UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
(Amendment No. 1)10-Q
Commission File Number: 001-39285 Partners Bancorp (Exact name of registrant as specified in its charter)
410-548-1100 (Registrant’s telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act:
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer”, "accelerated filer", "smaller reporting company" and “emerging growth company” in Rule 12b-2 of the Exchange Act.
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ As of
2 PART I – FINANCIAL INFORMATION Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
* Derived from audited consolidated financial statements
3 PARTNERS BANCORP CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
The Notes to the Unaudited Consolidated Financial Statements are an integral part of these consolidated financial statements. 4 PARTNERS BANCORP CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
The Notes to the Unaudited Consolidated Financial Statements are an integral part of these consolidated financial statements. 5 PARTNERS BANCORP CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)
The Notes to the Unaudited Consolidated Financial Statements are an integral part of these consolidated financial statements. 6 PARTNERS BANCORP CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
The Notes to the Unaudited Consolidated Financial Statements are an integral part of these consolidated financial statements. 7 PARTNERS BANCORP NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS Note 1. Nature of Business and Its Significant Accounting Policies Partners Bancorp (the “Company”) is a multi-bank holding company with 2 wholly owned subsidiaries (the “Subsidiaries”), The Bank of Delmarva (“Delmarva”), a commercial bank headquartered in Seaford, Delaware that operates primarily in Wicomico and Worcester counties in Maryland, Sussex County in Delaware, and Camden and Burlington counties in New Jersey, and Virginia Partners Bank (“Partners”), a commercial bank headquartered in Fredericksburg, Virginia that operates primarily in and around the greater Fredericksburg, Virginia area, including Stafford County, Spotsylvania County, King George County, Caroline County, and the Cities of Fredericksburg and Reston, Virginia. Partners also operates in Anne Arundel County and the three counties of Southern Maryland, including Charles County, Calvert County, and St. Mary’s County. The Subsidiaries engage in the general banking business and provide a broad range of financial services to individual and corporate customers, and are subject to competition from other financial institutions. The Subsidiaries are also subject to the regulations of certain federal and state agencies and undergo periodic examinations by those regulatory authorities. The accounting and reporting policies of the Company and its Subsidiaries conform to accounting principles generally accepted in the United States of America (“U.S. GAAP”) and practices within the banking industry. Significant accounting policies not disclosed elsewhere in the consolidated financial statements are as follows: Principles of Consolidation: The consolidated financial statements include the accounts of the Company; the Subsidiaries, along with their consolidated subsidiaries: Delmarva Real Estate Holdings, LLC., a wholly owned subsidiary of Delmarva, which is a real estate holding company; Davie Circle, LLC, a wholly owned subsidiary of Delmarva, which is a real estate holding company; Delmarva BK Holdings, LLC, a wholly owned subsidiary of Delmarva, which is a real estate holding company; DHB Development, LLC, of which Delmarva holds a 40.55% interest, and which is a real estate holding company; West Nithsdale Enterprises, LLC, of which Delmarva holds a 10% interest, and which is a real estate holding company; and FBW, LLC, of which Delmarva holds 50% interest, and which is a real estate holding company; Bear Holdings, Inc., a wholly owned subsidiary of Partners, which is a real estate holding company; Johnson Mortgage Company, LLC, of which Partners owns a 51% interest, and which is a residential mortgage company; and 410 William Street, LLC, a wholly owned subsidiary of Partners, which holds investment property. All significant intercompany accounts and transactions have been eliminated in consolidation. Financial Statement Presentation: The unaudited interim consolidated financial statements do not include all information and notes necessary for a complete presentation of financial position, results of operations, changes in stockholder's equity, and cash flows in conformity with U.S. GAAP. In the opinion of management, the unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the consolidated financial position at September 30, 2021 and December 31, 2020, the results of its operations for three and nine months and its cash flows for the Operating results for the three and nine months ended September 30, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021, Use of Estimates: The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 8 Securities Available for Sale: Marketable debt securities not classified as held to maturity are classified as available for sale. Securities available for sale are acquired as part of the Subsidiaries' asset/liability management strategy and may be sold in response to changes in interest rates, loan demand, changes in prepayment risk, and other factors. Securities available for sale are carried at fair value as determined by quoted market prices. Unrealized gains or losses based on the difference between amortized cost and fair value are reported in other comprehensive income, net of deferred tax. Realized gains and losses, using the specific identification method, are included as a separate component of other income (expense) and, when applicable, are reported as a reclassification adjustment, net of tax, in other comprehensive income. Premiums and discounts are recognized in interest income using the interest method over the period to maturity. Additionally, declines in the fair value of individual investment securities below their cost that are other than temporary are reflected as realized losses in the consolidated statements of income. Impairment may result from credit deterioration of the issuer or collateral underlying the security. In performing an assessment of recoverability, all relevant information is considered, including the length of time and extent to which fair value has been less than the amortized cost basis, the cause of the price decline, credit performance of the issuer and underlying collateral, and recoveries or further declines in fair value subsequent to the balance sheet date. For debt securities, the Company measures and recognizes other-than-temporary impairment (“OTTI”) losses through earnings if (1) the Company has the intent to sell the security or (2) it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis. In these circumstances, the impairment loss is equal to the full difference between the amortized cost basis and the fair value of the security. For securities that are considered OTTI that the Company has the intent and ability to hold in an unrealized loss position, the OTTI write-down is separated into an amount representing the credit loss, which is recognized in earnings, and the amount related to other factors, which is recognized as a component of other comprehensive income (“OCI”). Restricted Stock, Equity Securities and Other Investments: Federal Reserve Bank (“FRB”) stock, at cost, Federal Home Loan Bank (“FHLB”) stock, at cost, Atlantic Central Bankers Bank (“ACBB”) stock, at cost, and Community Bankers Bank (“CBB”) stock, are equity interests in the FRB, FHLB, ACBB, and CBB, respectively. These securities do not have a readily determinable fair value for purposes of ASC 320-10 Investments-Debts and Equity Securities (“ASC 320-10”) because their ownership is restricted and they lack an active market. As there is no readily determinable fair value for these securities, they are carried at cost less any OTTI. Equity securities with readily determinable fair values are carried at fair value, with changes in fair value reported in net income. Any equity securities without readily determinable fair values are carried at cost, minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments. The entirety of any impairment on equity securities is recognized in earnings. Other investments includes an equity ownership of Solomon Hess SBA Loan Fund LLC which the value is adjusted for its prorata share of assets in the fund. Other investments also includes equity securities the Company holds with Community Capital Management in their Community Reinvestment Act (“CRA”) Qualified Investment Fund. Bank Owned Life Insurance The Company has purchased life insurance policies on certain key executives. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other changes or amounts due that are probable at settlement. 9 Loans and the Allowance for Credit Losses: Loans are generally carried at the amount of unpaid principal, adjusted for unearned loan fees, which are amortized over the term of the loan using the effective interest rate method. Interest on loans is accrued based on the principal amounts outstanding. It is the Subsidiaries' policy to discontinue the accrual of interest when a loan is specifically determined to be impaired or when principal or interest is delinquent for ninety days or more. When a loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Cash collections on such loans are applied as reductions of the loan principal balance and no interest income is recognized on those loans until the principal balance has been collected. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received. The carrying value of impaired loans is based on the present value of the loan's expected future cash flows or, alternatively, the observable market price of the loan or the fair value of the collateral. The allowance for loan losses is maintained at a level believed to be adequate by management to absorb probable losses inherent in the loan portfolio and is based on the size and current risk characteristics of the loan portfolio, an assessment of individual problem loans and actual loss experience, the value of the underlying collateral, and current economic events in specific industries and geographical areas, including unemployment levels, and other pertinent factors, including regulatory guidance and general economic conditions. Determination of the allowance is inherently subjective, as it requires significant estimates, including the amounts and timing on historical loss experience, and consideration of current economic trends, all of which may be susceptible to significant change. Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for credit losses is charged to operations based on management's periodic evaluation of the factors previously mentioned, as well as other pertinent factors. Evaluations are conducted at least monthly and more often if deemed necessary. The allowance for credit losses typically consists of an allocated component and an unallocated component. The allocated component of the allowance for credit losses reflects expected losses resulting from analyses developed through specific credit allocations for individual loans and historical loss experience for each loan category. The specific credit allocations are based on regular analyses of all loans over a fixed-dollar amount where the internal credit rating is at or below a predetermined classification. The historical loan loss element is determined statistically using an informal loss migration analysis that examines loss experience and the related internal gradings of loans charged off over a current 3 year period. The loss migration analysis is performed quarterly and loss factors are updated regularly based on actual experience. The allocated component of the allowance for credit losses also includes consideration of concentrations and changes in portfolio mix and volume. Any unallocated portion of the allowance reflects management's estimate of probable inherent but undetected losses within the portfolio due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrower's financial condition, the difficulty in identifying triggering events that correlate perfectly to subsequent loss rates, and risk factors that have not yet manifested themselves in loss allocation factors. The historical losses used in the migration analysis may not be representative of actual unrealized losses inherent in the portfolio. It is management's intent to continually refine the methodology for the allowance for credit losses in an attempt to directly allocate potential losses in the loan portfolio under ASC Topic 310 and minimize the unallocated portion of the allowance for credit losses. Loan Charge-off Policies Loans are generally fully or partially charged down to the fair value of securing collateral when:
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Acquired Loans Loans acquired in connection with business combinations are recorded at their acquisition-date fair value with no carry over of related allowance for credit losses. Any allowance for credit loss on these pools reflect only losses incurred after the acquisition (meaning the present value of all cash flows expected at acquisition that ultimately are not expected to be received). Determining the fair value of the acquired loans involves estimating the principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest. Management considered a number of factors in evaluating the acquisition-date fair value including the remaining life of the acquired loans, delinquency status, estimated prepayments, payment options and other loan features, internal risk grade, estimated value of the underlying collateral and interest rate environment. Acquired loans that meet the criteria for nonaccrual of interest prior to the acquisition may be considered performing upon acquisition, regardless of whether the customer is contractually delinquent, if we can reasonably estimate the timing and amount of the expected cash flows on such loans and if we expect to fully collect the new carrying value of the loans, including the impact of any accretable yield. Loans acquired with deteriorated credit quality are accounted for in accordance with ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (ASC 310-30) if, at acquisition, the loans have evidence of credit quality deterioration since origination and it is probable that all contractually required payments will not be collected. At acquisition, the Company considered several factors as an indicator that an acquired loan had evidence of deterioration in credit quality. These factors include; loans 90 days or more past due, loans with an internal risk grade of substandard or below, loans classified as non-accrual by the acquired institution, and loans that have been previously modified in a troubled debt restructuring. Under the ASC 310-30 model, the excess of cash flows expected to be collected at acquisition over recorded fair value is referred to as the accretable yield and is the interest component of expected cash flow. The accretable yield is recognized into income over the remaining life of the loan if the timing and/or amount of cash flows expected to be collected can be reasonably estimated (the accretion method). If the timing or amount of cash flows expected to be collected cannot be reasonably estimated, the cost recovery method of income recognition is used. The difference between the loan's total scheduled principal and interest payment over all cash flows expected to be collected at acquisition, considering the impact of prepayments, is referred to as the non-accretable difference. The non-accretable difference represents contractually required principal and interest payments which the Company does not expect to collect. Over the life of the loan, management continues to estimate cash flows expected to be collected. Decreases in expected cash flows are recognized as impairments through a charge to the provision for credit losses resulting in an increase in the allowance for credit losses. Subsequent improvements in cash flows result in first, reversal of existing valuation allowances recognized subsequent to acquisition, if any, and next, an increase in the amount of accretable yield to be subsequently recognized as interest income on a prospective basis over the loan's remaining life. Acquired loans that were not individually determined to be purchased with deteriorated credit quality are accounted for in accordance with ASC 310-20, Nonrefundable Fees and Other Costs (ASC 310-20), whereby the premium or discount derived from the fair market value adjustment, on a loan-by-loan or pooled basis, is recognized into interest income on a level yield basis over the remaining expected life of the loan or pool. 11 Troubled Debt Restructurings A loan is accounted for and reported as a troubled debt restructuring (“TDR”) when, for economic or legal reasons, we grant a concession to a borrower experiencing financial difficulty that we would not otherwise consider. Management strives to identify borrowers in financial difficulty early and works with them to modify to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. A restructuring that results in only an insignificant delay in payment is not considered a concession. A delay may be considered insignificant if the payments subject to the delay are insignificant relative to the unpaid principal or collateral value and the contractual amount due, or the delay in timing of the restructured payment period is insignificant relative to the frequency of the payments, the debt’s original contractual maturity or original expected duration. TDRs are designated as impaired loans because interest and principal payments will not be received in accordance with the original contract terms. TDRs that are performing and on accrual status as of the date of the modification remain on accrual status. TDRs that are nonperforming as of the date of modification generally remain as nonaccrual until the prospect of future payments in accordance with the modified loan agreement is reasonably assured, generally demonstrated when the borrower maintains compliance with the restructured terms for a predetermined period, normally at least six months. TDRs with temporary below-market concessions remain designated as a TDR and impaired regardless of the accrual or performance status until the loan is paid off. However, if the TDR loan has been modified in a subsequent restructure with market terms and the borrower is not currently experiencing financial difficulty, then the loan may be no longer designated as a TDR. The COVID-19 pandemic has caused a significant disruption in economic activity worldwide, including in market areas served by the Company. Estimates for the allowance for loan losses at September 30, 2021 include probable losses related to the pandemic. The Company expects that the pandemic will continue to have an effect on its results of operations. If economic conditions deteriorate further, then additional provision for loan losses may be required in future periods. It is unknown how long these conditions will last and what the ultimate financial impact will be to the Company. Depending on the severity and duration of the economic consequences of the pandemic, the Company’s goodwill may become impaired. The Company had accommodated certain borrowers affected by the COVID-19 pandemic by granting short-term payment deferrals or periods of interest-only payments. As of September 30, 2021, all of the loan balances that were approved by the Company, on a consolidated basis, for loan payment deferrals or payments of interest only have either resumed regular payments or have been paid off. Generally, a short-term payment deferral does not result in a loan modification being classified as a TDR. Additionally, the Coronavirus Aid, Relief and Economic Security Act (CARES Act), enacted on March 27, 2020, and as subsequently supplemented, provided that certain loan modifications that were (1) related to COVID-19 and (2) for loans that were not more than 30 days past due as of December 31, 2019 are not required to be designated as TDRs. Loans Held for Sale: These loans consist of loans made through Partners’ majority owned subsidiary Johnson Mortgage Company, LLC (“JMC”). JMC is engaged in the mortgage brokerage business in which JMC originates, closes, and immediately sells mortgage loans and related servicing rights to permanent investors in the secondary market. JMC has written commitments from several permanent investors (large financial institutions) and only closes loans that meet the lending requirements of the permanent investors. Loans are made in connection with the purchase or refinancing of existing and new 1-to-4 family residences primarily in southeastern and northern Virginia. Loans are initially funded primarily by JMC’s lines of credit. With the concurrent sale and delivery of mortgage loans to the permanent investors, JMC records receivables for mortgage loans sold and recognizes the related gains and losses on such sales. The receivables for mortgage loans sold are usually satisfied within 30 days of sale, whereupon the related borrowings on the lines of credit are repaid. Because of the short holding period, these loans are carried at the lower of cost or market and 0 12 market adjustments were deemed necessary in the first three quarters of 2021 or during 2020. JMC’s agreements with its permanent investors include provisions that could require JMC to repurchase loans under certain circumstances, and also provide for the assessment of fees if loans go into default or are refinanced within specified periods of time. JMC has never been required to repurchase a loan and 0 allowance has been made as of September 30, 2021 or December 31, 2020 for possible repurchases. Management does not believe that a provision for early default or refinancing costs is necessary at September 30, 2021 or December 31, 2020. JMC enters into commitments with its customers to originate loans where the interest rate on the loans is determined (locked) prior to funding. While this subjects JMC to the risk that interest rates may change from the commitment date to the funding date, JMC simultaneously enters into financial agreements (best efforts forward sales commitments) with its permanent investors giving JMC the right to deliver (put) loans to the investors at specified yields, thus enabling JMC to manage its exposure to changes in interest rates such that JMC is not subject to fluctuations in fair values of these agreements due to changes in interest rates. However, a default by a permanent investor required to purchase loans under such an agreement would expose JMC to potential fluctuation in selling prices of loans due to changes in interest rate. The fair value of rate lock commitments and forward sales commitments was considered immaterial at September 30, 2021 and December 31, 2020 and an adjustment was not recorded. Gains and losses on the sale of mortgages as well as origination fees, brokerage fees, interest rate lock-in fees and other fees paid by mortgagors are included in Mortgage banking income on the Company’s consolidated statements of income. Other Real Estate Owned (“OREO”): OREO comprises properties acquired in partial or total satisfaction of problem loans. The properties are recorded at fair value at the date acquired. Losses arising at the time of acquisition of such properties are charged against the allowance for credit losses. Subsequent write-downs that may be required and expenses of operation are included in other expenses. Gains and losses realized from the sale of OREO are included in other expenses. At September 30, 2021 there were 3 properties with a combined estimated value of $1.3 million included in OREO and at December 31, 2020, there were 5 properties with a combined estimated value of $2.7 million included in OREO. Intangible Assets and Amortization: During the fourth quarter of 2019, the Company acquired Partners and during the first quarter of 2018, the Company acquired Liberty Bell Bank (“Liberty”). ASC 350, Intangibles-Goodwill and Other (“ASC 350”) prescribes accounting for intangible assets subsequent to initial recognition. Acquired intangible assets (such as core deposit intangibles) are separately recognized if the benefit of the assets can be sold, transferred, licensed, rented, or exchanged, and amortized over their useful lives. Intangible assets related to the acquisitions are amortized (See Note 13 – Goodwill and Intangible Assets for further information). Goodwill The Company’s goodwill was recognized in connection with the acquisitions of Partners and Liberty. The Company reviews the carrying value of goodwill at least annually or more frequently if certain impairment indicators exist. In testing goodwill for impairment, the Company may first consider qualitative factors to determine whether the existence of events or circumstances lead to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events and circumstances, we conclude that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then no further testing is required and the goodwill of the reporting unit is not impaired. If the Company elects to bypass the qualitative assessment or if we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the fair value of the reporting unit is compared with its carrying amount to determine whether an impairment exists. Accounting for Stock Based Compensation: The Company follows ASC 718-10, Compensation—Stock Compensation (“ASC 718-10”) for accounting and reporting for stock-based compensation plans. ASC 718-10 defines a fair value at grant date to be used for measuring compensation expense for stock-based compensation plans to be recognized in the statement of income. 13 Earnings Per Share: Basic earnings per common share are determined by dividing net income and accretion of warrants by the weighted average number of shares outstanding for each period, giving retroactive effect to stock splits and dividends. Weighted average common shares outstanding were17,788,472 and 17,758,074 for the three and nine months ended September 30, 2021, respectively. Calculations of diluted earnings per common share include the average dilutive common stock equivalents outstanding during the period, unless they are anti-dilutive. Dilutive common equivalent shares consist of stock options calculated using the treasury stock method and restricted stock awards (See Note 9 – Earnings Per Share for further information). Note 2. Investment Securities Securities available for sale are as follows:
Gross unrealized losses and fair values, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2021 and December 31, 2020, are as follows:
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For individual securities classified as either available for sale or held to maturity, the Company must determine whether a decline in fair value below the amortized cost basis is other than temporary. In estimating OTTI losses, management considers, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, and (iii) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. If the decline in fair value is considered to be other than temporary, the cost basis of the individual security shall be written down to the fair value as a new cost basis and the amount of the write-down shall be included in earnings (that is, accounted for as a realized loss). At September 30, 2021 there were 16 mortgage-backed securities (“MBS”), 3 agency investments, 1 subordinated debt investment and 4 municipal securities that have been in a continuous unrealized loss position for less than twelve months. At September 30, 2021 there was 1 MBS security and 1 agency security that had been in a continuous unrealized loss position for more than twelve months. Management found no evidence of OTTI on any of these securities and believes that unrealized losses are due to fluctuations in fair values resulting from changes in market interest rates and are considered temporary. As of September 30, 2021, management also believes it has the ability and intent to hold the securities for a period of time sufficient for a recovery of cost. During the three and nine months ended September 30, 2021 the Company sold 4 and 14 securities, respectively, resulting in a gain of $3 thousand and $17 thousand, respectively. During the three and nine months ended September 30, 2020, the Company sold 10 securities, resulting in a gain of $401 thousand. During the three and nine months ended September 30, 2021, 3 and 10 securities were either matured or called, respectively, resulting in a gain of $0 and $5 thousand, respectively. During the three and nine months ended September 30, 2020, 14 securities were either matured or called, resulting in a net gain of $167 thousand for both periods. The Company has pledged certain securities as collateral for qualified customers’ deposit accounts at September 30, 2021 and December 31, 2020. The amortized cost and fair value of these pledged securities was $11.2 million and $11.6 million, respectively, at September 30, 2021. The amortized cost and fair value of these pledged securities was $8.9 million and $9.3 million, respectively, at December 31, 2020. Contractual maturities of investment securities at September 30, 2021 are shown below. Actual maturities may differ from contractual maturities because debtors may have the right to call or prepay obligations with or without call or prepayment penalties. MBS have no stated maturity and primarily reflect investments in various Pass-through and Participation Certificates issued by the Federal National Mortgage Association and the Government National Mortgage Association. Repayment of MBS is affected by the contractual repayment terms of the underlying mortgages collateralizing these obligations and the current level of interest rates. 15 The following is a summary of maturities, calls, or repricing of securities available for sale:
Note 3. Loans, Allowance for Credit Losses and Impaired Loans Major categories of loans as of September 30, 2021 and December 31, 2020 are as follows:
16 Allowance for Credit Losses Management has an established methodology to determine the adequacy of the allowance for credit losses that assesses the risks and losses inherent in the loan portfolio. For purposes of determining the allowance for credit losses, the Company has segmented the loan portfolio into the following classifications:
Each of these segments are reviewed and analyzed quarterly using historical charge-off experience for their respective segments as well as the following qualitative factors:
The above factors result in a FASB ASC 450-10- 20 calculated reserve for environmental factors. All credit exposures graded at a rating of “non-pass” with outstanding balances less than or equal to $250 thousand and credit exposures graded at a rating of “pass” are reviewed and analyzed quarterly using historical charge-off experience for their respective segments as well as the qualitative factors discussed above. The historical charge-off experience is further adjusted based on delinquency risk trend assessments and concentration risk assessments. All credit exposures graded at a rating of “non-pass” with outstanding balances greater than $250 thousand and all credit exposures classified as TDR’s are to be reviewed no less than quarterly for the purpose of determining if a specific allocation is needed for that credit. The determination for a specific reserve is measured based on the present value of expected future cash flows, discounted at the loan's effective interest rate, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the collateral. In these cases management uses the current fair value of the collateral, less selling cost when foreclosure is probable, instead of discounted cash flows. If management determines that the value of the loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance for credit losses estimate or a charge-off to the allowance for credit losses. 17 The establishment of a specific reserve does not necessarily mean that the credit with the specific reserve will definitely incur loss at the reserve level. It is only an estimation of the potential loss based upon anticipated events. A specific reserve will not be established unless loss elements can be determined and quantified based on known facts. The total allowance reflects management's estimate of credit losses inherent in the loan portfolio as of September 30, 2021 and December 31, 2020. The following tables include impairment information relating to loans and the allowance for credit losses as of September 30, 2021 and December 31, 2020:
Note: The balances above include unamortized discounts on acquired loans of $2.7 million.
Note: The balances above include unamortized discounts on acquired loans of $4.0 million. 18 The following tables provide a summary of the activity in the allowance for credit losses allocated by loan class for three and nine months ended September 30, 2021 and the year ended December 31, 2020. Allocation of a portion of the allowance to one loan class does not preclude its availability to absorb losses in other loan classes.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into law, which established the Paycheck Protection Program (“PPP”) and allocated $349.0 billion of loans to be issued by financial institutions. Under the PPP, the Small Business Administration (“SBA”) will forgive loans, in whole or in part, made by approved lenders to eligible borrowers for Paycheck and other permitted purposes in accordance with the requirements of the PPP. These loans carry a fixed rate of 1.00% and a term of two years, if not forgiven, in whole or in part. The loans are 100% guaranteed by the SBA and payments are deferred for the first six months of the loan. The Bank receives a processing fee ranging from 1% to 5% based on the size of the loan from the SBA. In April 2020, the PPP was established and the Health Care Enhancement Act was signed into law and authorized additional funding of $310.0 billion for PPP loans. In December 2020, the Consolidated Appropriations Act 2021 (“CAA”) was passed, which extended the PPP and allocated additional funds for 2021. The Company has provided $95.1 million in funding to over 1,100 customers through the PPP as of September 30, 2021. Because these loans are 100% guaranteed by the SBA and did not undergo the Bank’s typical underwriting process, they are not graded and do not have an associated reserve at this time. At September 30, 2021, the Company had $13.7 million of PPP loans outstanding, net of fees, included in commercial loan balances. Credit Quality Information The following tables represent credit exposures by creditworthiness category at September 30, 2021 and December 31, 2020. The use of creditworthiness categories to grade loans permits management to estimate a portion of credit risk. The Company’s internal creditworthiness is based on experience with similarly graded credits. The Company uses the definitions below for categorizing and managing its criticized loans. Loans categorized as “Pass” do not meet the criteria set forth below and are not considered criticized. 19 Marginal — Loans in this category are presently protected from loss, but weaknesses are apparent which, if not corrected, could cause future problems. Loans in this category may not meet required underwriting criteria and have no mitigating factors. More than the ordinary amount of attention is warranted for these loans. Substandard — Loans in this category exhibit well-defined weaknesses that would typically bring normal repayment into jeopardy. These loans are no longer adequately protected due to well-defined weaknesses that affect the repayment capacity of the borrower. The possibility of loss is much more evident and above average supervision is required for these loans. Doubtful — Loans in this category have all the weaknesses inherent in a loan categorized as Substandard, with the characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Loss — Loans in this category are of little value and are not warranted as a bankable asset. Non-accruals In general, a loan will be placed on non-accrual status at the end of the reporting month in which the interest or principal is past due more than 90 days. Exceptions to the policy are those loans that are in the process of collection and are well-secured. A well-secured loan is secured by collateral with sufficient market value to repay principal and all accrued interest. A summary of loans by risk rating is as follows:
20 A summary of loans that were modified under the terms of a TDR for the three and nine months ended September 30, 2021 and 2020 is shown below by class. The post-modification recorded balance reflects the period end balances, inclusive of any interest capitalized to principal, partial principal pay-downs, and principal charge-offs since the modification date. Loans modified as TDRs that were fully paid down, charged off, or foreclosed upon by period end are not reported.
During the nine months ended September 30, 2021, there were 0 loans modified as TDRs that subsequently defaulted during the period ended September 30, 2021 which had been modified as TDRs during the twelve months prior to default. During the nine months ended September 30, 2020, there was 1 loan modified as a TDR that subsequently defaulted which had been modified as a TDR during the twelve months prior to default. This loan had a balance of $1.2 million prior to charge-offs of $707 thousand. 21 There was 1 loan secured by 1-4 family residential properties with a balance of $266 thousand that was in the process of foreclosure at September 30, 2021. There were 2 loans secured by 1-4 family residential properties with aggregate balances of $353 thousand that were in the process of foreclosure at December 31, 2020. The following tables include an aging analysis of the recorded investment of past due financing receivables as of September 30, 2021 and December 31, 2020:
* Includes $39 thousand of non-accrual loans. ** Includes $111 thousand of non-accrual loans. *** Includes $1.7 million of non-accrual loans. ****Includes $4.9 million of non-accrual loans.
* Includes $683 thousand of non-accrual loans. ** Includes $227 thousand of non-accrual loans. *** Includes $3.5 million of non-accrual loans. ****Includes $458 thousand of non-accrual loans. 22 Impaired Loans Impaired loans are defined as non-accrual loans, TDRs, purchased credit impaired loans (“PCI”) and loans risk rated substandard or above. When management identifies a loan as impaired, the impairment is measured for potential loss based on the present value of expected future cash flows, discounted at the loan's effective interest rate, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the collateral. In these cases management uses the current fair value of the collateral, less selling cost when foreclosure is probable, instead of discounted cash flows. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance. When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on non-accrual status, all payments are applied to principal, under the cost recovery method. When the ultimate collectability of the total principal of an impaired loan is not in doubt and the loan is on non-accrual status, contractual interest is credited to interest income when received, under the cash basis method. The following tables include the recorded investment and unpaid principal balances for impaired financing receivables, excluding purchased credit impaired, with the associated allowance amount, if applicable. Also presented are the average recorded investments in the impaired loans and the related amount of interest recognized during the time within the period that the impaired loans were impaired.
Total impaired loans of $11.0 million at September 30, 2021 do not include PCI loan balances of $3.8 million, which are net of a discount of $426,000. 23
Total impaired loans of $10.6 million at December 31, 2020 do not include PCI loan balances of $4.5 million, which are net of a discount of $644 thousand. All acquired loans were initially recorded at fair value at the acquisition date. The outstanding balance and the carrying amount of acquired loans included in the consolidated balance sheets are as follows:
The following table provides changes in accretable yield for all acquired loans accounted for under ASC 310-20:
During the three and nine months ended September 30, 2021, the Company recorded $9 thousand and $23 thousand, respectively, in accretion on acquired loans accounted for under ASC 310-30. During the three and nine months ended September 30, 2020, the Company recorded $54 thousand and $180 thousand, respectively, in accretion on acquired loans accounted for under ASC 310-30. Non-accretable yield on PCI loans was $1.4 million and $1.6 million at September 30, 2021 and December 31, 2020, respectively. 24 Concentration of Risk: The Company makes loans to customers located primarily within Anne Arundel, Charles, Calvert, St. Mary’s, Wicomico, and Worcester Counties, Maryland; Sussex County, Delaware; Camden and Burlington Counties, New Jersey; Stafford, Spotsylvania, King George, and Caroline Counties, Virginia; and the Cities of Fredericksburg and Reston, Virginia. A substantial portion of its loan portfolio consists of residential and commercial real estate mortgages. The ability of the Company’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in these areas. The Company had 0 commitments to loan additional funds to the borrowers of restructured, impaired, or non-accrual loans as of September 30, 2021 and December 31, 2020. Note 4. Borrowings and Notes Payable The Company owns capital stock of the FHLB as a condition for a $401.8 million convertible advance credit facility from the FHLB. As of September 30, 2021, the Company had remaining credit availability of $375.3 million under this facility. The following table details the advances the Company had outstanding with the FHLB at September 30, 2021 and December 31, 2020 and outstanding lines of credit:
The Company did 0t have any short-term borrowings from the FHLB for the nine months ended September 30, 2021 and average short-term borrowings from FHLB approximated $24.8 million for the year ended December 31, 2020. Borrowings from the FHLB are considered short-term if they have an original maturity of less than a year. The Company has pledged a portion of its residential and commercial mortgage loan portfolio as collateral for these credit facilities. Principal balances outstanding on these pledged loans totaled approximately $188.0 million and $178.6 million at September 30, 2021 and December 31, 2020, respectively. 25 In addition to the FHLB credit facility, in October 2015, the Company entered into a subordinated loan agreement for an aggregate principal amount of $2.0 million, net of issuance costs. Interest-only payments were due quarterly at 6.710% per annum, and the outstanding principal balance would have matured in October 2025. During July 2021, the prepayment provisions in the agreement were exercised, and the principal balance and any remaining accrued interest of this subordinated debt were paid in full. In January 2018, the Company entered into a subordinated loan agreement for an aggregate principal amount of $4.5 million to fund the acquisition of Liberty Bell Bank, net of loan costs. Interest-only payments are due quarterly at 6.875% per annum, and the outstanding principal balance matures in April 2028. In June 2020, the Company entered into a subordinated loan agreement for an aggregate principal amount of $17.6 million, net of issuance costs, to provide capital to support organic growth or growth through strategic acquisitions and capital expenditures. The notes will initially bear interest at 6.000% per annum, beginning June 25, 2020 to but excluding July 1, 2025, payable semi-annually in arrears. From and including July 1, 2025 to but excluding July 1, 2030, or an earlier redemption date, the interest rate shall reset quarterly to an interest rate per annum equal to the then current three-month SOFR plus 590 basis points, payable quarterly in arrears. Beginning on July 1, 2025 through maturity, the notes may be redeemed, at the Company’s option, on any scheduled interest payment date. The notes will mature on July 1, 2030. The notes are subject to customary representations, warranties and covenants made by the Company and the purchasers. Partners owns a one-half undivided interest in 410 William Street, Fredericksburg, Virginia. Partners purchased a one-half interest in the land for cash, plus additional settlement costs, and assumption of one-half of the remaining deed of trust loan on December 14, 2012. Partners indemnified the personal guarantors of the deed of trust loan in the amount of $886 thousand, which was one-half of the outstanding balance of the loan as of the purchase date. Partners has a remaining obligation under the note payable of $661 thousand as of September 30, 2021. This note is carried on the balance sheet net of a discount of $21 thousand. The loan was refinanced on April 30, 2015 with a twenty-five year amortization. The interest rate is fixed at 3.60% for the first 10 years, and then becomes a variable rate of 3.0% plus the 10 year Treasury rate until maturity. The Company provides JMC a warehouse line of credit, which is eliminated in consolidation. In addition, JMC has a warehouse line of credit with another financial institution in the amount of $3.0 million. The interest rate is the weekly average of the one month LIBOR plus 2.250%, rounded to the nearest 0.125% (2.750% at September 30, 2021 and December 31, 2020). The rate is subject to change the first of every month. Amounts borrowed are collateralized by a security interest in the mortgage loans financed under the line and are payable upon demand. The warehouse line of credit is set to renew or mature on November 30, 2021. The balance outstanding at September 30, 2021 and December 31, 2020 was $0 and $142 thousand, respectively. Interest expense on the warehouse lines of credit was $21 thousand and $77 thousand during the three and nine months ended September 30, 2021. During the second quarter of 2020, in connection with the loans originated as part of the PPP, the Company borrowed under the Federal Reserve’s Paycheck Protection Program Liquidity Facility (“PPPLF”). Under the terms of the PPPLF, the Company can borrow funds which are secured by the Company’s PPP loans. As of September 30, 2021, the Company did 0t have any outstanding advances under the PPPLF. At December 31, 2020, the Company had outstanding advances under the PPPLF of $41.6 million. The proceeds of these long-term borrowings were generally used to purchase higher yielding investment securities, fund additional loans, redeem preferred stock, or fund acquisitions. Additionally, the Company has secured credit availability of $5.0 million with a correspondent bank and unsecured credit availability of $87.0 million with several other correspondent banks for short-term liquidity needs, if necessary. The secured facility must be collateralized by specific securities at the time of any usage. At September 30, 2021 and December 31, 2020, there were 0 borrowings outstanding under these credit agreements. The Company has pledged investment securities available for sale with an amortized cost and fair value of $3.9 million with the FRB to secure Discount Window borrowings at September 30, 2021. The combined amortized cost and fair value of these pledged investment securities were $2.3 million and $2.4 million, respectively, at December 31, 2020. At September 30, 2021 and December 31, 2020 there were 0 outstanding borrowings under these facilities. 26 Maturities on debt are as follows (dollars in thousands):
Note 5. Lease Commitments The Company leases 19 locations for administrative offices and branch locations. NaN leases were classified as operating leases and 2 as finance leases. Leases with an initial term of 12 months or less as well as leases with a discounted present value of future cash flows below $25 thousand are not recorded on the balance sheet and the related lease expense is recognized over the lease term. The Company elected to use the practical expedient to not recognize short-term leases on the consolidated balance sheet and instead account for them as executory contracts. Certain leases include options to renew, with renewal terms that can extend the lease term, typically for five years. Lease assets and liabilities include related options that are reasonably certain of being exercised. The Company has determined that it will place a limit on exercises of available lease renewal options that would extend the lease term up to a maximum of fifteen years, including the initial term. The depreciable life of leased assets are limited by the expected lease term. The following tables present information about the Company’s leases for the periods ended:
27
Minimum lease payments at September 30, 2021, for the next five years and thereafter, assuming renewal options are exercised, are approximately as follows:
Note 6. Stock Option Plans Partners Bancorp Stock Option Plan The Company had employee and director stock option plans and had reserved shares of stock for issuance thereunder. Options granted under these plans had a ten-year life with a four-year vesting period that began one year after date of grant, and were exercisable at a price equal to the fair value of the Company’s stock on the date of the grant. Each award from all plans was evidenced by an award agreement that specifies the option price, the duration of the option, the number of shares to which the option pertains, and such other provisions as the grantor determines. The plan term ended in 2014, therefore 0 new options can be granted.All remaining stock options expired during the second quarter of 2019. Liberty Bell Bank Stock Option Plans In 2004, Liberty adopted the 2004 Incentive Stock Option Plan and the 2004 Non-Qualified Stock Option Plan, which were stock-based incentive compensation plans (the “Liberty Plans”). In February 2014, the Liberty Plans expired pursuant to their terms. Options under these plans had a 10 year life and vested over 5 years. Remaining options under the Liberty Plans became fully vested with the approval by the board of directors of Liberty signing the Agreement of Merger with the Company in July 2017 (the “Liberty Merger”). In accordance with the terms of the Agreement of Merger between the Company and Liberty, the Liberty Plans were assumed by the Company, and the options were converted into and became an option to purchase an adjusted number of shares of the common stock of the Company at an adjusted exercise price per share. The number of shares was determined by multiplying the number of shares of Liberty common stock for which the option was exercisable by the number of shares of the Company’s common stock into which shares of Liberty common stock were convertible in the Liberty Merger, which was 0.2857 (the “Liberty Conversion Ratio”), rounded to the next lower whole share. The exercise price was determined by dividing the exercise price per share of Liberty common stock by the Liberty Conversion Ratio, rounded up to the nearest cent. At the 28 effective time of the Liberty Merger there were 48,225 options outstanding at an exercise price of $1.18. These shares were converted to 13,771 options outstanding at an exercise price of $4.14. A summary of stock option transactions with respect to such options for the nine months ended September 30, 2021 is as follows:
Virginia Partners Bank Stock Option Plan In 2015 Virginia Partners Bank adopted the 2015 Stock Option Plan (the “2015 Partners Plan”), which allowed both incentive stock options and nonqualified stock options to be granted. The exercise price of each stock option equaled the market price of Partners' common stock on the date of grant and a stock option’s maximum term was 10 years. Stock options granted in the years ended December 31, 2018 and 2017 vested over 3 years. Partners previous stock compensation plan (the “2008 Partners Plan”) provided for the grant of share based awards in the form of incentive stock options and nonqualified stock options to Partners’ directors, officers and employees. In April 2015, the 2008 Partners Plan was terminated and replaced with the 2015 Partners Plan. Stock options outstanding prior to April 2015 were granted under the 2008 Partners Plan and became subject to the provisions of the 2015 Partners Plan. The 2008 Partners Plan also provided for stock options to be granted to seed investors as a reward for the contribution to organizational funds which were at risk if Partners’ organization had not been successful. Under the 2008 Partners Plan, Partners granted stock options to seed investors in 2008, which were fully vested upon the date of the grant. As a result of the Share Exchange, each stock option (the "Partners Options"), whether vested or unvested, issued and outstanding immediately prior to the effective time under the 2008 Partners Plan or the 2015 Partners Plan and together with the 2008 Partners Plan, (the "Partners Stock Plans"), immediately 100% vested, to the extent not already vested, and converted into and became stock options to purchase the Company common stock. In addition, the Company assumed each Partners Stock Plan, and assumed each Partners Option in accordance with the terms and conditions of the Partners Stock Plan pursuant to which it was issued. As such, Partners Options to acquire 149,200 shares of Partner’s common stock at a weighted average exercise price of $10.52 per share were converted into stock options to acquire 256,294 shares of the Company common stock at a weighted average exercise price of $6.13 per share. The number of shares was determined by multiplying the number of shares of Partners’ common stock for which the option was exercisable by the number of shares of the Company common stock into which shares of Partners common stock were convertible in the Share Exchange, which was 1.7179 (the “Conversion Ratio”), rounded to the next lower whole share. The exercise price was determined by dividing the exercise price per share of Partners common stock by the Conversion Ratio, rounded up to the nearest cent. 29 A summary of stock option transactions with respect to such options for the nine months ended September 30, 2021 is as follows:
The intrinsic value represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock options exceeds the exercise price) that would have been received by the holders had they exercised their stock options on September 30, 2021. As stated in Note 1, the Company follows ASC 718-10 which requires that stock-based compensation to employees and directors be recognized as compensation cost in the income statement based on their fair values on the measurement date, which, for the Company, is the date of the grant. All stock option expenses had been fully recognized prior to 2020. Note 7. Restricted Stock Plan The Company had an employee and director restricted stock plan (the “Company Plan”) and reserved 405,805 shares of stock for issuance thereunder. The Company adopted the Company Plan, pursuant to which employee and directors of the Company could acquire shares of common stock. The Company Plan was adopted by the Company’s Board of Directors in April 2014, and was subject to the right of the Board of Directors to terminate the Company Plan at any time. The Company Plan terminated at its scheduled date on June 30, 2018. The termination of the Company Plan, either at the scheduled termination date or before such date, did not affect any award issued prior to termination. During 2017 and 2018 the Company awarded 5,000 and 9,000 shares, respectively, to individual employees based on certain employment criteria. These shares vested over two or three years, based on the specific employment agreement. Each award from the plan is evidenced by an award agreement that specifies the vesting period of the restricted stock plan, the number of shares to which the award pertains, and such other provisions as the grantor determines. As of September 30, 2021 there were 0 remaining non-vested restricted stock awards. A schedule of vested awards in 2021 as of September 30, 2021 is as follows:
30 As stated in Note 1, the Company follows ASC 718-10 which requires that restricted stock-based compensation to employees and directors be recognized as compensation cost in the income statement based on their fair values on the measurement date. The fair value of restricted stock granted is equal to the underlying fair value of the stock. NaN expense was recognized during the three months ended September 30, 2021. During the nine months ended September 30, 2021 the Company recognized restricted stock-based compensation expense of $4 thousand, or $3 thousand net of tax, related to the restricted stock awards under the Company Plan. During the three months ended September 30, 2020 the Company recognized restricted stock-based compensation expense of $6 thousand, or $4 thousand net of tax, related to the restricted stock awards under the Company Plan. During the nine months ended September 30, 2020 the Company recognized restricted stock-based compensation expense of $17 thousand, or $12 thousand net of tax, related to the restricted stock awards under the Company Plan. The Company did 0t have any unrecognized restricted stock-based compensation expense related to restricted stock awards under the Company Plan at September 30, 2021. Note 8. Incentive Stock Plan At the 2021 annual meeting of shareholders held on May 19, 2021 (the “2021 Annual Meeting”), the Company’s shareholders approved the Partners Bancorp 2021 Incentive Stock Plan (the “2021 Incentive Stock Plan”), which the Company’s Board of Directors had adopted, subject to shareholder approval, on January 27, 2021, based on the recommendation of the Compensation Committee of the Company’s Board of Directors (the “Committee”). The 2021 Incentive Stock Plan became effective upon shareholder approval at the 2021 Annual Meeting. The 2021 Incentive Stock Plan authorizes the granting of stock options, stock appreciation rights, restricted stock, restricted stock units, stock awards and performance units to key employees and non-employee directors, including members of advisory boards, of the Company and certain of its subsidiaries, as determined by the Committee. Subject to the right of the Board of Directors to terminate the 2021 Incentive Stock Plan at any time, awards may be granted under the 2021 Incentive Stock Plan until May 18, 2031. Subject to adjustment in the event of certain changes in the Company’s capital structure, the maximum number of shares of the Company’s common stock that may be issued under the 2021 Incentive Stock Plan is 1,250,000. As of September 30, 2021, there are 0 awards outstanding under the 2021 Incentive Stock Plan. On April 28, 2021, the Company’s Board of Directors granted 58,824 shares of restricted stock to 2 senior officers of Partners in accordance with Nasdaq Listing Rule 5635(c)(4) as inducements material to each of them accepting employment with Partners. All of these shares are subject to time vesting in 3 equal annual installments beginning on April 28, 2022. As of September 30, 2021, there were 58,824 non-vested shares related to restricted stock awards. A schedule of non-vested shares related to restricted stock awards as of September 30, 2021 is as follows:
As a result of applying the provisions of ASC 718-10, during the three and nine months ended September 30, 2021, the Company recognized restricted stock-based compensation expense of $37 thousand, or $28 thousand net of tax, and $62 thousand, or $46 thousand net of tax, respectively, related to the restricted stock awards. Restricted stock-based compensation expense is accounted for using the fair value of the Company’s common stock on the date the restricted shares were awarded, which was $7.65 for the awards granted on April 28, 2021. Unrecognized restricted stock-based compensation expense related to the restricted stock awards totaled approximately $388 thousand at September 30, 2021. The remaining period over which this unrecognized restricted stock-compensation expense is expected to be recognized is approximately 2.6 years. 31 Note 9. Earnings Per Share Basic earnings per share (EPS) is computed by dividing net income or loss by the weighted average number of shares outstanding during the period. Diluted EPS is computed using the weighted average number of shares outstanding during the period, including the effect of all potentially dilutive shares outstanding attributable to stock instruments. Applicable guidance requires that outstanding, unvested share-based payment awards that contain voting rights and rights to nonforfeitable dividends participate in undistributed earnings with common shareholders. Accordingly, the weighted average number of shares of the Company’s common stock used in the calculation of basic and diluted net income per common share includes unvested shares of the Company’s outstanding restricted common stock. The following table presents basic and diluted EPS for the three and nine months ended September 30, 2021 and 2020:
Note 10. Regulatory Capital Requirements The Company’s subsidiaries are subject to various regulatory capital requirements administered by Federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory — and possibly additional discretionary — actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company’s subsidiaries must meet specific capital adequacy guidelines that involve quantitative measures of the Company’s subsidiaries assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s subsidiaries’ capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weighting, and other factors. Federal banking regulations also impose regulatory capital requirements on bank holding companies. Under the small bank holding company policy statement of the Federal Reserve Board, which applies to certain bank holding companies with consolidated total assets of less than $3 billion, the Company is not subject to regulatory capital requirements. 32 On September 17, 2019, the Federal Deposit Insurance Corporation finalized a rule that introduced an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio (CBLR) framework), as required by the Economic Growth, Regulatory Relief and Consumer Protection Act. The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework. In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of at least 9 percent, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations and will not be required to report or calculate risk-based capital. The Company has elected not to opt into the CBLR framework at this time. Quantitative measures established by regulation to ensure capital adequacy require the Company’s subsidiaries to maintain minimum amounts and ratios (as defined in the regulations) of total and Tier 1 capital to risk-weighted assets, Tier 1 capital to average assets, and common equity Tier 1 capital to risk-weighted assets. Management believes as of September 30, 2021 that the Company’s subsidiaries met all capital adequacy requirements to which they are subject. As of September 30, 2021, the most recent notification from the Federal Deposit Insurance Corporation (“FDIC”) categorized the Company’s subsidiaries as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Company’s subsidiaries must maintain minimum total risk-based, Tier 1 risk-based, Tier 1 leverage and common equity Tier 1 risk-based ratios. There are no conditions or events since that notification that management believes have changed the Company’s subsidiaries category. The Common Equity Tier 1, Tier 1 and Total capital ratios are calculated by dividing the respective capital amounts by risk-weighted assets. Risk-weighted assets are calculated based on regulatory requirements and include total assets, with certain exclusions, allocated by risk weight category, and certain off-balance-sheet items, among other things. The Tier 1 leverage ratio is calculated by dividing Tier 1 capital by adjusted quarterly average total assets, which exclude goodwill and other intangible assets, among other things. The Basel III Capital Rules require the Company’s subsidiaries to maintain (i) a minimum ratio of Common Equity Tier 1 capital to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% Common Equity Tier 1 capital ratio, effectively resulting in a minimum ratio of Common Equity Tier 1 capital to risk-weighted assets of at least 7.0%), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio, effectively resulting in a minimum Tier 1 capital ratio of 8.5%), (iii) a minimum ratio of Total capital (that is, Tier 1 capital plus Tier 2 capital) to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% Total capital ratio, effectively resulting in a minimum Total capital ratio of 10.5%) and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average quarterly assets. The implementation of the capital conservation buffer became fully phased in on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress and, as detailed above, effectively increases the minimum required risk-weighted capital ratios. Banking institutions with a ratio of Common Equity Tier 1 capital to risk-weighted assets below the effective minimum (4.5% plus the capital conservation buffer and, if applicable, the countercyclical capital buffer) will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall. 33 The following table presents actual and required capital ratios as of September 30, 2021 and December 31, 2020 for the Company’s subsidiaries under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of September 30, 2021 and December 31, 2020 based on the fully phased-in provisions of the Basel III Capital Rules. Capital levels required to be considered well capitalized are based on prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. A comparison of the Company’s subsidiaries’ capital amounts and ratios as of September 30, 2021 and December 31, 2020 with the minimum requirements are presented below.
Banking regulations also limit the amount of dividends that may be paid without prior approval of the Company’s regulatory agencies. Regulatory approval is required to pay dividends, which exceed the Company’s net profits for the current year plus its retained net profits for the preceding two years. 34 Note 11. Fair Values of Financial Instruments FASB ASC 825, Financial Instruments (“ASC 825”) requires disclosure about fair value of financial instruments, including those financial assets and financial liabilities that are not required to be measured and reported at fair value on a recurring or nonrecurring basis. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company. Additionally, in accordance with ASU 2016-01, the Company uses the exit price notion, rather than the entry price notion, in calculating the fair values of financial instruments not measured at fair value on a recurring basis. The estimated fair values, and related carrying amounts, of the Company’s financial instruments are as follows:
35 The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to repay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Bank's overall interest rate risk. Note 12. Fair Value Measurements The Company follows ASC 820-10 Fair Value Measurements and Disclosures (“ASC 820-10”), which provides a framework for measuring and disclosing fair value under generally accepted accounting principles. ASC Topic 820 requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available for sale investments securities) or on a nonrecurring basis (for example, impaired loans). ASC Topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC Topic 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value. Fair Value Hierarchy In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. Level 1 - Valuation is based on quoted prices in active markets for identical assets and liabilities. Level 2 - Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market. Level 3 - Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market. The following describes the valuation techniques used by the Company to measure certain financial assets recorded at fair value on a recurring basis in the financial statements: Investment Securities Available for Sale: Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. Currently, all of the Company’s investment securities available for sale are considered to be Level 2 securities. 36 The following tables present the balances of financial assets measured at fair value on a recurring basis as of September 30, 2021 and December 31, 2020:
Certain financial assets are measured at fair value on a nonrecurring basis in accordance with U.S. GAAP. Adjustments to the fair value of these financial assets usually result from the application of lower of cost or market accounting or write-downs of individual assets. The following describes the valuation techniques used by the Company to measure certain financial assets recorded at fair value on a nonrecurring basis in the financial statements: Loans Held for Sale: Loans held for sale are loans originated by JMC for sale in the secondary market. Loans originated for sale by JMC are recorded at lower of cost or market. No market adjustments were required at September 30, 2021; therefore, loans held for sale were carried at cost. Because of the short-term nature, the book value of these loans approximates fair value at September 30, 2021. Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected when due. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’s financial statements if not considered significant. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as a provision for loan losses on the consolidated statement of income. 37 Other Real Estate Owned: OREO is measured at fair value less cost to sell, based on an appraisal conducted by an independent, licensed appraiser outside of the Company. If the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3. OREO is measured at fair value on a nonrecurring basis. Any initial fair value adjustment is charged against the allowance for loan losses. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense on the consolidated statement of income. The following table presents the balances of financial assets measured at fair value on a non-recurring basis as of September 30, 2021 and December 31, 2020.
The following table presents additional quantitative information about assets measured at fair value on a non-recurring basis and for which the Company has utilized Level 3 inputs to determine fair value as of September 30, 2021 and December 31, 2020:
38 Note 13. Goodwill and Intangible Assets The Company accounts for goodwill and other intangible assets in accordance with ASC Topic 350, Intangibles—Goodwill and Other (“ASC 350). The Company records the excess of cost acquired entities over the fair value of identifiable tangible and intangible assets acquired, less liabilities assumed, as goodwill. The Company amortizes acquired intangible assets with definite useful economic lives over their useful economic lives. On a periodic basis, management assesses whether events or changes in circumstances indicate that the carrying amount of the intangible assets may be impaired. The Company does not amortize goodwill or any acquired intangible assets with an indefinite useful economic life, but reviews them for impairment on an annual basis, or when events or changes in circumstances indicate that the carrying amounts may be impaired. The Company has performed the required goodwill impairment test and has determined that goodwill was not impaired as of December 31, 2020. Goodwill: The following table provides changes in goodwill for the nine months ended September 30, 2021 and the year ended December 31, 2020:
The measurement period adjustments in the table above relate to the finalization of tax and related deferred tax adjustments in connection with the acquisition of Partners. Core Deposit Intangible: The Company acquired core deposit intangibles in the Liberty merger and the Partners Share Exchange. For the core deposit intangible related to Liberty, the Company utilizes the double declining balance method of amortization, in which the straight line amortization rate is doubled and applied to the remaining unamortized portion of the intangible asset. The amortization method changes to the straight line method of amortization when the straight line amortization amount exceeds the amount that would be calculated under the double declining balance method. This core deposit intangible is being amortized over seven years. For the core deposit intangible related to Partners, the Company utilizes the sum of months method and an estimated average life of 120 months. The following table provides changes for the nine months ended September 30, 2021, and the year ended December 31, 2020:
The following table provides the amortization expense for the core deposit intangible over the years indicated below:
39 Net Deposits Purchased Premium and Discount: The Company paid a deposit premium in the Liberty Merger and received a deposit discount in the Partners Share Exchange, which are included in the balances of time deposits on the balance sheets. The premium amount is amortized as a reduction in interest expense over the life of the acquired time deposits and the discount is accreted as an increase in interest expense over the life of the acquired time deposits. The premium and discount on deposits will both be amortized and accreted over approximately five years. The following table provides changes in the net deposit discount for the nine months ended September 30, 2021 and the year ended December 31, 2020:
The following table provides the accretion for the net deposit discount over the years indicated below:
The net effect of the amortization of premiums and accretion of discounts associated with the Bank’s acquisition accounting adjustments to assets acquired and liabilities assumed had the following impact on the consolidated statement of income for the periods indicated below:
40 Note 14. Revenue Recognition The Company follows ASU No. 2014-09 Revenue from Contracts with Customers (“Topic 606”) and all subsequent ASUs that modified Topic 606. Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. Topic 606 is applicable to noninterest revenue streams such as deposit related fees, interchange fees and merchant income. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Substantially all of the Company’s revenue is generated from contracts with customers. Noninterest revenue streams in-scope of Topic 606 are discussed below. Service Charges on Deposit Accounts Service charges on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business and public checking accounts), monthly service fees, check orders, and other deposit account related fees. The Company’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account related fees are largely transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or at the end of the month through a direct charge to customers’ accounts. Mortgage Banking Income Mortgage banking income, which is included in noninterest income, consists of gains and losses on the sale of mortgages as well as origination fees, brokerage fees, interest rate lock-in fees and other fees paid by mortgagors generated through Partners majority owned subsidiary JMC. JMC is engaged in the mortgage brokerage business in which JMC originates, closes, and immediately sells mortgage loans and related servicing rights to permanent investors in the secondary market. Loans are initially funded primarily by JMC’s warehouse lines of credit. With the concurrent sale and delivery of mortgage loans to the permanent investors, JMC records receivables for mortgage loans sold and recognizes the related gains and losses on such sales. The receivables for mortgage loans sold are usually satisfied within 30 days of sale, whereupon the related borrowings on the warehouse lines of credit are repaid. Mortgage Division Income Mortgage banking income, which is included is noninterest income, consists of fees for loans originated by the Company through an application process that are sent to a mortgage broker. The loan application and underwriting processes are completed by other various financial institutions. The Company receives a pre-negotiated fee at settlement for initiating the loan origination. The Company receives the fee and recognizes the income when the loan goes to settlement. 41 Other Noninterest Income Other noninterest income consists of: fees, exchange, other service charges, safety deposit box rental fees, and other miscellaneous revenue streams. Fees and other service charges are primarily comprised of debit and credit card income, ATM fees, merchant services income, and other service charges. Debit and credit card income is primarily comprised of interchange fees earned whenever the Company’s debit and credit cards are processed through card payment networks such as Visa. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. Other service charges include revenue from processing wire transfers, bill pay service, cashier’s checks, and other services. The Company’s performance obligation for fees, exchange, and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month. Safe deposit box rental fees are charged to the customer on an annual basis and recognized upon receipt of payment. Note 15. Subsequent Event On November 4, 2021, the Company entered into an Agreement and Plan of Merger (the “Agreement”) with OceanFirst Financial Corp., a Delaware corporation (“OCFC”) and Coastal Merger Sub Corp., a Maryland corporation and a direct wholly-owned subsidiary of OCFC (“Merger Sub”). Pursuant to the Agreement, Merger Sub will be merged with and into the Company, whereby the separate corporate existence of Merger Sub will cease and the Company will be the surviving corporation as a wholly-owned direct subsidiary of OCFC (the “First-Step Merger”). Immediately thereafter, the Company will be merged with and into OCFC, whereby the separate corporate existence of the Company will cease and OCFC will be the surviving corporation in the merger (the “Second-Step Merger”, and together with the First-Step Merger, the “Integrated Mergers”). Immediately following the consummation of the Integrated Mergers, Delmarva will be merged with and into OceanFirst Bank N.A., the wholly-owned national banking association subsidiary of OCFC (“OceanFirst Bank”), with OceanFirst Bank as the surviving bank (the “Delmarva Merger”). Immediately following the consummation of the Delmarva Merger, Partners will be merged with and into OceanFirst Bank, with OceanFirst Bank as the surviving bank (the “Partners Merger”). At the effective time of the First-Step Merger, each share of Company common stock that is issued and outstanding immediately prior to the effective time of the First-Step Merger, other than Exception Shares (as defined in the Agreement), will be converted into the right to receive either (a) 0.4512 shares of common stock, par value $0.01 per share, of OCFC or (b) $10.00, in each case, at the election of the holder of the Company’s common stock, subject to (x) a maximum of forty percent (40%) of the shares of the Company’s common stock being convertible into cash and (y) the allocation and proration provisions of the Agreement. For more information on this pending transaction refer to the Company's Current Report on Form 8-K filed with the SEC on November 4, 2021. Note 16. Recent Accounting Pronouncements In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, “Financial Instruments – Credit Losses” (“Topic 326”): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The FASB has issued multiple updates to ASU 2016-13 as codified in Topic 326, including ASU’s 2019-04, 2019-05, 2019-10, 2019-11, 2020-02, and 2020-03. These ASU’s have provided for various minor technical corrections and improvements to the codification as well as other transition matters. Smaller reporting companies who file with the U.S. Securities and Exchange Commission (“SEC”) and all other entities who do not file with the SEC are required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. The Company 42 is currently evaluating the potential impact of ASU 2016-13 on
Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin (SAB) 119. SAB 119 updated portions of SEC interpretative guidance to align with ASC 326. It covers topics including (1) measuring current expected credit losses; (2) development, governance, and documentation of a systematic methodology; (3) documenting the results of a systematic methodology; and (4) validating a systematic methodology. In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740) – Simplifying the Accounting for Income Taxes” (“ASU 2019-12”). The ASU is expected to reduce cost and complexity related to the accounting for income taxes by removing specific exceptions to general principles in Topic 740 (eliminating the need for an organization to analyze whether certain exceptions apply in a given period) and improving financial statement preparers’ application of certain income tax-related guidance. This ASU is part of the In January 2020, the FASB issued ASU 2020-01, “Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures” (“Topic 323”), and “Derivatives and Hedging” (“Topic 815”) – Clarifying the Interactions between Topic 321, Topic 323, and Topic 815.” The ASU is based on a consensus of the Emerging Issues Task Force and is expected to increase comparability in accounting for these transactions. ASU 2016-01 made targeted improvements to accounting for financial instruments, including providing an entity the ability to measure certain equity securities without a readily determinable fair value at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Among other topics, the amendments clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting. ASU 2020-01 was effective for the Company on January 1, 2021 and did not have a material impact on its consolidated financial statements. In March 2020, the FASB issued ASU No. 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting” (“Topic 848”). These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. Subsequently, in January 2021, the FASB issued ASU No. 2021-01 “Reference Rate Reform (Topic 848): Scope”. This 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. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity may elect to apply ASU No. 2021-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications from any date within the interim period that includes or is subsequent to January 7, 2021, up to the date that financial statements are available to be issued. An entity may elect to 43 apply ASU No. 2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includes March 12, 2020, and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020. The Company is assessing ASU 2020-04 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments, and is currently evaluating the effect that ASU 2020-04 will have on the Company’s consolidated financial statements. In August 2020,the FASB issued ASU) No. 2020-06 “Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity.” The ASU simplifies accounting for convertible instruments by removing major separation models required under current U.S. GAAP. Consequently, more convertible debt instruments will be reported as a single liability instrument and more convertible preferred stock as a single equity instrument with no separate accounting for embedded conversion features. The ASU removes certain settlement conditions that are required for equity contracts to qualify for the derivative scope exception, which will permit more equity contracts to qualify for it. The ASU also simplifies the diluted earnings per share (“EPS”) calculation in certain areas. In addition, the amendment updates the disclosure requirements for convertible instruments to increase the information transparency. For public business entities, excluding smaller reporting companies, the amendments in the ASU are effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. For all other entities, the standard will be effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of ASU 2020-06 to have a material impact on its consolidated financial statements. In October 2020, the FASB issued ASU 2020-08, “Codification Improvements to Subtopic 310-20, Receivables – Nonrefundable fees and Other Costs” (“ASU 2020-08”). This ASU clarifies that an entity should reevaluate whether a callable debt security is within the scope of ASC paragraph 310-20-35-33 for each reporting period. ASU 2020-08 was effective for the Company on January 1, 2021 and did not have a material impact on its consolidated financial statements. In December 2020, the CAA was passed. Under Section 541 of the CAA, Congress extended or modified many of the relief programs first created by the CARES Act, including the PPP loan program and treatment of certain loan modifications related to the COVID-19 pandemic. The CAA did not have a material impact on the Company’s consolidated financial statements. (See Note 3 – Loans, Allowance for Credit Losses and Impaired Loans for further information). In May 2021, the FASB issued ASU 2021-04, “Earnings Per Share (Topic 260), Debt - Modifications and Extinguishments (Subtopic 470-50), Compensation - Stock Compensation (Topic 718), and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40): Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity – Classified Written Call Options (a consensus of the FASB Emerging Issues Task Force).” The ASU addresses how an issuer should account for modifications or an exchange of freestanding written call options classified as equity that is not within the scope of another Topic. For both public and private companies, the ASU is effective for fiscal years beginning after December 15, 2021. Transition is prospective. Early adoption is permitted. The Company does not expect the adoption of ASU 2021-04 to have a material impact on its consolidated financial statements. In August 2021, the FASB issued ASU 2021-06, “'Presentation of Financial Statements (Topic 205), Financial Services—Depository and Lending (Topic 942), and Financial Services—Investment Companies (Topic 946): Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No. 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No. 33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants. This ASU incorporates recent SEC rule changes into the FASB Codification, including SEC Final Rule Releases No. 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No. 33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants”. The ASU is effective upon addition to the FASB Codification. The Company does not expect the adoption of ASU 2021-06 to have a material impact on its financial statements. 44 ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion compares the Company’s financial condition at September 30, 2021 to its financial condition at December 31, 2020 and the results of operations for the three and nine months ended September 30, 2021 and 2020. This discussion should be read in conjunction with the
Certain statements in this Quarterly Report on Form 10-Q may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that include, without limitation, projections, predictions, expectations, or beliefs about future events or results that are not statements of historical fact. Such forward-looking statements are based on various assumptions as of the time they are made, and are inherently subject to known and unknown risks, uncertainties, and other factors, some of which cannot be predicted or quantified, that may cause actual results, performance or achievements to be materially different from those expressed or implied by such forward-looking statements. Forward-looking statements are often accompanied by words that convey projected future events or outcomes such as “expect,” “believe,” “estimate,” “plan,” “project,” “anticipate,” “intend,” “will,” “may,” “view,” “opportunity,” “potential,” or words of similar meaning or other statements concerning opinions or judgment of the Company and its management about future events. Although the Company believes that its expectations with respect to forward-looking statements are based upon reasonable assumptions within the bounds of its existing knowledge of its business and operations, there can be no assurance that actual results, performance, or achievements of, or trends affecting, the Company will not differ materially from any projected future results, performance, achievements or trends expressed or implied by such forward-looking statements. Actual future results, performance, achievements or trends may differ materially from historical results or those anticipated depending on a variety of factors, including, but not limited to:
45
Please refer to the “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections of the Company’s 2020 Annual Report on Form 10-K and comparable sections of this Quarterly Report on Form 10-Q for the quarter ended September 30, 2021 (this “Quarterly Report”) and related disclosures in other filings which have been filed with the SEC and are available on the SEC’s website at www.sec.gov. All of the forward-looking statements made in this Quarterly Report are expressly qualified by the cautionary statements contained or referred to in this Quarterly Report. The actual results or developments anticipated may not be realized or, even if substantially realized, they may not have the expected consequences to or effects on the Company or its businesses or operations. Readers are cautioned not to rely too heavily on the forward-looking statements contained in this Quarterly Report. Forward-looking statements speak only as of the date they are made and the Company does not undertake any obligation to update, revise, or clarify these forward-looking statements whether as a result of new information, future events or otherwise. Overview Partners Bancorp, a bank holding corporation, through its wholly owned subsidiaries, The Bank of Delmarva (“Delmarva”) and Virginia Partners Bank (“Virginia Partners”), each of which are commercial banking corporations, engages in general commercial banking operations, with twenty branches throughout Wicomico, Charles, Anne Arundel, and Worcester Counties in Maryland, Sussex County in Delaware, Camden and Burlington Counties in New Jersey, the cities of Fredericksburg and Reston, Virginia, and Spotsylvania County, Virginia. 46 The Company derives the majority of its income from interest received on our loans and investment securities. The primary source of funding for making these loans and acquiring investment securities are deposits and secondarily, borrowings. Consequently, one of the key measures of the Company’s success is the amount of net interest income, or the difference between the income on interest-earning assets, such as loans and investment securities, and the expense on interest-bearing liabilities, such as deposits and borrowings. The resulting ratio of that difference as a percentage of average interest-earning assets represents the net interest margin. Another key measure is the spread between the yield earned on interest-earning assets and the rate paid on interest-bearing liabilities, which is called the net interest spread. In addition to earning interest on loans and investment securities, the Company earns income through fees and other charges to customers. Also included is a discussion of the various components of this noninterest income, as well as of noninterest expense. There are risks inherent in all loans, so the Company maintains an allowance for credit losses to absorb probable losses on existing loans that may become uncollectible. The Company maintains this allowance for credit losses by charging a provision for credit losses as needed against its operating earnings for each period. The Company has included a detailed discussion of this process, as well as several tables describing its allowance for credit losses. On November 4, 2021, the Company announced the signing of a definitive Agreement and Plan of Merger, dated as of November 4, 2021, pursuant to which the Company will be acquired by OCFC. Under the terms of the merger agreement, each share of Company common stock (other than Exception Shares, as defined in the merger agreement), will be converted into the right to receive either 0.4512 shares of common stock of OCFC or $10.00, in each case, at the election of the holder of Company common stock, subject to a maximum of forty percent (40%) of the shares of Company common stock being convertible into cash and the allocation and proration provisions of the merger agreement. For more information on this pending transaction refer to Note 15—Subsequent Events to the unaudited consolidated financial statements in this Quarterly Report on Form 10-Q and the Company’s Current Report on Form 8-K filed with the SEC on November 4, 2021. The Company’s financial performance generally, and in particular the ability of its borrowers to repay their loans, the value of collateral securing those loans, as well as demand for loans and other products and services the Company offers, is highly dependent on the business environment in the Company’s primary markets where the Company operates and in the United States as a whole. The COVID-19 pandemic has severely disrupted supply chains and adversely affected production, demand, sales and employee productivity across a range of industries and dramatically increased unemployment in the Company’s areas of operation and nationally. These events have continued to affect the Company’s operations in the first nine months of 2021 and are likely to impact the Company’s financial results throughout the remainder of fiscal year 2021. The extent of the impact of the COVID-19 pandemic on the Company’s operational and financial performance will depend on certain developments, including the duration and spread of the outbreak, the impact on the Company’s customers, employees and vendors and the nature and effect of past and future federal and state governmental and private sector responses to the pandemic, all of which are uncertain and cannot be predicted. In connection with the ongoing COVID-19 pandemic, both Delmarva and Virginia Partners continue to follow their pandemic response plans, which were enacted in February 2020. To date, management believes that the plans have been implemented successfully. The operation of these plans continues to require daily oversight in order to properly navigate this complex and ever-changing environment. The roll out of these plans previously resulted in adjustments to both Delmarva and Virginia Partners branch operations, including, but not limited to, lobby and drive-thru hours as well as physical access, the provision of personal protection equipment to employees and customers, and having employees work remotely whenever possible. As of September 30, 2021, both Delmarva and Virginia Partners branch operations were operating under normal lobby and drive-thru hours. In addition, the majority of Delmarva’s and Virginia Partners’ employees, with a few exceptions, have shifted from remote work to returning to the office on either a full-time or hybrid basis. Delmarva and Virginia Partners continue to proactively work with their local, state and federal government agencies to ensure their response to the COVID-19 pandemic is both safe and sound with little disruption to their customers. Additionally, Delmarva and Virginia Partners continue to take necessary precautions in order to protect their staffs, customers and their families as well as their communities, and to limit the ongoing impact of the COVID-19 pandemic. 47 Future developments with respect to the COVID-19 pandemic are highly uncertain and cannot be predicted and new information may emerge concerning the severity of the outbreak and the actions to contain the outbreak or treat its impact, among others. Other national health concerns, including the outbreak of other contagious diseases or pandemics may adversely affect the Company in the future. Please refer to the “Provision for (Reversal of) Credit Losses and Allowance for Credit Losses” section of this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more information related to payment deferrals, concentrations in higher risk industries, and the impact on the allowance for credit losses. The following discussion and analysis also identifies significant factors that have affected the Company’s financial position and operating results during the periods included in the consolidated financial statements accompanying this report. This management's discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and the notes thereto included in Item 1 in this Quarterly Report on Form 10-Q, and the other statistical information included in this Quarterly Report. Critical Accounting Policies Certain critical accounting policies affect significant judgments and estimates used in the preparation of the Company’s consolidated financial statements. These significant accounting policies are described in the notes to the consolidated financial statements included in this Quarterly Report as well as in Item 8 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2020. The accounting principles the Company follows and the methods of applying these principles conform to U.S. GAAP and general banking industry practices. The Company’s most critical accounting policy relates to the determination of the allowance for credit losses, which reflects the estimated losses resulting from the inability of borrowers to make loan payments. The determination of the adequacy of the allowance for credit losses involves significant judgment and complexity and is based on many factors. If the financial condition of the Company’s borrowers were to deteriorate, resulting in an impairment of their ability to make payments, the estimates would be updated and additional provisions for credit losses may be required. See “Provision for (Reversal of) Credit Losses and Allowance for Credit Losses” and Note 1 and Note 3 of the unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q. Another of the Company’s critical accounting policies, with the acquisitions of Liberty in 2018 and Virginia Partners in 2019, relates to the valuation of goodwill and intangible assets. The Company accounted for the Liberty Merger and the Virginia Partners Share Exchange in accordance with ASC Topic No. 805, which requires the use of the acquisition method of accounting. Under this method, assets acquired, including intangible assets, and liabilities assumed, are recorded at their fair value. Determination of fair value involves estimates based on internal valuations of discounted cash flow analyses performed, third party valuations, or other valuation techniques that involve subjective assumptions. Additionally, the term of the useful lives and appropriate amortization periods of intangible assets is subjective. Resulting goodwill from the Liberty Merger and the Virginia Partners Share Exchange, which totaled approximately $5.2 million and $4.4 million, respectively, under the acquisition method of accounting represents the excess of the purchase price over the fair value of net assets acquired. Goodwill is not amortized, but is evaluated for impairment annually or more frequently if deemed necessary. If the fair value of an asset exceeds the carrying amount of the asset, no charge to goodwill is made. If the carrying amount exceeds the fair value of the asset, goodwill will be adjusted through a charge to earnings, which is limited to the amount of goodwill allocated to that reporting unit. In evaluating the goodwill on its consolidated balance sheet for impairment after the consummation date of the Liberty Merger and the Virginia Partners Share Exchange, the Company will first assess qualitative factors to determine whether it is more likely than not that the fair value of our acquired assets is less than the carrying amount of the acquired assets, as allowed under ASU 2017-04. After making the assessment based on several factors, which will include, but is not limited to, the current economic environment, the economic outlook in our markets, our financial performance and common stock value as compared to our peers, we will determine if it is more likely than not that the fair value of our assets is greater than their carrying amount and, accordingly, will determine whether impairment of goodwill should be recorded as a charge to earnings in years subsequent to the Liberty Merger and the Virginia Partners Share Exchange. This assessment was performed during the fourth quarter of 2020, and resulted in no impairment of goodwill. Depending on the severity of the economic consequences of the COVID-19 pandemic and their impact on the Company, management may determine that goodwill is required to be evaluated for impairment due to the presence of a triggering event, which may have a negative impact on the Company’s results of operations. Management considered the impact of the COVID-19 pandemic on goodwill and determined that a triggering event had not occurred as of September 30, 48 2021. See Note 13 – Goodwill and Intangible Assets of the unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q for more information related to goodwill and intangible assets. In addition to the Company’s policies related to the valuation of goodwill and intangible assets, ongoing accounting for acquired loans is considered a critical accounting policy. Acquired loans are classified as either PCI loans or purchased performing loans and are recorded at fair value on the date of acquisition. PCI loans are those for which there is evidence of credit deterioration since origination and for which it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the “nonaccretable difference.” Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the “accretable yield” and is recognized as interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows. Periodically, the Company evaluates its estimate of cash flows expected to be collected on PCI loans. Estimates of cash flows for PCI loans require significant judgment. Subsequent decreases to the expected cash flows will generally result in a provision for credit losses resulting in an increase to the allowance for credit losses. Subsequent significant increases in cash flows may result in a reversal of post-acquisition provision for credit losses or a transfer from nonaccretable difference to accretable yield that increases interest income over the remaining life of the loan, or pool(s) of loans. The Company accounts for purchased performing loans using the contractual cash flows method of recognizing discount accretion based on the acquired loans’ contractual cash flows. Purchased performing loans are recorded at fair value, including a credit discount. The fair value discount is accreted as an adjustment to yield over the estimated lives of the loans. There is no allowance for credit losses established at the acquisition date for purchased performing loans, but a provision for credit losses may be required for any deterioration in these loans in future periods. The Company evaluates purchased performing loans quarterly for deterioration and records any required additional provision for credit losses. Results of Operations Net income attributable to the Company was $2.7 million, or $0.15 per basic and diluted share, for the three months ended September 30, 2021, a $1.6 million, or 141.1%, increase when compared to net income attributable to the Company of $1.1 million, or $0.06 per basic and diluted share, for the same period in 2020. The increase in net income attributable to the Company for the three months ended September 30, 2021, as compared to the same period in 2020, was driven by an increase in net interest income and a lower provision for credit losses, and was partially offset by a decrease in other income and higher other expenses and federal and state income taxes. Net income attributable to the Company was $5.9 million, or $0.33 per basic and diluted share, for the nine months ended September 30, 2021, a $1.4 million or 30.3% increase when compared to net income attributable to the Company of $4.6 million, or $0.26 per basic and diluted share, for the same period in 2020. The increase in net income attributable to the Company for the nine months ended September 30, 2021, as compared to the same period in 2020, was driven by an increase in net interest income, lower provision for credit losses, and an increase in other income, and was partially offset by higher other expenses and federal and state income taxes. The Company’s results of operations for the three and nine months ended September 30, 2021 were directly impacted by the following: Positive Impacts:
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Negative Impacts:
For the three months ended September 30, 2021, the Company’s annualized return on average assets, annualized return on average equity and efficiency ratio were 0.66%, 7.79% and 73.86%, respectively, as compared to 0.29%, 3.30% and 71.45%, respectively, for the same period in 2020. For the nine months ended September 30, 2021, the Company’s annualized return on average assets, annualized return on average equity and efficiency ratio were 0.50%, 5.86% and 73.49%, respectively, as compared to 0.44%, 4.57% and 70.93%, respectively, for the same period in 2020. Financial Condition Total assets as of September 30, 2021 were $1.64 billion, an increase of $123.6 million, or 8.2%, from December 31, 2020. Key drivers of this change were increases in cash and cash equivalents and total loans held for investment. Changes in key balance sheet components as of September 30, 2021 compared to December 31, 2020 were as follows:
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Delmarva's Tier 1 leverage capital ratio was 7.9% at September 30, 2021 as compared to 8.1% at December 31, 2020. At September 30, 2021, Delmarva's Tier 1 risk weighted capital ratio and total risk weighted capital ratio were 11.5% and 12.8%, respectively, as compared to a Tier 1 risk weighted capital ratio and total risk weighted capital ratio of 11.6% and 12.9%, respectively, at December 31, 2020. Virginia Partners’ Tier 1 leverage capital ratio was 8.8% at September 30, 2021 as compared to 9.5% at December 31, 2020. At September 30, 2021, Virginia Partners’ Tier 1 risk weighted capital ratio and total risk weighted capital ratio were 11.7% and 12.4%, respectively, as compared to a Tier 1 risk weighted capital ratio and total risk weighted capital ratio of 13.1% and 13.5%, respectively, at December 31, 2020. As of September 30, 2021, all of the capital ratios of Delmarva and Virginia Partners continue to exceed regulatory requirements, with total risk-based capital substantially above well-capitalized regulatory requirements. See “Capital” below for additional information about Delmarva’s and Virginia Partners’ capital ratios and requirements. At September 30, 2021, nonperforming assets totaled $8.1 million, an increase from December 31, 2020 balances of $7.6 million. The primary driver of this increase was an increase in nonaccrual loans, which was partially offset by decreases in loans past due 90 days or more and still accruing interest and OREO, net. Nonaccrual loans totaled approximately $6.8 million at September 30, 2021, as compared to $4.9 million at December 31, 2020. Loans past due 90 days or more and still accruing interest totaled $0 at September 30, 2021, as compared to $2 thousand at December 31, 2020. OREO, net as of September 30, 2021 totaled $1.3 million, as compared to $2.7 million at December 31, 2020. Nonperforming loans as a percentage of total assets was 0.41% at September 30, 2021, as compared to 0.32% at December 31, 2020. Nonperforming assets to total assets as of September 30, 2021 was 0.49%, as compared to 0.50% at December 31, 2020. Loans classified as TDRs totaled $7.9 million at September 30, 2021, as compared to $6.7 million at December 31, 2020, representing an increase of $1.2 million during the first nine months of 2021. This increase was primarily due to one loan relationship that was classified as a TDR during the first nine months of 2021, partially offset by four loan relationships that no longer met the definition of a TDR, two loan relationships that were charged-off, and two loan relationships that were paid off. Net charge-offs were $249 thousand, or 0.09% of average total loans (annualized), for the three months ended September 30, 2021, as compared to $572 thousand, or 0.22% of average total loans (annualized), for the same period of 2020. Net charge-offs were $740 thousand, or 0.09% of average total loans (annualized), for the nine months ended September 30, 2021, as compared to $1.1 million, or 0.13% of average total loans (annualized), for the same period of 2020. The allowance for credit losses to total loans ratio was 1.36% at September 30, 2021, as compared to 1.28% at December 31, 2020. In addition to the allowance for credit losses, as of September 30, 2021 and December 31, 2020, the Company had $2.7 million and $4.0 million, respectively, in unamortized discounts on acquired loans related to the acquisitions of Liberty and Virginia Partners. This discount is amortized over the life of the remaining loans. 51 Summary of Return on Equity and Assets
Earnings Analysis The Company’s primary source of revenue is interest income and fees, which it earns by lending and investing the funds which are held on deposit. Because loans generally earn higher rates of interest than investment securities, the Company seeks to deploy as much of its deposit funds as possible in the form of loans to individuals, businesses, and other organizations. To ensure sufficient liquidity, the Company also maintains a portion of its deposits in cash and cash equivalents, government securities, interest bearing deposits in other financial institutions, and overnight loans of excess reserves (known as ‘‘Federal Funds Sold’’) to correspondent banks. The revenue which the Company earns (prior to deducting its overhead expenses) is essentially a function of the amount of the Company’s loans and deposits, as well as the profit margin (‘‘interest spread’’) and fee income which can be generated on these amounts. Net income attributable to the Company was $2.7 million and $5.9 million for the three and nine months ended September 30, 2021, respectively, as compared to net income attributable to the Company of $1.1 million and $4.6 million, respectively, for the same periods of 2020. The following is a summary of the results of operations by the Company for the three and nine months ended September 30, 2021 and 2020.
Interest Income and Expense – Three Months Ended September 30, 2021 and 2020 Net interest income and net interest margin The largest component of net income for the Company is net interest income, which is the difference between the income earned on assets, such as loans and investment securities, and interest paid on liabilities, such as deposits and borrowings, used to support such assets. Net interest income is determined by the rates earned on the Company's interest-earning assets and the rates paid on its interest-bearing liabilities, the relative amounts of interest-earning assets and interest-bearing liabilities, and the degree of mismatch and the maturity and repricing characteristics of its interest-earning assets and interest-bearing liabilities. 52 Net interest income in the third quarter of 2021 increased by $1.4 million, or 13.1%, when compared to the third quarter of 2020. The Company's net interest margin (tax equivalent basis) increased to 3.02%, representing an increase of 16 basis points for the three months ended September 30, 2021 as compared to the same period in 2020. The increase in the net interest margin (tax equivalent basis) was primarily due to an increase in the average balance of and yields earned on average loans, due primarily to higher net loan fees earned related to the forgiveness of loans originated and funded under the PPP, and lower average balances of and rates paid on average interest-bearing liabilities, which were partially offset by lower average balances of and yields earned on average investment securities. The Company’s net interest margin (tax equivalent basis) was also negatively impacted by higher average balances of interest bearing deposits in other financial institutions and federal funds sold, and were partially offset by lower average balances of cash and due from banks, each of which are lower yielding interest-earning assets. Total interest income increased by $427 thousand, or 3.1%, for the three months ended September 30, 2021 while total interest expense decreased by $958 thousand, or 30.9%, both as compared to the same period in 2020. The most significant factors impacting net interest income during the three month period ended September 30, 2021 were as follows: Positive Impacts:
Negative Impacts:
Loans Average loan balances increased by $37.7 million, or 3.6%, and average yields earned increased by 0.05% to 4.86% for the three months ended September 30, 2021, as compared to the same period in 2020. The increase in average loan balances was primarily due to organic loan growth, including average growth of approximately $38.5 million in loans related to Virginia Partners’ recent expansion into the Greater Washington market, which was partially offset by the forgiveness of loans originated and funded under the PPP. Organic loan growth continues to be negatively impacted by higher pay-offs and tempered loan demand due to the uncertainty surrounding the COVID-19 pandemic. The increase in average yields earned was primarily due to higher net loan fees earned related to the forgiveness of loans originated and funded under the PPP, which was partially offset by pay-offs of higher yielding fixed rate loans, repricing of variable rate loans, and lower average yields on new loan originations, including loans originated under the PPP at an interest rate of 53 1%. Total average loans were 69.4% of total average interest-earning assets for the three months ended September 30, 2021, compared to 71.8% for the three months ended September 30, 2020. Investment securities Average total investment securities balances decreased by $13.2 million, or 9.4%, and average yields earned decreased by 0.46% to 1.99% for the three months ended September 30, 2021, as compared to the same period in 2020, primarily due to accelerated pre-payments on mortgage-backed investment securities and calls on higher yielding investment securities in the low interest rate environment and lower interest rates over the comparable period. The accelerated pre-payments on mortgage-backed investment securities have caused the premiums paid on these investment securities to be amortized into expense on an accelerated basis thereby reducing income and yield earned. Total average investment securities were 8.1% of total average interest-earning assets for the three months ended September 30, 2021, compared to 9.5% for the three months ended September 30, 2020. Interest-bearing deposits Average total interest-bearing deposit balances increased by $100.8 million, or 12.1%, and average rates paid decreased by 0.40% to 0.70% for the three months ended September 30, 2021, as compared to the same period in 2020, primarily due to organic deposit growth, including average growth of approximately $52.5 million in deposits related to Virginia Partners’ recent expansion into the Greater Washington market, and a decrease in the average rate paid on money market and time deposits due to the decline in interest rates beginning late in the first quarter of 2020. Borrowings Average total borrowings decreased by $113.4 million, or 69.5%, and average rates paid increased by 1.97% to 3.92% for the three months ended September 30, 2021, as compared to the same period in 2020. The decrease in average total borrowings balances was primarily due to a decrease in the average balance of Federal Home Loan Bank advances resulting from maturities and payoffs of borrowings that were not replaced, a decrease in average borrowings at the Federal Reserve Bank Discount Window under the PPP Liquidity Facility in which the loans under the PPP originated by the Company were previously pledged as collateral, and the early redemption of $2.0 million in subordinated notes payable, net, in early July 2021. The increase in average rates paid was primarily due to the decreases in the average balances of Federal Home Loan Bank advances and borrowings at the Federal Reserve Bank Discount Window under the PPP Liquidity Facility, which were lower cost interest-bearing liabilities, partially offset by the early redemption of subordinated notes payable, which was a higher cost interest-bearing liability. Interest Income and Expense – Nine Months Ended September 30, 2021 and 2020 Net interest income and net interest margin Net interest income in the first nine months of 2021 increased by $2.0 million, or 6.2%, when compared to the first nine months of 2020. The Company's net interest margin (tax equivalent basis) decreased to 3.05%, representing a decrease of 18 basis points for the nine months ended September 30, 2021 as compared to the same period in 2020. The decrease in the net interest margin (tax equivalent basis) was primarily due to a decrease in the yields earned on average loans and investment securities, and higher average balances of interest-bearing liabilities. These margin pressures were offset by higher net loan fees earned related to the forgiveness of loans originated and funded under the PPP, increases in average loan and investment securities balances, and lower rates paid on average interest-bearing liabilities. The Company’s net interest margin (tax equivalent basis) was also negatively impacted by higher average balances of cash and due from banks, interest bearing deposits in other financial institutions and federal funds sold, which are lower yielding interest-earning assets. Total interest income decreased by $457 thousand, or 1.1%, for the nine months ended September 30, 2021 while total interest expense decreased by $2.5 million, or 26.5%, both as compared to the same period in 2020. 54 The most significant factors impacting net interest income during the nine months ended September 30, 2021 were as follows: Positive Impacts:
Negative Impacts:
Loans Average loan balances increased by $41.3 million, or 4.0%, and average yields earned decreased by 0.12% to 4.90% for the nine months ended September 30, 2021, as compared to the same period in 2020. The increase in average loan balances was primarily due to organic loan growth, including average growth of approximately $38.5 million in loans related to Virginia Partners’ recent expansion into the Greater Washington market, and loans originated and funded under the PPP, which were partially offset by the forgiveness of loans originated and funded under the PPP. Organic loan growth continues to be negatively impacted by higher pay-offs and tempered loan demand due to the uncertainty surrounding the COVID-19 pandemic. The decrease in average yields earned was primarily due to pay-offs of higher yielding fixed rate loans, repricing of variable rate loans, and lower average yields on new loan originations, including loans originated under the PPP at an interest rate of 1%, which were partially offset by higher net loan fees earned related to the forgiveness of loans originated and funded under the PPP. Total average loans were 70.8% of total average interest-earning assets for the nine months ended September 30, 2021, compared to 77.2% for the nine months ended September 30, 2020. Investment securities Average total investment securities balances increased by $3.9 million, or 3.1%, and average yields earned decreased by 0.85% to 1.86% for the nine months ended September 30, 2021, as compared to the same period in 2020, primarily due to management of the investment securities portfolio in light of the Company's liquidity needs and lower interest rates over the comparable period. In addition, the decrease in average yields earned was driven by accelerated prepayments on mortgage-backed investment securities in the low interest rate environment. These prepayments have caused the premiums paid on these investment securities to be amortized into expense on an accelerated basis thereby reducing income and yield earned. Total average investment securities were 8.5% of total average interest-earning assets for the nine months ended September 30, 2021, compared to 9.3% for the nine months ended September 30, 2020. 55 Interest-bearing deposits Average total interest-bearing deposit balances increased by $112.5 million, or 14.3%, and average rates paid decreased by 0.46% to 0.78% for the nine months ended September 30, 2021, as compared to the same period in 2020, primarily due to organic deposit growth, including average growth of approximately $52.5 million in deposits related to Virginia Partners’ recent expansion into the Greater Washington market, and a decrease in the average rate paid on money market and time deposits due to the decline in interest rates beginning late in the first quarter of 2020. Borrowings Average total borrowings decreased by $71.1 million, or 53.5%, and average rates paid increased by 1.49% to 3.51% for the nine months ended September 30, 2021, as compared to the same period in 2020. The decrease in average total borrowings balances was primarily due to a decrease in the average balance of Federal Home Loan Bank advances resulting from maturities and payoffs of borrowings that were not replaced, a decrease in average borrowings at the Federal Reserve Bank Discount Window under the PPP Liquidity Facility in which the loans under the PPP originated by the Company were previously pledged as collateral, and the early redemption of $2.0 million in subordinated notes payable, net, in early July 2021, which were partially offset by the issuance of $18.1 million in subordinated notes payable, net, in late June 2020. The increase in average rates paid was primarily due to the issuance of subordinated notes payable, which is a higher cost interest-bearing liability, and the decreases in the average balances of Federal Home Loan Bank advances and borrowings at the Federal Reserve Bank Discount Window under the PPP Liquidity Facility, which were both lower cost interest-bearing liabilities, partially offset by the early redemption of subordinated notes payable, which was a higher cost interest-bearing liability. Interest earned on assets and interest paid on liabilities is significantly influenced by market factors, specifically interest rate targets established by the Federal Reserve. The Federal Open Markets Committee (“FOMC”) lowered Federal Funds target rates for the first time in 11 years on July 31, 2019 and then again in September 2019 and October 2019, for a combined decrease of 75 basis points during 2019. In response to market volatility related to the COVID-19 pandemic, the FOMC again lowered Federal Funds target rates twice in March 2020, for a combined decrease of 150 basis points. The FOMC’s current Federal Funds target rate range is currently 0% to 0.25%. As a consequence, long-term interest rates have decreased. The Company anticipates that these actions by the FOMC will continue to put downward pressure on its net interest margin. In general, the Company believes interest rate increases lead to improved net interest margins whereas interest rate decreases result in correspondingly lower net interest margins. The following tables depict, for the periods indicated, certain information related to the average balance sheet and average yields earned on assets and average costs paid on liabilities for the Company. Such yields and costs are derived by dividing income or expense by the average balance of the corresponding assets or liabilities. Average balances have been derived from daily averages. 56
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58 The level of net interest income is affected primarily by variations in the volume and mix of these interest-earning assets and interest-bearing liabilities, as well as changes in interest rates. The following tables show the effect that these factors had on the interest earned from the Company’s interest-earning assets and interest paid on its interest-bearing liabilities for the period indicated. Rate and Volume Analysis Three Months Ended September 30, 2021 Versus September 30, 2020 (Dollars in Thousands)
Rate and Volume Analysis Nine Months Ended September 30, 2021 Versus September 30, 2020 (Dollars in Thousands)
59 Interest Sensitivity. The Company monitors and manages the pricing and maturity of its assets and liabilities in order to diminish the potential adverse impact that changes in interest rates could have on its net interest income. The Company also performs asset/liability modeling to assess the impact varying interest rates and balance sheet mix assumptions will have on net interest income. Interest rate sensitivity can be managed by repricing assets or liabilities, selling investment securities available for sale, replacing an asset or liability at maturity, or adjusting the interest rate during the life of an asset or liability. Managing the amount of assets and liabilities repricing in the same time interval helps to hedge the risk and minimize the impact on net interest income of rising or falling interest rates. The Company evaluates interest sensitivity risk and then formulates guidelines regarding asset generation and repricing, funding sources and pricing, and off-balance sheet commitments in order to decrease interest rate sensitivity risk. At September 30, 2021 and December 31, 2020, the Company was asset sensitive within the one-year time frame when looking at a repricing gap analysis. The cumulative gap, in an unchanged interest rate environment, as a percentage of total assets up to one year is 28.0% and 23.0%, respectively, at September 30, 2021 and December 31, 2020. A positive gap indicates more assets than liabilities are repricing within the indicated time frame. Management believes there is more upside potential than downside risk and, based on the current and projected interest rate environment, management expects to see net interest income rise in the future. Provision for (Reversal of) Credit Losses and Allowance for Credit Losses The Company has developed policies and procedures for evaluating the overall quality of its credit portfolio and for timely identifying potential problem loans. Management's judgment as to the adequacy of the allowance for credit losses is based upon a number of assumptions about future events which it believes to be reasonable, but which may not prove to be accurate. Thus, there can be no assurance that loan charge-offs in future periods will not exceed the allowance for credit losses or that additional increases in the allowance for credit losses will not be required. The Company's allowance for credit losses consists of two parts. The first part is determined in accordance with authoritative guidance issued by the FASB regarding the allowance for credit losses. The Company's determination of this part of the allowance for credit losses is based upon quantitative and qualitative factors. A loan loss history based upon the prior three years is utilized in determining the appropriate allowance for credit losses. Historical loss factors are determined by criticized and uncriticized loans by loan type. These historical loss factors are applied to the loans by loan type to determine an indicated allowance for credit losses. The historical loss factors may also be modified based upon other qualitative factors including, but not limited to, local and national economic conditions, trends of delinquent loans, changes in lending policies and underwriting standards, concentrations, and management's knowledge of the loan portfolio. The second part of the allowance for credit losses is determined in accordance with guidance issued by the FASB regarding impaired loans. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis. Impaired loans not deemed collateral dependent are analyzed according to the ultimate repayment source, whether that is cash flow from the borrower, guarantor or some other source of repayment. Impaired loans are deemed collateral dependent if in the Company's opinion the ultimate source of repayment will be generated from the liquidation of collateral. The sum of the two parts constitutes management's best estimate of an appropriate allowance for credit losses. When the estimated allowance for credit losses is determined, it is presented to the Company's Board of Directors for review and approval on a quarterly basis. 60 At September 30, 2021, the Company’s allowance for credit losses was $15.0 million, or 1.4% of total outstanding loans. At December 31, 2020, the Company's allowance for credit losses was $13.2 million, or 1.3% of total outstanding loans. The increase in the allowance for credit losses and as a percentage of total outstanding loans as of September 30, 2021, as compared to December 31, 2020, was primarily due to organic loan growth, loans acquired in the Virginia Partners acquisition that have converted from acquired to originated status, the deterioration in asset quality and increased specific reserves of two loan relationships, the deterioration in asset quality and the establishment of a specific reserve on one loan relationship that has been individually evaluated for impairment, and an increase in historical loss rates, which were partially offset by a reduction of qualitative adjustment factors that had previously been increased in the allowance for credit losses related to the COVID-19 pandemic and the uncertainty in the economic environment. The (reversal of) credit losses in the third quarter of 2021 was $30 thousand, a decrease of $2.0 million, or 101.5%, when compared to the provision for credit losses of $2.0 million in the third quarter of 2020. The (reversal of) credit losses in the third quarter of 2021, as compared to the provision for credit losses in the same period of 2020, was primarily due to a reduction of qualitative adjustment factors that had previously been increased in the allowance for credit losses related to the COVID-19 pandemic and the uncertainty in the economic environment, which was partially offset by the deterioration in asset quality and establishment of a specific reserve on one loan relationship that has been individually evaluated for impairment, an increase in historical loss rates, loans acquired in the Virginia Partners acquisition that have converted from acquired to originated status, and organic loan growth. The provision for credit losses in the first nine months of 2021 was $2.6 million, a decrease of approximately $2.6 million, or 50.1%, when compared to the provision for credit losses of $5.1 million in the first nine months of 2020. The decrease in the provision for credit losses during the nine months ended September 30, 2021, as compared to the same period of 2020, was primarily due to a reduction of qualitative adjustment factors that had previously been increased in the allowance for credit losses related to the COVID-19 pandemic and the uncertainty in the economic environment, which was partially offset by the deterioration in asset quality and increased specific reserves of two loan relationships, the deterioration in asset quality and the establishment of a specific reserve on one loan relationship that has been individually evaluated for impairment, an increase in historical loss rates, loans acquired in the Virginia Partners acquisition that have converted from acquired to originated status, and organic loan growth. The (reversal of) provision for credit losses during the three and nine months ended September 30, 2021, as well as the allowance for credit losses as of September 30, 2021, represents management’s best estimate of the impact of the COVID-19 pandemic on the ability of the Company’s borrowers to repay their loans. Management continues to carefully assess the exposure of the Company’s loan portfolio to COVID-19 pandemic related factors, economic trends and their potential effect on asset quality. As of September 30, 2021, the Company’s delinquencies and nonperforming assets had not been materially impacted by the COVID-19 pandemic The Company discontinues accrual of interest on loans when management believes, after considering economic and business conditions and collection efforts that a borrower’s financial condition is such that the collection of interest is doubtful. Generally, the Company will place a delinquent loan in nonaccrual status when the loan becomes 90 days or more past due. At the time a loan is placed in nonaccrual status, all interest which has been accrued on the loan but remains unpaid is reversed and deducted from earnings as a reduction of reported interest income. No additional interest is accrued on the loan balance until the collection of both principal and interest becomes reasonably certain. 61 The following tables illustrate the Company’s past due and nonaccrual loans at September 30, 2021 and December 31, 2020: Past Due and Nonaccrual Loans (Dollars in Thousands) At September 30, 2021 and December 31, 2020
Total nonaccrual loans at September 30, 2021 were $6.8 million, which reflects an increase of approximately $1.8 million from $4.9 million at December 31, 2020. Management believes the relationships on nonaccrual were adequately reserved at September 30, 2021. TDR’s not past due more than 90 days or on nonaccrual at September 30, 2021 amounted to $3.9 million, as compared to $4.9 million at December 31, 2020. This decrease was primarily due to four loan relationships that no longer met the definition of a TDR and pay-downs of principal loan balances during the nine months ended September 30, 2021. Total TDR’s increased $1.2 million to $7.9 million at September 30, 2021, compared to $6.7 million at December 31, 2020. This increase was primarily due to one loan relationship that was classified as a TDR during the first nine months of 2021, partially offset by four loan relationships that no longer met the definition of a TDR, two loan relationships that were charged-off, and two loan relationships that were paid off. Nonperforming assets, defined as nonaccrual loans, loans past due 90 days or more and accruing, and OREO, net, at September 30, 2021 was $8.1 million compared to $7.6 million at December 31, 2020. The Company's ratio of nonperforming assets to total assets was 0.49% at September 30, 2021 compared to 0.50% at December 31, 2020. As noted above, there was an increase in nonaccrual loans during the nine months ended September 30, 2021. This increase was primarily due to the deteriorated financial condition of loan relationships totaling approximately $4.6 million, which was partially offset by pay-offs of approximately $1.7 million, charge-offs of approximately $481 thousand, normal paydowns of approximately $272 thousand, and the improved financial condition of loan relationships totaling approximately $276 thousand. Loans past due 90 days or more and accruing decreased during the nine months ended September 30, 2021. This decrease was primarily due to Delmarva selling its VISA credit card portfolio during the first quarter of 2021. OREO, net decreased during the nine months ended September 30, 2021 by $1.4 million. There were two properties with aggregate values of $1.1 million that were sold at a gain of $111 thousand during the first nine months of 2021, and valuation adjustments of $229 thousand were recorded on three properties with values of $1.5 million during the first nine months of 2021. 62 It is possible that the COVID-19 pandemic and the economic disruption related to it will negatively impact the Company’s financial position and results of operations during the fourth quarter of 2021. The Company may experience deterioration in asset quality, increased levels of charge-offs, and an increased level of provision for credit losses. The following tables provide additional information on the Company’s nonperforming assets at September 30, 2021 and December 31, 2020. Nonperforming Assets At September 30, 2021 and December 31, 2020 (Dollars in thousands)
Nonperforming Loans by Type At September 30, 2021 and December 31, 2020 (Dollars in thousands)
63 The following table provides data related to loan balances and the allowance for credit losses for the nine months ended September 30, 2021 and the year ended December 31, 2020. Allowance for Credit Losses Data (Dollars in Thousands) At September 30, 2021 and December 31, 2020
The following table represents the activity of the allowance for credit losses for the three and nine months ended September 30, 2021 and 2020 by loan type: Allowance for Credit Losses and Recorded Investments in Financing Receivables (Dollars in Thousands)
64
The following table provides information related to the allocation of the allowance for credit losses by loan category, the related loan balance for each category, and the percentage of loan balance to total loans by category: Allocation of the Allowance for Credit Losses At September 30, 2021 and December 31, 2020 (Dollars in thousands)
In March 2020, the five federal bank regulatory agencies and the Conference of State Bank Supervisors issued joint guidance with respect to loan modifications for borrowers affected by the COVID-19 pandemic (the “Joint Guidance”). The Joint Guidance encouraged banks, savings associations, and credit unions to make loan modifications for borrowers affected by the COVID-19 pandemic and assured those financial institutions that they will not (i) receive supervisory criticism for such prudent loan modifications and (ii) be required by examiners to automatically categorize COVID-19-related loan modifications as TDRs. The federal banking regulators confirmed with FASB that short-term loan modifications made on a good faith basis in response to the COVID-19 pandemic to borrowers who were current (i.e., less than 30 days past due on contractual payments) prior to any loan modification are not TDRs. In addition, Section 4013 of the CARES Act provides banks, savings associations, and credit unions with the ability to make loan modifications related to the COVID-19 pandemic without categorizing the loans as a TDR or conducting the analysis to make the determination, which is intended to streamline the loan modification process. Any such suspension is effective for the term of the loan modification; however, the suspension is only permitted for loan modifications made during the effective period and only for those loans that were not more than thirty (30) days past due as of December 31, 2019. 65 In addition, in an effort to support the Company’s borrowers in their times of need, the Company has granted loan payment deferrals to certain borrowers, who were current on their payments prior to the COVID-19 pandemic, on a short-term basis of three to six months. At the peak, which occurred during the second quarter of 2020, the Company, on a consolidated basis, had approved loan payment deferrals or payments of interest only for 548 loans totaling $286.6 million, which represented approximately 28.8% of total loan balances outstanding. As of September 30, 2021, all of the loan balances that were approved by the Company, on a consolidated basis, for loan payment deferrals or payments of interest only have either resumed regular payments or have been paid off. The Company continues to closely monitor credit risk and its exposure to increased loan losses resulting from the impact of the COVID-19 pandemic on its borrowers. The Company has identified nine specific higher risk industries to monitor the credit exposure of during this crisis. The table below identifies these higher risk industries and the Company’s exposure to them as of September 30, 2021:
As of September 30, 2021, there were no loans within these higher risk industries with respect to which the Company has granted loan payment deferrals. Noninterest Income Noninterest Income. The Company's primary source of noninterest income is service charges on deposit accounts, mortgage banking income and other income. Sources of other noninterest income include ATM, merchant card and credit card fees, debit card income, safe deposit box income, earnings on bank owned life insurance policies and investment fees and commissions. Noninterest income during the three months ended September 30, 2021 decreased by $254 thousand, or 10.9%, when compared to the three months ended September 30, 2020. Key changes in the components of noninterest income for the three months ended September 30, 2021, as compared to the same period in 2020, are as follows:
66
Noninterest income during the nine months ended September 30, 2021 increased by $523 thousand, or 8.7%, when compared to the nine months ended September 30, 2020. Key changes in the components of noninterest income for the nine months ended September 30, 2021, as compared to the same period in 2020, are as follows:
Noninterest Expense Noninterest Expense. Noninterest expense includes all expenses with the exception of those paid for interest on deposits and borrowings. Significant expense items included in this component are salaries and employee benefits, premises and equipment and other operating expenses. Noninterest expense during the three months ended September 30, 2021 increased by $1.1 million, or 12.3%, when compared to the three months ended September 30, 2020. Key changes in the components of noninterest expense for the three months ended September 30, 2021, as compared to the same period in 2020, are as follows:
67
Noninterest expense during the nine months ended September 30, 2021 increased by $3.2 million, or 12.0%, when compared to the nine months ended September 30, 2020. Key changes in the components of noninterest expense for the nine months ended September 30, 2021, as compared to the same period in 2020, are as follows:
68 Income Taxes The provision for income taxes was $839 thousand during the three months ended September 30, 2021, compared to the provision for income taxes of $308 thousand during the three months ended September 30, 2020, an increase of $532 thousand or 172.7%. This increase was due primarily to higher consolidated income before taxes, which was partially offset by higher earnings on tax-exempt income, primarily bank owned life insurance policies. For the three months ended September 30, 2021, the Company’s effective tax rate was approximately 23.8% as compared to 21.6% for the same period in 2020. The provision for income taxes was $1.8 million during the nine months ended September 30, 2021, compared to the provision for income taxes of $1.4 million during the nine months ended September 30, 2020, an increase of $436 thousand or 30.9%. This increase was due primarily to higher consolidated income before taxes, which was partially offset by higher earnings on tax-exempt income, primarily bank owned life insurance policies. For the nine months ended September 30, 2021, the Company’s effective tax rate was approximately 23.7% as compared to 23.6% for the same period in 2020. In addition, Virginia Partners is not subject to Virginia state income tax, but instead pays Virginia franchise tax. The Virginia franchise tax paid by Virginia Partners is recorded in the “Other operating expenses” line item on the Consolidated Statements of Income for the three and nine months ended September 30, 2021 and 2020. Financial Condition Interest Earning Assets Loans. Loans typically provide higher yields than the other types of interest-earning assets, and thus one of the Company's goals is to increase loan balances. Management attempts to control and counterbalance the inherent credit and liquidity risks associated with the higher loan yields without sacrificing asset quality to achieve its asset mix goals. Total gross loans, including unamortized discounts on acquired loans, averaged $1.09 billion and $1.06 billion during the three months ended September 30, 2021 and 2020, respectively, and averaged $1.08 billion and $1.04 billion during the nine months ended September 30, 2021 and 2020, respectively. The following table shows the composition of the loan portfolio by category at September 30, 2021 and December 31, 2020: Composition of Loan Portfolio by Category (Dollars in Thousands) As of September 30, 2021 and December 31, 2020
69 The following table sets forth the repricing characteristics and sensitivity to interest rate changes of the Company’s loan portfolio at September30,2021: Loan Maturities and Interest Rate Sensitivity (Dollars in thousands)
At September 30, 2021, real estate mortgage loans included $278.3 million of owner-occupied non-farm, non-residential loans, and $293.9 million of other non-farm, non-residential loans, which is 28.8% and 30.5% of real estate mortgage loans, respectively. By comparison, at December 31, 2020, real estate mortgage loans included $254.7 million of owner-occupied non-farm, non-residential loans, and $263.5 million of other non-farm, non-residential loans, which is 29.0% and 30.0% of real estate mortgage loans, respectively. This represents an increase at September 30, 2021 of $23.7 million and $30.4 million, or 9.3% and 11.5%, in owner-occupied non-farm, non-residential loans and other non-farm, non-residential loans, respectively. At September 30, 2021, real estate mortgage loans included $103.1 million of construction and land development loans, and $28.9 million of multi-family residential loans, which are 10.7% and 3.0% of real estate mortgage loans, respectively. By comparison, at December 31, 2020, real estate mortgage loans included $74.7 million of construction and land development loans, and $28.6 million of multi-family residential loans, which were 8.5% and 3.4% of real estate mortgage loans, respectively. This represents an increase at September 30, 2021 of $28.4 million, or 38.0%, in construction and land development loans, and an increase at September 30, 2021 of $332 thousand, or 1.2%, in multi-family residential loans, respectively. Commercial real estate loans, excluding owner-occupied non-farm, non-residential loans, were 259.9% of total risk-based capital at September 30, 2021, as compared to 234.0% at December 31, 2020. Construction and land development loans were 62.9% of total risk-based capital at September 30, 2021, as compared to 47.7% at December 31, 2020. At September 30, 2021, real estate mortgage loans included home equity loans of $33.5 million and residential real estate loans of $209.9 million, compared to $34.2 million and $199.3 million at December 31, 2020, respectively. Home equity loans decreased $724 thousand, or 2.1%, during the nine months ended September 30, 2021, while residential real estate loans increased $10.5 million, or 5.3%, during the nine months ended September 30, 2021. At September 30, 2021, commercial loans were $135.6 million, compared to $152.8 million at December 31, 2020, a decrease of $17.2 million, or 11.2%, during the nine months ended September 30, 2021. 70 The overall increase in loans from the year ended December 31, 2020 to September 30, 2021 was due primarily to the origination and funding of approximately $30.9 million in loans under round two of the PPP, which was partially offset by forgiveness payments received of approximately $58.8 million under rounds one and two of the PPP, and an increase in organic growth, including growth of approximately $40.6 million in loans related to Virginia Partners’ recent expansion into the Greater Washington market. As of September 30, 2021, approximately $14.4 million in loans under rounds one and two of the PPP were still outstanding. Beginning late in the first quarter of 2020, both Delmarva and Virginia Partners began assisting their customers in obtaining loans under the PPP in order to further assist their communities. Delmarva has provided access for customers and noncustomers to the program, allowing individuals or businesses visiting their website to access the SBA loan application and complete the process through a third party vendor. Loans processed through Delmarva’s website are funded by other banks or outside funding sources. During round one of this program, Virginia Partners, an SBA approved lender, directly originated and funded almost 700 loans totaling approximately $64.2 million, all of which were previously pledged as collateral to the Federal Reserve Bank Discount Window under the PPP Liquidity Facility. Beginning in the fourth quarter of 2020 and continuing through the third quarter of 2021, Virginia Partners received forgiveness payments from the Small Business Administration related to many of these loans. As of September 30, 2021, Virginia Partners had approximately $48 thousand in loans still outstanding under round one of this program, none of which have been pledged as collateral to the Federal Reserve Bank Discount Window under the PPP Liquidity Facility. Remaining aggregate fees, net of costs to originate, from the Small Business Administration of approximately $2 thousand will continue to be recognized in interest income over the life of these loans. Upon forgiveness of these loans, the remaining aggregate fees, net of costs to originate, will be recognized in interest income on an accelerated basis, which Virginia Partners expects to continue through 2021. Beginning early in the first quarter of 2021, both Delmarva and Virginia Partners began assisting their customers in obtaining loans under round two of this program in an identical manner as was done by each under round one of the program. As of September 30, 2021, Virginia Partners has directly originated and funded over 430 loans totaling approximately $30.9 million, none of which have been pledged as collateral to the Federal Reserve Bank Discount Window under the PPP Liquidity Facility. As of September 30, 2021, Virginia Partners had approximately $14.4 million in loans still outstanding under round two of this program. Aggregate fees, net of costs to originate, from the Small Business Administration of approximately $733 thousand will continue to be recognized in interest income over the life of these loans. Upon forgiveness of these loans, the remaining aggregate fees, net of costs to originate, will be recognized in interest income on an accelerated basis. Investment Securities. The investment securities portfolio is a significant component of the Company's total interest-earning assets. Total investment securities averaged $127.2 million during the three months ended September 30, 2021 as compared to $140.4 million for the three months ended September 30, 2020. This represented 8.1% and 9.5% of total average interest-earning assets for the three months ended September 30, 2021 and 2020, respectively. Total investment securities averaged $129.4 million during the nine months ended September 30, 2021 as compared to $125.4 million for the nine months ended September 30, 2020. This represented 8.5% and 9.3% of total average interest-earning assets for the nine months ended September 30, 2021 and 2020, respectively. The decrease in average total investment securities for the three months ended September 30, 2021, as compared to the same period of 2020, was primarily due to accelerated pre-payments on mortgage-backed investment securities and calls on higher yielding investment securities in the low interest rate environment. The increase in average total investment securities for the nine months ended September 30, 2021, as compared to the same period of 2020, was due to management of the investment securities portfolio in light of the Company’s liquidity needs, which was partially offset by accelerated pre-payments on mortgage-backed investment securities and calls on higher yielding investment securities in the low interest rate environment. The Company classifies all of its investment securities as available for sale. This classification requires that investment securities be recorded at their fair value with any difference between the fair value and amortized cost (the purchase price adjusted by any discount accretion or premium amortization) reported as a component of stockholders’ equity (accumulated other comprehensive income), net of deferred taxes. At September 30, 2021 and December 31, 2020, investment securities available for sale, at fair value totaled $115.6 million and $124.9 million, respectively. Investment securities available for sale, at fair value decreased by $9.4 million, or 7.5%, during the nine months ended 71 September 30, 2021. This decrease was primarily due to higher yielding investment securities being called, accelerated prepayments on mortgage-backed investment securities in the low interest rate environment and a decrease in unrealized gains on the investment securities available for sale portfolio. The Company attempts to maintain an investment securities portfolio of high quality, highly liquid investments with returns competitive with short-term U.S. Treasury or agency obligations. This objective is particularly important as the Company focuses on growing its loan portfolio. The Company primarily invests in securities of U.S. Government agencies, municipals, and corporate obligations. At September 30, 2021 and December 31, 2020 there were no issuers, other than the U.S. Government and its agencies, whose securities owned by the Company had a book or fair value exceeding 10% of the Company's stockholders' equity. The following table summarizes the amortized cost and fair value of investment securities available for sale for the as of September 30, 2021: Amortized Cost and Fair Value of Investment Securities (Dollars in Thousands)
In addition, the Company holds stock in various correspondent banks as well as the Federal Reserve Bank. The balance of these securities was $4.9 million and $5.4 million at September 30, 2021 and December 31, 2020, respectively, a decrease of $575 thousand, or 10.6%, for the nine months ended September 30, 2021. Due to the increase in longer term interest rates and ongoing volatility in the securities markets during the nine months ended September 30, 2021, the net unrealized gains in the Company’s investment securities available for sale portfolio decreased by approximately $1.8 million, or 59.8%, to $1.2 million at September 30, 2021. Subsequent interest rate fluctuations could have an adverse effect on our investment securities available for sale portfolio by increasing reinvestment risk and reducing our ability to achieve our targeted investment returns. Interest Bearing Liabilities Deposits. Average total deposits increased from $1.22 billion to $1.43 billion, an increase of $214.6 million, or 17.7%, for the three months ended September 30, 2021 over the average total deposits for the three months ended September 30, 2020. Average total deposits increased from $1.12 billion to $1.37 billion, an increase of $255.8 million, or 22.9%, for the nine months ended September 30, 2021 over the average total deposits for the nine months ended September 30, 2020. These increases were primarily due to organic deposit growth. At September 30, 2021, total deposits were $1.44 billion as compared to $1.27 billion at December 31, 2020, an increase of $167.3 million, or 13.2%. This increase was primarily driven by organic growth as a result of our continued focus on total relationship banking and Virginia Partners’ recent expansion into the Greater Washington market, customers seeking the liquidity and safety of deposit accounts in light of continuing economic uncertainty surrounding the COVID-19 pandemic, and the funding of loans under round two of the PPP, the proceeds of which are deposited directly into the operating accounts of these customers at the Company. Non-interest bearing demand deposits increased to $493.8 million at September 30, 2021, a $103.3 million, or 26.4%, increase from $390.5 million in non-interest bearing demand deposits at December 31, 2020, due primarily to the aforementioned items above with respect to average total deposits. 72 The following table sets forth the deposits of the Company by category for the period indicated: Deposits by Category As of September 30, 2021 and December 31, 2020 (Dollars in Thousands)
The Company's loan-to-deposit ratio was 77.0% at September 30, 2021 as compared to 81.7% at December 31, 2020. Core deposits, which exclude certificates of deposit of more than $250 thousand, provide a relatively stable funding source for the Company's loan portfolio and other interest-earning assets. The Company's core deposits were $1.34 billion at September 30, 2021, an increase of $205.6 million, or 18.1%, from $1.13 billion at December 31, 2020, and excluded $95.2 million and $133.5 million in certificates of deposit of $250 thousand or more as of those dates, respectively. Management anticipates that a stable base of deposits will be the Company's primary source of funding to meet both its short-term and long-term liquidity needs in the future, and, therefore, feels that presenting core deposits provides valuable information to investors. The following table provides a summary of the Company’s maturity distribution for certificates of deposit at the date indicated: Maturities of Certificates of Deposit (Dollars in Thousands)
The following table provides a summary of the Company’s maturity distribution for certificates of deposit of greater than $100 thousand or more at the date indicated: Maturities of Certificates of Deposit Greater than $100 Thousand (Dollars in Thousands)
73 Borrowings. Borrowings at September 30, 2021 and December 31, 2020 consist primarily of long-term borrowings with the FHLB, subordinated notes payable, net, and other borrowings. At September 30, 2021 and December 31, 2020, there were no short-term borrowings with the FHLB. At September 30, 2021, long-term borrowings with the FHLB were $26.5 million as compared to $33.0 million at December 31, 2020, a decrease of $6.5 million, or 19.7%. This decrease was primarily due to maturities and payoffs of borrowings that were not replaced. These borrowings are collateralized by a blanket lien on the first mortgage loans in the amount of the outstanding borrowings, FHLB capital stock, and amounts on deposit with the FHLB. At September 30, 2021, subordinated notes payable, net, were $22.2 million as compared to $24.1 million at December 31, 2020, a decrease of $1.9 million, or 8.1% related tothe early redemption of $2.0 million in subordinated notes payable, net, in early July 2021, partially offset by the amortization of the debt issuance costs. At September 30, 2021, other borrowings were $640 thousand as compared to $42.4 million at December 31, 2020, a decrease of $41.7 million, or 98.5%. This decrease was primarily due to a decrease in borrowings at the Federal Reserve Bank Discount Window under the PPP Liquidity Facility in which the loans under the PPP originated by Virginia Partners had previously been pledged as collateral. During the first quarter of 2021, Virginia Partners used a portion of its excess cash and cash equivalents to repay all borrowings that were previously outstanding under the PPP Liquidity Facility. In addition, Virginia Partners majority owned subsidiary, Johnson Mortgage Company, LLC, has a warehouse line of credit with another financial institution in the amount of $3.0 million, of which $0 and $142 thousand were outstanding as of September 30, 2021 and December 31, 2020, respectively. See Note 4 – Borrowings and Notes Payable of the unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q for additional information on the Company’s subordinated notes payable, net, and Johnson Mortgage Company, LLC’s warehouse line of credit. The following table provides a summary of average outstanding short term borrowings and weighted average rate for each period: Average Short Term Borrowings At September 30, 2021 and December 31, 2020 (Dollars in Thousands)
74 Average short-term borrowings decreased by $21.2 million, or 100.0%, and average rates paid decreased by 0.21% for the three months ended September 30, 2021 as compared to the same period in 2020. Average short-term borrowings decreased by $27.8 million, or 100.0%, and average rates paid decreased by 0.93% for the nine months ended September 30, 2021 as compared to the same period in 2020. These decreases were due primarily to decreases in short-term borrowings with the FHLB due to maturities that were not replaced. Average total borrowings decreased by $113.4 million, or 69.5%, and average rates paid increased by 1.97% to 3.92% for the three months ended September 30, 2021, as compared to the same period in 2020. The decrease in average total borrowings balances was primarily due to a decrease in the average balance of Federal Home Loan Bank advances resulting from maturities and payoffs of borrowings that were not replaced, a decrease in average borrowings at the Federal Reserve Bank Discount Window under the PPP Liquidity Facility in which the loans under the PPP originated by the Company were previously pledged as collateral, and the early redemption of $2.0 million in subordinated notes payable, net, in early July 2021. The increase in average rates paid was primarily due to the decreases in the average balances of Federal Home Loan Bank advances and borrowings at the Federal Reserve Bank Discount Window under the PPP Liquidity Facility, which were lower cost interest-bearing liabilities, partially offset by the early redemption of subordinated notes payable, which was a higher cost interest-bearing liability. Average total borrowings decreased by $71.1 million, or 53.5%, and average rates paid increased by 1.49% to 3.51% for the nine months ended September 30, 2021, as compared to the same period in 2020. The decrease in average total borrowings balances was primarily due to a decrease in the average balance of Federal Home Loan Bank advances resulting from maturities and payoffs of borrowings that were not replaced, a decrease in average borrowings at the Federal Reserve Bank Discount Window under the PPP Liquidity Facility in which the loans under the PPP originated by the Company were previously pledged as collateral, and the early redemption of $2.0 million in subordinated notes payable, net, in early July 2021, which were partially offset by the issuance of $18.1 million in subordinated notes payable, net, in late June 2020. The increase in average rates paid was primarily due to the issuance of subordinated notes payable, which is a higher cost interest-bearing liability, and the decreases in the average balances of Federal Home Loan Bank advances and borrowings at the Federal Reserve Bank Discount Window under the PPP Liquidity Facility, which were both lower cost interest-bearing liabilities, partially offset by the early redemption of subordinated notes payable, which was a higher cost interest-bearing liability. Capital Total stockholders’ equity as of September 30, 2021 was $139.5 million, an increase of $2.9 million, or 2.1%, from December 31, 2020. Key drivers of this change was the net income attributable to the Company for the nine months ended September 30, 2021, which was partially offset by the decrease in accumulated other comprehensive income, net of tax, cash dividends paid to shareholders and the repurchase of shares of the Company’s common stock under the Company’s Board of Directors approved stock purchase plan. The Federal Reserve and other bank regulatory agencies require bank holding companies and financial institutions to maintain capital at adequate levels based on a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 100%. The following table presents actual and required capital ratios as of September 30, 2021 and December 31, 2020 for Delmarva and Virginia Partners under Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of September 30, 2021 based on the phase-in provisions of the Basel III Capital Rules and the minimum required capital levels as of January 1, 2019 when the Basel III Capital Rules were fully phased-in. Capital levels required for an institution to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. See Note 10 – Regulatory Capital Requirements of the unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q for a more in depth discussion of regulatory capital requirements. 75 Capital Components Capital Components At September 30, 2021 and December 31, 2020 (Dollars in Thousands)
76 Liquidity Management Liquidity management involves monitoring the Company's sources and uses of funds in order to meet its day-to-day cash flow requirements while maximizing profits. Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of the available for sale investment securities portfolio is very predictable and subject to a high degree of control at the time investment decisions are made; however, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control. Asset liquidity is provided by cash and assets which are readily marketable, which can be pledged, or which will mature in the near future. Liability liquidity is provided by access to core funding sources, principally the ability to generate customer deposits in the Company's market area. The Company's cash and cash equivalents position, which includes funds in cash and due from banks, interest bearing deposits in other financial institutions, and federal funds sold, averaged $354.7 million and $316.3 million during the three and nine months ended September 30, 2021, respectively, and totaled $346.9 million at September 30, 2021, as compared to an average of $275.1 million and $180.8 million during the three and nine months ended September 30, 2020, respectively, and a year-end position of $282.6 million at December 31, 2020. Also, the Company has available advances from the FHLB. Advances available are generally based upon the amount of qualified first mortgage loans which can be used for collateral. At September 30, 2021, advances available totaled approximately $401.8 million of which $26.5 million had been drawn, or used for letters of credit. Management regularly reviews the liquidity position of the Company and has implemented internal policies which establish guidelines for sources of asset-based liquidity and limit the total amount of purchased funds used to support the balance sheet and funding from non-core sources. Subject to certain aggregation rules, FDIC deposit insurance covers the funds in deposit accounts up to $250 thousand. Impact of Inflation Unlike most industrial companies, the assets and liabilities of financial institutions such as the Company are primarily monetary in nature. Therefore, interest rates have a more significant effect on the Company's performance than do the effects of changes in the general rate of inflation and change in prices. In addition, interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. As discussed previously, management seeks to manage the relationships between interest sensitive assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation. Off-Balance Sheet Arrangements With the exception of the Company's obligations in connection with its irrevocable letters of credit and loan commitments, the Company has no other off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on its financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources, that is material to investors. Accounting Standards Update See Note 16 - Recent Accounting Pronouncements of the unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q for details on recently issued accounting pronouncements and their expected impact on the Company’s financial statements. 77 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not required. ITEM 4. CONTROLS AND PROCEDURES. The Company’s management, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, evaluated, as of the last day of the period covered by this report, the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2021. There were no changes in the Company’s internal control over financial reporting as defined in the Exchange Act Rules 13a-15(f) and 15d-15(f) that occurred during the first nine months of 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. PART II – OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. From time to time the Company, Delmarva and Partners are a party to various litigation matters incidental to the conduct of their respective businesses. The Company, Delmarva and Partners are not presently party to any legal proceedings the resolution of which the Company, Delmarva and Partners believes would have a material adverse effect on their respective businesses, prospects, financial condition, liquidity, results of operation, cash flows or capital levels. ITEM 1A. RISK FACTORS. The following risk factors should be considered in addition to the risk factors disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2020. Such factors relate to the Company's pending merger with OCFC. Because the market price of OCFC common stock will fluctuate, the value of the merger consideration to be received by our shareholders may change. On November 4, 2021, the Company announced the signing of a definitive Agreement and Plan of Merger, dated as of November 4, 2021, pursuant to which the Company will be acquired by OCFC. Under the terms of the merger agreement, each share of Company common stock (other than Exception Shares, as defined in the merger agreement), will be converted into the right to receive either 0.4512 shares of common stock of OCFC or $10.00, in each case, at the election of the holder of Company common stock, subject to a maximum of forty percent (40%) of the shares of Company common stock being convertible into cash and the allocation and proration provisions of the merger agreement. The closing price of OCFC common stock on the date that the merger is completed may vary from the closing price of OCFC common stock on the date OCFC and the Company announced the signing of the merger agreement and the date of the special meeting of Company shareholders regarding the merger. Because the stock portion of the merger consideration is determined by a fixed exchange ratio, at the time of the Company special meeting and at the time of the election with respect to the receipt of stock or cash consideration, Company shareholders will not know or be able to calculate the value of the shares of OCFC common stock they may receive upon completion of the merger. Any change in the market price of OCFC common stock prior to completion of the merger may affect the value of the stock portion of the merger consideration. Stock price changes may result from a variety of factors, including general market and economic conditions, changes in the companies’ respective businesses, operations and prospects, and regulatory considerations, among other things. Many of these factors are beyond the control of OCFC and the Company. Company shareholders should obtain current market quotations for shares of OCFC common stock and Company common stock before voting their shares at the Company special meeting and making their election with respect to the form of merger consideration they wish to receive. 78 Company shareholders may receive a form of consideration different from what they elect with respect to the merger with OCFC. Although each holder of Company common stock may elect to receive as consideration shares of OCFC common stock, only cash or a combination of OCFC common stock and cash, such elections are subject to a maximum of forty percent (40%) of the shares of Company common stock being convertible into cash and the allocation and proration provisions of the merger agreement. As a result, if the aggregate cash elections exceed forty percent (40%) of the shares of Company common stock, Company shareholders who elected cash will receive some of their merger consideration in a form that they did not elect. Regulatory approvals may not be received, may take longer than expected or may impose conditions that are not presently anticipated or cannot be met. Before the transactions contemplated by the merger agreement may be completed, various approvals must be obtained from bank regulatory authorities. In determining whether to grant these approvals, the applicable regulatory authorities consider a variety of factors, including the competitive impact of the proposal in the relevant geographic markets; financial, managerial and other supervisory considerations of each party; convenience and needs of the communities to be served and the record of the insured depository institution subsidiaries under the Community Reinvestment Act of 1977 and the regulations promulgated thereunder; effectiveness of the parties in combating money laundering activities; any significant outstanding supervisory matters; and the extent to which the proposal would result in greater or more concentrated risks to the stability of the United States banking or financial system. These regulatory authorities may impose conditions on the granting of such approvals. Such conditions or changes and the process of obtaining regulatory approvals could have the effect of delaying completion of the merger or of imposing additional costs or limitations on the combined company following the merger. The regulatory approvals may not be received at all, may not be received in a timely fashion, or may contain conditions on the completion of the mergers that are not anticipated or cannot be met. Furthermore, such conditions or changes may constitute a burdensome condition that may allow OCFC to terminate the merger agreement and OCFC may exercise its right to terminate the merger agreement. If the consummation of the mergers is delayed, including by a delay in receipt of necessary regulatory approvals, the business, financial condition and results of operations of the Company may also be materially and adversely affected. Failure of the merger to be completed, the termination of the merger agreement or a significant delay in the consummation of the merger could negatively impact the Company. The merger agreement is subject to a number of conditions which must be fulfilled in order to complete the mergers. These conditions to the consummation of the merger may not be fulfilled and, accordingly, the merger may not be completed. In addition, if the merger is not completed by November 4, 2022, either OCFC or the Company may choose to terminate the merger agreement at any time after that date if the failure of the effective time to occur on or before that date is not caused by any breach of the merger agreement by the party electing to terminate the merger agreement. If the merger is not consummated, the ongoing business, financial condition and results of operations of the Company may be materially adversely affected and the market price of the Company’s common stock may decline significantly, particularly to the extent that the current market price reflects a market assumption that the merger will be consummated. In addition, the Company has incurred and will incur substantial expenses in connection with the negotiation and completion of the transactions contemplated by the merger agreement. If the merger is not completed, the Company would have to recognize these expenses without realizing the expected benefits of the merger. Any of the foregoing, or other risks arising in connection with the failure of or delay in consummating the merger, including the diversion of management attention from pursuing other opportunities and the constraints in the merger agreement on the ability to make significant changes to the Company’s ongoing business during the pendency of the merger, could have a material adverse effect on the Company’s business, financial condition and results of operations. If the merger agreement is terminated and the Company’s board of directors seeks another merger or business combination, Company shareholders cannot be certain that the Company will be able to find a party willing to engage in a transaction on more attractive terms than the merger with OCFC. 79 The Company will be subject to business uncertainties and contractual restrictions while the mergers are pending. Uncertainty about the effect of the merger on employees, customers (including depositors and borrowers), suppliers and vendors may have an adverse effect on the business, financial condition and results of operations of the Company. These uncertainties may impair the Company’s ability to attract, retain and motivate key personnel and customers (including depositors and borrowers) pending the consummation of the merger, as such personnel and customers may experience uncertainty about their future roles and relationships following the consummation of the merger. Additionally, these uncertainties could cause customers (including depositors and borrowers), suppliers, vendors and others who deal with the Company to seek to change existing business relationships with the Company or fail to extend an existing relationship with the Company. In addition, competitors may target the Company’s existing customers by highlighting potential uncertainties and integration difficulties that may result from the merger. The pursuit of the merger and the preparation for the integration may place a burden on the Company’s management and internal resources. Any significant diversion of management attention away from ongoing business concerns and any difficulties encountered in the transition and integration process could have a material adverse effect on the Company’s business, financial condition and results of operations. In addition, the merger agreement restricts each party from taking certain actions without the other party’s consent while the merger is pending. These restrictions could have a material adverse effect on the Company’s business, financial condition and results of operations. The merger agreement contains provisions that may discourage other companies from pursuing, announcing or submitting a business combination proposal to the Company that might result in greater value to Company shareholders. The merger agreement contains provisions that may discourage a third party from pursuing, announcing or submitting a business combination proposal to the Company that might result in greater value to Company shareholders than the merger with OCFC. These provisions include a general prohibition on the Company from soliciting, or, subject to certain exceptions, entering into discussions with any third party regarding any acquisition proposal or offers for competing transactions. Furthermore, if the merger agreement is terminated, under certain circumstances, the Company may be required to pay OCFC a termination fee equal to $7,400,000. The Company also has an obligation to submit its merger-related proposals to a vote by its shareholders, including if the Company receives an unsolicited proposal that the Company board of directors believes is superior to the merger, unless the merger agreement is terminated by the Company under certain conditions described in the merger agreement. Litigation against the Company or OCFC, or the members of the Company’s or OCFC’s board of directors, could prevent or delay the completion of the OCFC Merger. Purported shareholder plaintiffs may assert legal claims related to the OCFC merger. The results of any such potential legal proceeding would be difficult to predict and such legal proceedings could delay or prevent the merger from being completed in a timely manner. The existence of litigation related to the merger could affect the likelihood of obtaining the required approval from Company’s shareholders. Moreover, any litigation could be time consuming and expensive, and could divert attention of the Company’s and OCFC’s respective management teams away from their companies’ regular business. Any lawsuit adversely resolved against the Company, OCFC or members of their respective boards of directors, could have a material adverse effect on each party’s business, financial condition and results of operations. One of the conditions to the consummation of the merger is the absence of any law, order, decree or injunction (whether temporary, preliminary or permanent) or other action taken by the governmental authority of competent jurisdiction that restricts, enjoins or prohibits or makes illegal the consummation of the transactions contemplated by the merger agreement, including the merger. Consequently, if a settlement or other resolution is not reached in any lawsuit that is filed or any regulatory proceeding and a claimant secures injunctive or other relief or a governmental authority issues an order or other directive restricting, prohibiting or making illegal the completion of the transactions 80 contemplated by the merger agreement, including the merger, then such injunctive or other relief may prevent the merger from being completed in a timely manner or at all. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. On November 12, 2020, the Company issued a press releaseannouncing that its Board of Directors approved a stock repurchase program (the “Program”). Under the Program, the Company is authorized to purchase up to 356,000 outstanding shares of its common stock. The Company may repurchase shares in the open market or through privately negotiated transactions. The actual timing, number and value of shares repurchased under the Program depends on a number of factors, including constraints specified in any Rule 10b5-1 trading plans, price, general business and market conditions, and alternative investment opportunities. The Program does not obligate the Company to acquire any specific number of shares in any period, and may be expanded, extended, modified or discontinued at any time. Any shares acquired will be cancelled and become authorized but unissued shares, available for future issuance. During the quarter ended
ITEM 3. DEFAULTS UPON SENIOR SECURITIES. Not applicable. ITEM 4. MINE SAFETY DISCLOSURES. None. ITEM 5. OTHER INFORMATION. None. 81 ITEM 6.EXHIBIT
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** Management contract or compensatory plan or agreement. 83 SIGNATURES Pursuant to the requirements
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