SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2020.
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 001-39285
(Exact name of registrant as specified in its charter)
(State or Other Jurisdiction of Incorporation or Organization)
(I.R.S. Employer Identification No.)
2245 Northwood Drive, Salisbury, Maryland
(Address of Principal Executive Offices)
Registrant's telephone number, including area code (410)-548-1100
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on which registered
Common Stock, par value $.01 per share
Nasdaq Capital Market
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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 ☒ 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark 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 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 ☐
Accelerated Filer ☐
Non-accelerated Filer ☒
Smaller Reporting Company ☒
Emerging Growth Company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of June 30, 2020, which was the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $66,035,182 based on the closing price of $6.57 per share on the Nasdaq Capital Market on that date.
As of March 30, 2021, there were 17,726,648 shares outstanding of the registrant’s common stock, $0.01 par value.
Documents Incorporated by Reference:
TABLE OF CONTENTS
Partners Bancorp. Partners Bancorp (the “Company”) is a Maryland chartered corporation and a bank holding company registered with and supervised by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Company holds all of the issued and outstanding shares of common stock of The Bank of Delmarva (“Delmarva”) and Virginia Partners Bank (“Partners” and, together with Delmarva, the “Affiliate Banks”). The Company was incorporated as Delmar Bancorp on January 6, 1988 under the general corporation law of Maryland for the purpose of becoming a bank holding company, and changed its name to Partners Bancorp effective on August 19, 2020. Partners is a commercial bank which was organized under the laws of the Commonwealth of Virginia and commenced regular operations on July 8, 2008. The Company acquired Partners on November 15, 2019 through an exchange of shares in an all-stock transaction (the “Share Exchange”) pursuant to which each share of Partners common stock was exchanged for 1.7179 shares of the Company common stock. Options and warrants to acquire Partners common stock were assumed by the Company and converted into options and warrants to acquire shares of the Company common stock.
The Company has no direct subsidiaries other than Delmarva and Partners. The principal executive office of the Company is located at 2245 Northwood Drive, Salisbury, Maryland 21801.
Since commencing operations, the Company’s business has consisted primarily of managing and supervising Delmarva and Partners and its principal source of income has been revenues generated by Delmarva and Partners. The Company anticipates that going forward its business will continue to consist primarily of managing and supervising the Affiliate Banks and that its principal source of income will be revenues generated by the Affiliate Banks.
The Company provides various services to the Affiliate Banks which include, but are not limited to, management assistance, internal auditing services, compliance management, financial reporting and training, and vendor management support.
The Bank of Delmarva. Delmarva, a community oriented financial institution, was established in Maryland in 1896, reorganized as a national bank in 1996, and reorganized as a Delaware state chartered bank in 2003. Delmarva provides a broad range of commercial and consumer banking services to individuals, small and medium-sized businesses and professionals in Southern New Jersey and the eastern shore regions of Maryland and Delaware, including Sussex County, Delaware, Wicomico County, Maryland and Worcester County, Maryland. Delmarva currently operates 14 full service banking offices, located in Delmar, Salisbury and Ocean City, Maryland and Laurel, Dagsboro Rehoboth, Delaware, and Cherry Hill, Evesham and Moorestown, New Jersey, along with 16 automated teller machines (“ATMs”). In March 2018, the Company completed its acquisition of Liberty Bell Bank through a merger with Delmarva, with Delmarva being the surviving entity. Through the merger, Delmarva gained the branches in Cherry Hill, Evesham and Moorestown, New Jersey, which are operated under the name Liberty Bell Bank, a Division of The Bank of Delmarva. Delmarva’s main office is located at 910 Norman Eskridge Highway, Seaford, Delaware.
Delmarva has five consolidated subsidiaries, three of which are wholly owned, organized to hold foreclosed real estate.
Virginia Partners Bank. Partners is headquartered in Fredericksburg, Virginia, which is also the location of an operations center. Partners has three branches in Fredericksburg, Virginia. In Maryland, Partners trades under the name Maryland Partners Bank (a division of Virginia Partners Bank), and operates a full service branch and commercial banking office in La Plata, Maryland and a Loan Production Office in Annapolis, Maryland. Partners engages in the general banking business and provides financial services to the communities in and around the Greater Fredericksburg, Virginia area (Stafford County, Spotsylvania County, King George County, Caroline County, and the City of Fredericksburg, Virginia), and Anne Arundel County and the three counties of Southern Maryland (Charles County, Calvert County and St. Mary’s County).
Partners has two wholly owned subsidiaries and one majority owned subsidiary. Bear Holdings, Inc. was established in 2011 for the purpose of holding properties acquired through foreclosure that are classified as other real estate owned. In 2012, 410 William Street, LLC was formed for the purpose of acquiring and holding an interest in the property at 410 William Street, which houses one of Partners’ four branches, including the executive offices. On January 1, 2018, Partners acquired a 51% ownership interest in Johnson Mortgage Company, LLC (“JMC”), which is a residential mortgage company headquartered in Newport News, Virginia, with branch offices in Fredericksburg and Williamsburg, Virginia. JMC is engaged in the mortgage banking business in which JMC originates, closes, and immediately sells mortgage loans and related servicing rights to permanent investors in the secondary market. The financial position and operating results of these subsidiaries are included in Partners consolidated financial statements. For JMC, Partners reflects the issued and outstanding interest not held by Partners in its consolidated financial statements as noncontrolling interest.
The Company is a multi-bank holding company, whose wholly-owned subsidiaries are The Bank of Delmarva and Virginia Partners Bank. Combined, these banks make the Company a $1.5 billion company, serving customers from southern New Jersey and Delaware, into Maryland and Virginia.
As member banks of the "Affiliate Bank" model, the Company’s Affiliate Banks employ hundreds of people and invest millions of dollars into their local economies. Ultimately, the Company’s community banks put families into homes, send kids to college, and provide critical financial support to allow "Main Street businesses" to prosper.
The Affiliate Bank model offers other community banks the best of both worlds: keep what is best about community banking, while enjoying the benefits of a larger, stronger parent company with better access to technology and capital, and improved shareholder liquidity. Affiliate banks keep their own charters, names, boards, and management. Affiliate bank customers experience better service through the combined branch network of the affiliates and the larger lending capacity created by the affiliation.
It is a strategic goal of the Company to add additional affiliate banks to the Company, to create a connected marketplace in the greater mid-Atlantic region.
Products and Services
Each Affiliate Bank is a full service community bank, and offers a comprehensive array of deposit products, loan services, and other services to its customers, filling both retail and commercial needs. These products and services include:
• Time Deposit Accounts
• Free Personal Checking Accounts
• Business Checking Accounts
• NOW Accounts
• Tiered Money Market Accounts
• IRA Accounts
• Statement Savings Accounts
• Remote Deposit Capture
• Cash Management Accounts and Services
• Mobile Deposit Services
• Lines of Credit
• Equipment Loans
• Commercial Real Estate Loans
• Letters of Credit
• Small Business Administration Loans
• Home Equity Loans
• Term Loans
• US Department of Agriculture Loans
• Business Credit Cards
• New and Used Car Loans
• Mobile Home, Boats, RV and Motorcycle Loans
• Unsecured Consumer Loans
• Purchase and Refinance Mortgage Loans
• Construction/Permanent Mortgage Loans
• Bridge Loans
• Lot Loans
• Phone Banking
• Mobile Banking App
• Cash Management/Sweep/Zero Balance/ACH Origination/Cash Concentration/Payroll Direct Deposit
• Internet Banking and Online Bill Payment
• Full Service ATMs
• Merchant Services
• External Transfers
• Cash Advance Service
• ATM/Debit Cards
• Surcharge Free ATM Network Access
Market Area and Deposit Share
Delmarva’s primary market area consists of Sussex County, Delaware, Wicomico County, Maryland, Worcester County, Maryland, Camden County, New Jersey and Burlington County, New Jersey and contiguous counties in Maryland, Delaware and New Jersey. As of June 30, 2020, Delmarva had the third highest level of deposits of banks active in the Salisbury MD-DE MSA, excluding a large credit card bank which reports all of its deposits in the market. Delmarva’s market share in the Philadelphia—Camden—Wilmington, Pennsylvania, New Jersey, Delaware, Maryland is less than 0.1%.
In Greater Fredericksburg, Partners has two offices in the City of Fredericksburg (including Partners’ headquarters) and one office in Spotsylvania County. In Maryland, Partners has a full service branch and commercial lending office in La Plata, Maryland, and a Loan Production Office in Annapolis, Maryland. All branch locations have drive-thru facilities and ATMs. JMC has locations in Newport News, Williamsburg, and Spotsylvania, Virginia. The Spotsylvania office is co-located with a branch of Partners.
Partners has two distinct market areas for commercial banking: Greater Fredericksburg (Stafford County, Spotsylvania County, King George County, Caroline County, and the City of Fredericksburg, Virginia); and, Anne Arundel County and the three counties of Southern Maryland (Charles County, Calvert County and St. Mary’s County). The markets for JMC include the Newport News/Williamsburg, Virginia markets, and Greater Fredericksburg.
The Washington-Arlington-Alexandria, DC-VA-MD-WV MSA, where all of Partners branches are located, had a combined deposit market of $314 billion as of June 30, 2020. Partners was ranked 35th out of 72 financial institutions, with total deposits of $416 million as of June 30, 2020. In Fredericksburg City, Virginia, Partners was ranked 2nd, with a
17.69% market share, as of June 30, 2020. In Spotsylvania County, Virginia, Partners was ranked 8th, with a 2.76% market share, as of June 30, 2020. In Charles County, Maryland, Partners was ranked 9th, with a 2.29% market share, as of June 30, 2020.
Both Delmarva and Partners face significant competition for the attraction of deposits and the origination of loans from other community banks and larger banks with regional or national footprints. The Affiliate Banks also face competition from other financial services companies such as brokerage firms, credit unions and insurance companies, mortgage companies, insurance companies and nonbank and online depositories and lenders. Larger bank competitors may have many offices operating over a wide geographic area. Among the advantages such large banks have over Delmarva and Partners is their ability to finance wide-ranging advertising campaigns, and by virtue of their greater total capitalization, to have substantially higher lending limits than Delmarva and Partners. Factors such as interest rates offered, the number and location of branches and the types of products offered, as well as the reputation of the institution, affect competition for deposits and loans.
Both Delmarva and Partners differentiate themselves from their competitors through superior customer service and responsiveness with accountability to a local management team, board of directors and advisory board. The Company believes that its multi-bank model permits its Affiliate Banks to maintain their character as community banks and the close relationships they maintain with their customers and communities, while affiliating with a larger organization that can provide more sophisticated technology and products, access to capital and support and guidance from partnered institutions.
The Company believes that effective risk management is of primary importance. Risk management refers to the activities by which the Company identifies, measures, monitors, evaluates and manages the risks its faces in the course of its banking activities. These include liquidity, interest rate, credit, operational, compliance, regulatory, strategic, financial and reputational risk exposures. The Company’s and the Affiliate Banks’ boards of directors and management teams have created a risk-conscious culture that is focused on quality growth, which starts with capable and experienced risk management teams and infrastructure capable of addressing the evolving risks the Company faces, as well as the changing regulatory and compliance landscape. The Company’s risk management approach employs comprehensive policies and processes to establish robust governance. The Company believes a disciplined and conservative underwriting approach has been the key to its strong asset quality.
The lending activities in which the Affiliate Banks engage carry the risk that the borrowers will be unable to perform on their obligations. As such, interest rate policies of the Federal Reserve and general economic conditions, nationally and in Delmarva’s and Partners’ market areas, could have a significant impact on Delmarva’s and Partners’ results of operations, respectively. To the extent that economic conditions deteriorate, business and individual borrowers may be less able to meet their obligations in full, in a timely manner, resulting in decreased earnings or losses. Economic conditions may also adversely affect the value and liquidity of property pledged as security for loans.
Through its Affiliate Banks, the Company’s goal is to mitigate risks in the event of unforeseen threats to the loan portfolio as a result of economic downturn or other negative influences. Plans for mitigating inherent risks in managing loan assets include: carefully enforcing loan policies and procedures, evaluating each borrower’s business plan during the underwriting process and throughout the loan term, identifying and monitoring primary and alternative sources for loan repayment, and obtaining collateral to mitigate economic loss in the event of liquidation. Specific loan reserves are established based upon credit and/or collateral risks on an individual loan basis. A risk rating system is employed to proactively estimate loss exposure and provide a measuring system for setting general and specific reserve allocations. The Affiliate Bank’s management, lending officers and credit administration team emphasize a strong risk management culture supported by comprehensive policies and procedures for credit underwriting, funding and administration that the Affiliate Banks believe have enabled them to maintain sound asset quality. The underwriting methodology emphasizes establishing and monitoring strong overall cash flow throughout a customer’s business operations, appropriate loan-to-value ratios, full or partial guarantors when deemed necessary, and/or strong tertiary
sources of re-payment. The Affiliate Banks’ tiered underwriting structure includes progressive levels of individual loan authority, concurrent authority and senior loan committee approval. The Affiliate Banks’ loan review function performs regular internal loan reviews and identifies early warning indicators to proactively monitor the loan portfolio. Asset quality is regularly reported to, and monitored by, the Company’s board.
Each of the Affiliate Banks’ lending activities are subject to a variety of lending limits imposed by state and federal law. These limits will increase or decrease in response to increases or decreases in its level of capital. At December 31, 2020, Delmarva had a legal lending limit of $13.3 million. At December 31, 2020, Delmarva’s average funded loan size outstanding for commercial real estate (including commercial construction) and commercial loans was $534 thousand and $145 thousand, respectively. At December 31, 2020, Partners had a legal lending limit of $7.8 million. At December 31, 2020, Partner’s average funded loan size outstanding for commercial real estate (including commercial construction) and commercial loans was $675 thousand and $93 thousand, respectively.
Concentrations of Credit Risk. Most of the Company’s lending is conducted with businesses and individuals in eastern shore regions of Maryland and Delaware and in southern New Jersey (through Delmarva) and Fredericksburg, Virginia, Charles County, Maryland and Anne Arundel County, Maryland (through Partners). The Company’s loan portfolio consists primarily of commercial real estate loans, including construction and land loans, which totaled $644.5 million and constituted 62.20% of total loans as of December 31, 2020, and 1-4 family residential real estate loans, which totaled $199.3 million and constituted 19.3% of total loans as of December 31, 2020. The geographic concentration of the Company’s loans subjects its business to the general economic conditions within that market area. The Share Exchange with Partners somewhat reduced the geographic concentration of Delmarva’s loans, but Delmarva’s current and prospective market areas are largely affected by the same general economic factors that affect Partners. The risks created by such concentrations have been considered by management in the determination of the adequacy of the allowance for loan losses. The Company’s management believes the allowance for loan losses of each Affiliate Bank is adequate to cover probable incurred losses in the loan portfolios of each respective Affiliate Bank as of December 31, 2020.
Comprehensive risk management practices and appropriate capital levels are essential elements of a sound commercial real estate lending program. A concentration in commercial real estate adds a dimension of risk that compounds the risk inherent in individual loans. The federal banking agencies have issued guidance governing financial institutions with concentrations in commercial real estate lending. The guidance provides that institutions that have (i) total reported loans for construction, land development, and other land which represent 100% or more of an institution’s total risk-based capital; or (ii) total reported commercial real estate loans, excluding loans secured by owner-occupied commercial real estate, representing 300% or more of the institution’s total risk-based capital and the institution’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months, are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital.
Delmarva has a concentration in both non-owner-occupied commercial real estate and construction and land development loans. At December 31, 2020, Delmarva’s non-owner-occupied commercial real estate loan portfolio constituted 225.5% of capital and its construction, land development and land loans constituted 65.7% of capital.
Partners has a concentration in both non-owner-occupied commercial real estate and construction and land development loans. At December 31, 2020, Partners’ non-owner-occupied commercial real estate loan portfolio constituted 189.4% of capital and its construction, land development and land loans constituted 35.7% of capital.
As of December 31, 2020, the Company had approximately 220 full-time equivalent employees. The Company believes that its employee relations are good.
Supervision and Regulation
The Company’s and the Affiliate Banks’ business and operations are subject to extensive federal and state governmental regulation and supervision. The following is a brief summary of certain statutes and rules and regulations that affect or will affect us. This summary is not complete, and the Company refers you to the particular statutory or regulatory provisions or proposals for more information. Because regulation of financial institutions changes regularly and is the subject of constant legislative and regulatory debate, the Company cannot forecast how federal and state regulation and supervision of financial institutions may change in the future and affect the operations of the Company and the Affiliate Banks. Supervision, regulation, and examination by the regulatory agencies are intended primarily for the protection of depositors and the Deposit Insurance Fund (“DIF”), rather than shareholders.
Regulatory Reform. The financial crisis of 2008, including the downturn of global economic, financial and money markets and the threat of collapse of numerous financial institutions, and other events led to the adoption of numerous laws and regulations that apply to, and focus on, financial institutions. The most significant of these laws is the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which was enacted on July 21, 2010 and, in part, was intended to implement significant structural reforms to the financial services industry.
The Dodd-Frank Act implemented far-reaching changes across the financial regulatory landscape, including changes that have significantly affected the business of all bank holding companies and banks, including the Company and the Affiliate Banks. Some of the rules that have been proposed and, in some cases, adopted to comply with the Dodd-Frank Act's mandates are discussed further below. In May 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the “EGRRCPA”) was enacted to reduce the regulatory burden on certain banking organizations, including community banks, by modifying or eliminating certain federal regulatory requirements. While the EGRRCPA maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain aspects of the regulatory framework for small depository institutions with assets of less than $10 billion as well as for larger banks with assets above $50 billion. In addition, the EGRRCPA included regulatory relief for community banks regarding regulatory examination cycles, call reports, application of the Volcker Rule (proprietary trading prohibitions), mortgage disclosures, qualified mortgages, and risk weights for certain high-risk commercial real estate loans. However, federal banking agencies retain broad discretion to impose additional regulatory requirements on banking organizations based on safety and soundness and U.S. financial system stability considerations.
The Company continues to experience ongoing regulatory reform. These regulatory changes could have a significant effect on how the Company and the Affiliate Banks conduct their businesses, including increased compliance costs and other adverse effects on the business, financial condition and results of operations of the Company and the Affiliate Banks. The specific implications of potential regulatory reforms cannot yet be fully predicted and will depend to a large extent on the specific regulations that are to be adopted in the future. Certain aspects of the Dodd-Frank Act and the EGRRCPA are discussed in more detail below.
CARES Act and the PPP. The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was enacted in March 2020 to provide economic relief in response to the public health and economic impacts of a novel strain of coronavirus disease (“COVID-19”). Many of the CARES Act’s programs are, and remain, dependent upon the direct involvement of U.S. financial institutions like the Company and the Affiliate Banks. These programs have been implemented through rules and guidance adopted by federal departments and agencies, including the U.S. Department of Treasury, the Small Business Administration (the “SBA”), the Federal Reserve, and other federal bank regulatory authorities, including those with direct supervisory jurisdiction over the Company and the Affiliate Banks. Furthermore, as the COVID-19 pandemic evolves, federal regulatory authorities continue to issue additional guidance and regulations with respect to the implementation, lifecycle, and eligibility requirements for the various CARES Act programs as well as industry-specific recovery procedures for COVID-19. The Company continues to assess the impact of the CARES Act, the potential impact of new COVID-19 legislation, and other statutes, regulations, and supervisory guidance related to the COVID-19 pandemic.
The CARES Act amended the SBA’s 7(a) loan program, in which the Affiliate Banks participate, to create a guaranteed, unsecured loan program, the Paycheck Protection Program (the “PPP”), to fund operational costs of eligible businesses, organizations and self-employed persons during COVID-19. In December 2020, Congress revived the PPP and allocated additional PPP funds for 2021. As a result, the SBA is anticipated to review and modify prior guidance and promulgate new regulations and guidance to conform with and implement the new provisions during the first quarter of 2021. As participating PPP lenders, the Affiliate Banks continue to monitor legislative, regulatory, and supervisory developments related thereto.
The American Rescue Plan. On March 11, 2021, President Biden signed into law the American Rescue Plan Act of 2021 (the “American Rescue Plan”) to provide additional relief and address the ongoing COVID-19 pandemic. The American Rescue Plan allocates $1.9 trillion in funding for a multitude of programs addressing the national economy, public health, state and local governments, individuals, and businesses. These programs include, among others, (i) small business assistance, including modification and expansion of the PPP, (ii) extension of unemployment benefits and related services, (iii) tax relief related to unemployment compensation, (iv) a maximum tax recovery rebate of $1,400 per eligible individual, and (v) the expansion and modification of certain tax credits, including the child tax credit and the earned income tax credit. Guidance related to these programs will be developed by the responsible federal agencies as new information becomes available and additional program details are finalized. At this time, the Company cannot predict what impact, if any, the American Rescue Plan will have on its operations. The Company continues to monitor developments related to the American Rescue Plan.
The Company. The Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the “BHC Act”) and subject to regulation and supervision by the Federal Reserve. The BHC Act and other federal laws subject bank holding companies to restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations and unsafe and unsound banking practices. As a bank holding company, the Company is required to file with the Federal Reserve an annual report and such other additional information as the Federal Reserve may require pursuant to the BHC Act. The Federal Reserve may also examine the Company and each of its subsidiaries.
The BHC Act requires approval of the Federal Reserve for, among other things, a bank holding company’s direct or indirect acquisition of control of more than 5% of the voting shares, or substantially all the assets, of any bank or the merger or consolidation by a bank holding company with another bank holding company. The BHC Act generally permits the acquisition by a bank holding company of control or substantially all the assets of any bank located in a state other than the home state of the bank holding company, except where the bank has not been in existence for the minimum period of time required by state law; but if the bank is at least five years old, the Federal Reserve may approve the acquisition. In April 2020, the Federal Reserve adopted a final rule codifying the presumptions used in determinations of whether a company has the ability to exercise a controlling influence over another company for purposes of the BHCA, and providing greater transparency on the types of relationships that the Federal Reserve generally views as supporting a determination of control.
With limited exceptions, a bank holding company is prohibited from acquiring control of any voting shares of any company which is not a bank or bank holding company and from engaging directly or indirectly in any activity other than banking or managing or controlling banks or furnishing services to or performing service for its authorized subsidiaries. A bank holding company may, however, engage in, or acquire an interest in, a company that engages in activities which the Federal Reserve has determined by order or regulation to be so closely related to banking or managing or controlling banks as to be properly incident thereto. In making such a determination, the Federal Reserve is required to consider whether the performance of such activities can reasonably be expected to produce benefits to the public, such as convenience, increased competition or gains in efficiency, which outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. The Federal Reserve is also empowered to differentiate between activities commenced de novo and activities commenced by the acquisition, in whole or in part, of a going concern.
The Federal Reserve may order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding
company’s continued ownership, activity or control constitutes a serious risk to the financial safety, soundness, or stability of it or any of its bank subsidiaries.
Subsidiary banks of a bank holding company are subject to restrictions imposed by the Federal Reserve Act on any extensions of credit to a bank holding company or any of its subsidiaries, or investments in the stock or other securities thereof, and on the taking of such stock or securities as collateral for loans to any borrower. Further, a bank holding company and any subsidiary bank are prohibited from engaging in tie-in arrangements in connection with the extension of credit. A subsidiary bank may not extend credit, lease or sell property, or furnish any services, or fix or vary the consideration for any of the foregoing on the condition that: (i) the customer obtain or provide some additional credit, property or services from or to such bank other than a loan, discount, deposit or trust service; (ii) the customer obtain or provide some additional credit, property or service from or to the Company or any of its subsidiaries; or (iii) the customer not obtain some other credit, property or service from competitors, except for reasonable requirements to assure the soundness of credit extended.
The Gramm-Leach-Bliley Act (the “GLB Act”) allows a bank holding company or other company to elect to become a financial holding company, which would allow that company to engage in activities that are financial in nature, that are incidental to such activities, or are complementary to such activities. The GLB Act enumerates certain activities that are deemed financial in nature, such as underwriting insurance or acting as an insurance principal, agent or broker, underwriting, dealing in or making markets in securities, and engaging in merchant banking under certain restrictions. It also authorizes the Federal Reserve to determine by regulation what other activities are financial in nature, or incidental or complementary thereto. The Company has not elected financial holding company status.
The Federal Deposit Insurance Act (the “FDIA”) and Federal Reserve policy require a bank holding company to serve as a source of financial and managerial strength to its bank subsidiaries. In addition, where a bank holding company has more than one FDIC-insured bank or thrift subsidiary, like the Company, each of the bank holding company’s subsidiary FDIC-insured depository institutions is responsible for any losses to the FDIC as a result of an affiliated depository institution’s failure. As a result of a bank holding company’s source of strength obligation, a bank holding company may be required to provide funds to a bank subsidiary in the form of subordinate capital or other instruments which qualify as capital under bank regulatory rules. Any loans from the holding company to such subsidiary banks likely would be unsecured and subordinated to such bank’s depositors and perhaps to other creditors of Delmarva and Partners.
A bank holding company is generally required to give the Federal Reserve prior written notice of any purchase or redemption of its own then outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the company’s consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, Federal Reserve order or directive, or any condition imposed by, or written agreement with, the Federal Reserve. The Federal Reserve has adopted an exception to this approval requirement for well-capitalized bank holding companies that meet certain conditions.
As a Maryland corporation, the Company is subject to limitations on and requirements for its activities. For example, state law restrictions include limitations and restrictions relating to indemnification of directors, distributions to shareholders, transactions involving directors, officers or interested shareholders, maintenance of books, records, minutes, borrowing and the observance of corporate formalities.
The Affiliate Banks. Delmarva is a Delaware chartered commercial bank and a member of the Federal Reserve System (a “state member bank”) whose accounts are insured by the DIF of the FDIC up to the maximum legal limits. Delmarva is subject to regulation, supervision and regular examination by the State Bank Commissioner of the State of Delaware (the “Delaware Commissioner”) and the Federal Reserve.
Partners is a Virginia chartered commercial bank and also a state member bank whose accounts are insured by the DIF of the FDIC up to the maximum legal limits. Partners is subject to regulation, supervision and regular examination by the Bureau of Financial Institutions of the State Corporation Commission of the Commonwealth of Virginia (the “Virginia Bureau”) and the Federal Reserve.
The regulations of these various agencies govern most aspects of Delmarva’s and Partners’ businesses, including required reserves against deposits, loans, investments, mergers and acquisitions, borrowing, dividends and location and number of branch offices. The laws and regulations governing the Affiliate Banks generally have been promulgated to protect depositors and the DIF, and not for the purpose of protecting shareholders. Competition among commercial banks, savings and loan associations, and credit unions has increased following enactment of legislation, which greatly expanded the ability of banks and bank holding companies to engage in interstate banking or acquisition activities.
Banking is a business that depends on interest rate differentials. In general, the differences between the interest paid by a bank on its deposits and its other borrowings and the interest received by a bank on loans extended to its customers and securities held in its investment portfolio constitute the major portion of Delmarva’s and Partners’ earnings. Thus, the earnings and growth of both Affiliate Banks will be subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve, which regulates the supply of money through various means including open market dealings in United States government securities. The nature and timing of changes in such policies and their impact on Delmarva and Partners cannot be predicted.
Branching and Interstate Banking. The federal banking agencies are authorized to approve interstate bank merger transactions without regard to whether such transaction is prohibited by the law of any state, unless the home state of one of the banks has opted out of the interstate bank merger provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Riegle-Neal Act”) by adopting a law after the date of enactment of the Riegle-Neal Act and prior to June 1, 1997 which applies equally to all out-of-state banks and expressly prohibits merger transactions involving out-of-state banks. Interstate acquisitions of branches are permitted only if the law of the state in which the branch is located permits such acquisitions. Such interstate bank mergers and branch acquisitions are also subject to the nationwide and statewide insured deposit concentration limitations described in the Riegle-Neal Act. The Dodd-Frank Act authorizes national and state banks to establish de novo branches in other states to the same extent as a bank chartered by that state would be permitted to branch.
Basel III Capital Framework. The Federal Reserve and the FDIC have adopted rules to implement the Basel III capital framework as outlined by the Basel Committee on Banking Supervision and standards for calculating risk-weighted assets and risk-based capital measurements (collectively, the “Basel III Final Rules”) that apply to banking institutions they supervise. For the purposes of these capital rules, (i) common equity tier 1 capital (“CET1”) consists principally of common stock (including surplus) and retained earnings; (ii) Tier 1 capital consists principally of CET1 plus non-cumulative preferred stock and related surplus, and certain grandfathered cumulative preferred stocks and trust preferred securities; and (iii) Tier 2 capital consists of other capital instruments, principally qualifying subordinated debt and preferred stock, and limited amounts of an institution’s allowance for loan losses. Each regulatory capital classification is subject to certain adjustments and limitations, as implemented by the Basel III Final Rules. The Basel III Final Rules also establish risk weightings that are applied to many classes of assets held by community banks, importantly including applying higher risk weightings to certain commercial real estate loans.
The Basel III Final Rules and minimum capital ratios required to be maintained by banks were effective January 1, 2015. The Basel III Final Rules also include a requirement that banks maintain additional capital (the “capital conservation buffer”), which was phased in beginning January 1, 2016 and was fully phased in effective January 1, 2019. The Basel III Final Rules and fully phased in capital conservation buffer require banks to maintain (i) a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% capital conservation buffer (which is added to the minimum CET1 ratio, effectively resulting in a required ratio of CET1 to risk-weighted assets of at least 7%), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (effectively resulting in a required Tier 1 capital ratio of 8.5%), (iii) a minimum ratio of total (that is, Tier 1 plus Tier 2) capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (effectively resulting in a required total capital ratio of 10.5%) and (iv) a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average total assets, subject to certain adjustments and limitations.
The Basel III Final Rules provide deductions from and adjustments to regulatory capital measures, primarily to CET1, including deductions and adjustments that were not applied to reduce CET1 under historical regulatory capital rules. For example, mortgage servicing rights, deferred tax assets dependent upon future taxable income, and significant investments in non-consolidated financial entities must be deducted from CET1 to the extent that any one such category exceeds 10.0% of CET1 or all such categories in the aggregate exceed 15.0% of CET1.
The capital ratios described above are the minimum levels that the federal banking agencies expect. State and federal regulators have the discretion to require an institution to maintain higher capital levels based upon its concentrations of loans, the risk of its lending or other activities, the performance of its loan and investment portfolios and other factors. Failure to maintain such higher capital expectations could result in a lower composite regulatory rating, which would impact the institution’s deposit insurance premiums and could affect its ability to borrow and costs of borrowing, and could result in additional or more severe enforcement actions. In respect of institutions with high concentrations of loans in areas deemed to be higher risk, or during periods of significant economic stress, regulators may require an institution to maintain a higher level of capital, and/or to maintain more stringent risk management measures, than those required by these regulations.
As of December 31, 2020, the Affiliate Banks met all capital adequacy requirements under the Basel III Final Rules, including the capital conservation buffer on a fully phased-in basis.
Community Bank Leverage Ratio. As a result of the EGRRCPA, the federal banking agencies were required to develop a Community Bank Leverage Ratio (the ratio of a bank’s tangible equity capital to average total consolidated assets) for banking organizations with assets of less than $10 billion, such as either of the Affiliate Banks or the Company. On October 29, 2019, the federal banking agencies issued a final rule that implements the Community Bank Leverage Ratio Framework (the “CBLRF”). To qualify for the CBLRF, a bank must have less than $10 billion in total consolidated assets, limited amounts of off-balance sheet exposures and trading assets and liabilities, and a leverage ratio greater than 9.0%. A bank that elects the CBLRF and has a leverage ratio greater than 9.0% will be considered to be in compliance with Basel III capital requirements and exempt from the complex Basel III calculations and will also be deemed “well capitalized” under Prompt Corrective Action regulations, discussed below. A bank that falls out of compliance with the CBLRF will have a two-quarter grace period to come back into full compliance, provided its leverage ratio remains above 8.0% (a bank will be deemed “well capitalized” during the grace period). The CBLRF became available for banking organizations to use as of March 31, 2020 (with the flexibility for banking organizations to subsequently opt into or out of the CBLRF, as applicable). The federal banking regulatory agencies issued an interim final rule in April 2020 to implement certain provisions of the CARES Act that temporarily modified the minimum leverage ratio requirements of the CBLRF. The minimum leverage ratio requirement was reduced from 9 percent to 8 percent for the second through fourth quarters of 2020 and 8.5 percent through 2021. Neither the Company nor the Affiliate Banks have elected to use the CBLRF.
Small Bank Holding Company. The EGRRCPA also expanded the category of bank holding companies that may rely on the Federal Reserve’s Small Bank Holding Company Policy Statement by raising the maximum amount of assets a qualifying bank holding company may have from $1 billion to $3 billion. In addition to meeting the asset threshold, a bank holding company must not engage in significant nonbanking activities, not conduct significant off-balance sheet activities, and not have a material amount of debt or equity securities outstanding and registered with the Securities and Exchange Commission (the “SEC”) (subject to certain exceptions). The Federal Reserve may, in its discretion, exclude any bank holding company from the application of the Small Bank Holding Company Policy Statement if such action is warranted for supervisory purposes.
In August 2018, the Federal Reserve issued an interim final rule to apply the Small Bank Holding Company Policy Statement to bank holding companies with consolidated total assets of less than $3 billion. The policy statement, which, among other things, exempts certain bank holding companies from minimum consolidated regulatory capital ratios that apply to other bank holding companies. As a result of the interim final rule, which was effective August 30, 2018, the Company expects that it will be treated as a small bank holding company and will not be subject to regulatory capital requirements. The comment period on the interim final rule closed on October 29, 2018 and, to date, the Federal Reserve has not issued a final rule to replace the interim final rule. The Affiliate Banks remains subject to the regulatory capital requirements described above.
Prompt Corrective Action. Under Section 38 of the FDIA, each federal banking agency is required to implement a system of prompt corrective action for institutions which it regulates. The federal banking agencies have promulgated substantially similar regulations to implement the system of prompt corrective action established by Section 38 of the FDIA. The federal banking agencies have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institution in question is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” These terms are defined under uniform regulations issued by each of the federal banking agencies regulating these institutions. An insured depository institution which is less than adequately capitalized must adopt an acceptable capital restoration plan, is subject to increased regulatory oversight and is increasingly restricted in the scope of its permissible activities. As of December 31, 2020, both Affiliate Banks were considered “well capitalized.”
Limits on Dividends. The Company, as a Maryland corporation, is a legal entity that is separate and distinct from the Affiliate Banks. A significant portion of the revenues of the Company result from dividends paid to it by the Affiliate Banks. Both the Company and the Affiliate Banks remain subject to laws and regulations that limit the payment of dividends, including limits on the sources of dividends and requirements to maintain capital at or above regulatory minimums. In particular, Federal Reserve supervisory guidance indicates that the Federal Reserve may have safety and soundness concerns if a bank holding company pays dividends that exceed earnings for the period in which the dividend is being paid. Further, the FDIA prohibits insured depository institutions such as the Affiliate Banks from making capital distributions, including paying dividends, if, after making such distribution, the institution would become undercapitalized as defined in the statute. The Company does not expect that any of these laws, regulations or policies will materially affect the ability of the Company or the Affiliate Banks to pay dividends.
Regulatory Enforcement Authority. Federal banking law grants substantial enforcement powers to federal banking agencies. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions against banking organizations and institution-affiliated parties. 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. In addition, the FDIC could terminate the institution’s deposit insurance if it determines that the institution’s financial condition is unsafe or unsound or that the institution engaged in unsafe or unsound practices that violated an applicable rule, regulation, order or condition enacted or imposed by the institution’s regulators.
As a result of the volatility and instability in the financial system in recent years, Congress, the bank regulatory authorities and other government agencies have called for or proposed additional regulation and restrictions on the activities, practices and operations of banks and their holding companies. Congress and the federal banking agencies have broad authority to require all banks and holding companies to adhere to more rigorous or costly operating procedures, corporate governance procedures, or to engage in activities or practices which they would not otherwise elect. Any such requirement could adversely affect the Company’s business and results of operations.
Community Reinvestment Act. The Community Reinvestment Act (the “CRA”) requires that, in connection with examinations of financial institutions within their respective jurisdictions, the federal banking agencies will evaluate the record of each financial institution in meeting the needs of its local community, including low- and moderate-income neighborhoods. A bank’s CRA performance is also considered in evaluating applications seeking approval for mergers, acquisitions, and new offices or facilities. Failure to adequately meet these criteria could result in additional requirements and limitations being imposed. Additionally, banks must publicly disclose the terms of certain CRA-related agreements. These factors also are considered in evaluating share exchanges, mergers, acquisitions and applications to open a branch or facility. In their most recent CRA evaluations, each Affiliate Bank received a “Satisfactory” CRA rating.
Fair and Responsible Banking. Banks and other financial institutions are subject to numerous laws and regulations intended to promote fair and responsible banking and prohibit unlawful discrimination and unfair, deceptive or abusive practices in banking. These laws include, among others, the Dodd-Frank Act, Section 5 of the Federal Trade Commission Act, the Equal Credit Opportunity Act, and the Fair Housing Act. Many states and local jurisdictions have consumer protection laws analogous, and in addition, to those listed above. These federal, state and local laws regulate the manner in which financial institutions deal with customers taking deposits, making loans or conducting other types of transactions. Failure to comply with these laws and regulations could give rise to regulatory sanctions, and actions by the U.S. Department of Justice and state attorneys general.
Consumer Financial Protection Bureau. The Dodd-Frank Act created the CFPB, an independent federal agency within the Federal Reserve System having broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Practices Act, the consumer financial privacy provisions of the GLB Act and certain other statutes. The CFPB has examination and primary enforcement authority with respect to depository institutions with more than $10.0 billion in assets. Smaller institutions, including Delmarva and Partners, are subject to rules promulgated by the CFPB but continue to be examined and supervised by federal banking agencies for compliance with federal consumer protection laws and regulations. The CFPB also has authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.
The CFPB has proposed or issued a number of important rules affecting a wide range of consumer financial products. The changes resulting from the Dodd-Frank Act and CFPB rulemakings and enforcement policies may impact the profitability of our business activities, limit our ability to make, or the desirability of making, certain types of loans, require us to change our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect our business or profitability.
The CFPB has concentrated much of its rulemaking efforts on reforms related to residential mortgage transactions. The CFPB has issued rules related to a borrower’s ability to repay and qualified mortgage standards, mortgage servicing standards, loan originator compensation standards, requirements for high cost mortgages, appraisal and escrow standards and requirements for higher-priced mortgages. The CFPB has also issued rules establishing integrated disclosure requirements for lenders and settlement agents in connection with most closed end, real estate secured consumer loans; and rules which, among other things, expand the scope of information lenders must report in connection with mortgage and other housing-related loan applications under the Home Mortgage Disclosure Act. These rules include significant regulatory and compliance changes and are expected to have a broad impact on the financial services industry.
The rule implementing the Dodd-Frank Act requirement that lenders determine whether a consumer has the ability to repay a mortgage loan, established certain minimum requirements for creditors when making ability to pay determinations, and established certain protections from liability for mortgages meeting the definition of “qualified mortgages.” Generally, the rule applies to all consumer-purpose, closed-end loans secured by a dwelling including home-purchase loans, refinances and home equity loans—whether first or subordinate lien. The rule does not cover, among other things, home equity lines of credit or other open-end credit; temporary or “bridge” loans with a term of 12 months or less, such as a loan to finance the initial construction of a dwelling; a construction phase of 12 months or less of a construction-to-permanent loan; and business-purpose loans, even if secured by a dwelling. The rule afforded greater legal protections for lenders making qualified mortgages that are not “higher priced.” Qualified mortgages must generally satisfy detailed requirements related to product features, underwriting standards, and a points and fees requirement whereby the total points and fees on a mortgage loan cannot exceed specified amounts or percentages of the total loan amount. Mandatory features of a qualified mortgage include: (i) a loan term not exceeding 30 years; and (ii) regular periodic payments that do not result in negative amortization, deferral of principal repayment, or a balloon payment. Further, the rule clarified that qualified mortgages do not include “no-doc” loans and loans with negative amortization, interest-only payments, or balloon payments. The rule created special categories of qualified mortgages originated by certain smaller creditors. Under the EGRRCPA, most residential mortgage loans originated and held in portfolio by a bank with less than $10 billion in assets will be designated as “qualified mortgages.” Higher-priced qualified mortgages (e.g., sub-prime loans) receive a rebuttable presumption of compliance with ability-to-repay rules, and other qualified mortgages (e.g., prime loans) are deemed to comply with the ability-to-repay rules.
FDIC Insurance. The deposits of the Affiliate Banks are insured by the DIF of the FDIC up to the standard maximum insurance amount for each deposit insurance ownership category. The basic limit on FDIC deposit insurance coverage is $250,000 per depositor. Under the FDIA, the FDIC may terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations as an insured institution, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC, subject to administrative and potential judicial hearing and review processes. The FDIC may also suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance if the institution has no tangible capital. If deposit insurance is terminated, the deposits at the institution at the time of termination, less subsequent withdrawals, shall continue to be insured for a period from six months to two years, as determined by the FDIC. Management is aware of no existing circumstances that could result in termination of the Affiliate Banks’ deposit insurance.
The DIF is funded by assessments on banks and other depository institutions calculated based on average consolidated total assets minus average tangible equity (defined as Tier 1 capital). As required by the Dodd-Frank Act, the FDIC has adopted a large-bank pricing assessment scheme, set a target “designated reserve ratio” (described in more detail below) of 2.0% for the DIF and, in lieu of dividends, provides for a lower assessment rate schedule when the reserve ratio reaches 2.0% and 2.5%. An institution's assessment rate is based on a statistical analysis of financial ratios that estimates the likelihood of failure over a three-year period, which considers the institution’s weighted average CAMELS component rating, and is subject to further adjustments including those related to levels of unsecured debt and brokered deposits (not applicable to banks with less than $10.0 billion in assets). At December 31, 2020, total base assessment rates for institutions that have been insured for at least five years range from 1.5 to 30 basis points applying to banks with less than $10.0 billion in assets.
The Dodd-Frank Act transferred to the FDIC increased discretion with regard to managing the required amount of reserves for the DIF, or the “designated reserve ratio.” The FDIA requires that the FDIC consider the appropriate level for the designated reserve ratio on at least an annual basis. As of December 31, 2020, the designated reserve ratio was 2.00 percent and the minimum designated reserve ratio was 1.35 percent.
At September 30, 2019, the reserve ratio was 1.41 percent. Banks with less than $10 billion in total consolidated assets are eligible for credits to offset the portion of their assessments that helped to raise the reserve ratio to 1.35 percent. The FDIC automatically applies these credits to reduce an eligible bank’s regular DIF assessment up to the entire amount of the assessment. The FDIC will remit any such remaining credits in a lump sum to the appropriate bank following application to the bank’s regular DIF assessment for four quarterly assessment periods. Delmarva was awarded credits of $176 thousand, all of which was used to offset its DIF assessment in the third and fourth quarters of 2019; Partners was awarded credits of $94 thousand, of which $55 thousand was used to offset its DIF assessment in the third and fourth quarters of 2019 and $39 thousand was used to offset its DIF assessment in the first quarter of 2020. All available credits were used at the end of the year ended December 31, 2020.
In June 2020, the FDIC adopted a final rule that generally removes the effect of PPP lending when calculating a bank’s deposit insurance assessment by providing an offset to the bank’s total assessment amount for the increase in the assessment base attributable to the bank’s participation in the PPP. This final rule began applying to FDIC deposit insurance assessments during the second quarter of 2020.
Concentration and Risk Guidance. The federal banking agencies promulgated joint interagency guidance regarding material direct and indirect asset and funding concentrations. The guidance defines a concentration as any of the following: (i) asset concentrations of 25% or more of Total Capital (loan related) or Tier 1 Capital (non-loan related) by individual borrower, small interrelated group of individuals, single repayment source or individual project; (ii) asset concentrations of 100% or more of Total Capital (loan related) or Tier 1 Capital (non-loan related) by industry, product line, type of collateral, or short-term obligations of one financial institution or affiliated group; (iii) funding concentrations from a single source representing 10% or more of Total Assets; or (iv) potentially volatile funding sources that when combined represent 25% or more of Total Assets (these sources may include brokered, large, high-rate, uninsured, internet-listing-service deposits, Federal funds purchased or other potentially volatile deposits or borrowings). If a concentration is present, management must employ heightened risk management practices including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing, third party review and increasing capital requirements. Delmarva adheres to the practices recommended in this guidance.
Additionally, the federal banking agencies have issued guidance governing financial institutions with concentrations in commercial real estate lending. The guidance provides that institutions that have: (i) total reported loans for construction, land development, and other land which represent 100% or more of an institution’s total risk-based capital; or (ii) total reported commercial real estate loans, excluding loans secured by owner-occupied commercial real estate, representing 300% or more of the institution’s total risk-based capital and the institution’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months, are identified as having potential commercial real estate concentration risk. Institutions, which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital.
Brokered Deposits. Section 29 of the FDIA and FDIC regulations generally limit the ability of any bank to accept, renew or roll over any brokered deposit unless it is “well capitalized” or, with the FDIC’s approval, “adequately capitalized.” However, as a result of the EGRRCPA, the FDIC is undertaking a comprehensive review of its regulatory approach to brokered deposits, including reciprocal deposits, and interest rate caps applicable to banks that are less than “well capitalized.” On December 15, 2020, the FDIC issued final rules that amend the FDIC’s methodology for calculating interest rate caps, provide a new process for banks that seek FDIC approval to offer a competitive rate on deposits when the prevailing rate in the bank’s local market exceeds the national rate cap, and provides specific exemptions and streamlined application and notice procedures for certain deposit-placement arrangements that are not subject to brokered deposit restrictions. These final rules become effective on April 1, 2021. Neither the Company nor the Affiliate Banks anticipate any material impact at this time from the new rule.
USA PATRIOT Act. Under the USA PATRIOT Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships, as well as enhanced due diligence standards intended to detect, and prevent, the use of the United States financial system for money laundering and terrorist financing activities. The PATRIOT Act requires financial institutions, including banks, to establish anti-money laundering programs, including employee training and independent audit requirements, meet minimum standards specified by the act, follow minimum standards for customer identification and maintenance of customer identification records, and regularly compare customer lists against lists of suspected terrorists, terrorist organizations and money launderers. The costs or other effects of the compliance burdens imposed by the PATRIOT Act or future anti-terrorist, homeland security or anti-money laundering legislation or regulation cannot be predicted with certainty.
Bank Secrecy Act. The Bank Secrecy Act (the “BSA”), which is intended to require financial institutions to develop policies, procedures and practices to prevent and deter money laundering, mandates that every bank have a written, board-approved program that is reasonably designed to assure and monitor compliance with the BSA. The program must, at a minimum: (i) provide for a system of internal controls to assure ongoing compliance; (ii) provide for independent testing for compliance; (iii) designate an individual responsible for coordinating and monitoring day-to-day compliance; and (iv) provide training for appropriate personnel. In addition, banks are required to adopt a customer identification program as part of its BSA compliance program. Financial institutions are generally required to report cash transactions involving more than $10,000 to the U.S. Treasury Department. In addition, financial institutions are required to file suspicious activity reports for transactions that involve more than $5,000 and which the financial institution knows, suspects or has reason to suspect involves illegal funds, is designed to evade the requirements of the BSA or has no lawful purpose. The regulations implementing the BSA explicitly include risk-based procedures for conducting ongoing customer due diligence, to include understanding the nature and purpose of customer relationships for the purpose of developing a customer risk profile. In addition, banks must identify and verify the identity of the beneficial owners of all legal entity customers (other than those that are excluded) at the time a new account is opened (other than accounts that are exempted).
Temporary BSA Reporting Relief. The U.S. Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) provided targeted relief from certain BSA reporting requirements and provided updated guidance to financial institutions on complying with such requirements during COVID-19. Specifically, FinCEN (i) granted targeted relief to financial institutions participating in the PPP, stating that PPP loans to existing customers will not require re-verification under applicable BSA requirements, unless re-verification is otherwise required under the financial institution’s risk-based BSA compliance program, (ii) acknowledged that there may be “reasonable delays in compliance” due to COVID-19, and (iii) temporarily suspended implementation if its February 2020 ruling, which would have entailed significant changes to currency transaction reporting filing requirements for transactions involving sole proprietorships and entities operating under a “doing business as” or other assumed name. The Company and the Affiliate Banks continue to monitor developments related to FinCEN’s targeted and temporary relief measures.
Office of Foreign Assets Control. The United States has imposed economic sanctions that affect transactions with designated foreign countries, foreign nationals and others, which are administered by the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”). The OFAC-administered sanctions targeting countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on a “U.S. person” engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of a sanctioned country have an interest by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g., property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences.
Increased Focus on Lending to Members of the Military. The federal banking agencies and the U.S. Department of Justice have recently increased their focus on financial institution compliance with the Servicemembers Civil Relief Act (the “SCRA”). The SCRA requires a bank to cap the interest rate at 6% for any loan to a member of the military who goes on active duty after taking out the loan. It also limits the actions Delmarva or Partners can take when a servicemember is in foreclosure. The EGRRCPA also adds certain protections for consumers, including veterans and active duty military personnel, expanded credit freezes and creation of an identity theft protection database.
Incentive Compensation. The Federal Reserve, the Office of the Comptroller of the Currency and the FDIC have issued regulatory guidance intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not “large, complex banking organizations.” The findings will be included in reports of examination, and deficiencies will be incorporated into the organization’s supervisory ratings. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.
In 2016, the SEC and the federal banking agencies proposed rules that prohibit covered financial institutions (including bank holding companies and banks) from establishing or maintaining incentive-based compensation arrangements that encourage inappropriate risk taking by providing covered persons (consisting of senior executive officers and significant risk takers, as defined in the rules) with excessive compensation, fees or benefits that could lead to material financial loss to the financial institution. The proposed rules outline factors to be considered when analyzing whether compensation is excessive and whether an incentive-based compensation arrangement encourages inappropriate risks that could lead to material loss to the covered financial institution, and establishes minimum requirements that incentive-based compensation arrangements must meet to be considered to not encourage inappropriate risks and to appropriately balance risk and reward. The proposed rules also impose additional corporate governance requirements on the boards of directors of covered financial institutions and impose additional record-keeping requirements. The comment period for these proposed rules has closed and a final rule has not yet been published. At this time, the Company cannot predict what impact, if any, the final rule will have on its operations.
Volcker Rule. The Volcker Rule under the Dodd-Frank Act prohibits bank holding companies and their subsidiary banks from engaging in proprietary trading except in limited circumstances, and places limits on ownership of equity investments in private equity and hedge funds. The EGRRCPA exempted all banks with less than $10 billion in assets (including their holding companies and affiliates) from the Volcker Rule, provided that the institution has total trading assets and liabilities of 5.0% or less of total assets, subject to certain limited exceptions. On July 9, 2019, the federal banking agencies along with the Commodity Futures Trading Commission and the SEC issued a final rule to exclude community banks, like the Affiliate Banks, from the application of the Volcker Rule.
Call Reports and Examination Cycle. All institutions, regardless of size, submit a quarterly call report that includes data used by federal banking agencies to monitor the condition, performance, and risk profile of individual institutions and the industry as a whole. The EGRRCPA contained provisions expanding the number of regulated institutions eligible to use streamline call report forms. In November 2018, the federal banking agencies issued a proposal to permit insured depository institutions with total assets of less than $5 billion that do not engage in certain complex or international activities to file the most streamlined version of the quarterly call report, and to reduce data reportable on certain streamlined call report submissions.
In December 2018, consistent with the provisions of the EGRRCPA, the federal banking agencies jointly adopted final rules that permit banks with up to $3 billion in total assets, that received a composite CAMELS rating of “1” or “2,” and that meet certain other criteria (including not having undergone any change in control during the previous 12-month period, and not being subject to a formal enforcement proceeding or order), to qualify for an 18-month on-site examination cycle.
Stress Testing. As required by the Dodd-Frank Act, the federal banking agencies implemented stress testing requirements for certain financial institutions, including bank holding companies and state-chartered banks, with more than $10 billion in total consolidated assets. The EGRRCPA subsequently raised the asset thresholds for company-run stress testing and mandatory stress testing conducted by the Federal Reserve to $50 billion and $100 billion, respectively. Although these requirements do not apply to the Company or the Affiliate Banks, the federal banking agencies emphasize that all banking organizations, regardless of size, should have the capacity to analyze the potential effect of adverse market conditions or outcomes on the organization’s financial condition. Based on existing regulatory guidance, the Company will be expected to consider the institution’s interest rate risk management, commercial real estate loan concentrations and other credit-related information, and funding and liquidity management during this analysis of adverse market conditions or outcomes.
Confidentiality and Required Disclosures of Customer Information. Under the Federal Right to Privacy Act of 1978, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records, financial institutions are required to disclose their policies for collecting and protecting confidential information. The Affiliate Banks are also subject to various laws and regulations that address the privacy of nonpublic personal financial information of consumers. The GLB Act and certain regulations issued thereunder protect against the transfer and use by financial institutions of consumer nonpublic personal information. A financial institution must provide to its customers, at the beginning of the customer relationship and annually thereafter, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. These privacy provisions generally prohibit a financial institution from providing a customer’s personal financial information to unaffiliated third parties unless the institution discloses to the customer that the information may be so provided and the customer is given the opportunity to opt out of such disclosure.
In August 2018, the CFPB published its final rule to update Regulation P pursuant to the amended GLB Act. Under this rule, certain qualifying financial institutions are not required to provide annual privacy notices to customers. To qualify, a financial institution must not share nonpublic personal information about customers except as described in certain statutory exceptions which do not trigger a customer’s statutory opt-out right. In addition, the financial institution must not have changed its disclosure policies and practices from those disclosed in its most recent privacy notice. The rule sets forth timing requirements for delivery of annual privacy notices in the event that a financial institution that qualified for the annual notice exemption later changes its policies or practices in such a way that it no longer qualifies for the exemption.
Although these laws and programs impose compliance costs and create privacy obligations and, in some cases, reporting obligations, and compliance with all of the laws, programs, and privacy and reporting obligations may require significant resources of the Company, these laws and programs do not materially affect the Company’s products, services or other business activities.
Cybersecurity. The federal banking agencies have adopted guidelines for establishing information security standards and cybersecurity programs for implementing safeguards under the supervision of a financial institution’s board of directors. These guidelines, along with related regulatory materials, increasingly focus on risk management and processes related to information technology and the use of third parties in the provision of financial products and services.
In particular, in March 2015, federal regulators issued two related statements regarding cybersecurity. One statement indicates that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institution. The other statement indicates that a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving destructive malware. A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack. If the Company fails to observe the regulatory guidance, it could be subject to various regulatory sanctions, including financial penalties. To date, the Company has not experienced a significant compromise, significant data loss or any material financial losses related to cybersecurity attacks, but its systems and those of its customers and third-party service providers are under constant threat and it is possible that the Company could experience a significant event in the future. Risks and exposures related to cybersecurity attacks are expected to remain high for the foreseeable future due to the rapidly evolving nature and sophistication of these threats, as well as due to the expanding use of Internet banking, mobile banking and other technology-based products and services by the Company and its customers. If the Company fails to meet the expectations set forth in the federal banking agencies’ regulatory guidance, it could be subject to various regulatory actions and any remediation efforts may require significant resources of the Company.
Future Regulation. From time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and the operating environment of the Company in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. The Company cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would have on the financial condition or results of operations of the Company or the Affiliate Banks. A change in statutes, regulations or regulatory policies applicable to the Company or any of its subsidiaries could have a material effect on our business.
Filings with the SEC
The Company files annual, quarterly, and current reports under the Exchange Act with the SEC. These reports and this Form 10-K are posted and available at no cost on the Company’s investor relations website, partnersbancorp.com/investor-relations, as soon as reasonably practicable after the Company files such documents with the SEC. The information contained on the Company’s website is not a part of this Form 10-K or of any other filing with the SEC. The Company’s filings with the SEC are also available through the SEC’s website at http://www.sec.gov.
An investment in the Company’s securities involves risks and uncertainties. Below are the material risks and uncertainties, of which the Company is currently aware, that could have a material adverse effect on the Company’s business, results of operations, and financial condition. For other factors that may cause actual results to differ materially from those indicated in any forward-looking statement or projection contained in this Annual Report on Form 10-K, please see “Forward-Looking Statements” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Risks Related to Our Business
The COVID-19 pandemic could adversely affect our business, financial condition and results of operations, the extent of which is not now known or predictable.
The ongoing COVID-19 global and national health emergency has caused significant disruption in the United States and international economies and financial markets. The spread of COVID-19 in the United States has caused
illness, quarantines, cancellation of events and travel, business and school shutdowns, reduction in commercial activity and financial transactions, supply chain interruptions, increased unemployment, and overall economic and financial market instability.
The COVID-19 pandemic has caused disruptions to the Company’s business and could cause material disruptions to the Company’s business and operations in the future. Impacts to the Company’s business have included increases in costs and reductions in operating effectiveness due to additional health and safety precautions implemented at the Company’s branches and the transition of a portion of the Company’s workforce to home locations, decreases in customer traffic in branches, and increases in requests for and the making of loan modifications. The Company anticipates that additional future impacts to its business may include further increases in customers’ inability to make scheduled loan payments and increases in requests for forbearance. Further, loan payment deferment programs implemented by the Company or under government stimulus programs, like the Paycheck Protection Program of the Small Business Administration, may mask credit deterioration in the Company’s loan portfolio by making less applicable standard measures of identifying developing financial weakness in a client or portfolio, such as past due monitoring and non-accrual assessments. To the extent that commercial and social restrictions remain in place or increase, the Company’s expenses, delinquencies, charge-offs, foreclosures and credit losses may materially increase, and the Company could experience reductions in fee income. In addition, any declines in credit quality could significantly affect the adequacy of the Company’s allowance for credit losses, which would lead to increases in the provision for credit losses and related declines in the Company’s net income.
Unfavorable economic conditions and increasing unemployment figures may also make it more difficult for the Company to maintain deposit levels and loan origination volume and to obtain additional financing. Furthermore, such conditions may cause the value of the Company’s investment portfolio and of collateral associated with its existing loans to decline.
While the Company has taken and is continuing to take precautions to protect the safety and well-being of its employees and customers, no assurance can be given that the steps being taken will be deemed to be adequate or appropriate, nor can the Company predict the level of disruption which will occur to its employee's ability to provide customer support and service. The continued or renewed spread of COVID-19 could negatively impact the availability of key personnel necessary to conduct the Company’s business, the business and operations of the Company’s third-party service providers who perform critical services for the Company’s business, or the businesses of many of the Company’s customers and borrowers.
Among the factors outside the Company’s control that are likely to affect the impact the COVID-19 pandemic will ultimately have on the Company’s business are, without limitation:
|●||the pandemic’s course and severity, including the impact related to the distribution and effectiveness of the COVID-19 vaccines;|
|●||the direct and indirect results of the pandemic, such as recessionary economic trends, including with respect to employment, wages and benefits, commercial activity, the residential housing market, consumer spending and real estate and investment securities market values;|
|●||political, legal and regulatory actions and policies in response to the pandemic, including the effects of restrictions on commerce and banking, such as current temporary or required continuing moratoria and other suspensions of collections, foreclosures, and related obligations;|
|●||the timing, magnitude and effect of public spending, directly or through subsidies, its direct and indirect effects on commercial activity and incentives of employers and individuals to resume or increase employment, wages and benefits and commercial activity;|
|●||effects on the Company’s liquidity position due to changes in customers’ deposit and loan activity in response to the pandemic and its economic effects;|
|●||the timing and availability of direct and indirect governmental support for various financial assets, including mortgage loans;|
|●||the long-term effect of the economic downturn on the Company’s intangible assets such as its deferred tax asset and goodwill;|
|●||potential longer-term effects of increased government spending on the interest rate environment and borrowing costs for non-governmental parties;|
|●||the ability of the Company’s employees to work effectively during the course of the pandemic;|
|●||the ability of the Company’s third-party vendors to maintain a high-quality and effective level of service;|
|●||the possibility of increased fraud, cybercrime and similar incidents, due to vulnerabilities posed by the significant increase in the Company employees and customers handling their banking interactions remotely from home, recent government-sponsored lending programs like the Paycheck Protection Program, or otherwise;|
|●||required changes to the Company’s internal controls over financial reporting to reflect a rapidly changing work environment;|
|●||potential longer-term shifts toward mobile banking, telecommuting and telecommerce; and|
|●||geographic variation in the severity and duration of the COVID-19 pandemic, including in states in which we operate physically such as Maryland, Virginia, Delaware, and New Jersey.|
If the COVID-19 pandemic results in a continuation or worsening of current economic conditions and commercial environments, our business, financial condition and results of operations could be materially adversely affected. Additional ongoing and potential risks and effects related to the COVID-19 pandemic are discussed in the other risk factors contained in this report.
Changes in interest rates could adversely impact the Company’s financial condition and results of operations.
The Company’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets, such as loans and securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond the Company’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the amount of interest the Company receives on loans and securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) the Company’s ability to originate loans and obtain deposits, (ii) the fair value of the Company’s financial assets and liabilities, and (iii) the average duration of the Company’s mortgage-backed securities portfolio. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, the Company’s net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.
In an emergency measure aimed at blunting the economic impact of COVID-19, the Federal Reserve lowered the target for the federal funds rate to a range of between 0%-0.25% on March 15, 2020.If the Federal Reserve decreases the targeted federal funds rates further in response to the economic effects of COVID-19, overall interest rates will likely decline, which may negatively impact our net interest income. Alternatively, if the COVID-19 outbreak abates and general economic conditions improve, the Federal Reserve may determine to increase the targeted federal funds rates and overall interest rates will likely rise, which will positively impact our net interest income, but may negatively impact the housing market by reducing refinancing activity, new home purchases, commercial lending activity, and the U.S. economy.
Any substantial, unexpected or prolonged change in market interest rates could have a material adverse effect on the Company’s business, financial condition and results of operations.
The earnings of financial services companies are significantly affected by general business and economic conditions.
The Company’s operations and profitability are impacted by general business and economic conditions in the United States and abroad. These conditions include short-term and long-term interest rates, inflation, money supply, political issues, legislative and regulatory changes, fluctuations in both debt and equity capital markets, broad trends in industry and finance, and the strength of the U.S. economy and the local economies in which the Company operates, all
of which are beyond the Company’s control. In addition, geopolitical developments, international trade disputes, public health crises, such as the COVID-19 pandemic, and other events beyond our control, can increase levels of political and economic unpredictability globally and increase the volatility of economic conditions on a local, national, and global scale. Deterioration in economic conditions could result in an increase in loan delinquencies and non-performing assets, decreases in loan collateral values, and a decrease in demand for the Company’s products and services, among other things, any of which could have a material adverse impact on the Company’s business, financial condition and results of operations.
If the Company has higher loan losses than it has allowed for, the Company’s earnings could materially decrease.
The Company maintains an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, that represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management’s continuing evaluation of the following: industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions; and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires the Company to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, and other factors, both within and outside of the Company’s control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review the allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. Further, if charge-offs in future periods exceed the allowance for loan losses, the Company will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income, and possibly capital, and may have a material adverse effect on the Company’s business, financial condition and results of operations.
The Company’s profitability will depend significantly on economic conditions in the States of Delaware, New Jersey, and Maryland and the Commonwealth of Virginia.
The Company’s success depends primarily on the general economic conditions of the States of Delaware, New Jersey and Maryland and the Commonwealth of Virginia, and the specific local markets in which Delmarva and Partners operate. Unlike larger national or other regional banks that are more geographically diversified, the Affiliate Banks have relatively compact geographic footprints. Delmarva provides banking and financial services to customers primarily in the eastern regions in Delaware and Maryland and in the Camden and Burlington counties of New Jersey. Partners serves the communities in and around the Greater Fredericksburg, Virginia area and Anne Arundel County and the three counties of Southern Maryland. The local economic conditions in these areas have a significant impact on the demand for the Affiliate Banks’ products and services, as well as the ability of the Affiliate Banks’ customers to repay loans, the value of the collateral securing the loans, and the stability of the Affiliate Banks’ deposit funding sources. Like most states and local economies, these areas have been significantly impacted by the COVID-19 pandemic and related governmental and societal actions. A significant decline in general economic conditions caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences, unemployment, changes in securities markets, or other factors, including the continuation of the on-going COVID-19 pandemic, could impact these local economic conditions and, in turn, have a material adverse effect on the Affiliate Banks’, and therefore the Company’s, financial condition and results of operations.
Because the Company emphasizes commercial real estate and commercial loan originations, its credit risk may increase and future downturns in the local real estate market or economy could adversely affect its earnings.
Commercial real estate and commercial loans generally have more inherent risk than residential real estate loans. Because the repayment of commercial real estate and commercial loans depends on the successful management and operation of the borrower’s properties or related businesses, repayment of such loans can be affected by adverse conditions in the local real estate market or economy. Commercial real estate and commercial loans also may involve
relatively large loan balances to individual borrowers or groups of related borrowers. A future downturn in the local economy could adversely affect the value of properties securing the loan or the revenues from the borrower’s business, thereby increasing the risk of nonperforming loans. As the Company’s commercial real estate and commercial loan portfolios increase, the corresponding risks and potential for losses from these loans may also increase. Furthermore, it may be difficult to assess the future performance of newly originated commercial loans, as such loans may have delinquency or charge-off levels above our historical experience, which could adversely affect the Company’s future performance.
The severity and duration of a future economic downturn and the composition of the Company’s loan portfolio could impact the level of loan charge-offs and provision for loan losses and may adversely affect the Company’s net income or loss.
Lending money is a substantial part of the Company’s businesses. However, every loan that the Company makes carries a certain risk of non-payment. The Company cannot assure that its allowance for loan losses will be sufficient to absorb actual loan losses. The Company also cannot assure that it will not experience significant losses in its loan portfolio that may require significant increases to the allowance for loan losses in the future.
Although the Company evaluates every loan that it makes against its underwriting criteria, the Company may experience losses by reasons of factors beyond its control, including from occurrences and circumstances unrelated to the underwriting criteria applied to a particular borrower, such as the current COVID-19 outbreak, which has a high potential for negative impact on financial markets generally as well as the local markets in which we conduct business.. Some of these factors include changes in market conditions affecting the value of real estate and unexpected problems affecting the creditworthiness of the Company’s borrowers.
The Company determines the adequacy of its allowance for loan losses by considering various factors, including:
• An analysis of the risk characteristics of various classifications of loans
• Previous loan loss experience
• Specific loans that would have loan loss potential
• Delinquency trends
• Estimated fair value of the underlying collateral
• Current economic conditions
• The views of their respective regulators
• Reports of internal auditors
• Reports of external auditors
• Reports of loan reviews conducted by independent organizations
• Geographic and industry loan concentrations.
Local economic conditions could impact the Company’s loan portfolio. For example, an increase in unemployment, a decrease in real estate values, or increases in interest rates, as well as other factors, could weaken the economies of the communities that the Company serves. Weakness in the market areas served by the Company could depress its earnings and, consequently, its financial condition because:
|●||Borrowers may not be able to repay their loans|
|●||The value of the collateral securing the Company’s loans to borrowers may decline|
|●||The quality of the Company’s loan portfolio may decline|
Although, based on the aforementioned procedures implemented by the Company, management believes the current allowance for loan losses is adequate, the Company may have to increase its provision for loan losses should local economic conditions deteriorate which could negatively impact the Company’s business, financial condition and results of operations.
Changes in real estate values may adversely impact the Company’s loans that are secured by real estate.
A significant portion of the Company’s loan portfolio consists of residential and commercial mortgages, as well as consumer loans, secured by real estate. These properties are concentrated within the local markets served by Delmarva and Partners. Real estate values and real estate markets generally are affected by, among other things, changes in national, regional or local economic conditions, fluctuations in interest rates, the availability of loans to potential purchasers, changes in the tax laws and other government statutes, regulations and policies, as well as other factors outside of our control such as natural disasters, geopolitical events, and public health crises (like the current COVID-19 pandemic). If real estate prices decline, particularly in the Company’s market area, the value of the real estate collateral securing the Company’s loans could be reduced. This reduction in the value of the collateral could increase the number of non-performing loans and could have a material adverse impact on the Company’s business, financial condition and results of operations.
The Company’s ability to pay dividends depends primarily on receiving dividends from the Affiliate Banks, which is subject to regulatory limits on such bank’s performance.
The Company is a bank holding company and its operations are conducted by its subsidiaries, Delmarva and Partners. The Company’s ability to pay dividends depends on its receipt of dividends from Delmarva and Partners. Dividend payments from Delmarva and Partners are subject to legal and regulatory limitations, generally based on net profits and retained earnings, imposed by the various banking regulatory agencies. The ability of Delmarva or Partners to pay dividends is also subject to their profitability, financial condition, capital requirements, and their respective cash flow requirements. There is no assurance that Delmarva or Partners will be able to pay dividends in the future or that the Company will generate adequate cash flow from Delmarva and Partners to pay dividends in the future. The Company’s failure to pay dividends on its common stock could have a material adverse effect on the market price of its common stock.
For additional information, please see Item 5, Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Competition from other traditional and nontraditional financial institutions and service providers may adversely affect the Company’s profitability.
The banking business is highly competitive. The Company competes as a financial intermediary with commercial banks, savings banks, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds and other financial institutions operating in their respective markets, as well as nontraditional competitors such as fintech companies and internet-based lenders, depositories and payment systems. The Company’s profitability depends upon its continued ability to successfully compete with traditional and new financial services providers, some of which maintain a physical presence in its market areas and others of which maintain only a virtual presence.
Many of the Company’s competitors have substantially greater resources and lending limits than the Company has, and offer certain services, such as extensive and established branch networks and trust services, that the Company does not currently provide or currently expect to provide in the near future. Moreover, larger institutions operating in their respective market areas have access to borrowed funds at lower cost than will be available to the Company. The Company’s failure to compete effectively in its markets could restrain the Company’s growth or cause it to lose market share, which could have a material adverse effect on the Company’s business, financial condition and results of operations.
New lines of business or new products and services may subject the Company to additional risks.
From time to time, the Company may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services, the Company may invest significant time and resources. Initial timetables for the introduction and
development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, shifting market preferences, natural disasters, geopolitical events, and public health crises (such as the current COVID-19 pandemic) may also impact the successful implementation of a new line of business and/or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of the Company’s system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business and new products or services could have a material adverse effect on the Company’s business, financial condition, and results of operations.
The Company is subject to an extensive body of accounting rules and best practices. Periodic changes to such rules may change the treatment and recognition of critical financial line items and affect the Company’s profitability.
The nature of the Company’s business makes them sensitive to the large body of accounting rules in the U.S. From time to time, the governing bodies that oversee changes to accounting rules and reporting requirements may release new guidance for the preparation of our financial statements. These changes can materially impact how the Company records and reports its financial condition and results of operations. In some instances, the Company could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements. Recently implemented changes include requirements that the Company record the value of and liabilities relating to operating leases on its balance sheet. Changes which have been approved for future implementation, or which are currently proposed or expected to be proposed or adopted include requirements that the Company calculate the allowance for loan losses on the basis of the current expected credit losses over the lifetime of our loans, or the CECL model, which is expected to be applicable to us beginning in 2023, and may result in increases in its allowance for loan losses and future provisions for loan losses.
Under the CECL model, banks 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 required under current accounting principles generally accepted in the United States (“GAAP”), which delays recognition until it is probable a loss has been incurred. The Company expects to recognize a one-time cumulative-effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, consistent with regulatory expectations set forth in interagency guidance issued at the end of 2016. The Company cannot yet determine the magnitude of any such one-time cumulative adjustment or of the overall impact of the new standard on its financial condition or results of operations. Accordingly, the Company expects that the adoption of the CECL model will materially affect how it determines its allowance for loan losses, and could require it to significantly increase its allowance. Moreover, the CECL model may create more volatility in the level of the allowance for loan losses. If the Company is required to materially increase the level of its allowance for loan losses for any reason, such increase could adversely affect its capital, regulatory capital ratios, ability to make larger loans, earnings and performance metrics. Any such changes could have a material adverse effect on the Company’s business, financial condition, results of operations and stock price.
The soundness of other financial institutions may adversely affect the Company.
Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. The Company has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and institutional clients. Many of these transactions expose the Company to credit risk in the event of a default by a counterparty or client. In the past, defaults by, or even speculation about, one or more financial services institutions or the financial services industry generally during moments of economic crisis have led to market-wide liquidity problems. The economic volatility resulting from the current COVID-19 pandemic could, as similar events in the past have, result in similar defaults and, as a result, impair the confidence of our counterparties and ultimately affect our ability to effect transactions. In addition, the Company’s credit risk may be exacerbated when the collateral held by the Company cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit
exposure due to the Company. Any such losses could have a material adverse effect on the Company’s financial condition and results of operations.
Market volatility may have materially adverse effects on the Company’s liquidity and financial condition.
The capital and credit markets have experienced extreme volatility and disruption. Over the last several years, in some cases, the markets have exerted downward pressure on stock prices, security prices, and credit capacity for certain issuers without regard to those issuers’ underlying financial strength. Moreover, the current COVID-19 pandemic is disrupting supply chains and affecting production and sales across a range of industries (including businesses and industries in the geographies served by our Affiliate Banks) and has caused a significant amount of market disruption and volatility. The extent of the impact of the current COVID-19 pandemic on our liquidity and financial condition will depend on certain developments, including the duration and spread of the outbreak, the impact to our customers, employees and vendors, and the impact to the financial services and banking industry and the economy as a whole – all of which are uncertain and cannot be predicted at this time. If the market disruption and volatility associated with COVID-19 continues, there can be no assurance that the Company will not experience adverse effects, which may be material, on its liquidity, financial condition, and profitability.
Any future acquisitions by the Company could dilute shareholder ownership and may cause it to become more susceptible to adverse economic events.
The Company may use its common stock to acquire other companies. The Company may issue additional shares of common stock to pay for future acquisitions, which would dilute current investors’ ownership interest in the Company. Future business acquisitions could be material to the Company, and the degree of success achieved in acquiring and integrating these businesses into the Company could have a material effect on the value of the Company’s common stock. In addition, any acquisition could require it to use substantial cash or other liquid assets or to incur debt. In those events, the Company could become more susceptible to economic downturns and competitive pressures.
Maryland business corporation law and various anti-takeover provisions under the Company’s articles could impede the takeover of the Company.
Various Maryland laws affecting business corporations may have the effect of discouraging offers to acquire the Company, even if the acquisition would be advantageous to shareholders. In addition, the Company has various anti-takeover measures in place under its articles of incorporation and bylaws, including a staggered Board of Directors, and the absence of cumulative voting. Any one or more of these measures may impede the takeover of the Company without the approval of the Board of Directors and may prevent shareholders from taking part in a transaction in which they could realize a premium over the current market price of the Company common stock.
If the Company concludes that the decline in value of any of its investment securities is an other-than-temporary impairment, the Company is required to write down the value of that security through a charge to earnings.
The Company reviews its investment securities portfolio at each quarter-end to determine whether the fair value is below the current carrying value. When the fair value of any of its investment securities has declined below its carrying value, the Company is required to assess whether the decline is an other-than-temporary impairment. If the Company determines that the decline is an other-than-temporary impairment, it is required to write down the value of that security through a charge to earnings for credit related impairment. Non-credit related reductions in the value of a security do not require a write down of the value through earnings unless the Company intends to, or is required to, sell the security. Changes in the expected cash flows related to the credit related piece of the investment of a security in the Company’s investment portfolio or a prolonged price decline may result in the Company’s conclusion in future periods that an impairment is other than temporary, which would require a charge to earnings to write down the security to fair value. Due to the complexity of the calculations and assumptions used in determining whether an asset has an impairment that is other than temporary, the impairment disclosed may not accurately reflect the actual impairment in the future.
Liquidity risk could impair the Company’s ability to fund operations and meet its obligations as they become due and failure to maintain sufficient liquidity could materially adversely affect the Company’s growth, business, profitability and financial condition.
Liquidity is essential to the Company’s business. Liquidity risk is the potential that the Company will be unable to meet its obligations as they become due because of an inability to liquidate assets or obtain adequate funding at a reasonable cost, in a timely manner and without adverse conditions or consequences. The Company requires sufficient liquidity to fund asset growth, meet customer loan requests, customer deposit maturities and withdrawals, payments on its debt obligations as they come due and other cash commitments under both normal operations conditions and other unpredictable circumstances, including events causing industry or general financial market stress. Liquidity risk can increase due to a number of factors, including an over-reliance on a particular source of funding or market-wide phenomena such as market dislocation and major disasters, including public health crises such as the current COVID-19 pandemic. Factors that could detrimentally impact access to liquidity sources include, but are not limited to, a decrease in the level of its business activity as a result of a downturn in the markets in which its loans are concentrated, adverse regulatory actions against the Company, or changes in the liquidity needs of depositors. Market conditions or other events could also negatively affect the level or cost of funding, affecting its 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. The Company’s inability to raise funds through deposits, borrowings, the sale of loans, and other sources could have a substantial negative effect on its business, and could result in the closure of the Company or either of the Affiliate Banks. The Company’s access to funding sources in amounts adequate to finance its activities or on acceptable terms could be impaired by factors that affect its organization specifically or the financial services industry or economy in general. Any substantial, unexpected, and/or prolonged change in the level or cost of liquidity could impair the Company’s ability to fund operations and meet its obligations as they become due and could have a material adverse effect on its business, financial condition and results of operations.
The Company relies on customer deposits, advances from the Federal Home Loan Bank and brokered deposits to fund its operations. Although the Company has historically been able to replace maturing deposits and advances if desired, including throughout the most recent recession, it may not be able to replace such funds in the future if its financial condition, the financial condition of the Federal Home Loan Bank or market conditions were to change. Federal Home Loan Bank borrowings and other current sources of liquidity may not be available or, if available, sufficient to provide adequate funding for operations.
The Company is subject to environmental liability risk associated with lending activities.
A significant portion of the Company’s loan portfolio is secured by real property. During the ordinary course of business, the Company may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, the Company may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require the Company to incur substantial expense and may materially reduce the affected property’s value or limit the Company’s ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase the Company’s exposure to environmental liability. Although the Company has policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on the Company’s financial condition and results of operations and in turn, the Company’s financial condition, results of operations and stock price.
Financial services companies depend on the accuracy and completeness of information about customers and counterparties.
In deciding whether to extend credit or enter into other transactions, the Company may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports, and other financial information. The Company may also rely on representations of those customers, counterparties or other third
parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports, or other financial information could have a material adverse impact on the Company’s business, financial condition and results of operations.
Consumers may decide not to use banks to complete their financial transactions.
Technology and other changes are allowing parties to complete financial transactions that historically have involved banks through alternative methods. For example, consumers can now maintain funds in brokerage accounts or mutual funds that would have historically been held as bank deposits. Consumers can also complete transactions such as obtaining loans, paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of loans, customer deposits and the related income generated from those transactions. The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on the Company’s business, financial condition and results of operations.
Risks Related to Bank and Bank Holding Company Regulation
The banking industry is highly regulated, and the regulatory framework, together with any future legislative or regulatory changes, may have a materially adverse effect on the Company’s operations.
The banking industry is highly regulated and supervised under both federal and state laws and regulations that are intended primarily for the protection of depositors, customers, the public, the banking system as a whole or the FDIC Deposit Insurance Fund, not for the protection of our shareholders and creditors. The Company is subject to primary regulation and supervision by the Federal Reserve, Delmarva is subject to primary regulation and supervision by the FDIC and the Delaware Commissioner and Partners is subject to primary regulation by the Federal Reserve and the Virginia Bureau. Compliance with these laws and regulations can be difficult and costly, and changes to laws and regulations can impose additional compliance costs. The federal, state and local laws and regulations applicable to the Affiliate Banks govern a variety of matters, including permissible types, amounts and terms of loans and investments it may make, the maximum interest rate that may be charged, the amount of reserves it must hold against deposits it takes, the types of deposits it may accept and the rates it may pay on such deposits, maintenance of adequate capital and liquidity, changes in control of the Company and the Affiliate Banks, transactions between the Company and the Affiliate Banks, handling of nonpublic information, restrictions on dividends, establishment of new offices, and the monitoring and reporting of suspicious activity and customers who are perceived to present a heightened risk of money laundering or other illegal activity. The Company and the Affiliate Banks must obtain approval from their regulators before engaging in certain activities, and there is risk that such approvals may not be granted, either in a timely manner or at all. These requirements may constrain the Company’s operations, and the adoption of new laws and changes to or repeal of existing laws may have a further impact on the Company’s business, financial condition and results of operations. Also, the burden imposed by those federal and state regulations may place banks in general, including the Affiliate Banks in particular, at a competitive disadvantage compared to non-bank competitors. The Company’s failure to comply with any applicable laws or regulations, or regulatory policies and interpretations of such laws and regulations, could result in sanctions by regulatory agencies, civil money penalties or damage to our reputation, all of which could have a material adverse effect on the Company’s business, financial condition and results of operations.
Bank holding companies and financial institutions currently face an uncertain regulatory environment. Applicable laws, regulations, interpretations, enforcement policies and accounting principles have been subject to significant changes in recent years, and may be subject to significant future changes. Future changes may have a material adverse effect on the Company’s business, financial condition and results of operations.
Federal, state and local legislative bodies and regulatory agencies may adopt changes to their laws or regulations or change the manner in which existing regulations are applied. We cannot predict the substance or effect of pending or future legislation or regulation or the application of laws and regulations to us. Compliance with current and potential regulation, as well as regulatory scrutiny, may significantly increase our costs, impede the efficiency of our internal business processes, require the Company to increase its regulatory capital, and limit its ability to pursue business
opportunities in an efficient manner by requiring the Company to expend significant time, effort and resources to ensure compliance and respond to any regulatory inquiries or investigations.
In addition, given the current economic and financial environment, including the adverse effects thereto as a result of the current COVID-19 pandemic, regulators may elect to alter standards or the interpretation of the standards used to measure regulatory compliance or to determine the adequacy of liquidity, risk management or other operational practices for financial service companies in a manner that impacts the Company’s ability to implement its strategy and could affect the Company in substantial and unpredictable ways, and could have a material adverse effect on the Company’s business, financial condition and results of operations. Furthermore, the regulatory agencies have extremely broad discretion in their interpretation of laws and regulations and their assessment of the quality of our loan portfolio, securities portfolio and other assets. If any regulatory agency’s assessment of the quality of our assets, operations, lending practices, investment practices, capital structure or other aspects of the Company’s business differs from the Company’s assessment, the Company may be required to take additional charges or undertake, or refrain from taking, actions that could have a material adverse effect on the Company’s business, financial condition and results of operations.
Regulatory initiatives regarding bank capital requirements may require heightened capital.
Regulatory capital rules adopted in July 2013 implemented higher minimum capital requirements for bank holding companies and banks. These rules, which implement the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision, include a common equity Tier 1 capital requirement and establish criteria that instruments must meet to be considered common equity Tier 1 capital, additional Tier 1 capital or Tier 2 capital. These enhancements were intended to both improve the quality and increase the quantity of capital required to be held by banking organizations, and to better equip the U.S. banking system to deal with adverse economic conditions. The capital rules require bank holding companies and banks to maintain a common equity Tier 1 capital ratio of 4.5%, a minimum total Tier 1 risk based capital ratio of 6%, a minimum total risk based capital ratio of 8%, and a minimum leverage ratio of 4%. Bank holding companies and banks are also required to hold a capital conservation buffer of common equity Tier 1 capital of 2.5% to avoid limitations on capital distributions and discretionary executive compensation payments. The revised capital rules will also require banks to maintain a common equity Tier 1 capital ratio of 6.5% or greater, a Tier 1 capital ratio of 8% or greater, a total capital ratio of 10% or greater and a leverage ratio of 5% or greater to be deemed “well-capitalized” for purposes of certain rules and prompt corrective action requirements.
The Federal Reserve may also set higher capital requirements for holding companies whose circumstances warrant it. For example, holding companies experiencing significant internal growth or making acquisitions are expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. Our regulatory capital ratios currently are in excess of the levels established for “well-capitalized” institutions. Future regulatory change could impose higher capital standards.
As a result of the Economic Growth, Regulatory Relief and Consumer Protection Act (the “EGRRCPA”), the federal banking agencies were required to develop a Community Bank Leverage Ratio (the ratio of a bank’s tangible equity capital to average total consolidated assets) for banking organizations with assets of less than $10 billion, such as the Bank. On October 29, 2019, the federal banking agencies issued a final rule that implements the Community Bank Leverage Ratio Framework (the “CBLRF”). To qualify for the CBLRF, a bank must have less than $10 billion in total consolidated assets, limited amounts of off-balance sheet exposures and trading assets and liabilities, and a leverage ratio greater than 9.0%. A bank that elects the CBLRF and has a leverage ratio greater than 9.0% will be considered to be in compliance with Basel III capital requirements and exempt from the complex Basel III calculations and will also be deemed “well capitalized” under Prompt Corrective Action regulations, discussed below. A bank that falls out of compliance with the CBLRF will have a two-quarter grace period to come back into full compliance, provided its leverage ratio remains above 8.0% (a bank will be deemed “well capitalized” during the grace period). The CBLRF became available for banking organizations to use as of March 31, 2020 (with the flexibility for banking organizations to subsequently opt into or out of the CBLRF, as applicable). The federal banking regulatory agencies issued an interim final rule in April 2020 to implement certain provisions of the CARES Act that temporarily modified the minimum leverage ratio requirements of the CBLRF. The minimum leverage ratio requirement was reduced from 9 percent to 8
percent for the second through fourth quarters of 2020 and 8.5 percent through 2021. If the Company, Delmarva and Partners elect to use this simplified capital regime, there can be no assurance that satisfaction of the CBLRF will provide adequate capital for their operations and growth, or an adequate cushion against increase levels of nonperforming assets or weakened economic conditions.
The current COVID-19 pandemic continues to have a significant impact on financial markets, which has resulted in a volatile environment for banks and bank holding companies. As a result, there is the potential for new laws and regulations regarding lending and funding practices and capital and liquidity standards, and bank regulatory agencies have been (and are expected to continue to be) very proactive in responding to both market and supervisory concerns arising from the COVID-19 pandemic. Any new or revised standards adopted in the future – whether in response to the COVID-19 pandemic or other events – may require us to maintain materially more capital, with common equity as a more predominant component, or manage the configuration of our assets and liabilities to comply with formulaic liquidity requirements. The Company may not be able to raise additional capital at all, or on terms acceptable to it. Failure to maintain capital to meet current or future regulatory requirements could have a significant material adverse effect on the Company’s business, financial condition and results of operations.
For additional information, please see “Supervision and Regulation” in Item 1, Business.
The Company may need or be compelled to raise additional capital in the future which could dilute shareholders or be unavailable when needed or at unfavorable terms.
The Company’s regulators or market conditions may require it to increase its capital levels. If the Company raises capital through the issuance of additional shares of its common stock or other securities, it would likely dilute the ownership interests of shareholders and may dilute the per share book value and earnings per share of its common stock. Furthermore, it may have an adverse impact on the Company’s stock price. New investors may also have rights, preferences and privileges senior to the Company’s shareholders, which may adversely impact its shareholders. The Company’s ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside its control, and on its financial performance. Accordingly, the Company cannot be assured of its ability to raise additional capital on terms and time frames acceptable to it or to raise additional capital at all. If the Company cannot raise additional capital in sufficient amounts when needed, its ability to comply with regulatory capital requirements could be materially impaired. Additionally, the inability to raise capital in sufficient amounts may adversely affect the Company’s business, financial condition, and results of operations.
Risks Related to the Company’s Common Stock
The Company’s ownership is concentrated in one significant shareholder.
Kenneth R. Lehman beneficially owns approximately 41.5% of the Company’s common stock. As a result, Mr. Lehman has the ability to exercise significant control over the Company’s business policies and affairs, such as the composition of the Company’s board of directors and any action requiring the approval of the Company’s shareholders, including the adoption of amendments to its articles of incorporation and the approval of a merger, share exchange or sale of substantially all of its assets. Mr. Lehman is able to vote his shares in favor of his interests that may not always coincide with the interests of the other shareholders.
For additional information, please see Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Risks Related to Information Technology
The Company’s operations of its business, including its transactions with customers, are increasingly done via electronic means, and this has increased its risks related to cybersecurity.
The Company relies heavily on communications and information systems to conduct its business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in the Company’s customer
relationship management, general ledger, deposit, loan and other systems. While the Company has policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of its 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. Although the Company maintains insurance coverage that may, subject to policy terms and conditions including significant self-insured deductibles, cover certain aspects of cyber risks, such insurance coverage may be insufficient to cover all losses. The Company is exposed to the risk of cyber-attacks in the normal course of business. In addition, the Company is exposed to cyber-attacks on vendors and merchants that affect the Company and its customers. In general, cyber incidents can result from deliberate attacks or unintentional events. The Company has observed an increased level of attention in the industry focused on cyber-attacks that include, but are not limited to, gaining unauthorized access to digital systems for purposes of misappropriating assets or sensitive information, corrupting data, or causing operational disruption. To combat against these attacks, policies and procedures are in place to prevent or limit the effect of the possible security breach of its information systems. While the Company maintains insurance coverage that may, subject to policy terms and conditions including significant self-insured deductibles, cover certain aspects of cyber risks, such insurance coverage may be insufficient to cover all losses. While the Company has not incurred any material losses related to cyber-attacks, nor is it aware of any specific or threatened cyber incidents as of the date of this report, it may incur substantial costs and suffer other negative consequences if it falls victim to successful cyber-attacks. Such negative consequences could include remediation costs that may include liability for stolen assets or information and repairing system damage that may have been caused; deploying additional personnel and protection technologies, training employees, and engaging third-party experts and consultants; lost revenues resulting from unauthorized use of proprietary information or the failure to retain or attract customers following an attack; disruption or failures of physical infrastructure, operating systems or networks that support the Company’s business and customers resulting in the loss of customers and business opportunities; additional regulatory scrutiny and possible regulatory penalties; litigation; and, reputational damage adversely affecting customer or investor confidence.
The Company’s financial performance may suffer if its information technology is unable to keep pace with growth or industry developments.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. The Company’s future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in the Company’s operations. Many of the Company’s competitors have substantially greater resources to invest in technological improvements. The Company may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on Delmarva’s business and, in turn, the Company’s business, financial condition and results of operations.
The increasing use of social media platforms presents new risks and challenges and the inability or failure to recognize, respond to, and effectively manage the accelerated impact of social media could materially adversely impact the Company’s business.
There has been a marked increase in the use of social media platforms, including weblogs (blogs), social media websites, and other forms of Internet-based communications which allow individuals access to a broad audience of consumers and other interested persons. Social media practices in the banking industry are evolving, which creates uncertainty and risk of noncompliance with regulations applicable to the Company’s business. Consumers value readily available information concerning businesses and their goods and services and often act on such information without further investigation and without regard to its accuracy. Many social media platforms immediately publish the content their subscribers and participants post, often without filters or checks on accuracy of the content posted. Information posted on such platforms at any time may be adverse to the Company’s interests and/or may be inaccurate. The dissemination of information online could harm the Company’s business, prospects, financial condition, and results of operations, regardless of the information’s accuracy. The harm may be immediate without affording the Company an opportunity for redress or correction.
Other risks associated with the use of social media include improper disclosure of proprietary information, negative comments about the Company’s business, exposure of personally identifiable information, fraud, out-of-date information, and improper use by employees and customers. The inappropriate use of social media by the Company’s customers or employees could result in negative consequences such as remediation costs including training for employees, additional regulatory scrutiny and possible regulatory penalties, litigation, or negative publicity that could damage the Company’s reputation adversely affecting customer or investor confidence.
General Risk Factors
The Company’s stock price may be volatile, and you could lose part or all of your investment as a result.
Stock price volatility may negatively impact the price at which our common stock may be sold, and may also negatively impact the timing of any sale. The Company’s stock price may fluctuate widely in response to a variety of factors including the risk factors described herein and, among other things:
|●||actual or anticipated variations in quarterly operating results, financial conditions or credit quality|
|●||changes in business or economic conditions|
|●||recommendations or research reports about the Company, the Affiliate Banks or the financial services industry in general published by securities analysts|
|●||changes in financial estimates or publication of research reports and recommendations by financial analysts or actions taken by rating agencies with respect to the Company, the Affiliate Banks or other financial institutions|
|●||news reports relating to trends, concerns and other issues in the financial services industry|
|●||perceptions in the marketplace regarding the Company or the Affiliate Banks and their competitors|
|●||significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving the Company, the Affiliate Banks or their competitors|
|●||additional investments from third parties|
|●||additions or departures of key personnel|
|●||future sales or issuance of additional shares of stock|
|●||fluctuations in the stock price and operating results of the Company’s competitors|
|●||changes or proposed changes in laws or regulations, or differing interpretations thereof affecting the businesses of the Company or the Affiliate Banks, or enforcement of these laws or regulations|
|●||new technology used, or services offered, by competitors|
|●||additional investments from third parties|
|●||geo-political conditions such as acts or threats of terrorism, public health crises and disease pandemics (including the current COVID-19 pandemic) or military conflicts.|
In particular, the ongoing COVID-19 pandemic has resulted in severe volatility in the financial markets including with respect to the Company’s common stock. Depending on the extent and duration of the COVID-19 pandemic, the price of the Company’s common stock may continue to experience volatility and declines.
The Company may not be able to attract and retain skilled people.
The Company’s success depends, in large part, on its ability to attract and retain key people. Competition for the best people in most activities engaged in by the Company can be intense, and the Company may not be able to hire people or to retain them. The unexpected loss of services of one or more of the Company’s key personnel could have a material adverse impact on the Company’s business because it would no longer have the benefit of their skills, knowledge of the Company’s markets, as well as years of industry experience, and it would be difficult to promptly find qualified replacement personnel.
Litigation and regulatory actions, including possible enforcement actions, could subject the Company to significant fines, penalties, judgments or other requirements resulting in increased expenses or restrictions on its business activities.
In the normal course of business, from time to time, the Company or the Affiliate Banks may be named as a defendant in various legal actions, arising in connection with their current and/or prior business activities. Legal actions could include claims for substantial compensatory or punitive damages or claims for indeterminate amounts of damages. Further, the Company or the Affiliate Banks may in the future be subject to consent orders or other formal or informal enforcement agreements with their regulators. They may also, from time to time, be the subject of subpoenas, requests for information, reviews, investigations and proceedings (both formal and informal) by governmental agencies regarding current and/or prior business activities. Any such legal or regulatory actions may subject the Company to substantial compensatory or punitive damages, significant fines, penalties, obligations to change business practices or other requirements resulting in increased expenses, diminished income and damage to their reputation. Involvement in any such matters, whether tangential or otherwise and even if the matters are ultimately determined in their favor, could also cause significant harm to their reputation and divert management attention from the operation of their business. Further, any settlement, consent order, other enforcement agreement or adverse judgment in connection with any formal or informal proceeding or investigation by government agencies may result in litigation, investigations or proceedings as other litigants and government agencies begin independent reviews of the same activities. As a result, the outcome of legal and regulatory actions could have a material adverse effect on the Company’s business, financial condition and results of operations.
The Company’s controls and procedures may fail or be circumvented and have a material adverse effect on its business, financial condition, and results of operations.
Management regularly reviews and updates the Company’s internal controls, disclosure controls and procedures, as well as corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the Company’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on its business, financial condition, and results of operations.
Severe weather, natural disasters, acts of war or terrorism, other external events, including the ongoing COVID-19 pandemic or the outbreak of another highly infectious or contagious disease, could significantly impact the Company’s business.
The unpredictable nature of events such as severe weather, natural disasters, pandemics or other public health issues, acts of war or terrorism, other adverse external events, including the COVID-19 pandemic or the outbreak of another highly infectious or contagious disease could have a significant impact on the Company’s ability to conduct business. If any of its financial, accounting, network or other information processing systems fail or have other significant shortcomings due to such external events, the Company could be materially adversely affected. Third parties with which the Company does business could also be sources of operational risk to the Company, including the risk that the third parties’ own network and information processing systems could fail. Any of these occurrences could materially diminish the Company’s ability to operate its business, or result in potential liability to clients, reputational damage, and regulatory intervention, any of which could materially adversely affect the Company. Such events could affect the stability of the Company’s deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, impair the Company’s liquidity, cause significant property damage, result in loss of revenue, and/or cause the Company to incur additional expenses.
The Company may be subject to disruptions or failures of the financial, accounting, network and other information processing systems arising from events that are wholly or partially beyond the Company’s control, which may include, for example, computer viruses, electrical or telecommunications outages, natural disasters, public health crises and disease pandemics (including the current COVID-19 pandemic), damage to property or physical assets, or terrorist acts. The Company has developed a comprehensive business continuity plan which includes plans to maintain or resume operations in the event of an emergency, such as a power outage or disease pandemic, and contingency plans in
the event that operations or systems cannot be resumed or restored. The business continuity plan is updated as needed, periodically reviewed, and components are regularly tested. The Company also reviews and evaluates the business continuity plans of critical third-party service providers. While the Company believes its business continuity plan and efforts to evaluate the business continuity plans of critical third-party service providers help mitigate risks, disruptions or failures affecting any of these systems may cause interruptions in service to customers, damage to the Company’s reputation, and loss or liability to the Company.
The Company has no unresolved staff comments to report.
Delmarva currently maintains 14 branches and other facilities as set forth in the table below.
910 Norman Eskridge Hwy
Accounting & Customer Service Office
100 E. Main Street
Salisbury, MD 21801
IT & HR Office
2013 Northwood Drive
Salisbury, MD 21801
145 North Maple Avenue
Partners currently maintains four branches and other facilities as set forth in the table below.
Principal and Executive Office
410 William Street
Fredericksburg, VA 22401
Fredericksburg, VA 22407
Fredericksburg, VA 22401
La Plata, MD 20646
2661 Riva Road, Building 1000, Suite 1035, Annapolis, MD 21404
520 William Street,
Fredericksburg, VA 22401
All of the foregoing properties are used by Delmarva and Partners in the normal course of their businesses. The Company believes all of these properties are in good operating condition and are adequate for the Company’s present and anticipated future needs. The Company maintains comprehensive general liability and casualty loss insurance covering its properties and activities conducted in or about its properties. The Company believes this insurance provides adequate protection for liabilities or losses that might arise out of the ownership and use of such properties.
From time to time the Company, Delmarva and Partners are a party to various litigation matters incidental to the conduct of their respective businesses. The Company and the Affiliate Banks are not presently party to any legal proceedings the resolution of which the Company believes would have a material adverse effect on their respective businesses, prospects, financial condition, liquidity, results of operation, cash flows or capital levels.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
As of February 26, 2021, there were 17,726,648 shares of the Company common stock outstanding which were held by approximately 615 holders of record, which does not reflect the number of individuals or institutional investors holding stock in nominee name through banks, brokerage firms, and others.
The Company’s common stock is listed on the NASDAQ Capital Market (“Nasdaq”) under the symbol “PTRS”. The stock began trading on Nasdaq on May 6, 2020. On February 26, 2021, the closing price of the Company’s common stock on the Nasdaq was $7.11 per share.
The Company currently pays a quarterly dividend of $0.025 per share. The most recent quarterly dividend was declared on January 27, 2021 and is payable on April 1, 2021 to holders of record as of March 24, 2021. When declaring dividends, the Board of Directors considers, among other things, the Company’s long-term outlook, the Company’s financial condition and results of operations during recent financial periods, and trends in the investment and financing markets.
There can be no assurance that future earnings will be sufficient to allow the Company to maintain or increase the amount of the cash dividend. Substantially all of the Company's income from which it can pay dividends is the receipt of dividends from the Affiliate Banks. The availability of dividends from the Affiliate Banks is limited by various statutes and regulations. It also is possible, depending on the financial condition of the Affiliate Banks, and other factors, that the applicable regulatory authorities could assert that payment of dividends or other payments is an unsafe or unsound banking practice. In the event that either of the Affiliate Banks is unable to pay dividends to the Company, the Company may not be able to pay dividends on its common stock. As of the date of filing this Annual Report on Form 10-K, the Company has no such restrictions.
Under Maryland law, dividends may only be paid out of retained earnings. State and federal bank regulatory agencies also have authority to prohibit a bank from paying dividends if such payment is deemed to be an unsafe or unsound practice, and the Federal Reserve has the same authority over bank holding companies. At December 31, 2020, each of the Affiliate Banks could pay dividends to the Company to the extent of its retained earnings so long as it maintained required capital ratios.
The Federal Reserve has established requirements with respect to the maintenance of appropriate levels of capital by registered bank holding companies. Compliance with such standards, as presently in effect, or as they may be amended from time to time, could possibly limit the amount of dividends that the Company may pay in the future. In 1985, the Federal Reserve issued a policy statement on the payment of cash dividends by bank holding companies. In the statement, the Federal Reserve expressed its view that a holding company experiencing earnings weaknesses should not pay cash dividends exceeding its net income, or which could only be funded in ways that weaken the holding company’s financial health, such as by borrowing. As depository institutions, the deposits of which are insured by the FDIC, neither of the Affiliate Banks may pay dividends or distribute any of its capital assets while it remains in default on any assessment due the FDIC. The Affiliate Banks currently are not in default under any of their obligations to the FDIC.
Computershare is the transfer agent for the Company’s common stock:
Shareholder Website: www.computershare.com/investor
Shareholder Online Inquiries: www.computershare.com/investor/contact
Telephone: 1 (800) 368-5948
Computershare Inc. (Overnight Delivery)Computershare Inc. (Regular Mail)
462 South 4th Street Suite 1600P.O. Box 505000
Louisville, KY 40202Louisville, KY 40233-5000
ISSUER PURCHASES OF EQUITY SECURITIES
In November 2020 the Company’s Board of Directors approved a stock repurchase program. Under the stock repurchase program, the Company is authorized to repurchase up to 356,000 shares of its common stock, which represented approximately 2% of its outstanding shares of common stock at the time of the Board of Directors’ approval. The program may be limited or terminated at any time without prior notice. During the year ended December 31, 2020, the Company repurchased 68,400 shares under the stock repurchase program.
The following table provides information with respect to purchases made by or on behalf of us or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Exchange Act) of the Company’s common stock during the fourth quarter of 2020.
of Shares Purchased as Part
Of Shares that May Yet Be
of the Publicly Announced
Purchased Under the
Plans or Programs
Plans or Programs
November 1, 2020 to November 30, 2020
December 1, 2020 to December 31, 2020
The following discussion compares the Company’s financial condition at December 31, 2020 to its financial condition at December 31, 2019 and the results of operations for the years ended December 31, 2020 and 2019. This discussion should be read in conjunction with the Consolidated Financial Statements and the Notes thereto appearing in Item 8 of Part II of this Annual Report on Form 10-K.
Certain statements in this Annual Report on Form 10-K may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that include, without limitation, projections, predictions, expectations, or beliefs about future events or results that are not statements of historical fact. Such forward-looking statements are based on various assumptions as of the time they are made, and are inherently subject to known and unknown risks, uncertainties, and other factors, some of which cannot be predicted or quantified, that may cause actual results, performance or achievements to be materially different from those expressed or implied by such forward-looking statements. Forward-looking statements are often accompanied by words that convey projected future events or outcomes such as “expect,” “believe,” “estimate,” “plan,” “project,” “anticipate,” “intend,” “will,” “may,” “view,” “opportunity,” “potential,” or words of similar meaning or other statements concerning opinions or judgment of the Company and its management about future events. Although the Company believes that its expectations with respect to forward-looking statements are based upon reasonable assumptions within the bounds of its existing knowledge of its business and operations, there can be no assurance that actual results, performance, or achievements of, or trends affecting, the Company will not differ materially from any projected future results, performance, achievements or trends expressed or implied by such forward-looking statements. Actual future results, performance, achievements or trends may differ materially from historical results or those anticipated depending on a variety of factors, including, but not limited to:
|●||changes in interest rates;|
|●||general economic and financial market conditions, in the United States generally and particularly in the markets in which the Company operates and in which its loans are concentrated, including the effects of declines in real estate values, increases in or sustained high levels of unemployment and bankruptcies and slowdowns in economic growth, including as a result of the pandemic caused by a novel strain of coronavirus (“COVID-19”);|
|●||the quality or composition of the loan or investment portfolios and changes therein;|
|●||demand for loan products and financial services in the Company’s market area;|
|●||the Company’s ability to manage its growth or implement its growth strategy;|
|●||the introduction of new lines of business or new products and services;|
|●||the Company’s ability to recruit and retain key employees;|
|●||real estate values in the Company’s lending area;|
|●||an insufficient allowance for credit losses;|
|●||the Company’s liquidity and capital positions;|
|●||concentrations of loans secured by real estate, particularly commercial real estate;|
|●||the effectiveness of the Company’s credit processes and management of the Company’s credit risk;|
|●||the Company’s ability to compete in the market for financial services;|
|●||technological risks and developments, and cyber threats, attacks, or events;|
|●||the potential adverse effects of unusual and infrequently occurring events, such as weather-related disasters, terrorist acts or public health events (including the COVID-19 pandemic), and of governmental and societal responses thereto; these potential adverse effects may include, without limitation, adverse effects on the ability of the Company’s borrowers to satisfy their obligations to the Company, on the value of collateral securing loans, on the demand for the Company’s loans or its other products and services, on incidents of cyberattack and fraud, on the Company’s liquidity or capital positions, on risks posed by reliance on third-party service providers, on other aspects of the Company’s business operations and on financial markets and economic growth;|
|●||the potential effect of the COVID-19 pandemic, the steps the Company takes in response to the pandemic, the severity and duration of the pandemic, and the distribution and efficacy of vaccines, including the pace of recovery when the pandemic subsides and the heightened impact it has on many of the risks described herein;|
|●||performance by the Company’s counterparties or vendors;|
|●||the availability of financing and the terms thereof;|
|●||the level of prepayments on loans and mortgage-backed securities;|
|●||legislative or regulatory changes and requirements, including the impact of the CARES Act and other legislative and regulatory reactions to the COVID-19 pandemic;|
|●||the effects of changes in federal, state or local tax laws and regulations;|
|●||monetary and fiscal policies of the U.S. government including policies of the U.S. Department of the Treasury and the Federal Reserve;|
|●||changes to applicable accounting principles and guidelines; and|
|●||other factors, many of which are beyond the control of the Company.|
These factors should not be considered exhaustive and should be read together with other cautionary statements that are included in this Annual Report on Form 10-K including those discussed in Item 1A. “Risk Factors.” All of the forward-looking statements made in this Annual Report are expressly qualified by the cautionary statements contained or referred to in this Annual Report. The actual results or developments anticipated may not be realized or, even if substantially realized, they may not have the expected consequences to or effects on the Company or its businesses or operations. Readers are cautioned not to place undue reliance on the forward-looking statements contained in this Annual Report. Forward-looking statements speak only as of the date they are made and the Company does not undertake any obligation to update, revise, or clarify these forward-looking statements whether as a result of new information, future events or otherwise.
Partners Bancorp, a bank holding corporation, through its wholly owned subsidiaries, The Bank of Delmarva (“Delmarva”) and Virginia Partners Bank (“Partners”), each of which are commercial banking corporations, engages in general commercial banking operations, with eighteen branches throughout Wicomico, Charles, Anne Arundel, and Worcester Counties in Maryland, Sussex County in Delaware, Camden and Burlington Counties in New Jersey, the city of Fredericksburg, Virginia, and Spotsylvania County, Virginia.
The Company derives the majority of its income from interest received on our loans and investment securities. The primary source of funding for making these loans and investment securities are deposits and secondarily, borrowings. Consequently, one of the key measures of the Company’s success is the amount of net interest income, or the difference between the income on interest earning assets, such as loans and investment securities, and the expense on interest bearing liabilities, such as deposits and borrowings. The resulting ratio of that difference as a percentage of average interest earning assets represents the net interest margin. Another key measure is the spread between the yield earned on interest earning assets and the rate paid on interest bearing liabilities, which is called the net interest spread. In addition to earning interest on loans and investment securities, the Company earns income through fees and other charges to customers. Also included is a discussion of the various components of this noninterest income, as well as of noninterest expense.
There are risks inherent in all loans, so the Company maintains an allowance for credit losses to absorb probable losses on existing loans that may become uncollectible. The Company maintains this allowance for credit losses by charging a provision for credit losses as needed against our operating earnings for each period. The Company has included a detailed discussion of this process, as well as several tables describing its allowance for credit losses.
The Company plans to continue to grow both organically and possibly through future acquisitions, including potential expansion into new market areas, such as its proposed expansion into the Greater Washington and Northern Virginia Markets. The Company believes its current financial condition, coupled with its scalable operational capabilities, will allow it to act upon growth opportunities in the current banking environment. The Company’s financial performance generally, and in particular the ability of its borrowers to repay their loans, the value of collateral securing those loans, as well as demand for loans and other products and services the Company offers, is highly dependent on the business environment in the Company’s primary markets where the Company operates and in the United States as a whole.
The ongoing COVID-19 pandemic has severely disrupted supply chains and adversely affected production, demand, sales and employee productivity across a range of industries, dramatically increased unemployment in the Company’s areas of operation and nationally, and resulted in orders directing the closing or limited operation of certain businesses and restrictions on public gatherings, many of which remain in place. These events affected the Company’s operations during 2020 and are expected to impact the Company’s financial results continuing on into 2021. The extent of the impact of the COVID-19 pandemic on the Company’s operational and financial performance will depend on certain developments, including the duration and spread of the outbreak, the impact on the Company’s customers, employees and vendors and the nature and effect of past and future federal and state governmental and private sector responses to the pandemic, all of which are uncertain and cannot be predicted.
In connection with the ongoing COVID-19 pandemic, both Delmarva and Partners continue to follow their pandemic response plans, which were enacted in February 2020. To date, management believes that the plans have been implemented successfully. The operation of these plans continues to require daily oversight in order to properly navigate this complex and ever-changing environment. The roll out of these plans previously resulted in adjustments to both Delmarva and Partners branch operations, including, but not limited to, lobby and drive-thru hours as well as physical access, the provision of personal protective equipment to employees and customers, and having employees work remotely whenever possible. As of December 31, 2020, both Delmarva and Partners branch operations were operating under normal lobby and drive-thru hours with facemasks being required to enter one of their branch facilities and signage and floor markings in their branch lobbies to help facilitate compliance with social distancing guidelines. In addition, the majority of Delmarva’s and Partners’ employees, with a few exceptions, have shifted from remote work to returning to the office on either a full-time or hybrid basis. Delmarva and Partners continue to proactively work with their local, state and federal government agencies to ensure their response to the COVID-19 pandemic is both safe and sound with little disruption to their customers. Additionally, Delmarva and Partners continue to take necessary precautions in order to protect their staffs, customers and their families as well as their communities, and to limit the ongoing impact of the COVID-19 pandemic.
Future developments with respect to the COVID-19 pandemic are highly uncertain and cannot be predicted and new information may emerge concerning the severity of the outbreak and the actions to contain the outbreak or treat its impact, among others. Other national health concerns, including the outbreak of other contagious diseases or pandemics may adversely affect the Company in the future. Please refer to the “Provision and Allowance for Credit Losses” section of this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more information related to payment deferrals, concentrations in higher risk industries, and the impact on the allowance for credit losses.
The following discussion and analysis also identifies significant factors that have affected the Company's financial position and operating results during the periods included in the consolidated financial statements accompanying this report. You are encouraged to read this management's discussion and analysis in conjunction with the consolidated financial statements and the notes thereto included in Item 8 in this Annual Report on Form 10-K, and the other statistical information included in this Form 10-K.
Critical Accounting Policies
Certain critical accounting policies affect significant judgments and estimates used in the preparation of the Company's consolidated financial statements. These significant accounting policies are described in the notes to the consolidated financial statements included in Item 8 in this Annual Report on Form 10-K. The accounting principles the Company follows and the methods of applying these principles conform to U.S. GAAP and general banking industry practices. The Company's most critical accounting policy relates to the determination of the allowance for credit losses,
which reflects the estimated losses resulting from the inability of borrowers to make loan payments. The determination of the adequacy of the allowance for credit losses involves significant judgment and complexity and is based on many factors. If the financial condition of our borrowers were to deteriorate, resulting in an impairment of their ability to make payments, the estimates would be updated and additional provisions for credit losses may be required. See “Provision and Allowance for Credit Losses” and Note 1 and Note 3 of the consolidated financial statements for the year ended December 31, 2020.
Another of the Company’s critical accounting policies, with the acquisitions of Liberty in 2018 and Partners in 2019, relates to the valuation of goodwill and intangible assets. The Company accounted for the Liberty Merger and the Share Exchange in accordance with ASC Topic No. 805, which requires the use of the acquisition method of accounting. Under this method, assets acquired, including intangible assets, and liabilities assumed, are recorded at their fair value. Determination of fair value involves estimates based on internal valuations of discounted cash flow analyses performed, third party valuations, or other valuation techniques that involve subjective assumptions. Additionally, the term of the useful lives and appropriate amortization periods of intangible assets is subjective. Resulting goodwill from the Liberty Merger and the Share Exchange, which totaled approximately $5.2 million and $4.4 million, respectively, under the acquisition method of accounting represents the excess of the purchase price over the fair value of net assets acquired. Goodwill is not amortized, but is evaluated for impairment annually or more frequently if deemed necessary. If the fair value of an asset exceeds the carrying amount of the asset, no charge to goodwill is made. If the carrying amount exceeds the fair value of the asset, goodwill will be adjusted through a charge to earnings, which is limited to the amount of goodwill allocated to that reporting unit. In evaluating the goodwill on its consolidated balance sheet for impairment after the consummation date of the Liberty Merger and the Share Exchange, the Company will first assess qualitative factors to determine whether it is more likely than not that the fair value of our acquired assets is less than the carrying amount of the acquired assets, as allowed under ASU 2017-04. After making the assessment based on several factors, which will include, but is not limited to, the current economic environment, the economic outlook in our markets, our financial performance and common stock value as compared to our peers, we will determine if it is more likely than not that the fair value of our assets is greater than their carrying amount and, accordingly, will determine whether impairment of goodwill should be recorded as a charge to earnings in years subsequent to the Liberty Merger and the Share Exchange. This assessment was performed during the fourth quarter of 2020, and resulted in no impairment of goodwill. Depending on the severity of the economic consequences of the COVID-19 pandemic and their impact on the Company, management may determine that goodwill is required to be evaluated for impairment due to the presence of a triggering event, which may have a negative impact on the Company’s results of operations. See Note 20 – Virginia Partners Bank Transaction in the audited consolidated financial statements for the year ended December 31, 2020 for more information related to the fair value of net assets acquired in the acquisition of Partners, including goodwill and intangible assets.
In addition to the Company’s policies related to the valuation of goodwill, intangible assets and other acquisition accounting adjustments, ongoing accounting for acquired loans is considered a critical accounting policy. Acquired loans are classified as either purchase credit impaired (“PCI “) loans or purchased performing loans and are recorded at fair value on the date of acquisition. PCI loans are those for which there is evidence of credit deterioration since origination and for which it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the “nonaccretable difference.” Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the “accretable yield” and is recognized as interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows. Periodically, we evaluate our estimate of cash flows expected to be collected on PCI loans. Estimates of cash flows for PCI loans require significant judgment. Subsequent decreases to the expected cash flows will generally result in a provision for credit losses resulting in an increase to the allowance for credit losses. Subsequent significant increases in cash flows may result in a reversal of post-acquisition provision for credit losses or a transfer from nonaccretable difference to accretable yield that increases interest income over the remaining life of the loan, or pool(s) of loans. The Company accounts for purchased performing loans using the contractual cash flows method of recognizing discount accretion based on the acquired loans’ contractual cash flows. Purchased performing loans are recorded at fair value, including a credit discount. The fair value discount is accreted as an adjustment to yield over the estimated lives of the loans. There is no allowance for credit losses established at the acquisition date for purchased performing loans, but a provision for credit losses may be required for any deterioration in these loans in future periods. The Company evaluates purchased performing loans quarterly for deterioration and records any required additional provision for credit losses.
Another critical accounting policy relates to deferred tax assets and liabilities. The Company records deferred tax assets and deferred tax liabilities for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Future tax benefits, such as net operating loss carry forwards available from the Liberty acquisition, are recognized to the extent that realization of such benefits is more likely than not. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the assets and liabilities are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date. In the event the future tax consequences of differences between the financial reporting bases and the tax bases of our assets and liabilities results in deferred tax assets, an evaluation of the probability of being able to realize the future benefits indicated by such assets is required. A valuation allowance is provided when it is more likely than not that a portion or the full amount of the deferred tax asset will not be realized. In assessing the ability to realize the deferred tax assets, management considers the scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies. Such a deferred tax liability will only be recognized when it becomes apparent that those temporary differences will reverse in the foreseeable future. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50 percent more likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.
Results of Operations
Net income attributable to the Company for the year ended December 31, 2020 totaled $5.7 million, or $0.32 per basic and diluted share, as compared to $5.9 million, or $0.54 per basic and diluted share, for the year ended December 31, 2019, a $215 thousand or 3.7% decrease. The Company’s results of operations for the year ended December 31, 2020 were directly impacted by the acquisition of Partners, whose results of operations were not fully present for the same period of 2019, and significantly higher provision for credit losses due to the current economic environment stemming from the COVID-19 pandemic.
As previously disclosed, effective after the close of business on November 15, 2019, the Company and Partners completed their share exchange (the “Share Exchange”), pursuant to which Partners became a wholly owned subsidiary of the Company. As a result of the Share Exchange, the Company acquired from Partners total assets of $454.2 million, including investment securities available for sale of $65.4 million and loans held for investment of $355.2 million, and total liabilities of $405.0 million, including total deposits of $348.6 million and total borrowings of $49.0 million.
For the year ended December 31, 2020, the Company’s return on average assets, return on average equity and efficiency ratio were 0.40%, 4.24% and 71.96%, respectively, as compared to 0.70%, 7.22% and 71.40%, respectively, for the same period in 2019.
The decrease in net income attributable to the Company for the year ended December 31, 2020, as compared to the same period in 2019, was driven by higher provision for credit losses and noninterest expenses, and was partially offset by increases in net interest income and noninterest income, and lower income taxes.
Total assets as of December 31, 2020 were $1.51 billion, an increase of $261.7 million, or 20.9%, from December 31, 2019. Key drivers of this change were increases in cash and cash equivalents, investment securities available for sale, at fair value and total loans held for investment. Changes in key balance sheet components as of December 31, 2020 compared to December 31, 2019 were as follows:
|●||Cash and due from banks as of December 31, 2020 were $13.6 million, a decrease of $20.8 million, or 60.4%, from December 31, 2019. Key drivers of this change were increases in interest bearing deposits in other financial institutions and federal funds sold as the Company repositioned its excess liquidity in order to earn higher amounts of interest income;|
|●||Interest bearing deposits in other financial institutions as of December 31, 2020 were $218.7 million, an increase of $189.3 million, or 643.9%, from December 31, 2019. Key drivers of this change were the aforementioned item noted in the cash and due from banks analysis, total deposit growth outpacing total loan growth and increases in subordinated debt, net of issuance costs and other borrowings, which were partially offset by an increase in investment securities available for sale, at fair value, a decrease in Federal Home Loan Bank borrowings, and the maturity of certificate of deposit investments in other financial institutions that were not replaced;|
|●||Federal funds sold as of December 31, 2020 were $50.3 million, an increase of $19.1 million, or 61.1%, from December 31, 2019. Key drivers of this change were the aforementioned items noted in the analysis of cash and due from banks and interest bearing deposits in other financial institutions;|
|●||Investment securities available for sale, at fair value as of December 31, 2020 were $124.9 million, an increase of $20.6 million, or 19.7%, from December 31, 2019. Key drivers of this change were management of the investment securities available for sale portfolio in light of the Company's liquidity needs and an increase in unrealized gains on the investment securities available for sale portfolio. The significant inflow of deposits presented the Company with the opportunity to deploy excess cash and cash equivalents primarily into liquid, cash-flowing products while expanding net interest margin and increasing earnings per share;|
|●||Loans, net of unamortized discounts on acquired loans of $4.0 million as of December 31, 2020 were $1.04 billion, an increase of $41.5 million, or 4.2%, from December 31, 2019. Key drivers of this change were the origination and funding of approximately $64.2 million in loans under the PPP, of which approximately $42.3 million were still outstanding as of December 31, 2020, which was partially offset by a decrease in organic growth due to higher pay-offs and tempered loan demand due to the uncertainty surrounding the COVID-19 pandemic;|
|●||Total deposits as of December 31, 2020 were $1.27 billion, an increase of $261.8 million, or 26.0%, from December 31, 2019. Key drivers of this change were organic growth as a result of the Company’s continued focus on total relationship banking, customers seeking the liquidity and safety of deposit accounts in light of continuing economic uncertainty surrounding the COVID-19 pandemic, and the funding of loans under the PPP, the proceeds of which are deposited directly into the operating account of these customers at the Company;|
|●||Total borrowings as of December 31, 2020 were $99.5 million, a decrease of $5.1 million, or 4.8%, from December 31, 2019. Key drivers of this change were a decrease in Federal Home Loan Bank borrowings due to maturities that were not replaced, which was partially offset by an increase in borrowings at the Federal Reserve Bank Discount Window under the PPP Liquidity Facility in which the loans under the PPP originated by the Company have been pledged as collateral, and the issuance of $18.1 million in subordinated debt in June 2020; and|
|●||Total stockholders’ equity as of December 31, 2020 was $136.7 million, an increase of $5.8 million, or 4.4%, from December 31, 2019. Key drivers of this change were the net income attributable to the Company for the year ended December 31, 2020 and an increase in accumulated other comprehensive income, net of deferred tax, which were partially offset by cash dividends paid to shareholders and the repurchase of shares of the Company’s common stock under the Company’s Board of Directors approved stock purchase plan.|
Delmarva's Tier 1 leverage capital ratio was 8.1% at December 31, 2020 as compared to 9.1% at December 31, 2019. At December 31, 2020, Delmarva's Tier 1 risk weighted capital and total risk-weighted capital ratios were 11.6% and 12.9%, respectively, as compared to Tier 1 risk weighted capital and total risk weighted capital ratios of 11.6% and 12.7%, respectively, at December 31, 2019.
Partners’ Tier 1 leverage capital ratio was 9.5% at December 31, 2020 as compared to 10.4% at December 31, 2019. At December 31, 2020, Partners’ Tier 1 risk-weighted capital and total risk-weighted capital ratios were 13.2% and 13.6%, respectively, as compared to Tier 1 risk-weighted capital and total risk-weighted capital ratios of 12.4% and 12.5%, respectively, at December 31, 2019.
As of December 31, 2020, all of the capital ratios of Delmarva and Partners continue to exceed regulatory requirements, with total risk-based capital substantially above well-capitalized regulatory requirements.
See “Capital” below for additional information about Delmarva’s and Partners’ capital ratios and requirements.
At December 31, 2020, nonperforming assets totaled $7.6 million, an increase from December 31, 2019 balances of $7.0 million. Most of this increase was due to an increase in nonaccrual loans, which totaled $4.9 million at December 31, 2020 compared with a balance of $4.5 million at December 31, 2019. There was one loan past due 90 days or more and still accruing interest at the end of 2020 with a balance of $2 thousand, compared to one loan past due 90 days or more and still accruing interest at December 31, 2019 with a balance of $5 thousand. The remaining increase was due to an increase in other real estate owned. Other real estate owned as of December 31, 2020 was $2.7 million, as compared to $2.4 million at December 31, 2019. Nonperforming loans as a percentage of total assets was 0.3% at December 31, 2020 and 0.4% at December 31, 2019. Nonperforming assets to total assets as of December 31, 2020 was 0.5% compared to 0.6% at December 31, 2019. Loans classified as TDRs totaled $8.1 million at December 31, 2020 and $10.3 million at December 31, 2019, a decrease of $2.2 million during the year. This decrease was mainly due to two relationships that paid off during the year with aggregrate balances of $1.6 million.
Net charge-offs were 0.1% of average total loans for the year ended December 31, 2020 and 0.2% for the year ended December 31, 2019. The allowance for credit losses to total loans ratio was 1.3% at December 31, 2020, compared to 0.7% at December 31, 2019. In addition to the allowance for credit losses, as of December 31, 2020 and December 31, 2019, the Company had $4.0 million and $6.1 million, respectively, in unamortized discounts on acquired loans related to the acquisitions of Liberty and Partners. This discount is amortized over the life of the remaining loans.
Summary of Return on Equity and Assets
Yield on earning assets
Return on average assets
Return on average equity
Average equity to average assets
Tier I risk-based capital ratio/CET1 ratio (Delmarva)
Tier I risk-based capital ratio/CET1 ratio (Partners)
Total risk-based capital ratio (Delmarva)
Total risk-based capital ratio (Partners)
Leverage capital ratio (Delmarva)
Leverage capital ratio (Partners)
(See Note 15 – Regulatory Capital Requirements of the Company’s consolidated financial statements for the year ended December 31, 2020.)
The Company's primary source of revenue is interest income and fees, which it earns by lending and investing the funds which are held on deposit. Because loans generally earn higher rates of interest than investment securities, the Company seeks to deploy as much of its deposit funds as possible in the form of loans to individuals, businesses, and other organizations. To ensure sufficient liquidity, the Company also maintains a portion of its deposits in cash and cash equivalents, government securities, interest bearing deposits in other financial institutions, and overnight loans of excess reserves (known as “Federal Funds Sold”) to correspondent banks. The revenue which the Company earns (prior to deducting its overhead expenses) is essentially a function of the amount of the Company's loans and deposits, as well as the profit margin (“interest spread”) and fee income which can be generated on these amounts.
Net income attributable to the Company was $5.7 million and $5.9 million for the years ended December 31, 2020 and 2019, respectively, as reported in its audited consolidated financial statements. The following discussion should be read in conjunction with the Company's consolidated financial statements and the notes to the consolidated financial statements included at Item 8 of this Annual Report on Form 10-K.
The following is a summary of the results of operations by the Company for the years ended December 31, 2020 and 2019.
(Dollars in Thousands)
Net interest income
Provision for credit losses
Provision for income taxes
Net income attributable to Partners Bancorp
Basic earnings per share
Diluted earnings per share
At year end:
(Dollars in Thousands)
Loans receivable, net
Investment securities, available for sale
Federal funds sold
Demand and NOW deposits
Savings, money market, and time deposits
Tangible common equity per share
Interest Income and Expense – Years Ended December 31, 2020 and 2019
Net Interest Income and Net Interest Margin
The largest component of net income for the Company is net interest income, which is the difference between the income earned on assets, such as loans and investment securities, and interest paid on liabilities, such as deposits and borrowings, used to support such assets. Net interest income is determined by the rates earned on the Company's interest-earning assets and the rates paid on its interest-bearing liabilities, the relative amounts of interest-earning assets and interest-bearing liabilities, and the degree of mismatch and the maturity and repricing characteristics of its interest-earning assets and interest-bearing liabilities.
Net interest income for the year ended December 31, 2020 increased by $12.8 million, or 41.1%, when compared to the same period of 2019. The Company's net interest margin (tax equivalent basis) decreased to 3.2%, representing a decrease of 72 basis points for the year ended December 31, 2020 as compared to the same period in 2019. The decrease in the net interest margin (tax equivalent basis) was primarily due to a decrease in the yields earned on average loans and investment securities, and higher average balances of interest-bearing liabilities. The Company’s net interest spread, the difference between the yield earned on average interest-earning assets and the rates paid on average interest-bearing liabilities, decreased to 2.8%, representing a decrease of 65 basis points for the year ended December 31, 2020 as compared to the same period in 2019. These margin pressures were offset by increases in average loan and investment securities balances, and lower rates paid on average interest-bearing liabilities. The Company’s net interest margin (tax equivalent basis) was also negatively impacted by higher average balances of cash and due from banks, interest bearing deposits from banks and federal funds sold, which are lower yielding interest-earning assets. Total interest income increased by $16.7 million, or 42.4%, for the year ended December 31, 2020 while total interest expense increased by $3.9 million, or 47.5%, both as compared to the same period in 2019. The most significant factors impacting net interest income during the year ended December 31, 2020 were as follows:
|●||Increases in average loan balances, primarily due to the acquisition of Partners, partially offset by lower loan yields;|
|●||Increases in average investment securities balances, primarily due to the acquisition of Partners, partially offset by lower investment securities yields; and|
|●||Decrease in the rate paid on average interest-bearing deposit balances, primarily due to lower rates paid on average time deposits, partially offset by increases in average interest-bearing deposit balances, primarily due to the acquisition of Partners and organic deposit growth.|
|●||Increases in average cash and due from banks, interest bearing deposits from banks and federal funds sold, primarily due to the acquisition of Partners and deposit growth outpacing loan growth, and lower yields on each; and|
|●||Increases in average borrowings balances, partially offset by lower rates paid on average borrowings, in each case primarily due to the acquisition of Partners and the Company’s issuance of subordinated debt late in the second quarter of 2020.|
Average loan balances increased by $357.7 million, or 52.1%, and average yields earned decreased by 0.3% to 5.0% for the year ended December 31, 2020, as compared to the same period in 2019. The increase in average loan balances was primarily due to the inclusion of a full year, or $402.1 million, in Partners average loan balances and the origination and funding of loans under the PPP, which were partially offset by a decrease in organic growth due to higher pay-offs and tempered loan demand due to the uncertainty surrounding the COVID-19 pandemic. The decrease in average yields earned was primarily due to pay-offs of higher yielding fixed rate loans, repricing of variable rate loans, and lower average yields on new loan originations, including loans originated under the PPP. Total average loans were 75.4% of total average interest-earning assets for the year ended December 31, 2020, compared to 85.9% for the year ended December 31, 2019.
Average total investment securities balances increased by $67.1 million, or 110.1%, and average yields earned decreased by 0.7% to 2.5% for the year ended December 31, 2020, as compared to the same period in 2019, primarily due to the inclusion of a full year, or $62.4 million, in Partners total average investment securities balances and management of the investment securities portfolio in light of the Company's liquidity needs. Total average investment securities were 9.3% of total average interest-earning assets for the year ended December 31, 2020, compared to 7.6% for the year ended December 31, 2019.
Average total interest-bearing deposit balances increased by $326.6 million, or 67.7%, and average rates paid decreased by 0.2% to 1.2% for the year ended December 31, 2020, as compared to the same period in 2019, primarily due to the inclusion of a full year, or $312.8 million, in Partners total average interest-bearing deposit balances and organic deposit growth, and a decrease in the rate paid on average time deposits due to the decline in interest rates beginning late in the first quarter of 2020.
Average total borrowings increased by $72.6 million, or 116.0%, and average rates paid decreased by 0.9% to 2.0% for the year ended December 31, 2020, as compared to the same period in 2019, primarily due to the inclusion of a full year, or $81.2 million, in Partners average total borrowings and the Company’s issuance of $18.1 million in subordinated debt late in the second quarter of 2020, and a decrease in the average balance of and rates paid on Federal Home Loan Bank advances due to maturities that were not replaced and the decline in interest rates beginning late in the first quarter of 2020.
Interest earned on assets and interest paid on liabilities is significantly influenced by market factors, specifically interest rate targets established by the Federal Reserve.
The Federal Open Markets Committee (“FOMC”) lowered Federal Funds target rates for the first time in 11 years on July 31, 2019 and then again in September 2019 and October 2019, for a combined decrease of 75 basis points during 2019. In response to market volatility related to the COVID-19 pandemic, the FOMC again lowered Federal Funds target rates twice in March 2020, for a combined decrease of 150 basis points. The FOMC’s current Federal Funds target rate range is currently 0% to 0.25%. As a consequence, long-term interest rates have decreased. The Company anticipates that these actions by the FOMC will continue to put downward pressure on its net interest margin. In general, the Company believes interest rate increases lead to improved net interest margins whereas interest rate decreases result in correspondingly lower net interest margins.
The following tables depict, for the periods indicated, certain information related to the average balance sheet and average yields earned on assets and average costs paid on liabilities for the Company. Such yields and costs are derived by dividing income or expense by the average balance of the corresponding assets or liabilities. Average balances have been derived from daily averages
December 31, 2020
December 31, 2019
(Dollars in Thousands)
Cash & Due From Banks
Interest Bearing Deposits From Banks
Taxable Securities (1)
Tax‑exempt Securities (2)
Total Investment Securities (1) (2)
Federal Funds Sold
Commercial and Industrial (4)
Real Estate (4)
Keyline Equity (4)
Visa Credit Card
State and Political
Total Loans (2)
Allowance For Credit Losses
Unamoritized Discounts on Acquired Loans
Total Loans, Net
Total Assets/Interest Income
Liabilities and Stockholders' Equity
Deposits In Domestic Offices
Non‑interest Bearing Demand
Interest Bearing Demand
Money Market Accounts
All Time Deposits
Total Interest Bearing Deposits
Total Liabilities & Equity/Interest Expense
Earning Assets/Interest Income (2)
Interest Bearing Liabilities/Interest Expense
Net interest income (5)
Earning Assets/Interest Expense
Net Interest Spread (2)
Net Interest Margin (2)
|(1)||Yields on securities available-for-sale have been calculated on the basis of historical cost and do not give effect to changes in the fair value of those securities, which is reflected as a component of shareholder's equity.|
|(2)||Presented on a taxable-equivalent basis using the statutory income tax rate of 21.0% for 2020 and 2019. Taxable equivalent adjustments of $322 thousand and $10 thousand are included in the calculation of tax exempt income for investment interest income and loan interest income, respectively for the year ended December 31, 2020 and $226 thousand and $11 thousand respectively, for the year ended December 31, 2019.|
|(3)||Loans placed on nonaccrual are included in average balances.|
|(4)||Yields do not include the average balance of the fair value adjustment for pools of non-credit impaired loans acquired or discounts on credit impaired loans acquired.|
|(5)||Net interest income on the financial statements includes fees and charges on loans of $364 and $370 for the years ended December 31, 2020 and 2019, respectively.|
The level of net interest income is affected primarily by variations in the volume and mix of these interest-earning assets and interest-bearing liabilities, as well as changes in interest rates. The following table shows the effect that these factors had on the interest earned from the Company's interest earning assets and interest paid on its interest bearing liabilities for the year ended December 31, 2020 versus 2019.
Rate and Volume Analysis
Year Ended December 31, 2020 Versus December 31, 2019
(Dollars in Thousands)
Increase (Decrease) Due to
Exempt from Federal income tax
Federal funds sold
Other interest income
Total interest income
Interest Bearing Liabilities
Interest bearing deposits
Notes payable and leases
Total Interest Expense
Net Interest Income
|(1)||Nonaccrual loans are included in average balances and do not have a material effect on the average yield.|
Interest Sensitivity. The Company monitors and manages the pricing and maturity of its assets and liabilities in order to diminish the potential adverse impact that changes in interest rates could have on its net interest income. The Company also performs asset/liability modeling to assess the impact varying interest rates and balance sheet mix assumptions will have on net interest income. Interest rate sensitivity can be managed by repricing assets or liabilities, selling investment securities available-for-sale, replacing an asset or liability at maturity, or adjusting the interest rate during the life of an asset or liability. Managing the amount of assets and liabilities repricing in the same time interval helps to hedge the risk and minimize the impact on net interest income of rising or falling interest rates. The Company evaluates interest sensitivity risk and then formulates guidelines regarding asset generation and repricing, funding sources and pricing, and off-balance sheet commitments in order to decrease interest rate sensitivity risk.
At December 31, 2020, the Company was asset sensitive within the one-year time frame when looking at a repricing gap analysis. The cumulative gap, in an unchanged interest rate environment, as a percentage of total assets up to one year is 23.0%. A positive gap indicates more assets than liabilities are repricing within the indicated time frame. Management believes there is more upside potential than downside risk and, based on the current and projected interest rate environment, management expects to see net interest income rise in the future.
Provision and Allowance for Credit Losses
The Company has developed policies and procedures for evaluating the overall quality of its credit portfolio and for timely identifying potential problem loans. Management's judgment as to the adequacy of the allowance for credit losses is based upon a number of assumptions about future events which it believes to be reasonable, but which may not prove to be accurate. Thus, there can be no assurance that loan charge-offs in future periods will not exceed the allowance for credit losses or that additional increases in the allowance for credit losses will not be required.
The Company's allowance for credit losses consists of two parts. The first part is determined in accordance with authoritative guidance issued by the FASB regarding the allowance for credit losses. The Company's determination of this part of the allowance for credit losses is based upon quantitative and qualitative factors. A loan loss history based upon the prior three years is utilized in determining the appropriate allowance for credit losses. Historical loss factors are determined by criticized and uncriticized loans by loan type. These historical loss factors are applied to the loans by loan type to determine an indicated allowance for credit losses. The historical loss factors may also be modified based upon other qualitative factors including, but not limited to, local and national economic conditions, trends of delinquent loans, changes in lending policies and underwriting standards, concentrations, and management's knowledge of the loan portfolio.
The second part of the allowance for credit losses is determined in accordance with guidance issued by the FASB regarding impaired loans. A loan is considered impaired when, based on current information and events, it is probable that the Company 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. Management determines 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. Impairment is measured on a loan by loan basis. Impaired loans not deemed collateral dependent are analyzed according to the ultimate repayment source, whether that is cash flow from the borrower, guarantor or some other source of repayment. Impaired loans are deemed collateral dependent if in the Company's opinion the ultimate source of repayment will be generated from the liquidation of collateral.
The sum of the two parts constitutes management's best estimate of an appropriate allowance for credit losses. When the estimated allowance for credit losses is determined, it is presented to the Company's Board of Directors for review and approval on a quarterly basis.
At December 31, 2020, the Company's allowance for credit losses was $13.2 million, or 1.3% of total outstanding loans. At December 31, 2019, the allowance for credit losses was $7.3 million, or 0.7% of total outstanding loans. The Company's provision for credit losses was $6.9 million for the year ended December 31, 2020, as compared to $1.4 million for the year ended December 31, 2019. The increase in the provision for credit losses for the year ended December 31, 2020, as compared to the same period of 2019 was primarily due to the COVID-19 pandemic and qualitative adjustment factors made to the allowance for credit losses related to elevated unemployment and economic uncertainty in the Company’s markets, and loans originated by Partners subsequent to the Share Exchange. The provision for credit losses during the year ended December 31, 2020, as well as the allowance for credit losses as of December 31, 2020, represents management’s best estimate of the impact of the COVID-19 pandemic on the ability of the Company’s borrowers to repay their loans. Management continues to carefully assess the exposure of the Company’s loan portfolio to the COVID-19 pandemic related factors, including economic trends and their potential effect on asset quality.
The Company discontinues accrual of interest on loans when management believes, after considering economic and business conditions and collection efforts that a borrower's financial condition is such that the collection of interest is doubtful. Generally, the Company will place a delinquent loan in nonaccrual status when the loan becomes 90 days or more past due. At the time a loan is placed in nonaccrual status, all interest which has been accrued on the loan but remains unpaid is reversed and deducted from earnings as a reduction of reported interest income. No additional interest is accrued on the loan balance until the collection of both principal and interest becomes reasonably certain.
The following tables illustrate the Company's past due and nonaccrual loans at December 31, 2020 and 2019:
Past Due and Nonaccrual Loans
(Dollars in Thousands)
At December 31, 2020 and 2019
30 - 89 Days
Greater than 90 Days
December 31, 2020
Real Estate Mortgage
Construction and land development
Residential real estate
Home equity loans
Consumer and other loans
30 - 89 Days
Greater than 90 Days
December 31, 2019
Real Estate Mortgage
Construction and land development
Residential real estate
Home equity loans
Consumer and other loans
Total nonaccrual loans at December 31, 2020 were $4.9 million, which reflects an increase of $525 thousand from $4.5 million at December 31, 2019. Management believes the relationships on nonaccrual were adequately reserved at December 31, 2020. TDR’s not past due or on nonaccrual at December 31, 2020 amounted to $6.2 million, as compared to $8.4 million at December 31, 2019. The decrease was due to two relationships with balances of approximately $1.6 million at December 31, 2019 that paid off during 2020. Total TDR’s decreased $2.2 million to $8.1 million at December 31, 2020, compared to $10.3 million at December 31, 2019. This decrease was mainly due to the items noted above and pay-downs of principal loan balances.
Nonperforming assets, defined as nonaccrual loans, loans past due 90 days or more and accruing, and other real estate owned, net (“OREO”), at December 31, 2020 was $7.6 million compared to $7.0 million at December 31, 2019. The Company's ratio of nonperforming assets to total assets was 0.5% at December 31, 2020 compared to 0.6% at December 31, 2019. As noted above, there was an increase in nonaccrual loans during the year ended December 31, 2020. OREO, net increased during the year ended December 31, 2020 by $260 thousand. There was one additional property that was classified as OREO during 2020.
It is likely that the COVID-19 pandemic and the economic disruption related to it will continue to negatively impact the Company’s financial position and results of operations during the year ending December 31, 2021. Although it is too early to determine what the ultimate impact will be on the Company, we believe we may experience deterioration in asset quality, increased levels of charge-offs, and an increased level of provision for credit losses.
The following tables provide additional information on the Company's nonperforming assets at December 31, 2020 and 2019.
(Dollars in thousands)
Loans past due 90 days or more and accruing
Total nonperforming loans (NPLs)
Other real estate owned (OREO)
Total nonperforming assets (NPAs)
Performing TDR's and TDR's 30-89 days past due
NPAs and TDRs/Total Assets
Allowance for credit losses/NPLs
Nonperforming Loans by Type
(Dollars in thousands)
Real Estate Mortgage
Construction and land development
Residential real estate
Home equity loans
Consumer and other loans
The following table provides data related to loan balances and the allowance for loan losses for the years ended December 31, 2020 and 2019.
Allowance for Loan Losses Data
(Dollars in Thousands)
At December 31, 2020 and 2019
Average loans outstanding
Total loans outstanding
Total nonaccrual loans
Net loans charged off
Provision for credit losses
Allowance for credit losses
Allowance as a percentage of total loans outstanding
Net loans charged off to average loans outstanding
Nonaccrual loans as a percentage of total loans outstanding
The following table represents the activity of the allowance for loan losses for the years ended December 31, 2020 and 2019 by loan type:
Allowance for Credit Losses and Recorded Investments in Financing Receivables
(Dollars in Thousands)
At December 31, 2020 and 2019
Real Estate Mortgage
Balance at December 31, 2019
Balance at December 31, 2020