Section 1: 10-K (ANNUAL REPORT)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018
OR
For the Transition Period from to
Commission file number 001-38671
CAPITAL BANCORP, INC.
(Exact name of registrant as specified in its charter)
Maryland
(State or other jurisdiction of incorporation or organization)
2275 Research Boulevard, Suite 600,
Rockville, Maryland 20850
(Address of principal executive offices)
52-2083046
(IRS Employer Identification No.)
20850
(Zip Code)
(301) 468-8848
Registrant’s telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $0.01 per share
(Title of Each Class)
The Nasdaq Stock Market, LLC
(Name of Exchange on Which Registered)
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of
Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes
☒ No ☐
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an
emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule
12b-2 of the Exchange Act.
Large accelerated filer
☐
Accelerated filer
Non-accelerated filer
☐ (Do not check if a smaller reporting company)
Smaller reporting company
☐
☒
☒
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or
revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
At June 30, 2018 there was not a public market for the Registrant’s common stock. The aggregate market value of the voting and non-voting common equity
held by non-affiliates of the Registrant as of December 31, 2018 was $88,887,597.
As of March 15, 2019, the Registrant had 13,711,365 shares of common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Items 10, 11, 12, 13 and 14 of Part III of this Annual Report on Form 10-K will be found in the Company’s definitive proxy
statement for its 2019 Annual Meeting of Stockholders, to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, and
such information is incorporated herein by this reference.
Capital Bancorp, Inc. and Subsidiaries
Annual Report on Form 10-K
Index
PART I
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
PART II
Item 5.
Item 6
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
PART III
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
PART IV
Item 15.
SIGNATURES
Business
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Mine Safety Disclosures
Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures about Market Risk
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
Directors, Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain Relationships and Related Transactions and Director Independence
Principal Accounting Fees and Services
Exhibits, Financial Statement Schedules
Page
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139
139
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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K and oral statements made from time-to-time by our representatives contain “forward-looking statements”
within the meaning of the Private Securities Litigation Reform Act of 1995 that are subject to risks and uncertainties. You should not place
undue reliance on such statements because they are subject to numerous risks and uncertainties relating to our operations and the business
environment in which we operate, all of which are difficult to predict and many of which are beyond our control. Forward-looking statements
include information concerning our possible or assumed future results of operations, including descriptions of our business strategy,
expectations, beliefs, projections, anticipated events or trends, growth prospects, financial performance, and similar expressions concerning
matters that are not historical facts. These statements often include words such as “may,” “believe,” “expect,” “anticipate,” “potential,”
“opportunity,” “intend,” “plan,” “estimate,” “could,” “project,” “seek,” “should,” “will,” or “would,” or the negative of these words and phrases or
similar words and phrases.
These forward-looking statements are subject to risks and uncertainties that could cause actual results, performance or achievements to
differ materially from those projected. These risks and uncertainties, some of which are beyond our control, include, but are not limited to:
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economic conditions (including interest rate environment, government economic and monetary policies, the strength of global financial
markets and inflation and deflation) that impact the financial services industry as a whole and/or our business;
the concentration of our business in the Washington, D.C. and Baltimore metropolitan areas and the effect of changes in the economic,
political and environmental conditions on these markets;
our ability to prudently manage our growth and execute our strategy;
our plans to grow our commercial real estate and commercial business loan portfolios which may carry greater risks of non-payment or
other unfavorable consequences;
adequacy of reserves, including our allowance for loan losses;
deterioration of our asset quality;
risks associated with our residential mortgage banking business;
risks associated with our OpenSky® credit card division, including compliance with applicable consumer finance and fraud prevention
regulations;
results of examinations of us by our regulators, including the possibility that our regulators may, among other things, require us to
increase our allowance for loan losses or to write-down assets;
the effectiveness of our internal control over financial reporting and our ability to remediate any future material weakness in our internal
control over financial reporting;
changes in the value of collateral securing our loans;
our dependence on our management team and board of directors and changes in management and board composition;
liquidity risks associated with our business;
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interest rate risk associated with our business, including sensitivity of our interest earning assets and interest bearing liabilities to
interest rates, and the impact to our earnings from changes in interest rates;
our ability to maintain important deposit customer relationships and our reputation;
operational risks associated with our business;
strategic acquisitions we may undertake to achieve our goals;
the sufficiency of our capital, including sources of capital and the extent to which we may be required to raise additional capital to meet
our goals;
fluctuations to the fair value of our investment securities that are beyond our control;
potential exposure to fraud, negligence, computer theft and cyber-crime;
the adequacy of our risk management framework;
our dependence on our information technology and telecommunications systems and the potential for any systems failures or
interruptions;
our dependence upon outside third parties for the processing and handling of our records and data;
our ability to adapt to technological change;
our engagement in derivative transactions;
volatility and direction of market interest rates;
increased competition in the financial services industry, particularly from regional and national institutions;
our involvement from time to time in legal proceedings, examinations and remedial actions by regulators;
changes in the laws, rules, regulations, interpretations or policies relating to financial institution, accounting, tax, trade, monetary and
fiscal matters;
the financial soundness of other financial institutions;
further government intervention in the U.S. financial system;
natural disasters and adverse weather, acts of terrorism, an outbreak of hostilities or other international or domestic calamities, and
other matters beyond our control; and
other factors that are discussed in Item 1A. Risk Factors.
As you read and consider forward-looking statements, you should understand that these statements are not guarantees of performance or
results. They involve risks, uncertainties and assumptions and can change as a result of many possible events or factors, not all of which are
known to us or in our control. Although we believe that these forward-looking statements are based on reasonable assumptions, beliefs, and
expectations, if a change occurs or our beliefs, assumptions, or expectations were incorrect, our business, financial condition, liquidity or
results of operations may vary materially from those expressed in our forward-
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looking statements. You should be aware that many factors could affect our actual financial results or results of operations and could cause
actual results to differ materially from those in the forward-looking statements. These factors include those described under Item 1A. hereunder.
You should keep in mind that any forward-looking statement made by us speaks only as of the date on which we make it. New risks and
uncertainties arise from time to time, and it is impossible for us to predict these events or how they may affect us. We have no duty to, and do
not intend to, and disclaim any obligation to, update or revise any industry information or forward-looking statements after the date on which
they are made. In light of these risks and uncertainties, you should keep in mind that any forward-looking statement made in this document or
elsewhere might not reflect actual results.
ITEM 1. BUSINESS
PART I
We are Capital Bancorp, Inc., a bank holding company and a Maryland corporation, operating primarily through our wholly owned
subsidiary, Capital Bank, N.A., a commercial-focused community bank based in the Washington, D.C. and Baltimore metropolitan areas. We
serve businesses, not-for-profit associations and entrepreneurs throughout the region. Capital Bank is headquartered in Rockville, Maryland
and operates a branch-lite model through five commercial bank branches, four mortgage offices, one loan production office, a limited service
branch, corporate offices and operations facilities located in key markets throughout our operating area. As of December 31, 2018, we had total
assets of $1.1 billion, total loans held for investment of $1.0 billion, total deposits of $955 million, and total stockholders’ equity of $115 million.
Capital Bank currently operates three divisions: Commercial Banking, Church Street Mortgage, or CSM, and OpenSky®. Our Commercial
Banking division operates in the Washington, D.C. and Baltimore metropolitan areas and focuses on providing personalized service to
commercial clients throughout our area of operations. Church Street Mortgage and OpenSky® both leverage Capital Bank’s national banking
charter to operate as national consumer business lines; Church Street Mortgage acts as our residential mortgage origination platform and
OpenSky® provides nationwide, digitally-based, secured credit cards to under-banked populations and those looking to rebuild their credit
scores.
In addition to the three divisions of Capital Bank, Church Street Capital, or CSC, also operates as a wholly owned subsidiary of Capital
Bancorp, Inc. CSC originates and services a portfolio of mezzanine loans with certain characteristics that do not meet Capital Bank’s general
underwriting standards and thereby command a higher rate of return. CSC typically retains 10% to 20% of the exposure related to these loans
and continues to service them, thereby maintaining a close relationship with the customer. CSC sells participations for the remainder of the
balance to other real estate investors (including certain of the Company’s and the Bank’s directors) and high net worth individuals. All
participations sold to directors were sold on terms no less favorable than terms generally available to unaffiliated third parties. For additional
information on participations sold to our directors, please see “Certain Relationships and Related Party Transactions—Loan Participations with
the Bank.” At December 31, 2018, the net portfolio of retained loans for CSC amounted to approximately $2.6 million. All of these loans were
originated in our operating markets in the Washington, D.C. and Baltimore metropolitan areas.
In addition to its subsidiaries discussed above, Capital Bank, N.A. and Church Street Capital, Capital Bancorp, Inc. owns all of the stock of
Capital Bancorp (MD) Statutory Trust I (the “Trust”). The Trust is a special purpose non-consolidated entity organized for the sole purpose of
issuing trust preferred securities.
Commercial Banking Division
As of December 31, 2018, our Commercial Banking division accounted for approximately 94%, or $1.0 billion, of Capital Bank’s total
assets. The Commercial Banking division operates out of three full service
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banking locations in the Washington, D.C. Metropolitan Statistical Area (“MSA”) and its full service banking location of Columbia, Maryland in
the Baltimore, Maryland MSA. Additionally, we have two loan production offices located throughout the Washington, D.C. and Baltimore
metropolitan areas. Our Commercial Banking division’s nine commercial loan officers and three commercial real estate loan officers provide
commercial and industrial, or C&I, commercial real estate and construction lending solutions to business clients in Capital Bank’s operating
markets.
Construction lending is a core competency of our Commercial Banking division. Construction loans have increased from $100.8 million as
of December 31, 2013 to $157.6 million as of December 31, 2018. However, as a percent of total gross loans, construction loans have
decreased from 25% as of December 31, 2013 to 16% as of December 31, 2018. Our construction loan portfolio provides Capital Bank with
short duration and higher yield loans. Our construction lending is focused on commercial and residential construction projects within the
Washington, D.C. and Baltimore-Columbia-Towson, Maryland metropolitan operating areas and not suburban subdivision tract development.
Our construction lending team consists of long-term employees of Capital Bank who are responsible for sourcing and structuring all
construction loans that are originated. Our team’s strong underwriting capabilities are demonstrated by the fact that we have had no charge-offs
on our construction portfolio since 2013.
In addition to its loan officers, our Commercial Banking division currently has a team of ten business development officers concentrating on
continuing to diversify Capital Bank’s funding sources away from wholesale funding and towards core deposit funding by focusing on core
deposits and treasury management. These business development officers, in conjunction with our recently introduced incentive program based
upon core deposit capture from lending customers, have successfully reduced Capital Bank’s net non-core funding dependence ratio from
24.1% at December 31, 2014 to 17.4% at December 31, 2018. We expect that our deposit gathering teams will continue to help decrease our
wholesale funding dependence through improved low-cost core funding.
Church Street Mortgage Division
Church Street Mortgage originates conventional and government-guaranteed residential mortgage loans on a national basis, for sale into
the secondary market and in certain, limited circumstances for our loan portfolio. Loans sold into the secondary market are sold servicing
released. Loans retained for our portfolio are generally adjustable rate mortgage loans on primary residences within Capital Bank’s operating
markets to individuals who own businesses where Capital Bank may also pursue a commercial lending relationship and has a vested interest in
maintaining full control of the lending relationship.
The following table presents, for the periods indicated, certain loan origination data for Church Street Mortgage.
(Dollars are in thousands)
Mortgage Metrics:
2018
2017
2016
2015
2014
Years Ended December 31,
Loans held for sale originations
Loans held for sale proceeds net of mortgage banking
revenue
Purchase volume as a % of originations
Gain on sale of loans
Gain on sale as a % of loans sold
$
$
$
337,122
344,940
$
$
79.43%
$
9,477
2.75%
418,912
441,960
$
$
52.50%
10,377
$
2.01%
853,674
844,464
$
$
18.79%
15,373
$
1.82%
754,965
759,350
$
$
22.51%
11,541
$
1.52%
493,273
470,534
29.83%
7,827
1.66%
Historically, Church Street Mortgage has relied heavily on refinance origination volume as opposed to purchase origination volume. For the
years ended December 31, 2015 and 2016, purchase origination volume accounted for approximately 23% and 19%, respectively, of Church
Street Mortgage’s origination volume. However, anticipating the potential end of the refinance trends based on the expected interest rate
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environment as the Federal Reserve began increasing short-term interest rates, Church Street Mortgage initiated an effort to broaden its
mortgage product suite (including starting its Community Lending Group focused on supporting first time home buyers and a group focused on
originating loans conforming to the specifications of Fannie Mae’s HomeStyle® Renovation Mortgage program) and to focus on hiring mortgage
loan officers concentrated on purchase origination volume. These efforts resulted in our successfully hiring 8 new mortgage loan officers during
calendar year 2017 and transitioning from 19% purchase origination volume for the year ended December 31, 2016 to 79% purchase
origination volume for the year ended December 31, 2018.
Approximately 70% of Church Street Mortgage’s originations by volume occur within Capital Bank’s operating markets in Maryland, Virginia
and Washington, D.C. The remainder of originations are national in scope and occur primarily through a consumer direct channel utilizing
consumer marketing, including through social media applications.
OpenSky® Secured Credit Card Division
The OpenSky® division provides secured credit cards (with a minimum initial deposit of $200 and maximum initial deposits of $3,000 per
card and $5,000 per individual) on a nationwide basis to under-banked populations and those looking to rebuild their credit scores. In order to
obtain a credit card from us, the customer must select a credit line amount that they are willing to secure with a matching deposit amount. A
deposit equal to the full credit limit of the card is made, using a debit card, check, wire or Western Union transfer, into a noninterest-bearing
demand account with the Bank when the account is opened and the deposit is required to be maintained throughout the life of the card. The
customer’s funding of the deposit account as collateral is not a consideration in the credit card approval process, but is a prerequisite to
activating the credit line. Credit card eligibility is based on identity and income verification. Once the customer’s deposit account has been
funded, the credit line is activated and the collateral funds are generally available to absorb any losses on the account that may occur. As of
December 31, 2018, approximately 11% of our credit card portfolio was delinquent by 30 days or more. Based on our prior experience,
approximately 20% of our new secured credit cards will experience a charge-off within the first year of issuance primarily due to the relative
inexperience of this under-banked population in effectively managing credit card debt.
Additionally, using our proprietary scoring model, which considers credit score and repayment history (typically a minimum of six months of
on-time repayments, but ultimately determined on a case-by-case basis), the Bank has recently begun to offer certain customers an unsecured
line in excess of their secured line of credit. OpenSky® secured credit cards have floating interest rates, which are beneficial in a rising rate
environment, and we believe the OpenSky® secured credit card product provides a counter-cyclical benefit as more people enter its target
segment of credit rebuilders during an economic downturn. At December 31, 2018, we had $2.1 million of unsecured unused lines of credit and
$1.8 million of outstanding unsecured credit card advances.
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Credit Card Loans and Deposits ($ in millions)
Open Credit Card Accounts and
Average Monthly Account Openings
Capital Bank evaluates its OpenSky® customers using analytics that track consumer behaviors and score each customer on risk and
behavior metrics. These real-time monitoring capabilities give our management insight into the credit trends of our portfolio on a consumer by
consumer basis, allowing them to identify potential fraud situations and mitigate any associated losses quickly and efficiently, as well as to
obtain insights into how to optimize the profitability and life cycle of each account. The model utilizes data proprietary to Capital Bank. We have
invested heavily in technology and systems to prevent and detect fraudulent behavior and mitigate losses but such investments may not be
adequate, and our systems may not adequately monitor or mitigate potential losses arising from these risks. See “Risk Factors—Risks Related
to Our Business—Delinquencies and credit losses from our OpenSky® credit card division could adversely affect our business, financial
condition and results of operations.”
OpenSky®’s cards operate on a fully digital and mobile platform with all marketing and application procedures conducted through its
website or mobile application. Given the secured nature of the cards, credit checks are not required at the time of application, however, as each
customer’s account ages, we obtain credit scores to baseline their improvement as an input into any decision to extend unsecured credit in the
future.
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Our Business Strategy
Regulations, technology and competition have fundamentally impacted the economics of the banking sector. We believe that by using
technology-enabled strategies and advice-based solutions, we can deliver attractive shareholder returns in excess of our cost of capital. We
have adopted the following strategies that we believe will continue to drive growth while maintaining consistent profitability and enhancing
shareholder value:
Deliver premium advice-based solutions that drive organic loan and core deposit growth with corresponding superior net interest margin
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Serve as financial partners to our customers, helping them to grow their businesses through advice-based financial solutions;
Endeavor to provide comprehensive loan and deposit solutions to our customers that are tailored to their needs;
Expand expertise in the non-profit, basic industries, fiduciary and community lending groups while building a greater presence in the
government contracting sector;
Capitalize on market dislocation from recent in-market acquisitions to continue to attract top sales talent, like our Fiduciary Banking
Team and the leader of our Business Banking group, and acquire new commercial banking relationships from local competitors; and
Selectively add banking centers where sales teams have already proved an ability to capture market share and leverage customer
relationships.
Leverage technology to improve the customer experience and loyalty and deliver operational efficiencies
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Use solution structuring and customized technology implementation as differentiators to add value to clients with complex needs and
further our relationships within our existing customer base;
Deploy technologies that better support our lending associates and simplify our processes;
• Maximize the potential of web-based and mobile banking applications to drive core funding while maintaining our branch-lite business
model; and
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Enhance cross-selling capabilities among our OpenSky®, Church Street Mortgage and Commercial Banking division customers.
Increase scale in our consumer fee based platforms through delivery of high value products and services
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Utilize our customer acquisition system, Apollo, and leverage our investment in a new core processing system, together with our
expertise in data, analytics and marketing, to deliver new products and services and grow our secured credit card business;
Retain OpenSky® customers that “graduate” from our secured credit product through the limited use of partially unsecured credit
products; and
Expand our purchase-oriented mortgage loan sales both in-market and in adjacent markets through the hiring of high quality mortgage
originators and continuing to improve on our direct to consumer marketing channels.
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Pursue acquisitions opportunistically
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Seek strategic acquisitions in the Washington, D.C., Baltimore, Maryland, and surrounding metropolitan areas;
Evaluate specialty finance company opportunities where we can add value through increasing interest and fee income and leveraging
our management’s expertise and existing strategic assets; and
Use our management’s and Board’s expertise to structure transactions that minimize the integration and execution risk for the Bank.
Summary Demographic and Other Market Data
According to the U.S. Census Bureau, the Washington, D.C. and Baltimore, Maryland MSAs include the four wealthiest counties in the
United States, as well as five of the 10 wealthiest counties. Overall, the Washington, D.C. MSA ranks first out of the largest 20 MSAs (ranked
by population) in income levels with a current median household income of approximately $99,400, which is approximately 63% higher than the
national average. Additionally, the Washington, D.C. MSA is currently the sixth largest MSA in the United States with a total population of more
than 6.2 million people (and when combined with the Baltimore, Maryland MSA, the Washington, D.C. and Baltimore metropolitan areas are
home to a population of more than 9.0 million). We expect our strategies to benefit from continued growth in population and high income of our
market area’s residents.
State
Washington D.C. MSA
Baltimore, Maryland MSA
State of Maryland
District of Columbia
Counties of Operation (1)
Total
Population
2018
(Actual)
Population
Change
2010-2018
Projected
Population
Change
2018-2023
Median
Household
Income
2018
6,224,774
2,813,526
6,061,065
698,375
2,341,222
326,533,070
10.44%
5.19% $
3.8
4.98
16.06
10.06
5.76
2.51
3.02
7.98
5.02
3.5
99,400
77,704
81,294
82,192
100,613
61,045
HH Income
Change
2011-2018
23.35%
22.98
21.21
50.75
26.74
22.76
Unemployment Rate
(May 2018)
3.2%
4.0
3.9
5.2
3.5
3.6
United States
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Source: S&P Global Market Intelligence, U.S. Bureau of Labor Statistics
(1) Data consists of deposit-weighted average using county-level deposits.
The Washington, D.C. MSA has a large and diversified economy, with an annual gross domestic product of nearly $510 billion, according to
the Bureau of Economic Analysis. When combined with the Baltimore, Maryland MSA, the Washington, D.C. and Baltimore metropolitan areas
in which we operate has a combined gross domestic product of more than $696 billion, and this combined GDP has grown approximately 19%
between 2010 and 2016. The Washington, D.C. MSA is a desirable market for a broad range of companies in a variety of industries, including
15 companies from the 2017 Fortune 500 list, and four of the United States’ largest 100 private companies, according to the 2017 Forbes list of
largest private companies by revenue. The following table provides an in-depth view of the distribution of employment within the Washington,
D.C. MSA.
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Washington, D.C. MSA Employment By Sector
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Source: U.S. Bureau of Labor Statistics; Data as of February 2018
Note: Data not seasonally adjusted
As the home of the federal government, the broader Washington, D.C. region benefits from consistent population growth and remains well
positioned to capitalize on any increase in government spending and infrastructure. Further, as banks in our market have experienced
continued consolidation over the last few years, our opportunities to attract talented employees and capitalize on customer dislocation have
increased.
With its strong demographic characteristics, scale and robust economic activity we believe that the Washington, D.C. and Baltimore
metropolitan areas represent a strong geographic market for us to realize our continued growth strategies within our Commercial Banking
division. The Washington, D.C. area serves as a regional, national and global center for several industries, including:
Government Contracting
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The Washington, D.C. metro area received $70 billion in government contracting awards from October 2015 to September 2016,
according to data from USASpending.gov. We expect the region to benefit from anticipated increases in government contract spending
under the Trump administration.
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•
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According to the Annual Review of Government Contracting of the National Contract Management Association, Virginia, Maryland and
the District of Columbia represent three of the top five markets in the United States for annual government contracts awarded in 2015.
The Washington, D.C. MSA is home to some of the largest defense contracting companies in the world, including Lockheed Martin
(Bethesda, Maryland) and General Dynamics (Falls Church, Virginia).
Hospitality and Tourism
•
The Washington, D.C. MSA is home to three of the world’s largest hotel and resort chains, Marriott International, Inc. (Bethesda,
Maryland), Hilton Worldwide Holdings Inc. (McLean, Virginia) and Host Hotels & Resorts, Inc. (Bethesda, Maryland).
• Worldwide interest in Washington, D.C.’s monuments, museums, diverse neighborhoods drives a strong interest in tourism in the area.
According to the Associated Press, the area was visited by more than 22 million domestic and international tourists in 2016. The high
volume of tourists contributed to $7.3 billion of spending in the area in 2016, an increase of 2.8% from 2015. The tourism industry
supports 74,000 jobs in Washington, D.C., according to Destination DC.
In addition to their diverse economies, we believe the Washington, D.C. and Baltimore, Maryland metropolitan areas provide a favorable
environment for economic strength going forward. As the home of the federal government, the broader Washington, D.C. region benefits from
consistent population growth and remains well positioned to capitalize on any increase in government spending and infrastructure. Further, as
banks in our market have experienced continued consolidation over the last few years, our opportunities to attract talented employees and
capitalize on customer dislocation have increased. Thirteen bank mergers in the Washington, D.C. and Baltimore, Maryland MSAs have been
announced or completed since the start of 2016. With the shrinking number of locally headquartered community banks (seven of the top 10
banks in Washington, D.C. MSA by market share are not headquartered in the region), we believe that we have the ability to continue our
historical growth by serving the middle market businesses and their owners in the Washington, D.C. and Baltimore, Maryland MSAs who prefer
high quality service and local decision making that is unavailable at larger, out-of-market banking institutions.
With its unique demographic characteristics, scale and robust economic activity, we believe that the Washington, D.C. and Baltimore
metropolitan areas are a strong geographic market in which we can realize our continued growth strategies for our Commercial Banking
division.
Lending Activities
Overview. We maintain a diversified loan portfolio of types of loan products and customer characteristics with a focus on variable rate,
shorter term and higher yielding products. Our lending services cover residential and commercial real estate loans, both on an owner and non-
owner-occupied basis, construction loans, commercial business loans and credit card lines (substantially all of which are secured by a deposit
at the Bank in an amount equal to the full credit limit of the credit card). Lending activities originate from the efforts of our bankers, with an
emphasis on lending to individuals, professionals, small- to medium-sized businesses and commercial companies located in our market areas.
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The following table presents the composition of our total loan portfolio, by category, as of December 31, 2018.
LOAN PORTFOLIO COMPOSITION
Loan Composition
(Dollars in thousands)
Real estate:
Residential
Commercial
Construction
Subtotal real estate
Commercial
Credit card
Other consumer
Total
Amount
Percentage of
Total Loans
$
$
407,844
278,691
157,586
844,121
122,264
34,673
1,202
1,002,260
41%
28
16
85
12
3
—
100.0%
Residential Real Estate Loans. We offer one-to-four family mortgage loans primarily on owner-occupied primary residences and, to a lesser
extent, investor owned residences. We also offer home equity lines of credit. Our residential real estate lending products are offered primarily to
customers within our geographic markets. Our owner-occupied residential real estate loans usually have fixed rates for five or seven years and
adjust on an annual basis after the initial term based on a typical maturity of 30 years. Our investor residential real estate loans are based on
25-year amortization terms with a balloon payment due after five years. The required minimum debt service coverage ratio is 1.15.
Commercial Real Estate Loans. We offer real estate loans for commercial property that is owner-occupied as well as commercial property
owned by real estate investors. Commercial loans that are secured by owner-occupied commercial real estate and primarily collateralized by
operating cash flows are also included in this category of loans. As of December 31, 2018, we had approximately $128.9 million of owner-
occupied commercial real estate loans, representing approximately 46% of our commercial real estate portfolio. Commercial real estate loan
terms are generally extended for 10 years or less and amortize generally over 25 years or less. The interest rates on our commercial real
estate loans have initial fixed rate terms that adjust typically at 5 years and we routinely charge an origination fee for our services. We generally
require personal guarantees from the principal owners of the business supported by a review of the principal owners’ personal financial
statements and global debt service obligations. The real estate securing our existing commercial real estate loans includes a wide variety of
property types, such as owner-occupied offices, warehouses, production facilities, office buildings, mixed-use residential/commercial property,
retail centers and multifamily properties.
Construction Loans. Our construction loan portfolio primarily includes loans to builders for the construction of single-family homes and
condominium and townhouse conversions or renovations and, to a lesser extent, loans to individual clients for construction of owner-occupied
single-family homes in our market areas. Construction loans are generally made with a term of 12 to 18 months. According to our underwriting
standards, the ratio of loan principal to collateral value, as established by an independent appraisal, cannot exceed 75% for investor-owned
and 80% for owner-occupied properties. Loan proceeds are disbursed based on the completion of certain milestones and only after the project
has been inspected by an experienced construction lender or third-party inspector.
Commercial Business Loans. In addition to our other loan products, we provide general commercial loans, including commercial lines of
credit, working capital loans, term loans, equipment financing, letters of credit and other loan products, primarily in our target markets, that are
underwritten based on each borrower’s ability to service debt from income. We typically take as collateral a lien on general business
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assets including, among other things, available real estate, accounts receivable, promissory notes, inventory and equipment and we generally
obtain a personal guaranty from the borrower or other principal. Other than lines of credit, our commercial loans generally have fixed interest
rates and five or seven year terms depending on factors such as the type and size of the loan, the financial strength of the borrower/guarantor
and the age, type and value of the collateral.
Credit Cards. Through our OpenSky® credit card division, we provide credit cards on a nationwide basis to under-banked populations and
those looking to rebuild their credit scores through a fully digital and mobile platform. Substantially all of the lines of credit are secured by a
noninterest bearing demand account at the Bank in an amount equal to the full credit limit of the credit card. In addition, using our proprietary
scoring model, which considers credit score and repayment history (typically a minimum of six months of on-time repayments, but ultimately
determined on a case-by-case basis) the Bank has recently begun to offer certain customers an unsecured line in excess of their secured line
of credit.
Other Consumer Loans. To a very limited extent, we also make loans to individuals, including secured and unsecured installment and term
loans, car loans and boat loans. We offer consumer loans as an accommodation to our existing customers and do not market consumer loans
to persons who do not have a pre-existing relationship with us.
Credit Policies and Procedures
General. We maintain asset quality through an emphasis on local market knowledge, long-term customer relationships, consistent and
thorough underwriting for all loans and a conservative credit culture. Our lending policies do not provide for any loans that are highly
speculative, subprime or that have high loan-to-value ratios. These components, together with active credit management, are the foundation of
our credit culture.
We have a service-driven, relationship-based, business-focused credit culture, rather than a price-driven, transaction-based culture.
Substantially all of our commercial loans are made to borrowers located or operating in our primary market areas with whom we have ongoing
relationships across various product lines. We only have a limited number of loans secured by properties located in out-of-market areas.
Credit Concentrations. We actively manage the composition of our loan portfolio, including credit concentrations. Our loan approval policies
establish concentrations limits with respect to loan product types to enhance portfolio diversification. The Bank’s concentration management
program couples quantitative data with a qualitative approach to provide an in-depth understanding of its loan portfolio concentrations. The
Bank’s routine commercial real estate portfolio analysis includes concentration trends by portfolio product type, overall commercial real estate
growth trends, pool correlations, risk rating trends, policy and/or underwriting exceptions, non-performing trends, stress testing, market and
submarket analysis and changing economic conditions. The portfolio concentration limits set forth in Bank’s Credit Underwriting Guidelines are
reviewed and approved by the Loan Committee of the Bank’s board of directors at least annually and are based on risk profile, strategic
portfolio diversification goals, quality of the portfolio segment, overall budgeted growth goals and comparisons to peers of the Bank.
Concentration levels are monitored by management and reported to the Bank’s board of directors monthly.
Loan Approval Process. As of December 31, 2018, the Bank had a legal lending limit of approximately $16.1 million for loans secured
without readily marketable collateral, and its “in-house” lending limit was $12.5 million as of such date. The Bank’s lending activities are
governed by written underwriting policies and procedures that have been approved by the Loan Committee of the Bank’s board of directors.
The policies provide several levels of delegated lending authority to the Management Loan Committee, the Credit Loan Committee and senior
management and loan officers of the Bank. The lending authority hierarchy varies depending on loan amount, collateral type and total borrower
exposure. A multi-tiered group level approach based on experience, capability and management position dictates lending authorities for senior
management and loan officers.
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We conduct weekly loan meetings, attended by substantially all of our loan officers, related loan production staff and credit administration
staff at which asset quality and delinquencies are reviewed. Our evaluation and compensation program for our loan officers includes significant
goals, such as the percentages of past due loans and charge-offs to total loans in the loan officer’s portfolio, that we believe motivate loan
officers to focus on the origination and maintenance of high quality credits consistent with our strategic focus on asset quality.
It is our policy to discuss each loan that has one or more past due payment at our weekly meetings with all lending personnel. Our policies
require rapid notification of delinquency and prompt initiation of collection actions. Loan officers, credit administration personnel and senior
management proactively support collection activities.
In accordance with our procedures, we perform annual asset reviews of our loan exposures in excess of $100,000. As part of these asset
review procedures, we analyze recent financial statements of the property, borrower and any guarantor to determine the current level of
occupancy, revenues and expenses and to investigate any deterioration in the value of the real estate collateral or in the borrower’s and any
guarantor’s financial condition. Upon completion, we update the grade assigned to each loan. Loan officers are encouraged to bring potential
credit issues to the attention of credit administration personnel. We maintain a list of loans that receive additional attention if we believe there
may be a potential credit risk.
Loans in excess of $250,000 that are downgraded or classified undergo a detailed quarterly review by the Special Asset Committee of the
Bank’s board of directors. This review includes an evaluation of market conditions, the property’s trends, the borrower and guarantor status, the
level of reserves required and loan accrual status. Additionally, we periodically have an independent, third-party review performed on our loan
grades and our credit administration functions. Finally, we perform an annual stress test of our loan portfolio during which we evaluate the
impact of declining economic conditions on the portfolio based on previous recessionary periods. Management reviews these reports and
presents them to the Loan Committee of the Bank’s board of directors. These asset review procedures provide management with additional
information for assessing our asset quality. In addition, we perform frequent evaluations and regular monitoring of business and personal loans
that are not secured by real estate.
Deposits
Our deposits serve as the primary funding source for lending, investing and other general banking purposes. We provide a full range of
deposit products and services, including a variety of checking and savings accounts, certificates of deposit, money market accounts, debit
cards, remote deposit capture, online banking, mobile banking, e-Statements, bank-by-mail and direct deposit services. We also offer business
accounts and cash management services, including business checking and savings accounts and treasury management services. We solicit
deposits through our relationship-driven team of dedicated and accessible bankers and through community-focused marketing. We also
selectively seek to cross-sell deposit products at loan origination. We supplement our retail deposits with wholesale funding sources such as
deposit listing services, CDARS and brokered deposits. We actively market our certificate of deposit products and rely primarily on competitive
pricing policies to attract and retain these deposits. Our credit card customers are also a signification source of deposits.
Residential Mortgage Origination
We originate residential mortgages for sale on the secondary market through Church Street Mortgage, the mortgage division of our Bank.
We have developed a scalable platform for mortgage originations within this division and believe that we have significant opportunities to grow
the business. We sell substantially all mortgage loans we originate with servicing released to various investors in the secondary market. As a
result of recent changes in the interest rate environment, our mortgage division is currently undergoing a transition from being heavily weighted
toward refinance volume to being more weighted toward purchase volume and niche products with relatively higher margins. As part of this
effort, we have recently established
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our Community Lending Group, which focuses on first-time home buyers, and our Renovation Group, which focuses on originating renovation
focused loans, within the division, as well as hiring several new originators focused primarily on purchase originations. At December 31, 2018,
we had a dedicated team of 33 mortgage loan officers to service this line of business.
Investments
We manage our securities portfolio and cash to maintain adequate liquidity and to ensure the safety and preservation of invested principal,
with a secondary focus on yield and returns. Specific goals of our investment portfolio are as follows:
•
•
•
to provide a ready source of balance sheet liquidity, ensuring adequate availability of funds to meet fluctuations in loan demand,
deposit balances and other changes in balance sheet volumes and composition;
to serve as a means for diversification of our assets with respect to credit quality, maturity and other attributes; and
to serve as a tool for modifying our interest rate risk profile pursuant to our established policies.
Our investment portfolio is comprised primarily of U.S. government agency securities, high quality corporate debt, mortgage-backed
securities backed by government-sponsored entities and equity securities.
Our investment policy is reviewed annually by our Asset/Liability Management Committee, or ALCO, and subsequently ratified by our board
of directors. Overall investment goals are established by our board, CEO, CFO and members of our ALCO. Our board of directors has
delegated the responsibility of monitoring our investment activities to our ALCO. Day-to-day activities pertaining to the securities portfolio are
conducted under the supervision of our CFO. We actively monitor our investments on an ongoing basis to identify any material changes in our
mix of securities. We also review our securities for potential impairment (other than temporary impairments) at least quarterly.
Competition
The banking and financial services industry is highly competitive, and we compete with a wide range of financial institutions within our
markets, including local, regional and national commercial banks and credit unions. We also compete with mortgage companies, brokerage
firms, consumer finance companies, mutual funds, securities firms, insurance companies, credit card companies, third-party payment
processors, financial technology, or fintech, companies and other financial intermediaries for certain of our products and services. Some of our
competitors are not subject to the regulatory restrictions and level of regulatory supervision applicable to us.
Interest rates on loans and deposits, as well as prices on fee-based services, are typically significant competitive factors within banking and
financial services industry. Many of our competitors are much larger financial institutions that have greater financial resources than we do and
compete aggressively for market share. These competitors attempt to gain market share through their financial product mix, pricing strategies
and banking center locations. Other important competitive factors in our industry and markets include office locations and hours, quality of
customer service, community reputation, continuity of personnel and services, capacity and willingness to extend credit, and ability to offer
sophisticated banking products and services. While we seek to remain competitive with respect to fees charged, interest rates and pricing, we
believe that our broad and sophisticated commercial banking product suite, our high quality customer service culture, our positive reputation
and long-standing community relationships will enable us to compete successfully within our markets and enhance our ability to attract and
retain customers.
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Our Employees
As of December 31, 2018, we employed 204 full-time equivalent persons. None of our employees are represented by any collective
bargaining unit or are parties to a collective bargaining agreement. We consider our relations with our employees to be good.
General
SUPERVISION AND REGULATION
We are extensively regulated under both federal and state law. These laws restrict permissible activities and investments and require
compliance with various consumer protection provisions applicable to lending, deposit, brokerage, and fiduciary activities. They also impose
capital adequacy requirements and conditions on a bank holding company’s, or BHC, ability to repurchase stock or to receive dividends from its
subsidiary banks. We are subject to comprehensive examination and supervision by the Federal Reserve, and the Bank is subject to
comprehensive examination and supervision by the Office of the Comptroller of the Currency, or the OCC. We are required to file with the
Federal Reserve quarterly and annual reports and such additional information as the Federal Reserve may require pursuant to the Bank
Holding Company Act of 1956, as amended, or the BHC Act. The Federal Reserve may conduct examinations of BHCs and their subsidiaries.
The Bank’s deposits are insured by the Federal Deposit Insurance Corporation, or the FDIC, through the Deposit Insurance Fund, or DIF. As a
result of this deposit insurance function, the FDIC also has certain supervisory authority and powers over the Bank as well as all other FDIC
insured institutions. The Company’s and the Bank’s regulators generally have broad discretion to impose restrictions and limitations on our
operations. Bank regulation is intended to protect depositors and consumers and not shareholders. This supervisory framework could
materially impact the conduct and profitability of our activities.
To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to the text
of the particular statutory and regulatory provisions. Proposals to change the laws and regulations governing the banking industry are
frequently raised at both the state and federal levels. The likelihood and timing of any changes in these laws and regulations, and the impact
such changes may have on us, are difficult to ascertain. A change in applicable laws and regulations, or in the manner such laws or regulations
are interpreted by regulatory agencies or courts, may have a material effect on our business, operations, and earnings.
Regulation of Capital Bancorp, Inc.
We are registered as a BHC under the BHC Act and are subject to regulation and supervision by the Federal Reserve. The BHC Act
requires us to secure the prior approval of the Federal Reserve before we own or control, directly or indirectly, more than 5% of the voting
shares or substantially all of the assets of any bank or thrift, or merge or consolidate with another bank or thrift holding company. Further, under
the BHC Act, our activities and those of any nonbank subsidiary are limited to: (i) those activities that the Federal Reserve determines to be so
closely related to banking as to be a proper incident thereto, and (ii) investments in companies not engaged in activities closely related to
banking, subject to quantitative limitations on the value of such investments. Prior approval of the Federal Reserve may be required before
engaging in certain activities. In making such determinations, the Federal Reserve is required to weigh the expected benefits to the public, such
as greater convenience, increased competition, and gains in efficiency, against the possible adverse effects, such as undue concentration of
resources, decreased or unfair competition, conflicts of interest, and unsound banking practices.
Subject to various exceptions, the BHC Act and the Change in Bank Control Act, together with related regulations, require Federal Reserve
approval prior to any person or company acquiring “control” of a BHC. Control is conclusively presumed to exist if an individual or company
acquires 25% or more of any class of voting securities of the BHC, and a rebuttable presumption arises if a person or company acquires 10%
or
17
more, but less than 25%, of any class of voting securities and either: (i) the BHC has registered securities under Section 12 of the Securities
Act of 1933, as amended, or the Securities Act; or (ii) no other person owns a greater percentage of that class of voting securities immediately
after the transaction. As a policy matter, the Federal Reserve expects a company that proposes to acquire more than 7.5% but less than 25%
of a class of voting securities to consult with the agency. The Federal Reserve Board may require the company to enter into passivity and, if
other companies are making similar investments, anti-association commitments.
The BHC Act was substantially amended by the Gramm-Leach-Bliley Act, or the GLBA, which, among other things, permits a “financial
holding company” to engage in a broader range of non-banking activities, and to engage on less restrictive terms in certain activities than were
previously permitted. These expanded activities include securities underwriting and dealing, insurance underwriting and sales, and merchant
banking activities. To become a financial holding company, a BHC must certify that it and all depository institutions that it controls are both “well
capitalized” and “well managed” (as defined by federal law), and that all subsidiary depository institutions have at least a “satisfactory” CRA
rating. At this time, we have not elected to become a financial holding company, nor do we expect to make such an election in the foreseeable
future.
There are a number of restrictions imposed on us by law and regulatory policy that are designed to minimize potential loss to depositors
and to the DIF in the event that a subsidiary depository institution should become insolvent. For example, federal law requires a BHC to serve
as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances
where it might not do so in the absence of the rule. The Federal Reserve also has the authority under the BHC Act to require a BHC to
terminate any activity or to relinquish control of a non-bank subsidiary upon the Federal Reserve’s determination that such activity or control
constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the BHC.
Any capital loan by a BHC to a subsidiary depository institution is subordinate in right of payment to deposits and certain other
indebtedness of the institution. In addition, in the event of the BHC’s bankruptcy, any commitment made by the BHC to a federal banking
regulatory agency to maintain the capital of its subsidiary depository institution(s) will be assumed by the bankruptcy trustee and entitled to a
priority of payment.
The Federal Deposit Insurance Act, or FDIA, provides that, in the event of the “liquidation or other resolution” of an insured depository
institution, the claims of depositors of the institution (including the claims of the FDIC as a subrogee of insured depositors) and certain claims
for administrative expenses of the FDIC as a receiver will have priority over other general unsecured claims against the institution. If an insured
depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, non-
deposit creditors, including the institution’s holding company, with respect to any extensions of credit they have made to such insured
depository institution.
Regulation of Capital Bank
The operations and investments of our Bank are subject to the supervision, examination, and reporting requirements of the National Bank
Act and the regulations of the OCC as well as other federal banking statutes and regulations, including with respect to the level of reserves that
our Bank must maintain against deposits, restrictions on the types, amount, and terms and conditions of loans it may originate, and limits on
the types of other activities in which our Bank may engage and the investments that it may make. The OCC also has the power to prevent the
continuance or development of unsafe or unsound banking practices or other violations of law. Because our Bank’s deposits are insured by the
FDIC to the maximum extent provided by law, it is also subject to certain FDIC regulations, and the FDIC has backup examination authority and
some enforcement powers over our Bank. If, as a result of an examination of our Bank, the regulators should determine that the financial
condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of the Bank’s operations are
unsatisfactory or that the Bank or our management is
18
violating or has violated any law or regulation, various remedies are available to the regulators. Such remedies include the power to enjoin
unsafe or unsound practices, require affirmative action to correct any conditions resulting from any violation or practice, issue an administrative
order that can be judicially enforced, direct an increase in capital, to restrict growth, assess civil monetary penalties and remove officers and
directors. The regulators also may request the FDIC to terminate the Bank’s deposit insurance.
Regulatory Relief Act
On May 24, 2018, President Trump signed into law the Regulatory Relief Act, which amends parts of the Dodd-Frank Wall Street Reform
and Consumer Protection Act, or Dodd-Frank Act, as well as other laws that involve regulation of the financial industry. While the Regulatory
Relief Act keeps in place fundamental aspects of the Dodd-Frank Act’s regulatory framework, it does change the regulatory framework for
depository institutions with assets under $10 billion, such as the Bank, and for large depository institutions with assets over $50 billion. The
legislation includes a number of provisions which are favorable to BHCs with total consolidated assets of less than $10 billion, such as the
Company, and also makes changes to consumer mortgage and credit reporting regulations and to the authorities of the agencies that regulate
the financial industry. A number of the provisions included in the Regulatory Relief Act require the federal banking agencies to either
promulgate regulations or amend existing regulations, and it will likely take some time for these agencies to implement the necessary changes.
The following is a brief summary of select provisions of the Regulatory Relief Act which are not otherwise covered in other sections below.
Modified Process for Designating Systemically Important Financial Institutions. The Regulatory Relief Act changes which BHCs will be
designated as “Systemically Important Financial Institutions” or SIFIs. Prior to passage of the Regulatory Relief Act, all BHCs with assets
exceeding $50 billion were automatically designated as SIFIs and were subject to the enhanced prudential standards, or EPS of the Dodd-
Frank Act, which required these BHCs to undergo special stress tests, develop resolution plans, and maintain certain levels of liquidity and
financial capacity to absorb losses. The Regulatory Relief Act raised the $50 billion “SIFI threshold” to $250 billion, but staggered the
application of this change for certain institutions, based on the size of the BHC. Upon enactment, BHCs with total consolidated assets of less
than $100 billion are no longer subject to the EPS of the Dodd-Frank Act. BHCs with total consolidated assets of more than $100 billion but
less than $250 billion will no longer be subject to such requirements, beginning 18 months after the date of enactment. During the 18-month
transition period, the Federal Reserve may exempt a BHC from any EPS requirement, and the Federal Reserve is also provided with
discretionary authority to apply any EPS to a BHC within this asset category, subject to it following specified procedural requirements. BHCs
with more than $250 billion in consolidated assets, as well as any domestic BHC that has been identified as a “global systemically important”
BHC, remain fully subject to EPS. Because the Regulatory Relief Act does not amend the regulations that the federal banking agencies have
promulgated to implement the EPS, it will likely take some time for these agencies to amend their regulations to account for the new thresholds
included in the Regulatory Relief Act.
Many of the changes in the Regulatory Relief Act amend provisions of Dodd-Frank Act that apply at the BHC level, but not to subsidiary
national banks or other insured depository institutions. The OCC and the FDIC have adopted their own counterparts to some EPS for the bank
subsidiaries that they regulate, including recovery and resolution planning. The OCC and the FDIC will need to address whether they intend to
take similar measures under their regulations and guidance to align asset thresholds with what is reflected in the Regulatory Relief Act.
Provisions that are Favorable to Community Banks. There are a number of provisions in the Regulatory Relief Act that will have a favorable
impact on community banks such as the Bank. These are briefly referenced below.
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Elimination of Company-Run Stress Tests. The Regulatory Relief Act exempts all banking organizations-including not only BHCs, but also
depository institutions and savings and loan holding companies, or SLHCs, with less than $250 billion in total consolidated assets from the
current requirement to conduct company-run stress tests. Banking organizations with $250 billion or more in total consolidated assets are still
required to conduct company-run stress tests on a periodic basis but are no longer be required to do so on a semi-annual or annual basis.
Increase in Small BHC Policy Threshold. The threshold for qualifying for the Federal Reserve’s “Small BHC Policy Statement”, or the
Policy, is increased by the Regulatory Relief Act from $1 billion to $3 billion, provided the small BHC or SLHC is not engaged in significant non-
banking activities, is not engaged in significant off-balance sheet activities and does not have a material amount of debt or equity registered
with the Securities and Exchange Commission, or the SEC. The Federal Reserve retains the authority to exclude any BHC or SLHC from the
Policy if such action is warranted for supervisory purposes. The Policy allows covered holding companies to operate with higher levels of debt
than would normally be permitted. Also, holding companies that are subject to the Policy are exempt from the Federal Reserve’s consolidated
risk-based and leverage capital rules and have less extensive regulatory reporting requirements than larger organizations. Specifically, they file
semi-annual rather than quarterly reports. Companies that are subject to the Policy are not to pay dividends if their debt-to-equity ratio exceeds
1:1. In addition, the Federal Reserve expects that holding companies will retire all debt within 25 years and reduce debt to 30 percent or less of
equity within 12 years of incurring the debt. The foregoing requirements are intended to ensure that the higher leverage the Policy allows does
not pose an undue burden on subsidiary depository institutions. Finally, the Policy directs that each depository institution subsidiary of a
covered holding company remain well-capitalized.
Increase in Asset Threshold for Requirement to Establish a Risk Committee. The Regulatory Relief Act raises the asset threshold for the
requirement that a publicly-traded BHC establish a risk committee from $10 billion to $50 billion or more in total consolidated assets.
Increase in Asset Threshold for Qualifying for an 18-Month Examination Cycle. The Regulatory Relief Act increases the asset threshold for
institutions qualifying for an 18-month on-site examination cycle from $1 billion to $3 billion in total consolidated assets.
Short Form Call Reports. The Regulatory Relief Act requires the federal banking agencies to promulgate regulations allowing an insured
depository institution with less than $5 billion in total consolidated assets (and that satisfies such other criteria as determined to be appropriate
by the agencies) to submit a short-form call report for its first and third quarters of a calendar year.
Consumer Protection Enhancements. The Regulatory Relief Act includes various provisions to address consumer protection challenges
facing the credit reporting industry and borrowers in certain credit markets, specifically markets including active duty service members,
veterans, and student loan borrowers. The Regulatory Relief Act subjects credit reporting agencies to additional requirements, including
requirements to generally provide fraud alerts for consumer files for at least one year and to allow consumers to place security freezes on their
credit reports.
The Regulatory Relief Act also allows consumers to request that information related to a default on a qualified private student loan be
removed from a credit report if the borrower satisfies the requirements of a loan rehabilitation program offered by a private lender. The
Regulatory Relief Act prohibits lenders from declaring automatic default in the case of death or bankruptcy of the co-signer of a student loan
and requires lenders to release cosigners from obligations related to a student loan in the event of the death of the student borrower. In
addition, credit reporting agencies will be required to exclude certain medical debt from veterans’ credit reports.
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Transactions with Affiliates and Insiders
We are subject to federal laws, such as Sections 23A and 23B of the Federal Reserve Act, or FRA, that limit the size and number of the
transactions that depository institutions may engage in with their affiliates. Under these provisions, transactions (such as loans or investments)
by a bank with nonbank affiliates are generally limited to 10% of the bank’s capital and surplus for all covered transactions with any one
affiliate, and 20% of capital and surplus for all covered transactions with all affiliates. Any extensions of credit to affiliates, with limited
exceptions, must be secured by eligible collateral in specified amounts. Banks are also prohibited from purchasing any “low quality” assets from
an affiliate. The Dodd-Frank Act generally enhanced the restrictions on transactions with affiliates under Section 23A and 23B of the FRA,
including an expansion of the definition of “covered transactions” and an increase in the amount of time for which collateral requirements
regarding covered credit transactions must be satisfied. Insider transaction limitations are expanded through the strengthening of restrictions on
loans to insiders and the expansion of the types of transactions subject to the various limits, including derivatives transactions, repurchase
agreements, reverse repurchase agreements and securities lending or borrowing transactions. The Federal Reserve has promulgated
Regulation W, which codifies prior interpretations under Sections 23A and 23B of the FRA and provides interpretive guidance with respect to
affiliate transactions. Affiliates of a bank include, among other entities, a bank’s BHC and companies that are under common control with the
bank. We are considered to be an affiliate of the Bank.
We are also subject to restrictions on extensions of credit to our executive officers, directors, stockholders who own more than 10% of our
common stock, and their related interests. These extensions of credit must be made on substantially the same terms, including interest rates
and collateral, as those prevailing at the time for comparable transactions with third parties, and must not involve more than the normal risk of
repayment or present other unfavorable features. Loans to such persons and certain affiliated entities of any of the foregoing may not exceed,
together with all other outstanding loans to such person and affiliated entities, the institution’s loans-to-one-borrower limit. Federal regulations
also prohibit loans above amounts prescribed by the appropriate federal banking agency to directors, executive officers, stockholders who own
more than 10% of an institution, and their respective affiliates, unless such loans are approved in advance by a majority of the board of
directors of the institution. Any “interested” director may not participate in the vote. The proscribed loan amount, which includes all other
outstanding loans to such person, as to which such prior board of director approval is required, is the greater of $25,000 or 5% of capital and
surplus up to $500,000. Furthermore, we are prohibited from engaging in asset purchases or sales transactions with our officers, directors, or
principal stockholders unless the transaction is on market terms and, if the transaction represents greater than 10% of the capital and surplus
of the Bank, a majority of the Bank’s disinterested directors has approved the transaction.
Indemnification payments to any director, officer or employee of either a bank or a BHC are subject to certain constraints imposed by the
FDIC.
Incentive Compensation
Federal banking agencies have issued guidance on incentive compensation policies intended to ensure that the incentive compensation
policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The
guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, is based upon the key
principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking
beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management,
and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. In
accordance with the Dodd-Frank Act, the federal banking agencies prohibit incentive-based compensation arrangements that encourage
inappropriate risk taking by covered financial institutions (generally institutions that have over $1 billion in assets) and are deemed to be
excessive, or that may lead to material losses.
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The Federal Reserve will review, as part of its standard, risk-focused examination process, the incentive compensation arrangements of
banking organizations (such as the Company) that are not “large, complex banking organizations.” These reviews will be tailored to each
organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements.
The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s
supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken
against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose
a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.
The scope and content of the U.S. banking regulators’ policies on executive compensation may continue to evolve in the near future. It
cannot be determined at this time whether compliance with such policies will adversely affect the Company’s ability to hire, retain and motivate
its key employees.
Deposit Insurance
Our deposits are insured up to applicable limits by the DIF of the FDIC. The DIF is the successor to the Bank Insurance Fund and the
Savings Association Insurance Fund, which were merged in 2006. Deposit insurance is mandatory. We are required to pay assessments to the
FDIC on a quarterly basis. The assessment amount is the product of multiplying the assessment base by the assessment amount.
The assessment base against which the assessment rate is applied to determine the total assessment due for a given period is the
depository institution’s average total consolidated assets during the assessment period less average tangible equity during that assessment
period. Tangible equity is defined in the assessment rule as Tier 1 Capital and is calculated monthly, unless the insured depository institution
has less than $1 billion in assets, in which case the insured depository institution calculates Tier 1 Capital on an end-of-quarter basis. Parents
or holding companies of other insured depository institutions are required to report separately from their subsidiary depository institutions.
The FDIC’s methodology for setting assessments for individual banks has changed over time, although the broad policy is that lower-risk
institutions should pay lower assessments than higher-risk institutions. The FDIC now uses a methodology, known as the “financial ratios
method,” that began to apply on July 1, 2016, in order to meet requirements of the Dodd-Frank Act. The statute established a minimum
designated reserve ratio, or the DRR, for the DIF of 1.35% of the estimated insured deposits and required the FDIC to adopt a restoration plan
should the reserve ratio fall below 1.35%. The financial ratios took effect when the DRR exceeded 1.15%. The FDIC declared that the DIF
reserve ratio exceeded 1.15% by the end of the second quarter of 2016. Accordingly, beginning July 1, 2016, the FDIC began to use the
financial ratios method. This methodology assigns a specific assessment rate to each institution based on the institution’s leverage capital,
supervisory ratings, and information from the institution’s call report. Under this methodology, the assessment rate schedules used to determine
assessments due from insured depository institutions become progressively lower when the reserve ratio in the DIF exceeds 2% and 2.5%.
In addition to the assessment for deposit insurance, insured depository institutions are required to make payments on bonds issued in the
late 1980s by the Financing Corporation to recapitalize a predecessor deposit insurance fund. This payment is established quarterly and, for
the fourth quarter in calendar year 2018, equaled .32 basis points on assessable deposits.
The Dodd-Frank Act also raised the limit for federal deposit insurance to $250,000 for most deposit accounts and increased the cash limit
of Securities Investor Protection Corporation protection from $100,000 to $250,000.
The FDIC has authority to increase insurance assessments. A significant increase in insurance assessments would likely have an adverse
effect on our operating expenses and results of operations. We
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cannot predict what insurance assessment rates will be in the future. Furthermore, deposit insurance may be terminated by the FDIC upon a
finding that an insured depository institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue
operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC.
Dividends
Capital Bancorp, Inc. is a legal entity separate and distinct from Capital Bank. Our ability to pay dividends and make other distributions
depends in part upon the receipt of dividends from the Bank and is limited by federal and state law. The specific limits depend upon a number
of factors, including the bank’s recent earnings, recent dividends, level of capital, and regulatory status. The regulators are authorized, and
under certain circumstances are required, to determine that the payment of dividends or other distributions by a bank would be an unsafe or
unsound practice and to prohibit that payment. For example, the FDIA generally prohibits a depository institution from making any capital
distribution (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would
thereafter be undercapitalized. Failure to satisfy the capital conservation buffer requirement may also result in limits on our ability to pay
dividends. See “—Capital Adequacy Guidelines.”
A national bank generally may not withdraw, either in the form of a dividend or otherwise, any portion of its permanent capital and may not
declare a dividend in excess of its retained net profits. Further, dividends that may be paid by a national bank without the express approval of
the OCC are limited to an amount equal to the bank’s retained net profits for the preceding two calendar years plus retained net profits up to
the date of any dividend declaration in the current calendar year. Retained net profits, as defined by the OCC, consist of net income, less
dividends declared during the period. Dividend payments by the Bank in the future will require the generation of net income and could require
regulatory approval if any proposed dividends are in excess of prescribed guidelines.
Capital Adequacy Guidelines
In December 2010, the Basel Committee on Banking Supervision released its final framework for strengthening international capital and
liquidity regulation, or Basel III. Basel III requires banks to maintain a higher level of capital than previously required, with a greater emphasis
on common equity. The Dodd-Frank Act imposed generally applicable capital requirements with respect to BHCs and their bank subsidiaries
and mandated that the federal banking regulatory agencies adopt rules and regulations to implement the Basel III requirements.
Among other things, the Dodd-Frank Act requires the Federal Reserve to apply consolidated capital requirements to a BHC that are no less
stringent than those currently applied to depository institutions. In July 2013, the federal banking agencies adopted a final rule, or the Basel III
Final Rule, implementing these standards. Under the Basel III Final Rule, trust preferred securities are excluded from Tier I capital unless such
securities were issued prior to May 19, 2010 by a BHC with less than $15 billion in assets, subject to certain limits. The Dodd-Frank Act
additionally provides for countercyclical capital requirements so that the required amount of capital increases in times of economic expansion
and decreases in times of economic contraction, consistent with safety and soundness. Under the Basel III Final Rule, which implements this
concept, banks must maintain a capital conservation buffer consisting of additional common equity Tier 1 capital equal to 2.5% of risk-weighted
assets above each of the required minimum capital levels in order to avoid limitations on paying dividends, engaging in share repurchases, and
paying certain discretionary bonuses. This new capital conservation buffer requirement began to be phased in beginning in January 2016 at
0.625% of risk-weighted assets and will increase by this amount each year until fully implemented at 2.5% in January 2019. As of January 1,
2018, the capital conservation buffer had phased in to 1.875%.
For purposes of calculating risk-weighted assets, the federal banking agencies have promulgated risk-based capital guidelines designed to
make regulatory capital requirements more sensitive to differences in risk profiles among banks, to account for off-balance sheet exposures,
and to minimize disincentives for
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holding liquid assets. Under these guidelines, assets and off-balance sheet items are assigned to broad risk categories, each with appropriate
weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.
In addition, certain off-balance sheet items are assigned certain credit conversion factors to convert them to asset-equivalent amounts to
which an appropriate risk-weighting will apply. Those computations result in the total risk-weighted assets. Most loans are assigned to the
100% risk category, except for performing first mortgage loans fully secured by residential property, which carry a 50% risk weighting. Most
investment securities (including, primarily, general obligation claims of states or other political subdivisions of the United States) are assigned to
the 20% category. Exceptions include municipal or state revenue bonds, which have a 50% risk weighting, and direct obligations of the United
States Treasury or obligations backed by the full faith and credit of the United States government, which have a 0% risk weighting. In
converting off-balance sheet items, direct credit substitutes, including general guarantees and standby letters of credit backing financial
obligations, are given a 100% risk weighting. Transaction-related contingencies such as bid bonds, standby letters of credit backing non-
financial obligations, and undrawn commitments (including commercial credit lines with an initial maturity of more than one year) have a 50%
risk weighting. Short-term commercial letters of credit have a 20% risk weighting, and certain short-term unconditionally cancelable
commitments have a 0% risk weighting.
Revised minimum capital standards for banks of our size took effect on January 1, 2015 with a phase-in period that generally extended
through January 1, 2019 for certain of the changes.
Under the Basel III Final Rule, the minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such
as standby letters of credit) is 8%. The required ratio of “Tier 1 Capital” (consisting generally of stockholders’ equity and qualifying preferred
stock, less certain goodwill items and other intangible assets) to risk-weighted assets rose to 6% from the earlier 4%. While there was
previously no required ratio of “Common Equity Tier 1 Capital,” or CET1 (which generally consists of common stock, retained earnings, certain
qualifying capital instruments issued by consolidated subsidiaries, and Accumulated Other Comprehensive Income, subject to certain
adjustments) to risk-weighted assets, a required minimum ratio of 4.5% became effective on January 1, 2015 as well. The remainder of total
capital, or Tier 2 Capital, may consist of (a) the allowance for loan losses of up to 1.25% of risk-weighted assets, (b) preferred stock not
qualifying as Tier 1 Capital, (c) hybrid capital instruments, (d) perpetual debt, (e) mandatory convertible securities, and (f) certain subordinated
debt and intermediate-term preferred stock up to 50% of Tier 1 Capital. Total Capital is the sum of Tier 1 Capital and Tier 2 Capital (which is
included only to the extent of Tier 1 Capital), less reciprocal holdings of other banking organizations’ capital instruments, investments in
unconsolidated subsidiaries, and any other deductions as determined by the appropriate regulator.
During 2018, banking organizations, including the Bank, were required to maintain a CET1 capital ratio of at least 6.375%, a Tier 1 capital
ratio of at least 7.875%, and a total capital ratio of at least 9.875% to avoid limitations on capital distributions and certain discretionary incentive
compensation payments. The requirements were fully phased-in on January 1, 2019, including the 2.5% capital conservation buffer, and the
Bank is now required to meet a minimum Tier 1 leverage ratio of 4.0%, a minimum CET1 to risk-weighted assets ratio of 7%, a Tier 1 capital to
risk-weighted assets ratio of 8.5% and a minimum total capital to risk-weighted assets ratio of 10.5%. In August of 2018 the Regulatory Relief
Act directed the Federal Reserve Board to revise the Small BHC Policy Statement to raise the total consolidated asset limit in the Small BHC
Policy Statement from $1 billion to $3 billion. The Company was previously required to comply with the minimum capital requirements on a
consolidated basis; however, the Company continues to meet the conditions of the revised Small BHC Policy Statement and was, therefore,
exempt from the consolidated capital requirements at December 31, 2018.
The Basel III Final Rule also established minimum leverage ratio requirements for banking organizations, calculated as the ratio of Tier 1
Capital to adjusted average consolidated assets. Prior to the effective date of the Basel III Final Rule, banks and BHCs meeting certain
specified criteria, including having the highest
24
regulatory rating and not experiencing significant growth or expansion, were permitted to maintain a minimum leverage ratio of Tier 1 Capital to
adjusted average quarterly assets equal to 3%. Other banks and BHCs generally were required to maintain a minimum leverage ratio between
4% and 5%. Under the Basel III Final Rule, as of January 1, 2015, the required minimum leverage ratio for all banks is 4%. As discussed under
“—Prompt Corrective Action,” depository institutions and depository holding companies with less than $10 billion in total consolidated assets,
such as the Company and the Bank, will be deemed to satisfy both the leverage and risk-based capital requirements, provided they satisfy a
new “Community Bank Leverage Ratio” required to be promulgated by the federal banking agencies.
As an additional means of identifying problems in the financial management of depository institutions, the federal banking regulatory
agencies have established certain non-capital safety and soundness standards for institutions for which they are the primary federal regulator.
The standards relate generally to operations and management, asset quality, interest rate exposure, and executive compensation. The
agencies are authorized to take action against institutions that fail to meet such standards.
The requirements of the Dodd-Frank Act are still in the process of being implemented over time and most will be subject to regulations
implemented over the course of several years. In addition, the Regulatory Relief Act modifies a number of provisions in the Dodd-Frank Act, but
are subject to implementing regulations. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act and
the Regulatory Relief Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such
requirements will have on our operations is unclear. On August 25, 2017, the federal banking agencies proposed an extension of the transition
period for application of the Basel III-based capital rules to certain investments. If the proposed extension of the transition period is finalized
substantially as proposed in August 2017, the capital treatment proposed therein would remain effective until such time as the changes
proposed in the new rule proposal would be finalized and effective. On September 27, 2017, the federal banking agencies proposed a rule
intended to reduce the regulatory compliance burden, particularly on community banking organizations, by simplifying several requirements in
the Basel III-based capital rules. Specifically, the proposed rule simplifies the capital treatment for certain acquisition, development, and
construction loans, mortgage servicing assets, certain deferred tax assets, investments in the capital instruments of unconsolidated financial
institutions, and minority interest. The Regulatory Relief Act addressed the capital treatment of certain acquisition, development and
construction loans. See “—Commercial Real Estate Concentration Guidelines.”
In December 2017, the Basel Committee published standards that it described as the finalization of the Basel III post-crisis regulatory
reforms, which standards are commonly referred to as Basel IV. Among other things, these standards revise the Basel Committee’s
standardized approach for credit risk (including the recalibration of the risk weights and the introduction of new capital requirements for certain
“unconditionally cancellable commitments,” such as unused credit card lines of credit) and provides a new standardized approach for
operational risk capital. Under the Basel framework, these standards will generally be effective on January 1, 2022, with an aggregate output
floor phasing in through January 1, 2027. Under the current U.S. capital rules, operational risk capital requirements and a capital floor apply
only to advanced approaches institutions, and not to the Bank. The impact of Basel IV on us will depend on the manner in which it is
implemented by the federal bank regulators.
Commercial Real Estate Concentration Guidelines
In December 2006, the federal banking regulators issued guidance entitled “Concentrations in Commercial Real Estate Lending, Sound
Risk Management Practices” to address increased concentrations in commercial real estate, or CRE, loans. In addition, in December 2015, the
federal bank agencies issued additional guidance entitled “Statement on Prudent Risk Management for Commercial Real Estate Lending.”
Together, these guidelines describe the criteria the agencies will use as indicators to identify institutions potentially exposed to CRE
concentration risk. An institution that has (i) experienced rapid growth in CRE lending, (ii) notable exposure to a specific type of CRE, (iii) total
reported loans for construction, land development, and other land representing 100% or more of the institution’s capital, or (iv) total non-owner-
25
occupied CRE (including construction) loans representing 300% or more of the institution’s capital, and the outstanding balance of the
institutions CRE portfolio has increased by 50% or more in the prior 36 months, may be identified for further supervisory analysis of the level
and nature of its CRE concentration risk.
Currently, loans categorized as “high-volatility commercial real estate,” or HVCRE, loans are required to be assigned a 150% risk weight,
and require additional capital support. HVCRE loans are defined to include any credit facility that finances or has financed the acquisition,
development or construction of real property, unless it finances: 1-4 family residential properties; certain community development investments;
agricultural land used or usable for, and whose value is based on, agricultural use; or commercial real estate projects in which (i) the loan to
value is less than the applicable maximum supervisory loan to value ratio established by the bank regulatory agencies, (ii) the borrower has
contributed cash or unencumbered readily marketable assets, or has paid development expenses out of pocket, equal to at least 15% of the
appraised “as completed” value, (iii) the borrower contributes its 15% before the bank advances any funds and (iv) the capital contributed by
the borrower, and any funds internally generated by the project, are contractually required to remain in the project until the facility is converted
to permanent financing, sold or paid in full.
The Regulatory Relief Act prohibits federal banking agencies from assigning heightened risk weights to HVCRE exposures, unless the
exposures are classified as HVCRE acquisition, development and construction loans. The Federal banking agencies issued a proposal in
September 2017 to simplify the treatment of HVCRE and to create a new category of commercial real estate loans called “high-volatility
acquisition, development or construction,” or HVADC, loans, with a lower risk weight of 130%. A significant difference between the Regulatory
Relief Act and the agencies’ HVADC proposal arises from the Regulatory Relief Act’s preservation of the exemption for projects where the
borrower has contributed at least 15% of the real property’s appraised “as completed” value.
At December 31, 2018, the Bank’s construction to total capital ratio was 143.4%, its total non-owner occupied commercial real estate
(including construction) to total capital ratio was 339.5% and therefore exceeded the 100% and 300% regulatory guideline thresholds set forth
in clauses (iii) and (iv) above. As a result, we are deemed to have a concentration in commercial real estate lending under applicable regulatory
guidelines.
Prompt Corrective Action
In addition to the required minimum capital levels described above, federal law establishes a system of “prompt corrective actions” that
federal banking agencies are required to take, and certain actions that they have discretion to take, based upon the capital category into which
a federally regulated depository institution falls. Regulations set forth detailed procedures and criteria for implementing prompt corrective action
in the case of any institution which is not adequately capitalized. Under the prompt corrective action rules, an institution is deemed “well
capitalized” if its leverage ratio, Common Equity Tier 1 ratio, Tier 1 Capital ratio, and Total Capital ratio meet or exceed 5%, 6.5%, 8%, and
10%, respectively. An institution is deemed to be “adequately capitalized” or better if its leverage, Common Equity Tier 1, Tier 1, and Total
Capital ratios meet or exceed the minimum federal regulatory capital requirements set forth in the Basel III Final Rule. An institution is
“undercapitalized” if it fails to meet the minimum capital requirements. An institution is “significantly undercapitalized” if any one of its leverage,
Common Equity Tier 1, Tier 1, and Total Capital ratios falls below 3%, 3%, 4%, and 6%, respectively, and “critically undercapitalized” if the
institution has a ratio of tangible equity to total assets that is equal to or less than 2%.
The Regulatory Relief Act requires the federal banking agencies to promulgate a rule establishing a new “Community Bank Leverage
Ratio,” or CBLR, of 8% to 10% for depository institutions and depository institution holding companies, including banks and BHCs, with less
than $10 billion in total consolidated assets, such as the Company and the Bank. If such a depository institution or holding company maintains
tangible equity in excess of this leverage ratio, it would be deemed in compliance with (1) the leverage and risk-based capital requirements
promulgated by the federal banking agencies; (2) in the case of a depository institution, the capital ratio requirements to be considered “well
capitalized” under the federal banking
26
agencies’ “prompt corrective action” regime; and (3) any other capital or leverage requirements to which the depository institution or holding
company is subject, in each case, unless the appropriate federal banking agency determines otherwise based on the particular institution’s risk
profile. The Regulatory Relief Act defines the CBLR differently from the leverage ratio used in determining a bank’s prompt corrective action
status.
The prompt corrective action rules require an undercapitalized institution to file a written capital restoration plan, along with a performance
guaranty by its holding company or a third party. In addition, an undercapitalized institution becomes subject to certain automatic restrictions,
including a prohibition on payment of dividends and a limitation on asset growth and expansion in certain cases, a limitation on the payment of
bonuses or raises to senior executive officers, and a prohibition on the payment of certain “management fees” to any “controlling person.”
Institutions that are classified as undercapitalized are also subject to certain additional supervisory actions, including increased reporting
burdens and regulatory monitoring; limitations on the institution’s ability to make acquisitions, open new branch offices or engage in new lines
of business; obligations to raise additional capital; restrictions on transactions with affiliates; and restrictions on interest rates paid by the
institution on deposits. In certain cases, banking regulatory agencies may require replacement of senior executive officers or directors, or sale
of the institution to a willing purchaser. If an institution is deemed to be “critically undercapitalized” and continues in that category for 90 days,
the statute requires, with certain narrowly limited exceptions, that the institution be placed in receivership.
An insured depository institution’s capital levels may have consequences outside the prompt corrective action regime. For example, only
well-capitalized institutions may accept brokered deposits without restrictions on rates, while adequately capitalized institutions must seek a
waiver from the FDIC to accept such deposits and are subject to rate restrictions. Well-capitalized institutions may be eligible for expedited
treatment of certain applications, an advantage not available to other institutions.
As noted above, Basel III integrates the new capital requirements into the prompt corrective action category definitions. The following
capital requirements have applied to the Bank since January 1, 2015.
Capital
Category
Total Risk-Based
Capital Ratio
Tier 1 Risk-Based
Capital Ratio
Common Equity
Tier 1 (CET1) Capital
Ratio
Leverage Ratio
Tangible Equity
to Assets
Supplemental
Leverage Ratio
Well Capitalized
10% or greater
8% or greater
6.5% or greater
5% or greater
Adequately Capitalized
8% or greater
6% or greater
4.5% or greater
4% or greater
Undercapitalized
Less than 8%
Less than 6%
Less than 4.5%
Less than 4%
Significantly Undercapitalized
Less than 6%
Less than 4%
Less than 3%
Less than 3%
n/a
n/a
n/a
n/a
Critically Undercapitalized
n/a
n/a
n/a
n/a
Less than 2%
n/a
3% or greater
Less than 3%
n/a
n/a
As of December 31, 2018, the Bank was well capitalized according to the guidelines generally discussed above. As of December 31, 2018,
the Company had a consolidated ratio of 14.2% of total capital to risk-weighted assets, a consolidated ratio of 13.0% of Tier 1 capital to risk-
weighted assets, a consolidated ratio of 12.7% of common equity Tier 1 capital, and a leverage ratio of 10.8%, and the Bank had a ratio of
12.3% of total capital to risk-weighted assets, a ratio of 11.0% of common equity Tier 1 capital, a ratio of 11.0% of Tier 1 capital to risk-weighted
assets and a leverage ratio of 9.1%.
Safety and Soundness Standards
The federal banking agencies have adopted guidelines designed to assist the federal banking agencies in identifying and addressing
potential safety and soundness concerns before capital becomes impaired. The guidelines set forth operational and managerial standards
relating to (i) internal controls, information systems and internal audit systems, (ii) loan documentation, (iii) credit underwriting, (iv) asset
growth, (v) earnings and (vi) compensation, fees and benefits.
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In addition, the federal banking agencies have adopted safety and soundness guidelines with respect to asset quality and for evaluating
and monitoring earnings to ensure that earnings are sufficient for the maintenance of adequate capital and reserves. These guidelines provide
six standards for establishing and maintaining a system to identify problem assets and prevent those assets from deteriorating. Under these
standards, an insured depository institution should (i) conduct periodic asset quality reviews to identify problem assets, (ii) estimate the inherent
losses in problem assets and establish reserves that are sufficient to absorb estimated losses, (iii) compare problem asset totals to capital, (iv)
take appropriate corrective action to resolve problem assets, (v) consider the size and potential risks of material asset concentrations and (vi)
provide periodic asset quality reports with adequate information for management and the board of directors to assess the level of asset risk.
Community Reinvestment Act
The CRA requires the federal banking regulatory agencies to assess all financial institutions that they regulate to determine whether these
institutions are meeting the credit needs of the communities they serve, including their assessment area(s) (as established for these purposes
in accordance with applicable regulations based principally on the location of branch offices). In addition to substantial penalties and corrective
measures that may be required for a violation of certain fair lending laws, the federal banking agencies may take compliance with such laws
and the CRA into account when regulating and supervising other activities and when reviewing applications for various purposes, including
bank mergers and the establishment of new branch offices. Under the CRA, institutions are assigned a rating of “outstanding,” “satisfactory,”
“needs to improve,” or “unsatisfactory.” An institution’s record in meeting the requirements of the CRA is based on a performance-based
evaluation system, and is made publicly available and is taken into consideration in connection with any applications it files with federal
regulators to engage in certain activities, including approval of a branch or other deposit facility, mergers and acquisitions, office relocations, or
expansions into non-banking activities. Our Bank received a “satisfactory” rating in its most recent CRA evaluation.
Anti-Terrorism, Money Laundering Legislation and OFAC
The Bank is subject to the Bank Secrecy Act and the Uniting and Strengthening America by Providing Appropriate Tools Required to
Intercept and Obstruct Terrorism Act of 2001, or the USA Patriot Act. These statutes and related rules and regulations impose requirements
and limitations on specified financial transactions and accounts and other relationships intended to guard against money laundering and
terrorism financing. The principal requirements for an insured depository institution include (i) establishment of an anti-money laundering
program that includes training and audit components, (ii) establishment of a “know your customer” program involving due diligence to confirm
the identities of persons seeking to open accounts and to deny accounts to those persons unable to demonstrate their identities, (iii) the filing of
currency transaction reports for deposits and withdrawals of large amounts of cash, (iv) additional precautions for accounts sought and
managed for non-U.S. persons and (v) verification and certification of money laundering risk with respect to private banking and foreign
correspondent banking relationships. For many of these tasks a bank must keep records to be made available to its primary federal regulator.
Anti-money laundering rules and policies are developed by a bureau within the U.S. Department of the Treasury, or the Treasury Department ,
the Financial Crimes Enforcement Network, but compliance by individual institutions is overseen by its primary federal regulator.
The Bank has established appropriate anti-money laundering and customer identification programs. The Bank also maintains records of
cash purchases of negotiable instruments, files reports of certain cash transactions exceeding $10,000 (daily aggregate amount), and reports
suspicious activity that might signify money laundering, tax evasion, or other criminal activities pursuant to the Bank Secrecy Act. The Bank
otherwise has implemented policies and procedures to comply with the foregoing requirements.
The Treasury Department’s Office of Foreign Assets Control, or OFAC, is responsible for helping to ensure that U.S. entities do not engage
in transactions with certain prohibited parties, as defined by various
28
Executive Orders and Acts of Congress. OFAC publishes lists of persons, organizations and countries suspected of aiding, harboring or
engaging in terrorist acts, known as Specially Designated Nationals and Blocked Persons. If the Company or the Bank finds a name on any
transaction, account or wire transfer that is on an OFAC list, the Company or the Bank must freeze or block such account or transaction, file a
suspicious activity report, and notify the appropriate authorities.
Data Privacy and Cybersecurity
The GLBA and the implementing regulations issued by federal regulatory agencies require financial institutions (including banks, insurance
agencies, and broker/dealers) to adopt policies and procedures regarding the disclosure of nonpublic personal information about their
customers to non-affiliated third parties. In general, financial institutions are required to explain to customers their policies and procedures
regarding the disclosure of such nonpublic personal information and, unless otherwise required or permitted by law, financial institutions are
prohibited from disclosing such information except as provided in their policies and procedures. Specifically, the GLBA established certain
information security guidelines that require each financial institution, under the supervision and ongoing oversight of its board of directors or an
appropriate committee thereof, to develop, implement, and maintain a comprehensive written information security program designed to ensure
the security and confidentiality of customer information, to protect against anticipated threats or hazards to the security or integrity of such
information, and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to
any customer.
Recent cyber-attacks against banks and other financial institutions that resulted in unauthorized access to confidential customer
information have prompted the federal banking regulators to issue extensive guidance on cybersecurity. Among other things, financial
institutions are expected to design multiple layers of security controls to establish lines of defense and ensure that their risk management
processes address the risks posed by compromised customer credentials, including security measures to authenticate customers accessing
internet-based services. A financial institution also should have a robust business continuity program to recover from a cyberattack and
procedures for monitoring the security of third-party service providers that may have access to nonpublic data at the institution.
The Consumer Financial Protection Bureau
The Dodd-Frank Act created the Consumer Financial Protection Bureau, or the CFPB, which is an independent bureau with broad authority
to regulate the consumer finance industry, including regulated financial institutions, non-banks and others involved in extending credit to
consumers. The CFPB has authority through rulemaking, orders, policy statements, guidance, and enforcement actions to administer and
enforce federal consumer financial laws, to oversee several entities and market segments not previously under the supervision of a federal
regulator, and to impose its own regulations and pursue enforcement actions when it determines that a practice is unfair, deceptive, or abusive.
The federal consumer financial laws and all of the functions and responsibilities associated with them, many of which were previously enforced
by other federal regulatory agencies, were transferred to the CFPB on July 21, 2011. While the CFPB has the power to interpret, administer,
and enforce federal consumer financial laws, the Dodd-Frank Act provides that the federal banking regulatory agencies continue to have
examination and enforcement powers over the financial institutions that they supervise relating to the matters within the jurisdiction of the CFPB
if such institutions have less than $10 billion in assets. The Dodd-Frank Act also gives state attorneys general the ability to enforce federal
consumer protection laws.
Mortgage Loan Origination
The Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages, including a
determination of the borrower’s ability to repay. Under the Dodd-Frank Act and the implementing final rule adopted by the CFPB, or the
ATR/QM Rule, which became effective on January 10, 2014, a financial institution may not make a residential mortgage loan to a consumer
unless it
29
first makes a “reasonable and good faith determination” that the consumer has a “reasonable ability” to repay the loan. In addition, the ATR/QM
Rule limits prepayment penalties and permits borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified
mortgage,” as defined by the CFPB. For this purpose, the ATR/QM Rule defines a “qualified mortgage” to include a loan with a borrower debt-
to-income ratio of less than or equal to 43% or, alternatively, a loan eligible for purchase by Fannie Mae or Freddie Mac while they operate
under federal conservatorship or receivership, and loans eligible for insurance or guarantee by the Federal Housing Administration, the
Veterans Administration or the United States Department of Agriculture. Additionally, a qualified mortgage may not (i) contain excess upfront
points and fees, (ii) have a term greater than 30 years or (iii) include interest only or negative amortization payments. The ATR/QM Rule
specifies the types of income and assets that may be considered in the ability-to-repay determination, the permissible sources for verification,
and the required methods of calculating the loan’s monthly payments.
The Regulatory Relief Act provides that for certain insured depository institutions and insured credit unions with less than $10 billion in total
consolidated assets, mortgage loans that are originated and retained in portfolio will automatically be deemed to satisfy the “ability to repay”
requirement. In order to qualify, the insured depository institutions and credit unions must meet conditions relating to prepayment penalties,
points and fees, negative amortization, interest-only features and documentation.
The Regulatory Relief Act directs federal banking agencies to issue regulations exempting certain insured depository institutions and
insured credit unions with assets of $10 billion or less from the requirement to establish escrow accounts in connection with certain residential
mortgage loans.
Insured depository institutions and insured credit unions that originated fewer than 500 closed-end mortgage loans or 500 open-end lines of
credit in each of the two preceding years are exempt from a subset of disclosure requirements (recently imposed by the CFPB) under the
Home Mortgage Disclosure Act, or HMDA, provided they have received certain minimum CRA ratings in their most recent examinations.
The Regulatory Relief Act also directs the Comptroller of the Currency to conduct a study assessing the effect of the exemption described
above on the amount of HMDA data available at the national and local level.
In addition, Section 941 of the Dodd-Frank Act amended the Securities Exchange Act of 1934, as amended, or the Exchange Act, to
require sponsors of asset-backed securities, or ABS, to retain at least 5% of the credit risk of the assets underlying the securities and generally
prohibits sponsors from transferring or hedging that credit risk. In October 2014, the federal banking regulatory agencies adopted a final rule to
implement this requirement, or the Risk Retention Rule. Among other things, the Risk Retention Rule requires a securitizer to retain not less
than 5% of the credit risk of any asset that the securitizer, through the issuance of an ABS, transfers, sells, or conveys to a third party; and
prohibits a securitizer from directly or indirectly hedging or otherwise transferring the credit risk that the securitizer is required to retain. In
certain situations, the final rule allows securitizers to allocate a portion of the risk retention requirement to the originator(s) of the securitized
assets, if an originator contributes at least 20% of the assets in the securitization. The Risk Retention Rule also provides an exemption to the
risk retention requirements for an ABS collateralized exclusively by Qualified Residential Mortgages, or QRMs, and ties the definition of a QRM
to the definition of a “qualified mortgage” established by the CFPB for purposes of evaluating a consumer’s ability to repay a mortgage loan.
The federal banking agencies have agreed to review the definition of QRMs in 2019, following the CFPB’s own review of its “qualified
mortgage” regulation. For purposes of residential mortgage securitizations, the Risk Retention Rule took effect on December 24, 2015. For all
other securitizations, the rule took effect on December 24, 2016.
The Volcker Rule
In December 2013, five federal financial regulatory agencies, including the Federal Reserve, adopted final rules implementing the so-called
“Volcker Rule” embodied in Section 13 of the BHC Act, which was
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added by the Dodd-Frank Act. In general, the Volcker Rule prohibits banking entities from (1) engaging in short-term proprietary trading for their
own accounts, and (2) having certain ownership interests in, and relationships with, hedge funds or private equity funds, or covered funds. The
Volcker Rule is intended to provide greater clarity with respect to both the extent of those primary prohibitions and the related exemptions and
exclusions.
The Regulatory Relief Act creates an exemption from prohibitions on propriety trading, and relationships with certain investment funds for
banking entities with (i) less than $10 billion in total consolidated assets, and (ii) trading assets and trading liabilities of less than 5% of its total
consolidated assets. Currently, all banks are subject to these prohibitions pursuant to the Dodd-Frank Act. Any insured depository institution
that is controlled by a company that itself exceeds these $10 billion and 5% thresholds would not qualify for the exemption. While the Company
would be exempt from the prohibition on proprietary trading pursuant to the Regulatory Relief Act, the Company currently does not have any
ownership interest in, or relationships with, hedge funds or private equity funds, or covered funds, or engage in any activities that would have
previously subjected it to the Volcker Rule.
Other Provisions of the Dodd-Frank Act
The Dodd-Frank Act implements far-reaching changes across the financial regulatory landscape. In addition to the reforms previously
mentioned, the Dodd-Frank Act also:
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requires BHCs and banks to be both well capitalized and well managed in order to acquire banks located outside their home state and
requires any BHC electing to be treated as a financial holding company to be both well managed and well capitalized;
eliminates all remaining restrictions on interstate banking by authorizing national and state banks to establish de novo branches in any
state that would permit a bank chartered in that state to open a branch at that location; and
repeals Regulation Q, the federal prohibition on the payment of interest on demand deposits, thereby permitting depository institutions
to pay interest on business transaction and other accounts.
A significant number of the rules and regulations mandated by the Dodd-Frank Act have been finalized. Given the uncertainty associated
with both the manner in which the provisions of the Dodd-Frank Act will be implemented and the changes required by the Regulatory Relief Act,
the full impact of new regulations and guidance on financial institutions’ operations is unclear.
Federal Home Loan Bank Membership
The Bank is a member of the FHLB. Each member of the FHLB is required to maintain a minimum investment in the Class B stock of the
FHLB. The Board of Directors of the FHLB can increase the minimum investment requirements in the event it has concluded that additional
capital is required to allow it to meet its own regulatory capital requirements. Any increase in the minimum investment requirements outside of
specified ranges requires the approval of the Federal Housing Finance Agency. Because the extent of any obligation to increase the level of
investment in the FHLB depends entirely upon the occurrence of a future event, we are unable to determine the extent of future required
potential payments to the FHLB at this time. Additionally, in the event that a member financial institution fails, the right of the FHLB to seek
repayment of funds loaned to that institution will take priority (a super lien) over the rights of all other creditors.
Tax Cuts and Jobs Act of 2017
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In December 2017, the Tax Cuts and Jobs Act of 2017, or the Tax Act, was signed into law. The Tax Act includes a number of provisions
that impact us, including the following:
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Tax Rate. The Tax Act replaces the graduated corporate tax rates applicable under prior law, which imposed a maximum tax rate of
35%, with a reduced 21% flat tax rate. Although the reduced tax rate generally should be favorable to us by resulting in increased
earnings and capital, it will decrease the value of our existing deferred tax assets. Generally accepted accounting principles (“GAAP”)
requires that the impact of the provisions of the Tax Act be accounted for in the period of enactment, which was 2017. As a result, we
recorded net income tax expense of $1.4 million related to this revaluation. Of this amount, $40 thousand of expense was attributable
to our net deferred tax asset for unrealized losses on available for sale securities and cash flow hedge. In addition to adjusting the
deferred tax asset for this item, we recorded an adjustment to accumulated other comprehensive income with a transfer to retained
earnings.
Employee Compensation. A “publicly held corporation” is not permitted to deduct compensation in excess of $1 million per year paid to
certain employees. The Tax Act eliminates certain exceptions to the $1 million limit applicable under prior to law related to
performance-based compensation, such as equity grants and cash bonuses that are paid only on the attainment of performance goals.
Business Asset Expensing. The Tax Act allows taxpayers immediately to expense the entire cost (instead of only 50%, as under prior
law) of certain depreciable tangible property and real property improvements acquired and placed in service after September 27, 2017
and before January 1, 2023 (with an additional year for certain property). This 100% “bonus” depreciation is phased out proportionately
for property placed in service on or after January 1, 2023 and before January 1, 2027 (with an additional year for certain property).
Interest Expense. The Tax Act limits a taxpayer’s annual deduction of business interest expense to the sum of (i) business interest
income and (ii) 30% of “adjusted taxable income,” defined as a business’s taxable income without taking into account business interest
income or expense, net operating losses, and, for 2018 through 2021, depreciation, amortization and depletion.
Other Laws and Regulations
Our operations are subject to several additional laws, some of which are specific to banking and others of which are applicable to
commercial operations generally. For example, with respect to our lending practices, we are subject to the following laws and regulations,
among several others:
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Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
HMDA, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial
institution is fulfilling its obligation to help meet the housing needs of the community it serves;
Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed, or other prohibited factors in extending credit;
Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act, governing the use and provision of
information to credit reporting agencies, certain identity theft protections, and certain credit and other disclosures;
Fair Debt Collection Practices Act, governing the manner in which consumer debts may be collected by collection agencies;
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•
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Real Estate Settlement Procedures Act, requiring certain disclosures concerning loan closing costs and escrows, and governing
transfers of loan servicing and the amounts of escrows in connection with loans secured by one-to-four family residential properties;
Rules and regulations established by the National Flood Insurance Program; and
Rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.
Our deposit operations are subject to federal laws applicable to depository accounts, including:
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Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes
procedures for complying with administrative subpoenas of financial records;
Truth-In-Savings Act, requiring certain disclosures for consumer deposit accounts;
Electronic Funds Transfer Act and Regulation E of the Federal Reserve, which govern automatic deposits to and withdrawals from
deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking
services; and
Rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.
We are also subject to a variety of laws and regulations that are not limited to banking organizations. For example, in lending to commercial
and consumer borrowers, and in owning and operating our own property, we are subject to regulations and potential liabilities under state and
federal environmental laws. In addition, we must comply with privacy and data security laws and regulations at both the federal and state level.
We are heavily regulated by regulatory agencies at the federal and state levels. Like most of our competitors, we have faced and expect to
continue to face increased regulation and regulatory and political scrutiny, which creates significant uncertainty for us, as well as for the
financial services industry in general.
Enforcement Powers
The federal regulatory agencies have substantial penalties available to use against depository institutions and certain “institution-affiliated
parties.” Institution-affiliated parties primarily include management, employees, and agents of a financial institution, as well as independent
contractors and consultants, such as attorneys, accountants, and others who participate in the conduct of the financial institution’s affairs. An
institution can be subject to an enforcement action due to the failure to timely file required reports, the filing of false or misleading information,
or the submission of inaccurate reports, or engaging in other unsafe or unsound banking practices. Civil penalties may be as high as
$1,924,589 per day for violations.
The Financial Institution Reform Recovery and Enforcement Act provided regulators with greater flexibility to commence enforcement
actions against institutions and institution-affiliated parties and to terminate an institution’s deposit insurance. It also expanded the power of
banking regulatory agencies to issue regulatory orders. Such orders may, among other things, require affirmative action to correct any harm
resulting from a violation or practice, including restitution, reimbursement, indemnification, or guarantees against loss. A financial institution
may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts, or take other actions as determined by
the ordering agency to be appropriate. The Dodd-Frank Act increases regulatory oversight, supervision and examination of banks, BHCs, and
their respective subsidiaries by the appropriate regulatory agency.
Future Legislation and Regulation
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Regulators have increased their focus on the regulation of the financial services industry in recent years, leading in many cases to greater
uncertainty and compliance costs for regulated entities. Proposals that could substantially intensify the regulation of the financial services
industry have been and may be expected to continue to be introduced in the United States Congress, in state legislatures, and by applicable
regulatory authorities. These proposals may change banking statutes and regulations and our operating environment in substantial and
unpredictable ways. If enacted, these proposals could increase or decrease the cost of doing business, limit or expand permissible activities or
affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. We cannot predict whether
any of these proposals will be enacted and, if enacted, the effect that these proposals, or any implementing regulations, would have on our
business, results of operations, or financial condition. See “Risk Factors —Risks Related to the Regulation of Our Industry Legislative and
regulatory actions taken now or in the future may increase our costs and impact our business governance structure, financial condition or
results of operations.”
ITEM 1A. RISK FACTORS.
Ownership of our common stock involves certain risks. The risks and uncertainties described below are not the only ones we face. You
should carefully consider the risks described below, as well as all other information contained in this Annual Report on Form 10-K. Additional
risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. If any of these
risks actually occurs, our business, financial condition or results of operations could be materially, adversely affected.
Risks Related to Our Business
As a business operating in the financial services industry, our business and operations may be adversely affected in numerous and
complex ways by weak economic conditions.
Our business and operations, which primarily consist of lending money to clients in the form of loans, borrowing money from clients in the
form of deposits and investing in securities, are sensitive to general business and economic conditions in the United States. If the U.S.
economy weakens, our growth and profitability from our lending, deposit and investment operations could be constrained. Uncertainty about
the federal fiscal policymaking process, the medium- and long-term fiscal outlook of the federal government and future tax rates is a concern
for businesses, consumers and investors in the United States. In recent years there has been a gradual improvement in the U.S. economy as
evidenced by a rebound in the housing market, lower unemployment and higher equity capital markets; however, economic growth has been
uneven and opinions vary on the strength and direction of the economy. Uncertainties also have arisen regarding the potential for a reversal or
renegotiation of international trade agreements, the effects of the Tax Act and the impact such actions and other policies the current
administration may have on economic and market conditions.
Weak economic conditions are characterized by numerous factors, including deflation, fluctuations in debt and equity capital markets, a
lack of liquidity and depressed prices in the secondary market for mortgage loans, increased delinquencies on mortgage, consumer and
commercial loans, residential and commercial real estate price declines and lower home sales and commercial activity. The current economic
environment is characterized by interest rates at near historically low levels, which impacts our ability to attract deposits and to generate
attractive earnings through our loan and investment portfolios. All of these factors can individually or in the aggregate be detrimental to our
business, and the interplay between these factors can be complex and unpredictable. Adverse economic conditions could have a material
adverse effect on our business, financial condition and results of operations.
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Our commercial business and operations are concentrated in the Washington, D.C. and Baltimore metropolitan areas and we are
more sensitive than our more geographically diversified competitors to adverse changes in the local economy.
Unlike many of our larger competitors that maintain significant operations located outside our market area, substantially all of our
commercial business clients are located and doing business in the Washington, D.C. and Baltimore metropolitan areas. As of December 31,
2018, approximately 93% of our loans held for investment (measured by dollar amount) were made to borrowers who live or conduct business
in the Washington, D.C. and Baltimore metropolitan areas. Therefore, our success depends upon the general economic conditions in this area,
which we cannot predict with certainty. As a result, our operations and profitability may be more adversely affected by a local economic
downturn in the Washington, D.C. and Baltimore metropolitan areas than those of larger, more geographically diverse competitors. A downturn
in the local economy generally could make it more difficult for our borrowers to repay their loans and may lead to loan losses that are not offset
by operations in other markets; it may also reduce the ability of our depositors to make or maintain deposits with us. For these reasons, any
regional or local economic downturn that affects the Washington, D.C. and Baltimore metropolitan areas, or existing or prospective borrowers
or depositors in the Washington, D.C. and Baltimore metropolitan areas could have a material adverse effect on our business, financial
condition and results of operations. From time to time, our Bank may provide financing to clients who live or have companies or properties
located outside our core markets. In such cases, we would face similar local market risk in those communities for these clients.
Our customers and businesses in the Washington, D.C. metropolitan area may be adversely impacted as a result of changes in
government spending.
The Washington, D.C. metropolitan area is characterized by a significant number of businesses that are federal government contractors or
subcontractors, or which depend on such businesses for a significant portion of their revenues. The impact of a decline in federal government
spending, a reallocation of government spending to different industries or different areas of the country or a delay in payments to such
contractors could have a ripple effect. Temporary layoffs, staffing freezes, salary reductions or furloughs of government employees or
government contractors could have adverse impacts on other businesses in the Company’s market and the general economy of the greater
Washington, D.C. metropolitan area, and may indirectly lead to a loss of revenues by the Company’s customers, including vendors and lessors
to the federal government and government contractors or to their employees, as well as a wide variety of commercial and retail businesses.
Accordingly, such potential federal government activities could lead to increases in past due loans, nonperforming loans, loan loss reserves
and charge-offs, and to a corresponding decline in liquidity.
We may not be able to implement aspects of our growth strategy, which may adversely affect our ability to maintain our historical
growth and earnings trends.
We have grown rapidly over the last several years, primarily through organic growth. We may not be able to execute on aspects of our
expansion strategy, which may impair our ability to sustain our historical rate of growth or prevent us from growing at all. More specifically, we
may not be able to generate sufficient new loans and deposits within acceptable risk and expense tolerances or obtain the personnel or funding
necessary for additional growth. Various factors, such as economic conditions and competition with other financial institutions, may impede or
prohibit the growth of our operations. Further, we may be unable to attract and retain experienced bankers, which could adversely affect our
growth. The success of our strategy also depends on our ability to manage our growth effectively, which depends on a number of factors,
including our ability to adapt our credit, operational, technology and governance infrastructure to accommodate expanded operations. If we are
successful in continuing our growth, we cannot assure you that further growth would offer the same levels of potential profitability, or that we
would be successful in controlling costs and maintaining asset quality in the face of that growth. Accordingly, an inability to maintain growth, or
an inability to effectively manage growth, could have an adverse effect on our business, financial condition and results of operations.
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We may not be able to measure and limit our credit risk adequately, which could lead to unexpected losses.
The primary component of our business involves making loans to customers. The business of lending is inherently risky, including risks that
the principal of or interest on any loan will not be repaid in a timely manner or at all or that the value of any collateral supporting the loan will be
insufficient to cover our outstanding exposure. These risks may be affected by the strength of the borrower’s business sector and local,
regional and national market and economic conditions. Many of our loans are made to small- to medium-sized businesses that may be less
able to withstand competitive, economic and financial pressures than larger borrowers. Our risk management practices, such as monitoring the
concentration of our loans within specific industries, and our credit approval practices may not adequately reduce credit risk. Further, our credit
administration personnel, policies and procedures may not adequately adapt to changes in economic or any other conditions affecting
customers and the quality of the loan portfolio. A failure to measure and limit the credit risk associated with our loan portfolio effectively could
lead to unexpected losses and have an adverse effect on our business, financial condition and results of operations.
Our allowance for loan losses may prove to be insufficient to absorb potential losses in our loan portfolio.
We maintain an allowance for loan losses that represents management’s judgment of probable losses and risks inherent in our loan
portfolio. As of December 31, 2018, our allowance for loan losses totaled $11.3 million, which represents approximately 1.13% of our total
loans held for investment. The level of the allowance reflects management’s continuing evaluation of general economic conditions,
diversification and seasoning of the loan portfolio, historic loss experience, identified credit problems, delinquency levels and adequacy of
collateral. The determination of the appropriate level of our allowance for loan losses is inherently highly subjective and requires management
to make significant estimates of and assumptions regarding current credit risks and future trends, all of which may undergo material changes.
Inaccurate management assumptions, deterioration of economic conditions affecting borrowers, new information regarding existing loans,
identification or deterioration of additional problem loans, acquisition of problem loans and other factors (including third-party review and
analysis), both within and outside of our control, may require us to increase our allowance for loan losses. In addition, our regulators, as an
integral part of their periodic examination, review our methodology for calculating, and the adequacy of, our allowance for loan losses and may
direct us to make additions to the allowance based on their judgments about information available to them at the time of their examination.
Further, if actual charge-offs in future periods exceed the amounts allocated to our allowance for loan losses, we may need additional
provisions for loan losses to restore the adequacy of our allowance for loan losses. Finally, the measure of our allowance for loan losses
depends on the adoption and interpretation of accounting standards. The Financial Accounting Standards Board, or FASB, has recently issued
a new credit impairment model, the Current Expected Credit Loss, or CECL model, which will become applicable to us on January 1, 2020.
CECL will require financial institutions to estimate and develop a provision for credit losses over the lifetime of the loan at origination, as
opposed to reserving for incurred or probable losses up to the balance sheet date. Under the CECL model, credit deterioration would be
reflected in the income statement in the period of origination or acquisition of the loan, with changes in expected credit losses due to further
credit deterioration or improvement reflected in the periods in which the expectation changes. Accordingly, the CECL model could require
financial institutions like the Bank to increase their allowances for loan losses. Moreover, the CECL model may create more volatility in our level
of allowance for loan losses. If we are required to materially increase our level of allowance for loan losses for any reason, such increase could
adversely affect our business, financial condition and results of operations.
The small- to medium-sized businesses that we lend to may have fewer resources to weather adverse business developments, which
may impair our borrowers’ ability to repay loans.
As of December 31, 2018, we had approximately $122.3 million of commercial and industrial loans to businesses, which represents
approximately 12% of our total loan portfolio held for investment. Small- to medium-sized businesses frequently have smaller market shares
than their competition, may be more
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vulnerable to economic downturns, often need substantial additional capital to expand or compete and may experience substantial volatility in
operating results, any of which may impair a borrower’s ability to repay a loan. In addition, the success of a small- and medium-sized business
often depends on the management skills, talents and efforts of a small group of people, and the death, disability or resignation of one or more
of these people could have an adverse effect on the business and its ability to repay its loan. If our borrowers are unable to repay their loans,
our business, financial condition and results of operations could be adversely affected.
Our commercial real estate and real estate construction loan portfolio exposes us to credit risks that may be greater than the risks
related to other types of loans.
As of December 31, 2018, approximately $270.1 million, or 27%, of our total loans held for investment were nonresidential real estate loans
(including owner-occupied commercial real estate loans) and approximately $157.6 million, or 16%, of our total loans held for investment were
construction loans. Further, as of December 31, 2018, our commercial real estate loans (excluding owner-occupied commercial real estate
loans) totaled 340% and our construction loans totaled 143% of our total risk based capital, respectively. These loans typically involve
repayment that depends upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover
operating expenses and debt service. The availability of such income for repayment may be adversely affected by changes in the economy or
local market conditions. These loans expose a lender to the risk of liquidating the collateral securing these loans in times where there may be
significant fluctuation of commercial real estate values. Additionally, commercial real estate loans generally involve relatively large balances to
single borrowers or related groups of borrowers. Unexpected deterioration in the credit quality of our commercial real estate loan portfolio could
require us to increase our allowance for loan losses, which would reduce our profitability and could have an adverse effect on our business,
financial condition and results of operations.
Construction loans also involve risks because loan funds are secured by a project under construction and the project is of uncertain value
prior to its completion. It can be difficult to accurately evaluate the total funds required to complete a project, and construction lending often
involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability
of a borrower or guarantor to repay the loan. If we are forced to foreclose on a project prior to completion, we may be unable to recover the
entire unpaid portion of the loan. In addition, we may be required to fund additional amounts to complete a project, incur taxes, maintenance
and compliance costs for a foreclosed property and may have to hold the property for an indeterminate period of time, any of which could
adversely affect our business, financial condition and results of operations.
Because a significant portion of our loan portfolio held for investment is comprised of real estate loans, negative changes in the
economy affecting real estate values and liquidity could impair the value of collateral securing our real estate loans and result in loan
and other losses.
As of December 31, 2018, approximately $844.1 million, or 85%, of our total loans held for investment were loans with real estate as a
primary or secondary component of collateral. The market value of real estate can fluctuate significantly in a short period of time. As a result,
adverse developments affecting real estate values and the liquidity of real estate in our primary markets could increase the credit risk
associated with our loan portfolio, and could result in losses that adversely affect credit quality, financial condition and results of operations.
Negative changes in the economy affecting real estate values and liquidity in our market areas could significantly impair the value of property
pledged as collateral on loans and affect our ability to sell the collateral upon foreclosure without a loss or additional losses. Collateral may
have to be sold for less than the outstanding balance of the loan, which could result in losses on such loans. Such declines and losses would
have an adverse effect on our business, financial condition and results of operations. If real estate values decline, it is also more likely that we
would be required to increase our allowance for loan losses, which would adversely affect our business, financial condition and results of
operations.
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A portion of our loan portfolio is comprised of commercial loans secured by receivables, inventory, equipment or other commercial
collateral, the deterioration in value of which could expose us to credit losses.
As of December 31, 2018, approximately $122.3 million, or 12%, of our total loans held for investment were commercial loans to
businesses. In general, these loans are collateralized by general business assets, including, among other things, accounts receivable,
inventory and equipment, and most are backed by a personal guaranty of the borrower or principal. These commercial loans are typically larger
in amount than loans to individuals and, therefore, have the potential for larger losses on a single loan basis. Additionally, the repayment of
commercial loans is subject to the ongoing business operations of the borrower. The collateral securing such loans generally includes movable
property such as equipment and inventory, which may decline in value more rapidly than we anticipate exposing us to increased credit risk.
Significant adverse changes in the economy or local market conditions in which our commercial lending customers operate could cause rapid
declines in loan collectability and the values associated with general business assets resulting in inadequate collateral coverage that may
expose us to credit losses and could adversely affect our business, financial condition and results of operations.
System failure or cybersecurity breaches of our network security could subject us to increased operating costs as well as litigation
and other potential losses.
Our computer systems and network infrastructure could be vulnerable to hardware and cybersecurity issues. Our operations are dependent
upon our ability to protect our computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic
event. We could also experience a breach by intentional or negligent conduct on the part of employees or other internal sources. Any damage
or failure that causes an interruption in our operations could have an adverse effect on our financial condition and results of operations.
Our operations are also dependent upon our ability to protect our computer systems and network infrastructure, including our digital, mobile
and internet banking activities, against damage from physical break-ins, cybersecurity breaches and other disruptive problems caused by the
internet or other users. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted
through our computer systems and network infrastructure, which may result in significant liability, damage our reputation and inhibit the use of
our internet banking services by current and potential customers. We regularly add additional security measures to our computer systems and
network infrastructure to mitigate the possibility of cybersecurity breaches, including firewalls and penetration testing. However, it is difficult or
impossible to defend against every risk being posed by changing technologies as well as acts of cyber-crime. Increasing sophistication of cyber
criminals and terrorists make keeping up with new threats difficult and could result in a system breach. Controls employed by our information
technology department and cloud vendors could prove inadequate. A breach of our security that results in unauthorized access to our data
could expose us to a disruption or challenges relating to our daily operations, as well as to data loss, litigation, damages, fines and penalties,
significant increases in compliance costs and reputational damage, any of which could have an adverse effect on our business, financial
condition and results of operations.
Our concentration of large loans to a limited number of borrowers may increase our credit risk.
Our growth over the last several years has been partially attributable to our ability to originate and retain large loans. In addition to
regulatory limits to which the Bank is subject, we have established an internal policy limiting loans to one borrower, principal or guarantor based
on “total exposure,” which represents the aggregate exposure of economically related borrowers for approval purposes; loans in excess of our
internal limit require acknowledgment by the Loan Committee of the Bank’s board of directors. Many of these loans have been made to a small
number of borrowers, resulting in a concentration of large loans to certain borrowers. As of December 31, 2018, our 10 largest borrowing
relationships accounted for approximately 8% of our total loan portfolio held for investment. Along with other risks inherent in these loans, such
as the deterioration of the underlying businesses or property securing these loans, this high concentration of
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borrowers presents a risk to our lending operations. If any one of these borrowers becomes unable to repay its loan obligations as a result of
economic or market conditions, or personal circumstances, such as divorce or death, our non-accrual loans and our allowance for loan and
lease losses could increase significantly, which could have a material adverse effect on our assets, business, cash flow, condition (financial or
otherwise), liquidity, prospects and results of operations.
Appraisals and other valuation techniques we use in evaluating and monitoring loans secured by real property, other real estate
owned and repossessed personal property may not accurately describe the net value of the asset.
In considering whether to make a loan secured by real property, we generally require an appraisal of the property. However, an appraisal is
only an estimate of the value of the property at the time the appraisal is made and, as real estate values may change significantly in value in
relatively short periods of time (especially in periods of heightened economic uncertainty), this estimate may not accurately describe the net
value of the real property collateral after the loan is made. As a result, we may not be able to realize the full amount of any remaining
indebtedness when we foreclose on and sell the relevant property. In addition, we rely on appraisals and other valuation techniques to establish
the value of our other real estate owned, or OREO, and personal property that we acquire through foreclosure proceedings and to determine
certain loan impairments. If any of these valuations are inaccurate, our combined and consolidated financial statements may not reflect the
correct value of our OREO, and our allowance for loan losses may not reflect accurate loan impairments. This could have an adverse effect on
our business, financial condition or results of operations.
We engage in lending secured by real estate and may be forced to foreclose on the collateral and own the underlying real estate,
subjecting us to the costs and potential risks associated with the ownership of the real property, or consumer protection initiatives
or changes in state or federal law may substantially raise the cost of foreclosure or prevent us from foreclosing at all.
Since we originate loans secured by real estate, we may have to foreclose on the collateral property to protect our investment and may
thereafter own and operate such property, in which case we would be exposed to the risks inherent in the ownership of real estate. As of
December 31, 2018, we held approximately $142 thousand in OREO that is currently marketed for sale. The amount that we, as a mortgagee,
may realize after a default depends on factors outside of our control, including, but not limited to, general or local economic conditions,
environmental cleanup liabilities, assessments, interest rates, real estate tax rates, operating expenses of the mortgaged properties, our ability
to obtain and maintain adequate occupancy of the properties, zoning laws, governmental and regulatory rules, and natural disasters. Our
inability to manage the amount of costs or size of the risks associated with the ownership of real estate, or writedowns in the value of OREO,
could have an adverse effect on our business, financial condition and results of operations.
Additionally, consumer protection initiatives or changes in state or federal law may substantially increase the time and expense associated
with the foreclosure process or prevent us from foreclosing at all. A number of states in recent years have either considered or adopted
foreclosure reform laws that make it substantially more difficult and expensive for lenders to foreclose on properties in default. Additionally,
federal regulators have prosecuted a number of mortgage servicing companies for alleged consumer law violations. If new state or federal laws
or regulations are ultimately enacted that significantly raise the cost of foreclosure or raise outright barriers, such could have an adverse effect
on our business, financial condition and results of operation.
A lack of liquidity could impair our ability to fund operations and adversely impact our business, financial condition and results of
operations.
Liquidity is essential to our business. We rely on our ability to generate deposits and effectively manage the repayment and maturity
schedules of our loans and investment securities, respectively, to ensure that we have adequate liquidity to fund our operations. An inability to
raise funds through deposits, borrowings,
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sales of our investment securities, sales of loans or other sources could have a substantial negative effect on our liquidity and our ability to
continue our growth strategy.
Our most important source of funds is deposits. As of December 31, 2018, approximately $377.5 million, or 39.5%, of our total deposits
were negotiable order of withdrawal, or NOW, savings and money market accounts. Historically our savings, money market deposit and NOW
accounts have been stable sources of funds. However, these deposits are subject to potentially dramatic fluctuations in availability or price due
to certain factors that may be outside of our control, such as a loss of confidence by customers in us or the banking sector generally, customer
perceptions of our financial health and general reputation, increasing competitive pressures from other financial services firms for consumer or
corporate customer deposits, changes in interest rates and returns on other investment classes, any of which could result in significant outflows
of deposits within short periods of time or significant changes in pricing necessary to maintain current customer deposits or attract additional
deposits, increasing our funding costs and reducing our net interest income and net income.
Additional liquidity is provided by our ability to borrow from the Federal Home Loan Bank of Atlanta, or the FHLB, and the Federal Reserve
Bank of Richmond. We also may borrow funds from third-party lenders, such as other financial institutions. Our access to funding sources in
amounts adequate to finance or capitalize our activities, or on terms that are acceptable to us, could be impaired by factors that affect us
directly or the financial services industry or economy in general, such as disruptions in the financial markets or negative views and expectations
about the prospects for the financial services industry. Our access to funding sources could also be affected by one or more adverse regulatory
actions against us.
Any decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses or fulfill
obligations such as repaying our borrowings or meeting deposit withdrawal demands, any of which could, in turn, have an adverse effect on our
business, financial condition and results of operations.
Our liquidity could be adversely impacted by our use of wholesale funding sources, including certificates of deposit, and by potential
limitations on our ability to obtain brokered deposits.
We utilize brokered deposits as a complementary funding source. We had $115.3 million, or 12% of our total deposits, in “brokered deposit”
accounts at December 31, 2018. A brokered deposit is a deposit that is obtained from or through the mediation or assistance of a deposit
broker, which includes larger correspondent banks and securities brokerage firms. These deposit brokers attract deposits from individuals and
companies whose deposit decisions are based almost exclusively on obtaining the highest interest rates. There are risks associated with using
brokered deposits. In order to continue to maintain our level of brokered deposits, we may be forced to pay higher interest rates than
contemplated by our asset-liability pricing strategy. In addition, banks that become less than “well capitalized” under applicable regulatory
capital requirements may be restricted in their ability to accept, or prohibited from accepting, brokered deposits. If this funding source becomes
more difficult to access, we will have to seek alternative funding sources in order to continue to fund our growth. This may include increasing
our reliance on FHLB advances, attempting to attract non-brokered deposits and selling loans. There can be no assurance that brokered
deposits will be available, or if available, sufficient to support our continued growth.
The maturity of brokered certificates of deposit could result in this funding source maturing at one time. Should this occur, it might be
difficult to replace the maturing certificates with new brokered certificates of deposit. We have used brokers to obtain these deposits which
results in depositors with whom we have no other relationships since these depositors are outside of our market, and there may not be a
sufficient source of new brokered certificates of deposit at the time of maturity. In addition, upon maturity, brokers could require us to offer some
of the highest interest rates in the country to retain these deposits, which would negatively impact our earnings.
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In addition, we had $99.4 million, or 10% of our deposits, in certificates of deposit of $250,000 and greater at December 31, 2018, of which
$61.0 million, or 61%, were due to mature within one year. These deposits are, like brokered deposits, generally interest rate sensitive. We also
use listing service deposits that tend to be interest rate sensitive. As of December 31, 2018, our certificates of deposit from listing services
amounted to $78.9 million or 8% of our deposits. Consequently, these types of deposits may not provide the same stability to a bank’s deposit
base as traditional local retail deposit relationships and our liquidity may be negatively affected if that funding source experiences supply
difficulties due to loss of investor confidence or a flight to other investments.
We have several large depositor relationships, the loss of which could force us to fund our business through more expensive and
less stable sources.
As of December 31, 2018, our 10 largest non-brokered depositors accounted for $205.9 million in deposits, or approximately 22% of our
total deposits. Our board of directors, directly and indirectly, accounted for $155.8 million of deposits as of December 31, 2018. Withdrawals of
deposits by any one of our largest depositors could force us to rely more heavily on borrowings and other sources of funding for our business
and withdrawal demands, adversely affecting our net interest margin and results of operations. We may also be forced, as a result of any
withdrawal of deposits, to rely more heavily on other, potentially more expensive and less stable funding sources. Consequently, the
occurrence of any of these events could have a material adverse effect on our business, financial condition and results of operations.
Our mortgage banking division may not continue to provide us with significant noninterest income.
For the year ended December 31, 2018, the Bank originated $337.1 million and sold $344.9 million of residential mortgage loans net of
mortgage banking revenue, and in 2017, the Bank originated $418.9 million and sold $442.0 million of residential mortgage loans net of
mortgage banking revenue. The residential mortgage business is highly competitive and highly susceptible to changes in market interest rates,
consumer confidence levels, employment statistics, the capacity and willingness of secondary market purchasers to acquire and hold or
securitize loans, and other factors beyond our control. Additionally, in many respects, the traditional mortgage origination business is
relationship-based, and dependent on the services of individual mortgage loan officers. The loss of services of one or more loan officers could
have the effect of reducing the level of our mortgage production, or the rate of growth of production. As a result of these factors, we cannot be
certain that we will be able to maintain or increase the volume or percentage of revenue or net income produced by the residential mortgage
business.
We earn income by originating residential mortgage loans for resale in the secondary mortgage market, and disruptions in that
market could reduce our operating income.
Historically, we have earned income by originating mortgage loans for sale in the secondary market. A historical focus of our loan
origination and sales activities has been to enter into formal commitments and informal agreements with larger banking companies and
mortgage investors. Under these arrangements, we originate single-family mortgages that are priced and underwritten to conform to previously
agreed criteria before loan funding and are delivered to the investor shortly after funding. However, in the recent past, disruptions in the
secondary market for residential mortgage loans have limited the market for, and liquidity of, most mortgage loans other than conforming
Fannie Mae and Federal Home Loan Mortgage Corporation, or Freddie Mac, loans. The effects of these disruptions in the secondary market
for residential mortgage loans may reappear.
In addition, because government-sponsored entities like Fannie Mae and Freddie Mac, which account for a substantial portion of the
secondary market, are governed by federal law, any future changes in laws that significantly affect the activity of these entities could, in turn,
adversely affect our operations. In September 2008, Fannie Mae and Freddie Mac were placed into conservatorship by the federal
government. The federal government has for many years considered proposals to reform Fannie Mae and Freddie Mac, but the results
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of any such reform and their impact on us are difficult to predict. To date, no reform proposal has been enacted.
These disruptions may not only affect us but also the ability and desire of mortgage investors and other banks to purchase residential
mortgage loans that we originate. As a result, we may not be able to maintain or grow the income we receive from originating and reselling
residential mortgage loans, which would reduce our operating income. Additionally, we hold certain mortgage loans that we originated for sale,
increasing our exposure to interest rate risk and the value of the residential real estate that serves as collateral for the mortgage loan prior to
sale.
Our financial condition, earnings and asset quality could be adversely affected if we are required to repurchase loans originated for
sale by our mortgage banking division.
The Bank originates residential mortgage loans for sale to secondary market investors, subject to contractually specified and limited
recourse provisions. Because the loans are intended to be originated within investor guidelines, using designated automated underwriting and
product-specific requirements as part of the loan application, the loans sold have a limited recourse provision. In general, the Bank may be
required to repurchase a previously sold mortgage loan or indemnify an investor if there is non-compliance with defined loan origination or
documentation standards including fraud, negligence, material misstatement in the loan documents or non-compliance with applicable law. In
addition, the Bank may have an obligation to repurchase a loan if the mortgagor has defaulted early in the loan term or return profits made
should the loan prepay within a short period. The potential mortgagor early default repurchase period is up to approximately twelve months
after sale of the loan to the investor. The recourse period for fraud, material misstatement, breach of representations and warranties, non-
compliance with law or similar matters could be as long as the term of the loan. Mortgages subject to recourse are collateralized by single-
family residential properties. Should such loan repurchases become a material issue, our earnings and asset quality could be adversely
impacted, which could adversely impact business, financial condition and results of operations.
Delinquencies and credit losses from our OpenSky® credit card division could adversely affect our business, financial condition and
results of operations.
Our OpenSky® division provides secured credit cards on a nationwide basis to under-banked populations and those looking to rebuild their
credit scores. In order to obtain a credit card from us, the customer must select a credit line amount that they are willing to secure with a
matching deposit amount. Available credit lines vary from a minimum of $200 to a maximum of $3,000 per card, with a maximum line of $5,000
available per individual. Customers then fund a deposit account in an amount equal to the maximum credit line being extended using a debit
card, check, wire or Western Union transfer. The customer’s funding of the deposit account as collateral is not a consideration in the credit card
approval process, but is a prerequisite to activating the credit line. Credit card eligibility is based on identity and income verification. Our Apollo
customer acquisition system includes decision engine software, which we license, to contact relevant third-party data services for identity and
income verification. Once the customer’s deposit account has been funded, the credit line is activated and the collateral funds are available to
absorb all losses on the account that may occur, except those stated below. As a result, except in those select circumstances identified below,
all OpenSky® accounts are secured by deposits up to the amount of the maximum credit limit at the time of account verification.
Although OpenSky® credit cards are secured, losses may occur primarily as a result of fraud, when the account exceeds its established
limit or if a cardholder ceases to maintain the account in good standing. Fraud, such as identity fraud, payment fraud and funding fraud (where
an individual funds a card using information from someone they know well, such as a relative or roommate) can result in substantial losses. In
the case of an OpenSky® account that is funded through fraud on the part of an applicant, we are required by applicable laws to refund the
amount of the original deposit, and we charge off balances which were subsequently charged on the card. Customers exceeding established
credit limits occurs due to certain VISA membership policies that allow cardholders to incur certain charges even if they exceed their card limits,
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which include, but are not limited to, rental car charges, gas stations and hotel deposits. If an OpenSky® cardholder exceeds his or her credit
limit as a result of purchases in one of these categories, we may incur losses for amounts in excess of the collateral deposited if the borrower is
unable to repay such excess amounts. Finally, losses to our credit card portfolio may arise if cardholders cease to maintain the account in good
standing with timely payments. For example, in the event a card becomes more than 120 days past due, the credit card balance is recovered
against the corresponding deposit account and a charge-off is recorded for any related fees, accrued interest or other charges in excess of the
deposit account balance. We have invested heavily in technology and systems to prevent and detect fraudulent behavior and mitigate losses
but such investments may not be adequate, and our systems may not adequately monitor or mitigate potential losses arising from these risks.
As of December 31, 2018, OpenSky® credit card balances were $34.7 million, of which $32.5 million were fully secured. Total noninterest
bearing collateral deposit account balances were $60.0 million as of the same date. As of December 31, 2018, approximately 11% of our credit
card portfolio was delinquent by 30 days or more. Based on our prior experience, approximately 19% of our new secured credit cards will
experience a charge-off within the first year of issuance primarily due to the relative inexperience of this under-banked population in effectively
managing credit card debt.
Further, using our proprietary scoring model, which considers credit score and repayment history, the Bank has recently begun to offer
certain customers an unsecured line in excess of their secured line of credit. At December 31, 2018, we had $1.8 million of unsecured unused
lines of credit and $2.1 million of outstanding unsecured credit card advances.
A high credit loss rate (the rate at which we charge off uncollectible loans) on either our secured or unsecured portfolio could adversely
impact our overall financial performance. We maintain an allowance for credit losses, which we believe to be adequate to cover credit losses
inherent in our OpenSky® portfolio, but we cannot assure you that the allowance will be sufficient to cover actual credit losses. If credit losses
from our OpenSky® portfolio exceed our allowance for credit losses, our revenues will be reduced by the excess of such credit losses.
The inability of our OpenSky® credit card division to continue its growth rate could adversely affect our earnings.
Our credit card portfolio has increased from $9.6 million at December 31, 2014 to $34.7 million at December 31, 2018 and certain
corresponding fees have been a significant portion of our income. We cannot assure you that we will be able to retain existing customers or
attract new customers, or that we will be able to increase account balances for new or existing customers. Many factors could adversely affect
our ability to retain or attract customers and our ability to grow account balances. These factors include general economic factors, competition,
the effectiveness of our marketing initiatives, negative press reports regarding our industry or the Company, the general interest rate
environment, our ability to recruit or replace experienced management and operations personnel, the availability of funding and delinquency
and credit loss rates.
We expect the development and expansion of new credit card products and related cardholder service products to be an important
contributor to our growth and earnings in the future. If we are unable to implement new cardholder products and features, our ability to grow will
be negatively affected. Declining sales of cardholder service products would likely result in reduced income from fees.
Our business, financial condition and results of operations may be adversely affected by merchants’ increasing focus on the fees
charged by credit card networks and by regulation and legislation impacting such fees.
Credit card interchange fees are generally one of the largest components of the costs that merchants pay in connection with the
acceptance of credit cards and are a meaningful source of revenue for our OpenSky® division. Interchange fees are the subject of significant
and intense global legal, regulatory and
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legislative focus, and the resulting decisions, regulations and legislation may have an adverse impact on our business, financial condition and
results of operations.
In addition to this regulatory activity, merchants are also seeking avenues to reduce interchange fees. During the past few years,
merchants and their trade groups have filed numerous lawsuits against Visa, MasterCard, American Express and their card-issuing banks,
claiming that their practices toward merchants, including interchange and similar fees, violate federal antitrust laws.
Some major retailers may have sufficient bargaining power to independently negotiate lower interchange fees with MasterCard and Visa,
which could, in turn, result in lower interchange fees for us when our cardholders undertake purchase transactions with these retailers. In 2016,
some of the largest merchants individually negotiated lower interchange rates with MasterCard and Visa. These and other merchants also
continue to lobby aggressively for caps and restrictions on interchange fees and there can be no assurance that their efforts will not be
successful or that they will not in the future bring legal proceedings against us or other credit card and debit card issuers and networks.
Beyond pursuing litigation, legislation and regulation, merchants may also promote forms of payment with lower fees, such as ACH-based
payments, or seek to impose surcharges at the point of sale for use of credit or debit cards. New payment systems, particularly mobile-based
payment technologies, could also gain widespread adoption and lead to issuer transaction fees or the displacement of credit card accounts as
a payment method.
The heightened focus by merchants and regulatory and legislative bodies on the fees charged by credit and debit card networks, and the
ability of certain merchants to negotiate discounts to interchange fees with MasterCard and Visa successfully or develop alternative payment
systems could result in a reduction of interchange fees. Any resulting loss in income to us could have an adverse effect on our business,
financial condition and results of operations.
By engaging in derivative transactions, we are exposed to additional credit and market risk.
As part of our mortgage banking activities, we enter into interest rate lock agreements with the consumer. These are commitments to
originate loans at a specified interest rate and lock expiration which is set prior to closing. The Company has two options. We may choose to
lock the loan and rate directly with an investor using a best effort commitment. This type of commitment has no negative impact to the Bank as
long as the loan is closed and funded. Once settlement commences, this type of commitment typically contains a mandatory delivery. Secondly,
the Bank may elect to protect the interest rate to the consumer and deliver the loan using short term mandatory commitments once the loan is
closed. When the Company chooses this strategy, we hedge the risk by selling an offsetting short position of a mortgage backed security or
MBS most correlated to the loan type an expiration. The hedged loan(s) and shorted MBS positions are recorded at fair value with changes in
the mark to market recorded as mortgage banking revenue. Furthermore, the hedged interest rate locks and commitments to deliver loans to
investors are considered derivatives. The market value of loans with best effort rate lock commitments are not readily ascertainable with
precision because they are not actively traded in stand-alone market. The Company determines the fair value of rate lock commitments and
delivery contracts by measuring the fair value of the underlying asset, which is impacted by current interest rates, and taking into consideration
the probability that the rate lock commitments will close or will be funded.
Hedging interest rate risk is a complex process, requiring sophisticated models and routine monitoring. As a result of interest rate
fluctuations, hedged assets and liabilities will appreciate or depreciate in market value. The effect of this unrealized appreciation or depreciation
in assets (loans) will generally be offset by income or loss in the corresponding MBS derivative instruments that are linked to the hedged assets
and liabilities. By engaging in derivative transactions, we are exposed to counterparty credit and market risk. If the counterparty fails to perform,
credit risk exists to the extent of the fair value gain in the derivative. Market risk exists to the extent that interest rates change in ways that are
significantly different from what was
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modeled when we entered into the derivative transaction. The existence of credit and market risk associated with our derivative instruments
could adversely affect our mortgage banking revenue and, therefore, could have a material adverse effect on our business, financial condition
and results of operations.
We are subject to interest rate risk as fluctuations in interest rates may adversely affect our earnings.
The majority of our banking assets and liabilities are monetary in nature and subject to risk from changes in interest rates. Like most
financial institutions, our earnings are significantly dependent on our net interest income, the principal component of our earnings, which is the
difference between interest earned by us from our interest earning assets, such as loans and investment securities, and interest paid by us on
our interest bearing liabilities, such as deposits and borrowings. We expect that we will periodically experience “gaps” in the interest rate
sensitivities of our assets and liabilities, meaning that either our interest bearing liabilities will be more sensitive to changes in market interest
rates than our interest earning assets, or vice versa. In either case, if market interest rates should move contrary to our position, this gap will
negatively impact our earnings. The impact on earnings is more adverse when the slope of the yield curve flattens; that is, when short-term
interest rates increase more than long-term interest rates or when long-term interest rates decrease more than short-term interest rates. Many
factors impact interest rates, including governmental monetary policies, inflation, recession, changes in unemployment, the money supply,
international economic weakness and disorder and instability in domestic and foreign financial markets. As of December 31, 2018,
approximately 59% of our interest earning assets and approximately 52% of our interest bearing liabilities had a variable interest rate.
Interest rate increases often result in larger payment requirements for our borrowers, which increases the potential for default and could
result in a decrease in the demand for loans. At the same time, the marketability of the property securing a loan may be adversely affected by
any reduced demand resulting from higher interest rates. In a declining interest rate environment, there may be an increase in prepayments on
loans as borrowers refinance their loans at lower rates. In addition, in a low interest rate environment, loan customers often pursue long-term
fixed rate credits, which could adversely affect our earnings and net interest margin if rates later increase. Changes in interest rates also can
affect the value of loans, securities and other assets. An increase in interest rates that adversely affects the ability of borrowers to pay the
principal or interest on loans may lead to an increase in nonperforming assets and a reduction of income recognized, which could have an
adverse effect on our results of operations and cash flows. Further, when we place a loan on nonaccrual status, we reverse any accrued but
unpaid interest receivable, which decreases interest income. At the same time, we continue to incur costs to fund the loan, which is reflected as
interest expense, without any interest income to offset the associated funding expense. Thus, an increase in the amount of nonperforming
assets would have an adverse impact on net interest income. If short-term interest rates remain at their historically low levels for a prolonged
period and assuming longer-term interest rates fall further, we could experience net interest margin compression as our interest earning assets
would continue to reprice downward while our interest bearing liability rates could fail to decline in tandem. Such an occurrence would have an
adverse effect on our net interest income and could have an adverse effect on our business, financial condition and results of operations.
Uncertainty about the future of LIBOR may adversely affect our business.
On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced that it
intends to stop persuading or compelling banks to submit rates for the calibration of LIBOR to the administrator of LIBOR after 2021. The
announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. It is impossible to
predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional
reforms to LIBOR may be enacted in the United Kingdom or elsewhere. At this time, no consensus exists as to what rate or rates may become
acceptable alternatives to LIBOR and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based securities and
variable rate loans, subordinated debentures, or other securities or financial arrangements, given LIBOR’s role in determining
45
market interest rates globally. Uncertainty as to the nature of alternative reference rates and as to potential changes or other reforms to LIBOR
may adversely affect LIBOR rates and other interest rates. In the event that a published LIBOR rate is unavailable after 2021, the value of
certain of the Company’s assets and liabilities could be adversely affected. Currently, the manner and impact of this transition and related
developments, as well as the effect of these developments on our funding costs, securities portfolio and business, is uncertain.
We face strong competition from financial services companies and other companies that offer banking services.
We operate in the highly competitive financial services industry and face significant competition for customers from financial institutions
located both within and beyond our principal markets. We compete with commercial banks, savings banks, credit unions, nonbank financial
services companies and other financial institutions operating within or near the areas we serve. Additionally, certain large banks headquartered
outside of our markets and large community banking institutions target the same customers we do. In addition, as customer preferences and
expectations continue to evolve, technology has lowered barriers to entry and made it possible for banks to expand their geographic reach by
providing services over the internet and for nonbanks to offer products and services traditionally provided by banks, such as automatic transfer
and automatic payment systems. The banking industry is experiencing rapid changes in technology and, as a result, our future success will
depend in part on our ability to address our customers’ needs by using technology. Customer loyalty can be influenced by a competitor’s new
products, especially offerings that could provide cost savings or a higher return to the customer. Increased lending activity of competing banks
following the recent downturn has also led to increased competitive pressures on loan rates and terms for high quality credits. We may not be
able to compete successfully with other financial institutions in our markets, and we may have to pay higher interest rates to attract deposits,
accept lower yields to attract loans and pay higher wages for new employees, resulting in lower net interest margins and reduced profitability.
Many of our non-bank competitors are not subject to the same extensive regulations that govern our activities and may have greater
flexibility in competing for business. The financial services industry could become even more competitive as a result of legislative, regulatory
and technological changes and continued consolidation. In addition, some of our current commercial banking customers may seek alternative
banking sources as they develop needs for credit facilities larger than we may be able to accommodate. Our inability to compete successfully in
the markets in which we operate could have an adverse effect on our business, financial condition or results of operations.
We are currently subject to certain pending litigation, and may be subject to litigation in the future.
From time to time we may be subject to various litigation matters incidental to the conduct of our business, including foreclosure
proceedings, title disputes, commercial disputes, labor and employment disputes and securities class actions. See Note 18 - Litigation,
included in our Notes to Consolidated Financial Statements under Part II. Item 8 for a description of material legal actions in which we are
currently involved.
We vigorously defend ourselves in all legal proceedings we are involved in; however, the outcome of litigation and other legal matters is
always uncertain. Regardless of the outcome, legal proceedings can have an adverse impact on us because of legal fees and costs, diversion
of management resources, and other factors, such as reputational damage. Determining whether reserves are required for any pending
proceeding and the amount of any such reserves is a complex, fact-intensive process that requires significant judgment. Any material change
in facts and circumstances in a proceeding could cause any reserves we have established to be inadequate. It is possible that a resolution of
one or more such proceedings could result in us paying monetary awards, fines or penalties that could adversely affect our business, results of
operations, and financial condition.
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Risks Related to the Regulation of Our Industry
We operate in a highly regulated environment and the laws and regulations that govern our operations, corporate governance,
executive compensation and accounting principles, or changes in them, or our failure to comply with them, could adversely affect
us.
Banking is highly regulated under federal and state law. As such, we are subject to extensive regulation, supervision and legal
requirements that govern almost all aspects of our operations. These laws and regulations are not intended to protect our shareholders. Rather,
these laws and regulations are intended to protect customers, depositors, the Deposit Insurance Fund and the overall financial stability of the
United States. These laws and regulations, among other matters, prescribe minimum capital requirements, impose limitations on the business
activities in which we can engage, limit the dividend or distributions that the Bank can pay to the Company, restrict the ability of institutions to
guarantee our debt and impose certain specific accounting requirements on us that may be more restrictive and may result in greater or earlier
charges to earnings or reductions in our capital than GAAP would require. Compliance with laws and regulations can be difficult and costly, and
changes to laws and regulations often impose additional operating costs. Our failure to comply with these laws and regulations, even if the
failure follows good faith effort or reflects a difference in interpretation, could subject us to restrictions on our business activities, enforcement
actions and fines and other penalties, any of which could adversely affect our results of operations, regulatory capital levels and the price of our
securities. Further, any new laws, rules and regulations, such as the Dodd-Frank Act, could make compliance more difficult or expensive or
otherwise adversely affect our business, financial condition and results of operations.
Legislative and regulatory actions taken now or in the future may increase our costs and impact our business, governance structure,
financial condition or results of operations.
Economic conditions that contributed to the financial crisis in 2008, particularly in the financial markets, resulted in government regulatory
agencies and political bodies placing increased focus and scrutiny on the financial services industry. The Dodd-Frank Act, which was enacted
in 2010 in response to the financial crisis, significantly changed the regulation of financial institutions and the financial services industry. The
Dodd-Frank Act and the regulations thereunder have affected both large and small financial institutions. The Dodd-Frank Act, among other
things, imposed new capital requirements on bank holding companies; changed the base for Federal Deposit Insurance Corporation, or FDIC,
insurance assessments to a bank’s average consolidated total assets minus average tangible equity, rather than upon its deposit base;
permanently raised the current standard deposit insurance limit to $250,000; and expanded the FDIC’s authority to raise insurance premiums.
The Dodd-Frank Act established the Consumer Financial Protection Bureau), or CFPB, as an independent entity within the Federal Reserve,
which has broad rulemaking, supervisory and enforcement authority over consumer financial products and services, including deposit products,
residential mortgages, home-equity loans and credit cards, and contains provisions on residential mortgage-related matters that address
steering incentives, determinations as to a borrower’s ability to repay, prepayment penalties and disclosures to borrowers. Although the
applicability of certain elements of the Dodd-Frank Act is limited to institutions with more than $10 billion in assets, there can be no guarantee
that such applicability will not be extended in the future or that regulators or other third parties will not seek to impose such requirements on
institutions with less than $10 billion in assets, such as the Bank. Compliance with the Dodd-Frank Act and its implementing regulations has
and may continue to result in additional operating and compliance costs that could have a material adverse effect on our business, financial
condition, results of operations and growth prospects.
On May 24, 2018, President Trump signed into law the “Economic Growth, Regulatory Relief and Consumer Protection Act,” or the
Regulatory Relief Act, which amends parts of the Dodd-Frank Act, as well as other laws that involve regulation of the financial industry. While
the Regulatory Relief Act keeps in place fundamental aspects of the Dodd-Frank Act’s regulatory framework, it does change the regulatory
framework for depository institutions with assets under $10 billion, such as the Bank, as well as easing some requirements for larger depository
institutions. As more fully discussed under “Supervision and Regulation- Regulatory
47
Relief Act,” the legislation includes a number of provisions which are favorable to bank holding companies, or BHCs, with total consolidated
assets of less than $10 billion, such as the Company, and also makes changes to consumer mortgage and credit reporting regulations and to
the authorities of the agencies that regulate the financial industry. Because a number of the provisions included in the Regulatory Relief Act
require the federal banking agencies to undertake notice and comment rulemaking, it will likely take some time before these provisions are fully
implemented.
Federal and state regulatory agencies frequently adopt changes to their regulations or change the manner in which existing regulations are
applied. Regulatory or legislative changes to laws applicable to the financial industry, if enacted or adopted, may impact the profitability of our
business activities, require more oversight or change certain of our business practices, including the ability to offer new products, obtain
financing, attract deposits, make loans and achieve satisfactory interest spreads and could expose us to additional costs, including increased
compliance costs. These changes also may require us to invest significant management attention and resources to make any necessary
changes to operations to comply and could have an adverse effect on our business, financial condition and results of operations.
As a result of the Dodd-Frank Act and recent rulemaking, the Bank and the Company are subject to more stringent capital
requirements.
In July 2013, the U.S. federal banking authorities approved the implementation of the Basel III regulatory capital reforms, or Basel III, and
issued rules effecting certain changes required by the Dodd-Frank Act. Basel III is applicable to all U.S. banks that are subject to minimum
capital requirements as well as to bank and saving and loan holding companies like us with consolidated assets of more than $1.0 billion. Basel
III not only increases most of the required minimum regulatory capital ratios, it introduces a new common equity Tier 1 capital ratio and the
concept of a capital conservation buffer. Basel III also expands the current definition of capital by establishing additional criteria that capital
instruments must meet to be considered additional Tier 1 and Tier 2 capital. In order to be a “well-capitalized” depository institution under the
new regime, an institution must maintain a common equity Tier 1 capital ratio of 6.5% or more; a Tier 1 capital ratio of 8% or more; a total
capital ratio of 10% or more; and a Tier 1 leverage ratio of 5% or more. The Basel III capital rules became effective as applied to the Bank on
January 1, 2015 and to the Company on January 1, 2018 with a phase-in period that generally extends through January 1, 2019 for many of
the changes.
The failure to meet applicable regulatory capital requirements could result in one or more of our regulators placing limitations or conditions
on our activities, including our growth initiatives, or restricting the commencement of new activities, and could affect customer and investor
confidence, our costs of funds and FDIC insurance costs, our ability to pay dividends on our common stock, our ability to make acquisitions,
and our business, results of operations and financial condition.
Federal banking agencies periodically conduct examinations of our business, including compliance with laws and regulations, and
our failure to comply with any supervisory actions to which we are or become subject as a result of such examinations could
adversely affect us.
As part of the bank regulatory process, the OCC and the Federal Reserve, periodically conduct examinations of our business, including
compliance with laws and regulations. If, as a result of an examination, one of these federal banking agencies were to determine that the
financial condition, capital resources, asset quality, earnings prospects, management, liquidity, asset sensitivity, risk management or other
aspects of any of our operations have become unsatisfactory, or that the Company, the Bank or their respective management were in violation
of any law or regulation, it may take a number of different remedial actions as it deems appropriate. These actions include the power to enjoin
“unsafe or unsound” practices, to require affirmative actions to correct any conditions resulting from any violation or practice, to issue an
administrative order that can be judicially enforced, to direct an increase in our capital levels, to restrict our growth, to assess civil monetary
penalties against us, the Bank or their respective officers or directors, to remove officers and directors and, if it is concluded that such
conditions cannot be corrected or there is an imminent risk of
48
loss to depositors, to terminate the Bank’s deposit insurance. If we become subject to such regulatory actions, our business, financial condition,
results of operations and reputation could be adversely affected.
Monetary policies and regulations of the Federal Reserve could adversely affect our business, financial condition and results of
operations.
In addition to being affected by general economic conditions, our earnings and growth are affected by the policies of the Federal Reserve.
An important function of the Federal Reserve is to regulate the U.S. money supply and credit conditions. Among the instruments used by the
Federal Reserve to implement these objectives are open market purchases and sales of securities by the Federal Reserve, adjustments of
both the discount rate and the federal funds rate and changes in reserve requirements against bank deposits. These instruments are used in
varying combinations to influence overall economic growth and the distribution of credit, bank loans, investments and deposits. Their use also
affects interest rates charged on loans or paid on deposits.
The monetary policies and regulations of the Federal Reserve have had a significant effect on the operating results of commercial banks in
the past and are expected to continue to do so in the future. Although we cannot determine the effects of such policies on us at this time, such
policies could adversely affect our business, financial condition and results of operations.
Regulatory requirements affecting our loans secured by commercial real estate could limit our ability to leverage our capital and
adversely affect our growth and profitability.
The federal bank regulatory agencies have indicated their view that banks with high concentrations of loans secured by commercial real
estate are subject to increased risk and should implement robust risk management policies and maintain higher capital than regulatory
minimums to maintain an appropriate cushion against loss that is commensurate with the perceived risk. Federal bank regulatory guidelines
identify institutions potentially exposed to commercial real estate concentration risk as those that have (i) experienced rapid growth in
commercial real estate lending, (ii) notable exposure to a specific type of commercial real estate, (iii) total reported loans for construction, land
development and other land loans representing 100% or more of the institution’s capital, or (iv) total non-owner-occupied commercial real
estate (including construction) loans representing 300% or more of the institution’s capital if the outstanding balance of the institution’s non-
owner-occupied commercial real estate (including construction) loan portfolio has increased 50% or more during the prior 36 months. At
December 31, 2018, the Bank’s construction to total capital ratio was 143%, its total non-owner occupied commercial real estate (including
construction) to total capital ratio was 340% and therefore exceeded the 100% and 300% regulatory guideline thresholds set forth in clauses
(iii) and (iv) above. As a result, we are deemed to have a concentration in commercial real estate lending under applicable regulatory
guidelines. Because a significant portion of our loan portfolio depends on commercial real estate, a change in the regulatory capital
requirements applicable to us or a decline in our regulatory capital could limit our ability to leverage our capital as a result of these policies,
which could have a material adverse effect on our business, financial condition and results of operations.
We cannot guarantee that any risk management practices we implement will be effective to prevent losses relating to our commercial real
estate portfolio. Management has implemented controls to monitor our commercial real estate lending concentrations, but we cannot predict
the extent to which this guidance will impact our operations or capital requirements.
49
Risks Related to Ownership of Our Common Stock
The price of our common stock, like many of our peers, has fluctuated significantly over the recent past and may fluctuate significantly in
the future, which may make it difficult for you to resell your shares of common stock at times or at prices you find attractive.
Stock price volatility may make it difficult for holders of our common stock to resell their common stock when desired and at desirable
prices. There are many factors that may affect the market price and trading volume of our common stock, including, without limitation, the risks
discussed elsewhere in this “Risk Factors” section and:
•
•
•
•
•
•
•
•
•
•
•
actual or anticipated fluctuations in our operating results, financial condition or asset quality;
changes in economic or business conditions;
the effects of, and changes in, trade, monetary and fiscal policies, including the interest rate policies of the Federal Reserve;
publication of research reports about us, our competitors or the financial services industry generally, or changes in, or failure to meet,
securities analysts’ estimates of our financial and operating performance, or lack of research reports by industry analysts or ceasing of
coverage;
operating and stock price performance of companies that investors deem comparable to us;
additional or anticipated sales of our common stock or other securities by us or our existing shareholders;
additions or departures of key personnel;
perceptions in the marketplace regarding our competitors or us;
significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving our
competitors or us;
other economic, competitive, governmental, regulatory or technological factors affecting our operations, pricing, products and services;
and
other news, announcements or disclosures (whether by us or others) related to us, our competitors, our core markets or the financial
services industry.
The stock market and, in particular, the market for financial institution stocks has experienced substantial fluctuations in recent years, which
in many cases have been unrelated to the operating performance and prospects of particular companies. In addition, significant fluctuations in
the trading volume in our common stock may cause significant price variations to occur. Increased market volatility may materially and
adversely affect the market price of our common stock, which could make it difficult to sell your shares at the volume, prices and times desired.
The market price of our common stock could decline significantly due to actual or anticipated issuances or sales of our common
stock in the future.
Our board of directors may determine from time to time that we need to raise additional capital by issuing additional shares of our common
stock or other securities. We are not restricted from issuing additional shares of common stock, including securities that are convertible into or
exchangeable for, or that represent the right to receive, common stock. Because our decision to issue securities in any future offering will
depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of any future
offerings, or the prices at which such offerings may be
50
effected. Such offerings could be dilutive to common shareholders. New investors also may have rights, preferences and privileges that are
senior to, and that adversely affect, our then current common shareholders. Additionally, if we raise additional capital by making additional
offerings of debt or preferred equity securities, upon liquidation of the Company, holders of our debt securities and shares of preferred stock,
and lenders with respect to other borrowings, will receive distributions of our available assets prior to the holders of our common stock.
Additional equity offerings may dilute the holdings of our existing shareholders or reduce the market price of our common stock, or both. Holder
of our common stock are not entitled to preemptive rights or other protections against dilution.In addition, we may issue shares of our common
stock or other securities from time to time as consideration for future acquisitions and investments and pursuant to compensation and incentive
plans. If any such acquisition or investment is significant, the number of shares of our common stock, or the number or aggregate principal
amount, as the case may be, of other securities that we may issue may be substantial. After expiration of the lock-up period described above,
we may also grant registration rights covering those shares of our common stock or other securities in connection with any such acquisitions
and investments.
We cannot predict the size of future issuances of our common stock or the effect, if any, that future issuances and sales of our common
stock will have on the market price of our common stock. Sales of substantial amounts of our common stock (including shares of our common
stock issued in connection with an acquisition or under a compensation or incentive plan), or the perception that such sales could occur, may
adversely affect prevailing market prices for our common stock and could impair our ability to raise capital through future sales of our securities.
Our management and board of directors have significant control over our business.
As of December 31, 2018, our directors, directors of the Bank, our named executive officers and their respective family members and affiliated
entities beneficially owned an aggregate of 5,726,681 shares, or approximately 42% of our issued and outstanding common stock.
Consequently, our management and board of directors may be able to significantly affect the outcome of the election of directors and the
potential outcome of other matters submitted to a vote of our shareholders, such as mergers, the sale of substantially all of our assets and
other extraordinary corporate matters. The interests of these insiders could conflict with the interests of our other shareholders, including you.
The holders of our existing debt obligations, as well as debt obligations that may be outstanding in the future, will have priority over
our common stock with respect to payment in the event of liquidation, dissolution or winding up and with respect to the payment of
interest.
In the event of any liquidation, dissolution or winding up of the Company, our common stock would rank below all claims of debt holders
against us. As of December 31, 2018 we had outstanding approximately $13.5 million in aggregate principal amount of subordinated notes and
$2.1 million in aggregate principal amount of junior subordinated debentures issued to a statutory trust that, in turn, issued $2.0 million of trust
preferred securities. Payments of the principal and interest on the trust preferred securities are conditionally guaranteed by us. Our debt
obligations are senior to our shares of common stock. As a result, we must make payments on our debt obligations before any dividends can
be paid on our common stock. In the event of our bankruptcy, dissolution or liquidation, the holders of our debt obligations must be satisfied
before any distributions can be made to the holders of our common stock. To the extent that we issue additional debt obligations, the additional
debt obligations will be of equal rank with, or senior to, our existing debt obligations and senior to our shares of common stock.
We are dependent upon the Bank for cash flow, and the Bank’s ability to make cash distributions is restricted.
Our primary asset is Capital Bank. We depend upon the Bank for cash distributions (through dividends on the Bank’s common stock) that
we use to pay our operating expenses and satisfy our obligations (including our subordinated debentures and our other debt obligations).
Federal statutes, regulations and policies
51
restrict the Bank’s ability to make cash distributions to us. These statutes and regulations require, among other things, that the Bank maintain
certain levels of capital in order to pay a dividend. Further, the OCC has the ability to restrict the Bank’s payment of dividends by supervisory
action. If the Bank is unable to pay dividends to us, we may not be able to satisfy our obligations or, if applicable, pay dividends on our common
stock.
Our future ability to pay dividends is subject to restrictions.
Holders of our common stock are only entitled to receive dividends when, as and if declared by our board of directors out of funds legally
available for dividends. We have not paid any cash dividends on our capital stock since inception and we do not plan to pay cash dividends in
the foreseeable future. Any declaration and payment of dividends on common stock in the future will depend on regulatory restrictions, our
earnings and financial condition, our liquidity and capital requirements, the general economic climate, contractual restrictions, our ability to
service any equity or debt obligations senior to our common stock and other factors deemed relevant by our board of directors. Furthermore,
consistent with our strategic plans, growth initiatives, capital availability, projected liquidity needs and other factors, we have made, and will
continue to make, capital management decisions and policies that could adversely affect the amount of dividends, if any, paid to our common
shareholders.
The Federal Reserve has indicated that bank holding companies should carefully review their dividend policy in relation to the
organization’s overall asset quality, current and prospective earnings and level, composition and quality of capital. The guidance provides that
we inform and consult with the Federal Reserve prior to declaring and paying a dividend that exceeds earnings for the period for which the
dividend is being paid or that could result in an adverse change to our capital structure, including interest on the subordinated debt obligations,
the subordinated debentures underlying our trust preferred securities and our other debt obligations. If regularly scheduled payments on our
outstanding junior subordinated debentures, held by our unconsolidated subsidiary trust, or our other debt obligations, are not made or are
deferred, or dividends on any preferred stock we may issue are not paid, we will be prohibited from paying dividends on our common stock.
Provisions in our governing documents and Maryland law may have an anti-takeover effect, and there are substitutional regulatory
limitations on changes of control of bank holding companies.
Our corporate organizational documents and provisions of federal and state law to which we are subject contain certain provisions that
could have an anti-takeover effect and may delay, make more difficult or prevent an attempted acquisition that you may favor or an attempted
replacement of our board of directors or management.
Our Amended and Restated Articles of Incorporation, or Articles, and our Amended and Restated Bylaws, or Bylaws, may have an anti-
takeover effect and may delay, discourage or prevent an attempted acquisition or change of control or a replacement of our board of directors
or management. Our governing documents and Maryland law include provisions that:
•
•
•
•
•
empower our board of directors, without shareholder approval, to issue our preferred stock, the terms of which, including voting power,
are to be set by our board of directors;
divide our board of directors into three classes serving staggered three-year terms;
provide that directors may be removed from office (i) without cause but only upon a 66.67% vote of shareholders and (ii) for cause but
only upon a majority shareholder vote;
eliminate cumulative voting in elections of directors;
permit our board of directors to alter, amend or repeal our Bylaws or to adopt new bylaws;
52
•
•
•
•
permit our board of directors to increase or decrease the number of authorized shares of our common stock and preferred stock;
require the request of holders of at least a majority of the outstanding shares of our capital stock entitled to vote at a meeting to call a
special shareholders’ meeting;
require shareholders that wish to bring business before annual or special meetings of shareholders, or to nominate candidates for
election as directors at our annual meeting of shareholders, to provide timely notice of their intent in writing; and
enable our board of directors to increase, between annual meetings, the number of persons serving as directors and to fill the
vacancies created as a result of the increase by a majority vote of the directors present at a meeting of directors.
In addition, certain provisions of Maryland law may delay, discourage or prevent an attempted acquisition or change in control.
Furthermore, banking laws impose notice, approval, and ongoing regulatory requirements on any shareholder or other party that seeks to
acquire direct or indirect “control” of an FDIC-insured depository institution or its holding company. These laws include the BHC Act and the
Change in Bank Control Act, or the CBCA. These laws could delay or prevent an acquisition.
Our common stock is not insured by any governmental entity.
Our common stock is not a deposit account or other obligation of any bank and is not insured by the FDIC or any other governmental entity.
Investment in our common stock is subject to risk, including possible loss.
53
ITEM 1B UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Our headquarters are currently located at 2275 Research Boulevard, Suite 600, Rockville, Maryland 20850. The following table
summarizes pertinent details of our commercial bank branch locations, mortgage banking offices, loan production offices, or LPOs, and our
credit card operations office. Our mortgage offices typically contain both origination and operations professionals.
Location
Owned/Leased
Lease Expiration
Leased
6/30/24
Type of office
Commercial Branch
One Church Street
Suite 100
Rockville, MD 20850
2275 Research Blvd.
Suite 600
Rockville, MD 20850
1776 Eye Street
Washington, D.C. 20006
6000 Executive Boulevard
Suite 101
North Bethesda, MD 20852
6711 Columbia Gateway Drive
Suite 170
Columbia, MD 21046
110 Gibraltar Road
Suite 130
Horsham, PA 19044
185 Harry S. Truman Parkway
Suite 100
Annapolis, MD 21401
14231 Jarrettsville Pike
Phoenix, MD 21131
1801 E Jefferson St.
Rockville, MD 20852
818 Connecticut Ave
Suite 900
Washington, D.C. 20006
10700 Parkridge Boulevard
Suite 180
Reston, VA 20191
Sub-Leased
10/31/2024
Corporate
Leased
Leased
Leased
Leased
Leased
Leased
Leased
4/30/22
9/30/21
Commercial Branch
Commercial Branch
5/31/22
Commercial Branch/Mortgage Office
5/31/20
OpenSky® Operations
9/30/21
2/29/20
8/31/19
Mortgage Office
Mortgage Office
Limited Service Branch
Sub-Leased
Month-to-month
LPO
Leased
10/31/2023
Commercial Branch and Mortgage
Office
54
ITEM 3. LEGAL PROCEEDINGS.
From time to time, we are a party to various litigation matters incidental to our ordinary conduct of our business. We are not presently a
party to any material legal proceedings other than as described in Note 18 - Litigation, included in our Notes to Consolidated Financial
Statements under Part II. Item 8. Financial Statements and Supplementary Data.
ITEM 4. MINE SAFETY DISCLOSURES.
Not applicable.
55
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF
EQUITY SECURITIES
PART II
Shareholder Information
The common stock of the Company has been publicly traded since September 2018 and is currently traded on the Nasdaq Global Select
Market under the symbol CBNK. As of February 28, 2019, there were approximately 228 holders of record of our common stock.
On October 4, 2018, the Underwriters of the Company’s initial public offering, or IPO, that closed on September 28, 2018, exercised in full their
option to purchase an additional 334,310 shares of common stock from the Company. The sale of additional shares of the Company’s common
stock closed on October 4, 2018. The Company received proceeds of approximately $3.9 million from the sale of the additional shares after
deducting underwriting discounts. After giving effect to the exercise of the Underwriters’ option, the Company sold a total of 1,834,310 shares
of common stock and raised approximately $20.2 million in net proceeds at the completion of the IPO. There has been no material change in
the planned use of proceeds from our IPO as described in our prospectus filed with the SEC on September 26, 2018 pursuant to Rule 424(b)
(4) under the Securities Act.
Dividends
It is our policy to retain earnings, if any, to provide funds for use in our business. Although we have never declared or paid dividends on our
common stock, our board of directors periodically reviews whether to declare or pay cash dividends taking into account, among other things,
general business conditions, our financial results. future prospects, capital requirements, legal and regulatory restrictions, and such other
factors as our board may deem relevant.
Our ability to pay dividends on our common stock is dependent on the Bank’s ability to pay dividends to the Company. Various statutory
provisions restrict the amount of dividends that the Bank can pay without regulatory approval. For information on the statutory and regulatory
limitations on the ability of the Company to pay dividends to its stockholders and on the Bank to pay dividends to the Company, see “Item 1.
Business-Supervision and Regulation—Dividends” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of
Operations – Liquidity.”
Equity Compensation Plan Information
The following table provides information as of December 31, 2018, with respect to options and RSUs outstanding and shares available for
future awards under the Company’s active equity incentive plans.
56
Plan Category
Number of Securities to be Issued
Upon Exercise of Outstanding
Options, Warrants and Rights
Weighted-Average Exercise Price of
Outstanding Options, Warrants and
Rights
Number of Securities Remaining
Available for Future Issuance under
Equity Compensation Plans
(excluding securities reflected in
column (a))
(a)
(b)
(c)
Equity compensation plans approved by security holders:
HCNB Bancorp, Inc. 2002 Stock Option Plan
Capital Bancorp, Inc. 2017 Stock and Incentive
Compensation Plan
Equity compensation plans not approved by security holders
Total
803,510 $
628,350
—
1,431,860 $
7.47
11.82
—
9.38
—
542,215
—
542,215
Unregistered Sales and Issuer Repurchases of Common Stock
There were no unregistered sales of the Company’s stock during the fourth quarter of 2018. The Company did not repurchase any of its shares
during the fourth quarter of 2018 and does not have any authorized share repurchase programs.
57
ITEM 6. SELECTED FINANCIAL DATA
You should read the following selected historical consolidated financial and other data in conjunction with our consolidated financial
statements and related notes and the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of
Operations” and “Capitalization” included elsewhere in this report. The following tables set forth selected historical consolidated financial and
other data for the years ended December 31, 2018, 2017, 2016, 2015, and 2014. Selected financial data as of and for the years ended
December 31, 2018 and 2017 have been derived from our audited financial statements included elsewhere in this report. We have derived the
selected financial data as of and for the years ended December 31, 2016, 2015 and 2014 from our audited financial statements not included in
this filing. The information presented in the table below has been adjusted to give effect to a four-for-one stock split of our common stock
completed effective August 15, 2018. The effect of the stock split on outstanding shares and per share figures has been retroactively applied to
all periods presented below. Our historical results are not necessarily indicative of any future period. The performance ratios, asset quality and
capital ratios, mortgage metrics and credit card portfolio metrics are unaudited and derived from our audited financial statements and other
financial information as of and for the periods presented. Average balances have been calculated using daily averages. The selected historical
consolidated financial and other data presented below contains certain financial measures that are not presented in accordance with
accounting principles generally accepted in the United States and have not been audited. See “—GAAP Reconciliation and Management
Explanation of Non-GAAP Financial Measures.”
(Dollars are in thousands, except per share information)
2018
2017
2016
2015
2014
Years Ended December 31,
Statement of Income Data:
Total interest income
Total interest expense
Net interest income
Provision for loan losses
Total noninterest income
Total noninterest expense
Income before income taxes
Income tax expense
Net income
Net income, as adjusted(1)
Balance Sheet Data:
Cash and due from banks
Investment securities available for sale
Loans held for sale
Loans, net of unearned income
Core deposit intangible
Total assets
Total deposits
FHLB advances and repurchase agreements
Senior promissory note, due July 31, 2019
Subordinated debentures
Total liabilities
Total stockholders’ equity
Tangible common equity(2)
56,666 $
7,755
48,911
2,655
15,149
47,306
14,099
6,990
7,109
11,293
8,189 $
54,029
26,344
887,420
—
1,026,009
904,899
13,260
2,000
15,361
945,890
80,119
80,119
49,243 $
6,484
42,759
4,291
20,473
43,380
15,561
6,120
9,441
9,441
4,827 $
47,985
49,167
763,430
—
905,600
790,924
15,659
2,000
15,327
834,853
70,748
70,748
38,254 $
4,578
33,676
1,609
14,929
34,817
12,179
4,687
7,492
7,492
4,129 $
39,175
38,878
639,350
17
743,429
629,817
23,440
5,000
18,629
683,772
59,657
59,640
32,852
3,135
29,717
1,230
11,442
28,821
11,108
4,315
6,793
6,793
3,849
39,393
42,659
506,339
39
618,749
501,974
47,988
5,000
7,062
568,533
50,216
50,177
$
$
69,127 $
11,239
57,888
2,140
16,124
54,123
17,749
4,982
12,767
12,767
10,431 $
46,932
18,526
1,000,268
—
1,105,058
955,241
5,332
—
15,393
990,494
114,564
114,564
58
(Dollars are in thousands, except per share information)
2018
2017
2016
2015
2014
Years Ended December 31,
Selected Performance Ratios:
Return on average assets (ROAA)
Return on average assets, as adjusted(1)
Return on average equity (ROAE)
Return on average equity, as adjusted(1)
Return on average tangible common equity (ROATCE)(2)(3)(4)
Return on average tangible common equity, as adjusted(1)(2)
Net interest margin (3)
Net interest margin, as adjusted(1)(2)(3)
Net interest margin, excluding credit card portfolio (3)
Noninterest income / average assets
Noninterest expense / average assets
Net operating expense / average assets
Efficiency ratio (4)
Efficiency ratio, as adjusted (1)(4)
Loan yield (5)
Loan yield, excluding credit card portfolio(5)
Per Share Data:(6)
Common shares issued and outstanding
Basic weighted average shares outstanding
Diluted weighted average shares outstanding
Basic earnings per share
Diluted earnings per share(7)
Diluted earnings per share, as adjusted(1)(2)(7)
Book value per share
Tangible book value per share(2)
Non-Performing Assets:
Non-performing loans
Troubled debt restructurings
Foreclosed real estate
Non-performing assets
Asset Quality Ratios:
Non-performing assets / assets
Non-performing loans / loans (8)
Non-performing assets / loans (8) + foreclosed real estate
Net charge-offs (recoveries) to average loans(8)
Allowance for loan losses to total loans
1.22%
0.74%
1.13%
1.10%
1.25%
1.22
13.94
13.94
13.94
13.94
5.59
5.59
4.28
1.54
5.18
3.63
73.13
73.13
7.16
5.76
1.17
9.29
14.75
9.29
14.75
5.12
5.37
4.31
1.57
4.90
3.33
73.85
67.79
6.44
5.57
1.13
14.39
14.39
14.41
14.41
5.18
5.18
4.53
2.46
5.21
2.75
68.60
68.60
6.45
5.76
1.10
13.90
13.90
13.94
13.94
5.02
5.02
4.60
2.20
5.12
2.93
71.63
71.63
6.18
5.78
1.25
14.84
14.84
14.90
14.90
5.59
5.59
5.47
2.11
5.32
3.21
70.02
70.02
6.74
6.62
13,672,479
12,116,459
12,462,138
11,537,196
11,261,132
11,428,000
11,144,696
10,963,132
11,289,044
10,225,780
9,620,080
9,562,820
9,427,396
10,488,036
10,279,548
$
$
1.05
1.02
1.02
8.38
8.38
$
4,679
$
284
142
4,821
0.63
0.62
0.99
6.94
6.94
5,407
3,811
93
5,500
$
$
0.86
0.84
0.84
6.35
6.35
$
4,518
$
941
90
4,608
$
$
0.78
0.74
0.74
5.83
5.83
5,775
2,422
203
5,978
0.72
0.69
0.69
5.25
5.25
6,359
2,768
454
6,813
0.44%
0.54%
0.51%
0.80%
1.10%
0.47
0.48
0.09
1.13
0.61
0.62
0.15
1.13
0.59
0.60
0.33
1.13
0.90
0.94
0.10
1.03
1.26
1.35
0.09
1.09
86.97
Allowance for loan losses to non-performing loans
241.72
185.57
190.32
113.83
59
(Dollars are in thousands, except per share information)
2018
2017
2016
2015
2014
Years Ended December 31,
Bank Capital Ratios:
Tier 1 leverage ratio
Common equity tier 1 capital
Tier 1 risk-based capital
Total risk-based capital ratio
Common equity to total assets
Composition of Loans Held for Investment:
Residential real estate
Commercial real estate
Construction real estate
Commercial
Credit card
Other consumer
9.06 %
8.55%
8.86 %
9.51 %
9.44 %
11.00
11.00
12.25
8.89
407,844
278,691
157,586
122,264
34,673
1,202
$
10.78
10.78
12.03
8.46
342,684
259,853
144,932
108,982
31,507
1,053
$
11.12
11.12
12.37
8.94
286,332
234,869
134,540
87,563
20,446
1,157
$
11.35
11.35
12.51
9.38
225,185
190,776
129,304
79,003
13,812
2,233
$
n/a
11.96
13.21
8.98
157,370
162,697
111,618
63,750
9,562
1,624
$
Mortgage Metrics (CSM only):
Origination of loans held for sale
Proceeds from loans held for sale, net of mortgage banking
revenue
Purchase volume as a % of originations
Gain on sale of loans
Gain on sale as a % of loans sold
Credit Card Portfolio Metrics:
Total active customer accounts
Total loans
Total deposits at the Bank
$
337,122
$
418,912
$
853,674
$
754,965
$
493,273
344,940
441,960
844,464
759,350
470,534
79.43%
$
9,477
2.75%
52.50%
10,377
$
2.01%
18.79%
22.51%
15,373
$
11,541
$
1.82%
1.52%
29.83%
7,827
1.66%
169,981
34,673
59,954
$
149,226
31,507
53,625
$
96,404
20,446
39,062
$
63,398
13,812
27,849
$
38,922
9,562
18,415
$
$
_______________
(1) Presentation of this financial measure as of or for the year ended December 31, 2017 excludes the effects of certain non-recurring expenses incurred with the conversion of
our credit card processing systems and the revaluation of our deferred tax assets due to the effects of the Tax Act. See “—GAAP Reconciliation and Management Explanation
of Non-GAAP Financial Measures” for a reconciliation of this financial measure to its most comparable GAAP financial measure.
(2) This financial measure is not recognized under GAAP and is therefore considered to be a non-GAAP measure. See “—GAAP Reconciliation and Management Explanation of
Non-GAAP Financial Measures” for a reconciliation of this financial measure to its most comparable GAAP financial measure.
(3) Net interest margin is a ratio calculated as net interest income divided by average interest earning assets for the same period.
(4) Efficiency ratio is calculated by dividing noninterest expense by net interest income plus noninterest income.
(5)
(6) Gives effect to a four-for-one stock split of our common stock completed effective August 15, 2018. The effect of the stock split on outstanding shares and per share figures
Includes non-accrual loans and loans 90 days and more past due.
has been retroactively applied to all periods presented.
(7) Calculations of diluted earnings per share before bargain purchase gain, diluted earnings per share and diluted earnings per share, as adjusted, include interest on
convertible debt.
(8) Loans exclude loans held for sale at each of the dates presented.
60
GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures
Our accounting and reporting policies conform to GAAP and the prevailing practices in the banking industry. However, we also evaluate our
performance based on certain additional financial measures discussed in this report as being “non-GAAP financial measures.” We classify a
financial measure as a non-GAAP financial measure if that financial measure excludes or includes amounts, or is subject to adjustments that
have the effect of excluding or including amounts, that are not included or excluded, as the case may be, in the most directly comparable
measure calculated and presented in accordance with GAAP as in effect from time to time in the United States in our statements of income,
balance sheets or statements of cash flows. Non-GAAP financial measures do not include operating and other statistical measures or ratios
that are calculated using exclusively financial measures presented in accordance with GAAP.
This report includes certain non-GAAP financial measures for the year ended December 31, 2017 in order to present our results of
operations for that period on a basis consistent with our historical operations. During the fourth quarter of 2017, we undertook a conversion of
our credit card portfolio system to further scale our OpenSky® credit card division. The one-time expense related to this data processing
system conversion was approximately $2.3 million in the fourth quarter of 2017. As a result of the conversion, we refunded or did not charge
our OpenSky® customers for 60 days of interest and applicable fees on their accounts, which resulted in a loss of revenue of approximately
$2.4 million. This forbearance of certain interest and fees on customers’ accounts was conducted in accordance with the safe harbor provisions
of the Truth in Lending Act as implemented by Regulation Z.
The provisions of Regulation Z address, among other areas, open-end credit, such as credit cards or home equity lines, and closed-end
credit, such as car loans or mortgages, as well as certain administrative matters such as a change to the payment address. In connection with
the conversion of our credit card portfolio system, the address for the payment of principal, interest and fees related to our credit card portfolio
was changed and, accordingly, we did not assess certain interest and fees on customers’ accounts for a period of 60 days during the fourth
quarter of 2017 in accordance with the safe harbor provisions of Regulation Z.
We believe that these non-GAAP financial measures provide useful information to management and investors that is supplementary to our
financial condition, results of operations and cash flows computed in accordance with GAAP. However, non-GAAP financial measures have a
number of limitations, are not necessarily comparable to GAAP measures and should not be considered in isolation or viewed as a substitute
for the most directly comparable or other financial measures calculated in accordance with GAAP. Moreover, the manner in which we calculate
non-GAAP financial measures may differ from that of other companies reporting non-GAAP measures with similar names. You should
understand how such other companies calculate their financial measures that may be similar or have names that are similar to the non-GAAP
financial measures discussed herein when comparing such non-GAAP financial measures. Our management uses the non-GAAP financial
measures set forth below in its analysis of our performance.
•
•
•
“Net interest margin, as adjusted” is a non-GAAP measure herein defined as net interest income, plus non-recurring foregone interest
and fees, divided by average interest earning assets.
“Net income, as adjusted” is a non-GAAP measure herein defined as net income, less bargain purchase gain (net of taxes), plus non-
recurring foregone interest and fees, plus non-recurring data processing expenses, plus non-recurring deferred tax revaluation and less
the tax impact of conversion-related items.
“Efficiency ratio, as adjusted” is a non-GAAP measure herein defined as total noninterest expense, less non-recurring data processing
expenses, divided by the sum of net interest income, noninterest income and non-recurring foregone interest and fees.
61
•
•
•
•
•
•
•
“Diluted earnings per share, as adjusted” is a non-GAAP measure herein defined as net income, less bargain purchase gain (net of
taxes), plus non-recurring foregone interest and fees, plus non-recurring data processing expenses, plus non-recurring deferred tax
revaluation, less the tax impact of conversion-related items, divided by the diluted weighted average shares outstanding.
“Return on average assets, as adjusted” is a non-GAAP measure herein defined as net income, less bargain purchase gain (net of
taxes), plus non-recurring foregone interest and fees, plus non-recurring data processing expenses, plus non-recurring deferred tax
revaluation, less the tax impact of conversion-related items, divided by average total assets.
“Return on average equity, as adjusted” is a non-GAAP measure herein defined as net income, less bargain purchase gain (net of
taxes), plus non-recurring foregone interest and fees, plus non-recurring data processing expenses, plus non-recurring deferred tax
revaluation, less the tax impact of conversion-related items, divided by average total equity.
“Tangible common equity” is a non-GAAP measure defined as total stockholders’ equity, less intangible assets.
“Return on average tangible common equity” is a non-GAAP measure herein defined as net income, less bargain purchase gain (net of
taxes), plus the amortization of intangible assets (net of taxes), divided by average total equity net of average intangible assets.
“Return on average tangible common equity, as adjusted” is a non-GAAP measure herein defined as net income, less bargain
purchase gain (net of taxes), plus non-recurring foregone interest and fees, plus non-recurring data processing expenses, plus non-
recurring deferred tax revaluation, less the tax impact of conversion-related items, plus the amortization of intangible assets (net of
taxes), divided by average total equity, net of average intangible assets.
“Tangible book value per share” is a non-GAAP measure defined as total stockholders’ equity, less intangible assets, divided by shares
of common stock outstanding.
The following reconciliation table provides a more detailed analysis of these non-GAAP financial measures:
(Dollars are in thousands, except per share information)
2018
2017
2016
2015
2014
Years Ended December 31,
Net Interest Margin, as adjusted:
Net interest income
Add: Non-recurring foregone interest and fees
Adjusted net interest income
Divide by average interest earning assets
Net interest margin, as adjusted
Net Income, as adjusted:
Net income
Add: Non-recurring foregone interest and fees
Add: Non-recurring data processing expenses
Add: Non-recurring deferred tax revaluation
Less: Tax impact of conversion related items(1)
Net income, as adjusted
$
57,888
$
48,911
$
42,759
$
33,676
$
—
57,888
1,035,731
2,370
51,281
955,479
—
—
42,759
825,676
33,676
671,275
29,717
—
29,717
531,505
5.59%
5.37%
5.18%
5.02%
5.59%
$
12,767
$
—
—
—
—
7,109
2,370
2,275
1,386
(1,847)
$
9,441
$
7,492
$
6,793
—
—
—
—
—
—
—
—
—
—
—
—
$
12,767
$
11,293
$
9,441
$
7,492
$
6,793
62
(Dollars are in thousands, except per share information)
2018
2017
2016
2015
2014
Years Ended December 31,
Efficiency Ratio, as adjusted:
Total noninterest expense
Less: Non-recurring data processing expenses
Adjusted noninterest expense
Net interest income
Add: Noninterest income
Add: Non-recurring foregone interest and fees
Divide by adjusted revenue
Efficiency ratio, as adjusted
$
54,123
$
47,306
$
43,380
$
34,817
$
—
54,123
57,888
16,124
—
74,012
73.13%
2,275
45,031
48,911
15,149
2,370
66,430
67.79%
—
—
43,380
42,759
20,473
—
63,232
68.60%
34,817
33,676
14,929
—
48,605
71.63%
28,821
—
28,821
29,717
11,442
—
41,159
70.02%
Diluted Earnings per Share, as adjusted:
Net income, as adjusted
Add: Convertible debt interest expense
Net income for diluted earnings per share, as adjusted
$
12,767
$
11,293
$
—
—
12,767
$
11,293
$
9,441
$
—
9,441
$
7,492
$
281
7,773
$
6,793
281
7,074
Diluted weighted average shares outstanding(2)
12,462,138
11,428,000
11,289,044
10,488,036
10,279,548
Diluted earnings per share, as adjusted(2)
$
1.02
$
0.99
$
0.84
$
0.74
$
0.69
Return on Average Assets, as adjusted:
Net income, as adjusted
Divide by average total assets
Return on average assets, as adjusted
Return on Average Equity, as adjusted:
Net income, as adjusted
Divide by average total equity
Return on average equity, as adjusted
Tangible Common Equity:
Total stockholders’ equity
Less: intangible assets
Tangible common equity
Return on Average Tangible Common Equity:
Net income
Less: Bargain purchase gain, net of taxes
Add: Intangible asset amortization, net of taxes
Net income excluding intangible amortization, as adjusted
Average total equity
Less: average intangible assets
Divide by average tangible common equity
Return on average tangible common equity
$
12,767
$
11,293
$
9,441
$
7,492
$
1,045,732
964,946
832,619
679,595
1.22%
1.17%
1.13%
1.10%
$
12,767
$
11,293
$
9,441
$
7,492
$
91,590
13.94%
76,543
14.75%
65,590
14.39%
53,883
13.90%
$
$
114,564
$
80,119
$
70,748
$
59,657
$
—
—
—
17
114,564
$
80,119
$
70,748
$
59,640
$
$
12,767
$
7,109
$
9,441
$
7,492
$
—
—
7,109
76,543
—
76,543
9.29%
—
10
9,451
65,590
8
65,582
14.41%
—
14
7,506
53,883
26
53,857
13.94%
—
—
12,767
91,590
—
91,590
13.94%
63
6,793
541,934
1.25%
6,793
45,775
14.84%
50,216
39
50,177
6,793
—
20
6,813
45,775
53
45,722
14.90%
(Dollars are in thousands, except per share information)
2018
2017
2016
2015
2014
Years Ended December 31,
Return on Average Tangible Common Equity, as adjusted:
Net income, as adjusted
$
12,767
$
11,293
$
9,441
$
7,492
$
Add: Intangible asset amortization, net of taxes
—
Net income excluding intangible amortization, as adjusted
Average total equity
Less: average intangible assets
Divide by average tangible common equity
Return on average tangible common equity, as adjusted
12,767
91,590
—
91,590
13.94%
—
11,293
76,543
—
76,543
14.75%
10
9,451
65,590
8
14
7,506
53,883
26
65,582
14.41%
53,857
13.94%
Tangible Book Value per Share:
Total stockholders’ equity
Less: intangible assets
Tangible common equity
Divide by shares of common stock outstanding(2)
Tangible book value per share(2)
$
$
$
114,564
$
80,119
$
70,748
$
59,657
$
—
—
—
17
114,564
$
80,119
$
70,748
$
59,640
$
50,177
13,672,479
11,537,196
11,144,696
10,225,780
9,562,820
8.38
$
6.94
$
6.35
$
5.83
$
5.25
_______________
(1) Assumes an income tax rate of 39.75% for the year ended December 31, 2017, which is tax expense exclusive of the effect of the deferred tax revaluation.
(2) Gives effect to a four-for-one stock split of our common stock completed effective August 15, 2018. The effect of the stock split on outstanding shares and per share figures
has been retroactively applied to all periods presented.
64
6,793
20
6,813
45,775
53
45,722
14.90%
50,216
39
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis is intended as a review of significant factors affecting the Company’s financial condition and results
of operations for the periods indicated. This discussion and analysis should be read in conjunction with the accompanying consolidated
financial statements and the related notes.
The discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Certain risks,
uncertainties and other factors, including but not limited to those set forth under “Cautionary Note Regarding Forward-Looking Statements,”
“Risk Factors” and elsewhere in this Form 10-K, may cause actual results to differ materially from those projected in the forward-looking
statements. We assume no obligation to update any of these forward-looking statements
Results of Operations for the Years Ended December 31, 2018 and 2017
Net Income
The following table sets forth the principal components of net income for the periods indicated.
(in thousands)
Interest income
Interest expense
Net interest income
Provision for loan losses
Net interest income after provision
Noninterest income
Noninterest expense
Net income before income taxes
Income tax expense
Net income
Years Ended December 31,
2018
2017
% Change
$
$
69,127 $
11,239
57,888
2,140
55,748
16,124
54,123
17,749
4,982
12,767 $
56,666
7,755
48,911
2,655
46,256
15,149
47,306
14,099
6,990
7,109
22.0 %
44.9 %
18.4 %
(19.4)%
20.5 %
6.4 %
14.4 %
25.9 %
(28.7)%
79.6 %
Net income for the year ended December 31, 2018 was $12.8 million, an increase of $5.7 million, or 79.6%, from net income for the year
ended December 31, 2017 of $7.1 million. The increase was primarily due to nonrecurring items in 2017 including $2.3 million of nonrecurring
data processing expenses due to a system conversion, $2.4 million of interest and fees waived on our credit card portfolio due to that system
conversion, net the nonrecurring tax impact of $1.8 million on those items, and a nonrecurring tax expense of $1.4 million due to the revaluation
of deferred tax assets as a result of the Tax Act.
Net Interest Income and Net Margin Analysis
We analyze our ability to maximize income generated from interest earning assets and control the interest expenses of our liabilities,
measured as net interest income, through our net interest margin and net interest spread. Net interest income is the difference between the
interest and fees earned on interest earning assets, such as loans and securities, and the interest expense incurred in connection with interest
bearing liabilities, such as deposits and borrowings, which are used to fund those assets. Net interest margin is a ratio calculated as net
interest income divided by average interest earning assets for the same period. Net interest spread is the difference between average interest
rates earned on interest earning assets and average interest rates paid on interest bearing liabilities.
Changes in market interest rates and the interest rates we earn on interest earning assets or pay on
65
interest bearing liabilities, as well as in the volume and types of interest earning assets, interest bearing and noninterest bearing liabilities and
stockholders’ equity, are usually the largest drivers of periodic changes in net interest income, net interest margin and net interest spread.
Fluctuations in market interest rates are driven by many factors, including governmental monetary policies, inflation, deflation, macroeconomic
developments, changes in unemployment, the money supply, political and international conditions and conditions in domestic and foreign
financial markets. Periodic changes in the volume and types of loans in our loan portfolio are affected by, among other factors, economic and
competitive conditions in the Washington, D.C. and Baltimore metropolitan areas, as well as developments affecting the real estate, technology,
government services, hospitality and tourism and financial services sectors within our target markets and throughout the Washington, D.C. and
Baltimore metropolitan areas. Our ability to respond to changes in these factors by using effective asset-liability management techniques is
critical to maintaining the stability of our net interest income and net interest margin as our primary sources of earnings.
66
The following table shows the average outstanding balance of each principal category of our assets, liabilities and stockholders’ equity,
together with the average yields on our assets and the average costs of our liabilities for the periods indicated. Such yields and cost are
calculated by dividing income or expense by the average daily balances of the corresponding assets or liabilities for the same period.
AVERAGE BALANCE SHEET AND NET INTEREST ANALYSIS
Average
Outstanding
Balance
2018
Interest
Income/
Expense
Average
Yield/
Rate
Average
Outstanding
Balance
2017
Interest
Income/
Expense
Average
Yield/
Rate
Average
Outstanding
Balance
2016
Interest
Income/
Expense
Average
Yield/
Rate
Years Ended December 31,
$
41,858
$
1,537
2,724
50,074
939,538
1,035,731
10,001
687
27
143
1,041
67,229
69,127
1.64% $
1.79%
5.26%
2.08%
7.16%
6.67%
$
480
14
108
1,068
54,996
56,666
45,385 $
1,451
2,521
52,419
853,703
955,479
9,467
964,946
1.06% $
0.96%
4.27%
2.04%
6.44%
5.93%
$
31,558 $
1,159
2,665
45,051
745,243
825,676
6,943
832,619
149
5
135
890
48,064
49,243
0.47%
0.41%
5.05%
1.98%
6.45%
5.96%
671,639
32,893
704,532
8,164
175,707
76,543
964,946
9,792
1,447
11,239
1.42% $
4.19%
1.55%
$
57,888
$
5.12%
5.59%
4.28%
6,434
1,321
7,755
0.96% $
4.02%
1.10%
571,066
47,436
618,502
4,857
1,627
6,484
0.85%
3.43%
1.05%
7,002
141,525
65,590
832,619
$
42,759
4.91%
5.18%
4.53%
$
4.83%
5.12%
4.31%
$
48,911
(in thousands)
Assets
Interest earning assets:
Interest bearing deposits
Federal funds sold
Restricted investments
Investment securities
Loans(1)(2)(3)
Total interest earning assets
Noninterest earning assets
Total assets
$
1,045,732
Liabilities and Stockholders’ Equity
Interest bearing liabilities:
Interest bearing deposits
$
689,311
Borrowed funds
Total interest bearing liabilities
Noninterest bearing liabilities:
Noninterest bearing liabilities
Noninterest bearing deposits
Stockholders’ equity
34,558
723,869
9,828
220,445
91,590
Total liabilities and stockholders’ equity
$
1,045,732
Net interest spread(4)
Net interest income
Net interest margin(5)
Net interest margin excluding credit card portfolio
_______________
Includes loans held for sale.
Includes nonaccrual loans.
Interest income includes amortization of deferred loan fees, net of deferred loan costs.
(1)
(2)
(3)
(4) Net interest spread is the difference between interest rates earned on interest earning assets and interest rates paid on interest bearing liabilities.
(5) Net interest margin is a ratio calculated as net interest income divided by average interest earning assets for the same period.
67
The following table presents information regarding the dollar amount of changes in interest income and interest expense for the periods
indicated for each major component of interest earning assets and interest bearing liabilities and distinguishes between the changes
attributable to changes in volume and changes attributable to changes in interest rates. For purposes of this table, changes attributable to both
rate and volume that cannot be segregated have been proportionately allocated to both volume and rate.
ANALYSIS OF CHANGES IN NET INTEREST INCOME
Year Ended December 31, 2018
Year Ended December 31, 2017
Compared to the
Compared to the
Year Ended December 31, 2017
Year Ended December 31, 2016
Change Due To
Change Due To
Volume
Rate
Interest Variance
Volume
Rate
Interest Variance
(In thousands)
Interest Income:
Interest bearing deposits
$
Federal funds sold
Restricted stock
Investment securities
Loans
Total interest income
Interest Expense:
Interest bearing deposits
Borrowed funds
Total interest expense
Net interest income
(34) $
1
9
(49)
5,821
5,748
241 $
12
26
22
6,412
6,713
207 $
13
35
(27)
12,233
12,461
87 $
1
(7)
149
6,987
7,217
174
68
242
3,184
58
3,242
3,358
126
3,484
918
(691)
227
$
5,506 $
3,471 $
8,977 $
6,990 $
245 $
8
(20)
28
(55)
206
659
385
1,044
(838) $
332
9
(27)
177
6,932
7,423
1,577
(306)
1,271
6,152
Net interest income increased by $9.0 million to $57.9 million for the year ended December 31, 2018 compared to the year ended
December 31, 2017. The Company’s total interest income included an increase in interest earning assets and seven market rate increases
between March 15, 2017 and December 19, 2018. The year over year increase of total interest income was impacted by $2.4 million of interest
and fees waived on our credit card portfolio in 2017 due to a system conversion. Average total interest earning assets were $1.0 billion for the
year ended December 31, 2018 compared with $955.5 million for the year ended December 31, 2017. The yield on those interest earning
assets increased 74 basis points from 5.93% for 2017 to 6.67% for 2018. The increase in the average balance of interest earning assets was
driven almost entirely by growth in the average balance of the loan portfolio of $85.8 million, or 10%, to $939.5 million for the year ended
December 31, 2018 compared to $853.7 million for the year ended December 31, 2017.
Average interest bearing liabilities increased by $19.3 million from $704.5 million for the year ended December 31, 2017 to $723.9 million
for the year ended December 31, 2018. The increase was due to an increase in the average balance of interest bearing deposits of $17.7
million, or 3%, and an increase in the average balance of borrowed funds of $1.7 million, or 5%. Deposits are our primary funding source. The
increase in the average balance of interest bearing deposits was primarily due to increases in certificates of deposit and money market
accounts for the year ended December 31, 2018 compared to the year ended December 31, 2017, and, to a lesser extent, NOW accounts. The
average interest rate paid on interest bearing liabilities increased to 1.55% for 2018 compared to 1.10% for 2017, while the average interest
rate paid on interest bearing deposits increased 46 basis points and the average interest rate paid on borrowed funds decreased by 17 basis
points. The increases in average interest rates reflect an increase in market interest rates between March 2017 and December 2018. For the
year ended December 31, 2018, the Company’s net interest margin was 5.59% and net interest spread was 5.12%. For the year ended
December 31, 2017, net interest margin was 5.12% and net interest spread was 4.83%. With the impact of the Company’s 2017 non-recurring
foregone interest and fees of $2.4 million for the credit card portfolio, the net interest
68
margin as adjusted was 5.37% for the year ended December 31, 2017, compared to 5.59% for the year ended December 31, 2018, an
increase of 22 basis points year over year.
Provision for Loan Losses
The provision for loan losses is a charge to income in order to bring our allowance for loan losses to a level deemed appropriate by
management. For a description of the factors taken into account by our management in determining the allowance for loan losses see
“Financial Condition—Allowance for Loan Losses.”
Our provision for loan losses amounted to $2.1 million for the year ended December 31, 2018 and $2.7 million for the year ended
December 31, 2017. Our allowance for loan losses as a percent of total loans remained steady at 1.13% at December 31, 2018 and 2017.
Charge-offs amounted to $1.1 million for the year ended December 31, 2018 compared to $1.7 million for the year ended December 31, 2017.
The credit card portfolio represented 74% and 68%, respectively, of total charge-offs.
Noninterest Income
Our primary sources of recurring noninterest income are service charges on deposit accounts, certain credit card fees, such as interchange
fees and statement fees, and mortgage banking revenue. Noninterest income does not include (i) loan origination fees to the extent they
exceed the direct loan origination costs, which are generally recognized over the life of the related loan as an adjustment to yield using the
interest method or (ii) annual, renewal and late fees related to our credit card portfolio, which are generally recognized over the twelve month
life of the related loan as an adjustment to yield using the interest method.
The following table presents, for the periods indicated, the major categories of noninterest income:
NONINTEREST INCOME
(in thousands)
Noninterest income:
Service charges on deposit accounts
Credit card fees
Mortgage banking revenue
Loss on sale of securities
Loss on sale of foreclosed real estate
Loss on disposal of premises and equipment
Other fees and charges
Total noninterest income
Years Ended December 31,
2018
2017
% Change
$
$
484 $
6,048
9,477
(2)
(21)
(276)
414
16,124 $
460
4,014
10,377
—
(52)
(77)
427
15,149
5.2 %
50.7 %
(8.7)%
— %
(59.6)%
258.4 %
(3.0)%
6.4 %
Noninterest income for the the year ended December 31, 2018 was $16.1 million, a $975 thousand or 6% increase compared to
noninterest income of $15.1 million for the year ended December 31, 2017. Credit card fees increased $2.0 million, or 51%, for the year ended
December 31, 2018 to $6.0 million compared to $4.0 million for the year ended December 31, 2017, primarily as a result of an increase in
outstanding cards from 149,226 at December 31, 2017 to 169,981 at December 31, 2018. Mortgage banking revenue decreased $900
thousand, or 9%, during 2018 to $9.5 million compared to $10.4 million for 2017. In response to changing market conditions during 2017, we
shifted our mortgage origination focus within Church Street Mortgage, which had been heavily dependent on refinance transactions, to
purchase transactions, which have slightly higher rates and prices. Proceeds from the sale of loans held for sale amounted to $354.4 million for
the year ended December 31, 2018 compared to $452.3 million for the year ended December 31, 2017.
69
Noninterest Expense
Generally, noninterest expense is composed of all employee expenses and costs associated with operating our facilities, obtaining and
retaining customer relationships and providing bank services. The largest component of noninterest expense is salaries and employee benefits.
Noninterest expense also includes operational expenses, such as occupancy and equipment expenses, professional fees, advertising
expenses, loan processing expenses and other general and administrative expenses, including FDIC assessments, communications, travel,
meals, training, supplies and postage.
The following table presents, for the periods indicated, the major categories of noninterest expense:
NONINTEREST EXPENSE
(in thousands)
Noninterest expense:
Salaries and employee benefits
Occupancy and equipment
Professional services
Data processing
Advertising
Loan processing
Other real estate expense, net
Other
Total noninterest expense
Years Ended December 31,
2018
2017
% Change
$
$
25,164 $
4,319
2,124
14,184
1,460
1,077
28
5,767
54,123 $
23,819
3,829
1,874
9,621
1,922
1,409
32
4,800
47,306
5.6 %
12.8 %
13.3 %
47.4 %
(24.0)%
(23.6)%
(12.5)%
20.1 %
14.4 %
Noninterest expense amounted to $54.1 million for the year ended December 31, 2018, an increase of $6.8 million, or 14%, compared to
$47.3 million for the year ended December 31, 2017. The increase was primarily due to an increase in data processing expenses and, to a
lesser extent, increases in salaries and employee benefits, occupancy and equipment expenses, professional services and other expenses.
During 2017, to further scale the business and enhance our capabilities, we converted our credit card processing system to a new vendor. Data
processing costs will continue to be a significant expense due to the growth of our credit card, mortgage and commercial banking businesses.
Salaries and employee benefits increased mainly due to additional personnel. Occupancy and equipment expenses increased due to additional
software licensing fees related to our credit card platform, and rental expense associated with our new branch locations in Columbia, Maryland
and Reston, Virginia. The increase in professional services was primarily due to audit and other outside services related to being a public
company, and other expenses increased due to other credit card expenses.
Income Tax Expense
The amount of income tax expense we incur is influenced by our pre-tax income and our other nondeductible expenses. Deferred tax
assets and liabilities are reflected at current income tax rates in effect for the period in which the deferred tax assets and liabilities are expected
to be realized or settled. As changes in tax laws or rates are enacted, such as the Tax Act deferred tax assets and liabilities are adjusted
through the provision for income taxes. Valuation allowances are established when necessary to reduce deferred tax assets to the amount
expected to be realized.
Income tax expense was $5.0 million for 2018 compared to $7.0 million for 2017. Our effective tax rates for those periods were 28% and
50%, respectively. Our effective tax rate decreased in 2018 primarily as a result of the Tax Act, which includes a number of changes to existing
U.S. tax laws that impact the Company, most notably a reduction of the U.S. corporate income tax rate to 21% for tax years beginning after
December
70
31, 2017, as well as the significant charge of $1.4 million taken in 2017 to revalue deferred tax assets due to the Tax Act.
Financial Condition
As of December 31, 2018, our total assets increased $79.0 million from December 31, 2017 to approximately $1.1 billion. Loans receivable
and cash increased, while interest bearing deposits at other financial institutions, loans held for sale and securities decreased over that period.
Deposits increased $50.3 million, and securities sold under agreements to repurchase decreased $7.9 million due mainly to transfers of
customer deposits to interest bearing checking accounts. Stockholders’ equity increased $34.4 million, or 43%, to $114.6 million at
December 31, 2018, primarily due to our IPO which closed on September 28, 2018, including the exercise in full by the underwriters of their
option to purchase an additional 334,310 shares of our common stock on October 4, 2018, and our 2018 net income.
Interest Bearing Deposits at Other Financial Institutions
As of December 31, 2018, interest bearing deposits at other financial institutions decreased $18.4 million, or 45%, to $22.0 million from
$40.4 million at December 31, 2017. The decrease was primarily due to increased loan funding during the year ended December 31, 2018.
Securities
We use our securities portfolio to provide a source of liquidity, provide an appropriate return on funds invested, manage interest rate risk,
meet collateral requirements and meet regulatory capital requirements.
Management classifies investment securities as either held to maturity or available for sale based on our intentions and the Company’s
ability to hold such securities until maturity. In determining such classifications, securities that management has the positive intent and the
Company has the ability to hold until maturity are classified as held to maturity and carried at amortized cost. All other securities are designated
as available for sale and carried at estimated fair value with unrealized gains and losses included in shareholders’ equity on an after-tax basis.
For the years presented, all securities were classified as available for sale.
Our investment portfolio decreased 13%, or approximately $7.1 million, from $54.0 million at December 31, 2017, to $46.9 million at
December 31, 2018 primarily due to paydowns received on mortgage-backed securities. To supplement interest income earned on our loan
portfolio, we invest in high quality mortgage-backed securities, government agency bonds, high quality municipal and corporate bonds.
The following tables summarize the contractual maturities and weighted-average yields of investment securities at December 31, 2018 and
the amortized cost and carrying value of those securities as of the indicated dates.
71
INVESTMENT PORTFOLIO
One Year or Less
More Than One Year Through
Five Years
More Than Five Years
Through 10 Years
More Than 10 Years
Total
At December 31, 2018
Book Value Weighted
Average Yield Book Value Weighted
Average Yield Book Value Weighted
Average Yield Book Value Weighted
Average Yield Book Value
Fair Value
Weighted
Average Yield
(dollars in thousands)
Securities Available for Sale:
U.S. government-sponsored
agencies
Municipal
Corporate bonds
Mortgage-backed securities
Total
$ 16,496
—
—
2
$ 16,498
(in thousands)
Securities Available for Sale:
U.S. government-sponsored agencies
Municipal
Corporate bonds
Mortgage-backed securities
Total
Loan Portfolio
1.38% $ 1,000
—
—%
—
—%
5.53%
—
1.38% $ 1,000
1.45% $
—%
—%
—%
—
—
2,000
13,279
1.45% $ 15,279
—
—% $
517
—%
908
5.50%
1.38%
13,555
1.92% $ 14,980
—% $ 17,496 $
517
2,908
26,836
2.49%
5.69%
2.76%
2.93% $ 47,757 $
17,360
501
2,885
26,186
46,932
1.47%
2.49%
3.69%
2.23%
2.04%
2018
December 31,
2017
2016
Book Value Fair Value Book Value Fair Value Book Value
Fair Value
$
$
17,496 $
517
2,908
26,836
47,757 $
17,360 $
501
2,885
26,186
46,932 $
17,489 $
518
3,060
33,310
54,377 $
17,370 $
515
3,077
33,067
54,029 $
17,480 $
—
3,060
27,490
48,030 $
17,468
—
3,079
27,438
47,985
Our primary source of income is derived from interest earned on loans. Our loan portfolio consists of loans secured by real estate as well
as commercial business loans, credit card loans, substantially all of which are secured by corresponding deposits at the Bank and, to a very
limited extent, other consumer loans. Our loan customers primarily consist of small- to medium-sized businesses, professionals, real estate
investors, small residential builders and individuals. Our owner-occupied and investment commercial real estate loans, residential construction
loans and commercial business loans provide us with higher risk-adjusted returns, shorter maturities and more sensitivity to interest rate
fluctuations, and are complemented by our relatively lower risk residential real estate loans to individuals. To a lesser but growing extent, our
credit card portfolio supplements our traditional lending products with enhanced yields. Our lending activities are principally directed to our
market area consisting of the Washington, D.C. and Baltimore metropolitan areas.
72
The following table summarizes our loan portfolio by type of loan as of the dates indicated:
COMPOSITION OF LOAN PORTFOLIO
2018
2017
December 31,
2016
2015
2014
(in thousands)
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Real estate:
Residential
$
Commercial
Construction
Commercial
Credit card
Other consumer
407,844
278,691
157,586
122,264
34,673
1,202
Total gross loans
1,002,260
Unearned income
(1,992)
Total loans, net of
unearned income
1,000,268
41% $
28
16
12
3
—
100%
Allowance for loan
losses
Total net loans
$
(11,308)
988,960
$
342,684
259,853
144,932
108,982
31,507
1,053
889,011
(1,591)
887,420
(10,033)
877,387
39%
29
16
12
4
—
100%
35%
30
20
12
2
1
100%
286,332
234,869
134,540
87,563
20,446
1,157
764,907
(1,477)
763,430
(8,597)
754,833
37%
31
18
11
3
—
100%
225,185
190,776
129,304
79,003
13,812
2,233
640,313
(963)
639,350
(6,573)
632,777
31%
32
22
13
2
—
100%
157,370
162,697
111,618
63,750
9,562
1,624
506,621
(282)
506,339
(5,531)
500,808
Residential Real Estate Loans. We offer one-to-four family mortgage loans primarily on owner-occupied primary residences and, to a lesser
extent, investor owned residences. Residential loans are originated through our commercial sales teams and our Church Street Mortgage
division. Our residential loans also include home equity lines of credit. Our one-to-four family residential loans have a relatively small balance
spread between many individual borrowers compared to our other loan categories. Our owner-occupied residential real estate loans usually
have fixed rates for five or seven years and adjust on an annual basis after the initial term based on a typical maturity of 30 years. Our investor
residential real estate loans are based on 25-year terms with a balloon payment due after five years. The required minimum debt service
coverage ratio is 1.15. Residential real estate loans have represented a stable and growing portion of our loan portfolio. We intend to continue
to emphasize residential real estate lending.
Commercial Real Estate Loans. We originate both owner-occupied and non-owner-occupied commercial real estate loans. These loans
may be more adversely affected by conditions in the real estate markets or in the general economy. Commercial loans that are secured by
owner-occupied commercial real estate and primarily collateralized by operating cash flows are also included in this category of loans. As of
December 31, 2018, we had approximately $129.1 million of owner-occupied commercial real estate loans, representing approximately 46% of
our commercial real estate portfolio. Commercial real estate loan terms are generally extended for 10 years or less and amortize generally over
25 years or less. The interest rates on our commercial real estate loans have initial fixed rate terms that adjust typically at 5 years and we
routinely charge an origination fee for our services. We generally require personal guarantees from the principal owners of the business,
supported by a review of the principal owners’ personal financial statements and global debt service obligations. The properties securing the
portfolio are located primarily throughout our markets and are generally diverse in terms of type. This diversity helps reduce the exposure to
adverse economic events that affect any single industry.
Construction Loans. Our construction loans are offered within our Washington, D.C. and Baltimore, Maryland metropolitan operating areas
to builders primarily for the construction of single-family homes and condominium and townhouse conversions or renovations and, to a lesser
extent, to individuals. Our construction loans typically have terms of 12 to 18 months with the goal of transitioning the borrowers to permanent
financing or re-underwriting and selling into the secondary market through Church Street Mortgage. According to our underwriting standards,
the ratio of loan principal to collateral value, as established by an independent appraisal, cannot exceed 75% for investor-owned and 80% for
owner-occupied properties. We conduct semi-annual stress testing of our construction loan portfolio and closely monitor underlying real estate
conditions as well as our borrower’s trends of sales valuations as compared to underwriting valuations as part of our ongoing risk management
efforts. We also closely monitor our borrowers’ progress in construction buildout and strictly enforce our original underwriting guidelines for
construction milestones and completion timelines.
73
Commercial Business Loans. In addition to our other loan products, we provide general commercial loans, including commercial lines of
credit, working capital loans, term loans, equipment financing, letters of credit and other loan products, primarily in our target markets, and
underwritten based on each borrower’s ability to service debt from income. These loans are primarily made based on the identified cash flows
of the borrower and secondarily, on the underlying collateral provided by the borrower. Most commercial business loans are secured by a lien
on general business assets including, among other things, available real estate, accounts receivable, promissory notes, inventory and
equipment, and we generally obtain a personal guaranty from the borrower or other principal.
Credit Cards. Through our OpenSky® credit card division, we provide credit cards on a nationwide basis to under-banked populations and
those looking to rebuild their credit scores through a fully digital and mobile platform. Substantially all of the lines of credit are secured by a
noninterest bearing demand account at the Bank in an amount equal to the full credit limit of the credit card. In addition, using our proprietary
scoring model, which considers credit score and repayment history (typically a minimum of six months of on-time repayments, but ultimately
determined on a case-by-case basis) the Bank has recently begun to offer certain customers an unsecured line in excess of their secured line
of credit.
Other Consumer Loans. To a very limited extent and typically as an accommodation to existing customers, we offer personal consumer
loans such as term loans, car loans or boat loans.
The repayment of loans is a source of additional liquidity for us. The following table details maturities and sensitivity to interest rate
changes for our loan portfolio at December 31, 2018:
LOAN MATURITY AND SENSITIVITY TO CHANGES IN INTEREST RATES
(in thousands)
Real estate:
Residential
Commercial
Construction
Commercial
Credit card
Other consumer
Total loans
Amounts with fixed rates
Amounts with floating rates
Nonperforming Assets
Due in One Year
or Less
Due in One to
Five Years
Due After
Five Years
Total
As of December 31, 2018
$
$
$
$
113,517 $
66,333
147,072
61,724
34,673
653
423,972 $
107,708 $
316,264 $
100,412 $
134,505
10,514
48,615
—
549
294,595 $
217,545 $
77,050 $
193,915 $
77,853
—
11,925
—
—
283,693 $
44,964 $
238,729 $
407,844
278,691
157,586
122,264
34,673
1,202
1,002,260
370,217
632,043
Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were
due. Loans are placed on nonaccrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they
become due, as well as when required by regulatory provisions. Loans may be placed on nonaccrual status regardless of whether or not such
loans are considered past due. In general, we place loans on nonaccrual status when they become 90 days past due. We also place loans on
nonaccrual status if they are less than 90 days past due if the collection of principal or interest is in doubt. When interest accrual is
discontinued, all unpaid accrued interest is reversed from income. Interest income is subsequently recognized only to the extent cash
payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually
due are brought current and future payments are, in management’s opinion, reasonably assured. Any loan which the Bank deems to be
uncollectible, in whole or in part, is charged off to the extent of the anticipated loss. Consumer credit card balances are moved into the charge
off queue after they become more than 90 days past due and are charged off not later than 120 days after they become past due. Loans that
are past due for 180 days or more are charged off unless the loan is well secured and in the process of collection.
74
We believe our disciplined lending approach and focused management of nonperforming assets has resulted in sound asset quality and
timely resolution of problem assets. We have several procedures in place to assist us in maintaining the overall quality of our loan portfolio. We
have established underwriting guidelines to be followed by our bankers, and we also monitor our delinquency levels for any negative or
adverse trends. There can be no assurance, however, that our loan portfolio will not become subject to increasing pressures from deteriorating
borrower credit due to general economic conditions.
Nonperforming loans decreased to $4.7 million, or 0.47% of total loans, at December 31, 2018 compared to $5.4 million, or 0.61% of total
loans, at December 31, 2017. Foreclosed real estate increased to $142 thousand as of December 31, 2018 compared to $93 thousand as of
December 31, 2017 due to the foreclosure of a construction loan for $188 thousand and two non-owner occupied residential loans totaling
$179 thousand in the aggregate. OREO of approximately $357 thousand was sold during 2018. Accruing restructured loans decreased $3.2
million between December 31, 2017 and December 31, 2018 primarily due to two restructured performing loans which were repaid in full in
April 2018.
Total nonperforming assets were $4.8 million at December 31, 2018 compared to $5.5 million at December 31, 2017, or 0.44% and 0.54%,
respectively, of corresponding total assets.
The following table presents information regarding nonperforming assets at the dates indicated:
NONPERFORMING ASSETS
(in thousands)
Nonaccrual loans
Real Estate:
Residential
Commercial
Construction
Commercial
Accruing loans 90 or more days past due
Total nonperforming loans
Other real estate owned
Total nonperforming assets
Restructured loans-nonaccrual
Restructured loans-accruing
Nonperforming loans to total loans
Nonperforming assets to total assets
Potential Problem Loans
2018
2017
2016
2015
2014
December 31,
$
$
$
$
$
2,207
1,486
—
749
237
4,679
142
4,821
$
284
$
— $
0.47%
0.44%
1,828
1,648
499
1,067
365
5,407
93
5,500
$
1,822
1,193
—
750
753
4,518
90
2,392
1,675
—
936
772
5,775
203
4,608
$
5,978
$
592
3,219
0.61%
0.54%
941
$
— $
0.59%
0.51%
$
$
2,155
267
0.90%
0.80%
2,440
3,182
—
673
64
6,359
454
6,813
2,300
468
1.26%
1.10%
From a credit risk standpoint, we grade watchlist and problem loans into one of five categories: pass/watch, special mention, substandard,
doubtful or loss. The classifications of loans reflect a judgment about the risks of default and loss associated with the loan. We review the
ratings on credits regularly. Ratings are adjusted regularly to reflect the degree of risk and loss that our management believes to be appropriate
for each credit. Our methodology is structured so that specific reserve allocations are increased in accordance with deterioration in credit
quality (and a corresponding increase in risk and loss) or decreased in accordance with improvement in credit quality (and a corresponding
decrease in risk and loss). Our lending policy requires the routine monitoring of weekly past due reports, daily overdraft reports, monthly
maturing loans, monthly risk rating reports and internal loan review reports. The lending and credit management of the Bank remain actively
engaged in weekly meetings to review loans rated pass/watch. The focus of each meeting is to identify and promptly determine any necessary
required action with this loan population, which consists of loans that, although considered satisfactory and performing to terms, may exhibit
special risk features that warrant management’s attention.
75
Loans that are deemed special mention, substandard, doubtful or loss are listed in the Bank’s Problem Loan Status Report. The Problem
Loan Status Report provides a detailed summary of the borrower and guarantor status, loan accrual status, collateral evaluation and includes a
description of the planned collection and administration program designed to mitigate the Bank’s risk of loss and remove the loan from problem
status. The Special Asset Committee reviews the Problem Loan Status Report on a quarterly basis for borrowers with an overall loan exposure
in excess of $250,000.
The Bank uses the following definitions for watch list risk ratings:
•
Pass/Watch. Borrowers who are considered satisfactory and performing to terms, however exhibit special risk features such as
declining earnings, strained cash flow, increasing leverage, and/or weakening fundamentals that indicate above average risk.
•
Special Mention. A special mention loan has potential weaknesses deserving of management’s attention. If uncorrected, such
weaknesses may result in deterioration of the repayment prospects for the asset or in our credit position at some future date.
•
Substandard. A substandard loan is inadequately protected by the current financial condition and paying capacity of the obligor or of
the collateral pledged, if any. Assets so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They
are characterized by the distinct possibility that we will sustain some loss if deficiencies are not corrected. Loss potential, while existing in the
aggregate amount of substandard assets, does not have to exist in individual assets that are classified as substandard.
•
Doubtful. A doubtful loan has all weaknesses inherent in one classified as substandard, with the added characteristic that weaknesses
make collection or liquidation in full, on the basis of existing facts, conditions, and values, highly questionable and improbable. The probability
of loss is extremely high, but certain important and reasonably specific factors that may work to the advantage and strengthening of the asset
exist. Therefore, its classification as an estimated loss is deferred until a more precise status may be determined by management. Pending
factors include proposed merger, acquisition or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing
plans.
Loss. Credits rated as loss are charged-off. We have no expectation of the recovery of any payments in respect of credits rated as
•
loss.
76
Loans not meeting the criteria above are considered to be pass-rated loans. The following tables present the loan balances by category as
well as risk rating. No assets were classified as loss during the periods presented.
(in thousands)
December 31, 2018
Real estate:
Residential
Commercial
Construction
Commercial
Credit card
Other consumer
Total
December 31, 2017
Real estate:
Residential
Commercial
Construction
Commercial
Credit card
Other consumer
Total
LOAN CLASSIFICATION
Pass(1)
Special Mention
Substandard
Doubtful
Total
$
$
$
$
405,532 $
274,247
154,643
117,670
34,673
1,202
987,967 $
340,854 $
251,292
144,433
101,868
31,507
1,053
871,007 $
118 $
2,958
843
3,844
—
—
7,763 $
— $
6,175
—
5,730
—
—
11,905 $
2,194 $
1,486
2,100
750
—
—
6,530 $
1,830 $
2,386
499
1,384
—
—
6,099 $
— $
—
—
—
—
—
— $
— $
—
—
—
—
—
— $
407,844
278,691
157,586
122,264
34,673
1,202
1,002,260
342,684
259,853
144,932
108,982
31,507
1,053
889,011
_______________
(1) Category includes loans graded exceptional, very good, good, satisfactory and pass / watch.
At December 31, 2018, the recorded investment in impaired loans was $4.4 million, $386 thousand of which required a specific reserve of
$262 thousand compared to a recorded investment in impaired loans of $8.2 million including $366 thousand requiring a specific reserve of $60
thousand at December 31, 2017. Of the $8.2 million of impaired loans at December 31, 2017, approximately $3.1 million was related to one
loan relationship. The Bank received payment in full on the $3.1 million indebtedness in April 2018.
Impaired loans also include certain loans that have been modified as troubled debt restructurings (“TDRs”). At December 31, 2018, the
Company had four loans amounting to $284 thousand that were considered to be TDRs, compared to nine loans amounting to $3.8 million at
December 31, 2017. The decline from December 31, 2017 to December 31, 2018 was largely due to one accruing TDR relationship amounting
to $3.1 million that was paid in full during the period.
Allowance for Loan Losses
We maintain an allowance for loan losses that represents management’s best estimate of the loan losses and risks inherent in our loan
portfolio. The amount of the allowance for loan losses should not be interpreted as an indication that charge-offs in future periods will
necessarily occur in those amounts, or at all. In determining the allowance for loan losses, we estimate losses on specific loans, or groups of
loans, where the probable loss can be identified and reasonably determined. The balance of the allowance for loan losses is based on
internally assigned risk classifications of loans, historical loan loss rates, changes in the nature of our loan portfolio, overall portfolio quality,
industry concentrations, delinquency trends, current economic factors and the estimated impact of current economic conditions on certain
historical loan loss rates.
77
The following table presents a summary of changes in the allowance for loan losses for the periods and dates indicated:
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
(in thousands)
2018
2017
2016
2015
2014
Allowance for loan losses at beginning of period
$
10,033
$
8,597
$
6,573
$
5,531
$
4,735
For the Years Ended December 31,
Charge-offs:
Real estate:
Residential
Commercial
Construction
Commercial
Credit card
Other consumer
Total charge-offs
Recoveries:
Real estate:
Residential
Commercial
Construction
Commercial
Credit card
Other consumer
Total recoveries
Net charge-offs
Provision for loan losses
(121)
(22)
—
(147)
(806)
—
(190)
(312)
—
(25)
(1,124)
—
(42)
(62)
—
(1,765)
(640)
—
(1,096)
(1,651)
(2,509)
3
152
—
34
42
—
231
(865)
2,140
—
115
—
3
314
—
432
(1,219)
2,655
7
89
—
8
138
—
242
(2,267)
4,291
$
8,597
1.13%
0.33%
(13)
(154)
—
(263)
(230)
—
(660)
—
—
76
17
—
—
93
(567)
1,609
$
6,573
1.03%
0.10%
(294)
(20)
—
(139)
—
—
(453)
6
—
—
13
—
—
19
(434)
1,230
5,531
1.09%
0.09%
Allowance for loan losses at period end
Allowance for loan losses to period end loans
Net charge-offs to average loans
$
11,308
$
10,033
$
1.13%
0.09%
1.13%
0.15%
Our allowance for loan losses at December 31, 2018 and December 31, 2017 was $11.3 million and $10.0 million, respectively, or 1.13% of
loans for each respective period end. The allowance for loan losses at December 31, 2018 included specific reserves of $262 thousand set
aside for impaired loans. Our charge-offs for the year ended December 31, 2018 were $1.1 million and were partially offset by recoveries of
$231 thousand. The allowance for loan losses at December 31, 2017 included specific reserves of $60 thousand set aside for impaired loans.
Our charge-offs for the year ended December 31, 2017 were $1.7 million and were partially offset by recoveries of $432 thousand. The charge-
offs for the years ended December 31, 2018 and 2017 were primarily due to credit card charge-offs as a result of growth in our credit card
portfolio and certain charges in excess of credit limits.
Although we believe that we have established our allowance for loan losses in accordance with GAAP and that the allowance for loan
losses was adequate to provide for known and inherent losses in the portfolio at all times shown above, future provisions for loan losses will be
subject to ongoing evaluations of the risks in our loan portfolio.
The following table shows the allocation of the allowance for loan losses among loan categories and certain other information as of the
dates indicated. The total allowance is available to absorb losses from any loan category.
78
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
2018
2017
December 31,
2016
2015
2014
Amount
Percent(1)
Amount
Percent(1)
Amount
Percent(1)
Amount
Percent(1)
Amount
Percent(1)
30% $
27
19
14
10
—
3,137
2,860
1,646
1,497
885
8
100% $
10,033
31%
29
16
15
9
—
100%
2,664
2,682
1,591
1,174
477
9
8,597
30%
31
19
14
6
—
100%
2,006
2,111
1,565
727
110
53
6,572
30%
32
24
11
2
1
100%
1,458
1,967
1,257
811
—
38
5,531
26%
36
23
15
—
—
100%
(in thousands)
Real estate:
Residential
Commercial
Construction
Commercial
Credit card
Other consumer
Total allowance for loan
$
3,541
3,003
2,093
1,578
1,084
9
losses
_______________
(1) Loan category as a percentage of total loans.
$
11,308
Deposits
Deposits are the major source of funding for the Company. We offer a variety of deposit products including NOW, savings, money market
and time accounts all of which we actively market at competitive pricing. We generate deposits from our customers on a relationship basis and
through the efforts of our commercial lending officers and our business banking officers. Our credit card customers are also a significant source
of low cost deposits. As of December 31, 2018, our credit card customers accounted for $60.0 million, or 25%, of our total noninterest bearing
deposit balances. We supplement our deposits with wholesale funding sources such as the Certificate of Deposit Account Registry Service
(“CDARS”) and brokered deposits.
Interest bearing deposits increased $4.7 million, or 0.67%, from December 31, 2017 to December 31, 2018 primarily due to a limited
number of large withdrawals in commercial money market accounts. During the same period, certificates of deposit increased $18.1 million or
31% due mainly to two large public fund accounts. In order to fund the loan growth of the Bank, we built upon our prior success of focusing our
strategic efforts to grow core deposits through an expanded deposits sales force, incentives to our commercial loan team and increased
marketing efforts. The average rate paid on interest bearing deposits increased 46 basis points from 0.96% for the year ended December 31,
2017 to 1.42% for the year ended December 31, 2018. Rates paid on certificates of deposit increased 57 basis points over the same period.
The increase in the average rates was primarily due to increases in market interest rates.
The following table presents the average balances and average rates paid on deposits for the periods indicated:
COMPOSITION OF DEPOSITS
(in thousands)
NOW accounts
Money market accounts
Savings accounts
Certificates of deposit
Total interest bearing deposits
Noninterest bearing demand accounts
Total deposits
2018
December 31,
2017
2016
Average
Balance
Average
Rate
Average
Balance
Average
Rate
Average
Balance
Average
Rate
$
$
72,523
286,257
3,704
326,827
689,311
220,445
909,756
0.29% $
1.33%
0.32%
1.77%
1.42%
1.08% $
69,455
282,840
3,365
315,979
671,639
175,707
847,346
0.22% $
0.88%
0.15%
1.20%
0.96%
0.76% $
50,628
252,486
3,326
264,626
571,066
141,525
712,591
0.21%
0.81%
0.15%
1.02%
0.85%
0.68%
79
The following table presents the maturities of our certificates of deposit as of December 31, 2018.
MATURITIES OF CERTIFICATES OF DEPOSIT
(in thousands)
$100,000 or more
Less than $100,000
Total
Borrowings
Three
Months or
Less
Over
Three
Through
Six
Months
Over Six
Through
Twelve
Months
Over
Twelve
Months
$
$
85,739 $
21,242
106,981 $
36,718 $
13,378
50,096 $
87,371 $
20,379
107,750 $
62,357 $
8,288
70,645 $
Total
272,185
63,287
335,472
We primarily utilize short-term and long-term borrowings to supplement deposits to fund our lending and investment activities, each of
which is discussed below.
FHLB Advances. The FHLB allows us to borrow up to 25% of our assets on a blanket floating lien status collateralized by certain securities
and loans. As of December 31, 2018, approximately $235.2 million in real estate loans and $6.7 million in investment securities were pledged
as collateral for our FHLB borrowings. We utilize these borrowings to meet liquidity needs and to fund certain fixed rate loans in our portfolio.
As of December 31, 2018, we had $2.0 million in outstanding advances and $185.6 million in available borrowing capacity from the FHLB.
The following table sets forth certain information on our FHLB borrowings during the periods presented:
FHLB ADVANCES
(in thousands)
Amount outstanding at period-end
Weighted average interest rate at period-end
Maximum month-end balance during the period
Average balance outstanding during the period
Weighted average interest rate during the period
$
$
$
Years Ended December 31,
2018
2017
2016
$
2,000
4.26%
$
2,000
4.26%
$
$
17,000
8,101
2.83%
$
$
11,000
4,910
3.23%
6,000
3.03%
21,000
16,516
1.53%
Other borrowed funds. The Company has also issued a senior promissory note, junior subordinated debentures and other subordinated
notes. At December 31, 2018, these other borrowings amounted to $15.4 million.
On July 30, 2014, we issued a senior promissory note in an aggregate principal amount of $5.0 million, which was scheduled to mature on
July 31, 2019. The senior promissory note was repaid during the first quarter of 2018.
At December 31, 2018, our junior subordinated debentures amounted to $2.1 million. The junior subordinated debentures were issued in
June of 2006, mature on June 15, 2036, and may be redeemed prior to that date under certain circumstances. The principal amount of the
debentures has not changed since issuance, and they accrue interest at a floating rate equal to the three-month LIBOR plus 1.87%.
On November 24, 2015, the Company issued $13.5 million in aggregate principal amount of subordinated notes with a maturity date of
December 1, 2025. The notes may be redeemed prior to the maturity date under certain circumstances. The notes bear interest at 6.95% for
the first five years, then adjust to the three-month LIBOR plus 5.33%.
Federal Reserve Bank of Richmond. The Federal Reserve Bank of Richmond has an available borrower in custody arrangement which
allows us to borrow on a collateralized basis. The Company’s borrowing capacity
80
under the Federal Reserve’s discount window program was $13.1 million as of December 31, 2018. Certain commercial loans are pledged
under this arrangement. We maintain this borrowing arrangement to meet liquidity needs pursuant to our contingency funding plan. No
advances were outstanding under this facility as of December 31, 2018.
The Company also has available lines of credit of $28.0 million with other correspondent banks at December 31, 2018, as well as access to
certificate of deposit funding through a financial network which is limited to 15% of the Bank’s assets. The total outstanding lines of credit, or
federal funds purchased from correspondent banks was $2.0 million at December 31, 2018.
The Company also sells securities under repurchase agreements to provide cash management services to commercial account customers.
These borrowings totaled $3.3 million as of December 31, 2018.
81
Liquidity
Liquidity is defined as the Bank’s capacity to meet its cash and collateral obligations at a reasonable cost. Maintaining an adequate level of
liquidity depends on the Bank’s ability to meet both expected and unexpected cash flows and collateral needs efficiently without adversely
affecting either daily operations or the financial condition of the Bank. Liquidity risk is the risk that we will be unable to meet our obligations as
they become due because of an inability to liquidate assets or obtain adequate funding. The Bank’s obligations, and the funding sources used
to meet them, depend significantly on our business mix, balance sheet structure and the cash flow profiles of our on- and off-balance sheet
obligations. In managing our cash flows, management regularly confronts situations that can give rise to increased liquidity risk. These include
funding mismatches, market constraints on the ability to convert assets into cash or in accessing sources of funds (i.e., market liquidity) and
contingent liquidity events. Changes in economic conditions or exposure to credit, market, operation, legal and reputational risks also could
affect the Bank’s liquidity risk profile and are considered in the assessment of liquidity and asset/liability management.
Management has established a comprehensive management process for identifying, measuring, monitoring and controlling liquidity risk.
Because of its critical importance to the viability of the Bank, liquidity risk management is fully integrated into our risk management processes.
Critical elements of our liquidity risk management include: effective corporate governance consisting of oversight by the board of directors and
active involvement by management; appropriate strategies, policies, procedures, and limits used to manage and mitigate liquidity risk;
comprehensive liquidity risk measurement and monitoring systems (including assessments of the current and prospective cash flows or
sources and uses of funds) that are commensurate with the complexity and business activities of the Bank; active management of intraday
liquidity and collateral; an appropriately diverse mix of existing and potential future funding sources; adequate levels of highly liquid marketable
securities free of legal, regulatory or operational impediments, that can be used to meet liquidity needs in stressful situations; comprehensive
contingency funding plans that sufficiently address potential adverse liquidity events and emergency cash flow requirements; and internal
controls and internal audit processes sufficient to determine the adequacy of the institution’s liquidity risk management process.
We expect funds to be available from a number of basic banking activity sources, including the core deposit base, the repayment and
maturity of loans and investment security cash flows. Other potential funding sources include brokered certificates of deposit, deposit listing
services, CDARS, borrowings from the FHLB and other lines of credit.
We did not have any borrowings outstanding with the Federal Reserve Bank of Richmond at December 31, 2018 or December 31, 2017,
and our borrowing capacity is limited only by eligible collateral. As of December 31, 2018, we had $185.6 million of available borrowing capacity
from the FHLB, $13.1 million of available borrowing capacity from the Federal Reserve Bank of Richmond and available lines of credit of $26.0
million with other correspondent banks. Cash and cash equivalents were $34.7 million at December 31, 2018 and $52.3 million at December
31, 2017. Accordingly, our liquidity resources were at sufficient levels to fund loans and meet other cash needs as necessary.
82
Capital Resources
Stockholders’ equity increased $34.4 million for the year ended December 31, 2018 compared to the year ended December 31, 2017. The
Company’s IPO added approximately $19.8 million of capital. Net income resulted in an increase to retained earnings of $12.5 million as of
December 31, 2018. Stock options exercised, shares issued as compensation, shares sold and stock-based compensation increased common
stock and additional paid-in capital aggregately by $2.3 million. This increase was offset by $45 thousand, or 5,500 shares, repurchased and
retired during 2018, and net unrealized losses on available for sale securities and cash flow hedging derivative of $595 thousand.
The Company uses several indicators of capital strength. The most commonly used measure is average common equity to average assets
(computed as average equity divided by average total assets), which was 8.76% at December 31, 2018 and 7.93% at December 31, 2017.
The following table shows the return on average assets (computed as net income divided by average total assets), return on average
equity (computed as net income divided by average equity) and average equity to average assets ratios for the years ended December 31,
2018 and 2017.
Return on Average Assets
Return on Average Equity
Average Equity to Average Assets
December 31, 2018
December 31, 2017
1.22%
13.94%
8.76%
0.74%
9.29%
7.93%
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a
material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance sheet
items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by
the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum ratios of common equity
Tier 1, Tier 1, and total capital as a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 1250%.
The Bank is also required to maintain capital at a minimum level based on quarterly average assets, which is known as the leverage ratio.
In July 2013, federal bank regulatory agencies issued a final rule that revised their risk-based capital requirements and the method for
calculating risk-weighted assets to make them consistent with certain standards that were developed by Basel III and certain provisions of the
Dodd-Frank Act. The final rule applies to all depository institutions and bank holding companies and savings and loan holding companies with
total consolidated assets of more than $1 billion. The Bank was required to implement the new Basel III capital standards (subject to the phase-
in for certain parts of the new rules) as of January 1, 2015. In August of 2018 the Regulatory Relief Act directed the Federal Reserve Board to
revise the Small BHC Policy Statement to raise the total consolidated asset limit in the Small BHC Policy Statement from $1 billion to $3 billion.
The Company was previously required to comply with the minimum capital requirements on a consolidated basis; however, the Company
continues to meet the conditions of the revised Small BHC Policy Statement and was, therefore, exempt from the consolidated capital
requirements at December 31, 2018.
As of December 31, 2018, the Company and the Bank were in compliance with all applicable regulatory capital requirements to which they
were subject, and the Bank was classified as “well capitalized” for purposes of the prompt corrective action regulations. As we deploy our
capital and continue to grow our operations,
83
our regulatory capital levels may decrease depending on our level of earnings. However, we intend to monitor and control our growth in order to
remain in compliance with all regulatory capital standards applicable to us.
The following table presents the regulatory capital ratios for the Company and the Bank as of the dates indicated.
(dollars in thousands)
December 31, 2018
The Company
Actual
Minimum Capital
Adequacy
To Be Well
Capitalized
Full Phase In
of Basel III
Amount
Ratio
Amount
Ratio
Amount
Ratio
Amount
Ratio
Tier 1 leverage ratio (to average assets)
Tier 1 capital (to risk-weighted assets)
Common equity tier 1 capital ratio (to risk-weighted assets)
Total capital ratio (to risk-weighted assets)
The Bank
Tier 1 leverage ratio (to average assets)
Tier 1 capital (to risk-weighted assets)
Common equity tier 1 capital ratio (to risk-weighted assets)
Total capital ratio (to risk-weighted assets)
December 31, 2017
The Company
Tier 1 leverage ratio (to average assets)
Tier 1 capital (to risk-weighted assets)
Common equity tier 1 capital ratio (to risk-weighted assets)
Total capital ratio (to risk-weighted assets)
The Bank
Tier 1 leverage ratio (to average assets)
Tier 1 capital (to risk-weighted assets)
Common equity tier 1 capital ratio (to risk-weighted assets)
Total capital ratio (to risk-weighted assets)
$
$
$
$
117,220
117,220
115,158
117,231
96,122
96,122
96,122
107,061
82,428
82,428
80,366
92,562
86,150
86,150
86,150
96,148
10.76% $
12.95%
12.73%
12.96%
43,575
71,259
57,686
89,356
4.00%
7.875%
6.375%
9.875%
N/A
N/A
N/A
N/A
$
N/A
N/A
N/A
N/A
43,575
76,914
63,341
95,012
9.06% $
11.00%
11.00%
12.25%
42,445
68,822
55,713
86,301
4.00% $
7.875%
6.375%
9.875%
53,056
69,914
56,805
87,393
5.00% $
8.00%
6.50%
10.00%
42,445
74,284
61,175
91,763
8.10% $
10.18%
9.92%
11.43%
40,724
58,717
46,569
74,915
4.00%
7.25%
5.75%
9.25%
N/A
N/A
N/A
N/A
$
N/A
N/A
N/A
N/A
40,724
68,841
56,693
85,039
8.55% $
10.78%
10.78%
12.03%
40,316
57,928
45,943
73,908
4.00% $
7.25%
5.75%
9.25%
50,395
63,920
51,935
79,900
5.00% $
8.00%
6.50%
10.00%
40,316
67,915
55,930
83,895
4.00%
8.50%
7.00%
10.50%
4.00%
8.50%
7.00%
10.50%
4.00%
8.50%
7.00%
10.50%
4.00%
8.50%
7.00%
10.50%
84
Contractual Obligations
We have contractual obligations to make future payments on debt and lease agreements. While our liquidity monitoring and management
consider both present and future demands for and sources of liquidity, the following table of contractual commitments focuses only on future
obligations and summarizes our contractual obligations as of December 31, 2018.
CONTRACTUAL OBLIGATIONS
Due in One Year or
Less
Due After One
Through Three Years
Due After Three
Through Five Years
Due After 5
Years
Total
As of December 31, 2018
$
$
2,000 $
2,000
209,828
54,999
—
268,827 $
— $
—
61,611
8,159
—
69,770 $
— $
—
746
129
—
875 $
— $
—
—
—
15,393
15,393 $
2,000
2,000
272,185
63,287
15,393
354,865
(in thousands)
FHLB advances
Line of credit advances
Certificates of deposit $100,000 or more
Certificates of deposit less than $100,000
Subordinated debt
Total
Off-Balance Sheet Items
In the normal course of business, we enter into various transactions that, in accordance with GAAP, are not included in our consolidated
balance sheets. We enter into these transactions to meet the financing needs of our customers. These transactions include commitments to
extend credit and issue letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts
recognized in our consolidated balance sheets. Our exposure to credit loss is represented by the contractual amounts of these commitments.
The same credit policies and procedures are used in making these commitments as for on-balance sheet instruments. We are not aware of any
accounting loss to be incurred by funding these commitments, however we maintain an allowance for off-balance sheet credit risk which is
recorded in other liabilities on the consolidated balance sheet.
Our commitments associated with outstanding letters of credit and commitments to extend credit expiring by period as of the date indicated
are summarized below. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts
shown do not necessarily reflect the actual future cash funding requirements.
CREDIT EXTENSION COMMITMENTS
(in thousands)
Unfunded lines of credit
Commitments to originate residential loans held for sale
Letters of credit
Total credit extension commitments
December 31,
2018
2017
209,209 $
647
6,216
216,072 $
180,698
4,138
6,759
191,595
$
$
Unfunded lines of credit represent unused credit facilities to our current borrowers that represent no change in credit risk that exist in our
portfolio. Letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. Lines of credit
generally have variable interest rates. In the event of nonperformance by the customer in accordance with the terms of the agreement with
85
the third party, we would be required to fund the commitment. The maximum potential amount of future payments we could be required to make
is represented by the contractual amount of the commitment. If the commitment is funded, we would be entitled to seek recovery from the client
from the underlying collateral, which can include commercial real estate, physical plant and property, inventory, receivables, cash and/or
marketable securities. Our policies generally require that letter of credit arrangements contain security and debt covenants similar to those
contained in loan agreements and our credit risk associated with issuing letters of credit is essentially the same as the risk involved in
extending loan facilities to our customers.
We minimize our exposure to loss under letters of credit and credit commitments by subjecting them to the same credit approval and
monitoring procedures as we do for on-balance sheet instruments. The effect on our revenue, expenses, cash flows and liquidity of the unused
portions of these letters of credit commitments cannot be precisely predicted because there is no guarantee that the lines of credit will be used.
Commitments to extend credit are agreements to lend funds to a customer, as long as there is no violation of any condition established in
the contract, for a specific purpose. Commitments generally have variable interest rates, fixed expiration dates or other termination clauses and
may require payment of a fee. Since many of the commitments are expected to expire without being fully drawn, the total commitment amounts
disclosed above do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case
basis. The amount of collateral obtained, if considered necessary by us, upon extension of credit is based on management’s credit evaluation
of the customer.
We enter into forward commitments for the delivery of mortgage loans in our current pipeline. Interest rate lock commitments are entered
into in order to economically hedge the effect of changes in interest rates resulting from our commitments to fund the loans. These
commitments to fund mortgage loans, to be sold into the secondary market, (interest rate lock commitments) and forward commitments for the
future delivery of mortgage loans to third party investors are considered derivatives.
Impact of Inflation
Our consolidated financial statements and related notes included elsewhere in this report have been prepared in accordance with GAAP.
GAAP requires the measurement of financial position and operating results in terms of historical dollars, without considering changes in the
relative value of money over time due to inflation or recession.
Unlike many industrial companies, substantially all of our assets and liabilities are monetary in nature. As a result, interest rates have a
more significant impact on our performance than the effects of general levels of inflation. Interest rates may not necessarily move in the same
direction or in the same magnitude as the prices of goods and services. However, other operating expenses do reflect general levels of
inflation.
86
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Many assumptions are used to calculate the impact of interest rate fluctuations on our net interest income, such as asset prepayments,
non-maturity deposit price sensitivity and decay rates, and key rate drivers. Because of the inherent use of these estimates and assumptions in
the model, our actual results may, and most likely will, differ from our static earnings at risk (“EAR”) results. In addition, static EAR results do
not include actions that our management may undertake to manage the risks in response to anticipated changes in interest rates or client
behavior. For example, as part of our asset/liability management strategy, management has the ability to increase asset duration and decrease
liability duration in order to reduce asset sensitivity, or to decrease asset duration and increase liability duration in order to increase asset
sensitivity.
The following table summarizes the results of our EAR analysis in simulating the change in net interest income and fair value of equity over
a 12-month horizon as of December 31, 2018:
IMPACT ON NET INTEREST INCOME UNDER A STATIC BALANCE SHEET, PARALLEL INTEREST RATE SHOCK
Earnings at Risk
December 31, 2018
-100 bps
Flat
+100 bps
+200 bps
+300 bps
(4.2)%
0.0%
4.3%
8.5%
12.8%
Utilizing an economic value of equity (“EVE”) approach, we analyze the risk to capital from the effects of various interest rate scenarios
through a long-term discounted cash flow model. This measures the difference between the economic value of our assets and the economic
value of our liabilities, which is a proxy for our liquidation value. While this provides some value as a risk measurement tool, management
believes EAR is more appropriate in accordance with the going concern principle.
The following table illustrates the results of our EVE analysis as of December 31, 2018.
ECONOMIC VALUE OF EQUITY ANALYSIS UNDER A STATIC BALANCE SHEET, PARALLEL INTEREST RATE SHOCK
Economic Value of Equity
-100 bps
Flat
+100 bps
+200 bps
+300 bps
December 31, 2018
2.9%
0.0%
(3.5)%
(7.7)%
(12.0)%
87
Interest Rate Sensitivity and Market Risk
As a financial institution, our primary component of market risk is interest rate volatility. Our asset liability and funds management policy
provides management with the guidelines for effective funds management, and we have established a measurement system for monitoring our
net interest rate sensitivity position. We manage our sensitivity position within our established guidelines.
Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on most of our assets and liabilities, and
the market value of all interest earning assets and interest bearing liabilities, other than those that have a short term to maturity. Interest rate
risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net
interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the
balance sheet to minimize the inherent risk while at the same time maximizing income.
We manage our exposure to interest rates by structuring our balance sheet in the ordinary course of business. We do not enter into
instruments such as leveraged derivatives, financial options or financial future contracts for the purpose of reducing interest rate risk. We do
hedge the interest rate risks of our available for sale mortgage pipeline by using mortgage-backed securities short positions, and of our
subordinated debentures by utilizing an interest rate swap. Based on the nature of our operations, we are not subject to foreign exchange or
commodity price risk. We do not own any trading assets.
Our exposure to interest rate risk is managed by the Bank’s ALCO in accordance with policies approved by our board of directors. The
committee formulates strategies based on appropriate levels of interest rate risk. In determining the appropriate level of interest rate risk, the
committee considers the impact on earnings and capital on the current outlook on interest rates, potential changes in interest rates, regional
economies, liquidity, business strategies and other factors. The committee meets regularly to review, among other things, the sensitivity of
assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses, purchase and
sale activities, commitments to originate loans and the maturities of investments and borrowings. Additionally, the committee reviews liquidity,
cash flow flexibility, maturities of deposits and consumer and commercial deposit activity. Management employs methodologies to manage
interest rate risk, which include an analysis of relationships between interest earning assets and interest bearing liabilities and an interest rate
shock simulation model.
The following table indicates that, for periods less than one year, rate-sensitive assets exceeded rate-sensitive liabilities, resulting in an
asset-sensitive position. For a bank with an asset-sensitive position, or positive gap, rising interest rates would generally be expected to have a
positive effect on net interest income, and falling interest rates would generally be expected to have the opposite effect.
88
December 31, 2018
(in thousands)
Assets
Interest earning assets
Loans (1)
Securities
Interest bearing deposits at other financial institutions
Federal funds sold
Total earning assets
Liabilities
Interest bearing liabilities
Interest bearing deposits
Time deposits
Total interest bearing deposits
Securities sold under agreements to repurchase
FHLB Advances
Other borrowed funds
Total interest bearing liabilities
Period gap
Cumulative gap
Ratio of cumulative gap to total earning assets
_______________
(1)
Includes loans held for sale.
INTEREST SENSITIVITY GAP
Within One Month
After One Month
Through Three
Months
After Three
Through Twelve
Months
Within One Year
Greater Than One
Year or Non-
Sensitive
Total
$
190,825
$
255,511
$
128,474
$
574,810
$
443,984
$
1,018,794
1,366
22,007
2,285
—
—
—
16,502
—
—
17,868
22,007
2,285
29,064
—
—
46,932
22,007
2,285
$
216,483
$
255,511
$
144,976
$
616,970
$
473,048
$
1,090,018
$
369,010
$
3,560
$
5,277
$
19,117
388,127
3,332
2,000
2,000
52,445
56,005
169,616
174,893
—
—
—
—
—
377,847
241,178
619,025
3,332
2,000
2,000
$
(339)
$
94,294
93,955
—
—
13,393
395,459
$
56,005
$
174,893
$
626,357
$
107,348
$
377,508
335,472
712,980
3,332
2,000
15,393
733,705
(178,976)
(178,976)
$
$
(16.42)%
199,506
20,530
$
$
1.88%
$
$
(9,387)
(0.86)%
$
$
(9,387)
(0.86)%
365,700
$
356,313
356,313
32.69%
(29,917)
(9,387)
$
$
$
We use quarterly EAR simulations to assess the impact of changing interest rates on our earnings under a variety of scenarios and time
horizons. These simulations utilize both instantaneous and parallel changes in the level of interest rates, as well as non-parallel changes such
as changing slopes and twists of the yield curve. Static simulation models are based on current exposures and assume a constant balance
sheet with no new growth. Dynamic simulation models are also utilized that rely on detailed assumptions regarding changes in existing lines of
business, new business, and changes in management and client behavior.
We also use economic value-based methodologies to measure the degree to which the economic values of the Bank’s positions change
under different interest rate scenarios. The economic-value approach focuses on a longer-term time horizon and captures all future cash flows
expected from existing assets and liabilities. The economic value model utilizes a static approach in that the analysis does not incorporate new
business; rather, the analysis shows a snapshot in time of the risk inherent in the balance sheet.
89
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
90
To the Stockholders and the Board of Directors of Capital Bancorp, Inc.
Report of Independent Registered Public Accounting Firm
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Capital Bancorp, Inc. and Subsidiaries (the “Company”) as of
December 31, 2018 and 2017, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity,
and cash flows for the years then ended, and the related notes to the consolidated financial statements and schedules (collectively, the
“consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial
position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years then
ended, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s
financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board
(United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and
the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or
fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting under
PCAOB standards. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the
purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting under PCAOB standards.
Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or
fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the
amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant
estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a
reasonable basis for our opinion.
/s/ Elliott Davis, PLLC
We have served as the Company’s auditor since 2017.
Raleigh, North Carolina
April 1, 2019
elliottdavis.com
Capital Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheets
As of December 31, 2018 and 2017
(dollars in thousands)
Assets
Cash and due from banks
Interest bearing deposits at other financial institutions
Federal funds sold
Total cash and cash equivalents
Investment securities available for sale
Restricted investments
Loans held for sale
Loans receivable, net of allowance for loan losses of $11,308 and $10,033 at December 31, 2018 and 2017, respectively
Premises and equipment, net
Accrued interest receivable
Deferred income taxes
Foreclosed real estate
Prepaid income taxes
Other assets
Total assets
Liabilities
Deposits
Noninterest bearing, including related party balances of $11,214 and $18,316 for the periods ended December 31, 2018
and 2017, respectively
Interest bearing, including related party balances of $144,624 and $159,656 for the periods ended December 31, 2018 and
2017, respectively
Total deposits
Securities sold under agreements to repurchase
Federal funds purchased
Federal Home Loan Bank advances
Other borrowed funds
Accrued interest payable
Other liabilities
Total liabilities
Stockholders' equity
Preferred stock, $.01 par value; 1,000,000 shares authorized; no shares issued or outstanding at December 31, 2018 and
2017
Common stock, $.01 par value; 49,000,000 shares authorized; 13,672,479 and 11,537,196 issued and outstanding at
December 31, 2018 and 2017, respectively
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss
Total stockholders' equity
Total liabilities and stockholders' equity
See Notes to Consolidated Financial Statements
92
2018
2017
10,431 $
22,007
2,285
34,723
46,932
2,503
18,526
988,960
2,975
4,462
3,654
142
90
2,091
1,105,058 $
242,259 $
712,981
955,240
3,332
2,000
2,000
15,393
1,565
10,964
990,494
—
137
49,321
65,701
(595)
114,564
1,105,058 $
8,189
40,356
3,766
52,311
54,029
2,369
26,344
877,387
2,601
3,867
3,381
93
1,532
2,095
1,026,009
196,635
708,264
904,899
11,260
—
2,000
17,361
1,084
9,286
945,890
—
115
27,051
53,200
(247)
80,119
1,026,009
$
$
$
$
Capital Bancorp, Inc. and Subsidiaries
Consolidated Statements of Income
For the Years Ended December 31, 2018 and 2017
(dollars in thousands except per share data)
Interest income
Loans, including fees
Investment securities available for sale
Federal funds sold and other
Total interest income
Interest expense
Deposits, including $1,727 and $1,172 paid to related parties for the years ended December 31, 2018 and
2017, respectively
Borrowed funds
Total interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Noninterest income
Service charges on deposits
Credit card fees
Mortgage banking revenue
Loss on sale of investment securities available for sale
Loss on sale of foreclosed real estate
Loss on disposal of premises and equipment
Other fees and charges
Total noninterest income
Noninterest expenses
Salaries and employee benefits
Occupancy and equipment
Professional fees
Data processing
Advertising
Loan processing
Other real estate expenses, net
Other operating
Total noninterest expenses
Income before income taxes
Income tax expense
Net income
Basic earnings per share
Diluted earnings per share
2018
2017
67,229 $
1,041
857
69,127
9,792
1,447
11,239
57,888
2,140
55,748
484
6,048
9,477
(2)
(21)
(276)
414
16,124
25,164
4,319
2,124
14,184
1,460
1,077
28
5,767
54,123
17,749
4,982
12,767 $
1.05 $
1.02 $
54,996
1,068
602
56,666
6,434
1,321
7,755
48,911
2,655
46,256
460
4,014
10,377
—
(52)
(77)
427
15,149
23,819
3,829
1,874
9,621
1,922
1,409
32
4,800
47,306
14,099
6,990
7,109
0.63
0.62
$
$
$
$
Weighted average common shares outstanding:
Basic
Diluted
See Notes to Consolidated Financial Statements
93
12,116,459
12,462,138
11,261,132
11,428,000
Capital Bancorp, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income
For the Years Ended December 31, 2018 and 2017
(in thousands)
Net income
Other comprehensive income (loss):
Unrealized loss on investment securities available for sale
Reclassification of realized loss on sale of investment securities available for sale
Unrealized gain (loss) on cash flow hedging derivative
Income tax benefit relating to the items above
Other comprehensive loss
Comprehensive income
See Notes to Consolidated Financial Statements
94
Years Ended December 31,
2018
2017
$
12,767 $
7,109
(479)
2
(1)
(478)
130
(348)
12,419 $
$
(302)
—
13
(289)
114
(175)
6,934
Capital Bancorp, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders’ Equity
For the Years Ended December 31, 2018 and 2017
Common Stock
(dollars in thousands)
Balance, December 31, 2016
Shares
11,144,696 $
Amount
Additional
Paid-in
Capital
Retained
Earnings
Accumulated Other
Comprehensive Loss
Total
Stockholders'
Equity
111 $
24,617 $
46,050 $
(31) $
70,747
Net income
Unrealized loss on investment securities available for sale,
net of income taxes
Unrealized gain on cash flow hedging derivative, net of
income taxes
Reclassification of other comprehensive loss due to tax rate
change
Stock options exercised, including tax benefit
Shares issued as compensation
Stock-based compensation
Shares repurchased and retired
Balance, December 31, 2017
Net income
Unrealized loss on investment securities available for sale,
net of income taxes
Unrealized loss on cash flow hedging derivative, net of
income taxes
Stock options exercised, including tax benefit
Shares issued as compensation
Stock-based compensation
Shares sold
Shares repurchased and retired
—
—
—
358,332
102,660
—
—
—
—
4
1
—
(68,492)
11,537,196 $
(1)
115 $
—
—
—
230,894
59,579
—
16,000
(5,500)
—
—
—
2
1
—
—
—
—
—
—
1,664
775
506
(511)
27,051 $
—
—
—
1,307
495
570
198
(45)
7,109
—
—
41
—
—
—
—
53,200 $
12,767
—
—
(266)
—
—
—
—
—
(183)
8
(41)
—
—
—
—
(247) $
—
(346)
(2)
—
—
—
—
—
7,109
(183)
8
—
1,668
776
506
(512)
80,119
12,767
(346)
(2)
1,043
496
570
198
(45)
Initial public offering, common stock issued, net of costs and
underwriting discount of $3.2 million
Balance, December 31, 2018
1,834,310
13,672,479 $
19
137 $
19,745
49,321 $
—
65,701 $
—
(595) $
19,764
114,564
See Notes to Consolidated Financial Statements
95
Capital Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2018 and 2017
(in thousands)
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses
Provision for mortgage put-back reserve
Provision for off balance sheet reserves
Net amortization on investments
Depreciation
Stock-based compensation expense
Director and employee compensation paid in Company stock
Deferred income tax benefit
Amortization of debt issuance expense
Loss on sale of securities available for sale
Losses on sales of foreclosed real estate
Losses on disposal of premises and equipment
Mortgage banking revenue
Sales of loans held for sale
Originations of loans held for sale
Changes in assets and liabilities:
Accrued interest receivable
Prepaid income taxes and taxes payable
Other assets
Accrued interest payable
Other liabilities
Net cash provided by operating activities
Cash flows from investing activities
Purchases of securities available for sale
Proceeds from maturities, calls and principal paydowns of securities available for sale
Proceeds from sale of securities available for sale
Purchases of restricted investments
Increase in loans receivable
Net purchases of premises and equipment
Proceeds from sales of foreclosed real estate
Net cash used by investing activities
See Notes to Consolidated Financial Statements
96
2018
2017
$
12,767 $
2,140
106
152
225
1,085
570
496
(141)
32
2
21
276
(9,477)
354,417
(337,122)
(595)
1,529
4
481
1,334
28,302
—
6,044
345
(134)
(114,140)
(1,735)
357
(109,263)
7,109
2,655
115
100
261
983
506
776
(239)
34
—
52
77
(10,377)
452,337
(418,912)
(654)
(393)
913
307
(836)
34,814
(12,810)
6,203
—
(76)
(126,290)
(1,422)
1,026
(133,369)
Capital Bancorp, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2018 and 2017
(in thousands)
Cash flows from financing activities
Net increase (decrease) in:
Noninterest bearing deposits
Interest bearing deposits
Securities sold under agreements to repurchase
Federal Home Loan Bank advances, net
Federal funds purchased
Other borrowed funds
Repurchase of common stock
Proceeds from exercise of stock options
Proceeds from shares sold
Proceeds from initial public offering, net
Net cash provided by financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents, beginning of year
Cash and cash equivalents, end of year
Noncash investing and financing activities:
Loans transferred to foreclosed real estate
Change in unrealized gains on investments
Change in fair value of loans held for sale
Change in fair value of cash flow hedging derivative
Change in corporate tax rate
Cash paid during the period for:
Taxes
Interest
See Notes to Consolidated Financial Statements
97
2018
2017
45,624
4,717
(7,928)
—
2,000
(2,000)
(45)
1,043
198
19,764
63,373
40,430
73,545
1,601
(4,000)
—
—
(512)
1,668
—
—
112,732
(17,588)
14,177
52,311
38,134
34,723 $
52,311
427 $
(480) $
4 $
(2) $
— $
2,655 $
10,758 $
1,081
(302)
225
13
(1,386)
7,993
7,448
$
$
$
$
$
$
$
$
Capital Bancorp, Inc. and Subsidiaries
Annual Report on Form 10-K
Index
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 1 - Nature of Business and Basis of Presentation
Nature of operations:
Capital Bancorp, Inc., is a Maryland corporation and bank holding company (the “Company”) for Capital Bank, N.A. (the “Bank”). The
Company's primary operations are conducted by the Bank, which operates branches in Rockville, Columbia and North Bethesda, Maryland,
Reston, Virginia, and the District of Columbia. The Bank is principally engaged in the business of investing in commercial, real estate, and
credit card loans and attracting deposits. We conduct mortgage business through Church Street Mortgage, our residential mortgage banking
arm; and credit card business through OpenSky®, a secured, digitally-driven nationwide credit card platform.
The Bank also originates residential mortgages for sale in the secondary market. The Company formed Church Street Capital, LLC
(“Church Street Capital”) in 2014 to provide short-term secured real estate financing to Washington, D.C. area investors and developers that
may not meet all Bank credit criteria.
In addition, the Company owns all of the stock of Capital Bancorp (MD) Statutory Trust I (the “Trust”). The Trust is a special purpose non-
consolidated entity organized for the sole purpose of issuing trust preferred securities.
The Company completed its initial public offering (“IPO”) of 2,563,046 shares of its common stock at a price to the public of $12.50 per
share, 1,834,310 shares of which were sold by the Company and 728,736 shares of which were sold by certain of the Company’s shareholders
(the “selling shareholders”). The net proceeds to the Company from the IPO were $19.8 million after deducting the underwriting discount and
offering expenses of $3.2 million. The Company did not receive any proceeds from the sales of shares by the selling shareholders.
Basis of presentation:
The accompanying consolidated financial statements include the activity of the Company and its wholly-owned subsidiaries, the Bank and
Church Street Capital. All intercompany transactions have been eliminated in consolidation. The Company reports its activities as a single
business segment. In determining the appropriateness of segment definition, the Company considers components of the business about which
financial information is available and regularly evaluated relative to resource allocation and performance assessment. The accompanying
consolidated financial statements have been prepared in accordance with accounting principals generally accepted in the United States of
America (“GAAP”), and conform to general practices within the banking industry.
On August 15, 2018, the Company completed a four-for-one stock split of the Company's authorized, issued, and outstanding common
stock, par value $.01 per share (the “Stock Split”). At the effective time of the Stock Split, each share of the Company's issued and outstanding
common stock was automatically increased to four shares issued and outstanding. No fractional shares were issued in connection with the
Stock Split. All share and share-related information presented in these consolidated financial statements have been retroactively adjusted to
reflect the increased number of shares resulting from the Stock Split.
Significant Accounting Policies:
The preparation of consolidated financial statements in accordance with GAAP requires estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. The basis of the estimates is
on historical experience and on various other assumptions that are believed to be reasonable under current circumstances, results of which
form the basis for making judgments about the carrying value of certain assets and liabilities that are
98
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 1 - Nature of Business and Basis of Presentation (continued)
not readily available from other sources. Estimates are evaluated on an ongoing basis. Actual results may differ from these estimates under
different assumptions or conditions.
Cash and cash equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest bearing deposits
with banks and federal funds sold. Generally, federal funds are sold for one-day periods.
Investment securities
Investment securities are classified as available for sale and carried at fair value with unrealized gains and losses included in stockholders’
equity on an after-tax basis. Premiums and discounts on investment securities are amortized or accreted using the interest method. Changes in
the fair value of debt securities available for sale are included in stockholder’s equity as unrealized gains and losses, net of the related tax
effect. Unrealized losses are periodically reviewed to determine whether the loss represents an other than temporary impairment. Any
unrealized losses judged to be other than a temporary impairment will be charged to income.
Loans held for sale
Mortgage loans originated and intended for sale are recorded at fair value, determined individually, as of the balance sheet date. Fair value
is determined based on outstanding investor commitments, or in the absence of such commitments, based on current investor yield
requirements. Gains and losses on loan sales are determined by the specific-identification method. The Company’s current practice is to sell
residential mortgage loans on a servicing released basis, and, therefore, it has no intangible asset recorded for the value of such servicing.
Interest on loans held for sale is credited to income based on the principal amounts outstanding.
Upon sale and delivery, loans are legally isolated from the Company and the Company has no ability to restrict or constrain the ability of
third‑party investors to pledge or exchange the mortgage loans. The Company does not have the entitlement or ability to repurchase the
mortgage loans or unilaterally cause third‑party investors to put the mortgage loans back to the Company. Unrealized and realized gains on
loan sales are determined using the specific-identification method and are recognized through mortgage banking activity in the Consolidated
Statements of Income.
The Company elected to measure loans held for sale at fair value to better align reported results with the underlying economic changes in
value of the loans on the Company’s balance sheet.
Loans and the Allowance for Loan Losses
Loans are stated at the principal amount outstanding, adjusted for deferred origination fees, deferred origination costs, discounts on loans
acquired, and the allowance for loan losses. Interest is accrued based on the loan principal balances and stated interest rates. Origination fees
and costs are recognized as an adjustment to the related loan yield using approximate interest methods. The Company discontinues the
accrual of interest when any portion of the principal and interest is 90 days past due and collateral is insufficient to discharge the debt in full.
Generally, interest payments on nonaccrual loans are recorded as a reduction of the principal balance.
Loans are considered impaired when, based on current information, management believes the Company will not collect all principal and
interest payments according to contractual terms. Generally, loans are
99
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 1 - Nature of Business and Basis of Presentation (continued)
reviewed for impairment when the risk grade for a loan is downgraded to a classified asset category. The loans are evaluated for appropriate
classification, accrual, impairment, and troubled debt restructure status. If collection of principal is evaluated as doubtful, all payments are
applied to principal. A modification of a loan is considered a TDR when a borrower is experiencing financial difficulty and the modification
constitutes a concession. The Company may consider interest rate reductions, changes to payment terms, extensions of maturities and/or
principal reductions.
Loans are generally charged-off in part or in full when management determines the loan to be uncollectible. Factors for charge-off that may
be considered include: repayments deemed to be projected beyond reasonable time frames, client bankruptcy and lack of assets, and/or
collateral deficiencies.
The allowance for loan losses is estimated to adequately provide for probable future losses on existing loans. The allowance consists of
specific and general components. For loans that are classified as impaired, an allowance is established when the collateral value, if the loan is
collateral dependent, or the discounted cash flows of the impaired loan is lower than the carrying value of that loan. The general component
covers pools of nonclassified loans and is based on historical loss experience adjusted for qualitative factors. There may be an unallocated
component of the allowance, which reflects the margin of imprecision inherent in the underlying assumptions used in the method for estimating
specific and general losses in the portfolio. Actual loan performance may differ from those estimates. A loss is recognized as a charge to the
allowance when management believes that collection of the loan is unlikely. Collections of loans previously charged off are added to the
allowance at the time of recovery.
We determine the allowance for loan losses based on the accumulation of various components that are calculated independently in
accordance with ASC 450 for pools of loans, ASC 310 for Troubled Debt Restructuring, and ASC 310 for individually evaluated loans. The
process for determining an appropriate allowance for loan losses is based on a comprehensive, well-documented, and consistently applied
analysis of the loan portfolio. The analysis considers all significant factors that affect the collectibility of the portfolio and supports the credit
losses estimated by this process. It is important to recognize that the related process, methodology, and underlying assumptions require a
substantial degree of judgment.
Premises and equipment
Premises and equipment are stated at cost less accumulated depreciation and amortization over two to seven years. Depreciation and
amortization are computed using the straight-line method over the estimated useful lives of the related property. Leasehold improvements are
amortized over the estimated useful lives of the improvements, approximately ten years, or the term of the lease, whichever is less.
Expenditures for maintenance, repairs, and minor replacements are charged to noninterest expenses as incurred.
Derivative Financial Instruments
The Company enters into commitments to fund residential mortgage loans (interest rate locks) with the intention of selling them in the
secondary market. The Company also enters into forward sales agreements for certain funded loans and loan commitments. The Company
records unfunded commitments intended for loans held for sale and forward sales agreements at fair value with changes in fair value recorded
as a component of mortgage banking revenue. Loans originated and intended for sale in the secondary market are carried at fair value. For
pipeline loans which are not pre-sold to an investor, the Company manages the interest rate risk on rate lock commitments by entering into
forward sale contracts, whereby the Company obtains the right to deliver securities to investors in the future at a specified price. Such contracts
are accounted for as derivatives and are recorded at fair value as derivative assets or liabilities, with changes in fair value recorded in mortgage
banking revenue.
100
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 1 - Nature of Business and Basis of Presentation (continued)
The Company accounts for derivative instruments and hedging activities according to guidelines established in Financial Accounting
Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 815-10, Accounting for Derivative Instruments and Hedging Activities, as
amended. The Company recognizes all derivatives as either assets or liabilities on the balance sheet and measures those instruments at fair
value. Changes in fair value of derivatives designated and accounted for as cash flow hedges, to the extent they are effective as hedges, are
recorded in other comprehensive income, net of deferred taxes. Any hedge ineffectiveness would be recognized in the income statement line
item pertaining to the hedged item.
Fair Value Measurements
Fair value is the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for
an asset or liability in an orderly transaction between market participants at the measurement date. The degree of management judgment
involved in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market
inputs. For financial instruments that are traded actively and have quoted market prices or observable market inputs, there is minimal
subjectivity involved in measuring fair value. However, when quoted market prices or observable market inputs are not fully available,
significant management judgment may be necessary to estimate fair value. In developing our fair value estimates, we maximize the use of
observable inputs and minimize the use of unobservable inputs.
The fair value hierarchy defines Level 1 valuations as those based on quoted prices (unadjusted) for identical assets or liabilities in active
markets. Level 2 valuations include inputs based on quoted prices for similar assets or liabilities in active markets, and inputs that are
observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 3 valuations are
based on at least one significant assumption not observable in the market, or significant management judgment or estimation, some of which
may be internally developed.
Financial assets that are recorded at fair value on a recurring basis include investment securities available for sale, loans held for sale, and
derivative financial instruments. Financial liabilities that are recorded at fair value on a recurring basis are comprised of derivative financial
instruments. See the Fair Value note to our consolidated financial statements.
Income Taxes
Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and
liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are recognized
when it is deemed more likely than not that the benefits of such deferred income taxes will be realized.
In December of 2017, President Trump signed the the Tax Cuts and Jobs Act of 2017, the (”Tax Act”) into law. While a reduction in the
federal corporate income tax rate from 35% to 21% took effect in 2018, the enactment of the law in 2017 required the Company to revalue its
deferred tax assets and liabilities as of December 31, 2017. This revaluation reduced the Company’s deferred tax asset by $1.4 million, which
increased 2017 income tax expense by $1.4 million. Of this amount, $40 thousand of expense was attributable to the Company's net deferred
tax asset for unrealized losses on available for sale securities and cash flow hedge. In addition to adjusting the deferred tax asset for this item,
the Company recorded an adjustment to accumulated other comprehensive income with a transfer to retained earnings.
101
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 1 - Nature of Business and Basis of Presentation (continued)
Earnings per share:
Earnings per share is computed by dividing net income available to common stockholders by the weighted average number of shares
outstanding. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares outstanding,
adjusted for the dilutive effect of stock options and restricted stock using the treasury stock method. At December 31, 2018 and 2017, there
were 7,000 and 246,500 stock options, respectively, that were not included in the calculation as their effect would have been anti-dilutive. The
following is a reconciliation of the numerators and denominators used in computing basic and diluted earnings per common share as adjusted
for the Stock Split:
(dollars in thousands, except per share information)
Basic EPS
Net income available to common stockholders
Effect of dilutive securities
Dilutive EPS per common share
Comprehensive income:
For the Years Ended December 31,
2018
2017
Income
Weighted Average
Shares
Per Share
Amount
Income
Weighted Average
Shares
Per Share
Amount
$
$
12,767
—
12,767
12,116,459 $
345,679
12,462,138 $
1.05 $
1.02 $
7,109
—
7,109
11,261,132 $
166,868
11,428,000 $
0.63
0.62
The Company reports as comprehensive income all changes in stockholders' equity during the year from sources other than stockholders.
Other comprehensive income refers to all components (income, expenses, gains, and losses) of comprehensive income that are excluded from
net income.
The Company's only two components of other comprehensive income are unrealized gains and losses on investment securities available
for sale, net of income taxes, and unrealized gains and losses on cash flow hedges, net of income taxes. Information concerning the
Company's accumulated other comprehensive income (loss) as of December 31, 2018, and 2017 are as follows (in thousands):
(in thousands)
Unrealized losses on securities available for sale
Deferred tax benefit
Other comprehensive loss, net of tax
Unrealized gains on cash flow hedges
Deferred tax expense
Other comprehensive income, net of tax
Total accumulated comprehensive loss
Recently issued accounting pronouncements:
For the Years Ended December 31,
2018
2017
$
$
(825) $
227
(598)
5
(2)
3
(595) $
(348)
97
(251)
6
(2)
4
(247)
In May 2014, the FASB issued guidance to change the recognition of revenue from contracts with customers. The core principle of the new
guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the
consideration the entity receives or expects to receive. The guidance became effective for the Company on January 1, 2018.
The Company applied the guidance using a modified retrospective approach. The Company’s revenue is comprised of net interest income
and noninterest income. The scope of the guidance explicitly excludes net interest income as well as many other revenues for financial assets
and liabilities including loans, leases,
102
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 1 - Nature of Business and Basis of Presentation (continued)
securities, and derivatives. Accordingly, the majority of our revenues were not affected. The Company performed an assessment of our
revenue contracts related to revenue streams that are within the scope of the standard. Our accounting policies did not change materially since
the principles of revenue recognition from the Accounting Standards Update (“ASU”) are largely consistent with existing practices and guidance
applied by our businesses. The Company has not identified material changes to the timing or amount of revenue recognition for deposit service
charges, credit card fees and mortgage banking fees. Deposit service charges are based on customer transaction activity and are recognized
either daily or monthly when the activity occurs. Credit card fees are recognized monthly according to guidance for receivables and deferred
fees. Revenue for mortgage banking is recognized monthly within the scope of other guidance for transfers and servicing, and derivatives and
hedging. As such, the Company does not consider the guidance to have a material effect on its financial statements.
In January 2016, the FASB amended the Financial Instruments topic of the ASC to address certain aspects of recognition, measurement,
presentation, and disclosure of financial instruments. The amendment became effective January 1, 2018 and did not have a material effect on
the financial statements. As discussed in Note 16, the Company measured the fair value of its loan portfolio using an exit price notion as of
December 31, 2018.
In February 2016, the FASB amended the Leases topic of the ASC to revise certain aspects of recognition, measurement, presentation,
and disclosure of leasing transactions. The amendments will be effective for fiscal years beginning after December 15, 2018, including interim
periods within those fiscal years.
In February 2016, the FASB issued guidance on leases. The standard requires a lessee to recognize assets and liabilities on the balance
sheet for leases with lease terms greater than 12 months, and is effective for fiscal years after December 15, 2018. In July 2018, new guidance
was issued to provide an additional transition method that allow entities to not apply this new guidance in the comparative periods presented in
the financial statements and instead recognize a cumulative effect adjustment to the beginning retained earnings at the date of application. The
Company assessed this guidance and collected relevant terms for each of its lease agreements. The Company concluded that all of its leases
will be classified as operating leases. The Company has estimated its Lease Liability and Right of Use Asset will be in the range of
approximately $4.9 million to $5.2 million, with an expected reduction to retained earnings of approximately $50 thousand. The Company does
not expect that the adoption of the new standard will have a material impact on its Consolidated Statements of Income.
In March 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify
the implementation guidance on principal versus agent considerations and address how an entity should assess whether it is the principal or
the agent in contracts that include three or more parties. The amendments became effective for the Company on January 1, 2018 and did not
have a material effect on its financial statements.
In June 2016, the FASB issued guidance to change the accounting for credit losses and modify the impairment model for certain debt
securities. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. Early adoption is
permitted for all organizations for periods beginning after December 15, 2018.
The Company will apply the amendments to the ASU through a cumulative-effect adjustment to retained earnings as of the beginning of the
year of adoption. While early adoption is permitted beginning in first quarter 2019, the Company does not expect to elect that option. The
Company is evaluating the impact of the ASU on the consolidated financial statements. In addition to our allowance for loan losses, the
Company will also record an allowance for credit losses on debt securities instead of applying the impairment model
103
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 1 - Nature of Business and Basis of Presentation (continued)
currently utilized. The amount of the adjustments will be impacted by each portfolio’s composition and credit quality at the adoption date as well
as economic conditions and forecasts at that time.
In February 2017, the FASB amended the Other Income Topic of the ASC to clarify the scope of the guidance on nonfinancial asset
derecognition as well as the accounting for partial sales of nonfinancial assets. The amendments conform the derecognition guidance on
nonfinancial assets with the model for transactions in the new revenue standard. The amendments became effective for the Company on
January 1, 2018 and did not have a material effect on its financial statements.
In March 2017, the FASB amended the Receivables topic of the ASC to eliminate the current diversity in practice with respect to the
amortization period for certain purchased callable debt securities held at a premium. The amendments in this update shorten the amortization
period for the premium to the earliest call date. This guidance is effective for the Company beginning after December 15, 2019. Early adoption
is permitted. The Company does not expect these amendments to have a material effect on its financial statements.
In May 2017, the FASB amended the requirements in the Compensation-Stock Compensation Topic of the ASC related to changes to the
terms or conditions of a share-based payment award. The amendments provide guidance about which changes to the terms or conditions of a
share-based payment award require an entity to apply modification accounting. The amendments were effective for the Company on January
1, 2018 and did not have a material effect on its financial statements.
In August 2017, the FASB amended the requirements of the Derivatives and Hedging Topic of the Accounting Standards Codification to
improve the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its
financial statements. The amendments will be effective for the Company for interim and annual periods beginning after December 15, 2018.
Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.
In February 2018, the FASB amended the Income Statement – Reporting Comprehensive Income Topic of the ASC. The amendments
allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Act.
The Company has early adopted this pronouncement by retrospective application to each period in which the effect of the change in the tax
rate under the Tax Act is recognized. The impact of the reclassification from other comprehensive income to retained earnings was included in
the Statement of Changes in Stockholders’ Equity as of December 31, 2017.
In March 2018, the FASB updated the Income Taxes Topic of the ASC. The amendments incorporate recent SEC guidance related to the
income tax accounting implications of the Tax Cuts and Jobs Act. The amendments were effective upon issuance and did not have a material
effect on its financial statements.
In June 2018, the FASB amended the Compensation-Stock Compensation Topic of the Accounting Standards Codification. The
amendments expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from
nonemployees. The amendments are effective for fiscal years beginning after December 15, 2018, including interim periods within that fiscal
year. Early adoption is permitted, but no earlier than an entity’s adoption date of Topic 606. The Company does not expect these amendments
to have a material effect on its financial statements.
In August 2018, the FASB amended the Fair Value Measurement Topic 820 disclosure framework. These amendments include additions,
removals and modifications to the fair value disclosure requirements in Topic 820, and are effective for all entities for fiscal years, and interim
periods within those fiscal years, beginning
104
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 1 - Nature of Business and Basis of Presentation (continued)
after December 15, 2019. Early adoption is permitted on removed or modified disclosures. The Company does not expect these amendments
to have a material effect on its financial statements.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a
material impact on the Company's financial position, results of operations or cash flows.
Reclassifications:
Certain reclassifications have been made to the amounts reported in prior periods to conform to the current period presentation. The
reclassifications had no effect on net income or total stockholders' equity.
Note 2 - Cash and Cash Equivalents
Cash and cash equivalents include cash and due from banks, interest bearing deposits and federal funds sold. The Bank is required by
regulation to maintain an average cash reserve balance based on a percentage of deposits. At December 31, 2018 and 2017, the requirements
were satisfied by amounts on deposits with the Federal Reserve Bank and cash on hand.
Note 3 - Investment Securities
The amortized cost and estimated fair value of investment securities at December 31, 2018 and 2017 are summarized as follows (in
thousands):
Investment Securities Available for Sale
(in thousands)
December 31, 2018
U.S. government-sponsored enterprises
Municipal
Corporate
Mortgage-backed securities
December 31, 2017
U.S. government-sponsored enterprises
Municipal
Corporate
Mortgage-backed securities
Amortized
Cost
Unrealized
Gains
Unrealized
Losses
Fair
Value
$
$
$
$
17,496 $
517
2,908
26,836
47,757 $
17,489 $
518
3,060
33,310
54,377 $
— $
—
28
46
74 $
1 $
—
67
179
247 $
(136) $
(16)
(51)
(696)
(899) $
(120) $
(3)
(50)
(422)
(595) $
17,360
501
2,885
26,186
46,932
17,370
515
3,077
33,067
54,029
Proceeds from sales of securities sold during the year ended December 31, 2018, were $345 thousand and resulted in aggregate realized
losses of $2 thousand. No securities were sold during the year ended December 31, 2017.
105
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 3 - Investment Securities (continued)
Information related to unrealized losses in the investment portfolio as of December 31, 2018 and 2017 are as follows (in thousands):
Investment Securities Unrealized Losses
December 31, 2018
U.S. government-sponsored enterprises
Municipal
Corporate
Mortgage-backed securities
December 31, 2017
U.S. government-sponsored enterprises
Municipal
Corporate
Mortgage-backed securities
Less than 12 months
12 months or longer
Total
(in thousands)
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
Fair
Value
Unrealized
Losses
$
$
$
$
496 $
—
—
2,294
2,790 $
8,967 $
515
—
11,204
20,686 $
$
(2)
—
—
(7)
(9)
$
16,864 $
501
857
21,037
39,259 $
(26)
$
(3)
—
(165)
(194)
$
7,906 $
—
1,010
13,645
22,561 $
(134) $
(16)
(51)
(689)
(890) $
(94) $
—
(50)
(257)
(401) $
17,360 $
501
857
23,331
42,049 $
16,873 $
515
1,010
24,849
43,247 $
(136)
(16)
(51)
(696)
(899)
(120)
(3)
(50)
(422)
(595)
At December 31, 2018, there were nine U.S. government-sponsored enterprises securities, two corporate securities, fifteen mortgage-
backed securities, and one municipal security that had been in a loss position for greater than twelve months. Management believes that all
unrealized losses have resulted from temporary changes in the interest rates and current market conditions and not as a result of credit
deterioration. Management has the ability and the intent to hold these investment securities until maturity or until they recover in value.
A summary of pledged securities at December 31, 2018 and 2017 are shown below:
Pledged Securities
(in thousands)
Securities sold under agreements to repurchase
Federal Home Loan Bank advances
For the Years Ended December 31,
2018
2017
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
$
$
16,032 $
6,713
22,745 $
15,862 $
6,662
22,524 $
14,405 $
7,433
21,838 $
14,475
7,454
21,929
106
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 3 - Investment Securities (continued)
Contractual maturities of U.S. government-sponsored enterprises and corporate securities at December 31, 2018 and 2017 are shown
below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without
call or prepayment penalties.
Investment Securities - Contractual Maturities
(in thousands)
Within one year
Over one to five years
Over five to ten years
Over ten years
Mortgage-backed securities(1)
_______________
(1) Mortgage-backed securities are due in monthly installments.
For the Years Ended December 31,
2018
2017
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
16,496 $
1,000
2,000
1,425
26,836
47,757 $
16,377 $
983
2,028
1,358
26,186
46,932 $
— $
17,489
2,518
1,060
33,310
54,377 $
—
17,370
2,582
1,010
33,067
54,029
$
$
107
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 4 - Loans Receivable
Major categories of loans are as follows:
Loan Categories
(in thousands)
Real estate:
Residential
Commercial
Construction
Commercial
Credit card
Other consumer
Deferred origination fees, net
Allowance for loan losses
Loans receivable, net
For the Years Ended December 31,
2018
2017
$
$
407,844 $
278,691
157,586
122,264
34,673
1,202
1,002,260
(1,992)
(11,308)
988,960 $
342,684
259,853
144,932
108,982
31,507
1,053
889,011
(1,591)
(10,033)
877,387
The Company makes loans to customers located primarily in the Washington, D.C. metropolitan area. Although the loan portfolio is
diversified, its performance will be influenced by the regional economy. The Company’s loan categories are described below.
Residential Real Estate Loans. One-to-four family mortgage loans are primarily on owner-occupied primary residences and, to a lesser
extent, investor owned residences. Residential loans are originated through the commercial sales teams and Church Street Mortgage division.
Residential loans also include home equity lines of credit. One-to-four family residential loans have a relatively small balance spread between
many individual borrowers compared to our other loan categories. Owner-occupied residential real estate loans usually have fixed rates for five
or seven years and adjust on an annual basis after the initial term based on a typical maturity of 30 years. Investor residential real estate loans
are based on 25-year terms with a balloon payment due after five years. The required minimum debt service coverage ratio is 1.15. Residential
real estate loans have represented a stable and growing portion of our loan portfolio. The emphasis will continue to be on residential real estate
lending.
Commercial Real Estate Loans. Commercial real estate loans are originated on owner-occupied and non-owner-occupied properties.
These loans may be more adversely affected by conditions in the real estate markets or in the general economy. Commercial loans that are
secured by owner-occupied commercial real estate and primarily collateralized by operating cash flows are also included in this category of
loans. As of December 31, 2018, there were approximately $129.1 million of owner-occupied commercial real estate loans, representing
approximately 46% of the commercial real estate portfolio. Commercial real estate loan terms are generally extended for 10 years or less and
amortize generally over 25 years or less. The interest rates on commercial real estate loans have initial fixed rate terms that adjust typically at 5
years and origination fees are routinely charged for services. Personal guarantees from the principal owners of the business are generally
required, supported by a review of the principal owners’ personal financial statements and global debt service obligations. The properties
securing the portfolio are located primarily throughout the Company’s markets and are generally diverse in terms of type. This diversity helps
reduce the exposure to adverse economic events that affect any single industry.
Construction Loans. Construction loans are offered within the Company’s Washington, D.C. and Baltimore, Maryland metropolitan
operating areas to builders primarily for the construction of single-family homes and condominium and townhouse conversions or renovations
and, to a lesser extent, to individuals. Construction loans typically have terms of 12 to 18 months with the goal of transitioning the borrowers to
permanent financing or re-underwriting and selling into the secondary market through Church Street Mortgage. According to underwriting
standards, the ratio of loan principal to collateral value, as established by an independent appraisal, cannot exceed 75% for investor-owned
and 80% for owner-occupied properties. Semi-annual stress testing of
108
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 4 - Loans Receivable (continued)
the construction loan portfolio is conducted, and underlying real estate conditions are closely monitored as well as the borrower’s trends of
sales valuations as compared to underwriting valuations as part of the ongoing risk management efforts. The borrowers’ progress in
construction buildout is closely monitored and the original underwriting guidelines for construction milestones and completion timelines are
strictly enforced.
Commercial Business Loans. In addition to other loan products, general commercial loans, including commercial lines of credit, working
capital loans, term loans, equipment financing, letters of credit and other loan products are offered, primarily in target markets, and underwritten
based on each borrower’s ability to service debt from income. These loans are primarily made based on the identified cash flows of the
borrower and secondarily, on the underlying collateral provided by the borrower. Most commercial business loans are secured by a lien on
general business assets including, among other things, available real estate, accounts receivable, promissory notes, inventory and equipment,
and personal guaranties from the borrower or other principal are generally obtained.
Credit Cards. Through the OpenSky® credit card division, credit cards on a nationwide basis to under-banked populations and those
looking to rebuild their credit scores are provided through a fully digital and mobile platform. Substantially all of the lines of credit are secured
by a noninterest bearing demand account at the Bank in an amount equal to the full credit limit of the credit card. In addition, using a proprietary
scoring model, which considers credit score and repayment history (typically a minimum of six months of on-time repayments, but ultimately
determined on a case-by-case basis) the Bank has recently begun to offer certain customers an unsecured line in excess of their secured line
of credit. Approximately $32.5 million and $29.4 million of the credit card balances were secured by savings deposits held by the Bank as of
December 31, 2018 and 2017, respectively.
Other Consumer Loans. To a very limited extent and typically as an accommodation to existing customers, personal consumer loans such
as term loans, car loans or boat loans are offered.
Loans acquired through acquisitions are recorded at estimated fair value on their purchase date with no carryover of the related allowance
for loan losses. In estimating the fair value of loans acquired, certain factors were considered, including the remaining lives of the acquired
loans, payment history, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, and the net present value of
cash flows expected. Discounts on loans that were not considered impaired at acquisition were recorded as an accretable discount, which will
be recognized in interest income over the terms of the related loans. For loans considered to be impaired, the difference between the
contractually required payments and expected cash flows was recorded as a nonaccretable discount. The remaining nonaccretable discounts
on loans acquired were $354 thousand and $601 thousand as of December 31, 2018 and 2017, respectively. Loans with nonaccretable
discounts had a carrying value of $1.3 million and $1.5 million as of December 31, 2018 and 2017, respectively.
The activity in the accretable discounts on loans acquired was as follows:
Accretable Discounts on Loans Acquired
(in thousands)
Accretable discount at beginning of period
Less: Accretion and payoff of loans
Accretable discount at end of period
For the Years Ended December 31,
2018
2017
$
$
543 $
(105)
438 $
676
(133)
543
The allowance for loan losses consists of specific and general components. The specific component relates to loans that are individually
classified as impaired. The general component covers non-impaired loans and is based on historical loss experience adjusted for current
economic factors. The following tables present, by class
109
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 4 - Loans Receivable (continued)
and reserving methodology, the allocation of the allowance for loan losses and the gross investment in loans for the years ended December 31,
2018 and 2017.
Allowance for Loan Losses
(in thousands)
December 31, 2018
Real estate:
Residential
Commercial
Construction
Commercial
Credit card
Other consumer
December 31, 2017
Real estate:
Residential
Commercial
Construction
Commercial
Credit card
Other consumer
Beginning
Balance
Provision for
Loan Losses
Charge-Offs
Recoveries
Ending
Balance
Individually
Collectively
Individually
Collectively
Allowance for Loan Losses
Ending Balance Evaluated
for Impairment:
Outstanding Loan
Balances Evaluated
for Impairment:
$
$
$
$
3,137 $
2,860
1,646
1,497
885
8
10,033 $
2,664 $
2,682
1,591
1,174
477
9
8,597 $
522 $
13
447
194
963
1
2,140 $
(121) $
(22)
—
(147)
(806)
—
(1,096) $
3 $
152
—
34
42
—
231 $
3,541 $
3,003
2,093
1,578
1,084
9
11,308 $
664 $
375
55
345
1,217
(1)
2,655 $
(191) $
(312)
—
(25)
(1,124)
—
(1,652) $
— $
115
—
3
315
—
433 $
3,137 $
2,860
1,646
1,497
885
8
10,033 $
110
— $
—
—
262
—
—
262 $
— $
—
—
60
—
—
60 $
3,541 $
3,003
2,093
1,316
1,084
9
11,046 $
3,137 $
2,860
1,646
1,437
885
8
9,973 $
2,120 $
1,486
—
749
—
—
4,355 $
1,766 $
4,293
627
1,544
—
—
8,230 $
405,724
277,205
157,586
121,515
34,673
1,202
997,905
340,918
255,560
144,305
107,438
31,507
1,053
880,781
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 4 - Loans Receivable (continued)
Past due loans, segregated by age and class of loans, as of December 31, 2018 and 2017 were as follows:
Loans Past Due
(in thousands)
December 31, 2018
Real estate:
Residential
Commercial
Construction
Commercial
Credit card
Other consumer
Acquired loans included above
December 31, 2017
Real estate:
Residential
Commercial
Construction
Commercial
Credit card
Other consumer
Acquired loans included above
$
$
$
$
$
$
Loans
30-89 Days
Past Due
Loans
90 or More
Days
Past Due
Total
Past Due
Loans
Current
Loans
Total
Loans
Accruing
Loans 90 or
More days
Past Due
Nonaccrual
Loans
1,070 $
1,746
—
612
3,771
—
7,199 $
2,081 $
1,431
—
398
2
—
3,912 $
3,151 $
3,177
—
1,010
3,773
—
11,111 $
404,693 $
275,514
157,586
121,254
30,900
1,202
991,149 $
407,844 $
278,691
157,586
122,264
34,673
1,202
1,002,260 $
235 $
—
—
—
2
—
237 $
2,207
1,486
—
749
—
—
4,442
521 $
488 $
1,009 $
7,275 $
8,284 $
235 $
582
8,311 $
128
—
1,219
2,982
—
12,640 $
968 $
333
280
911
85
—
2,577 $
9,279 $
461
280
2,130
3,067
—
15,217 $
333,405 $
259,392
144,652
106,852
28,440
1,053
873,794 $
342,684 $
259,853
144,932
108,982
31,507
1,053
889,011 $
— $
—
280
—
85
—
365 $
1,828
1,648
499
1,067
—
—
5,042
208 $
635 $
843 $
9,526 $
10,368 $
— $
1,367
111
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 4 - Loans Receivable (continued)
Impaired loans include loans acquired on which management has recorded a nonaccretable discount. Impaired loans as of December 31,
2018 and 2017 were as follows:
Impaired Loans
(in thousands)
December 31, 2018
Real estate
Residential
Commercial
Construction
Commercial
Acquired loans included
above
December 31, 2017
Real estate
Residential
Commercial
Construction
Commercial
Acquired loans included
above
$
$
$
$
$
$
Unpaid
contractual
principal
balance
Recorded
investment
with no
allowance
Recorded
investment
with
allowance
Total
recorded
investment
Related
allowance
Average
recorded
investment
Interest
recognized
2,411 $
1,551
32
856
4,850 $
2,120 $
1,486
—
363
3,969 $
— $
—
—
386
386 $
2,120 $
1,486
—
749
4,355 $
— $
—
—
262
262 $
2,564 $
1,591
140
1,270
5,565 $
775 $
497 $
— $
497 $
— $
— $
2,329 $
4,677
659
1,824
9,489 $
1,766 $
4,293
627
1,178
7,864 $
— $
—
—
366
366 $
1,766 $
4,293
627
1,544
8,230 $
— $
—
—
60
60 $
1,948 $
4,407
880
1,600
8,835 $
2,149 $
1,366 $
— $
1,366 $
— $
1,553 $
28
—
—
—
28
—
30
169
24
48
271
1
There were $221 thousand and $503 thousand, respectively, of loans secured by one to four family residential properties in the process of
foreclosure as of December 31, 2018 and December 31, 2017.
Credit quality indicators
As part of the ongoing monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators
including trends related to the risk grade of loans, the level of classified loans, net charge-offs, nonperforming loans, and the general economic
conditions in the Company’s market.
The Company utilizes a risk grading matrix to assign a risk grade to each of its loans. A description of the general characteristics of loans
characterized as classified is as follows:
Special Mention
A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential
weaknesses may result in deterioration of the repayment prospects for the asset or in the Company’s credit position at some future date.
Special mention loans are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.
Borrowers may exhibit poor liquidity and leverage positions resulting from generally negative cash flow or negative trends in earnings.
Access to alternative financing may be limited to finance companies for business borrowers and may be unavailable for commercial real estate
borrowers.
112
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 4 - Loans Receivable (continued)
Substandard
A substandard loan is inadequately protected by the current financial condition and paying capacity of the obligor or of the collateral
pledged, if any. Substandard loans have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. They are
characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
Borrowers may exhibit recent or unexpected unprofitable operations, an inadequate debt service coverage ratio, or marginal liquidity and
capitalization. These loans require more intense supervision by Company management.
Doubtful
A doubtful loan has all the weaknesses inherent as a substandard loan with the added characteristic that the weaknesses make collection
or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
The following table presents the balances of classified loans based on the risk grade. Classified loans include Special Mention,
Substandard, and Doubtful loans:
Loan Classifications
(in thousands)
December 31, 2018
Real estate:
Residential
Commercial
Construction
Commercial
Credit card
Other consumer
Total
December 31, 2017
Real estate:
Residential
Commercial
Construction
Commercial
Credit card
Other consumer
Total
Pass(1)
Special Mention
Substandard
Doubtful
Total
$
$
$
$
405,532 $
274,247
154,643
117,670
34,673
1,202
987,967 $
340,854 $
251,292
144,433
101,868
31,507
1,053
871,007 $
118 $
2,958
843
3,844
—
—
7,763 $
— $
6,175
—
5,730
—
—
11,905 $
2,194 $
1,486
2,100
750
—
—
6,530 $
1,830 $
2,386
499
1,384
—
—
6,099 $
— $
—
—
—
—
—
— $
— $
—
—
—
—
—
— $
407,844
278,691
157,586
122,264
34,673
1,202
1,002,260
342,684
259,853
144,932
108,982
31,507
1,053
889,011
________________________
(1) Classification includes loans graded exceptional, very good, good, satisfactory and pass/watch
Impaired loans also include certain loans that have been modified in troubled debt restructurings (“TDRs”) where economic concessions
have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result
from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal,
forbearance or other actions. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned
113
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 4 - Loans Receivable (continued)
to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months. The
status of TDRs is as follows:
Troubled Debt Restructurings
(dollars in thousands)
December 31, 2018
Real estate:
Residential
Commercial
Total
Acquired loans included above
December 31, 2017
Real estate:
Residential
Commercial
Commercial
Total
Acquired loans included above
Number of
Contracts
Recorded Investment
Performing
Nonperforming
Total
3 $
1
4 $
3 $
5 $
1
3
9 $
4 $
— $
—
— $
— $
— $
2,709
510
3,219 $
145 $
139
284 $
145 $
254 $
—
338
592 $
145
139
284
145
254
2,709
848
3,811
— $
151 $
151
During the year ended December 31, 2018, the Company had no new modified loans that were considered TDRs, and no defaulted loans
over the last twelve months. Of the four loans designated as troubled debt restructing at December 31, 2018, three loans were due to changes
in interest rates and payment terms, and one loan was due to a change in interest rate, payment terms and a principal reduction. At
December 31, 2017, three loans were designated as troubled debt restructuring due to payment terms and extension of maturity, four loans
due to changes in interest rates and payment terms, and two loans for extensions of maturity dates. There were three restructured loans
charged off in the amount of $291 thousand, and two performing restructured loans paid off for $3.2 million during the year ended December
31, 2018.
114
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 4 - Loans Receivable (continued)
Outstanding loan commitments were as follows:
Loan Commitments
(in thousands)
Unused lines of credit
Commercial
Commercial real estate
Residential real estate
Home equity
Secured credit card
Personal
Construction commitments
Residential real estate
Commercial real estate
Commitments to originate residential loans held for sale
Letters of credit
For the Years Ended December 31,
2018
2017
$
$
$
$
52,083 $
8,980
12,853
27,243
29,142
126
72,424
6,358
209,209 $
647 $
6,216 $
46,580
7,530
7,072
25,395
30,161
148
56,463
7,350
180,699
4,138
6,759
Lines of credit are agreements to lend to a customer as long as there is no violation of any condition of the contract. 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. Loan commitments generally have variable interest rates, fixed expiration dates, and may require payment of
a fee. Letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. In the event of
nonperformance by the customer in accordance with the terms of the agreement with the third party, we would be required to fund the
commitment.
The Company's maximum exposure to credit loss in the event of nonperformance by the customer is the contractual amount of the credit
commitment. Loan commitments and lines of credit are made on the same terms, including collateral, as outstanding loans. Management is not
aware of any accounting loss to be incurred by funding these loan commitments. As of December 31, 2018 and December 31, 2017
respectively, the Company had an allowance for off-balance-sheet credit risk of $1,053 thousand and $901 thousand, recorded in other
liabilities on the consolidated balance sheet.
The Company makes representations and warranties that loans sold to investors meet their program's guidelines and that the information
provided by the borrowers is accurate and complete. In the event of a default on a loan sold, the investor may make a claim for losses due to
document deficiencies, program compliance, early payment default, and fraud or borrower misrepresentations.
115
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 4 - Loans Receivable (continued)
The Company maintains a liability account for estimated reserves on off balance sheet items such as unfunded lines of credit. Activity for
this accounts is as follows:
Off Balance Sheet Reserves
(in thousands)
Balance at beginning of period
Add: Provision
Add: Recoveries
Less: Charge-offs
Balance at end of period
For the Years Ended December 31,
2018
2017
$
$
901 $
152
—
—
1,053 $
801
100
—
—
901
The Company maintains a reserve in other liabilities for potential losses on mortgage loans sold. Activity in this reserve is as follows for the
periods presented:
Mortgage Loan Put-back Reserve
(in thousands)
Balance at beginning of period
Add: Provision
Add: Recoveries
Less: Charge-offs
Balance at end of period
Note 5 - Premises and Equipment
For the Years Ended December 31,
2018
2017
457 $
106
—
(62)
501 $
442
115
—
(100)
457
$
$
Premises and equipment and the related depreciation and amortization consist of the following:
Premises and Equipment
(in thousands)
Leasehold improvements
Furniture and equipment
Vehicle
Software
Construction in progress
Less: Accumulated depreciation and amortization
Premises and equipment, net
Depreciation and amortization expense
2018
2017
$
$
$
1,686 $
4,430
54
2,405
19
8,594
5,619
2,975 $
1,085 $
1,065
4,107
54
2,163
114
7,503
4,902
2,601
983
116
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 6 - Derivative Financial Instruments
As part of its mortgage banking activities, the Company enters into interest rate lock commitments, which are commitments to originate
loans whereby the interest rate on the loan is determined prior to funding and the customers have locked into that interest rate. The Company
then either locks the loan and rate in with an investor and commits to deliver the loan if settlement occurs (Best Efforts) or commits to deliver
the locked loan to an investor in a binding (Mandatory) delivery program. Certain loans under rate lock commitments are covered under forward
sales contracts. Forward sales contracts are recorded at fair value with changes in fair value recorded in mortgage banking revenue. Interest
rate lock commitments and commitments to deliver loans to investors are considered derivatives. The market value of interest rate lock
commitments and best efforts contracts are not readily ascertainable with precision because they are not actively traded in stand-alone
markets. The Company determines the fair value of rate lock commitments and delivery contracts by measuring the fair value of the underlying
asset, which is impacted by current interest rates and takes into consideration the probability that the rate lock commitments will close or will be
funded.
At December 31, 2018 and 2017, the Company had open forward sales agreements with notional values of $25.0 million and $41.0 million,
respectively. At December 31, 2018 and 2017, the Company had open mandatory delivery commitments of $4.3 million and $12.6 million,
respectively. The open forward delivery sales agreements are composed of forward sales of loans. The fair values of the open forward sales
agreements were $(253) thousand and $(42) thousand at December 31, 2018 and 2017, respectively. The fair values of the open mandatory
delivery commitments were $59 thousand and $18 thousand at December 31, 2018 and 2017, respectively.
Interest rate lock commitments totaled $32.9 million and $56.9 million at December 31, 2018 and 2017, respectively and included $1.8
million and $6.2 million of commitments that were made on a best efforts basis at December 31, 2018 and 2017, respectively. The fair values of
these best efforts commitments were $31 thousand and $102 thousand at December 31, 2018 and 2017, respectively. The remaining hedged
interest rate lock commitments totaling $31.1 million and $50.7 million at December 31, 2018 and 2017, had fair values of $234 thousand and
$108 thousand, respectively. Loans held for sale include the portion of fair value remaining for hedged interest rate lock commitments related to
closed loans, the fair value of open mandatory delivery commitments, and the fair value of best efforts commitments.
On January 7, 2015, the Company entered into an interest rate swap transaction with a notional amount of $2 million. The swap qualifies
as a derivative and is designated as a hedging instrument. The swap fixes the interest rate the Company will pay on the floating rate junior
subordinated debentures for four years beginning on March 16, 2015. Based on the notional amount, the Company pays the counter-party
quarterly interest at a fixed rate of 3.493% and the counter-party pays the Company interest at a rate of three‑month LIBOR plus 1.87%. As of
December 31, 2018 and 2017, the swap had a fair value of $5 thousand and $7 thousand, respectively. The unrealized loss, net of income tax,
has been recorded in other comprehensive income. Management believes there is no hedge ineffectiveness as of December 31, 2018.
117
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 7 - Interest Bearing Deposits
Major categories of interest bearing deposits are as follows:
Interest Bearing Deposits
(in thousands)
NOW accounts
Money market accounts
Savings
Certificates of deposit of $250,000 or more
Other time deposits
Total Interest Bearing Deposits
At December 31,
2018
2017
$
$
85,747 $
288,896
2,866
99,412
236,060
712,981 $
74,663
312,809
3,450
74,930
242,412
708,264
The aggregate amount of brokered certificates of deposit was $76.1 million and $72.5 million at December 31, 2018 and 2017, respectively.
The aggregate amount of Certificate of Deposit Account Registry Service (“CDARS”) deposits was $45.1 million and $61.0 million at
December 31, 2018 and 2017, respectively.
As of December 31, 2018, certificates of deposit mature as follows:
Maturities of Certificates of Deposit
(in thousands)
2019
2020
2021
2022
2023, and thereafter
$
241,195
80,468
12,924
275
610
$
335,472
Note 8 - Securities Sold Under Agreements to Repurchase
The Company sells securities under repurchase agreements to provide cash management services to commercial account customers.
These borrowings are summarized as follows:
Securities Sold Under Agreements to Repurchase
(dollars in thousands)
Average amount outstanding
Average rate paid during the year
Maximum amount outstanding at month end
Investment securities pledged to secure the underlying agreements at year end:
Amortized cost
Fair value
118
$
$
$
2018
2017
10,596
$
1.38%
12,445
$
16,032
$
15,862
9,684
0.15%
12,472
14,405
14,475
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 9 - Borrowed Funds
As of December 31, 2018 and 2017, the Company was indebted as follows.
Borrowed Funds
(dollars in thousands)
Pacific Coast Bankers Bank
Total - Federal funds purchased
FHLB advance due March 25, 2019
Total - FHLB advances
Senior promissory note due July 31, 2019
Junior subordinated debentures due June 15, 2036
Other subordinated notes due December 1, 2025
Less: Unamortized debt issuance costs
Total - Other borrowed funds
Federal Home Loan Bank advances
2018
2017
Balance
Interest
Balance
Interest
2,000
2,000
2,000
2,000
—
2,062
13,500
(169)
15,393
$
$
$
$
3.28%
4.26%
—%
4.68%
6.95%
$
$
$
—
—
2,000
2,000
2,000
2,062
13,500
(201)
17,361
—%
4.26%
5.50%
3.56%
6.95%
The Federal Home Loan Bank advances require quarterly interest payments with principal and any remaining accrued interest due at
maturity.
Senior promissory note
On July 30, 2014, the Company issued a $5,000,000 senior promissory note (the “Note”) with a maturity date of July 31, 2019. The
Company repaid $3,000,000 on this note on July 30, 2016. On that date, the Note was amended and the interest rate was fixed at 5.00%
through September 30, 2017. Effective October 1, 2017, the Note was again amended to fix the interest rate at 5.50% through March 31, 2018,
and was paid off on March 30, 2018.
Junior subordinated debentures
In June 2006, the Company formed Capital Bancorp (MD) Statutory Trust I (the “Trust”) and on June 15, 2006, the Trust issued 2,000
floating Rate Capital Securities (the “Capital Securities”) with an aggregate liquidation value of $2,000,000 to a third party in a private
placement. Concurrent with the issuance of the Capital Securities, the Trust issued trust common securities to the Company in the aggregate
liquidation value of $62,000.
The proceeds of the issuance of the Capital Securities and trust common securities were invested in the Company’s Floating Rate Junior
Subordinated Deferrable Interest Debentures (the “Floating Rate Debentures”). The Floating Rate Debentures for the Trust will mature on June
15, 2036, which may be shortened if certain conditions are met (including the Company having received prior approval of the Board of
Governors of the Federal Reserve System and any other required regulatory approvals). These Floating Rate Debentures, which are the only
assets of the Trust, are subordinate and junior in right of payment to all present and future senior indebtedness (as defined in the Indenture
dated June 15, 2006) of the Company. The Floating Rate Debentures for the Trust accrue interest at a floating rate equal to the three-month
LIBOR plus 1.87%, payable quarterly. As of December 31, 2018 and 2017, the rate for the Trust was 4.68% and 3.56%, respectively. The
quarterly distributions on the Capital Securities will be paid at the same rate that interest is paid on the Floating Rate Debentures.
119
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 9 - Borrowed Funds
The Company has fully and unconditionally guaranteed the Trust’s obligation under the Capital Securities. The Trust must redeem the
Capital Securities when the Floating Rate Debentures are paid at maturity or upon any earlier prepayment of the Floating Rate Debentures.
The Floating Rate Debentures may be prepaid if certain events occur, including a change in the tax status or regulatory capital treatment of the
Capital Securities, or a change in existing laws that requires the Trust to register as an investment company.
The junior subordinated debentures are treated as Tier 1 capital, to a limited extent, by the Federal Reserve.
Other subordinated notes
On November 24, 2015, the Company issued $13,500,000 of subordinated notes. The notes mature on December 1, 2025. The notes bear
interest at 6.95% for the first five years, then adjust to the three‑month LIBOR plus 5.33% adjusted on March 1, June 1, September 1, and
December 1 of each year. Interest is payable quarterly. There were related debt issuance costs incurred totaling $278,231. The costs are
amortized to interest expense through the maturity date of the notes.
Available lines of credit
The Company has available lines of credit of $28,000,000 with other correspondent banks, and $2,000,000 was outstanding with Pacific
Coast Bankers Bank at December 31, 2018, and paid off on January 2, 2019.
The Company may borrow up to 25% of its assets from the FHLB, based on collateral available to pledge to secure the borrowings.
Borrowings from the FHLB are secured by a portion of the Company’s loan and/or investment portfolio. As of December 31, 2018 and 2017,
the Company had pledged loans providing borrowing capacity of $235.2 million and $78.8 million, respectively. As of December 31, 2018 and
2017, the Company had pledged investment securities with a fair value of $6.7 million and $7.5 million, respectively, to the FHLB. As of
December 31, 2018 and 2017, the Company had $185.6 million and $84.1 million, respectively, of available borrowing capacity from the FHLB.
As of December 31, 2018 and 2017, the Company had pledged commercial loans to the Federal Reserve Bank of Richmond to provide a
borrowing capacity totaling $13.1 million and $17.9 million, respectively, under its discount window program. There were no advances
outstanding under this facility as of December 31, 2018 and 2017.
Certificate of deposit funding through a financial network is limited to 15% of the Bank’s assets, or approximately $161.2 million and $152.4
million as of December 31, 2018 and 2017, respectively.
Note 10 - Retirement Plan
The Company provides a defined contribution plan qualifying under Section 401(k) of the Internal Revenue Code to eligible employees.
The Company contributes 3% of eligible compensation on behalf of all full‑time employees up to limits prescribed by the Internal Revenue
Code. The Company’s contribution to the plan was $553,224 in 2018 and $527,031 in 2017.
Note 11 - Related-Party Transactions
Certain executive officers and directors of the Company and Bank, and companies with which they are affiliated, are clients of and have
banking transactions with the Company in the ordinary course of business.
120
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 11 - Related-Party Transactions (continued)
These transactions are conducted on substantially the same terms, including interest rates and collateral, as those prevailing at the time for
comparable transactions with persons not related to the Company.
Activity in related-party loans during 2018 and 2017 is shown below:
Related Party Loans
(in thousands)
Balance at beginning of year
Add: New loans
Less: Amounts collected
Add (deduct): Relationship changes
Balance at end of year
$
$
2018
2017
16,268 $
2,093
(3,588)
(1,552)
13,221 $
13,529
34,386
(36,447)
4,800
16,268
Deposits from officers and directors and their related interests were $155.8 million at December 31, 2018, and $178.0 million at
December 31, 2017.
A director of the Company owns an interest in an entity from which the Company leases space for its Rockville, Maryland location.
Payments made in accordance with the lease were $566 thousand and $555 thousand in 2018 and 2017, respectively.
Company directors, or their related interests, held $1.4 million of the senior promissory notes outstanding as of December 31, 2017. These
notes were paid off on March 30, 2018.
Company directors, or their related interests, held $1.0 million of the convertible subordinated notes outstanding as of December 31, 2018
and 2017.
Company directors, or their related interests, held $4.5 million and $7.1 million of participation loans from the Bank as of December 31,
2018 and 2017, respectively. Company and Bank directors, or their related interests, held $2.0 million and $4.9 million of participation loans
from Church Street Capital as of December 31, 2018 and 2017, respectively.
Note 12 - Income Taxes
On December 22, 2017, the Tax Cuts and Jobs Act (the “2017 Tax Act”) became law. The 2017 Tax Act includes a number of changes to
existing U.S. tax laws that impact the Company, most notably a reduction of the U.S. corporate income tax rate to 21 percent for tax years
beginning after December 31, 2017.
The components of income tax expense are as follows:
Income Tax Expense
(in thousands)
Current
Federal
State
Total Current Expense
Deferred tax benefit
Change in corporate income tax rate
Total Income Tax Expense
For the Years Ended December 31,
2018
2017
$
$
3,696 $
1,427
5,123
(141)
—
4,982 $
4,612
1,231
5,843
(239)
1,386
6,990
121
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 12 - Income Taxes (continued)
The components of the net deferred tax asset are:
Net Deferred Tax Asset
(in thousands)
Deferred tax assets
Allowance for loan and credit losses
Reserve for recourse on mortgage loans sold
Nonaccrual interest
Foreclosed real estate write-downs
Stock-based compensation
Long-term incentive program (LTIP)
Core deposit intangible
Unrealized loss on investment securities available for sale
Net operating loss carryforward
Deferred tax liabilities
Unrealized gain on cash flow hedging derivative
Unrealized gain on loans held for sale
Accumulated depreciation
Deferred casualty gain
Other
Net deferred tax asset before valuation allowance
Less: Valuation allowance
Net deferred tax asset
2018
2017
3,384
138
63
3
239
189
24
227
244
4,511
2
51
516
1
43
613
3,898
244
3,654
The differences between the federal income tax rate and the effective tax rate for the Company are reconciled as follows:
Reconciliation of Federal Tax Rate to the Effective Rate
Statutory federal income tax rate
Increase (decrease) resulting from
State income taxes, net of federal income tax benefit
Nondeductible expenses
Tax exempt income
Change in corporate income tax rate
Other
Effective Tax Rate
2018
2017
21.00 %
6.35
0.42
(0.04)
—
0.34
28.07 %
3,003
125
268
8
188
77
26
97
212
4,004
2
9
399
1
—
411
3,593
212
3,381
34.00 %
5.37
0.84
(0.22)
9.83
(0.24)
49.58 %
Deferred tax assets represent the future tax benefit of deductible differences and, if it is more likely than not that a tax asset will not be
realized, a valuation allowance is required to reduce the net deferred tax assets to net realizable value. As of December 31, 2018,
management has determined that it is more likely than not that the majority of the deferred tax asset from continuing operations will be realized.
At December 31, 2018 and 2017, a valuation allowance of $244,376 and $212,367 was recognized, respectively, for a State of Maryland net
operating loss carryforward that may not be realizable.
The Company does not have material uncertain tax positions and did not recognize any adjustments for unrecognized tax benefits. The
Company remains subject to examination of income tax returns for the
122
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 12 - Income Taxes (continued)
years ending after December 31, 2015.
Note 13 - Capital Standards
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 capital adequacy guidelines and 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.
The Basel III Capital Rules became effective for the Bank on January 1, 2015 (subject to a phase‑in period for certain provisions).
Quantitative measures established by the Basel III Capital Rules to ensure capital adequacy require the maintenance of minimum amounts and
ratios (set forth in the following table) of Common Equity Tier 1 capital, Tier 1 capital, and Total capital (as defined in the regulations) to
risk‑weighted assets (as defined), and of Tier 1 capital to adjusted quarterly average assets (as defined).
In connection with the adoption of the Basel III Capital Rules, the Bank elected to opt‑out of the requirement to include accumulated other
comprehensive income in Common Equity Tier 1 capital. Common Equity Tier 1 capital for the Bank is reduced by goodwill and other intangible
assets, net of associated deferred tax liabilities and subject to transition provisions.
Under the revised prompt corrective action requirements, as of January 1, 2015, insured depository institutions are required to meet the
following in order to qualify as “well capitalized:” (1) a common equity Tier 1 risk‑based capital ratio of 6.5%; (2) a Tier 1 risk-based capital ratio
of 8%; (3) a total risk‑based capital ratio of 10%; and (4) a Tier 1 leverage ratio of 5%. Management believes that, as of December 31, 2017,
the Bank met all capital adequacy requirements under the Basel III Capital Rules on a fully phased‑in basis as if such requirements were fully
in effect.
The implementation of the capital conservation buffer began on January 1, 2016, at the 0.625% level and will be phased in over a four-year
period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019). The Basel III Capital Rules also
provide for a “countercyclical capital buffer” that is applicable to only certain covered institutions and does not have any current applicability to
the Bank.
The aforementioned capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a
ratio of Common Equity Tier 1 capital to risk‑weighted assets above the minimum but below the conservation buffer (or below the combined
capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases,
and compensation based on the amount of the shortfall.
As of December 31, 2018 the most recent notification from the OCC has categorized the Bank as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain ratios as set forth in the table. There
have been no conditions or events since that notification that management believes have changed the Bank’s category.
The OCC, through formal or informal agreement, has the authority to require an institution to maintain higher capital ratios than those
provided by statute, to be categorized as well capitalized under the regulatory framework for prompt corrective action.
123
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 13 - Capital Standards (continued)
The following table presents actual and required capital ratios as of December 31, 2018 and 2017 for the Bank under the Basel III Capital
Rules. The minimum required capital amounts presented include the minimum required capital levels as of December 31, 2018 and 2017
based on the phase-in provisions of the Basel III Capital Rules. Capital levels required to be considered well capitalized are based upon prompt
corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. Based on recent changes to the Federal
Reserve’s definition of a “Small Bank Holding Company” that increased the threshold to $3 billion in assets, the Company is not currently
subject to separate minimum capital measurements. At such time as the Company reaches the $3 billion asset level, it will again be subject to
capital measurements independent of the Bank. For comparison purposes, the Company’s ratios are presented in the following table as well,
all of which would have exceeded the “well-capitalized” level had the Company been subject to separate capital minimums.
Regulatory Capital
(Dollar amounts in thousands)
Amount
Ratio
Amount
Ratio
Amount
Ratio
Amount
Ratio
Actual
Minimum Capital
Adequacy
To Be Well
Capitalized
Full Phase In of Basel III
December 31, 2018
The Company
Tier 1 leverage ratio (to average assets)
Tier 1 capital (to risk-weighted assets)
Common equity tier 1 capital ratio (to risk-weighted assets)
Total capital ratio (to risk-weighted assets)
The Bank
Tier 1 leverage ratio (to average assets)
Tier 1 capital (to risk-weighted assets)
Common equity tier 1 capital ratio (to risk-weighted assets)
Total capital ratio (to risk-weighted assets)
December 31, 2017
The Company
Tier 1 leverage ratio (to average assets)
Tier 1 capital (to risk-weighted assets)
Common equity tier 1 capital ratio (to risk-weighted assets)
Total capital ratio (to risk-weighted assets)
The Bank
Tier 1 leverage ratio (to average assets)
Tier 1 capital (to risk-weighted assets)
Common equity tier 1 capital ratio (to risk-weighted assets)
Total capital ratio (to risk-weighted assets)
$
$
$
$
117,220
117,220
115,158
128,544
96,122
96,122
96,122
107,061
82,428
82,428
80,366
92,562
86,150
86,150
86,150
96,148
10.76% $
12.95%
12.73%
14.21%
43,575
71,259
57,686
89,356
4.000%
7.875%
6.375%
9.875%
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
$
43,575
76,914
63,341
95,012
9.06% $
11.00%
11.00%
12.25%
42,445
68,822
55,713
86,301
4.000% $
7.875%
6.375%
9.875%
53,056
69,914
56,805
87,393
5.00% $
8.00%
6.50%
10.00%
42,445
74,284
61,175
91,763
8.10% $
10.18%
9.92%
11.43%
40,724
58,717
46,569
74,915
4.000%
7.250%
5.750%
9.250%
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
$
40,724
68,841
56,693
85,039
8.55% $
10.78%
10.78%
12.03%
40,316
57,928
45,943
73,908
4.000% $
7.250%
5.750%
9.250%
50,395
63,920
51,935
79,900
5.00% $
8.00%
6.50%
10.00%
40,316
67,915
55,930
83,895
4.00%
8.50%
7.00%
10.50%
4.00%
8.50%
7.00%
10.50%
4.00%
8.50%
7.00%
10.50%
4.00%
8.50%
7.00%
10.50%
124
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 14 - Stock-Based Compensation
Compensation cost is recognized for stock options and restricted stock awards issued to employees. Compensation cost is measured as
the fair value of these awards on their date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the
market price of the Company’s common stock at the date of grant is used as the fair value of restricted stock awards. Compensation cost is
recognized over the required service period, generally defined as the vesting period for stock option awards and as the restriction period for
restricted stock awards. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service
period for the entire award.
The expense recognition of employee stock option and restricted stock awards resulted in net expense of approximately $723,711 and
$625,870 during the years ended December 31, 2018 and 2017, respectively.
All share and per common share amounts have been adjusted to reflect the Stock Split. Refer to Notes 1 and 21 for additional information.
Stock options:
In April 2002, the Company adopted a stock option plan. The plan provides for granting options to purchase shares of common stock to the
directors and selected key employees of the Company and the Bank. The options granted to employees are intended to qualify as incentive
stock options under Section 422 of the Internal Revenue Code. In August 2017, the Company’s stockholders approved an increase in the
number of shares available for grant to 4,173,520, of which 542,215 are available for future grant at December 31, 2018. Option prices are
equal to or greater than the estimated fair value of the common stock at the date of grant. Options outstanding vest over a four-year period,
whereby 25% of the options become exercisable on each anniversary of the grant date.
Information with respect to options outstanding during the years ended December 31, 2018 and 2017 is as follows:
Stock Options Outstanding
Outstanding at beginning of year
Add: Granted
Less: Exercised
Less: Retired on exercise
Less: Expired/cancelled/forfeited
Outstanding at end of year
Exercisable at end of year
2018
2017
Shares
Weighted Average
Exercise Price
Shares
Weighted Average
Exercise Price
1,363,444 $
373,750
(230,894)
(37,240)
(37,200)
1,431,860 $
643,610 $
8.01
11.44
5.67
5.07
7.34
9.38
7.78
1,599,976 $
260,600
(358,332)
—
(138,800)
1,363,444 $
644,472 $
6.36
12.38
4.65
—
5.87
8.01
6.47
The weighted average fair value of options granted during the years ended December 31, 2018 and 2017, was $2.56 and $2.68,
respectively.
125
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 14 - Stock-Based Compensation (continued)
A summary of information about stock options outstanding is as follows:
Stock Option Summary
December 31, 2018
Total outstanding options
Intrinsic value on December 31, 2018
December 31, 2017
Total outstanding options
Intrinsic value on December 31, 2017
Weighted
Average
Exercise Price
Average
Remaining Life
(years)
Outstanding Shares Exercisable Shares
$
$
6.63
7.50
8.50
11.38
12.38
12.80
9.38
5.00
6.63
7.50
8.50
12.38
8.01
1.0
2.0
3.0
5.0
4.0
4.8
3.1
283,886
297,348
222,276
354,750
266,600
7,000
1,431,860
268,886
207,898
103,176
—
63,650
—
643,610
$
3,178,491 $
2,399,743
1.0
2.0
3.0
4.0
5.0
2.6
211,952
323,792
328,900
238,200
260,600
1,363,444
$
5,951,363 $
211,952
218,868
154,100
59,552
—
644,472
4,271,277
The aggregate intrinsic value as presented in the preceding tables is calculated by determining the difference between the estimated fair
value of the stock as of December 31, 2018 and 2017, and the exercise price of the option, then multiply by the number of options outstanding.
Stock options with exercise prices greater than the estimated fair value of the stock are not included in this calculation.
At December 31, 2018, there was $1,382,842 of total unrecognized compensation expense related to stock options to be recognized over
the next five years. At December 31, 2017, there was $996,283 of total unrecognized compensation expense related to nonvested stock
options to be recognized over the next four years.
The intrinsic value of stock options exercised was $1.3 million and $1.2 million during the years ended December 31, 2018 and 2017,
respectively.
The weighted average fair value of options granted during 2018 and 2017 were estimated using the Black-Scholes option-pricing model
with the following weighted average assumptions:
Stock Option Pricing Assumptions
Dividend yield
Risk free interest rate
Expected volatility
Expected life in years
2018
0.00%
2.53%
18.94%
5
2017
0.00%
2.20%
18.94%
5
126
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 14 - Stock-Based Compensation (continued)
Restricted stock:
The Company from time-to-time also grants shares of restricted stock to key employees. These awards help align the interests of these
employees with the interests of the stockholders of the Company by providing economic value directly related to increases in the value of the
Company’s stock. These awards typically hold service requirements over various vesting periods. The value of the stock awarded is
established as the fair market value of the stock at the time of the grant. The Company recognizes expense, equal to the total value of such
awards, ratably over the vesting period of the stock grants.
All restricted stock agreements are conditioned upon continued employment. Termination of employment prior to a vesting date, as
described below, would terminate any interest in non-vested shares. All restricted shares will fully vest in the event of change in control of the
Company.
Nonvested restricted stock for the years ended December 31, 2018 and 2017 is summarized in the following table.
Restricted Stock Summary
Nonvested at beginning of year
Add: Granted
Less: Vested
Less: Forfeited
Nonvested at end of year
2018
2017
Shares
Weighted Average
Grant-Date Fair
Value
Shares
Weighted Average
Grant-Date Fair Value
42,000 $
12,000
(16,000)
—
38,000 $
8.66
12.38
7.50
—
10.32
52,000 $
10,000
(16,000)
(4,000)
42,000 $
The vesting schedule of restricted shares as of December 31, 2018 is as follows:
Restricted Stock Vesting Schedule
Year
2019
2020
2021
2022
2023
Shares
At December 31, 2018 there was $230 thousand of total unrecognized compensation expense related to nonvested restricted stock. At
December 31, 2017, there was $244 thousand of total unrecognized compensation expense related to nonvested restricted stock.
127
7.45
12.38
7.50
6.88
8.66
18,500
5,500
5,500
5,500
3,000
38,000
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 15 - Parent Company Financial Information
The balance sheets as of December 31, 2018 and 2017 and statements of income and cash flows for the years then ended, for Capital
Bancorp, Inc. (Parent only) are presented below. All share and per common share amounts have been adjusted to reflect the Stock Split. Refer
to Note 1 for additional information.
Parent Company Only Balance Sheets
(in thousands)
Assets
Cash and cash equivalents
Investment in Bank
Investment in Church Street Capital
Investment in Trust
Loans receivable, net of allowance for loan losses of $208 and $44 at December 31, 2018 and
2017, respectively
Accrued interest receivable
Due from subsidiaries
Prepaid income taxes
Deferred income taxes
Other assets
Liabilities and Stockholders’ Equity
Borrowed funds
Accrued interest payable
Due to subsidiaries
Other liabilities
Stockholders’ equity
Common stock
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss
Total stockholders’ equity
2018
2017
$
$
$
$
3,768 $
95,524
3,284
62
27,032
106
54
90
18
134
130,072 $
15,393 $
81
—
34
15,508
137
49,321
65,701
(595)
114,564
130,072 $
798
85,898
3,092
62
7,208
83
—
135
18
537
97,831
17,361
82
94
175
17,712
115
27,051
53,200
(247)
80,119
97,831
128
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 15 - Parent Company Financial Information (continued)
Parent Company Only Statements of Income
(in thousands)
Interest and dividend revenue
Dividend from Bank
Total interest and dividend revenue
Interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Noninterest income
Noninterest expenses
Income before income taxes
Income tax benefit
Income before undistributed net income of subsidiaries
Equity in undistributed net income of subsidiaries
Net income
129
2018
2017
$
$
577 $
4,250
4,827
1,071
3,756
164
3,592
8
(248)
3,352
188
3,540
9,227
12,767 $
342
2,450
2,792
1,148
1,644
—
1,644
3
(137)
1,510
308
1,818
5,291
7,109
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 15 - Parent Company Financial Information (continued)
Parent Company Only Statements of Cash Flows
(in thousands)
Cash flows from operating activities
Net Income
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses
Equity in undistributed income-subsidiary
(Increase) decrease in receivable from subsidiary bank
Stock-based compensation expense
Director and employee compensation paid in Company stock
Deferred income tax benefit
Amortization of debt issuance costs
Changes in assets and liabilities:
Accrued interest receivable
Prepaid income taxes and taxes payable
Other assets
Accrued interest payable
Other liabilities
Net cash provided by operating activities
Cash flows from investing activities
Net increase in loans receivable
Capital injections to subsidiaries
Net cash provided by investing activities
Cash flows from financing activities
Repayment of debt
Repurchase of common stock
Proceeds from exercise of stock options
Proceeds from shares sold
Proceeds from initial public offering, net
Net cash provided by financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of year
2018
2017
12,767
7,109
164
(9,227)
(148)
570
496
(141)
32
(23)
45
(169)
(1)
—
4,365
(19,988)
(367)
(20,355)
(2,000)
(45)
1,043
198
19,764
18,960
2,970
798
—
(6,380)
144
506
776
(239)
34
(26)
69
(443)
—
18
1,568
(3,558)
80
(3,478)
—
(512)
1,668
—
—
1,156
(754)
1,552
798
Cash and cash equivalents, end of year
$
3,768 $
130
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 16 - Fair Value
Generally accepted accounting principles define fair value, establish a framework for measuring fair value, recommend disclosures about fair
value, and establish a hierarchy for determining fair value measurement. The hierarchy includes three levels and is based upon the valuation
techniques used to measure assets and liabilities. The three levels are as follows:
Level 1 - Inputs to the valuation method are quoted prices (unadjusted) for identical assets or liabilities in active markets;
Level 2 - Inputs to the valuation method include quoted prices for similar assets and liabilities in active markets, and inputs that are
observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument; and
Level 3 - Inputs to the valuation method are unobservable and significant to the fair value measurement.
Fair value measurements on a recurring basis
Investment securities available for sale - The fair values of the Company's investment securities available for sale are provided by an
independent pricing service. The fair values of the Company's securities are determined based on quoted prices for similar securities under
Level 2 inputs.
Loans held for sale - The fair value of loans held for sale is determined using Level 2 inputs of quoted prices for a similar asset, adjusted for
specific attributes of that loan.
Derivative financial instruments - Derivative instruments used to hedge residential mortgage loans held for sale and the related interest rate
lock commitments include forward commitments to sell mortgage loans and are reported at fair value utilizing Level 2 inputs. The fair values of
derivative financial instruments are based on derivative market data inputs as of the valuation date and the underlying value of mortgage loans
for rate lock commitments.
The interest rate swap is reported at fair value utilizing Level 2 inputs. The Company obtains dealer quotations to value its swap. For
purposes of potential valuation adjustments to its derivative position, the Company evaluates the credit risk of its counterparty. Accordingly, the
Company has considered factors such as the likelihood of default by the counterparty and the remaining contractual life, among other things, in
determining if any fair value adjustment related to credit risk is required.
131
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 16 - Fair Value (continued)
The Company has categorized its financial instruments measured at fair value on a recurring basis as of December 31, 2018 and
December 31, 2017 as follows:
Fair Value of Financial Instruments
(in thousands)
December 31, 2018
Investment securities available for sale
U.S. government-sponsored enterprises
Municipal
Corporate
Mortgage-backed securities
Loans held for sale
Derivative assets
Derivative liabilities
December 31, 2017
Investment securities available for sale
U.S. government-sponsored enterprises
Municipal
Corporate
Mortgage-backed securities
Loans held for sale
Derivative assets
Derivative liabilities
Total
Level 1 Inputs
Level 2 Inputs
Level 3 Inputs
$
$
$
$
$
$
$
$
$
$
17,360 $
501
2,885
26,186
46,932 $
18,526 $
112 $
253 $
17,370 $
516
3,076
33,067
54,028 $
26,344 $
100 $
42 $
— $
—
—
—
— $
— $
— $
— $
— $
—
—
—
— $
— $
— $
— $
17,360 $
501
2,885
26,186
46,932 $
18,526 $
112 $
253 $
17,370 $
516
3,076
33,067
54,028 $
26,344 $
100 $
42 $
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
Financial instruments recorded using FASB ASC 825-10
Under FASB ASC 825-10, the Company may elect to report most financial instruments and certain other items at fair value on an
instrument-by-instrument basis with changes in fair value reported in net income. After the initial adoption, the election is made at the
acquisition of an eligible financial asset, financial liability or firm commitment or when certain specified reconsideration events occur. The fair
value election, with respect to an item, may not be revoked once an election is made.
The following table reflects the difference between the fair value carrying amount of loans held for sale, measured at fair value under FASB
ASC 825-10, and the aggregate unpaid principal amount the Company is contractually entitled to receive at maturity:
Fair Value of Loans Held for Sale
(in thousands)
Loans held for sale
Aggregate fair value
Contractual principal
Difference
2018
2017
$
$
18,526 $
17,822
704 $
26,344
25,637
707
As of December 31, 2018 and December 31, 2017, the Company elected to account for loans held for sale at fair value to eliminate the
mismatch that would occur by recording changes in market value on
132
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 16 - Fair Value (continued)
derivative instruments used to hedge loans held for sale while carrying the loans at the lower of cost or market.
Fair value measurements on a nonrecurring basis
Impaired loans - The Company has measured impairment generally based on the fair value of the loan's collateral and discounted cash
flow analysis. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows
based upon the expected proceeds. These assets are included as Level 3 fair values. As of December 31, 2018 and December 31, 2017, the
fair values consist of loan balances of $4.4 million and $8.2 million, with valuation allowances of $262 thousand and $60 thousand,
respectively.
Foreclosed real estate - The Company's foreclosed real estate is measured at fair value less cost to sell. Fair value was determined based
on offers and/or appraisals. Cost to sell the real estate was based on standard market factors. The Company has categorized its foreclosed
real estate as Level 3.
Fair Value of Impaired Loans and Foreclosed Real Estate
(in thousands)
Impaired loans
Level 1 Inputs
Level 2 Inputs
Level 3 Inputs
Total
Foreclosed real estate
Level 1 Inputs
Level 2 Inputs
Level 3 Inputs
Total
2018
2017
$
$
$
$
— $
—
4,093
4,093 $
— $
—
142
142 $
—
—
8,170
8,170
—
—
93
93
The following table provides information describing the unobservable inputs used in Level 3 fair value measurements at December 31,
2018 and 2017:
Inputs
Valuation Technique
Unobservable Inputs
General Range of Inputs
Impaired Loans
Appraised Value/Discounted Cash
Flows
Discounts to appraisals or cash flows for estimated
holding and/or selling costs
Foreclosed Real Estate
Appraised Value/Comparable Sales
Discounts to appraisals for estimated holding and/or
selling costs
0 - 25%
0 - 25%
Fair value of financial instruments
Fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practical to estimate the
value is based upon the characteristics of the instruments and relevant market information. Financial instruments include cash, evidence of
ownership in an entity, or contracts that convey or impose on an entity that contractual right or obligation to either receive or deliver cash for
another financial instrument.
133
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 16 - Fair Value (continued)
The information used to determine fair value is highly subjective and judgmental in nature and, therefore, the results may not be precise.
Subjective factors include, among other things, estimates of cash flows, risk characteristics, credit quality, and interest rates, all of which are
subject to change. Since the fair value is estimated as of the balance sheet date, the amounts that will actually be realized or paid upon
settlement or maturity on these various instruments could be significantly different.
During the first quarter of 2018, the Company adopted ASU 2016-01, “Recognition and Measurement of Financial Assets and Liabilities.”
The amendments included within this standard, which are applied prospectively, require the Company to disclose fair value of financial
instruments measured at amortized cost on the balance sheet and to measure that fair value using an exit price notion. Prior to adopting the
amendments included in the standard, the Company was allowed to measure fair value under an entry price notion. The entry price notion
previously applied by the Company used a discounted cash flows technique to calculate the present value of expected future cash flows for a
financial instrument. The exit price notion uses the same approach, but also incorporates other factors, such as enhanced credit risk, illiquidity
risk, and market factors that sometimes exist in exit prices in dislocated markets.
As of December 31, 2018, the technique used by the Company to estimate the exit price of the loan portfolio consists of similar procedures
to those used as of December 31, 2017, but with added emphasis on both illiquidity risk and credit risk not captured by the previously applied
entry price notion. The fair value of the Company’s loan portfolio has always included a credit risk assumption in the determination of the fair
value of its loans. This credit risk assumption is intended to approximate the fair value that a market participant would realize in a hypothetical
orderly transaction. The Company’s loan portfolio is initially fair valued using a segmented approach. The Company divides its loan portfolio
into the following categories: variable rate loans, impaired loans, and all other loans. The results are then adjusted to account for credit risk as
described above. However, under the new guidance, the Company believes a further credit risk discount must be applied through the use of a
discounted cash flow model to compensate for illiquidity risk, based on certain assumptions included within the discounted cash flow model,
primarily the use of discount rates that better capture inherent credit risk over the lifetime of a loan. This consideration of enhanced credit risk
provides an estimated exit price for the Company’s loan portfolio.
For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values approximate carrying values. Fair
values for impaired loans are estimated using discounted cash flow models or based on the fair value of the underlying collateral.
The fair value of cash and cash equivalents, interest bearing deposits at other financial institutions, federal funds sold and restricted
investments is the carrying amount. Restricted stock includes equity of the Federal Reserve and other banker’s banks.
The fair value of noninterest bearing deposits and securities sold under agreements to repurchase is the carrying amount.
The fair value of checking and savings deposits, and money market accounts, is the amount payable on demand at the reporting date. Fair
value of fixed maturity term accounts and individual retirement accounts is estimated using rates currently offered for accounts of similar
remaining maturities.
The fair value of certificates of deposit in other financial institutions is estimated based on interest rates currently offered for deposits of
similar remaining maturities.
The fair value of borrowings is estimated by discounting the value of contractual cash flows using current market rates for borrowings with
similar terms and remaining maturities.
134
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 16 - Fair Value (continued)
The fair value of outstanding loan commitments, unused lines of credit, and letters of credit are not included in the table since the carrying
value generally approximates fair value. These instruments generate fees that approximate those currently charged to originate similar
commitments.
The table below presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments
(in thousands).
Fair Value of Financial Assets and Liabilities
(in thousands)
Financial assets
Level 1
Cash and due from banks
Interest bearing deposits at other financial institutions
Federal funds sold
Restricted investments
Level 3
Loans receivable, net
Financial liabilities
Level 1
Noninterest bearing deposits
Securities sold under agreements to repurchase
Level 3
Interest bearing deposits
FHLB advances and other borrowed funds
December 31, 2018
December 31, 2017
Carrying
Amount
Fair Value
Carrying
Amount
Fair Value
10,431 $
22,007
2,285
2,503
10,431 $
22,007
2,285
2,503
8,189 $
40,356
3,766
2,369
8,189
40,356
3,766
2,369
988,960 $
979,058 $
877,387 $
872,446
242,259 $
3,332
242,259 $
3,332
196,635 $
11,260
196,635
11,260
712,981
19,393
711,876
19,447
708,264
19,361
702,930
19,413
$
$
$
135
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 17 - Lease Commitments
Certain agreements include options for the Company to renew for additional terms. Certain agreements require the payment of common
area maintenance expenses, in addition to rent.
At December 31, 2018, the minimum rental commitment under the noncancellable leases is as follows:
Lease Commitments
(in thousands)
2019
2020
2021
2022
2023
After 2023
$
$
1,089
1,204
1,187
824
712
420
5,436
Rent expense was $1.5 million and $1.4 million for the years ended December 31, 2018 and 2017, respectively.
Note 18 - Litigation
The Bank, along with two other banking institutions, is a defendant in a lawsuit currently pending in the Circuit Court for Montgomery
County, Maryland (Case No. 426478V). The three counts pled are (i) aiding and abetting fraudulent misrepresentation, (ii) aiding and abetting
fraudulent concealment and (iii) abetting constructive fraud. The three defendants filed motions for summary judgment, which were each
denied by the Circuit Court in mid-March 2019. The trial for this matter has been set for April 29, 2019 and mediation is scheduled for April 9,
2019.
The Bank and the other named defendants dispute plaintiff’s allegations, as well as plaintiff’s statements of the underlying factual
circumstances, and believe these claims are without merit. The defendants plan to vigorously defend this case. The Bank has insurance
policies that will provide coverage on this case, and the related insurance carrier has been advised of these claims. However, if the case is not
settled and goes to trial where there is a finding of fraud, the Bank’s insurance carrier has issued a reservation of rights letter and may deny
coverage. At this time, the Company cannot predict the outcome of this legal proceeding or estimate its impact on the Company’s financial
condition or results of operations. However, based on discussions with outside legal counsel regarding the merits of this lawsuit, management
believes there is a reasonable possibility that if there is an adverse judgment entered against the Bank, such judgment may be up to $4.0
million.
In addition to the lawsuit described above, the Company is involved in legal proceedings occurring in the ordinary course of business.
Based on an assessment of the merits of the lawsuit described above by litigation counsel, management believes that neither the lawsuit
described above nor any legal proceedings occurring in the ordinary course of business, individually or in the aggregate, will have a material
adverse impact on the results of operations or financial condition of the Company.
136
Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2018 and 2017
Note 19 - Quarterly Results of Operations (unaudited)
The following table presents condensed unaudited information relating to quarterly periods in 2018 and 2017. All share and per common
share amounts have been adjusted to reflect the Stock Split. Refer to Note 1 for additional information.
Quarterly Results of Operations
(in thousands)
Interest Income
Interest Expense
Net Interest Income
Provision for Loan Losses
Noninterest Income
Noninterest Expense
Income Before Provision for Income Taxes
Provision for Income Taxes
Net Income (Loss)
Basic earnings (losses) per common share
Diluted earnings (losses) per common share
Note 20 - Subsequent Events
$
$
$
$
2018
2017
Dec 31
Sep 30
Jun 30
Mar 31
Dec 31
Sep 30
Jun 30
Mar 31
18,238 $
3,348
14,890
500
3,466
13,094
4,762
1,276
3,486 $
17,447 $
2,955
14,492
495
4,240
13,900
4,337
1,190
3,147 $
16,778 $
2,657
14,121
630
4,340
13,529
4,302
1,158
3,144 $
16,664 $
2,279
14,385
515
4,078
13,600
4,348
1,358
2,990 $
14,679 $
2,117
12,562
785
3,024
13,385
1,416
2,062
(646) $
15,003 $
2,044
12,959
700
4,901
12,180
4,980
1,941
3,039 $
14,211 $
1,866
12,345
620
4,342
11,387
4,680
1,822
2,858 $
12,773
1,728
11,045
550
2,883
10,355
3,023
1,164
1,859
0.26 $
0.25 $
0.27 $
0.26 $
0.26 $
0.26 $
0.26 $
0.25 $
(0.06) $
(0.06) $
0.27 $
0.27 $
0.26 $
0.25 $
0.17
0.17
Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued.
Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the
balance sheet, including the estimates inherent in the process of preparing financial statements. Non-recognized subsequent events are events
that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.
137
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
The Company’s management, including our Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of our
disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act as of the end of the period covered by this report.
Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were
effective to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act is (i) recorded,
processed, summarized and reported as and when required and (ii) accumulated and communicated to our management, including our Chief
Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Evaluation of Internal Control over Financial Reporting
This annual report does not include a report of management’s assessment regarding internal control over financial reporting or an attestation
report of the Company’s independent registered public accounting firm due to a transition period established by rules of the SEC for newly
public companies.
Changes in Internal Control over Financial Reporting
There has been no change in the Company’s internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the
Exchange Act) during the fourth quarter of 2018 to which this report relates that has materially affected, or is reasonably likely to materially
affect, the Company’s internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
None.
138
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
PART III
The information required by this Item with respect to our directors and certain corporate governance practices is contained in our Proxy
Statement for our 2019 Annual Meeting of Shareholders (the “Proxy Statement”) to be filed with the SEC within 120 days after the end of the
Company’s fiscal year ended December 31, 2018. Such information is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by reference to our Proxy Statement to be filed with the SEC within 120
days after the end of the Company’s fiscal year ended December 31, 2018.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGMENT AND RELATED STOCKHOLDER MATTERS
The information required by this Item regarding security ownership of certain beneficial owners and management is incorporated by
reference to our Proxy Statement to be filed with the SEC within 120 days after the end of the Company’s fiscal year ended December 31,
2018. Information relating to securities authorized for issuance under the Company’s equity compensation plans is included in Part II of this
Annual Report on Form 10-K under “Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of
Equity Securities.”
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is incorporated herein by reference to our Proxy Statement to be filed with the SEC within 120
days after the end of the Company’s fiscal year ended December 31, 2018.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item is incorporated herein by reference to our Proxy Statement to be filed with the SEC within 120
days after the end of the Company’s fiscal year ended December 31, 2018.
139
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
INDEX TO EXHIBITS
Exhibit
Number
PART IV
Description
3.1
3.2
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
23.1
31.1
31.2
32
101
Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the Company’s Form S-1 filed on August 31, 2018)
Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2 to the Company’s Form S-1 filed on August 31, 2018)
Capital Bancorp, Inc. 2017 Stock and Incentive Compensation Plan (incorporated by reference to Exhibit 10.1 to the Company’s Form S-1 filed on August 31,
2018)
Form of Restricted Stock Award Agreement under the Capital Bancorp, Inc. 2017 Stock and Incentive Compensation Plan (incorporated by reference to
Exhibit 10.2 to the Company’s Form S-1/A filed on September 17, 2018)
Form of Restricted Stock Unit Award Agreement under the Capital Bancorp, Inc. 2017 Stock and Incentive Compensation Plan (incorporated by reference to
Exhibit 10.3 to the Company’s Form S-1/A filed on September 17, 2018)
Form of Incentive Stock Option Award Agreement under the Capital Bancorp, Inc. 2017 Stock and Incentive Compensation Plan (incorporated by reference to
Exhibit 10.4 to the Company’s Form S-1/A filed on September 17, 2018)
Form of Non-Qualified Stock Option Award Agreement under the Capital Bancorp, Inc. 2017 Stock and Incentive Compensation Plan (incorporated by
reference to Exhibit 10.5 to the Company’s Form S-1/A filed on September 17, 2018)
Form of Stock Appreciation Right Award Agreement under the Capital Bancorp, Inc. 2017 Stock and Incentive Compensation Plan (incorporated by reference
to Exhibit 10.6 to the Company’s Form S-1/A filed on September 17, 2018)
Employment Agreement, effective January 1, 2019, by and among Capital Bancorp, Inc., Capital Bank, N.A. and Edward F. Barry (incorporated by reference
to Exhibit 10.1 to the Company’s Form 8-K filed on January 10, 2019)
Employment Agreement dated January 1, 2013 between Capital Bank, N.A. and Scot R. Browning (incorporated by reference to Exhibit 10.7 to the
Company’s Form S-1 filed on August 31, 2018)
Consent of Elliott Davis, PLLC
Rule 13a-14(a) Certification of the Principal Executive Officer
Rule 13a-14(a) Certification of the Principal Financial Officer
Section 1350 Certification of Chief Executive Officer and Chief Financial Officer
The following materials from the Annual Report on Form 10-K of Capital Bancorp, Inc. for the year ended December 31, 2018, formatted in eXtensible
Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of
Comprehensive Income, (iv) Consolidated Statement of Changes in Shareholders’ Equity, (v) Consolidated Statements of Cash Flows and (vi) Notes to
Unaudited Consolidated Financial Statements.
140
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
CAPITAL BANCORP, INC.
By:/s/ Edward F. Barry
Edward F. Barry
Chief Executive Officer
Dated: April 1, 2019
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
141
Signature
Title
Date
By:
/s/ Edward F. Barry
Edward F. Barry
By:
/s/ Alan W. Jackson
Alan W. Jackson
By:
/s/ Stephen N. Ashman
Stephen N. Ashman
By:
/s/ C. Scott Brannan
C. Scott Brannan
By:
/s/ Scot. R. Browning
Scot R. Browning
By:
/s/ Joshua Bernstein
Joshua Bernstein
By:
/s/ Michael Burke
Michael Burke
By:
/s/ Randall. J. Levitt
Randall J. Levitt
By:
/s/ Deborah Ratner Salzberg
Deborah Ratner Salzberg
By:
/s/ Steven J. Schwartz
Steven J. Schwartz
By:
/s/ James F. Whalen
James F. Whalen
April 1, 2019
April 1, 2019
April 1, 2019
April 1, 2019
April 1, 2019
April 1, 2019
April 1, 2019
April 1, 2019
April 1, 2019
April 1, 2019
April 1, 2019
Chief Executive
Officer and Director
(Principal Executive Officer)
Executive Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer)
Chairman of the Board of Directors
Director
Director
Director
Director
Director
Director
Director
Director
142
Exhibit 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to incorporation by reference in the Registration Statement No. 333-228524 on Form S-8 of Capital Bancorp, Inc. of our report
dated April 1, 2019, relating to the consolidated financial statements of Capital Bancorp, Inc., which appear in this Annual Report on Form 10-K
for the year ended December 31, 2018.
/s/ Elliott Davis, PLLC
Raleigh, North Carolina
April 1, 2019
Section 2: EX-31.1 (RULE 13A-14(A) CERTIFICATION OF THE PRINCIPAL EXECUTIVE OFFICER)
Exhibit 31.1
Rule 13a-14(a) Certification of the Principal Executive Officer.
Exhibit 31.1
Rule 13a-14(a) Certification of the Principal Executive Officer.
I, Ed Barry, certify that:
1. I have reviewed this annual report on Form 10-K of Capital Bancorp, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period
covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects
the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the period in which this report is being prepared;
b) [Paragraph omitted in accordance with Exchange Act Rule 13a-14(a)];
c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such
evaluation; and
d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's
most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over
financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting,
to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: April 1, 2019 By: /s/ Ed Barry
Ed Barry
Chief Executive Officer
Section 2: EX-31.2 (RULE 13A-14(A) CERTIFICATION OF THE PRINCIPAL FINANCIAL OFFICER)
Exhibit 31.2
Rule 13a-14(a) Certification of the Principal Financial Officer.
Exhibit 31.2
Rule 13a-14(a) Certification of the Principal Financial Officer.
I, Alan W. Jackson, certify that:
1. I have reviewed this annual report on Form 10-K of Capital Bancorp, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period
covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects
the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the period in which this report is being prepared;
b) [Paragraph omitted in accordance with Exchange Act Rule 13a-14(a)];
c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about
the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation;
and
d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's
most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over
financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting,
to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: April 1, 2019 By: /s/ Alan W. Jackson
Alan W. Jackson
Chief Financial Officer
Section 2: EX-32 (Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002)
Exhibit 32
Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 32
Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
In connection with the Annual Report of Capital Bancorp, Inc. (the “Company”) on Form 10-K for the period ended December 31, 2018, as filed
with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned hereby certify, pursuant to 18 U.S.C. § 1350,
as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that to the undersigned’s best knowledge and belief:
1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the
Company.
Date: April 1, 2019 By: /s/ Ed Barry
Ed Barry
Chief Executive Officer
By: /s/ Alan W. Jackson
Alan W. Jackson
Chief Financial Officer