Note 3 - Summary of Significant Accounting Policies

9 Months Ended

Sep. 30, 2022

Notes to Financial Statements

Significant Accounting Policies [Text Block]

Note 3: Summary of Significant Accounting Policies

Risks and Uncertainties

The earnings of the Company depend primarily on the earnings of Republic. The earnings of Republic are heavily dependent upon the level of net interest income, which is the difference between interest earned on its interest-earning assets, such as loans and investments, and the interest paid on its interest-bearing liabilities, such as deposits and borrowings. Accordingly, the Company’s results of operations are subject to risks and uncertainties surrounding Republic’s exposure to changes in the interest rate environment. Prepayments on residential real estate mortgage and other fixed rate loans and mortgage-backed securities vary significantly and may cause significant fluctuations in interest margins.

The coronavirus (“COVID-19”) outbreak and the public health response to contain it resulted in unprecedented economic and financial market conditions. Additionally, more recent geopolitical (including the conflict in Ukraine), inflationary pressures, interest rate hikes by the Board of Governors of the Federal Reserve System (“Federal Reserve”) and potential recessionary conditions have added even further uncertainty to the overall economic environment. During 2022, the federal funds target range increased by 425 basis points to a range of 4.25% - 4.50% to curb inflation, with continued increases planned.   

The effects of geopolitical conflict, inflationary pressures, higher interest rates and potential recessionary conditions may meaningfully impact loan production, income levels, and the measurement of certain significant estimates such the allowance for credit losses.  Moreover, if in a period of economic contraction, elevated levels of credit losses and reduced interest income may occur.  The extent to which the economic environment impacts the Company's business, results of operations, and financial condition, as well as the Company's regulatory capital and liquidity ratios, will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the current economic environment and actions taken by governmental authorities and other third parties in response to geopolitical conflict and inflationary pressures.

The preparation of financial statements in conformity with U.S. GAAP requires management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Significant estimates are made by management in determining the allowance for credit losses and the realization of deferred income tax assets. Consideration is given to a variety of factors in establishing these estimates.

Mortgage Banking Activities and Mortgage Loans Held for Sale

Mortgage loans held for sale are originated and held until sold to permanent investors. Management elected to adopt the fair value option in accordance with FASB Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures, and record loans held for sale at fair value.

Mortgage loans held for sale originated on or subsequent to the election of the fair value option are recorded on the balance sheet at fair value. The fair value is determined on a recurring basis by utilizing quoted prices from dealers in such securities. Changes in fair value are reflected in mortgage banking income in the statements of income. Direct loan origination costs are recognized when incurred and are included in non-interest expense in the statements of income.

Interest Rate Lock Commitments

Mortgage loan commitments known as interest rate locks that relate to the origination of a mortgage that will be held for sale upon funding are considered derivative instruments under the derivatives and hedging accounting guidance in FASB ASC 815, Derivatives and Hedging. Loan commitments that are classified as derivatives are recognized at fair value on the balance sheet as other assets and other liabilities with changes in their fair values recorded as mortgage banking income and included in non-interest income in the statements of income. Outstanding interest rate lock commitments (“IRLCs”) are subject to interest rate risk and related price risk during the period from the date of issuance through the date of loan funding, cancellation, or expiration. Loan commitments generally range between 30 and 90 days; however, the borrower is not obligated to obtain the loan. Republic is subject to fallout risk related to IRLCs, which is realized if approved borrowers choose not to close on the loans within the terms of the IRLCs. Republic uses best efforts commitments to substantially eliminate these risks. The valuation of the IRLCs issued by Republic includes the value of the servicing released premium. Republic sells loans where the servicing is released, and the servicing released premium is included in the market price. See Note 12: Derivatives and Risk Management Activities for further detail of IRLCs.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Significant estimates are made by management in determining the allowance for credit losses for in-scope financial instruments including investments of debt securities, loans, unfunded commitments, and the realization of deferred income tax assets. Consideration is given to a variety of factors in establishing these estimates.

In estimating the allowance for credit losses, management considers current economic conditions, past loss experience, the composition of the loan portfolio, delinquency statistics, results of internal loan reviews and regulatory examinations, borrowers perceived financial and managerial strengths, the adequacy of underlying collateral, if collateral dependent, or present value of future cash flows, and other relevant and qualitative risk factors. Subsequent to foreclosure, an estimate for the carrying value of other real estate owned is normally determined through valuations that are periodically performed by management and the assets are carried at the lower of carrying amount or fair value, less the cost to sell. Because the allowance for credit losses and carrying value of other real estate owned are dependent, to a great extent, on the general economy and other conditions that may be beyond Republic’s control, the estimates of the allowance for credit losses and the carrying values of other real estate owned could differ materially in the near term.

The Company adopted ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments for their current expected credit losses effective January 1, 2022.  Our implementation process included, among other things, assessment and documentation of governance and reporting processes and related internal controls; model development, documentation and validation; and the incorporation of qualitative adjustments for model limitations.  ASU 2016-13 lists several credit loss methods that are acceptable such as a discounted cash flow method, loss-rate method and probability of default/loss given default (“PD/LGD”).  We contracted with a third-party vendor to assist us in the application of ASU 2016-13 and utilize various methodologies such as Cohort and Weighted Average Remaining Maturity to estimate the allowance for credit losses.

In evaluating the Company’s ability to recover deferred tax assets, management considers available positive and negative evidence, including the past operating results and forecasts of future taxable income. In determining future taxable income, management makes assumptions for the amount of taxable income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require management to make judgments about the future taxable income and are consistent with the plans and estimates used to manage the business. A material reduction in estimated future taxable income may require management to record a valuation allowance against the deferred tax assets. The establishment of or an increase in the valuation allowance would result in additional income tax expense in the period and could have a significant impact on future earnings.

Stock-Based Compensation

The Company has a Stock Option and Restricted Stock Plan (the “2005 Plan”), under which the Company granted options, restricted stock or stock appreciation rights to the Company’s employees, directors, and certain consultants. Under the terms of the 2005 Plan, 1.5 million shares of common stock, plus an annual increase equal to the number of shares needed to restore the maximum number of shares that could be available for grant under the 2005 Plan to 1.5 million shares, were available for such grants. As of September 30, 2022, the only grants outstanding under the 2005 Plan were option grants. The 2005 Plan provided that the exercise price of each option granted equaled the market price of the Company’s stock on the date of the grant. Options granted pursuant to the 2005 Plan vest within one to four years and have a maximum term of 10 years. The 2005 Plan terminated on November 14, 2015.

On April 29, 2014, the Company’s shareholders approved the Republic First Bancorp, Inc. 2014 Equity Incentive Plan (the “2014 Plan”), under which the Company may grant options, restricted stock, stock units, or stock appreciation rights to the Company’s employees, directors, independent contractors, and consultants.  Under the terms of the 2014 Plan, 2.6 million shares of common stock, plus an annual adjustment to be no less than 10% of the outstanding shares or such lower number as the Board of Directors may determine, are available for such grants. Compensation cost for all awards is calculated and recognized over the vesting period of the awards. If the service conditions are not met, the Company reverses previously recorded compensation expense upon forfeiture. The Company’s accounting policy election is to recognize forfeitures as they occur. At September 30, 2022, the maximum number of common shares issuable under the 2014 Plan was 6.5 million shares. During the nine months ended September 30, 2022, 714,167 stock units were granted under the 2014 Plan with a fair value of $3.7 million.

On April 27, 2021, the Company’s shareholders approved the Republic First Bancorp, Inc. 2021 Equity Incentive Plan (the “2021 Plan”), under which the Company may grant options, restricted stock, stock units, or stock appreciation rights to the Company’s employees, directors, independent contractors, and consultants. Under the terms of the 2021 Plan, the maximum number of shares which may be issued or awarded is 7.5 million shares of common stock. As of September 30, 2022, 41,400 stock units were granted under the 2021 Plan with a fair value of $149,000. 

The Company utilizes the Black-Scholes option pricing model to calculate the estimated fair value of each stock option granted on the date of the grant.

During the nine months ended September 30, 2022 and 2021, 841,209 options and 636,635 options vested, respectively.  Expense is recognized ratably over the period required to vest.  At September 30, 2022, the intrinsic value of the 4,905,350 options outstanding was $44,000, while the intrinsic value of the 4,217,544 exercisable (vested) options was $26,000. At September 30, 2021, the intrinsic value of the 5,561,349 options outstanding was $398,000, while the intrinsic value of the 3,807,260 exercisable (vested) options was $278,000. During the nine months ended September 30, 2022, 259,008 options were exercised resulting in cash receipts of $719,000 and 168,417 options were forfeited with a weighted average grant date fair value of $334,000. During the nine months ended September 30, 2021, 54,375 options were exercised resulting in cash receipts of $140,000 and 283,701 options were forfeited with a weighted average grant date fair value of $578,051.

Information regarding stock-based compensation for the nine months ended September 30, 2022 and 2021 is set forth below:

	2022		2021
Stock-based compensation expense recognized	$	366,000	$	1,133,000
Number of unvested stock options		687,806		1,754,089
Fair value of unvested stock options	$	19,290	$	2,918,535
Amount remaining to be recognized as expense	$	367,765	$	1,493,293

The remaining unrecognized expense amount of $367,765 will be recognized ratably as expense through December 2024.

The Company granted stock units under the 2014 Plan during the nine-month period ended September 30, 2022 and 2021. The compensation expense for the stock units is recognized based on the market price of the stock at the grant date over the vesting period, adjusted for estimated and actual forfeitures.

The following table details the Stock Units under the 2014 plan for the three and nine months ended September 30, 2022 and September 30, 2021:

	Three Months Ended September 30, 2022					Three Months Ended September 30, 2021
	Number of Units			Weighted Average Grant Date Fair Value		Number of Units			Weighted Average Grant Date Fair Value
Beginning balance		1,013,442		$	4.66		524,863		$	3.35
Granted		-			-		2,500			3.45
Vested		(104	)		3.42		-			-
Forfeited		(70,011	)		5.14		(3,300	)		3.34
Ending balance		943,327		$	4.60		524,063		$	3.35

	Nine Months Ended September 30, 2022					Nine Months Ended September 30, 2021
	Number of Units			Weighted Average Grant Date Fair Value		Number of Units			Weighted Average Grant Date Fair Value
Beginning balance		516,513		$	3.36		-		$	-
Granted		714,167			5.16		532,513			3.35
Vested		(176,579	)		3.42		-			-
Forfeited		(110,774	)		4.69		(8.450	)		3.34
Ending balance		943,327		$	4.60		524,063		$	3.35

Information regarding stock unit compensation under the 2014 plan for the nine months ended September 30, 2022 and 2021 is set forth below:

	2022		2021
Stock based compensation expense recognized	$	885,000	$	428,756
Number of unvested stock units		943,327		524,063
Fair value of unvested stock units	$	2,624,235	$	1,783,518
Amount remaining to be recognized as expense	$	3,464,152	$	1,354,762

The remaining unrecognized expense amount of $3,464,152 will be recognized ratably as expense through June 2026.

The Company granted stock units under the 2021 Plan during the nine-month period ended September 30, 2022. The compensation expense for the stock units is recognized based on the market price of the stock at the grant date over the vesting period, adjusted for estimated and actual forfeitures.

The following table details the Stock Units under the 2021 plan for the three and nine months ended September 30, 2022.

	Three Months Ended September 30, 2022					Nine Months Ended September 30, 2022
	Number of Units			Weighted Average Grant Date Fair Value		Number of Units			Weighted Average Grant Date Fair Value
Beginning balance		-		$	-		-		$	-
Granted		41,400			3.59		41,400			3.59
Vested		-			-		-			-
Forfeited		(500	)		3.59		(500	)		3.59
Ending balance		40,900		$	3.59		40,900		$	3.59

Information regarding stock unit compensation under the 2021 plan for the nine months ended September 30, 2022 and 2021 is set forth below:

	2022		2021
Stock based compensation expense recognized	$	4,000	$	-
Number of unvested stock units		40,900		-
Fair value of unvested stock units	$	115,747	$	-
Amount remaining to be recognized as expense	$	142,406	$	-

The remaining unrecognized expense amount of $142,406 will be recognized ratably as expense through August 2026.

Earnings per Share

Earnings per share (“EPS”) consists of two separate components: basic EPS and diluted EPS. Basic EPS is computed by dividing net income by the weighted average number of common shares outstanding for each period presented. Diluted EPS is calculated by dividing net income by the weighted average number of common shares outstanding plus dilutive common stock equivalents (“CSEs”). CSEs consist of units and convertible preferred stock/dilutive stock options granted through the Company’s stock option plans for the three- and nine-months ended September 30, 2022 and September 30, 2021.

The calculation of EPS for the three and nine months ended September 30, 2022 and 2021 is as follows (in thousands, except per share amounts):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Net income attributable to basic common shareholders	$	909	$	5,221	$	9,627	$	16,473
Weighted average shares outstanding		63,767		58,895		62,265		58,877
Net income per share – basic	$	0.01	$	0.09	$	0.15	$	0.28
Preferred stock dividends	$	644	$	875	$	2,154	$	2,625
Net income attributable to diluted common shareholders	$	1,553	$	6,096	$	11,781	$	19,098
Weighted average shares outstanding (including dilutive CSEs)		76,209		75,876		75,995		75,946
Net income per share – diluted	$	0.01	$	0.08	$	0.14	$	0.25

The following is a summary of securities that could potentially dilute basic earnings per common share in future periods. These securities were not included in the computation of diluted earnings per common share because the effect would have been anti-dilutive for the periods presented. Anti-dilutive options are those options with weighted average exercise prices in excess of the weighted average market value for the periods presented.

(in thousands)	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
Anti-dilutive securities
Share based compensation awards		5,690		5,771		5,348		5,683
Convertible preferred stock		-		-		-		-
Total anti-dilutive securities		5,690		5,771		5,348		5,683

Recent Accounting Pronouncements

ASU 2016-13

The Company adopted ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments for their current expected credit losses (“CECL”) effective January 1, 2022. Our implementation process included, among other things, assessment and documentation of governance and reporting processes and related internal controls; model development, documentation and validation; and the incorporation of qualitative adjustments for model limitations. ASU 2016-13 lists several credit loss methods that are acceptable such as a discounted cash flow method, loss-rate method and probability of default/loss given default (“PD/LGD”). We contracted with a third-party vendor to assist us in the application of ASU 2016-13 and utilize various methodologies such as Cohort and Weighted Average Remaining Maturity to estimate the allowance for credit losses.

Section 4014 of the CARES Act provided financial institutions with optional temporary relief from having to comply with ASU 2016-13, including the CECL methodology for estimating the allowance for credit losses. This temporary relief was set to expire on the earlier of the date on which the national emergency concerning COVID-19 terminated or December 31, 2020, with adoption being effective retrospectively as of January 1, 2020.

Section 540 of the Consolidated Appropriations Act, 2021, amended Section 4014 of the CARES Act by extending the relief period provided in the CARES Act. The Consolidated Appropriations Act, 2021, modified the CARES Act so that temporary relief will expire on the earlier of the first day of the fiscal year that begins after the date on which the national emergency concerning COVID-19 terminates or January 1, 2022.

The Company elected to delay the implementation of ASU 2016-13 following the approval of the CARES Act and continued to use the incurred loss methodology for estimating the allowance for credit losses in 2020 and 2021. ASU 2016-13 requires financial institutions to calculate an allowance utilizing a reasonable and supportable forecast period, which the Company has established as a one-year period. In the unprecedented circumstances surrounding the COVID-19 pandemic and the response thereto, the Company believed that adopting ASU 2016-13 in the first quarter of 2020 would have added an unnecessary level of subjectivity and volatility to the calculation of the allowance for credit losses. With the approval of the Consolidated Appropriations Act, 2021, management elected to delay adoption of ASU 2016-13 to January 1, 2022. This allowed the Company to utilize the CECL standard for the entire year of adoption.

The Company adopted ASC 326 using the modified retrospective method for all financial assets measured at amortized cost and off-balance-sheet (OBS) credit exposures. Results for reporting periods beginning after January 1, 2022 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP. The Company recorded a net decrease to retained earnings of $3.6 million as of January 1, 2022 for the cumulative effect of adopting ASC 326.

An analysis of the impact of adoption of ASC 326 as of January 1, 2022 is disclosed in Note 2: Changes to Previously Reported Allowance for Credit Losses.

An analysis of the allowance for credit losses for the three months ended March 31, 2022 and June 30, 2022 is disclosed in Note 2: Correction of Immaterial Errors in Previously Filed Financial Statements.

ASU 2020-04

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The ASU provides optional guidance for a limited period of time to ease the potential burden in accounting for (or derecognizing the effects of) reference rate reform on financial reporting. Specifically, the amendments provide optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. These relate only to those contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The ASU became effective as of March 12, 2020 and can be adopted anytime during the period of January 1, 2020 through December 31, 2022. There is only one relationship that has LIBOR pricing with a maturity date beyond December 31, 2022. The loan documentation for the relationship contains language for an alternative pricing index when LIBOR is no longer available.

ASU 2021-01

In January 2021, the FASB issued ASU 2021-01, Reference Rate Reform (Topic 848): Scope. The ASU clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition, including derivative instruments that use an interest rate for margining, discounting, or contract price alignment that is modified as a result of reference rate reform. The ASU became effective as of March 12, 2020 and can be adopted anytime during the period of January 1, 2020 through December 31, 2022. There is only one relationship that has LIBOR pricing with a maturity date beyond December 31, 2022. The loan documentation for the relationship contains language for an alternative pricing index when LIBOR is no longer available.

ASU 2022-02

In March 2022, the FASB issued ASU No. 2022-02, "Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures." The amendments in this update eliminate the accounting guidance for TDRs by creditors in Subtopic 310-40, Receivables—Troubled Debt Restructurings by creditors, while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. The amendments in this update also require that an entity disclose current-period gross write-offs by year of origination for financing receivables and net investments in leases within the scope of Subtopic 326-20, Financial Instruments—Credit Losses—Measured at Amortized Cost. This ASU will become effective for the Company on January 1, 2023. The adoption of ASU No. 2022-02 is not expected to have a material impact on the Company's financial statements.