail departments are fully staffed and
available to assist customers remotely;
? acted as a participating lender in the PPP as well as the second round
of PPP that expires
as a community bank to assist the SBA in the distribution of funds
authorized under the CARES Act and subsequent legislation to our
customers and communities, which we have carried out in a prudent and
responsible manner. As of December 31, 2020 , we held $30.2 million in
PPP loans in our loan portfolio, and are working diligently withcustomers on the loan forgiveness aspect of the program (see "Notes to
Consolidated Financial Statements - Note 3 - Loans Receivable and the
Allowance" in this Annual Report on Form 10-K and "Financial Condition
- Credit Risk Management and the Allowance - TDRs" later in this Item
for more information regarding PPP loans and loan modifications under
the CARES Act); and
? closing all branches to customer activity indefinitely, except for
drive-up and appointment only services. We continue to pay allemployees according to their normal work schedule, even if their work
has been reduced. No employees have been furloughed. Employees whose
job responsibilities can be effectively carried out remotely are
working from home. Employees whose critical duties require their
continued presence on-site are observing social distancing and cleaning
protocols.
Overview
The Company provides a wide range of personal and commercial banking services.
Personal services include mortgage and consumer lending as well as deposit
products such as personal Internet banking and online bill pay, checking
accounts, individual retirement accounts, money market accounts, and savings and
CDs. Commercial services include commercial secured and unsecured lending
services as well as business Internet banking, corporate cash management
services, and deposit services, including services related to the medical-use
cannabis industry. The Company also provides ATMs, credit cards, debit cards,
safe deposit boxes, and telephone banking, among other products and services.
We have experienced a decreased level of profitability in our operations in
2020, primarily due to loan runoff and increased noninterest expenses as well as
the effects of the COVID-19 pandemic. Less interest income was generated from
lower volumes of interest-earning assets, as well as a decreased interest rate
environment. Loan interest income decreased from lower loan volumes, which was
slightly offset by a reduction in interest expense from less reliance on
borrowings and a lower interest rate environment. Our income before income taxes
amounted to $9.4 million in 2020 and $11.6 million in 2019. In 2020, both the
Mid-Atlantic region in which we operate and the national economy experienced
decreased economic activity primarily due to the COVID-19 pandemic and increased
unemployment. Consumer confidence has been affected by certain economic trends
such as higher unemployment and the uncertainty around the COPVID-19 pandemic.
While we have been operating in a depressed economic environment, we have been
able to maintain strong levels of liquidity, capital, and credit quality,
despite decreased profitability.
The Company expects to experience similar market conditions during 2021, at
least through the duration of the COVID-19 pandemic. If interest rates increase,
demand for borrowing may decrease and our interest rate spread could decrease.
Additionally, an interest rate increase could negatively impact mortgage-banking
revenue. If interest rates decrease, demand for borrowing may increase, which
could improve our interest rate spread, depending on other factors. We will
continue to manage loan and deposit pricing against the risks of rising costs
of our deposits and borrowings. Interest rates
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are outside of our control, so we must attempt to balance the pricing and duration of the loan portfolio against the risks of rising costs of our deposits and borrowings.
The continued success and attraction of
If the market and/or economy worsens, our business, financial condition, results of operations, access to funds, and the price of our stock could be materially and adversely impacted. Critical Accounting Policies
Our accounting and financial reporting policies conform to GAAP and general practice within the banking industry. Accordingly, preparation of the financial statements requires management to exercise significant judgment or discretion or make significant assumptions and estimates based on the information available that have, or could have, a material impact on the carrying value of certain assets or on income. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the periods presented. The accounting policies we view as critical are those relating to the Allowance, the valuation of real estate acquired through foreclosure, and the valuation of deferred tax assets and liabilities. Significant accounting policies are discussed in detail in "Notes to Consolidated Financial Statements - Note 1 - Summary of Significant Account Policies" in this Annual Report on Form 10-K. Results of OperationsNet Income Net income decreased by$1.6 million , or 19.0%, to$6.7 million for 2020, compared to$8.3 million for 2019. Basic and diluted income per share decreased to$0.52 for 2020, compared to$0.65 and$0.64 , respectively, for 2019. We recognized a decrease in net interest income and an increase in noninterest income compared to 2019, primarily a result of increased mortgage-banking revenue. Noninterest expenses increased in 2020 compared to 2019 due primarily to an increase in compensation and related expenses, and we recorded a provision for loan losses in 2020 primarily as a result of the COVID-19 pandemic compared to a reversal of provision for loan losses in 2019.
Net Interest Income
Net interest income, which is interest earned net of interest expense, decreased by$3.0 million , or 9.8%, to$27.5 million for 2020, compared to$30.5 million for 2019. The decrease in net interest income was primarily due to the decreased average balance and yield on interest-earning assets, partially offset by the decreased average balance and yield on interest-bearing liabilities. Our net interest margin decreased from 3.50% in 2019 to 3.29% in 2020 and our net interest spread decreased from 3.17% in 2019 to 2.91% in 2020.
Interest Income
Interest income decreased by$5.9 million , or 14.8%, to$33.9 million for 2020, compared to$39.8 million for 2019. Average interest-earning assets decreased from$871.5 million in 2019 to$837.0 million in 2020. The yield on average assets decreased from 4.57% for 2019 to 4.05% in 2020 primarily as a result of decreasing interest rates in the depressed COVID-19 pandemic economy. The average yield on loans decreased from 5.27% in 2019 to 4.91% in 2020. Average loans outstanding decreased by$24.6 million in 2020 compared to 2019 due primarily to significant loan runoff in 2020 as a result of the low interest rate environment despite increased overall loan originations in 2020. Average held-to-maturity ("HTM") securities decreased by$12.8 million in 2020 compared to 2019 due to maturities of securities and repayments from MBS. Average available-for-sale ("AFS") securities increased$10.4 million due to securities purchases in 2020. Average other interest-earning assets decreased from$133.9 million in 2019 to$120.9 million in 2020. The decrease was primarily due to the aforementioned securities purchases. 33 Table of Contents Interest Expense Interest expense decreased by$2.9 million , or 31.3%, to$6.4 million for 2020, compared to$9.3 million for 2019. The decrease was primarily due to the decreased average rate paid on our deposit accounts attributable to the decreased interest rate environment in 2020, as well as the decreased average balance of deposits. The average rate paid on deposits decreased from 1.25% in 2019 to 1.03% in 2020. The average balance of interest-bearing deposits decreased from$589.4 million in 2019 to$511.9 million in 2020. The decrease resulted from a decrease in both checking and savings accounts as well as CDs. The average balance of CDs decreased due to maturities. The average balance of checking and savings accounts decreased due primarily to medical-use cannabis related accounts, which fluctuate depending on customer investment opportunities. The average rate paid on CDs decreased from 2.38% in 2019 to 1.60% in 2020. We also recognized a decrease in interest expense related to borrowings due to both a decrease in the average borrowings in 2020 compared to 2019 and a decreased average rate paid on borrowings in 2020 compared to 2019. Average borrowings decreased$26.7 million in 2020 compared to 2019. We paid off$25.0 million in long-term FHLB advances in 2020. The following table sets forth, for the years indicated, information regarding the average balances of interest-earning assets and interest-bearing liabilities and the resulting yields on average interest-earning assets and rates paid on average interest-bearing liabilities. Average balances are also provided for noninterest-earning assets and noninterest-bearing liabilities. 2020 2019 2018 Average Yield/ Average Yield/ Average Yield/ Balance Interest (2) Rate Balance Interest (2) Rate Balance Interest (2) Rate ASSETS (dollars in thousands) Loans (1)$ 652,008 $ 32,002 4.91 %$ 676,622 $ 35,639 5.27 %$ 675,418 $ 34,643 5.13 % Mortgage loans held for sale ("LHFS") 17,239 328 1.90 % 10,962 562 5.13 % 5,598 234 4.18 % AFS securities 21,804 574 2.63 % 11,392 202 1.77 % 11,795 208 1.76 % HTM securities 22,782 460 2.02 % 35,584 728 2.05 % 49,867 988 1.98 % Other interest-earning assets (3) 120,906 463 0.38 % 133,935 2,499 1.87 % 46,470 1,338 2.88 % Restricted stock investments, at cost 2,268 84 3.70 % 3,038 180 5.92 % 4,612 249 5.40 % Total interest-earning assets 837,007 33,911 4.05 %
871,533 39,810 4.57 % 793,760 37,660 4.74 % Allowance (7,644) (8,042) (8,179) Cash and other noninterest-earning assets 44,315 44,512 43,055 Total assets$ 873,678 33,911$ 908,003 39,810$ 828,636 37,660 LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing deposits: Checking and savings$ 320,238 2,181 0.68 %$ 386,206 2,517 0.65 %$ 255,665 1,794 0.70 % Certificates of deposit 191,619 3,071 1.60 % 203,165 4,833 2.38 % 224,222 3,894 1.74 %
Total interest-bearing deposits 511,857 5,252 1.03 %
589,371 7,350 1.25 % 479,887 5,688 1.19 % Borrowings 48,260 1,139 2.36 % 74,949 1,953 2.61 % 111,788 2,915 2.61 % Total interest-bearing liabilities 560,117 6,391 1.14 % 664,320 9,303 1.40 % 591,675 8,603 1.45 % Noninterest-bearing deposit accounts 193,621 135,027 139,467 Other noninterest-bearing liabilities 12,546 6,039 2,283 Stockholders' equity 107,394 102,617 95,211 Total liabilities and stockholders' equity$ 873,678 6,391$ 908,003 9,303$ 828,636 8,603 Net interest income/net interest spread$ 27,520 2.91 %$ 30,507 3.17 %$ 29,057 3.29 % Net interest margin 3.29 % 3.50 % 3.66 %
(1) Nonaccrual loans are included in average loans.
(2) There are no tax equivalency adjustments.
(3) Other interest-earning assets include interest-earning deposits, federal
funds sold, and certificates of deposit held for investment.
The "Rate/Volume Analysis" below indicates the changes in our net interest income as a result of changes in volume and rates. We maintain an asset and liability management policy designed to provide a proper balance between rate-sensitive assets and rate-sensitive liabilities to attempt to optimize interest margins while providing adequate liquidity for our
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anticipated needs. Changes in interest income and interest expense that result from variances in both volume and rates have been allocated to rate and volume changes in proportion to the absolute dollar amounts of the change in each.
2020 vs. 2019 2019 vs. 2018
Due to Variances in Due to Variances in
Rate Volume Total Rate Volume Total
Interest earned on: (dollars in thousands) Loans$ (2,371) $ (1,266) $ (3,637) $ 934 $ 62 $ 996 LHFS (459) 225 (234) 63 265 328 AFS securities 129 243 372 - (6) (6) HTM Securities (10) (258) (268) 32 (292) (260) Other interest-earning assets (1,814) (222) (2,036) (611) 1,772 1,161 Restricted stock investments, at cost (58) (38) (96) 23 (92) (69) Total interest income (4,583) (1,316)
(5,899) 441 1,709 2,150
Interest paid on: Interest-bearing deposits: Checking and savings 108 (444) (336) (136) 859 723 Certificates of deposit (1,500) (262) (1,762) 1,332 (393) 939 Total interest-bearing deposits (1,392) (706) (2,098) 1,196 466 1,662 Borrowings (170) (644) (814) (2) (960) (962) Total interest expense (1,562) (1,350) (2,912) 1,194 (494) 700 Net interest income$ (3,021) $ 34 $ (2,987) $ (753) $ 2,203 $ 1,450 Provision for Loan Losses Our loan portfolio is subject to varying degrees of credit risk and an Allowance is maintained to absorb losses inherent in our loan portfolio. Credit risk includes, but is not limited to, the potential for borrower default and the failure of collateral to be worth what we determined it was worth at the time of the origination of the loan. We monitor loan delinquencies at least monthly. All loans that are delinquent and all loans within the various categories of our portfolio as a group are evaluated. Management, with the advice and recommendation of the Company's Board of Directors, estimates an Allowance to be set aside for probable loan losses inherent in the loan portfolio. Included in determining the calculation are such factors as historical losses for each loan portfolio, current market value of the loan's underlying collateral, inherent risk contained within the portfolio after considering the state of the general economy, economic trends, consideration of particular risks inherent in different kinds of lending, and consideration of known information that may affect loan collectability. Additionally, some of those factors were adjusted in 2020 to reflect the effects of the COVID-19 pandemic. As a result of our Allowance analysis, for the years endedDecember 31, 2020 and 2019, we determined that a provision and a (reversal of provision) of$900,000 and$(500,000) , respectively, were appropriate.
See additional information about the provision for loan losses under "Credit Risk Management and the Allowance" later in this Item.
Noninterest Income
Total noninterest income increased by$5.6 million , or 54.1%, to$15.8 million for 2020 compared to$10.3 million for 2019, primarily due to increased mortgage-banking revenue, increased deposit service charges, and increased title company revenue. Mortgage-banking revenue increased$5.7 million , or 152.6%, to$9.5 million for 2020 compared to$3.7 million for 2019. This increase was the result of an increase in mortgage-banking activity in 2020, with an increase of originations from$171.8 million in 2019 to$320.1 million in 2020 primarily as a result of the decrease in interest rates. Deposit service charges increased$103,000 , or 4.7%, to$2.3 million in 2020, compared to$2.2 million in 2019 due primarily to on-boarding and monthly service fees charged to medical-use cannabis customers. Title company revenue increased$231,000 from$1.1 million in 2019 to$1.4 million in 2020 due to increased loan closings. Real estate 35
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commissions by Hyatt Commercial decreased by$621,000 , or 33.9%, to$1.2 million for 2020 compared to$1.8 million for 2019. The decrease was due to decreased commercial sales activity in 2020, primarily due to the COVID-19 pandemic.
Noninterest Expense
Total noninterest expense increased$3.4 million , or 11.4%, to$33.1 million for 2020, compared to$29.7 million for 2019, primarily due to increases in compensation and related expenses and data processing costs. Compensation and related expenses increased by$3.4 million , or 17.5%, to$23.2 million for 2020, compared to$19.7 million for 2019. This increase was primarily due to annual salary increases, increased commissions, and bonuses. Data processing fees increased$244,000 in 2020 compared to 2019 due to additional efficiency and security enhancements to our core and related systems, as well as the implementation of a new customer relationship management ("CRM") system in the latter part of 2019. Professional fees decreased by$285,000 , or 24.8%, to$862,000 in 2020 compared to$1.1 million in 2019, primarily due to decreased external audit and consulting fees in 2020. The 2019 fiscal year contained increased expenses due to significant internal controls related work.
Income Tax Provision
We recognized a$2.7 million provision for income taxes on income before income taxes of$9.4 million for an effective tax rate of 28.5% during 2020 compared to a provision for income taxes of$3.3 million on income before taxes of$11.6 million for an effective tax rate of 28.7% in 2019.
Financial Condition
Total assets increased$126.5 million , or 15.3%, to$952.6 million atDecember 31, 2020 compared to$826.0 million atDecember 31, 2019 . Cash and cash equivalents increased by$68.4 million , or 77.6%, to$156.6 million atDecember 31, 2020 compared to$88.2 million atDecember 31, 2019 , primarily due to the increase in deposits noted below. Total securities increased$42.2 million , or 108.5%, due to securities purchases made to utilize our excess liquidity. LHFS increased$25.4 million , or 232.7%, to$36.3 million atDecember 31, 2020 compared to$10.9 million atDecember 31, 2019 . This increase was due to an increased volume of originations from$171.8 million in 2019 to$320.1 million in 2020, as well as timing of sales to investors. Loans decreased$2.8 million , or 0.4%, to$642.9 million atDecember 31, 2020 compared to$645.7 million atDecember 31, 2019 due to loan runoff, which offset increased origination activity in 2020. Real estate acquired through foreclosure decreased$1.4 million , or 57.7%, to$1.0 million atDecember 31, 2020 compared to$2.4 million atDecember 31, 2019 . This decrease was due to the sale of three properties. Total deposits increased$145.4 million , or 22.0%, to$806.5 million atDecember 31, 2020 compared to$661.0 million atDecember 31, 2019 , primarily due to increased medical-use cannabis deposits and fluctuations in medical-use cannabis related deposit accounts. Additionally, customers have been maintaining increasing cash balances during the pandemic. Long-term borrowings decreased by$25.0 million , or 71.4%, to$10.0 million atDecember 31, 2020 compared to$35.0 million atDecember 31, 2019 as we paid off FHLB advances.
Securities
We utilize the securities portfolio as part of our overall asset/liability management practices to enhance interest revenue while providing necessary liquidity for the funding of loan growth or deposit withdrawals. We continually monitor the credit risk associated with investments and diversify the risk in the securities portfolios. We held$65.1 million and$12.9 million in securities classified as AFS as ofDecember 31, 2020 and 2019, respectively. We held$15.9 million and$26.0 million in securities classified as HTM as ofDecember 31, 2020 and 2019, respectively. Changes in current market conditions, such as interest rates and the economic uncertainties in the mortgage, housing, and banking industries impact the securities market. Quarterly, we review each security in our AFS portfolio to determine the nature of any decline in value and evaluate if any impairment should be classified as other-than-temporary impairment ("OTTI"). Such evaluations resulted in the determination that no OTTI charges were required during 2020 or 2019. 36 Table of Contents All of the AFS and HTM securities that were impaired as ofDecember 31, 2020 were so due to declines in fair values resulting from changes in interest rates or increased credit/liquidity spreads compared to the time they were purchased. We have the intent to hold these securities to maturity and it is more likely than not that we will not be required to sell the securities before recovery of value. As such, management considers the impairments to be temporary.
Our securities portfolio composition was as follows at
AFS HTM
2020 2019 2020 2019
(dollars in thousands)
U.S. Treasury securities $ - $ - $ - $ 994
U.S. government agency notes 6,660 5,019 1,986 4,986
Corporate obligations 2,034 - - -
MBS 56,404 7,887 13,957 19,980
$ 65,098 $ 12,906 $ 15,943 $ 25,960
The amortized cost, estimated fair values, and weighted average yields of debt
securities at December 31, 2020 , by contractual maturity, are shown below.
Actual maturities may differ from contractual maturities because issuers have
the right to call or prepay obligations.
Weighted
Amortized Unrealized Estimated Average
Cost Gains Losses Fair Value Yield
AFS Securities: (dollars inthousands)
U.S. government agency notes: Due after one to five years$ 153 $ 1 $ -$ 154 5.12 % Due after five to ten years 3,023 42 13 3,052 2.54 % Due after ten years 3,464 2 12 3,454 1.25 % Corporate obligations: Due after five to ten years 2,000 34 - 2,034 3.38 % MBS: Due after five to ten years 748 23
- 771 3.00 %
Due after ten years 55,637 316 320 55,633 2.45 %
$ 65,025 $ 418 $ 345 $ 65,098 2.43 %
HTM Securities :
US government agency notes:
Due one to five years $ 1,986 $ 145 $ - $ 2,131 2.80 %
MBS:
Due after one to five years 2,001 51 - 2,052 2.36 %
Due after five to ten years 8,047 315
- 8,362 2.65 %
Due after ten years 3,909 149 - 4,058 3.25 %
$ 15,943 $ 660 $ - $ 16,603 2.78 %
Weighted average yields are based on amortized cost. MBS are assigned to maturity categories based on their final maturity.
LHFS
We originate residential mortgage loans for sale on the secondary market.
At
When we sell mortgage loans we make certain representations to the purchaser
related to loan ownership, loan compliance and legality, and accurate
documentation, among other things. If a loan is found to be out of compliance
with any of the representations subsequent to the date of purchase, we may be
required to repurchase the loan or indemnify the purchaser
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for losses related to the loan, depending on the agreement with the purchaser. In addition other factors may cause us to be required to repurchase or "make-whole" a loan previously sold.
The most common reason for a loan repurchase is due to a documentation error or disagreement with an investor, or on rare occasions for fraud. Repurchase requests are negotiated with each investor at the time we are notified of the demand and an appropriate reserve is taken at that time. We did not repurchase any loans during 2020 or 2019. We do not expect increases in repurchases or related losses to be a growing trend nor do we see it having a significant impact on our financial results.
Loans
Our loan portfolio is expected to produce higher yields than investment securities and other interest-earning assets; the absolute volume and mix of loans and the volume and mix of loans as a percentage of total interest-earning assets is an important determinant of our net interest margin.
The following table sets forth the composition of our loan portfolio before net
unearned loan fees as of
2020 2019
Percent Percent
Amount of Total Amount of Total
(dollars in thousands)
Residential Mortgage $ 209,659 32.4 % $ 269,654 41.5 %
Commercial 63,842 9.9 % 43,127 6.7 %
Commercial real estate 243,435 37.7 % 229,257 35.4 %
ADC 112,938 17.5 % 92,822 14.3 %
Home equity/2nds 14,712 2.3 % 12,031 1.9 %
Consumer 1,485 0.2 %
1,541 0.2 %
Loans receivable, before net unearned fees
Loans, net of unearned fees, decreased by$2.8 million , or 0.4%, to$642.9 million atDecember 31, 2020 compared to$645.7 million atDecember 31, 2019 . This decrease was primarily due to significant runoff of residential mortgage loans resulting from refinancings in the low interest rate environment, partially offset by increased commercial, commercial real estate, ADC, and home equity/2nds loan demand. Approximately 42% of our loans had adjustable rates as ofDecember 31, 2020 . Our variable-rate loans adjust to the current interest rate environment, whereas fixed rates do not allow this flexibility. If interest rates were to increase in the future, our interest earned on the variable-rate loans would improve, and if rates were to fall, the interest we earn on such loans would decline, thus impacting our interest income. Some variable-rate loans have rate floors and/or ceilings which may delay and/or limit changes in interest income in a period of changing rates. See our discussion in "Interest Rate Sensitivity" later in this Item for more information on interest rate fluctuations. 38
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The following table sets forth the maturity distribution for our loan portfolio atDecember 31, 2020 . Some of our loans may be renewed or repaid prior to maturity. Therefore, the following table should not be used as a forecast of our future cash collections. Maturing In one year or less After 1 through 5
years After 5 through 15 years After 15 years
Fixed Variable Fixed Variable Fixed Variable Fixed Variable Total
(dollars in thousands)
Residential Mortgage $ 5,716 $ 6,460 $ 27,751 $ 1,770 $ 15,980 $ 13,672 $ 35,725 $ 102,585 $ 209,659
Commercial 2,062 8,552 37,018 1,382 9,692 4,098 100 938 63,842
Commercial real estate 11,891 5,829 64,409 10,197 90,780 40,941 - 19,388 243,435
ADC 58,296 26,641 7,673 9,094 1,643 3,004 2,292 4,295 112,938
Home equity/2nds - - 110 - - 3,735 190 10,677 14,712
Consumer - - 419 - 476 - 422 168 1,485
$ 77,965 $ 47,482 $ 137,380 $ 22,443 $ 118,571 $ 65,450 $ 38,729 $ 138,051 $ 646,071
$ 125,447 $ 159,823 $ 184,021 $ 176,780 Credit Risk Management and the Allowance
Credit risk is the risk of loss arising from the inability of a borrower to meet
his or her obligations and entails both general risks, which are inherent in the
process of lending, and risks specific to individual borrowers. Our credit risk
is mitigated through portfolio diversification, which limits exposure to any
single customer, industry, or collateral type.
We manage credit risk by evaluating the risk profile of the borrower, repayment
sources, the nature of the underlying collateral, and other support given
current events, conditions, and expectations. We attempt to manage the risk
characteristics of our loan portfolio through various control processes, such as
credit evaluation of borrowers, establishment of lending limits, and application
of lending procedures, including the holding of adequate collateral and the
maintenance of compensating balances. However, we seek to rely primarily on the
cash flow of our borrowers as the principal source of repayment. Although credit
policies and evaluation processes are designed to minimize our risk, management
recognizes that loan losses will occur and the amount of these losses will
fluctuate depending on the risk characteristics of our loan portfolio, as well
as general and regional economic conditions.
Management has an established methodology to determine the adequacy of the
Allowance that assesses the risks and losses inherent in the loan portfolio. Our
Allowance methodology employs management's assessment as to the level of future
losses on existing loans based on our internal review of the loan portfolio,
including an analysis of the borrowers' current financial position, and the
consideration of current and anticipated economic conditions and their potential
effects on specific borrowers and/or lines of business. In determining our
ability to collect certain loans, we also consider the fair value of any
underlying collateral. In addition, we evaluate credit risk concentrations,
including trends in large dollar exposures to related borrowers, industry and
geographic concentrations, and economic and environmental factors. Our risk
management practices are designed to ensure timely identification of changes in
loan risk profiles; however, undetected losses may inherently exist within the
loan portfolio. The assessment aspects involved in analyzing the quality of
individual loans and assessing collateral values can also contribute to
undetected, but probable, losses. In 2020, we adjusted our economic risk factors
to incorporate the current economic implications and rising unemployment rate
from the COVID-19 pandemic. For more detailed information about our Allowance
methodology and risk rating system, see Note 3 to the Consolidated Financial
Statements contained in this Annual Report on Form 10-K.
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The following table summarizes the activity in our Allowance by portfolio
segment as of and for the years ended
2020 2019
(dollars in thousands)
Allowance, beginning of year $ 7,138 $ 8,044
Charge-offs:
Residential mortgage (39) (20)
Commercial - -
Commercial real estate (8) (537)
ADC - -
Home equity/2nds - -
Consumer (15) (14)
Total charge-offs (62) (571)
Recoveries:
Residential mortgage 494 14
Commercial 16 -
Commercial real estate 169 130
ADC - 5
Home equity/2nds 11 11
Consumer 4 5
Total recoveries 694 165
Net recoveries (charge-offs) 632 (406)
Provision for (reversal of) loan losses 900 (500)
Allowance, end of year$ 8,670 $
7,138
Loans:
Year-end balance, net of unearned loan fees$ 642,882 $
645,685
Average balance during year 652,008
676,622
Allowance as a percentage of year-end loan balance (1) 1.35 % 1.11 % Percent of average loans: Provision for (reversal of) loan losses 0.14 % (0.07) % Net recoveries (charge-offs) 0.10 % (0.06) %
(1) The allowance at
loans was 1.42%
The following tables summarize our allocation of the Allowance by loan segment
as of December 31 :
2020 2019
Percent Percent
of Loans of Loans
Percent to Total Percent to Total
Amount of Total Loans Amount of Total Loans
(dollars in thousands)
Residential mortgage$ 2,259 26.0 % 32.4 %$ 2,264 31.7 % 41.5 % Commercial 1,670 19.3 % 9.9 % 1,421 19.9 % 6.7 % Commercial real estate 1,516 17.5 % 37.7 %
984 13.8 % 35.4 % ADC 2,947 34.0 % 17.5 % 2,286 32.0 % 14.3 % Home equity/2nds 168 1.9 % 2.3 % 134 1.9 % 1.9 % Consumer - - 0.2 % - - 0.2 % Unallocated 110 1.3 % - % 49 0.7 % - % Total$ 8,670 100.0 % 100.0 %$ 7,138 100.0 % 100.0 %
Based upon management's evaluation, provisions are made to maintain the
Allowance as a best estimate of inherent losses within the portfolio. The
Allowance totaled
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Any changes in the Allowance from period to period reflect management's ongoing
application of its methodologies to establish the Allowance, which, for the year
ended December 31, 2020 , resulted in a provision for loan losses of $900,000 ,
compared to a reversal of provision for loan losses of $500,000 for the year
ended December 31, 2019 and resulted in increased allocated Allowances for the
majority of the loan segments, primarily due to economic factors related tothe COVID-19 pandemic. During 2020 we recorded net recoveries of$632,000 compared to net charge-offs of$406,000 during 2019. During 2020, net recoveries as compared to average loans outstanding amounted to 0.10% compared to net charge-offs as compared to average loans outstanding of 0.06% during 2019. The Allowance as a percentage of outstanding loans increased from 1.11% as ofDecember 31, 2019 to 1.35% as ofDecember 31, 2020 , reflecting the deterioration in economic factors included in our Allowance calculation related to the COVID-19 pandemic. Although management uses available information to establish the appropriate level of the Allowance, future additions or reductions to the Allowance may be necessary based on estimates that are susceptible to change as a result of changes in economic conditions and other factors. As a result, our Allowance may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially adversely affect our operating results. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our Allowance and related methodology. Such agencies may require us to recognize adjustments to the Allowance based on their judgments about information available to them at the time of their examination. Management believes the Allowance is adequate as ofDecember 31, 2020 and is sufficient to address the credit losses inherent in the current loan portfolio. Management will continue to evaluate the adequacy of the Allowance as more economic data becomes available and as changes within our portfolio are known. The effects of the COVID-19 pandemic may require us to fund additional increases in the Allowance in future periods.
Nonperforming Assets ("NPAs")
Given the volatility of the real estate market, it is very important for us to have current appraisals on our NPAs. In general, we obtain appraisals on NPAs on an annual basis. As part of our asset monitoring activities, we maintain a Loss Mitigation Committee that meets once a month. During these Loss Mitigation Committee meetings, all NPAs and loan delinquencies are reviewed. We also produce an NPA report which is distributed monthly to senior management and is also discussed and reviewed at the Loss Mitigation Committee meetings. This report contains all relevant data on the NPAs, including the latest appraised value and valuation date. Accordingly, these reports identify which assets will require an updated appraisal. As a result, we have not experienced any internal delays in identifying which loans/credits require appraisals. With respect to the ordering process of the appraisals, we have not experienced any delays in turnaround time nor has this been an issue over the past three years. Furthermore, we have not had any delays in turnaround time or variances thereof in our specific loan operating markets. NPAs, expressed as a percentage of total assets, totaled 0.6% atDecember 31, 2020 and 0.8% atDecember 31, 2019 . The decrease in the ratio was due primarily to the decrease in real estate acquired through foreclosure and the increase in total assets fromDecember 31, 2019 toDecember 31, 2020 . The ratio of the Allowance to nonaccrual loans was 197.9% atDecember 31, 2020 and 168.3% atDecember 31, 2019 . The increase in this ratio fromDecember 31, 2019 toDecember 31, 2020 was primarily a reflection of the increase in the Allowance due to COVID-19 related factors. The ratio of nonaccrual loans to total loans was 0.7% at bothDecember 31, 2020
and 2019.
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The distribution of our NPAs is illustrated in the following table as of
December 31 :
2020 2019
Nonaccrual Loans: (dollars in thousands)
Residential mortgage $ 4,080 $ 3,766
Commercial real estate 126 237
ADC 60 89
Home equity/2nds 114 150
4,380 4,242
Real Estate Acquired Through Foreclosure:
Residential mortgage - 1,377
Commercial real estate 452 452
ADC 558 558
1,010 2,387
Total NPAs $ 5,390 $ 6,629
Nonaccrual loans amounted to $4.4 million at December 31, 2020 and $4.2 million
at December 31, 2019 . Significant activity in nonaccrual loans during 2020
included additions of $2.9 million , returns to accrual status of $808,000 , and
pay-offs of $1.4 million .
Real estate acquired through foreclosure decreased $1.4 million to $1.0 million
at December 31, 2020 compared to $2.4 million at December 31, 2019 , due to the
sale of three properties.
The activity in our real estate acquired through foreclosure was as follows as
of and for the years ended
2020 2019
(dollars in thousands)
Balance at beginning of year $ 2,387 $ 1,537 Real estate acquired in satisfaction of loans -
1,342
Write-downs and losses on real estate acquired through foreclosure (80)
(259)
Proceeds from sales of real estate acquired through foreclosure (1,297) (233) Balance at end of year$ 1,010 $ 2,387
There were no loans greater than 90 days past due and still accruing at
TDRs and Other Loan Modifications
In situations where, for economic or legal reasons related to a borrower's financial difficulties, management may grant a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the related loan is classified as a TDR.
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The composition of our TDRs is illustrated in the following table as ofDecember 31 : 2020 2019 Residential mortgage: (dollars in thousands) Nonaccrual$ 163 $ 85
<90 days past due/current 5,787 7,675 Commercial real estate: Nonaccrual
- -
<90 days past due/current 421 984
ADC:
Nonaccrual - - <90 days past due/current 128 130 Home equity/2nds: Nonaccrual - - <90 days past due/current 190 -
Consumer:
Nonaccrual - - <90 days past due/current 63 69
Totals:
Nonaccrual 163 85
<90 days past due/current 6,589 8,858
$ 6,752 $ 8,943
See additional information on TDRs in Note 3 to the Consolidated Financial Statements contained in this Annual Report on Form 10-K.
In the wake of the COVID-19 pandemic, loan modification requests have been granted to defer principal and/or interest payments or modify interest rates. These loans are not classified as TDRs according to Section 4013 of the CARES Act, as long as the specific criteria set forth in the Act are met. The table below presents information related to loan modifications made in compliance with the CARES Act as of and for the year endedDecember 31, 2020 : Commercial Home Equity/ Residential Commercial Real Estate ADC 2nds Consumer Total (dollars in thousands) Balance at beginning of year $ - $ - $ - $ - $ - $ - $ - CARES Act modifications granted 18,394 5,608 83,611 7,088 434 353 115,488 CARES Act modifications returned to normal payment status (12,062) (2,909) (66,836) (7,338) (286) (188) (89,619) (Principal payments) net of draws on active deferred loans (323) (647) (1,785) 250 (7) (7) (2,519)
Balance at end of year
Deposits Deposits were$806.5 million atDecember 31, 2020 and$661.0 million atDecember 31, 2019 . During the year endedDecember 31, 2020 , we experienced increases in all categories of deposit accounts, excluding CDs, due primarily to marketing campaigns required in the current competitive market. Additionally, customers were holding more cash balances in 2020 due to the COVID-19 pandemic. CDs decreased due to maturing CDs and a decline in the use of third-party listing services. In 2020 we saw increases in short-term medical-use cannabis related funds (funds that have not actually been used in the medical-use cannabis industry yet) that account holders hold to relocate to investment opportunities outside of the Bank in the future. Management is aware of the short-term nature of certain medical-use cannabis related deposits and offsets those funds by maintaining short-term liquidity to meet any deposit outflows. 43 Table of Contents
The deposit breakdown is as follows as of
2020 2019
(dollars in thousands)
NOW $ 106,589 $ 83,612
Money market 191,506 162,621
Savings 63,464 61,514
CDs 199,804 230,401
Total interest-bearing deposits 561,363 538,148
Noninterest-bearing deposits 245,093 122,901
Total deposits $ 806,456 $ 661,049
The following table provides the maturities of CDs in amounts of $250,000 or
more at December 31 :
2020 2019
Maturing in: (dollars in thousands)
3 months or less $ 5,230 $ 2,432
Over 3 months through 6 months 2,798 3,881
Over 6 months through 12 months 6,217 12,452
Over 12 months 9,575 13,393
$ 23,820 $ 32,158 Total deposits with balances of
Borrowings
Our borrowings consist of advances from the FHLB.
The FHLB advances are available under a specific collateral pledge and security agreement, which requires that we maintain collateral for all of our borrowings equal to 30% of total assets. Our advances from the FHLB may be in the form of short-term or long-term obligations. Short-term advances have maturities for one year or less and may contain prepayment penalties. Long-term borrowings through the FHLB have original maturities up to 20 years and generally contain prepayment penalties. AtDecember 31, 2020 , our total available credit line with the FHLB was$280.9 million . The Bank, from time to time, utilizes the line of credit when interest rates are more favorable than obtaining deposits from the public. Our outstanding FHLB advance balance atDecember 31, 2020 and 2019 was$10.0 million and$35.0 million , respectively. AtDecember 31, 2020 , we also maintained a line of credit with a bankers' bank in the amount of$11.0 million , which we had not drawn upon as ofDecember 31, 2020 . OnSeptember 30, 2016 , we entered into a loan agreement with a commercial bank whereby we borrowed$3.5 million for a term of 8 years. The unsecured note bore interest at a fixed rate of 4.25% for the first 36 months then converted to a floating rate of the Wall Street Journal Prime plus 50 basis points for the remaining five years. Repayment terms were monthly interest only payments for the first 36 months, then quarterly principal payments of$175,000 plus interest. During the fourth quarter of 2019, we repaid the loan without penalty.
The following table sets forth information concerning the interest rates and
maturity dates of the advances from the FHLB as of
Principal
Amount (in thousands) Rate Maturity
$10,000 2.19% 2022 44 Table of Contents Subordinated Debentures As ofDecember 31, 2020 and 2019, the Company had outstanding$20.6 million in principal amount ofJunior Subordinated Debt Securities , due in 2035 (the "2035 Debentures"). The 2035 Debentures were issued pursuant to an Indenture dated as ofDecember 17, 2004 (the "2035 Indenture") between the Company andWells Fargo Bank, National Association as Trustee. The 2035 Debentures pay interest quarterly at a floating rate of interest of 3-month LIBOR plus 200 basis points and mature onJanuary 7, 2035 . Payments of principal, interest, premium, and other amounts under the 2035 Debentures are subordinated and junior in right of payment to the prior payment in full of all senior indebtedness of the Company, as defined in the 2035 Indenture. The 2035 Debentures became redeemable, in whole or in part, by the Company onJanuary 7, 2010 . The 2035 Debentures were issued and sold to Severn Capital Trust I (the "Trust"), of which 100% of the common equity is owned by the Company. The Trust was formed for the purpose of issuing corporation-obligated mandatorily redeemable Capital Securities ("Capital Securities") to third-party investors and using the proceeds from the sale of such Capital Securities to purchase the 2035 Debentures. The 2035 Debentures held by the Trust are the sole assets of the Trust. Distributions on the Capital Securities issued by the Trust are payable quarterly at a rate per annum equal to the interest rate being earned by the Trust on the 2035 Debentures.The Capital Securities are subject to mandatory redemption, in whole or in part, upon repayment of the 2035 Debentures. We have entered into an agreement which, taken collectively, fully and unconditionally guarantees the Capital Securities subject to the terms of the guarantee.
Under the terms of the 2035 Debentures, we are permitted to defer the payment of
interest on the 2035 Debentures for up to 20 consecutive quarterly periods,
provided that no event of default has occurred and is continuing. As of
Capital Resources
Total stockholders' equity increased
Immaterial Correction of an Error
During 2020, the Company corrected an immaterial accounting error related to$885,000 of DTAs recorded in years prior to 2020 by the holding company. These DTAs were related to state net operating losses ("NOLs") which accumulated over the span of many years. As the holding company has not previously generated taxable income and continues to generate no taxable income, it has no ability to utilize the NOLs. To correct this immaterial accounting error, the Company recorded an adjustment to 2019's opening retained earnings in the amount of$793,000 and additional tax expense of$92,000 (the amount deemed applicable for 2019) for the year endedDecember 31, 2019 . See Note 1 to the Consolidated Financial Statements contained in this Annual Report on Form 10-K for additional information. Capital Adequacy
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 possible additional discretionary, actions by the regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. OnJanuary 1, 2020 , the Bank elected to be subject to the Community Bank Leverage Ratio.
See details of our capital ratios in Note 10 to the Consolidated Financial Statements contained in this Annual Report on Form 10-K.
As of bothDecember 31, 2020 and 2019, the Bank exceeded all capital adequacy requirements to which it is subject and met the qualifications to be considered "well-capitalized." 45 Table of Contents
Off-Balance Sheet Arrangements and Derivatives
We enter into off-balance sheet arrangements in the normal course of business. These arrangements consist primarily of commitments to extend credit, lines of credit, and letters of credit.
Credit Commitments
Credit commitments are agreements to lend to a customer as long as there is no violation of any condition to the contract. Loan commitments generally have interest rates fixed at current market amounts, fixed expiration dates, and may require payment of a fee. Lines of credit generally have variable interest rates. Such lines do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time. Letters of credit are commitments issued to guarantee the performance of a customer to a third party. Our exposure to credit loss in the event of nonperformance by the borrower is the contract amount of the commitment. Loan commitments, lines of credit, and letters of credit are made on the same terms, including collateral, as outstanding loans. We are not aware of any accounting loss we would incur by funding our commitments.
See more detailed information on credit commitments below under "Liquidity."
Derivatives
We maintain and account for derivatives, in the form of interest rate lock
commitments ("IRLCs") and mandatory forward contracts, in accordance with the
Financial Accounting Standards Board ("FASB") guidance on accounting for
derivative instruments and hedging activities. We recognize gains and losses on
IRLCs, mandatory forward contracts, and best effort forward contracts on the
loan pipeline through mortgage-banking revenue in the Consolidated Statements of
Income.
IRLCs on mortgage loans that we intend to sell in the secondary market are
considered derivatives. We are exposed to price risk from the time a mortgage
loan is locked in until the time the loan is sold. The period of time between
issuance of a loan commitment and closing and sale of the loan generally ranges
from 14 days to 120 days. For these IRLCs, we attempt to protect the Bank from
changes in interest rates through the use of to be announced ("TBA") securities,
which are forward contracts, as well as loan level commitments in the form of
best efforts and mandatory forward contracts. Mandatory forward contracts are
also considered derivatives. Best efforts forward contracts are not derivatives,
however, we have elected to measure and report these commitments at fair value.
These assets and liabilities are included in the Consolidated Statements of
Financial Condition in other assets and accrued expenses and other liabilities,
respectively.
See Note 16 to the Consolidated Financial Statements contained in this Annual Report on Form 10-K for more information on our derivatives.
Liquidity
Liquidity describes our ability to meet financial obligations, including lending
commitments and contingencies, which arise during the normal course of business.
Liquidity is primarily needed to meet the borrowing and deposit withdrawal
requirements of our customers, to fund our mortgage-banking operations, as well
as to meet current and planned expenditures. These cash requirements are met on
a daily basis through the inflow of deposit funds, the maintenance of short-term
overnight investments, maturities and calls in our securities portfolio, and
available lines of credit with the FHLB, which requires pledged collateral.
Fluctuations in deposit and short-term borrowing balances may be influenced by
the interest rates paid, general consumer confidence, and the overall economic
environment. There can be no assurances that deposit withdrawals and loan
fundings will not exceed all available sources of liquidity on a short-term
basis. Such a situation would have an adverse effect on our ability to originate
new loans and maintain reasonable loan and deposit interest rates, which would
negatively impact earnings.
Our principal sources of liquidity are loan repayments, maturing investments,
sales of AFS securities, deposits, borrowed funds, and proceeds from loans sold
on the secondary market. The levels of such sources are dependent on the Bank's
operating, financing, and investing activities at any given time. We consider
core deposits stable funding sources and
46
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include all deposits, except CDs of$100,000 or more. The Bank's experience has been that a substantial portion of CDs renew at time of maturity and remain on deposit with the Bank. CDs scheduled to mature within one year amounted to$118.7 million atDecember 31, 2020 . Additionally, loan payments, maturities, deposit growth, and earnings contribute to our flow of funds. In addition to our ability to generate deposits, we have external sources of funds, which may be drawn upon when desired. The primary source of external liquidity is an available line of credit with the FHLB. Our credit availability under the FHLB's credit availability program was$280.9 million atDecember 31, 2020 , of which$10.0 million was outstanding. The borrowing requirements of customers include commitments to extend credit and the unused portion of lines of credit (collectively "commitments"), which totaled$121.8 million atDecember 31, 2020 . Historically, many of the commitments expire without being fully drawn; therefore, the total commitment amounts do not necessarily represent future cash requirements. As ofDecember 31, 2020 , we had$17.0 million in unadvanced commitments for home equity lines of credit,$74.6 million outstanding in unadvanced construction commitments, and commitments under lines of credit for$30.2 million , which we expect to fund from the sources of liquidity described above. Standby letters of credit amounted to$3.3 million atDecember 31, 2020 . Customer withdrawals are also a principal use of liquidity, but are generally mitigated by growth in customer funding sources, such as deposits and short-term borrowings. In addition to the foregoing, the payment of dividends is a use of cash, but is not expected to have a material effect on liquidity. As ofDecember 31, 2020 , we had no material commitments for capital expenditures. Our ability to acquire deposits or borrow could be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole. AtDecember 31, 2020 , management considered the Company's liquidity level to be sufficient for the purposes of meeting our cash flow requirements. We are not aware of any undisclosed known trends, demands, commitments, or uncertainties that are reasonably likely to result in material changes in our liquidity. We anticipate that our primary sources of liquidity over the next twelve months will be from loan repayments, maturing investments, deposit growth, and borrowed funds. We believe that these sources of liquidity will be sufficient for us to meet our liquidity needs over the next twelve months.
Interest Rate Sensitivity
Interest rate sensitivity is an important factor in the management of the
composition and maturity configurations of our interest-earning assets and our
funding sources. The primary objective of our asset/liability management is to
ensure the steady growth of our primary earnings component, net interest income.
Our net interest income can fluctuate with significant interest rate movements.
We may attempt to structure the statement of financial condition so that
repricing opportunities exist for both assets and liabilities in roughly
equivalent amounts at approximately the same time intervals. However, imbalances
in these repricing opportunities at any point in time may be appropriate to
mitigate risks from fee income subject to interest rate risk, such as
mortgage-banking activities.
The measurement of our interest rate sensitivity, or "gap," is one of the
techniques used in asset/liability management. Interest sensitive gap is the
dollar difference between our assets and liabilities which are subject to
interest rate pricing within a given time period, including both floating-rate
or adjustable-rate instruments and instruments which are approaching maturity.
More assets repricing or maturing than liabilities over a given time period is
considered asset-sensitive and is reflected as a positive gap, and more
liabilities repricing or maturing than assets over a given time period is
considered liability-sensitive and is reflected as negative gap. An
asset-sensitive position (i.e., a positive gap) will generally enhance earnings
in a rising interest rate environment and will negatively impact earnings in a
falling interest rate environment, while a liability-sensitive position (i.e., a
negative gap) will generally enhance earnings in a falling interest rate
environment and negatively impact earnings in a rising interest rate
environment. Fluctuations in interest rates are not predictable or controllable.
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Our management and our board of directors oversee the asset/liability management
function and meet periodically to monitor and manage the statement of financial
condition, control interest rate exposure, and evaluate pricing strategies. We
evaluate the asset mix of the statement of financial condition continually in
terms of several variables: yield, credit quality, funding sources, and
liquidity. Our management of the liability mix of the statement of financial
condition focuses on expanding our various funding sources and promotion of
deposit products with desirable repricing or maturity characteristics.
In theory, we can diminish interest rate risk through maintaining a nominal
level of interest rate sensitivity. In practice, this is made difficult by a
number of factors including cyclical variation in loan demand, different impacts
on our interest-sensitive assets and liabilities when interest rates change, and
the availability of our funding sources. Accordingly, we strive to manage the
interest rate sensitivity gap by adjusting the maturity of and establishing
rates on the interest-earning asset portfolio and certain interest-bearing
liabilities commensurate with our expectations relative to market interest
rates. Additionally, we may employ the use of off-balance sheet instruments,
such as interest rate swaps or caps, to manage our exposure to interest rate
movements. Generally, we attempt to maintain a balance between rate-sensitive
assets and liabilities that is appropriate to minimize our overall interest rate
risk, not just our net interest margin.
Our interest rate sensitivity position as of December 31, 2020 is presented in
the following table. Our assets and liabilities are scheduled based on maturity
or repricing data except for core deposits which are based on internal core
deposit analyses. These assumptions are validated periodically by management.
The difference between our rate-sensitive assets and rate-sensitive liabilities,
or the interest rate sensitivity gap, is shown at the bottom of the table. As
of December 31, 2020 , we had a one-year cumulative negative gap of $107.8
million.
180 days 181 days - One-five
or less one year years > 5 years Total
(dollars in thousands)
Interest-bearing deposits (1)
$ -$ 160,189 Securities 1,407 1,407 16,928 61,299 81,041 Restricted stock investments 1,236 - -
- 1,236
LHFS 36,299 - - - 36,299
Loans 113,381 52,148 329,078 148,275 642,882
$ 312,512 $ 53,555 $ 346,006 $ 209,574 $ 921,647
NOWs $ 74,723 $ 31,866 $ - $ - $ 106,589
Money market 157,772 24,096 9,638 - 191,506
Savings 21,931 21,597 19,936 - 63,464
CDs 65,100 56,186 78,518 - 199,804
Borrowings - - 10,000 - 10,000
Subordinated debentures 20,619 - - - 20,619
$ 340,145 $ 133,745 $ 118,092 $ - $ 591,982
Period $ (27,633) $ (80,190) $ 227,914 $ 209,574
% of Assets (2.90) % (8.42) % 23.93 % 22.00 %
Cumulative $ (27,633) $ (107,823) $ 120,091 $ 329,665
% of Assets (2.90) % (11.32) % 12.61% 34.61 % Cumulative assets to liabilities 91.88 % 77.25 % 120.29 % 155.69 %
(1) Includes CDs held for investment
While we monitor interest rate sensitivity gap reports, we primarily test our
interest rate sensitivity through the deployment of simulation analysis. We use
earnings simulation models to estimate what effect specific interest rate
changes would have on our net interest income. Simulation analysis provides us
with a more rigorous and dynamic measure of interest sensitivity. Changes in
prepayments have been included where changes in behavior patterns are assumed to
be significant to the simulation, particularly mortgage-related assets. Call
features on certain securities and borrowings are based on their call
probability in view of the projected rate change, and pricing features such as
interest rate floors are incorporated. We attempt to structure our asset and
liability management strategies to mitigate the impact on net interest income by
changes
48
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in market interest rates. However, there can be no assurance that we will be
able to manage interest rate risk so as to avoid significant adverse effects on
net interest income. We use the PROFITstar® model to monitor our exposure to
interest rate risk, which calculates changes in the economic value of equity
("EVE").
At
Change in Rates Amount $ Change % Change
(dollars in thousands)
+400 bp $ 201,003 $ 17,757 0.10 %
+300 bp 197,363 14,117 0.08 %
+200 bp 187,314 4,068 0.02 %
+100 bp 185,177 1,931 0.01 %
0 bp 183,246
-100 bp 66,970 (116,276) (0.63) %
-200 bp (98,186) (281,432) (1.54) %
The preceding income simulation analysis does not represent a forecast of actual
results and should not be relied upon as being indicative of expected operating
results. These hypothetical estimates are based upon numerous assumptions, which
are subject to change, including: the nature and timing of interest rate levels
including the yield curve shape, prepayments on loans and securities, deposit
decay rates, pricing decisions on loans and deposits, reinvestment/replacement
of asset and liability cash flows, and others. Also, as market conditions vary,
prepayment/refinancing levels, the varying impact of interest rate changes on
caps and floors embedded in adjustable-rate loans, early withdrawal of deposits,
changes in product preferences, and other internal/external variables will
likely deviate from those assumed.
Inflation
The Consolidated Financial Statements and related consolidated financial data presented herein have been prepared in accordance with GAAP and practices within the banking industry which require the measurement of financial condition and operating results in terms of historical dollars, without considering the changes in the relative purchasing power of money over time due to inflation. As a financial institution, virtually all of our assets and liabilities are monetary in nature and interest rates have a more significant impact on our performance than the effects of general levels of inflation. A prolonged period of inflation could cause interest rates, wages, and other costs to increase and could adversely affect our results of operations unless mitigated by increases in our revenues correspondingly. However, we believe that the impact of inflation on our operations was not material for 2020 or 2019.
Subsequent Events
Asset Sale
OnJanuary 1, 2021 , we sold the majority of the assets of our real estate company, Hyatt Commercial, with the exception of cash and certain fixed assets. At the time of the sale, Hyatt Commercial had$1.6 million in assets,$1.1 million of which was in cash that stayed with the Company. The remainder of the assets were sold for$334,000 and we realized a loss of approximately$45,000 . Dividend
On
Proposed Merger with Shore Bancshares, Inc.
OnMarch 3, 2021 , the Company and Shore Bancshares, Inc. ("Shore") entered into an agreement and plan of merger (the "Merger Agreement") that provides that the Company will merge with and into Shore, with Shore as the surviving corporation (the "Merger"). Following the Merger, the Bank will merge with and into Shore's wholly-owned bank 49 Table of Contents
subsidiary,Shore United Bank , withShore United Bank as the surviving bank (the "Bank Merger"). At the effective time of the Merger, each outstanding share of the Company's common stock will be converted into the right to receive (i) 0.6207 shares of Shore common stock and (ii)$1.59 in cash, together with cash in lieu of fractional shares, if any. The merger consideration is 85% stock
and 15% cash. The completion of the Merger and the Bank Merger are subject to customary closing conditions, including approval by the Company's stockholders, Shore's stockholders and the receipt of regulatory approvals or waivers from the OCC and theBoard of Governors of theFederal Reserve System . Prior to the completion of the Bank Merger,Shore United Bank must obtain the approval of the OCC to convert to a national banking association. The Merger is expected to be completed in the third quarter of 2021.
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