UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period ended June 30, 2019         OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from to

Commission file number 001-38671

CAPITAL BANCORP, INC.

(Exact name of registrant as specified in its charter)

Maryland	52-2083046
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)
2275 Research Boulevard, Suite 600, Rockville, Maryland 20850	20850
(Address of principal executive offices)	(Zip Code)

(301) 468-8848

Registrant’s telephone number, including area code

Not Applicable

(Former Name or Former Address, if Changed Since Last Report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).             Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨	Smaller reporting company	x
		Emerging growth company	x

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.     x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, par value $0.01 per share	CBNK	NASDAQ Stock Market

As of July 31, 2019, the Company had 13,724,027 shares of common stock, par value $0.01 per share, outstanding.

Capital Bancorp, Inc. and Subsidiaries

Form 10-Q

INDEX

PART I - CONSOLIDATED FINANCIAL INFORMATION		Page
Item 1.	Consolidated Financial Statements	2
	Consolidated Balance Sheets	2
	Consolidated Statements of Income	3
	Consolidated Statements of Comprehensive Income	4
	Consolidated Statements of Changes in Stockholders’ Equity	5
	Consolidated Statements of Cash Flows	6
	Notes to Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	37
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	61
Item 4.	Controls and Procedures	64
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	65
Item 1A.	Risk Factors	65
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	65
Item 3.	Defaults upon Senior Securities	66
Item 4.	Mine Safety Disclosures	66
Item 5.	Other Information	66
Item 6.	Exhibits	66

PART I. CONSOLIDATED FINANCIAL INFORMATION

Item 1. CONSOLIDATED FINANCIAL STATEMENTS

Capital Bancorp, Inc. and Subsidiaries Consolidated Balance Sheets
(in thousands)	June 30, 2019 (unaudited)			December 31, 2018 (audited)
Assets
Cash and due from banks	$	12,253		$	10,431
Interest bearing deposits at other financial institutions	65,284			22,007
Federal funds sold	1,991			2,285
Total cash and cash equivalents	79,528			34,723
Investment securities available for sale	39,157			46,932
Restricted investments	4,137			2,503
Loans held for sale	47,744			18,526
Loans receivable, net of allowance for loan losses of $11,913 and $11,308 at June 30, 2019 and December 31, 2018, respectively	1,044,377			988,960
Premises and equipment, net	7,202			2,975
Accrued interest receivable	4,649			4,462
Deferred income taxes	3,504			3,654
Foreclosed real estate	149			142
Prepaid income taxes	268			90
Other assets	3,442			2,091
Total assets	$	1,234,157		$	1,105,058
Liabilities
Deposits
Noninterest-bearing, including related party balances of $10,055 and $11,214 at June 30, 2019 and December 31, 2018, respectively	$	279,484		$	242,259
Interest-bearing, including related party balances of $119,185 and $144,624 at June 30, 2019 and December 31, 2018, respectively	757,520			712,981
Total deposits	1,037,004			955,240
Securities sold under agreements to repurchase	—			3,332
Federal funds purchased	—			2,000
Federal Home Loan Bank advances	38,889			2,000
Other borrowed funds	15,409			15,393
Accrued interest payable	2,039			1,565
Other liabilities	17,698			10,964
Total liabilities	1,111,039			990,494
Stockholders' equity
Preferred stock, $.01 par value; 1,000,000 shares authorized; no shares issued or outstanding at June 30, 2019 and December 31, 2018	—			—
Common stock, $.01 par value; 49,000,000 shares authorized; 13,718,665 and 13,672,479 issued and outstanding at June 30, 2019 and December 31, 2018, respectively	137			137
Additional paid-in capital	50,071			49,321
Retained earnings	72,940			65,701
Accumulated other comprehensive loss	(30		)	(595		)
Total stockholders' equity	123,118			114,564
Total liabilities and stockholders' equity	$	1,234,157		$	1,105,058

See Notes to Consolidated Financial Statements

2

Capital Bancorp, Inc. and Subsidiaries

Consolidated Statements of Income

(unaudited)

	Three Months Ended June 30,				Six Months Ended June 30,
(dollars in thousands except per share data)	2019		2018		2019		2018
Interest income
Loans, including fees	$	19,804	$	16,232	$	37,648	$	32,500
Investment securities available for sale	234		276		492		515
Federal funds sold and other	251		259		467		416
Total interest income	20,289		16,767		38,607		33,431
Interest expense
Deposits, includes payments to related parties of $459 and $976 for the three and six months ended June 30, 2019, respectively, and $350 and $689 for the three and six months ended June 30, 2018, respectively.	3,195		2,309		6,438		4,259
Borrowed funds	563		336		894		665
Total interest expense	3,758		2,645		7,332		4,924
Net interest income	16,531		14,122		31,275		28,507
Provision for loan losses	677		630		798		1,145
Net interest income after provision for loan losses	15,854		13,492		30,477		27,362
Noninterest income
Service charges on deposits	138		117		236		242
Credit card fees	1,970		1,562		3,462		3,017
Mortgage banking revenue	3,715		2,499		6,091		4,928
Gain (loss) on sale of investment securities available for sale	26		1		26		(2		)
Other fees and charges	78		160		204		232
Total noninterest income	5,927		4,339		10,019		8,417
Noninterest expenses
Salaries and employee benefits	8,111		6,211		14,898		12,512
Occupancy and equipment	1,102		1,088		2,196		2,171
Professional fees	609		471		1,228		845
Data processing	3,716		3,540		7,029		7,222
Advertising	531		331		973		755
Loan processing	340		348		645		609
Other real estate owned expenses, net	28		7		50		31
Other operating	1,773		1,532		3,521		2,983
Total noninterest expenses	16,210		13,528		30,540		27,128
Income before income taxes	5,571		4,303		9,956		8,651
Income tax expense	1,548		1,158		2,614		2,516
Net income	$	4,023	$	3,145	$	7,342	$	6,135
Basic earnings per share	$	0.30	$	0.27	$	0.54	$	0.53
Diluted earnings per share	$	0.29	$	0.26	$	0.53	$	0.51
Weighted average common shares outstanding:
Basic	13,718,665		11,610,540		13,707,631		11,587,188
Diluted	13,914,042		11,994,389		13,888,050		11,986,310

See Notes to Consolidated Financial Statements

3

Capital Bancorp, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
(in thousands)	2019			2018			2019			2018
Net income	$	4,023		$	3,145		$	7,342		$	6,135
Other comprehensive income (loss):
Unrealized gain (loss) on investment securities available for sale	440			(197		)	810			(704		)
Reclassification of realized (gain) loss on sale of investment securities available for sale	(26		)	(1		)	(26		)	2
Unrealized gain (loss) on cash flow hedging derivative	—			(1		)	(5		)	6
	414			(199		)	779			(696		)
Income tax (expense) benefit relating to the items above	(114		)	(14		)	(214		)	191
Other comprehensive income (loss)	300			(213		)	565			(505		)
Comprehensive income	$	4,323		$	2,932		$	7,907		$	5,630

See Notes to Consolidated Financial Statements

4

Capital Bancorp, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

(unaudited)

	Common Stock				Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Loss			Total Stockholders' Equity
(dollars in thousands)	Shares		Amount
Balance, December 31, 2017	11,537,196		$	115	$	27,051		$	53,200		$	(247	)	$	80,119
Net income	—		—		—			2,990			—			2,990
Unrealized loss on investment securities available for sale, net of income taxes	—		—		—			—			(297		)	(297		)
Unrealized gain on cash flow hedging derivative, net of income taxes	—		—		—			—			5			5
Stock options exercised, including tax benefit	10,408		—		285			—			—			285
Shares issued as compensation	4,068		—		122			—			—			122
Stock-based compensation	—		—		143			—			—			143
Balance, March 31, 2018	11,551,672		$	115	$	27,601		$	56,190		$	(539	)	$	83,367
Net income	—		—		—			3,145			—			3,145
Unrealized loss on investment securities available for sale, net of income taxes	—		—		—			—			(212		)	(212		)
Unrealized loss on cash flow hedging derivative, net of income taxes	—		—		—			—			(1		)	(1		)
Stock options exercised, including tax benefit	63,124		1		198			—			—			199
Shares issued as compensation	36,076		1		199			—			—			200
Stock-based compensation	—		—		142			—			—			142
Shares issued	16,000		—		198			—			—			198
Shares repurchased and retired	(5,500	)	—		(44		)	—			—			(44		)
Balance, June 30, 2018	11,661,372		$	117	$	28,294		$	59,335		$	(752	)	$	86,994
Balance, December 31, 2018	13,672,479		$	137	$	49,321		$	65,701		$	(595	)	$	114,564
Net income	—		—		—			3,319			—			3,319
Unrealized gain on investment securities available for sale, net of income taxes	—		—		—			—			270			270
Unrealized loss on cash flow hedging derivative, net of income taxes	—		—		—			—			(5		)	(5		)
Stock options exercised, including tax benefit	21,706		—		155			(48		)	—			107
Shares issued as compensation	18,380		—		150			—			—			150
Stock-based compensation	—		—		199			—			—			199
Adoption of lease standard	—		—		—			(54		)	—			(54		)
Balance, March 31, 2019	13,712,565		$	137	$	49,825		$	68,918		$	(330	)	$	118,550
Net income	—		—		—			4,023			—			4,023
Unrealized gain on investment securities available for sale, net of income taxes	—		—		—			—			300			300
Stock options exercised, including tax benefit	6,100		—		47			(1		)	—			46
Stock-based compensation	—		—		199			—			—			199
Balance, June 30, 2019	13,718,665		$	137	$	50,071		$	72,940		$	(30	)	$	123,118

See Notes to Consolidated Financial Statements

5

Capital Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(unaudited)

	Six Months Ended June 30,
(in thousands)	2019			2018
Cash flows from operating activities
Net income	$	7,342		$	6,135
Adjustments to reconcile net income to net cash provided (used) by operating activities:
Provision for loan losses	798			1,145
Provision for losses on mortgage loans sold	67			58
Provision for off balance sheet credit risk	93			89
Net amortization on investments	63			145
Depreciation	569			546
Stock-based compensation expense	398			285
Director and employee compensation paid in Company stock	150			322
Deferred income tax benefit	(64		)	(80		)
Amortization of debt issuance expense	16			16
(Gain) loss on sale of securities available for sale	(26		)	2
Loss on sale of foreclosed real estate	—			17
Mortgage banking revenue	(6,091		)	(4,928		)
Proceeds from sales of loans held for sale	186,305			193,155
Originations of loans held for sale	(209,432		)	(183,317		)
Changes in assets and liabilities:
Accrued interest receivable	(187		)	(51		)
Prepaid income taxes and taxes payable	(178		)	956
Other assets	(1,351		)	(1,490		)
Accrued interest payable	474			134
Other liabilities	1,357			1,962
Net cash provided (used) by operating activities	(19,697		)	15,101
Cash flows from investing activities
Purchases of securities available for sale	(8,202		)	—
Maturities, calls and principal paydowns of securities available for sale	13,444			3,036
Proceeds from sale of securities available for sale	3,280			345
Purchases of restricted investments	(1,634		)	(119		)
Increase in loans receivable	(56,272		)	(34,521		)
Net (purchases) disposals of premises and equipment	362			(746		)
Proceeds from sales of foreclosed real estate	50			9
Net cash used by investing activities	(48,972		)	(31,996		)

See Notes to Consolidated Financial Statements

6

Capital Bancorp, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(unaudited)

	Six Months Ended June 30,
(in thousands)	2019			2018
Cash flows from financing activities
Net increase (decrease) in:
Noninterest bearing deposits	37,225			40,726
Interest bearing deposits	44,539			(7,260		)
Securities sold under agreements to repurchase	(3,332		)	1,184
Federal funds purchased	(2,000		)	—
Federal Home Loan Bank advances, net	36,889			—
Other borrowed funds	—			(2,000		)
Repurchase of common stock	—			(44		)
Proceeds from exercise of stock options	153			484
Proceeds from shares issued	—			198
Net cash provided by financing activities	113,474			33,288
Net increase in cash and cash equivalents	44,805			16,393
Cash and cash equivalents, beginning of year	34,723			52,311
Cash and cash equivalents, end of year	$	79,528		$	68,704
Noncash activities:
Loans transferred to foreclosed real estate	$	57		$	427
Change in unrealized gains (losses) on investments	$	784		$	(702	)
Change in fair value of cash flow hedging derivative	$	(5	)	$	6
Establishment of lease right-of-use asset	$	5,158		$	—
Establishment of lease liability	$	5,358		$	—
Cash paid during the period for:
Taxes	$	2,721		$	910
Interest	$	6,858		$	4,801

See Notes to Consolidated Financial Statements

7

Capital Bancorp, Inc. and Subsidiaries

Form 10-Q

INDEX

Capital Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Note 1 - Nature of Business and Basis of Presentation

Nature of operations:

Capital Bancorp, Inc. is a Maryland corporation and bank holding company (the “Company”) for Capital Bank, N.A. (the “Bank”). The Company's primary operations are conducted by the Bank, which operates branches in Rockville, Columbia and North Bethesda, Maryland, Reston, Virginia, and the District of Columbia. The Bank is principally engaged in the business of investing in commercial, real estate, and credit card loans and attracting deposits. The Company conducts mortgage business through Capital Bank Home Loans, formerly Church Street Mortgage, our residential mortgage banking arm; and credit card business through OpenSky®, a secured, digitally-driven nationwide credit card platform.

The Bank also originates residential mortgages for sale in the secondary market. The Company formed Church Street Capital, LLC (“Church Street Capital”) in 2014 to provide short-term secured real estate financing to Washington, D.C. area investors and developers that may not meet all Bank credit criteria.

In addition, the Company owns all of the stock of Capital Bancorp (MD) Statutory Trust I (the “Trust”). The Trust is a special purpose non-consolidated entity organized for the sole purpose of issuing trust preferred securities.

In October 2018, the Company completed its initial public offering (“IPO”) of 2,563,046 shares of its common stock at a price to the public of $12.50 per share, 1,834,310 shares of which were sold by the Company and 728,736 shares of which were sold by certain of the Company’s shareholders (the “selling shareholders”).  The net proceeds to the Company from the IPO were $19.8 million after deducting the underwriting discount and offering expenses of $3.2 million. The Company did not receive any proceeds from the sales of shares by the selling shareholders.

Basis of presentation:

The accompanying consolidated financial statements include the activity of the Company and its wholly-owned subsidiaries, the Bank and Church Street Capital. All intercompany transactions have been eliminated in consolidation. The Company reports its activities as a single business segment. In determining the appropriateness of segment definition, the Company considers components of the business about which financial information is available and regularly evaluated relative to resource allocation and performance assessment. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), and conform to general practices within the banking industry.

On August 15, 2018, the Company completed a four-for-one stock split of the Company's authorized, issued, and outstanding common stock, par value $0.01 per share (the “Stock Split”). At the effective time of the Stock Split, each share of the Company's issued and outstanding common stock was automatically increased to four shares issued and outstanding. No fractional shares were issued in connection with the Stock Split. All share and share-related information presented in these consolidated financial statements have been retroactively adjusted to reflect the increased number of shares resulting from the Stock Split.

Significant Accounting Policies:

The preparation of consolidated financial statements in accordance with GAAP requires estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. The basis of the estimates is on historical experience and on various other assumptions that are believed to be reasonable under current circumstances, results of which form the basis for making judgments about the carrying value of certain assets and liabilities that are

8

Capital Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Note 1 - Nature of Business and Basis of Presentation (continued)

not readily available from other sources. Estimates are evaluated on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.

Cash and cash equivalents

For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from financial institutions, interest bearing deposits with financial institutions and federal funds sold. Generally, federal funds are sold for one-day periods.

Investment securities

Investment securities are classified as available for sale and carried at fair value with unrealized gains and losses included in stockholders’ equity on an after-tax basis. Premiums and discounts on investment securities are amortized or accreted using the interest method. Changes in the fair value of debt securities available for sale are included in stockholders’ equity as unrealized gains and losses, net of the related tax effect. Unrealized losses are periodically reviewed to determine whether the loss represents an other than temporary impairment. Any unrealized losses judged to be other than a temporary impairment will be charged to income.

Loans held for sale

Mortgage loans originated and intended for sale are recorded at fair value, determined individually, as of the balance sheet date. Fair value is determined based on outstanding investor commitments, or in the absence of such commitments, based on current investor yield requirements. Gains and losses on loan sales are determined by the specific-identification method. The Company’s current practice is to sell residential mortgage loans on a servicing released basis, and, therefore, it has no intangible asset recorded for the value of such servicing. Interest on loans held for sale is credited to income based on the principal amounts outstanding.

Upon sale and delivery, loans are legally isolated from the Company and the Company has no ability to restrict or constrain the ability of third‑party investors to pledge or exchange the mortgage loans. The Company does not have the entitlement or ability to repurchase the mortgage loans or unilaterally cause third‑party investors to put the mortgage loans back to the Company. Unrealized and realized gains on loan sales are determined using the specific-identification method and are recognized through mortgage banking activity in the Consolidated Statements of Income.

The Company elected to measure loans held for sale at fair value to better align reported results with the underlying economic changes in value of the loans on the Company’s balance sheet.

Loans and the Allowance for Loan Losses

Loans are stated at the principal amount outstanding, adjusted for deferred origination fees, deferred origination costs, discounts on loans acquired, and the allowance for loan losses. Interest is accrued based on the loan principal balances and stated interest rates. Origination fees and costs are recognized as an adjustment to the related loan yield using approximate interest methods. The Company discontinues the accrual of interest when any portion of the principal and interest is 90 days past due and collateral is insufficient to discharge the debt in full. Generally, interest payments on nonaccrual loans are recorded as a reduction of the principal balance.

Loans are considered impaired when, based on current information, management believes the Company

9

Capital Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Note 1 - Nature of Business and Basis of Presentation (continued)

will not collect all principal and interest payments according to contractual terms. Generally, loans are reviewed for impairment when the risk grade for a loan is downgraded to a classified asset category. The loans are evaluated for appropriate classification, accrual, impairment, and troubled debt restructure (“TDR”) status. If collection of principal is evaluated as doubtful, all payments are applied to principal. A modification of a loan is considered a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Company may consider interest rate reductions, changes to payment terms, extensions of maturities and/or principal reductions.

Loans are generally charged-off in part or in full when management determines the loan to be uncollectible. Factors for charge-off that may be considered include: repayments deemed to be projected beyond reasonable time frames, client bankruptcy and lack of assets, and/or collateral deficiencies.

The allowance for loan losses is estimated to adequately provide for probable future losses on existing loans. The allowance consists of specific and general components. For loans that are classified as impaired, an allowance is established when the collateral value, if the loan is collateral dependent, or the discounted cash flows of the impaired loan is lower than the carrying value of that loan. The general component covers pools of nonclassified loans and is based on historical loss experience adjusted for qualitative factors. There may be an unallocated component of the allowance, which reflects the margin of imprecision inherent in the underlying assumptions used in the method for estimating specific and general losses in the portfolio. Actual loan performance may differ from those estimates. A loss is recognized as a charge to the allowance when management believes that collection of the loan is unlikely. Collections of loans previously charged off are added to the allowance at the time of recovery.

We determine the allowance for loan losses based on the accumulation of various components that are calculated independently in accordance with ASC 450 for pools of loans, ASC 310 for Troubled Debt Restructuring, and ASC 310 for individually evaluated loans. The process for determining an appropriate allowance for loan losses is based on a comprehensive and consistently applied analysis of the loan portfolio. The analysis considers all significant factors that affect the collectibility of the portfolio and supports the credit losses estimated by this process. It is important to recognize that the related process, methodology, and underlying assumptions require a substantial degree of judgment.

Premises and equipment

Premises and equipment are stated at cost less accumulated depreciation and amortization over two to seven years. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the related property. Leasehold improvements are amortized over the estimated useful lives of the improvements, approximately tenyears, or the term of the lease, whichever is less. Expenditures for maintenance, repairs, and minor replacements are charged to noninterest expenses as incurred.

Leases

During the first quarter of 2019, the Company adopted Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842) (“ASU 2016-02”). ASU 2016-02 applies a right-of-use (“ROU”) model that requires a lessee to record, for all leases with a lease term of more than 12 months, an asset representing its right to use the underlying asset and a liability to make lease payments. The Company has elected to apply the package of practical expedients permitting entities to not reassess: 1) whether any expired or existing contracts are or contain leases; 2) the lease classification for any expired or existing leases; and 3) initial direct costs for any existing leases. Additionally, as provided by ASU 2016-02, the Company has elected not to apply the recognition requirements of ASC 842 to short-term leases, defined as leases with a term of

10

Capital Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Note 1 - Nature of Business and Basis of Presentation (continued)

12 months or less, and to recognize the lease payments in net income on short-term leases on a straight-line basis over the lease term.

We adopted the guidance using the modified retrospective approach on January 1, 2019 and elected the practical expedients for transition including the transition option provided in ASU 2018-11, Leases (Topic 842) Targeted Improvements, which allowed the Company to initially apply the new leases standard at the adoption date. Consequently, the reporting for the comparative periods presented continued to be in accordance with ASC Topic 840, Leases. Therefore, the 2018 financial results and disclosures have not been adjusted.

The Company is largely accounting for our existing operating leases consistent with prior guidance except for the incremental balance sheet recognition for leases. The adoption of this standard resulted in the Company recognizing lease right-of-use assets and related lease liabilities totaling $5.2 million and $5.4 million, respectively, as of January 1, 2019. The difference between the lease assets and the lease liabilities was $146 thousand of deferred rent, which was reclassified to lease liabilities, and the remainder was recorded as an adjustment to retained earnings in the amount of $54 thousand. The adoption of this ASU did not have a significant impact on the Company’s consolidated statement of income. See Note 5 for Leases for more information.

Derivative Financial Instruments

The Company enters into commitments to fund residential mortgage loans (interest rate locks) with the intention of selling them in the secondary market. The Company also enters into forward sales agreements for certain funded loans and loan commitments. The Company records unfunded commitments intended for loans held for sale and forward sales agreements at fair value with changes in fair value recorded as a component of mortgage banking revenue. Loans originated and intended for sale in the secondary market are carried at fair value. For pipeline loans which are not pre-sold to an investor, the Company manages the interest rate risk on rate lock commitments by entering into forward sale contracts, whereby the Company obtains the right to deliver securities to investors in the future at a specified price. Such contracts are accounted for as derivatives and are recorded at fair value as derivative assets or liabilities, with changes in fair value recorded in mortgage banking revenue.

The Company accounts for derivative instruments and hedging activities according to guidelines established in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 815-10, Accounting for Derivative Instruments and Hedging Activities, as amended. The Company recognizes all derivatives as either assets or liabilities on the balance sheet and measures those instruments at fair value. Changes in fair value of derivatives designated and accounted for as cash flow hedges, to the extent they are effective as hedges, are recorded in other comprehensive income, net of deferred taxes. Any hedge ineffectiveness would be recognized in the income statement line item pertaining to the hedged item.

Fair Value Measurements

Fair value is the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market inputs. For financial instruments that are traded actively and have quoted market prices or observable market inputs, there is minimal subjectivity involved in measuring fair value. However, when quoted market prices or observable market inputs are not fully available, significant management judgment may be necessary to estimate fair value. In developing our fair value estimates, we maximize the use of observable inputs and

11

Capital Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Note 1 - Nature of Business and Basis of Presentation (continued)

minimize the use of unobservable inputs.

The fair value hierarchy defines Level 1 valuations as those based on quoted prices (unadjusted) for identical assets or liabilities in active markets. Level 2 valuations include inputs based on quoted prices for similar assets or liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. Level 3 valuations are based on at least one significant assumption not observable in the market, or significant management judgment or estimation, some of which may be internally developed.

Financial assets that are recorded at fair value on a recurring basis include investment securities available for sale, loans held for sale, and derivative financial instruments. Financial liabilities that are recorded at fair value on a recurring basis are comprised of derivative financial instruments. See the Fair Value note to our consolidated financial statements.

Income Taxes

Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are recognized when it is deemed more likely than not that the benefits of such deferred income taxes will be realized.

Earnings per share:

Earnings per share is computed by dividing net income available to common stockholders by the weighted average number of shares outstanding. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares outstanding, adjusted for the dilutive effect of stock options and restricted stock using the treasury stock method. At June 30, 2019 and 2018, there were 273,600 and 263,252 stock options, respectively, that were not included in the calculation as their effect would have been anti-dilutive. The following is a reconciliation of the numerators and denominators used in computing basic and diluted earnings per common share as adjusted for the Stock Split:

	For the Three Months Ended June 30,
	2019					2018
(dollars in thousands, except per share information)	Income (Numerator)		Shares (Denominator)	Per Share Amount		Income (Numerator)		Shares (Denominator)	Per Share Amount
Basic EPS
Net income available to common stockholders	$	4,023	13,718,665	$	0.30	$	3,145	11,610,540	$	0.27
Effect of dilutive securities	—		195,377			—		383,849
Dilutive EPS per common share	$	4,023	13,914,042	$	0.29	$	3,145	11,994,389	$	0.26

12

Capital Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Note 1 - Nature of Business and Basis of Presentation (continued)

	For the Six Months Ended June 30,
	2019					2018
(dollars in thousands, except per share information)	Income (Numerator)		Shares (Denominator)	Per Share Amount		Income (Numerator)		Shares (Denominator)	Per Share Amount
Basic EPS
Net income available to common stockholders	$	7,342	13,707,631	$	0.54	$	6,135	11,587,188	$	0.53
Effect of dilutive securities	—		180,419			—		399,122
Dilutive EPS per common share	$	7,342	13,888,050	$	0.53	$	6,135	11,986,310	$	0.51

Comprehensive income:

The Company reports as comprehensive income all changes in stockholders' equity during the year from sources other than stockholders. Other comprehensive income refers to all components (income, expenses, gains, and losses) of comprehensive income that are excluded from net income.

The Company's only two components of other comprehensive income are unrealized gains and losses on investment securities available for sale, net of income taxes, and unrealized gains and losses on cash flow hedges, net of income taxes. Information concerning the Company's accumulated other comprehensive income (loss) as of June 30, 2019 and December 31, 2018 are as follows:

(in thousands)	June 30, 2019			December 31, 2018
Unrealized losses on securities available for sale	$	(41	)	$	(825	)
Deferred tax benefit	11			227
Other comprehensive loss, net of tax	(30		)	(598		)
Unrealized gains on cash flow hedges	—			5
Deferred tax expense	—			(2		)
Other comprehensive income, net of tax	—			3
Total accumulated comprehensive loss	$	(30	)	$	(595	)

Recently issued accounting pronouncements:

In June 2016, the FASB issued guidance to change the accounting for credit losses and modify the impairment model for certain debt securities. On July 17, 2019, the FASB voted to issue a proposal for public comment that would potentially result in a postponement of the current expected credit loss standard until January 2023 for certain companies including small reporting companies (as defined by the SEC). Management will continue to monitor any new developments regarding this possible delay.

The Company will apply the amendments to the ASU through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. While early adoption is permitted beginning in first quarter 2019, the Company does not expect to elect that option. The Company is evaluating the impact of

13

Capital Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Note 1 - Nature of Business and Basis of Presentation (continued)

the ASU on our consolidated financial statements. In addition to our allowance for loan losses, the Company will also record an allowance for credit losses on debt securities instead of applying the impairment model currently utilized. The amount of the adjustments will be impacted by each portfolio’s composition and credit quality at the adoption date as well as economic conditions and forecasts at that time.

In August 2018, the FASB amended the Fair Value Measurement Topic 820 disclosure framework. These amendments include additions, removals and modifications to the fair value disclosure requirements in Topic 820, and are effective for the Company for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted on removed or modified disclosures. The Company does not expect these amendments to have a material effect on its financial statements.

In March 2019, the FASB issued codification improvements to ASU Topic 842 - Leases, which clarifies fair value of leases, cash presentation and accounting change disclosures. These codification improvements were adopted to coincide with the adoption of ASU Topic 842 Leases. The adoption of this ASU did not have a material impact on the Company’s Consolidated Financial Statements.

In April 2019, the FASB issued codification improvements to ASU Topic 326 - Financial Instruments - Credit Loss, Topic 815 - Derivatives and Hedging, and Subtopic 825-10 - Financial Instruments. This codification provides technical corrections and clarifies issues related to fair value hedges. The Company early adopted this guidance upon issuance, and it did not have a material impact on the Company’s Consolidated Financial Statements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company's financial position, results of operations or cash flows.

Reclassifications:

Certain reclassifications have been made to the amounts reported in prior periods to conform to the current period presentation. The reclassifications had no effect on net income or total stockholders' equity.

14

Capital Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

Note 2 - Investment Securities

The amortized cost and estimated fair value of investment securities at June 30, 2019 and December 31, 2018 are summarized as follows:

Investment Securities Available for Sale
(in thousands)
June 30, 2019	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
Available for sale
U.S. government-sponsored enterprises	$	6,499	$	—	$	(22	)	$	6,477
Municipal	516		5		—			521
Corporate	2,907		28		(45		)	2,890
Mortgage-backed securities	29,276		72		(79		)	29,269
	$	39,198	$	105	$	(146	)	$	39,157
December 31, 2018
Available for sale
U.S. government-sponsored enterprises	$	17,496	$	—	$	(136	)	$	17,360
Municipal	517		—		(16		)	501
Corporate	2,908		28		(51		)	2,885
Mortgage-backed securities	26,836		46		(696		)	26,186
	$	47,757	$	74	$	(899	)	$	46,932

Proceeds from sales of securities sold during the six months ended June 30, were $3.3 millionand $345 thousand for 2019 and 2018, respectively. The investment sales resulted in realized gains of $26 thousand for the quarter ended and the six months ended June 30, 2019 period. In 2018, investment sales resulted in a $1 thousand gain and losses of $2 thousand, for the quarter ended and the six months ended June 30, 2018 period, respectively.

15

Capital Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Note 2 - Investment Securities (continued)

Information related to unrealized losses in the investment portfolio as of June 30, 2019 and December 31, 2018 are as follows:

Investment Securities Unrealized Losses
(in thousands)	Less than 12 months					12 months or longer					Total
June 30, 2019	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
U.S. government-sponsored enterprises	$	—	$	—		$	6,477	$	(22	)	$	6,477	$	(22	)
Municipal	—		—			—		—			—		—
Corporate	—		—			862		(45		)	862		(45		)
Mortgage-backed securities	—		—			14,357		(79		)	14,357		(79		)
	$	—	$	—		$	21,696	$	(146	)	$	21,696	$	(146	)
December 31, 2018
U.S. government-sponsored enterprises	$	496	$	(2	)	$	16,864	$	(134	)	$	17,360	$	(136	)
Municipal	—		—			501		(16		)	501		(16		)
Corporate	—		—			857		(51		)	857		(51		)
Mortgage-backed securities	2,294		(7		)	21,037		(689		)	23,331		(696		)
	$	2,790	$	(9	)	$	39,259	$	(890	)	$	42,049	$	(899	)

At June 30, 2019, there were four U.S. government-sponsored enterprises securities, two corporate securities, and ten mortgage-backed securities that had been in a loss position for greater than twelve months. At December 31, 2018, there were nine U.S. government-sponsored enterprises securities, two corporate securities, and fifteen mortgage-backed securities that had been in a loss position for greater than twelve months. Management believes that all unrealized losses have resulted from changes in the interest rates and current market conditions and not as a result of credit deterioration. Management has the ability and the intent to hold these investment securities until maturity or until they recover in value.

A summary of pledged securities at June 30, 2019 and December 31, 2018 are shown below:

Pledged Securities
	June 30, 2019				December 31, 2018
(in thousands)	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Securities sold under agreements to repurchase	$	—	$	—	$	16,032	$	15,862
Federal Home Loan Bank advances	1,664		1,674		6,713		6,662
	$	1,664	$	1,674	$	22,745	$	22,524

16

Capital Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Note 2 - Investment Securities (continued)

Contractual maturities of U.S. government-sponsored enterprises and corporate securities at June 30, 2019 and December 31, 2018 are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

Contractual Maturities
	June 30, 2019				December 31, 2018
(in thousands)	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Within one year	$	6,499	$	6,477	$	16,496	$	16,377
Over one to five years	—		—		1,000		983
Over five to ten years	2,000		2,028		2,000		2,028
Over ten years	1,423		1,383		1,425		1,358
Mortgage-backed securities(1)	29,276		29,269		26,836		26,186
	$	39,198	$	39,157	$	47,757	$	46,932

_______________

⁽¹⁾  Mortgage-backed securities are due in monthly installments.

17

Capital Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Note 3 - Loans Receivable

Major classifications of loans as are as follows:

Loan Categories
(in thousands)	June 30, 2019			December 31, 2018
Real estate
Residential	$	426,887		$	407,844
Commercial	297,891			278,691
Construction	169,225			157,586
Commercial	124,436			122,264
Credit card	40,141			34,673
Other consumer	1,015			1,202
	1,059,595			1,002,260
Deferred origination fees, net	(3,305		)	(1,992		)
Allowance for loan losses	(11,913		)	(11,308		)
Loans receivable, net	$	1,044,377		$	988,960

The Company makes loans to customers located primarily in the Washington, D.C. and Baltimore metropolitan areas. Although the loan portfolio is diversified, its performance is influenced by the regional economy. The Company’s loan categories are described below.

Residential Real Estate Loans. One-to-four family mortgage loans are primarily secured by owner-occupied primary residences and, to a lesser extent, investor owned residences. Residential loans are originated through the commercial sales teams and Capital Bank Home Loans division. Residential loans also include home equity lines of credit. One-to-four family residential loans have a relatively small balance spread between many individual borrowers compared to our other loan categories. Owner-occupied residential real estate loans usually have fixed rates for five or seven years and adjust on an annual basis after the initial term based on a typical maturity of 30 years. Investor residential real estate loans are generally based on 25-year terms with a balloon payment due after five years. The required minimum debt service coverage ratio is 1.15. Residential real estate loans have represented a stable and growing portion of our loan portfolio. The emphasis will continue to be on residential real estate lending.

Commercial Real Estate Loans. Commercial real estate loans are originated on owner-occupied and non-owner-occupied properties. These loans may be more adversely affected by conditions in the real estate markets or in the general economy. Commercial loans that are secured by owner-occupied commercial real estate and primarily collateralized by operating cash flows are also included in this category of loans. As of June 30, 2019, there were approximately $139.6 million of owner-occupied commercial real estate loans, representing approximately 47% of the commercial real estate portfolio. Commercial real estate loan terms are generally extended for 10 years or less and amortize generally over 25 years or less. The interest rates on commercial real estate loans have initial fixed rate terms that adjust typically at 5 years and origination fees are routinely charged for services. Personal guarantees from the principal owners of the business are generally required, supported by a review of the principal owners’ personal financial statements and global debt service obligations. The properties securing the portfolio are located primarily throughout the Company’s markets and are generally diverse in terms of type. This diversity helps reduce the exposure to adverse economic events that affect any single industry.

Construction Loans. Construction loans are offered within the Company’s Washington, D.C. and Baltimore, Maryland metropolitan operating areas to builders primarily for the construction of single-family homes and condominium and townhouse conversions or renovations and, to a lesser extent, to individuals.

18

Capital Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Note 3 - Loans Receivable (continued)

Construction loans typically have terms of 12 to 18 months with the goal of transitioning the borrowers to permanent financing or re-underwriting and selling into the secondary market through Capital Bank Home Loans. According to underwriting standards, the ratio of loan principal to collateral value, as established by an independent appraisal, cannot exceed 75% for investor-owned and 80% for owner-occupied properties. On a case by case basis, exceptions to these limits may be granted with appropriate credit mitigants. Semi-annual stress testing of the construction loan portfolio is conducted, and underlying real estate conditions are closely monitored as well as the borrower’s trends of sales valuations as compared to underwriting valuations as part of the ongoing risk management efforts. The borrowers’ progress in construction buildout is closely monitored and the original underwriting guidelines for construction milestones and completion timelines are strictly enforced.

Commercial Business Loans. In addition to other loan products, general commercial loans, including commercial lines of credit, working capital loans, term loans, equipment financing, letters of credit and other loan products are offered, primarily in target markets, and underwritten based on each borrower’s ability to service debt from income. These loans are primarily made based on the identified cash flows of the borrower and secondarily, on the underlying collateral provided by the borrower. Most commercial business loans are secured by a lien on general business assets including, among other things, available real estate, accounts receivable, promissory notes, inventory and equipment, and personal guaranties from the borrower or other principal are generally obtained.

Credit Cards. Our OpenSky® credit card division provides, on a nationwide basis, credit cards are provided to under-banked populations and those looking to rebuild their credit scores through a fully digital and mobile platform. Substantially all of the lines of credit are secured by a noninterest bearing demand account at the Bank in an amount equal to the full credit limit of the credit card. In addition, using a proprietary scoring model, which considers credit score and repayment history (typically a minimum of six months of on-time repayments, but ultimately determined on a case-by-case basis) the Bank has recently begun to offer certain customers an unsecured line in excess of their secured line of credit. Approximately $37.9 million and $32.5 million of the credit card balances were secured by savings deposits held by the Company as of June 30, 2019 and December 31, 2018, respectively.

Other Consumer Loans. To a very limited extent and typically as an accommodation to existing customers, personal consumer loans such as term loans, car loans or boat loans are offered.

Loans acquired through acquisitions are recorded at estimated fair value on their purchase date with no carryover of the related allowance for loan losses. In estimating the fair value of loans acquired, certain factors were considered, including the remaining lives of the acquired loans, payment history, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, and the net present value of cash flows expected. Discounts on loans that were not considered impaired at acquisition were recorded as an accretable discount, which will be recognized in interest income over the terms of the related loans. For loans considered to be impaired, the difference between the contractually required payments and expected cash flows was recorded as a nonaccretable discount. Generally, the nonaccretable discount will be recognized after collection of the discounted fair value of the related loan. The remaining nonaccretable discounts on loans acquired were $354 thousand as of both June 30, 2019 and December 31, 2018. Loans with nonaccretable discounts had a carrying value of $1.3 million as of both June 30, 2019 and December 31, 2018.

19

Capital Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Note 3 - Loans Receivable (continued)

Accretable discounts on loans acquired is summarized as follows:

Accretable Discounts on Loans Acquired
(in thousands)	For the Three Months Ended						For the Six Months Ended
	June 30, 2019			June 30, 2018			June 30, 2019			June 30, 2018
Accretable discount at beginning of period	$	430		$	531		$	438		$	543
Accretion and payoff of loans	(6		)	(12		)	(14		)	(24		)
Accretable discount at end of period	$	424		$	519		$	424		$	519

The following tables set forth the changes in the allowance for loan losses and an allocation of the allowance for loan losses by class for the three and six months ended June 30, 2019 and June 30, 2018.

Allowance for Loan Losses
(in thousands)	Beginning Balance		Provision for Loan Losses			Charge-Offs					Ending Balance
Three Months Ended June 30, 2019									Recoveries
Real estate
Residential	$	3,939	$	(24	)	$	—		$	—	$	3,915
Commercial	2,894		217			—			5		3,116
Construction	2,062		142			—			—		2,204
Commercial	1,451		49			(28		)	—		1,472
Credit card	992		295			(90		)	2		1,199
Other consumer	9		(2		)	—			—		7
	$	11,347	$	677		$	(118	)	$	7	$	11,913
Six Months Ended June 30, 2019
Real estate
Residential	$	3,541	$	374		$	—		$	—	$	3,915
Commercial	3,003		106			—			7		3,116
Construction	2,093		111			—			—		2,204
Commercial	1,578		(78		)	(28		)	—		1,472
Credit card	1,084		287			(183		)	11		1,199
Other consumer	9		(2		)	—			—		7
	$	11,308	$	798		$	(211	)	$	18	$	11,913

20

Capital Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Note 3 - Loans Receivable (continued)

Allowance for Loan Losses
(in thousands)	Beginning Balance		Provision for Loan Losses		Charge-Offs					Ending Balance
Three Months Ended June 30, 2018								Recoveries
Real estate
Residential	$	3,175	$	31	$	—		$	1	$	3,207
Commercial	2,933		33		(22		)	4		2,948
Construction	1,804		85		—			—		1,889
Commercial	1,414		113		(131		)	—		1,396
Credit card	823		367		(252		)	60		998
Other consumer	8		1		—			—		9
	$	10,157	$	630	$	(405	)	$	65	$	10,447
Six Months Ended June 30, 2018
Real estate
Residential	$	3,137	$	68	$	—		$	2	$	3,207
Commercial	2,860		103		(22		)	7		2,948
Construction	1,646		243		—			—		1,889
Commercial	1,497		45		(147		)	1		1,396
Credit card	885		685		(658		)	86		998
Other consumer	8		1		—			—		9
	$	10,033	$	1,145	$	(827	)	$	96	$	10,447

21

Capital Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Note 3 - Loans Receivable (continued)

The following tables present, by class and reserving methodology, the allocation of the allowance for loan losses and the gross investment in loans. The allowance for loan losses consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component covers non-impaired loans and is based on historical loss experience adjusted for current economic factors.

Allowance for Loan Loss Composition
(in thousands)	Allowance for Loan Losses Ending Balance Evaluated for Impairment:				Outstanding Loan Balances Evaluated for Impairment:
June 30, 2019	Individually		Collectively		Individually		Collectively
Real estate
Residential	$	—	$	3,915	$	2,187	$	424,700
Commercial	—		3,116		1,465		296,426
Construction	43		2,161		2,143		167,082
Commercial	334		1,138		1,002		123,434
Credit card	—		1,199		—		40,141
Other consumer	—		7		—		1,015