THE COMMUNITY FINANCIAL CORPORATION CRITICAL ACCOUNTING POLICIES
Critical accounting policies are defined as those that involve significant
judgments and uncertainties and could result in materially different results
under different assumptions and conditions. The Company considers its
determination of the allowance for credit losses ("ACL"), goodwill impairment,
and the valuation of deferred tax assets to be critical accounting policies. The
Company believes that the most critical accounting policies upon which its
financial condition and results of operation depend, and which involve the most
complex subjective decisions or assessments, are included in the discussion
entitled "Critical Accounting Policies" in Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operations," in the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 2021 , as filed
with the SEC .
For additional information regarding the ACL, Goodwill , and the valuation of
deferred taxes, refer to Notes 1, 3, 4, and 14 in the Consolidated Financial
Statements as presented in the Company's Form 10-K for the year ended
December 31, 2021 .
On January 1, 2022 , the Company adopted FASB ASU 2016-13, which changes the
accounting for the allowance for credit losses. For a discussion of this new
accounting policy, refer to Note 1 "Basis of Presentation" to the Consolidated
Financial Statements.
OVERVIEW
Community Bank of the Chesapeake (the "Bank") is headquartered in Southern
Maryland with 12 branches located in Maryland and Virginia . The Bank is a
wholly-owned subsidiary of The Community Financial Corporation (the "Company").
The Company provides financial services to individuals and businesses through
its offices in Southern Maryland and Fredericksburg, Virginia . Its primary
deposit products are demand, savings and time deposits, and its primary lending
products are commercial and residential mortgage loans, commercial loans,
construction and land development loans, home equity and second mortgages and
commercial equipment loans.
Our customer focus is to serve small and medium sized commercial businesses as
well as local municipal agencies and not-for-profits. Relationship teams provide
customers with specific banker contacts and a support team to address product
and service demands. The Bank believes that its ability to offer fast, flexible,
local decision-making will continue to attract significant new business
relationships. Our structure provides a consistent and superior level of
professional service and excelling at customer service is a critical part of our
culture. The Bank's marketing is directed towards increasing its balances of
transactional deposit accounts. The Bank believes that increases in these
account types will lessen the Bank's dependence on higher-cost funding, such as
certificates of deposit and borrowings.
The Company's income is primarily earned from interest received on its loans and
investments. The Company's primary source of funds for making these loans and
investments is its deposits. One of the key measures of the Company's success is
its net interest income, or the difference between the income on loans and
investments, and the expense on deposits and borrowings. Another key measure is
the spread between the yield the Company earns on these interest-earning assets
and the rate the Company pays on interest-bearing liabilities, which is called
net interest spread. In addition to earning interest on loans and investments,
the Company earns income through fees and other charges for services to clients.
Management will continue to focus on growth and operating efficiency to deliver
strong results during 2022. During the first six months of 2022, we had robust
portfolio loan growth, strong non-interest bearing and transaction deposit
growth, and continued to optimize our branch and virtual banking operations.
•The Company reported record net income for the three months ended June 30, 2022
of $6.8 million , or $1.21 per diluted common share compared to net income of
$6.4 million or $1.10 per diluted common share for the quarter ended June 30,
2021 . The Company reported record net income for the six months ended June 30,
2022 of $13.1 million or diluted earnings per share of $2.31 compared to net
income for the comparable 2021 period of $12.7 million or diluted earnings per
share of $2.17 .
•Portfolio loan end of period contractual rates increased by 21 basis points to
4.05% at June 30, 2022 compared to December 31, 2021 . The loan portfolio is
positioned for rising rates with $482.1 million or 29% of loans, excluding the
allowance for credit losses, scheduled to reprice monthly or in the next three
months and an additional $53.1 million or 3% repricing the following nine
months. The Bank's effective duration on the loan portfolio was 2.1 years at
June 30, 2022 . In addition, increased non-interest bearing accounts as a
percentage of deposits also better positions the Company for a rising rate
environment.
41--------------------------------------------------------------------------------
Table of Contents
•Total portfolio loans increased$73.6 million or 9.3% annualized to$1,652.5 million fromDecember 31, 2021 , as the Company maintained its market dominance inSouthern Maryland and continued to gain market share inVirginia . The loan pipeline atJune 2022 was$166.0 million , which is expected to provide solid loan growth in the third quarter. •Non-interest-bearing accounts increased$189.9 million to$635.6 million or 30.48% of deposits atJune 30, 2022 , from 21.68% of deposits atDecember 31, 2021 . Transaction deposits increased$42.3 million , or 4.90% annualized, to$1,771.1 million in the first six months of 2022. The Company's change in funding mix has well positioned the balance sheet for a rising rate environment. •As ofJune 30, 2022 , theFOMC had increased the federal funds target rate range to between 1.50%-1.75%. As a result of the Company's balance sheet being asset sensitive, net interest margin increased 13 basis points to 3.25% for the three months endedJune 30, 2022 compared to the first quarter of 2022. •Total stockholders' equity decreased$23.3 million during the six months endedJune 30, 2022 . The decrease in equity was primarily due to an increase of$29.9 million in accumulated other comprehensive loss ("AOCL") in the Bank's AFS securities portfolio due to changes in market interest rates, partially offset by net income of$13.1 million . Management intends and has the ability to hold its AFS securities until maturity. See discussion in Liquidity and Capital Resources section of this MD&A. •The Company's common equity to assets ratio decreased to 7.96% atJune 30, 2022 from 8.94% atDecember 31, 2021 . The Company's ratio of tangible common equity ("TCE") to tangible assets decreased to 7.49% atJune 30, 2022 from 8.48% atDecember 31, 2021 (see Non-GAAP reconciliation schedules) due primarily to increases in AOCL. Regulatory capital was not impacted by the increase in AOCL and Tier 1 capital to average asset ratios at the Bank and the Company remained strong. •Asset quality continues to improve as non-accrual loans, OREO and TDRs were$6.7 million or 0.29% of total assets atJune 2022 compared to$8.1 million or 0.35% of total assets atDecember 31, 2021 . •The Bank opened its secondVirginia branch inMay 2022 inFredericksburg . Additionally, with ourVirginia lending team managing approximately 50% of the Bank's loans, the Bank intends to open a loan production office inCharlottesville in the fourth quarter of 2022 to support our existing efforts there. Management believes the greaterFredericksburg area provides significant opportunities for continued organic growth supported by our efficient operating model and ability to leverage technology.
Subsequent events
The Company has evaluated subsequent events for potential recognition and/or disclosure through the date the unaudited Consolidated Financial Statements included in this Quarterly Report on Form 10-Q were issued.
42--------------------------------------------------------------------------------
Table of Contents
USE OF NON-GAAP FINANCIAL MEASURES
Statements included in management's discussion and analysis include non-GAAP financial measures and should be read along with the accompanying tables, which provide a reconciliation of non-GAAP financial measures to GAAP financial measures. The Company's management uses these non-GAAP financial measures and believes that non-GAAP financial measures provide additional useful information that allows readers to evaluate the ongoing performance of the Company. Non-GAAP financial measures should not be considered as an alternative to any measure of performance or financial condition as promulgated under GAAP, and investors should consider the Company's performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the Company. Non-GAAP financial measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analysis of the results or financial condition as reported under GAAP. See Non-GAAP reconciliation schedules that immediately follow:
RECONCILIATION OF NON-GAAP MEASURES (UNAUDITED)
Reconciliation ofU.S. GAAP total assets, common equity, common equity to assets and book value to Non-GAAP tangible assets, tangible common equity, tangible common equity to tangible assets and tangible book value. This Form 10-Q, including the accompanying financial statement tables, contains financial information determined by methods other than in accordance with GAAP. This financial information includes certain performance measures, which exclude intangible assets. These non-GAAP measures are included because the Company believes they may provide useful supplemental information for evaluating the underlying performance trends of the Company. (dollars in thousands, except per share amounts) June 30, 2022 December 31, 2021 June 30, 2021 Total assets$ 2,323,514 $ 2,327,306 $ 2,195,059 Less: intangible assets Goodwill 10,835 10,835 10,835 Core deposit intangible 821 1,032 1,267 Total intangible assets 11,656 11,867 12,102 Tangible assets$ 2,311,858 $ 2,315,439 $ 2,182,957 Total common equity$ 184,871 $ 208,133$ 203,962 Less: intangible assets 11,656 11,867 12,102 Tangible common equity$ 173,215 $
196,266
Common shares outstanding at end of period 5,649,729 5,718,528 5,786,928 GAAP common equity to assets 7.96 % 8.94 % 9.29 % Non-GAAP tangible common equity to tangible assets 7.49 % 8.48 % 8.79 % GAAP common book value per share$ 32.72 $ 36.40$ 35.25 Non-GAAP tangible common book value per share$ 30.66 $ 34.32$ 33.15 43
--------------------------------------------------------------------------------
Table of Contents
RECONCILIATION OF NON-GAAP MEASURES (UNAUDITED)
Return on Average Common Equity ("ROACE")
The ROACE is a financial ratio that measures the profitability of a company in
relation to the average shareholders' equity. This financial metric is expressed
in the form of a percentage which is equal to net income after tax divided by
the average shareholders' equity for a specific period of time.
Three Months Ended June 30, Six Months Ended June 30,
(dollars in thousands) 2022 2021 2022 2021
Net income (as reported) $ 6,834 $ 6,432 $ 13,122 $ 12,731
ROACE 14.39 % 12.62 % 13.31 % 12.57 %
Average equity $ 189,992 $ 203,893 $ 197,233 $ 202,516 Return on Average Tangible Common Equity ("ROATCE")
ROATCE is computed by dividing net earnings applicable to common shareholders by
average tangible common shareholders' equity. Management believes that ROATCE is
meaningful because it measures the performance of a business consistently,
whether acquired or internally developed. ROATCE is a non-GAAP measure and may
not be comparable to similar non-GAAP measures used by other companies.
Three Months Ended June 30, Six Months Ended June 30,
(dollars in thousands) 2022 2021 2022 2021
Net income (as reported) $ 6,834 $ 6,432 $ 13,122 $ 12,731
Core deposit intangible amortization
(net of tax) 76 94 157 193
Net earnings applicable to common
shareholders $ 6,910 $ 6,526 $ 13,279 $ 12,924
ROATCE 15.50 % 13.62 % 14.32 % 13.59 %
Average tangible common equity $ 178,269 $ 191,708 $ 185,457 $ 190,266
44--------------------------------------------------------------------------------
Table of Contents
SUMMARY OF OPERATING RESULTS
A comparison of the results of operations for the three and six months ended
(Unaudited) (Unaudited)
Three Months Ended June 30, Six Months Ended June 30,
(dollars in thousands, except per
share amounts) 2022 2021 2022 2021
OPERATING DATA
Interest and dividend income $ 18,774 $ 17,444 $ 36,110 $ 35,122
Interest expenses 1,206 1,009 2,073 2,178
Net interest income ("NII") 17,568 16,435 34,037 32,944
Provision for credit losses 425 291 875 586
Provision (recovery) for unfunded
commitments 26 - (5) -
NII after provision for credit
losses and unfunded commitments 17,117 16,144 33,167 32,358
Noninterest income 1,424 1,856 2,875 4,216
Noninterest expenses 9,338 9,378 18,418 19,526
Income before income taxes 9,203 8,622 17,624 17,048
Income taxes 2,369 2,190 4,502 4,317
Net income 6,834 6,432 13,122 12,731
Income available to common shares $ 6,834 $ 6,432 $ 13,122 $ 12,731
(Unaudited) (Unaudited)
Three Months Ended June 30, Six Months Ended June 30,
2022 2021 2022 2021
KEY OPERATING RATIOS
Return on average assets ("ROAA") 1.19 % 1.22 % 1.14 % 1.22 %
Return on average common equity
("ROACE") 14.39 12.62 13.31 12.57
Return on Average Tangible Common
Equity ("ROATCE") 15.50 13.62 14.32 13.59
Average total equity to average
total assets 8.28 9.63 8.54 9.67
Interest rate spread 3.14 3.30 3.10 3.36
Net interest margin 3.25 3.37 3.19 3.43
Efficiency ratio(1) 49.17 51.27 49.90 52.55
Non-interest income to average
assets 0.25 0.35 0.25 0.40
Non-interest expense to average
assets 1.63 1.77 1.59 1.87
Net operating expense to average
assets(2) 1.38 1.42 1.35 1.46
COMMON SHARE DATA
Basic net income per common share $ 1.21 $ 1.10 $ 2.32 $ 2.17
Diluted net income per common share $ 1.21 $ 1.10 $ 2.31 $ 2.17
Cash dividends paid per common share $ 0.175 $ 0.150 $ 0.350 $ 0.275
Common dividend payout ratio 14.46 % 13.63 % 15.12 % 12.67 %
_______________________________________
(1) Efficiency ratio is noninterest expense divided by the sum of net interest income and noninterest income.
(2) Net operating expense is the sum of non-interest expense offset by non-interest income.
45--------------------------------------------------------------------------------
Table of Contents
COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED
Summary of Financial Results The Company reported net income for the three months endedJune 30, 2022 of$6.8 million or diluted earnings per share of$1.21 compared to net income of$6.4 million or$1.10 per diluted earnings per share for the three months endedJune 30, 2021 . The Company's ROAA and ROACE were 1.19% and 14.39% for the three months endedJune 30, 2022 compared to 1.22% and 12.62% inJune 30, 2021 . Net income in the second quarter of 2022 increased 6.3% compared to the same quarter in 2021, primarily due to increased net interest income partially offset by lower noninterest income. Three Months Ended June 30, (dollars in thousands) 2022 2021 $ Change % Change Interest and dividend income$ 18,774 $ 17,444 $ 1,330 7.6 % Interest expense 1,206 1,009 197 19.5 % Net interest income 17,568 16,435 1,133 6.9 % Provision for credit losses 425 291 134 46.0 % Provision (recovery) for unfunded commitments 26 - 26 - % Noninterest income 1,424 1,856 (432) (23.3) % Noninterest expense 9,338 9,378 (40) (0.4) % Income before income taxes 9,203 8,622 581 6.7 % Income tax (income) expense 2,369 2,190 179 8.2 % Net income$ 6,834 $ 6,432 $ 402 6.3 % Net Interest Income Net interest income is the difference between income earned on assets and interest paid on the deposits and borrowings used to fund them. Net interest income is affected by the difference between the yields earned on the Company's interest-earning assets and the rates paid on interest-bearing liabilities, as well as the relative amounts of such assets and liabilities. Net interest income, divided by average interest-earning assets, represents the Company's net interest margin. The following table shows the components of net interest income and the dollar and percentage changes for the periods presented. Three Months Ended June
30,
(dollars in thousands) 2022 2021 $ Change % Change Interest and Dividend Income Loans, including fees$ 16,772 $ 16,320 $ 452 2.8 % Taxable interest and dividends on investment securities 1,924 1,101 823 74.8 % Interest on deposits with banks 78 23 55 239.1 % Total Interest and Dividend Income 18,774 17,444 1,330 7.6 % Interest Expenses Deposits 819 640 179 28.0 % Short-term borrowings 16 - 16 - % Long-term debt 371 369 2 0.5 % Total Interest Expenses 1,206 1,009 197 19.5 % Net Interest Income (NII)$ 17,568 $ 16,435 $ 1,133 6.9 % 46
--------------------------------------------------------------------------------
Table of Contents
Average Balances and Yields
The following table sets forth average balances, average yields and costs, and
certain other information for the periods indicated. No tax-equivalent yield
adjustments were made, as the effect thereof was not material. All average
balances are daily average balances. Non-accrual loans were included in the
computation of average balances. The yields set forth below include the effect
of deferred fees, discounts and premiums that are amortized or accreted to
interest income or expense.
Three Months Ended June 30,
2022 2021
(dollars in thousands) Average Balance Interest Average Yield/Cost Average Balance Interest Average Yield/Cost
Assets
Commercial real estate $ 1,181,885 $ 11,842 4.01 % $ 1,089,781 $ 10,953 4.02 %
Residential first mortgages 85,030 730 3.43 % 109,296 838 3.07 %
Residential rentals 194,972 1,999 4.10 % 139,080 1,410 4.06 %
Construction and land development 30,302 361 4.77 % 38,315 425 4.44 %
Home equity and second mortgages 26,101 274 4.20 % 29,061 251 3.45 %
Commercial loans 42,744 517 4.84 % 43,100 516 4.79 %
Commercial equipment loans 68,349 699 4.09 % 61,017 592 3.88 %
U.S. SBA PPP loans 11,847 315 10.64 % 104,426 1,318 5.05 %
Consumer loans 4,040 35 3.47 % 1,425 17 4.77 %
Allowance for credit losses (21,375) - - (18,265) - 0.00 %
Loan portfolio (1) 1,623,895 16,772 4.13 % 1,597,236 16,320 4.09 %
Taxable investment securities 484,079 1,808 1.49 % 276,019 1,020 1.48 %
Nontaxable investment securities 21,304 117 2.20 % 15,559 81 2.08 %
Interest-bearing deposits in other banks 23,958 63 1.05 % 28,844 13 0.18 %
Federal funds sold 6,178 14 0.91 % 34,778 10 0.12 %
Interest-Earning Assets ("IEAs") 2,159,414 18,774 3.48 % 1,952,436 17,444 3.57 %
Cash and cash equivalents 28,645 65,897
Goodwill 10,835 10,835
Core deposit intangible 888 1,350
Other assets 93,754 86,421
Total Assets $ 2,293,536 $ 2,116,939
Liabilities and Stockholders' Equity
Noninterest-bearing demand deposits $ 650,249 $ - - % $ 406,166 $ - - %
Interest-bearing demand deposits
Savings 120,645 15 0.05 % 105,814 13 0.05 %
Demand deposits 571,475 431 0.30 % 622,544 86 0.06 %
Money market deposits 385,594 103 0.11 % 354,657 99 0.11 %
Certificates of deposit 317,930 270 0.34 % 344,533 442 0.51 %
Total interest-bearing deposits 1,395,644 819 0.23 % 1,427,548 640 0.18 %
Total Deposits 2,045,893 819 0.16 % 1,833,714 640 0.14 %
Long-term debt 3,350 22 2.63 % 27,273 43 0.63 %
Short-term borrowings 5,791 16 1.11 % - - - %
Subordinated Notes 19,529 252 5.16 % 19,473 251 5.16 %
Guaranteed preferred beneficial interest in
junior subordinated debentures ("TRUPs") 12,000 97 3.23 % 12,000 75 2.50 %
Total Debt 40,670 387 3.81 % 58,746 369 2.51 %
47--------------------------------------------------------------------------------
Table of Contents
© Edgar Online, source