2019 Annual Report
Building A Legacy
a preface
As we send this letter to the printer, I cannot help
but reflect on the fact that 30 days ago, as we
were finalizing the first draft of this communication
and contemplating, as always, what could cause
a major shift in the region that we and our
customers live in, we saw significant systemic
risks. We’ve described them in the body of this
letter, along with what we believed to be our
preparedness and even our advantages in dealing
with those shifts and risks.
Having lived through floods that devastated
one of our local communities a few years ago,
not once but twice, and always remembering
the mind-numbing shock of 9/11, we added, as a
banker’s note of caution, that exogenous shocks
can always create downturns. We also noted that
in our experience, in the darkest days after those
shocks, it is hard to step back and realize that the
economic contractions that follow those shocks
are brutal but they do end. The length of their lives
is, of course, very much influenced by the reaction
of the communities that suffered the shock as well
as the quality of the support provided to those
suffering and most importantly, the leadership in
the community that must determine the best way to
acknowledge the problem quickly and shorten the
duration of the shock.
So 20 days after writing that first draft, we faced
a decision. Do we change the thrust of our
message to deal with this very significant shock
of a global pandemic? Today at Howard Bank our
staff is working remotely, our branch network is
temporarily dependent on our drive-thru locations,
and we are grappling hand-in-hand with distraught
borrowers to craft the right individualized
solutions to their temporary cash flow shortages.
We did not expect to be doing any of this right
now. We are, at the same time, however, proudly
surveying an excellent capital position, a strong
liquidity pool – on-and-off balance sheet – and
an enviable reputation. And we are seeing
remarkable agility from our colleagues. We are still
seeing our legacy. And we are still seeing some
of the longer-term headwinds that exacerbated,
if not created, this most recent challenge. But we
are confident because we still care about here
and we know that more than ever, humans yearn
for face-to-face interactions.
The world has once again changed. We will, once
again, as a community, a nation, and a world,
learn from this change. We will, with the right
leadership, be better for it so that we do not have
to do this again. However, we have decided that
this change must not define us. The relevance
of our message and our story - told below - has
not changed. Therefore, we’ve focused on the
long-term as we always do while dealing with the
interim dislocations. We are incredibly grateful
to our team - they make all the difference in the
world as the rest of this letter goes on to tell. They
passed yet another test in the last few days and
they’ve certainly…built a few more legacies.
H O W A R D B A N C O R P 2 0 1 9 A N N U A L R E P O R T 3
H O W A R D B A N C O R P 2 0 1 9 A N N U A L R E P O R T 3
our vision
Building our legacy by helping
others build theirs.
our mission
Our mission is to help build
enduring legacies for our
customers, our employees and
our community.
We will achieve this by combining
expertise with experience, staying
committed to our values, and
dedicating ourselves to building
lasting relationships with the
people we serve.
2019 by the numbers
$0.89
eps
total deposits
$1.7b
$1.7b
total loans
total assets
$2.4b
20%
employees serve on boards
donated to
charitable organizations
$337k
1,161
hours volunteered by employees
H O W A R D B A N C O R P 2 0 1 9 A N N U A L R E P O R T 5
dear shareholders,
Building Our Legacy
By Helping Others
Build Theirs
It’s Howard Bank’s vision. And
while it may seem straightforward,
it expresses a deeper, holistic view
of the interdependency of each of
our stakeholders – shareholders,
customers, and colleagues - especially
if our aim is sustainable value creation.
We believe that our shareholders
benefit from our success in profitably
and growing relationships with
customers who see the relevance of
maintaining a full banking relationship
with a local bank. We believe that
customers benefit from our consistent
development and rewarding of our
colleagues and the resulting ability to
retain and attract employees. And, we
believe that the best employees value
the impact they can make not only on
their families and their clients but also
on the communities served by them.
These elements of ensuring relevance
to customers and impact for
employees to maximize shareholder
value sustainability have always guided
us and guide us still. And, in total, they
form the foundation of our choice of
legacy as the centerpiece of our vision.
Legacy is certainly not small-minded
– there are no such things as small
legacies. Legacy is a big, hairy,
audacious goal. But how do we create
a legacy in a world that spins faster
every day? What does legacy mean in
a world of constant change?
Shortly after the end of the Cold War in
the late 20th century, the Military War
College began to focus on the concept
of a world that was inherently less
predictable – more Volatile, Uncertain,
Complex and Ambiguous - “VUCA”.
Early in the 21st century, business
leaders recognized the applicability
of this term for what they were
encountering in their own companies.
The impact of these new dynamics is
certainly apparent in financial services
and creates numerous headwinds
to value creation. It’s the response
to these headwinds that can create
tailwinds.
Environmental Headwinds
Massive sectoral shifts cloud the
way forward forcing astute business
leaders to acknowledge the need
for new mindsets and approaches.
Unemployment has been at an all-
time low and labor force participation
is climbing but despite these two
favorable trends, wage distribution has
been more uneven than it has been
at any time in the last eight decades.
Evidence of an increasingly unequal
country offset for some of us the
optimism normally associated with low
unemployment. And the pause is not
just philosophical. Income inequalities
impact spending patterns since the
shrinking middle class is historically
the most predictable purchaser of
goods. This, in turn, exacerbates the
dominance of the service sector. Even
for a commercial bank focused on
business investment, sectoral shifts
that affect consumer spending patterns
must be monitored.
Housing markets have shown the
results of these long term shifts
as well. Household formation is
down - whether related to income
inequality, generational preferences,
unprecedented levels of student debt,
or all of the above. Where demand
is healthy, supply pressures abound.
Housing is increasingly expensive
because of the scarcity of skilled
construction labor and high land prices
related to both government zoning
policies and the need for more fee
income to fund government deficits.
Mary Ann Scully
Chairman, Chief Executive Officer
...there are
no such
things
as small
legacies.
6 H O W A R D B A N C O R P 2 0 1 9 A N N U A L R E P O R T
These local businesses
understand that they
need access... not just
to decision-makers but
to policy-makers.
banks. To that end, some banks like
us chose to focus on local commercial
activities.
All of these new realities have
made high inflation and traditional
recessions less likely. The present
economy is long-lived in part because
it is not particularly robust. However,
economies that are not particularly
robust are more susceptible to the
unknown. Something exogenous to the
day-to-day, like an outside shock, could
stop an extraordinarily long, albeit
sometimes anemic, recovery period. If
so, perspective remains important. The
country and the bank have experience
with exogenous shocks - periodic
hurricanes, incapacitating blizzards,
catastrophic localized flooding, the
2008 recession, the 2009 H1N1 flu
outbreaks, and multiple government
shutdowns most recently. Some were
financial, some purely dysfunctional,
some natural disasters, one health-
related, and yet they all provide that
longer-term lesson that we can and do
get past setbacks. There is not always
a long recession but in all cases, there
is substantial pain.
So how do we confidently move
forward and succeed in a world that
has already fundamentally shifted and
can continue to shift more? At Howard
Bank, we embrace the need to see
the market for what it is, not what we
want it to be. We have always adopted
a more entrepreneurial approach to
charting our future course. And we
always believe that we have the ability
to find the opportunities lurking in
every challenge and to differentiate
ourselves to create our own tailwinds.
When wage distribution, retailing, and
housing show signs of major shifts we
must all pay attention. Two years past a
major fiscal stimulus package and four
years into unprecedented monetary
stimulus, business investment has left
something to be desired as well.
Business investment lethargy is a
less straightforward dilemma than the
consumer trends above. Economists
postulate that the failure of national
leaders to bring more clarity to policies,
regulations and their execution
may account for the unparalleled
dominance of sentiment over facts
in moderating the levels of business
investment despite aggressive fiscal
and monetary actions. Bank regulators,
concerned about the statistical
likelihood of a recession after a ten-
year recovery, have encouraged banks
to be even more liquid. Much of the
resulting liquidity goes into the US
Treasury to fund a sharply growing
deficit. However, much also seeks yield
and moves into the stock market and
an investor real estate market. Those
trends together have been driving a
low and flat yield curve, low real estate
cap rates and a booming equity market
that has, in turn, led to some clearly
unsustainable private and public
offering pricing.
The search for yield in a low-interest
rate world has meant that competition
comes from all sides as banks seek
to grow market share. Other insured
depositories, life insurance companies
seeking to grow their revenue streams,
private equity firms seeking diversified
returns, and credit unions who lack
commercial expertise but also lack
the need to pay income taxes are
all competitors. Meanwhile, fintechs
compete even more successfully
in consumer lending. As a result of
this competition, both fair and unfair,
commercial banks dominate fewer
lending segments than in the past with
the mortgage lending and consumer
lending market now owned by non-
H O W A R D B A N C O R P 2 0 1 9 A N N U A L R E P O R T 7
access not just to decision-makers
but to policy-makers. Interestingly,
these companies, especially the
upper end of the small business
market and the middle market, are
less able to be disintermediated by
technological lending solutions and
are more vulnerable to the impacts
of the continuous disruption created
by consolidation in the banking
industry. This is especially true with
consolidation driven by out-of-market
entrants to greater Baltimore and
Maryland. Our success in executing
this SME focus has allowed us to
see 16% compound annual growth
in commercial loans over the last
five years resulting in the highest
percentage of C&I loans of any of our
local competitors.
This focus on small businesses is
complemented by our approach to
maintain full relationships, creating
operating accounts that are “stickier”,
of longer duration and less volatility.
They are less driven by interest rates
and more by product functionality
and service. Our 38% transaction
deposit mix is also higher than our
peers. These operating deposits are
garnered from the operating accounts
of our clients, their executives and
employees, and retail customers in
a 3 to 5-mile radius of our branches.
The ability to garner deposit accounts
has recently been enhanced with
a differentiated utilization of online
account opening technology. This in
concert with a fintech strategic partner
is further enhanced by linking online
account opening with face-to-face
bank assistance. The breadth of our
employee/workplace cross-sell focus
has also been enriched with a new,
more robust Health Savings Account
(HSA) offering.
Strategic Tailwinds
Howard Bank was founded in 2004
on the principle that it is imperative to
differentiate in a world where change
itself is the only constant. We have
never enjoyed the luxury of operating
in a steady-state economy, have
always faced non-bank competition,
and have always had to battle a
perception that banking products are
commodities. We’ve lived through each
of those exogenous shocks described
above. Knowing only the 21st century
has given us a distinct advantage in
that we chose our business model and
points of differentiation knowing only
the world that we live in. At the end
of the day, we believe that in a world
dominated by “VUCA”, legacies are
still relevant but are created by both
values and business models that we
choose and execute, not those that
circumstances hand us. Ironically, we
have learned that disruption can be a
tailwind.
Our points of differentiation center on
the ability to focus on the following
areas:
SME Relationships
Our focus has always been on serving
businesses. The ability of banks to
compete for consumer business is
limited by most consumers’ focus on
the tangible characteristics of a bank
- convenient access, initially branches,
then ATMs, call centers, online
banking, and now mobile access. small
and medium-sized enterprises (SME)
value those points of access and as a
result, Howard offers all of them. With
that said, the SME market understands
those are necessary calling cards
but not differentiators. These local
businesses understand that they
need expertise from an advisor
familiar with companies dependent
on both character and competency
rather than consumer-like formulaic
credit scores or large corporation-
like financial statements with pages
and pages of footnotes. They need
He demonstrated
the value that
knowledge
seekers, and
more importantly,
knowledge
creators see
in face-to-face
interactions with
other knowledge
holders.
8 H O W A R D B A N C O R P 2 0 1 9 A N N U A L R E P O R T
Our profitable
growth has also
allowed us to
achieve more
scale in an
industry where all
of the competitive
headwinds noted
above have
made efficiency
and scale
more important
than ever to
shareholders.
Place
Howard Bank came to life when
the internet was firmly established.
We understand though that while
information can be shared long-
distance, knowledge requires
proximity. Richard Florida in his
epic The Rise of the Creative Class
challenged some paradigms that
suggested place did not matter in a
converging world. He demonstrated
the value that knowledge seekers,
and more importantly, knowledge
creators see in face-to-face
interactions with other knowledge
holders. Florida pointing out the need
for hyper-local connections to foster
the best environment for sharing of
intangibles, which is more in keeping
with an information-based, service-
oriented economy. Our focus for 15
years has been on Greater Baltimore.
First starting in Howard County,
one of the wealthiest markets in the
United States, then moving to similarly
wealthy Anne Arundel County, then
to Baltimore organically and through
acquisition, as well as Harford County
and north through branch acquisitions
and an opportunistic FDIC failed bank
transaction. Our capstone acquisition
of and merger with, 1st Mariner Bank
in 2018 enhanced our presence in
each of these markets.
Greater Baltimore is one of the top
20 markets in the US with higher than
average household income. It includes
six legal jurisdictions but is sometimes
best known for Baltimore City, one of
the most troubled cities in the country
but also a city with incredible assets -
geographic location in the mid-Atlantic
corridor, a major deep-water port,
world-class anchor institutions of both
higher learning and medical prowess,
a vibrant venture capital industry, and
outsized opportunities for Generation
Z and female entrepreneurs.
Howard Bank is now the largest
locally-owned bank in Greater
Baltimore – a significant additional
point of differentiation for the targeted
SME segment described above.
However, we note our proximity
to Washington as well. Significant
M&A disruption in Maryland banking
resulted in almost $13 billion in
deposits being merged, consolidated,
and converted within 24 months. This
consolidation is expected to make
Howard Bank the third-largest locally
headquartered bank in Maryland. We
see an enormous upside in leveraging
our position in this place.
Profitable Growth
Howard has grown organically and
by acquisition from $17 million in
assets at our founding to $2.4 billion
in assets in 15 short years. We have
not sought growth for growth’s sake;
our need for focus on segments and
place would preclude that. Rather, we
have always placed profitable growth
as a key metric. Growth has allowed
us to assure our relevance to the SME
marketplace as our $30 million lending
limit gives us the ability to handle the
needs of the vast majority of companies
in our marketplace. It has also allowed
us to create a workplace for our
colleagues where opportunities to
grow are more abundant than ever but
where the executive leadership team
still knows intimately the background
and the dreams of each employee. It
has allowed us to continue to be one
of the largest corporate philanthropists
in the region, recognized annually as
one of the top 25 in Greater Baltimore
in absolute dollars donated. We have
very intentionally and systemically
expanded that philanthropic outreach
with our VTO (Volunteer Time Off)
Program allowing each employee
twenty hours of additional paid time off
if spent in community service.
H O W A R D B A N C O R P 2 0 1 9 A N N U A L R E P O R T 9
Our profitable growth has also allowed
us to achieve more scale in an industry
where all of the competitive headwinds
noted above have made efficiency
and scale more important than ever to
shareholders. Our growth not just in our
balance sheet size but in EPS, ROTCE,
and operating leverage (revenue vs
expense growth) demonstrates that
scale. And we focus as much on
the strength, mix, and quality of our
balance sheet as we do on its size. It is
also a source of strength for our clients,
colleagues, and communities.
We have focused on costs as well
as revenue opportunities. The bank
followed its merger-related cost
savings of over 50% in 2018 with
a branch optimization program
in 2019 and a strategic exit from
residential mortgage banking. Why
these reconfigurations and exits? We
acknowledged the radically different
customer behaviors that have lead,
for all banks, to fewer branch visits
associated with transaction activity
but a concurrent need for physical
presence in strategic locations across
our footprint. We have rationalized
our branch delivery system from a pro
forma 28 branches at the time of the
announced merger with 1st Mariner
Bank to 15 branches today resulting in
a high performing average of over $100
million in deposits per branch.
We exited our mortgage operation after
three years of reduction and refocusing
– concluding in 2019 that this is a
product set likely to be dominated by
non-banks for the foreseeable future.
We exited that business with no loss
of jobs and a strategic partnership
that allows former colleagues to serve
Howard Bank customers and prospects
while providing Howard Bank with an
option to selectively purchase loans for
the portfolio.
Transparency
The company has, from inception,
encouraged all stakeholders to avail
themselves of as much information
on the company as possible. We
became an SEC registrant in 2012 and
are listed on the NASDAQ exchange.
While there are considerable
costs and occasional bumpy rides
associated with this transparency,
we believe it is important to provide
stakeholders with as much information
as possible on any bank where they
place their funds and on whom they
need to rely on for their financing.
We are also committed to providing
our shareholders with the liquidity
and the optionality that only a
listing on a national exchange can
provide. This differentiates us from
many local banks in the industry.
We also have seen the advantage
that this transparency provides us
in acquiring new shareholders, both
through capital raises and through
the acquisition of shares in an M&A
transaction. Our long-term focus is on
making sure that our shares represent
an attractive currency for existing and
prospective owners.
Quality
When a financial services institution
describes quality, one immediately
thinks of asset quality. And this is
critically important to Howard Bank
especially given our reliance and focus
on privately owned family businesses
and the need to track our success in
underwriting those “story” credits. As
the bank has grown, NPA ratios can
fluctuate but we are extremely proud
of the consistent improvement in our
non-performing asset ratios within
a very short time period after each
acquisition, including our most recent
reduction to under 1%.
We are also
committed to
providing our
shareholders with
the liquidity and
the optionality that
only a listing on a
national exchange
can provide.
10 H O W A R D B A N C O R P 2 0 1 9 A N N U A L R E P O R T
Our focus in 2020 is continuing
this tangible progress in improving
and growing returns and impact by
seizing the significant advantage
that we have in a continuously
disrupted market. And, as a result,
advancing our vision to continue
Building Our Legacy By Helping
Others Build Theirs. We greatly
appreciate the opportunity you’ve
given us to Build Your Legacy by
being a stakeholder in Howard Bank.
Mary Ann Scully
Chairman,
Chief Executive Officer
At Howard Bank,
however, quality
does not just
refer to asset
quality but refers
to the quality of
our interactions
through
experienced
individuals who
are qualified to
advise our clients.
At Howard Bank, however, quality
does not just refer to asset quality but
refers to the quality of our interactions
through experienced individuals who
are qualified to advise our clients.
Quality refers to the quality of the
experience that both our clients and
our colleagues have. We noted the
importance of values as well as a
business model in discussing the
relevance of legacy in a world of
volatility, uncertainty, complexity, and
ambiguity. Howard Bank’s core values
of Invested, Insightful, Passionate and
Agile speak to how we execute on
the business model principles above.
Agility especially captures the essence
of that innovative spirit that allows
us to say that we can create our own
tailwinds and prove the relevance of
legacy in a changing, complex and
unpredictable world.
Throughout this letter, we have noted
that we remain fully cognizant of the
challenges, many of them systemic
as well as transitory, that we, as a
traditional bank face but that also
allow us to benefit from in many
situations. We’ve seen significant
progress in 2019 in moving forward
the performance metrics that are the
best demonstration of our success
in creating these tailwinds that help
us to not only survive but thrive in
challenging times.
H O W A R D B A N C O R P 2 0 1 9 A N N U A L R E P O R T 11
Our brand is important to us.
Most importantly, our brand represents
our highest aspirations. It is a promise
that we make to our customers, and to
ourselves. We believe that by working
together, it is a promise we can fulfill.
It’s more than simply a logo or a catchy
tagline, it’s who we are and what we
believe in. It unites us behind a common
vision, helping us tell the Howard Bank
story to potential customers and the
wider world.
Simply put, our brand is the intersection
between expectation and experience in
the hearts and minds of our clients and
employees. It is the driving force behind
all our actions and communications;
everything we do and say should express
our beliefs.
At Howard Bank,
business is always personal.
It’s the difference between a good banker and an exceptional one.
We believe that outstanding service doesn’t come from a set of guidelines.
It comes from understanding the connection you have with the people you serve.
We believe that the fate of a business isn’t decided solely on numbers, but also the
quality of the person sitting right in front of you.
And we believe that good values are not old- fashioned, they’re how legacies are built.
We want to be a place where we are making a difference. Whether we’re making
someone’s dreams come true, making their dollar stretch a bit further, or simply
making their day a little brighter.
Together, we will be respected for our convictions, admired for our tenacity and
celebrated for our success.
But most importantly, we want Howard to be a bank you’re proud to be a part of.
12 H O W A R D B A N C O R P 2 0 1 9 A N N U A L R E P O R T
12 H O W A R D B A N C O R P 2 0 1 9 A N N U A L R E P O R T
Agile
At Howard Bank, agility is as much about proaction as it is
reaction. It’s about being able to offer a quick solution and a
straight answer – often before the question is even asked.
Passionate
We love what we do because what we do matters.
It drives us to do our best work, compels us to build
tighter teams, and helps us forge lasting relationships.
Invested
We don’t just work here; we’re from here. So we help people
who live here succeed. From our people, to our customers,
to the communities we serve, Howard Bank is invested.
Insightful
We’re really good at what we do.
But it’s more than our banking
pedigree. Our wealth of experience
coupled with our local market
intelligence enables us to deliver
financial advice based on real-world
experience, not just the numbers.
H O W A R D B A N C O R P 2 0 1 9 A N N U A L R E P O R T 13
H O W A R D B A N C O R P 2 0 1 9 A N N U A L R E P O R T 13
we are... Planted
trees in a
low-income
city public
housing
neighbor-
hood.
our people
Community Volunteers
Our Volunteer Time Off (VTO) program
allows employees to use work hours
to give back to the community. The
program provides each employee
20 paid hours a year to volunteer
during work hours and has helped
align employees with Howard Bank’s
community-centered approach. In
the first 10 months of operation, 132
of the bank’s 320 employees took
part in the program representing a
41 percent participation rate in 2018.
The program has continued to grow in
2019. From September 2018 to June
2019 employees logged 1,352 hours
at 13 different non-profits around
Baltimore, including The Maryland
Zoo, The Maryland Food Bank, Blue
Water Baltimore, and the Ed Reed
Foundation Summer Camp and Clinic.
2019 VTO Activities
• Our Daily Bread
• Maryland Food Bank
• Blue Water Baltimore
• Junior Achievement of
Central Maryland
• Anne Arundel County Food Bank
• Maryland Zoo
• Ed Reed Foundation
• Maryland New Directions
• Oregon Ridge Nature Center
• Parks and People Foundation
• Kennedy Krieger Institute
VTO Committee
The VTO Committee hosted five
Group Service Projects in the short
amount of time that VTO was active
in 2018. The committee set a goal
to host 12 Group Service Projects in
2019 but ended up exceeding their
goal with 18 hosted events. The VTO
Committee’s goal for 2020 is to reach
2,000 total volunteer hours.
2018 2019
%
Increase
877
1,161
32%
39% 43%
4%
6.64 8.80
32%
5
18
260%
181
480
165%
Number of
VTO Hours
Used
Percentage
of Employees
Who Used
VTO
Average
Number of
Hours Used
for VTO
Number of
Coordinated
Group
Service
Projects
Number of
Hours Used
for Coordinat-
ed Projects
Ultimately, we saw a 32% increase
in VTO hours used in 2019 and an
increase in the number of people
using the hours. We saw a nice
increase in the number of hours
contributed through our coordinated
events.
14 H O W A R D B A N C O R P 2 0 1 9 A N N U A L R E P O R T
Cristo Rey Jesuit High School
Howard Bank currently sponsors three
high school students from Cristo Rey
Jesuit High School as bank interns.
The students come one day every
week, and one Friday every month
during the 2019-2020 school year,
and Howard Bank paid $22,800
to help subsidize their education.
Currently two students intern in the IT
department, and one in Administration,
learning career and workforce
development. Students are eligible for
the intern program under a financial
needs basis through Cristo Rey.
Employees on Boards
Howard Bank takes a community-
centered approach in everything
we do. That’s why we encourage
our employees to volunteer and join
boards for nonprofits.
As of 2019, 78% of our executive team
and 20% of our total employee base
was an active board member.
Philanthropy
At Howard Bank, we are committed to
the counties and businesses we serve
and all of the individuals who reside
there. In 2019, we donated $337,533
to charities in and around Baltimore
City. The donations supported 107
total organizations.
United Way Employee
Contributions
At Howard Bank, giving is not just a
corporate event, our employees give
too! Our partnership with United Way
allows employees of Howard Bank
to give back to our communities.
Through payroll deduction our
employees can give directly to
the United Way general fund or
organizations that are important to
them. We’ve committed $40,000
through employee participation.
Community
Reinvestment Act
At Howard Bank, we’re committed
to our Community Reinvestment Act
(CRA) responsibilities. Through our
lending, services, and investments
we seek to meet the credit needs
of all the communities we serve,
including low- and moderate-income
neighborhoods. We are focused
on understanding and supporting
the needs of local businesses and
nonprofit organizations through
volunteer efforts, financial donations,
and contributing professional
expertise through Board of Director
memberships.
107
organizations
supported
with a total of
$337,533 in
charitable
donations.
H O W A R D B A N C O R P 2 0 1 9 A N N U A L R E P O R T 15
82
female
employees
of Howard
Bank hold
officer titles.
Diversity and Inclusion
Howard Bank has partnered with
outreach organizations to help create
a diverse and inclusive workforce.
These organizations are focused
in the areas of community, veteran,
disability, and diversity. The following
organizations receive notifications
as Howard Bank job opportunities
become available:
• Greater Baltimore Urban League
• Bel Air Workforce Center
• Mayor’s Office of Employment
Development
• Bowie University
• Maryland Department of Veteran
Affairs
• Spanish Speaking Community of
Maryland
• Maryland Department of
Rehabilitation
• Goodwill Industries
• Harford Community College
• William & Lanaea C. Featherstone
Foundation
• Abilities Network
The Howard Bank Women In
Leadership (HBWIL) group was
established in 2018 to create an
environment that recognizes,
cultivates and utilizes the talent
of women to develop leadership
qualities in a group setting.
2019 was our first full calendar year
with HBWIL in place. We invited
both inside and outside experts to
participate in a quarterly speaker
series to discuss topics that would
allow participants to grow, enhance
communication skills, and ultimately
get a better understanding of the
benefits of having a more diverse
workforce.
16 H O W A R D B A N C O R P 2 0 1 9 A N N U A L R E P O R T
2019 financial tables
(Year ended December 31)
statements of operations data
in thousands, except per share data
Interest income
Interest expense
Provision for credit losses
Non-interest income
Non-interest expense
Federal and state income tax expense
Net income (loss)
Preferred stock dividends
2019
2018
2017
2016
2015
$91,434
$80,389
$43,026
$38,741
$33,349
22,124
4,193
21,034
64,078
5,192
16,881
-
13,771
6,091
5,167
1,831
17,860
19,524
4,562
2,037
14,796
83,112
45,200
38,699
(897)
(3,828)
-
3,152
7,200
-
2,936
5,303
166
5,137
3,072
1,836
11,935
38,261
973
1,142
126
1,016
Net income available to common shareholders
16,881
(3,828)
7,200
per share data and shares outstanding
Net income (loss) per common share, diluted
Book value per common share at period end
$0.89
$(0.22)
$16.48
$15.48
$0.75
$13.47
$0.73
$12.27
$0.16
$11.54
Shares outstanding at period end
19,066,913
19,039,347
9,820,592
6,991,072
6,962,139
financial condition data
Total assets
Loans receivable (gross)
Total deposits
Borrowings
$2,374,619
$2,266,514
$1,149,950
$1,026,957
$946,759
1,745,513
1,649,751
936,608
821,524
757,002
1,714,365
1,685,806
863,908
808,734
747,408
319,368
276,653
148,920
127,574
98,828
Total stockholders’ equity
314,148
294,683
132,253
85,790
92,899
selected performance ratios
Return on average assets
Return on average common equity
Net interest margin1
Efficiency ratio2
0.75%
5.54%
3.50%
(0.19)%
(1.44)%
3.78%
0.67%
5.82%
3.73%
0.55%
6.48 %
3.73%
0.15%
1.80%
4.08%
70.93%
98.38%
78.77%
79.01 %
90.64%
asset quality ratios
Non-performing assets to loans and other real estate
Non-performing assets to total assets
1.27%
0.94%
1.76%
1.28%
1.57%
1.28%
1.41%
1.16%
1.68%
1.35%
capital ratios
Leverage ratio
Total risk-based capital ratio
Average equity to average assets
9.55%
13.14%
8.77%
12.14%
13.55%
13.32%
11.70%
13.72%
11.53%
8.36%
9.90%
10.83%
12.09%
8.88%
9.73%
1 Net interest margin is net interest income divided by average earning assets.
2 Efficiency ratio is noninterest expense divided by the sum of net interest income and noninterest income.
H O W A R D B A N C O R P 2 0 1 9 A N N U A L R E P O R T 17
H O W A R D B A N C O R P 2 0 1 9 A N N U A L R E P O R T 17
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
For the fiscal year ended December 31, 2019
Commission file number: 001-35489
HOWARD BANCORP, INC.
(Exact name of registrant as specified in its charter)
Maryland
State or other jurisdiction
of incorporation or organization
3301 Boston Street, Baltimore, MD
(Address of principal executive offices)
20-3735949
(I.R.S. Employer
Identification No.)
21224
(Zip Code)
(410) 750-0020
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class:
Common Stock, par value $0.01 per share
Trading Symbol
HBMD
Name of each exchange on which registered:
The Nasdaq Stock Market LLC
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 (cid:31) No (cid:95)
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 (cid:31) No (cid:95)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities 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 (cid:95) No (cid:31)
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 (cid:95) No (cid:31)
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or emerging growth
company. See the 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 (cid:31) Accelerated filer (cid:95) Non-accelerated filer (cid:31) Smaller reporting company (cid:58)(cid:3)Emerging growth company (cid:133)
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. (cid:133)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
(cid:3)
The aggregate market value of the voting common stock of the registrant held by non-affiliates on June 28, 2019, was approximately $208.7 million. At February 27,
2020, the number of outstanding shares of Common Stock, $0.01 par value, of the Corporation was 18,714,844.
Yes (cid:31) No (cid:95)(cid:3)
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Form 10-K incorporates by reference certain information from the registrant’s definitive Proxy Statement for the 2020 Annual Meeting of Stockholders.
TABLE OF CONTENTS
PART I
PART II
PART III
Business
Item 1.
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2.
Item 3.
Item 4.
Item 5.
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
Item 6.
Item 7.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Financial Statements and Supplementary Data
Item 8.
Reports of Independent Registered Public Accounting Firm
Consolidated Financial Statements
Notes to the Consolidated Financial Statements
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Item 9.
Item 9A. Controls and Procedures
Item 9B. Other Information
Item 10. Directors, Executive Officers and Corporate Governance
Item 11.
Item 12.
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
Item 13.
Item 14.
2
16
29
29
29
29
30
31
32
57
59
59
61
65
107
107
108
108
108
108
109
109
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K (this “report”) contains “forward-looking statements,” as that phrase is defined in the Private
Securities Litigation Reform Act of 1995, which can be identified by the use of words such as “estimate,” “project,” “believe,”
“goal,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may,” “should,” “could” and words of similar meaning. You can
also identify them by the fact that they do not relate strictly to historical or current facts. These forward-looking statements include,
but are not limited to statements of our goals, intentions and expectations, including the expected impact of exiting our mortgage
banking activities, statements regarding our business plan and strategies, including opening of additional branches, expansion into
new markets, potential acquisitions, market share, loans, investments and asset growth, revenue and profit growth and expanding
client relationships. Actual results could differ materially from those anticipated in such forward-looking statements as a result of
risks and uncertainties more fully described under “Item 1A. Risk Factors.” Factors that might cause such differences include, but
are not limited to:
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
deterioration in general economic conditions, either nationally or in our market area, or a return to recessionary conditions;
competition among depository and other financial institutions;
inflation and changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments;
adverse changes in the securities markets;
changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and
capital requirements;
the composition of our management team and our ability to attract and retain key personnel;
our ability to enter new markets successfully and capitalize on growth opportunities, and to otherwise implement our growth
strategy;
(cid:120) material weaknesses in our internal control over financial reporting;
(cid:120)
(cid:120)
(cid:120)
(cid:120)
our ability to successfully integrate acquired entities, if any;
our inability to replace income lost from exiting our mortgage banking activities with new revenues;
changes in consumer spending, borrowing and savings habits;
changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting
Standards Board, the U.S. Securities and Exchange Commission and the Public Company Accounting Oversight Board;
changes in our organization, compensation and benefit plans;
loss of key personnel;
negative reactions to our branch closures by our customers, employees and other counterparties;
execution risk related to the opening of new branches, including increased expenses;
our ability to maintain the asset quality of our investment portfolios and the anticipated recovery and collection of unrealized
losses on securities available for sale;
our ability to continue our expected focus on commercial customers as well as maintaining our residential mortgage loan
portfolio;
changes in our expected occupancy and equipment expenses;
changes to our allowance for credit losses, and the adequacy thereof;
our ability to maintain adequate liquidity levels and future sources of liquidity;
our ability to retain a large portion of maturing certificates of deposit;
the impact on us of recent changes to accounting standards;
the impact of future cash requirements relating to commitments to extend credit;
risks associated with actual or potential litigation or investigations by customers, regulatory agencies or others;
the risk of changes in technology and customer preferences;
the impact of any material failure or breach in our infrastructure or the infrastructure of third parties on which we rely as a
result of cyber-attacks;
the impact of interest rate changes on our net interest income;
natural disasters, war, terrorist activities, and disease epidemics or pandemics;
other economic, competitive, governmental, regulatory, technological, and geopolitical factors affecting our operations,
pricing, and services; and
other risks discussed in this report, including those discussed in “Item 1A. Risk Factors.”
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
Because of these and a wide variety of other uncertainties, our actual future results may be materially different from the results indicated
by these forward-looking statements. You should not put undue reliance on any forward-looking statements. These forward-looking
statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive
uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to
assumptions with respect to future business strategies and decisions that are subject to change. We are under no duty to and do not
undertake any obligation to update any forward-looking statements after the date of this report.
Part I
Item 1. Business
General
Howard Bancorp, Inc., the parent company of Howard Bank, was incorporated in April 2005 under the laws of the State of Maryland to
serve as the bank holding company of Howard Bank. Howard Bank is a Maryland-chartered trust company that was formed in March
2004 and commenced banking operations in August 2004. Howard Bank does not currently exercise trust powers, and our business,
powers and regulatory structure are the same as a Maryland-chartered commercial bank. The Bank has nine subsidiaries—six were
formed to hold foreclosed real estate (three of which are currently inactive), two own and manage real estate used for corporate purposes,
and one holds historic tax credit investments.
In this report, unless the context suggests otherwise, references to the “Company” refer to Howard Bancorp, Inc. and references to “we,”
“us,” and “our” mean the combined business of the Company and the Bank and its wholly-owned subsidiaries.
Howard Bank is headquartered in Baltimore City, Maryland. We consider our primary market area to be the Greater Baltimore
metropolitan area. We engage in a general commercial banking business, making various types of loans and accepting deposits. We
market our financial services to small- and medium-sized businesses and their owners, professionals and executives, and high-net-worth
individuals. Our loans are primarily funded by core deposits of customers in our market.
Our core business strategy involves driving organic growth by delivering advice and superior customer service to clients through local
decision makers. Our customer focus is small- and medium-sized businesses in our local markets and we compete by providing our
customers a broad array of products, new technology and access to seasoned banking professionals. Our experienced executives seek
to establish a relationship with each client and bring value to all phases of a client’s business and personal banking needs. To develop
this strategy, we have established long-standing relationships with key customers in the community and with local business leaders who
can create business opportunities.
Our leadership team is deep and experienced both as it relates to tenure with us and to industry experience. Our Chairman and Chief
Executive Officer, Mary Ann Scully, founded the Company and has over 35 years of banking experience, mainly in senior executive
roles with larger financial institutions. Our President, Robert D. Kunisch, Jr., joined our leadership team as a result of our merger with
First Mariner Bank and has over 30 years of banking experience. In addition, we employ a strong stable of next level senior leadership,
which we believe is critical for the successful implementation of our strategic initiatives. It is this leadership experience that has driven
our growth since our founding.
Our strategic plan focuses on enhancing stockholder value through market share growth as reflected in balance sheet growth, related
revenue growth and resulting growth in operating profits. During the past several years, we have expanded our branch locations both
through opening new branches and acquiring branch offices via acquisition. More recently, we have focused on branch optimization
initiatives that have resulted in a reduction in branches. While we may open additional branches in the counties where we now operate
and in contiguous counties over the next several years, we currently have no definitive plans or agreements in place with respect to any
additional branches. Our long-term vision also includes supplementing our organic growth with strategic acquisitions. As discussed
below, we have completed and integrated multiple bank acquisitions and we consider additional acquisitions to be a critical component
of furthering our future growth. We believe that acquiring other financial institutions, in whole or in part, through business line spin-
offs, branch purchases or the hiring of teams of individuals, will allow us to expand our market, achieve certain operating efficiencies,
and grow our stockholder base and thus our share value and liquidity. We believe that our demonstrated expertise in commercial lending
and deposit gathering (especially non-interest bearing transactional deposits), our demonstrated ability to attract additional investment
and capital, and community leadership, positions us as an attractive acquirer.
Recent Development of the Business
On December 18, 2019, we entered into an agreement to release certain management members of our mortgage division from their
employment contracts and allow those individuals to create a limited liability company (“LLC”) for the purpose of hiring our remaining
mortgage employees. We also agreed to transfer ownership of the domain name “VAmortgage.com” to the newly created LLC. In
consideration of the release of the employment agreements, the transfer of our mortgage employees, and the sale of the domain name,
the LLC paid us $750 thousand. Under the agreement, there is a transition period of approximately 45 days, after which we have agreed
to cease originating residential first lien mortgage loans and exit our mortgage banking activities. Accordingly, we expect to have the
majority of the residential first lien mortgage pipeline processed by the end of the first quarter of 2020. In order to manage future loan
run-off within our residential mortgage loan portfolio, we plan on buying first lien residential mortgage loans, on a servicing released
basis, from both the LLC and other third-party originators.
2
On December 6, 2018, we entered into Subordinated Note Purchase Agreements with certain institutional accredited investors pursuant
to which we sold and issued $25.0 million in aggregate principal amount of 6.00% Fixed-to-Floating Rate Subordinated Notes due
December 6, 2028 (the “Notes”). We used the net proceeds from this offering for general corporate purposes, to provide for continued
growth and to supplement our regulatory capital ratios.
On March 1, 2018, we completed our merger with First Mariner Bank, a Maryland chartered trust company (“First Mariner”). At the
effective time of the merger, First Mariner merged with and into the Bank, with the Bank continuing as the surviving bank. At the
effective time of the merger, each outstanding share of First Mariner common stock and First Mariner Series A Non-Voting Non-
Cumulative Perpetual Preferred Stock issued and outstanding was cancelled and converted into the right to receive 1.6624 shares of our
common stock with cash paid in lieu of fractional shares. The aggregate merger consideration of $173.8 million included $9.2 million
of cash and 9,143,222 shares of our common stock, which was valued at approximately $164.6 million. In our merger with First Mariner,
we acquired 14 branches located in Baltimore City and Baltimore, Harford, Howard and Anne Arundel counties. First Mariner had total
assets with a fair value of $1.01 billion as of March 1, 2018, including $664.3 million of loans, net of purchase accounting adjustments.
On February 1, 2017, we closed an underwritten public offering of 2,760,000 shares of our common stock, which included the exercise
in full of the underwriters’ over-allotment option, at a public offering price of $15.00 per share. The amount of gross proceeds raised in
the offering was approximately $41.4 million, after underwriting discounts and estimated expenses, and the amount of net proceeds
raised in this offering was $38.4 million. We used the proceeds of the offering to pay off a $12.7 million loan to Raymond James Bank,
N.A. and retained the remainder. This had a positive impact on our liquidity and capital position in 2017 and provided funds that allowed
us to continue to grow our loans and investments.
Our Market Area
Our headquarters are located in Baltimore City, Maryland. We consider our primary market area to be the Greater Baltimore
Metropolitan Area in Maryland. As of December 31, 2019, we had 16 full-service branches and eight mortgage and commercial lending
offices located throughout Maryland. For additional detail regarding branch and lending offices, see “Item 2. Properties” below in this
report.
Competition
Our primary market area is highly competitive and heavily branched by other financial institutions of all sizes. The principal methods
of competition for financial services are price (interest rates paid on deposits, interest rates charged on loans and fees charged for
services) and service (convenience and quality of services rendered to customers). In addition to competition from other commercial
banks, we face significant competition from non-bank financial institutions, including savings and loan associations, credit unions,
finance companies, insurance companies and investment firms. The financial services industry has become more competitive as
technology advances have lowered barriers to entry, enabling more companies, including nonbank companies, to provide financial
services. Many of our nonbank competitors which are not subject to the same extensive federal regulations that govern bank holding
companies and banks, such as the Company and the Bank, may have certain competitive advantages. Technological advances may
diminish the importance of depository institutions and other financial institutions. We also compete for deposits with a broad range of
other types of investments, including mutual funds and annuities.
Mergers and acquisitions have also led to increased concentration in the banking industry, placing added competitive pressure on our
core banking products and services as we see competitors enter some of our markets or offer similar products. While we believe that
acquisitions of several local competitors by larger institutions headquartered outside of the State of Maryland during the last several
years has enhanced our competitive position as a locally-headquartered and managed community bank, many of these competitors have
substantially greater resources and lending limits than we do and offer services, such as extensive and established branch networks and
trust services, that we do not expect to provide in the near future or ever.
As a community bank with over $2 billion in assets, we believe that we are well positioned to navigate the ongoing market consolidation
and heightened regulatory environment. We have the ability to outsource certain activities (internal audit, compliance review,
information security monitoring) and to source new products and services in a highly efficient manner, allowing us to avoid the risk of
impairment of operating earnings faced by some banks. We believe this offers an advantage over our competitors which may be locked
into legacy systems, or which may find the onslaught of new regulations and evolving consumer expectations challenging. Strategic
partnerships for these outsourced activities include contractual relationships with some of the largest and strongest providers of item
processing, data processing, information monitoring and payment systems alternatives. We believe that this provides us with the best
of technology and product selection without sacrificing the more intimate delivery advantages of a community bank. We further believe
the current economic and regulatory environment will continue to result in greater consolidation among financial institutions, including
community banks. Some of that consolidation will occur with larger banks, thus exacerbating the scarcity of banks able to underwrite
and offer advice in interactions with customers as we do, which we believe gives us a wider window of opportunity to extend our brand
and value proposition. We believe, however, that to the extent some of that consolidation occurs between and among smaller banks,
3
the resulting combined institutions will be better positioned to differentiate themselves. Areas of our primary market are currently
experiencing significant disruption due to industry consolidation, management turnover and de novo banking activities. We believe
these disruptions will continue in the short-term and may accelerate, which could create additional opportunities for us.
We believe that “Our Mission to Build our Legacy by Helping Others to Build Theirs” approach to delivering services to small and
medium-sized businesses is essential to our competitive position. Through a team of experienced advisors, we provide our customers
with access to local policy and decision makers. We also offer an array of competitive credit and cash management services that we
feel fills a “white space” in the market. We believe that we fit well between sophisticated, but often distracted large banks and
responsive, but less capable small banks. Our relationship managers, team leaders and executive management generally have decades
of banking experiences and are well established in the communities that they serve. They are able to interface with clients directly to
share that experience and to provide connections with their own network of other specialized advisors. We believe we also benefit from
our committed leadership, at both the executive management and board level, who bring a broad array of skills and experiences and who
are able to position us for consistent profitable growth.
Lending Activities
General
Our primary focus is making loans to and gathering deposits from small and medium-sized businesses and their owners, professionals
and executives, and high-net-worth individuals in our primary market area. Our loans are made to customers primarily in the Greater
Baltimore market. Our lending activities consist generally of short to medium-term commercial lending, commercial mortgage lending
for both owner occupied and investment properties, residential mortgage lending, and consumer lending, both secured and unsecured.
A substantial portion of our loan portfolio consists of loans to businesses secured by real estate and/or other business assets.
Credit Policies and Administration
We have adopted a comprehensive lending policy that includes stringent underwriting standards for all types of loans. Our lending
teams follow pricing guidelines established periodically by our management team. In an effort to manage risk, minimal lending authority
is given to individual loan officers. Most loan officers can approve loans up to $100,000 (with a select number of loan officers having
the authority to $1,000,000). The Chief Credit Officer, the Chief Commercial Banking Officer, the Chief Executive Officer and the
President can approve loans up to $2,000,000, or any two together can approve loans up to $4,000,000. Loans above these amounts are
reviewed by our Loan Committee. Under the leadership of our executive management team, we believe that we employ experienced
lending officers, secure appropriate collateral, and carefully monitor the financial condition of our borrowers and the concentration of
loans in our portfolio.
In addition to the normal repayment risks, all loans in the portfolio are subject to the state of the economy and the related effects on the
borrower and/or the real estate market. Generally, longer-term loans have periodic interest rate adjustments and/or call provisions.
Senior management monitors the loan portfolio closely to ensure that we minimize past due loans and that we swiftly deal with potential
problem loans.
We also retain an outside, independent firm to annually perform a detailed review of our loan portfolio. We use the results of the firm’s
report primarily to validate the risk ratings applied to loans in the portfolio and identify any systemic weaknesses in underwriting,
documentation or management of the portfolio. Results of the annual review are presented to executive management, the Asset Quality
Committee of the board of directors of the Bank and the full board of directors of the Bank and are available to and used by regulatory
examiners when they review the Bank’s asset quality.
We also use an internal credit administration group that assists us in the underwriting and serves as an additional reviewer of
underwriting. In addition, a separately-managed loan administration group oversees documentation, compliance and timeliness of
collection activities. Our outsourced internal audit firm also reviews documentation, compliance and file management.
Commercial Lending
Our commercial lending consists of lines of credit, revolving credit facilities, accounts receivable and inventory financing, term loans,
equipment loans, equipment leases, small business administration (“SBA”) loans, stand-by letters of credit and unsecured loans. We
originate commercial loans for any business purpose, including the financing of leasehold improvements and equipment, the carrying
of accounts receivable, general working capital, contract administration and acquisition activities. These loans typically have maturities
of seven years or less. We have a diverse client base and we do not have a concentration of these types of loans in any specific industry
segment. We generally secure commercial business loans with accounts receivable and inventory, equipment, indemnity deeds of trust
and other collateral such as marketable securities, cash value of life insurance, and time deposits at the Bank. Commercial business
loans have a higher degree of risk than residential mortgage loans because the availability of funds for repayment generally depends on
4
the success of the business. To help manage this risk, we establish parameters/covenants at the inception of the loan to provide early
warning systems before payment default. We normally seek to obtain appropriate collateral and personal guarantees from the borrower’s
principal owners. We are able, given our business model, to proactively monitor the financial condition of the business.
Commercial Mortgage Lending
We finance commercial real estate for our clients, for both owner-occupied properties and investment properties (including residential
properties). We generally will finance owner occupied commercial real estate at a maximum loan-to-value of 85% and non-owner
occupied at a maximum loan-to-value of 80%. Our underwriting policies and processes focus on the underlying credit of the owner for
owner occupied real estate and on the rental income stream (including rent terms and strength of tenants) for non-owner occupied real
estate as well as an assessment of the underlying real estate. Risks inherent in managing a commercial real estate portfolio relate to
vacancy rates/absorption rates for surrounding properties, sudden or gradual drops in property values as well as changes in the economic
climate. We attempt to mitigate these risks by carefully underwriting loans of this type as well as by following appropriate loan-to-
value standards. We are cash flow lenders and we generally do not rely solely on property valuations in reaching a lending decision.
Personal guarantees are often required for commercial real estate loans as they are for other commercial loans. Most of our real estate
loans carry fixed interest rates and amortize over 20 to 25 years but have five to seven-year maturities. Properties securing our
commercial real estate loans primarily include office buildings, office condominiums, distribution facilities and manufacturing plants.
Substantially all of our commercial real estate loans are secured by properties located in our market area.
Commercial real estate loans generally carry higher interest rates and have shorter terms than one-to-four family residential mortgage
loans. Commercial real estate loans, however, entail significant additional risks as compared with residential mortgage lending, as they
typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment of
loans secured by income-producing properties typically depends on the successful operation of the property, as repayment of the loan
generally is dependent, in large part, on sufficient income from the property to cover operating expenses and debt service. Changes in
economic conditions that are not in the control of the borrower or lender could affect the value of the collateral for the loan or the future
cash flow of the property. Additionally, any decline in real estate values may be more pronounced for commercial real estate than
residential properties.
Construction Lending
Construction lending can cover funding for land acquisition, land development and/or construction of residential or commercial
structures. Our construction loans generally bear a variable rate of interest and have terms of one to two years. Funds are advanced on
a percentage-of-completion basis. These loans are generally repaid at the end of the development or construction phase, although loans
for both residential and commercial construction will often convert into a permanent mortgage loan at the end of the term of the loan.
Loan to value parameters range from 65% of the value of land to 75% for developed land, 80% for commercial or multifamily
construction and 85% for residential construction. These loan-to-value ratios represent the upper limit of advance rates to remain in
compliance with Bank policy. Typically, loan-to-value ratios should be somewhat lower than these upper limits, requiring the borrower
to provide significant equity at the inception of the loan. Our underwriting looks not only at the value of the property but the expected
cash flows to be generated by sale of the parcels or completed construction. We expect the borrower to demonstrate solid experience in
this type of construction and personal guarantees are usually required.
Construction lending entails significant risks compared with residential mortgage lending. These risks involve larger loan balances
concentrated with single borrowers with funds advanced upon the security of the land or the project under construction. The value of
the project is estimated prior to the completion of construction. Thus, it is more difficult to evaluate accurately the total loan funds
required to complete a project and related loan to value ratios. If the estimate of construction or development cost proves to be inaccurate,
we may be required to advance additional funds beyond the amount originally committed in order to protect the value of the property.
Moreover, if the estimated value of the completed project proves to be inaccurate, the borrower may hold a property with a value that is
insufficient to assure full repayment. To mitigate these risks, in addition to the underwriting considerations noted above, we maintain
an in-house construction monitoring unit that has oversight for the projects and we require both site visits and frequent reporting before
funds are advanced.
Residential Mortgage Lending
With the exit of our mortgage banking activities, we will cease to originate residential first-lien mortgage loans in early 2020. However,
in order to manage loan run-off within our residential mortgage loan portfolio, we plan on buying first lien residential mortgage loans,
on a servicing released basis, from both the LLC and other third-party originators. We previously originated first mortgage loans to
individuals, most of which had a loan to value not exceeding 85%. The remainder of this portion of our portfolio consists of home
equity lines of credit and fixed rate home equity loans. Our residential mortgage loans are generally for a primary residence although
we occasionally originated loans for a second home where the borrower has extremely strong credit. We originated adjustable rate
residential mortgage loans with initial fixed-rate terms of five to seven years, as well as fixed rate residential mortgage loans with
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primarily 15- or 30-year terms. In general, we made residential mortgage loans based on the borrower’s ability to repay the loan from
his or her salary and other income; such loans are secured by residential real estate, the value of which is generally readily ascertainable.
We made these loans consistent with our appraisal and real estate lending policies, which detail maximum loan-to-value ratios and
maturities. We generally made residential mortgage loans and home equity lines of credit secured by owner-occupied property within
the guidelines of our regular purchasers of these loans.
Our home equity loans and home equity lines of credit are primarily secured by a second mortgage on owner occupied one-to-four
family residences. Our home equity loans are originated at fixed interest rates and with terms of between five and 30 years for primary
residences and between five and 15 years for secondary and rental properties, and are fully amortizing. Our home equity lines allow for
the borrower to draw against the line for ten years, after which the line is refinanced into a 20-year fixed-rate loan. Home equity lines
of credit carry a variable rate of interest and minimum monthly payments during the draw period, which are the greater of (i) $50.00 or
(ii) depending on credit score, loan-to-value and debt-to-income ratios, either the interest due or interest due plus 1% of the outstanding
loan balance. Home equity loans and lines of credit are generally underwritten with a maximum loan-to-value ratio of 85% (80% when
appraised value is greater than $1 million) for a primary residence when combined with the principal balance of the existing mortgage
loan. At the time we close a home equity loan or line of credit, we record a mortgage to perfect our security interest in the underlying
collateral.
Home equity loans and lines of credit generally have greater risk than owner-occupied residential loans secured by first mortgages.
When customers default on their loans we attempt to foreclose on the property. However, the value of the collateral may not be sufficient
to repay the amount of the unpaid loan, and we may be unsuccessful in recovering the remaining balance from these customers. In
addition, decreases in property values could adversely affect the value of properties used as collateral for the loans. These second lien
loans represent a smaller portion of our portfolio than our first lien residential mortgage loans.
Our home equity and home improvement loan portfolio gives us a diverse client base. Although most of these loans are in our primary
market area, we believe the diversity of the individual loans in the portfolio reduces our potential risk.
Consumer Lending
We offer various types of secured and unsecured consumer loans. Generally, our consumer loans are made for personal, family or
household purposes as a convenience to our customer base. As a general guideline, a consumer’s total debt service should not exceed
40% of their gross income. The underwriting standards for consumer loans include a determination of the applicant’s payment history
on other debts and an assessment of his or her ability to meet existing obligations and payments on the proposed loan.
Consumer loans may present greater credit risk than residential mortgage loans because many consumer loans are unsecured or are
secured by rapidly depreciating assets. Repossessed collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance because of the greater likelihood of damage, loss or depreciation. Consumer loan collections
also depend on the borrower’s continuing financial stability. If a borrower suffers personal financial difficulties, the loan may not be
repaid. Also, various federal and state laws, including bankruptcy and insolvency laws, may limit the amount we can recover on such
loans.
Loan Originations, Purchases, Sales, Participations and Servicing
All loans that we originate or purchase are underwritten pursuant to our policies and procedures, which incorporate standard underwriting
guidelines. We originate both fixed and variable rate loans. Our loan origination activity may be adversely affected by a rising interest
rate environment that typically results in decreased loan demand. We generally retain in our portfolio the majority of loans that we
originate, except for first lien residential mortgage loans where we sell the majority of the loans into the secondary market. With the
exit of our mortgage banking activities, we will cease to originate residential first lien mortgage loans in early 2020. However, in order
to manage loan run-off within our residential mortgage loan portfolio, we plan on buying first lien residential mortgage loans, on a
servicing released basis, from both the LLC and other third-party originators. We do not retain the servicing rights on sold loans.
We occasionally sell participations in commercial loans to correspondent banks if the amount of the loan exceeds our internal limits.
More rarely, we purchase loan participations from correspondent banks in the local market as well. Those loans are underwritten in-
house with the same care of loans directly originated.
Loan Approval Procedures and Authority
Our lending activities follow written, non-discriminatory underwriting standards and loan origination procedures established by our
board of directors. The loan approval process is intended to assess the borrower’s ability to repay the loan, the viability of the loan, and
the adequacy of the value of the collateral that will secure the loan, if applicable. To assess a business borrower’s ability to repay, we
review and analyze, among other factors, current income, credit history including our prior experience with the borrower, cash flow,
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any secondary sources of repayment, other debt obligations in regards to the equity/net worth of the borrower and collateral available to
us to secure the loan.
We generally require appraisals of all real property securing one- to four-family residential and commercial real estate loans and home
equity loans and lines of credit. All appraisers are state-licensed or state-certified appraisers, and our practice is to have local appraisers
approved by our board of directors annually.
Mortgage Banking
As previously noted, on December 18, 2019, we entered into an agreement to cease originating residential first lien mortgage loans and
exit our mortgage banking activities in early 2020. Our mortgage banking activities, prior to the exit of these activities, generated
revenue by providing an extensive line of consumer real estate products and services to customers nationwide. We historically offered
products available to customers through a retail network of mortgage loan officers and bankers as well as a sales force offering our
customers direct access to our products.
Until we cease originating residential first lien mortgage loans in early 2020, we will continue to originate residential mortgage loans
that remain in our pipeline primarily as a correspondent lender. Activity in the residential mortgage loan market is highly sensitive to
changes in interest rates and product availability. While we do have delegated underwriting authority from most of our loan purchasers,
at times we also employ the services of the purchaser to underwrite the loans. Because the loans are originated within purchaser
guidelines and designated automated underwriting and product specific requirements as part of the loan application, the loans sold have
a limited recourse provision. Most contracts with investors contain recourse periods. In general, we may be required to repurchase a
previously sold mortgage loan or indemnify the purchaser if there is non-compliance with defined loan origination or documentation
standards, including fraud, negligence or material misstatement in the loan documents. In addition, we may have an obligation to
repurchase a loan if the mortgagor has defaulted early in the loan term. The potential default repurchase period varies by purchaser but
can be up to approximately 12 months after sale of the loan to the purchaser. The recourse period for fraud, material misstatement,
breach of representations and warranties, noncompliance 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, follow purchaser guidelines, and carry private mortgage
insurance, where applicable.
Until we cease originating residential first lien mortgage loans in early 2020, we will continue to enter into commitments to originate
residential mortgage loans whereby the interest rate on the loan is determined prior to funding (i.e. rate lock commitments). Such rate
lock commitments on mortgage loans to be sold in the secondary market are considered to be derivatives. To protect against the price
risk inherent in residential mortgage loan commitments, we use “best efforts” in delivering to purchasers. Under a “best efforts” contract,
we commit to deliver an individual mortgage loan of a specified principal amount and quality to a purchaser and the purchaser commits
to a price that it will purchase the loan from us if the loan to the underlying borrower closes. We protect the Bank from changes in
interest rates through the use of best efforts forward delivery commitments, whereby the purchaser commits to purchase a loan at a price
representing a premium on the day the borrower commits to an interest rate with the intent that the purchaser has assumed the interest
rate risk on the loan. As a result, we are not generally exposed to losses on loans sold utilizing best efforts. Nor will we realize gains
related to rate lock commitments due to changes in interest rates. The market values of rate lock commitments and best efforts contracts
are not readily ascertainable with precision because rate lock commitments and best efforts contracts are not actively traded. Because
of the high correlation between rate lock commitments and best efforts contracts, we do not expect to incur any gain or loss on the rate
lock commitments.
Investments and Funding
We balance our liquidity needs based on loan and deposit growth through both our investment and borrowings portfolios. It is our goal
to provide adequate funding in support of loan growth and ample contingent liquidity against unusual funding needs. A portion of our
investment portfolio is generally kept in highly liquid securities, and a portion of the portfolio is used to generate additional positive
earnings. Our primary source of funds is, and will continue to be, core deposits generated from our market area. Additional funding is
provided by overnight unsecured master notes, customer repurchase agreements, Federal Home Loan Bank of Atlanta (“FHLB”)
advances, the Board of Governors of the Federal Reserve (the “FRB”) Discount Window, subordinated debentures and other purchased
funds. Other purchased funds may include certificates of deposit (“CDs”) over $100,000, federal funds purchased, and institutional or
brokered deposits. Lines of credit are maintained to protect liquidity levels resulting from unexpected deposit withdrawals and natural-
market credit demand.
Our investment policy is reviewed annually by our board of directors. Our board of directors has appointed its Board Asset Liability
Committee to serve as the Investment Committee. The Board Asset Liability Committee therefore meets at regular intervals (not less
than quarterly) and provides a report on the investment portfolio performance to our full board of directors. The investment officer is
designated by the Chief Executive Officer and is responsible for the day-to-day management of liquidity and the investment portfolio
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in accordance with the policies approved by our board of directors. We actively monitor our investment portfolio and we classify the
majority of the portfolio as “available for sale.” In general, under such a classification, we may sell investment instruments as
management deems appropriate.
Other Banking Products
We offer our customers wire transfer services, ATM and check cards, automated teller machines (“ATMs”) at all of our branch locations,
safe deposit boxes at most branches and credit cards through a third party processor. In addition, we offer our business customers
merchant card services, overnight sweep services, ACH origination capabilities, ACH and check positive pay and remote deposit capture
devices for those customers who have a high volume of checks to deposit.
We also provide Internet banking capabilities to our customers. With our Internet banking service, our customers may open accounts
online, view their accounts online and electronically remit bill payments including an option for same day payment. Our Online and
Mobile Banking capabilities allow both consumer and business customers to essentially do their banking from anywhere at any time.
All customers have the ability to check balances, view eStatements, pay bills, pay people via PopMoney, set real-time account alerts,
manage cards, and deposit checks from their mobile devices.
Deposit Activities
Deposits are the major source of our funding. We offer a broad array of consumer and business deposit products that include demand,
money market, savings, individual retirement accounts, and certificates of deposit. Utilizing key technology partnerships, we offer a
competitive array of commercial cash management products that allow us to attract demand deposits. We believe that we pay
competitive rates on our interest bearing deposits. As a relationship-oriented organization, we generally seek to obtain deposit
relationships with our loan clients.
Employees
We have 299 full-time and eight part-time employees as of December 31, 2019. None of our employees are represented by any collective
bargaining unit, and we believe that relations with our employees are good.
Lending Limit
The Bank’s legal lending limit for loans to one borrower was $35.8 million as of December 31, 2019, and we further monitor our
exposure to one borrower through a policy to limit our “in-house” lending limit to $25.0 million as of December 31, 2019, which in-
house limit can be exceeded on a limited basis. As part of our risk management strategy, we may participate a portion of larger loans
to other financial institutions. This strategy allows us to maintain customer relationships yet observe the legal lending limit and manage
credit exposure. However, this strategy may not always be available.
Available Information
The Company is a public company subject to the reporting requirements of the U.S. Securities and Exchange Commission (the “SEC”).
We file electronically with the SEC our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-
K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as
amended (the “Exchange Act”). We make available on the investor relations page of our website at www.howardbank.com, free of
charge, copies of these reports as soon as reasonably practicable after filing or furnishing them to the SEC. The information on our
website is not incorporated by reference in this Annual Report on Form 10-K.
SUPERVISION AND REGULATION
As a financial institution, we operate in a highly regulated environment. The regulatory framework under which we operate is intended
primarily for the protection of depositors and the Federal Deposit Insurance Corporation’s (the “FDIC’s”) Deposit Insurance Fund and
not for the protection of our stockholders and creditors. The following is a general summary of the material aspects of certain statutes
and regulations applicable to us. These summary descriptions are not complete, and you should refer to the full text of the statutes,
regulations, and corresponding guidance for more information. These statutes and regulations are subject to change, and additional
statutes, regulations, and corresponding guidance may be adopted. We are unable to predict these future changes or the effects, if any,
that these changes could have on our business, revenues, and results of operations.
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Howard Bancorp, Inc.
We are a bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). We are subject to
regulation and examination by the Board of Governors of the Federal Reserve (the “FRB”) and the Maryland Office of the Commissioner
of Financial Regulation (the “Commissioner”) and are required to file periodic reports and any additional information that the FRB and
the Commissioner may require. In addition, the FRB and the Commissioner have enforcement authority over the Company, which
includes the power to remove officers and directors and the authority to issue cease and desist orders to prevent us from engaging in
unsafe or unsound practices or violating laws or regulations governing our business. In general, these enforcement actions may be
initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for
enforcement action, including misleading or untimely reports filed with regulatory authorities.
The status of Howard Bancorp as a registered bank holding company under the BHC Act and a Maryland-chartered bank holding
company does not exempt it from certain federal and state laws and regulations applicable to corporations generally, including, without
limitation, certain provisions of the federal securities laws.
Source of Strength
Under FRB regulations, a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary
banks and may not conduct its operations in an unsafe or unsound manner. Under this requirement, we could, in the future, be required
to provide financial assistance to the Bank should the Bank experience financial distress. In addition, in serving as a source of strength
to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its
subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital raising capacity
to obtain additional resources for assisting its subsidiary banks. A bank holding company’s failure to meet its obligations to serve as a
source of strength to its subsidiary banks will generally be considered by the FRB to be an unsafe and unsound banking practice, a
violation of FRB regulations or both. The FRB may require a bank holding company to terminate any activity or relinquish control of a
nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the FRB’s determination that such activity or control constitutes
a serious risk to the financial soundness or stability of any subsidiary depository institution of the bank holding company. Further,
federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or nonbank
subsidiary if the agency determines that divestiture may aid the depository institution’s financial condition.
Acquisitions
The primary purpose of a bank holding company is to control and manage banks. The BHC Act generally requires the prior approval
of the Federal Reserve for any merger involving a bank holding company or any acquisition by a bank holding company of another bank
or bank holding company. Subject to certain conditions (including deposit concentration limits established by the BHC Act), the Federal
Reserve may allow a bank holding company to acquire banks located in any state of the United States. In approving interstate
acquisitions, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that
may be held by the acquiring bank holding company and its FDIC-insured institution affiliates in the state in which the target bank is
located (provided that those limits do not discriminate against out-of-state institutions or their holding companies) and state laws that
require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an
out-of-state bank holding company. Furthermore, in accordance with the Dodd-Frank Wall Street Reform and Consumer Protection
Act (the “Dodd-Frank Act”), bank holding companies must be well-capitalized and examiners must rate them well-managed in order to
effect interstate mergers or acquisitions.
Change in Control
The BHC Act requires regulatory filings by a stockholder or other party that seeks to acquire direct or indirect “control” of a bank, as
defined in the BHC Act. The determination whether an investor “controls” a bank is based on all of the facts and circumstances
surrounding the investment. As a general matter, a party is deemed to control a bank or other company if the party: (i) owns or controls
25% or more of any class of voting securities of the bank or other company; (ii) can elect or appoint a majority of the board of directors,
or similar body, of the bank or other company; or (iii) exercises a “controlling influence” over the bank or other company. The FRB
may require a company that owns between 5% and 25% of any class of voting securities of a bank or bank holding company to make
certain non-control or “passivity” commitments. If a party were deemed to “control” the Company for BHC Act purposes, the party
would become a bank holding company and subject it to filing and other regulatory requirements.
Separately, an investor that owns or controls 10% or more of any class of voting stock of a bank or bank holding company and (i) the
institution has registered securities under Section 12 of the Exchange Act and (ii) no other person owns, controls or has the power to
vote a greater percentage of that class of voting securities is considered a “control” person under the Change in Bank Control Act (the
“CIBC Act”) and may be required to file a change in control notice with the primary federal regulator of the bank or with the FRB. For
the purposes of both the BHC Act and the CIBC Act, ownership by affiliated parties, or parties acting in concert, is typically aggregated.
9
Activities
Pursuant to provisions of the BHC Act and regulations promulgated by the FRB thereunder, the Company may only engage in or own
companies that engage in activities deemed by the FRB to be so closely related to the business of banking or managing or controlling
banks as to be a proper incident thereto, and the holding company must obtain permission from the FRB prior to engaging in most new
business activities. As a bank holding company, we also can elect to be treated as a “financial holding company,” which would allow
us to engage in a broader array of activities. In sum, a financial holding company can engage in activities that are financial in nature or
incidental or complementary to financial activities, including insurance underwriting, sales and brokerage activities, providing financial
and investment advisory services and underwriting services, and engaging in limited merchant banking activities. We have not sought
financial holding company status, but we may elect that status in the future as our business matures. If we were to elect in writing for
financial holding company status, we would be required to be well capitalized and well managed, and each insured depository institution
we control would also have to be well capitalized, well managed and have at least a satisfactory rating under the Community
Reinvestment Act (discussed below).
Capital Requirements
The Federal Reserve imposes certain capital requirements on a bank holding company under the BHC Act, including a minimum
leverage ratio and a minimum ratio of “qualifying” capital to risk-weighted assets. These requirements are essentially the same as those
that apply to the Bank and are described below under “Howard Bank—Capital Requirements.” However, because the Company
currently has less than $3.0 billion in consolidated assets, it currently qualifies as a small bank holding company, and these capital
requirements do not currently apply to the Company. Subject to certain restrictions, we are able to borrow money to make a capital
contribution to the Bank, and these loans may be repaid from dividends paid from the Bank to the Company.
Dividends
The Company is a legal entity separate and distinct from the Bank. The FRB has issued a policy statement regarding the payment of
dividends by bank holding companies. In general, the FRB’s policies provide that dividends should be paid only out of current earnings
and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital
needs, asset quality, and overall financial condition. Under the prompt corrective action rules discussed below, the ability of a bank
holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could
affect the ability of the Company to pay dividends or otherwise engage in capital distributions.
In addition, funds for cash distributions to our stockholders are derived primarily from dividends received from our Bank. Our Bank is
subject to various general regulatory policies and requirements relating to the payment of dividends. Any restriction on the ability of
our Bank to pay dividends will indirectly restrict the ability of the Company to pay dividends to our stockholders. See “Howard Bank—
Dividends” below.
Federal Securities Regulation
Our common stock is registered with the SEC under the Exchange Act. As such, we are subject to the information, proxy solicitation,
insider trading restrictions and other requirements of the Exchange Act.
Further, if we wish to sell common stock or other securities to raise capital in the future, we will be subject to the registration, anti-fraud,
and other applicable provisions of state and federal securities laws. For example, we will have to register the sales of such securities
under the Securities Act, the Maryland Securities Act, and the applicable securities laws of each state in which we offer or sell the
securities, unless an applicable exemption from registration exists with respect to such sales. Such exemptions may, among other things,
limit the number and types of persons we could sell such securities to and the manner in which we could market the securities. We
would also be subject to federal and state anti-fraud requirements with respect to any statements we make to potential purchasers in
connection with the offer and sale of such securities.
Sarbanes-Oxley Act of 2002
The Sarbanes Oxley Act of 2002 addresses, among other issues, corporate governance, auditing and accounting, executive
compensation, and enhanced and timely disclosure of corporate information. We have adopted policies, procedures and systems
designed to ensure compliance with the Sarbanes Oxley Act and related regulations.
Howard Bank
Howard Bank is a Maryland-chartered trust company (with all powers of a commercial bank), and its deposit accounts are insured by
the FDIC up to the maximum legal limits. It is subject to regulation, supervision and regular examination by the Commissioner and the
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FDIC. The regulations of these agencies govern most aspects of the Bank’s business, including required reserves against deposits, loans,
investments, mergers and acquisitions, borrowing, dividends and location and number of branch offices.
Financial Institutions Article of the Maryland Annotated Code
The Financial Institutions Article of the Maryland Annotated Code (the “Banking Code”) contains detailed provisions governing the
organization, operations, corporate powers, commercial and investment authority, branching rights and responsibilities of directors,
officers and employees of Maryland banking institutions. The Banking Code delegates extensive rulemaking power and administrative
discretion to the Commissioner in its supervision and regulation of state-chartered banking institutions. The Commissioner may order
any banking institution to discontinue any violation of law or unsafe or unsound business practice.
The Economic Growth, Regulatory Relief, and Consumer Protection Act
On May 24, 2018, President Trump signed into law the first major financial services reform bill since the enactment of the Dodd-Frank
Act. The Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Reform Law”) modifies or eliminates certain
requirements on community and regional banks and nonbank financial institutions. For instance, under the Reform Act and related rule
making:
(cid:120)
(cid:120)
(cid:120)
(cid:120)
banks that have less than $10 billion in total consolidated assets and total trading assets and trading liabilities of less than five
percent of total consolidated assets are exempt from Section 619 of the Dodd-Frank Act, known as the “Volcker Rule”, which
prohibits “proprietary trading” and the ownership or sponsorship of private equity or hedge funds that are referred to as “covered
funds”;
the asset threshold for bank holding companies to qualify for treatment under the “Small Bank Holding Company and Savings
and Loan Holding Company Policy Statement” was raised from $1 billion to $3 billion, which exempts these institutions
(including the Company) from certain regulatory requirements including the Basel III capital rules;
a new “community bank leverage ratio” was adopted, which is applicable to certain banks and bank holding companies with
total assets of less than $10 billion (as described below under “Capital Requirements”); and
banks with up to $3 billion in total consolidated assets may be examined by their federal banking regulator every 18 months
(as opposed to every 12 months).
Capital Requirements
Regulatory capital rules adopted in July 2013 and fully phased in as of January 1, 2019, which we refer to as Basel III, impose minimum
capital requirements for bank holding companies and banks. The Basel III rules apply to all national and state banks and savings and
loan associations regardless of size and bank holding companies and savings and loan holding companies other than “small bank holding
companies,” generally holding companies with consolidated assets of less than $3 billion. The Company is currently considered a “small
bank holding company.” More stringent requirements are imposed on “advanced approaches” banking organizations-those organizations
with $250 billion or more in total consolidated assets, $10 billion or more in total foreign exposures, or that have opted in to the Basel
II capital regime. Specifically, the following minimum capital requirements apply to the Bank:
(cid:120)
(cid:120)
(cid:120)
(cid:120)
a common equity Tier 1 (“CET1”) risk-based capital ratio of 4.5%;
a Tier 1 risk-based capital ratio of 6%;
a total risk-based capital ratio of 8%; and
a leverage ratio of 4%.
The final rules also established a “capital conservation buffer” above the regulatory minimum capital requirements, which must consist
entirely of CET1 risk-based capital, which was phased in over several years. The fully phased-in capital conservation buffer of 2.500%,
which became effective on January 1, 2019, resulted in the following effective minimum capital ratios beginning in 2019: (i) a CET1
risk-based capital ratio of 7.0%, (ii) a Tier 1 risk-based capital ratio of 8.5%, and (iii) a total risk-based capital ratio of 10.5%. Under
Basel III, institutions are subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if
their capital levels fall below the buffer amount. These limitations establish a maximum percentage of eligible retained income that
could be utilized for such actions.
Under Basel III, Tier 1 capital includes two components: CET1 capital and additional Tier 1 capital. The highest form of capital, CET1
capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, otherwise
referred to as AOCI, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital is primarily
comprised of noncumulative perpetual preferred stock, Tier 1 minority interests and grandfathered trust preferred securities (as discussed
below). Tier 2 capital generally includes the allowance for credit losses up to 1.25% of risk-weighted assets, qualifying preferred stock,
subordinated debt and qualifying tier 2 minority interests, less any deductions in Tier 2 instruments of an unconsolidated financial
institution. Cumulative perpetual preferred stock is included only in Tier 2 capital, except that the Basel III rules permit bank holding
11
companies with less than $15 billion in total consolidated assets to continue to include trust preferred securities and cumulative perpetual
preferred stock issued before May 19, 2010 in Tier 1 Capital (but not in CET1 capital), subject to certain restrictions. The regulations
also require unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating
regulatory capital unless the Bank elected to opt-out from this treatment, which it did.
On December 21, 2018, the federal banking agencies issued a joint final rule to revise their regulatory capital rules to (i) address the
upcoming implementation of a new credit impairment model, the Current Expected Credit Loss, or CECL model, an accounting standard
under GAAP; (ii) provide an optional three-year phase-in period for the day-one adverse regulatory capital effects that banking
organizations are expected to experience upon adopting CECL; and (iii) require the use of CECL in stress tests beginning with the 2020
capital planning and stress testing cycle for certain banking organizations that are subject to stress testing. We are currently evaluating
the impact the CECL model will have on our accounting, and expect to recognize a one-time cumulative-effect adjustment to our
allowance for credit losses as of the beginning of the first quarter of 2023, the first reporting period in which the new standard is effective
for us. At this time, we cannot yet reasonably determine the magnitude of such one-time cumulative adjustment, if any, or of the overall
impact of the new standard on our business, financial condition or results of operations.
In November 2019, the federal banking regulators published final rules implementing a simplified measure of capital adequacy for
certain banking organizations that have less than $10 billion in total consolidated assets. Under the final rules, which went into effect
on January 1, 2020, depository institutions and depository institution holding companies that have less than $10 billion in total
consolidated assets and meet other qualifying criteria, including a leverage ratio of greater than 9%, off-balance-sheet exposures of 25%
or less of total consolidated assets and trading assets plus trading liabilities of 5% or less of total consolidated assets, are deemed
“qualifying community banking organizations” and are eligible to opt into the “community bank leverage ratio framework.” A qualifying
community banking organization that elects to use the community bank leverage ratio framework and that maintains a leverage ratio of
greater than 9% is considered to have satisfied the generally applicable risk-based and leverage capital requirements under the Basel III
rules and, if applicable, is considered to have met the “well capitalized” ratio requirements for purposes of its primary federal regulator’s
prompt corrective action rules, discussed below. The final rules include a two-quarter grace period during which a qualifying community
banking organization that temporarily fails to meet any of the qualifying criteria, including the greater-than-9% leverage capital ratio
requirement, is generally still deemed “well capitalized” so long as the banking organization maintains a leverage capital ratio greater
than 8%. A banking organization that fails to maintain a leverage capital ratio greater than 8% is not permitted to use the grace period
and must comply with the generally applicable requirements under the Basel III rules and file the appropriate regulatory reports. We do
not have any immediate plans to elect to use the community bank leverage ratio framework but may make such an election in the future.
Prompt Corrective Action
Under federal prompt corrective action regulations, the bank regulatory agencies are authorized and, under certain circumstances,
required, to take various “prompt corrective actions” to resolve the problems of any bank subject to their jurisdiction that is not
adequately capitalized. Depending on their capital levels, every insured depository institution is in one of five capital tiers:
well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Under the
prompt corrective action regulations, a bank is considered “well capitalized” if it: (i) has a total risk-based capital ratio of 10.0% or
greater; (ii) a Tier 1 risk-based capital ratio of 8.0% or greater; (iii) a CET1 ratio of 6.5% or greater; (iv) a leverage capital ratio of 5.0%
or greater; and (iv) is not subject to any written agreement, order, capital directive, or prompt corrective action directive to meet and
maintain a specific capital level for any capital measure. Well capitalized status is a prerequisite for certain types of favorable regulatory
treatment, including expedited processing of applications by the FDIC and the ability to rely on brokered deposits.
The Bank has been “well capitalized” since it commenced its business operations.
Effective with the March 31, 2020 Call Report, qualifying community banking organizations that elect to use the new community bank
leverage ratio framework and that maintain a leverage ratio of greater than 9.0% will be considered to have satisfied the risk-based and
leverage capital requirements to be deemed well-capitalized.
The bank regulatory agencies may impose higher capital requirements on certain banks, and future regulatory change could impose
higher capital standards as a routine matter. The regulators may also set higher capital requirements for holding companies whose
circumstances warrant it. For example, holding companies experiencing internal growth or making acquisitions are expected to maintain
strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets.
As an additional means to identify problems in the financial management of depository institutions, the Federal Deposit Insurance Act
requires federal bank regulatory agencies to establish 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.
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Dividends
The Company is a legal entity separate and distinct from the Bank. Virtually all of the Company’s revenue available for the payment
of dividends on its common stock results from dividends paid to the Company by the Bank. Under Maryland law, the Bank may declare
a cash dividend, after providing for due or accrued expenses, losses, interest and taxes, from its undivided profits or, with the prior
approval of the Commissioner, from its surplus in excess of 100% of its required capital stock. Also, if the Bank’s surplus is less than
100% of its required capital stock, then, until its surplus is 100% of its capital stock, the Bank must transfer to its surplus annually at
least 10% of its net earnings and may not declare or pay any cash dividends that exceed 90% of its net earnings. In addition, federal
bank regulators have stated that paying dividends that deplete a banking organization’s capital base to an inadequate level would be an
unsafe and unsound banking practice and that banking organizations should generally only pay dividends out of current earnings. The
Bank must also maintain the CET1 capital conservation buffer of 2.5% to avoid becoming subject to restrictions on capital distributions,
including dividends, as described above.
Deposit Insurance Assessments
The Bank’s deposit accounts are insured by the FDIC generally up to a maximum of $250,000 per separately insured depositor. FDIC-
insured depository institutions are required to pay deposit insurance assessments to the FDIC. The amount of a particular institution’s
deposit insurance assessment is determined by an FDIC risk-based assessment system. The assessment is a function of a financial ratios
method that takes into account seven financial ratios and the institution’s weighted average CAMELS component ratings. The
assessment must be within a range that depends on the institution’s composite CAMELS rating, and the assessment will be adjusted up
or down to come within the range. Assessment rates (inclusive of possible adjustments) for institutions with less than $10 billion in
consolidated assets currently range from 1.5 to 30 basis points of each institution’s total assets less tangible capital. The FDIC may
increase or decrease the range of assessments uniformly, except that no adjustment can deviate more than two basis points from the base
assessment rate without notice and comment rulemaking. The FDIC may terminate insurance of deposits upon a finding that the
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.
In addition to the ordinary assessments described above, the FDIC has the ability to impose special assessments in certain instances.
For example, under the Dodd-Frank Act, the minimum designated reserve ratio for the Deposit Insurance Fund (“DIF”) was increased
to 1.35% of the estimated total amount of insured deposits. On September 30, 2018, the DIF reached 1.36%, exceeding the statutorily
required minimum reserve ratio of 1.35%. On reaching the minimum reserve ratio of 1.35%, FDIC regulations provided for two changes
to deposit insurance assessments: (i) surcharges on insured depository institutions with total consolidated assets of $10 billion or more
(large institutions) ceased; and (ii) small banks were to receive assessment credits for the portion of their assessments that contributed
to the growth in the reserve ratio from between 1.15% and 1.35%, to be applied when the reserve ratio is at or above 1.38%. The Bank
subsequently received such assessment credits.
Maryland Regulatory Assessment
The Commissioner annually assesses state banking institutions to cover the expense of regulating banking institutions. The Bank’s asset
size determines the amount of the assessment.
Liquidity
The Bank is subject to the reserve requirements imposed by the State of Maryland. A Maryland banking institution is required to have
at all times a reserve equal to at least 15% of its demand deposits. The Bank is also subject to the uniform reserve requirements of the
FRB’s Regulation D, which applies to all insured depository institutions with transaction accounts or non-personal time deposits. During
2019, amounts in transaction accounts above $16.9 million and up to $110.6 million were required to have reserves held against them
in the ratio of 3% of such amounts. Amounts above $110.6 million required reserves of $3.2 million plus 10% of the amount in excess
of $110.6 million. The FRB changes its reserve requirements on an annual basis and the Bank is subject to new requirements for 2020.
The Bank was in compliance with its reserve requirements at December 31, 2019 and is in compliance with its current reserve
requirements.
Loans-to-One-Borrower Limitation
With certain limited exceptions, a Maryland banking institution may lend to a single or related group of borrowers an aggregate amount
not more than 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and
surplus, if such loan is secured by readily marketable collateral, which is defined to include certain securities and bullion, but generally
does not include real estate. The Bank is in compliance with the loans-to-one borrower limitations.
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Commercial Real Estate Loans
Commercial real estate (“CRE”) loans are subject to two types of regulatory oversight. If total reported loans for construction, land
development, and other land represent more than 100% of a bank’s total capital or if total CRE loans represent 300% or more of total
capital and have grown by 50% or more in the last 36 months, the bank is expected to have enhanced risk management and will be
subject to greater regulatory scrutiny. In addition, the risk-based capital rules (so long as they are applicable) presumptively risk weight
CRE loans at 100% but impose a 150% risk weight on loans deemed to be high volatility. Among other things, the capital rules required
that a borrower contribute 15% of the equity of a financed project in order for the loan to qualify for the lower risk weight. The Reform
Act narrowed the types of loans potentially subject to the higher risk weight but did not eliminate that risk weight.
Community Reinvestment Act and Fair Lending Laws
Under the Community Reinvestment Act of 1977 (“CRA”), the FDIC is required to assess the record of all financial institutions regulated
by it to determine if such institutions are meeting the credit needs of the communities (including low and moderate income
neighborhoods) that they serve. CRA performance evaluations are based on a four-tiered rating system: Outstanding, Satisfactory,
Needs to Improve and Substantial Noncompliance. CRA performance evaluations are considered in evaluating applications for such
things as mergers, acquisitions and new branches. The Bank has a CRA rating of “Satisfactory.”
In December 2019, the FDIC and the Office of the Comptroller of the Currency proposed changes to the regulations implementing the
CRA, which, if adopted will result in changes to the current CRA framework. The FRB did not join the proposal.
In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices
on the basis of characteristics, such as ethnicity, gender, and race, as specified in each statute. The failure to comply with the Equal
Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the FDIC, the Department of Housing and
Urban Development, and the Department of Justice, and in private civil actions by borrowers.
Transactions with Related Parties
Transactions between banks and their related parties or affiliates are limited by Sections 23A and 23B of the Federal Reserve Act. An
affiliate of a bank is any company or entity that controls, is controlled by or is under common control with the bank. In a holding
company context, the parent bank holding company and any companies which are controlled by such parent holding company are
affiliates of the bank.
Generally, Section 23A of the Federal Reserve Act and the FRB’s Regulation W limit the “covered transactions” in which a bank or its
subsidiaries may engage with any one affiliate to an amount equal to 10% of such bank’s capital stock and surplus, and limit such
covered transactions with all affiliates to an amount equal to 20% of such bank’s capital stock and surplus. The term ‘‘covered
transaction’’ includes loans, asset purchases, issuances of guarantees, and other similar transactions that expose the bank to the credit
risk of an affiliate. In addition, loans or other extensions of credit by the bank to an affiliate must be collateralized in accordance with
regulatory requirements. The Bank’s transactions with affiliates must be consistent with safe and sound banking practices and may not
involve the purchase by the Bank of any low-quality asset. Section 23B applies to covered transactions as well as certain other
transactions and requires that all such transactions be on terms substantially the same, or at least as favorable, to the bank or subsidiary
as those provided to non-affiliates.
Section 22(h) of the Federal Reserve Act and the FRB’s Regulation O govern extensions of credit made by a bank to its directors,
executive officers, and principal stockholders (‘‘insiders’’). Among other things, these provisions require that extensions of credit to
insiders be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than,
those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment
or present other unfavorable features. Further, such extensions may not exceed certain limitations on the amount of credit extended to
such persons, individually and in the aggregate, which limits are based, in part, on the amount of Howard Bank’s capital. Extensions of
credit in excess of certain limits must also be approved by the board of directors.
On December 27, 2019, the federal banking agencies issued an interagency statement explaining that such agencies will provide
temporary relief from enforcement action against banks or asset managers, which become principal stockholders of banks, with respect
to certain extensions of credit by banks that otherwise would violate Regulation O, provided the asset managers and banks satisfy certain
conditions designed to ensure that there is a lack of control by the asset manager over the bank. This temporary relief will apply while
the Federal Reserve, in consultation with the other federal banking agencies, considers whether to amend Regulation O.
Standards for Safety and Soundness
Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards
relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest
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rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate.
Interagency guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems
at insured depository institutions before capital becomes impaired. If the appropriate federal banking agency determines that an
institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an
acceptable plan to achieve compliance with the standard.
Enforcement Powers
The Bank and its “institution-affiliated parties,” including its management, employees, agents, independent contractors, and consultants
such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs, are subject to potential
civil and criminal penalties for violations of law, regulations or written orders of a government agency. These practices can include the
failure of an institution to timely file required reports or the filing of false or misleading information or the submission of inaccurate
reports. Potential civil penalties have been substantially increased. Criminal penalties for some financial institution crimes have been
increased to 20 years.
In addition, regulators are provided with considerable flexibility to commence enforcement actions against institutions and
institution-affiliated parties. Possible enforcement actions include the termination of deposit insurance. Furthermore, banking agencies’
have expansive power to issue cease-and-desist orders. These orders may, among other things, require affirmative action to correct any
harm resulting from a violation or practice, including restitution, reimbursement, indemnifications 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.
Further, state attorneys general may bring civil actions or other proceedings under the Dodd-Frank Act or regulations against
state-chartered banks, including the Bank.
Anti-Money Laundering and Office of Foreign Assets Control
Under federal law, financial institutions must maintain programs to prevent money laundering and the financing of terrorism that include
established internal policies, procedures and controls; a designated compliance officer; an ongoing employee training program; testing
of the program by an independent audit function; and a “know your customer” program with enhanced due diligence of certain
customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against
money laundering; they must file currency transaction reports for deposits and withdrawals of large amounts of currency and suspicious
activity reports of possible criminal activity. Financial institutions also must assess their money laundering risk with respect to private
banking and foreign correspondent banking relationships. Law enforcement authorities have been granted increased access to financial
information maintained by financial institutions. Bank regulators routinely examine institutions for compliance with these obligations,
and they must consider an institution’s compliance in connection with the regulatory review of applications, including applications for
banking mergers and acquisitions. The regulatory authorities have imposed “cease and desist” orders and civil money penalty sanctions
against institutions found to be violating these obligations.
Bank Secrecy Act and anti-money laundering compliance has been a special focus of the Federal banking agencies in recent years. Any
non-compliance is likely to result in an enforcement action, often with substantial monetary penalties and reputation damage. A savings
association or bank that is required to strengthen its compliance program often must put on hold any initiatives that require banking
agency approval.
The Office of Foreign Assets Control, (“OFAC”) is responsible for helping to ensure that U.S. entities do not engage in transactions
with certain prohibited parties, as defined by various Executive Orders and Acts of Congress. OFAC sends bank regulatory agencies
lists of persons and organizations suspected of aiding, harboring or engaging in terrorist acts, known as Specially Designated Nationals
and Blocked Persons. If we find a name on any transaction, account or wire transfer that is on an OFAC list, we must freeze such
account, file a suspicious activity report and notify the appropriate authorities.
USA PATRIOT Act
The Patriot Act became effective on October 26, 2001 and amended the Bank Secrecy Act. The Patriot Act provides, in part, for the
facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and
money laundering by enhancing anti-money laundering and financial transparency laws, as well as enhanced information collection
tools and enforcement mechanics for the U.S. government, including:
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requiring standards for verifying customer identification at account opening;
rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties
that may be involved in terrorism or money laundering;
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reports by nonfinancial trades and businesses filed with the Treasury Department’s Financial Crimes Enforcement Network
for transactions exceeding $10,000; and
filing suspicious activities reports by brokers and dealers if they believe a customer may be violating U.S. laws and
regulations.
The Patriot Act requires financial institutions to undertake enhanced due diligence of private bank accounts or correspondent accounts
for non-U.S. persons that they administer, maintain, or manage. Bank regulators routinely examine institutions for compliance with
these obligations and are required to consider compliance in connection with the regulatory review of applications.
Under the Patriot Act, the Financial Crimes Enforcement Network (“FinCEN”) can send the Bank a list of the names of persons
suspected of involvement in terrorist activities or money laundering. The Bank may be requested to search its records for any
relationships or transactions with persons on the list. If the Bank finds any relationships or transactions, it must report those relationships
or transactions to FinCEN.
Consumer Protection Laws
We are subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the
economy. These laws include the Equal Credit Opportunity Act, the Fair Housing Act, the Fair Credit Reporting Act, the Fair and
Accurate Credit Transactions Act, the Truth in Lending Act, the Home Mortgage Disclosure Act, and the Real Estate Settlement
Procedures Act, and various state law counterparts. Further, the Dodd-Frank Act established the Consumer Financial Protection Bureau
(“CFPB”), which has the responsibility for making rules and regulations under the federal consumer protection laws relating to
financial products and services. The CFPB has the authority to supervise and examine depository institutions with more than $10
billion in assets for compliance with federal consumer laws. The authority to supervise and examine depository institutions with $10
billion or less in assets, such as the Bank, for compliance with federal consumer laws remains largely with those institutions’ primary
regulators. However, the CFPB may participate in examinations of these smaller institutions on a “sampling basis” and may refer
potential enforcement actions against such institutions to their primary regulators. As such, the CFPB may participate in examinations
of the Bank. The CFPB also has a broad mandate to prohibit unfair, deceptive or abusive acts and practices and is specifically
empowered to require certain disclosures to consumers and draft model disclosure forms. Failure to comply with consumer protection
laws and regulations can subject financial institutions to enforcement actions, fines and other penalties.
In addition, federal law currently contains extensive customer privacy protection provisions. Under these provisions, a financial
institution must provide to its customers, at the inception of the customer relationship and annually thereafter, the institution’s policies
and practices regarding the handling of customers’ nonpublic personal financial information. These provisions also provide that, except
for certain limited exceptions, a financial institution may not provide such personal information to unaffiliated third parties unless the
institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of
such disclosure. Further, under the ‘‘Interagency Guidelines Establishing Information Security Standards,’’ banks must implement a
comprehensive information security program that includes administrative, technical, and physical safeguards to ensure the security and
confidentiality of customer information. Federal law makes it a criminal offense, except in limited circumstances, to obtain or attempt
to obtain customer information of a financial nature by fraudulent or deceptive means.
Effect of Governmental Monetary Policies
Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and
its agencies. The FRB’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of
commercial banks through the FRB’s power to implement national monetary policy in order, among other things, to curb inflation or
combat a recession. The monetary policies of the FRB affect the levels of bank loans, investments and deposits through the FRB’s
control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its
influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in
monetary and fiscal policies.
Item 1A. Risk Factors
You should consider carefully the following risks, along with the other information contained in and incorporated into this report. The
risks and uncertainties described below are not the only ones that may affect us. Additional risks and uncertainties also may adversely
affect our business and operations. If any of the following events actually occur, our business and financial results could be materially
adversely affected.
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Risk Factors Relating to Our Business
Because our loan portfolio consists largely of commercial business and commercial real estate loans, our portfolio carries a
higher degree of risk than would a portfolio composed primarily of residential mortgage loans.
Our loan portfolio is made up largely of commercial business loans and commercial real estate loans, most of which is collateralized by
real estate. These types of loans generally expose a lender to a higher degree of risk of non-payment and loss than do residential
mortgage loans because of several factors, including dependence on the successful operation of a business or a project for repayment,
the collateral securing these loans may not be sold as easily as residential real estate, and loan terms with a balloon payment rather than
full amortization over the loan term. In addition, commercial real estate and commercial loans typically involve larger loan balances to
single borrowers or groups of related borrowers compared to one- to four-family residential mortgage loans. Consequently, an adverse
development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an
adverse development with respect to a one- to four-family residential mortgage loan. Underwriting and portfolio management activities
cannot completely eliminate all risks related to these loans. Any significant failure to pay on time by our customers or a significant
default by our customers would materially and adversely affect us.
We make both secured and some unsecured commercial and industrial loans. Unsecured loans generally involve a higher degree of risk
of loss than do secured loans because, without collateral, repayment is wholly dependent upon the success of the borrowers’ businesses.
Secured commercial and industrial loans are generally collateralized by accounts receivable, inventory, equipment or other assets owned
by the borrower and include a personal guaranty of the business owner. Compared to real estate, that type of collateral is more difficult
to monitor, its value is harder to ascertain, it may depreciate more rapidly and it may not be as readily saleable if repossessed. Further,
commercial and industrial loans generally will be serviced primarily from the operation of the business, which may not be successful,
and commercial real estate loans generally will be serviced from income on the properties securing the loans.
While any declines in the value of our real estate collateral securing loans have been reflected in existing reserves, the discounts and
reserves we have taken against our loan portfolio based on our internal review of economic conditions and their impact on real estate
values in our market areas may be insufficient. Deterioration in the real estate market or the economy could adversely affect the value
of the properties securing the loans or revenues from borrowers’ businesses, thereby increasing the risk of non-performing loans and
increased portfolio losses that could materially and adversely affect us.
The small businesses that make up the majority of our commercial borrowers generally do not have the cash reserves to help cushion
them from an economic slowdown to the same extent that large borrowers do and thus may be more heavily impacted by an economic
downturn. A return of recessionary conditions and/or other negative developments in the domestic or international credit markets or
economies may have a negative effect on the ability of our commercial borrowers to make timely repayments of their loans, which could
have an adverse impact on our earnings.
Construction loans are subject to risks during the construction phase that are not present in standard residential real estate and commercial
real estate loans. These risks include:
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the viability of the contractor;
the value of the project being subject to successful completion;
the contractor’s ability to complete the project, to meet deadlines and time schedules and to stay within cost estimates; and
concentrations of such loans with a single contractor and its affiliates.
Real estate construction and land loans also present risks of default in the event of declines in property values or volatility in the real
estate market during the construction phase. If we are forced to foreclose on a project prior to completion, we may not be able to recover
the entire unpaid portion of the loan, may be required to fund additional amounts to complete a project and may have to hold the property
for an indeterminate amount of time. If any of these risks were to occur, it could adversely affect our financial condition, results of
operations and cash flows.
As of December 31, 2019, our commercial real estate loans were equal to 288% of our total risk-based capital. The federal banking
agencies have issued guidance regarding high concentrations of commercial real estate loans within bank loan portfolios. The guidance
requires financial institutions that exceed certain levels of commercial real estate lending compared with their total capital to maintain
heightened risk management practices that address the following key elements: board and management oversight and strategic planning,
portfolio management, development of underwriting standards, risk assessment and monitoring through market analysis and stress
testing, and maintenance of increased capital levels as needed to support the level of commercial real estate lending. If there is any
deterioration in our commercial real estate or real estate construction and land portfolios or if our regulators conclude that we have not
implemented appropriate risk management practices, it could adversely affect our business and result in a requirement that we increase
our capital levels, and such capital may not be available to us on acceptable terms or at all.
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A failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and other
service providers or other third parties, including as a result of cyber-attacks, could disrupt our businesses, result in the
disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and cause losses.
We rely heavily on communications and information systems to conduct our business. Information security risks for financial institutions
such as ours have generally increased in recent years in part because of the proliferation of new technologies, the use of the internet and
telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime,
hackers, terrorists, activists, and other external parties. As client, public, and regulatory expectations regarding operational and
information security have increased, our operational systems and infrastructure must continue to be safeguarded and monitored for
potential failures, disruptions, and breakdowns. Our business, financial, accounting and data processing systems, or other operating
systems and facilities may stop operating properly or become disabled or damaged as a result of a number of factors, including events
that are wholly or partially beyond our control. For example, there could be electrical or telecommunications outages; natural disasters
such as earthquakes, tornadoes, and hurricanes; disease pandemics; events arising from local or larger scale political or social matters,
including terrorist acts; and, as described below, cyber-attacks.
As noted above, our business relies on our digital technologies, computer and email systems, software, and networks to conduct its
operations. Although we have information security procedures and controls in place, our technologies, systems, networks, and our
clients’ devices may become the target of cyberattacks or information security breaches that could result in the unauthorized release,
gathering, monitoring, misuse, loss or destruction of our or our clients’ confidential, proprietary and other information, or otherwise
disrupt our or our clients’ or other third parties’ business operations. Third parties with whom we do business or that facilitate our
business activities, including financial intermediaries, or vendors that provide services or security solutions for our operations, and other
third parties, could also be sources of operational and information security risk to us, including from breakdowns or failures of their
own systems or capacity constraints.
While we have disaster recovery and other policies and procedures designed to prevent or limit the effect of the failure, interruption or
security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not
occur or, if they do occur, that they will be adequately addressed. Our risk and exposure to these matters remains heightened because of
the evolving nature of these threats. As a result, cybersecurity and the continued development and enhancement of our controls, processes
and practices designed to protect our systems, computers, software, data and networks from attack, damage or unauthorized access
remain a focus for us. As threats continue to evolve, we may be required to expend additional resources to continue to modify or enhance
our protective measures or to investigate and remediate information security vulnerabilities. Disruptions or failures in the physical
infrastructure or operating systems that support our businesses and clients, or cyber-attacks or security breaches of the networks, systems
or devices that our clients use to access our products and services could result in client attrition, regulatory fines, penalties or intervention,
reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially
adversely affect our results of operations or financial condition.
We depend on information technology and telecommunications systems of third-party servicers, and systems failures,
interruptions or breaches of security involving these systems could have an adverse effect on our operations, financial condition
and results of operations.
Our business is highly dependent on the successful and uninterrupted functioning of our information technology and telecommunications
systems, third-party servicers accounting systems and mobile and online banking platforms. We outsource many of our major systems,
such as data processing, deposit processing systems and online banking platforms. While we have selected these vendors carefully, we
do not control their actions. The failure of these systems, or the termination of a third-party software license or service agreement on
which any of these systems is based, could interrupt our operations. Financial or operational difficulties of a vendor could also hurt our
operations if those difficulties interfere with the vendor’s ability to serve us. Furthermore, our vendors could also be sources of
operational and information security risk to us, including from breakdowns or failures of their own systems or capacity constraints.
Replacing these third-party vendors could also create significant delay and expense. Because our information technology and
telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such
services exceeds capacity or such third-party systems fail or experience interruptions. If sustained or repeated, a system failure or service
denial could result in a deterioration of our ability to process new and renewal loans, gather deposits and provide customer service,
compromise our ability to operate effectively, damage our reputation, result in a loss of customer business and/or subject us to additional
regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on our financial condition and
results of operations.
Because our loan portfolio includes residential real estate loans, our earnings are sensitive to the credit risks associated with
these types of loans.
While we will cease originating residential first lien mortgage loans in early 2020, we will continue to originate home equity loans and
home equity lines of credit within our local market area. In addition, we will purchase residential first lien mortgage loans in order to
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offset portfolio runoff. While residential real estate loans are more diversified than loans to commercial borrowers, and our local real
estate market and economy have performed better than many other markets, a downturn could cause higher unemployment, more
delinquencies, and could adversely affect the value of properties securing loans in our portfolio. In addition, should values begin to
decline again, the real estate market may take longer to recover or not recover to previous levels. These risks increase the probability
of an adverse impact on our financial results as fewer borrowers would be eligible to borrow and property values could be below
necessary levels required for adequate coverage on the requested loan.
We may be unable to successfully implement a disposition or wind-down of certain business activities which no longer fit our
strategic plan.
In December 2019, we entered into an agreement to sell certain assets related to our mortgage business, and we agreed to cease
originating residential first lien mortgage loans and exit our mortgage banking activities in early 2020. In addition, we may engage in
future dispositions or wind-downs of certain business. Key risks associated with exiting a business include:
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our ability to price a sale transaction appropriately and otherwise negotiate acceptable terms;
our ability to identify and implement key customer, technology systems, and other transition actions to avoid or minimize
negative effects on retained business activities;
our ability to assess and manage any loss of synergies that the exited business activity had with our retained business activities;
our ability to replace legacy earnings from the exited business or activity with new revenues; and
our ability to manage capital, liquidity, and other challenges that may arise if an exit results in significant legacy cash
expenditures or financial loss.
Our financial condition, earnings and asset quality could be adversely affected if we are required to repurchase loans originated
for sale by our residential lending department.
As discussed in “Item 1. Business — Mortgage Banking,” most loans that we sell in the secondary market are with recourse. Therefore,
we may be required to repurchase a previously sold mortgage loan or indemnify the purchaser if there is non-compliance with defined
loan origination or documentation standards, including fraud, negligence or material misstatement in the loan documents, if the
mortgagor has defaulted early in the loan term, or noncompliance with applicable law. While to date we have had to repurchase only a
minimal amount of loans previously sold, should repurchases become a material issue, our earnings and asset quality could be adversely
impacted, which could adversely impact the market price of our common stock.
If our allowance for credit losses is not sufficient to cover actual loan losses, our earnings would decrease.
We are exposed to the risk that our customers will be unable to repay their loans according to their terms and that any collateral securing
the payment of their loans will not be sufficient to ensure full repayment. Credit losses are inherent in the lending business and could
have a material adverse effect on our operating results and ability to meet our obligations. Volatility and deterioration in domestic
markets may also increase our risk for credit losses. We maintain an allowance for credit losses that we believe is adequate for absorbing
any potential losses in our loan portfolio. Management, through a periodic review and consideration of our loan portfolio, determines
the amount of the allowance for credit losses. We cannot, however, predict with certainty the amount of probable losses in our portfolio
or be sure that our allowance will be adequate in the future. If management’s assumptions and judgments prove to be incorrect and the
allowance for credit losses is inadequate to absorb future losses, our losses will increase and our earnings will suffer.
We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our
borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining
the amount of the allowance for credit losses, we review our loans and our loss and delinquency experience, and we evaluate economic
conditions. If our assumptions are incorrect, our allowance for credit losses may not be sufficient to cover probable incurred losses in
our loan portfolio, resulting in additions to the allowance and a corresponding decrease to earnings. Material additions to the allowance
could materially decrease our net income. If delinquencies and defaults should increase, we may be required to further increase our
provision for loan losses.
Significant increases to our allowance would materially decrease our net income. In addition, bank regulators periodically review our
allowance for credit losses and may require us to increase our provision for credit losses or recognize further loan charge-offs to the
allowance for credit losses. Any increase in the allowance for credit losses or loan charge-offs might have a material adverse effect on
our financial condition and results of operations.
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New accounting standards could require us to increase our allowance for credit losses and may have a material adverse effect
on our financial condition and results of operations.
The measure of our allowance for credit losses is dependent on the adoption and interpretation of accounting standards. The Financial
Accounting Standards Board, or FASB, recently issued a new credit impairment model, the Current Expected Credit Loss, or CECL
model, which will become applicable to us in 2023. Under the CECL model, we will be required to present certain financial assets
carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be
collected. The measurement of expected credit losses is to be based on information about past events, including historical experience,
current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will
take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the
“incurred loss” model currently required under GAAP, which delays recognition until it is probable a loss has been incurred.
Accordingly, we expect that the adoption of the CECL model will materially affect how we determine our allowance for credit losses
and could require us to significantly increase our allowance. Moreover, the CECL model may create more volatility in the level of our
allowance for credit losses. If we are required to materially increase our level of allowance for credit losses for any reason, such increase
could adversely affect our business, financial condition and results of operations.
Certain of our estimates related to accounting for acquired loans may differ from actual results.
The application of the purchase method of accounting in our mergers and any future mergers or acquisitions will impact our allowance
for credit losses. Under the purchase method of accounting, all acquired loans were recorded in our Consolidated Financial Statements
at their estimated fair value at the time of acquisition and any related allowance for loan loss was eliminated because credit quality,
among other factors, was considered in the determination of fair value. To the extent that our estimates of fair value are too high, we
will incur losses associated with the acquired loans. The allowance associated with our acquired credit impaired loans reflects
deterioration in cash flows since acquisition resulting from our quarterly re-estimation of cash flows which involves complex cash flow
projections and significant judgment on timing of loan resolution.
If the estimates we have made regarding the performance of loans we have acquired are inaccurate, the fair value estimates may exceed
the actual collectability of the balances, and this may result in the related loans being considered by us as impaired, which would result
in a reduction in interest income. The tangible book value we measure is based in part on these estimates, and if fair value estimates
differ from actual collectability, then subsequent earnings may also differ from original estimates. Measures of tangible book value and
earnings impact of business combinations are frequently used in evaluating the merits and value of business combinations. Numerous
assumptions and estimates are integral to purchased loan accounting, and actual results could be different from prior estimates.
Our growth strategy may not be successful, may be dilutive and may have other adverse consequences.
As previously mentioned, a key component of our growth strategy is to pursue acquisitions of other financial institutions or branches of
other financial institutions, and we routinely evaluate opportunities to acquire additional financial institutions or branches or to open
new branches. As consolidation of the banking industry continues, the competition for suitable acquisition candidates may increase.
We compete with other banking companies for acquisition opportunities, and there are a limited number of candidates that meet our
acquisition criteria. Consequently, we may not be able to identify suitable candidates for acquisitions. If we are unable to locate suitable
acquisition candidates willing to sell on terms acceptable to us, our net income could decline and we would be required to find other
methods to grow our business. We may also open additional branches organically and expand into new markets or offer new products
and services.
Our merger and acquisition activities could be material and could require us to use a substantial amount of common stock and dilute our
existing stockholders, cash, other liquid assets, and/or incur debt. In addition, if goodwill recorded in connection with our prior or
potential future acquisitions were determined to be impaired, then we would be required to recognize a charge against our earnings,
which could materially and adversely affect our results of operations during the period in which the impairment was recognized.
Our expansion activities could involve a number of additional risks, including:
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the time and expense associated with identifying and evaluating potential acquisition and merger partners;
using inaccurate estimates and judgments to evaluate credit, operations, management and market risks with respect to the target
institution or its branches or assets;
the time and expense associated with evaluating new markets for expansion, hiring experienced local management and opening
new offices or branches as there may be a substantial time lag between these activities before we generate sufficient assets and
deposits to support the costs of the expansion;
operating in markets in which we have had no or only limited experience;
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taking a significant amount of time negotiating a transaction or working on expansion plans, resulting in management’s time and
attention being diverted from the operation of our existing business;
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difficulty or unanticipated expense associated with converting the operating systems of the acquired or merged company into ours;
the possibility that we will be unable to successfully implement integration strategies, due to challenges associated with integrating
complex systems, technology, banking centers, and other assets of the acquired bank in a manner that minimizes any adverse effect
on customers, suppliers, employees, and other constituencies;
the possibility that the expected benefits of a transaction may not materialize in the timeframe expected or at all, or may be costlier
to achieve;
the ability to realize the anticipated benefits of the merger or acquisition;
creating an adverse short-term effect on our results of operations;
losing key employees and customers as a result of a merger or acquisition that is poorly received;
the possibility of regulatory approval being delayed, impeded, conditioned or denied due to existing or new regulatory issues
surrounding the Company, the target institution or the proposed combined entity as a result of, among other things, issues related
to anti-money laundering/Bank Secrecy Act compliance, fair lending laws, fair housing laws, consumer protection laws, unfair,
deceptive or abusive acts or practices regulations, or the CRA;
delay in completing a merger or acquisition due to litigation;
inability to obtain additional financing (including by issuing additional common equity), if necessary, on favorable terms or at all;
and
unforeseen adjustments, write-downs, write-offs or restructuring or other impairment charges.
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Also, the costs to lease and start up new branch facilities or to acquire existing financial institutions or branches, and the additional costs
to operate these facilities, may increase our noninterest expense. It also may be difficult to adequately and profitably manage the
anticipated growth from the new branches. We can provide no assurance that any new branch sites will successfully attract a sufficient
level of deposits and other banking business to offset their operating expenses.
Further, we plan to continue to make investments in our infrastructure in the future. We also currently plan to open additional branches
in the areas where we now operate and in other markets over the next few years. We anticipate that this will have the short-term effect
of, at least temporarily, increasing our expenses at a faster rate than revenue growth, which will have an adverse effect on net income.
If we grow too quickly and are not able to control costs and maintain asset quality, growth could materially and adversely affect our
financial condition and results of operations. Further, we may not be successful in our growth strategy, which would negatively impact
our financial condition and results of operations.
Consumers may decide not to use banks to complete their financial transactions.
Technology and other changes are allowing consumers to complete financial transactions through alternative methods that historically
have involved banks. For example, consumers can now maintain funds that would have historically been held as bank deposits in
brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions such as
paying bills and transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, which
may increase as consumers become more comfortable with these new technologies and offerings, could result in the loss of fee income,
as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and
the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.
Strong competition within our market area may limit our growth and profitability.
Competition in the banking and financial services industry within our market area is intense. In our market area, we compete with,
among others, commercial banks, savings institutions, mortgage brokerage firms, credit unions, mutual funds, insurance companies and
brokerage and investment banking firms operating locally and elsewhere. There are also a number of smaller community-based banks
that pursue similar operating strategies as the Bank. In addition, some of our competitors have recently offered loans with lower fixed
rates and on more attractive terms than we have been willing to offer. Our continued profitability depends on our continued ability to
successfully compete in our market area. The greater resources and broader range of deposit and loan products offered by our
competition may limit our ability to increase our interest earning assets and profitability. See “Item 1. Business -Competition” for more
information about competition in our market area.
We expect competition to remain intense in the future as a result of legislative, regulatory and technological changes and the continuing
trend of consolidation in the financial services industry. Banks, securities firms and insurance companies can merge under the umbrella
of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting,
insurance (both agency and underwriting) and merchant banking. Increased competition among financial services companies due to the
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recent consolidation of certain competing financial institutions may adversely affect our ability to market our products and services.
Also, technological advances have lowered barriers to entry and made it possible for banks to compete in our market without a retail
footprint by offering competitive rates and for non-banks to offer products and services that have traditionally been provided by banks.
Additionally, due to their size, many of our competitors may offer a broader range of products and services as well as better pricing for
certain products and services than we can, which could affect our ability to grow and remain profitable on a long-term basis. Our
profitability depends on our ability to successfully compete in our market area, and competition for deposits and the origination of loans
could limit our ability to successfully implement our business plan, and could adversely affect our results of operations in the future.
Further, if we must raise interest rates paid on deposits or lower interest rates charged on our loans, our net interest margin and
profitability could be adversely affected.
Furthermore, competition in the banking and financial services industry is coming not only from traditional competitors but from
technology-oriented financial services (“FinTech”) companies, which are subject to limited regulation. They offer user friendly front-
end, quick turnaround times for loans and other benefits. While we are considering the possibility of developing relationships with
FinTech companies for efficiency in processing and/or as a source of loans and other benefits, we cannot limit the possibility that our
customers or future prospects will work directly with a FinTech company instead. This could impact our growth and profitability going
forward.
We continually encounter technological change.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology
driven by new or modified products and services. The effective use of technology increases efficiency and enables financial institutions
to better serve customers and to reduce costs. Our future success depends, in part, on our ability to address the needs of our customers
by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in
our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be
able to effectively implement new technology-driven products and services or be successful in marketing these products and services to
our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a
material adverse effect on our business and, in turn, our financial condition and results of operations.
We must comply with extensive and complex governmental regulation, which could have an adverse effect on our business and
our growth strategy, and we may be adversely affected by changes in laws and regulations.
We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various federal
and state regulatory agencies. The Company is subject to FRB regulation, and the Bank is subject to extensive regulation, supervision
and examination by the FDIC and the Commissioner.
Many of these regulations are intended to protect depositors, the public or the FDIC insurance funds, not stockholders. Regulatory
requirements affect our lending practices, capital structure, investment practices, dividend policy and many other aspects of our business.
These requirements may constrain our operations, and changes in regulations could adversely affect us. The burden imposed by these
federal and state regulations may place banks in general, and the Bank specifically, at a competitive disadvantage compared to less
regulated competitors. In addition, the cost of compliance with regulatory requirements could adversely affect our ability to operate
profitably or increase profitability. See “Supervision and Regulation” for more information about applicable banking laws and
regulations.
Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions
on our operations, classification of our assets and determination of the level of our allowance for credit losses. In addition, changes to
statutes, regulations or regulatory policies or supervisory guidance, including changes in interpretation or implementation of statutes,
regulations, policies or supervisory guidance, could affect us in substantial and unpredictable ways, including, among other things,
subjecting us to increased capital, liquidity and risk management requirements, creating additional costs, limiting the types of financial
services and products we may offer and/or increasing the ability of non-banks to offer competing financial services and products. Failure
to comply with laws, regulations or policies could also result in heightened regulatory scrutiny and in sanctions by regulatory agencies
(such as a memorandum of understanding, a written supervisory agreement or a cease and desist order), civil money penalties and/or
reputation damage. Any of these consequences could restrict our ability to expand our business or could require us to raise additional
capital or sell assets on terms that are not advantageous to us or our shareholders and could have a material adverse effect on our
business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations,
such violations may occur despite our best efforts.
Further, as a public company, we incur significant legal, accounting, insurance and other expenses in connection with compliance with
rules of the SEC and The Nasdaq Stock Market LLC.
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We face a risk of noncompliance and enforcement action with the Patriot Act, the Bank Secrecy Act and other anti-money
laundering statutes and regulations.
Financial institutions are required under the PATRIOT Act, Bank Secrecy Act and other laws and regulations to, among other duties,
institute and maintain effective anti-money laundering programs and file suspicious activity and currency transaction reports as
appropriate. These rules also require financial institutions to establish procedures for identifying and verifying the identity of customers
seeking to open new financial accounts. The federal Financial Crimes Enforcement Network, established by the U.S. Treasury
Department to administer the Bank Secrecy Act, is authorized to impose significant civil money penalties for violations of those
requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the
U.S. Department of Justice, Drug Enforcement Administration and Internal Revenue Service. There is also increased scrutiny of
compliance with the rules enforced by the OFAC. Federal and state bank regulators also have begun to focus on compliance with Bank
Secrecy Act and anti-money laundering regulations. If our policies, procedures and systems are deemed deficient or the policies,
procedures and systems of the financial institutions that we have already acquired or may acquire in the future are deficient, we would
be subject to liability, including fines and regulatory actions such as restrictions on our ability to pay dividends and the necessity to
obtain regulatory approvals to proceed with certain aspects of our business plan, including our acquisition plans, which would negatively
impact our business, financial condition and results of operations. Failure to maintain and implement adequate programs to combat
money laundering and terrorist financing could also have serious reputational consequences for us.
Our business may be adversely affected by economic conditions.
Our financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans
and the value of collateral securing those loans, as well as demand for loans and other products and services we offer and whose success
we rely on to drive our growth, is highly dependent upon the business environment in the primary markets where we operate and in the
United States as a whole. Unlike larger banks that are more geographically diversified, we are a regional bank that provides banking
and financial services to customers primarily in the Great Baltimore Metropolitan area. The economic conditions in this local market
may be different from, and in some instances worse than, the economic conditions in the United States as a whole. In addition, due to
the proximity of our primary market area to Washington, D.C., decreases in spending by the Federal government or cuts to Federal
government employment could impact us to a greater degree than banks that serve a larger or a different geographical area. Such risks
are beyond our control and may have a material adverse effect on our financial condition and results of operations and, in turn, the value
of our common stock. Some elements of the business environment that affect our financial performance include short-term and long-
term interest rates, the prevailing yield curve, inflation and price levels, monetary and trade policy, unemployment and the strength of
the domestic economy and the local economy in the markets in which we operate. Unfavorable market conditions can result in a
deterioration in the credit quality of our borrowers and the demand for our products and services, an increase in the number of loan
delinquencies, defaults and charge-offs, additional provisions for loan losses, adverse asset values of the collateral securing our loans
and an overall material adverse effect on the quality of our loan portfolio. Unfavorable or uncertain economic and market conditions
can be caused by declines in economic growth, business activity or investor or business confidence; limitations on the availability or
increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment; natural disasters; epidemics or
pandemics; or a combination of these or other factors.
During 2019, the U.S. economy has continued to grow across a wide range of industries and regions in the United States. However,
there are continuing concerns related to, among other things, the level of U.S. government debt and fiscal actions that may be taken to
address that debt, the potential effects of the novel coronavirus on international trade (including supply chains and export levels), travel,
employee productivity and other economic activities, depressed oil prices and the U.S.-China trade disputes and related tariffs, that may
have a destabilizing effect on financial markets and economic activity. There can be no assurance that current economic conditions will
continue or improve, and economic conditions could worsen. Economic pressure on consumers and uncertainty regarding continuing
economic improvement may result in changes in consumer and business spending, borrowing and saving habits. A return of recessionary
conditions and/or other negative developments in the domestic or international credit markets or economies may significantly affect the
markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Declines
in real estate values and sales volumes and high unemployment or underemployment may also result in higher than expected loan
delinquencies, increases in our levels of nonperforming and classified assets and a decline in demand for our products and services.
These negative events may cause us to incur losses and may adversely affect our capital, liquidity and financial condition.
Changes in U.S. trade policies and other factors beyond our control, including the imposition of tariffs and retaliatory tariffs
and the impacts of epidemics or pandemics, may adversely impact our business, financial condition and results of operations.
There have been changes and discussions with respect to U.S. trade policies, legislation, treaties and tariffs, including trade policies and
tariffs affecting other countries, including China, the European Union, Canada and Mexico and retaliatory tariffs by such countries.
Tariffs and retaliatory tariffs have been imposed, and additional tariffs and retaliation tariffs have been proposed. Such tariffs, retaliatory
tariffs or other trade restrictions on products and materials that our customers import or export could cause the prices of our customers’
products to increase which could reduce demand for such products, or reduce our customer margins, and adversely impact their revenues,
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financial results and ability to service debt; which, in turn, could adversely affect our financial condition and results of operations. In
addition, to the extent changes in the political environment have a negative impact on us or on the markets in which we operate our
business, results of operations and financial condition could be materially and adversely impacted in the future. It remains unclear what
the U.S. Administration or foreign governments will or will not do with respect to tariffs already imposed, additional tariffs that may be
imposed, or international trade agreements and policies. On January 26, 2020, President Trump signed a new trade deal between the
United States, Canada and Mexico to replace the North American Free Trade Agreement. The full impact of this agreement on us, our
customers and on the economic conditions in our primary banking markets is currently unknown. In addition, the novel coronavirus and
concerns regarding the extent to which it may spread have affected, and may increasingly affect, international trade (including supply
chains and export levels), travel, employee productivity and other economic activities. A trade war or other governmental action related
to tariffs or international trade agreements or policies, as well as coronavirus or other potential epidemics or pandemics, have the
potential to negatively impact ours and/or our customers’ costs, demand for our customers' products, and/or the U.S. economy or certain
sectors thereof and, thus, adversely affect our business, financial condition, and results of operations.
Our profitability depends on interest rates, and changes in interest rates could have an adverse impact on our results of
operations and financial condition.
Our results of operations depends to a large extent on our “net interest income,” which is the difference between the interest income
received from our interest-earning assets, such as loans and investment securities, and the interest expense incurred in connection with
our interest-bearing liabilities, such as interest on deposit accounts. Changes in interest rates can increase or decrease our net interest
income, because different types of assets and liabilities may react differently, and at different times, to market interest rate changes.
When interest bearing liabilities mature or reprice more quickly than interest earning assets in a period, an increase in interest rates could
reduce net interest income. Similarly, when interest earning assets mature or reprice more quickly than interest bearing liabilities, falling
interest rates could reduce net interest income. Additionally, an increase in interest rates may, among other things, reduce loan demand
and our ability to originate loans (which would also decrease our ability to generate noninterest income through the sale of loans into
the secondary market), and make it more difficult for borrowers to repay adjustable-rate loans or otherwise decrease loan repayment
rates. A decrease in the general level of interest rates may affect us through, among other things, increased prepayments on our loan
and mortgage-backed securities portfolios and increased competition for deposits. Accordingly, changes in the level of market interest
rates affect our net yield on interest earning assets, loan origination volume, loan and mortgage-backed securities portfolios, and our
overall results. Fluctuations in interest rates are highly sensitive to many factors that are not predictable or controllable. Therefore,
while we attempt to manage our risk from changes in market interest rates by adjusting the rates, maturity, repricing, and balances of
the different types of interest-earning assets and interest bearing liabilities, we might not be able to maintain a consistent positive spread
between the interest that we receive and the interest that we pay. As a result, a rapid increase or decrease in interest rates could have an
adverse effect on our net interest margin and results of operations.
In addition, as market interest rates rise, we will have competitive pressures to increase the rates we pay on deposits. Because interest
rates we pay on our deposits could be expected to increase more quickly than the increase in the yields we earn on our interest-earning
assets, our net interest income would be adversely affected.
Governmental economic and monetary policy will influence our results of operations. The rates of interest payable on deposits and
chargeable on loans are affected by monetary policy as determined by various governmental and regulatory authorities, in particular the
FRB, as well as by national, state and local economic conditions. The FRB, in an attempt to help the overall economy, has among other
things kept interest rates low through its targeted federal funds rate and the purchase of Treasury and mortgage-backed securities. If the
FRB increases the federal funds rate in the near term, overall interest rates will likely rise, which may negatively impact the housing
markets and U.S. economic growth. If rates remain relatively low it could create deflationary pressures, which while possibly lowering
our operating costs, could have a negative impact on our borrowers, especially our commercial borrowers, and the values of collateral
securing our loans, which could negatively affect our financial performance.
We also are subject to reinvestment risk associated with changes in interest rates. Changes in interest rates may affect the average life
of loans and mortgage-related securities. Decreases in interest rates can result in increased prepayments of loans and mortgage-related
securities, as borrowers refinance to reduce borrowing costs. Under these circumstances, we are subject to reinvestment risk to the
extent that we are unable to reinvest the cash received from such prepayments at rates that are comparable to the interest rates on existing
loans and securities.
Reforms to and uncertainty of the London Inter-bank Offered Rate, or LIBOR, calculation process and potential phasing out
of LIBOR may adversely affect us.
In 2017, the United Kingdom’s Financial Conduct Authority announced that after 2021 it would no longer compel banks to submit the
rates required to calculate the LIBOR. This announcement indicates that the continuation of LIBOR on the current basis cannot and will
not be guaranteed after 2021. Consequently, at this time, it is not possible to predict whether and to what extent banks will continue to
provide submissions for the calculation of LIBOR. Similarly, it is not possible to predict whether LIBOR will continue to be viewed as
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an acceptable market benchmark, what rate or rates may become accepted alternatives to LIBOR, or what the effect of any such changes
in views or alternatives may be on the markets for LIBOR-indexed financial instruments. The FRB in conjunction with the Alternative
Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, is considering replacing the U.S. dollar
LIBOR with a new index calculated by short-term repurchase agreements, backed by Treasury securities (“SOFR”). SOFR is observed
and backward looking, which stands in contrast with LIBOR under the current methodology, which is an estimated forward-looking rate
and relies, to some degree, on the expert judgment of submitting panel members. Given that SOFR is a secured rate backed by
government securities, it will be a rate that does not take into account bank credit risk (as is the case with LIBOR). SOFR is therefore
likely to be lower than LIBOR and is less likely to correlate with the funding costs of financial institutions. Whether or not SOFR attains
traction as a LIBOR replacement tool remains in question, although some transactions using SOFR have been completed in 2019, and
the future of LIBOR remains uncertain as this time. 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 the value of LIBOR-based loans, and securities in our portfolio. If
LIBOR rates are no longer available, and we are required to implement substitute indices for the calculation of interest rates under our
loan agreements with our borrowers, we may experience significant expenses in effecting the transition, and may be subject to disputes
or litigation with customers and creditors over the appropriateness or comparability to LIBOR of the substitute indices, which could
have an adverse effect on our results of operations.
We may be subject to more stringent capital requirements in the future.
We are subject to regulatory requirements specifying minimum amounts and types of capital that we must maintain. From time to time,
the regulators change these regulatory capital adequacy guidelines. If we fail to meet these minimum capital guidelines and other
regulatory requirements, we may be restricted in the types of activities we may conduct and we may be prohibited from taking certain
capital actions, such as paying dividends and repurchasing or redeeming capital securities.
In particular, the capital requirements applicable to the Bank under the Basel III rules become fully phased-in on January 1, 2019. The
Bank is now required to satisfy additional, more stringent, capital adequacy standards than it had in the past. While we expect to meet
the requirements of the Basel III rules, we may fail to do so. Failure to meet minimum capital requirements could result in certain
mandatory and possible additional discretionary actions by regulators that, if undertaken, could have an adverse material effect on our
financial condition and results of operations. In addition, these requirements could have a negative impact on our ability to lend, grow
deposit balances, make acquisitions or make capital distributions in the form of dividends or share repurchases. Higher capital levels
could also lower our return on equity.
Our business may be adversely affected by increasing prevalence of fraud and other financial crimes.
As a financial institution, we are subject to risk of loss due to fraud and other financial crimes. Nationally, reported incidents of fraud
and other financial crimes have increased. We believe we have controls in place to detect and prevent such losses, but in some cases
multi-party collusion or other sophisticated methods of hiding fraud may not be readily detected or detectable, and could result in losses
that affect our financial condition and results of operations.
Financial crime is not limited to the financial services industry. Our customers could experience fraud in their businesses, which could
materially impact their ability to repay their loans, and deposit customers in all financial institutions are constantly and unwittingly
solicited by others in fraud schemes that vary from easily detectable and obvious attempts to high-level and very complex international
schemes that could drain an account of millions of dollars and require detailed financial forensics to unravel. While we have controls
in place, contractual agreements with our customers partitioning liability, and insurance to help mitigate the risk, none of these are
guarantees that we will not experience a loss, potentially a loss that could have a material adverse effect on our financial condition,
reputation and results of operations.
The small and medium-sized businesses that we lend to may have fewer resources to weather a downturn in the economy, which
may impair a borrower’s ability to repay a loan to the Bank that could materially harm our operating results.
We target our business development and marketing strategy primarily to serve the banking and financial services needs of small and
medium-sized businesses. These small and medium-sized businesses frequently have a smaller market share than their competition,
may be more vulnerable to economic downturns, may need substantial additional capital to expand or compete and may experience
significant volatility in operating results. Any one or more of these factors may impair their ability to repay a loan. In addition, the
success of a small and medium-sized business often depends on the management talents and efforts of one or two persons or a small
group of persons, and the death, disability or resignation of one or more of these persons could have a material adverse impact on its
business and its ability to repay a loan. As a result, economic downturns and other events that negatively impact our market areas and
the businesses we serve could cause us to incur substantial credit losses that could negatively affect our results of operations and financial
condition.
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Changes in tax laws may negatively impact our financial performance.
Changes in tax laws contained in the Tax Cuts and Jobs Act, which was enacted in December 2017, contain a number of provisions that
could have an impact on the banking industry, borrowers and the market for single family residential and multifamily residential real
estate. Among the changes are: lower limits on the deductibility of mortgage interest on single family residential mortgages; limitations
on deductibility of business interest expense; and limitations on the deductibility of property taxes and state and local income taxes.
Such changes may have an adverse effect on the market for and valuation of single family residential properties and multifamily
residential properties, as well as on the demand for such loans in the future. If home ownership or multifamily residential property
ownership become less attractive, demand for mortgage loans would decrease, which could have a material adverse effect on our
mortgage banking operations and as a result on our revenues, net income, operating results and financial condition. In addition, the
value of the properties securing loans in our portfolio may be adversely impacted as a result of the changing economics of home
ownership and multifamily residential ownership, which could require an increase in our provision for credit losses, which would reduce
our profitability and could materially adversely affect our business, financial condition and results of operations. Additionally, certain
borrowers could become less able to service their debts as a result of higher tax obligations. These changes could adversely affect our
business, financial condition and results of operations.
We are subject to liquidity risks.
Market conditions could negatively affect the level or cost of available liquidity, which would affect our ongoing ability to accommodate
liability maturities and deposit withdrawals, meet contractual obligations, and fund asset growth and new business transactions at a
reasonable cost, in a timely manner, and without adverse consequences. Core deposits are our primary source of funding, but this is
supplemented by overnight unsecured master notes, customer repurchase agreements, FHLB advances, the FRB Discount Window,
subordinated debentures and other purchased funds. A significant decrease in our core deposits, an inability to renew FHLB advances
or access the Discount Window, an inability to obtain alternative funding to core deposits or our other traditional sources of funds, or a
substantial, unexpected, or prolonged change in the level or cost of liquidity could have a negative effect on our business, financial
condition and results of operations.
We depend heavily on key employees, Mary Ann Scully and Robert D. Kunisch, Jr., to continue the implementation of our long-
term business strategy and the loss of their services could disrupt our operations and result in reduced earnings.
Ms. Scully is our Chairman and Chief Executive Officer, and Mr. Kunisch is our President. We believe that our continued growth and
future success will depend in large part on the skills of our senior management team. We believe these two executive officers possess
valuable knowledge about and experience in the banking industry and that their knowledge and relationships would be difficult to
replicate. We have entered into an employment agreement with each of Ms. Scully and Mr. Kunisch and acquired key-person life
insurance on each, but the existence of such agreements and insurance does not assure that we will be able to retain their services or
recover losses associated with the loss of their services. The unexpected loss of the services of Ms. Scully or Mr. Kunisch could have a
material adverse effect on our business, operations, financial condition and operating results, as well as the value of our common stock.
We may be required to raise additional capital in the future, but that capital may not be available when it is needed on attractive
terms, or at all.
We are required by regulatory authorities to maintain adequate levels of capital to support our operations. Our capital requirements for
the foreseeable future are currently satisfied. We may at some point, however, need to raise additional capital to support our continued
growth or if our liquidity is adversely affected by external factors such as a return of recessionary conditions and/or other negative
developments in the domestic or international credit markets. Our ability to raise additional capital, if needed, will depend in part on
conditions in the capital markets at that time, which are outside our control. Accordingly, we cannot assure you of our ability to raise
additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand
our operations could be materially impaired, or the failure to raise additional capital could have a material adverse effect on our liquidity,
financial condition or results of operations. In addition, if we decide to raise additional equity capital, your interest in the Company
could be diluted. Furthermore, if we raise additional capital through the issuance of debt securities, there can be no assurance that
sufficient revenues or cash flow will exist to service such debt.
Our investment securities portfolio is subject to credit risk, market risk, and liquidity risk.
Our investment securities portfolio is subject to risks beyond our control that may significantly influence its fair value. These include,
but are not limited to, rating agency downgrades of the securities, defaults of the issuers of the securities, lack of market pricing of the
securities, and instability in the credit markets. Lack of market activity with respect to some securities has, in certain circumstances,
required us to base their fair market valuation on unobservable inputs. Any changes in these risk factors, in current accounting principles
or interpretations of these principles could impact our assessment of fair value and thus the determination of other-than-temporary
impairment of the securities in the investment securities portfolio. Investment securities that previously were determined to be other-
26
than-temporarily impaired could require further write-downs due to continued erosion of the creditworthiness of the issuer. Write-
downs of investment securities would negatively affect our earnings and regulatory capital ratios.
Further, most of our securities investment portfolio as of December 31, 2019 has been designated as available for sale pursuant to
Statement of Financial Accounting Standards, Accounting Standards Codification (“ASC”) Topic 320 – “Investments.” ASC Topic 320
requires that unrealized gains and losses in the estimated value of the available for sale portfolio be “marked to market” and reflected as
a separate item in stockholders’ equity, net of tax. If the market value of the investment portfolio declines, this could cause a
corresponding decline in stockholders’ equity.
Our lending limit may limit our growth.
We are limited in the amount we can loan to a single borrower by the amount of our capital. Generally, under current law, we may lend
up to 15% of our unimpaired capital and surplus to any one borrower. Based upon our current capital levels, such amount is significantly
less than that of many of our competitors and may discourage potential borrowers who have credit needs in excess of our lending limit
from doing business with us. We accommodate larger loans by selling participations in those loans to other financial institutions, but
this strategy may not always be available.
The failure to maintain our reputation may materially adversely affect our ability to grow and generate revenue.
Our reputation is one of the most valuable components of our business. Damage to our reputation could undermines the confidence of
clients and prospects in our ability to serve them and therefore could negatively affect our earnings. Negative public opinion can result
from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, mergers and
acquisitions and cybersecurity incidents, and from actions taken by government regulators and community organizations in response to
those activities. Damage to our reputation could affect the confidence of rating agencies, regulators, stockholders and other parties in a
wide range of transactions that are important to our business. Failure to maintain our reputation ultimately would have an adverse effect
on our ability to maintain and grow our business. Actions by the financial services industry generally or by other members of or
individuals in the financial services industry also could impact our reputation negatively. The considerable expansion in the use of
social media over recent years has increased the risk that our reputation could be negatively impacted in a short amount of time. If we
are unable to quickly and effectively respond to any incidents negatively impacting our reputation, it could have a material and long-
term negative impact on our business and, therefore, our operating results.
We are party to various claims and lawsuits incidental to our business. Litigation is subject to many uncertainties such that the
expenses and ultimate exposure with respect to many of these matters cannot be ascertained.
From time to time, we are the subject of various claims and legal actions by customers, employees, stockholders and others. Whether
such claims and legal actions are legitimate or unfounded, if such claims and legal actions are not resolved in our favor, they may result
in significant financial liability and/or adversely affect the market perception of us and our products and services as well as impact
customer demand for those products and services. In light of the potential cost and uncertainty involved in litigation, we have in the
past and may in the future settle matters even when we believe we have a meritorious defense. Certain claims may seek injunctive relief,
which could disrupt the ordinary conduct of our business and operations or increase our cost of doing business. Our insurance or
indemnities may not cover all claims that may be asserted against us. Any judgments or settlements in any pending litigation or future
claims, litigation or investigation could have a material adverse effect on our business, reputation, financial condition and results of
operations.
From time to time we are, or may become, involved in suits, legal proceedings, information-gatherings, investigations and
proceedings by governmental and self-regulatory agencies that may lead to adverse consequences.
Many aspects of the banking business involve a substantial risk of legal liability. From time to time, we are, or may become, the subject
of information-gathering requests, reviews, investigations and proceedings, and other forms of regulatory inquiry, including by bank
regulatory agencies, self-regulatory agencies, the SEC and law enforcement authorities. The results of such proceedings could lead to
significant civil or criminal penalties, including monetary penalties, damages, adverse judgements, settlements, fines, injunctions,
restrictions on the way we conduct our business or reputational harm.
Risks Related to an Investment in Our Common Stock
Anti-takeover provisions in our corporate documents and in federal and state law may make it difficult and expensive to remove
current management.
Anti-takeover provisions in our articles of incorporation and bylaws and federal and state banking laws, including regulatory approval
requirements, could make it more difficult for a third party to acquire us, even if doing so would be perceived to be beneficial to our
27
stockholders. For example, we have a classified board of directors with three-year staggered terms, which may delay the ability of
stockholders to change the membership of a majority of our board. In addition, directors may only be removed from office by the
affirmative vote of at least 80% of all of the votes of our stockholders entitled to be cast. Our articles of incorporation also authorize
our board to classify or reclassify shares of our stock in one or more classes or series, to cause the issuance of additional shares of our
stock, and to amend our articles without stockholder approval to increase or decrease the number of shares of stock that we have authority
to issue. The combination of these provisions may inhibit a non-negotiated merger or other business combination, which, in turn, could
adversely affect the market price of our common stock. These provisions could also discourage proxy contests and make it more difficult
and expensive for holders of our common stock to elect directors other than the candidates nominated by our board of directors or
otherwise remove existing directors and management, even if current management is not performing adequately.
Maryland law and our articles of incorporation limit the liability of our directors and officers and the rights of us and our
stockholders to take action against our directors and officers.
Maryland law provides that a director will not have any liability as a director as long as he or she performs his or her duties in accordance
with the applicable standard of conduct. In addition, our articles of incorporation eliminate our directors’ and officers’ liability to us
and our stockholders for money damages to the fullest extent permitted by Maryland law. Our articles of incorporation and bylaws also
require us to indemnify our directors and officers for liability resulting from actions taken by them in those capacities to the maximum
extent permitted by Maryland law. As a result, we and our stockholders may have more limited rights against our directors and officers
than might otherwise exist under common law. In addition, we may be obligated to fund the defense costs incurred by our directors and
officers.
The market price for our common stock may be volatile.
The market price of our common stock could be subject to significant fluctuations due to changes in sentiment in the market regarding
our operations or business prospects. Factors that may affect market sentiment include:
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
operating results that vary from the expectations of our management or of securities analysts and investors;
developments in our business or in the financial service sector generally;
regulatory or legislative changes affecting our industry generally or our business and operations in particular;
operating and securities price performance of companies that investors consider to be comparable to us;
changes in estimates or recommendations by securities analysts;
announcements of strategic developments, acquisitions, dispositions, financings and other material events by us or our competitors;
and
changes in financial markets and national and local economies and general market conditions, such as interest rates and stock,
commodity, credit or asset valuations or volatility.(cid:3)
(cid:3)
While the U.S. and other governments continue efforts to restore confidence in financial markets and promote economic growth, market
and economic turmoil could still occur in the near- or long-term, negatively affecting our business, financial condition and results of
operations, as well as the price, trading volume and volatility of our common stock.
We may be unable to, or may continue to choose not to, pay dividends on our common stock.
We have never paid cash dividends to holders of our common stock. Although we may pay cash dividends in the future, we currently
intend to retain a large majority of any earnings to help fund our growth. Our ability to pay cash dividends may be limited by regulatory
restrictions, by our Bank’s ability to pay cash dividends to the Company and by our need to maintain sufficient capital to support our
operations. The FRB has issued a policy statement regarding the payment of dividends by bank holding companies. In general, the
FRB’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention
by the bank holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. The
FRB’s policies also require that a bank holding company serve as a source of financial strength to its subsidiary banks by standing ready
to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by
maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where
necessary. Under the prompt corrective action regulations, the ability of a bank holding company to pay dividends may be restricted if
a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of the Company to pay dividends or
otherwise engage in capital distributions.
Since the Company is a legal entity separate and distinct from the Bank and does not conduct stand-alone operations, its ability to pay
dividends depends on the ability of the Bank to pay dividends to it. As a Maryland-chartered trust company, the Bank is subject to
limitations on the amount of dividends that it is permitted to pay. The federal banking agencies have also issued policy statements which
provide that bank holding companies and insured banks should generally only pay dividends out of current earnings.
28
If our Bank is not permitted to pay cash dividends to the Company, it is unlikely that we would be able to pay cash dividends on our
common stock. Moreover, holders of our common stock are entitled to receive dividends only when, and if declared by our board of
directors. If we fail to pay dividends in the future, capital appreciation, if any, of our common stock may be the sole opportunity for
gains on an investment in our common stock. In addition, in the event the Bank becomes unable to pay dividends to the Company, we
may not be able to service our debt or pay our other obligations. Accordingly, the Company’s inability to receive dividends from the
Bank could also have a material adverse effect on our business, financial condition and results of operations.
We can sell additional shares of common stock without consulting stockholders and without offering shares to existing
stockholders, which would result in dilution of our stockholders’ interests and could depress our stock price.
Our articles of incorporation currently authorize an aggregate of 20,000,000 shares of common stock, 18,714,844 of which are
outstanding as of February 27, 2020. As permitted by Maryland law, our articles of incorporation provide that our board of directors
can amend our articles of incorporation, without stockholder approval, to increase or decrease the aggregate number of shares of stock
or the number of shares of any class of stock that we have the authority to issue. Our board of directors is further authorized to issue
additional shares of common stock and preferred stock, at such times and for such consideration as it may determine, without stockholder
action. Because our common stockholders do not have preemptive rights to purchase shares of our capital stock (that is, the right to
purchase a stockholder’s pro rata share of any securities issued by us), any future offering of capital stock could have a dilutive effect
on holders of our common stock.
Item 1B. Unresolved Staff Comments
None
Item 2. Properties
Our headquarters are located at 3301 Boston Street, Baltimore, Maryland in a building that we own, which also includes a full-service
branch office. Including the headquarters building, at December 31, 2019, we owned ten of our sixteen full-service branches and leased
the remaining six branches, all of which are located in our Greater Baltimore Metropolitan market area. In addition, we lease five
regional mortgage banking or commercial lending offices (four in Maryland and one in Delaware) and lease one former branch location.
We also own two former branch facilities that are classified as long-lived assets within “Interest receivable and other assets” on our
Consolidated Balance Sheet. See Notes to the Consolidated Financial Statements, “Premises and Equipment,” and “Leases” for
information with respect to the amount at which our premises and equipment are recorded and commitments under long-term leases.
Item 3. Legal Proceedings
From time to time, we may be involved in litigation relating to claims arising out of our normal course of business. As of the date of
this report, we are not aware of any material pending litigation matters.
Item 4. Mine Safety Disclosures
Not applicable
29
Part II
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchase
of Equity Securities
Our common stock is listed on The Nasdaq Stock Market under the symbol “HBMD.” At February 27, 2020, we had 387 stockholders
of record.
Dividends
We have not declared or paid any dividends on our common stock. We currently intend to retain all of our future earnings, if any, for
use in our business and do not anticipate paying cash dividends on our common stock in the foreseeable future; however, our board of
directors may decide to declare dividends in the future. Payments of future dividends, if any, will be at the discretion of our board of
directors after taking into account various factors, including our business, operating results and financial condition, current and
anticipated cash needs, plans for expansion, tax considerations, general economic conditions and other factors deemed relevant to our
board. We are not obligated to pay dividends on our common stock.
As a Maryland corporation, we are subject to certain restrictions on dividends under the Maryland General Corporation Law. Generally,
Maryland law limits cash dividends if the corporation would not be able to pay its debts in the usual course of business after giving
effect to the cash dividend or if the corporation’s total assets would be less than the corporation’s total liabilities plus the amount needed
to satisfy the preferential rights upon dissolution of stockholders whose preferential rights on dissolution are superior to those receiving
the distribution. We are also subject to certain restrictions on the payment of cash dividends as a result of banking laws, regulations and
policies. See “Supervision and Regulation—Howard Bancorp, Inc.—Dividends.”
Because we are a bank holding company and do not engage directly in business activities of a material nature, our ability to pay dividends
to our stockholders depends, in large part, upon our receipt of dividends from the Bank, which is also subject to numerous limitations
on the payment of dividends under federal and state banking laws, regulations and policies. See “Supervision and Regulation—Howard
Bank—Dividends.”
Securities Authorized for Issuance Under Equity Compensation Plans
The information required by this section of this Item is incorporated by reference to the information included under the captions
“Securities Authorized for Issuance Under Equity Compensation Plans” in the Proxy Statement.
Issuer Purchases of Equity Securities
The following table reflects information regarding our share repurchases for the three months ended December 31, 2019:
Period
October 1, 2019 - October 31, 2019
November 1, 2019 - November 30, 2019
December 1, 2019 - December 31, 2019
Total
Total Number of
Shares Purchased
-
-
14,864
14,864
Average Price
Paid per Share
-
$
-
17.11
17.11
$
Total Number of
Shares Purchased
as Part of
Publicly
Announced Plans
or Programs
-
-
14,864
14,864
Maximum Dollar
Value of Shares
that May Yet Be
Purchased Under
the Plans or
Programs (1)
$
6,931,443
6,931,443
6,677,138
(1) On April 24, 2019, our Board of Directors authorized a stock repurchase program under which we can, from time to time, purchase
up to $7.0 million of our outstanding common shares, until the program expires on October 24, 2020. Under the stock repurchase
program, shares of common stock may be repurchased by us in open market transactions or in privately negotiated transactions as
permitted under applicable rules and regulations or through a 10b5-1 trading plan under the Exchange Act, which would permit shares
to be repurchased when we might otherwise be precluded from doing so because of self-imposed trading blackout periods or other
regulatory restrictions. Repurchases may be conducted, suspended, or terminated at any time without notice. The extent to which we
repurchase any shares and the timing of such repurchases will depend upon market conditions and other considerations as may be
considered in our sole discretion. A total of 19,764 shares at an average price paid per share of $16.34 were repurchased under this
30
program as of December 31, 2019. As of February 24, 2020, we had repurchased all remaining shares under the stock repurchase
program, resulting in a total of 392,565 shares repurchased at an average price paid per share of $17.83.
Item 6. Selected Financial Data
(in thousands, except per share data.)
Statements of operations data:
Interest income
Interest expense
Provision for credit losses
Noninterest income
Noninterest expense
Federal and state income tax expense
Net income (loss)
Preferred stock dividends
Net income available to common shareholders
Per share data and shares outstanding:
Net income (loss) per common share, basic
Net income (loss) per common share, diluted
Book value per common share at period end
Average common shares outstanding
Diluted average common shares outstanding
Shares outstanding at period end
Financial Condition data:
Total assets
Loans receivable (gross)
Allowance for credit losses
Other interest-earning assets
Total deposits
Borrowings
Total stockholders’ equity
Common equity
Average assets
Average stockholders' equity
Average common stockholders' equity
Selected performance ratios:
Return on average assets
Return on average common equity
Net interest margin(1)
Efficiency ratio(2)
Asset quality ratios:
Nonperforming loans to gross loans
Allowance for credit losses to loans
Allowance for credit losses to nonperforming loans
Nonperforming assets to loans and other real estate
Nonperforming assets to total assets
Capital ratios:
Leverage ratio
Common equity tier 1 capital ratio
Tier I risk-based capital ratio
Total risk-based capital ratio
Average equity to average assets
2019
2018
Year ended December 31,
2017
2016
2015
$
91,434
22,124
4,193
21,034
64,078
5,192
16,881
-
16,881
$
$
$
0.89
0.89
16.48
19,068,246
19,071,077
19,066,913
$
2,374,619
1,745,513
10,401
363,320
1,714,365
319,368
314,148
314,148
2,250,334
304,925
304,925
$
80,389
13,771
6,091
17,860
83,112
(897)
(3,828)
-
(3,828)
$
43,026
5,167
1,831
19,524
45,200
3,152
7,200
-
7,200
$
$
$
(0.22)
(0.22)
15.48
17,556,554
17,556,554
19,039,347
$
$
$
0.75
0.75
13.47
9,555,952
9,596,804
9,820,592
$
2,266,514
1,649,751
9,873
351,917
1,685,806
276,653
294,683
294,683
$
1,149,950
936,608
6,159
152,343
863,908
148,920
132,253
132,253
$
38,741
4,562
2,037
14,796
38,699
2,936
5,303
166
5,137
$
$
$
0.74
0.73
12.27
6,975,662
6,998,982
6,991,072
$
1,026,957
821,524
6,428
152,075
808,734
127,574
85,790
85,790
$
33,349
3,072
1,836
11,935
38,261
973
1,142
126
1,016
$
$
$
0.16
0.16
11.54
6,160,005
6,223,496
6,962,139
$
946,759
757,002
4,869
138,137
747,408
98,828
92,899
80,337
1,997,474
266,075
266,075
1,072,943
123,763
123,763
970,710
86,221
81,896
782,441
76,143
63,581
0.75
5.54
3.50
70.93
1.10
0.60
54.33
1.27
0.94
9.55
11.09
11.09
13.14
13.55
%
%
%
%
%
%
%
%
%
%
%
%
%
%
(0.19)
(1.44)
3.78
98.38
1.50
0.60
39.94
1.76
1.28
8.77
10.00
10.00
12.14
13.32
%
%
%
%
%
%
%
%
%
%
%
%
%
%
0.67
5.82
3.73
78.77
1.41
0.66
46.70
1.57
1.28
11.70
12.77
12.77
13.72
11.53
%
%
%
%
%
%
%
%
%
%
%
%
%
%
0.55
6.48
3.73
79.01
1.17
0.78
69.24
1.41
1.16
8.36
9.71
9.71
10.83
8.88
%
%
%
%
%
%
%
%
%
%
%
%
%
%
0.15
1.80
4.08
90.64
1.37
0.64
46.95
1.68
1.35
9.90
11.47
11.47
12.09
9.73
%
%
%
%
%
%
%
%
%
%
%
%
%
%
(1) Net interest margin is net interest income divided by average earning assets.
(2) Efficiency ratio is noninterest expense divided by the sum of net interest income and noninterest income.
31
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion provides additional information regarding our operations for the twelve-month periods ending
December 31, 2019, 2018 and 2017, and financial condition at December 31, 2019 and 2018, and should be read in conjunction with
our Consolidated Financial Statements and related notes that appear elsewhere in this report. Historical results of operations and the
percentage relationships among any amounts included, and any trends that may appear, may not indicate trends in operations or results
of operations for any future periods.
We have made, and will continue to make, various forward-looking statements with respect to financial, business and economic matters.
Comments regarding our business that are not historical facts are considered forward-looking statements that involve inherent risks and
uncertainties. Actual results may differ materially from those contained in these forward-looking statements. For additional information
regarding our cautionary disclosures, see the “Cautionary Note Regarding Forward-Looking Statements” at the beginning of this report.
Overview
Howard Bancorp, Inc. is the holding company for Howard Bank. Howard Bank was formed in 2004. Howard Bank’s business has
consisted primarily of originating both commercial and real estate loans secured by property in our market area. We are headquartered
in Baltimore, Maryland. We consider our primary market area to be the Greater Baltimore Metropolitan Area. We engage in a general
commercial banking business, making various types of loans and accepting deposits. We market our financial services primarily to
small- and medium-sized businesses and their owners, professionals and executives, and high-net-worth individuals. Our loans are
primarily funded by core deposits of customers in our market.
On December 18, 2019, we entered into an agreement to release certain management members of our mortgage division from their
employment contracts and allow those individuals to create a limited liability company (“LLC”) for the purpose of hiring our 91
remaining mortgage employees. We also agreed to transfer ownership of the domain name “VAmortgage.com” to the newly created
LLC. In consideration of the release of the employment agreements, the transfer of our mortgage employees, and the sale of the domain
name, the LLC paid us $750 thousand. Under the agreement, there is a transition period of approximately 45 days, after which we have
agreed to cease originating residential first lien mortgage loans and exit our mortgage banking activities. Accordingly, we expect to have
the majority of the residential first lien mortgage pipeline processed by the end of the first quarter of 2020. In order to manage future
loan run-off within our residential mortgage loan portfolio, we plan on buying first lien residential mortgage loans, on a servicing
released basis, from both the LLC and other third-party originators.
While our mortgage banking activities were marginally profitable in two of the last three years and our decision to exit this activity will
eliminate that source of income, we believe that the exit of these activities will have a negligible impact on our net income over the next
twelve months and will improve our efficiency ratio. Most importantly, we believe that exiting these activities will allow us to focus
resources on growing our more profitable and less volatile commercial banking business that represents our core competency. We expect
that this renewed focus will more than replace the marginal levels of net income from our mortgage banking activities within the next
twelve months. While we estimate that the after tax income from these activities in 2019 was $1.6 million, compared to an after tax loss
of $1.4 million in 2018, the operating expenses we attributed to the mortgage banking activities represented only direct costs and did
not include shared services expense for staff and support activities such as loan operations, wire transfer operations, human resources,
finance, internal audit, and compliance. If we had allocated these shared services expenses to our mortgage banking activities, the
financial returns on our mortgage banking activities would have been even less.
We originally began our residential mortgage banking activities to provide increased diversification to our net interest income and
noninterest income revenue. While we sold the majority of our residential first lien mortgage loan originations to investors, we held a
portion of these originations in our loan portfolio to diversify our loan mix. We continued to grow our mortgage banking business until
shortly after our merger with First Mariner in 2018, at which time we determined to reduce our mortgage banking activities. This
decision was shaped by our impressions of both the evolution of the mortgage banking industry and the characteristics of the returns
associated with our original diversification strategy. For instance, we saw a growing need for both scale and technology investments as
non-depository institutions began to dominate this space, which would require us to re-allocate our resources of both human and financial
capital into a non-core business activity. In addition, despite management efforts to increase returns on mortgage originations through
changes in mortgage banking management, processes and product array, we were not meeting our internal expectations. As a result,
after also considering, among other factors, regulatory risks related to mortgage banking, the distraction of management from our core
customer business, the need to allocate resources to a non-core business activity, and the adverse impact of our mortgage business on
our efficiency ratio, we ultimately determined to exit our mortgage banking activities. After a ten-month period of negotiations with
both internal and external parties, in December 2019, we entered into an agreement to exit our mortgage banking activities which resulted
in a positive return on the sale of the domain name (VAMortgage.com) and no severance or lease termination costs, other than $288
thousand of exit costs associated with change in control and retention agreements. The exit of our mortgage banking activities is
discussed in Note 3 to the Consolidated Financial Statements.
32
On December 6, 2018, we entered into Subordinated Note Purchase Agreements with certain institutional accredited investors pursuant
to which we sold and issued $25.0 million in aggregate principal amount of 6.00% Fixed-to-Floating Rate Subordinated Notes due
December 6, 2028 (the “Notes”). We used the net proceeds from this offering for general corporate purposes, to provide for continued
growth and to supplement our regulatory capital ratios.
On March 1, 2018, we completed our merger with First Mariner Bank, a Maryland chartered trust company (“First Mariner”). At the
effective time of the merger, First Mariner merged with and into the Bank, with the Bank continuing as the surviving bank. At the
effective time of the merger, each outstanding share of First Mariner common stock and First Mariner Series A Non-Voting Non-
Cumulative Perpetual Preferred Stock issued and outstanding was cancelled and converted into the right to receive 1.6624 shares of our
common stock with cash paid in lieu of fractional shares. The aggregate merger consideration of $173.8 million included $9.2 million
of cash and 9,143,222 shares of our common stock, which was valued at approximately $164.6 million. In our merger with First Mariner,
we acquired 14 branches located in Baltimore City and Baltimore, Harford, Howard and Anne Arundel counties. First Mariner had total
assets with a fair value of $1.01 billion as of March 1, 2018, including $664.3 million of loans, net of purchase accounting adjustments.
On February 1, 2017, we closed an underwritten public offering of 2,760,000 shares of our common stock, which included the exercise
in full of the underwriters’ over-allotment option, at a public offering price of $15.00 per share. The amount of gross proceeds raised in
the offering was approximately $41.4 million, after underwriting discounts and estimated expenses, and the amount of net proceeds
raised in this offering was $38.4 million. We used the proceeds of the offering to pay off a $12.7 million loan to Raymond James Bank,
N.A. and retained the remainder. This had a positive impact on our liquidity and capital position in 2018 and provided funds that allowed
us to continue to grow our loans and investments.
Recent Market Conditions
Our financial performance generally, and in particular the ability of our borrowers to repay their loans, the value of collateral securing
those loans, as well as demand for loans and other products and services we offer, is highly dependent on the business environment in
our primary markets where we operate and in the United States as a whole. In early 2020, an outbreak of a novel strain of coronavirus
was identified in Wuhan, China. The coronavirus has since spread within China and infections have been found in a number of countries
around the world, including the United States. The coronavirus and its associated impacts on trade (including supply chains and export
levels), travel, employee productivity and other economic activities has had, and may continue to have, a destabilizing effect on financial
markets and economic activity. The extent of the impact of the coronavirus on our operational and financial performance is currently
uncertain and cannot be predicted and will depend on certain developments, including, among others, the duration and spread of the
outbreak, its impact on our customers, employees and vendors, and governmental, regulatory and private sector responses, which may
be precautionary, to the coronavirus.
Financial Highlights
Financial highlights for 2019 are as follows:
(cid:120) Our net income was $16.9 million, or $0.89 per diluted share in 2019, compared to a net loss of $3.8 million, or $(0.22) per
diluted share in 2018. Our 2018 results were adversely impacted by $15.5 million of merger and restructuring expenses
associated with the First Mariner merger.(cid:3)
(cid:120) Our return on average assets (“ROA”) and return on average equity (“ROE”) was 0.75% and 5.54%, respectively, in 2019,
compared to -0.19% and -1.44%, respectively, in 2018.(cid:3)
(cid:120) Our net interest margin decreased by 28 basis points to 3.50% in 2019, compared to 2018, due primarily to a 44 basis point
increase in funding costs which more than offset the six basis point increase in the yield on our earning assets.(cid:3)
(cid:120)
Loans and leases were $1.75 billion at December 31, 2019, an increase of $95.8 million, or 5.8%, from December 31, 2018.(cid:3)
(cid:120) Our total assets were $2.37 billion at December 31, 2019, an increase of $108.1 million, or 4.8%, from December 31, 2018,
driven primarily by net loan growth.(cid:3)
Total deposits were $1.71 billion at December 31, 2019, an increase of $28.6 million, or 1.9% year over year.(cid:3)
(cid:120)
(cid:120) We repositioned our balance sheet through the sale of $35.4 million of available for sale investment securities in 2019,
generating securities gains of $645 thousand. In addition, we restructured our borrowings, resulting in a $692 thousand
prepayment penalty on FHLB borrowings. (cid:3)
(cid:120) We recorded additional occupancy expenses related to our branch optimization initiative of $3.6 million in 2019.(cid:3)
(cid:120) Our nonperforming assets declined to 0.94% of total assets at year end compared to 1.28% at the prior year end.(cid:3)
(cid:120) We ended 2019 with a book value per common share of $16.48, a $1.00 per share increase over the prior year of $15.48.(cid:3)
(cid:120) We remain “well capitalized” by all regulatory measures, with all year-end regulatory capital ratios above the prior year end
levels.(cid:3)
33
(cid:120)
In December 2019, we entered into an agreement to exit our mortgage banking activities, and we expect to have the majority
of the residential first lien mortgage pipeline processed by the end of the first quarter of 2020. (cid:3)
Critical Accounting Policies
Our accounting and financial reporting policies conform to the accounting principles generally accepted in the United States of America
(“GAAP”) and general practice within the banking industry. Application of these principles requires management to make estimates,
assumptions and complex judgements that affect the amounts reported in our Consolidated Financial Statements and accompanying
notes. These estimates, assumptions and judgments are based on historical experience and various assumptions that we believe to be
reasonable as of the date of the financial statements; accordingly, as this information changes, our Consolidated Financial Statements
could reflect different estimates, assumptions and judgments. Actual results could differ significantly from those estimates.
Certain accounting measurements inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such,
have a greater possibility of producing results that could be materially different than originally reported. The accounting policies we
view as critical accounting policies are those relating to the allowance for credit losses, goodwill and other intangible assets, income
taxes, share based compensation and accounting for business combinations and loans acquired in business combinations.
In reviewing and understanding our financial information, we also encourage you to review our significant accounting policies used in
preparing our financial statements. See Note 1 to our Consolidated Financial Statements for further discussion of our significant
accounting policies.
Allowance for Credit Losses
Our allowance for credit losses is established through a provision for credit losses charged against income. Loans are charged against
the allowance for credit losses when we believe that the collectability of the principal is unlikely. Subsequent recoveries are added to
the allowance. The allowance is an amount that represents the amount of probable and reasonably estimable known and inherent losses
in the loan portfolio, based on evaluations of the collectability of loans. The evaluations take into consideration such factors as changes
in the types and amount of loans in the loan portfolio, historical loss experience, adverse situations that may affect the borrower’s ability
to repay, estimated value of any underlying collateral, estimated losses relating to specifically identified loans, and current economic
conditions. This evaluation is inherently subjective as it requires material estimates including, among others, exposure at default, the
amount and timing of expected future cash flows on impaired loans, value of collateral, estimated losses on our loan portfolios as well
as consideration of general loss experience. Based on our estimate of the level of allowance for credit losses required, we record a
provision for credit losses to maintain the allowance for credit losses at an appropriate level.
We cannot predict with certainty the amount of loan charge-offs that we will incur. We do not currently determine a range of loss with
respect to the allowance for credit losses. In addition, our regulatory agencies, as an integral part of their examination processes,
periodically review our allowance for credit losses. Such agencies may require that we recognize additions to the allowance for credit
losses based on their judgments about information available to them at the time of their examination. To the extent that actual outcomes
differ from management’s estimates, additional provisions to the allowance for credit losses may be required that would adversely
impact earnings in future periods. Note 8 to our Consolidated Financial Statements describes the methodology used to determine the
allowance for credit losses.
Goodwill and Other Intangible Assets
Goodwill represents the excess of the purchase price over the sum of the estimated fair values of tangible and identifiable intangible
assets acquired in a business combination, less the estimated fair value of the liabilities assumed. Core deposit intangibles represent the
estimated value of long-term deposit relationships acquired in a business combination. Our core deposit intangible is amortized over the
estimated useful lives of the acquired long-term deposits, and the remaining amounts of our core deposit intangible are periodically
reviewed for reasonableness. Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events
and circumstances indicate that the asset might be impaired. We perform a qualitative assessment annually to determine whether it is
more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing updated qualitative factors,
we determine that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, we do not have to
perform the two step impairment test. Determining the fair value under the first step of the goodwill impairment test and determining
the fair value if individual assets and liabilities of a reporting unit under the second step of the goodwill impairment test are judgmental
and often involve the use of significant estimates and assumptions. Similarly, estimates and assumptions are used in determining the
fair value of other intangible assets. Estimates of fair value are primarily determined using discounted cash flows, market comparisons
and recent transactions. Significant estimates and assumptions include projected future cash flows, discount rates, reflective market rate
of return, projected growth rates and determination and evaluation of appropriate market comparables. Future events could cause us to
conclude that goodwill or other intangible assets have become impaired, which would result in our recording of an impairment loss.
Any resulting impairment loss could have a material impact on our financial condition and results of operations. Based on the results
34
of our qualitative assessment, we determined that there was not an impairment of the carrying value of either the goodwill or core deposit
intangible at December 31, 2019.
Income Taxes
We account for income taxes under the asset/liability method. We recognize deferred tax assets and liabilities for the future
consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their
respective tax bases, as well as operating loss and tax credit carry-forwards. We measure deferred tax assets and liabilities using enacted
tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.
We recognize the effect on deferred tax assets and liabilities of a change in tax rates in income in the period indicated by the enactment
date. We establish a valuation allowance for deferred tax assets when, in the judgment of management, it is more likely than not that
such deferred tax assets will not become realizable. The judgment about the level of future taxable income is dependent to a great extent
on matters that may, at least in part, be beyond our control. It is at least reasonably possible that management’s judgment about the need
for a valuation allowance for deferred tax assets could change in the near term.
Share Based Compensation
We follow the provisions of ASC Topic 718 “Compensation – Stock Compensation,” which requires the expense recognition over the
respective service period for the fair value of share based compensation awards, such as stock options, restricted stock, and performance
based shares. This standard allows management to establish modeling assumptions as to expected stock price volatility, option terms,
forfeiture rates and dividend rates which directly impact estimated fair value. The accounting standard also allows for the use of
alternative option pricing models which may impact fair value as determined. Our practice is to utilize reasonable and supportable
assumptions that are reviewed with the appropriate board committee.
Accounting for Business Combinations
We account for transactions that meet the definition of a purchase business combination by recording the assets acquired and liabilities
assumed at their fair value on the acquisition date. Determining the fair value of assets acquired, including identified intangible assets,
and liabilities assumed often involves estimates based on third-party valuations, such as appraisals, or internal valuations based on
discounted cash flow analysis or other valuation techniques that may include estimates of attrition, inflation, asset growth rates, discount
rates, multiples of earnings or other relevant factors. In addition, the determination of the useful lives over which an intangible asset will
be amortized is subjective. If the fair value of the assets acquired exceeds the purchase price plus the fair value of the liabilities assumed,
a bargain purchase gain is recognized. Conversely, if the purchase price plus the fair value of the liabilities assumed exceeds the fair
value of the assets acquired, goodwill is recognized.
Loans Acquired in Business Combinations
We record acquired loans at fair value at the date of acquisition based on a discounted cash flow methodology that considers various
factors, including the type of loan and related collateral, classification status, whether the loan has a fixed or variable interest rate, its
term and whether or not the loan was amortizing, and our assessment of risk inherent in the cash flow estimates. These cash flow
evaluations are inherently subjective as they require material estimates, all of which may be susceptible to significant change. Acquired
loans are segregated into two categories upon purchase: (1) loans purchased without evidence of deteriorated credit quality since
origination, referred to in this report as “acquired performing loans,” and (2) loans purchased with evidence of deteriorated credit quality
since origination for which it is probable that all contractually required payments will not be collected, referred to in this report as
“acquired credit impaired loans.”
We account for and evaluate acquired credit impaired loans for impairment in accordance with the provisions of ASC 310-30. We
estimate the cash flows expected to be collected on purchased loans based upon the expected remaining life of the loans, which includes
the effects of estimated prepayments. Cash flow evaluations are inherently subjective as they require material estimates, all of which
may be susceptible to significant change. Subsequent to the acquisition date, we continue to monitor cash flows on a quarterly basis, to
determine the performance of each acquired credit impaired loan in comparison to management’s initial performance expectations.
Subsequent decreases in the present value of expected cash flows are recorded as an increase in the allowance for credit losses through
a provision for loan losses. Subsequent significant increases in cash flows result in a reversal of the provision for loan losses to the
extent of prior provisions or a reclassification of amount from non-accretable difference to accretable yield, with a positive impact on
the accretion of interest income in future periods.
Acquired performing loans outside the scope of ASC 310-30 are accounted for under ASC 310-20. For acquired performing loans,
credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value and the
discount is accreted to interest income over the life of the loan. Subsequent to the purchase date, the method used to evaluate the
35
sufficiency of the credit discount is similar to organic loans, and if necessary, additional reserves are recognized in the allowance for
loan and lease losses.
Balance Sheet Analysis and Comparison of Financial Condition
A comparison between December 31, 2019 and December 31, 2018 balance sheets is presented below.
General
Total assets increased $108.1 million, or 4.8%, to $2.37 billion at December 31, 2019 compared to assets of $2.27 billion at December
31, 2018. Our asset growth consisted primarily of increases in our portfolio loans of $95.8 million, loans held for sale of $9.4 million,
cash and cash equivalents of $8.5 million and other assets of $11.5 million, partially offset by a decline of $9.9 million in investment
securities. The primary sources of funding asset growth were increases in deposit balances and FHLB borrowings. Customer deposits
increased $28.6 million, or 1.7%, in 2019 over 2018, while total borrowings increased $42.7 million, or 15.4%. Within total borrowings,
FHLB borrowings increased $55.0 million. Total stockholders’ equity increased $19.5 million during 2019 primarily as a result of
retained earnings.
Investment Securities
Available for sale
Our available for sale securities are reported at fair value. At December 31, 2019, we held U.S. agency debentures, mortgage backed
securities, and corporate debentures. This portfolio is used primarily to provide sufficient liquidity to fund our loans and provide funds
for withdrawals of deposits. In addition, this portfolio is used as collateral for funding via commercial customer overnight securities
sold under agreement to repurchase (“repurchase agreements”) and as a source of earnings.
Held to maturity
Held to maturity securities are reported at amortized cost. The only investments that we have classified as held to maturity are certain
corporate debentures. These investments are intended to be held until maturity.
The following table sets forth the composition of our investment securities portfolio at the dates indicated.
(in thousands)
Available for sale
U.S. Government
Agencies
Treasuries
Mortgage-backed
Other investments
Held to maturity
Corporate debentures
2019
Amortized
Cost
December 31,
2018
2017
Estimated
Fair Value
Amortized
Cost
Estimated
Fair Value
Amortized
Cost
Estimated
Fair Value
$
66,428
-
139,918
5,510
$
67,312
-
142,699
5,494
$
130,088
-
90,242
3,011
$
130,397
-
90,460
3,001
$
68,082
1,505
2,541
2,579
$
67,740
1,494
2,479
2,543
$
211,856
$
215,505
$
223,341
$
223,858
$
74,707
$
74,256
$
7,750
$
7,897
$
9,250
$
9,253
$
9,250
$
9,421
We had available for sale securities of $215.5 million at December 31, 2019, a decrease of $8.4 million, compared to $223.9 million at
December 31, 2018. As part of our overall interest rate risk strategy, we sold $35.4 million of available for sale investment securities
in 2019, recording a gain on the sale of $645 thousand. This gain was offset by prepayment penalties of $692 thousand related to the
early redemption of $114.0 million of FHLB borrowings. The sale of the securities and early repayment of the FHLB borrowings was
primarily for asset/liability management purposes. In 2018, we repositioned a portion of our pre-acquisition portfolio through the sale
of primarily shorter duration agency debenture bonds with maturities over one year, recording a loss on the sale of $364 thousand. We
did not sell any securities during 2017. At December 31, 2019, $1.5 million of our securities portfolio matures in one year or less
compared to $38.9 million at December 31, 2018. Available for sale securities give us the capacity to fund future loan growth while
maintaining an appropriate amount of securities to provide the required collateral under our repurchase agreements.
36
Our held to maturity securities balances were $7.8 million at December 31, 2019 and $9.3 million at December 31, 2018., consisting of
investments in corporate debentures. The $1.5 million decrease year over year was the result of a bond call initiated by the underlying
issuer.
Our available for sale securities portfolio contained 16 securities with unrealized losses of $166 thousand at December 31, 2019, and 31
securities with unrealized losses of $275 thousand at December 31, 2018. Changes in the fair value of these securities resulted primarily
from interest rate fluctuations. We do not intend to sell these securities nor is it more likely than not that we would be required to sell
these securities before their anticipated recovery, and we believe the collection of the investment and related interest is probable. Based
on this analysis, we do not consider any of the unrealized losses to be other than temporary impairment. There were no held to maturity
securities in a loss position at December 31, 2019, and one at December 31, 2018. Note 5 to our Consolidated Financial Statements
provides more detail concerning the composition of our portfolio and our process for evaluating the portfolio for other-than-temporary
impairment.
Portfolio Maturities and Yields
The composition and maturities of the investment securities portfolio (with respect to those securities that have a fixed maturity date) at
December 31, 2019 is summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect
the impact of prepayments or early redemptions that may occur.
(in thousands)
One year or less
Weighted
Amortized Average
After one
through five years
Weighted
Amortized Average
As of December 31, 2019
After five
through ten years
Weighted
Amortized Average
After ten years
Total
Weighted
Amortized Average
Weighted
Amortized Average
Cost
Yield
Cost
Yield
Cost
Yield
Cost
Yield
Cost
Yield
U.S. Government
Agencies
Mortgage-backed
Other investments
Held to maturity
Corporate debentures
$
1,497
-
-
$
1,497
1.96
-
-
1.96
%
$
49,162
4
-
%
$
49,166
3.01
4.74
-
3.01
%
$
15,769
4,547
5,510
%
$
25,826
2.50
3.13
6.70
3.51
%
$
-
135,367
-
%
$
135,367
-
2.95
-
2.95
%
$
66,428
139,918
5,510
%
$
211,856
2.87
2.96
6.70
3.02
%
%
$
-
-
$
-
-
$
7,750
5.79
$
-
-
$
7,750
5.79
%
Nonmarketable Equity Securities
At December 31, 2019 and 2018, we held an investment in stock of the Federal Home Loan Bank (“FHLB”) of $14.2 million and $11.8
million, respectively. This investment is required for continued FHLB membership and is based partially upon the amount of borrowings
outstanding from the FHLB. This FHLB stock is carried at cost.
Loan and Lease Portfolio
Total loans and leases increased $95.8 million, or 5.8%, to $1.74 billion at December 31, 2019 from $1.65 billion at December 31, 2018,
primarily as a result of organic growth. Overall, residential real estate loans increased $38.9 million, commercial loans and leases
increased $36.0 million, and commercial real estate loans increased $24.0 million in 2019, from 2018, as we continued to focus on the
needs of small- and medium-sized businesses in our market area. Within residential real estate, first lien mortgages increased $54.4
million, including $27.4 million purchased from a non-affiliated mortgage banking entity, which was partially offset by a $15.5 million
decrease in residential-junior lien mortgages.
37
The following table sets forth the composition of our loan portfolio at the dates indicated.
(dollars in thousands)
2019
2018
December 31,
2017
2016
2015
Amount
Percent
Amount
Percent
Amount Percent
Amount Percent
Amount Percent
Real Estate
Construction and land
Residential - first lien
Residential - junior lien
Total residential real estate
Commercial - owner occupied
Commercial - non-owner occupied
Total commercial real estate
Total real estate loans
Commercial loans and leases
Consumer loans
$
128,285
7.3
%
$
123,671
7.5
%
$
74,398
7.9
%
$
72,973
8.9
%
$
69,385
9.1
%
437,409
74,164
511,573
241,795
444,052
685,847
1,325,705
372,872
46,936
25.1
4.2
29.3
13.9
25.4
39.3
75.9
21.4
2.7
383,044
89,645
472,689
234,102
427,747
661,849
1,258,209
336,876
54,666
23.2
5.4
28.6
14.2
25.9
40.1
76.2
20.5
3.3
194,896
43,047
237,943
170,408
260,802
431,210
743,551
188,729
4,328
20.8
4.6
25.4
18.2
27.8
46.0
79.3
20.2
0.5
195,032
35,009
230,041
134,213
216,781
350,994
654,008
162,715
4,801
23.7
4.3
28.0
16.3
26.4
42.7
79.6
19.8
0.6
182,988
27,477
210,465
131,114
181,361
312,475
592,325
160,424
4,253
24.1
3.6
27.7
17.3
23.9
41.2
78.0
21.4
0.6
Total loans and leases
$
1,745,513
$
100.0 % 1,649,751
100.0
% 936,608
$
100.0
% 821,524
$
100.0
% 757,002
$
100.0
%
Loan Portfolio Maturities
The following table summarizes the scheduled repayments of our loan portfolio and sets forth the scheduled repayments of fixed and
adjustable rate loans in our portfolio at December 31, 2019.
At December 31, 2019
After one
One year or less
through five years After five years
Total
$
51,305
880
697
$
31,994
4,996
3,763
$
44,986
431,533
69,704
$
128,285
437,409
74,164
1,577
15,665
18,021
33,686
86,568
49,224
645
8,759
91,403
220,219
311,622
352,375
121,251
15,138
501,237
134,727
205,812
340,539
886,762
202,397
31,153
511,573
241,795
444,052
685,847
1,325,705
372,872
46,936
$
136,437
$
488,764
$
1,120,312
$
1,745,513
$
59,496
76,941
$
364,779
123,985
$
519,678
600,634
$
943,953
801,560
$
136,437
$
488,764
$
1,120,312
$
1,745,513
(dollars in thousands)
Real Estate
Construction and land
Residential - first lien
Residential - junior lien
Total residential real estate
Commercial - owner occupied
Commercial - non-owner occupied
Total commercial real estate
Total real estate loans
Commercial loans and leases
Consumer loans
Total
Rate terms:
Fixed rate
Adjustable rate
Total
Loans Held for Sale
We sell the majority of the residential mortgage loans that we originate. Outstanding balances for the loans held for sale portfolio
increased $9.4 million to $30.7 million at December 31, 2019, from $21.3 million at December 31, 2018. Our mortgage loan origination
for sale volume was $573.3 million in 2019 compared to $586.4 million in 2018. As previously mentioned, in December 2019, we
entered into an agreement to exit our mortgage banking activities, and we expect to have the majority of the residential first lien mortgage
pipeline processed by the end of the first quarter of 2020.
Goodwill and Other Intangible Assets
Goodwill represents the consideration paid in excess of the fair value of net assets acquired (including identifiable intangibles) in a
business combination. We initially recorded $70.1 million of goodwill associated with the First Mariner merger in 2018. Based upon
updated information the goodwill was adjusted downward in the first quarter of 2019 by $4.7 million to reflect adjustments to net
38
deferred tax assets as detailed in Note 2 of our Consolidated Financial Statements, resulting in a decrease of our total goodwill at
December 31, 2019 to $65.9 million.
Our core deposit intangible represents the estimated value of long-term deposit relationships acquired in a business combination and is
amortized over the estimated useful lives of the long-term deposits acquired. The unamortized balance of our core deposit intangible
was $8.5 million at December 31, 2019, compared to $11.5 million at December 31, 2018. Amortization expense reflected in noninterest
expense totaled $3.0 million, $2.9 million and $0.5 million for the years ended December 31, 2019, 2018 and 2017, respectively.
Leases
As a result of us adopting Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842), we recognized $14.1 million in right-
of-use assets and $14.5 million of lease liabilities for operating leases. These amounts are reflected in other assets and other liabilities
on our Consolidated Balance Sheet at December 31, 2019, and primarily account for the net changes in interest receivable and other
assets and accrued expenses and other liabilities from the amounts reported at December 31, 2018.
Deposits
We accept deposits primarily from the areas in which our branches and offices are located. We have consistently focused on building
broader customer relationships and targeting small business customers to increase our core deposits. We also rely on our customer
service to attract and retain deposits. We offer a variety of deposit accounts with a range of interest rates and terms. Customer deposits
have historically provided us with a sizeable source of relatively stable and low-cost funds to support asset growth. Our deposit accounts
consist of commercial and retail checking accounts, savings accounts, certificates of deposit, money market accounts, and individual
retirement accounts. We do not currently accept brokered deposits other than those obtained under Promontory Interfinancial Network’s
certificate of deposit account registry service program.
We review and update interest rates paid, maturity terms, service fees and withdrawal penalties on a periodic basis. Deposit rates and
terms are based primarily on current operating strategies and market interest rates, liquidity requirements, anticipated short term loan
demand and our deposit growth goals.
Deposits increased from $1.69 billion at December 31, 2018 to $1.71 billion at December 31, 2019, an increase of $28.6 million.
Noteworthy increases included growth of $39.8 million in noninterest-bearing demand accounts and $32.8 million in certificates of
deposit. Offsetting this growth was a decline of $43.9 million in interest-bearing demand accounts. This decline was a result of our
largest deposit relationship reducing their interest-bearing demand balances by $61.6 million during the second quarter of 2019 to fund
new opportunities and investments. Other interesting-bearing deposit balances remained relatively flat year over year.
The following table sets forth the distribution of total deposits, by account type, at the dates indicated:
(dollars in thousands)
Noninterest-bearing demand
Interest-bearing checking
Money market accounts
Savings
Certificates of deposit
2019
% of
Total
%
27
11
21
7
34
Amount
$
468,975
183,447
360,711
130,141
571,091
December 31,
2018
Weighted
Average
Rate
-
0.46
0.79
0.18
2.06
%
Amount
$
429,200
227,322
356,130
134,893
538,261
% of
Total
26
%
13
21
8
32
Weighted
Average
%
Rate
-
0.35
0.61
0.15
1.31
Amount
$
218,139
71,642
252,453
52,078
269,596
2017
% of
Total
26
%
8
29
6
31
Weighted
Average
Rate
-
0.25
0.43
0.14
1.05
%
Total deposits
$
1,714,365
100
%
1.24
%
$
1,685,806
100
%
0.79
%
$
863,908
100
%
0.63
%
The following table sets forth the maturity of certificates of deposit of $100,000 or more at December 31, 2019.
(in thousands)
Three months or less
Over three to six months
Over six to twelve months
Over twelve months
$
226,443
39,211
64,069
54,993
$
384,716
39
Borrowings
Customer deposits remain the primary source of funds that we use to meet loan growth, but we supplement this with short and long-
term borrowings. Our borrowings consist of overnight unsecured master notes, customer repurchase agreements, FHLB advances and
subordinated debentures. Repurchase agreements consist of overnight electronic sweep products that move customer excess funds from
noninterest-bearing deposit accounts to an interest-bearing repurchase agreement, which is classified as a borrowing. Master notes
similarly sweep funds from the Bank’s customer accounts to the Company but do not require pledged collateral. Repurchase agreements
sweep funds within the Bank and are secured primarily by pledged U.S. Government Agency securities, based upon their fair value, as
collateral for 100% of the principal and accrued interest of our repurchase agreements. Total borrowings were $319.4 million at
December 31, 2019 and $276.7 million at December 31, 2018.
Subordinated Debt
On December 6, 2018, the Company entered into Subordinated Note Purchase Agreements with certain Purchasers pursuant to which
the Company sold and issued $25.0 million in aggregate principal amount of 6.00% Fixed-to-Floating Rate Subordinated Notes due
December 6, 2028. The Company used the net proceeds of this offering for general corporate purposes, to provide for continued growth
and to supplement its regulatory capital ratios. The Notes were structured to qualify initially as Tier 2 capital for regulatory capital
purposes and bear an initial interest rate of 6.00% per annum from and including December 6, 2018, to but excluding December 6, 2023,
with interest during this period payable semi-annually in arrears. From and including December 6, 2023, to but excluding the maturity
date or early redemption date, the interest rate will reset quarterly to an annual floating rate equal to three-month LIBOR, plus 302 basis
points, with interest during this period payable quarterly in arrears. The Notes are redeemable by the Company at its option, in whole or
in part, on or after December 6, 2023.
Patapsco Statutory Trust I, a Connecticut statutory business trust and an unconsolidated wholly-owned subsidiary of the Company (the
“Trust”), issued $5.0 million of capital trust pass-through securities to investors. The interest rate currently adjusts on a quarterly basis
at the rate of the three-month LIBOR plus 1.48%. The Trust purchased $5,155,000 of junior subordinated deferrable interest debentures
from Patapsco Bancorp, a bank holding company that we acquired in 2015. The debentures are the sole asset of the Trust and, in our
acquisition of Patapsco Bancorp, we assumed its obligation to fully and unconditionally guaranteed the obligations of the Trust under
the capital securities. The capital securities are redeemable by us at par. The capital securities must be redeemed upon final maturity of
the subordinated debentures on December 31, 2035.
Short-term borrowings
Short-term borrowings are summarized in the following table:
(dollars in thousands)
Period-end balance:
FHLB advances
Repurchase agreements 1
Federal funds purchased
2019
December 31,
2018
2017
Amount
Rate
Amount
Rate
Amount
Rate
$
230,000
6,127
-
%
1.70
0.19
-
$
118,000
16,576
-
%
2.34
0.21
-
$
14,356
116,029
-
%
0.12
1.50
-
Total
$
236,127
1.66
%
$
134,576
2.08
%
$
130,385
1.35
%
Average balance for the year:
FHLB advances
Repurchase agreements 1
Federal funds purchased
$
148,460
7,122
625
%
2.30
0.19
2.30
$
125,108
18,927
2,015
%
1.80
0.19
2.04
$
13,460
74,763
290
%
0.13
1.14
1.22
Total
$
156,207
2.20
%
$
146,050
1.59
%
$
88,513
0.99
%
Maximum month-end balance:
FHLB advances
Repurchase agreements 1
Federal funds purchased
$
273,000
15,293
-
1 Includes overnight unsecured master notes
$
310,023
25,291
30,000
$
16,563
116,029
-
40
Short-term borrowings totaled $236.1 million at December 31, 2019 and $134.6 million at December 31, 2018, an increase of $101.5
million. Short-term borrowings at December 31, 2019 consisted of repurchase agreements of $6.0 million, master notes totaling $101
thousand, and seven short-term FHLB advances totaling $230.0 million.
Long-term borrowings totaled $83.2 million at December 31, 2019, consisting of four long-term FHLB advances totaling $55.0 million
and subordinated debt of $28.2 million, discussed above, compared to long term borrowings of $142.1 million at December 31, 2018,
consisting of five long-term fixed rate FHLB advances totaling $114.0 million and subordinated debt of $28.1 million. The December
31, 2019 long-term borrowings included three ten-year term, three-month Bermudan convertible borrowings. In each of these
borrowings, the Bank has sold the option for call, and each borrowing’s first call occurs in the first quarter of 2020. In 2019, we repaid
$114 million of long-term FHLB borrowings prior to their maturity, incurring prepayment penalties of $692 thousand which are included
in our other operating expenses. The early repayment of these advances was primarily for asset/liability management purposes.
Stockholders’ Equity
Total stockholders’ equity increased $19.5 million, or 6.6%, to $314.1 million at December 31, 2019, from $294.7 million at December
31, 2018. Our increase in stockholders’ equity was primarily the result of our net income for 2019 as well as an increase in unrealized
gains in our investment portfolio as a result of lower market interest rates. On April 24, 2019, we announced a share buyback program
to purchase up to $7.0 million of our common shares. We repurchased a total of 19,764 of our common shares in 2019, reducing our
equity by $322 thousand. The extent to which we repurchase any additional shares and the timing of such repurchases will depend upon
market conditions and other considerations as may be considered in our sole discretion. Total stockholders’ equity at December 31,
2019 represents an equity to assets ratio of 13.2%, compared to 13.0% at December 31, 2018. Our book value per share was $16.48 at
December 31, 2019 and $15.48 at December 31, 2018.
Comparison of Results of Operations
General
Our results of operations depend mainly on our net interest income, which is the difference between the interest income we earn on our
loan and investment portfolios, as well as accretion income on acquired loans, and the interest expense we pay on deposits and
borrowings. Our net interest income can be significantly influenced by a variety of factors, including overall loan demand, economic
conditions, credit risk, the amount of nonearning assets including nonperforming loans and acquired credit impaired loans, the amounts
of and rates at which assets and liabilities reprice, variances in prepayment of loans and securities, early withdrawal of deposits, exercise
of call options on borrowings or securities, a general rise or decline in interest rates, changes in the slope of the yield-curve, and balance
sheet growth or contraction.
Our results of operations are also affected by provisions for credit losses, noninterest income and noninterest expense. Our noninterest
expense consists primarily of compensation and employee benefits, as well as office occupancy, data processing, deposit insurance, and
general administrative expenses.
A discussion of our results of operations for the years ended December 31, 2019, 2018 and 2017 follows.
Average Balance and Yields
The following tables set forth average balances, average yields and costs, and certain other information for the periods indicated. No
tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances.
Non-accrual loans were included in the computation of average balances, and have been reflected in the table as loans carrying a zero
yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest
income or expense.
41
%
%
4.58
4.70
4.82
4.33
5.64
4.59
3.71
0.95
0.84
1.16
2.63
6.18
3.88
2.08
4.24
0.25
0.43
0.14
1.05
0.63
0.99
3.28
0.71
(dollars in thousands)
Earning assets
Loans and leases: 1
Commercial loans and leases
Commercial real estate
Construction and land
Residential real estate
Consumer
Total loans and leases
Loans held for sale
Other earning assets 2
Securities: 3
U.S. Treasury
U.S Gov agencies
Mortgage-backed
Corporate debentures
Other investments
Total securities
Average
Balance
2019
Income
/ Expense
Yield
/ Rate
Average
Balance
December 31,
2018
Income
/ Expense
Yield
/ Rate
Average
Balance
2017
Income
/ Expense
Yield
/ Rate
$
357,129
667,557
121,156
487,586
50,017
$
17,880
33,424
6,782
21,803
2,471
1,683,445
82,360
30,276
63,806
-
85,421
93,566
9,503
14,258
202,748
1,195
1,094
-
2,376
2,889
583
937
6,785
5.00
4.97
5.48
4.39
5.16
4.85
4.09
1.57
0.83
2.07
3.06
6.15
5.36
2.99
4.56
5.01
5.01
5.60
4.47
4.94
4.89
3.95
1.71
2.78
3.09
6.13
6.57
3.35
4.62
%
$
320,435
610,111
107,962
429,986
44,361
$
16,017
30,328
5,917
18,891
2,289
1,512,855
73,442
38,261
69,103
1,241
72,659
44,748
9,277
15,682
143,607
1,567
1,083
10
1,507
1,369
571
840
4,297
1,763,826
80,389
16,928
45,830
177,056
(6,166)
%
$
177,167
373,972
79,177
234,429
4,475
$
8,113
17,584
3,813
10,151
252
869,220
39,913
35,065
41,953
1,494
50,002
1,439
8,750
6,306
67,991
1,300
397
12
581
38
541
244
1,416
1,014,229
43,026
8,903
19,673
35,815
(5,677)
$
1,997,474
$
1,072,943
Total earning assets
1,980,275
91,434
Cash and due from banks
Bank premises and equipment, net
Other assets
Less: allowance for credit losses
Total assets
Interest-bearing liabilities
Deposits:
Interest-bearing demand accounts
Money market
Savings
Time deposits
Total interest-bearing deposits
Short-term borrowings
Long-term borrowings
Total interest-bearing funds
Noninterest-bearing deposits
Other liabilities and accrued expenses
Total liabilities
Shareholders' equity
13,970
43,823
221,764
(9,498)
$
2,250,334
$
199,091
356,955
135,868
556,398
1,248,312
156,208
86,367
1,490,887
431,557
22,965
1,945,409
304,925
912
2,814
249
11,487
15,462
3,441
3,221
22,124
0.46
0.79
0.18
2.06
1.24
2.20
3.73
1.48
0.35
0.61
0.15
1.31
0.79
1.59
2.86
1.04
%
$
157,523
361,101
129,586
426,958
$
554
2,197
197
5,592
8,540
2,327
2,904
13,771
1,075,168
146,023
101,488
1,322,679
403,656
5,064
1,731,399
266,075
%
$
68,097
265,927
52,964
247,854
$
168
1,143
73
2,613
3,997
876
294
5,167
634,842
88,513
8,967
732,322
212,261
4,597
949,180
123,763
Total liabilities & shareholders' equity
$
2,250,334
$
1,997,474
$
1,072,943
Net interest rate spread 4
Effect of noninterest-bearing funds
Net interest margin on earning assets 5
$
69,310
%
3.13
0.37
3.50 %
$
66,618
%
3.52
0.26
3.78
%
$
37,859
%
3.53
0.20
3.73
%
(1) Loan fee income is included in the interest income calculation, and non-accrual loans are included in the average loan base upon which the
interest rate earned on loans is calculated.
(2) Includes Federal funds sold and interest-bearing deposits with banks.
(3) Available for sale securities are presented at fair value, held to maturity securities are presented at amortized cost.
(4) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing
liabilities.
(5) Net interest margin represents net interest income divided by average total interest-earning assets.
Rate/Volume Analysis
The following table presents the effects of changing rates and volumes on our net interest income for the periods indicated. The rate
column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the
effects attributable to changes in volume (changes in volume multiplied by prior rate). The total of the changes set forth in the rate and
volume columns are presented in the total column.
42
(in thousands)
Interest earned on:
Loans and leases:
Commercial loans and leases
Commercial real estate
Construction and land
Residential real estate
Consumer
Loans held for sale
Securities
Other earning assets
Total interest income
Interest paid on:
Interest bearing checking
Money market accounts
Savings deposits
Time deposits
Short-term borrowings
Long-term borrowings
Total interest expense
For the year ended December 31,
2019 vs. 2018
2018 vs. 2017
Due to variances in
Due to variances in
Total
Rates
Volumes
1
Total
Rates
Volumes
1
$
1,863
3,096
865
2,912
182
(372)
2,488
11
$
21
225
127
351
(97)
(55)
512
100
$
1,842
2,871
738
2,561
279
(317)
1,976
(89)
$
7,904
12,744
2,104
8,740
2,037
267
2,881
686
$
741
1,013
523
148
(21)
135
620
259
$
7,163
11,731
1,581
8,592
2,058
132
2,261
427
11,045
1,184
9,861
37,363
3,418
33,945
358
617
52
5,895
1,114
317
8,353
170
644
43
3,222
895
881
5,855
188
(27)
9
2,673
219
(564)
2,498
386
1,054
124
2,979
1,451
2,610
8,604
69
475
6
644
534
(38)
1,690
317
579
118
2,335
917
2,648
6,914
Net interest earned
$
2,692
$
(4,672)
$
7,363
$
28,759
$
1,728
$
27,031
(1) Change attributed to mix (rate and volume) is included in volume variance.
Comparison of the years ended December 31, 2019 and December 31, 2018
General
Our net income increased $20.7 million to $16.9 million in 2019, compared to a net loss of $3.8 million in 2018. The net loss in 2018
was primarily driven by $15.5 million of merger and restructuring expenses related to our March 1, 2018 merger with First Mariner,
which were not repeated in 2019. The increase in net income in 2019 was also driven by a $11.0 million increase in interest income,
compared to 2018, primarily from an increase in interest and fees earned on loans and leases as a result of organic growth and a full-
year impact of our merger with First Mariner, partially offset by an $8.4 million increase in interest expense. In 2019, net income was
also partially offset by $3.6 million of expense, included within occupancy and equipment expense, related to our branch optimization
initiative that resulted in three branch closures in 2019, and the expected consolidation of two additional branches in the first quarter of
2020. Our results for 2019 also included the proceeds from our agreement to exit our mortgage banking activities (net of expenses
recorded) of $462 thousand.
Both our basic and diluted earnings per common share were $0.89 in 2019, compared to both a basic and diluted loss per common share
of $(0.22) in 2018.
Interest Income
Interest income increased $11.0 million, or 13.7%, to $91.4 million in 2019, compared to $80.4 million in 2018. $8.9 million of this
increase was attributable to interest and fees on loans and leases (excluding loans held for sale) and was primarily attributable to organic
loan growth with the average balance of our loans and leases up $170.6 million, or 11.3%, in 2019. Interest income was further aided
by a four-basis point increase in the average yield on our loans and leases, with increases in yields in all categories of loans other than
consumer loans. The accretion of fair value adjustments in our loan portfolio added ten-basis points to the average yield on loans in
2019, compared to 15-basis points in 2018. Interest and dividends on investment securities increased $2.5 million in 2019 as a result of
both an increase in average balances of $59.1 million and a 36-basis point increase in the average yield.
43
Interest Expense
Interest expense increased $8.4 million, or 60.7%, to $22.1 million, in 2019, compared to $13.8 million in 2018. Interest expense on
deposits increased by $6.9 million in 2019, compared to 2018, with $3.9 million of the increase resulting from increases in average
volumes and $3.0 million resulting from increases in rates paid on interest-bearing deposits. These increases were influenced by a
$129.4 million increase in the average balance of time deposits and a corresponding 75-basis point increase in the rate paid on such
deposits. Average non-maturity interest bearing deposits increased $43.7 million with a 12-basis point increase in the average rate paid
on such deposits. We increased the interest rates on our interest-bearing deposits in response to the prevailing competitive rates in our
market. The amortization of fair value adjustments in our interest-bearing liabilities, primarily in time deposits, reduced the rate on
interest bearing liabilities by one-basis point in 2019, compared to six-basis points in 2018. Overall, the average interest rate paid on
interest bearing deposits increased 45 basis points in 2019. In addition, interest expense on short- and long-term borrowings increased
an aggregate of $1.4 million in 2019, compared to 2018, resulting from a 148-basis point increase in the average rate paid on such
borrowings. The increase in average rates paid on borrowings more than offset the $4.9 million decrease in our average balance of
short- and long-term borrowings in 2019, compared to 2018.
Net Interest Income
Net interest income is our largest source of operating revenue. Net interest income is affected by various factors including changes in
interest rates and the composition of interest-earning assets and interest-bearing liabilities and maturities. Net interest income is
determined by the interest rate spread (i.e., the difference between the yields earned on interest-earning assets and the rates paid on
interest-bearing liabilities) and the relative amounts of interest-earning assets and interest-bearing liabilities. Net interest income
increased $2.7 million in 2019, compared to 2018. The increase in net interest income, while up $7.3 million due to favorable volume
variances, was offset by unfavorable rate variances of $4.6 million.
Our net interest margin was 3.50% in 2019, a decline of 28 basis points, compared to 3.78% in 2018. This decrease was primarily driven
by a 44-basis point increase in the average rate paid on interest bearing liabilities, which more than offset the six-basis point increase in
the average yield on interest earning assets. The net accretion of fair value adjustments added eight-basis points to our net interest
margin in 2019, compared to 18-basis points in 2018.
Provision for Credit Losses
We recorded a provision for credit losses of $4.2 million for 2019, compared to $6.1 million for 2018, a decrease of $1.9 million. The
decrease included the impact of a decrease in specific reserves from $2.4 million at December 31, 2018 to $500 thousand at December
31, 2019. The trend in our asset quality metrics indicate year over year improvement. Our nonperforming loans, as a percentage of
gross loans, declined to 1.10% at 2019, from 1.50% at 2018, and nonperforming assets, as a percentage of total assets, declined to 0.94%
at 2019 from 1.28% at 2018.
Notes 7 and 8 to our Consolidated Financial Statements as well as the Nonperforming and Problem Assets and Allowance for Credit
Losses sections of this Management’s Discussion and Analysis provide additional information on our loan portfolio, asset quality, and
the allowance for credit losses.
Noninterest Income
The following table presents the major categories of noninterest income for the years ended December 31, 2019 and 2018:
(in thousands)
Service charges on deposit accounts
Realized and unrealized gains on mortgage banking activity
Gain (loss) on the sale of securities
Loss on the disposal of bank premises & equipment
Income from bank owned life insurance
Loan related fees and service charges
Other operating income
Total noninterest income
2019
$
2,747
7,798
645
(70)
1,858
3,934
2018
$
2,216
5,245
(364)
(345)
1,614
5,624
$ Change
$
531
2,553
1,009
275
244
(1,690)
4,122
3,870
252
$
21,034
$
17,860
$
3,174
%
% Change
24.0
48.7
277.2
79.7
15.1
(30.1)
6.5
17.8
%
Noninterest income was $21.0 million for 2019, compared to $17.9 million for 2018. This increase was primarily driven by a $2.6
million increase in realized and unrealized gains on mortgage banking activity and the net $1.0 million increase in gain (loss) on the
sale of securities. While our mortgage loans originated for sale were down 2.2% in 2019, compared to 2018, our increase in realized
44
and unrealized gains was up 48.7%. This represents an average gain on loans originated for sale of 1.36% in 2019, compared to 0.89%
in 2018. The improvement in our average gain on loans originated for sale was the result of a stronger management focus on originating
a more profitable product mix. The gain/(loss) on the sale of securities in 2019 and 2018, respectively, were both due to our interest rate
positioning strategies at the time of the respective sales.
Service charges on deposit accounts, which consisted of account activity fees such as overdraft fees and other traditional banking fees,
increased $531 thousand in 2019, compared to 2018, primarily as a result of increased overdraft activities resulting from deposit growth
during 2019.
Other operating income, which consisted mainly of non-depository account fees such as wire, merchant card and ATM services,
increased $252 thousand in 2019, compared to 2018. Reflected in 2019 other operating income was $750 thousand in revenue associated
with the previously disclosed exit of our mortgage banking activities. In 2018, other operating income included a $750 thousand
insurance refund.
Partially offsetting the above increases was a $1.7 million decrease in loan related fees and service charges. This decrease was primarily
due to a $2.0 million reduction in underwriting and processing fees in 2019. Underwriting and processing fees from our mortgage
banking activities decreased $2.3 million in 2019, compared to 2018. This reduction resulted from our decision to discontinue our
national consumer direct origination channel in mid-2018. The loans originated from this channel generated substantially higher
underwriting and processing fees per loan than comparable fees on loans originated from our retail origination channel.
Our mortgage banking activities generated total noninterest income of $10.6 million in 2019 and $10.2 million in 2018. The level of
noninterest income generated by our mortgage banking activities will be substantially lower in 2020 as a result of our decision to exit
all mortgage banking activities in early 2020.
Noninterest Expenses
The following table presents the major categories of noninterest expense for the years ended December 31, 2019 and 2018:
(in thousands)
Compensation and benefits
Occupancy and equipment
Amortization of core deposit intangible
Marketing and business development
Professional fees
Data processing fees
Merger and restructuring expense
FDIC assessment
Other real estate owned
Loan production expense
Other operating expense
2019
2018
$ Change
$
$
$
32,056
9,076
3,013
2,339
2,954
4,914
-
667
845
2,700
5,514
64,078
33,674
10,650
2,856
3,338
2,471
4,037
15,549
1,268
500
3,523
5,246
83,112
(1,618)
(1,574)
157
(999)
483
877
(15,549)
(601)
345
(823)
268
(19,034)
% Change
(4.8)
(14.8)
5.5
(29.9)
19.6
21.7
(100.0)
(47.4)
69.0
(23.3)
5.1
(22.9)
%
%
Total noninterest expense
$
$
$
Noninterest expenses decreased $19.0 million, or 22.9%, to $64.1 million for 2019, compared to $83.1 million for 2018. This decrease
was primarily driven by $15.5 million of merger and restructuring expenses related to our merger with First Mariner in 2018, which
were not repeated in 2019.
Compensation and benefits expense are the largest component of our noninterest expenses, and decreased $1.6 million in 2019, compared
to 2018. The primary driver of this decrease was decreases in staff related to our branch optimization initiative in 2019.
Occupancy and equipment expense decreased $1.6 million in 2019, compared to 2018. Following our merger with First Mariner in 2018,
we evaluated our retail branch network, which resulted in the closing of several acquired and existing locations that we deemed to be
redundant. In 2019, we continued to evaluate our branch delivery system and further optimized our branch locations. Because of our
branch optimization efforts, we incurred $3.6 million and $2.7 million in lease termination and location closing costs in 2019 and 2018,
respectively, partially offset by a reduction in lease liability expense on one branch location closed in 2019. These efficiencies also
reduced general operating expenses (rent, janitorial, utilities, and depreciation) by $2.0 million in 2019, and equipment expenses
(hardware and maintenance contracts and real estate taxes) by $281 thousand in 2019.
45
Marketing and business development expenses decreased by $1.0 million, or 29.9%, to $2.3 million in 2019. The 2018 expense level
included $1.1 million of costs associated with mortgage lead generation from our former national leads-based consumer direct residential
first lien mortgage origination channel that we discontinued in mid-2018.
Data processing fees consist of core system processors and banking network costs. These costs increased by $877 thousand to $4.9
million in 2019, from $4.0 million in 2018, resulting from the large growth in loan and deposit accounts primarily resulting from our
merger with First Mariner, which increased our core processing cost, as well as improved technology to enhance product deliveries.
Our FDIC insurance expense was down $601 thousand in 2019. We received small bank assessment credits from the FDIC of $522
thousand in 2019, resulting from the Deposit Insurance Fund ratio exceeding 1.38%.
Other operating expenses consist mainly of a variety of general expenses such as telephone and data lines, supplies and postage, courier
services, general insurance, and director fees. In aggregate, these expenses increased $268 thousand in 2019, compared to 2018,
primarily as a result of a $700 thousand charge related to the settlement of a litigation claim related to mortgages originated by First
Mariner before our acquisition of the bank and $692 thousand of prepayment penalties resulting from our early redemption of FHLB
advances. Partially offsetting these increases was a $1.4 million reduction in various categories of other expense, due primarily to
merger integration and branch optimization efficiencies.
Income Tax Expense
Income tax expense for 2019 was $5.2 million, compared to an income tax benefit in 2018 of $897 thousand. Our effective tax rate
(income tax expense as a percentage of pretax income) was 23.5% in 2019 and 19.0% in 2018. The effective tax rate is influenced by
sources of non-taxable income, such as the income from Bank Owned Life Insurance (“BOLI”) as well as certain non-deductible expense
items. Certain merger and acquisition costs are deemed not deductible for income tax purposes, which impacted the effective tax rate
for 2018. Income tax expense for 2019 was favorably impacted by a 2019 U.S. Treasury Department change in tax regulations that
provided for retroactive application to the taxability of income from BOLI contracts that were acquired in certain tax-free merger
transactions. As a result of the change in tax regulations, we recognized a $232 thousand net reduction of tax expense in 2019 pertained
to BOLI income that was earned, and initially treated as subject to income tax, in 2018. Excluding the impact of the $232 thousand of
BOLI income, the effective tax rate for 2019 would have been 24.5%.
Comparison of the years ended December 31, 2018 and December 31, 2017
General
We recorded a net loss for 2018 of $3.8 million, compared to net income of $7.2 million for 2017. The decrease in net income was
primarily driven by $15.5 million of merger and restructuring expenses in 2018, compared to $567 thousand in 2017. Our basic and
diluted loss per common share were both $(0.22) in 2018, compared to both basic and diluted income per common share of $0.75 in
2017. Average common shares outstanding increased 8.0 million in 2018, compared to 2017, as a result of the 9.1 million shares we
issued on March 1, 2018 in connection with the First Mariner merger.
Interest Income
Interest income increased $37.4 million, or 86.8%, to $80.4 million for, 2018 compared to $43.0 million for 2017. $33.5 million of the
increase was in interest and fees on loans and leases (excluding loans held for sale), due primarily to a $643.6 million, or 80.9%, increase
in the average balance of our portfolio loans due primarily to the First Mariner merger. This asset growth was complimented by a 26-
basis point increase in the average yield on our portfolio loans and leases, partially related to the 2018 increases in the prime lending
rate. Interest and dividends on investment securities increased $2.9 million in 2018, compared to 2017, as a result of a 99-basis point
increase in the average yield on our securities portfolio. Other interest income increased $686 thousand in 2018, compared to 2017, as
a result of increases in both the average balance and the average yield on these assets. Overall, total average earning assets increased
by $749.6 million, or 74%, in 2018, compared to 2017, and the average yield on all interest earning assets increased by 32 basis points.
Interest Expense
Interest expense increased $8.6 million, to $13.8 million, for 2018, from $5.2 million for 2017. Interest expense on deposits increased
by $4.5 million in 2018, compared to 2017, with $3.3 million of the increase resulting from increases in average volumes and $1.2
million resulting from increase in rates paid on interest-bearing deposits. These increases were due largely to a $179.1 million increase
in the average balance of time deposits and a corresponding 26-basis point increase in the rate paid on such deposits. In 2018, we
increased the interest rates on our time deposits in response to the prevailing competitive rates in our market. In addition, interest
expense on short- and long-term borrowings increased by an aggregate of $4.1 million in 2018, compared to 2017, primarily as a result
of a $150.0 million increase in the average balance of such borrowings. The average rate paid on our short-term borrowings increased
46
60 basis points in 2018, compared to 2017, while the average rate paid on our long-term borrowings decreased 42 basis points. Because
of the timing of the closing of our Notes offering in December 2018, the offering did not have a significant impact on interest expense
in 2018.
Net Interest Income
Net interest income increased $28.8 million, or 76.0%, in 2018, compared to 2017. The increase in net interest income was primarily
due to balance sheet growth related to the First Mariner merger, and our successful management of our interest expense even with the
sizable growth in deposits and borrowings year over year.
Our net interest margin was 3.78% in 2018, an increase of five basis points, compared to 3.73% in 2017. This increase was primarily
driven by a 34-basis point increase in the average rate paid on interest earnings assets, which more than offset the 33-basis point increase
in the average yield on interest bearing liabilities.
Provision for Credit Losses
We recorded a provision for credit losses of $6.1 million in 2018, an increase of $4.3 million, compared to $1.8 million in 2017. The
provision level for 2018 was impacted by an increased level of net charge-offs and a specific reserve of $2.4 million related to a long-
term relationship.
Noninterest Income
The following table presents the major categories of noninterest income for the years ended December 31, 2018 and 2017:
(in thousands)
Service charges on deposit accounts
Realized and unrealized gains on mortgage banking activity
Gain (loss) on the sale of securities
Gain on the sale of portfolio loans
Loss on the disposal of bank premises & equipment
Income from bank owned life insurance
Loan related fees and service charges
Other operating income
Total noninterest income
2018
$
2,216
5,245
(364)
-
(345)
1,614
5,624
3,870
2017
$ Change
923
11,035
-
86
(13)
760
5,722
1,011
$
1,293
(5,790)
(364)
(86)
(332)
854
(98)
2,859
% Change
140.1
(52.5)
%
N/M
(100.0)
(2,553.8)
112.4
(1.7)
282.8
$
17,860
$
19,524
$
(1,664)
(8.5)
%
Noninterest income was $17.9 million for 2018, compared to $19.5 million for 2017. The decrease in noninterest income was primarily
driven by reductions in our mortgage banking activities. Soon after the First Mariner merger, management announced the
discontinuation of the national leads-based consumer direct unit of our mortgage division and a de-emphasis on mortgage operations to
mitigate the inherent volatility of this business line, both of which resulted in a reduction of origination levels for 2018 and the
corresponding decrease in mortgage based noninterest income. We account for both our loans held for sale as well as our interest rate
locks using the fair value approach, and under this methodology, revenues are negatively impacted when the levels of either of these
decline. Because of the overall reduction in the levels of originations and the fair value accounting for loans held for sale and interest
rate locks our overall mortgage-based revenue declined by $5.8 million for 2018, compared to 2017, as reflected in the decrease in
realized and unrealized gains on mortgage banking activity.
Service charges on deposit accounts increased $1.3 million, in 2018, compared to 2017, primarily as a result of increased overdraft
activities resulting from both acquired and organic deposit growth.
Earnings on BOLI increased $854 thousand in 2018, compared to 2017, as a result of our acquisition of $44.8 million of additional
BOLI in the First Mariner merger.
Other operating income, which consisted mainly of non-depository account fees such as wire, merchant card and ATM services,
increased $2.6 million in 2018, compared to 2017, due to increased transaction volumes primarily from the First Mariner merger.
Partially offsetting the above increases was a $332 thousand loss in 2018 on the disposal of certain fixed assets that were part of the exit
cost associated with the First Mariner merger and reorganization strategies and a $364 thousand loss on the sale of securities in 2018.
47
Noninterest Expenses
The following table presents the major categories of noninterest expense for the years ended December 31, 2018 and 2017:
(in thousands)
Compensation and benefits
Occupancy and equipment
Amortization of core deposit intangible
Marketing and business development
Professional fees
Data processing fees
Merger and restructuring expense
FDIC assessment
Other real estate owned
Loan production expense
Other operating expense
2018
2017
$ Change
$
$
33,674
10,650
2,856
3,338
2,471
4,037
15,549
1,268
500
3,523
5,246
83,112
23,573
4,154
505
4,231
1,968
2,038
567
650
655
3,743
3,116
45,200
$
10,101
6,496
2,351
(893)
503
1,999
14,982
618
(155)
(220)
2,130
37,912
% Change
42.8
156.4
465.5
(21.1)
25.6
98.1
2,642.3
95.1
(23.7)
(5.9)
68.4
83.9
%
%
Total noninterest expense
$
$
Noninterest expenses increased $37.9 million, or 83.9%, to $83.1 million for 2018, compared to $45.2 million for 2017. The First
Mariner merger had the most significant impact on noninterest expenses in 2018. Merger and restructuring expense were $15.5 million
in 2018, compared to $567 thousand in 2017.
Compensation and benefits expense are the largest component of noninterest expenses, and grew by $10.1 million, or 42.9%, for 2018,
compared to 2017. The primary driver of this increase was the expanded size of our operational sales and branch staff resulting from
the First Mariner merger. In 2018, employee insurance costs increased $563 thousand, employee related tax expense increased $654
thousand, and other employee benefits increased $356 thousand.
Occupancy and equipment expense increased $6.5 million in 2018, compared to 2017. Following our First Mariner merger in 2018, we
evaluated our retail branch network, which resulted in the closing of several acquired and existing locations that we deemed to be
redundant. At the time of the First Mariner merger, we operated 14 branches and First Mariner operated 13 branches. At year-end 2018,
we had closed six branches and had a scheduled closing in the first quarter of 2019. Because of these efforts, in 2018, we incurred $2.7
million in lease termination and location closing costs. General operating expenses (rental, janitorial, maintenance, taxes and
depreciation) increased $3.1 million in 2018, and equipment expenses (hardware, maintenance contracts and depreciation) increased
$704 thousand in 2018.
In the First Mariner merger, we recorded a $12.3 million core deposit intangible, which is amortized against noninterest expenses using
an accelerated amortization schedule, which increased our core deposit intangible amortization expense by $2.4 million for 2018,
compared to 2017.
Data processing fees consist of core system processors and banking network costs. These costs increased $2.0 million, or 98.1%, in
2019 to $4.0 million, from $2.0 million in 2017, resulting from the large growth in loan and deposit accounts staff resulting from the
First Mariner merger. 2018 data processing expenses were also inflated as we were running dual core processing systems from the
closing of the First Mariner merger in March 2018 until the conversion and integration of each business onto one consolidated platform,
which occurred in May 2018.
Other operating expenses consisted mainly of a variety of general expenses such as telephone and data lines, supplies and postage and
courier services. In aggregate, these expenses increased $2.1 million, in 2018, compared to 2017, as a result of the increased costs to
support our expanding infrastructure. In 2018, compared to 2017, we saw increases in software licensing cost of $687 thousand,
telephone and date line cost of $243 thousand, armored carrier, security and postage expenses of $203 thousand and general supplies
and operating costs of $246 thousand.
Income Tax Expense
We recorded an income tax benefit for 2018 of $897 thousand, compared to an income tax expense in 2017 of $3.2 million. Our effective
tax rate (income tax expense as a percentage of pretax income) was 19.0% in 2018 and 30.4% in 2017. The effective tax rate is influenced
by sources of non-taxable income, such as the income from Bank Owned Life Insurance (“BOLI”) as well as certain non-deductible
expense items. Certain merger and acquisition costs are deemed not deductible for income tax purposes, which impacted the effective
48
tax rate for 2018. The lower effective tax rate in 2018 was due to the lower corporate income tax rates enacted late in 2017 in conjunction
with the Tax Cuts and Jobs Act (“TCJA”). Among other things, the TCJA, enacted on December 22, 2017, lowered the corporate federal
statutory income tax rate of 21% from the prior maximum corporate rate of 35%; for us, this change was effective for the year ended December
31, 2018.
Nonperforming and Problem Assets
We perform reviews of all delinquent loans and our loan officers contact customers to attempt to resolve potential credit issues in a
timely manner.
Loans are placed on non-accrual status when payment of principal or interest is 90 days or more past due and the value of the collateral
securing the loan, if any, is less than the outstanding balance of the loan. Loans are also placed on non-accrual status if we have serious
doubt about further collectability of principal or interest on the loan, even though the loan is currently performing. When loans are
placed on a non-accrual status, unpaid accrued interest is fully reversed, and subsequent income, if any, is recognized only to the extent
received. The loan may be returned to accrual status if the loan is brought current, has performed in accordance with the contractual
terms for a reasonable period of time and ultimate collectability of the total contractual principal and interest is no longer in doubt.
Under GAAP we are required to account for certain loan modifications or restructurings as troubled debt restructurings (“TDRs”). In
general, the modification or restructuring of a debt constitutes a TDR if we, for economic or legal reasons related to the borrower’s
financial difficulties, grant a concession, such as a reduction in the effective interest rate, to the borrower that we would not otherwise
consider. However, all debt restructurings or loan modifications for a borrower do not necessarily constitute troubled debt restructurings.
We believe loan modifications will potentially result in a lower level of loan losses and loan collection costs than if we proceeded
immediately through the foreclosure process with these borrowers.
49
The table below sets forth the amounts and categories of our nonperforming assets, which consist of non-accrual loans, troubled debt
restructurings and OREO (which includes real estate acquired through, or in lieu of, foreclosure), at the dates indicated.
(in thousands)
Non-accrual loans:
Real estate loans:
Construction and land
Residential - first lien
Residential - junior lien
Commercial owner occupied
Commercial non-owner occupied
Commercial and leases
Consumer
2019
2018
December 31,
2017
2016
2015
$
481
12,162
786
566
1,725
1,960
127
$
1,323
12,278
1,137
1,268
5,018
2,417
174
$
637
1,722
396
508
5,867
3,438
-
-
$
491
37
509
1,075
4,624
167
-
$
693
63
232
916
5,935
150
Total non-accrual loans
17,807
23,615
12,568
6,903
7,989
Accruing troubled debt restructured loans:
Real estate loans:
Construction and land
Residential - first lien
Commercial non-owner occupied
Commercial and leases
Total accruing troubled debt restructured loans
Total non-performing loans
Other real estate owned:
Land
Residential - first lien
Commercial non-owner occupied
Total other real estate owned
-
968
-
367
1,335
19,142
1,559
1,344
195
3,098
125
982
-
-
1,107
24,722
1,772
1,062
1,558
4,392
125
287
-
208
620
13,188
956
-
593
1,549
125
294
2,073
183
2,675
9,578
1,220
-
1,130
2,350
-
301
2,073
7
2,381
10,370
964
-
1,405
2,369
Total non-performing assets
$
22,240
$
29,114
$
14,737
$
11,928
$
12,739
Ratios:
Non-performing loans to total gross loans
Non-performing assets to total assets
1.10
0.94
%
%
1.50
1.28
%
%
1.41
1.28
%
%
1.17
1.16
%
%
1.37
1.35
%
%
Loans past due 90 days still accruing:
Real estate loans:
Construction and land
Residential - first lien
Residential - junior lien
Commercial owner occupied
Commercial non-owner occupied
Commercial and leases
Consumer
-
$
47
-
-
-
-
-
$
47
$
351
570
-
-
-
-
-
-
$
328
50
131
2,963
-
-
1
$
298
-
-
2,703
-
1
$
15
941
30
236
445
147
2
$
921
$
3,472
$
3,003
$
1,816
Included in total non-accrual loans at December 31, 2019 are five TDRs with a net carrying balance totaling $813 thousand that were
not performing in accordance with their modified terms, and the accrual of interest has ceased. There was one new commercial loan
with its term extended and its payment restructured during 2019 of $17 thousand. Additionally, we had one land development loan that
was restructured in 2016 of $125 thousand that had been performing in accordance with its modified terms in 2018 that was downgraded
to not performing in 2019.
50
Interest income that would have been recorded during the years ended 2019, 2018 and 2017 if the non-accrual loans had been current
and in accordance with their original terms was $461 thousand, $317 thousand and $198 thousand, respectively. No interest income was
recorded on such loans during these periods.
Our nonperforming assets were $22.2 million, or 0.94% of total assets, at December 31, 2019 compared to $29.1 million, or 1.28% of
total assets, at December 31, 2018, and $14.7 million, or 1.28% of total assets, at December 31, 2017. Total nonperforming assets
decreased $6.9 million during 2019.
The composition of our nonperforming loans at December 31, 2019 is further described below:
Non-Accrual Loans
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
Two construction and land loan
47 residential first lien loans, three with a combined fair value of $2.7 million in the process of foreclosure
20 residential junior lien loans, one with a fair value of $23 thousand in the process of foreclosure
Three commercial owner-occupied loans
6 commercial non-owner-occupied loans representing four separate relationships
15 commercial loans representing six separate relationships, one with a Small Business Administration (“SBA”) guarantee, and six
to one relationship with specific reserves totaling $500 thousand
Two consumer loans
Accruing Troubled Debt Restructured Loans
(cid:120)
(cid:120)
Two residential real estate loans
Two commercial loan
Other Real Estate Owned
Real estate we acquire as a result of foreclosure is classified as Other Real Estate Owned (“OREO”). When a property is acquired as a
result of foreclosure, it is recorded at fair value less the anticipated cost to sell at the date of foreclosure. If there is a subsequent change
in the value of OREO, we record a valuation allowance to adjust the carrying value of the real estate to its current fair value less estimated
disposal costs. Costs relating to holding such real estate are expensed in the current period while costs relating to improving such real
estate are capitalized up to the property’s net realizable value until a saleable condition is reached. Costs in excess of the property’s net
realizable value would be expensed in the current period.
We had OREO of $3.1 million at December 31, 2019, $4.4 million at December 31, 2018, and $1.5 million at 2017. Included in
noninterest expenses were $473 thousand, $352 thousand and $581 thousand for 2019, 2018 and 2017, respectively, attributable to net
increases in valuation allowances as the current appraised value of OREO properties, less estimated cost to sell, was insufficient to cover
the recorded OREO amount. Additionally, we sold two parcels of land, one commercial real estate property and seven residential real
estate properties recording a net loss of $28 thousand in 2019. OREO additions in 2019 consisted of two residential real estate properties
with a net carrying balance of $1.2 million.
OREO at December 31, 2019 consisted of:
Several parcels of unimproved land.
(cid:120)
(cid:120) One commercial real estate property.
Four residential 1-4 family properties.
(cid:120)
Classification of Loans
Our policies, consistent with regulatory guidelines, provide for the classification of loans and other assets that are considered to be of
lesser quality as Substandard, Doubtful, or Loss assets. An asset is considered Substandard if it is inadequately protected by the current
net worth and paying capacity of the obligor or by the collateral pledged, if any. Substandard assets include those assets characterized
by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Assets classified as Doubtful have all of
the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses present make collection or
liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable or improbable. Assets (or portions
of assets) classified as Loss are those considered uncollectible and of such little value that their continuance as assets is not warranted.
Assets that do not expose us to risk sufficient to warrant classification in one of the aforementioned categories, but which possess
potential weaknesses that deserve our close attention, are required to be designated as Special Mention.
51
We maintain an allowance for credit losses at an amount estimated to equal all credit losses incurred in our loan portfolio that are both
probable and reasonable to estimate at a balance sheet date. Our determination as to the classification of our assets is subject to review
by the Commissioner and the FDIC. We regularly review our asset portfolio to determine whether any assets require classification in
accordance with applicable regulations.
The following table sets forth our amounts of classified loans and criticized loans (classified loans and loans designated as Special
Mention) at the dates indicated.
(in thousands)
Classified loans:
Substandard
Doubtful
2019
December 31,
2018
2017
$
17,882
-
$
24,610
-
$
6,779
6,310
Total classified loans
Special mention
17,882
-
24,610
3,955
13,089
1,592
Total criticized loans
$
17,882
$
28,565
$
14,681
Allowance for Credit Losses
We provide for credit losses based upon the consistent application of our documented allowance for credit loss methodology. All credit
losses are charged to the allowance for credit losses and all recoveries are credited to it. Additions to the allowance for credit losses are
provided by charges to income based on various factors that, in our judgment, deserve current recognition in estimating probable losses.
We regularly review the loan portfolio and make provisions for credit losses in order to maintain the allowance for credit losses in
accordance with GAAP.
In accordance with accounting guidance for business combinations, there was no allowance for credit losses brought forward on any
acquired loans in our acquisitions. For acquired performing loans, credit discounts representing the principal losses expected over the
life of the loan are a component of the initial fair value and the discount is accreted to interest income over the life of the loan. Subsequent
to the purchase date, the method used to evaluate the sufficiency of the credit discount is similar to originated loans, and if necessary,
additional reserves are recognized in the allowance for credit losses.
We recorded acquired credit impaired loans in our acquisitions net of purchase accounting adjustments. Subsequent to the acquisition
date, management continues to monitor cash flows on a quarterly basis, to determine the performance of each acquired credit impaired
loan in comparison to management’s initial performance expectations. Subsequent decreases in the present value of expected cash flows
will be recorded as an increase in the allowance for credit losses through a provision for loan losses. Subsequent significant increases in
cash flows result in a reversal of the provision for loan losses to the extent of prior provisions or a reclassification of amount from non-
accretable difference to accretable yield, with a positive impact on the accretion of interest income in future periods.
The allowance for credit losses consists primarily of two components:
1) Specific allowances are established for loans classified as impaired. For loans classified as impaired, the allowance is established
when the net realizable value (collateral value less costs to sell) of the impaired loan is lower than the carrying amount of the loan.
The amount of impairment provided for as a specific allowance is represented by the deficiency, if any, between the underlying
collateral value and the carrying value of the loan. Impaired loans for which the estimated fair value of the loan, or the loan’s
observable market price or the fair value of the underlying collateral, if the loan is collateral dependent, exceeds the carrying value
of the loan are not considered in establishing specific allowances for credit losses; and
2) General allowances established for credit losses on a portfolio basis for loans that do not meet the definition of impaired loans. The
portfolio is grouped into similar risk characteristics, primarily loan type and regulatory classification. We apply an estimated loss
rate to each loan group. The loss rates applied are based upon our loss experience adjusted, as appropriate, for the qualitative factors
discussed below. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant
revisions based upon changes in economic and real estate market conditions.
The allowance for credit losses is maintained at a level to provide for losses that are probable and can be reasonably estimated. Our
periodic evaluation of the adequacy of the allowance is based on past credit loss experience, known and inherent losses in the portfolio,
adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the
loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material
52
estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received
on impaired loans.
A loan is considered past due or delinquent when a contractual payment is not paid on the day it is due. A loan is considered impaired
when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or
interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining
impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when
due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. We determine
the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record
and the amount of the shortfall in relation to the principal and interest owed. The impairment of a loan may be measured based on the
present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if repayment
is expected to be provided by the collateral. Generally, our impairment on such loans is measured by reference to the fair value of the
collateral. Interest income on impaired loans is recognized on the cash basis.
Our loan policies state that after all collection efforts have been exhausted, and the loan is deemed to be a loss, then the remaining loan
balance will be charged to the established allowance for credit losses. All loans are evaluated for loss potential once it has been
determined by our Watch Committee that the likelihood of repayment is in doubt. When a loan is past due for at least 90 days or a
deterioration in debt service coverage ratio, guarantor liquidity, or loan-to-value ratio has occurred that would cause concern regarding
the likelihood of the full repayment of principal and interest, and the loan is deemed not to be well secured, the loan should be moved
to non-accrual status and a specific reserve is established if the net realizable value is less than the principal value of the loan balance(s).
Once the actual loss value has been determined a charge-off against the allowance for credit losses for the amount of the loss is taken.
Each loss is evaluated on its specific facts regarding the appropriate timing to recognize the loss.
The adjustments to historical loss experience are based on our evaluation of several qualitative factors, including:
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
changes in lending policies, procedures, practices or personnel;
changes in the level and composition of construction portfolio and related risks;
changes and migration of classified assets;
changes in exposure to subordinate collateral lien positions;
levels and composition of existing guarantees on loans by SBA or other agencies;
changes in national, state and local economic trends and business conditions;
changes and trends in levels of loan payment delinquencies; and
any other factors that management considers relevant to the quality or performance of the loan portfolio.
We evaluate the allowance for credit losses based upon the combined total of the specific and general components. Generally, when
the loan portfolio increases, absent other factors, the allowance for credit loss methodology results in a higher dollar amount of estimated
probable losses than would be the case without the increase. Generally, when the loan portfolio decreases, absent other factors, the
allowance for credit loss methodology results in a lower dollar amount of estimated probable losses than would be the case without the
decrease.
Commercial and commercial real estate loans generally have greater credit risks compared to the one- to four-family residential mortgage
loans we originate, as they typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In
addition, the payment experience on loans secured by income-producing properties typically depends on the successful operation of the
related business and thus may be subject to a greater extent to adverse conditions in the real estate market and in the general economy.
Actual credit losses may be significantly more than the allowance for credit losses we have established, which could have a material
negative effect on our financial results.
Generally, we underwrite commercial loans based on cash flow and business history and receive personal guarantees from the borrowers
where appropriate. We generally underwrite commercial real estate loans and residential real estate loans at a loan-to-value ratio of
85% or less at origination. Accordingly, in the event that a loan becomes past due and, randomly with respect to performing loans, we
will conduct visual inspections of collateral properties and/or review publicly available information, such as online databases, to
ascertain property values. We will also obtain formal appraisals on a regular basis even if we are not considering liquidation of the
property to repay a loan. It is our practice to obtain updated appraisals if there is a material change in market conditions or if we become
aware of new or additional facts that indicate a potential material reduction in the value of any individual property collateral.
For impaired loans, we utilize the appraised value or present value of expected cash flows in determining the appropriate specific
allowance for credit losses attributable to a loan. In addition, changes in the appraised value of multiple properties securing our loans
53
may result in an increase or decrease in our general allowance for credit losses as an adjustment to our historical loss experience due to
qualitative and environmental factors, as described above.
As of December 31, 2019 and 2018, nonperforming loans were $19.1 million and $24.7 million, respectively. The amount of
nonperforming loans requiring specific reserves totaled $554 thousand and $3.0 million, respectively, and the amount of nonperforming
loans with no specific valuation allowance totaled $18.5 million and $21.7 million, respectively, at December 31, 2019 and December
31, 2018.
Nonperforming loans are evaluated and valued at the time the loan is identified as impaired on a case by case basis, at the lower of cost
or market value. Market value is measured based on the value of the collateral securing the loan. The value of real estate collateral is
determined based on an appraisal by qualified licensed appraisers hired by us. Appraised values may be discounted based on
management’s historical experience, changes in market conditions from the time of valuation, and/or management’s expertise and
knowledge of the client and the client’s business. The difference between the appraised value and the principal balance of the loan will
determine the specific allowance valuation required for the loan, if any. Nonperforming loans are reviewed and evaluated on at least a
quarterly basis for additional impairment and adjusted accordingly.
We evaluate the loan portfolio on at least a quarterly basis, more frequently if conditions warrant, and the allowance is adjusted
accordingly. While we use the best information available to make evaluations, future adjustments to the allowance may be necessary if
conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of their examination
process, the Commissioner and the FDIC will periodically review the allowance for credit losses. The Commissioner and the FDIC
may require us to recognize additions to the allowance based on their analysis of information available to them at the time of their
examination.
The following table sets forth activity in our allowance for credit losses for the year ended:
(in thousands)
Balance at beginning of year
Charge-offs:
Real estate
Construction and land loans
Residential first lien loans
Residential junior lien loans
Commercial owner occupied loans
Commercial non-owner occupied loans
Commercial loans and leases
Consumer loans
Recoveries:
Real estate
Construction and land loans
Residential first lien loans
Residential junior lien loans
Commercial owner occupied loans
Commercial non-owner occupied loans
Commercial loans and leases
Consumer loans
Net charge-offs
Provision for credit losses
Balance at end of year
2019
2018
December 31,
2017
2016
2015
$
9,873
$
6,159
$
6,428
$
4,869
$
3,602
(282)
(518)
(532)
(46)
(2,026)
(622)
(210)
(4,236)
80
-
115
-
17
357
2
(202)
(142)
(195)
(28)
(797)
(1,092)
(63)
(2,519)
-
8
10
-
32
88
4
(155)
(133)
(31)
(235)
-
(1,605)
(108)
(2,267)
6
-
1
6
6
113
35
571
(3,665)
142
(2,377)
167
(2,100)
(216)
-
-
(191)
-
(234)
(20)
(661)
-
-
-
40
5
101
37
183
(478)
-
(23)
(12)
-
(82)
(825)
(5)
(947)
-
3
1
-
318
52
4
378
(569)
4,193
10,401
$
6,091
9,873
$
1,831
6,159
$
2,037
6,428
$
1,836
4,869
$
Net charge-offs to average loans and leases
0.22
%
0.16
%
0.24
%
0.06
%
0.09
%
54
Allocation of Allowance for Credit Losses
The following tables set forth the allowance for credit losses allocated by loan category and the percent of loans in each category to total
loans at the dates indicated. The allowance for credit losses allocated to each category is not necessarily indicative of future losses in
any particular category and does not restrict the use of the allowance to absorb losses in other categories.
(dollars in thousands)
Real estate
Construction and land loans
Residential first lien loans
Residential junior lien loans
Commercial owner occupied loans
Commercial non-owner occupied loans
Commercial loans and leases
Consumer loans
2019
Amount
1
Percent
2018
December 31,
2017
2016
2015
Amount
Percent 1
Amount Percent 1
Amount Percent 1
Amount Percent 1
$
1,256
2,256
478
788
2,968
2,103
552
7.3
25.1
4.2
13.9
25.4
21.4
2.7
%
$
741
1,170
292
735
4,057
2,644
234
7.5
23.2
5.4
14.2
25.9
20.5
3.3
%
$
735
668
177
617
1,410
2,529
23
7.9
20.8
4.6
18.2
27.8
20.2
0.5
%
$
511
454
89
327
1,120
3,800
127
8.9
23.7
4.3
16.3
26.4
19.8
0.6
%
$
265
300
47
309
728
3,094
126
%
9.1
24.1
3.6
17.3
23.8
21.5
0.6
Total
$
10,401
100.0
%
$
9,873
100.0
%
$
6,159
100.0
%
$
6,428
100.0
%
$
4,869
100.0
%
(1) Represents the percent of loans in each category to total loans.
Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial obligations. Our primary sources of funds consist of deposit inflows, loan
repayments, advances from the FHLB, and the sale of securities available for sale. While maturities and scheduled amortization of loans
and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates,
economic conditions and competition. Our Asset/Liability Committee (“ALCO”) is responsible for establishing and monitoring our
liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals
of our customers as well as unanticipated contingencies. We believe that we had enough sources of liquidity to satisfy our short- and
long-term liquidity needs as of December 31, 2019 and December 31, 2018.
We regularly monitor and adjust our investments in liquid assets based upon our assessment of:
Expected loan demand;
Expected deposit flows and borrowing maturities;
(cid:120)
(cid:120)
(cid:120) Yields available on interest-earning deposits and securities; and
The objectives of our asset/liability management program.
(cid:120)
Excess liquid assets are invested generally in interest-bearing deposits in banks (primarily the Federal Reserve Bank) and short-term
investment securities.
The most liquid of all assets are cash and cash equivalents. The level of these assets is dependent on our operating, financing, lending
and investing activities during any given period. At December 31, 2019 and 2018, cash and cash equivalents totaled $110.0 million and
$101.5 million, respectively.
Our cash flows are derived from operating activities, investing activities and financing activities as reported in our statements of cash
flows included in our financial statements.
At December 31, 2019 and 2018, we had $386.8 million and $387.3 million, respectively, in loan commitments outstanding, consisting
of commitments issued to originate loans of $77.3 million and $104.5 million at December 31, 2019 and 2018, respectively, and $309.5
million and $382.8 million in unused lines of credit to borrowers at December 31, 2019 and 2018, respectively. In addition to
commitments to originate loans and unused lines of credit, we had $13.9 million and $16.7 million in letters of credit at December 31,
2019 and 2018, respectively. CDs due within one year totaled $458.9 million, or 26.8% of total deposits, and $325.5 million, or $19.3%
of total deposits, at December 31, 2019 and 2018, respectively. If we do not retain these deposits, we may be required to seek other
sources of funds, including loan and securities sales and FHLB advances. Depending on market conditions, we may be required to pay
higher rates on our deposits or other borrowings than we currently pay on the CDs held in our portfolio as of December 31, 2019. We
believe, however, based on historical experience and current market interest rates that we will retain upon maturity a large portion of
our CDs with maturities of one year or less as of December 31, 2019.
Our primary investing activity is originating loans. During the years ended December 31, 2019 and December 31, 2018, cash used to
fund net loan growth was $99.2 million and $50.0 million, respectively. During 2019, we purchased $102.7 million of securities which
55
partially offset $80.4 million of securities maturities / calls and $35.4 million of securities sales. In 2018, we purchased $193.8 million
of new securities while $169.3 million of securities either matured, were called, or sold.
Financing activities consist primarily of activity in deposit accounts and FHLB advances. We experienced a net increase in cash provided
from deposits of $28.6 million and $115.5 million, respectively, during the years ended December 31, 2019 and 2018. Deposit flows
are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors, and by other
factors.
Liquidity management is both a daily and long-term function of business management. If we require funds beyond our ability to generate
them internally, borrowing agreements exist with the FHLB, which provide an additional source of funds. FHLB advances increased
to $285.0 million at December 31, 2019 compared to $232.0 million at December 31, 2018. At December 31, 2019, we had an available
line of credit for $573.3 million at the FHLB, with borrowings limited to a total of $435.4 million based on pledged collateral. At
December 31, 2018, this available line of credit at the FHLB was $538.4 million, with borrowings limited to a total of $345.9 million
based on pledged collateral.
The Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines
include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-
balance sheet items to broad risk categories. At December 31, 2019 and 2018, we exceeded all regulatory capital requirements. We are
considered “well capitalized” under regulatory guidelines. See “Item 1. Business—Supervision and Regulation—Howard Bank—
Capital Requirements” and Note 22 of our Consolidated Financial Statements.
Commitments, Contingent Liabilities, and Off-Balance Sheet Arrangements
We are party to financial instruments with off-balance sheet risk in the normal course of business to meet the financial needs of our
customers. These financial instruments are limited to commitments to originate loans and involve, to varying degrees, elements of
credit, interest rate, and liquidity risk. These do not represent unusual risks, and management does not anticipate any losses that would
have a material effect on us.
Outstanding loan commitments and lines of credit at December 31, 2019 and December 31, 2018 are as follows:
(in thousands)
Unfunded loan commitments
Unused lines of credit
Letters of credit
December 31,
2019
2018
$
77,314
309,519
13,853
$
104,466
282,822
16,661
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the
contract. We generally require collateral to support financial instruments with credit risk on the same basis as we do for balance sheet
instruments. Management generally bases the collateral required on the credit evaluation of the counterparty. Commitments generally
have interest rates at current market rates, expiration dates or other termination clauses and may require payment of a fee. Available
credit lines represent the unused portion of lines of credit previously extended and available to the customer so long as there is no
violation of any contractual condition. These lines generally have variable interest rates. Since we expect many of the commitments to
expire without being drawn upon, and since it is unlikely that all customers will draw upon their lines of credit in full at any one time,
the total commitment amount or line of credit amount does not necessarily represent future cash requirements. We evaluate each
customer’s credit-worthiness on a case-by-case basis. Because we conservatively underwrite these facilities at inception, we have not
had to withdraw any commitments. We are not aware of any loss that we would incur by funding our commitments or lines of credit.
The credit risk involved in these financial instruments is essentially the same as that involved in extending loan facilities to customers.
No amount has been recognized in consolidated balance sheets at December 31, 2019 or December 31, 2018 as a liability for credit loss
related to these commitments.
We have contractual obligations to make future payments on debt and lease agreements. In the normal course of business, we enter into
contractual arrangements whereby we commit to future purchases of products or services from unaffiliated parties. These purchase
obligations are legally binding agreements whereby we agree to purchase products or services with a specific minimum quantity at a
fixed, minimum or variable price over a specified period of time. Purchase obligations may include vendor contracts, communication
services, processing services and software contracts. We also have contractual obligations under real property leases for certain facilities
we utilize.
56
Payments due by period for our contractual obligations at December 31, 2019 are as follows:
(in thousands)
Certificates of deposit
Long-term borrowings
Estimated interest due on certificate
of deposit and long-term borrowings
Contractual service obligations
Future lease payments
Within
one year
$
458,908
-
One to
three years
108,120
$
-
Three to
five years
$
4,063
5,000
Over
five years
$
-
50,000
Total
$
571,091
55,000
4,937
3,649
1,636
1,440
8,517
2,950
1,117
15,317
2,312
1,383
-
11,341
8,877
27,483
18,239
$
469,130
$
121,027
$
27,809
$
62,724
$
680,690
Impact of Inflation and Changing Prices
Our financial statements and related notes have been prepared in accordance with GAAP. GAAP generally requires the measurement
of financial position and operating results in terms of historical dollars without consideration of changes in the relative purchasing power
of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial
companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact
on performance than the effects of inflation.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Liquidity and Funding
The objective of effective liquidity management is to ensure that we can meet customer loan requests, customer deposit
maturities/withdrawals, and other cash commitments efficiently under both normal operating conditions as well as under unforeseen and
unpredictable circumstances of industry or market stress. To achieve this objective, ALCO establishes and monitors liquidity guidelines
requiring sufficient asset based liquidity to cover potential funding requirements and to avoid over-dependence on volatile, less reliable
funding markets. We manage liquidity at both the parent and subsidiary levels through active management of the balance sheet.
The additional information called for by this item is incorporated herein by reference to the “Liquidity and Capital Resources”
section of Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of this Annual
Report on Form 10-K.
Interest Rate Risk
Interest rate risk, one of the more prominent risks in terms of potential earnings impact, is an inevitable part of being a financial
intermediary. It can occur for any one or more of the following reasons: (a) assets and liabilities may mature or reprice at different times
(for example, if assets reprice faster than liabilities and interest rates are generally falling, our earnings will initially decline); (b) assets
and liabilities may re-price at the same time but by different amounts (when the general level of interest rates is falling, we may choose
for customer management, competitive, or other reasons to reduce the rates paid on checking and savings deposit accounts by an amount
that is less than the general decline in market interest rates); (c) short-term and long-term market interest rates may change by different
amounts (i.e. the shape of the yield curve may impact new loan yields and funding costs differently); or (d) the remaining maturity of
various assets or liabilities may shorten or lengthen as interest rates change (for example, mortgage-backed securities held in the
securities available for sale portfolio may prepay significantly earlier than anticipated – with an associated reduction in portfolio yield
and income – if long-term mortgage rates decline sharply). In addition to the direct impact of interest rate changes on net interest income
through these categories, interest rates indirectly impact earnings through their effect on loan demand, credit losses, mortgage origination
fees, and other sources of our earnings.
In determining the appropriate level of interest rate risk, we consider the impact on earnings and capital of the current outlook on interest
rates, potential changes in interest rates, regional economies, liquidity, business strategies and other factors. We believe that short term
interest rate risk is best measured by simulation modeling. We prepare a current base case and standard alternative scenarios at least
once quarterly and report the analysis both internally to the Asset / Liability Committee and to the Board of Directors. More frequent
or alternative scenarios are often prepared at our discretion.
The balance sheet is subject to quarterly testing for the standard alternative interest rate shock possibilities to indicate the inherent
interest rate risk. Current and forward rates are shocked by +/- 100, +/- 200, +300, and +400 basis points (“bp”). Certain scenarios may
57
be impractical under different economic circumstances. We seek to structure the balance sheet so that net interest income at risk over a
twelve month period does not exceed policy guidelines at the various interest rate shock levels.
Measures of the net interest income at risk produced by the simulation analysis are indicators of an institution’s short-term performance
in alternative rate environments. The measures are typically based upon a relatively brief period, usually one year, and do not provide
meaningful insight into the institution’s long-term performance. Our net interest income exposure to these rate shocks at both December
31, 2019 and 2018 are presented in the following table. Due to relatively low current market interest rates, it was not possible to calculate
a decrease of 2% because many of the market interest rates would fall below zero in that scenario. All measures were in compliance
with our policy limits.
Estimated Change in Net Interest Income
Change in interest rates:
Policy limits
December 31, 2019
December 31, 2018
+ 400 bp
-15 %
-13.1 %
5.9 %
+ 300 bp
+ 200 bp
+ 100 bp
- 100 bp
- 200 bp
-12 %
-9.7 %
4.5 %
-12 %
-6.3 %
3.2 %
-10 %
-3.0 %
2.0 %
-10 %
-0.6 %
-3.6 %
-12 %
na
-10.7 %
58
Part II
Item 8. Financial Statements and Supplementary Data
Report Of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors
Howard Bancorp, Inc.
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Howard Bancorp, Inc. and Subsidiary (the “Company”)
as of December 31, 2019 and 2018, and the related consolidated statements of operations, comprehensive income,
changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2019, and
the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly,
in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of their
operations and their cash flows for each of the three years in the period ended December 31, 2019, in conformity with U.S.
generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States)
("PCAOB"), the Company's internal control over financial reporting as of December 31, 2019, based on criteria established
in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated March 16, 2020 expressed an unqualified opinion thereon.
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 PCAOB
and are required to be independent with respect to the Company in accordance with the 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 financial statements are free of material misstatement, whether
due to error or fraud.
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.
We have served as the Company’s auditor since 2016.
/s/ Dixon Hughes Goodman LLP
Baltimore, Maryland
March 16, 2020
59
Report Of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors
Howard Bancorp, Inc.
Opinion on Internal Control Over Financial Reporting
We have audited Howard Bancorp, Inc. and Subsidiary (the “Company”)’s internal control over financial reporting as of
December 31, 2019, based on criteria established in Internal Control – Integrated Framework (2013) issued by the
Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, Howard Bancorp, Inc. and Subsidiary
maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on
criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations
of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States)
("PCAOB"), the consolidated financial statements of Howard Bancorp, Inc. and Subsidiary as of December 31, 2019 and
2018, for each of the years in the three years ended December 31, 2019, and our report dated March 16, 2020 expressed
an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal controls over financial reporting, and for its
assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s
Report on Internal Control over Financial Reporting. Our responsibility is to express and opinion on the Company’s internal
control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are
required to be independent with respect to the Company in accordance with the 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 effective internal control over financial reporting was maintained in
all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing
the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control
based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We
believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures
that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary
to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts
and expenditures of the company are being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition,
use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become in adequate
because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Dixon Hughes Goodman LLP
Baltimore, Maryland
March 16, 2020
60
Howard Bancorp, Inc. and Subsidiary
Consolidated Balance Sheets
(in thousands, except share data)
ASSETS
Cash and due from banks
Interest-bearing deposits with banks
Total cash and cash equivalents
Securities available for sale, at fair value
Securities held to maturity, at amortized cost
Nonmarketable equity securities
Loans held for sale, at fair value
Loans and leases, net of unearned income
Allowance for credit losses
Net loans and leases
Bank premises and equipment, net
Goodwill
Core deposit intangible
Bank owned life insurance
Other real estate owned
Deferred tax assets, net
Interest receivable and other assets
Total assets
LIABILITIES
Noninterest-bearing deposits
Interest-bearing deposits
Total deposits
Short-term borrowings
Long-term borrowings
Accrued expenses and other liabilities
Total liabilities
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock - par value of $0.01 authorized 20,000,000 shares; issued and outstanding
19,066,913 shares at December 31, 2019 and 19,039,347 at December 31, 2018
Capital surplus
Retained earnings
Accumulated other comprehensive income
Total stockholders’ equity
Total liabilities and stockholders’ equity
The accompanying notes are an integral part of these consolidated financial statements.
61
December 31,
2019
2018
$
12,992
$
14,860
96,985
109,977
215,505
7,750
14,152
30,710
1,745,513
(10,401)
1,735,112
42,724
65,949
8,469
75,830
3,098
36,010
29,333
86,638
101,498
223,858
9,250
11,786
21,261
1,649,751
(9,873)
1,639,878
45,137
70,697
11,482
74,153
4,392
35,285
17,837
$
2,374,619
$
2,266,514
$
468,975
$
429,200
1,245,390
1,714,365
236,127
83,241
26,738
2,060,471
191
276,156
35,158
2,643
314,148
1,256,606
1,685,806
134,576
142,077
9,372
1,971,831
190
275,843
18,277
373
294,683
$
2,374,619
$
2,266,514
Consolidated Statements of Operations
(in thousands, except share data)
INTEREST INCOME
Interest and fees on loans and leases
Interest and dividends on securities
Other interest income
Total interest income
INTEREST EXPENSE
Deposits
Short-term borrowings
Long-term borrowings
Total interest expense
NET INTEREST INCOME
Provision for credit losses
Net interest income after provision for credit losses
NONINTEREST INCOME
Service charges on deposit accounts
Realized and unrealized gains on mortgage banking activity
Gain (loss) on the sale of securities
Gain on the sale of portfolio loans
Loss on the disposal of bank premises & equipment
Income from bank owned life insurance
Loan related fees and service charges
Other operating income
Total noninterest income
NONINTEREST EXPENSE
Compensation and benefits
Occupancy and equipment
Amortization of core deposit intangible
Marketing and business development
Professional fees
Data processing fees
Merger and restructuring expense
FDIC assessment
Other real estate owned
Loan production expense
Other operating expense
Total noninterest expense
INCOME (LOSS) BEFORE INCOME TAXES
Income tax expense (benefit)
NET INCOME (LOSS)
NET INCOME (LOSS) PER COMMON SHARE
Basic
Diluted
2019
Year Ended December 31,
2018
2017
$
83,555
6,785
$
75,009
4,297
$
41,213
1,416
1,094
91,434
15,462
3,441
3,221
22,124
69,310
4,193
65,117
2,747
7,798
645
-
(70)
1,858
3,934
4,122
21,034
32,056
9,076
3,013
2,339
2,954
4,914
-
667
845
2,700
5,514
64,078
22,073
5,192
1,083
80,389
8,540
2,327
2,904
13,771
66,618
6,091
60,527
2,216
5,245
(364)
-
(345)
1,614
5,624
3,870
17,860
33,674
10,650
2,856
3,338
2,471
4,037
15,549
1,268
500
3,523
5,246
83,112
(4,725)
(897)
397
43,026
3,997
876
294
5,167
37,859
1,831
36,028
923
11,035
-
86
(13)
760
5,722
1,011
19,524
23,573
4,154
505
4,231
1,968
2,038
567
650
655
3,743
3,116
45,200
10,352
3,152
$
16,881
$
(3,828)
$
7,200
$
0.89
$
(0.22)
$
0.75
$
0.89
$
(0.22)
$
0.75
The accompanying notes are an integral part of these consolidated financial statements.
62
Consolidated Statements of Comprehensive Income
(in thousands)
Net Income (Loss)
Other comprehensive income (loss)
Investments available-for-sale:
Reclassification adjustment for (gain) loss
Related income tax
Unrealized holding gains (losses)
Related income tax (expense) benefit
2019
December 31,
2018
2017
$
16,881
$
(3,828)
$
7,200
(645)
177
3,778
(1,040)
364
(100)
602
(156)
-
-
(217)
30
Comprehensive income (loss)
$
19,151
$
(3,118)
$
7,013
Consolidated Statements of Changes in Stockholders’ Equity
(dollars in thousands, except share data)
Number of
shares
Common
stock
Capital
surplus
Retained
earnings
Accumulated
other
comprehensive
income (loss)
Total
Balances at January 1, 2017
6,991,072
$
70
$
71,021
$
14,849
$
(150)
Net income
Other comprehensive loss
Reclassification of tax effects resulting
from the Tax Cuts and Jobs Act
Common stock offering
Director stock awards
Exercise of options
Stock-based compensation
-
-
-
2,760,000
11,404
27,113
31,003
Balances at December 31, 2017
9,820,592
Net loss
Other comprehensive gain
-
-
Acquisition of First Mariner Bank
9,143,222
Director stock awards
Exercise of options
Stock-based compensation
11,868
9,123
54,542
-
-
-
28
-
-
-
98
-
-
92
-
-
-
-
-
-
38,355
205
316
490
110,387
-
-
164,486
217
97
656
Balances at December 31, 2018
19,039,347
190
275,843
Net income
Other comprehensive gain
Director stock awards
Exercise of options
Employee stock purchase plan
Repurchased shares
Stock-based compensation
Balances at December 31, 2019
-
-
9,202
13,418
19,539
(19,764)
5,171
-
-
-
1
-
-
-
-
-
127
115
280
(322)
113
7,200
-
56
-
-
-
-
22,105
(3,828)
-
-
-
-
-
18,277
16,881
-
-
-
-
-
-
-
(187)
-
-
-
-
-
(337)
-
710
-
-
-
-
373
-
2,270
-
-
-
-
-
The accompanying notes are an integral part of these consolidated financial statements.
63
85,790
7,200
(187)
56
38,383
205
316
490
132,253
(3,828)
710
164,578
217
97
656
294,683
16,881
2,270
127
116
280
(322)
113
19,066,913
$
191
$
276,156
$
35,158
$
2,643
$
314,148
Consolidated Statements of Cash Flows
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)
Adjustments to reconcile net income (loss) to net cash from operating activities:
Provision for credit losses
Deferred income tax (benefit)
Provision for other real estate owned
Depreciation and amortization
Stock-based compensation
Net accretion of discount on purchased loans
(Gain) loss on sale of securities
Loss on sale of premises and equipment
Net amortization of intangible asset
Loans originated for sale
Proceeds from sale of loans originated for sale
Realized and unrealized gains on mortgage banking activity
Gain on sale of other real estate owned, net
Cash surrender value of BOLI
Decrease (increase) in other assets
Increase (decrease) in other liabilities
Other - net
Net cash provided by operating activities
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities of interest bearing deposits with banks
Purchases of investment securities
Proceeds from sale,maturities and calls of investment securities
Net increase in loans and leases outstanding
Purchase of bank owned life insurance
Proceeds from the sale of other real estate owned
Proceeds from the sale of portfolio loans
Purchase of premises and equipment
Proceeds from the sale of premises and equipment
Cash acquired in acquisition
Net cash used in investing activities
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits
Net increase (decrease) in short-term borrowings
Proceeds from issuance of long-term debt
Repayment of long-term debt
Net proceeds from issuance of common stock, net of cost
Cash consideration paid in acquisition
Repurchase of common stock
Net cash provided by financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
Year Ended December 31,
2018
2017
2019
$
16,881
$
(3,828)
$
7,200
4,193
3,160
473
2,348
240
(1,640)
(645)
70
3,013
(573,306)
571,656
(7,798)
(28)
(1,858)
2,044
1,618
140
20,561
-
(102,748)
115,758
(99,177)
-
2,238
-
(1,429)
2,092
-
(83,266)
28,559
101,551
55,000
(114,000)
396
-
(322)
71,184
8,479
101,498
6,091
(3,468)
352
2,188
873
(2,313)
364
345
2,856
(586,385)
640,710
(5,245)
(64)
(1,614)
5,041
(1,091)
(1)
54,811
-
(193,805)
169,291
(49,995)
-
1,088
-
(1,943)
5,161
38,889
(31,314)
115,463
(180,829)
123,543
-
97
(9,245)
-
49,029
72,526
28,972
1,831
(1,132)
581
1,287
695
(575)
-
13
505
(673,448)
693,384
(11,035)
(12)
(760)
(2,044)
417
(5)
16,902
19,513
(62,347)
23,520
(120,321)
(6,500)
232
3,798
(409)
-
-
(142,514)
55,174
23,329
15,016
(17,000)
38,699
-
-
115,218
(10,394)
39,366
Cash and cash equivalents at end of period
$
109,977
$
101,498
$
28,972
SUPPLEMENTAL INFORMATION
Cash payments for interest
Cash payments for income taxes
Transferred from loans to other real estate owned
Cash payments for operating leases
Assets acquired in business combination (net of cash received)
Liabilities assumed in business combination
Lease liabilities arising from obtaining right of use assets (see Note 11)
Goodwill reduction for adjustments to acquired net deferred tax assets
$
22,341
135
1,389
1,337
-
-
18,009
4,748
$
13,123
-
917
3,159
971,431
897,569
-
-
$
5,044
3,440
-
1,995
-
-
-
-
The accompanying notes are an integral part of these consolidated financial statements.
64
Notes to Consolidated Financial Statements
Note 1: Summary of Significant Accounting Policies
Nature of Operations
Howard Bancorp, Inc. (“Bancorp” or the “Company”) was incorporated in April 2005 under the laws of the State of Maryland. On
December 15, 2005, Bancorp acquired all of the stock of Howard Bank (the “Bank”) pursuant to the Plan of Reorganization approved
by the stockholders of the Bank and by federal and state regulatory agencies. Each share of the Bank’s common stock was converted
into two shares of Bancorp common stock effected by the filing of Articles of Exchange on that date, and the stockholders of the Bank
became the stockholders of Bancorp. Bancorp is now a bank holding company registered under the Bank Holding Company Act of
1956, with a single bank subsidiary, Howard Bank, which operates as a state trust company with commercial banking powers regulated
by the Maryland Office of the Commissioner of Financial Regulation (the “Commissioner”).
The Bank has nine subsidiaries—six were formed to hold foreclosed real estate (three of which are currently inactive), two own and
manage real estate used for corporate purposes, and one holds historic tax credit investments.
The Company is a diversified financial services company providing commercial banking, mortgage banking and consumer finance
through banking branches, the internet and other distribution channels to businesses, business owners, professionals and other consumers
located primarily in the Greater Baltimore Metropolitan Area.
Basis of Presentation
The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of
America (“GAAP”) and prevailing practices within the financial services industry for financial information.
Principles of Consolidation
The consolidated financial statements include the accounts of Bancorp, the Bank and the Bank’s subsidiaries. All significant
intercompany accounts and transactions have been eliminated. The parent company only financial statements report investments in the
Bank under the equity method.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material
estimates that are particularly susceptible to significant changes in the near-term relate to the determination of the allowance for credit
losses, goodwill, deferred tax assets, other-than-temporary impairment of investment securities and the fair value of loans held for sale.
Segment Information
The Company has one reportable segment, “Community Banking.” All of the Company’s activities are interrelated, and each activity
is dependent and assessed based on how each of the activities of the Company supports the others. For example, lending is dependent
upon the ability of the Bank to fund itself with deposits and other borrowings and manage interest rate and credit risk. Accordingly, all
significant operating decisions are based upon analysis of the Company as one segment or unit.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, amounts due from banks, cash items in the process of clearing, federal funds sold, and
interest-bearing deposits with banks with original maturities of less than 90 days. Generally, federal funds are sold as overnight
investments.
Investment Securities
Debt securities not classified as held-to-maturity are classified as available-for-sale. Investments held-to-maturity represents securities
that the Company has both the intent and ability to hold until maturity. Securities available-for-sale are acquired as part of the Bank's
asset/liability management strategy and may be sold in response to changes in interest rates, loan demand, changes in prepayment risk
and other factors. Securities available-for-sale are carried at estimated fair value, with unrealized gains or losses based on the difference
between amortized cost and fair value reported as accumulated other comprehensive income (loss), net of deferred taxes, a separate
65
component of stockholders’ equity, when appropriate. Realized gains and losses, using the specific identification method, are included
as a separate component of noninterest income. Related interest and dividends are included in interest income. Premiums and discounts
on held-to-maturity investments are amortized to interest income using the effective interest method. Declines in the fair value of
individual securities below their amortized cost that are other-than-temporary result in write-downs of the individual securities to their
fair value. Factors affecting the determination of whether an other-than-temporary impairment has occurred include a downgrading of
the security by a rating agency, a significant deterioration in the financial condition of the issuer, or a change in management’s intent
and ability to hold a security for a period of time sufficient to allow for any anticipated recovery in fair value.
Nonmarketable Equity Securities
Nonmarketable equity securities include equity securities that are not publicly traded or are held to meet regulatory requirements such
as Federal Home Loan Bank of Atlanta (“FHLB”) stock. These securities are accounted for at cost and evaluated for impairment each
reporting period. Due to redemptive provisions of the FHLB, cost approximates fair value.
Marketable Equity Securities
Marketable equity securities are carried at estimated fair value based on quoted prices. Changes in fair value of marketable equity
securities are recognized in net income. At December 31, 2019 and 2018, marketable equity securities amounted to $4.0 million and
$3.7 million, respectively, and are included in the interest receivable and other assets caption of the consolidated balance sheet.
Derivative Instruments and Hedging Activity
Interest Rate Swaps
The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies.
These interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with a third party, such
that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this
activity do not meet the strict hedge accounting requirements, changes in fair value of both the customer swaps and the offsetting swaps
are recognized directly in earnings.
By using derivative instruments, the Company is exposed to credit and market risk. If the counterparty fails to perform, credit risk is
equal to the fair value gain in a derivative. When the fair value of a derivative contract is positive, this situation generally indicates that
the counterparty is obligated to pay the Company, and, therefore, creates a repayment risk for the Company. When the fair value of a
derivative contract is negative, the Company is obligated to pay the counterparty and therefore, has no repayment risk. The Company
minimizes the credit risk in derivative instruments by entering into transactions with high-quality counterparties that are reviewed
periodically by the Company.
The Company recognizes the fair value of derivatives as assets or liabilities in the financial statements. The accounting for the changes
in the fair value of a derivative depends on the intended use of the derivative instrument at inception. The change in fair value of the
effective portion of cash flow hedges is accounted for in other comprehensive income rather than net income. Changes in fair value of
derivative instruments that are not intended as a hedge are accounted for in the net income in the period of the change (see Derivatives
and Hedging Activities footnote for further disclosure).
Interest Rate Lock Commitments
In connection with its mortgage banking activities, the Company enters into commitments to originate residential mortgage loans
whereby the interest rate on the loan is determined prior to funding (i.e. rate lock commitment). Such rate lock commitments on
mortgage loans to be sold in the secondary market are considered to be derivatives. The period of time between issuance of a loan
commitment and closing and sale of the loan generally ranges from 15 to 60 days. The Company protects itself from changes in interest
rates through the use of best efforts forward delivery commitments, whereby the Company commits to sell a loan at a premium at the
time the borrower commits to an interest rate with the intent that the buyer has assumed interest rate risk on the loan.
For purposes of calculating fair value of rate lock commitments, the Bank estimates loan closing and investor delivery rate based on
historical experience. The measurement of the estimated fair value of the rate lock commitments is presented as realized and unrealized
gains from mortgage banking activities with the corresponding balance sheet amount presented within other assets.
Loans Held For Sale
The Company engages in sales of residential mortgage loans originated by the Bank. Loans held for sale are carried at fair value. Fair
value is based on outstanding investor commitments or, in the absence of such commitments, on current investor yield requirements
based on third party models. The Company elected to measure loans held for sale under the fair value option to better align reported
results with the underlying economic changes in value of the loans on the Company’s balance sheet. Changes in the fair value of these
66
loans are recorded in earnings as a component of realized and unrealized gains from mortgage banking activities in noninterest income
in the Consolidated Statements of Operations. 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.
Loans held for sale that were not ultimately sold, but instead were placed into the Bank’s portfolio, are reclassified to loans held for
investment and continue to be recorded at fair value.
Loans and Leases
Loans and leases are stated at their principal balance outstanding, plus deferred origination costs, less unearned discounts and deferred
origination fees. Interest on loans and leases is credited to income based on the principal amounts outstanding. Origination fees and
costs are amortized to income over the contractual life of the related loans and leases. Generally, accrual of interest on a loan or lease
is discontinued when the loan or lease is delinquent more than 90 days unless the collateral securing the loan or lease is sufficient to
liquidate the loan. All interest accrued but not collected for loans and leases that are placed on non-accrual or charged-off is reversed
against interest income. Interest on these loans and leases is accounted for on the cash basis, until qualifying for return to accrual. Loans
and leases are returned to accrual status when all principal and interest amounts contractually due are brought current and future
payments are reasonably assured.
Management considers loans and leases impaired when, based on current information, it is probable that the Company will not collect
all principal and interest payments according to contractual terms. Loans and leases are tested for impairment no later than when
principal or interest payments become 90 days or more past due and they are placed on non-accrual. Management also considers the
financial condition of the borrower, cash flows of the loan or lease and the value of the related collateral. Impaired loans and leases do
not include large groups of smaller balance homogeneous loans and leases such as residential real estate and consumer installment loans
which are evaluated collectively for impairment. Loans and leases specifically reviewed for impairment are not considered impaired
during periods of “minimal delay” in payment (90 days or less) provided eventual collection of all amounts due is expected. The
impairment of a loan or lease may be measured based on the present value of expected future cash flows discounted at the loan or lease’s
effective interest rate, or the fair value of the collateral if repayment is expected to be provided by the collateral. Generally, the
Company’s impairment on such loans and leases is measured by reference to the fair value of the collateral. Interest income on impaired
loans and leases is recognized on the cash basis.
The segments of the Company’s loan and lease portfolio are disaggregated to a level that allows management to monitor risk and
performance. The commercial real estate (“CRE”) loan segment is further disaggregated into two classes; owner occupied loans and
non-owner occupied loans. Non-owner occupied CRE loans, which include loans secured by non-owner occupied nonfarm
nonresidential properties, generally have a greater risk profile than owner occupied CRE loans. The residential mortgage loan segment
is further disaggregated into two classes: first lien mortgages and second or junior lien mortgages.
Acquired Loans
Acquired loans are recorded at fair value at the date of acquisition, and accordingly, no allowance for loan losses is transferred to the
acquiring entity under the acquisition method. The fair values of loans with evidence of credit deterioration (acquired credit impaired
loans) are initially recorded at fair value, but thereafter accounted for differently than purchased, non-credit-impaired loans. For acquired
credit impaired loans, the excess of all cash flows estimated to be collectable at the date of acquisition over the initial investment in the
acquired credit impaired loan is recognized as interest income, using a level-yield basis over the life of the loan. This amount is referred
to as the accretable yield. The acquired credit impaired loan’s contractually-required payments receivable estimated to be in excess of
the amount of its future cash flows expected at the date of acquisition is referred to as the non-accretable difference, and is not reflected
as an adjustment to the yield, but in the form of a loss accrual or a valuation allowance.
Subsequent to the acquisition date, management continues to monitor cash flows on a quarterly basis, to determine the performance of
each acquired credit impaired loan in comparison to management’s initial performance expectations. Subsequent decreases in the present
value of expected cash flows will be recorded as an increase in the allowance for credit losses through a provision for loan losses.
Subsequent significant increases in cash flows result in a reversal of the provision for loan losses to the extent of prior provisions or a
reclassification of amount from non-accretable difference to accretable yield, with a positive impact on the accretion of interest income
in future periods.
Allowance for Credit Losses
The allowance for credit losses is maintained at a level believed adequate by management to absorb probable losses inherent in the loan
and lease portfolio and is based on the size and current risk characteristics of the loan and lease portfolio, an assessment of individual
problem loans and leases, actual loss experience, current economic events in specific industries and geographic areas including
67
unemployment levels and other pertinent factors including general economic conditions. Determination of the allowance is inherently
subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans and
leases, estimated losses on pools of homogenous loans and leases based on historical loss experience and consideration of economic
trends, all of which may be susceptible to significant change. Credit losses are charged off against the allowance, while recoveries of
amounts previously charged off are credited to the allowance. A provision for credit losses is charged to operations based on
management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors. Evaluations are conducted at
least quarterly and more often if deemed necessary.
The allowance for credit losses consists of a specific component and a nonspecific component. The components of the allowance for
credit losses represent an estimation done pursuant to either the Financial Accounting Standards Board’s (the “FASB”) Accounting
Standards Codification (“ASC”) Topic 450 Contingencies or ASC Topic 310 Receivables. The specific component of the allowance
for credit losses reflects expected losses resulting from analysis developed through credit allocations for individual loans and leases.
The credit allocations are based on a regular analysis of all loans and leases over a fixed-dollar amount where the internal credit rating
is at or below a predetermined classification. The specific component of the allowance for credit losses also includes management’s
determination of the amounts necessary given concentrations and changes in portfolio mix and volume.
The nonspecific portion of the allowance is determined based on management’s assessment of general economic conditions, as well as
economic factors in the individual markets in which the Company operates including the strength and timing of economic cycles and
concerns over the effects of a prolonged economic downturn in the current cycle. This determination inherently involves a higher risk
of uncertainty and considers current risk factors that may not have yet manifested themselves in the Bank’s historical loss factors used
to determine the nonspecific component of the allowance, and it recognizes knowledge of the portfolio may be incomplete. The Bank’s
historic loss factors are based upon actual losses incurred by portfolio segment over the preceding 24-month period. In portfolio
segments where no actual losses have been incurred within the most recent 24-month period, industry loss data for that portfolio segment,
as provided by the Federal Deposit Insurance Corporation (“FDIC”), are utilized. In addition to historic loss factors, the Bank’s
methodology for the allowance for credit losses also incorporates other risk factors that may be inherent within the portfolio segments.
For each portfolio segment, in addition to the historic loss experience, the other factors that are measured and monitored in the overall
determination of the allowance include:
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
changes in lending policies, procedures, practices or personnel;
changes in the level and composition of construction portfolio and related risks;
changes and migration of classified assets;
changes in exposure to subordinate collateral lien positions;
levels and composition of existing guarantees on loans by the Small Business Administration or other agencies;
changes in national, state and local economic trends and business conditions;
changes and trends in levels of loan and lease payment delinquencies; and
any other factors that management considers relevant to the quality or performance of the loan and lease portfolio.
Each of these qualitative risk factors is measured based upon data generated either internally, or in the case of economic conditions
utilizing independently provided data on items such as unemployment rates, commercial real estate vacancy rates, or other market data
deemed relevant to the business conditions within the markets served.
The Company’s loan and lease policies state that after all collection efforts have been exhausted, and the loan or lease is deemed to be
a loss, then the remaining loan or lease balance will be charged to the Company’s established allowance for credit losses. All loans and
leases are evaluated for loss potential once it has been determined by the Watch Committee that the likelihood of repayment is in doubt.
When a loan is past due for at least 90 days or a deterioration in debt service coverage ratio, guarantor liquidity, or loan-to-value ratio
has occurred that would cause concern regarding the likelihood of the full repayment of principal and interest, and the loan or lease is
deemed not to be well secured, the loan or lease would be moved to non-accrual status and a specific reserve is established if the net
realizable value is less than the principal value of the loan balance(s). Once the actual loss value has been determined, a charge-off
against the allowance for credit losses for the amount of the loss is taken. Each loss is evaluated on its specific facts regarding the
appropriate timing to recognize the loss.
Goodwill, Other Intangible Assets and Long-Lived Assets
Goodwill represents the excess of the purchase price over the sum of the estimated fair values of tangible and identifiable intangible
assets acquired less the estimated fair value of the liabilities assumed. Core deposit intangibles represent the estimated value of long-term
deposit relationships acquired in a business combination. The core deposit intangible is amortized over the estimated useful lives of the
long-term deposits acquired, and the remaining amounts of the core deposit intangible are periodically reviewed for impairment.
Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate
that the asset might be impaired. Long-lived assets are those that provide the Company with a future economic benefit beyond the current
year or operating period. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the
68
carrying amount of an asset is greater than the fair value of the asset. Assets to be disposed of are reported at the lower of the cost or the
fair value, less costs to sell. An impairment analysis is performed annually.
Management has determined that Bancorp has one reporting unit, and based upon the annual impairment analysis, it was determined
that there was not an impairment of the carrying value of either the goodwill, core deposit intangible or other long-lived assets for 2019.
The Company is not aware of any issues that have arisen since our last impairment analysis performed in the fourth quarter of 2019.
Business Combinations
GAAP requires that the acquisition method of accounting be used for all business combinations and that an acquirer be identified for
each business combination. Under GAAP, the acquirer is the entity that obtains control of one or more businesses in the business
combination, and the acquisition date is the date the acquirer achieves control. GAAP requires that the acquirer recognize the fair value
of assets acquired, liabilities assumed, and any non-controlling interest in the acquired entity at the acquisition date.
Other Real Estate Owned
Other real estate acquired through, or in lieu of, foreclosure is initially recorded at fair value less estimated cost to sell at the date of
acquisition, establishing a new cost basis. Gains or losses arising at the date of acquisition of such properties are charged against the
allowance for credit losses. Subsequent to foreclosure, valuations are periodically performed by management and a valuation allowance
is established, if necessary, by a charge to noninterest expense if the carrying value of a property exceeds its estimated fair value less
estimated costs to sell. Gains and losses realized from the sale of OREO as well as expenses of operation are recorded in noninterest
expense.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation and amortization computed using the straight-line method.
Premises and equipment are depreciated over the useful lives of the assets, which generally range from three to 10 years for furniture,
fixtures and equipment and three to five years for computer software and hardware. Bank owned premises are depreciated over a range
of 20 to 30 years. Leasehold improvements are amortized over the terms of the respective leases or the estimated useful lives of the
improvements, whichever is shorter. The costs of major renewals and betterments are capitalized, while the costs of ordinary
maintenance and repairs are included in noninterest expense.
Leases
The Company determines if an arrangement is a lease at inception. All of the Company’s leases are currently classified as operating
leases and are included in other assets and other liabilities on the Company’s Consolidated Balance Sheet.
Right-of-use (“ROU”) assets represent the Company’s right to use an underlying asset for the lease term, and lease liabilities represent
the Company’s obligation to make lease payments arising from the lease arrangements. Operating lease ROU assets and liabilities are
recognized at the lease commencement date based on the present value of the expected future lease payments over the remaining lease
term. In determining the present value of future lease payments, the Company uses its incremental borrowing rate based on the
information available at the lease commencement date. The operating ROU assets are adjusted for any lease payments made at or before
lease commencement date, initial direct costs and any lease incentives received. The Company’s lease terms may include options to
extend or terminate the lease when it is reasonably certain that the Company will exercise such options. Lease expense is recognized on
a straight line basis over the expected lease term. Lease agreements that include lease and non-lease components, such as common area
maintenance charges, are accounted for separately.
Income Taxes
The Company uses the asset/liability method of accounting for income taxes. Under the asset/liability method, deferred tax assets and
liabilities are determined based on differences between the financial statement carrying amounts and the tax bases of existing assets and
liabilities (i.e., temporary differences) and are measured at the enacted rates that will be in effect when these differences reverse. As
changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. In
addition, deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that
some portion or the entire deferred tax asset will not be realized. The Company does not have uncertain tax positions that are deemed
material, and did not recognize any adjustments for unrecognized tax benefits. The Company’s policy is to recognize interest and
penalties on income taxes in other noninterest expenses. The Company remains subject to examination by federal and state taxing
authorities for income tax returns for the years ending after December 31, 2014.
69
Net Income per Common Share
Basic net income per common share is computed by dividing net income available to common stockholders by the weighted average
number of common shares outstanding during the year. Diluted net income per common share is computed by dividing net income
available to common stockholders by the weighted average number of common shares outstanding during the year including any
potential dilutive effects of common stock equivalents. Dilutive common stock equivalents consist of stock options and restricted stock
units, calculated under the treasury stock method.
Share-Based Compensation
Compensation cost is recognized for stock options issued to directors and 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. Compensation cost
is recognized over the required service period, generally defined as the vesting period for stock option awards. For awards with graded
vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. When an award
is granted to an employee who is retirement eligible, the compensation cost of these awards is recognized over the period up to when
the director or employee first becomes eligible to retire.
Compensation expense for non-vested common stock awards is based on the fair value of the awards, which is generally the market
price of the common stock on the measurement date, which, for the Company, is the date of grant, and is recognized ratably over the
service period of the award.
Off-Balance Sheet Financial Instruments
In the ordinary course of business, the Company has entered into off-balance sheet financial instruments consisting of commitments to
extend credit. Such financial instruments are recorded in the consolidated balance sheet when they are funded. Potential exposure to
loss on commitments to extend credit, if deemed necessary, would be recorded in other liabilities.
As noted under Loans Held for Sale, the Company originates and sells residential mortgage loans to a variety of investors. Mortgage
loans sold are subject to representations and warranties made to the third party purchasers regarding certain attributes. Subsequent to
the sale, if a material underwriting deficiency or documentation defect is determined, the Company may be obligated to repurchase the
mortgage loan or reimburse the investor for losses incurred if the deficiency or defect cannot be rectified within a specific period
subsequent to discovery. The Company monitors the activity regarding the requirement to repurchase loans and the associated losses
incurred. This information is applied to determine an estimated recourse reserve that is recorded in other liabilities.
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Certain changes
in assets and liabilities, such as unrealized gains and losses on securities available for sale, are reported as a separate component of the
equity section of the consolidated balance sheets, such items, along with net income, are components of comprehensive income. The
Company’s sole component of accumulated other comprehensive income/loss is unrealized gains/losses on available for sale securities.
Transfer of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred
assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free
of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company
does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. In certain
cases, the recourse to the Bank to repurchase assets may exist but is deemed immaterial based on the specific facts and circumstances.
Reclassifications
Certain reclassifications to 2018 and 2017 financial presentation were made to conform to the 2019 presentation. These reclassifications
did not affect previously reported net income or total stockholders’ equity.
Recent Accounting Pronouncements
The Financial Accounting Standards Board (“FASB”) has issued Accounting Standards Update (“ASU”) 2019-12, Income Taxes (Topic
740) - Simplifying the Accounting for Income Taxes. The guidance issued in this update simplifies the accounting for income taxes by
eliminating certain exceptions to the guidance in ASC 740 related to the approach for intraperiod tax allocation, the methodology for
calculating income taxes in an interim period and the recognition for deferred tax liabilities for outside basis differences. This ASU also
70
simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for
transactions that result in a step-up in the tax basis of goodwill. The amendments in this ASU are effective for fiscal years, and interim
periods within those fiscal years, beginning after December 15, 2020, with early adoption permitted, and is not expected to have a
material impact on the Company’s Consolidated Financial Statements.
The FASB has issued ASU 2018-16, Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate
(“SOFR”) Overnight Index Swap (“OIS”) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes. This ASU permits use
of the OIS rate based on SOFR as a U.S. benchmark interest rate for hedge accounting purposes. Alternative Reference Rates Committee
has proposed that the SOFR is the rate that represents best practice as the alternative to derivatives currently indexed to London Inter-
Bank Offered Rate (“LIBOR”). The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years,
beginning after December 15, 2019. The amendments should be adopted on a prospective basis for qualifying new or re-designated
hedging relationships entered into on or after the date of adoption. The Company has non-designated hedge contracts that are indexed
to LIBOR and is monitoring this activity and evaluating the related risks as they relate to derivatives.
The FASB has issued ASU 2019-10, Financial Instruments – Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and
Leases (Topic 842). This ASU amends the effective date of the credit loss standard (ASU 2016-13) for smaller reporting companies, as
defined by the SEC. The one-time determination of whether an entity is eligible to be a smaller reporting company is based on an entity’s
most recent determination as of November 15, 2019, in accordance with SEC regulations. The Company met this definition of smaller
reporting company based on its most recent determination as of November 15, 2019. As a result, the effective date of this ASU for the
Company has been amended from fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, to fiscal
years beginning after December 31, 2022, and interim periods within those fiscal years. In addition, this ASU amended the mandatory
effective date for the elimination of Step 2 from the goodwill impairment test (ASU 2017-04 discussed below). As a smaller reporting
company, the effective date of the goodwill impairment standard for the Company has been amended from fiscal years beginning after
December 15, 2019, and interim periods within those fiscal years, to fiscal years beginning after December 31, 2022, and interim periods
within those fiscal years.
The FASB has issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework— Changes to the Disclosure
Requirements for Fair Value Measurement. This ASU eliminates, adds and modifies certain disclosure requirements for fair value
measurements. Among the changes, entities will no longer be required to disclose the amount of and reason for transfers between Level
1 and Level 2 of the fair value hierarchy, but will be required to disclose the range and weighted average used to develop significant
unobservable inputs for Level 3 fair value measurements. The amendments in this ASU are effective for fiscal years, and interim periods
within those fiscal years, beginning after December 15, 2019; early adoption is permitted. Entities are also allowed to elect early adoption
of the eliminated or modified disclosure requirements and delay adoption of the new disclosure requirements until their effective date.
ASU 2018-13 is not expected have a material impact on the Company’s Consolidated Financial Statements.
The FASB has issued ASU 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. The
amendments in this Update simplify the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test.
The Company should perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount.
Impairment charges should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value, however,
the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The impairment charge is limited to
the amount of goodwill allocated to that reporting unit. As discussed above, this ASU, as amended by ASU 2019-10, will be effective
for the Company on January 1, 2023. The Company will evaluate the guidance in this Update but does not expect it to have a significant
impact on the Company’s financial position or results of operations.
The FASB has issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326). The main objective of this update is to provide
financial statement users with more decision-useful information about the expected credit losses on financial instruments and other
commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the guidance in this Update
replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires
consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The measurement of expected
credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and
supportable forecasts that affect the collectability of the reported amount. An entity must use judgment in determining the relevant
information and estimation methods that are appropriate in its circumstances. As discussed above, this ASU, as amended by ASU 2019-
10, will be effective for the Company on January 1, 2023. The Company has engaged a third party vendor and is currently gathering
historical data and reviewing the methodologies and assumptions utilized to determine the impact of this update on the Company’s
Consolidated Financial Statements.
71
Note 2: Business Combinations
First Mariner Acquisition
On March 1, 2018, Bancorp completed its previously announced merger with First Mariner Bank (“First Mariner”). At the effective
time of the merger, First Mariner merged with and into the Bank, with the Bank continuing as the surviving bank in the merger. At the
effective time of merger, under the terms of the merger agreement, each outstanding share of First Mariner common stock and First
Mariner Series A Non-Voting Non-Cumulative Perpetual Preferred Stock issued and outstanding was cancelled and converted into the
right to receive 1.6624 shares of Bancorp common stock, provided that cash was paid in lieu of any fractional shares. The aggregate
merger consideration of $173.8 million included $9.2 million of cash and 9,143,222 shares of Bancorp’s common stock, which was
valued at approximately $164.6 million based on Bancorp’s closing stock price of $18.00 on February 28, 2018.
The Company has accounted for the First Mariner merger under the acquisition method of accounting in accordance with FASB ASC
Topic 805, “Business Combinations,” whereby the acquired assets and assumed liabilities were recorded by the Company at their
estimated fair values as of their acquisition date.
Management made significant estimates and exercised significant judgment in accounting for the acquisition of First Mariner.
Management judgmentally assigned risk ratings to loans based on appraisals and estimated collateral values, expected cash flows,
prepayment speeds and estimated loss factors to measure fair values for loans. Deposits and borrowings were valued based upon interest
rates, original and remaining terms and maturities, as well as current rates for similar funds in the same markets. Premises and equipment
was valued based on recent appraised values. Management used quoted or current market prices to determine the fair value of investment
securities.
The following table provides the purchase price as of the acquisition date, the current identifiable assets acquired and liabilities assumed
at their estimated fair values, and the resulting goodwill of $65.3 million recorded from the acquisition:
(in thousands)
The goodwill resulting from the First Mariner merger at December 31, 2019 of $65.3 million is lower than the $70.1 million reflected
at December 31, 2018 due to a change in the acquired value of the net deferred tax asset included in other assets above. At the acquisition
date, it was unclear under the Tax Cuts and Jobs Act (“TCJA”) whether appreciation in the cash value of acquired BOLI would be
considered exempt from taxation. However, in the first quarter of 2019, the IRS issued new guidance which clarified the new law and
made it more likely than not that the appreciated value of the BOLI acquired by the Company would be tax exempt. As a result, this
72
eliminated the need for a deferred tax liability associated with acquired BOLI. The final regulation maintaining the tax exemption for
acquired BOLI was issued in October 2019.
Acquired loans
The following table outlines the contractually required payments receivable, cash flows that the Company expects to receive, non-
accretable credit adjustments and the accretable yield for all First Mariner loans as of the acquisition date.
(in thousands)
Performing loans acquired
Credit impaired loans acquired
Contractually
Required
Payments
Receivable
654,621
$
29,470
Non-Accretable Cash Flows
Credit
Adjustment
$
-
9,644
Expected to be
Collected
654,621
19,826
$
Accretable
FMV
Adjustment
9,054
$
1,055
Carring Value
of Loans
Receivable
$
645,567
18,771
Total loans acquired
$
684,091
$
9,644
$
674,447
$
10,109
$
664,338
As of the effective date of the merger, all loans acquired were recorded at the estimated fair value on the purchase date with no carryover
of the related allowance for loan losses. On the effective date of the merger, the acquired loan portfolio was segregated into two loan
pools, performing and non-performing loans to be retained in our portfolio.
The Company determined the net discounted value of cash flows on approximately 2,700 performing loans totaling $654.6 million. The
valuation took into consideration the loans' underlying characteristics, including account types, remaining terms, annual interest rates,
interest types such as fixed or variable rate, past delinquencies, timing of principal and interest payments, current market rates, loan-to-
value ratios, loss exposures, and remaining balances. These performing loans were segregated into pools based on loan and payment
type and in some cases, risk grade. The effect of this valuation process was a net accretable discount adjustment of $9.1 million on the
effective date of the merger.
The Company also individually evaluated 57 impaired loans totaling $29.5 million of contractually required payments, to determine the
fair value as of the March 1, 2018 measurement date. In determining the fair value for each individually evaluated impaired loan, the
Company considered a number of factors including the remaining life of the acquired loan, estimated prepayments, estimated loss ratios,
estimated value of the underlying collateral and net present value of cash flows the Company expects to receive, among others.
The Company established a credit risk related non-accretable difference of $9.6 million relating to these acquired credit impaired loans,
reflected in the recorded net fair value. The Company further estimated the timing and amount of expected cash flows in excess of the
estimated fair value and established an accretable discount adjustment of $1.1 million at acquisition relating to these credit impaired
loans.
The Company incurred no merger related costs in the year ended December 31, 2019 and $567 thousand of merger related costs in the
year ended December 31, 2017. Merger related costs included in the Consolidated Statements of Operations for the year ended December
31, 2018 are summarized as follows:
(in thousands)
Compensation related
Equipment disposition
Legal and consulting
Contract terminations
Accounting and other
Total
$
9,871
1,918
2,005
677
1,078
15,549
$
Pro Forma Condensed Combined Financial Information:
The following table presents unaudited pro forma information as if the First Mariner merger had been completed on January 1, 2018
and January 1, 2017. The pro forma information does not necessarily reflect the results of operations that would have occurred had the
First Mariner merger occurred at the beginning of 2018 or 2017. Supplemental pro forma earnings were adjusted to exclude merger
related costs. The expected future amortizations of the various fair value adjustments were included beginning in each year presented.
Cost savings are not reflected in the unaudited pro forma amounts for the periods presented. The pro forma financial information does
73
not include the impact of possible business model changes, nor does it consider any potential impacts of current market conditions on
revenues, expense efficiencies, or other factors.
(in thousands)
Net interest income after provision
Noninterest income
Noninterest expense
Net income
Net income per share
December 31,
2018
2017
$ 66,873
19,890
77,699
6,569
0.35
$
$ 59,626
29,285
80,721
1,315
0.09
$
Note 3: Exit of Mortgage Banking Activities
On December 18, 2019, the Company entered into an agreement to release certain management members of the mortgage division from
their employment contracts and allow those individuals to create a limited liability company (“LLC”) for the purpose of hiring all
remaining mortgage employees. The Company also agreed to transfer ownership of the domain name “VAmortgage.com” to the newly
created LLC. In consideration of the release of the employment agreements, the transfer of the mortgage employees, and the sale of the
domain name, the LLC paid the Company $750 thousand. Under the agreement, there is a transition period of approximately 45 days,
after which the Company has agreed to cease originating residential first lien mortgage loans and will exit all mortgage banking activities.
Accordingly, the majority of the residential first lien mortgage pipeline is expected to be processed by the end of the first quarter of
2020. In order to manage loan run-off within the residential mortgage loan portfolio, the Company plans on buying first lien residential
mortgage loans, on a servicing released basis, from both the LLC and other third-party originators.
The following table presents a rollforward of loans held for sale, showing loans originated for sale and loans sold into the secondary
market, for the years ended December 31, 2019, 2018, and 2017. In addition, the volume of loans originated for the Company’s loan
portfolio as well as a statement of operations for the mortgage banking activities for the years ended December 31, 2019, 2018, and
2017. Since the mortgage banking activities were conducted within a division of the Bank, formal financial statements were not
prepared. The statement of operations presented below reflects only the direct costs associated with the Company’s mortgage banking
activities and is thus representative of the incremental after tax impact of exiting this activity.
(dollars in thousands)
Loans held for sale, January 1
Loans originated for sale
Loans held for sale acquired in First Mariner acquisition
Loans sold into the secondary market
Loans held for sale, December 31
Year Ended December 31,
2018
2017
2019
$
21,261
573,306
-
(563,857)
30,710
$
$
42,153
586,385
28,189
(635,466)
21,261
$
$
51,054
673,448
-
(682,349)
42,153
$
Loans originated for the Bank's portfolio
$
114,561
$
57,440
$
52,905
Statement of Operations:
Net interest income
Realized and unrealized gains on mortgage banking activity
Loan related fees and service charges
Total noninterest income
Salaries and benefits
Occupany
All other operating expenses
Total noninterest expense
Pretax contribution
Income tax expense (benefit)
After tax contribution
$
681
$
1,403
$
1,505
7,798
2,830
10,628
6,394
354
2,287
9,035
2,274
626
1,648
$
5,245
4,993
10,238
7,083
1,710
4,718
13,511
(1,870)
(515)
(1,355)
$
11,035
5,083
16,118
7,673
661
7,133
15,467
2,156
850
1,306
$
Since the Bank’s 91 employees that were engaged in mortgage banking activities will be hired by the LLC under the terms of the
agreement, no severance costs were recorded. However, the Company recorded $288 thousand of exit costs associated with change in
74
control and retention agreements. Since the LLC will sublease the office space that was used by these employees, no exit costs associated
with lease terminations were recorded.
Note 4: Cash and Due from Banks
Regulation D of the Federal Reserve Act requires that banks maintain reserve balances with the Federal Reserve Bank based principally
on the type and amount of their deposits. During 2019 and 2018, the Company maintained balances at the Federal Reserve (in addition
to vault cash) to meet the reserve requirements as well as balances to partially compensate for services. Additionally, the Company
maintained balances with the Federal Home Loan Bank and other domestic correspondent financial institutions as partial compensation
for services they provided to the Company.
Note 5: Investment Securities
The Company holds securities classified as available for sale and held to maturity.
The amortized cost and estimated fair values of investments are as follows:
December 31,
(in thousands)
Gross
2019
Gross
Amortized Unrealized Unrealized Estimated
Fair Value
Losses
Gains
Cost
2018
Gross
Gross
Amortized Unrealized Unrealized
Gains
Losses
Cost
Estimated
Fair Value
Available for sale
U.S. Government
Agencies
Mortgage-backed
Other investments
Held to maturity
Corporate debentures
$
66,428
139,918
5,510
$
963
2,848
4
$
79
67
20
$
67,312
142,699
5,494
$
130,088
90,242
3,011
$
428
364
-
$
119
146
10
$
130,397
90,460
3,001
$
211,856
$
3,815
$
166
$
215,505
$
223,341
$
792
$
275
$
223,858
$
7,750
$
147
$
-
$
7,897
$
9,250
$
45
$
42
$
9,253
The $1.5 million net decrease in held to maturity securities from December 31, 2018 to December 31, 2019 consisted of a $2.0 million
call and a $0.5 million purchase.
Gross unrealized losses and fair value by investment category and length of time the individual securities have been in a continuous
unrealized loss position at December 31, 2019 and December 31, 2018 are presented below:
December 31, 2019
(in thousands)
Available for sale
U.S. Government
Agencies
Mortgage-backed
Other investments
Held to maturity
Less than 12 months
Gross
Unrealized
Losses
Fair
Value
12 months or more
Gross
Unrealized
Losses
Fair
Value
Total
Fair
Value
Gross
Unrealized
Losses
$
10,689
35,512
-
$
79
60
-
$
-
975
2,990
-
$
7
20
$
10,689
36,487
2,990
$
79
67
20
$
46,201
$
139
$
3,965
$
27
$
50,166
$
166
Corporate debentures
$
-
$
-
$
-
$
-
$
-
$
-
75
December 31, 2018
(in thousands)
Available for sale
U.S. Government
Agencies
Mortgage-backed
Other investments
Held to maturity
Less than 12 months
Gross
Unrealized
Losses
Fair
Value
12 months or more
Total
Fair
Value
Gross
Unrealized
Losses
Fair
Value
Gross
Unrealized
Losses
$
3,049
26,197
3,001
$
3
54
10
$
13,887
2,107
-
$
116
92
-
$
16,936
28,304
3,001
$
119
146
10
$
32,247
$
67
$
15,994
$
208
$
48,241
$
275
Corporate debentures
$
2,458
$
42
$
-
$
-
$
2,458
$
42
The unrealized losses that existed were a result of market changes in interest rates since the original purchase. Management
systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires
management to consider various factors, which include (1) duration and magnitude of the decline in value, (2) the financial condition of
the issuer or issuers and (3) structure of the security. Securities in the portfolio with unrealized losses totaled 16 and 31 at December 31,
2019 and 2018, respectively.
An impairment loss is recognized in earnings if any of the following are true: (1) the Company intends to sell the debt security; (2) it is
more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis; or (3) the Company
does not expect to recover the entire amortized cost basis of the security. In situations where the Company intends to sell or when it is
more likely than not that the Company will be required to sell the security, the entire impairment loss must be recognized in earnings.
In all other situations, only the portion of the impairment loss representing the credit loss must be recognized in earnings, with the
remaining portion being recognized in stockholders’ equity as a component of other comprehensive income, net of deferred tax.
The amortized cost and estimated fair values of investments by contractual maturity are shown below:
(in thousands)
2019
2018
December 31,
Amounts maturing:
One year or less
After one through five years
After five through ten years
After ten years
Amortized
Cost
Estimated Fair
Value
Amortized
Cost
Estimated Fair
Value
$
1,497
49,166
33,576
135,367
$
1,500
50,048
33,915
137,939
$
38,936
88,175
19,873
85,607
$
38,892
88,513
19,921
85,785
$
219,606
$
223,402
$
232,591
$
233,111
At December 31, 2019 and December 31, 2018, $11.6 million and $42.3 million fair value of securities, respectively, were pledged as
collateral for both repurchase agreements and deposits of local government entities that require pledged collateral as a condition of
maintaining these deposit accounts. No single issuer of securities, except for government agencies and mortgage backed securities, had
outstanding balances that exceeded ten percent of stockholders’ equity at December 31, 2019.
Note 6: Nonmarketable Equity Securities
At December 31, 2019 and December 31, 2018, the Company’s investment in nonmarketable equity securities consisted of FHLB stock,
which is required for continued membership, of $14.2 million and $11.8 million, respectively. This investment is carried at cost.
76
Note 7: Loans and Leases
The Company makes loans and leases to customers primarily in the Greater Baltimore Maryland metropolitan area, and surrounding
communities. A substantial portion of the Company’s loan portfolio consists of loans to businesses secured by real estate and/or other
business assets.
The loan and lease portfolio segment balances at December 31, 2019 and December 31, 2018 are presented in the following table:
(in thousands)
Real estate
Construction and land
Residential - first lien
Residential - junior lien
Total residential real estate
Commercial - owner occupied
Commercial - non-owner occupied
Total commercial real estate
Total real estate loans
Commercial loans and leases
Consumer
Total loans and leases
December 31,
2019
Total
% of
Total
2018
Total
% of
Total
$
128,285
7.3
%
$
123,671
7.5
%
437,409
74,164
511,573
241,795
444,052
685,847
1,325,705
372,872
46,936
25.1
4.2
29.3
13.9
25.4
39.3
75.9
21.4
2.7
383,044
89,645
472,689
234,102
427,747
661,849
1,258,209
336,876
54,666
23.2
5.4
28.6
14.2
25.9
40.1
76.2
20.5
3.3
$
1,745,513
100.0
%
$
1,649,751
100.0
%
1 Includes leases of $6,382 and $7,607 at December 31, 2019 and 2018, respectively.
Net loan and lease origination fees, which are included in the amounts above, totaled $1.3 million and $307 thousand at December 31,
2019 and 2018, respectively.
Portfolio Segments
The Company currently manages its credit products and the respective exposure to credit losses (credit risk) by the following specific
portfolio segments (classes) which are levels at which the Company develops and documents its systematic methodology to determine
the allowance for credit losses attributable to each respective portfolio segment. These segments are:
(cid:120) Commercial business loans & leases – Commercial loans are made to provide funds for equipment and general corporate
needs. Repayment of a loan primarily uses the funds obtained from the operation of the borrower’s business. Commercial loans
also include lines of credit that are utilized to finance a borrower’s short-term credit needs and/or to finance a percentage of eligible
receivables and inventory. The Company’s loan portfolio also includes a small portfolio of equipment leases, which consists of
leases for essential commercial equipment used by small- and medium-sized businesses.
(cid:120) Construction and land loans – Commercial acquisition, development and construction loans are intended to finance the
construction of commercial and residential properties and include loans for the acquisition and development of land. Construction
loans represent a higher degree of risk than permanent real estate loans and may be affected by a variety of factors such as the
borrower’s ability to control costs and adhere to time schedules and the risk that constructed units may not be absorbed by the
market within the anticipated time frame or at the anticipated price. The loan commitment on these loans often includes an interest
reserve that allows the lender to periodically advance loan funds to pay interest charges on the outstanding balance of the loan.
(cid:120) Commercial owner occupied real estate loans – Commercial owner-occupied real estate loans consist of commercial mortgage
loans secured by owner occupied properties where an established banking relationship exists and involves a variety of property
types to conduct the borrower’s operations. The primary source of repayment for this type of loan is the cash flow from the business
and is based upon the borrower’s financial health and the ability of the borrower and the business to repay.
(cid:120) Commercial non-owner occupied real estate loans – Commercial non-owner occupied loans consist of properties where an
established banking relationship exists and involves investment properties for warehouse, retail, and office space with a history of
occupancy and cash flow. This commercial real estate category contains mortgage loans to the developers and owners of
77
commercial real estate where the borrower intends to operate or sell the property at a profit and use the income stream or proceeds
from the sale(s) to repay the loan.
(cid:120) Consumer loans – This category of loans includes primarily installment loans and personal lines of credit. Consumer loans include
installment loans used by customers to purchase automobiles, boats and recreational vehicles.
(cid:120) Residential first lien mortgage loans – The residential real estate category contains permanent mortgage loans principally to
consumers secured by residential real estate. Residential real estate loans are evaluated for the adequacy of repayment sources at
the time of approval, based upon measures including credit scores, debt-to-income ratios, and collateral values. Loans may be either
conforming or non-conforming.
(cid:120) Residential junior lien mortgage loans – This category of loans includes primarily home equity loans and lines. The home equity
category consists mainly of revolving lines of credit to consumers which are secured by residential real estate. These loans are
typically secured with second mortgages on the homes.
Acquired Credit Impaired Loans
The following table documents changes in the accretable discount on acquired credit impaired loans at December 31, 2019, 2018 and
2017:
(in thousands)
Balance at beginning of period
Impaired loans acquired
Accretion of fair value discounts
2019
$
877
-
(188)
December 31,
2018
$
-
1,055
(178)
2017
$
60
-
(60)
Balance at end of period
$
689
$
877
$
-
The table below presents the outstanding balances and related carrying amounts for all acquired credit impaired loans at the end of the
respective periods:
(in thousands)
At December 31, 2019
At December 31, 2018
Contractually
Required
Payments
Receivable
10,929
$
15,463
Carrying
Amount
$
8,706
11,446
Note 8: Credit Quality Assessment
Allowance for Credit Losses
Credit risk can vary significantly as losses, as a percentage of outstanding loans and leases, can vary widely during economic cycles and
are sensitive to changing economic conditions. The amount of loss in any particular type of loan or lease can vary depending on the
purpose of the loan or lease and the underlying collateral securing the loan or lease. Collateral securing commercial loans and leases
can range from accounts receivable to equipment to improved or unimproved real estate depending on the purpose of the loan or
lease. Home mortgage and home equity loans and lines are typically secured by first or second liens on residential real estate. Consumer
loans may be secured by personal property, such as auto loans or they may be unsecured loan products.
To control and manage credit risk, management has an internal credit process in place to determine whether credit standards are
maintained along with an in-house loan and lease administration accompanied by oversight and review procedures. The primary purpose
of loan and lease underwriting is the evaluation of specific lending risks that involves the analysis of the borrower’s ability to service
the debt as well as the assessment of the value of the underlying collateral. Oversight and review procedures include the monitoring of
the portfolio credit quality, early identification of potential problem credits and the management of the problem credits. As part of the
oversight and review process, the Company maintains an allowance for credit losses (the “allowance”) to absorb estimated and probable
losses in the loan and lease portfolio. The allowance is based on consistent, continuous review and evaluation of the loan and lease
portfolio, along with ongoing assessments of the probable losses and problem credits in each portfolio. While portions of the allowance
are attributed to specific portfolio segments, the entire allowance is available for credit losses inherent in the total loan and lease portfolio.
78
The following table provides information on the activity in the allowance for credit losses by the respective loan and lease portfolio
segment for the years ended December 31, 2019, 2018 and 2017:
(in thousands)
Allowance for credit losses:
Beginning balance
Charge-offs
Recoveries
Provision for credit losses
Construction Residential real estate
junior lien
first lien
and land
owner
occupied
non-owner
occupied
December 31, 2019
Commercial real estate
Commercial
loans
and leases
Consumer
loans
Total
$
741
$
1,170
$
292
$
735
$
4,057
$
2,644
$
234
$
9,873
(282)
80
717
(518)
-
1,604
(532)
115
603
(46)
-
99
(2,026)
17
920
(622)
357
(276)
(210)
2
526
(4,236)
571
4,193
Ending balance
$
1,256
$
2,256
$
478
$
788
$
2,968
$
2,103
$
552
$
10,401
Allowance allocated to:
individually evaluated for impairment
$
-
$
-
$
-
$
-
$
-
$
500
$
-
$
500
collectively evaluated for impairment
$
1,256
$
2,256
$
478
$
788
$
2,968
$
1,603
$
552
$
9,901
Loans and leases:
Ending balance
$
128,285
$
437,409
$
74,164
$
241,795
$
444,052
$
372,872
$
46,936
$
1,745,513
individually evaluated for impairment
$
481
$
13,131
$
786
$
566
$
1,725
$
2,360
$
127
$
19,176
collectively evaluated for impairment
$
127,804
$
424,278
$
73,378
$
241,229
$
442,327
$
370,512
$
46,809
$
1,726,337
December 31, 2018
Commercial real estate
Commercial
(in thousands)
Allowance for credit losses:
Beginning balance
Charge-offs
Recoveries
Provision for credit losses
Construction Residential real estate
junior lien
first lien
and land
owner
occupied
non-owner
occupied
loans
and leases
Consumer
loans
Total
$
735
(202)
-
$
668
(142)
8
$
177
(195)
10
$
617
(28)
-
$
1,410
(797)
32
$
2,529
(1,092)
88
$
23
(63)
4
$
6,159
(2,519)
142
208
636
300
146
3,412
1,119
270
6,091
Ending balance
$
741
$
1,170
$
292
$
735
$
4,057
$
2,644
$
234
$
9,873
Allowance allocated to:
individually evaluated for impairment
$
-
$
-
$
-
$
-
$
2,195
$
200
$
-
$
2,395
collectively evaluated for impairment
$
741
$
1,170
$
292
$
735
$
1,862
$
2,444
$
234
7,478
Loans and leases:
Ending balance
$
123,671
$
383,044
$
89,645
$
234,102
$
427,747
$
336,876
$
54,666
$
1,649,751
individually evaluated for impairment
$
1,449
$
13,259
$
1,137
$
1,268
$
5,018
$
2,455
$
174
24,760
collectively evaluated for impairment
$
122,222
$
369,785
$
88,508
$
232,834
$
422,729
$
334,421
$
54,492
$
1,624,991
Acquired loans from the First Mariner merger in 2018 were evaluated for impairment subsequent to the merger. No allowance was
required on these loans due to the assigned credit marks on these loans.
79
(in thousands)
Allowance for credit losses:
Beginning balance
Charge-offs
Recoveries
Provision for credit losses
Construction Residential real estate
junior lien
first lien
and land
owner
occupied
non-owner
occupied
December 31, 2017
Commercial real estate
Commercial
loans
and leases
Consumer
loans
Total
$
511
(155)
6
373
$
454
(133)
-
347
$
89
(31)
1
118
$
327
(235)
6
519
$
1,120
-
6
284
$
3,800
(1,605)
113
221
$
127
(108)
35
(31)
$
6,428
(2,267)
167
1,831
Ending balance
$
735
$
668
$
177
$
617
$
1,410
$
2,529
$
23
$
6,159
Allowance allocated to:
individually evaluated for impairment
$
202
$
-
$
29
$
-
$
11
$
668
$
-
$
910
collectively evaluated for impairment
$
533
$
668
$
148
$
617
$
1,399
$
1,861
$
23
$
5,249
Loans and leases:
Ending balance
$
74,398
$
194,896
$
43,047
$
170,408
$
260,802
$
188,729
$
4,328
$
936,608
individually evaluated for impairment
$
761
$
2,009
$
396
$
508
$
5,867
$
3,724
$
-
$
13,265
collectively evaluated for impairment
$
73,637
$
192,887
$
42,651
$
169,900
$
254,935
$
185,005
$
4,328
$
923,343
Integral to the assessment of the allowance process is an evaluation that is performed to determine whether a specific reserve on an
impaired credit is warranted. At such time an action plan is agreed upon for the particular loan or lease, an appraisal will be ordered
(for real estate based collateral) depending on the time elapsed since the prior appraisal, the loan or lease balance and/or the result of the
internal evaluation. The Company’s policy is to strictly adhere to regulatory appraisal standards. If an appraisal is ordered, no more
than a 45 day turnaround is requested from the appraiser, who is selected from an approved appraiser list. After receipt of the updated
appraisal, the Company’s Watch Committee will determine whether a specific reserve or a charge-off should be taken based upon an
impairment analysis. When potential losses are identified, a specific provision and/or charge-off may be taken, based on the then current
likelihood of repayment, that is at least in the amount of the collateral deficiency, and any potential collection costs, as determined by
the independent third party appraisal. Any further collateral deterioration may result in either further specific reserves being established
or additional charge-offs. The President and the Chief Lending Officer have the authority to approve a specific reserve or charge-off
between Watch Committee meetings to ensure that there are no significant time lapses during this process.
The Company’s systematic methodology for evaluating whether a loan or lease is impaired begins with risk-rating credits on an
individual basis and includes consideration of the borrower’s overall financial condition, resources and payment record, the sufficiency
of collateral and, in a select few cases, support from financial guarantors. In measuring impairment, the Company looks to the discounted
cash flows of the project itself or the value of the collateral as the primary sources of repayment of the loan or lease. The Company will
consider the existence of guarantees and the financial strength and wherewithal of the guarantors involved in any loan or lease
relationship as both a secondary source of repayment and for the potential as the primary repayment of the loan or lease.
The Company typically relies on recent third party appraisals of the collateral to assist in measuring impairment.
Management has established a credit process that dictates that structured procedures be performed to monitor these loans or leases
between the receipt of an original appraisal and the updated appraisal. These procedures include the following:
(cid:120) An internal evaluation is updated quarterly to include borrower financial statements and/or cash flow projections.
(cid:120)
The borrower may be contacted for a meeting to discuss an update or revised action plan which may include a request for additional
collateral.
Re-verification of the documentation supporting the Company’s position with respect to the collateral securing the loan or lease.
(cid:120)
(cid:120) At the Watch Committee meeting the loan may be downgraded and a specific reserve may be decided upon in advance of the receipt
of the appraisal if it is determined that the likelihood of repayment is in doubt.
The Company generally follows a policy of not extending maturities on non-performing loans and leases under existing terms. The
Company may extend the maturity of a performing or current loan or lease that may have some inherent weakness associated with the
loan or lease. Maturity date extensions only occur under terms that clearly place the Company in a position to assure full collection of
the loan or lease under the contractual terms and/or terms at the time of the extension that may eliminate or mitigate the inherent
weakness in the loan or lease. These terms may incorporate, but are not limited to additional assignment of collateral, significant balance
curtailments/liquidations and assignments of additional project cash flows. Guarantees may be a consideration in the extension of loan
or lease maturities, but the Company does not extend loans or leases based solely on guarantees. As a general matter, the Company
does not view extension of a loan or lease to be a satisfactory approach to resolving non-performing credits. On an exception basis,
certain performing loans and leases that have displayed some inherent weakness in the underlying collateral values, an inability to
80
comply with certain loan or lease covenants which are not affecting the performance of the credit or other identified weakness may be
extended.
Collateral values or estimates of discounted cash flows (inclusive of any potential cash flow from guarantees) are evaluated to estimate
the probability and severity of potential losses. A specific amount of impairment is established based on the Company’s calculation of
the probable loss inherent in the individual loan or lease. The actual occurrence and severity of losses involving impaired credits can
differ substantially from estimates.
Credit risk profile by portfolio segment based upon internally assigned risk assignments are presented below:
(in thousands)
Cre dit quality indicators:
Not classified
Special mention
Substandard
Doubtful
Construction Residential real estate
junior lien
first lien
and land
owner
occupied
non-owner
occupied
December 31, 2019
Commercial real estate
Commercial
loans
and leases
Consumer
loans
Total
$
127,804
-
481
-
$
425,247
-
12,162
-
$
73,378
-
786
-
$
241,229
-
566
-
$
442,327
-
1,725
-
$
370,837
-
2,035
-
$
46,809
-
127
-
$
1,727,631
-
17,882
-
Total
$
128,285
$
437,409
$
74,164
$
241,795
$
444,052
$
372,872
$
46,936
$
1,745,513
(in thousands)
Credit quality indicators:
Not classified
Special mention
Substandard
Doubtful
Construction Residential real estate
junior lien
first lien
and land
owner
occupied
non-owner
occupied
December 31, 2018
Commercial real estate
Commercial
loans
and leases
Consumer
loans
Total
$
122,270
78
1,323
-
$
370,766
-
12,278
-
$
88,507
-
1,138
-
$
228,408
3,877
1,817
-
$
422,591
-
5,156
-
$
334,152
-
2,724
-
$
54,492
-
174
-
$
1,621,186
3,955
24,610
-
Total
$
123,671
$
383,044
$
89,645
$
234,102
$
427,747
$
336,876
$
54,666
$
1,649,751
(cid:120)
(cid:120)
Special Mention - A Special Mention asset 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 institution’s credit position
at some future date. Special Mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant
adverse classification.
Substandard - Substandard loans and leases are inadequately protected by the current sound worth and paying capacity of the
obligor or of the collateral pledged, if any. Loans and leases so classified must have a well-defined weakness or weaknesses that
jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the
deficiencies are not corrected.
(cid:120) Doubtful - Loans and leases classified Doubtful have all the weaknesses inherent in those classified Substandard with the added
characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values,
highly questionable and improbable.
Loans and leases classified Special Mention, Substandard, Doubtful or Loss are reviewed at least quarterly to determine their appropriate
classification. All commercial loan and lease relationships are reviewed annually. Non-classified residential mortgage loans and
consumer loans are not evaluated unless a specific event occurs to raise the awareness of a possible credit deterioration.
81
An aged analysis of past due loans and leases are as follows:
(in thousands)
Analysis of past due loans and leases:
Accruing loans and leases current
Accruing loans and leases past due:
30-59 days past due
60-89 days past due
Greater than 90 days past due
Total past due
Non-accrual loans and leases 1
Construction Residential real estate
and land
first lien
junior lien
owner
occupied
non-owner
occupied
December 31, 2019
Commercial real estate
Commercial
loans
and leases
Consumer
loans
Total
$
127,804
$
418,668
$
71,634
$
241,062
$
442,132
$
370,877
$
46,776
$
1,718,953
-
-
-
-
3,312
3,220
47
6,579
481
12,162
748
996
-
1,744
786
-
167
-
167
566
195
-
-
195
35
-
-
35
19
14
-
33
4,309
4,397
47
8,753
1,725
1,960
127
17,807
Total loans and leases
$
128,285
$
437,409
$
74,164
$
241,795
$
444,052
$
372,872
$
46,936
$
1,745,513
(in thousands)
Analysis of past due loans and leases:
Accruing loans and leases current
Accruing loans and leases past due:
30-59 days past due
60-89 days past due
Greater than 90 days past due
Total past due
Non-accrual loans and leases 1
Construction Residential real estate
and land
first lien
junior lien
owner
occupied
non-owner
occupied
December 31, 2018
Commercial real estate
Commercial
loans
and leases
Consumer
loans
Total
$
121,831
$
361,522
$
86,884
$
232,834
$
422,297
$
334,058
$
54,483
$
1,613,909
-
166
351
517
6,433
2,241
570
9,244
1,323
12,278
937
687
-
1,624
1,137
-
-
-
-
432
-
-
432
94
307
-
401
9
-
-
9
1,268
5,018
2,417
174
7,905
3,401
921
12,227
23,615
Total loans and leases
$
123,671
$
383,044
$
89,645
$
234,102
$
427,747
$
336,876
$
54,666
$
1,649,751
1 Included are acquired credit impaired loans where the Company amortizes the accretable discount into interest income, however these loans do not
accrue interest based on the terms of the loan.
Total loans and leases either in non-accrual status or in excess of 90 days delinquent totaled $17.9 million or 1.0% of total loans and
leases outstanding at December 31, 2019, which represents a $6.6 million decrease from $24.5 million at December 31, 2018.
The Company had no impaired leases for the years ended December 31, 2019 and 2018. The impaired loans for the years ended
December 31, 2019 and 2018 are as follows:
December 31, 2019
(in thousands)
Impaired loans:
Recorded investment 1
With an allowance recorded
With no related allowance recorded
Related allowance
Unpaid principal
Average balance of impaired loans
Interest income recognized
Construction Residential real estate
junior lien
first lien
and land
Commercial real estate Commercial
non-owner
occupied
loans
and leases
owner
occupied
Consumer
loans
Total
$
481
$
13,131
$
786
$
566
$
1,725
$
2,360
$
127
$
19,176
-
481
-
667
814
5
-
13,131
-
14,371
15,586
400
-
786
-
986
1,338
106
-
566
-
583
594
30
-
1,725
-
2,023
2,105
11
554
1,806
500
3,584
4,392
195
-
127
-
130
141
1
554
18,622
500
22,344
24,970
748
82
(in thousands)
Impaired loans:
Recorded investment 1
Construction Residential real estate
junior lien
first lien
and land
December 31, 2018
Commercial real estate Commercial
non-owner
occupied
loans
and leases
owner
occupied
Consumer
loans
Total
$
1,449
$
13,259
$
1,137
$
1,268
$
5,018
$
2,455
$
174
$
24,760
With an allowance recorded
-
-
With no related allowance recorded
1,449
13,259
Related allowance
Unpaid principal
Average balance of impaired loans
Interest income recognized
-
1,873
1,873
-
-
14,425
15,446
474
-
1,137
-
1,456
1,448
51
-
1,268
-
1,569
1,569
16
2,816
2,202
2,195
5,295
5,340
5
200
2,255
200
4,868
5,556
125
-
174
-
185
185
5
3,016
21,744
2,395
29,671
31,417
676
1 Included are acquired credit impaired loans where the Company amortizes the accretable discount into interest income, however these loans do
not accrue interest based on the terms of the loan.
Included in the total impaired loans above were non-accrual loans of $17.8 million and $23.6 million at December 31, 2019 and 2018,
respectively. Interest income that would have been recorded if non-accrual loans had been current and in accordance with their original
terms, was $748 thousand, $1.2 million and $898 thousand for the years ended December 31, 2019, 2018 and 2017, respectively.
Loans may have their terms restructured (e.g., interest rates, loan maturity date, payment and amortization period, etc.) in circumstances
that provide payment relief to a borrower experiencing financial difficulty. Such restructured loans are considered impaired loans that
may either be in accruing status or non-accruing status. Non-accruing restructured loans may return to accruing status provided there is
a sufficient period of payment performance in accordance with the restructure terms. Loans may be removed from the restructured
category in the year subsequent to the restructuring if they have performed based on all of the restructured loan terms.
The Company had no troubled debt restructured (“TDR”) leases at December 31, 2019 and December 31, 2018. The TDR loans at
December 31, 2019 and 2018 are as follows:
(dollars in thousands)
Construction and land
Residential real estate - first lien
Commercial loans and leases
Number
of Loans
1
2
1
Non-Accrual
Status
$
December 31, 2019
Number
of Loans
-
2
2
125
274
414
Accrual
Status
$
-
968
367
Total
TDRs
$
125
1,242
781
4
$
813
4
$
1,335
$
2,148
(dollars in thousands)
Construction and land
Residential real estate - first lien
Commercial - non-owner occupied
Commercial loans and leases
Number
of Loans
-
2
2
1
Non-Accrual
Status
-
$
291
2,815
514
December 31, 2018
Number
of Loans
1
2
-
-
Accrual
Status
$
Total
TDRs
$
125
1,273
2,815
514
125
982
-
-
5
$
3,620
3
$
1,107
$
4,727
83
A summary of TDR loan modifications outstanding and performance under modified terms is as follows:
(in thousands)
Construction and land
Extension or other modification
Residential real estate - first lien
Extension or other modification
Commercial loans
Extension or other modification
Forbearance
December 31, 2019
Not Performing
to Modified
Terms
Performing
to Modified
Terms
Related
Allowance
Total
TDRs
$
-
$
125
$
-
$
125
-
-
-
274
-
414
968
367
-
1,242
367
414
Total troubled debt restructured loans
$
-
$
813
$
1,335
$
2,148
(in thousands)
Construction and land
Extension or other modification
Residential real estate - first lien
Extension or other modification
Commercial RE - non-owner occupied
Rate modification
Commercial loans
Forbearance
December 31, 2018
Not Performing
to Modified
Terms
Performing
to Modified
Terms
Related
Allowance
Total
TDRs
$
-
$
-
$
125
$
125
-
2,195
-
291
2,815
514
982
-
-
1,273
2,815
514
Total troubled debt restructured loans
$
2,195
$
3,620
$
1,107
$
4,727
There were two new commercial loans with terms extended and their payments modified during 2019 totaling $367 thousand that are
currently performing in accordance with their modified terms. Additionally, the land development loan was downgraded from
performing to non-performing in 2019 and two commercial real estate loans totaling $2.4 million at December 31, 2018 were
subsequently charged-off in 2019.
Performing TDRs were in compliance with their modified terms and there are no further commitments associated with these loans.
Management routinely evaluates other real estate owned (“OREO”) based upon periodic appraisals. For the years ended December 31,
2019, 2018 and 2017 there were additional allowances recorded of $473 thousand, $352 thousand and $581 thousand, respectively, as
the current appraised value, less estimated cost to sell, was not sufficient to cover the recorded OREO amount. For 2019 there were
three residential first lien loans totaling $1.4 million transferred from loans to OREO. In 2019, the Company sold two land development
properties with a carrying value totaling $49 thousand, two commercial real estate properties with a carrying value of $1.1 million and
four residential first lien loan with a carrying value of $1.1 million, recording a $28 thousand gain from the sale of these properties. At
December 31, 2019, there were three residential first lien loans totaling $2.7 million, and one residential junior lien loan of $23 thousand
in the process of foreclosure.
Note 9: Derivatives and Hedging Activities
Non-designated Hedges of Interest Rate Risk
The Company maintains interest rate swap contracts with customers that are classified as non-designated hedges and are not speculative
in nature. These agreements are designed to convert customer’s variable rate loans with the Company to fixed rate. These interest rate
swaps are executed with loan customers to facilitate a respective risk management strategy and allow the customer to pay a fixed rate
interest to the Company. These interest rate swaps are simultaneously hedged by executing offsetting interest rate swaps with unrelated
market counterparties to minimize the net risk exposure to the Company resulting from the transactions and allow the Company to
receive a variable rate interest. The interest rate swaps pay and receive interest based on a floating rate based on one month LIBOR
plus credit spread with payment being calculated on the notional amount. The interest rate swaps are settled with varying maturities.
84
As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value
of both the customer swaps and the offsetting swaps are recognized directly in earnings. The fair value of the interest swap derivatives
are recorded in other assets and other liabilities. All changes in fair value are recorded through earnings as noninterest income. For
2019 and 2018, the Company recorded a net loss of $5 thousand and $6 thousand, respectively related to the change in fair value of
these interest rate swap derivatives.
The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the
Consolidated Balance Sheet at December 31, 2019 and December 31, 2018:
(dollars in thousands)
Not designated hedges of interest rate risk:
Customer related interest rate contracts:
Balance Sheet
Location
Notional
Amount
December 31, 2019
Estimated Fair Value
Gain
Loss
Matched interest rate swaps with borrowers
Other assets and
other liabilities
Matched interest rate swaps with counterparty Other assets and
other liabilities
$
2,853
$
217
$
-
$
2,853
$
-
$
228
(dollars in thousands)
Not designated hedges of interest rate risk:
Customer related interest rate contracts:
Balance Sheet
Location
Notional
Amount
December 31, 2018
Estimated Fair Value
Gain
Loss
Matched interest rate swaps with borrowers
Other assets and
other liabilities
Matched interest rate swaps with counterparty Other assets and
other liabilities
$
3,061
$
100
$
-
$
3,061
$
-
$
106
Note 10: Goodwill and Other Intangible Assets
Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate
that the asset would more-likely-than-not reduce the fair value below the carrying amount. The Bank has one reporting unit, which is
the core banking operation.
Based upon updated information, the goodwill relating to the First Mariner merger was adjusted downward in the first quarter of 2019
by $4.7 million to reflect revised valuations as detailed in Note 2.
The table below shows goodwill balances at December 31, 2019 and December 31, 2018.
(in thousands)
Goodwill
Banking
December 31,
2019
2018
$
65,949
$
70,697
Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in either business combinations or
other purchases of deposits and are amortized based upon the estimated economic benefits received. The gross carrying amount and
accumulated amortization of other intangible assets are as follows:
(in thousands)
Amortizing intangible assets:
Core deposit intangible
December 31, 2019
Gross
Carrying
Amount
Accumulated
Amortization
Net
Carrying
Amount
Weighted
Average
Remaining Life
(Years)
$
16,135
$
7,666
$
8,469
3.7
85
(in thousands)
Amortizing intangible assets:
Core deposit intangible
Gross
Carrying
Amount
December 31, 2018
Accumulated
Amortization
Net
Carrying
Amount
Weighted
Average
Remaining Life
(Years)
$
16,135
$
4,653
$
11,482
4.7
Estimated future amortization expense for amortizing intangible assets for the years ending December 31, is as follows:
(in thousands)
2020
2021
2022
2023
2024
$
2,674
2,326
1,915
1,298
256
Total amortizing intangible assets
$
8,469
Based upon an annual impairment analysis performed in 2019, it was determined that there was not an impairment of the carrying value
of either the goodwill or core deposit intangible.
Note 11: Bank Premises and Equipment
Premises and equipment include the following at:
(in thousands)
Land
Building and leasehold improvements
Furniture and equipment
Software
Less: accumulated depreciation and amortization
December 31,
2019
$
8,849
35,960
6,028
387
2018
$
10,239
35,571
6,686
419
51,224
8,500
52,915
7,778
Net premises and equipment
$
42,724
$
45,137
Depreciation and amortization expense for premises and equipment were $2.3 million, $2.1 million and $1.3 million for the years
ended December 31, 2019, 2018 and 2017, respectively.
Note 12: Leases
On January 1, 2019, the Company adopted the requirements of ASU 2016-02, Leases (Topic 842). The objective of this ASU, along
with several related ASUs subsequently issued, is to increase transparency and comparability between organizations that enter into lease
agreements. The most significant change is the requirement to recognize right of use (“ROU”) assets and lease liabilities for leases
classified as operating leases. The standard requires disclosures to meet the objective of enabling users of financial statements to assess
the amount, timing, and uncertainty of cash flows arising from leases. As part of the transition to the new standard, the Company was
required to measure and recognize leases that existed at January 1, 2019, and the Company elected a modified retrospective approach.
For leases existing at the effective date, the Company elected the package of three transition practical expedients and therefore did not
reassess whether an arrangement is or contains a lease, did not reassess lease classification, and did not reassess what qualifies as an
initial direct cost.
The adoption of Topic 842 resulted in the initial recognition of operating ROU assets and related lease liabilities of $18.0 million on
January 1, 2019, which were recorded in other assets and other liabilities, respectively. As of the adoption date, there were no lease
incentives that would have impacted the ROU asset balance.
In 2019, with the execution of the Company’s branch optimization initiative, under which the closing of three branch locations and the
consolidation of two other existing branch locations was announced, a $3.6 million charge to noninterest expenses, primarily related to
the early termination of existing lease arrangements for the closing locations, was recorded in the second quarter of 2019. The closing
86
of the three locations occurred in the third quarter of 2019, and the consolidation of the two branch locations into a single new location
is expected to occur in the first quarter of 2020. The early termination of these leases reduced the initial $18.0 million in ROU assets
recorded on January 1, 2019 to $14.5 million at December 31, 2019.
The Company has operating leases on land and buildings with remaining lease terms ranging from 2020 to 2030. Many of the leases
include renewal options, with renewal terms generally extending up to 10 years.
Operating leases included the following at:
(in thousands)
Operating Leases
Operating leases ROU
Operating lease liabilities
December 31, 2019
$
14,092
$
14,507
The components of lease expense were as follows:
(in thousands)
Operating lease cost
Sublease income
Amortization of ROU assets
Lease liability maturities are as follows:
(in thousands)
2020
2021
2022
2023
2024
Thereafter
Total future lease payments
Discount of cash flows
2019
$
1,899
(562)
150
December 31,
2018
$
3,693
(534)
-
2017
$
1,995
(387)
-
$
1,487
$
3,159
$
1,608
$
1,636
1,546
1,404
1,257
1,055
11,341
$
18,239
(3,732)
Present value on net future lease payments
$
14,507
Weighted average remaining term in years
Weighted average discount rate
6.89
3.02
%
Note 13: Deposits
The following table details the composition of deposits and the related percentage mix of total deposits, respectively, at the dates
indicated:
(dollars in thousands)
Noninterest-bearing demand
Interest-bearing checking
Money market accounts
Savings
Certificates of deposit $250 and over
Certificates of deposit under $250
December 31,
2019
2018
Amount
$
468,975
183,447
360,711
130,141
77,782
493,309
% of
Total
%
27
11
21
7
5
29
Amount
$
429,200
227,322
356,130
134,893
82,511
455,750
% of
Total
26
%
13
21
8
5
27
Total deposits
$
1,714,365
100
%
$
1,685,806
100
%
87
The following table presents the maturity schedule for time deposits maturing within years ending December 31:
(in thousands)
2020
2021
2022
2023
2024
$
458,908
87,877
14,613
5,630
4,063
Total time deposits
$
571,091
Interest expense on deposits for the twelve months ended December 31, 2019, December 31, 2018 and December 31, 2017 were as
follows:
(in thousands)
Interest-bearing checking
Savings and money market
Certificates of deposit
Total
2019
$
912
3,063
11,487
December 31,
2018
$
554
2,393
5,593
2017
$
168
1,217
2,612
$
15,462
$
8,540
$
3,997
Note 14: Short-Term Borrowings
Short-term borrowings consist of overnight securities sold under agreement to repurchase, overnight unsecured master notes, federal
funds purchased, and FHLB advances with a final remaining maturity of less than one year. Information relating to short-term
borrowings is presented below:
December 31,
2019
2018
(dollars in thousands)
Amount
Rate
Maximum
Month-End
Balance
Amount
Rate
Maximum
Month-End
Balance
FHLB advances
Repurchase agreements 1
Federal funds purchased
$
230,000
6,127
-
1.70
0.19
-
%
$
273,000
15,293
-
$
118,000
16,576
-
%
2.34
0.21
-
$
310,023
25,291
30,000
Total short-term borrowings
$
236,127
1.66
%
$
134,576
2.08
%
Averages for the year:
FHLB advances
Repurchase agreements 1
Federal funds purchased
$
148,460
7,122
625
%
2.30
0.19
2.30
Total short-term borrowings
$
156,207
2.20
%
1 Includes overnight unsecured master notes
$
125,108
18,927
2,015
%
1.80
0.19
2.04
$
146,050
1.59
%
The Company pledges mortgage-backed securities, based upon their fair value, as collateral for 100% of the principal and accrued
interest of its repurchase agreements. At December 31, 2019 and 2018 there were $6.6 million and $16.6 million, respectively, in
investment securities pledged under these agreements.
At December 31, 2019, the Company had an available line of credit for $573.3 million with the FHLB under which its borrowings are
limited to $435.4 million based on pledged collateral with $285.3 million borrowed against the line (including amounts classified as
long-term borrowings). At December 31, 2018, the FHLB line of credit was $538.4 million under which $345.9 million was available
based on pledged collateral with $232.6 million borrowed against the line (including amounts classified as long-term borrowings). Under
a blanket lien, the Company has pledged qualifying residential mortgage loans, home equity lines of credit, and commercial real estate
loans as collateral for this borrowing arrangement in the aggregate amount of $615.6 million and $518.0 million at December 31, 2019
and 2018, respectively.
88
In addition, the Company has unsecured lines of credit with correspondent banks of $65.0 million at both December 31, 2019 and 2018.
There were no outstanding borrowings against these lines of credit at either December 31, 2019 or 2018.
Note 15: Long-Term Borrowings
Long-term borrowings at December 31, 2019 and 2018 consisted of the following:
(in thousands)
Federal Home Loan Bank Advances
0.63% Due 2029
0.56% Due 2029
0.74% Due 2029
1.62% Due 2024
2.48% Due 2020
2.53% Due 2020
2.67% Due 2020
2.62% Due 2020
2.71% Due 2020
1
1
1
2
2
2
2
2
2
Total principal of long-term borrowings at FHLB
Subordinated debentures
3
2.48% Due 2035
6.00% Due 2028
4
Total principal of subordinated debentures
Total principal of long-term borrowings
Purchase accounting adjustment on acquired debt
Cost of issuance of subordinated debt
3
4
December 31,
2019
2018
$
15,000
20,000
15,000
5,000
-
$
-
-
-
-
14,000
-
-
-
-
55,000
5,000
25,000
30,000
85,000
(1,302)
(457)
15,000
30,000
30,000
25,000
114,000
5,000
25,000
30,000
144,000
(1,384)
(539)
Total long-term borrowings
$
83,241
$
142,077
(1) Convertible rate advances
(2) Fixed rate hybrid advances
(3) Subordinated debt acquired in 2015. Carrying value after purchase accounting adjustments of $3.7 million at December 31,
2019. Interest adjusts quarterly at the rate of three month LIBOR plus 1.48%
(4) Subordinated debt issued in 2018. Carrying value net of issuance costs of $24.5 million at December 31, 2019. Initial rate of
6.00% per annum for five years. Subsequent rate adjusts quarterly at the rate of three month LIBOR plus 3.02%
On December 6, 2018, the Company entered into Subordinated Note Purchase Agreements with certain Purchasers pursuant to which
the Company sold and issued $25,000,000 in aggregate principal amount of 6.00% Fixed-to-Floating Rate Subordinated Notes due
December 6, 2028. The Notes were issued by the Company to the Purchasers at a price equal to 100% of their face amount in reliance
on the exemptions from registration available under Section 4(a)(2) of the Securities Act and the provisions of Regulation D thereunder.
The Company used the net proceeds of this offering for general corporate purposes, to provide for continued growth and to supplement
its regulatory capital ratios.
The Notes have been structured to qualify initially as Tier 2 capital for regulatory capital purposes. The Note will initially bear interest
at a rate of 6.00% per annum from and including December 6, 2018, to but excluding December 6, 2023, with interest during this period
payable semi-annually in arrears. From an including December 6, 2023, to but excluding the maturity date or early redemption date, the
interest rate will reset quarterly to an annual floating rate equal to three-month LIBOR, plus 302 basis points, with interest during this
period payable quarterly in arrears. The Notes are redeemable by the Company at its option, in whole or in part, on or after December
6, 2023.
As a part of the acquisition of Patapsco Bancorp, Inc. (“Patapsco Bancorp”) in 2015, Bancorp assumed debt originally issued by Patapsco
Bancorp. In 2005 Patapsco Statutory Trust I, a Connecticut statutory business trust and an unconsolidated wholly-owned subsidiary of
Patapsco Bancorp and now of Bancorp (the “Trust”), issued $5 million of capital trust pass-through securities to investors. The interest
89
rate currently adjusts on a quarterly basis at the rate of the three month LIBOR plus 1.48%. The Trust purchased $5,155,000 of junior
subordinated deferrable interest debentures from Patapsco Bancorp. The debentures are the sole asset of the Trust. Patapsco Bancorp
also fully and unconditionally guaranteed the obligations of the Trust under the capital securities, which guarantee became an obligation
of Bancorp upon its acquisition of Patapsco Bancorp. The capital securities are redeemable by Bancorp at par. The capital securities
must be redeemed upon final maturity of the subordinated debentures on December 31, 2035.
Note 16: Income Taxes
Federal and state income tax expense (benefit) consists of the following for the years ended:
(in thousands)
Current federal income tax
Current state income tax
Deferred federal income tax
Deferred state income tax
2019
-
$
-
3,986
1,206
December 31,
2018
-
$
-
(627)
(270)
2017
$
3,243
1,038
(968)
(161)
Total income tax expense (benefit)
$
5,192
$
(897)
$
3,152
A reconciliation of the statutory federal income tax expense (benefit) to the Company’s effective tax (benefit) rate for the years ended
follows:
(in thousands)
Statutory federal income tax expense (benefit)
State income taxes, net of federal
Amount
$
4,635
2019
2018
2017
Percentage
of Pretax
Income
Amount
21.0
%
$
(992)
Percentage of
Pretax Income
21.0
Amount
%
$
3,520
Percentage of
Pretax Income
34.0
%
income tax benefit
Bank owned life insurance
Acquisition related costs
Revaluation of deferred taxes
Correction of error
Other, net
953
(568)
-
-
-
172
4.3
(2.6)
-
-
-
0.8
(213)
(162)
316
-
-
154
4.5
3.4
(6.7)
-
-
(3.3)
579
(258)
115
268
(675)
(396)
5.6
(2.5)
1.1
2.6
(6.5)
(3.8)
Total income tax expense (benefit)
$
5,192
23.5
%
$
(897)
19.0
%
$
3,152
30.4
%
Income tax expense for 2019 was favorably impacted by a 2019 U.S. Treasury Department change in tax regulations that provided for
retroactive application to the taxability of income from Bank Owned Life Insurance (“BOLI”) contracts that were acquired in certain
tax-free merger transactions. At the time of the First Mariner merger, the Company recorded a deferred tax liability of $4.6 million that
represented the combined federal and state income tax payable on the acquired balance of BOLI contracts. Based on the increase in the
cash surrender value of the BOLI contracts for the remainder of 2018, the balance of the deferred tax liability increased to $4.8 million
as of December 31, 2018. As a result of the change in tax regulations during the first quarter of 2019, the Company recognized a $232
thousand reduction of tax expense in 2019 that pertained to BOLI income that was earned, and initially treated as subject to income tax,
in 2018. In addition, the associated $4.8 million deferred tax liability was eliminated with a corresponding $4.6 million decrease in
goodwill.
In contrast to the reported pre-tax book income and the associated income tax expense recognized for 2019, the Company’s income tax
benefit for 2018 was the result of the loss incurred for the year. The benefit for 2018 was reduced by the impact of various merger-
related non-deductible costs.
Income tax expense for 2017 was adversely impacted by the adjustment of the Company’s deferred tax assets and liabilities related to
the reduction in the U.S. federal statutory income tax rate to 21% under the Tax Cuts and Jobs Act. As a result of the new law, the
Company recognized a net tax expense totaling $268 thousand. Income tax expense for 2017 was also impacted by a correction of an
overstatement of taxes that resulted from incorrectly classifying certain acquired loan fair value adjustments on acquired credit impaired
loans. As a result, for the year 2017, the Company recognized tax benefits totaling $675 thousand related to the 2015 through 2016 tax
years.
90
The following table is a summary of the tax effect of temporary differences that give rise to a significant portion of deferred tax assets
and liabilities:
(in thousands)
Deferred tax assets:
Net operating losses
Allowance for credit losses
Valuation on foreclosed real estate
Supplemental executive benefit plans
Stock-based compensation
Deferred loan fees and costs, net
Fair value adjustments for acquired assets and liabilities
Depreciation and amortization
Historic tax credits
Other assets
Total deferred tax assets
Deferred tax liabilities:
Core deposit intangible
Fair value adjustments for acquired assets and liabilities
Bank owned life insurance
Unrealized gain on securities
Depreciation and amortization
Total deferred tax liabilities
Net deferred tax assets
December, 31
2019
2018
$
30,010
2,862
406
559
8
185
3,003
-
1,933
1,680
40,646
$
35,415
2,717
617
782
29
576
4,007
276
-
605
45,024
2,130
1,468
-
1,004
34
4,636
36,010
$
2,929
1,898
4,802
110
-
9,739
35,285
$
Based on management’s belief that it is more likely than not that all net deferred tax assets will be realized, there was no valuation
allowance at either December 31, 2019 or 2018.
The Company's operating loss for the year ended December 31, 2018 generated a federal tax net operating loss of $8.0 million which
may be carried forward indefinitely subject to a maximum annual limitation of 80% of taxable income. In addition, as part of the
Company’s recent acquisitions, the Company assumed federal tax net operating loss carryforwards. The remaining balance of acquired
net operating loss carryforwards totaled approximately $103.5 million and $123.8 million at December 31, 2019 and 2018, respectively.
The acquired loss carryforwards can be deducted annually from future taxable income through 2039, subject to various annual
limitations.
Currently, tax years ending after December 31, 2014 are considered as open for examination by federal and state taxing authorities.
Tax Cuts and Jobs Act. The Tax Cuts and Jobs Act was enacted on December 22, 2017. Among other things, the new law (i) established
a new, flat corporate federal statutory income tax rate of 21%, (ii) eliminated the corporate alternative minimum tax and allows the use
of any tax net operating loss carryforwards to offset regular tax liability for any subsequent taxable year, (iii) limits the deduction for
net interest expense incurred by U.S. corporations, (iv) allows businesses to immediately expense, for tax purposes, the cost of new
investments in certain qualified depreciable assets, (v) eliminates or reduces certain deductions related to meals and entertainment
expenses, (vi) modifies the limitation on excessive employee remuneration to eliminate the exception for performance-based
compensation and clarifies the definition of a covered employee and (vii) limits the deductibility of deposit insurance premiums for
banks with $10 billion or more in assets. The Tax Cuts and Jobs Act also significantly changes U.S. tax law related to foreign operations,
however, such changes do not currently impact the Company.
As stated above, as a result of the enactment of the Tax Cuts and Jobs Act, the Company re-measured its deferred tax assets and liabilities
based upon the newly enacted U.S. statutory federal income tax rate of 21%, which is the tax rate at which assets and liabilities are
expected to reverse in the future. Nonetheless, for the year 2017 the Comapny recognized a tax expense related to the re-measurement
of our deferred tax assets and liabilities totaling $268 thousand.
91
Note 17: Related Party Loans and Deposits
In the normal course of business, loans are made to officers and directors of the Company, as well as to their related interests. In the
opinion of management, these loans are consistent with sound banking practices, are within regulatory lending limitations and do not
involve more than the normal risk of collectability.
Total outstanding balances to the Company’s executive officers, directors and their related interests are presented below.
(in thousands)
Balance January 1
Additions
Change in status
Repayments
December 31,
2019
$
7,218
6,519
(941)
(9,216)
2018
$
19,297
9,347
(11,412)
(10,014)
Balance December 31
$
3,580
$
7,218
In addition to the outstanding balances above, total unfunded commitments to these parties at December 31, 2019 and December 31,
2018 were $14.0 million and $21.7 million, respectively. The Bank also routinely enters into deposit relationships with its officers and
directors in the normal course of business. These deposit accounts bear the same terms and conditions for comparable deposit accounts
of unrelated parties and totaled $21.6 million at December 31, 2019 and $52.0 million at December 31, 2018.
Note 18: Financial Instruments with Off-Balance Sheet Risk and Contingencies
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business. These financial instruments
may include commitments to extend credit, standby letters of credit and purchase commitments. The Company uses these financial
instruments to meet the financing needs of its customers. Financial instruments involve, to varying degrees, elements of credit, interest
rate, and liquidity risk. These do not represent unusual risks, and management does not anticipate any losses which would have a
material effect on the accompanying financial statements.
Outstanding loan commitments and lines and letters of credit are as follows:
(in thousands)
Unfunded loan commitments
Unused lines of credit
Letters of credit
December 31,
2019
2018
$
77,314
309,519
13,853
$
104,466
282,822
16,661
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the
contract. The Company generally requires collateral to support financial instruments with credit risk on the same basis as it does for
on-balance sheet instruments. The collateral is based on management’s credit evaluation of the counterparty. Commitments have 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 drawn upon, the total commitment amount does not necessarily represent future cash requirements. Each customer’s
credit-worthiness is evaluated on a case-by-case basis.
Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party.
In the normal course of its business, the Company is involved in litigation arising from banking, financial, and other activities it conducts.
Management, after consultation with legal counsel, does not anticipate that the ultimate liability, if any, arising out of these matters will
have a material effect on the Company’s financial condition, operating results or liquidity.
92
Note 19: Stock Options and Stock Awards
Bancorp’s equity incentive plan provides for awards of nonqualified and incentive stock options as well as vested and non-vested
common stock awards. As of December 31, 2019, 564,414 shares are reserved for issuance pursuant to future grants under our stock
incentive plan. Employee stock options can be granted with exercise prices at the fair market value (as defined within the plan) of the
stock at the date of grant and with terms of up to ten years and typically vest over a three to five year period. Except as otherwise
permitted in the plan, upon termination of employment for reasons other than retirement, permanent disability or death, the option
exercise period is reduced or the options are canceled.
Stock awards may also be granted to non-employee members of the Company’s board of directors (the “Board of Directors” or “Board”)
as compensation for attendance and participation at meetings of the Board of Directors and meetings of the various committees of the
Board. In 2019, 2018 and 2017, Bancorp issued 9,202, 11,868 and 11,404 shares of common stock, respectively, to directors as
compensation for their service.
Stock Options
The fair value of Bancorp’s stock options granted as compensation is estimated on the measurement date, which, for the Company, is
the date of grant. The fair value of stock options is calculated using the Black-Scholes option-pricing model under which the Company
estimates expected market price volatility and expected term of the options based on historical data and other factors. There were 25,000
stock options granted in 2019, while no stock options were granted in 2018 or 2017. The valuation of Bancorp’s restricted stock and
restricted stock units is the closing price per share of Bancorp’s common stock on the date of grant.
The following table summarizes Bancorp’s stock option activity and related information for the years ended:
2019
Weighted
Average
Exercise
Price
$
8.76
14.54
8.58
10.10
Shares
15,268
25,000
(13,418)
(1,850)
December 31,
2018
Weighted
Average
Exercise
Price
$
9.69
-
10.63
10.52
Shares
30,991
-
(9,123)
(6,600)
25,000
$
14.54
-
$
-
15,268
15,268
$
8.76
$
8.76
2017
Weighted
Average
Exercise
Price
$
12.36
-
11.67
13.92
$
9.69
$
9.69
Shares
123,593
-
(27,113)
(65,489)
30,991
30,991
Balance at January 1,
Granted
Exercised
Forfeited
Balance at period end
Exercisable at period end
Weighted average fair value of options
granted during the year
$
5.83
$
-
$
-
The cash received from the exercise of stock options during 2019, 2018 and 2017 was $116 thousand, $97 thousand and $316 thousand,
respectively. The intrinsic value of a stock option is the amount that the market value of the underlying stock exceeds the exercise price
of the option. Based upon a fair market value of $16.88 on December 31, 2019 the options outstanding had an aggregate intrinsic value
of $59 thousand. At December 31, 2018, based upon a fair market value of $14.30, the options outstanding had an aggregate intrinsic
value of $85 thousand. At December 31, 2017, based upon a fair market value of $22.00, the options outstanding had an aggregate
intrinsic value of $382 thousand. The stock options outstanding as of December 31, 2019 have contractual terms that permit exercise of
the options through 2029.
At December 31, 2019, based on stock option awards outstanding at that time, the total unrecognized pre-tax compensation expense
related to unvested stock option awards was $101 thousand. Based upon the contractual terms, this expense is expected to be recognized
as follows:
(in thousands)
2020
2021
2022
$
49
48
4
$
101
93
Restricted Stock Units (“RSU”)
RSUs are equity awards where the recipient does not receive the stock immediately, but instead receives it according to a vesting plan
and distribution schedule after achieving required performance milestones or upon remaining with the employer for a particular length
of time. Each RSU that vests entitles the recipient to receive one share of the Company’s common stock on a specified issuance date.
The recipient does not have any stockholder rights, including voting, dividend or liquidation rights, with respect to the shares underlying
awarded RSUs until the recipient becomes the record holder of those shares. The valuation of the Company’s RSU is the closing price
per share of the Company’s common stock on the date of grant.
During 2019, the Company granted 26,500 RSUs which are subject to a three-year vesting schedule. The Company granted 20,732
RSUs during 2018 which vested immediately. During 2017, 18,500 RSUs were granted, all of which are subject to a three-year vesting
schedule.
A summary of the activity for Bancorp’s RSUs for the periods indicated is presented in the following table:
2019
Weighted
Average
Grant Date
Fair Value
$
17.29
15.16
16.13
14.54
Shares
9,731
26,500
(6,699)
(18,500)
December 31,
2018
Weighted
Average
Grant Date
Fair Value
$
15.09
19.90
16.63
14.41
Shares
52,155
20,732
(54,542)
(8,614)
2017
Weighted
Average
Grant Date
Fair Value
$
13.23
17.41
12.60
-
Shares
65,491
18,500
(31,836)
-
11,032
$
17.48
9,731
$
17.29
52,155
$
15.09
Balance at January 1,
Granted
Vested
Forfeited
Balance at period end
At December 31, 2019, based on RSU awards outstanding at that time, the total unrecognized pre-tax compensation expense related to
unvested RSU awards was $155 thousand. Based upon the contractual terms, this expense is expected to be recognized as follows:
(in thousands)
2020
2021
2022
$
74
44
37
$
155
Stock-Based Compensation Expense
Stock-based compensation expense attributable to stock options and RSUs is based on their fair values on the measurement date, which,
for the Company, is the date of the grant. This cost is then recognized in noninterest expense on a straight-line basis over the vesting
period of the respective stock options and RSUs. The amount that the Company recognized in stock-based compensation expense related
to the issuance of stock options and RSUs as well as director compensation paid in stock is presented in the following table:
(in thousands)
Stock-based compensation expense
Related to the issuance of RSUs
Related to the issuance of stock options
Director compensation paid in stock
For the year ended December 31,
2018
2017
2019
$
69
$
656
$
490
44
127
-
217
-
205
Total stock-based compensation expense
$
240
$
873
$
695
94
Note 20: Benefit Plans
Profit Sharing Plan
The Company sponsors a defined contribution retirement plan through a Section 401(k) profit sharing plan. Employees may contribute
up to 15% of their pretax compensation. Participants are eligible for matching Company contributions up to 4% of eligible compensation
dependent on the level of voluntary contributions. Company matching contributions totaled $1.0 million, $1.1 million and $766
thousand, respectively, for the years ended December 31, 2019, 2018 and 2017. The Company’s matching contributions vest
immediately.
Supplemental Executive Retirement Plan (“SERP”)
In 2014, the Bank created a SERP for the Chief Executive Officer (“CEO”). This plan was amended in 2016. Under the defined benefit
SERP, the CEO will receive $150,000 each year for 15 years after attainment of the Normal Retirement Age (as defined in the SERP).
The CEO earned vesting on a graduated schedule and she became fully vested on August 25, 2019, which had been established for
purposes of the SERP as the commencement date for SERP distributions. Expense related to this SERP totaled $216 thousand, $279
thousand and $275 thousand for 2019, 2018 and 2017, respectively. The accrued liability recorded for this SERP was $1.6 million and
$1.5 million at December 31, 2019 and December 31, 2018, respectively.
Employee Stock Purchase Plan
The 2017 Employee Stock Purchase Plan (the “Plan”) provides eligible employees of the Company and certain of its subsidiaries with
opportunities to purchase shares of the Company’s common stock at a discounted price, with the Company contributing up to a 15%
discount per offering period. An aggregate of 250,000 shares of the Company’s common stock was approved for issuance under the
Plan. The Plan is intended to qualify as an “employee stock purchase plan” as defined in Section 423 of the Internal Revenue Code of
1986, as amended, and the regulations promulgated thereunder, and shall be interpreted consistent therewith. The first offering period
under this plan commenced on October 1, 2018, and the expense related to the Plan totaled $39 thousand and $11 thousand for 2019
and 2018, respectively.
Note 21: Income (Loss) per Common Share
The table below shows the presentation of basic and diluted income (loss) per common share for the years ended:
(dollars in thousands, except per share data)
2019
December 31,
2018
2017
Net income (loss) available to common stockholders (numerator)
$
16,881
$
(3,828)
$
7,200
BASIC
Basic average common shares outstanding (denominator)
19,068,246
17,556,554
9,555,952
Basic income (loss) per common share
$
0.89
$
(0.22)
$
0.75
DILUTED
Average common shares outstanding
Dilutive effect of common stock equivalents
Diluted average common shares outstanding (denominator)
19,068,246
2,831
19,071,077
17,556,554
-
17,556,554
9,555,952
40,852
9,596,804
Diluted income (loss) per common share
$
0.89
$
(0.22)
$
0.75
Common stock equivalents outstanding that are
anti-dilutive and thus excluded from calculation of
diluted number of shares presented above
Note 22: Regulatory Matters
774
14,740
-
The Bank is subject to various regulatory capital requirements administered by the federal bank regulatory agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if
undertaken, could have a direct 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 Bank’s capital amounts
and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
95
In July 2013, the Federal Deposit Insurance Corporation (the “FDIC”) and the other federal bank regulatory agencies issued a final rule
that revised their leverage and risk-based capital requirements and the method for calculating risk-weighted assets to make them
consistent with agreements that were reached by the Basel Committee on Banking Supervision (“Basel III”) and certain provisions of
the Dodd-Frank Act. The final rule, which became effective on January 1, 2015, applies to all depository institutions, top-tier bank
holding companies with total consolidated assets of $3 billion or more and top-tier savings and loan holding companies. As of December
31, 2019, Bancorp had less than $3.0 billion in consolidated assets, and, therefore, the Basel III capital requirements do not currently
apply to Bancorp, but they do apply to the Bank.
The final rule created a new common equity Tier 1 (“CET1”) minimum capital requirement (4.5% of risk-weighted assets), increased
the minimum Tier 1 capital ratio (from 4% to 6% of risk-weighted assets), imposed a minimum leverage ratio of 4.0%, and changed the
risk-weight of certain assets to better reflect credit risk and other risk exposures. These include, among other things, a 150% risk weight
for certain high volatility commercial real estate acquisition, development and construction loans and for non-residential mortgage loans
that are 90 days past due or otherwise in non-accrual status, and a 20% credit conversion factor for the unused portion of a commitment
with an original maturity of one year or less that is not unconditionally cancellable. The final rule also required unrealized gains and
losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital unless the Company
elected to opt-out from this treatment. The Company has elected to permanently opt out of this treatment in the Company’s capital
calculations, as permitted by the final rule.
Additionally, subject to a transition schedule, which became fully phased-in on December 31, 2019, the rule limits the Company’s ability
to make capital distributions, engage in share repurchases and pay certain discretionary bonus payments if the they do not hold a “capital
conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to
meet its minimum risk-based capital requirements.
In addition, under revised prompt corrective action requirements, in order to be considered “well-capitalized,” the Bank must have a
total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, a common equity Tier 1 ratio of
6.5% or greater, a leverage capital ratio of 5.0% or greater, and not be subject to any written agreement, order, capital directive, or
prompt corrective action directive to meet and maintain a specific capital level for any capital measure.
There are three main categories of capital under the regulatory capital guidelines. Common equity tier 1 capital consists of paid-in
common stock, retained earnings and certain common equity Tier 1 minority interests. Various items, including certain amounts of
goodwill, intangible assets, deferred tax assets, must be deducted from common equity Tier 1 before capital ratios are calculated. Tier
1 capital (which, together with common equity tier 1 capital, makes up Tier 1 capital) generally consists of perpetual preferred stock
and, in certain circumstances and subject to certain limitations, minority investments in certain subsidiaries, less goodwill and other
non-qualifying intangible assets, and certain other deductions. Tier 2 capital consists of perpetual preferred stock that is not otherwise
eligible to be included as Tier 1 capital, hybrid capital instruments, term subordinated debt and intermediate-term preferred stock and,
subject to limitations, general allowances for credit losses. At least half of total capital must consist of Tier 1 capital. Under the
guidelines, capital is compared to the relative risk related to the balance sheet. To derive the risk included in the balance sheet, one of
several risk weights is applied to the different balance sheet and off-balance sheet assets, primarily based on the relative credit risk of
the counterparty. For example, claims guaranteed by the U.S. government or one of its agencies are risk-weighted at 0%. Off-balance
sheet items, such as loan commitments, are also applied a risk weight after calculating balance sheet equivalent amounts. One of four
credit conversion factors (0%, 20%, 50% and 100%) is assigned to loan commitments based on the likelihood of the off-balance sheet
item becoming an asset. For example, certain loan commitments are converted at 50% and then risk-weighted at 100%. The capital
amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other
factors
Management believes that, as of December 31, 2019 and December 31, 2018, Bancorp and the Bank met all capital adequacy
requirements to which they are subject.
96
The following table reflects Bancorp’s and the Bank’s capital as of December 31, 2019 and December 31, 2018:
(dollars in thousands)
As of Dcember 31, 2019:
Total capital (to risk-weighted assets)
Howard Bank
Howard Bancorp
Common equity tier 1 capital
(to risk-weighted assets)
Howard Bank
Howard Bancorp
Tier 1 capital (to risk-weighted assets)
Howard Bank
Howard Bancorp
Tier 1 capital (to average assets)
(Leverage ratio)
Howard Bank
Howard Bancorp
As of December 31, 2018:
Total capital (to risk-weighted assets)
Howard Bank
Howard Bancorp
Common equity tier 1 capital
(to risk-weighted assets)
Howard Bank
Howard Bancorp
Tier 1 capital (to risk-weighted assets)
Howard Bank
Howard Bancorp
Tier 1 capital (to average assets)
(Leverage ratio)
Howard Bank
Howard Bancorp
Actual
Amount
Ratio
For capital
adequacy purposes (1)
Ratio
Amount
To be well
capitalized under
the FDICIA
prompt corrective
action provisions
Amount
Ratio
$
$
238,384
247,761
12.86 %
13.14 %
$
$
148,314
150,872
8.00 %
8.00 %
$
185,392
N/A
10.00 %
$
$
227,983
209,119
12.30 %
11.09 %
$
$
83,427
84,866
4.50 %
4.50 %
$
120,505
N/A
$
$
227,983
209,119
12.30 %
11.09 %
$
$
111,235
113,154
6.00 %
6.00 %
$
148,314
N/A
6.50 %
8.00 %
$
$
227,983
209,119
10.43 %
9.55 %
$
$
87,434
87,599
4.00 %
4.00 %
$
109,293
N/A
5.00 %
$
$
212,099
218,425
11.80 %
12.14 %
$
$
143,810
143,889
8.00 %
8.00 %
$
179,762
N/A
10.00 %
$
$
202,226
179,935
11.25 %
10.00 %
$
$
80,893
80,938
4.50 %
4.50 %
$
116,846
N/A
$
$
202,226
179,935
11.25 %
10.00 %
$
$
107,857
107,917
6.00 %
6.00 %
$
143,810
N/A
6.50 %
8.00 %
$
$
202,226
179,935
9.84 %
8.77 %
$
$
82,212
82,046
4.00 %
4.00 %
$
102,765
N/A
5.00 %
(1) Amounts shown exclude the capital conservation buffer of 2.50% for December 31, 2019 and 1.875% for December 31, 2018.
Under the Federal Reserve’s Small Bank Holding Company Policy Statement, Bancorp is not subject to the minimum capital
adequacy and capital conservation buffer capital requirements at the holding company level, unless otherwise advised by the
FRB (such capital requirements are applicable only at the Bank level). Although the minimum regulatory capital requirements
are not applicable to Bancorp, the Company calculates these ratios for its own planning and monitoring purposes.
Note 23: Fair Value
FASB ASC Topic 820 “Fair Value Measurements” defines fair value as the exchange price that would be received for an asset or paid
to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction
between market participants on the measurement date. FASB ASC Topic 820 also establishes a fair value hierarchy, which requires an
entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures.
Securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be
required to record at fair value other assets on a nonrecurring basis, such as loans held for investment and certain other assets. These
nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual
assets.
Under FASB ASC Topic 820, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the
assets and liabilities are traded and the reliability of the assumptions used to determine the fair value. These hierarchy levels are:
97
Level 1: Valuations for assets and liabilities traded in active exchange markets. Valuations are obtained from readily available
pricing sources for market transactions involving identical assets or liabilities.
Level 2: Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third
party pricing services for identical or comparable assets or liabilities which use observable inputs other than Level 1 prices, such as
quoted prices for similar assets or liabilities; quoted prices in active markets that are not active; or other inputs that are observable or
can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the
assets or liabilities.
A financial instrument's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value
measurement.
Recurring Fair Value Measurements
All classes of investment securities available for sale are recorded at fair value using an industry-wide valuation service and therefore
fall into a Level 2 of the fair value hierarchy. The service uses evaluated pricing models that vary based on asset class and include
available trade, bid and other market information. Various methodologies include broker quotes, proprietary models, descriptive terms
and conditions databases, and quality control programs.
Fair value of loans held for sale is based upon outstanding investor commitments or, in the absence of such commitments, based on
current investor yield requirements or third party pricing models and are considered Level 2. Gains and losses on loan sales are
determined using specific identification method. Changes in fair value are recognized in the Consolidated Statement of Operations as
part of realized and unrealized gain on mortgage banking activities.
Interest rate lock commitments are recorded at fair value determined as the amount that would be required to settle each of these
derivatives at the balance sheet date. In the normal course of business, the Company enters into contractual interest rate lock
commitments to extend credit to borrowers with fixed expiration dates. The commitment becomes effective when the borrowers lock
in a specified interest rate within the time frames established by the mortgage division. All borrowers are evaluated for credit worthiness
prior to the extension of the commitment. Market risk arises if interest rates move adversely between the time interest rate is locked by
the borrower and the sale date of the loan to an investor. To mitigate this interest rate risk inherent in providing rate lock commitments
to borrowers, the Company enters into best effort forward sales contracts to sell loans to investors. The forward sales contracts lock in
an interest rate price for the sale of loans similar to the specific rate lock commitment. Rate lock commitments to the borrowers through
the date the loan closes are undesignated derivatives and accordingly, are marked to fair value in earnings. These valuations fall into a
Level 3 of the fair value hierarchy. The rate lock commitments are deemed as Level 3 inputs because the Company applies an estimated
pull-through rate, which is deemed an unobservable measure.
For loans held for investment that were originally intended to be sold and previously included as loans held for sale, fair value is
determined by discounting estimated cash flows using current rates at which similar loans would be made to borrowers with similar
credit ratings and for the same remaining maturities.
98
The following table sets forth the Company's financial assets and liabilities that were accounted for or disclosed at fair value on a
recurring basis at December 31, 2019 and December 31, 2018.
December 31, 2019
(in thousands)
Assets
Available for sale securities:
U.S. Government agencies
Mortgage-backed securities
Other investments
Loans held for sale
Loans held for investment
Rate lock commitments
Interest rate swap assets
Liabilities
Quoted Price in
Active Markets
for Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Carrying
Value
(Fair Value)
$
67,312
142,699
5,494
30,710
997
60
217
$
-
-
-
-
-
-
-
$
67,312
142,699
5,494
30,710
997
-
217
$
-
-
-
-
-
60
-
Interest rate swap liabilities
228
-
228
-
December 31, 2018
(in thousands)
Assets
Available for sale securities:
U.S. Government agencies
Mortgage-backed securities
Other investments
Loans held for sale
Loans held for investment
Rate lock commitments
Interest rate swap assets
Liabilities
Quoted Price in
Active Markets
for Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Carrying
Value
(Fair Value)
$
130,397
90,460
3,001
21,261
1,303
126
100
-
$
-
-
-
-
-
-
$
130,397
90,460
3,001
21,261
1,303
-
100
Significant
Unobservable
Inputs
(Level 3)
-
$
-
-
-
-
126
-
Interest rate swap liabilities
106
-
106
-
The following table presents a reconciliation of the assets that are measured at fair value on a recurring basis using significant
unobservable inputs (Level 3) for the periods presented:
(in thousands)
Balance, beginning of period
Privately held equity investment
Net losses included in realized and unrealized gains
on mortgage banking activity in noninterest income
December 31,
2019
$
126
December 31,
2018
$
530
-
(66)
(72)
(332)
Balance, end of period
$
60
$
126
99
Assets under fair value option are as follows:
December 31, 2019
(in thousands)
Loans held for sale
Loans held for investment
December 31, 2018
(in thousands)
Loans held for sale
Loans held for investment
Carrying
Fair Value
Amount
Aggregate
Unpaid
Principal
$
30,710
997
$
29,969
966
Carrying
Fair Value
Amount
Aggregate
Unpaid
Principal
$
21,261
1,303
$
20,785
1,342
Difference
$
741
31
Difference
$
476
(39)
The Company elected to measure the loans held for sale and the loans held for investment that were originally intended for sale, but
instead were added to the Bank’s portfolio at fair value to better align reported results with the underlying economic changes in value
of the loans on the Company’s balance sheet.
Non-recurring Fair Value Measurements
Level 3 is for positions that are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect
illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence. In the absence of such
evidence, management's best estimate is used.
Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of cost or market value. Market value
is measured based on the value of the collateral securing these loans and is classified at a Level 3 in the fair value hierarchy. Collateral
may be real estate and/or business assets including equipment, inventory and/or accounts receivable. The value of real estate collateral
is determined based on appraisal by qualified licensed appraisers hired by the Company. The value of business equipment, inventory
and accounts receivable collateral is based on the net book value on the business' financial statements and, if necessary, discounted
based on management's review and analysis. Appraised and reported values may be discounted based on management's historical
knowledge, changes in market conditions from the time of valuation, and/or management's expertise and knowledge of the client and
client's business. Impaired loans are reviewed and evaluated on at least a quarterly basis for additional impairment and adjusted
accordingly, based on the same factors identified above.
Other real estate owned acquired through, or in lieu of, foreclosure are held for sale and are initially recorded at fair value, less selling
costs. Any write-downs to fair value at the time of transfer to OREO are charged to the allowance for credit losses. Values are derived
from appraisals of underlying collateral and discounted cash flow analysis. There were valuation losses of $437 thousand and $352
thousand recognized for the years ended December 31, 2019 and 2018, respectively. These charges were for declines in the value of
OREO subsequent to foreclosure. OREO is classified within Level 3 of the hierarchy.
Net gain/(loss) from the changes included in earnings in fair value of loans held for sale was $265 thousand, $(181) thousand, and $62
thousand at December 31, 2019, 2018 and 2017, respectively. Net gain/(loss) from the changes included in earnings in fair value of
loans held for investment was $69 thousand, $(71) thousand and $247 thousand at December 31, 2019, 2018 and 2017 respectively
100
The following table sets forth the Company’s financial assets and liabilities that were accounted for or disclosed at fair value on a
nonrecurring basis as of December 31, 2019 and December 31, 2018.
December 31, 2019
(in thousands)
Other real estate owned
Impaired loans:
Construction and land
Residential - first lien
Residential - junior lien
Commercial - owner occupied
Commercial - non-owner occupied
Commercial loans and leases
Consumer
December 31, 2018
(in thousands)
Other real estate owned
Impaired loans:
Construction and land
Residential - first lien
Residential - junior lien
Commercial - owner occupied
Commercial - non-owner occupied
Commercial loans and leases
Consumer
Quoted Price in
Active Markets
for Identical
Assets
(Level 1)
$
-
Significant
Other
Observable
Inputs
(Level 2)
$
-
Significant
Unobservable
Inputs
(Level 3)
$
3,098
Carrying
Value
(Fair Value)
3,098
$
481
13,131
786
566
1,725
1,860
127
-
-
-
-
-
-
-
-
-
-
-
-
-
-
481
13,131
786
566
1,725
1,860
127
Quoted Price in
Active Markets
for Identical
Assets
(Level 1)
$
-
Significant
Other
Observable
Inputs
(Level 2)
$
-
Significant
Unobservable
Inputs
(Level 3)
$
4,392
Carrying
Value
(Fair Value)
$
4,392
1,449
13,259
1,137
1,268
2,823
2,255
174
-
-
-
-
-
-
-
-
-
-
-
-
-
-
1,449
13,259
1,137
1,268
2,823
2,255
174
At December 31, 2019, OREO with a carrying value of $3.1 million consisted of an outstanding balance of $4.6 million, less a valuation
allowance of $1.5 million. At December 31, 2018, OREO with a carrying value of $4.4 million consisted of an outstanding balance of
$6.6 million, less a valuation allowance of $2.2 million. Specific allocations of the allowance for credit losses attributable to impaired
loans at December 31, 2019 and 2018 were $500 thousand and $2.4 million, respectively.
Various techniques are used to value OREO and impaired loans. All loans where the underlying collateral is real estate, either
construction, land, commercial, or residential, an independent appraisal is used to identify the value of the collateral. The approaches
within the appraisal report include sales comparison, income, and replacement cost analysis. The resulting value will be adjusted by a
selling cost of 9.5% and the residual value will be used to determine if there is an impairment. Commercial loans and leases and consumer
loans utilize a liquidation approach to the impairment analysis.
The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between
willing parties, other than in a forced or liquidation sale. Fair value estimates are based on quoted market prices where available or
calculated using present value techniques. Since quoted market prices are not available on many of our financial instruments, estimates
may be based on the present value of estimated future cash flows and estimated discount rates.
101
The following table presents the estimated fair value of the Company’s financial instruments at the dates indicated:
December 31, 2019
Quoted Price in
Significant
Active Markets
for Identical
Assets
(Level 1)
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Carrying
Amount
Fair
Value
$
215,505
7,750
$
215,505
7,897
-
$
-
$
215,505
-
$
-
7,897
14,152
30,710
997
60
14,152
30,710
997
60
1,734,115
1,735,013
217
217
1,714,365
236,127
83,241
228
1,713,081
236,127
86,972
228
-
-
-
-
-
-
-
-
-
-
14,152
30,710
997
-
-
217
1,713,081
236,127
86,972
228
December 31, 2018
Quoted Price in
Active Markets
for Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Carrying
Amount
Fair
Value
$
223,858
9,250
11,786
21,261
1,303
126
$
223,858
9,253
11,786
21,261
1,303
126
-
$
-
-
-
-
-
$
223,858
-
11,786
21,261
1,303
-
1,638,575
1,613,506
100
100
1,685,806
134,576
142,077
106
1,681,295
134,576
142,296
106
-
-
-
-
-
-
-
100
1,681,295
134,576
142,296
106
-
-
-
60
1,735,013
-
-
-
-
-
Significant
Unobservable
Inputs
(Level 3)
$
-
9,253
-
-
-
126
1,613,506
-
-
-
-
-
(in thousands)
Financial Assets
Available for sale securities
Held to maturity securities
Nonmarketable equity securities
Loans held for sale
Loans held for investment
Rate lock commitments
Loans and leases 1
Interest rate swap
Financial Liabilities
Deposits
Short-term borrowings
Long-term borrowings
Interest rate swap
(in thousands)
Financial Assets
Available for sale securities
Held to maturity securities
Nonmarketable equity securities
Loans held for sale
Loans held for investment
Rate lock commitments
Loans and leases 1
Interest rate swap
Financial Liabilities
Deposits
Short-term borrowings
Long-term borrowings
Interest rate swap
(1) Carrying amount is net of unearned income and allowance for loan and lease losses. In accordance with the prospective adoption of ASU No.
2016-01, the fair value of loans were measured using an exit price notion.
Note 24: Revenue Recognition
Service Charges on Deposit Accounts
Service charges on deposit accounts consist of account analysis fees, monthly service fees, check orders, and other deposit account
related fees. The Banks’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related
revenue recognized, over the period in which the service is provided. Check orders and other deposit account related fees are largely
102
transactional based, and therefore, the Banks’s performance obligation is satisfied, and related revenue recognized, at a point in time.
Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to
customers’ accounts.
Other Operating Income
Other operating income is primarily comprised of debit and credit card income, ATM fees, merchant services income, revenue streams
such as safety deposit box rental fees, and other miscellaneous service charges. Debit and credit card income is primarily comprised of
interchange fees earned whenever the Banks’s debit and credit cards are processed through card payment networks such as Visa. ATM
fees are primarily generated when a Bank’s cardholder uses a non-Bank ATM or a non-Bank cardholder uses a Bank ATM. Merchant
services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account
management fees. Safe deposit box rental fees are charged to the customer on an annual basis and recognized upon receipt of payment.
The Bank determined that since rentals and renewals occur fairly consistently over time, revenue is recognized on a basis consistent
with the duration of the performance obligation. Other service charges include revenue from processing wire transfers, bill pay service,
cashier’s checks, and other services. The Bank’s performance obligation for fees, and other service charges are largely satisfied, and
related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the
following month.
The following presents noninterest income, segregated by revenue streams in scope and out of scope of Topic 606, for the twelve months
ended:
(in thousands)
NONINTEREST INCOME
Service charges on deposit accounts
Fees and other service charges
Other
Noninterest income in scope of Topic 606
Noninterest income out of scope of Topic 606
2019
$
951
2,556
58
3,565
17,469
December 31,
2018
2017
$
595
2,404
70
3,069
14,791
$
239
954
57
1,250
18,274
Total noninterest income
$
21,034
$
17,860
$
19,524
Contract Balances
A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a
contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to
transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Bank’s
noninterest revenue streams are largely based on transactional activity, or standard month-end revenue accruals. Consideration is often
received immediately or shortly after the Bank satisfies its performance obligation and revenue is recognized. The Bank does not
typically enter into long term revenue contracts with customers, and therefore, does not experience significant contract balances. As of
December 31, 2019 and December 31, 2018, the Bank did not have any significant contract balances.
Contract Acquisition Costs
In connection with the adoption of Topic 606, an entity is required to capitalize, and subsequently amortize into expense, certain
incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining
a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not
been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately
expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in
one year or less. Upon adoption of Topic 606, the Bank did not capitalize any contract acquisition costs.
103
Note 25: Parent Company Financial Information
The condensed financial statements for Bancorp (Parent Only) are presented below:
Howard Bancorp, Inc.
Balance Sheets
(in thousands)
ASSETS
Cash and cash equivalents
Investment in subsidiaries
Other assets
Total assets
LIABILITIES
Short-term borrowings
Long-term borrowings
Other liabilities
Total liabilities
SHAREHOLDERS' EQUITY
Common stock-par value of $0.01 authorized 20,000,000 shares; issued and outstanding
19,066,913 shares at December 31, 2019 and 19,039,347 at December 31, 2018
Capital surplus
Retained earnings
Accumulated other comprehensive income
Total shareholders’ equity
Total liabilities and shareholders’equity
December 31,
2019
2018
$
9,620
332,794
192
$
6,843
316,771
293
$
342,606
$
323,907
$
101
$
972
28,241
116
28,458
191
276,156
35,158
2,643
314,148
28,077
175
29,224
190
275,843
18,277
373
294,683
$
342,606
$
323,907
104
Statements of Operations
(in thousands)
INTEREST AND DIVIDEND INCOME
Cash dividends from subsidiary
Other interest income
Total interest and dividend income
INTEREST EXPENSE
Short-term borrowings
Long-term borrowings
Total interest expense
NET INTEREST INCOME
NONINTEREST INCOME
Other income
NONINTEREST EXPENSE
Compensation and benefits
Other operating expense
Total noninterest expense
INCOME (LOSS) BEFORE INCOME TAXES AND EQUITY IN
UNDISTRIBUTED INCOME OF SUBSIDIARY
Income tax benefit
Income (loss) before equity in undistributed income of subsidiary
Equity in undistributed income (loss) of subsidiary
Year Ended December 31,
2019
2018
2017
$
5,000
4
$
-
1
-
$
-
5,004
1
1,903
1,904
3,100
-
191
287
478
2,622
(506)
3,128
13,753
1
6
376
382
(381)
-
268
42
310
(691)
(176)
(515)
(3,313)
-
49
216
265
(265)
-
490
73
563
(828)
(349)
(479)
7,679
Net income (loss)
$
16,881
$
(3,828)
$
7,200
105
Statements of Cash Flows
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)
Adjustments to reconcile net income (loss) to net cash
from operating activities:
Deferred income taxes (benefits)
Share-based compensation
Amortization of debt issuance costs
Equity in undistributed (income) loss of subsidiary
Decrease (increase) in other assets
Increase (decrease) in other liabilities
Net cash provided by (used in) operating activities
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash paid for acquisition
Investment in subsidiary
Net cash used in investing activities
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase increase in short-term borrowings
Net increase (decrease) in long term debt
Net proceeds from issuance of common stock, net of cost
Repurchase of common stock
Net cash (used in) provided by financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
Year Ended December 31,
2019
2018
2017
$
16,881
$
(3,828)
$
7,200
(213)
240
164
(13,753)
101
154
3,574
-
-
-
(871)
-
396
(322)
(797)
2,777
6,843
(117)
873
-
3,313
(293)
(176)
(228)
(9,245)
(24,177)
(33,422)
155
24,542
97
-
24,794
(8,856)
15,699
(115)
695
-
(7,679)
40
84
225
-
(23,000)
(23,000)
(12,542)
82
38,699
-
26,239
3,464
12,235
Cash and cash equivalents at end of period
$
9,620
$
6,843
$
15,699
106
Note 26: Quarterly Financial Results (unaudited)
The following table provides a summary of selected consolidated quarterly financial data for the years ended December 31, 2019 and
December 31, 2018:
$
$
$
$
Net income per common share, basic
Net income per common share, diluted
$
$
0.31
0.31
$
$
0.24
0.24
$
$
0.11
0.11
$
$
0.22
0.22
Average common shares outstanding
Diluted average common shares outstanding
19,080,151
19,083,297
19,078,561
19,081,963
19,061,164
19,067,624
19,052,694
19,066,791
(in thousands, except share data.)
Interest income
Interest expense
Net interest income
Provision for loan losses
Noninterest income
Noninterest expense
Net income before income taxes
Income tax expense
Net income available to common shareholders
(in thousands, except share data.)
Interest income
Interest expense
Net interest income
Provision for loan losses
Noninterest income
Noninterest expense
Net income (loss) before income taxes
Income tax expense (benefit)
Net income (loss) available to common shareholders
Fourth
Quarter
2019
Third
Quarter
Second
Quarter
First
Quarter
$
$
$
$
22,550
5,283
17,267
750
5,625
14,362
7,780
1,880
5,900
22,428
4,485
17,943
2,850
3,683
18,425
351
206
145
22,955
5,740
17,215
608
5,033
15,405
6,235
1,598
4,637
22,436
3,789
18,647
696
3,856
16,396
5,411
1,432
3,979
23,145
5,791
17,354
1,110
5,841
19,454
2,631
543
2,088
21,165
3,285
17,880
1,425
5,617
25,140
(3,068)
(791)
(2,277)
22,784
5,310
17,474
1,725
4,535
14,857
5,427
1,171
4,256
14,360
2,212
12,148
1,120
4,704
23,151
(7,419)
(1,744)
(5,675)
Fourth
Quarter
2018
Third
Quarter
Second
Quarter
First
Quarter
$
$
$
$
$
$
$
$
Net income (loss) per common share, basic
Net income (loss) per common share, diluted
$
$
0.01
0.01
$
$
0.21
0.21
$
$
(0.12)
(0.12)
$
$
(0.43)
(0.43)
Average common shares outstanding
Diluted average common shares outstanding
19,035,316
19,041,880
19,025,855
19,035,192
19,002,851
19,002,851
13,080,614
13,080,614
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
None
Item 9A. Controls and Procedures
As required by SEC rules, the Company’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the
Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this
annual report on Form 10-K. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded
that the Company’s disclosure controls and procedures are effective as of December 31, 2019. Disclosure controls and procedures are
controls and other procedures that are designed to ensure that information required to be disclosed by the Company in the reports that it
files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s
rules and forms.
107
There were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange
Act) during the quarter ended December 31, 2019, that have materially affected, or are reasonably likely to materially affect, the
Company’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting (as
defined in Rule 13a-15(f) of the Exchange Act). The Company’s internal control over financial reporting is a process designed to
provide reasonable assurance to management and the Board of Directors regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United
States of America, as well as provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the Company’s assets that could have a material effect on the financial statements. Management evaluates the effectiveness
of internal control over financial reporting and tests for reliability through an internal audit process with actions taken to correct potential
deficiencies as they are identified. Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management evaluated the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019 using the
framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control – Integrated
Framework (2013). Based on that evaluation, management concluded that, as of December 31, 2019, the Company’s internal control
over financial reporting is effective. Dixon Hughes Goodman LLP, the registered public accounting firm that audited the Company’s
financial statements included in this report has issued an attestation report on the Company’s internal control over financial reporting as
of December 31, 2019 that is included elsewhere in this report.
Item 9B. Other Information
None
Part III
Item 10. Directors, Executive Officers and Corporate Governance
The Company has adopted a code of ethics (conduct) that applies to all of its employees and a separate code of ethics (conduct) that
applies to its non-employee directors. These codes of conduct are available on the Company’s website at www.howardbank.com.
The remainder of the information required by this Item is incorporated by reference to the information included under the captions “Item
1. Election of Directors,” “Corporate Governance—Committees of the Board of Directors” “Executive Officers” in the Company’s
definitive proxy statement for its Annual Meeting of Stockholders to be held on May 27, 2020 (the “Proxy Statement”).
There have been no material changes in the procedures previously disclosed by which stockholders may recommend nominees to the
Company's Board of Directors.
Item 11. Executive Compensation
The information required by this Item is incorporated by reference to the information included under the captions “Director
Compensation” and “Executive Compensation” in the Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
The information required by this Item is incorporated by reference to the information included under the captions “Securities Authorized
for Issuance Under Equity Compensation Plans” and “Security Ownership of Directors, Officers and Certain Beneficial Owners” in the
Proxy Statement.
108
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item is incorporated by reference to the information included under the captions “Corporate
Governance—Board Independence,” “Election of Directors” and “Certain Relationships and Related Transactions” in the Proxy
Statement.
Item 14. Principal Accounting Fees and Services
The information required by this Item is incorporated by reference to the information included under the captions “Fees to Independent
Registered Public Accounting Firm” and “Policy on Audit Committee Pre-Approval of Audit and Non-Audit Services of Independent
Registered Public Accounting Firm” in the Proxy Statement.
109
Howard Bancorp, Inc.
CORPORATE HEADQUARTERS
ANNUAL MEETING
Howard Bancorp, Inc.
3301 Boston Street
Baltimore, MD 21224
Phone: (410) 750-0020
Fax: (410) 750-8588
Website: www.howardbank.com
The annual meeting of Stockholders of Howard Bancorp, Inc.
will be held on Wednesday, May 27, 2020 at 11:30 a.m. at
the:
Corporate Offices of
Howard Bancorp, Inc.
3301 Boston Street
Baltimore, MD 21224
COMMON STOCK
Howard Bancorp, Inc.’s Common Stock is listed on
NASDAQ under the symbol HBMD.
INVESTOR RELATIONS
Howard Bancorp, Inc.’s Annual Report, Regulatory Filings,
and other corporate publications are on our website at
www.howardbank.com or are available to shareholders upon
request, without charge, by writing:
TRANSFER AGENT
Shareholders seeking information on stock transfer
requirements, lost certificates, or other shareholder matters
should contact our transfer agent:
Computershare Inc.
PO Box 30170
College Station, TX 77842
or
211 Quality Circle
Suite 210
College Station, TX 77845
(800) 368-5948
Website: www.computershare.co/investor
MARKET MAKERS
In order to facilitate shareholders or other investors in the
purchase or sale our common stock, there are several firms
which make a market in our common stock. The Company’s
market makers can be viewed at the About Us – Investor
Relations section of the Bank’s website
www.howardbank.com
David Borory
Howard Bancorp, Inc.
3301 Boston Street
Baltimore, MD 21224
Phone: (410) 750-0020
Fax: (410) 750-8588
E-mail: dborowy@howardbank.com
INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
Dixon Hughes Goodman LLP
809 Glen Eagles Court
Suite 200
Baltimore, MD 21286
Phone: (410) 823-8000
Phone: (800) 686-3883
Website: www.dhgllp.com
Howard Bancorp, Inc.
Board Of Directors
Richard G. Arnold
John J. Keenan
Mary Ann Scully
W. Gary Dorsch
Robert D. Kunisch, Jr.
Robert W. Smith Jr.
James T. Dresher, Jr.
Paul I. Latta, Jr.
Donna Hill Staton
Howard P. Feinglass
Kenneth C. Lundeen
Jack E. Steil
Michael B. High
Thomas P. O’Neill
Howard Bank
Board Of Directors
Richard G. Arnold
John J. Keenan
Mary Ann Scully
W. Gary Dorsch
Robert D. Kunisch, Jr.
Robert J. Smith, Jr.
James T. Dresher, Jr.
Paul I. Latta, Jr.
Donna Hill Staton
Howard P. Feinglass
Kenneth C. Lundeen
Jack E. Steil
Michael B. High
Thomas P. O’Neill
Executive Management
Mary Ann Scully
Robert D. Kunisch, Jr.
Robert L. Carpenter, Jr.
Chief Executive Officer
President
Interim Chief Financial
Officer
T. Randy Jones
Steven (Drew) McKone
Steven M. Poynot
Executive Vice President and
Chief Credit Officer
Executive Vice President and
Chief Deposit Officer
Executive Vice President and
Chief Information Officer
Charles E. Schwabe
Frank K. Turner, Jr.
Executive Vice President and
Chief Risk Officer
Executive Vice President and Chief Commercial
Banking Officer
We care about here.
3301 Boston Street, Baltimore, MD 21224
Phone: 410.750.0020
howardbank.com