FVCBankcorp, Inc.: Form 10-Q for the period ended Sep 30, 2024

The following presents management’s discussion and analysis of our consolidated financial condition at September 30, 2024 and December 31, 2023 and the results of our operations for the three and nine months ended September 30, 2024 and 2023. This discussion should be read in conjunction with our unaudited consolidated financial statements and the notes thereto appearing elsewhere in this report and the audited consolidated financial statements and the notes to consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2023. Results of operations for the three and nine month periods ended September 30, 2024 are not necessarily indicative of the results of operations for the balance of 2024, or for any other period. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause results to differ materially from management’s expectations.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Form 10-Q, as well as other periodic reports filed with the U.S. Securities and Exchange Commission (the "SEC"), and written or oral communications made from time to time by or on behalf of FVCBankcorp, Inc. and our subsidiary (the “Company”), may contain statements relating to future events or our future results that are considered “forward-looking statements” under the Private Securities Litigation Reform Act of 1995. These forward-looking statements represent plans, estimates, objectives, goals, guidelines, expectations, intentions, projections and statements of our beliefs concerning future events, business plans, objectives, expected operating results and the assumptions upon which those statements are based. Forward-looking statements include without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and are typically identified with words such as “may,” “could,” “should,” “will,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “aim,” “intend,” “plan,” or words or phases of similar meaning. We caution that the forward-looking statements are based largely on our expectations and are subject to a number of known and unknown risks and uncertainties that are subject to change based on factors which are, in many instances, beyond our control. Actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements.

The following factors, among others, could cause our financial performance to differ materially from that expressed in such forward-looking statements:

• general business and economic conditions, including higher inflation and its impacts, nationally or in the markets that we serve could adversely affect, among other things, real estate valuations, unemployment levels, the ability of businesses to remain viable, consumer and business confidence, and consumer or business spending, which could lead to decreases in demand for loans, deposits, and other financial services that we provide and increases in loan delinquencies and defaults;
• the impact of the interest rate environment on our business, financial condition and results of operation, and its impact on the composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest sensitive assets and liabilities;
• changes in our liquidity requirements could be adversely affected by changes in its assets and liabilities;
• changes in the assumptions underlying the establishment of reserves for possible credit losses and the possibility that future credit losses may be higher than currently expected;
• changes in market conditions, specifically declines in the commercial and residential real estate market, volatility and disruption of the capital and credit markets, and soundness of other financial institutions that we do business with;
• the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System (the "Federal Reserve"), inflation, interest rate, market and monetary fluctuations;
• Our investment securities portfolio is subject to credit risk, market risk, and liquidity risk as well as changes in the estimates used to value the securities in the portfolio;
• declines in our common stock price or the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause us to record a noncash impairment charge to earnings in future periods;
• geopolitical conditions, including acts or threats of terrorism, or actions taken by the United States or other governments in response to acts or threats of terrorism and/or military conflicts, which could impact business and economic conditions in the United States and abroad;
• the occurrence of significant natural disasters, including severe weather conditions, floods, health related issues or emergencies, and other catastrophic events;
• the management of risks inherent in our real estate loan portfolio, and the risk of a prolonged downturn in the real estate market, which could impair the value of loan collateral and the ability to sell collateral upon any foreclosure;
• the impact of changes in bank regulatory conditions, including laws, regulations and policies concerning capital requirements, deposit insurance premiums, taxes, securities, and the application thereof by regulatory bodies;
• the effect of changes in accounting policies and practices, as may be adopted from time to time by bank regulatory agencies, the SEC, the Public Company Accounting Oversight Board, the Financial Accounting Standards Board ("FASB") or other accounting standards setting bodies;
• competitive pressures among financial services companies, including the timely development of competitive new products and services and the acceptance of these products and services by new and existing customers;
• the effect of acquisitions and partnerships we may make, including, without limitation, the failure to achieve the expected revenue growth and/or expense savings from such acquisitions;
• Our involvement, from time to time, in legal proceedings and examination and remedial actions by regulators; and
• potential exposure to fraud, negligence, computer theft and cyber-crime, and our ability to maintain the security of our data processing and information technology systems.

The foregoing factors should not be considered exhaustive and should be read together with other cautionary statements that are included in our Annual Report on Form 10-K for the year ended December 31, 2023, including those discussed in the section entitled “Risk Factors”. If one or more of the factors affecting our forward-looking information and statements proves incorrect, then our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements contained in this Form 10-Q. Therefore, we caution you not to place undue reliance on our forward-looking information and statements. We will not update the forward-looking statements to reflect actual results or changes in the factors affecting the forward-looking statements. New risks and uncertainties may emerge from time to time, and it is not possible for us to predict their occurrence or how they will affect our operations, financial condition, or results of operations.

Overview

We are a bank holding company headquartered in Fairfax County, Virginia. Our sole subsidiary, FVCbank (the "Bank"), was formed in November 2007 as a community-oriented, locally-owned and managed commercial bank under the laws of the Commonwealth of Virginia. The Bank offers a wide range of traditional bank loan and deposit products and services to both our commercial and retail customers. Our commercial relationship officers focus on attracting small and medium sized businesses, commercial real estate developers and builders, including government contractors, non-profit organizations, and professionals. Our approach to our market features competitive customized financial services offered to customers and prospects in a personal relationship context by seasoned professionals.

On August 31, 2021, we announced that the Bank made an investment in Atlantic Coast Mortgage, LLC ("ACM") for $20.4 million to obtain a 28.7% ownership interest in ACM. The Bank provides a warehouse lending facility to ACM, which includes a construction-to-permanent financing line, and has developed portfolio mortgage products to diversify our held for investment loan portfolio.

On December 15, 2022, the Company announced that the Board of Directors approved a five-for-four split of the Company's common stock in the form of a 25% stock dividend for shareholders of record on January 9, 2023, payable on January 31, 2023. Earnings per share and all other per share information reflected herein have been adjusted for the five-for-four split of the Company's common stock for comparative purposes.

Net interest income is our primary source of revenue. We define revenue as net interest income plus noninterest income. We manage our balance sheet and interest rate risk exposure to maximize, and concurrently stabilize, net interest income. We do this by monitoring our liquidity position and the spread between the interest rates earned on interest-earning assets and the interest rates paid on interest-bearing liabilities. We attempt to minimize our exposure to interest rate risk, but are unable to eliminate it entirely. In addition to managing interest rate risk, we also analyze our loan portfolio for exposure to credit risk. Loan defaults and foreclosures are inherent risks in the banking industry, and we attempt to limit our exposure to these risks by carefully underwriting and then monitoring our extensions of credit. In addition to net interest income, noninterest income is a complementary source of revenue for us and includes, among other things, service charges on deposits and loans, income from minority membership interest in ACM, merchant services fee income, insurance commission income, income from bank owned life insurance ("BOLI"), and gains and losses on sales of investment securities available-for-sale.

Critical Accounting Policies

General

The accounting principles we apply under U.S generally accepted accounting principles ("GAAP") are complex and require management to apply significant judgment to various accounting, reporting and disclosure matters. Management must use assumptions, judgments and estimates when applying these principles where precise measurements are not possible or practical. These policies are critical because they are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such judgments, assumptions and estimates may have a significant impact on the consolidated financial statements. Actual results, in fact, could differ from initial estimates.

The accounting policies we view as critical are those relating to judgments, assumptions and estimates regarding the determination of the allowance for credit losses - loans & reserve for unfunded commitments, and fair value measurements.

Allowance for Credit Losses - Loans & Unfunded Commitments

We maintain the allowance for credit losses ("ACL") at a level that represents management’s best estimate of expected losses in our loan portfolio. We adopted the provisions of the current expected credit losses ("CECL") accounting standard as of January 1, 2023 in accordance with the required implementation date and recorded the impact of the adoption to retained earnings, net of deferred income taxes, as required by the standard. Prior to the adoption of CECL, we utilized an incurred loss model to derive our best estimate of the ACL.

Accounting Standards Codification ("ASC") 326 requires that an estimate of CECL be immediately recognized and reevaluated over the contractual life of the financial asset. The ACL is a valuation account that is deducted from the amortized cost basis of loans to present the net amount expected to be collected on the loan portfolio. Loans, or portions thereof, are charged off against the ACL when they are deemed uncollectible. Expected recoveries are recorded to the extent they do not exceed the aggregate of amounts previously and expected to be charged-off.

Reserves on loans that do not share risk characteristics are evaluated on an individual basis. Nonaccrual loans are specifically reviewed for loss potential and when deemed appropriate are assigned a reserve based on an individual evaluation. The remainder of the portfolio, representing all loans not evaluated individually for impairment, is segmented based on call report code and processed through a cash flow valuation model. In particular, loan-level probability of default ("PD") and severity (also referred to as loss given default ("LGD")) is applied to derive a baseline expected loss as of the valuation date. These expected default and severity rates, which are regression-derived and based on peer historical loan-level performance data, are calibrated to incorporate our reasonable and supportable forecast of future losses as well as any necessary qualitative adjustments.

Typically, financial institutions use their historical loss experience and trends in losses for each loan segment which are then adjusted for portfolio trends and economic and environmental factors in determining the ACL. Since the Bank’s inception in 2007, we have experienced minimal loss history within our loan portfolio. Due to the fact that limited internal loss history exists to generate statistical significance, we determined it was most prudent to rely on peer data when deriving our best estimate of PD and LGD. As part of our estimation process, we will continue to assess the reasonableness of the data, assumptions, and model methodology utilized to derive our allowance for credit losses.

For each of the modeled loan segments, we generate cash flow projections at the instrument level wherein payment expectations are adjusted for estimated prepayment speeds, PD rates, and LGD rates. The modeling of expected prepayment speeds is based on internal loan-level historical data. For our cash flow model, we utilize national unemployment for reasonable and supportable forecasting of expected default. To further adjust the ACL for expected losses not already within the quantitative component of the calculation, we may consider qualitative factors as prescribed in ASC 326.

Financial instruments include off-balance sheet credit instruments such as commitments to make loans and commercial letters of credit issued to meet customer financing needs. Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the contractual amount of those instruments. Such financial instruments are recorded when they are funded. We record a reserve for unfunded commitments on off-balance sheet credit exposures through a charge to provision for credit loss expense in our Consolidated Statement of Income. The reserve for unfunded commitments is estimated by call report code segmentation as of the valuation date under the CECL model using the same methodologies as portfolio loans taking utilization rates into consideration. The reserve for unfunded commitments is reflected as a liability on our Consolidated Statement of Condition.

While our methodology in establishing the ACL attributes portions of a combined reserve to multiple elements, we believe that the combined allowance for credit losses (which is inclusive of the reserve for unfunded commitments) represents the most appropriate coverage metric for loss absorption purposes.

Our methodology utilized in the estimation of the ACL, which is performed at least quarterly, is designed to be dynamic and responsive to changes in our loan portfolio credit quality, composition, and forecasted economic conditions. The review of the reasonableness and appropriateness of the ACL is reviewed by the ACL Committee for approval as of the valuation date. Additionally, information is provided to the Board of Directors on a quarterly basis along with our consolidated financial statements.

Credit losses are an inherent part of our business and, although we believe the methodologies for determining the ACL and the current level of the allowance and reserve on unfunded commitments are appropriate, it is possible that there may be unidentified losses in the portfolio at any particular time that may become evident at a future date pursuant to additional internal analysis or regulatory comment. Additional provisions for such losses, if necessary, would be recorded, and would negatively impact earnings.

Collateral Dependent Financial Assets

Loans that do not share risk characteristics are evaluated on an individual basis. For collateral dependent financial assets where we have determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and we expect repayment of the financial asset to be provided substantially through the sale of the collateral, the ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the asset as of the measurement date. When repayment is expected to be from the operation of the collateral, expected credit losses are calculated as the amount by which the amortized cost basis of the financial asset exceeds the net present value from the operation of the collateral. When repayment is expected to be from the sale of the collateral, expected credit losses are calculated as the amount by which the amortized cost basis of the financial asset exceeds the fair value of the underlying collateral less estimated cost to sell. The ACL may be zero if the fair value of the collateral at the measurement date exceeds the amortized cost basis of the financial asset.

Allowance for Credit Losses - Securities

We evaluate our available-for-sale and held-to-maturity debt securities portfolios for expected credit losses as of the valuation date under ASC 326. For available-for-sale debt securities in an unrealized loss position, we first assess whether we intend to sell, or if it is more likely than not that we will be required to sell, the security before recovery of our amortized cost basis. If either criterion is met, the security’s amortized cost basis is written down to fair value through income during the current period. For available-for-sale debt securities that do not meet the aforementioned criteria, we evaluate whether the decline in fair value has resulted from credit losses or other driving factors. If our assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security is compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, an ACL is recorded for the credit loss (which represents the difference between the expected cash flows and amortized cost basis), limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an ACL is recognized in other comprehensive income.

The entire amount of an impairment loss is recognized in earnings only when: (1) we intend to sell the security; or (2) it is more likely than not that we will have to sell the security before recovery of our amortized cost basis; or (3) we do not expect to recover the entire amortized cost basis of the security. In all other situations, only the portion of the impairment loss representing the credit loss must be recognized in earnings, with the remaining portion being recognized in shareholders' equity as comprehensive income, net of deferred taxes.

Changes in the ACL are recorded as a provision for (or reversal of) credit losses. Losses are charged against the ACL when we believe the uncollectibility of an available-for-sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met. Any impairment not recorded through an ACL is recognized in other comprehensive income as a noncredit-related impairment.

As part of our estimation process, we have made a policy election to exclude accrued interest from the amortized cost basis of available-for-sale debt securities and report accrued interest separately in other assets in the Consolidated Statement of Condition. Available-for-sale debt securities are placed on nonaccrual status when we no longer expect to receive all contractual amounts due, which is generally at 90 days past due. Accrued interest receivable is reversed against interest income when a security is placed on nonaccrual status. Accordingly, we do not recognize an ACL against accrued interest receivable. This approach is consistent with our nonaccrual policy implemented for our loan portfolio.

We separately evaluate our held-to-maturity investment securities for any credit losses. If we determine that a security indicates evidence of deteriorated credit quality, the security is individually-evaluated and a discounted cash flow analysis is performed and compared to the amortized cost basis. As of September 30, 2024, we had one security classified as held-to-maturity with an amortized cost basis of $265 thousand with the remainder of the securities portfolio held as available-for-sale.

Fair Value Measurements

We determine the fair values of financial instruments based on the fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value. Our investment securities available-for-sale are recorded at fair value using reliable and unbiased evaluations by an industry-wide valuation service. This service uses evaluated pricing models that vary based on asset class and include available trade, bid, and other market information. Generally, the methodology includes broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs. Depending on the availability of observable inputs and prices, different valuation models could produce materially different fair value estimates. The values presented may not represent future fair values and may not be realizable.

Results of Operations— Three and Nine Months Ended September 30, 2024 and 2023

Overview

We recorded net income of $4.7 million, or $0.25 diluted earnings per share, for the three months ended September 30, 2024, compared to net income of $4.0 million, or $0.22 diluted earnings per share, for the three months ended September 30, 2023, an increase of $630 thousand, or 16%. Net interest income increased $878 thousand, or 7%, to $14.2 million for the three months ended September 30, 2024, compared to $13.3 million for the same period of 2023. We released provisioning for credit losses totaling $200 thousand for the three months ended September 30, 2024, compared to a release of reserves for credit losses totaling $729 thousand for the three months ended September 30, 2023. Noninterest income was $815 thousand and $225 thousand for the three months ended September 30, 2024 and 2023, respectively. Noninterest expense was $9.2 million for the three months ended September 30, 2024, compared to $9.0 million for the three months ended September 30, 2023, a increase of $147 thousand, or 2%.

The annualized return on average assets for the three months ended September 30, 2024 and 2023 was 0.85% and 0.70%, respectively. The annualized return on average equity for the three months ended September 30, 2024 and 2023 was 8.15% and 7.57%, respectively.

For the nine months ended September 30, 2024, we recorded net income of $10.2 million, or $0.55 diluted earnings per share, compared to net income of $8.9 million, or $0.49 diluted earnings per share for the nine months ended September 30, 2023. Net income for the nine months ended September 30, 2024 includes the surrender of certain BOLI policies with an aggregate cash surrender value of $48.0 million. Upon the surrender, we received a cash payout and were required to accrue additional income tax on the appreciation of those policies which had previously been treated as tax-exempt income. This resulted in additional statutory income tax expense of $1.6 million and tax penalties of $722 thousand. The tax penalties related to the surrender of the BOLI were recorded in income tax expense. Additionally, net income for the nine months ended September 30, 2023 included losses on the sale of available-for-sale investment securities totaling $4.6 million.

Net interest income for the nine months ended September 30, 2024 was $40.7 million, compared to $41.7 million for the same period in 2023, a decrease of $1.1 million, or 3%. Provision for credit losses for the nine months ended September 30, 2024 was $6 thousand, compared to $132 thousand for the same period of 2023. Non-interest income was $2.1 million compared to a loss of $3.5 million for the nine months ended September 30, 2024 and 2023, respectively. Noninterest expense was $26.8 million and $27.3 million for the nine months ended September 30, 2024 and 2023, respectively, a decrease of $444 thousand, or 2%.

Commercial bank operating earnings, which exclude the nonrecurring taxes on the surrender of our BOLI policies recorded during the first quarter of 2024 and the after-tax losses on the sale of investment securities available-for-sale recorded during the first quarter 2023, for the three months ended September 30, 2024 and September 30, 2023 were $4.7 million and $4.0 million, respectively. For the nine months ended September 30, 2024 and September 30, 2023, commercial bank operating earnings were $12.6 million and $12.5 million, respectively.

Diluted commercial bank operating earnings per share for the three months ended September 30, 2024 and September 30, 2023 were each $0.25 and $0.22, respectively. For the nine months ended September 30, 2024 and 2023, diluted commercial bank operating earnings per share were $0.68 and $0.69, respectively.

We consider commercial bank operating earnings a useful financial measure of our operating performance. Commercial bank operating earnings is determined by methods other than in accordance with GAAP. A reconciliation of non-GAAP financial measures to their most comparable financial measure in accordance with GAAP can be found in the tables below.

Reconciliation of Net Income (GAAP) to Commercial Bank Operating Earnings (Non-GAAP)

For the Three and Nine Months Ended September 30, 2024 and 2023

(Dollars in thousands, except per share data)

43

Net Interest Income/Margin

Net interest income is our primary source of revenue, representing the difference between interest and fees earned on interest-earning assets and the interest paid on deposits and other interest-bearing liabilities. The following table presents average balance information, interest income, interest expense and the corresponding average yields earned and rates paid for the three months ended September 30, 2024 and 2023.

Average Balance Sheets and Interest Rates on Interest-Earning Assets and Interest-Bearing Liabilities

For the Three Months Ended September 30, 2024 and 2023

(Dollars in thousands)

(1) Non-accrual loans are included in average balances and do not have a material effect on the average yield. Interest income on non-accruing loans was not material for the quarters presented. Net loan fees and late charges included in interest income on loans totaled $448 thousand and $612 thousand for the quarters ended September 30, 2024 and 2023, respectively.

(2) The average balances for investment securities includes restricted stock.

The level of net interest income is affected primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates.

The following table shows the effect that these factors had on the interest earned from our interest-earning assets and interest incurred on our interest-bearing liabilities for the three months ended September 30, 2024 as compared to the three months ended September 30, 2023.

Rate and Volume Analysis

For the Three Months Ended September 30, 2024 and 2023

(Dollars in thousands)

(1) Non-accrual loans are included in average balances and do not have a material effect on the average yield. Interest income on non-accruing loans was not material for the years presented.

Net interest income totaled $14.2 million, an increase of $878 thousand, or 7%, for the three months ended September 30, 2024, compared to the three months ended September 30, 2023. The increase in net interest income is primarily a result of an increase in total interest income of $1.8 million, or 7%, for the third quarter of 2024 compared to the third quarter of 2023. Loan interest income increased $2.1 million, or 8%, to $27.4 million for the three months ended September 30, 2024, compared to $25.2 million for the three months ended September 30, 2023. Interest expense increased $926 thousand for the three months ended September 30, 2024 as compared to the same period of 2023.

Average earning assets decreased $72.8 million to $2.14 billion during the third quarter of 2024 as compared to $2.21 billion for the same period of 2023, which was primarily related to the sales of investment securities available-for-sale that were completed during the first and fourth quarters of 2023, decreasing the average balances of our investment securities by $76.4 million.

Interest income for the three months ended September 30, 2024 increased $1.8 million, or 7%, to $29.2 million, from $27.4 million for the three months ended September 30, 2023. Loan interest income during the third quarter of 2024 increased $2.1 million, or 8%, as compared to the year ago quarter due to both an increase in loan volume and an increase in yields earned on the loan portfolio. Income from investment securities decreased $258 thousand for the three months ended September 30, 2024 compared to the same period of 2023, primarily as a result of the aforementioned sales of investment securities executed during 2023. Interest income from deposits at other financial institutions decreased $74 thousand to $802 thousand for the third quarter of 2024 as compared to the third quarter of 2023, which was primarily due to lower average balances.

Average interest-bearing deposits decreased $111.2 million to $1.50 billion for the three months ended September 30, 2024 compared to $1.61 billion for the three months ended September 30, 2023, primarily as a result of a decrease in wholesale deposits. Average wholesale deposits decreased $116.8 million to $249.9 million for the three months ended September 30, 2024 compared to $366.7 million for the same period in 2023. Average non-interest-bearing deposits decreased $67.2 million to $358.6 million for the three months ended September 30, 2024 compared to $425.8 million for the same period in 2023. Average other borrowed funds, which primarily include federal funds purchased and advances from the Federal Home Loan Bank of Atlanta ("FHLB"), increased $47.9 million to $57.0 million for the three months ended September 30, 2024 compared to $9.1 million for the three months ended September 30, 2023.

Interest expense for the three months ended September 30, 2024 increased $926 thousand to $15.0 million, or 7%, from $14.1 million for the three months ended September 30, 2023. Deposit interest expense for the third quarter of 2024 increased $400 thousand compared to the year ago quarter primarily as a result of increased interest rates on interest-bearing deposits. Interest expense on other borrowed funds increased $528 thousand for the three months ended September 30, 2024 compared to the same period in 2023.

Our net interest margin, on a tax equivalent basis, for the three months ended September 30, 2024 and 2023 was 2.64% and 2.39%, respectively, an increase of 25 basis points, or 10%. The yield on interest-earning assets increased 51 basis points to 5.46% for the three months ended September 30, 2024, compared to 4.95% for the same period of 2023. The average yield of the loan portfolio for the three months ended September 30, 2024 and 2023 was 5.83% and 5.40%, respectively, an increase of 43 basis points. The cost of interest-bearing deposits increased 37 basis points to 3.77% for the three months ended September 30, 2024, compared to 3.40% for the same period of 2023, which was primarily attributable to the repricing of our interest-bearing deposits due to higher interest rates. Cost of deposits (which includes non-interest-bearing deposits) was 3.04% for the three months ended September 30, 2024 compared to 2.69% for the three months ended September 30, 2023. Cost of other borrowed funds increased to 3.93% for the three months ended September 30, 2024 compared to 1.53% for the three months ended September 30, 2023.

The following table presents average balance information, interest income, interest expense and the corresponding average yields earned and rates paid for the nine months ended September 30, 2024 and 2023.

Average Balance Sheets and Interest Rates on Interest-Earning Assets and Interest-Bearing Liabilities

For the Nine months ended September 30, 2024 and 2023

(Dollars in thousands)

(1) Non-accrual loans are included in average balances and do not have a material effect on the average yield. Interest income on non-accruing loans was not material for the periods presented. Net loan fees and late charges included in interest income on loans totaled $1.2 million and $1.5 million for the nine months ended September 30, 2024 and 2023, respectively.

(2) The average balances for investment securities includes restricted stock.

The following table shows the effect of variations in the volume and mix of our assets and liabilities, as well as the changes in interest rates had on the interest earned from our interest-earning assets and interest incurred on our interest-bearing liabilities for the nine months ended September 30, 2024.

Rate and Volume Analysis

For the Nine months ended September 30, 2024 and 2023

(Dollars in thousands)

(1) Non-accrual loans are included in average balances and do not have a material effect on the average yield. Interest income on non-accruing loans was not material for the years presented.

(2) The average yields for investment securities are reported on a fully taxable-equivalent basis at a rate of 22% for September 30, 2024 and September 30, 2023.

Net interest income for the nine months ended September 30, 2024 and September 30, 2023, was $40.7 million and $41.7 million, respectively, a decrease of $1.1 million, or 3%. The decrease in net interest income is primarily due to an increase in funding costs, which have increased precipitously as a result of Federal Reserve monetary policy, coupled with the need to meet intense competition from market area banks, brokerages, other financial institutions, and the U.S. Treasury.

Average earning assets decreased $91.4 million, to $2.12 billion, during the nine months ended September 30, 2024 as compared to $2.21 billion for the same period of 2023, which is primarily related to our sales of investment securities available-for-sale completed during 2023.

Interest income for the nine months ended September 30, 2024 increased $4.1 million to $84.0 million from $80.0 million for the nine months ended September 30, 2023. Loan interest income for the nine months ended September 30, 2024 increased $5.5 million as compared to the same nine month period of 2023, primarily as a result of the increase in yields earned on the loan portfolio. Income from investment securities decreased $1.0 million for the nine months ended September 30, 2024 compared to the same period of 2023, primarily as a result of the sales of investment securities executed during 2023. Income from deposits at other financial institutions decreased $447 thousand year-over-year, as excess liquidity was used to fund loan originations and paydown costly wholesale fundings.

Total average interest-bearing deposits increased $66.5 million to $1.44 billion for the nine months ended September 30, 2024 compared to $1.51 billion for the nine months ended September 30, 2023. Average noninterest-bearing deposits decreased $61.0 million to $372.3 million for the nine months ended September 30, 2024 compared to $433.3 million for the same period of 2023. Average wholesale deposits decreased $63.9 million to $268.3 million for the nine months ended September 30, 2024 compared to $332.2 million for the same period in 2023. Average other borrowed funds, which include federal funds purchased and FHLB advances, decreased $10.3 million to $88.1 million for the nine months ended September 30, 2024, compared to $98.4 million for the same period of 2023.

Interest expense for the nine months ended September 30, 2024 increased $5.1 million to $43.4 million from $38.2 million for the nine months ended September 30, 2023. Deposit interest expense for the year-to-date period of 2024 increased $5.0 million compared to the year ago nine month period primarily as a result of increased interest rates paid on deposits.

Our net interest margin for the nine months ended September 30, 2024 and 2023 was 2.57% and 2.53% respectively. The increase in net interest margin is a result of continued improvement in the yields earned on our loan portfolio and our management to control funding costs. The yield on interest-earning assets increased 46 basis points to 5.29% for the nine months ended September 30, 2024, compared to 4.83% for the same period of 2023. The average yield of the loan portfolio for the nine month periods ended September 30, 2024 and 2023 was 5.65% and 5.29%, respectively, an increase of 36 basis points. The cost of interest-bearing deposits increased 60 basis points to 3.67% for the nine months ended September 30, 2024, compared to 3.07% for the same period of 2023, which was primarily attributable to the repricing of our interest-bearing deposits due to higher interest rates. Cost of deposits (which includes noninterest-bearing deposits) was 2.92% for the nine months ended September 30, 2024 compared to 2.38% for the same nine month period of 2023. Cost of other borrowed funds increased 58 basis points to 4.47% for the nine months ended September 30, 2024 compared to 3.89% for the nine months ended September 30, 2023.

Average balances of nonperforming loans, which include nonaccrual loans, are included in the net interest margin calculation and did not have a material impact on our net interest margin in 2024 and 2023.

Provision Expense and Allowance for Credit Losses

Our policy is to maintain the ACL at a level that represents our best estimate of expected losses in the loan portfolio as of the valuation date. Both the amount of the provision and the level of the allowance for credit losses are impacted by many factors, including general and industry-specific economic conditions, actual and expected credit losses, historical trends and specific conditions of individual borrowers.

We recorded a release of provision for credit losses totaling $200 thousand and $729 thousand for the three months ended September 30, 2024 and 2023, respectively. For the nine months ended September 30, 2024 and 2023, provision for credit losses totaled $6 thousand and $132 thousand, respectively. The allowance for credit losses was $19.1 million and $18.9 million at September 30, 2024 and at December 31, 2023, respectively. Our allowance for credit losses on loans as a percent of total loans, net of deferred fees and costs, was 1.02 and 1.03% at September 30, 2024 and December 31, 2023, respectively.

We lend to well-established and relationship-driven borrowers which has contributed to our track record of low historical credit losses. We continue to maintain our disciplined credit guidelines during the current rate environment. We proactively monitor the impact of interest rates on our adjustable loans as the industry navigates through this economic cycle of increased inflation and higher interest rates. Nonperforming loans at September 30, 2024 totaled $3.6 million, or 0.16% of total assets, compared to $1.8 million, or 0.08%, of total assets at December 31, 2023. We had no other real estate owned at September 30, 2024 and at December 31, 2023. We recorded net recoveries of $63 thousand during the third quarter of 2024 compared to net recoveries of $7 thousand for same period of 2023. For the nine months ended September 30, 2024 and 2023, we recorded net recoveries of $98 thousand and net charge-offs of $326 thousand, respectively.

See “Asset Quality” below for additional information on the credit quality of the loan portfolio.

Noninterest Income

The following table provides detail for noninterest income for the three and nine months ended September 30, 2024 and 2023.

Noninterest Income

For the Three and Nine Months Ended September 30, 2024 and 2023

(Dollars in thousands)

Noninterest income includes service charges on deposits and loans, loan swap fee income, income from our membership interest in ACM and other investments, income from our BOLI policies, and other fee income, and continues to supplement our operating results. Non-interest income was $815 thousand for the three months ended September 30, 2024 compared to $225 thousand for same period of 2023. For the nine months ended September 30, 2024, we recorded noninterest income of $2.1 million compared to a loss of $3.5 million for same period of 2023.

We recorded income from our minority membership interest in ACM, totaling $278 thousand and $426 thousand for the three and nine months ended September 30, 2024, compared to a loss of $650 thousand and a loss of $1.4 million for the three and nine months ended September 30, 2023.

Fee income from loans was $54 thousand for the three months ended September 30, 2024, compared to $107 thousand for the same period of 2023, which included income from back-to-back loan swap transactions entered into during 2023. Service charges on deposits were $301 thousand for the three months ended September 30, 2024, compared to $284 thousand for the same period of 2023. Income from BOLI decreased to $70 thousand for the three months ended September 30, 2024 as compared to $373 thousand for the three months ended September 30, 2023, a result of surrendering our BOLI policies during the first quarter of 2024.

Fee income from loans was $141 thousand for the nine months ended September 30, 2024, compared to $352 thousand for the same period of 2023. Service charges on deposits were $841 thousand for the nine months ended

September 30, 2024, compared to $731 thousand for the same period of 2023, an increase of $110 thousand, or 15%. Income from BOLI decreased to $326 thousand for the nine months ended September 30, 2024 as compared to $1.1 million for the nine months ended September 30, 2023, a result of surrendering our BOLI policies during the first quarter of 2024.

Noninterest Expense

The following table reflects the components of noninterest expense for the three and nine months ended September 30, 2024 and 2023.

Noninterest Expense

For the Three and Nine Months Ended September 30, 2024 and 2023

(Dollars in thousands)

Noninterest expense includes, among other things, salaries and benefits, occupancy and equipment costs, professional fees, data processing, insurance and miscellaneous expenses. Noninterest expense was $9.2 million and $9.0 million for the three months ended September 30, 2024 and 2023, respectively.

Salaries and benefits expense decreased $415 thousand to $4.9 million for the three months ended September 30, 2024 compared to $5.3 million for the same period in 2023, a result of reduced staffing through process improvement resulting from the use of improved technologies. Occupancy expense decreased by $82 thousand, primarily as a result of the office space reduction efforts that were completed during the fourth quarter of 2023. These decreases were partially offset by an increase in internet banking and software expense of $46 thousand for the three months ended September 30, 2024 to $706 thousand, as compared to $660 thousand for the same period in 2023, a result of the implementation of enhanced customer software solutions. In addition, loan related expenses increased $430 thousand for the three months ended September 30, 2024 compared to the same period in 2023, a result of recovered loan legal expenses recorded during 2023.

Noninterest expense was $26.8 million and $27.3 million for the nine months ended September 30, 2024 and 2023, respectively. Salaries and benefits expense decreased $1.3 million to $14.1 million for the nine months ended September 30, 2024 compared to $15.4 million for the same period in 2023, which was primarily related to reduced staffing for the nine months ended September 30, 2024 compared to the same period of 2023. Occupancy expense decreased by $283 thousand for the nine months ended September 30, 2024 as compared to the same period of 2023, which was primarily related to the office space reduction initiatives that were completed during the fourth quarter of 2023. These decreases were partially offset by an increase in internet banking and software expense of $326 thousand for the nine months ended September 30, 2024 to $2.1 million, compared to $1.8 million for the same period in 2023, a result of the implementation of enhanced customer software solutions during 2023.

Income Taxes

We recorded a provision for income tax expense of $1.4 million and $1.2 million for the three months ended September 30, 2024 and 2023, respectively. The effective tax rate for the three months ended September 30, 2024 and 2023 was 22.6% and 22.9%, respectively.

For the nine months ended September 30, 2024 and 2023, the provision for income taxes was $5.8 million and $1.9 million, respectively. The provision for income taxes for the nine months ended September 30, 2024 includes $2.4 million in taxes and penalties related to the surrender of our BOLI policies. The provision for income taxes for the nine months ended September 30, 2023 was reduced as a result of the losses recorded on the sale of investment securities available-for-sale during 2023.

Discussion and Analysis of Financial Condition

Overview

At September 30, 2024, total assets were $2.29 billion, an increase of 5%, or $102.7 million, from $2.19 billion at December 31, 2023. Investment securities were $165.3 million at September 30, 2024, a decrease of $6.6 million, from $171.9 million at December 31, 2023. Total deposits increased 6%, or $115.5 million, to $1.96 billion at September 30, 2024, from $1.85 billion at December 31, 2023. From time to time, we may utilize other funding sources such as federal funds purchased and FHLB advances as an additional funding source for the Bank. We had no federal funds purchased at September 30, 2024 and December 31, 2023. The Bank had FHLB advances outstanding of $50.0 million and $85.0 million at September 30, 2024 and December 31, 2023, respectively. Subordinated debt, net of unamortized issuance costs, totaled $19.7 million and $19.6 million at September 30, 2024 and December 31, 2023.

Loans Receivable, Net

Loans receivable, net of deferred fees, were $1.87 billion at September 30, 2024 and $1.83 billion at December 31, 2023, an increase of $46.4 million, or 3%. During the third quarter of 2024, loan originations totaled $58.7 million with a weighted average rate of 9.27%, and were primarily comprised of commercial and industrial loans. Loan renewals totaled $60.4 million with a weighted average rate of 8.94%. Loans that paid off during the third quarter of 2024 totaled $51.6 million with a weighted average rate of 7.52%.

Commercial real estate loans totaled $1.06 billion and $1.09 billion at September 30, 2024 and December 31, 2023, and were approximately 57% and 60% of the total loans receivable at such dates, respectively. Owner-occupied commercial real estate loans were $196.3 million at September 30, 2024 compared to $212.9 million at December 31, 2023. Nonowner-occupied commercial real estate loans were $866.7 million at September 30, 2024 compared to $878.7 million at December 31, 2023. Commercial construction loans totaled $173.8 million at September 30, 2024, compared to $148.0 million at December 31, 2023 and comprised of 9% and 8% of total loans receivable at such dates, respectively. Our regulatory commercial real estate concentration (which includes nonowner-occupied real estate and construction loans) was 385% of our total risk-based capital at September 30, 2024. Our commercial real estate portfolio, including construction loans, is diversified by asset type and geographic concentration. We manage this portion of our portfolio in a disciplined manner. We have comprehensive policies to monitor, measure, and mitigate our loan concentrations within this portfolio segment, including rigorous credit approval, monitoring and administrative practices. Additional information on the stratification of these portfolio segments can be found below under "Asset Quality".

The following table presents the composition of our loans receivable portfolio at September 30, 2024 and December 31, 2023.

Loans Receivable

(Dollars in thousands)

Asset Quality

Nonperforming loans, defined as nonaccrual loans and loans contractually past due 90 days or more as to principal or interest and still accruing, were $3.6 million and $1.8 million at September 30, 2024 and December 31, 2023, respectively, an increase of $1.8 million. Loans that we have classified as nonperforming are a result of customer specific deterioration, mostly financial in nature, that are not a result of economic, industry, or environmental causes that we might see as a pattern for possible future losses within our loan portfolio. For each of our criticized assets, we individually evaluate each loan, generally through the performance of a collateral analysis to determine the amount of allowance required. As a result of the analysis completed, we had specific reserves totaling $802 thousand and $676 thousand at September 30, 2024 and December 31, 2023, respectively. Our ratio of nonperforming loans to total assets was 0.16% and 0.08% at September 30, 2024 and December 31, 2023, respectively. We had no other real estate owned and there were no loan modifications for borrowers who were experiencing financial difficulty during the quarter ended September 30, 2024.

We categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, collateral adequacy, credit documentation, and current economic trends, among other factors. We analyze loans individually by classifying the loans as to credit risk. This analysis includes larger, non-homogeneous loans such as commercial real estate and commercial and industrial loans. This analysis is performed on an ongoing basis as new information is obtained. At September 30, 2024, we had $15.4 million in loans identified as special mention, an increase of $9.2 million from December 31, 2023. Special mention rated loans have a potential weakness that deserves our close attention; however, the borrower continues to pay in accordance with their contractual terms, unless modified and disclosed. The increase from December 31, 2023 was driven by one loan that was downgraded to special mention during the second quarter of 2024. Loans rated as special mention are generally considered to be well-secured, and are not individually evaluated.

At September 30, 2024 , we had $3.2 million in loans identified as substandard, a decrease of $19.4 million from December 31, 2023. Substandard rated loans are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. For each of these substandard loans, a liquidation analysis is completed. At September 30, 2024, specific reserves totaling $802 thousand were allocated within the allowance for credit losses to supplement any shortfall of collateral.

At December 31, 2023, we downgraded an owner-occupied commercial real estate loan totaling $19.9 million to substandard due to concerns regarding the financial condition of this borrower’s parent company. During the third quarter ended September 30, 2024, the parent company closed on long term financing, strengthening its overall financial condition. As a result, we upgraded this loan to a pass rating.

We recorded annualized net recoveries to average loans receivable of (0.01)% for the nine months ended September 30, 2024, compared to annualized net charge-offs of 0.02% for the nine months ended September 30, 2023. For the nine months ended September 30, 2024, we have recorded net recoveries totaling $98 thousand, compared to net charge-offs of $326 thousand for the comparable nine month period of 2023. The following table provides additional information on our asset quality for the dates presented.

Nonperforming Loans and Assets

(Dollars in thousands)

We are closely and proactively monitoring the effects of recent market activity. As mentioned above, our commercial real estate loan portfolio totaled $1.06 billion, or 57% of total loans, at September 30, 2024 and $1.09 billion, or 60% of total loans, at December 31, 2023. The commercial real estate portfolio, including construction loans, is diversified by asset type and geographic concentration. We manage this portion of the portfolio in a disciplined manner, and have comprehensive policies to monitor, measure and mitigate our loan concentrations within this portfolio segment, including rigorous credit approval, monitoring and administrative practices. Included in commercial real estate are loans secured by office buildings totaling $137.4 million, or 7% of total loans, and retail shopping centers totaling $260.7 million, or 14% of total loans, at September 30, 2024. Loans secured by multi-family commercial properties totaled $164.6 million, or 9% of total loans, at September 30, 2024.

The following table provides further stratification of these and additional classes of commercial real estate and construction loans at September 30, 2024 (dollars in thousands).

(1).Loan-to-value is based on collateral valuation at origination date against current bank owned principal.

(2).Minimum debt service coverage policy is 1.30x for owner occupied and 1.25x for non-owner occupied at origination.

The loans shown in the above table exhibit strong credit quality, reflecting two classified loans at September 30, 2024 totaling $1.6 million. During our assessment of the allowance for credit losses on loans, we addressed the credit risks associated with these portfolio segments and believe that as a result of our conservative underwriting discipline at loan origination and our ongoing loan monitoring procedures, we have appropriately reserved for possible credit concerns in the event of a downturn in economic activity.

At September 30, 2024 and December 31, 2023, there were no performing loans considered potential problem loans. Potential problem loans are defined as loans that are not included in the 90 days or more past due, nonaccrual or restructured categories, but for which known information about possible credit problems causes us to be uncertain as to the ability of the borrowers to comply with the present loan repayment terms which may in the future result in disclosure in the past due, nonaccrual or restructured loan categories. We take a conservative approach with respect to risk rating loans in our portfolio. Based upon the status as a potential problem loan, these loans receive heightened scrutiny and ongoing intensive risk management. Additionally, our allowance for credit losses on loans estimation methodology adjusts expected losses to calibrate the likelihood of a default event to occur through the use of risk ratings.

Unexpected changes in economic growth could adversely affect our loan portfolio, including causing increases in delinquencies and default rates, which would adversely impact our charge-offs, allowance for credit losses, and provision for credit losses. Deterioration in real estate values, employment data and household incomes may also result in higher credit losses for us. Also, in the ordinary course of business, we may be subject to a concentration of credit risk to a particular industry, counterparty, borrower or issuer. A deterioration in the financial condition or prospects of a particular industry or a failure or downgrade of, or default by, any particular entity or group of entities could negatively impact our business, perhaps materially, and the systems by which we set limits and monitor the level of our credit exposure to individual entities and industries, may not function as we have anticipated.

See “Critical Accounting Policies” above for more information on our allowance for credit losses methodology.

The following tables present additional information pertaining to the activity in and allocation of the allowance for credit losses on loans by loan type and the percentage of the loan type to the total loan portfolio for the periods and at the dates presented. The allocation of the allowance for credit losses on loans to a category of loans is not necessarily indicative of future losses or charge-offs, and does not restrict the use of the allowance to any specific category of loans.

Allowance for Credit Losses on Loans

For the Three and Nine Months Ended September 30, 2024 and 2023

(Dollars in thousands)

56

Allocation of the Allowance for Credit Losses on Loans

(Dollars in thousands)

* Percentage of loan type to the total loan portfolio.

Investment Securities

Our investment securities portfolio is used as a source of income and liquidity. The investment portfolio consists of investment securities available-for-sale and investment securities held-to-maturity. Investment securities available-for-sale are those securities that we intend to hold for an indefinite period of time, but not necessarily until maturity. These securities are carried at fair value and may be sold as part of an asset/liability strategy, liquidity management or regulatory capital management. Investment securities held-to-maturity at September 30, 2024 and December 31, 2023 totaled $265 thousand and $264 thousand, respectively, and are those securities that we have the intent and ability to hold to maturity and are carried at amortized cost. The fair value of our investment securities available-for-sale was $165.0 million at September 30, 2024, a decrease of $6.6 million, or 4%, from $171.6 million at December 31, 2023, primarily due to principal repayments and maturities of $11.2 million, offset by an increase in the market value of the investment securities portfolio totaling $4.6 million at September 30, 2024.

As of September 30, 2024 and December 31, 2023, the majority of the investment securities portfolio consisted of securities rated AAA by a leading rating agency. Investment securities which carry a AAA rating are judged to be of the best quality and carry the smallest degree of investment risk. All of our mortgage-backed securities are guaranteed by either the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, or the Government National Mortgage Association. The effective duration of the investment securities portfolio continues to be slightly over five years, which is within the industry average. Investment securities that were pledged to secure public deposits totaled $45.2 million and $7.2 million at September 30, 2024 and December 31, 2023, respectively. Investment securities that were pledged to secure Federal Reserve Bank of Richmond ("FRB") borrowings totaled $6.3 million at September 30, 2024 and none at December 31, 2023.

In accordance with ASC 326, we complete periodic assessments on at least a quarterly basis to determine if credit deterioration exists within our investment securities portfolio and if an allowance for credit losses would be required as of a valuation date. For additional details related to management's assessment process, see the “Critical Accounting Policies” section above. As a result of the assessment performed as of September 30, 2024, the investment securities with unrealized losses are a result of pricing changes due to recent rising interest rate conditions in the current market environment and not as a result of credit deterioration. Contractual cash flows for agency-backed portfolios are guaranteed and funded by the U.S. government. Municipal securities have third party protective elements and there are no negative indications that the contractual cash flows will not be received when due. We do not intend to sell nor do we believe we will be required to sell any of our investment securities portfolio prior to the recovery of the amortized cost as of the valuation date. As such, no allowance was recognized for our investment securities portfolio as of September 30, 2024.

We hold restricted investments in equities of the FRB and FHLB. At September 30, 2024, we owned $4.1 million in FRB stock and $4.0 million in FHLB stock. At December 31, 2023, we owned $3.6 million in FRB stock and $5.8 million in FHLB stock.

The following table presents the weighted average yields of our investment portfolio for each of the maturity ranges at September 30, 2024 and December 31, 2023.

Investment Securities by Stated Yields

(Dollars in thousands)

58

Deposits and Other Borrowed Funds

The following table sets forth the average balances of deposits and the percentage of each category to total average deposits for the nine months ended September 30, 2024 and 2023:

Average Deposit Balances

For the nine months ended September 30, 2024 and 2023

(Dollars in thousands)

Total deposits increased $115.5 million, or 6%, to $1.96 billion at September 30, 2024 from $1.85 billion at December 31, 2023. Non-interest-bearing deposits were $357.0 million at September 30, 2024, or 18% of total deposits. At September 30, 2024, core deposits, which exclude wholesale deposits, increased $110.8 million from December 31, 2023, or 7%. Time deposits decreased $59.8 million, or 20%, to $246.5 million at September 30, 2024 from December 31, 2023, and were 14% of core deposits.

Wholesale deposits were $249.9 million at September 30, 2024 compared to $245.3 million at December 31, 2023, an increase of $4.6 million, or 2%. Wholesale deposits are partially fixed at a weighted average rate of 3.40% as we have executed $200.0 million in pay-fixed/receive-floating interest rate swaps to reduce funding costs. In addition, we are a member of the IntraFi Network (“IntraFi”), which gives us the ability to offer Certificates of Deposit Account Registry Service (“CDARS”) and Insured Cash Sweep (“ICS”) products to our customers who seek to maximize FDIC insurance protection. When a customer places a large deposit with us for IntraFi, funds are placed into certificates of deposit or other deposit products with other banks in the CDARS and ICS networks in increments of less than $250 thousand so that principal and interest are eligible for FDIC insurance protection. These deposits are part of our core deposit base. At September 30, 2024 and December 31, 2023, we had $238.1 million and $254.1 million, respectively, in CDARS reciprocal and ICS reciprocal products.

As of September 30, 2024, the estimated amount of total uninsured deposits (excluding collateralized deposits) was $790.0 million, or 40.3%, of total deposits. The estimate of uninsured deposits generally represents the portion of deposit accounts that exceed the FDIC insurance limit of $250,000 and is calculated based on the same methodologies and assumptions used for purposes of the Bank's regulatory reporting requirements. When excluding collateralized deposits, our estimate of uninsured deposits decreases to $633.7 million, or 32.3% of total deposits at September 30, 2024.

The following table reports maturities of the estimated amount of uninsured certificates of deposit at September 30, 2024.

Certificates of Deposit Greater than $250,000

At September 30, 2024

(Dollars in thousands)

Other borrowed funds, which include federal funds purchased, FHLB advances and Bank Term Funding Program ("BTFP") borrowings, were $57.0 million at September 30, 2024 compared to $85.0 million at December 31, 2023, a decrease of $28.0 million, or 33%. Subordinated debt, net of unamortized issuance costs, totaled $19.7 million and $19.6 million at September 30, 2024 and December 31, 2023, respectively. At September 30, 2024 and December 31, 2023, we did not have any federal funds purchased. During the first quarter of 2024, we borrowed $7.0 million from the BTFP. We did not access this facility during 2023. FHLB advances totaled $50.0 million and $85.0 million, respectively. All of our FHLB advances have pay-fixed/receive-floating interest rate swaps to reduce our funding costs, and as such, the weighted average rate of these FHLB advances are 3.60% and 3.21% at September 30, 2024 and December 31, 2023, respectively.

Total wholesale funding (which includes wholesale deposits, BTFP, and FHLB advances) decreased $23.4 million, or 7%, during 2024 to $306.9 million from $330.3 million at December 31, 2023.

Capital Resources

Capital adequacy is an important measure of financial stability and performance. Our objectives are to maintain a level of capitalization that is sufficient to sustain asset growth and promote depositor and investor confidence.

Regulatory agencies measure capital adequacy utilizing a formula that takes into account the individual risk profile of the financial institution. The minimum capital requirements for the Bank are: (i) a common equity Tier 1 ("CET1") capital ratio of 4.5%; (ii) a Tier 1 to risk-based assets capital ratio of 6%; (iii) a total risk-based capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. Additionally, a capital conservation buffer requirement of 2.5% of risk-weighted assets is designed to absorb losses during periods of economic stress and is applicable to the Bank’s CET1 capital, Tier 1 capital and total capital ratios. Including the conservation buffer, we currently consider the Bank’s minimum capital ratios to be as follows: 7.00% for CET1; 8.50% for Tier 1 capital; and 10.50% for total capital. Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the minimum plus the conservation buffer will face constraints on dividends, equity repurchases, and compensation.

Shareholders' equity at September 30, 2024 was $230.8 million, an increase of $13.7 million, compared to $217.1 million at December 31, 2023. Net income for the nine month period ended September 30, 2024 contributed $10.2 million to the increase in shareholders' equity. Accumulated other comprehensive loss decreased $1.4 million during the nine month period ended September 30, 2024, which is primarily related to the improvement in the market value of our investment securities portfolio.

Total shareholders' equity to total assets for September 30, 2024 and December 31, 2023 was 10.1% and 9.9%, respectively. Tangible book value per share (a non-GAAP financial measure which is defined in the table below) at September 30, 2024 and December 31, 2023 was $12.27 and $11.77, respectively.

As noted above, regulatory capital levels for the Bank meets those established for "well capitalized" institutions. While we are currently considered "well capitalized," we may from time to time find it necessary to access the capital markets to meet our growth objectives or capitalize on specific business opportunities.

As the Company is a bank holding company with less than $3.00 billion in assets, and which does not (i) conduct significant off-balance sheet activities, (ii) engage in significant non-banking activities, or (iii) have a material amount of securities registered under the Securities Exchange Act of 1934 (the “Exchange Act”), it is not currently subject to risk-based capital requirements adopted by the Federal Reserve, pursuant to the small bank holding company policy statement. The Federal Reserve has not historically deemed a bank holding company ineligible for application of the small bank holding company policy statement solely because its common stock is registered under the Exchange Act. There can be no assurance that the Federal Reserve will continue this practice.

On January 1, 2020, the federal banking agencies adopted a “Community Bank Leverage Ratio" ("CBLR"), which is calculated by dividing tangible equity capital by average consolidated total assets. If a “qualified community bank,” generally a depository institution or depository institution holding company with consolidated assets of less than $10.00 billion, opts into the CBLR framework and has a leverage ratio that exceeds the CBLR threshold, which was initially set at 9%, then such bank will be considered to have met all generally applicable leverage and risk based capital requirements under Basel III, the capital ratio requirements for “well capitalized” status under Section 38 of the Federal Deposit Insurance Act, and any other leverage or capital requirements to which it is subject. A bank or holding company may be excluded from qualifying community bank status based on its risk profile, including consideration of its off-balance sheet exposures; trading assets and liabilities; total notional derivatives exposures; and such other facts as the appropriate federal banking agencies determine to be appropriate. At January 1, 2020, we qualified and adopted this simplified capital structure. Effective September 30, 2022, we opted out of the CBLR framework. A banking organization that opts out of the CBLR framework can subsequently opt back into the CBLR framework if it meets the criteria listed above. We believe that the Bank met all capital adequacy requirements to which it was subject as of September 30, 2024 and December 31, 2023.

The following tables shows the minimum capital requirements and our capital position at September 30, 2024 and December 31, 2023 for the Bank.

Bank Capital Components

At September 30, 2024 and December 31, 2023

(Dollars in thousands)

(1).Includes capital conservation buffer.

Reconciliation of Book Value (GAAP) to Tangible Book Value (non-GAAP)

(Dollars in thousands, except per share data)

Liquidity

Liquidity in the banking industry is defined as the ability to meet the demand for funds of both depositors and borrowers. We must be able to meet these needs by obtaining funding from depositors or other lenders or by converting non-cash items into cash. The objective of our liquidity management program is to ensure that we always have sufficient resources to meet the demands of our depositors and borrowers. Stable core deposits and a strong capital position provide the base for our liquidity position. We believe we have demonstrated our ability to attract deposits because of our convenient branch locations, personal service, technology and pricing. As of September 30, 2024, estimated uninsured deposits (excluding collateralized deposits) for the Bank increased to 32.3% of total deposits from 31.1% at December 31, 2023.

In addition to deposits, we have access to the various wholesale funding markets. These markets include the brokered certificate of deposit market and the federal funds market. We are a member of the IntraFi Network, which allows banking customers to access FDIC insurance protection on deposits through the Bank which exceed FDIC insurance limits. As part of our membership with the IntraFi Network, we have one-way authority for both their CDARs and ICS products which provides the Bank the ability to access additional wholesale funding as needed. We also maintain secured lines of credit with the FRB and the FHLB for which we can borrow up to the allowable amount for the collateral pledged. Having diverse funding alternatives reduces our reliance on any one source for funding.

Liquid assets, which include cash and due from banks, federal funds sold and investment securities available for sale, totaled $342.7 million at September 30, 2024, or 15% of total assets, an increase from $232.1 million, or 11% of total assets, at December 31, 2023. At September 30, 2024 and December 31, 2023, $45.2 million and $7.2 million, respectively, in investment securities available for sale were pledged as collateral for municipal deposits and BTFP.

Cash flow from amortizing assets or maturing assets also provides funding to meet the needs of depositors and borrowers.

Secondary Liquidity Available and In Use

At September 30, 2024

(Dollars in thousands)

(1) The Bank has pledged a portion of the commercial real estate and residential loan portfolio to the FHLB to secure the line of credit. The Bank has obtain a letter of credit of $80 million to secure public funds.

(2) The Bank has pledged a portion of the commercial and industrial loan portfolio to the FRB to secure the line of the credit.

(3) The Bank has pledged a portion of the securities portfolio to the FRB to secure the line of credit. The BTFP program ended in March 2024.

We have established a formal liquidity contingency plan which establishes a liquidity management team and provides guidelines for liquidity management. For our liquidity management program, we first determine our current liquidity position and then forecast liquidity based on anticipated changes in the balance sheet. In this forecast, we expect to maintain a liquidity cushion. We also stress test our liquidity position under several different stress scenarios, from moderate to severe. Guidelines for the forecasted liquidity cushion and for liquidity cushions for each stress scenario have been established. We believe that we have sufficient resources to meet our liquidity needs.

Liquidity is essential to our business. Our liquidity could be impaired by an inability to access the capital markets or by unforeseen outflows of cash, including deposits. This situation may arise due to circumstances that we may be unable to control, such as general market disruption, negative views about the financial services industry generally, or an operational problem that affects a third party or us. Our ability to borrow from other financial institutions on favorable terms or at all could be adversely affected by disruptions in the capital markets or other events. While we believe we have a healthy liquidity position and do not anticipate the loss of deposits of any of the significant deposit customers, any of the factors discussed above could materially impact our liquidity position in the future.

Financial Instruments with Off-Balance-Sheet Risk and Credit Risk

We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet.

The Bank’s maximum exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. We evaluate each customer’s credit worthiness on a case-by-case basis and require collateral to support financial instruments when deemed necessary. The amount of collateral obtained upon extension of credit is based on our evaluation of the counterparty. Collateral held varies but may include deposits held by us, marketable securities, accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates up to one year or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. These instruments represent obligations to extend credit or guarantee borrowings and are not recorded on the consolidated statements of financial condition. The rates and terms of these instruments are competitive with others in the market in which we do business.

Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. Those lines of credit may not be drawn upon to the total extent to which we have committed.

Standby letters of credit are conditional commitments we issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. We hold certificates of deposit, deposit accounts, and real estate as collateral supporting those commitments for which collateral is deemed necessary.

With the exception of these off-balance sheet arrangements, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, results of operations, changes in financial condition, revenue, expenses, capital expenditures, or capital resources, that is material to our business.

At September 30, 2024 and December 31, 2023, unused commitments to fund loans and lines of credit totaled $226.5 million and $252.5 million, respectively. Commercial and standby letters of credit totaled $23.9 million at September 30, 2024 and $26.0 million at December 31, 2023, respectively.

The Company maintains disclosure controls and procedures (as defined in Rule 13a - 15(e) under the Exchange Act). As of the end of the period covered by this report, an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures was carried out under the supervision and with the participation of the Company’s management, including its chief executive officer and chief financial officer. Based on and as of the date of such evaluation, these officers concluded that the Company’s disclosure controls and procedures were effective.

The Company also maintains a system of internal accounting controls that is designed to provide assurance that assets are safeguarded and that transactions are executed in accordance with management’s authorization and are properly recorded. This system is continually reviewed and is augmented by written policies and procedures, the careful selection and training of qualified personnel, and an internal audit program to monitor its effectiveness. There were no changes in our internal controls over financial reporting that occurred during our last fiscal quarter that materially affected, or are likely to materially affect, our internal controls over financial reporting.

There have been no material changes in the risk factors from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2023.