SBA-PPP Loans

12 Months Ended

Dec. 31, 2021

Loans and Leases Receivable Disclosure [Line Items]

Portfolio Loans Receivable

Major categories of portfolio loans are as follows:


	December 31,
(in thousands)	2021		2020
Real estate:
Residential	$	401,607	$	437,860
Commercial	556,339		392,550
Construction	255,147		224,904
Commercial	175,956		157,127
Credit card, net of reserve	141,120		102,186
Other consumer	1,033		1,649
	1,531,202		1,316,276
Deferred origination fees, net	(7,220)		(774)
Allowance for loan losses	(25,181)		(23,434)
Portfolio loans receivable, net	$	1,498,801	$	1,292,068

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

Residential Real Estate Loans. One-to-four family mortgage loans are primarily on owner-occupied primary residences and, to a lesser extent, investor owned residences. Residential loans are originated through the commercial sales teams and Capital Bank Home Loan division. Residential loans also include home equity lines of credit. Owner-occupied residential real estate loans usually have fixed rates for five or seven years and adjust on an annual basis after the initial term based on a typical maturity of 30 years. Investor residential real estate loans are generally based on 25-year terms with a balloon payment due after five years. Generally, the required minimum debt service coverage ratio is 1.15.

Commercial Real Estate Loans. Commercial real estate loans are originated on owner-occupied and non-owner-occupied properties. These loans may be more adversely affected by conditions in the real estate markets or in the general economy. Commercial loans that are secured by owner-occupied commercial real estate and primarily collateralized by operating cash flows are also included in this category of loans. As of December 31, 2021, there were approximately $302.5 million of owner-occupied commercial real estate loans, representing approximately 19.8% of the portfolio loan total. Commercial real estate loan terms are generally extended for 10 years or less and typically amortize over 25 years or less. The interest rates on commercial real estate loans have initial fixed rate terms that normally adjust at 5 years and origination fees are routinely charged for services. Personal guarantees from the principal owners of the business are generally required, supported by a review of the principal owners’ personal financial statements and global debt service obligations. The properties securing the portfolio are generally diverse in terms and type. This diversity helps reduce the exposure to adverse economic events that affect any single industry.

Note 5 - Portfolio Loans Receivable (continued)

Construction Loans. Construction loans are offered within the Company’s Washington, D.C. and Baltimore, Maryland metropolitan operating areas to builders primarily for the construction of single-family homes and condominium and townhouse conversions or renovations and, to a lesser extent, to individuals. Construction loans typically have terms of 12 to 18 months. The Company often transitions the end purchaser to permanent financing or re-underwriting and selling into the secondary market through Capital Bank Home Loans. According to underwriting standards, the ratio of loan principal to collateral value, as established by an independent appraisal, should not exceed 75% for investor-owned and 80% for owner-occupied properties. Semi-annual stress testing of the construction loan portfolio is conducted, and underlying real estate conditions are closely monitored as well as the borrower’s trends of sales valuations as compared to underwriting valuations.

The borrowers’ progress in construction buildout is monitored including for adherence to construction milestones and completion timelines.

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

Credit Cards. Through the OpenSky® credit card division, the Company offers secured, partially secured, and unsecured credit cards on a nationwide basis to under-banked populations and those looking to rebuild their credit scores through a fully digital and mobile platform. The secured lines of credit are secured by a noninterest bearing demand account at the Bank in an amount equal to the full credit limit of the credit card. For the partially secured lines of credit, the Bank offers certain customers an unsecured line in excess of their secured line of credit by using a proprietary scoring model, which considers credit score and repayment history (typically a minimum of six months of on-time repayments, but ultimately determined on a case-by-case basis). Partially secured and unsecured credit cards are only extended to existing unsecured card customers who have demonstrated sound credit behaviors. Approximately $126.6 million and $98.5 million of the credit card balances were secured by savings deposits held by the Bank as of December 31, 2021 and 2020, respectively, with $16.7 million and $5.7 million of the credit card balances not secured by savings deposits as of December 31, 2021 and 2020, respectively.

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

Acquired loans through acquisitions are recorded at estimated fair value on their purchase date with no carryover of the related allowance for loan losses. In estimating the fair value of loans acquired, certain factors were considered, including the remaining lives of the acquired loans, payment history, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, and the net present value of cash flows expected. Discounts on loans that were not considered impaired at acquisition were recorded as an accretable discount, which will be recognized in interest income over the terms of the related loans. For loans considered to be impaired, the difference between the contractually required payments and expected cash flows was recorded as a nonaccretable discount. The remaining nonaccretable discounts on loans acquired were $285 thousand at December 31, 2021 and 2020. Loans with nonaccretable discounts had a carrying value of $817.8 thousand and $835.7 thousand as of December 31, 2021 and 2020, respectively.

Note 5 - Portfolio Loans Receivable (continued)

The activity in the accretable discounts on loans acquired was as follows:



	December 31,
(in thousands)	2021		2020
Accretable discount at beginning of period	$	221	$	429
Accretion and payoff of loans	(55)		(208)
Accretable discount at end of period	$	166	$	221

The allowance for loan losses consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component covers non-impaired loans and is based on historical loss experience adjusted for current economic factors. The following tables present, by class and reserving methodology, the allocation of the allowance for loan losses and the gross investment in loans as of December 31, 2021 and 2020.



(in thousands)			Provision for Loan Losses								Allowance for Loan Losses Ending Balance Evaluated for Impairment:				Outstanding Loan Balances Evaluated for Impairment:
December 31, 2021	Beginning Balance				Charge-Offs		Recoveries		Ending Balance		Individually		Collectively		Individually		Collectively
Real estate:
Residential	$	7,153	$	(1,541)	$	—	$	—	$	5,612	$	—	$	5,612	$	2,835	$	398,772
Commercial	6,786		1,941		(161)		—		8,566		—		8,566		25		556,314
Construction	4,595		103		—		1		4,699		—		4,699		7,803		247,344
Commercial	2,417		253		(39)		6		2,637		218		2,419		676		175,280
Credit card (1)	2,462		2,612		(1,454)		35		3,655		—		3,655		—		141,120
Other consumer	21		(9)		—		—		12		—		12		—		1,033
	$	23,434	$	3,359	$	(1,654)	$	42	$	25,181	$	218	$	24,963	$	11,339	$	1,519,863

December 31, 2020
Real estate:
Residential	$	4,135	$	3,018	$	—	$	—	$	7,153	$	—	$	7,153	$	4,687	$	433,173
Commercial	3,572		3,214		—		—		6,786		—		6,786		2,358		390,192
Construction	2,668		2,216		(296)		7		4,595		—		4,595		1,736		223,168
Commercial	1,548		1,102		(233)		—		2,417		253		2,164		1,182		155,945
Credit card (1)	1,368		1,681		(637)		50		2,462		—		2,462		—		102,186
Other consumer	10		11		—		—		21		—		21		—		1,649
	$	13,301	$	11,242	$	(1,166)	$	57	$	23,434	$	253	$	23,181	$	9,963	$	1,306,313

_______________

(1) Credit cards loans are collectively evaluated by past due status and as such are not individually risk rated.

Note 5 - Portfolio Loans Receivable (continued)

Past due portfolio loans, segregated by delinquency and class of loans, as of December 31, 2021 and 2020 were as follows:



	Loans 30-89 Days Past Due		Loans 90 or More Days Past Due		Total Past Due Loans		Current Loans		Total Loans		Accruing Loans 90 or More days Past Due		Nonaccrual Loans
(in thousands)
December 31, 2021
Real estate:
Residential	$	469	$	2,494	$	2,963	$	398,644	$	401,607	$	72	$	2,835
Commercial	367		25		392		555,947		556,339		—		25
Construction	—		7,803		7,803		247,344		255,147		—		7,803
Commercial	183		593		776		175,180		175,956		—		676
Credit card	19,022		10		19,032		122,088		141,120		10		—
Other consumer	—		—		—		1,033		1,033		—		—
	$	20,041	$	10,925	$	30,966	$	1,500,236	$	1,531,202	$	82	$	11,339



December 31, 2020
Real estate:
Residential	$	1,029	$	3,539	$	4,568	$	433,292	$	437,860	$	—	$	3,581
Commercial	36		2,583		2,619		389,931		392,550		225		2,358
Construction	1,444		442		1,886		223,018		224,904		—		1,886
Commercial	486		741		1,227		155,900		157,127		—		1,182
Credit card	13,811		6		13,817		88,369		102,186		6		—
Other consumer	—		—		—		1,649		1,649		—		—
	$	16,806	$	7,311	$	24,117	$	1,292,159	$	1,316,276	$	231	$	9,007

Impaired loans also include acquired loans for which management has recorded a nonaccretable discount. Impaired loans as of December 31, 2021 and 2020 were as follows:



	Unpaid Contractual Principal Balance		Recorded Investment with no Allowance		Recorded Investment with Allowance		Total Recorded Investment		Related Allowance		Average Recorded Investment		Interest Recognized
(in thousands)
December 31, 2021
Real estate
Residential	$	3,022	$	2,835	$	—	$	2,835	$	—	$	4,578	$	345
Commercial	90		25		—		25		—		90		82
Construction	7,885		7,803		—		7,803		—		9,746		209
Commercial	832		340		336		676		218		1,056		282


	$	11,829	$	11,003	$	336	$	11,339	$	218	$	15,470	$	918



December 31, 2020
Real estate
Residential	$	3,960	$	3,726	$	—	$	3,726	$	—	$	3,982	$	136
Commercial	2,490		2,358		—		2,358		—		2,519		46
Construction	1,996		1,886		—		1,886		—		1,809		15
Commercial	1,344		791		391		1,182		253		1,826		58


	$	9,790	$	8,761	$	391	$	9,152	$	253	$	10,136	$	255

Note 5 - Portfolio Loans Receivable (continued)

There were $6 thousand and $175 thousand, respectively, of loans secured by one to four family residential properties in the process of foreclosure as of December 31, 2021 and 2020.

Credit quality indicators

As part of the ongoing monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends related to the risk grade of loans, the level of classified loans, net charge-offs, nonperforming loans, and the general economic conditions in the Company’s market.

The Company utilizes a risk grading matrix to assign a risk grade to each of its loans. A description of the general characteristics of loans characterized as classified is as follows:

Special Mention

A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Company’s credit position at some future date. Special mention loans are not adversely classified and do not expose the Company to sufficient risk to warrant adverse classification.

Borrowers may exhibit poor liquidity and leverage positions resulting from generally negative cash flow or negative trends in earnings. Access to alternative financing may be limited to finance companies for business borrowers and may be unavailable for commercial real estate borrowers.

Substandard

A substandard loan is inadequately protected by the current financial condition and paying capacity of the obligor or of the collateral pledged, if any. Substandard loans have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Borrowers may exhibit recent or unexpected unprofitable operations, an inadequate debt service coverage ratio, or marginal liquidity and capitalization. These loans require more intense supervision by Company management.

Doubtful

A doubtful loan has all the weaknesses associated with a substandard loan with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Note 5 - Portfolio Loans Receivable (continued)

The following table presents the balances of classified loans based on the risk grade. The Company grades all credit cards loans as Pass. Classified loans include Special Mention, Substandard, and Doubtful loans:



(in thousands)	Pass(1)		Special Mention		Substandard		Doubtful		Total
December 31, 2021
Real estate:
Residential	$	394,488	$	2,540	$	4,579	$	—	$	401,607
Commercial	548,244		8,070		25		—		556,339
Construction	243,848		3,496		7,803		—		255,147
Commercial	164,066		10,417		1,473		—		175,956
Credit card	141,120		—		—		—		141,120
Other consumer	1,033		—		—		—		1,033
Total	$	1,492,799	$	24,523	$	13,880	$	—	$	1,531,202

December 31, 2020
Real estate:
Residential	$	428,260	$	5,150	$	4,450	$	—	$	437,860
Commercial	383,311		6,881		2,358		—		392,550
Construction	220,057		1,112		3,735		—		224,904
Commercial	145,365		9,766		1,996		—		157,127
Credit card	102,186		—		—		—		102,186
Other consumer	1,649		—		—		—		1,649
Total	$	1,280,828	$	22,909	$	12,539	$	—	$	1,316,276

________________________

(1) Pass includes loans graded exceptional, very good, good, satisfactory and pass/watch, in addition to credit card loans which are not individually graded.

Note 5 - Portfolio Loans Receivable (continued)

Impaired loans also include certain loans that have been modified in troubled debt restructurings (“TDRs”) where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months. The status of TDRs is as follows:


	Number of Contracts	Recorded Investment
(dollars in thousands)		Performing		Nonperforming		Total
December 31, 2021
Real estate:
Residential	4	$	—	$	450	$	450


Commercial	1	—		83		83


Total	5	$	—	$	533	$	533



December 31, 2020
Real estate:
Residential	3	$	—	$	145	$	145
Commercial	2	—		294		294

Total	5	$	—	$	439	$	439

During the year ended December 31, 2021, the Company did restructure one residential portfolio loan for $319 thousand in which the borrower was granted a rate reduction and payment recast. There were no material financial effects as a direct result of this modification There was one commercial TDR that was paid off during the twelve months ended December 31, 2021 for $200 thousand. The Company had no defaulted TDR loans in the twelve months ended December 31, 2021. During the year ended December 31, 2020, the Company did not incur any new TDR loans. The Company had no defaulted TDR loans in the twelve months ended December 31, 2020.

Note 5 - Portfolio Loans Receivable (continued)

Outstanding loan commitments were as follows:



	December 31,
(in thousands)	2021		2020
Unused lines of credit
Commercial	$	15,747	$	15,973
Commercial real estate	37,640		32,398
Residential real estate	17,225		20,848
Home equity	118,518		118,843
Commercial and industrial	45,135		50,877
Credit card(1)	123,874		92,452
Personal	2,247		185



	$	360,386	$	331,576

Commitments to originate residential loans held for sale	$	1,385	$	11,444

Letters of credit	$	5,105	$	5,102

_______________

(1) Outstanding loan commitments in the credit card portfolio include $98.2 million and $89.5 million in secured balances as of December 31, 2021 and 2020, respectively.

Lines of credit are agreements to lend to a customer as long as there is no violation of any condition of the contract. Lines of credit generally have variable interest rates. Such lines do not represent future cash requirements because it is unlikely that all customers will draw upon their lines in full at any time. Loan commitments generally have variable interest rates, fixed expiration dates, and may require payment of a fee. Letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. In the event of nonperformance by the customer in accordance with the terms of the agreement with the third party, the Company would be required to fund the commitment.

The Company's maximum exposure to credit loss in the event of nonperformance by the customer is the contractual amount of the credit commitment. Loan commitments and lines of credit are made on the same terms, including collateral, as outstanding loans. The Company is not aware of any accounting loss to be incurred by funding these loan commitments.

As of December 31, 2021 and 2020, respectively, the Company had an allowance for off-balance-sheet credit risk of $1.7 million and $1.8 million, recorded in other liabilities on the consolidated balance sheet.

Note 5 - Portfolio Loans Receivable (continued)

The Company maintains a reserve for off-balance sheet items such as unfunded lines of credit. Activity for this account is as follows:




(in thousands)	2021		2020
Balance at beginning of period	$	1,776	$	1,226
Provision expense (release)	(40)		550
Add: Recoveries	—		—
Less: Charge-offs	—		—
Balance at end of period	$	1,736	$	1,776

The Company makes representations and warranties that loans sold to investors meet their program's guidelines and that the information provided by the borrowers is accurate and complete. In the event of a default on a loan sold, the investor may make a claim for losses due to document deficiencies, program non-compliance, early payment default, and fraud or borrower misrepresentations.

The Company maintains a reserve for potential losses on mortgage loans sold. Activity in this reserve is as follows for the periods presented:



(in thousands)	2021		2020
Balance at beginning of period	$	1,160	$	576
Add: Provision	4		598
Add: Recoveries	—		—
Less: Charge-offs	—		(14)
Balance at end of period	$	1,164	$	1,160

Paycheck Protection Program

Loans and Leases Receivable Disclosure [Line Items]

SBA-PPP Loans

Pursuant to the CARES Act and the Consolidated Appropriations Act, 2021, the SBA-PPP provides forgivable loans to small businesses to enable them to maintain payroll, hire back employees who have been laid off, and cover applicable overhead. SBA-PPP loans have an interest rate of 1%, have 2 and 5 year terms, and carry a 100% guarantee of the SBA. The PPP Extension Act of 2021 extended the program through May 31, 2021.

The allowance for loan losses for SBA-PPP loans was separately evaluated given the explicit government guarantee. This analysis, which incorporated historical experience with similar SBA guarantees and underwriting, concluded that the likelihood of loss was remote and therefore no allowance for loan losses was assigned to these loans.

At December 31, 2021, SBA-PPP loans receivable, which totaled $111.5 million, are all rated as pass credits, not past due, nonaccrual, TDR, or otherwise impaired. Earned fees for the years ended December 31, 2021 and 2020 are $5.7 million and $2.8 million, respectively. Unearned net fees associated with the SBA-PPP loans amounted to $3.2 million and $3.9 million at December 31, 2021 and 2020, respectively. There were no outstanding commitments to extend additional SBA-PPP loans at December 31, 2021.