Meridian Corp - Annual Report: 2022 (Form 10-K)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20429
FORM 10-K
☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2022
Or
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 000-55983
(Exact name of registrant as specified in its charter)
| Pennsylvania | 83-1561918 | ||||
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | ||||
9 Old Lincoln Highway, Malvern, Pennsylvania 19355
(Address of principal executive offices) (Zip Code)
(484) 568-5000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class | Trading Symbol(s) | Name of Exchange on Which Registered | ||||||
| Common Stock, par value $1 per share | MRBK | The Nasdaq Stock Market LLC | ||||||
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ☐ Yes ☒ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ☐ Yes ☒ No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§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.
Large accelerated filer | ☐ | Accelerated filer | ☒ | Non-accelerated filer | ☐ | ||||||||||||
Smaller reporting company | ☒ | Emerging growth company | ☐ | ||||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 USC. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒ Yes ☐ No
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ☐ Yes ☒ No
The approximate aggregate market value of voting stock held by non-affiliates of the registrant is $156,634,880 as of June 30, 2022 based upon the last sales price in which our common stock was quoted on the NASDAQ Stock Market on June 30, 2022.
As of March 10, 2023 there were 11,388,104 shares of common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement for the 2023 Annual Meeting of Stockholders, are incorporated by reference into Part III of this Annual Report on Form 10-K.
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MERIDIAN CORPORATION
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2022
TABLE OF CONTENTS
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Glossary of Acronyms, Abbreviations, and Terms
The acronyms, abbreviations, and terms listed below are used in various sections of this report. As used throughout this report, the terms "Meridian", “we”, “our”, or “us” refer to Meridian Corporation and its consolidated subsidiaries, unless the context otherwise requires.
| Acronym | Description | ||||
| ACH | Automated clearing house | ||||
| AFS | Available-for-sale | ||||
| ALCO | Asset/Liability Committee | ||||
| ALLL | Allowance for loan and lease losses | ||||
| ALM | Asset / liability management | ||||
| AOCI | Accumulated other comprehensive income | ||||
| ASC | Accounting Standards Codification | ||||
| ASU | Accounting Standards Update | ||||
| BHC Act | Bank Holding Company Act of 1956 | ||||
| BOLI | Bank owned life insurance | ||||
| BSA-AML | Bank Secrecy Act - Anti-Money Laundering | ||||
| CBCA | Change in Bank Control Act | ||||
| CBLR | Community Bank Leverage Ratio | ||||
| CDARS | Certificate of Deposit Account Registry Service | ||||
| CECL | Current expected credit losses | ||||
| CET1 | Common equity tier 1 | ||||
| CFPB | Consumer Financial Protection Bureau | ||||
| CMO | Collateralized mortgage obligation | ||||
| COVID-19 | Coronavirus Disease 2019 | ||||
| CRE | Commercial real estate | ||||
| DIF | FDIC’s deposit insurance fund | ||||
| ECOA | Equal Credit Opportunity Act | ||||
| ESOP | Employee Stock Ownership Plan | ||||
| FASB | Financial Accounting Standards Board | ||||
| FDIA | Federal Deposit Insurance Act | ||||
| FDIC | Federal Deposit Insurance Corporation | ||||
| FFIEC | Federal Financial Institutions Examination Council | ||||
| FHA | Federal Housing Authority | ||||
| FHFA | Federal Housing Finance Agency | ||||
| FHLB | Federal Home Loan Bank of Pittsburgh | ||||
| FHLMC | Federal Home Loan Mortgage Corporation or Freddie Mac | ||||
| FICO | Financing Corporation | ||||
| FNMA | Federal National Mortgage Association or Fannie Mae | ||||
| FRB | Federal Reserve Bank of Philadelphia | ||||
| FTE | Fully taxable equivalent | ||||
| GAAP | U.S. generally accepted accounting principles | ||||
| GLB Act | Gramm-Leach-Bliley Act | ||||
| GNMA | Government National Mortgage Association or Ginnie Mae | ||||
| GSE | Government-sponsored entities | ||||
| HTM | Held-to-maturity | ||||
| ICBA | Independent Community Bankers of America | ||||
| JOBS Act | Jumpstart Our Business Startups Act of 2012 | ||||
| LBP | Look-back period | ||||
| LEP | Loss emergence period | ||||
| LIBOR | London Inter-bank Offering Rate | ||||
| MBS | Mortgage-backed securities | ||||
| MSLP | Main Street Lending Programs | ||||
| MSR | Mortgage servicing rights | ||||
| OFAC | Office of Foreign Assets Control | ||||
| OREO | Other real estate owned | ||||
| PCAOB | Public Company Accounting Oversight Board | ||||
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| PDBS | Pennsylvania Department of Banking and Securities | ||||
| PPP | Paycheck Protection Program | ||||
| ROU | Right-of-use | ||||
| SBA | Small Business Administration | ||||
| SEC | Securities and Exchange Commission | ||||
| SERP | Supplemental Executive Retirement Plan | ||||
| SNC | Shared national credit | ||||
| TILA | Truth in Lending Act | ||||
| TDR | Troubled debt restructuring | ||||
| USDA | U.S. Department of Agriculture | ||||
| VA | U.S. Department of Veteran’s Affairs | ||||
PART I
Cautionary Statement Regarding Forward-Looking Statements
Meridian Corporation (the “Corporation” or “Meridian”) may from time to time make written or oral “forward-looking statements” within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements with respect to Meridian Corporation’s strategies, goals, beliefs, expectations, estimates, intentions, capital raising efforts, financial condition and results of operations, future performance and business. Statements preceded by, followed by, or that include the words “will”, “may,” “could,” “should,” “pro forma,” “looking forward,” “would,” “believe,” “expect,” “anticipate,” “estimate,” “intend,” “plan,” “project”, or similar expressions generally indicate a forward-looking statement. Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:
•Local, regional, national and international economic conditions and the impact they may have on us and our customers and our assessment of that impact.
•Volatility and disruption in national and international financial markets.
•Government intervention in the U.S. financial system.
•Changes in the mix of loan geographies, sectors and types or the level of non-performing assets and charge-offs.
•Changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements.
•The effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board.
•Inflation, interest rate, securities market and monetary fluctuations.
•The effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which we and our subsidiaries must comply.
•Impairment of our goodwill or other intangible assets.
•Acts of God or of war or terrorism.
•Changes in consumer spending, borrowings and savings habits.
•Changes in the financial performance and/or condition of our borrowers.
•Technological changes.
•The cost and effects of cyber incidents or other failures, interruption or security breaches of our systems or those of third-party providers.
•Acquisitions and integration of acquired businesses.
•Our ability to increase market share and control expenses.
•Our ability to attract and retain qualified employees.
•Changes in the competitive environment in our markets and among banking organizations and other financial service providers.
•The effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the PCAOB, the FASB and other accounting standard setters.
•Changes in the reliability of our vendors, internal control systems or information systems.
•Changes in our liquidity position.
•Changes in our organization, compensation and benefit plans.
•Lingering impacts of the COVID-19 pandemic and any other pandemic, epidemic or health-related crisis.
•The costs and effects of legal and regulatory developments, the resolution of legal proceedings or regulatory or other governmental inquiries, the results of regulatory examinations or reviews and the ability to obtain required regulatory approvals.
•Greater than expected costs or difficulties related to the integration of new products and lines of business.
•Our success at managing the risks involved in the foregoing items.
Meridian Corporation cautions that the foregoing factors are not exclusive, and neither such factors nor any such forward-looking statement takes into account the impact of any future events.
All forward-looking statements and information set forth herein are based on management’s current beliefs and assumptions as of the date hereof and speak only as of the date they are made. For a more complete discussion of the assumptions, risks and uncertainties
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related to our business, you are encouraged to review the Corporation’s filings with the SEC, including this Annual Report on Form 10-K for the year ended December 31, 2022 and subsequently filed quarterly reports on Form 10-Q and current reports on Form 8-K that update or provide information in addition to the information included in the Form 10-K and Form 10-Q filings, if any. the Corporation does not undertake to update any forward-looking statement whether written or oral, that may be made from time to time by the Corporation or by or on behalf of Meridian Bank, except as may be required under applicable laws.
Item 1. Business
General
The Corporation is a bank holding company engaged in banking activities through its wholly-owned subsidiary, Meridian Bank (the “Bank”), a full-service, state-chartered commercial bank with offices in the Delaware Valley tri-state market, which includes Pennsylvania, New Jersey and Delaware, as well as in the Central Maryland market, and Florida. We have a financial services business model with non-interest revenue streams from mortgage lending, SBA lending and wealth management services. We provide services to small and middle market businesses, professionals and retail customers throughout our market area. We have a modern, progressive, consultative approach to creating innovative solutions for our customers. We are technology driven, with a culture that incorporates significant use of customer preferred alternative delivery channels, such as mobile banking, remote deposit capture and bank-to-bank ACH. Our ‘Meridian everywhere’ philosophy of community presence, along with our strategic business footprint, allows us to provide the high degree of service, convenience and products our customers need to achieve their financial objectives. We provide this service through three principal business line distribution channels, described further below.
Corporate Structure and Business Lines
The Corporation is the parent to the Bank. The Bank is the parent to four wholly-owned subsidiaries: Meridian Land Settlement Services, LLC, which provides title insurance services; Apex Realty, LLC, a real estate holding company; Meridian Wealth Partners, LLC, a registered investment advisory firm, (“Meridian Wealth”); and Meridian Equipment Finance, LLC, an equipment leasing company. With these subsidiaries, the Corporation is organized into the following three lines of business.
Commercial Banking
The first line of business is our traditional banking operations, serving both commercial and consumer customers. We have a strong credit culture that promotes diversity of lending products with a focus on commercial businesses. We provide deposit and treasury management services, commercial and industrial lending and leasing, commercial real estate lending, small business lending, consumer and home equity lending, private banking, merchant services, and title and land settlement services. Our commercial and industrial lending department supports our small business and middle market borrowers with a comprehensive selection of loan products including financing solutions for wholesalers, manufacturers, distributors, service providers, importers and exporters, among others. Our portfolio includes business lines of credit, term loans, SBA lending, lease financing, other financings, and SNCs. We have no particular credit concentration. Our commercial loans have been proactively managed in an effort to achieve a balanced portfolio with no unusual exposure to one industry.
Our SBA team and their alliances with local economic development councils provide SBA 504 and 7(a) financing options to help grow local businesses, create and retain jobs and stimulate our local economy. In addition, Meridian understands that connections with the local professional industries benefit us, not only with these individuals as customers or investors, but also given the proven potential for business referrals.
The commercial real estate division offers permanent financing for owner-occupied commercial real estate loans and land development and construction loans for residential and commercial projects. Our approach is to apply disciplined and integrated standards to underwriting, credit and portfolio management. The extensive backgrounds of our commercial real estate lending team, not only in banking, but also directly in the builder/developer fields, bring a unique perspective and ability to communicate and consider all elements of a project and related risk from the clients’ viewpoint as well as ours.
Mortgage Banking
The second line of business is mortgage banking. Our mortgage consultants guide our clients through the complex process of obtaining a loan to meet consumer needs. Originations consist of consumer for-sale mortgage loans, loans to be held within our portfolio, and wholesale mortgage loans. Clients include homeowners and smaller scale investors. The mortgage division operates and originates mortgage loans in the Delaware Valley tri-state market, and Maryland markets, most typically for 1-4 family dwellings, with the intention of selling substantially all of these loans in the secondary market to qualified investors, while often retaining the servicing rights on these loans. Mortgages are originated through sales and marketing initiatives, as well as realtor, builder, bank, advertising and customer referral resources. The mortgage division performs origination, processing, underwriting, closing and post-closing functions both from our Blue Bell mortgage headquarters with 6 other production/processing offices in the Delaware Valley tri-state market, and from Maryland through our expanded footprint of 6 other production/processing offices in the state.
Wealth Management and Advisory Services
Meridian Wealth, a registered investment advisor and wholly-owned subsidiary of the Bank, provides a comprehensive array of wealth management services and products and the trusted guidance to help its clients and our banking customers prepare for the future. Such clients include professionals, higher net worth individuals, companies seeking to provide benefits plans for their employees, and more. Acquiring and sustaining wealth is a gradual progression, one that requires a considerable amount of thought and planning. Our process takes a comprehensive approach to financial planning and encompasses all aspects of retirement, with an emphasis on
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sustainability. Meridian Wealth offers a significant enhancement to both our capacity and the variety of tools we can use to help bring effective financial planning and wealth management services to a broad segment of customers.
Market Area
Meridian is headquartered in Malvern, PA, and has an operations center in Exton, PA, and six full-service branches in Philadelphia and surrounding counties. Its main branch, in Paoli, serves the Main Line. The West Chester and Media branches serve Chester and Delaware counties, respectively, while the Doylestown and Blue Bell branches serve Bucks and Montgomery counties, respectively. Our sixth branch is in Philadelphia. These branches provide “Relationship Hubs” for our regional lending groups and allow Meridian to serve markets at or near the county seat of counties in and surrounding Philadelphia.
In addition to our deposit taking branches, there are currently 17 other locations, including Corporate headquarters, that serve as loan production offices. These offices extend from the Philadelphia market area to Central Maryland, and Florida.
Demographic information for the five county Philadelphia metropolitan area (Philadelphia County, Chester County, Delaware County, Montgomery County, Bucks County) shows our primary market to be stable, with moderate population growth. According to the U.S. Census Bureau – 2020, the median household income in this area is $80,261 compared to the national average of $62,843, while the total population in this market was 4,218,131. Demographic information for the five county Baltimore metropolitan area (Baltimore County, Howard County, Montgomery County, Anne Arundel County, Prince George’s County) also shows that this secondary market is stable. According to the U.S. Census Bureau – 2020, the median household income in the Baltimore metropolitan area is $98,513 compared to the national average of $62,843, while the total population in this market was 3,804,375.
| (dollars in thousands / population actual) | United States | Pennsylvania | Maryland | ||||||||
Population (1) | 308,449,281 | 13,002,700 | 6,177,224 | ||||||||
Median household income (1) | $ | 63 | $ | 62 | $ | 85 | |||||
Unemployment rate (2) | 3.30 | % | 5.50 | % | 3.20 | % | |||||
| Philadelphia Metropolitan Area Counties | ||||||||||||||||||||
| Bucks County | Montgomery County | Delaware County | Chester County | Philadelphia County | Total | |||||||||||||||
Population (1) | 646,538 | 856,553 | 576,830 | 534,413 | 1,603,797 | 4,218,131 | ||||||||||||||
Median household income (1) | $ | 89 | $ | 92 | $ | 74 | $ | 100 | $ | 46 | $ | 80 | ||||||||
Unemployment rate (2) | 2.90 | % | 2.60 | % | 3.30 | % | 2.40 | % | 4.50 | % | ||||||||||
| Baltimore Metropolitan Area Counties | ||||||||||||||||||||
| Howard County | Montgomery County | Anne Arundel County | Prince George's County | Baltimore County | Total | |||||||||||||||
Population (1) | 332,317 | 1,062,061 | 588,261 | 967,201 | 854,535 | 3,804,375 | ||||||||||||||
Median household income (1) | $ | 121 | $ | 109 | $ | 101 | $ | 85 | $ | 77 | $ | 99 | ||||||||
Unemployment rate (2) | 2.50 | % | 2.80 | % | 2.60 | % | 3.70 | % | 3.20 | % | ||||||||||
(1) Source: U.S. Census Data – 2020 | ||||||||||||||||||||
(2) Source: U.S. Bureau of Labor Statistics – December 2021 | ||||||||||||||||||||
Competition
Overall, the banking business in our market area is highly competitive. The Bank faces substantial competition both in attracting deposits and in originating loans. The Bank competes with local, regional and national commercial banks, savings banks, and savings and loan associations. Other competitors include non-bank fintech and finance companies, money market mutual funds, mortgage bankers, insurance companies, securities brokerage firms, regulated small loan companies, credit unions, and issuers of commercial paper and other securities.
The Bank seeks to compete for business principally on the basis of high quality, personal service to customers, customer access to our decision-makers, and customer preferred electronic delivery channels while providing an attractive banking platform and competitive interest rates and services.
Human Capital Resources
At December 31, 2022, we employed 366 individuals, nearly all of whom are full-time and of which 48% are women. Women make up 32% of all officers throughout the Meridian organization. None of these employees are covered by collective bargaining agreements, and Meridian believes it enjoys good relations with its personnel. The Bank was named to American Bankers 2022 Top 200 Community Banks and in December of 2020, the Bank was named by the ICBA as one of their ‘Best Community Banks to Work For’. As an integrated full-service financial institution, approximately 52% of our employees are employed through our banking segment, 45% through our mortgage segment, and 3% for our wealth segment.
The safety of our employees has always been our top priority over the last few years due to the COVID-19 pandemic and this priority continues today. A portion of our workforce continues to work remotely and we still provide appointment-only lobby hours when requested.
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Meridian is committed to giving back to our communities. In 2022, we donated $520 thousand to over 100 organizations throughout the various communities that we serve in Pennsylvania, New Jersey, Delaware, Maryland, and Florida. Meridian also sponsors individual / group service days and provides time off to employees to participate in charitable activities in the communities we serve.
In order to compete effectively and continue to provide excellent service to our clients, we must attract, retain, and motivate qualified professionals. During the hiring process Meridian looks to bring onboard well-qualified individuals, without bias to race or gender. As we are currently in a very competitive hiring market, we utilize various methods to find well-qualified talent including third party search firms, social media, internal candidates already in our organization and on campus recruiting at local universities.
During 2022, we hired 81 professionals, 30% of which were women, and 21% of which were ethnically diverse. For 2022, our turnover rate was approximately 3.0%, which makes our overall retention rate very high compared to peers. We believe our culture, our effort to maintain a meritocracy in terms of opportunity and our continued evolution and growth contribute to our success in attracting and retaining strong talent.
Our benefits are designed to attract and retain employees by providing employees and their families with health and wellness programs (medical, dental, vision), retirement wealth accumulation, paid time off, income replacement (paid sick and disability leaves and life insurance) and family oriented benefits (parental leaves and child care assistance).
We aim to continually build on the expertise of our workforce. At entry levels, we have implemented trainee and internship programs. During 2022 Meridian invested throughout the organization in terms of in-house and external training programs to help our employees develop leadership skills, stay current on professional development topic in their area of focus, as well as to keep up to date on cybersecurity, and risk & compliance matters that impact the organization overall.
Our Current Capital Stock Structure
As of December 31, 2022, Meridian had 13,156,308 shares of common stock, $1 par value, issued and 11,465,572 shares outstanding. There is 1,690,736 shares held in treasury. All share and per share amounts have been adjusted to reflect the two-for-one stock split effective February 28, 2023.
Update on Emerging Growth Company Status
We qualified as an “emerging growth company” as defined by the JOBS Act, until December 31, 2022, the end of the fiscal year following the fifth anniversary of the completion of our initial public offering. An emerging growth company is able to take advantage of reduced reporting requirements and is relieved of certain other significant requirements that are otherwise generally applicable to public companies. While we are no longer considered an emerging growth company, we still qualify as a “smaller reporting company” under Item 10(f)(1) of Regulation S-K, and as such are still able to present only two years of audited financial statements, as well as including less extensive narrative disclosures around executive compensation arrangements.
Information about Meridian
Our executive offices are located at 9 Old Lincoln Highway, Malvern, PA 19355 and our telephone number is (484) 568-5000. Our Internet website is www.meridianbanker.com and our investor relations page can be found at investor.meridianbanker.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and all amendments thereto have been filed, along with this Annual Report on Form 10-K, with the SEC. The Corporation’s filings with the SEC can also be accessed at the SEC’s internet website: http://www.sec.gov.
Investors can obtain copies of Meridian’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, on Meridian’s website (accessible under “Investor Relations” – “SEC Filings”) as soon as reasonably practicable after Meridian has filed such materials with, or furnished them to, the SEC. Meridian will also furnish a paper copy of such filings free of charge upon request. Also on our website are our Audit Committee and Compensation Committee Charters. The information contained in our website or in any websites linked by our website, is not part of this Annual Report on Form 10-K.
Reports of the Bank’s condition and income, known as “Call Reports,” are filed with the FDIC and the Parent Company Only Financial Statement for Small Holding Companies known as the “FR Y-9SP” with the Federal Reserve. These reports are available on the FFIEC Central Data Repository’s Public Data Distribution website at cdr.ffiec.gov/public.
SUPERVISION AND REGULATION
Meridian and its subsidiaries are subject to extensive regulation under federal and state banking laws that establish a comprehensive framework for our operations. This framework may materially affect our growth potential and financial performance and is intended primarily for the protection of depositors, customers, federal deposit insurance funds and the banking system as a whole, not for the protection of our shareholders and creditors. The following discussion summarizes certain laws, regulations and policies to which Corporation and the Bank are subject. It does not address all applicable laws, regulations and policies that affect us currently or might affect us in the future. This discussion is qualified in its entirety by reference to the full texts of the laws, regulations and policies described.
The Bank is an FDIC-insured commercial bank chartered under the laws of Pennsylvania with regulatory oversight from the FDIC and the PDBS. The holding company, Meridian Corporation, is subject to supervision and examination by, and the regulations and reporting requirements of, the FRB, and is subject to the disclosure and regulatory requirements of the Exchange Act. In order to adhere to regulatory expectations on an ongoing basis and to successfully prepare for the normal examination processes, Meridian maintains numerous internal controls including policies and programs appropriate to maintain the Bank’s safety and soundness, under such key areas as lending, compliance, BSA-AML, information security, human resources, deposit and cash management products, enterprise
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risk, merchant services, finance, title services, branch security and wealth management. As a public company, the Corporation also files reports with the SEC and is subject to its regulatory authority, as well as the disclosure and regulatory requirements of the Securities Act, as amended, and the Exchange Act, as amended, with respect to the Corporation’s securities, financial reporting and certain governance matters. Because the Corporation’s securities are listed on the NASDAQ Stock Market, we are subject to NASDAQ's rules for listed companies, including rules relating to corporate governance.
Permissible Activities for Bank Holding Companies
The Corporation is a registered bank holding company under the BHC Act. In general, the BHC Act limits the business of bank holding companies to banking, managing or controlling banks and other activities that the Federal Reserve has determined to be so closely related to banking as to be a proper incident thereto, which include certain activities relating to extending credit or acting as an investment or financial advisor.
The FRB has the power to order any bank holding company or any of its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when the FRB has reasonable grounds to believe that continuing such activity, ownership or control constitutes a serious risk to the financial soundness, safety or stability of any bank subsidiary of the bank holding company.
Permissible Activities for Banks
As a Pennsylvania-chartered commercial bank, our business is subject to extensive supervision and regulation by state and federal bank regulatory agencies. Our business is generally limited to activities permitted by Pennsylvania law and any applicable federal laws. Under the Pennsylvania Banking Code of 1965 (the “Pennsylvania Banking Code”), the Bank may generally engage in all usual banking activities, including, among other things, accepting deposits; lending money on personal and real estate security; issuing letters of credit; buying, selling, discounting, factoring, and negotiating promissory notes and other forms of indebtedness; buying and selling foreign currency and, subject to certain limitations, certain investment securities; engaging in certain insurance activities and management services providing cash.
The FDIC has adopted regulations pertaining to the other activity restrictions imposed upon insured state banks and their subsidiaries. Pursuant to such regulations, insured state banks engaging in impermissible activities may seek approval from the FDIC to continue such activities. State banks not engaging in such activities but that desire to engage in otherwise impermissible activities either directly or through a subsidiary may apply for approval from the FDIC to do so; however, if such bank fails to meet the minimum capital requirements or the activities present a significant risk to the Deposit Insurance Fund, such application will not be approved by the FDIC. Pursuant to this authority, the FDIC has determined that investments in certain majority-owned subsidiaries of insured state banks do not represent a significant risk to the deposit insurance funds. Investments permitted under that authority include real estate activities and securities activities.
Meridian currently conducts certain non-banking activities through certain of the Bank’s non-bank subsidiaries. Meridian Bank currently operates four wholly-owned subsidiaries: Meridian Land Settlement Services, which provides title insurance services; Apex Realty, a real estate holding company; Meridian Wealth, a registered investment advisory firm, and Meridian Equipment Finance, an equipment leasing company.
Pennsylvania law also imposes restrictions on the Bank’s activities intended to ensure the safety and soundness of the Bank. For example, Meridian Bank is restricted under the Pennsylvania Banking Code from investing in certain types of investment securities and is generally limited in the amount of money it can lend to a single borrower or invest in securities issued by a single issuer.
Acquisitions by Bank Holding Companies
Control Acquisitions. The CBCA prohibits a person or group of persons from acquiring “control” of a bank holding company unless the Federal Reserve has been notified and has not objected to the transaction. Under a rebuttable presumption established by the Federal Reserve, the acquisition of 10% or more of a class of voting stock of a bank holding company with a class of securities registered under Section 12 of the Exchange Act, such as Meridian Corporation, would, under the circumstances set forth in the presumption, constitute acquisition of control of Meridian Corporation.
In addition, the CBCA prohibits any entity from acquiring 25% (the BHC Act has a lower limit for acquirers that are existing bank holding companies) or more of a bank holding company’s or bank’s voting securities, or otherwise obtaining control or a controlling influence over a bank holding company or bank without the approval of the Federal Reserve. On January 31, 2020, the Federal Reserve Board approved the issuance of a final rule (which became effective April 1, 2020) that clarifies and codifies the Federal Reserve’s standards for determining whether one company has control over another. The final rule establishes four categories of tiered presumptions of non-control that are based on the percentage of voting shares held by the investor (less than 5%, 5-9.9%, 10-14.9% and 15-24.9%) and the presence of other indicia of control. As the percentage of ownership increases, fewer indicia of control are permitted without falling outside of the presumption of non-control. These indicia of control include nonvoting equity ownership, director representation, management interlocks, business relationship and restrictive contractual covenants. Under the final rule, investors can hold up to 24.9% of the voting securities and up to 33% of the total equity of a company without necessarily having a controlling influence.
Dividends
The Corporation is a legal entity separate and distinct from the Bank and the Bank’s wholly-owned subsidiaries. As a Pennsylvania banking institution, the Bank is subject to certain restrictions on its ability to pay dividends under applicable banking laws and regulations.
Federal banking regulators are authorized to determine under certain circumstances relating to the financial condition of a bank holding company or a bank that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. In particular, federal banking regulators have stated that paying dividends that deplete a banking organization’s capital base to an inadequate level
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would be an unsafe and unsound banking practice and that banking organizations should generally pay dividends only out of current operating earnings. In addition, in the current financial and economic environment, the federal banking regulators have indicated that banks should carefully review their dividend policy and have discouraged payment ratios that are at maximum allowable levels unless both asset quality and capital are very strong. Under the Capital Rules, institutions that seek to pay dividends must maintain 2.5% in Common Equity Tier 1 capital attributable to the capital conservation buffer. See “—Regulatory Capital Requirements”.
Our principal source of cash flow and income is dividends from our subsidiaries, which is also the component of our liquidity. In addition to the restrictions discussed above, the Bank is subject to limitations under Pennsylvania law regarding the level of dividends that it may pay to its shareholder. Under the Pennsylvania Banking Code, the Bank generally may not pay dividends in excess of its net profits.
Parity Regulation
A Pennsylvania banking institution may, in accordance with Pennsylvania law and regulations issued by the PDBS, exercise any power and engage in any activity that has been authorized for national banks, federal thrifts or state banks in a state other than Pennsylvania, provided that the activity is permissible under applicable federal law and not specifically prohibited by Pennsylvania law. Such powers and activities must be subject to the same limitations and restrictions imposed on the national bank, federal thrift or out-of-state bank that exercised the power or activity, subject to a required notice to the PDBS. The FDIA, however, prohibits state-chartered banks from making new investments, loans, or becoming involved in activities as principal and equity investments which are not permitted for national banks unless (1) the FDIC determines the activity or investment does not pose a significant risk of loss to the Deposit Insurance Fund and (2) the Bank meets all applicable capital requirements. Accordingly, the additional operating authority provided to the Bank by the Pennsylvania Banking Code is restricted by the FDIA.
Transactions with Affiliates and Insiders
Transactions between our subsidiaries, or between the Corporation and our subsidiaries, are regulated under Sections 23A and 23B of the Federal Reserve Act. The Federal Reserve Act imposes quantitative and qualitative requirements and collateral requirements on covered transactions by the Bank with, or for the benefit of, its affiliates. Generally, the Federal Reserve Act limits the extent to which a bank or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10% of a bank’s capital stock and surplus, limits the aggregate amount of all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus, and requires those transactions to be on terms at least as favorable to a bank as if the transaction were conducted with an unaffiliated third party. Covered transactions are defined by statute to include a loan or extension of credit, as well as a purchase of securities issued by an affiliate, a purchase of assets (unless otherwise exempted by the Federal Reserve) from the affiliate, certain derivative transactions with an affiliate, the acceptance of securities issued by the affiliate as collateral for a loan, and the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate. In addition, any credit transactions with any affiliate, must be secured by designated amounts of specified collateral.
Federal law also limits a bank’s authority to extend credit to its directors, executive officers and 10% shareholders, as well as to entities controlled by such persons. Among other things, extensions of credit to insiders are required to be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons. Also, the terms of such extensions of credit may not involve more than the normal risk of non-repayment or present other unfavorable features and may not exceed certain limitations on the amount of credit extended to such persons individually and in the aggregate.
Source of Strength
Federal Reserve policy and federal law require bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. Under this requirement, Meridian is expected to commit resources to support the Bank, including at times when it may not be in a financial position to provide such resources, and it may not be in our, or our shareholders’ or creditors’, best interests to do so. In addition, any capital loans Meridian makes to the Bank are subordinate in right of payment to depositors and to certain other indebtedness of the Bank. In the event of our bankruptcy, any commitment by us to a federal banking regulatory agency to maintain the capital of the Bank will be assumed by the bankruptcy trustee and entitled to priority of payment.
Regulatory Capital Requirements
The Federal Reserve monitors the capital adequacy of the holding company on a consolidated basis, and the FDIC and the PDBS monitor the capital adequacy of the Bank. The banking regulators use a combination of risk-based guidelines and a leverage ratio to evaluate capital adequacy. The risk-based capital guidelines applicable to us are based on capital framework, known as Basel III, as implemented by the federal banking regulators. The risk-based guidelines are intended to make regulatory capital requirements sensitive to differences in credit and market risk profiles among banks and bank holding companies, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets.
Under the Basel III Capital Rules, the minimum capital ratios are (i) 4.5% CET1 to risk-weighted assets, (ii) 6% Tier 1 capital (that is, CET1 plus Additional Tier 1 capital) to risk-weighted assets, (iii) 8% total capital (that is, Tier 1 capital plus Tier 2 capital) to risk-weighted assets and (iv) 4% Tier 1 capital to average consolidated assets as reported on consolidated financial statements (known as the “leverage ratio”).
The current Capital Rules also include a capital conservation buffer designed to absorb losses during periods of economic stress. The capital conservation buffer is composed entirely of CET1, on top of these minimum risk-weighted asset ratios.
The Capital Rules require us to maintain an additional capital conservation buffer of 2.5% of CET1, effectively resulting in minimum ratios of (i) 7% CET1 to risk-weighted assets, (ii) 8.5% Tier 1 capital to risk-weighted assets, (iii) 10.5% total capital to risk-weighted assets and (iv) a minimum leverage ratio of 4%. The Capital Rules provide for a number of deductions from and adjustments to CET1.
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These include, for example, the requirement that mortgage servicing rights, certain deferred tax assets and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1. In addition, the Capital Rules provide for a countercyclical capital buffer applicable only to certain covered institutions. We do not expect the countercyclical capital buffer to be applicable to us. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the capital conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall. In addition, the effects of accumulated other comprehensive income items included in capital were excluded for the purposes of determining regulatory capital ratios. Under the Capital Rules, the effects of certain accumulated other comprehensive income items are not excluded; however, non-advanced approaches banking organizations, including the Bank, were able to make a one-time permanent election to continue to exclude these items. The Bank made this election.
The Capital Rules prescribe a new standardized approach for risk weightings that expanded the risk-weighting categories from the current four Basel I-derived categories (0%, 20%, 50% and 100%) to a much larger and more risk-sensitive number of categories, depending on the nature of the assets, generally ranging from 0%, for U.S. government and agency securities, to 600%, for certain equity exposures, and resulting in higher risk weights for a variety of asset categories.
Community banks have long raised concerns with bank regulators about the regulatory burden, complexity, and costs associated with certain provisions of the Basel III Rule. In response, Congress provided an “off-ramp” for institutions, like us, with total consolidated assets of less than $10 billion. Section 201 of the Regulatory Relief Act instructed the federal banking regulators to establish a single CBLR of between 8 and 10%. Under the final rule, a community banking organization is eligible to elect the new framework if it has: less than $10 billion in total consolidated assets, limited amounts of certain assets and off-balance sheet exposures, and a CBLR greater than 9%.The bank regulatory agencies temporarily lowered the CBLR to 8% as a result of the COVID-19 pandemic. During the first quarter of 2020, the Bank adopted the community bank leverage ratio framework as its primary regulatory capital ratio.
With respect to the Bank, the Capital Rules also revised the prompt corrective action regulations pursuant to Section 38 of the FDIA. See “—Prompt Corrective Action Framework” below.
Prompt Corrective Action Framework
The FDIA, requires among other things, that the federal banking agencies take “prompt corrective action” with respect to banks that do not meet minimum capital requirements. The FDIA sets forth the following five capital tiers for purposes of implementing the PCA regulations: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.”
Liquidity Regulations
Historically, the regulation and monitoring of bank and bank holding company liquidity has been addressed as a supervisory matter, without required formulaic measures. The Basel final framework requires banks and bank holding companies to measure their liquidity against specific liquidity tests that, although similar in some respects to liquidity measures historically applied by banks and regulators for management and supervisory purposes, going forward would be required by regulation. One test, referred to as the liquidity coverage ratio, or LCR, is designed to ensure that the banking entity maintains an adequate level of unencumbered high-quality liquid assets equal to the entity’s expected net cash outflow for a 30-day time horizon (or, if greater, 25% of its expected total cash outflow) under an acute liquidity stress scenario. The other test, referred to as the net stable funding ratio, or NSFR, is designed to promote more medium- and long-term funding of the assets and activities of banking entities over a one-year time horizon. These requirements will incentivize banking entities to increase their holdings of U.S. Treasury securities and other sovereign debt as a component of assets and increase the use of long-term debt as a funding source.
Safety and Soundness Standards
The FDIA requires the federal banking agencies to prescribe standards, by regulations or guidelines, relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, stock valuation and compensation, fees and benefits, and such other operational and managerial standards as the agencies deem appropriate. The federal banking agencies have adopted the Interagency Guidelines for Establishing Standards for Safety and Soundness. The guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings and compensation, fees and benefits. In general, these guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines. These guidelines also prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal shareholder. In addition, the agencies adopted regulations that authorize, but do not require, an agency to order an institution that has been given notice by an agency that it is not satisfying all safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an acceptable compliance plan, the banking regulator must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution may be subject under the FDIA. See “—Prompt Corrective Action Framework”. If an institution fails to comply with such an order, the banking regulator may seek to enforce such order in judicial proceedings and to impose civil money penalties.
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Deposit Insurance
FDIC insurance assessments
As an FDIC-insured bank, the Bank must pay deposit insurance assessments to the FDIC based on its average total assets minus its average tangible equity. Deposits are insured up to applicable limits by the FDIC and such insurance is backed by the full faith and credit of the United States Government.
As an institution with less than $10 billion in assets, the Bank’s assessment rates are based on the level of risk it poses to the FDIC’s DIF. The initial base rate for deposit insurance is between three and 30 basis points. Total base assessment after possible adjustments now ranges between 1.5 and 40 basis points. For established smaller institutions, like the Bank, supervisory ratings are used along with (i) an initial base assessment rate, (ii) an unsecured debt adjustment (which can be positive or negative), and (iii) a brokered deposit adjustment, to calculate a total base assessment rate.
Under the Dodd-Frank Act, the limit on FDIC deposit insurance was increased to $250 thousand. The coverage limit is per depositor, per insured depository institution for each account ownership category. The Dodd-Frank Act also set a new minimum DIF reserve ratio at 1.35% of estimated insured deposits.
In October, 2022, the FDIC adopted a final rule to increase the initial base deposit insurance assessment rate schedules uniformly by 2 basis points beginning with the first quarterly assessment period of 2023. The increased assessment rate schedules would remain in effect unless and until the reserve ratio of the Deposit Insurance Fund meets or exceeds 2 percent. As a result of the new rule, the FDIC insurance costs of insured depository institutions, including Meridian Bank, would generally increase.
The FDIC adopted a final rule effective June 26, 2020, and applied as of April 1, 2020, to mitigate the effect on deposit insurance assessments of a bank’s participation in the Paycheck Protection Program, the Paycheck Protection Program Liquidity Facility and the Money Market Mutual Fund Liquidity Facility in connection with the COVID-19 pandemic.
Under the FDIA, the FDIC may terminate deposit insurance upon a finding that an institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
Other assessments
In addition, the Deposit Insurance Funds Act of 1996 authorized the FICO to impose assessments on certain deposits in order to service the interest on the FICO’s bond obligations from deposit insurance fund assessments. The amount assessed on individual institutions is in addition to the amount, if any, paid for deposit insurance according to the FDIC’s risk-related assessment rate schedules. Assessment rates may be adjusted quarterly to reflect changes in the assessment base.
Depositor Preference
The FDIA provides that, in the event of the “liquidation or other resolution” of an insured depository institution, the claims of deposits of the institution, including the claims of the FDIC as subrogate of insured depositors, and certain claims for administrative expenses of the FDIC as a receiver, will have priority over other general unsecured claims against the institution. If an insured depository institution fails, insured and uninsured depositors, along with the FDIC, will have priority in payment ahead of unsecured, non-deposit creditors, including depositors whose deposits are payable only outside of the United States and the parent bank holding company, with respect to any extensions of credit they have made to such insured depository institution.
Interstate Branching
Pennsylvania banking laws authorize banks in Pennsylvania to acquire existing branches or branch de novo in other states, and also permits out-of-state banks to acquire existing branches or branch de novo in Pennsylvania.
Federal law permits state and national banks to merge with banks in other states subject to: (i) regulatory approval; (ii) federal and state deposit concentration limits; and (iii) any state law limitations requiring the merging bank to have been in existence for a minimum period of time (not to exceed five years) prior to the merger. The establishment of new interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) has historically been permitted only in those states the laws of which expressly authorize such expansion. However, the Dodd-Frank Act permits well-capitalized and well-managed banks to establish new branches across state lines without these impediments.
Consumer Financial Protection
The Bank is subject to a number of federal and state consumer protection laws that extensively govern our relationship with our customers. These laws include the ECOA, the Fair Credit Reporting Act, the TILA, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Home Mortgage Disclosure Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Fair Debt Collection Practices Act, Fair Credit Reporting Act, the Service Members Civil Relief Act, the Right to Financial Privacy Act, Telephone Consumer Protection Act, CAN-SPAM Act, and these laws’ respective state-law counterparts, as well as state usury laws and laws regarding unfair and deceptive acts and practices. These and other federal laws, among other things, require disclosures of the cost of credit and terms of deposit accounts, provide substantive consumer rights, prohibit discrimination in credit transactions, regulate the use of credit report information, provide financial privacy protections, restrict our ability to raise interest rates on extensions of credit and subject us to substantial regulatory oversight. Violations of applicable consumer protection laws can result in significant potential liability from litigation brought by customers, including actual damages, restitution and attorneys’ fees. Federal banking regulators, state attorneys general and state and local consumer protection agencies may also seek to enforce consumer protection requirements and obtain these and other remedies, including regulatory sanctions, customer rescission rights,
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action by the state and local attorneys general in each jurisdiction in which we operate and civil money penalties. Failure to comply with consumer protection requirements may also result in our failure to obtain any required bank regulatory approval for merger or acquisition transactions we may wish to pursue or our prohibition from engaging in such transactions even if approval is not required.
The CFPB has broad rule making, supervisory and enforcement powers under various federal consumer financial protection laws with respect to certain consumer financial products and services, including the ability to require reimbursements and other payments to customers for alleged legal violations. The CFPB has the authority to impose significant penalties, as well as injunctive relief that prohibits lenders from engaging in allegedly unlawful practices. The CFPB is also authorized to engage in consumer financial education, track consumer complaints, request data and promote the availability of financial services to underserved consumers and communities. Although all institutions are subject to rules adopted by the CFPB and examination by the CFPB in conjunction with examinations by the institution’s primary federal regulator, the CFPB has primary examination and enforcement authority over institutions with assets of $10 billion or more. The FDIC has primary responsibility for examination of the Bank and enforcement with respect to various federal consumer protection laws so long as the Bank has total consolidated assets of less than $10 billion, and state authorities are responsible for monitoring our compliance with all state consumer laws. The CFPB also has the authority to require reports from institutions with less than $10 billion in assets, such as the Bank, to support the CFPB in implementing federal consumer protection laws, supporting examination activities, and assessing and detecting risks to consumers and financial markets.
The consumer protection provisions of the Dodd-Frank Act and the examination, supervision and enforcement of those laws and implementing regulations by the CFPB have created a more intense and complex environment for consumer finance regulation. The CFPB has significant authority to implement and enforce federal consumer finance laws, including the TILA, the ECOA and new requirements for financial services products provided for in the Dodd-Frank Act.
The CFPB has broad rule making authority for a wide range of consumer financial laws that apply to all banks including, among other things, the authority to prohibit “unfair, deceptive, or abusive” acts and practices. Abusive acts or practices are defined in the Dodd-Frank Act as those that (1) materially interfere with a consumer’s ability to understand a term or condition of a consumer financial product or service, or (2) take unreasonable advantage of a consumer’s (a) lack of financial savvy, (b) inability to protect herself or himself in the selection or use of consumer financial products or services, or (c) reasonable reliance on a covered entity to act in the consumer’s interests. The review of products and practices to prevent such acts and practices is a continuing focus of the CFPB, and of banking regulators more broadly. The ultimate impact of this heightened scrutiny is uncertain but it could result in changes to pricing, practices, products and procedures. It could also result in increased costs related to regulatory oversight, supervision and examination, additional remediation efforts and possible penalties. The Dodd-Frank Act does not prevent states from adopting stricter consumer protection standards. State regulation of financial products and potential enforcement actions could also adversely affect our business, financial condition or results of operations.
Federal Home Loan Bank Membership
The Bank is a member of the FHLB, which serves as a central credit facility for its members. The FHLB is funded primarily from proceeds from the sale of obligations of the FHLB system. It makes loans to member banks in the form of FHLB advances. All advances from the FHLB are required to be fully collateralized as determined by the FHLB.
Ability-To-Pay Rules and Qualified Mortgages
As required by the Dodd-Frank Act, the CFPB issued a series of final rules in January 2013 amending Regulation Z, implementing TILA, which requires mortgage lenders to make a reasonable and good faith determination, based on verified and documented information, that a consumer applying for a residential mortgage loan has a reasonable ability to repay the loan according to its terms. These final rules prohibit creditors, such as the Bank, from extending residential mortgage loans without regard for the consumer’s ability to repay and add restrictions and requirements to residential mortgage origination and servicing practices. In addition, these rules restrict the imposition of prepayment penalties and restrict compensation practices relating to residential mortgage loan origination. Mortgage lenders are required to determine consumers’ ability to repay in one of two ways. The first alternative requires the mortgage lender to consider eight underwriting factors when making the credit decision. Alternatively, the mortgage lender can originate “qualified mortgages”, which are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. In general, a qualified mortgage is a residential mortgage loan that does not have certain high risk features, such as negative amortization, interest-only payments, balloon payments, or a term exceeding 30 years. In addition, to be a qualified mortgage, the points and fees paid by a consumer cannot exceed 3% of the total loan amount and the borrower’s total debt-to-income ratio must be no higher than 43% (subject to certain limited exceptions for loans eligible for purchase, guarantee or insurance by a government sponsored enterprise or a federal agency).
Commercial Real Estate Guidance
In December 2015, the federal banking regulators released a statement entitled “Interagency Statement on Prudent Risk Management for Commercial Real Estate Lending” (the “CRE Guidance”). In the CRE Guidance, the federal banking regulators (i) expressed concerns with institutions that ease commercial real estate underwriting standards, (ii) directed financial institutions to maintain underwriting discipline and exercise risk management practices to identify, measure and monitor lending risks, and (iii) indicated that they will continue to pay special attention to commercial real estate lending activities and concentrations going forward. The federal banking regulators previously issued guidance in December 2006, entitled “Interagency Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices”, which stated that an institution is potentially exposed to significant commercial real estate concentration risk, and should employ enhanced risk management practices, where (1) total commercial real estate loans represent 300% or more of its total capital and (2) the outstanding balance of such institution’s commercial real estate loan portfolio has increased by 50% or more during the prior 36 months.
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Leveraged Lending Guidance
The federal banking regulators jointly issued guidance on leveraged lending that describes regulatory expectations for the sound risk management of leveraged lending activities, including the importance for institutions to maintain, among other things, (i) a credit limit and concentration framework consistent with the institution’s risk appetite, (ii) underwriting standards that define acceptable leverage levels, (iii) strong pipeline management policies and procedures and (iv) guidelines for conducting periodic portfolio and pipeline stress tests.
Community Reinvestment Act of 1977
Under the CRA, the Bank has an obligation, consistent with safe and sound operations, to help meet the credit needs of the market areas where it operates, which includes providing credit to low- and moderate-income individuals and communities. In connection with its examination of the Bank, the FDIC is required to assess our compliance with the CRA. Our bank’s failure to comply with the CRA could, among other things, result in the denial or delay in certain corporate applications filed by us, including applications for branch openings or relocations and applications to acquire, merge or consolidate with another banking institution or holding company. In May 2022, the Federal Reserve, the FDIC and the OCC issued a joint proposal that would, among other things (i) expand access to credit, investment and basic banking services in low - and moderate-income communities, (ii) adapt to changes in the banking industry, including internet and mobile banking, (iii) provide greater clarity, consistency and transparency in the application of the regulations and (iv) tailor performance standards to account for differences in bank size, business model, and local conditions. The Bank will continue to evaluate the impact of any changes to the regulations implementing the CRA and their impact to the Bank’s financial condition, results of operations, and/or liquidity, which cannot be predicted at this time. Our bank received a rating of “Satisfactory” in its most recently completed CRA examination in 2020 that was as of February 11, 2020.
Financial Privacy
The federal banking regulators have adopted rules limiting the ability of banks and other financial institutions to disclose non-public information about consumers to unaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to an unaffiliated third party. These regulations affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors.
Anti-Money Laundering and the USA PATRIOT ACT
The USA PATRIOT Act of 2001, which was enacted in the wake of the September 11, 2001 attacks, includes provisions designed to combat international money laundering and advance the U.S. government’s war against terrorism. The USA PATRIOT Act and the regulations which implement it contain many obligations which must be satisfied by financial institutions, including the Bank. Those regulations impose obligations on financial institutions, such as the Bank, to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their customers. The failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing could have serious legal and reputational consequences for the financial institution.
Office of Foreign Assets Control Regulation
The U.S. Treasury Department’s OFAC administers and enforces economic and trade sanctions against targeted foreign countries and regimes, under authority of various laws, including designated foreign countries, nationals and others. OFAC publishes lists of specially designated targets and countries. We are responsible for, among other things, blocking accounts of, and transactions with, such targets and countries, prohibiting unlicensed trade and financial transactions with them and reporting blocked transactions after their occurrence. Failure to comply with these sanctions could have serious legal and reputational consequences and could result in civil money penalties imposed on the institution by OFAC. Failure to comply with these sanctions could also cause applicable bank regulatory authorities not to approve merger or acquisition transactions when regulatory approval is required or to prohibit such transactions even if approval is not required.
Incentive Compensation
Our primary regulator, as part of the regular, risk-focused examination process, will review the incentive compensation arrangements of banking organizations, such as us, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.
For regulated entities having at least $1 billion in total assets the rules establish general qualitative requirements applicable to all covered entities, which include: (i) prohibiting incentive arrangements that encourage inappropriate risks by providing excessive compensation; (ii) prohibiting incentive arrangements that encourage inappropriate risks that could lead to a material financial loss; (iii) establishing requirements for performance measures to appropriately balance risk and reward; (iv) requiring board of director oversight of incentive arrangements; and (v) mandating appropriate record-keeping.
Pursuant to rules adopted by the stock exchanges and approved by the SEC in January 2013 under the Dodd-Frank Act, public company compensation committee members must meet heightened independence requirements and consider the independence of compensation consultants, legal counsel and other advisors to the compensation committee. A compensation committee must have the authority to hire advisors and to have the public company fund reasonable compensation of such advisors.
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In October 2022, the SEC adopted a final rule directing national securities exchanges and associations, including Nasdaq, to implement listing standards that require listed companies to adopt policies mandating the recovery or “clawback” of excess incentive-based compensation earned by a current or former executive officer during the three fiscal years preceding the date the listed company is required to prepare an accounting restatement, including to correct an error that would result in a material misstatement if the error were corrected in the current period or left uncorrected in the current period. The final rule requires Meridian to adopt a clawback policy within 60 days after such listing standard becomes effective.
Cybersecurity
The GLB Act requires financial institutions to implement a comprehensive information security program that includes administrative, technical, and physical safeguards to ensure the security and confidentiality of client records and information. The Cybersecurity Information Sharing Act is intended to improve cybersecurity in the U.S. by enhanced sharing of information about security threats among the U.S. government and private sector entities, including financial institutions. The Cybersecurity Information Sharing Act also authorizes companies to monitor their own systems notwithstanding any other provision of law and allows companies to carry out defensive measures on their own systems from cyber-attacks. The law includes liability protections for companies that share cyber threat information with third parties so long as such sharing activity is conducted in accordance with Cybersecurity Information Sharing Act.
In October 2016, the federal bank regulatory agencies issued an Advanced Notice of Proposed Rulemaking regarding enhanced cyber risk management standards, which would apply to a wide range of large financial institutions and their third-party service providers. The proposed rules would expand existing cybersecurity regulations and guidance to focus on cyber risk management and governance, management of internal and external dependencies, and incident response, cyber resilience, and situational awareness. In addition, the proposal contemplates more stringent standards for institutions with systems that are critical to the financial sector. These enhanced standards would apply only to depository institutions and depository institution holding companies with total consolidated assets of $50 billion or more. The federal banking agencies have not yet taken further action on these proposed standards.
Separately, in November 2021, the United States federal bank regulatory agencies adopted a rule regarding notification requirements for banking organizations related to significant computer security incidents. Under the final rule, a bank holding company and a state member bank are required to notify the FRB within 36 hours of incidents that have materially disrupted or degraded, or are reasonably likely to materially disrupt or degrade, the banking organization’s ability to deliver services to a material portion of its client base, jeopardize the viability of key operations of the banking organization, or impact the stability of the financial sector. In March 2022, the SEC proposed rules that would require disclosure of material cybersecurity incidents, as well as cybersecurity risk management, strategy and governance.
In the ordinary course of business, we rely on electronic communications and information systems to conduct our operations and to store sensitive data. We employ an in-depth, layered, defensive approach that leverages people, processes and technology to manage and maintain cybersecurity controls. We employ a variety of preventative and detective tools to monitor, block, and provide alerts regarding suspicious activity, as well as to report on any suspected advanced persistent threats. Notwithstanding the strength of our defensive measures, the threat from cyberattacks is severe, attacks are sophisticated and increasing in volume, and attackers respond rapidly to changes in defensive measures. While to date, we have not experienced a significant compromise, significant data loss or any material financial losses related to cybersecurity attacks, our systems and those of our customers and third party service providers are under constant threat and it is possible that we could experience a significant event in the future. Risks and exposures related to cybersecurity attacks are expected to remain high due to the rapidly evolving nature and sophistication of these threats.
Future Legislation and Regulation
Congress may enact legislation from time to time that affects the regulation of the financial services industry, and state legislatures may enact legislation from time to time affecting the regulation of financial institutions chartered by or operating in those states. Federal and state regulatory agencies also periodically propose and adopt changes to their regulations or change the manner in which existing regulations are applied. The substance or impact of pending or future legislation or regulation, or the application thereof, cannot be predicted, although enactment of the proposed legislation could affect the regulatory structure under which we operate and may significantly increase our costs, impede the efficiency of our internal business processes, require us to increase our regulatory capital or modify our business strategy, or limit our ability to pursue business opportunities in an efficient manner. Our business, financial condition, results of operations or prospects may be adversely affected, perhaps materially, as a result.
Item 1A. Risk Factors
Investing in our common stock involves a significant degree of risk. The material risks and uncertainties that management believes affect us are described below. Before investing in our common stock, you should carefully consider the risks and uncertainties described below, in addition to the other information contained in this Annual Report. Any of the following risks, as well as risks that we do not know or currently deem immaterial, could have a material adverse effect on our business, financial condition or results of operations. As a result, the trading price of our common stock could decline, and you could lose some or all of your investment. Further, to the extent that any of the information in this Annual Report on Form 10-K constitutes forward-looking statements, the risk factors below are cautionary statements identifying important factors that could cause actual results to differ materially from those expressed in any forward-looking statements made by us or on our behalf. See “Cautionary Note Regarding Forward-Looking Statements”.
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As of December 31, 2022, we are no longer an “emerging growth company” and, as a result, are required to comply with increased disclosure and governance requirements.
As more than five fiscal years have passed since the November 17, 2017, listing of common stock listing on the NASDAQ, we ceased to be an “emerging growth company” as defined in the JOBS Act as of December 31, 2022. As such, we are subject to certain requirements that apply to other public companies but did not previously apply to us. These requirements include:
•The provisions of Section 404(b) of the Sarbanes-Oxley Act requiring that our independent registered public accounting firm provide an attestation report on the effectiveness of our internal control over financial reporting;
•The requirement to provide detailed compensation discussion and analysis in proxy statements and reports filed under the Exchange Act; and
•The “say on pay” provisions (requiring a non-binding stockholder vote to approve compensation of certain executive officers) and the “say on golden parachute” provisions (requiring a non-binding stockholder vote to approve golden parachute arrangements for certain executive officers in connection with mergers and certain other business combinations) of the Dodd-Frank Act and some of the disclosure requirements of the Dodd-Frank Act relating to compensation of our chief executive officer.
Therefore, this Annual Report is subject to Section 404(b) of the Sarbanes-Oxley Act, which requires that our independent registered public accounting firm provide an attestation report on the effectiveness of our internal control over financial reporting. Compliance with Section 404 is expensive and time consuming for management and could result in the detection of internal control deficiencies of which we are currently unaware. The loss of “emerging growth company” status and compliance with the additional requirements substantially increases our legal and financial compliance costs and make some activities more time consuming and costly.
Risks Related to Our Business / Operations
Recent and future bank failures may adversely affect the national, regional, and local business environment, results of operation, and capital.
Recent and future bank failures may have a profound impact on the national, regional, and local business environment in which Meridian operates. These impacts can range from business disruptions to adversely affecting their customers and customers withdrawing their deposits from the Bank. Management currently does expect that one result of the events in connection with the closure of Silicon Valley Bank in California and Signature Bank in New York by regulators is that FDIC assessments will more likely than not increase as a cost of doing business to the Bank. These possible impacts may adversely affect the Bank’s future operating results, including net income, and negatively impact capital. While the Bank currently does not expect the Government takeovers of Silicon Valley Bank and Signature Bank to have such a negative effect, the Bank continues to monitor the ongoing events concerning these two banks and any future banks failures if and when they may occur.
Our business and operations may be materially adversely affected by national and local market economic conditions.
Our business and operations, which primarily consist of banking and wealth management activities, including lending money to customers in the form of loans and borrowing money from customers in the form of deposits, are sensitive to general business and economic conditions in the United States generally, and in our local markets in particular. If economic conditions in the United States or any of our local markets weaken, our growth and profitability from our operations could be constrained. The current economic environment is characterized by interest rates near historically high levels, which impacts our ability to attract deposits and to generate attractive earnings through our loan and investment portfolios. All of these factors can individually or in the aggregate be detrimental to our business, and the interplay between these factors can be complex and unpredictable. Unfavorable market conditions can result in a deterioration in the credit quality of our borrowers and the demand for our products and services, an increase in the number of delinquencies, defaults and charge-offs, additional provisions for loan losses, a decline in the value of our collateral, and an overall material adverse effect on the quality of our loan portfolio.
The economic conditions in our local markets may be different from the economic conditions in the United States as a whole. Our success depends to a certain extent on the general economic conditions of the geographic markets that we serve in Pennsylvania, New Jersey, Delaware, Maryland, and Florida. Local economic conditions in these areas have a significant impact on our commercial, real estate and construction loans, the ability of borrowers to repay these loans and the value of the collateral securing these loans. Adverse changes in the economic conditions of the northeastern United States in general or any one or more of these local markets could negatively impact the financial results of our banking operations and have a negative effect on our profitability.
The value of the financial instruments we own may decline in the future.
As of December 31, 2022, we owned $172.8 million of investment securities, which consisted primarily of our positions in U.S. government and government-sponsored enterprises and federal agency obligations, mortgage and asset-backed securities, corporate bonds, and municipal securities. We evaluate our investment securities on at least a quarterly basis, and more frequently when economic and market conditions warrant such an evaluation, to determine whether any decline in fair value below amortized cost is the result of an other-than-temporary impairment. The process for determining whether impairment is other-than-temporary usually requires complex, subjective judgments about the future financial performance of the issuer in order to assess the probability of receiving all contractual principal and interest payments on the security. Because of changing economic and market conditions affecting issuers, we may be required to recognize other-than-temporary impairment in future periods, which could adversely affect our business, results of operations or financial condition.
For those financial instruments measured at fair value, we are required to recognize the changes in the fair value of such instruments in earnings or AOCI each quarter. Therefore, any increases or decreases in the fair value of these financial instruments have a
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corresponding impact on reported earnings or AOCI. Fair value can be affected by a variety of factors, many of which are beyond our control, including our credit position, interest rate volatility, capital markets volatility, and other economic factors. Accordingly, we are subject to mark-to-market risk and the application of fair value accounting may cause our earnings and AOCI to be more volatile than would be suggested by our underlying performance.
Our small business customers may lack the resources to weather a downturn in the economy.
One of our primary focuses is to serve the banking and financial services needs of small and medium sized businesses. These businesses generally have fewer financial resources than larger entities and less access to capital sources and loan facilities. If economic conditions are generally unfavorable in our market areas, our small business borrowers may be disproportionately affected and their ability to repay outstanding loans may be negatively affected, resulting in an adverse effect on our results of operations and financial condition.
We may be adversely affected by risks associated with completed and potential acquisitions.
We evaluate opportunities to acquire and invest in banks and in other complementary businesses. As a result, we may engage in negotiations or discussions that, if they were to result in a transaction, could have a material effect on our operating results and financial condition, including short and long-term liquidity and capital structure. Our acquisition activities could be material to us. For example, we could issue additional shares of common stock in a merger transaction, which could dilute current shareholders' ownership interest. An acquisition could require us to use a substantial amount of cash, other liquid assets, and/or incur debt.
Our acquisition activities could involve a number of additional risks, including the risks of:
•Incurring time and expense associated with identifying and evaluating potential acquisitions and negotiating potential transactions;
•Using inaccurate estimates and judgments to evaluate credit, operations, management, and market risks with respect to the target institution or its assets;
•The time and expense required to integrate the operations and personnel of the combined businesses;
•Creating an adverse short-term effect on our results of operations;
•Failing to realize related revenue synergies and/or cost savings within expected time frames; and
•Losing key employees and customers or a reduction in our stock price as a result of an acquisition that is poorly.
We may not be successful in overcoming these risks or any other problems encountered in connection with potential acquisitions. Our inability to overcome these risks could have an adverse effect on our ability to achieve our business strategy and could have an adverse effect on our financial condition and results of operations.
Liquidity risks could affect operations and jeopardize our business, financial condition and results of operations.
Liquidity risk is the risk that we will not be able to meet our obligations, including financial commitments, as they come due and is inherent in our operations. An inability to raise funds through deposits, borrowings, the sale of loans and/or investment securities and from other sources could have a substantial negative effect on our liquidity. Our most important source of funds consists of our customer deposits. Deposit balances can decrease for a variety of reasons, including when customers perceive alternative investments, such as the stock market, as providing a better risk/return trade-off. If customers move money out of bank deposits and into other investments, we could lose a stable source of funds. This loss would require us to seek other funding alternatives, in order to continue to grow, thereby potentially increasing our funding costs and reducing our net interest income and net income.
Other primary sources of funds consist of cash from operations and investment maturities, redemptions and sales. To a lesser extent, proceeds from the issuance and sale of securities to investors has become a source of funds. Additional liquidity is provided by wholesale funding such as brokered deposits and borrowings from the FRB and the FHLB. We also may borrow from correspondent banks or third party lenders from time to time. Our access to funding sources in amounts adequate to finance or capitalize our activities or on terms that are acceptable to us could be impaired by factors that affect us directly or the financial services industry or economy in general, such as disruptions in the financial markets or negative views and expectations about the prospects for the financial services industry. Economic conditions and a loss of confidence in financial institutions may increase our cost of funding or access to certain customary sources of funds, including inter-bank borrowings, repurchase agreements and borrowings from the discount window of the Federal Reserve System.
Any decline in available funding could adversely impact our ability to continue to implement our business plan, including originating loans, investing in securities, meeting our expenses or fulfilling obligations such as repaying our borrowings and meeting deposit withdrawal demands, any of which could have a material adverse impact on our liquidity, business, financial condition and results of operations.
The Corporation’s liquidity is dependent on dividends from the Bank.
The Corporation is a legal entity separate and distinct from the Bank, which is a wholly-owned banking subsidiary. A substantial portion of our cash flow from operating activities, including cash flow to pay principal and interest on any debt we may incur, will come from dividends from the Bank. Various federal and state laws and regulations limit the amount of dividends that the Bank may pay to our shareholders. For example, Pennsylvania law only permits the Bank to pay dividends out of its net profits then on hand, after first deducting the Bank’s losses and any debts owed to the Bank on which interest is past due and unpaid for a period of six months or more, unless the same are well secured and in the process of collection. Also, our right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors.
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Our shareholders are only entitled to receive such dividends as our Board of Directors may declare out of funds legally available for such payments. Although we currently pay quarterly dividends on our common stock, we are not required to do so and may reduce or eliminate our common stock dividend in the future. Our ability to pay dividends to our shareholders is subject to the restrictions set forth in Pennsylvania law, by the Federal Reserve, and depends on, among other things, our results of operations, financial condition, debt service requirements, other cash needs and any other factors our Board of Directors deems relevant. Notification to the Federal Reserve is also required prior to our declaring and paying a cash dividend to our shareholders during any period in which our quarterly and/or cumulative twelve-month net earnings are insufficient to fund the dividend amount, among other requirements. We may not pay a dividend if the Federal Reserve objects or until such time as we receive approval from the Federal Reserve or we no longer need to provide notice under applicable regulations. In addition, we may be restricted by applicable law or regulation or actions taken by our regulators, now or in the future, from paying dividends to our shareholders. We cannot provide assurance that we will continue paying dividends on our common stock at current levels or at all. A reduction or discontinuance of dividends on our common stock could have a material adverse effect on our business, including the market price of our common stock.
Loss of deposits could increase our funding costs.
As do many banking companies, we rely on customer deposits to meet a considerable portion of our funding needs, and we continue to seek customer deposits to maintain this funding base. We accept deposits directly from consumer and commercial customers and, as of December 31, 2022, we had $1.7 billion in deposits. These deposits are subject to potentially dramatic fluctuations in availability or the price we must pay (in the form of interest) to obtain them due to certain factors outside our control, such as a loss of confidence by customers in us or the banking sector generally, customer perceptions of our financial health and general reputation, increasing competitive pressures from other financial services firms for consumer or corporate customer deposits, changes in interest rates and returns on other investment classes, which could result in significant outflows of deposits within short periods of time or significant changes in pricing necessary to maintain current customer deposits or attract additional deposits. The loss of customer deposits for any reason could increase our funding costs.
We may need to raise additional capital in the future, and such capital may not be available when needed or at all.
We may need to raise additional capital, in the form of debt or equity securities, in the future to have sufficient capital resources to meet our commitments and fund our business needs and future growth, particularly if the quality of our assets or earnings were to deteriorate significantly. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of our control, and our financial condition. We may not be able to obtain capital on acceptable terms or at all. Any occurrence that may limit our access to capital, such as a decline in the confidence of debt purchasers, depositors of the Bank or counterparties participating in the capital markets or other disruption in capital markets, may adversely affect our capital costs and our ability to raise capital and, in turn, our liquidity. Further, if we need to raise capital in the future, we may have to do so when many other financial institutions are also seeking to raise capital and would then have to compete with those institutions for investors. An inability to raise additional capital on acceptable terms when needed could have a material adverse effect on our business, financial condition or results of operations and could be dilutive to both tangible book value and our share price.
We may not be able to implement our growth strategy or manage costs effectively, resulting in lower earnings or profitability.
There can be no assurance that we will be able to continue to grow and to be profitable in future periods, or, if profitable, that our overall earnings will remain consistent or increase in the future. Our strategy is focused on organic growth, supplemented by opportunistic acquisitions.
Our growth requires that we increase our loans and deposits while managing risks by following prudent loan underwriting standards without increasing interest rate risk or compressing our net interest margin, maintaining more than adequate capital at all times, hiring and retaining qualified employees and successfully implementing strategic projects and initiatives. Even if we are able to increase our interest income, our earnings may nonetheless be reduced by increased expenses, such as additional employee compensation or other general and administrative expenses and increased interest expense on any liabilities incurred or deposits solicited to fund increases in assets. Additionally, if our competitors extend credit on terms we find to pose excessive risks, or at interest rates which we believe do not warrant the credit exposure, we may not be able to maintain our lending volume and could experience deteriorating financial performance.
Our inability to manage our growth successfully or to continue to expand into new markets could have a material adverse effect on our business, financial condition or results of operations.
The occurrence of fraudulent activity, breaches or failures of our information security controls or cybersecurity-related incidents could have a material adverse effect on our business, financial condition or results of operations.
We are subject to various privacy, information security and data protection laws, including requirements concerning security breach notification, and we could be negatively affected by these laws. As a financial institution, we are susceptible to fraudulent activity, information security breaches and cybersecurity-related incidents that may be committed against us or our clients, which may result in financial losses or increased costs to us or our clients, disclosure or misuse of our information or our client information, misappropriation of assets, privacy breaches against our clients, litigation or damage to our reputation. Compliance with current or future privacy, data protection and information security laws (including those regarding security breach notification) affecting customer or employee data to which we are subject could result in higher compliance and technology costs and could restrict our ability to provide certain products and services, which could have a material adverse effect on our business, financial conditions or results of operations.
Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other dishonest acts. Information security breaches and cybersecurity-related incidents may include fraudulent or unauthorized access to systems used by us or our clients, denial or degradation of service attacks, and malware or other cyberattacks. In recent periods, there
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continues to be a rise in electronic fraudulent activity, security breaches and cyberattacks within the financial services industry, especially in the commercial banking sector due to cyber criminals targeting commercial bank accounts. Consistent with industry trends, we have also experienced an increase in attempted electronic fraudulent activity, security breaches and cybersecurity-related incidents in recent periods. Moreover, in recent periods, several large corporations, including financial institutions and retail companies, have suffered major data breaches, in some cases exposing not only confidential and proprietary corporate information, but also sensitive financial and other personal information of their customers and employees and subjecting them to potential fraudulent activity. Some of our clients may have been affected by these breaches, which could increase their risks of identity theft and other fraudulent activity that could involve their accounts with us.
We also face risks related to cyberattacks and other security breaches in connection with debit card transactions that typically involve the transmission of sensitive information regarding our customers through various third parties, including retailers and payment processors. Some of these parties have in the past been the target of security breaches and cyberattacks, and because the transactions involve third parties and environments such as the point of sale that we do not control or secure, future security breaches or cyberattacks affecting any of these third parties could affect us through no fault of our own, and in some cases we may have exposure and suffer losses for breaches or attacks relating to them, including costs to replace compromised debit cards and address fraudulent transactions.
Information pertaining to us and our customers is maintained, and transactions are executed, on networks and systems maintained by us and certain third party partners, such as our online and cloud-based banking systems or third party services. The secure maintenance and transmission of confidential information, as well as execution of transactions over these systems, are essential to protect us and our customers against fraud and security breaches and to maintain our customers’ confidence. Breaches of information security also may occur, through intentional or unintentional acts by those having access to our systems or our customers’ or counterparties’ confidential information, including employees. In addition, increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries, vulnerabilities in third party technologies (including browsers and operating systems) or other developments could result in a compromise or breach of the technology, processes and controls that we use to prevent fraudulent transactions and to protect data about us, our customers and underlying transactions, as well as the technology used by our customers to access our systems. Although we have developed, and continue to invest in, systems and processes that are designed to detect and prevent security breaches and cyberattacks and periodically test our security, our or our third party partners’ inability to anticipate, or failure to adequately mitigate, breaches of security could result in: losses to us or our customers; our loss of business and/or customers; damage to our reputation; the occurrence of additional expenses; disruption to our business; our inability to grow our online services or other businesses; additional regulatory scrutiny or penalties; or our exposure to civil litigation and possible financial liability—any of which could have a material adverse effect on our business, financial condition or results of operations.
More generally, publicized information concerning security and cyber-related problems could inhibit the use or growth of electronic or web-based applications or solutions as a means of conducting commercial transactions. Such publicity may also cause damage to our reputation as a financial institution. As a result, our business, financial condition or results of operations could be adversely affected.
We depend on information technology and telecommunications systems of third parties, and any systems failures, interruptions or data breaches involving these systems could adversely affect our operations and financial condition.
We are dependent for the majority of our technology, including our core operating system, on third-party providers. If these companies were to discontinue providing services to us, we may experience significant disruption to our business. In addition, each of these third parties faces the risk of cyber attack, information breach or loss, or technology failure. If any of our third-party service providers experience such difficulties, or if there is any other disruption in our relationships with them, we may be required to find alternative sources of such services. We are dependent on these third-party providers securing their information systems, over which we have limited control, and a breach of their information systems could adversely affect our ability to process transactions, service our clients or manage our exposure to risk and could result in the disclosure of sensitive, personal customer information, which could have a material adverse impact on our business through damage to our reputation, loss of business, remedial costs, additional regulatory scrutiny or exposure to civil litigation and possible financial liability. Assurance cannot be provided that we could negotiate terms with alternative service sources that are as favorable or could obtain services with similar functionality as found in existing systems without the need to expend substantial resources, if at all, thereby resulting in a material adverse impact on our business and results of operations.
We continually encounter technological change.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new, technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to serve customers better and to reduce costs. Our future success depends, in part, on our ability to effectively embrace technology to better serve customers and reduce costs. The Corporation may be required to expend additional resources to employ the latest technologies. Failure to keep pace with technological change could potentially have an adverse effect on our business operations and financial condition and results of operations.
We may not be able to attract and retain key personnel and other skilled employees.
We are dependent on the ability and experience of a number of key management personnel, who have substantial experience with the markets in which we offer products and services, the financial services industry, and our operations. The loss of one or more senior executives or key managers may have an adverse effect on our businesses. We maintain change in control agreements with certain executive officers to aid in our retention of these individuals. Our success depends on our ability to continue to attract, manage, and retain other qualified management personnel.
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New lines of business, products, product enhancements or services may subject us to additional risks.
From time to time, we may implement new lines of business or offer new products and product enhancements as well as new services within our existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances in which the markets are not fully developed. In implementing, developing or marketing new lines of business, products, product enhancements or services, we may invest significant time and resources, but may not fully realize their expected benefits. Further, initial timetables for the introduction and development of new lines of business, products, product enhancements or services may not be achieved, and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives and shifting market preferences, may also affect the ultimate implementation of a new line of business or offerings of new products, product enhancements or services. Furthermore, any new line of business, product, product enhancement or service or system conversion could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or offerings of new products, product enhancements or services could have a material adverse effect on our business, financial condition or results of operations.
We operate in a highly competitive and changing industry and market area and compete with both banks and non-banks.
The banking and financial services industry in our market area is highly competitive. We may not be able to compete effectively in our markets, which could adversely affect our results of operations. The increasingly competitive environment is a result of changes in regulation, advances in technology and product delivery systems, and consolidation among financial service providers. Larger institutions have greater resources and access to capital markets, with higher lending limits, more advanced technology and broader suites of services. Competition at times requires increases in deposit rates and decreases in loan rates, and adversely impact our net interest margin.
Our ability to maintain, attract and retain customer relationships is highly dependent on our reputation.
We rely, in part, on the reputation of the Bank to attract customers and retain our customer relationships. Damage to our reputation could undermine the confidence of our current and potential customers in our ability to provide high-quality financial services. Such damage could also impair the confidence of our counterparties and vendors and ultimately affect our ability to effect transactions. Maintenance of our reputation depends not only on our success in maintaining our service-focused culture and controlling and mitigating the various risks described in this Annual Report on Form 10-K, but also on our success in identifying and appropriately addressing issues that may arise in areas such as potential conflicts of interest, anti-money laundering, customer personal information and privacy issues, customer and other third party fraud, record-keeping, regulatory investigations and any litigation that may arise from the failure or perceived failure of us to comply with legal and regulatory requirements. Maintaining our reputation also depends on our ability to successfully prevent third parties from infringing on the “Meridian” brand and associated trademarks and our other intellectual property. Defense of our reputation, trademarks and other intellectual property, including through litigation, could result in costs that could have a material adverse effect on our business, financial condition or results of operations.
Accounting standards periodically change and the application of our accounting policies and methods may require management to make estimates about matters that are uncertain.
The regulatory bodies that establish accounting standards, including, among others, the FASB and the SEC, periodically revise or issue new financial accounting and reporting standards that govern the preparation of our consolidated financial statements. The effect of such revised or new standards on our financial statements can be difficult to predict and can materially impact how we record and report our financial condition and results of operations.
In addition, management must exercise judgment in appropriately applying many of our accounting policies and methods so they comply with generally accepted accounting principles. In some cases, management may have to select a particular accounting policy or method from two or more alternatives. In some cases, the accounting policy or method chosen might be reasonable under the circumstances and yet might result in our reporting materially different amounts than would have been reported if we had selected a different policy or method. Accounting policies are critical to fairly presenting our financial condition and results of operations and may require management to make difficult, subjective or complex judgments about matters that are uncertain.
The Corporation’s controls and procedures may fail or be circumvented.
Our management diligently reviews and updates the Corporation’s internal controls over financial reporting, disclosure controls and procedures, and corporate governance policies and procedures. Any failure or undetected circumvention of these controls could have a material adverse impact on our financial condition and results of operations.
Risks Related to Interest Rates
We must effectively manage interest rate risk.
Our earnings and cash flows are largely dependent upon our net interest income. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investments and the amount of interest we pay on deposits and borrowings, but such changes could also affect (i) our ability to originate loans and obtain deposits; (ii) the fair value of our financial assets and liabilities; and (iii) the average duration of our mortgage portfolio and other interest-earning assets. In response to the economic conditions resulting from the COVID-19 pandemic, the Federal Reserve's target federal funds rate was reduced nearly to 0% and the yields on Treasury notes declined to historic lows. However, due to elevated levels of inflation and corresponding pressure to raise interest rates, the Federal Reserve announced in January of 2022 that it would be slowing the pace of its bond purchasing and increasing the target range for the federal funds rate over time. The FOMC since has increased the target range seven times throughout 2022. As of December 31, 2022, the target range for the federal funds rate had been increased to 4.25% to 4.50% and the FOMC signaled that future increases may be
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appropriate in order to attain a monetary policy sufficiently restrictive to return inflation to more normalized levels. Our interest rate spread, net interest margin and net interest income increased during this period of rising interest rates as our interest earning assets generally reprice more quickly than our interest earning liabilities.
If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.
Although management believes it has implemented effective asset and liability management strategies, including the potential use of derivatives as hedging instruments, to reduce the potential effects of changes in interest rates on our results of operations, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations, and any related economic downturn, especially domestically and in the regions in which we operate, may adversely affect our asset quality, deposit levels, loan demand and results of operations. Also, our interest rate risk modeling techniques and assumptions likely may not fully predict or capture the impact of actual interest rate changes on our balance sheet.
Like all financial institutions, the Corporation's consolidated statement of financial condition is affected by fluctuations in interest rates. See the section entitled “Quantitative and Qualitative Disclosures About Market Risk” in Management’s Discussion and Analysis of Financial Condition, for the Corporation’s position on interest earning assets and interest bearing liabilities.
The impact of interest rates on our mortgage banking business can have a significant impact on revenues.
Changes in interest rates can impact the volume of mortgage originations and re-financings, thus impacting our mortgage-related revenues and profitability of our mortgage segment. A decline in mortgage rates generally increases the demand for mortgage loans as borrowers refinance, but also generally leads to accelerated payoffs. Conversely, in a constant or increasing rate environment, we would expect fewer loans to be refinanced and a decline in payoffs. Although we use models to assess the impact of interest rates on mortgage-related revenues, the estimates of revenues produced by these models are dependent on estimates and assumptions of future loan demand, prepayment speeds and other factors which may differ from actual subsequent experience.
Changes in interest rates could also reduce the value of our residential mortgage-related securities and MSRs, which could negatively affect our earnings.
The Corporation earns revenue from the fees it receives for originating mortgage loans and for servicing mortgage loans. When rates rise, the demand for mortgage loans tends to fall, reducing the revenue the Corporation receives from loan originations. At the same time, revenue from MSRs can increase through increases in fair value. When rates fall, mortgage originations tend to increase and the value of MSRs tends to decline, also with some offsetting revenue effect. Even though the origination of mortgage loans can act as a "natural hedge," the hedge is not perfect, either in amount or timing. For example, the negative effect on revenue from a decrease in the fair value of residential MSRs is immediate, but any offsetting revenue benefit from more originations and the MSRs relating to the new loans would accrue over time. It is also possible that even if interest rates were to fall, mortgage originations may also fall or any increase in mortgage originations may not be enough to offset the decrease in the MSRs value caused by the lower rates.
The Corporation typically uses derivatives and other instruments to hedge its mortgage banking interest rate risk. The Corporation generally does not hedge all of its risks and the fact that hedges are used does not mean they will be successful. Hedging is a complex process, requiring sophisticated models and constant monitoring. The Corporation could incur significant losses from its hedging activities. There may be periods where the Corporation elects not to use derivatives and other instruments to hedge mortgage banking interest rate risk.
We may be adversely impacted by the transition from LIBOR as a reference rate.
In 2017, the United Kingdom’s Financial Conduct Authority announced that after 2021 it would no longer compel banks to submit the rates required to calculate LIBOR. In November 2020, the administrator of LIBOR announced it will consult on its intention to extend the retirement date of certain offered rates whereby the publication of the one week and two month LIBOR offered rates will cease after December 31, 2022; reputation risks, the bank regulatory agencies have indicated that entering into new contracts that use LIBOR as a reference rate after December 31, 2022, would create safety and soundness risks and that they will examine bank practices accordingly. Therefore, the agencies encouraged banks to cease entering into new contracts that use LIBOR as a reference rate by December 31, 2022.
At December 31, 2022, we did not have a significant number of loans, derivative contracts, borrowings and other financial instruments with attributes that are either directly or indirectly dependent on LIBOR. Since alternative rates are calculated differently, payments under contracts with new rates will differ from those referencing LIBOR. Transition from LIBOR did not have a material impact on our business, financial condition and results of operations.
Risks Related to Lending Activities
We must effectively manage the credit risks of our loan portfolio.
Our business depends on the creditworthiness of our customers. There are risks inherent in making loans, including risks of nonpayment, risks resulting from uncertainties of the future value of collateral, and risks resulting from changes in economic and industry conditions. We attempt to reduce our credit risk through prudent loan application, underwriting and approval procedures, including internal loan reviews before and after proceeds have been disbursed, careful monitoring of the concentration of our loans within specific industries, and collateral and guarantee requirements. These procedures cannot, however, be expected to completely eliminate our credit risks, and we can make no guarantees concerning the strength of our loan portfolio.
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Our allowance for loan and lease losses may be insufficient, and an increase in the allowance would reduce earnings.
We maintain an allowance for loan and lease losses at a level we believe adequate to absorb probable losses inherent in our existing loan portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; credit loss experience; current loan portfolio quality; present economic, political and regulatory conditions; and unidentified losses inherent in the current loan portfolio.
Determination of the allowance is inherently subjective as it requires significant estimates and management’s judgment of credit risks and future trends, all of which may undergo material changes. Deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review our allowance and may require an increase in the provision for loan losses or the recognition of additional loan charge-offs, based on judgments different from those of management. Also, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance. Any increases in provisions will result in a decrease in net income and capital and may have a material adverse effect on our financial condition and results of operations.
In addition, in June 2016, the FASB issued ASU 2016-13 (Topic 326 - Credit Losses), commonly referenced as CECL. This standard replaced the approach under GAAP for establishing allowances for loan and lease losses (the “Allowance”), which generally considers only past events and current conditions, with a forward-looking methodology that reflects the expected credit losses over the lives of financial assets, starting when such assets are first originated or acquired. Under the revised methodology, credit losses will be measured based on past events, current conditions and reasonable and supportable forecasts of future conditions that affect the collectability of financial assets.
The change to the CECL framework requires us to greatly increase the data we must collect and review to determine the appropriate level of the allowance for credit losses. The adoption of CECL may result in greater volatility in the level of the allowance for credit losses, depending on various factors and assumptions applied in the model, such as the reasonable and supportable forecasted economic conditions and loan payment behaviors. Any increase in the allowance for credit losses, or expenses incurred to determine the appropriate level of the allowance for credit losses, may have an adverse effect on our financial condition and results of operations.
The Corporation will adopt this new guidance effective January 1, 2023, retrospectively at the beginning of the period of adoption, through a cumulative-effect adjustment to retained earnings at January 1, 2023. The Corporation has largely completed its assessment of related processes, internal controls, and data sources and has developed, documented, and validated a model utilizing a third-party software provider. We are currently evaluating the effect that the new accounting standard will have on the consolidated financial statements and related disclosures. The Corporation anticipates that the Corporation and the Bank will continue to be well capitalized after the negative impact resulting from the adoption of CECL.
Our business, profitability and liquidity may be adversely affected by deterioration in the credit quality of, or defaults by, third parties who owe us money, securities or other assets or whose securities or obligations we hold.
In addition to relying on borrowers to repay their loans and leases, we are exposed to the risk that third parties that owe us money, securities or other assets will not perform their obligations. These parties may default on their obligations to us due to bankruptcy, lack of liquidity, operational failure or other reasons. A default by a significant market participant, or concerns that such a party may default, could lead to significant liquidity problems, losses or defaults by other parties, which in turn could adversely affect us.
We are also subject to the risk that our rights against third parties may not be enforceable in all circumstances. Deterioration in the credit quality of third parties whose securities or obligations we hold, including the Federal Home Loan Mortgage Corporation, Government National Mortgage Corporation and municipalities, could result in significant losses.
Our mortgage lending business may not provide us with significant non-interest income.
The residential mortgage business is highly competitive, and highly susceptible to changes in market interest rates, consumer confidence levels, employment statistics, the capacity and willingness of secondary market purchasers to acquire and hold or securitize loans, and other factors beyond our control.
Because we sell substantially all of the mortgage loans we originate, the profitability of our mortgage banking business also depends in large part on our ability to aggregate a high volume of loans and sell them in the secondary market at a gain. In fact, as rates rise, we expect increasing industry-wide competitive pressures related to changing market conditions to reduce our pricing margins and mortgage revenues generally. Thus, in addition to our dependence on the interest rate environment, we are dependent upon (i) the existence of an active secondary market and (ii) our ability to profitably sell loans or securities into that market. If our level of mortgage production declines, the profitability will depend upon our ability to reduce our costs commensurate with the reduction of revenue from our mortgage operations.
Our ability to originate and sell mortgage loans readily is dependent upon the availability of an active secondary market for single-family mortgage loans, which in turn depends in part upon the continuation of programs currently offered by GSEs and other institutional and non-institutional investors. These entities account for a substantial portion of the secondary market in residential mortgage loans. We are highly dependent on these purchasers continuing their mortgage purchasing programs. Additionally, because the largest participants in the secondary market are GNMA, FNMA and FHLMC, GSEs whose activities are governed by federal law, any future changes in laws that significantly affect the activity of these GSEs could, in turn, adversely affect our operations. Since September 2008 FNMA and FHLMC have been operating in a conservatorship setup by the U.S. government as a response to the financial crisis of 2008. The FHFA continues to carry out its responsibilities as conservator.
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Our SBA lending program is dependent upon the federal government and we face specific risks associated with originating SBA loans.
Our SBA lending program is dependent upon the federal government. As an SBA Preferred Lender, we enable our clients to obtain SBA loans without being subject to the potentially lengthy SBA approval process necessary for lenders that are not SBA Preferred Lenders. The SBA periodically reviews the lending operations of participating lenders to assess, among other things, whether the lender exhibits prudent risk management. When weaknesses are identified, the SBA may request corrective actions or impose enforcement actions, including revocation of the lender’s Preferred Lender status. If we lose our status as a Preferred Lender, we may lose some or all of our customers to lenders who are SBA Preferred Lenders. Also, any changes to the SBA program, including changes to the level of guarantee provided by the federal government on SBA loans, could adversely affect our business and earnings.
We generally sell the guaranteed portion of our SBA 7(a) program loans in the secondary market. These sales have resulted in premium income for us at the time of sale and created a stream of future servicing income. We may not be able to continue originating these loans or selling them in the secondary market. Furthermore, even if we are able to continue originating and selling SBA 7(a) program loans in the secondary market, we might not continue to realize premiums upon the sale of the guaranteed portion of these loans. When we sell the guaranteed portion of our SBA 7(a) program loans, we incur credit risk on the non-guaranteed portion of the loans, and if a customer defaults on the non-guaranteed portion of a loan, we share any loss and recovery related to the loan pro-rata with the SBA. If the SBA establishes that a loss on an SBA guaranteed loan is attributable to significant technical deficiencies in the manner in which the loan was originated, funded or serviced by us, the SBA may seek recovery of the principal loss related to the deficiency from us, which could adversely affect our business and earnings.
The laws, regulations and standard operating procedures that are applicable to SBA loan products may change in the future. We cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, changes in the laws, regulations and procedures applicable to SBA loans could adversely affect our business and earnings.
Our loan servicing rights could become impaired, which may require us to take non-cash charges.
Because we retain the servicing rights on many loans we sell in the secondary market, we are required to record mortgage servicing right assets and SBA servicing right assets, which we test quarterly for impairment. The values of these servicing rights are heavily dependent on market interest rates and tends to increase with rising interest rates and decrease with falling interest rates. If we are required to record an impairment charge, it would adversely affect our financial condition and results of operations.
We may be required to repurchase mortgage loans or indemnify buyers against losses in some circumstances, which could harm liquidity, results of operations and financial condition.
We sell substantially all of the mortgage loans held for sale that we originated. When mortgage loans are sold, whether as whole loans or pursuant to a securitization, we are required to make customary representations and warranties to purchasers, guarantors and insurers, including the GSEs, about the mortgage loans and the manner in which they were originated. Whole loan sale agreements require repurchase or substitute mortgage loans, or indemnify buyers against losses, in the event we breach these representations or warranties. In addition, we may be required to repurchase mortgage loans as a result of early payment default of the borrower on a mortgage loan, resulting in these mortgage loans being placed on our books and subjecting us to the risk of a potential default.
We are subject to environmental liability risk associated with our lending activities and with the properties we own.
In the course of our business, we may foreclose and take title to real estate and could be subject to environmental liabilities with respect to these properties. The Corporation may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination or the release of hazardous or toxic substances at a property. Our policies and procedures require environmental factors to be considered during the loan application process. An environmental review is performed before initiating any commercial foreclosure action; however, these reviews may not be sufficient to detect all potential environmental hazards. Possible remediation costs and liabilities could have a material adverse effect on our financial condition.
Our business is significantly dependent on the real estate markets in which we operate, as a significant percentage of our loan portfolio is secured by real estate or mortgage loans originated for sale.
Many of the loans in our portfolio are secured by real estate. As of December 31, 2022, our real estate loans, excluding mortgages held for sale, include $272.0 million of construction and development loans, $59.4 million of home equity loans, $565.4 million of CRE loans and $221.8 million of residential mortgage loans, with the majority of these real estate loans concentrated in the southeast Pennsylvania, Delaware and southern New Jersey. Real property values in our market may be different from, and in some instances worse than, real property values in other markets or in the United States as a whole, and may be affected by a variety of factors outside of our control and the control of our borrowers, including national and local economic conditions, generally. Southeast Pennsylvania, Delaware and southern New Jersey has experienced volatility in real estate values over the past decade. Declines in real estate values, including prices for homes and commercial properties in southeast Pennsylvania, Delaware and southern New Jersey, could result in a deterioration of the credit quality of our borrowers, an increase in the number of loan delinquencies, defaults and charge-offs, and reduced demand for our products and services, generally.
Risks Related our Wealth Management Business
An economic slowdown could impact Meridian Wealth division revenues.
A general economic slowdown may cause current clients to seek alternative investment opportunities with other providers, which would decrease the value of Meridian Wealth’s assets under management resulting in lower fee income to the Corporation.
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Risks Related to Regulation
Changes in laws and regulations and the cost of regulatory compliance with new laws and regulations may adversely affect our operations and/or increase our costs of operations.
We are subject to extensive regulation, supervision, and examination by our primary regulators, the Pennsylvania Department of Banking and Securities and federal regulators of the FDIC and Federal Reserve Bank of Philadelphia. Also, as a member of the FHLB, the Bank must comply with applicable regulations of the Federal Housing Finance Agency and the FHLB. Regulation by these agencies is intended primarily for the protection of our depositors and the deposit insurance fund and not for the benefit of our shareholders. The Bank's activities are also regulated under consumer protection laws applicable to our lending, deposit, and other activities. A large claim against the Bank under these laws or an enforcement action by our regulators could have a material adverse effect on our financial condition and results of operations. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the ability to impose restrictions on our operations, comments on the classification of our assets, and determine the level of our allowance for credit losses. These regulations, along with the currently existing tax, accounting, securities, deposit insurance and monetary laws, rules, standards, policies, and interpretations, control the ways financial institutions conduct business, implement strategic initiatives, and prepare financial reporting and disclosures. Changes in such regulation and oversight, whether in the form of regulatory policy, new regulations, legislation or supervisory action, may have a material impact on our operations. Further, compliance with such regulation may increase our costs and limit our ability to pursue business opportunities.
We cannot predict the effect of legislative and regulatory initiatives, which could increase our costs of doing business and adversely affect our results of operations and financial condition.
Changes to statutes, regulations, regulatory or accounting policies could affect the Corporation in substantial and unpredictable ways. Such changes could subject the Corporation to additional costs, limit the types of financial services and products the Corporation may offer, limit the fees we may charge, increase the ability of non-banks to offer competing financial services and products, change regulatory capital requirements or the required size of our allowance for loan losses and change deposit insurance assessments, any of which would negatively impact our financial condition and result of operations. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on the Corporation's business, financial condition and results of operations.
We are subject to capital adequacy requirements and may be subject to more stringent capital requirements.
We are subject to capital adequacy guidelines and other regulatory requirements specifying minimum amounts and types of capital that we must maintain. From time to time, the regulators change these regulatory capital adequacy and liquidity guidelines. If we fail to meet these minimum capital adequacy and liquidity guidelines and other regulatory requirements, we or our subsidiaries may be restricted in the types of activities we may conduct and we may be prohibited from taking certain capital actions, such as paying dividends and repurchasing or redeeming capital securities. See “Supervision and Regulation—Regulatory Capital Requirements” for more information on the capital adequacy standards that we must meet and maintain.
While we currently meet the requirements of the Basel III-based Capital Rules, we may fail to do so in the future. The failure to meet applicable regulatory capital requirements could result in one or more of our regulators placing limitations or conditions on our activities, including our growth initiatives, or restricting the commencement of new activities, and could affect customer and investor confidence, our costs of funds and level of required deposit insurance assessments to the FDIC, our ability to pay dividends on our capital stock, our ability to make acquisitions, and our business, results of operations and financial conditions, generally.
General Risk Factors
Our stock price, like many of our peers, may be volatile, and you could lose part or all of your investment as a result.
Our stock price may fluctuate significantly in response to a variety of factors including, among other things:
•actual or anticipated variations in our quarterly results of operations;
•the failure of securities analysts to cover, or continue to cover, us after this offering;
•operating and stock price performance of other companies that investors deem comparable to us;
•news reports relating to trends, concerns and other issues in the financial services industry;
•perceptions in the marketplace regarding us, our competitors or other financial institutions;
•future sales of our common stock;
•departure of our management team or other key personnel;
•new technology used, or services offered, by competitors;
•significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving us or our competitors;
•changes or proposed changes in laws or regulations, or differing interpretations thereof affecting our business, or enforcement of these laws and regulations;
•litigation and governmental investigations; and
•geopolitical conditions such as acts or threats of terrorism or military conflicts.
Certain banking laws and certain provisions of our articles of incorporation may have an anti-takeover effect.
Provisions of federal banking laws, including regulatory approval requirements, could make it difficult for a third party to acquire us, even if doing so would be perceived to be beneficial to our shareholders. Acquisition of 10% or more of any class of voting stock of a bank holding company or depository institution, generally creates a rebuttable presumption that the acquirer “controls” the bank holding company or depository institution. Also, a bank holding company must obtain the prior approval of the Federal Reserve before, among other things, acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank, including the Bank.
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There also are provisions in our articles of incorporation and our bylaws, such as limitations on the ability to call a special meeting of our shareholders, that may be used to delay or block a takeover attempt. In addition, our board of directors are be authorized under our articles of incorporation to issue shares of our preferred stock, and determine the rights, terms conditions and privileges of such preferred stock, without shareholder approval. These provisions may effectively inhibit a non-negotiated merger or other business combination, which, in turn, could have a material adverse effect on the market price of our common stock.
Risks Related to COVID-19
The COVID-19 pandemic has disrupted economic conditions, the financial and labor markets and workplace operating environments.
The COVID-19 pandemic created extensive economic and financial disruptions that adversely affected our business, financial condition, liquidity and results of operations. Federal and state governments have taken unprecedented actions to respond to such disruptions, including by enacting fiscal stimulus measures and legislation designed to deliver monetary aid and other relief.
The widespread availability of multiple COVID-19 vaccines and boosters has helped to curtail rates of infection in many parts of the United States and, in turn, mitigate many of the adverse social and economic effects of the pandemic. However, vaccination rates in many geographies have been lower than anticipated and the emergence of novel variants of COVID-19, as well as other viruses that largely were not present in many geographies for an extended period of time due to COVID-19-related activity restrictions, have complicated the efforts of the medical community and federal, state and local governments to manage social and economic disruptions caused by the pandemic.
The effects of the COVID-19 pandemic have varied significantly by region, and the extent of the effects of the pandemic on the U.S. and global economies, labor markets and financial markets are likely to continue to change. Future developments will be highly uncertain and cannot be predicted, including the effectiveness of post-pandemic remote working arrangements, third party providers’ ability to continue to support our operations, and any further actions taken by governmental authorities and other third parties. Accordingly, the pandemic and related dynamics could continue to materially and adversely affect our business, operations, operating results, financial condition, liquidity or capital levels.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
The Corporation is headquartered in Malvern, Pennsylvania and has six full-service branches. Its main branch, in Paoli, serves the Main Line. The West Chester and Media branches serve Chester and Delaware counties, respectively, while the Doylestown and Blue Bell branches serve Bucks and Montgomery counties, respectively. In addition to our deposit taking branches, there are currently 18 other offices, including headquarters for Corporate and Operations, the Wealth Division and the Mortgage Division. Other than our corporate and operations headquarters, all of our offices are leased. The Bank had a net book value of $10.1 million for all locations at December 31, 2022.
Branch locations:
•Paoli Branch – 1176 Lancaster Avenue, Paoli, PA 19301
•West Chester Branch – 16 W. Market Street, West Chester, PA 19382
•Media Branch – 100 E. State Street, Media, PA 19063
•Doylestown Branch – 1719A S. Easton Road, Doylestown, PA 18901
•Blue Bell Branch – 653 Skippack Pike, Ste. 116, Blue Bell, PA 19422
•Philadelphia Branch – 1760 Market Street, Philadelphia, PA 19103
Other offices:
•Corporate Headquarters – 9 Old Lincoln Highway, Malvern, PA 19355
•Mortgage Headquarters – 653 Skippack Pike, Suite 200, Blue Bell, PA 19462
•Operations Headquarters – 367 Eagleview Boulevard, Exton, PA 19341
•Meridian Wealth Office – 653 Skippack Pike, Suite 200, Blue Bell, PA 19462
•SBA Lending Group Office -1760 Market Street, Philadelphia, PA 19103
•Commercial Loan Office – 24860 S. Tamiami Trail, Suite 3, Bonita Springs, FL 34134
•Mortgage Loan Production Office – 1601 Concord Pike, Suite 45, Wilmington, DE 19803
•Mortgage Loan Production Office – 5301 Limestone Road, Suite 202, Wilmington, DE 19801
•Mortgage Loan Production Office – 22128 Sussex Highway, Seaford, DE 19973
•Mortgage Loan Production Office – 350 Highland Drive, Suite 160, Mountville, PA 17554
•Mortgage Loan Production Office – 2330 New Road, Northfield, NJ 08225
•Mortgage Loan Production Office – 1221 College Park Drive, Suite 118, Dover, DE 19904
•Mortgage Loan Production Office – 8894 Stanford Boulevard, #203, Columbia, MD 21045
•Mortgage Loan Production Office – 2448 Holly Avenue, Ste. 100, Annapolis, MD 21401
•Mortgage Loan Production Office – 110 West Road, Towson, MD 21204
•Mortgage Loan Production Office – 9515 Deereco Road, Timonium, MD 21093
•Mortgage Loan Production Office – 4940 Campbell Blvd., Baltimore, MD 21236
•Mortgage Loan Production Office – 15722 Crabbs Branch Way, Ste. 2D, Rockville, MD 20855
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Item 3. Legal Proceedings
None.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Shares of our common stock trade on the NASDAQ Global Select Market under the symbol "MRBK". All share and per share amounts have been adjusted to reflect the two-for-one stock split effective February 28, 2023. As of March 10, 2023, there were approximately 1,655 registered shareholders of the Corporation's common stock. Certain shares are held in “nominee” or “street” name and accordingly, the number of beneficial owners of such shares is not known or included in the foregoing number.
Share Repurchases
The following table presents the shares repurchased by the Corporation during the fourth quarter of 2022:
| Issuer Purchases of Equity Securities | |||||||||||||||||||||||
| Period | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Approximate Dollar Value that May Yet Be Purchased Under the Plan or Programs (1) | |||||||||||||||||||
| Dollars in thousands except share data | |||||||||||||||||||||||
October 1, 2022 to October 31, 2022 | 86,602 | $ | 15.43 | 86,602 | |||||||||||||||||||
November 1, 2022 to November 30, 2022 | 126,794 | 15.66 | 126,794 | ||||||||||||||||||||
December 1, 2022 to December 31, 2022 | 33,486 | 15.21 | 33,486 | ||||||||||||||||||||
| Total | 246,882 | $ | 15.52 | $ | 4,652 | ||||||||||||||||||
(1) On August 30, 2021, the Corporation announced a stock repurchase plan pursuant to which the Corporation may repurchase up to $20 million of the company’s outstanding common stock, par value $1.00 per share. Stock is purchased under the plan from time to time in the open market or through privately negotiated transactions, or otherwise, at the discretion of management of the company in accordance with legal requirements.
Dividend Policy
In 2020 the Corporation commenced quarterly cash dividends on its common stock. Future dividend payments will depend upon maintenance of a strong financial condition, future earnings and capital and regulatory requirements. Also, the Corporation and the Bank are subject to restrictions on the amount of dividends that may be paid without approval of banking regulatory authorities. During 2022, and 2021, the Board of Directors declared cash dividends as follows:
| Date Declared | Date of Record | Date Paid | Quarterly Dividend $ | Special Dividend $ | ||||||||||||||||||||||
| January 28, 2021 | February 8, 2021 | February 22, 2021 | 0.06 | — | ||||||||||||||||||||||
| February 16, 2021 | March 1, 2021 | March 15, 2021 | — | 0.50 | ||||||||||||||||||||||
| April 22, 2021 | May 10, 2021 | May 17, 2021 | 0.06 | — | ||||||||||||||||||||||
| July 22, 2021 | August 9, 2021 | August 16, 2021 | 0.06 | — | ||||||||||||||||||||||
| October 28, 2021 | November 15, 2021 | November 22, 2021 | 0.10 | — | ||||||||||||||||||||||
| January 27, 2022 | February 14, 2022 | February 21, 2022 | — | 0.50 | ||||||||||||||||||||||
| April 28, 2022 | May 16, 2022 | May 23, 2022 | 0.10 | — | ||||||||||||||||||||||
| July 28, 2022 | August 15, 2022 | August 22, 2022 | 0.10 | — | ||||||||||||||||||||||
| October 27, 2022 | November 14, 2022 | November 21, 2022 | 0.10 | — | ||||||||||||||||||||||
Item 6. Reserved
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion is intended to assist in understanding the financial condition and results of operations of Meridian as of and for the year ended December 31, 2022. The information contained in this section should be read together with the December 31, 2022 audited Consolidated Financial Statements and the accompanying Notes included in Item 8. Financial Statements And Supplementary Data of this Form 10-K.
This section of this Form 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2021 items and year-to-year comparisons between 2021 and 2020 that are not included in this Form 10-K can be found
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in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Corporation’s Form 10-K for the fiscal year ended December 31, 2021.
Recent Market Conditions
Our financial condition and performance, as well as the ability of our borrowers to repay their loans, the value of collateral securing those loans, and demand for loans and other products and services that we offer, are all highly dependent on the business environment in the primary markets in which we operate and in the United States as a whole.
Bank Sector Concerns
Meridian is a regional community bank with loans and deposits that are well diversified in size, type, location and industry. We manage this diversification carefully, while avoiding concentrations in business lines. Meridian’s model continues to build on our strong and stable financial position, which serves our regional customers and communities with the banking products and services needed to help build their prosperity.
Total balance sheet liquidity, which is derived from cash and investments, as well as salable commercial loans and residential mortgage loans held for sale, was $264.4 million at December 31, 2022. Meridian maintains a high-quality investment bond portfolio comprised of U.S Treasuries, government agencies, government agency mortgage-backed securities, and general obligation municipal securities with an average duration of 4 years. Meridian’s investment portfolio represented 8.5% of total assets at December 31, 2022.
Meridian also maintains borrowing arrangements with various correspondent banks to meet short-term liquidity needs and has access to approximately $850 million in liquidity from numerous sources including its borrowing capacity with the FHLB and other financial institutions, as well as funding through the CDARS program or through brokered CD arrangements. In addition, the Bank is eligible to receive funds under the new Bank Term Funding Program announced by the Federal Reserve. Management believes that the above sources of liquidity provide Meridian with the necessary resources to meet its short-term and long-term funding requirements.
COVID-19 Concerns
As discussed further in Part I, Item 1, during the first quarter of 2020, an outbreak of COVID-19 spread around the world, including the United States. COVID-19 and its associated impacts on trade (including supply chains and export levels), travel, employee productivity and other economic activities had a destabilizing effect on financial markets and economic activity.
The U.S. economy has since strengthened despite the spread of COVID-19 variants, with higher inflation and housing values beginning in 2021. Also, the ongoing global supply chain issues and the military conflict between Russia and Ukraine contributed to higher inflation in 2022. In response, the Federal Reserve began normalizing monetary policy with its decision in late 2021 to taper its quantitative easing and raising the federal funds rate beginning in March 2022. Inflation remains elevated in 2022, reflecting supply and demand imbalances related to COVID-19 and its variants, higher food and energy prices from the military conflict between Russia and Ukraine, and broader price pressures. The Federal Reserve has raised interest rates significantly throughout 2022 and in the early part of 2023 in attempts to bring the inflation to its long run target rate of two percent. Future rate hikes are expected during the remainder of 2023, as the Federal Reserve has indicated ongoing interest rate increases in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to two percent over time.
Significant uncertainties as to future economic conditions continue to exist, including higher inflation, global supply chain issues, and higher oil and commodity prices exacerbated by the military conflict between Russia and Ukraine. We have taken deliberate actions in response, including maintaining higher reserves for credit losses on loans and leases and off-balance sheet credit exposures and strong capital ratios. As our commercial loan portfolio has a high percentage of variable rate loans, we are well positioned to take advantage of this in a rising rate environment. We are also focused on growing our non-interest bearing and lower-cost interest-bearing deposits to position the Bank for higher interest rates. We also continue to monitor closely the impact of COVID-19 and its variants, macroeconomic uncertainties, as well as any effects that may result from the federal government's responses including future rate hikes; however, the extent to which these factors will impact our operations and financial results in 2023 is highly uncertain.
Critical Accounting Policies and Estimates
Our accounting and reporting policies conform to GAAP and conform to general practices within the industry in which we operate. To prepare financial statements in conformity with GAAP, management makes estimates, assumptions and judgments based on available information. These estimates, assumptions and judgments affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgements are based on information available as of the date of the financial statements and, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the financial statements. In particular, management has identified the provision and allowance for loan and lease losses as the accounting policy that, due to the estimates, assumptions and judgements inherent in that policy, is critical in understanding our financial statements. Management has presented the application of this policy to the audit committee of our board of directors.
While we were an emerging growth company (up to December 31, 2022), the JOBS Act permitted us an extended transition period for complying with new or revised accounting standards affecting public companies. We have elected to take advantage of this extended transition period, which means that the financial statements included in this Annual Report, as well as any financial statements that were filed prior to this Annual Report, will not be subject to all new or revised accounting standards generally applicable to public companies for the transition period.
The following is a discussion of the critical accounting policies and significant estimates that require us to make complex and subjective judgments. Additional information about these policies can be found in the “Summary of Significant Accounting Policies” in footnote 1 of the Corporation’s Consolidated Financial Statements as of and for the years ended December 31, 2022 and 2021.
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Provision and allowance for loan and lease losses
The provision for loan and lease losses reflects the amount required to maintain the allowance for loan and lease losses (“Allowance”) at an appropriate level based upon management’s evaluation of the adequacy of general and specific loss reserves, using an incurred loss model.
The Allowance is maintained at a level that management believes is appropriate to provide for incurred loan and lease losses as of the date of the Consolidated Balance Sheet and we have established methodologies for the determination of its adequacy. The methodologies are set forth in a formal policy and take into consideration the need for an overall general allowance as well as specific allowances that are determined on an individual loan basis for impaired loans. The Allowance is increased by charging provisions for losses against our income and decreased by charge-offs, net of recoveries.
The evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. While management uses available information to recognize losses on loans and leases, changes in economic or other conditions may necessitate revision of the estimate in future periods.
The Allowance is maintained at a level sufficient to provide for probable losses based upon an ongoing review of the loan and lease portfolios by portfolio category, which includes consideration of actual loss experience, peer loss experience, changes in the size and risk profile of the portfolio, identification of individual problem loan and lease situations which may affect a borrower’s ability to repay, and evaluation of prevailing economic conditions.
Beginning on January 1, 2023, the Corporation adopted an expected credit loss model retrospectively, at the beginning of the period of adoption, through a cumulative-effect adjustment to retained earnings at January 1, 2023. The Corporation has largely completed its assessment of related processes, internal controls, and data sources and has developed, documented, and validated a discounted cash flows model utilizing a third-party software provider. While the Corporation continues to analyze and evaluate the impact of the adoption of this guidance on the Corporation's financial statements, it is anticipated that the reserve for credit losses will increase by 10% to 20% and stockholders' equity will decrease by 1% to 3%. The Corporation anticipates that the Corporation and the Bank will continue to be well capitalized after the negative impact resulting from the adoption of CECL. See the section entitled “Recent Accounting Pronouncements” in footnote (1) Summary of Significant Accounting Policies.
Executive Overview
The following items highlight the Corporation’s changes in its financial condition as of December 31, 2022 compared to December 31, 2021 and the results of operations for the year ended December 31, 2022 compared to the same periods in 2021. More detailed information related to these highlights can be found in the sections that follow.
Changes in Financial Condition
•Total assets increased $348.8 million, or 20.4%, to $2.1 billion as of December 31, 2022.
•Portfolio loans, excluding PPP loans, increased $435.4 million, or 33.6%, to $1.73 billion as of December 31, 2022,
•PPP loans decreased to just $4.6 million as of December 31, 2022 which is a decrease of $83.7 million, or 94.8%, since December 31, 2021.
Results of Operations
•Consolidated net income decreased $13.8 million, or 38.7%, driven by a lower level of non-interest revenue from mortgage banking activity.
•The return on average assets and return on average equity was 1.18% and 13.87%, respectively, for the year ended December 31, 2022, compared to 2.06% and 23.74%, respectively, for the year ended December 31, 2021.
•Provision for loan losses increased $1.4 million, or 132.5%, due to loan growth, partially offset by decreases in specific reserves on non-performing loans.
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Key Performance Ratios
The following table presents key financial performance ratios for the periods indicated: | Year Ended December 31, | ||||||||||
| 2022 | 2021 | ||||||||||
| Return on average assets | 1.18 | % | 2.06 | % | |||||||
| Return on average equity | 13.87 | % | 23.74 | % | |||||||
| Net interest margin (tax effected yield) | 3.98 | % | 3.77 | % | |||||||
| Basic earnings per share | $ | 1.85 | $ | 2.96 | |||||||
| Diluted earnings per share | $ | 1.79 | $ | 2.87 | |||||||
The following table presents certain key period-end balances and ratios at the dates indicated:
| (dollars in thousands, except per share amounts) | December 31, 2022 | December 31, 2021 | |||||||||
| Book value per common share | $ | 13.37 | $ | 13.54 | |||||||
Tangible book value per common share (1) | $ | 13.01 | $ | 13.19 | |||||||
| Allowance as a percentage of loans and leases held for investment | 1.08 | % | 1.35 | % | |||||||
Allowance as a percentage of loans and leases held for investment (excl. loans at fair value and PPP loans) (1) | 1.09 | % | 1.46 | % | |||||||
| Tier I capital to risk weighted assets | 8.8 | % | 10.8 | % | |||||||
Tangible common equity to tangible assets ratio (1) | 8.1 | % | 9.4 | % | |||||||
| Loans and other finance receivables, net of fees and costs | $ | 1,743,682 | $ | 1,386,457 | |||||||
| Total assets | $ | 2,062,228 | $ | 1,713,443 | |||||||
| Total stockholders’ equity | $ | 153,280 | $ | 165,360 | |||||||
(1) Non-GAAP financial measure. See “Non-GAAP Financial Measures” below for Non-GAAP to GAAP reconciliation.
Components of Net Income
Net income is comprised of five major elements:
•Net Interest Income, or the difference between the interest income earned on loans, leases and investments and the interest expense paid on deposits and borrowed funds;
•Provision For Loan and Lease Losses, or the amount added to the Allowance to provide for estimated inherent losses on portfolio loans and leases;
•Non-interest Income, which is made up primarily of mortgage banking income, wealth management income, SBA loan sale income, fair value adjustments, gains and losses from the sale of loans, gains and losses from the sale of investment securities available for sale and other fees from loan and deposit services;
•Non-interest Expense, which consists primarily of salaries and employee benefits, occupancy, professional fees, advertising & promotion, data processing, information technology, loan expenses, and other operating expenses; and
•Income Taxes, which include state and federal jurisdictions.
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NET INTEREST INCOME
Net interest income is an integral source of the Corporation’s income. The tables below present a summary for the year ended December 31, 2022 and 2021, of the Corporation’s average balances and yields earned on its interest-earning assets and the rates paid on its interest-bearing liabilities. The net interest margin is the net interest income as a percentage of average interest-earning assets. The net interest spread is the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities. The difference between the net interest margin and the net interest spread is the result of net free funding sources such as non-interest bearing deposits and stockholders’ equity.
Analyses of Interest Rates and Interest Differential
The tables below present the major asset and liability categories on an average daily balance basis for the periods presented, along with interest income, interest expense and key rates and yields on a tax equivalent basis.
For the Year Ended December 31, | |||||||||||||||||||||||||||||||||||
| (dollars in thousands) | 2022 | 2021 | |||||||||||||||||||||||||||||||||
| Average Balance | Interest Income/ Expense | Yields/ Rates | Average Balance | Interest Income/ Expense | Yields/ Rates | ||||||||||||||||||||||||||||||
| Assets: | |||||||||||||||||||||||||||||||||||
| Due from banks | $ | 21,045 | $ | 279 | 1.33 | % | $ | 30,844 | $ | 41 | 0.13 | % | |||||||||||||||||||||||
| Federal funds sold | 1,160 | 7 | 0.60 | 17,823 | 7 | 0.04 | |||||||||||||||||||||||||||||
| Investment securities - taxable (1) | 106,246 | 2,420 | 2.28 | 83,720 | 1,463 | 1.75 | |||||||||||||||||||||||||||||
| Investment securities - tax exempt (1) | 63,425 | 1,691 | 2.67 | 64,440 | 1,464 | 2.27 | |||||||||||||||||||||||||||||
| Loans held for sale | 44,238 | 1,872 | 4.23 | 125,444 | 3,540 | 3.76 | |||||||||||||||||||||||||||||
| Loans held for investment (1) | 1,535,943 | 82,764 | 5.39 | 1,358,282 | 65,292 | 4.81 | |||||||||||||||||||||||||||||
| Total loans | 1,580,181 | 84,636 | 5.36 | 1,483,726 | 68,832 | 4.64 | |||||||||||||||||||||||||||||
| Total interest-earning assets | 1,772,057 | 89,033 | 5.02 | % | 1,680,553 | 71,807 | 4.27 | % | |||||||||||||||||||||||||||
| Noninterest earning assets | 76,983 | 48,015 | |||||||||||||||||||||||||||||||||
| Total assets | $ | 1,849,040 | $ | 1,728,568 | |||||||||||||||||||||||||||||||
| Liabilities and stockholders' equity: | |||||||||||||||||||||||||||||||||||
| Interest-bearing demand deposits | $ | 237,554 | $ | 2,570 | 1.08 | % | $ | 257,950 | $ | 880 | 0.34 | % | |||||||||||||||||||||||
| Money market and savings deposits | 703,561 | 7,854 | 1.12 | 630,977 | 3,346 | 0.53 | |||||||||||||||||||||||||||||
| Time deposits | 354,822 | 4,972 | 1.40 | 245,923 | 1,268 | 0.52 | |||||||||||||||||||||||||||||
| Total deposits | 1,295,937 | 15,396 | 1.19 | 1,134,850 | 5,494 | 0.48 | |||||||||||||||||||||||||||||
| Borrowings | 27,637 | 830 | 3.00 | 119,721 | 534 | 0.45 | |||||||||||||||||||||||||||||
| Subordinated debentures | 40,560 | 2,366 | 5.83 | 40,724 | 2,383 | 5.85 | |||||||||||||||||||||||||||||
| Total interest-bearing liabilities | 1,364,134 | 18,592 | 1.36 | 1,295,295 | 8,411 | 0.65 | |||||||||||||||||||||||||||||
| Noninterest-bearing deposits | 296,563 | 258,298 | |||||||||||||||||||||||||||||||||
| Other noninterest-bearing liabilities | 30,929 | 25,100 | |||||||||||||||||||||||||||||||||
| Total liabilities | 1,691,626 | 1,578,693 | |||||||||||||||||||||||||||||||||
| Total stockholders' equity | 157,414 | 149,875 | |||||||||||||||||||||||||||||||||
| Total stockholders' equity and liabilities | $ | 1,849,040 | $ | 1,728,568 | |||||||||||||||||||||||||||||||
Net interest income and spread (1) | $ | 70,441 | 3.66 | $ | 63,396 | 3.62 | |||||||||||||||||||||||||||||
| Net interest margin (1) | 3.98 | % | 3.77 | % | |||||||||||||||||||||||||||||||
(1)Yields and net interest income are reflected on a tax-equivalent basis.
29
Rate/Volume Analysis
The rate/volume analysis table below analyzes dollar changes in the components of interest income and interest expense as they relate to the change in balances (volume) and the change in interest rates (rate) of tax-equivalent net interest income for the year ended December 31, 2022 as compared to the same periods in 2021, allocated by rate and volume. Changes in interest income and/or expense attributable to both volume and rate have been allocated proportionately based on the relationship of the absolute dollar amount of the change in each category.
2022 Compared to 2021 | |||||||||||||||||
| (dollars in thousands) | Rate | Volume | Total | ||||||||||||||
| Interest income: | |||||||||||||||||
| Due from banks | $ | 255 | $ | (17) | $ | 238 | |||||||||||
| Federal funds sold | 12 | (12) | — | ||||||||||||||
Investment securities - taxable (1) | 507 | 450 | 957 | ||||||||||||||
Investment securities - tax exempt (1) | 250 | (23) | 227 | ||||||||||||||
| Loans held for sale | 1,270 | (2,938) | (1,668) | ||||||||||||||
Loans held for investment (1) | 8,395 | 9,077 | 17,472 | ||||||||||||||
| Total loans | 9,665 | 6,139 | 15,804 | ||||||||||||||
| Total interest income | $ | 10,689 | 6,537 | 17,226 | |||||||||||||
| Interest expense: | |||||||||||||||||
| Interest-bearing demand deposits | $ | 1,765 | (75) | 1,690 | |||||||||||||
| Money market and savings deposits | 4,083 | 425 | 4,508 | ||||||||||||||
| Time deposits | 2,945 | 759 | 3,704 | ||||||||||||||
| Total deposits | 8,793 | 1,109 | 9,902 | ||||||||||||||
| Borrowings | 985 | (689) | 296 | ||||||||||||||
| Subordinated debentures | (7) | (10) | (17) | ||||||||||||||
| Total interest expense | 9,771 | 410 | 10,181 | ||||||||||||||
| Interest differential | $ | 918 | $ | 6,127 | $ | 7,045 | |||||||||||
(1)Yields and net interest income are reflected on a tax-equivalent basis.
Interest income increased $17.2 million on a tax equivalent basis, year over year, due to a higher yield on earning assets, which went up 75 basis points, in addition to a higher level of average earning assets, which increased by $91.5 million. Included in interest income was approximately $280 thousand of one-time fees and interest recapture from the quarter ended December 31, 2022. The average yield on loans held for investment increased 58 basis points and the yield on cash and investments increased 46 basis points in total, reflecting the impact in rates caused by the Federal Reserve’s monetary policy. Average total loans held for investment, excluding PPP loans and residential loans for sale, increased $315.7 million, most notably in commercial real estate and construction, commercial loans and leases and small business loans, which increased $190.8 million on average, combined. Home equity loans and residential real estate loans held in portfolio increased $44.6 million on average, combined. Residential loans for sale and PPP loans decreased $81.2 million, and $138.0 million on average, respectively.
Interest expense increased $10.2 million, year over year, due primarily to market interest rate rises, as well as an increase of $161.1 million in average interest bearing deposits. Interest expense on deposits increased $9.9 million with the cost of interest-bearing deposits increasing 71 basis points to 1.19%. Total cost of deposits increased 58 basis points reflecting an increase of $38.3 million in average non-interest bearing deposits. Interest expense on borrowings increased $296 thousand as the cost increased 255 basis points, and total average short-term borrowings decreased $92.1 million.
Net interest margin increased 21 basis points to 3.98% for the year ended December 31, 2022 from 3.77% for the year ended December 31, 2021, as the increase in yield on earnings assets was higher than the increase of costs of funds, helped also by the $38.3 million increase in average non-interest bearing deposits. Excluding the impact from PPP, net interest margin increased 20 basis points to 3.92% from 3.72%. A reconciliation of this non-GAAP measure is included in the Appendix.
PROVISION FOR LOAN AND LEASE LOSSES
The provision for loan losses was $2.5 million for the year ended December 31, 2022, compared to an $1.1 million provision for the year ended December 31, 2021. The increase in the provision period over period is the result of provisioning for loan growth and charge-offs, offset partially by an improvement in specific reserves and the trend in economic qualitative factors in the allowance for loan losses calculation.
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NON-INTEREST INCOME
The following table presents the components of non-interest income for the periods indicated:
| Year Ended December 31, | |||||||||||||||||||||||
| (Dollars in thousands) | 2022 | 2021 | $ Change | % Change | |||||||||||||||||||
| Mortgage banking income | $ | 25,325 | $ | 75,932 | $ | (50,607) | (66.6) | % | |||||||||||||||
| Wealth management income | 4,733 | 4,801 | (68) | (1.4) | % | ||||||||||||||||||
| SBA loan income | 4,467 | 6,898 | (2,431) | (35.2) | % | ||||||||||||||||||
| Earnings on investment in life insurance | 553 | 365 | 188 | 51.5 | % | ||||||||||||||||||
| Net change in the fair value of derivative instruments | (703) | (4,338) | 3,635 | (83.8) | % | ||||||||||||||||||
| Net change in the fair value of loans held-for-sale | (844) | (3,311) | 2,467 | (74.5) | % | ||||||||||||||||||
| Net change in the fair value of loans held-for-investment | (2,408) | (189) | (2,219) | 1174.1 | % | ||||||||||||||||||
| Net gain on hedging activity | 5,439 | 2,961 | 2,478 | 83.7 | % | ||||||||||||||||||
| Net gain on sale of investment securities available-for-sale | — | 435 | (435) | (100.0) | % | ||||||||||||||||||
| Service charges | 125 | 129 | (4) | (3.1) | % | ||||||||||||||||||
| Other | 5,037 | 4,305 | 732 | 17.0 | % | ||||||||||||||||||
| Total non-interest income | $ | 41,724 | $ | 87,988 | $ | (46,264) | (52.6) | % | |||||||||||||||
Total non-interest income decreased $46.3 million as a result of lower mortgage banking revenue, and to a lesser degree, lower SBA loan sale income. Mortgage banking income was down $50.6 million, due primarily to lower levels of mortgage loan originations as rising interest rates and lack of housing inventory has had a negative impact on mortgage banking activity. Partially offsetting the impact of the decline in mortgage banking income were net changes in the fair value of derivative instruments and loans held-for-sale, along with an improvement in net gains on hedging activity increased $8.6 million, combined, year over year.
SBA loan sale income decreased $2.4 million, or 35.2%, over the prior year, despite an increase of $8.8 million, 13.0%, in the volume of loans sold in 2022 compared to 2021. The upward movement in interest rates during 2022 had a negative impact on gross margins on the SBA loan sales, which declined to 7.4% for all sales in 2022, compared to 11.4% in 2021. Also contributing to the decline in income was increased amortization of $340 thousand and increased impairment of $211 thousand on SBA servicing assets.
The net change in the fair value of loans held-for-investment decreased to a loss of $2.4 million for the year ended December 31, 2022, compared to a loss of $189 thousand for the comparable prior year, due to the negative impact the rising interest rate environment had on the fair value of the loans in portfolio that are held at fair value. Other non-interest income was up $732 thousand due to increases in title fee income, swap fee income, FHLB stock dividend income and broker fee income.
NON-INTEREST EXPENSE
The following table presents the components of non-interest income for the periods indicated:
| Year Ended December 31, | |||||||||||||||||||||||
| (Dollars in thousands) | 2022 | 2021 | $ Change | % Change | |||||||||||||||||||
| Salaries and employee benefits | $ | 54,378 | $ | 78,866 | $ | (24,488) | (31.1) | % | |||||||||||||||
| Occupancy and equipment | 4,837 | 4,545 | 292 | 6.4 | % | ||||||||||||||||||
| Professional fees | 3,635 | 3,558 | 77 | 2.2 | % | ||||||||||||||||||
| Advertising and promotion | 4,336 | 3,714 | 622 | 16.7 | % | ||||||||||||||||||
| Data processing and software | 5,451 | 4,382 | 1,069 | 24.4 | % | ||||||||||||||||||
| Pennsylvania bank shares tax | 793 | 609 | 184 | 30.2 | % | ||||||||||||||||||
| Other | 8,014 | 8,053 | (39) | (0.5) | % | ||||||||||||||||||
| Total non-interest expense | $ | 81,444 | $ | 103,727 | $ | (22,283) | (21.5) | % | |||||||||||||||
Total non-interest expense decreased $22.3 million due largely to a decrease in salaries and employee benefits expense at the mortgage segment, which recognized decreased fixed and variable compensation. Partially offsetting this decrease was an increase for the bank and wealth segments salaries & benefits, due to an increase in FTEs and a higher level of stock-based compensation expense. Advertising and promotion expense increased as the result of a renewed and focused priority placed on business development and community outreach efforts. Data processing and software expense increased as Meridian continued with our strategy to invest in technology that focuses on improving back-office efficiencies through automation and workflow processes.
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INCOME TAX EXPENSE
The following table presents income tax expense and related metrics for the periods indicated:
| Year Ended December 31, | |||||||||||||||||||||||
| (Dollars in thousands) | 2022 | 2021 | Change | % Change | |||||||||||||||||||
| Income before income taxes | $ | 27,920 | $ | 46,302 | $ | (18,382) | (39.7) | % | |||||||||||||||
| Income tax expense | $ | 6,091 | $ | 10,717 | $ | (4,626) | (43.2) | % | |||||||||||||||
| Effective tax rate | 21.81 | % | 23.14 | % | (1.33) | % | (5.7) | % | |||||||||||||||
The effective tax rate decreased as a result of higher levels of non-taxable revenue (BOLI and tax free interest), as well as lower level of state tax expense. Both income tax expense and the effective tax rate (as it related to state tax expense) decreased due primarily to the decrease in income before income taxes.
Balance Sheet Summary
Assets
As of December 31, 2022, total assets were $2.1 billion which increased $348.8 million, or 20.4%, from December 31, 2021. This growth in assets over the prior period was due primarily to loan portfolio growth, as detailed in the following section.
Loans
Our loan portfolio is the largest category of our interest-earning assets. As of December 31, 2022 and 2021, our total loans and leases amounted to $1.8 billion, and $1.5 billion, respectively. Our loan portfolio is comprised of loans originated to be held in portfolio, as well as residential mortgage loans originated for sale. Meridian engages in the origination of residential mortgages, most typically for 1-4 family dwellings, with the intention of the Corporation to principally sell substantially all of these loans in the secondary market to qualified investors. Our loans held in portfolio are originated by our commercial and consumer loan divisions. We have a strong credit culture that promotes diversity of lending products with a focus on commercial businesses. We have no particular credit concentration. Our commercial loans have been proactively managed in an effort to achieve a balanced portfolio with no unusual exposure to one industry.
The following table presents our loan and lease portfolio at the dates indicated:
| (Dollars in thousands) | December 31, 2022 | December 31, 2021 | $ Change | % Change | |||||||||||||||||||
| Mortgage loans held for sale | $ | 22,243 | $ | 80,882 | $ | (58,639) | (72.5) | % | |||||||||||||||
| Real estate loans: | |||||||||||||||||||||||
| Commercial mortgage | 565,400 | 516,928 | 48,472 | 9.4 | % | ||||||||||||||||||
| Home equity lines and loans | 59,399 | 52,299 | 7,100 | 13.6 | % | ||||||||||||||||||
| Residential mortgage | 221,837 | 68,175 | 153,662 | 225.4 | % | ||||||||||||||||||
| Construction | 271,955 | 160,905 | 111,050 | 69.0 | % | ||||||||||||||||||
| Total real estate loans | 1,118,591 | 798,307 | 320,284 | 40.1 | % | ||||||||||||||||||
| Commercial and industrial | 341,378 | 384,562 | (43,184) | (11.2) | % | ||||||||||||||||||
| Small business loans | 136,155 | 114,158 | 21,997 | 19.3 | % | ||||||||||||||||||
| Consumer | 488 | 419 | 69 | 16.5 | % | ||||||||||||||||||
| Leases, net | 138,986 | 88,242 | 50,744 | 57.5 | % | ||||||||||||||||||
| Total portfolio loans and leases | $ | 1,735,598 | $ | 1,385,688 | $ | 349,910 | 25.3 | % | |||||||||||||||
| Total loans and leases | $ | 1,757,841 | $ | 1,466,570 | $ | 291,271 | 19.9 | % | |||||||||||||||
Portfolio loans increased grew $349.9 million, or 25.3% to $1.7 billion as of December 31, 2022, from $1.4 billion as of December 31, 2021.
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The following table shows the amounts of loans outstanding as of December 31, 2022 which, based on remaining scheduled repayments of principal, are due in the periods indicated:
| (dollars in thousands) | 12 months or Less | 1 - 5 years | 5 - 15 years | After 15 years | Total | ||||||||||||||||||||||||
| Mortgage loans held for sale | $ | — | $ | — | $ | — | $ | 22,243 | $ | 22,243 | |||||||||||||||||||
| Commercial mortgage | 23,091 | 138,037 | 398,077 | 6,195 | 565,400 | ||||||||||||||||||||||||
| Home equity lines and loans | 725 | 3,533 | 50,272 | 4,869 | 59,399 | ||||||||||||||||||||||||
| Residential mortgage | 3,291 | 730 | 1,802 | 216,014 | 221,837 | ||||||||||||||||||||||||
| Construction | 120,064 | 62,178 | 89,713 | — | 271,955 | ||||||||||||||||||||||||
| Commercial and industrial | 26,002 | 135,355 | 62,629 | 117,392 | 341,378 | ||||||||||||||||||||||||
| Small business loans | 237 | 4,672 | 79,483 | 51,763 | 136,155 | ||||||||||||||||||||||||
| Consumer | 3 | 208 | 136 | 141 | 488 | ||||||||||||||||||||||||
| Leases, net | 129 | 123,034 | 15,823 | — | 138,986 | ||||||||||||||||||||||||
| Total | $ | 173,542 | $ | 467,747 | $ | 697,935 | $ | 418,617 | $ | 1,757,841 | |||||||||||||||||||
The amounts have been classified according to sensitivity to changes in interest rates for amounts due after one year, as of December 31, 2022. Variance rate loans are those loans with floating or adjustable interest rates.
| (dollars in thousands) | Fixed Rate | Variable Rate | Total | ||||||||||||||
| Mortgage loans held for sale | $ | 22,243 | $ | — | $ | 22,243 | |||||||||||
| Commercial mortgage | 94,119 | 471,281 | 565,400 | ||||||||||||||
| Home equity lines and loans | 5,928 | 53,471 | 59,399 | ||||||||||||||
| Residential mortgage | 199,472 | 22,365 | 221,837 | ||||||||||||||
| Construction | 46,854 | 225,101 | 271,955 | ||||||||||||||
| Commercial and industrial | 68,722 | 272,656 | 341,378 | ||||||||||||||
| Small business loans | 202 | 135,953 | 136,155 | ||||||||||||||
| Consumer | 353 | 135 | 488 | ||||||||||||||
| Leases, net | 138,986 | — | 138,986 | ||||||||||||||
| Total | $ | 576,879 | $ | 1,180,962 | $ | 1,757,841 | |||||||||||
Commercial real estate loans. Our commercial real estate loans are secured by real estate that is both owner-occupied and investor owned. Owner-occupied commercial real estate loans generally involve less risk than an investment property and are distinctly reported from non-owner occupied commercial real estate loans for measuring loan concentrations for regulatory purposes. Our owner-occupied commercial real estate loans are originated and managed within our commercial loan department and comprised 34.4% of our total commercial real estate loan portfolio at December 31, 2022. The remaining commercial real estate loans are managed by our commercial real estate department which offer the following commercial real estate products:
•Permanent – Investor Real Estate Loans
•Purchase and refinance loan opportunities for a number of product types, including single-family rentals, multi-family residential as well as tenanted income producing properties in a variety of real estate types, including office, retail, industrial, and flex space
•Construction Loans
•Residential construction loans to finance new construction and renovation of single and 1-4 family homes located within our market area
•Commercial construction loans for investment properties, generally with semi-permanent attributes
•Construction loans for new, expanded or renovated operations for our owner occupied business clients
•Land Development Loans
•Meridian considers a limited number of strictly land development oriented loans based upon the risk, merit of the future project and strength of the borrower/guarantor relationship
Our commercial real estate loans increased by $48.5 million, or 9.4%, to $565.4 million at December 31, 2022 from $516.9 million at December 31, 2021. Our total commercial real estate loan portfolio represented 32.2% and 35.2% of our total loan portfolio at December 31, 2022 and 2021, respectively. Construction loans increased $111.1 million, or 69.0%, to $272.0 million at December 31, 2022 from $160.9 million at December 31, 2021. Construction loans represented 15.5% of our total loan portfolio at both December 31, 2022 and 2021.
33
Commercial and Industrial Loans
We provide a variety of variable and fixed rate commercial business loans and lines of credit. These loans and lines of credit are made to small and medium-sized manufacturers and wholesale, retail and service-related businesses. Additionally, we lend to companies in the technology, healthcare, real estate and financial service industries. Commercial business loans generally include lines of credit and term loans with a maturity of five years or less. The primary source of repayment for commercial business loans is generally operating cash flows of the business and may also include collateralization of inventory, accounts receivable, equipment and/or personal guarantees. Our commercial and industrial loans decreased $43.2 million, or 11.2%, to $341.4 million at December 31, 2022 from $384.6 million at December 31, 2021, as PPP loans declined $85.5 million, or 94.8% during the year as nearly all such loans were forgiven by December 31, 2022. Commercial and industrial loans overall represented 19.4% and 26.2% of our total loan portfolio at December 31, 2022 and 2021, respectively.
Small Business Loans
We provide financing to small businesses in various industries that include guarantees under the Small Business Administration’s (SBA’s) loan programs. Our small business loans increased by $22.0 million, or 19.3%, to $136.2 million at December 31, 2022 from $114.2 million at December 31, 2021. During 2022 we sold $75.9 million in SBA loans, an increase of $8.8 million, or 13.0%, from $67.2 million in SBA loans sold in 2021. The small business loans portfolio represented 7.7% and 7.8% of our total loan portfolio at December 31, 2022 and 2021, respectively.
Consumer and Personal Loans
Our consumer-lending department principally originates residential mortgage and home equity based products for our clients and prospects. These loans typically fund completely at closing. Additional products include smaller dollar personal loans and our student loan refinance product, designed to provide additional flexibility in repayment terms desired in the marketplace. Home equity lines and loans increased $7.1 million, or 13.6%, to $59.4 million at December 31, 2022 from $57.6 million at December 31, 2021, while residential mortgage loans increased by $153.7 million, or 225.4%, to $221.8 million at December 31, 2022 from $68.2 million at December 31, 2021. Overall the total consumer loan portfolio represented 16.0% and 8.2% of our total loan portfolio at December 31, 2022 and 2021, respectively.
Leases, net
Meridian Equipment Finance specializes in small ticket equipment leases for small and mid-sized businesses nationally and through a broad range of industries. The Bank’s credit risk generally results from the potential default of borrowers which may be driven by customer specific or broader industry related conditions. Leases increased $50.7 million, or 57.5%, to $139.0 million at December 31, 2022 from $88.2 million at December 31, 2021.
Investments
Our securities portfolio is used to make various term investments, maintain a source of liquidity and serve as collateral for certain types of deposits and borrowings. We manage our investment portfolio according to written investment policies approved by our board of directors. Investments in our securities portfolio may change over time based on our funding needs and interest rate risk management objectives. Our liquidity levels take into account anticipated future cash flows and other available sources of funds and are maintained at levels that we believe are appropriate to provide the necessary flexibility to meet our anticipated funding requirements.
As of December 31, 2022 our available-for-sale investment portfolio had a fair value of $135.3 million, with an effective tax equivalent yield of 2.83% and an estimated duration of approximately 4 years. The largest category of this investment portfolio, or 28.7%, consists of municipal securities, along with 25.9% in U.S. agency securities, and 21.8% in U.S. Treasury securities. The remainder of our available-for-sale securities portfolio is invested in other securities. We regularly evaluate the composition of our investment portfolio as the interest rate yield curve changes and may sell investment securities from time to time to adjust our exposure to interest rates or to provide liquidity to meet loan demand. Not included in the tables below are equity investments that had fair values of $2.1 million and $2.4 million, as of December 31, 2022 and 2021, respectively. As of December 31, 2022 we also had a held-to-maturity investment portfolio with amortized cost of $37.5 million.
During the year ended December 31, 2022, $27.7 million of municipal securities, previously classified as available-for-sale on the balance sheet, were transferred to the held-to-maturity portfolio at fair value. After transfer, $1.3 million of unrealized losses remain in accumulated other comprehensive income. No gain or loss was recognized as a result of the transfer.
The following table presents the amortized cost and fair value of securities at the dates indicated:
| December 31, 2022 | |||||||||||||||||||||||||||||
| (dollars in thousands) | Amortized cost | Gross unrealized gains | Gross unrealized losses | Fair value | # of Securities in unrealized loss position | ||||||||||||||||||||||||
| Securities available-for-sale: | |||||||||||||||||||||||||||||
| U.S. asset backed securities | $ | 15,581 | $ | 14 | $ | (314) | $ | 15,281 | 12 | ||||||||||||||||||||
| U.S. government agency MBS | 12,272 | 5 | (538) | 11,739 | 12 | ||||||||||||||||||||||||
| U.S. government agency CMO | 25,520 | 40 | (2,242) | 23,318 | 29 | ||||||||||||||||||||||||
| State and municipal securities | 44,700 | — | (5,862) | 38,838 | 34 | ||||||||||||||||||||||||
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| December 31, 2022 | |||||||||||||||||||||||||||||
| (dollars in thousands) | Amortized cost | Gross unrealized gains | Gross unrealized losses | Fair value | # of Securities in unrealized loss position | ||||||||||||||||||||||||
| U.S. Treasuries | 32,980 | — | (3,457) | 29,523 | 25 | ||||||||||||||||||||||||
| Non-U.S. government agency CMO | 9,722 | — | (633) | 9,089 | 11 | ||||||||||||||||||||||||
| Corporate bonds | 8,201 | — | (643) | 7,558 | 12 | ||||||||||||||||||||||||
| Total securities available-for-sale | $ | 148,976 | $ | 59 | $ | (13,689) | $ | 135,346 | 135 | ||||||||||||||||||||
| Amortized cost | Gross unrecognized gains | Gross unrecognized losses | Fair value | # of Securities in unrecognized loss position | |||||||||||||||||||||||||
| Securities held-to-maturity: | |||||||||||||||||||||||||||||
| State and municipal securities | $ | 37,479 | $ | — | $ | (4,394) | $ | 33,085 | 25 | ||||||||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||||||||
| (dollars in thousands) | Amortized cost | Gross unrealized gains | Gross unrealized losses | Fair value | # of Securities in unrealized loss position | ||||||||||||||||||||||||
| Securities available-for-sale: | |||||||||||||||||||||||||||||
| U.S. asset backed securities | $ | 16,850 | $ | 55 | $ | (68) | $ | 16,837 | 10 | ||||||||||||||||||||
| U.S. government agency MBS | 9,749 | 124 | (60) | 9,813 | 3 | ||||||||||||||||||||||||
| U.S. government agency CMO | 22,276 | 358 | (253) | 22,381 | 10 | ||||||||||||||||||||||||
| State and municipal securities | 72,099 | 1,379 | (496) | 72,982 | 12 | ||||||||||||||||||||||||
| U.S. Treasuries | 29,973 | 1 | (246) | 29,728 | 21 | ||||||||||||||||||||||||
| Non-U.S. government agency CMO | 990 | — | (15) | 975 | 1 | ||||||||||||||||||||||||
| Corporate bonds | 6,450 | 154 | (18) | 6,586 | 5 | ||||||||||||||||||||||||
| Total securities available-for-sale | $ | 158,387 | $ | 2,071 | $ | (1,156) | $ | 159,302 | 62 | ||||||||||||||||||||
| Amortized cost | Gross unrecognized gains | Gross unrecognized losses | Fair value | # of Securities in unrecognized loss position | |||||||||||||||||||||||||
| Securities held-to-maturity: | |||||||||||||||||||||||||||||
| State and municipal securities | $ | 6,372 | $ | 219 | $ | — | $ | 6,591 | — | ||||||||||||||||||||
Asset Quality Summary
Meridian's credit culture is strong and asset quality remains a primary focus of management. The ratio of non-performing assets to total assets declined to 1.11% as of December 31, 2022, from 1.34% as of December 31, 2021. There was $1.7 million in other real estate property included in non-performing assets as of December 31, 2022 related to a well security residential property, and $0 as of December 31, 2021. Total non-performing loans were $21.2 million and $23.0 million as of December 31, 2022 and December 31, 2021, respectively. The decline in non-performing loans over the period was due to a $2.7 million payoff of a non-performing loan and principal payments on another non-performing loan relationship of over $3 million, both partially offset by an increase in SBA loans considered non-performing.
Meridian realized net charge-offs of $2.4 million, or 0.15%, of total average loans for the year ended December 31, 2022, compared to net charge-offs of $79 thousand, or 0.01%, of total average loans for the year ended December 31, 2021. Nearly all of the charge-offs for the year ended December 31, 2022 were from equipment leases, while recoveries were split between commercial loans, equipment leases, and home equity loans. The ratio of allowance for loan losses to total loans held for investment, excluding loans at fair value and PPP loans (a non-GAAP measure, see reconciliation in the Appendix), was 1.09% as of December 31, 2022 compared to 1.46% as of December 31, 2021. PPP loans are excluded from calculation of this ratio as they are guaranteed by the SBA and therefore we have not provided for in the allowance for loan losses. A reconciliation of this non-GAAP measure is included in the Non-GAAP Financial Measures section on page 36.
As of December 31, 2022, the Corporation had $3.8 million of TDRs, of which $3.6 million were in compliance with the modified terms and excluded from non-performing loans and leases. As of December 31, 2021, the Corporation had $3.8 million of TDRs, of which $3.4 million were in compliance with the modified terms, and were excluded from non-performing loans and leases.
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As of December 31, 2022, the Corporation had a recorded investment of $24.2 million of impaired loans and leases which included $3.8 million of TDRs, while as of December 31, 2021 impaired loans totaled $25.8 million, which included $3.8 million of TDRs. The decrease in impaired loans was largely due to payments received in the fourth quarter of 2022 on one commercial loan relationship that became a non-performing loan relationship late in 2021. This loan had a specific reserve of $1.4 million of as December 31, 2021, which decreased to $776 thousand as of December 31, 2022. Impaired loans and leases are those for which it is probable that the Corporation will not be able to collect all scheduled principal and interest in accordance with the original terms of the loans and leases. Refer to footnote 6 for more information regarding the Corporation’s impaired loans and leases.
The Corporation continues to be diligent in its credit underwriting process and proactive with its loan review process, including the engagement of the services of an independent outside loan review firm, which helps identify developing credit issues. Proactive steps that are taken include the procurement of additional collateral (preferably outside the current loan structure) whenever possible and frequent contact with the borrower. The Corporation believes that timely identification of credit issues and appropriate actions early in the process serve to mitigate overall risk of loss.
The following table presents nonperforming assets and related ratios for the periods indicated:
| (dollars in thousands) | December 31, 2022 | December 31, 2021 | |||||||||
| Non-performing assets: | |||||||||||
| Nonaccrual loans: | |||||||||||
| Real estate loans: | |||||||||||
| Commercial mortgage | $ | 140 | $ | — | |||||||
| Home equity lines and loans | 1,097 | 911 | |||||||||
| Residential mortgage | 2,085 | 2,398 | |||||||||
| Total real estate loans | 3,322 | 3,309 | |||||||||
| Commercial and industrial | 12,547 | 18,801 | |||||||||
| Small business loans | 4,465 | 666 | |||||||||
| Leases | 902 | 212 | |||||||||
| Total nonaccrual loans | 21,236 | 22,988 | |||||||||
| Other real estate owned | 1,703 | — | |||||||||
| Total non-performing assets | $ | 22,939 | $ | 22,988 | |||||||
| Troubled debt restructurings: | |||||||||||
| TDRs included in non-performing loans | $ | 207 | $ | 361 | |||||||
| TDRs in compliance with modified terms | 3,573 | 3,446 | |||||||||
| Total TDRs | $ | 3,780 | $ | 3,807 | |||||||
| Asset quality ratios: | |||||||||||
| Non-performing assets to total assets | 1.11 | % | 1.34 | % | |||||||
| Non-performing loans to: | |||||||||||
| Total loans and leases | 1.20 | % | 1.57 | % | |||||||
| Total loans held-for-investment | 1.22 | % | 1.66 | % | |||||||
Total loans held-for-investment (excluding loans at fair value and PPP loans) (1) | 1.23 | % | 1.80 | % | |||||||
| Allowance for loan losses to: | |||||||||||
| Total loans and leases | 1.07 | % | 1.28 | % | |||||||
| Total loans held-for-investment | 1.08 | % | 1.35 | % | |||||||
Total loans held-for-investment (excluding loans at fair value and PPP loans) (1) | 1.09 | % | 1.46 | % | |||||||
| Non-performing loans | 88.66 | % | 81.60 | % | |||||||
| Total loans and leases | $ | 1,765,925 | $ | 1,467,339 | |||||||
| Total loans and leases held-for-investment | $ | 1,743,682 | $ | 1,386,457 | |||||||
| Total loans and leases held-for-investment (excluding loans at fair value and PPP loans) | $ | 1,724,601 | $ | 1,280,654 | |||||||
| Allowance for loan and lease losses | $ | 18,828 | $ | 18,758 | |||||||
(1) The allowance for loan losses to total loans held-for-investment (excluding loans at fair value and PPP loans) ratio is a non-GAAP financial measure. See “Non-GAAP Financial Measures” for a reconciliation of this measure to its most comparable GAAP measure.
36
Allowance for Loan and Lease Losses
The following is a summary of the allocation of the allowance for loan and lease losses by loan category for the periods presented.
| (dollars in thousands) | December 31, 2022 | % of Loan Type to Total Loans | December 31, 2021 | % of Loan Type to Total Loans | |||||||||||||||||||
| Commercial mortgage | $ | 4,095 | 33% | $ | 4,950 | 37% | |||||||||||||||||
| Home equity lines and loans | 188 | 3% | 224 | 4% | |||||||||||||||||||
| Residential mortgage | 948 | 13% | 283 | 5% | |||||||||||||||||||
| Construction | 3,075 | 16% | 2,042 | 12% | |||||||||||||||||||
| Commercial and industrial | 4,012 | 19% | 6,533 | 28% | |||||||||||||||||||
| Small business loans | 4,909 | 8% | 3,737 | 8% | |||||||||||||||||||
| Consumer | 3 | —% | 3 | —% | |||||||||||||||||||
| Leases | 1,598 | 8% | 986 | 6% | |||||||||||||||||||
| Total | $ | 18,828 | 100% | $ | 18,758 | 100% | |||||||||||||||||
The following table provides information on (charge-offs) and recoveries by loan category:
| December 31, 2022 | December 31, 2021 | ||||||||||||||||
| Home equity lines and loans | $ | 31 | $ | 1 | |||||||||||||
| Residential mortgage | 2 | 5 | |||||||||||||||
| Commercial and industrial | 97 | 41 | |||||||||||||||
| Consumer | 4 | 4 | |||||||||||||||
| Leases | (2,552) | (130) | |||||||||||||||
| Total Net Charge-offs | $ | (2,418) | $ | (79) | |||||||||||||
Deposits
The following table presents the major categories of deposits at the dates indicated:
| (Dollars in thousands) | December 31, 2022 | December 31, 2021 | $ Change | % Change | |||||||||||||||||||
| Noninterest-bearing deposits | $ | 301,727 | $ | 274,528 | $ | 27,199 | 9.9 | % | |||||||||||||||
| Interest-bearing deposits: | |||||||||||||||||||||||
| Interest-bearing demand deposits | 219,838 | 268,248 | (48,410) | (18.0) | % | ||||||||||||||||||
| Money market and savings deposits | 697,564 | 697,628 | (64) | — | % | ||||||||||||||||||
| Time deposits | 493,350 | 206,009 | 287,341 | 139.5 | % | ||||||||||||||||||
| Total interest-bearing deposits | 1,410,752 | 1,171,885 | 238,867 | 20.4 | % | ||||||||||||||||||
| Total deposits | $ | 1,712,479 | $ | 1,446,413 | $ | 266,066 | 18.4 | % | |||||||||||||||
Total deposits were $1.7 billion as of December 31, 2022, up $266.1 million, or 18.4%, from December 31, 2021. Non-interest bearing deposits increased $27.2 million, or 9.9%, from December 31, 2021. Interest-bearing demand deposits decreased $48.4 million, or 18.0%, from December 31, 2021, while money market accounts/savings accounts did not change materially from December 31, 2021. Certificates of deposits increased $287.3 million, or 139.5%, from December 31, 2021, as lower levels of core deposits, combined with continued loan growth year over year, led to the need to obtain more wholesale funding.
Time deposits of $250 thousand or more had remaining maturities as follows:
| Year Ended December 31, 2022 | |||||||||||
| Amount | % | ||||||||||
| 3 months or less | $ | 183,758 | 46.6% | ||||||||
| Over 3 months through 6 months | 76,683 | 19.4% | |||||||||
| Over 6 months through 12 months | 64,923 | 16.5% | |||||||||
| Over 12 months | 68,921 | 17.5% | |||||||||
| Total | $ | 394,285 | 100.0% | ||||||||
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Equity
Consolidated stockholders’ equity of the Corporation was $153.3 million, or 7.4% of total assets as of December 31, 2022 as compared to $165.4 million, or 9.7% of total assets as of December 31, 2021. The change in stockholders’ equity is the result of year-to-date comprehensive loss of $12.2 million, dividends paid of $10.9 million and common stock repurchases of $13.0 million during 2022, partially offset by $1.0 million in stock-based compensation and stock options exercised. On February 28, 2023, the Corporation approved and declared a two-for-one stock split in the form of a 100% stock dividend, payable March 20, 2023, to shareholders of record as of March 14, 2023. Under the terms of the stock split, the Corporation’s shareholders will receive a dividend of one share for every share held on the record date. The dividend will be paid in authorized but unissued shares of common stock of the Corporation. The par value of the Corporation's stock was not affected by the split and remained at $1.00 per share. All share and per share amounts reported in the consolidated financial statements have been adjusted to reflect the two-for-one stock split effective February 28, 2023.
Non-GAAP Financial Measures
Meridian believes that non-GAAP measures are meaningful because they reflect adjustments commonly made by management, investors, regulators and analysts to evaluate performance trends and the adequacy of common equity. This non-GAAP disclosure has limitations as an analytical tool, should not be viewed as a substitute for performance and financial condition measures determined in accordance with GAAP, and should not be considered in isolation or as a substitute for analysis of Meridian’s results as reported under GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies.
The table below provides the non-GAAP reconciliation for our tangible common equity ratio and tangible book value per common share. All per share amounts have been adjusted to reflect the two-for-one stock split effective February 28, 2023.
| (dollars in thousands) | December 31, 2022 | December 31, 2021 | |||||||||
| Total stockholders' equity (GAAP) | $ | 153,280 | $ | 165,360 | |||||||
| Less: Goodwill and intangible assets | 4,074 | 4,278 | |||||||||
| Tangible common equity (non-GAAP) | 149,206 | 161,082 | |||||||||
| Total assets (GAAP) | 2,062,228 | 1,713,443 | |||||||||
| Less: Goodwill and intangible assets | 4,074 | 4,278 | |||||||||
| Tangible assets (non-GAAP) | $ | 2,058,154 | $ | 1,709,165 | |||||||
| Stockholders' equity to total assets (GAAP) | 7.43 | % | 9.65 | % | |||||||
| Tangible common equity to tangible assets (non-GAAP) | 7.25 | % | 9.42 | % | |||||||
| Shares outstanding | 11,466 | 12,216 | |||||||||
| Book value per share (GAAP) | $ | 13.37 | $ | 13.54 | |||||||
| Tangible book value per share (non-GAAP) | $ | 13.01 | $ | 13.19 | |||||||
The following is a reconciliation of the allowance for loan losses to total loans held for investment ratio at December 31, 2022. This is considered a non-GAAP measure as the calculation excludes the impact of loans held for investment that are fair valued and the impact of PPP loans as these loan types are not included in the allowance for loan losses calculation.
| (dollars in thousands) | December 31, 2022 | December 31, 2021 | |||||||||
| Allowance for loan and lease losses (GAAP) | $ | 18,828 | $ | 18,758 | |||||||
| Loans, net of fees and costs (GAAP) | 1,743,682 | 1,386,457 | |||||||||
| Less: PPP loans | (4,579) | (88,245) | |||||||||
| Less: Loans fair valued | (14,502) | (17,558) | |||||||||
| Loans, net of fees and costs, excluding PPP and fair valued loans (non-GAAP) | $ | 1,724,601 | $ | 1,280,654 | |||||||
| Allowance for loan and leases losses to loans, net of fees and costs (GAAP) | 1.08 | % | 1.35 | % | |||||||
| Allowance for loan and leases losses to loans, net of fees and costs, excluding PPP and fair valued loans (non-GAAP) | 1.09 | % | 1.46 | % | |||||||
38
Liquidity and Capital Resources
Management maintains liquidity to meet depositors’ needs for funds, to satisfy or fund loan commitments, and for other operating purposes. Meridian’s foundation for liquidity is a stable and loyal customer deposit base, cash and cash equivalents, and a marketable investment portfolio that provides periodic cash flow through regular maturities and amortization or that can be used as collateral to secure funding. In addition, as part of its liquidity management, Meridian maintains a segment of commercial loan assets that are comprised of SNCs, which have a national market and can be sold in a timely manner. Meridian’s available liquidity, which totaled $264.4 million at December 31, 2022, compared to $262.9 million at December 31, 2021, includes investments, SNCs, Federal funds sold, mortgages held-for-sale and cash and cash equivalents, less the amount of securities required to be pledged for certain liabilities. Meridian also anticipates scheduled payments and prepayments on its loan and mortgage-backed securities portfolios.
In addition, Meridian maintains borrowing arrangements with various correspondent banks, the FHLB and the FRB to meet short-term liquidity needs. Through its relationship at the FRB, Meridian had available credit of approximately $8.8 million at December 31, 2022. At December 31, 2022, Meridian had no borrowings from the Federal Reserve. As a member of the FHLB, we are eligible to borrow up to a specific credit limit, which is determined by the amount of our residential mortgages, commercial mortgages and other loans that have been pledged as collateral. As of December 31, 2022, Meridian’s maximum borrowing capacity with the FHLB was $561.7 million. At December 31, 2022, Meridian had borrowed $122.1 million and the FHLB had issued letters of credit, on Meridian’s behalf, totaling $49 million against its available credit lines. At December 31, 2022, Meridian also had available $39.0 million of unsecured federal funds lines of credit with other financial institutions as well as $237.6 million of available short or long term funding through the CDARS program and $241.0 million of available short or long term funding through brokered CD arrangements. Management believes that Meridian has adequate resources to meet its short-term and long-term funding requirements.
At December 31, 2022, Meridian had $525.2 million in unfunded loan commitments. Management anticipates these commitments will be funded by means of normal cash flows. Certificates of deposit greater than or equal to $250 thousand scheduled to mature in one year or less from December 31, 2022 totaled $325.4 million. Management believes that the majority of such deposits will be reinvested with Meridian and that certificates that are not renewed will be funded by a reduction in cash and cash equivalents or by pay-downs and maturities of loans and investments. At December 31, 2022, Meridian had a reserve for unfunded loan commitments of $173 thousand.
Meridian meets the definition of “well capitalized” for regulatory purposes on December 31, 2022. Our capital category is determined for the purposes of applying the bank regulators’ “prompt corrective action” regulations and for determining levels of deposit insurance assessments and may not constitute an accurate representation of Meridian’s overall financial condition or prospects.
Under federal banking laws and regulations, Meridian is required to maintain minimum capital as determined by certain regulatory ratios. Capital adequacy for regulatory purposes, and the capital category assigned to an institution by its regulators, may be determinative of an institution’s overall financial condition. Under the final capital rules that became effective as of January 1, 2019, a capital conservation buffer is fully phased in at 2.5%.
Community banks have long raised concerns with bank regulators about the regulatory burden, complexity, and costs associated with certain provisions of the Basel III Rule. In response, Congress provided an “off-ramp” for institutions, like us, with total consolidated assets of less than $10 billion. Section 201 of the Regulatory Relief Act instructed the federal banking regulators to establish a single CBLR of between 8 and 10%. The Bank adopted this framework in 2020. Under the final rule, a community banking organization is eligible to elect the new framework if it has: less than $10 billion in total consolidated assets, limited amounts of certain assets and off-balance sheet exposures, and a CBLR greater than 9%. This requirement was 8% in 2021 as the bank regulatory agencies temporarily lowered the CBLR as a result of the COVID-19 pandemic. The Bank’s CBLR was 9.95% and 11.51% as of December 31, 2022 and 2021, respectively, but reports all ratios for comparative purposes.
The following table summarizes data and ratios pertaining to our capital structure.
| Corporation | Bank | Well-capitalized minimum | |||||||||||||||||||||||||||
| December 31, 2022 | December 31, 2021 | December 31, 2022 | December 31, 2021 | ||||||||||||||||||||||||||
| Tier 1 leverage ratio | 8.13 | % | 9.39 | % | 9.95 | % | 11.51 | % | 5.00 | % | |||||||||||||||||||
| Common tier 1 risk-based capital ratio | 8.77 | % | 10.83 | % | 10.73 | % | 13.27 | % | 6.50 | % | |||||||||||||||||||
| Tier 1 risk-based capital ratio | 8.77 | % | 10.83 | % | 10.73 | % | 13.27 | % | 8.00 | % | |||||||||||||||||||
| Total risk-based capital ratio | 12.05 | % | 14.81 | % | 11.87 | % | 14.63 | % | 10.00 | % | |||||||||||||||||||
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Our primary market risk is interest rate risk, which is defined as the risk of loss of net interest income or net interest margin because of changes in interest rates.
Asset/Liability Management
As a financial institution, one of our primary market risks is interest rate volatility. Changes in market interest rates, whether they are increases or decreases, can trigger repricing and changes in the pace of payments for both assets and liabilities (prepayment risk), which individually or in combination may affect our net income, net interest income and net interest margin, either positively or negatively. In recognition of this, we actively manage our assets and liabilities to minimize the impact of changing interest rates on our net interest margin and maximize our net interest income and the return on equity, while maintaining adequate liquidity and capital.
Our board of directors has established a Board Risk Committee that, among other duties, sets broad asset and liability management policy (“ALM” policy) and directives for asset/liability management, as well as establishes review and control procedures to ensure adherence to this policy. The board of directors has delegated authority for the development and implementation of all asset and liability management policies, procedures, and strategies to the Asset Liability Committee (“ALCO”). ALCO is comprised of various members of senior management responsible for interpreting the longer range objectives established by the board of directors. As such, ALCO sets basic direction for the Corporation’s sources and uses of funds, establishes numerical ranges for primary and secondary objectives, monitors risk and the delivery of services, establishes subs to manage specific ALM activities, and monitors the counterparties engaged in ALM activities. Our ALM policy is reviewed by ALCO and the board of directors at least annually, which includes an evaluation of the ALM policy limits and guidelines in light of our risk profile, business strategies, regulatory guidelines and overall market conditions.
As part of our management of interest rate risk, we utilize the following modeling techniques that simulate the effects of variations in interest rates: (1) repricing gap analysis; (2) net interest income simulation; and (3) economic value of equity simulation. These models require that we use various assumptions, including asset and liability pricing responses, asset and liability new business, repayment and redemption responses, behavior of embedded options and sensitivity of relationships across different rate indexes and product types. These assumptions are inherently uncertain and, as a result, the models cannot precisely predict the fluctuations in market interest rates or precisely measure the impact of future changes in interest rates. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various management strategies.
Simulations of net interest income. We use a simulation model on a quarterly basis to measure and evaluate potential changes in our net interest income resulting from various hypothetical interest rate scenarios. Our model incorporates various assumptions that management believes to be reasonable, but which may have a significant impact on results such as:
•The timing of changes in interest rates;
•Shifts or rotations in the yield curve;
•Repricing characteristics for market rate sensitive instruments on the balance sheet;
•Differing sensitivities of financial instruments due to differing underlying rate indices;
•Varying timing of loan prepayments for different interest rate scenarios;
•The effect of interest rate floors, periodic loan caps and lifetime loan caps;
•Overall growth rates and product mix of interest-earning assets and interest-bearing liabilities.
Because of the limitations inherent in any approach used to measure interest rate risk, simulated results are not intended to be used as a forecast of the actual effect of a change in market interest rates on our results, but rather as a means to better plan and execute appropriate Asset / Liability Management (“ALM”) strategies.
Potential changes to our net interest income between a flat interest rate scenario and hypothetical rising and declining interest rate scenarios, measured over a one-year period as of December 31, 2022 and 2021 are presented in the following table. The simulation assumes rate shifts occur upward and downward on the yield curve in even increments over the first twelve months (ramp), followed by rates held constant thereafter.
Rate Ramp:
| Changes in Market Interest Rates | December 31, 2022 | December 31, 2021 | |||||||||
| +300 basis points over next 12 months | (0.56) | % | 0.21 | % | |||||||
| +200 basis points over next 12 months | (0.27) | % | (0.18) | % | |||||||
| +100 basis points over next 12 months | (0.06) | % | (0.31) | % | |||||||
| No Change | |||||||||||
| -100 basis points over next 12 months | (1.06) | % | (0.22) | % | |||||||
| -200 basis points over next 12 months | (2.04) | % | (2.34) | % | |||||||
The above interest rate simulation suggests that the Corporation’s balance sheet is narrowly liability sensitive as of December 31, 2022. In its current position, the table indicates that a 100-300 basis point increase in interest rates would have a modestly negative impact from rising rates on net interest income over the next 12 months and a more negative impact in a falling rate scenario. The simulated
40
exposure to a change in interest rates is contained, manageable and well within policy guidelines. The results reflect a higher degree of wholesale funding at December 31, 2022 and continue to drive our funding strategy of increasing relationship-based accounts (core deposits).
Simulation of economic value of equity. To quantify the amount of capital required to absorb potential losses in value of our interest-earning assets and interest-bearing liabilities resulting from adverse market movements, we calculate economic value of equity on a quarterly basis. We define economic value of equity as the net present value of our balance sheet’s cash flow, and we calculate economic value of equity by discounting anticipated principal and interest cash flows under the prevailing and hypothetical interest rate environments. Potential changes to our economic value of equity between a flat rate scenario and hypothetical rising and declining rate scenarios, measured as of December 31, 2022 and 2021, are presented in the following table. The projections assume shifts upward and downward in the yield curve of 100, 200 and 300 basis points occurring immediately. We would note that starting in the first quarter of 2021 that our simulations in a downward parallel shift of the yield curve, interest and discount rates at the short-end of the yield curve are allowed to decline below 0%. Management has and continues to employ strategies to mitigate risk in these scenarios. Strategies include actively lowering deposit and funding rates as well as adding and maintaining the use of interest rate floors on floating rate loans.
| Changes in Market Interest Rates | December 31, 2022 | December 31, 2021 | |||||||||
| +300 basis points | 2 | % | 60 | % | |||||||
| +200 basis points | 3 | % | 45 | % | |||||||
| +100 basis points | 3 | % | 26 | % | |||||||
| No Change | |||||||||||
| -100 basis points | (8) | % | (37) | % | |||||||
| -200 basis points | (23) | % | (97) | % | |||||||
This economic value of equity profile at December 31, 2022 suggests that we would experience a positive effect from an increase in rates, and that the impact would become greater as rates continue to rise due to the duration of our interest-earning assets. Conversely, we would experience a negative effect from a decrease in rates. While an instantaneous shift in interest rates is used in this analysis to provide an estimate of exposure, we believe that a gradual shift in interest rates would have a much more modest impact. Since economic value of equity measures the discounted present value of cash flows over the estimated lives of instruments, the change in economic value of equity does not directly correlate to the degree that earnings would be impacted over a shorter time horizon.
The results of our net interest income and economic value of equity simulation analysis are purely hypothetical, and a variety of factors might cause actual results to differ substantially from what is depicted. For example, if the timing and magnitude of interest rate changes differ from that projected, our net interest income might vary significantly. Non-parallel yield curve shifts or changes in interest rate spreads would also cause our net interest income to be different from that projected. An increasing interest rate environment could reduce projected net interest income if deposits and other short-term interest-bearing liabilities reprice faster than expected or faster than our interest-earning assets. Actual results could differ from those projected if we grow interest-earning assets and interest-bearing liabilities faster or slower than estimated, or otherwise change its mix of products. Actual results could also differ from those projected if we experience substantially different repayment speeds in our loan portfolio than those assumed in the simulation model. Furthermore, the results do not take into account the impact of changes in loan prepayment rates on loan discount accretion. If prepayment rates were to increase on our loans, we would recognize any remaining loan discounts into interest income. This would result in a current period offset to declining net interest income caused by higher rate loans prepaying. Finally, these simulation results do not contemplate all the actions that we may undertake in response to changes in interest rates, such as changes to our loan, investment, deposit, funding or other strategies.
41
Item 8. Financial Statements and Supplementary Data
The consolidated financial statements are set forth in this Annual Report on Form 10-K as follows:
i. Report of Crowe LLP, Independent Registered Public Accounting Firm (PCAOB ID 173)
ii. Consolidated Balance Sheets
iii. Consolidated Statements of Income
iv. Consolidated Statements of Comprehensive Income
v. Consolidated Statements of Stockholders’ Equity
vi. Consolidated Statements of Cash Flows
vii. Notes to Consolidated Financial Statements
42
Report of Independent Registered Public Accounting Firm
Shareholders and the Board of Directors of Meridian Corporation and Subsidiaries
Malvern, Pennsylvania
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Meridian Corporation and Subsidiaries (the "Company") as of December 31, 2022 and 2021, the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2022, and the related notes (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2022 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2022, based on criteria established in Internal Control – Integrated Framework: (2013) issued by COSO.
Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
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Allowance for Loan Losses – Qualitative Factors
The allowance for loan losses is a valuation allowance for probable incurred credit losses as described in Notes 1, 5 and 6 to the consolidated financial statements. The Company has identified the allowance for loan losses as a critical accounting estimate. The allowance consists of specific and general components. The specific component relates to loans that are individually evaluated as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. The general component has a quantitative component and a qualitative component. The quantitative component of the general reserve is based on historical loss experience and the qualitative component of the general reserve is based on qualitative factors applied to all loan segments. As of December 31, 2022, the allowance for loan losses attributable to loans held for investment is $18.8 million, consisting of 1) an allowance of $16.6 million for loans collectively evaluated for impairment and 2) an allowance of $2.2 million for loans individually evaluated for impairment.
The determination of the qualitative factors is subjective and subject to measurement uncertainty. We considered auditing the qualitative factors used in determining the allowance for loan losses to be a critical audit matter due to the high degree of auditor effort and judgment involved in evaluating management’s judgments and significant assumptions applied in the determination of qualitative factors.
The primary procedures we performed to address this critical audit matter included:
•Testing the operating effectiveness of the following controls:
•Management’s review of the completeness and accuracy of internally-produced data and the relevance and reliability of the external data used in the determination of the qualitative factors.
•Management’s review of the accuracy of the calculation of the qualitative factors and the judgments and significant assumptions used in the determination of the qualitative factors.
•Management’s review of the appropriateness and adequacy of the qualitative factors.
•Substantively testing management’s process to estimate the qualitative factors used in determining the allowance for loan losses, including testing:
•The relevance and reliability of the external data utilized in the determination of the qualitative factors.
•The completeness and accuracy of internally-produced data utilized in the determination of the qualitative factors.
•The mathematical accuracy of the calculation of the qualitative factors.
•The reasonableness of management’s judgments and significant assumptions used in the determination of the qualitative factors.
/s/ Crowe LLP
We have served as the Company’s auditor since 2020.
Washington, D.C.
March 16, 2023
44
MERIDIAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
| (dollars in thousands, except shares and per share data) | December 31, 2022 | December 31, 2021 | |||||||||
| Assets: | |||||||||||
| Cash and due from banks | $ | 11,299 | $ | 3,966 | |||||||
| Interest-bearing deposits at other banks | 27,092 | 19,514 | |||||||||
| Cash and cash equivalents | 38,391 | 23,480 | |||||||||
Securities available-for-sale, at fair value (amortized cost of $148,976 and $158,387, respectively) | 135,346 | 159,302 | |||||||||
Securities held-to-maturity, at amortized cost (fair value of $33,085 and $6,591, respectively) | 37,479 | 6,372 | |||||||||
| Equity investments | 2,086 | 2,354 | |||||||||
Mortgage loans held for sale (amortized cost of $22,207 and $80,002, respectively) | 22,243 | 80,882 | |||||||||
| Loans and other finance receivables, net of fees and costs | 1,743,682 | 1,386,457 | |||||||||
| Allowance for loan and lease losses | (18,828) | (18,758) | |||||||||
| Loans and other finance receivables, net of the allowance for loan and lease losses | 1,724,854 | 1,367,699 | |||||||||
| Restricted investment in bank stock | 6,931 | 5,117 | |||||||||
| Bank premises and equipment, net | 13,349 | 11,806 | |||||||||
| Bank owned life insurance | 28,055 | 22,503 | |||||||||
| Accrued interest receivable | 7,363 | 5,009 | |||||||||
| Other real estate owned | 1,703 | — | |||||||||
| Deferred income taxes | 3,936 | 1,413 | |||||||||
| Servicing assets | 12,346 | 12,765 | |||||||||
| Goodwill | 899 | 899 | |||||||||
| Intangible assets | 3,175 | 3,379 | |||||||||
| Other assets | 24,072 | 10,463 | |||||||||
| Total assets | $ | 2,062,228 | $ | 1,713,443 | |||||||
| Liabilities: | |||||||||||
| Deposits: | |||||||||||
| Non-interest bearing | $ | 301,727 | $ | 274,528 | |||||||
| Interest bearing | 1,410,752 | 1,171,885 | |||||||||
| Total deposits | 1,712,479 | 1,446,413 | |||||||||
| Borrowings | 122,082 | 41,344 | |||||||||
| Subordinated debentures | 40,346 | 40,508 | |||||||||
| Accrued interest payable | 2,389 | 31 | |||||||||
| Other liabilities | 31,652 | 19,787 | |||||||||
| Total liabilities | 1,908,948 | 1,548,083 | |||||||||
| Stockholders’ equity: | |||||||||||
Common stock, $1 par value: 25,000,000 shares authorized; 13,156,308 and 13,069,174 shares issued, respectively; and 11,465,572 and 12,215,788 shares outstanding, respectively. | 13,156 | 6,535 | |||||||||
| Surplus | 79,072 | 83,663 | |||||||||
Treasury stock - 1,690,736 and 853,386 shares, respectively, at cost | (21,821) | (8,860) | |||||||||
| Unearned common stock held by employee stock ownership plan | (1,403) | (1,602) | |||||||||
| Retained earnings | 95,815 | 84,916 | |||||||||
| Accumulated other comprehensive (loss) income | (11,539) | 708 | |||||||||
| Total stockholders’ equity | 153,280 | 165,360 | |||||||||
| Total liabilities and stockholders’ equity | $ | 2,062,228 | $ | 1,713,443 | |||||||
The accompanying notes are an integral part of these consolidated financial statements.
* All share amounts have been adjusted to reflect the two-for-one stock split effective February 28, 2023.
45
MERIDIAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
| Year Ended December 31, | |||||||||||
| (dollars in thousands, except shares and per share data) | 2022 | 2021 | |||||||||
| Interest income: | |||||||||||
| Loans and other finance receivables, including fees | $ | 84,627 | $ | 68,822 | |||||||
| Securities - taxable | 2,420 | 1,463 | |||||||||
| Securities - tax-exempt | 1,388 | 1,189 | |||||||||
| Cash and cash equivalents | 286 | 48 | |||||||||
| Total interest income | 88,721 | 71,522 | |||||||||
| Interest expense: | |||||||||||
| Deposits | 15,397 | 5,494 | |||||||||
| Borrowings | 3,196 | 2,917 | |||||||||
| Total interest expense | 18,593 | 8,411 | |||||||||
| Net interest income | 70,128 | 63,111 | |||||||||
| Provision for loan losses | 2,488 | 1,070 | |||||||||
| Net interest income after provision for loan losses | 67,640 | 62,041 | |||||||||
| Non-interest income: | |||||||||||
| Mortgage banking income | 25,325 | 75,932 | |||||||||
| Wealth management income | 4,733 | 4,801 | |||||||||
| SBA loan income | 4,467 | 6,898 | |||||||||
| Earnings on investment in life insurance | 553 | 365 | |||||||||
| Net change in the fair value of derivative instruments | (703) | (4,338) | |||||||||
| Net change in the fair value of loans held-for-sale | (844) | (3,311) | |||||||||
| Net change in the fair value of loans held-for-investment | (2,408) | (189) | |||||||||
| Net gain on hedging activity | 5,439 | 2,961 | |||||||||
| Net gain on sale of investment securities available-for-sale | — | 435 | |||||||||
| Service charges | 125 | 129 | |||||||||
| Other | 5,037 | 4,305 | |||||||||
| Total non-interest income | 41,724 | 87,988 | |||||||||
| Non-interest expense: | |||||||||||
| Salaries and employee benefits | 54,378 | 78,866 | |||||||||
| Occupancy and equipment | 4,837 | 4,545 | |||||||||
| Professional fees | 3,635 | 3,558 | |||||||||
| Advertising and promotion | 4,336 | 3,714 | |||||||||
| Data processing and software | 5,451 | 4,382 | |||||||||
| Pennsylvania bank shares tax | 793 | 609 | |||||||||
| Other | 8,014 | 8,053 | |||||||||
| Total non-interest expense | 81,444 | 103,727 | |||||||||
| Income before income taxes | 27,920 | 46,302 | |||||||||
| Income tax expense | 6,091 | 10,717 | |||||||||
| Net income | $ | 21,829 | $ | 35,585 | |||||||
| Basic earnings per common share | $ | 1.85 | $ | 2.96 | |||||||
| Diluted earnings per common share | $ | 1.79 | $ | 2.87 | |||||||
| Basic weighted average shares outstanding | 11,792 | 12,038 | |||||||||
| Diluted weighted average shares outstanding | 12,204 | 12,412 | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
* All share and per share amounts have been adjusted to reflect the two-for-one stock split effective February 28, 2023.
46
MERIDIAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
| Year Ended December 31, | |||||||||||
| (dollars in thousands) | 2022 | 2021 | |||||||||
| Net income: | $ | 21,829 | $ | 35,585 | |||||||
| Other comprehensive loss: | |||||||||||
| Net change in unrealized losses on investment securities available for sale: | |||||||||||
Change in fair value of investment securities available for sale, net of tax of $(3,059), and $(485), respectively | (11,285) | (1,514) | |||||||||
Reclassification adjustment for net losses (gains) realized in net income, net of tax effect of $0, and $(101), respectively | — | (334) | |||||||||
Reclassification adjustment for securities transferred from available-for-sale to held-to-maturity, net of tax effect of $(293), and $0, respectively | (962) | — | |||||||||
Unrealized investment losses, net of tax effect of $(3,352), and $(584), respectively | (12,247) | (1,848) | |||||||||
| Total other comprehensive loss | (12,247) | (1,848) | |||||||||
| Total comprehensive income | $ | 9,582 | $ | 33,737 | |||||||
The accompanying notes are an integral part of these consolidated financial statements.
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MERIDIAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
| (dollars in thousands, except per share data) | Common Stock | Surplus | Treasury Stock | Unearned ESOP | Retained Earnings | AOCI | Total | ||||||||||||||||||||||||||||||||||
| Balance at January 1, 2021 | $ | 6,456 | $ | 81,196 | $ | (5,828) | $ | (1,768) | $ | 59,010 | $ | 2,556 | $ | 141,622 | |||||||||||||||||||||||||||
| Net income | — | — | — | — | 35,585 | — | 35,585 | ||||||||||||||||||||||||||||||||||
| Other comprehensive loss | — | — | — | — | — | (1,848) | (1,848) | ||||||||||||||||||||||||||||||||||
Dividends declared, $0.79 per share | — | — | — | — | (9,679) | — | (9,679) | ||||||||||||||||||||||||||||||||||
Net purchase of treasury stock through publicly announced plans (213,386 shares) | — | — | (3,032) | — | — | — | (3,032) | ||||||||||||||||||||||||||||||||||
Common stock issued through share-based awards and exercises (158,042) | 79 | 1,026 | — | — | — | — | 1,105 | ||||||||||||||||||||||||||||||||||
ESOP shares committed to be released (26,656) | — | 228 | — | 166 | — | — | 394 | ||||||||||||||||||||||||||||||||||
| Stock based compensation expense | — | 1,213 | — | — | — | — | 1,213 | ||||||||||||||||||||||||||||||||||
| Balance at December 31, 2021 | $ | 6,535 | $ | 83,663 | $ | (8,860) | $ | (1,602) | $ | 84,916 | $ | 708 | $ | 165,360 | |||||||||||||||||||||||||||
| Net income | — | — | — | — | 21,829 | — | 21,829 | ||||||||||||||||||||||||||||||||||
| Other comprehensive loss | — | — | — | — | — | (12,247) | (12,247) | ||||||||||||||||||||||||||||||||||
Dividends paid or accrued, $0.90 per share | — | — | — | — | (10,930) | — | (10,930) | ||||||||||||||||||||||||||||||||||
Net purchase of treasury stock through publicly announced plans (837,350 shares) | — | — | (12,961) | — | — | — | (12,961) | ||||||||||||||||||||||||||||||||||
Common stock issued through share-based awards and exercises (86,734) | 43 | 711 | — | — | — | — | 754 | ||||||||||||||||||||||||||||||||||
ESOP shares committed to be released (26,656) | 228 | 199 | 427 | ||||||||||||||||||||||||||||||||||||||
| Stock based compensation expense | — | 1,048 | — | — | — | — | 1,048 | ||||||||||||||||||||||||||||||||||
| Two-for-one stock split in the form of a stock dividend | 6,578 | (6,578) | — | — | — | — | — | ||||||||||||||||||||||||||||||||||
| Balance at December 31, 2022 | $ | 13,156 | $ | 79,072 | $ | (21,821) | $ | (1,403) | $ | 95,815 | $ | (11,539) | $ | 153,280 | |||||||||||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
* All share and per share amounts have been adjusted to reflect the two-for-one stock split effective February 28, 2023.
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MERIDIAN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
| Year Ended December 31, | |||||||||||
| (dollars in thousands) | 2022 | 2021 | |||||||||
| Net income | $ | 21,829 | $ | 35,585 | |||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
| Gain on sale of investment securities | — | (435) | |||||||||
| Net amortization of investment premiums and discounts and change in fair value of equity securities | 1,202 | 1,369 | |||||||||
| Depreciation and amortization (accretion), net | (1,406) | (5,922) | |||||||||
| Provision for loan losses | 2,488 | 1,070 | |||||||||
| Amortization of issuance costs on subordinated debt | 117 | 118 | |||||||||
| Stock based compensation | 1,475 | 1,607 | |||||||||
| Net change in fair value of derivative instruments | 703 | 4,338 | |||||||||
| Net change in fair value of loans held for sale | 844 | 3,311 | |||||||||
| Net change in fair value of loans held for investment | 2,408 | 189 | |||||||||
| Amortization and net impairment of servicing rights | 2,483 | 1,109 | |||||||||
| SBA loan income | (4,467) | (6,898) | |||||||||
| Proceeds from sale of loans | 1,100,333 | 2,483,373 | |||||||||
| Loans originated for sale | (1,016,130) | (2,270,693) | |||||||||
| Mortgage banking income | (25,325) | (75,932) | |||||||||
| (Increase) decrease in accrued interest receivable | (2,354) | 473 | |||||||||
| Increase in other assets | (823) | (3,693) | |||||||||
| Earnings from investment in life insurance | (553) | (365) | |||||||||
| (Decrease) increase in deferred income tax | 1,112 | (768) | |||||||||
| Increase (decrease) in accrued interest payable | 2,358 | (1,122) | |||||||||
| Decrease in other liabilities | (1,623) | (1,591) | |||||||||
| Net cash provided by operating activities | 84,671 | 165,123 | |||||||||
| Cash flows used in investing activities: | |||||||||||
| Activity in available-for-sale securities: | |||||||||||
| Maturities, repayments and calls | 12,124 | 10,447 | |||||||||
| Sales | — | 23,585 | |||||||||
| Purchases | (31,496) | (74,341) | |||||||||
| Activity in held-to-maturity securities: | |||||||||||
| Maturities, repayments and calls | 905 | — | |||||||||
| Purchases | (5,500) | — | |||||||||
| (Decrease) increase in restricted stock | (1,814) | 2,743 | |||||||||
| Net increase in loans | (359,460) | (87,575) | |||||||||
| Purchases of premises and equipment | (2,907) | (5,374) | |||||||||
| Purchase of bank owned life insurance | (5,000) | (10,000) | |||||||||
| Net cash used in investing activities | (393,148) | (140,515) | |||||||||
| Cash flows provided by (used in) financing activities: | |||||||||||
| Net increase in deposits | 266,066 | 205,079 | |||||||||
| Decrease in short-term borrowings | — | (44,939) | |||||||||
| Decrease in short-term borrowings with original maturity > 90 days | 71,803 | (20,579) | |||||||||
| Increase in long-term debt | 8,935 | — | |||||||||
| Repayment of long-term debt, net | — | (165,546) | |||||||||
| Repayment of subordinated debt | (279) | (281) | |||||||||
49
| Net purchase of treasury stock | (12,961) | (3,032) | |||||||||
| Dividends paid | (10,930) | (9,679) | |||||||||
| Share based awards and exercises | 754 | 1,105 | |||||||||
| Net cash provided by (used in) financing activities | 323,388 | (37,872) | |||||||||
| Net change in cash and cash equivalents | 14,911 | (13,264) | |||||||||
| Cash and cash equivalents at beginning of period | 23,480 | 36,744 | |||||||||
| Cash and cash equivalents at end of period | $ | 38,391 | $ | 23,480 | |||||||
| Supplemental disclosure of cash flow information: | |||||||||||
| Cash paid during the period for: | |||||||||||
| Interest | $ | 16,235 | $ | 9,534 | |||||||
| Income taxes | 5,365 | 14,069 | |||||||||
| Transfers from loans held for sale to loans held for investment | 3,147 | 8,410 | |||||||||
| Non-cash transfers from loans receivable to OREO | 1,703 | — | |||||||||
| Transfer of securities from AFS to HTM | 23,655 | — | |||||||||
| Lease liabilities arising from obtaining right-of-use assets | 10,936 | — | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
50
MERIDIAN CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Summary of Significant Accounting Policies
Nature of Operations
Meridian Corporation (“Meridian” or the “Corporation”) is a bank holding company engaged in banking activities through its wholly-owned subsidiary, Meridian Bank (the “Bank”), a full-service, state-chartered commercial bank with offices in the Delaware Valley tri-state market, which includes Pennsylvania, New Jersey and Delaware, as well as the Central Maryland market area, and Florida. We have a financial services business model with significant noninterest income streams from mortgage banking, SBA lending and wealth management services. We provide services to small and middle market businesses, professionals and retail customers throughout our market area. We have a modern, progressive, consultative approach to creating innovative solutions for our customers. We are technology driven, with a culture that incorporates significant use of customer preferred alternative delivery channels, such as mobile banking, remote deposit capture and bank-to-bank ACH. Our ‘Meridian everywhere’ philosophy of community presence, along with our strategic business footprint, allows us to provide the high degree of service, convenience and products our customers need to achieve their financial objectives. We provide this service through three principal business line distribution channels, described further below.
The Corporation operates in highly competitive market areas that includes local, regional, and national banks as competitors along with savings banks, credit unions, fintech companies, insurance companies, trust companies and registered investment advisors. The Corporation and its subsidiaries are regulated by many regulatory agencies including the SEC, FDIC, the FRB and the PDBS.
The Bank was incorporated on March 16, 2004 under the laws of the Commonwealth of Pennsylvania and is a Pennsylvania state-chartered bank. The Bank commenced operations on July 8, 2004 and is a full-service bank providing personal and business lending and deposit services through 6 full-service banking offices in Pennsylvania, 7 mortgage loan production offices throughout the Delaware Valley, and 6 mortgage loan production offices in Maryland, and a lending office in Florida. The Bank and Corporation are headquartered in Malvern, Pennsylvania, located in the western suburbs of Philadelphia.
Basis of Presentation
The accounting policies of the Corporation conform to U.S. GAAP.
The consolidated financial statements include accounts of the Corporation and its wholly owned subsidiary, the Bank, and the wholly owned subsidiaries of the Bank: Meridian Land Settlement Services LLC (“MLSS”); APEX Realty LLC (“APEX”); Meridian Wealth Partners LLC (“MWP”); and Meridian Equipment Finance LLC (“MEF”). All significant intercompany balances and transactions have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform to the current year’s presentation. Reclassifications had no effect on prior year net income or total stockholders’ equity.
The preparation of financial statements in conformity with U.S. generally accepted accounting principles 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Significant Concentrations of Credit Risk
Most of the Corporation’s activities are with customers located in the Delaware Valley tri-state market and the central Maryland market area. Note 4 discusses the types of securities that the Corporation invests in. Note 5 discusses types of lending that the Corporation engages in. Although the Corporation has a diversified loan portfolio, its debtors’ ability to honor their contracts is influenced by the region’s economy. The Corporation does not have any significant concentrations to any one industry or customer, however there is significant concentration of commercial real estate-backed loans, amounting to 33% and 37% of total loans held for investment, as of December 31, 2022 and December 31, 2021, respectively.
Presentation of Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are purchased or sold for one day periods. The FRB removed cash minimum reserve requirements in March 2020. Net cash flows are reported for customer loan and deposit transactions, interest bearing deposits in other financial institutions, and the federal funds purchased and repurchased agreements.
Securities
Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date.
Securities classified as available-for-sale are those securities that the Corporation intends to hold for an indefinite period of time but not necessarily to maturity. Securities available-for-sale are carried at fair value. Any decision to sell a security classified as available-for-sale would be based on various factors, including significant movement in interest rates, changes in maturity mix of the Corporation’s assets and liabilities, liquidity needs, regulatory capital considerations and other similar factors. Unrealized gains and losses are reported as increases or decreases in other comprehensive income. Gains or losses on disposition are based on the net proceeds and cost of the securities sold, adjusted for the amortization of premiums and accretion of discounts, using the specific identification method.
Securities classified as held to maturity are those debt securities the Corporation has both the intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. These securities are carried at cost adjusted for the amortization of premium and accretion of discount, computed on a level yield basis.
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Investments in equity securities are recorded in accordance with ASC 321-10, Investments - Equity Securities. Equity securities are carried at fair value, with changes in fair value reported in net income. At December 31, 2022 and 2021, investments in equity securities consisted of an investment in mutual funds with a fair value of $2.1 million, and $2.4 million, respectively.
The Corporation’s accounting policy specifies that (a) if the Corporation does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired, unless there is a credit loss. When the Corporation does not intend to sell the security, and it is more likely than not, the Corporation will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. The Corporation did not recognize any other-than-temporary impairment charges during the years ended December 31, 2022 and 2021.
Loans and Other Finance Receivables
Loans and other finance receivables that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at their outstanding unpaid principal balances, net of an allowance for loan losses and any deferred fees or costs. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (interest income) of the related loans. The Corporation generally amortizes these amounts over the contractual life of the loan.
Loans that were originated by the Corporation and intended for sale in the secondary market to permanent investors, but were either repurchased or unsalable due to defect, are held for the foreseeable future or until maturity or payoff, are carried at fair value.
The accrual of interest is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest credited to income in the current year is reversed and charged against current year income. Interest received on nonaccrual loans generally is either applied against principal or reported as interest income, according to management’s judgment as to the collectability of principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectability of the total contractual principal and interest is no longer in doubt.
Allowance for Loan and Lease Losses
The Allowance or ALLL is a valuation for probable incurred credit losses established through provisions for loan losses charged against income. Loans deemed to be uncollectible are charged against the Allowance, and subsequent recoveries, if any, are credited to the Allowance. All, or part, of the principal balance of loans receivable are charged off to the Allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. Charge-offs for retail consumer loans and equipment leases are generally made for any balance not adequately secured after 120 days cumulative days past due.
The Allowance is maintained at a level considered adequate to provide for probable incurred credit losses. Management’s periodic evaluation of the adequacy of the Allowance is based on known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is subjective as it requires material estimates that may be susceptible to significant revisions as more information becomes available. In addition, Federal regulatory agencies, as an integral part of their examination process, periodically review the Corporation’s Allowance and may require the Corporation to recognize additions to the Allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management.
The Allowance consists of general and specific components. The general component covers non-classified loans, as well as, non-impaired classified loans and is based on historical loss experience adjusted for qualitative factors. The specific component relates to loans that are classified as doubtful, substandard, and are on non-accrual and have been deemed impaired. Loan classifications are determined based on various assessments such as the borrower’s overall financial condition, payment history, repayment sources, guarantors and value of collateral.
We apply historical loss rates to pools of loans with similar risk characteristics. Loss rates are calculated by historical charge-offs that have occurred within each pool of loans over the LEP. The LEP is an estimate of the average amount of time from when an event happens that causes the borrower to be unable to pay on a loan until the loss is confirmed through a loan charge-off.
Another key assumption is the LBP, which represents the historical data period utilized to calculate loss rates. Our LBP goes back to Q1 2010 for all portfolio segments, as applicable, which encompasses our loss experience during the Financial Crisis, and our more recent improved loss experience.
After consideration of the historic loss calculations, management applies qualitative adjustments so that the Allowance is reflective of the inherent losses that exist in the loan portfolio at the balance sheet date. Qualitative adjustments are made based upon changes in lending policies and practices, economic conditions, changes in the loan portfolio, changes in lending management, results of internal loan reviews, asset quality trends, collateral values, concentrations of credit risk and other external factors. The evaluation of the various components of the Allowance requires considerable judgment in order to estimate inherent loss exposures.
A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement, or a TDR. 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
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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.
For commercial and construction loans, impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral adjusted for cost to sell, if the loan is collateral dependent.
Large groups of smaller balance homogeneous residential mortgage and consumer loans are collectively evaluated for impairment. Accordingly, the Corporation does not separately identify individual loans of this nature for impairment disclosures, unless such loans become impaired or are troubled and the subject of a restructuring agreement.
Loans whose terms are modified are classified as TDRs if the Corporation grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a TDR generally involve a temporary reduction in interest rate or an extension of a loan’s stated maturity date. TDRs are considered impaired loans.
No portion of the Allowance is restricted to any individual loan or groups of loans, and the entire Allowance is available to absorb any and all loan and lease losses.
The Corporation has identified the following portfolio segments with similar risk characteristics for measuring credit losses:
Commercial mortgage – Our commercial real estate loans are secured by real estate that is both owner-occupied and investor owned. Owner-occupied commercial real estate loans generally involve less risk than an investment property and are distinctly reported from non-owner occupied commercial real estate loans for measuring loan concentrations for regulatory purposes. Repayment of commercial real estate loans depends on the cash flow of the borrower and the net operating income of the property, the borrower’s profitability, and the value of the underlying property. Of primary concern in commercial real estate lending is the borrower’s creditworthiness and the cash flows from the property. Payments on loans secured by income properties often depend on successful operation and management of the properties. As a result, repayment of such loans may be subject, to a greater extent than residential real estate loans, to adverse conditions in the real estate market or the economy. Commercial real estate is also subject to adverse market conditions that cause a decrease in market value or lease rates, obsolescence in location or function and market conditions associated with oversupply of units in a specific region.
Residential mortgage – Residential loans held in portfolio are primarily secured by single-family homes located in our market areas. Residential loans are generally made on the basis of the borrower’s ability to make repayment from employment income or other income, and are secured by real property whose value tends to be more easily ascertainable. Repayment of single-family loans are subject to adverse employment conditions in the local economy leading to increased default rates and decreased market values, including from oversupply in a geographic area. In general, these loans depend on the borrower’s continuing financial stability and, therefore, are likely to be adversely affected by various factors, including job loss, divorce, illness, or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.
Construction – Construction financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction and the estimated cost of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, additional funds may be required to be advanced in excess of the amount originally committed to permit completion of the building.
Commercial and Industrial – We provide a variety of variable and fixed rate commercial business loans, lines of credit, and other finance receivables. These credit facilities are made to small and medium-sized manufacturers and wholesale, retail and service-related businesses. Commercial business loans generally include lines of credit and term loans with a maturity of 5 years or less. The primary source of repayment for commercial business loans and other finance receivables is generally operating cash flows of the business and may also include collateralization of inventory, accounts receivable, equipment and/or personal guarantees. As a result, the availability of funds for repayment may depend substantially on the success of the business itself. Furthermore, any collateral may depreciate over time, may be difficult to appraise, and may fluctuate in value.
Leases – Meridian Equipment Finance specializes in small ticket equipment leases for small and mid-sized businesses nationally and through a broad range of industries. The Bank’s credit risk generally results from the potential default of borrowers which may be driven by customer specific or broader industry related conditions.
Consumer, including home equity – Our consumer-lending department principally originates home equity based products for our clients and prospects. These loans typically fund completely at closing. Additional products include smaller dollar personal loans and our student loan refinance product, designed to provide additional flexibility in repayment terms desired in the marketplace. Most consumer loans are originated in Meridian’s primary market and surrounding areas.
The largest component of Meridian’s consumer loan portfolio consists of fixed rate home equity loans and variable rate home equity lines of credit. Substantially all home equity loans and lines of credit are secured by junior lien mortgages on principal residences. The Bank will lend amounts, which, together with all prior liens, typically may be up to 90% of the appraised value of the property securing the loan. Home equity term loans may have maximum terms up to 20 years, while home equity lines of credit generally have maximum terms of 15 years .
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Credit risk on such loans is mitigated through prudent underwriting standards, including evaluation of the creditworthiness of the borrower through credit scores and debt-to-income ratios and, if secured, the collateral value of the assets.
Mortgage Banking Activities and Mortgage Loans Held for Sale
The Corporation’s mortgage banking division operates 7 offices in the tri-state area of Pennsylvania, Delaware and New Jersey and another 6 offices in Maryland. The mortgage banking division originates conventional mortgages, FHA, VA, USDA, and other state insured mortgages. The loans are generally sold to various investors in the secondary market.
Mortgage loans originated by the Corporation and intended for sale in the secondary market to permanent investors are classified as mortgage loans held for sale on the balance sheet as the Corporation has elected to measure loans held for sale at fair value. Fair value is based on outstanding investor commitments or, in the absence of such commitments, on current investor yield requirements based on third party models. Gains and losses on sales of these loans, as well as loan origination costs, are recorded as a component of non-interest income in the consolidated statements of income. The Corporation’s current practice is to sell residential mortgage loans and retain the servicing rights, as discussed further below. Interest on loans held for sale is credited to income based on the principal amounts outstanding.
The Corporation enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding (interest rate lock commitments). Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. Time elapsing between the issuance of a loan commitment and closing and sale of the loan generally ranges from 30 days to 120 days. The Corporation protects itself from changes in interest rates through the use of best efforts forward sale contracts, whereby the Corporation commits to sell a loan at the time the borrower commits to an interest rate with the intent that the buyer has assumed interest rate risk on the loan. The Corporation may also commit to loan sales through a mandatory sales channel which are economically hedged by the future sale of mortgage-backed securities to third-party counterparties to mitigate the effect of changes in interest rates on the values of both the interest rate locks and mortgage loans held for sale. By entering into best efforts commitments and economically hedging the mandatory commitments, the Corporation limits its exposure to loss and its realization of significant gains related to its rate lock commitments due to changes in interest rates.
The Corporation utilizes a third-party model to determine the fair value of rate lock commitments or forward sale contracts. This model uses investor quotes while taking into consideration the probability that the rate lock commitments will close. Net derivative assets and liabilities are recorded within other assets or other liabilities, respectively, on the consolidated balance sheets, with changes in fair value during the period recorded within net change in the fair value of derivative instruments on the consolidated statements of income.
Loan Servicing Rights
The Corporation sells substantially all of the residential mortgage loans originated for sale in the secondary market; however, the Corporation may retain the servicing rights related to some of these loans. A fee, usually based on a percentage of the outstanding principal balance of the loan, is received in return for these services. MSRs are recognized when a loan’s servicing rights are retained upon sale of a loan. When mortgage loans are sold with servicing retained, MSRs are initially recorded at fair value with the income effect recorded in non-interest income.
The Corporation also sells the guaranteed portion of certain SBA loans to third parties and retains servicing rights and receives servicing fees. All such transfers are accounted for as sales. While the Corporation may retain a portion of certain sold SBA loans, its continuing involvement in the portion of the loan that was sold is limited to certain servicing responsibilities.
These servicing assets amortize in proportion to, and over the period of, the estimated future net servicing life of the underlying loans. The servicing assets are evaluated quarterly for impairment based upon the fair value of the rights as compared to their amortized cost. Impairment is recognized on the income statement to the extent the fair value is less than the capitalized amount of the servicing assets.
Other Real Estate Owned
OREO is comprised of property acquired through a foreclosure proceeding or acceptance of a deed-in-lieu of foreclosure. The Corporation acquires OREO through the wholly owned subsidiary of the Bank, Apex Realty. OREO is recorded at the lower of cost or fair value, or the loan amount net of estimated selling costs, at the date of foreclosure. The cost basis of OREO is its recorded value at the time of acquisition. After acquisition, valuations are periodically performed by management and subsequent changes in the valuation allowance are charged to OREO expense. Revenues, such as rental income, and holding expenses, as applicable, are included in other income and other expenses, respectively. The Corporation had one $1.7 million single property in OREO at December 31, 2022 and $0 at December 31, 2021.
Restricted Investment in Bank Stock
Restricted bank stock is principally comprised of stock in the FHLB. Federal law requires a member institution of the FHLB to hold stock according to a predetermined formula. As of December 31, 2022, and 2021, the Corporation had an investment of $6.9 million and $5.1 million, respectively, related to the FHLB stock. Also included in restricted stock is secondary stock from a correspondent bank in the amount of $50 thousand as of December 31, 2022 and 2021. All restricted stock is carried at cost.
Management’s determination of whether these investments are impaired is based on their assessment of the ultimate recoverability of their cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of their cost is influenced by criteria such as (1) significance of the decline in net assets of the banks as compared to the capital stock amount and the length of time this situation has persisted, (2) commitments by the banks to make payments required by law or regulation and the level of such payments in relation to the operating performance of the banks, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the banks.
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Management believes no impairment charge is necessary related to these bank restricted stocks as of December 31, 2022 or 2021.
Transfers of Financial Assets
Transfers of financial assets, including loan and loan participation sales, are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Corporation, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Corporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Bank Premises and Equipment
Bank premises and equipment are stated at cost less accumulated depreciation. Land is carried at cost. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 12 to 40 years Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 7 years and 3 to 5 years for computer software and hardware, respectively. Leasehold improvements are amortized over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter. The costs of maintenance and repairs are expensed as incurred; while major replacements, improvements and additions are capitalized.
Lease Liabilities and Right of Use Assets
The Corporation is obligated under non-cancelable operating leases for premises for various retail branch locations and loan production offices. The Corporation determines if an arrangement is a lease at inception by assessing whether a contract contains a right to control an identified asset for a period of time in exchange for consideration. Operating leases are included in operating lease right-of-use assets and operating lease liabilities in the consolidated balance sheets. For purposes of calculating operating lease liabilities, lease terms include options to extend or terminate the lease when it is reasonably certain that the Corporation will exercise that option and begins when the Corporation has control and possession of the leased property, which may be before rental payments are due under the lease. Right-of use assets and operating lease liabilities are recognized based on the present value of lease payments, discounted using the Corporation's incremental borrowing rate, over the lease term at the possession date. The Corporation determines its incremental borrowing rate using publicly available information available for debt issuers with similar credit ratings as the Bank, as the substantial majority of the Corporation's leases are related to properties of the Bank. The Corporation separately accounts for lease and non-lease components such as property taxes, insurance, and maintenance costs. Operating lease expense for the Corporation's leases, which generally have escalating rental payments over the term of the lease, is recognized on a straight-line basis over the lease term. At December 31, 2022, the Corporation's leases have remaining terms of 2 months to 12 years.
Bank-Owned Life Insurance
The Corporation invests in BOLI as a source of funding for employee benefit expenses. BOLI involves the purchasing of life insurance by the Corporation on a chosen group of employees. The Corporation is the owner and beneficiary of the policies. This life insurance investment is carried at the cash surrender value of the underlying policies. Earnings from the increase in cash surrender value of the policies are included in non-interest income on the consolidated statements of income.
Advertising Costs
The Corporation follows the policy of charging the costs of advertising to expense as incurred.
Employee Benefit Plans
The Corporation has a 401(k) Plan (the Plan) and an ESOP. All employees are eligible to participate in the Plan and ESOP after they have attained the age of 21 and have also completed three months consecutively of service. Employees must participate in the Plan to be eligible for participation in the ESOP. The employees may contribute to the Plan up to the maximum percentage allowable by law of their compensation. The Corporation may make a discretionary matching contribution to the Plan and the ESOP. Full vesting in the Corporation’s contribution to the Plan and ESOP is over a three-year period. The Corporation recorded expense for the Plan and ESOP of $1.0 million and $1.1 million, respectively for the year ended December 31, 2022 and $1.4 million and $1.1 million, respectively for the year ended December 31, 2021. The expense recorded by the Corporation for the ESOP for the year ended December 31, 2022 included a $671 thousand employer contribution, in addition to $426 thousand in stock compensation related expense. The expense recorded by the Corporation for the ESOP for the year ended December 31, 2021 included a $663 thousand employer contribution, in addition to $437 thousand in stock compensation related expense.
During the year ended December 31, 2022, 0 shares were purchased by the ESOP, while for the year ended December 31, 2021, 91,212 shares were purchased by the ESOP at an average market value of $12.15. Shares in the ESOP that are committed to be released to employees are treated as outstanding shares in the Corporation’s computation of earnings per share. As of December 31, 2021, 53,312 of these common shares were released to the ESOP leaving 213,248 unallocated shares. There were 534,100 shares in the ESOP as of December 31, 2022. Shares in the ESOP would be impacted by any stock dividends and stock splits in the same manner as all other outstanding common shares of the Corporation.
Income Taxes
Deferred income taxes are provided on the asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and net operating losses and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and net operating loss carry-forwards and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that
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some portion of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
The Corporation follows accounting guidance related to accounting for uncertainty in income taxes. Under the “more likely than not” threshold guidelines, the Corporation believes no significant uncertain tax positions exist, either individually or in the aggregate, that would give rise to the non-recognition of an existing tax benefit. As of December 31, 2022, and 2021, the Corporation had no material unrecognized tax benefits or accrued interest and penalties. The Corporation’s policy is to account for interest as a component of interest expense and penalties as a component of other expense. The Corporation is no longer subject to examination by federal, state and local taxing authorities for years before January 1, 2019.
Stock Split
On February 28, 2023, the Corporation approved and declared a two-for-one stock split in the form of a stock dividend, payable March 20, 2023, to shareholders of record as of March 14, 2023. Under the terms of the stock split, the Corporation’s shareholders will receive a dividend of one share for every share held on the record date. The dividend will be paid in authorized but unissued shares of common stock of the Corporation. The par value of the Corporation's stock was not affected by the split and remained at $1.00 per share. All share and per share amounts reported in the consolidated financial statements have been adjusted to reflect the two-for-one stock split effective February 28, 2023.
Stock Compensation Plans
Stock compensation accounting guidance requires that the compensation cost relating to share-based payment transactions be recognized in the consolidated financial statements. That cost will be measured based on the grant date fair value of the equity or liability instruments issued. The stock compensation accounting guidance covers a wide range of share-based compensation arrangements including stock options and restricted share plans.
The stock compensation accounting guidance requires that compensation cost for all stock awards be calculated and recognized over the employees’ service period, generally defined as the vesting period. For awards with graded-vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. A Black-Scholes model is used to estimate the fair value of stock options, while the market price of the Corporation’s common stock at the date of grant is used for restricted stock awards. All stock compensation issued has been adjusted for the two-for-one stock split effective February 28, 2023, as discussed further in footnote 13.
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.
The components of other comprehensive income (loss) for the years ended December 31, 2022 and 2021 consist of unrealized holding gains and (losses) arising during the year on available-for-sale securities.
Off-Balance Sheet Financial Instruments
In the ordinary course of business, the Corporation has entered into off-balance sheet financial instruments consisting of commitments to extend credit and letters of credit. Such financial instruments are recorded in the balance sheet when they are funded.
Derivative Financial Instruments
The Corporation recognizes all derivative financial instruments related to its mortgage banking activities on its balance sheet at fair value. The Corporation utilizes investor quotes to determine the fair value of interest rate lock commitment derivatives and market pricing to determine the fair value of forward security purchase commitment derivatives. All changes in fair value of derivative instruments are recognized in earnings.
The Corporation enters into interest rate swaps that allow commercial loan customers to effectively convert a variable-rate commercial loan agreement to a fixed-rate commercial loan agreement. The interest rate swaps are recognized on the Corporation’s balance sheet at fair value. Under these agreements, the Corporation originates variable-rate loans with customers in addition to interest rate swap agreements, which serve to effectively swap the customers’ variable-rate loans into fixed-rate loans. The Corporation then enters into corresponding swap agreements with swap dealer counterparties to economically hedge its exposure on the variable and fixed components of the customer agreements. The interest rate swaps with both the customers and third parties are not designated as hedges under ASC 815 and are marked to market through earnings. As the interest rate swaps are structured to offset each other, changes to the underlying benchmark interest rates considered in the valuation of these instruments do not result in an impact to earnings; however, there may be fair value adjustments related to credit quality variations between counterparties, which may impact earnings as required by ASC 820.
Earnings per Common Share
Basic earnings per common share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average common shares outstanding during the period reduced by unearned ESOP Plan shares and treasury stock. Diluted earnings per common share takes into account the potential dilution that would occur if in the-money stock options were exercised and converted into shares of common stock and restricted stock awards and performance-based stock awards were vested. Proceeds assumed to have been received on options exercises are assumed to be used to purchase shares of the Corporation’s common stock
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at the average market price during the period, as required by the treasury stock method of accounting. The effects of stock options are excluded from the computation of diluted earnings per share in periods in which the effect would be antidilutive.
Revenue Recognition
The Corporation recognizes all sources of income on the accrual method, with the exception of nonaccrual loans and leases. In addition to lending and related activities, the Corporation offers various services that generate revenue, certain of which are in the scope of FASB ASU 2014-09 (Topic 606), “Revenue for Contracts with Customers” (ASC 606) is recognized within non-interest income and include wealth management fees, and transaction based and fees. Revenue is recognized when the transactions occur or as services as performed over primarily monthly or quarterly periods. Payment is typically received in the period the transactions occur. Fees may be fixed or, where applicable based on a percentage of transaction size. Wealth management income for the years ended December 31, 2022 and 2021 is $4.7 million and $4.8 million. Within other non-interest income is $1.1 million and $1.2 million for the years ended December 31, 2022 and 2021, respectively, which are in the scope of ASC 606. These amounts include wire transfer fees, ATM/debit card commissions, title fee income.
The Corporation earns wealth management fee income from investment advisory services provided to individual and 401k customers. Fees that are determined based on the market value of the assets held in their accounts are generally billed quarterly, in advance, based on the market value of assets at the end of the previous billing period. Other related services that are based on a fixed fee schedule are recognized when the services are rendered. Fees that are transaction based, including trade execution services, are recognized at the point in time that the transaction is executed, i.e. the trade date. Included in other assets on the balance sheet is a receivable for wealth management fees that have been earned but not yet collected.
The Corporation earns fees from its deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering, and ACH fees, are recognized at the time the transaction is executed as that is the point in time the Corporation fulfills the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Corporation satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on deposits are withdrawn from the customer’s account balance.
Other sources of the Corporation’s non-interest income that are not within the scope of ASC 606 include mortgage banking income, SBA loan income, net changes in fair values, hedging gains and losses, earnings on investments in life insurance, gains or losses on sale of investment securities, and dividends on FHLB stock.
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe such matters will have a material effect on the financial statements.
Operating Segments
While the chief decision-makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Corporation-wide basis. The Corporation has identified three segments: a banking segment, a wealth management segment and a mortgage banking segment, as more fully disclosed in the Segment note to the consolidated financial statements.
Fair Value of Financial Instruments
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in the Fair Value Measurements and Disclosures note to the consolidated financial statements. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.
Recent Accounting Pronouncements
As an “emerging growth company” under the JOBS Act until December 31, 2022, the Bank was permitted an extended transition period for complying with new or revised accounting standards affecting public companies up to this date. We were classified as an emerging growth company until the end of the fiscal year following the fifth anniversary of the completion of our initial public offering, which took place on November 7, 2022. While an emerging growth company we had elected to take advantage of this extended transition period, which means that the financial statements included herein, as well as any financial statements that we filed in the past, are not subject to all new or revised accounting standards generally applicable to public companies for the transition period.
FASB ASU 2016-02 (Topic 842), “Leases”
Issued in February 2016, and amended in June 2020, ASU 2016-02 revised the accounting related to lessee accounting. Under the new guidance, lessees are required to recognize a lease ROU liability and a ROU asset for all leases. The new lease guidance also simplifies the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. On January 1, 2022 the Corporation recognized a right-of-use asset and a lease obligation liability on the consolidated
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statement of financial condition. The adoption of the ASU was on a prospective basis and therefore comparative prior periods are still presented under ASC 840. Refer to footnote 11 - leases, for further details.
Pronouncements Not Effective as of December 31, 2022:
FASB ASU 2016-13 (Topic 326), “Measurement of Credit Losses on Financial Instruments”
Issued in June 2016, ASU 2016-13 significantly changes how companies measure and recognize credit impairment for many financial assets. This ASU requires businesses and other organizations to measure CECL on financial assets, such as loans, net investments in leases, certain debt securities, bond insurance and other receivables. The amendments affect entities holding financial assets and net investments in leases that are not accounted for at fair value through net income. Current GAAP requires an incurred loss methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. The amendments in this ASU replace the incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonableness and supportable information to inform credit loss estimates. An entity should apply the amendments through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (modified retrospective approach). Acquired credit impaired loans for which the guidance in Accounting Standards Codification (ASC) Topic 310-30 has been previously applied should prospectively apply the guidance in this ASU. A prospective transition approach is required for debt securities for which an other-than-temporary impairment has been recognized before the effective date. In October 2019, the FASB approved a delay for the implementation of the ASU. Accordingly, the Corporation’s effective date for the implementation of the ASU will be January 1, 2023. The Corporation has largely completed its assessment of related processes, internal controls, and data sources and has developed, documented, and validated a discounted cash flows model utilizing a third-party software provider. The Corporation anticipates that the Corporation and the Bank will continue to be well capitalized after the negative impact resulting from the adoption of CECL.
FASB ASU 2019-04, “Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments”
Issued in April 2019, ASU 2019-04 clarifies certain aspects of accounting for credit losses, hedging activities, and financial instruments (addressed by ASUs 2016-13, 2017-12, and 2016-01, respectively). The amendments to estimating expected credit losses (ASU 2016-13), in particular, how a company considers recoveries and extension options when estimating expected credit losses, are the most relevant to the Corporation. The ASU clarifies that (1) the estimate of expected credit losses should include expected recoveries of financial assets, including recoveries of amounts expected to be written off and those previously written off, and (2) that contractual extension or renewal options that are not unconditionally cancellable by the lender are considered when determining the contractual term over which expected credit losses are measured. Management will consider the impact of ASU 2019-04 when considering the impact of ASU 2016-13 upon adoption as of January 1, 2023.
FASB ASU 2022-02, "Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures."
In March 2022, the FASB issued ASU No. 2022-02, "Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures." The amendments eliminate the accounting guidance for troubled debt restructurings by creditors that have adopted CECL and enhance the disclosure requirements for modifications of receivables made with borrowers experiencing financial difficulty. In addition, the amendments require disclosure of current period gross write-offs by year of origination for financing receivables and net investment in leases in the existing vintage disclosures. This ASU is effective for fiscal years beginning after December 15, 2022 or January 1, 2023 for the Corporation, including interim periods within those fiscal years for entities that have adopted CECL.
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(2) Earnings per Common Share
Basic earnings per common share excludes dilution and is computed by dividing income available to common shareholders by the weighted-average common shares outstanding during the period reduced by unearned ESOP Plan shares and treasury shares. Diluted earnings per common share takes into account the potential dilution, computed pursuant to the treasury stock method, that could occur if stock options were exercised and converted into common stock; if restricted stock awards were vested; and SERP plan liabilities were satisfied with common shares. The effects of stock options are excluded from the computation of diluted earnings per share in periods in which the effect would be anti-dilutive. All share and per share amounts have been adjusted to reflect the two-for-one stock split effective February 28, 2023.
| Year Ended December 31, | |||||||||||
| (dollars in thousands, except per share data) | 2022 | 2021 | |||||||||
| Numerator for earnings per share: | |||||||||||
| Net income available to common stockholders | $ | 21,829 | $ | 35,585 | |||||||
| Denominators for earnings per share: | |||||||||||
| Weighted average shares outstanding | 11,992 | 12,266 | |||||||||
| Average unearned ESOP shares | (200) | (228) | |||||||||
| Basic weighted average shares outstanding | 11,792 | 12,038 | |||||||||
| Dilutive effects of assumed exercises of stock options | 268 | 260 | |||||||||
| Dilutive effects of SERP shares | 144 | 114 | |||||||||
| Diluted weighted average shares outstanding | 12,204 | 12,412 | |||||||||
| Basic earnings per share | $ | 1.85 | $ | 2.96 | |||||||
| Diluted earnings per share | $ | 1.79 | $ | 2.87 | |||||||
| Antidilutive shares excluded from computation of average dilutive earnings per share | 464 | 278 | |||||||||
(3) Goodwill and Other Intangibles
The Corporation’s goodwill and intangible assets are detailed below:
| (dollars in thousands) | December 31, 2021 | Amortization Expense | December 31, 2022 | Amortization Period (in years) | |||||||||||||||||||
| Goodwill | $ | 899 | $ | — | $ | 899 | Indefinite | ||||||||||||||||
| Intangible assets - customer relationships | 266 | — | 266 | Indefinite | |||||||||||||||||||
| Intangible assets - non competition agreements | 3,113 | (204) | 2,909 | 20 | |||||||||||||||||||
| Total Intangible Assets | $ | 3,379 | $ | (204) | $ | 3,175 | |||||||||||||||||
| Total | $ | 4,278 | $ | (204) | $ | 4,074 | |||||||||||||||||
Accumulated amortization of intangible assets was $1.4 million and $1.2 million as of December 31, 2022 and 2021, respectively.
In accordance with ASC Topic 350, the Corporation performed a qualitative assessment of goodwill and identifiable intangible assets as of December 31, 2022 and determined it was more likely than not that the fair value of the Corporation was more than its carrying amount.
At December 31, 2022, the schedule of future intangible asset amortization is as follows (in thousands):
| 2023 | $ | 204 | |||
| 2024 | 204 | ||||
| 2025 | 204 | ||||
| 2026 | 204 | ||||
| 2027 | 204 | ||||
| Thereafter | 1,889 | ||||
| Total | $ | 2,909 | |||
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(4) Securities
The following table presents the amortized cost and fair value of securities at the dates indicated:
| December 31, 2022 | |||||||||||||||||||||||||||||
| (dollars in thousands) | Amortized cost | Gross unrealized gains | Gross unrealized losses | Fair value | # of Securities in unrealized loss position | ||||||||||||||||||||||||
| Securities available-for-sale: | |||||||||||||||||||||||||||||
| U.S. asset backed securities | $ | 15,581 | $ | 14 | $ | (314) | $ | 15,281 | 12 | ||||||||||||||||||||
| U.S. government agency MBS | 12,272 | 5 | (538) | 11,739 | 12 | ||||||||||||||||||||||||
| U.S. government agency CMO | 25,520 | 40 | (2,242) | 23,318 | 29 | ||||||||||||||||||||||||
| State and municipal securities | 44,700 | — | (5,862) | 38,838 | 34 | ||||||||||||||||||||||||
| U.S. Treasuries | 32,980 | — | (3,457) | 29,523 | 25 | ||||||||||||||||||||||||
| Non-U.S. government agency CMO | 9,722 | — | (633) | 9,089 | 11 | ||||||||||||||||||||||||
| Corporate bonds | 8,201 | — | (643) | 7,558 | 12 | ||||||||||||||||||||||||
| Total securities available-for-sale | $ | 148,976 | $ | 59 | $ | (13,689) | $ | 135,346 | 135 | ||||||||||||||||||||
| Amortized cost | Gross unrecognized gains | Gross unrecognized losses | Fair value | # of Securities in unrecognized loss position | |||||||||||||||||||||||||
| Securities held-to-maturity: | |||||||||||||||||||||||||||||
| State and municipal securities | $ | 37,479 | $ | — | $ | (4,394) | $ | 33,085 | 25 | ||||||||||||||||||||
| Total securities held-to-maturity | $ | 37,479 | $ | — | $ | (4,394) | $ | 33,085 | 25 | ||||||||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||||||||
| (dollars in thousands) | Amortized cost | Gross unrealized gains | Gross unrealized losses | Fair value | # of Securities in unrealized loss position | ||||||||||||||||||||||||
| Securities available-for-sale: | |||||||||||||||||||||||||||||
| U.S. asset backed securities | $ | 16,850 | $ | 55 | $ | (68) | $ | 16,837 | 10 | ||||||||||||||||||||
| U.S. government agency MBS | 9,749 | 124 | (60) | 9,813 | 3 | ||||||||||||||||||||||||
| U.S. government agency CMO | 22,276 | 358 | (253) | 22,381 | 10 | ||||||||||||||||||||||||
| State and municipal securities | 72,099 | 1,379 | (496) | 72,982 | 12 | ||||||||||||||||||||||||
| U.S. Treasuries | 29,973 | 1 | (246) | 29,728 | 21 | ||||||||||||||||||||||||
| Non-U.S. government agency CMO | 990 | — | (15) | 975 | 1 | ||||||||||||||||||||||||
| Corporate bonds | 6,450 | 154 | (18) | 6,586 | 5 | ||||||||||||||||||||||||
| Total securities available-for-sale | $ | 158,387 | $ | 2,071 | $ | (1,156) | $ | 159,302 | 62 | ||||||||||||||||||||
| Amortized cost | Gross unrecognized gains | Gross unrecognized losses | Fair value | # of Securities in unrecognized loss position | |||||||||||||||||||||||||
| Securities held-to-maturity: | |||||||||||||||||||||||||||||
| State and municipal securities | $ | 6,372 | $ | 219 | $ | — | $ | 6,591 | — | ||||||||||||||||||||
| Total securities held-to-maturity | $ | 6,372 | $ | 219 | $ | — | $ | 6,591 | — | ||||||||||||||||||||
Although the Corporation’s investment portfolio overall is in a net unrealized loss position at December 31, 2022, the temporary impairment in the above noted securities is primarily the result of changes in market interest rates subsequent to purchase and it is more likely than not that the Corporation will not be required to sell these securities prior to recovery to satisfy liquidity needs, and therefore, no securities are deemed to be other-than-temporarily impaired.
During the quarter-ended March 31, 2022, $27.7 million of municipal securities, previously classified as available-for-sale on the balance sheet, were transferred to the held-to-maturity portfolio at fair value. At the time of transfer, $1.3 million of unrealized losses remained in accumulated other comprehensive income, to be amortized over the remaining life of the securities as an adjustment to yield. No gain or loss was recognized as a result of the transfer. As of December 31, 2022, $1.2 million of unrealized losses remained in accumulated other comprehensive income.
As of December 31, 2022 and December 31, 2021, securities having a fair value of $78.4 million and $92.2 million, respectively, were specifically pledged as collateral for public funds, the FRB discount window program, FHLB borrowings and other purposes. The FHLB
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has a blanket lien on non-pledged, mortgage-related loans and securities as part of the Corporation’s borrowing agreement with the FHLB.
The following table shows the Corporation’s investment gross unrealized losses and fair value aggregated by investment category and length of time that individual securities have been in continuous unrealized loss position at the dates indicated:
| December 31, 2022 | |||||||||||||||||||||||||||||||||||
| Less than 12 Months | 12 Months or more | Total | |||||||||||||||||||||||||||||||||
| (dollars in thousands) | Fair value | Unrealized losses | Fair value | Unrealized losses | Fair value | Unrealized losses | |||||||||||||||||||||||||||||
| Securities available-for-sale: | |||||||||||||||||||||||||||||||||||
| U.S. asset backed securities | $ | 6,531 | $ | (80) | $ | 4,863 | $ | (234) | $ | 11,394 | $ | (314) | |||||||||||||||||||||||
| U.S. government agency MBS | 6,022 | (230) | 4,637 | (308) | 10,659 | (538) | |||||||||||||||||||||||||||||
| U.S. government agency CMO | 9,859 | (821) | 9,549 | (1,421) | 19,408 | (2,242) | |||||||||||||||||||||||||||||
| State and municipal securities | 7,487 | (726) | 31,351 | (5,136) | 38,838 | (5,862) | |||||||||||||||||||||||||||||
| U.S. Treasuries | 1,902 | (97) | 27,622 | (3,360) | 29,524 | (3,457) | |||||||||||||||||||||||||||||
| Non-U.S. government agency CMO | 8,423 | (464) | 666 | (169) | 9,089 | (633) | |||||||||||||||||||||||||||||
| Corporate bonds | 5,019 | (431) | 1,538 | (212) | 6,557 | (643) | |||||||||||||||||||||||||||||
| Total securities available-for-sale | $ | 45,243 | $ | (2,849) | $ | 80,226 | $ | (10,840) | $ | 125,469 | $ | (13,689) | |||||||||||||||||||||||
| Less than 12 Months | 12 Months or more | Total | |||||||||||||||||||||||||||||||||
| Fair value | Unrecognized losses | Fair value | Unrecognized losses | Fair value | Unrecognized losses | ||||||||||||||||||||||||||||||
| Securities held-to-maturity: | |||||||||||||||||||||||||||||||||||
| State and municipal securities | $ | 10,130 | $ | (364) | $ | 22,543 | $ | (4,030) | $ | 32,673 | $ | (4,394) | |||||||||||||||||||||||
| Total securities held-to-maturity | $ | 10,130 | $ | (364) | $ | 22,543 | $ | (4,030) | $ | 32,673 | $ | (4,394) | |||||||||||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||||||||||||||
| Less than 12 Months | 12 Months or more | Total | |||||||||||||||||||||||||||||||||
| (dollars in thousands) | Fair value | Unrealized losses | Fair value | Unrealized losses | Fair value | Unrealized losses | |||||||||||||||||||||||||||||
| Securities available-for-sale: | |||||||||||||||||||||||||||||||||||
| U.S. asset backed securities | $ | 12,330 | $ | (68) | $ | — | $ | — | $ | 12,330 | $ | (68) | |||||||||||||||||||||||
| U.S. government agency MBS | 3,852 | (60) | — | — | 3,852 | (60) | |||||||||||||||||||||||||||||
| U.S. government agency CMO | 8,836 | (187) | 1,657 | (66) | 10,493 | (253) | |||||||||||||||||||||||||||||
| State and municipal securities | 14,994 | (427) | 2,019 | (69) | 17,013 | (496) | |||||||||||||||||||||||||||||
| U.S. Treasuries | 28,750 | (246) | — | — | 28,750 | (246) | |||||||||||||||||||||||||||||
| Non-U.S. government agency CMO | 975 | (15) | — | — | 975 | (15) | |||||||||||||||||||||||||||||
| Corporate bonds | 2,232 | (18) | — | — | 2,232 | (18) | |||||||||||||||||||||||||||||
| Total securities available-for-sale | $ | 71,969 | $ | (1,021) | $ | 3,676 | $ | (135) | $ | 75,645 | $ | (1,156) | |||||||||||||||||||||||
The amortized cost and carrying value of securities are shown below by contractual maturities at the dates indicated. Actual maturities may differ from contractual maturities as issuers may have the right to call or repay obligations with or without call or prepayment penalties.
| December 31, 2022 | December 31, 2021 | ||||||||||||||||||||||||||||||||||||||||||||||
| Available-for-sale | Held-to-maturity | Available-for-sale | Held-to-maturity | ||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Amortized cost | Fair value | Amortized cost | Fair value | Amortized cost | Fair value | Amortized cost | Fair value | |||||||||||||||||||||||||||||||||||||||
| Due in one year or less | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 763 | $ | 769 | |||||||||||||||||||||||||||||||
| Due after one year through five years | 18,865 | 17,289 | 4,275 | 4,238 | 12,934 | 12,885 | 2,354 | 2,397 | |||||||||||||||||||||||||||||||||||||||
| Due after five years through ten years | 28,647 | 25,459 | 2,998 | 2,683 | 30,890 | 30,798 | 3,255 | 3,425 | |||||||||||||||||||||||||||||||||||||||
| Due after ten years | 53,950 | 48,453 | 30,206 | 26,164 | 81,548 | 82,450 | — | — | |||||||||||||||||||||||||||||||||||||||
| Subtotal | 101,462 | 91,201 | 37,479 | 33,085 | 125,372 | 126,133 | 6,372 | 6,591 | |||||||||||||||||||||||||||||||||||||||
| Mortgage-related securities | 47,514 | 44,145 | — | — | 33,015 | 33,169 | — | — | |||||||||||||||||||||||||||||||||||||||
| Total | $ | 148,976 | $ | 135,346 | $ | 37,479 | $ | 33,085 | $ | 158,387 | $ | 159,302 | $ | 6,372 | $ | 6,591 | |||||||||||||||||||||||||||||||
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The following table presents the gross gain on sale of investment securities available for sale on the dates indicated:
| Years Ended December 31, | |||||||||||
| (dollars in thousands) | 2022 | 2021 | |||||||||
| Proceeds from sale of investment securities | $ | — | $ | 23,585 | |||||||
| Gross gain on sale of available for sale investments | — | 634 | |||||||||
| Gross loss on sale of available for sale investments | — | 199 | |||||||||
(5) Loans and Other Finance Receivables
The following table presents loans and other finance receivables, net of fees and costs detailed by category at the dates indicated:
| (dollars in thousands) | December 31, 2022 | December 31, 2021 | |||||||||
| Real estate loans: | |||||||||||
| Commercial mortgage | $ | 565,400 | $ | 516,928 | |||||||
| Home equity lines and loans | 59,399 | 52,299 | |||||||||
| Residential mortgage | 221,837 | 68,175 | |||||||||
| Construction | 271,955 | 160,905 | |||||||||
| Total real estate loans | 1,118,591 | 798,307 | |||||||||
| Commercial and industrial | 341,378 | 384,562 | |||||||||
| Small business loans | 136,155 | 114,158 | |||||||||
| Consumer | 488 | 419 | |||||||||
| Leases, net | 138,986 | 88,242 | |||||||||
| Loans and other finance receivables, net of fees and costs | $ | 1,735,598 | $ | 1,385,688 | |||||||
| Balances included in loans, net of fees and costs: | |||||||||||
| Residential mortgage real estate loans accounted under fair value option, at fair value | $ | 14,502 | $ | 17,558 | |||||||
| Residential mortgage real estate loans accounted under fair value option, at amortized cost | 16,930 | 17,106 | |||||||||
| Unearned lease income included in leases, net | (25,715) | (17,366) | |||||||||
| Unamortized net deferred loan origination costs | 8,084 | 769 | |||||||||
Fair Value Option for Residential Mortgage Real Estate Loans
Residential mortgage real estate loans that were originated by the Corporation and intended for sale in the secondary market to permanent investors, but were either repurchased or unsalable due to defect and that the Corporation has the ability and intent to hold for the foreseeable future or until maturity or payoff are carried at fair value pursuant to the Corporation's election of the fair value option for these loans. The remaining loans, net of fees and costs are stated at their outstanding unpaid principal balances, net of deferred fees or costs since the original intent for these loans was to hold them until payoff or maturity.
Nonaccrual and Past Due Loans, Net of Fees and Costs
The following tables present an aging of the Corporation’s loans, net of fees and costs at the dates indicated:
| December 31, 2022 | |||||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | 30-89 days past due | 90+ days past due and still accruing | Total past due | Current | Total Accruing Loans and leases | Nonaccrual loans and leases | Total loans, net of fees and costs | % Delinquent | |||||||||||||||||||||||||||||||||||||||
| Commercial mortgage | $ | — | $ | — | $ | — | $ | 565,260 | $ | 565,260 | $ | 140 | $ | 565,400 | 0.02 | % | |||||||||||||||||||||||||||||||
| Home equity lines and loans | 146 | — | 146 | 58,156 | 58,302 | 1,097 | 59,399 | 2.09 | |||||||||||||||||||||||||||||||||||||||
Residential mortgage (1) | 4,262 | — | 4,262 | 215,490 | 219,752 | 2,085 | 221,837 | 2.86 | |||||||||||||||||||||||||||||||||||||||
| Construction | 1,206 | — | 1,206 | 270,749 | 271,955 | — | 271,955 | 0.44 | |||||||||||||||||||||||||||||||||||||||
| Commercial and industrial | 101 | — | 101 | 328,730 | 328,831 | 12,547 | 341,378 | 3.70 | |||||||||||||||||||||||||||||||||||||||
| Small business loans | 939 | — | 939 | 130,751 | 131,690 | 4,465 | 136,155 | 3.97 | |||||||||||||||||||||||||||||||||||||||
| Consumer | — | — | — | 488 | 488 | — | 488 | — | |||||||||||||||||||||||||||||||||||||||
| Leases, net | 1,173 | — | 1,173 | 136,911 | 138,084 | 902 | 138,986 | 1.49 | % | ||||||||||||||||||||||||||||||||||||||
| Total | $ | 7,827 | $ | — | $ | 7,827 | $ | 1,706,535 | $ | 1,714,362 | $ | 21,236 | $ | 1,735,598 | 1.67 | % | |||||||||||||||||||||||||||||||
(1) Includes $14,502 of loans at fair value of which $13,760 are current, $184 are 30-89 days past due, and $558 are nonaccrual.
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| December 31, 2021 | |||||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | 30-89 days past due | 90+ days past due and still accruing | Total past due | Current | Total Accruing Loans and leases | Nonaccrual loans and leases | Total loans, net of fees and costs | % Delinquent | |||||||||||||||||||||||||||||||||||||||
| Commercial mortgage | $ | — | $ | — | $ | — | $ | 516,928 | $ | 516,928 | $ | — | $ | 516,928 | — | % | |||||||||||||||||||||||||||||||
| Home equity lines and loans | 103 | — | 103 | 51,285 | 51,388 | 911 | 52,299 | 1.94 | |||||||||||||||||||||||||||||||||||||||
Residential mortgage (1) | 600 | — | 600 | 65,177 | 65,777 | 2,398 | 68,175 | 4.40 | |||||||||||||||||||||||||||||||||||||||
| Construction | — | — | — | 160,905 | 160,905 | — | 160,905 | — | |||||||||||||||||||||||||||||||||||||||
| Commercial and industrial | — | — | — | 365,761 | 365,761 | 18,801 | 384,562 | 4.89 | |||||||||||||||||||||||||||||||||||||||
| Small business loans | — | — | — | 113,492 | 113,492 | 666 | 114,158 | 0.58 | |||||||||||||||||||||||||||||||||||||||
| Consumer | — | — | — | 419 | 419 | — | 419 | — | |||||||||||||||||||||||||||||||||||||||
| Leases, net | 390 | — | 390 | 87,640 | 88,030 | 212 | 88,242 | 0.68 | % | ||||||||||||||||||||||||||||||||||||||
| Total | $ | 1,093 | $ | — | $ | 1,093 | $ | 1,361,607 | $ | 1,362,700 | $ | 22,988 | $ | 1,385,688 | 1.74 | % | |||||||||||||||||||||||||||||||
(1) Includes $17,558 of loans at fair value of which $16,768 are current, $189 are 30-89 days past due and $601 are nonaccrual.
Foreclosed and Repossessed Assets
At December 31, 2022, there were 5 consumer mortgage loans totaling $942 thousand, secured by residential real estate properties (included in loans, net of fees and costs on the Consolidated Balance Sheets) for which formal foreclosure proceedings were in process.
Risks and Uncertainties
We have no particular credit concentration. Our commercial loans have been proactively managed in an effort to achieve a balanced portfolio with no unusual exposure to one industry. Additionally, most of our lending activity occurs within our primary market areas which are concentrated in southeastern Pennsylvania, Delaware, and Maryland as well as other contiguous markets and represents a geographic concentration. Additionally, our loan portfolio is concentrated in commercial loans. Commercial loans are generally viewed as having more inherent risk of default than residential real estate loans or other consumer loans. Also, the commercial loan balance per borrower is typically larger than that for residential real estate loans and consumer loans, implying higher potential losses on an individual loan basis.
(6) Allowance for Loan and Lease Losses (the Allowance)
The Allowance is evaluated on at least a quarterly basis, as losses are estimated to be probable and incurred. The provision for loan and lease losses increase or decrease the ALLL, if deemed necessary. Loans deemed to be uncollectible are charged against the Allowance, and subsequent recoveries, if any, are credited to the Allowance.
The Allowance is maintained at a level considered adequate to provide for losses that are probable and estimable. Management’s periodic evaluation of the adequacy of the Allowance is based on known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is subjective as it requires material estimates that may be susceptible to significant revisions as more information becomes available.
Roll-Forward of Allowance by Portfolio Segment
The following tables detail the roll-forward of the Corporation’s Allowance, by portfolio segment, for the periods indicated:
Year Ended December 31, 2022 | |||||||||||||||||||||||||||||
| (dollars in thousands) | Beginning Balance | Charge-offs | Recoveries | Provision (Credit) | Ending Balance | ||||||||||||||||||||||||
| Commercial mortgage | $ | 4,950 | $ | — | $ | — | $ | (855) | $ | 4,095 | |||||||||||||||||||
| Home equity lines and loans | 224 | (12) | 43 | (67) | 188 | ||||||||||||||||||||||||
| Residential mortgage | 283 | — | 2 | 663 | 948 | ||||||||||||||||||||||||
| Construction | 2,042 | — | — | 1,033 | 3,075 | ||||||||||||||||||||||||
| Commercial and industrial | 6,533 | — | 97 | (2,618) | 4,012 | ||||||||||||||||||||||||
| Small business loans | 3,737 | — | — | 1,172 | 4,909 | ||||||||||||||||||||||||
| Consumer | 3 | — | 4 | (4) | 3 | ||||||||||||||||||||||||
| Leases | 986 | (2,616) | 64 | 3,164 | 1,598 | ||||||||||||||||||||||||
| Total | $ | 18,758 | $ | (2,628) | $ | 210 | $ | 2,488 | $ | 18,828 | |||||||||||||||||||
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Year Ended December 31, 2021 | |||||||||||||||||||||||||||||
| (dollars in thousands) | Beginning Balance | Charge-offs | Recoveries | Provision (Credit) | Ending Balance | ||||||||||||||||||||||||
| Commercial mortgage | $ | 7,451 | $ | — | $ | — | $ | (2,501) | $ | 4,950 | |||||||||||||||||||
| Home equity lines and loans | 434 | (81) | 82 | (211) | 224 | ||||||||||||||||||||||||
| Residential mortgage | 385 | — | 5 | (107) | 283 | ||||||||||||||||||||||||
| Construction | 2,421 | — | — | (379) | 2,042 | ||||||||||||||||||||||||
| Commercial and industrial | 5,431 | — | 41 | 1,061 | 6,533 | ||||||||||||||||||||||||
| Small business loans | 1,259 | — | — | 2,478 | 3,737 | ||||||||||||||||||||||||
| Consumer | 4 | — | 4 | (5) | 3 | ||||||||||||||||||||||||
| Leases | 382 | (130) | — | 734 | 986 | ||||||||||||||||||||||||
| Total | $ | 17,767 | $ | (211) | $ | 132 | $ | 1,070 | $ | 18,758 | |||||||||||||||||||
Allowance Allocated by Portfolio Segment
The following tables detail the allocation of the allowance for loan and lease losses and the carrying value for loans and leases by portfolio segment based on the methodology used to evaluate the loans and leases for impairment at the dates indicated:
| December 31, 2022 | |||||||||||||||||||||||||||||||||||
| Allowance on loans and leases | Carrying value of loans and leases | ||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Individually evaluated for impairment | Collectively evaluated for impairment | Total | Individually evaluated for impairment | Collectively evaluated for impairment | Total | |||||||||||||||||||||||||||||
| Commercial mortgage | $ | — | $ | 4,095 | $ | 4,095 | $ | 2,445 | $ | 562,955 | $ | 565,400 | |||||||||||||||||||||||
| Home equity lines and loans | — | 188 | 188 | 1,097 | 58,302 | 59,399 | |||||||||||||||||||||||||||||
| Residential mortgage | — | 948 | 948 | 1,454 | 205,881 | 207,335 | |||||||||||||||||||||||||||||
| Construction | — | 3,075 | 3,075 | 1,206 | 270,749 | 271,955 | |||||||||||||||||||||||||||||
Commercial and industrial (2) | 776 | 3,236 | 4,012 | 12,547 | 328,831 | 341,378 | |||||||||||||||||||||||||||||
| Small business loans | 1,449 | 3,460 | 4,909 | 4,527 | 131,628 | 136,155 | |||||||||||||||||||||||||||||
| Consumer | — | 3 | 3 | — | 488 | 488 | |||||||||||||||||||||||||||||
| Leases | — | 1,598 | 1,598 | 902 | 138,084 | 138,986 | |||||||||||||||||||||||||||||
Total (1) | $ | 2,225 | $ | 16,603 | $ | 18,828 | $ | 24,178 | $ | 1,696,918 | $ | 1,721,096 | |||||||||||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||||||||||||||
| Allowance on loans and leases | Carrying value of loans and leases | ||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Individually evaluated for impairment | Collectively evaluated for impairment | Total | Individually evaluated for impairment | Collectively evaluated for impairment | Total | |||||||||||||||||||||||||||||
| Commercial mortgage | $ | — | $ | 4,950 | $ | 4,950 | $ | 3,556 | $ | 513,372 | $ | 516,928 | |||||||||||||||||||||||
| Home equity lines and loans | — | 224 | 224 | 905 | 51,394 | 52,299 | |||||||||||||||||||||||||||||
| Residential mortgage | — | 283 | 283 | 1,797 | 48,820 | 50,617 | |||||||||||||||||||||||||||||
| Construction | — | 2,042 | 2,042 | 1,206 | 159,699 | 160,905 | |||||||||||||||||||||||||||||
Commercial and industrial (2) | 2,900 | 3,633 | 6,533 | 17,361 | 367,201 | 384,562 | |||||||||||||||||||||||||||||
| Small business loans | 376 | 3,361 | 3,737 | 792 | 113,366 | 114,158 | |||||||||||||||||||||||||||||
| Consumer | — | 3 | 3 | — | 419 | 419 | |||||||||||||||||||||||||||||
| Leases | — | 986 | 986 | 212 | 88,030 | 88,242 | |||||||||||||||||||||||||||||
Total (1) | $ | 3,276 | $ | 15,482 | $ | 18,758 | $ | 25,829 | $ | 1,342,301 | $ | 1,368,130 | |||||||||||||||||||||||
(1) Excludes deferred fees and loans carried at fair value.
(2) Includes $4.7 million and $90.2 million of PPP loans as of December 31, 2022 and 2021, respectively, which are not reserved against as they are 100% guaranteed by the SBA.
Loans and Leases by Credit Ratings
As part of the process of determining the Allowance to the different segments of the loan and lease portfolio, Management considers certain credit quality indicators. For the commercial mortgage, construction and commercial and industrial loan segments, periodic
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reviews of the individual loans are performed by Management. The results of these reviews are reflected in the risk grade assigned to each loan. These internally assigned grades are as follows:
•Pass – Loans considered to be satisfactory with no indications of deterioration.
•Special mention – Loans classified as special mention have a potential weakness that deserves Management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
•Substandard – Loans classified as substandard are inadequately protected by the current net worth and payment 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 institution will sustain some loss if the deficiencies are not corrected.
•Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, 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. Loan balances classified as doubtful are carried at their net realizable values.
The following tables detail the carrying value of loans and leases by portfolio segment based on the credit quality indicators used to determine the allowance for loan and lease losses at the dates indicated:
| December 31, 2022 | |||||||||||||||||||||||||||||
| (dollars in thousands) | Pass | Special mention | Substandard | Doubtful | Total | ||||||||||||||||||||||||
| Commercial mortgage | $ | 536,705 | $ | 25,309 | $ | 3,386 | $ | — | $ | 565,400 | |||||||||||||||||||
| Home equity lines and loans | 57,822 | — | 1,577 | — | 59,399 | ||||||||||||||||||||||||
| Construction | 260,085 | 11,870 | — | — | 271,955 | ||||||||||||||||||||||||
| Commercial and industrial | 295,502 | 6,587 | 39,289 | — | 341,378 | ||||||||||||||||||||||||
| Small business loans | 131,690 | — | 4,465 | — | 136,155 | ||||||||||||||||||||||||
| Total | $ | 1,281,804 | $ | 43,766 | $ | 48,717 | $ | — | $ | 1,374,287 | |||||||||||||||||||
Commercial and industrial loans classified as substandard totaled $39.3 million as of December 31, 2022, a decrease of $3.6 million from $42.9 million as of December 31, 2021, due to payoffs and/or principal payments.
| December 31, 2021 | |||||||||||||||||||||||||||||
| (dollars in thousands) | Pass | Special mention | Substandard | Doubtful | Total | ||||||||||||||||||||||||
| Commercial mortgage | $ | 481,551 | $ | 29,452 | $ | 5,925 | $ | — | $ | 516,928 | |||||||||||||||||||
| Home equity lines and loans | 50,908 | — | 1,391 | — | 52,299 | ||||||||||||||||||||||||
| Construction | 151,608 | 9,297 | — | — | 160,905 | ||||||||||||||||||||||||
| Commercial and industrial | 327,089 | 14,603 | 42,870 | — | 384,562 | ||||||||||||||||||||||||
| Small business loans | 112,096 | — | 2,062 | — | 114,158 | ||||||||||||||||||||||||
| Total | $ | 1,123,252 | $ | 53,352 | $ | 52,248 | $ | — | $ | 1,228,852 | |||||||||||||||||||
In addition to credit quality indicators as shown in the above tables, allowance allocations for residential mortgages, consumer loans and leases are also applied based on their performance status at the dates indicated:
| December 31, 2022 | December 31, 2021 | ||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Performing | Non- performing | Total | Performing | Non- performing | Total | |||||||||||||||||||||||||||||
Residential mortgage (1) | $ | 205,881 | $ | 1,454 | $ | 207,335 | $ | 48,820 | $ | 1,797 | $ | 50,617 | |||||||||||||||||||||||
| Consumer | 488 | — | 488 | 419 | — | 419 | |||||||||||||||||||||||||||||
| Leases, net | 138,084 | 902 | 138,986 | 88,030 | 212 | 88,242 | |||||||||||||||||||||||||||||
| Total | $ | 344,453 | $ | 2,356 | $ | 346,809 | $ | 137,269 | $ | 2,009 | $ | 139,278 | |||||||||||||||||||||||
(1) There were four nonperforming residential mortgage loans at December 31, 2022 and four nonperforming residential mortgage loans at December 31, 2021 with a combined outstanding principal balance of $558 thousand and $601 thousand, respectively, which were carried at fair value and not included in the table above.
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Impaired Loans
The following tables detail the recorded investment and principal balance of impaired loans by portfolio segment, their related Allowance and interest income recognized at the dates indicated.
December 31, 2022 | December 31, 2021 | ||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Recorded investment | Principal balance | Related allowance | Recorded investment | Principal balance | Related allowance | |||||||||||||||||||||||||||||
| Impaired loans with related allowance: | |||||||||||||||||||||||||||||||||||
| Commercial and industrial | $ | 11,099 | $ | 12,095 | $ | 776 | $ | 17,147 | $ | 17,310 | $ | 2,900 | |||||||||||||||||||||||
| Small business loans | 3,730 | 3,730 | 1,449 | 666 | 666 | 376 | |||||||||||||||||||||||||||||
| Total | $ | 14,829 | $ | 15,825 | $ | 2,225 | $ | 17,813 | $ | 17,976 | $ | 3,276 | |||||||||||||||||||||||
| Impaired loans without related allowance: | |||||||||||||||||||||||||||||||||||
| Commercial mortgage | $ | 2,445 | $ | 2,456 | $ | — | $ | 3,556 | $ | 3,559 | $ | — | |||||||||||||||||||||||
| Commercial and industrial | 1,448 | 1,494 | — | 214 | 269 | — | |||||||||||||||||||||||||||||
| Small business loans | 797 | 797 | — | 126 | 126 | — | |||||||||||||||||||||||||||||
| Home equity lines and loans | 1,097 | 1,097 | — | 905 | 935 | — | |||||||||||||||||||||||||||||
| Residential mortgage | 1,454 | 1,454 | — | 1,797 | 1,797 | — | |||||||||||||||||||||||||||||
| Construction | 1,206 | 1,206 | — | 1,206 | 1,206 | — | |||||||||||||||||||||||||||||
| Leases | 902 | 902 | — | 212 | 212 | — | |||||||||||||||||||||||||||||
| Total | $ | 9,349 | $ | 9,406 | $ | — | $ | 8,016 | $ | 8,104 | $ | — | |||||||||||||||||||||||
| Grand Total | $ | 24,178 | $ | 25,231 | $ | 2,225 | $ | 25,829 | $ | 26,080 | $ | 3,276 | |||||||||||||||||||||||
The following table details the average recorded investment and interest income recognized on impaired loans by portfolio segment.
Year Ended December 31, 2022 | Year Ended December 31, 2021 | ||||||||||||||||||||||
| (dollars in thousands) | Average recorded investment | Interest income recognized | Average recorded investment | Interest income recognized | |||||||||||||||||||
| Impaired loans with related allowance: | |||||||||||||||||||||||
| Commercial and industrial | $ | 13,211 | $ | — | $ | 17,349 | $ | 15 | |||||||||||||||
| Small business loans | 3,731 | — | 887 | — | |||||||||||||||||||
| Total | $ | 16,942 | $ | — | $ | 18,236 | $ | 15 | |||||||||||||||
| Impaired loans without related allowance: | |||||||||||||||||||||||
| Commercial mortgage | $ | 2,523 | $ | 105 | $ | 3,578 | $ | 43 | |||||||||||||||
| Commercial and industrial | 559 | 297 | 239 | 24 | |||||||||||||||||||
| Small business loans | 802 | 9 | 154 | 14 | |||||||||||||||||||
| Home equity lines and loans | 1,097 | 38 | 914 | — | |||||||||||||||||||
| Residential mortgage | 1,473 | 205 | 1,807 | 11 | |||||||||||||||||||
| Construction | 1,206 | 78 | 1,206 | 62 | |||||||||||||||||||
| Leases | 825 | — | 240 | — | |||||||||||||||||||
| Total | $ | 8,485 | $ | 732 | $ | 8,138 | $ | 154 | |||||||||||||||
| Grand Total | $ | 25,427 | $ | 732 | $ | 26,374 | $ | 169 | |||||||||||||||
Troubled Debt Restructuring
The restructuring of a loan is considered a TDR if both of the following conditions are met: (i) the borrower is experiencing financial difficulties, and (ii) the creditor has granted a concession. The most common concessions granted include one or more modifications to the terms of the debt, such as (a) a reduction in the interest rate for the remaining life of the debt, (b) an extension of the maturity date at an interest rate lower than the current market rate for new debt with similar risk, (c) a temporary period of interest-only payments, (d) a reduction in the contractual payment amount for either a short period or remaining term of the loan, and (e) for leases, a reduced lease payment. A less common concession granted is the forgiveness of a portion of the principal.
The determination of whether a borrower is experiencing financial difficulties takes into account not only the current financial condition of the borrower, but also the potential financial condition of the borrower, were a concession not granted. The determination of whether a concession has been granted is very subjective in nature. For example, simply extending the term of a loan at its original interest rate or even at a higher interest rate could be interpreted as a concession unless the borrower could readily obtain similar credit terms from a different lender.
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The following table presents information about TDRs at the dates indicated:
| (dollars in thousands) | December 31, 2022 | December 31, 2021 | |||||||||
| TDRs included in nonperforming loans and leases | $ | 207 | $ | 361 | |||||||
| TDRs in compliance with modified terms | 3,573 | 3,446 | |||||||||
| Total TDRs | $ | 3,780 | $ | 3,807 | |||||||
There was 1 new modification on a commercial mortgage for $684 thousand for the year ended December 31, 2022, and 2 modifications granted during the year ended December 31, 2021 on commercial mortgages for $1.2 million. Total TDRs declined year-over-year, despite the new modification in 2022, as two TDRs from prior to 2021 totaling $563 thousand paid off in 2022. No modifications granted during the twelve months ended December 31, 2022 and 2021 subsequently defaulted during the same time period.
(7) Bank Premises and Equipment
The components of premises and equipment at December 31, 2022 and 2021 are as follows:
| (dollars in thousands) | December 31, 2022 | December 31, 2021 | |||||||||
| Buildings | $ | 9,150 | $ | 4,141 | |||||||
| Leasehold improvements | 3,347 | 3,347 | |||||||||
| Land | 600 | 600 | |||||||||
| Land Improvements | 218 | 218 | |||||||||
| Furniture, fixtures and equipment | 3,577 | 3,229 | |||||||||
| Computer equipment and data processing software | 9,242 | 7,971 | |||||||||
| Construction in process | 40 | 3,763 | |||||||||
| Less: accumulated depreciation | (12,825) | (11,463) | |||||||||
| Total | $ | 13,349 | $ | 11,806 | |||||||
Total depreciation expense for the years ended December 31, 2022 and 2021 totaled $1.4 million and $1.3 million, respectively.
(8) Deposits
The components of deposits at December 31, 2022 and 2021 are as follows:
| (dollars in thousands) | December 31, 2022 | December 31, 2021 | |||||||||
| Demand, non-interest bearing | $ | 301,727 | $ | 274,528 | |||||||
| Demand, interest bearing | 219,838 | 268,248 | |||||||||
| Savings accounts | 36,125 | 45,038 | |||||||||
| Money market accounts | 661,439 | 652,590 | |||||||||
| Time deposits | 493,350 | 206,009 | |||||||||
| Total | $ | 1,712,479 | $ | 1,446,413 | |||||||
The aggregate amount of time deposits in denominations over $250 thousand were $394.3 million and $179.8 million as of December 31, 2022 and 2021, respectively.
At December 31, 2022, the scheduled maturities of time deposits are as follows (in thousands):
| 2023 | $ | 414,853 | |||
| 2024 | 20,815 | ||||
| 2025 | 24,211 | ||||
| 2026 | 33,450 | ||||
| 2027 | 21 | ||||
| Total | $ | 493,350 | |||
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(9) Borrowings
The Corporation’s short-term borrowings generally consist of Federal funds purchased and short-term borrowings extended under agreements with the FHLB and two unsecured Federal funds borrowing facilities with correspondent banks: one of $24 million and one of $15 million. Federal funds purchased generally represent one-day borrowings. The Corporation had $0 in Federal funds purchased at December 31, 2022 and December 31, 2021. The Corporation also has a facility with the Federal Reserve Bank discount window of $8.8 million. This facility is fully secured by investment securities. There were no borrowings under this at December 31, 2022 and December 31, 2021.
The following table presents short-term borrowings at the dates indicated:
| (dollars in thousands) | Maturity date | Interest rate | December 31, 2022 | December 31, 2021 | |||||||||||||||||||
| FHLB Open Repo Plus Weekly | 6/5/2023 | 4.45% - 3.11% | $ | 113,147 | $ | 36,458 | |||||||||||||||||
| FHLB Mid-term Repo-fixed | 9/12/2022 | 0.23% | — | 4,886 | |||||||||||||||||||
| Total | $ | 113,147 | $ | 41,344 | |||||||||||||||||||
The Corporation had long-term debt of $8.9 million as of December 31, 2022, with an interest rate of 4.23% and a maturity date of December 22, 2025. The Corporation had no long-term debt as of December 31, 2021.
The FHLB has also issued $49.1 million of letters of credit to the Corporation for the benefit of the Corporation’s public deposit funds and loan customers. These letters of credit expire throughout 2023.
The Corporation has a maximum borrowing capacity with the FHLB of $561.7 million as of December 31, 2022 and $505.4 million as of December 31, 2021. All advances and letters of credit from the FHLB are secured by a blanket lien on non-pledged, mortgage-related loans and securities as part of the Corporation’s borrowing agreement with the FHLB.
(10) Subordinated Debentures
In December 2008, the Bank issued $550 thousand of mandatory convertible unsecured subordinated debentures (2008 Debentures). The 2008 Debentures have a maturity date of December 18, 2023 and interest on the 2008 Debentures is paid quarterly at 6%. The 2008 Debentures are convertible into 1 share of the Corporation’s common stock for every $15 in principal amount of the 2008 Debentures automatically on such date, if any, as accumulated losses of the Bank first exceed the sum of the retained earnings and capital surplus accounts of the Bank. The 2008 Debentures began to repay principal in eight equal installments which commenced in December of 2016. As of December 31, 2022, $56 thousand of the 2008 Debentures remained outstanding, after pay downs of $56 thousand each year during 2022 and 2021.
In December 2011, the Bank issued $1.4 million of mandatory convertible unsecured subordinated debentures (2011 Debentures). The 2011 Debentures have a maturity date of December 31, 2026 and interest on the 2011 Debentures is paid quarterly at 6%. The 2011 Debentures are convertible into 1 share of the Corporation’s common stock for every $17 in principal amount of the 2011 Debentures automatically on such date, if any, as accumulated losses of the Bank first exceed the sum of the retained earnings and capital surplus accounts of the Bank. The 2011 Debentures began to repay principal in eight equal installments which commenced in December of 2020. As of December 31, 2022, $462 thousand of the 2011 Debentures remained outstanding, after pay downs of $116 thousand each year during 2022 and 2021.
In April 2013, the Bank issued $1.4 million of mandatory convertible unsecured subordinated debentures (2013 Debentures). The 2013 Debentures have a maturity date of December 31, 2028 and interest on the 2013 Debentures is paid quarterly at 6.5%. The 2013 Debentures are convertible into 1 share of the Corporation’s common stock for every $22 in principal amount of the 2013 Debentures automatically on such date, if any, as accumulated losses of the Bank first exceed the sum of the retained earnings and capital surplus accounts of the Bank. As of December 31, 2022, $652 thousand of the 2013 Debentures remained outstanding, after pay downs of $109 thousand each year during 2022 and 2021. Subsequent to December 31, 2022 $56 thousand 2013 Debentures was redeemed by the holder.
Upon formation of the bank holding company, the Corporation assumed the 2008, 2011, and 2013 Debentures that were originally issued by the Bank.
During December 2019, the Corporation issued $40 million of fixed-to-floating rate non-convertible unsecured subordinated debentures (2019 Debentures). The 2019 Debentures have a maturity date of December 30, 2029 and interest on the 2019 Debentures is paid semiannually at 5.375%. The debt issuance costs are included as a direct deduction from the debt liability and these costs are amortized to interest expense using the effective yield method. During 2022 and 2021 the Corporation made interest payments of $2.2 million each year on the 2019 Debentures.
The 2008, 2011, and 2013 Debentures are includable as Tier 2 capital for determining the Bank’s compliance with regulatory capital requirements (see footnote 17). The 2019 Debentures are included as Tier 2 capital for the Corporation and as Tier 1 capital for the Bank.
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(11) Servicing Assets
The Corporation sells certain residential mortgage loans and the guaranteed portion of certain SBA loans to third parties and retains servicing rights and receives servicing fees. All such transfers are accounted for as sales. When the Corporation sells a residential mortgage loan, it does not retain any portion of that loan and its continuing involvement in such transfers is limited to certain servicing responsibilities. While the Corporation may retain a portion of certain sold SBA loans, its continuing involvement in the portion of the loan that was sold is limited to certain servicing responsibilities. When the contractual servicing fees on loans sold with servicing retained are expected to be more than adequate compensation to a servicer for performing the servicing, a capitalized servicing asset is recognized.
Residential Mortgage Loans
The related MSR asset is amortized over the period of the estimated future net servicing life of the underlying assets. MSRs are evaluated quarterly for impairment based upon the fair value of the rights as compared to their amortized cost. Impairment is recognized on the income statement to the extent the fair value is less than the capitalized amount of the MSR. The Corporation serviced $1.0 billion of residential mortgage loans as of December 31, 2022 and 2021. During the year ended December 31, 2022 the Corporation recognized servicing fee income of $2.6 million compared to $2.0 million, during the year ended December 31, 2021.
Changes in the MSR balance are summarized as follows:
| Year Ended December 31, | |||||||||||
| (dollars in thousands) | 2022 | 2021 | |||||||||
| Balance at beginning of the period | $ | 10,756 | $ | 4,647 | |||||||
| Servicing rights capitalized | 668 | 6,769 | |||||||||
| Amortization of servicing rights | (1,488) | (1,087) | |||||||||
| Change in valuation allowance | 6 | 427 | |||||||||
| Balance at end of the period | $ | 9,942 | $ | 10,756 | |||||||
Activity in the valuation allowance for MSRs was as follows:
| Year Ended December 31, | |||||||||||
| (dollars in thousands) | 2022 | 2021 | |||||||||
| Valuation allowance, beginning of period | $ | (8) | $ | (435) | |||||||
| Impairment | (4) | — | |||||||||
| Recovery | 10 | 427 | |||||||||
| Valuation allowance, end of period | $ | (2) | $ | (8) | |||||||
The Corporation uses assumptions and estimates in determining the fair value of MSRs. These assumptions include prepayment speeds and discount rates. The assumptions used in the valuation were based on input from buyers, brokers and other qualified personnel, as well as market knowledge. At December 31, 2022, the key assumptions used to determine the fair value of the Corporation’s MSRs included a lifetime constant prepayment rate equal to 8.05% and a discount rate equal to 9.50%. At December 31, 2021, the key assumptions used to determine the fair value of the Corporation’s MSRs included a lifetime constant prepayment rate equal to 7.23% and a discount rate equal to 9.00%. As interest rates increased and the number of mortgage refinancings have declined, model inputs have been adjusted to align the MSRs fair value with market conditions.
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The sensitivity of the current fair value of the residential mortgage servicing rights to immediate 10% and 20% favorable and unfavorable changes in key economic assumptions are included in the following table.
| (dollars in thousands) | December 31, 2022 | December 31, 2021 | |||||||||
| Fair value of residential mortgage servicing rights | $ | 11,567 | $ | 11,241 | |||||||
| Weighted average life (months) | 22 | 11 | |||||||||
| Prepayment speed | 8.05 | % | 7.23 | % | |||||||
| Impact on fair value: | |||||||||||
| 10% adverse change | $ | (268) | $ | (376) | |||||||
| 20% adverse change | (525) | (731) | |||||||||
| Discount rate | 9.50 | % | 9.00 | % | |||||||
| Impact on fair value: | |||||||||||
| 10% adverse change | $ | (404) | $ | (436) | |||||||
| 20% adverse change | (777) | (840) | |||||||||
The sensitivity calculations above are hypothetical and should not be considered to be predictive of future performance. As indicated, changes in fair value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of an adverse variation in a articular assumption on the fair value of the MSRs is calculated without changing any other assumption; while in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments), which may magnify or counteract the effect of the change.
SBA Loans
SBA loan servicing assets are amortized over the period of the estimated future net servicing life of the underlying assets. SBA loan servicing assets are evaluated quarterly for impairment based upon the fair value of the rights as compared to their amortized cost. Impairment is recognized on the income statement to the extent the fair value is less than the capitalized amount of the SBA loan servicing asset. The Corporation serviced $166.1 million and $115.1 million of SBA loans, as of December 31, 2022 and December 31, 2021, respectively.
Changes in the SBA loan servicing asset balance are summarized as follows:
| Year Ended December 31, | |||||||||||
| (dollars in thousands) | 2022 | 2021 | |||||||||
| Balance at beginning of the period | $ | 2,009 | $ | 970 | |||||||
| Servicing rights capitalized | 1,395 | 1,488 | |||||||||
| Amortization of servicing rights | (732) | (392) | |||||||||
| Change in valuation allowance | (268) | (57) | |||||||||
| Balance at end of the period | $ | 2,404 | $ | 2,009 | |||||||
Activity in the valuation allowance for SBA loan servicing assets was as follows:
| Year Ended December 31, | |||||||||||
| (dollars in thousands) | 2022 | 2021 | |||||||||
| Valuation allowance, beginning of period | $ | (96) | $ | (39) | |||||||
| Impairment | (408) | (57) | |||||||||
| Recovery | 140 | — | |||||||||
| Valuation allowance, end of period | $ | (364) | $ | (96) | |||||||
The Corporation uses assumptions and estimates in determining the fair value of SBA loan servicing rights. These assumptions include prepayment speeds, discount rates, and other assumptions. The assumptions used in the valuation were based on input from buyers, brokers and other qualified personnel, as well as market knowledge. At December 31, 2022, the key assumptions used to determine the fair value of the Corporation’s SBA loan servicing rights included a lifetime constant prepayment rate equal to 12.73% and a discount rate equal to 18.96%. At December 31, 2021, the key assumptions used to determine the fair value of the Corporation’s SBA loan servicing rights included a lifetime constant prepayment rate equal to 12.38% and a discount rate equal to 9.01%. The change in
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valuation allowance due to impairment noted in the tables above, was largely due to the increases in discount rate and prepayment speed as a result of the rising interest rate environment and depressed market pricing on sales of such loans.
The sensitivity of the current fair value of the SBA loan servicing rights to immediate 10% and 20% favorable and unfavorable changes in key economic assumptions are included in the following table.
| (dollars in thousands) | December 31, 2022 | December 31, 2021 | |||||||||
| Fair value of SBA loan servicing rights | $ | 2,422 | $ | 2,107 | |||||||
| Weighted average life (years) | 3.8 | 3.8 | |||||||||
| Prepayment speed | 12.73 | % | 12.38 | % | |||||||
| Impact on fair value: | |||||||||||
| 10% adverse change | $ | (73) | $ | (69) | |||||||
| 20% adverse change | (141) | (132) | |||||||||
| Discount rate | 18.96 | % | 9.01 | % | |||||||
| Impact on fair value: | |||||||||||
| 10% adverse change | $ | (53) | $ | (54) | |||||||
| 20% adverse change | (104) | (106) | |||||||||
The sensitivity calculations above are hypothetical and should not be considered to be predictive of future performance. As indicated, changes in fair value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of an adverse variation in a particular assumption on the fair value of the SBA servicing rights is calculated without changing any other assumption; while in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments), which may magnify or counteract the effect of the change.
(12) Lease Commitments
On January 1, 2022, the Corporation adopted ASU 2016-02 (Topic 842), “Leases”, as further explained in Note 1, Summary of Significant Accounting Policies. The Corporation’s operating leases consist of various retail branch locations and loan production offices. As of December 31, 2022, the Corporation’s leases have remaining lease terms ranging from 2 months to 12 years, including extension options.
The Corporation’s leases include fixed rental payments, and certain of our leases also include variable rental payments where lease payments may increase at pre-determined dates based on the change in the consumer price index. The Corporation’s lease agreements include gross leases as well as leases in which we make separate payments to the lessor for items such as the property taxes assessed on the property or a portion of the common area maintenance associated with the property. We have elected the practical expedient not to separate lease and non-lease components for all of our building leases. The Corporation also elected to not recognize ROU assets and lease liabilities for short-term leases.
As of December 31, 2022 the Corporation’s ROU assets and related lease liabilities were $9.0 million and $8.9 million, respectively. These amounts are included within and , respectively.
The components of lease expense were as follows:
| Year Ended December 31, | |||||
| (dollars in thousands) | 2022 | ||||
| Operating lease expense | $ | 2,242 | |||
| Short term lease expense | 13 | ||||
| Total lease expense | $ | 2,255 | |||
Supplemental cash flow information related to leases was as follows:
| (dollars in thousands) | December 31, 2022 | ||||
| Cash paid for amounts included in the measurement of lease liabilities | |||||
| Operating cash flows from operating leases | $ | 2,150 | |||
| ROU asset obtained in exchange for lease liabilities | 10,936 | ||||
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Maturities of operating lease liabilities were as follows for the period indicated:
| (dollars in thousands) | December 31, 2022 | ||||
| 2023 | $ | 1,919 | |||
| 2024 | 1,746 | ||||
| 2025 | 1,456 | ||||
| 2026 | 1,436 | ||||
| 2027 | 1,278 | ||||
| Thereafter | 1,856 | ||||
| $ | 9,691 | ||||
| Less: Present value discount | (827) | ||||
| Total operating lease liabilities | $ | 8,864 | |||
As of December 31, 2022, the weighted-average remaining lease term for all operating leases, including extension options that the Corporation is reasonably certain will be exercised for retail branch locations, is 6.2 years.
Because we generally do not have access to the rate implicit in the lease, we utilize our incremental borrowing rate as the discount rate. The weighted average discount rate associated with operating leases as of December 31, 2022 is 2.63%.
As of December 31, 2022, the Corporation entered into one additional lease for a branch re-location. This lease will commence upon discontinuance of the previous location.
Total rental expense for the year ended December 31, 2022 was $2.2 million.
(13) Stock-Based Compensation
The Corporation has issued stock options under the Meridian Bank 2004 Stock Option Plan (2004 Plan). The 2004 Plan authorized the Board of Directors to grant options up to an aggregate of 892,182 shares, as adjusted for the 5% stock dividends in 2012, 2014 and 2016, and the two-for-one stock split effective February 28, 2023, to officers, other employees and directors of the Corporation. No additional shares are available for future grants. The shares granted under the 2004 Plan to directors are nonqualified options. The shares granted under the 2004 Plan to officers and other employees are incentive stock options, and are subject to the limitations under Section 422 of the Internal Revenue Code.
The Meridian Bank 2016 Equity Incentive Plan (2016 Plan) was amended on May 24, 2019 to authorize the Board of Directors to grant up to an aggregate of 1,373,800 stock awards that can take different forms. A total of 1,124,000 stock options and 86,416 shares of restricted stock have been granted under the 2016 Plan through December 31, 2022, including the impact of the two-for-one stock split. As of December 31, 2022 there were 239,540 stock awards remaining to be issued. Options granted under the 2016 Plan to directors are nonqualified options, while options granted to officers and other employees are incentive stock options, and are subject to the limitations under Section 422 of the Internal Revenue Code.
Stock Options
Stock-based compensation cost is measured at the grant date, based on the fair value of the award and the cost is recognized as an expense over the vesting period. The fair value of stock option grants is determined using the Black-Scholes pricing model. The assumptions necessary for the calculation of the fair value are expected life of options, annual volatility of stock price, risk-free interest rate and annual dividend yield.
Stock option awards granted under the 2016 Plan have a term that does not exceed 10 years and vest according to each award’s specific vesting schedule. Currently, all option awards granted to date vest 25% upon grant and become fully exercisable after 3 years of service from the grant date.
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The following table provides information about stock options outstanding as of December 31, 2022 and 2021:
| Shares | Weighted average exercise price | Weighted average grant date fair value | |||||||||||||||
| Outstanding at December 31, 2020 | 801,454 | $ | 8.27 | $ | 2.35 | ||||||||||||
| Exercised | (154,530) | 6.84 | 2.18 | ||||||||||||||
| Granted | 285,300 | 13.75 | 4.74 | ||||||||||||||
| Forfeited | (8,296) | 9.32 | 3.29 | ||||||||||||||
| Outstanding at December 31, 2021 | 923,928 | $ | 10.19 | $ | 3.10 | ||||||||||||
| Exercised | (87,134) | 8.67 | 2.43 | ||||||||||||||
| Granted | 246,500 | 16.22 | 5.38 | ||||||||||||||
| Forfeited | (29,606) | 12.14 | 3.92 | ||||||||||||||
| Outstanding at December 31, 2022 | 1,053,688 | $ | 11.67 | $ | 3.67 | ||||||||||||
| Exercisable at December 31, 2022 | 694,670 | 10.26 | 3.09 | ||||||||||||||
| Nonvested at December 31, 2022 | 359,018 | 14.40 | 4.79 | ||||||||||||||
The weighted average remaining contractual life of the outstanding stock options at December 31, 2022 is 7.4 years. At December 31, 2022 the range of exercise prices is $5.90 to $17.76. The aggregate intrinsic value of options outstanding and exercisable was $3.9 million and $3.5 million, respectively, as of December 31, 2022.
The fair value of each option granted in 2022 was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: dividend yield of 2.6%, risk-free interest rate of between 3.01% and 4.26%, expected life of 5.75 years, and expected volatility of between 33.30% and 39.00% based on an average of the Corporation’s share price since going public. The weighted average fair value of options granted in 2022 was $4.67 to $5.82 per share.
The fair value of each option granted in 2021 was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions: dividend yield of 2.6%, risk-free interest rate of between 1.02% and 1.54%, expected life of 5.75 years, and expected volatility of 39.25% and 40.97%% based on an average of the Corporation’s share price since going public. The weighted average fair value of options granted in 2021 was $4.07 to $4.79 per share.
Total stock option compensation cost for the years ended December 31, 2022 and 2021 was $1.0 million and $803 thousand, respectively. During the year ended December 31, 2022 and 2021, the Corporation received $711 thousand and $1.0 million from the exercise of stock options, respectively. The Corporation recognized $116 thousand in excess tax benefits related to stock compensation cost for the twelve months ended December 31, 2022. No such excess tax benefits were recognized 2021.
In accordance with ASU 2016-09 – Compensation – Stock Compensation (ASU 2016-09), forfeitures are recognized as they occur instead of applying an estimated forfeiture rate to each grant. For purposes of the determination of stock-based compensation expense for the year ended December 31, 2022, we recognized the forfeiture of 29,606 of shares of stock options that were previously granted to officers and other employees.
As of December 31, 2022, there was $1.7 million of unrecognized compensation cost related to nonvested stock options. This cost will be recognized over a weighted average period of 7.4 years. During 2022, the intrinsic value of options exercised was $754 thousand.
Restricted Stock
The restricted stock awards granted under the 2016 Plan vest according to each award’s specific vesting schedule. No awards were granted in 2022. All awards granted in 2021 vested 100% one year from the grant date. The grant date fair value of the restricted stock is based on the closing price on the date prior to the grant.
| Shares | Weighted Average Grant Date Fair Value | ||||||||||
| Outstanding at December 31, 2020 | 66,416 | $ | 7.00 | ||||||||
| Granted | 20,000 | 13.18 | |||||||||
| Vested | (33,206) | 7.00 | |||||||||
| Outstanding at December 31, 2021 | 53,210 | $ | 9.33 | ||||||||
| Granted | — | — | |||||||||
| Vested | (53,210) | 9.33 | |||||||||
| Outstanding at December 31, 2022 | — | $ | — | ||||||||
| Nonvested at December 31, 2022 | — | — | |||||||||
Compensation expense for restricted stock is measured based on the market price of the stock on the day prior to the grant date and is recognized on a straight-line basis over the vesting period. For the years ended December 31, 2022 and 2021, the Corporation
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recognized $70 thousand and $460 thousand of expense related to the restricted stock, respectively. As of December 31, 2022, there was $0 in unrecognized compensation costs related to restricted stock.
(14) Income Taxes
The following table presents the components of federal and state income tax expense for the periods indicated:
| (dollars in thousands) | December 31, 2022 | December 31, 2021 | |||||||||
| Federal: | |||||||||||
| Current | $ | 4,580 | $ | 10,022 | |||||||
| Deferred | 903 | (717) | |||||||||
| Total federal income tax expense | $ | 5,483 | $ | 9,305 | |||||||
| State: | |||||||||||
| Current | $ | 494 | $ | 1,463 | |||||||
| Deferred | 114 | (51) | |||||||||
| Total state income tax expense | $ | 608 | $ | 1,412 | |||||||
| Total income tax expense | $ | 6,091 | $ | 10,717 | |||||||
A reconciliation of the statutory income tax at 21% to the income tax expense included in the statement of operations is as follows for 2022 and 2021, respectively:
| (dollars in thousands) | December 31, 2022 | December 31, 2021 | |||||||||||||||||||||
| Federal income tax at statutory rate | $ | 5,863 | 21.0 | % | $ | 9,733 | 21.0 | % | |||||||||||||||
| State tax expense, net of federal benefit | 480 | 1.7 | 1,116 | 2.4 | |||||||||||||||||||
| Tax exempt interest | (276) | (1.0) | (248) | (0.5) | |||||||||||||||||||
| Bank owned life insurance | (116) | (0.4) | (77) | (0.2) | |||||||||||||||||||
| Stock based compensation | 36 | 0.1 | 81 | 0.2 | |||||||||||||||||||
| ESOP | 48 | 0.2 | 41 | 0.1 | |||||||||||||||||||
| Other | 56 | 0.2 | 71 | 0.1 | |||||||||||||||||||
| Effective income tax rate | $ | 6,091 | 21.8 | % | $ | 10,717 | 23.1 | % | |||||||||||||||
The components of the net deferred tax asset at December 31, 2022 and 2021 are as follows:
| (dollars in thousands) | December 31, 2022 | December 31, 2021 | |||||||||
| Deferred tax assets: | |||||||||||
| Allowance for loan and lease losses | $ | 4,212 | $ | 4,345 | |||||||
| Unrealized loss on available for sale securities | 3,327 | — | |||||||||
| Accrued incentive compensation | — | 287 | |||||||||
| Accrued retirement | 891 | 874 | |||||||||
| Mortgage pipeline fair-value adjustment | 535 | — | |||||||||
| Deferred rent | 96 | 141 | |||||||||
| Mortgage repurchase reserve | 192 | 738 | |||||||||
| Other | 179 | 183 | |||||||||
| Total deferred tax asset | $ | 9,432 | $ | 6,568 | |||||||
| Deferred tax liabilities: | |||||||||||
| Property and equipment | $ | (948) | $ | (535) | |||||||
| Loan servicing rights | (2,762) | (2,957) | |||||||||
| Intangibles | (23) | (15) | |||||||||
| Mortgage pipeline fair-value adjustment | — | (308) | |||||||||
| Hedge instrument fair-value adjustment | (12) | (190) | |||||||||
| Unrealized gain on available for sale securities | — | (213) | |||||||||
| Prepaid expenses | (341) | (465) | |||||||||
| Deferred loan costs | (1,410) | (471) | |||||||||
| Other | — | (1) | |||||||||
| Total deferred tax liability | $ | (5,496) | $ | (5,155) | |||||||
| Net deferred tax asset | $ | 3,936 | $ | 1,413 | |||||||
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The effective tax rates for the twelve-month periods ended December 31, 2022 and 2021 were 21.8% and 23.1% respectively. The decrease in rate between 2021 and 2022 was primarily related to the decrease in pre-tax income as well as a reduction in state income tax expense.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based on the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Corporation will realize the benefits of these deferred tax assets.
As of December 31, 2022, the Corporation had an investment in low-income housing tax credits of $5.3 million on which it recognized tax credits of $294 thousand, amortization of $381 thousand and tax benefits from losses of $131 thousand during the year ended December 31, 2022. As of December 31, 2021, the Corporation had an investment in low-income housing tax credits of $3.3 million on which it recognized tax credits of $161 thousand, amortization of $183 thousand and tax benefits from losses of $144 thousand during the year ended December 31, 2021. The tax benefits are included within other in the statutory rate reconciliation above.
(15) Transactions with Executive Officers, Directors and Principal Stockholders
The Corporation has had, and may be expected to have in the future, banking transactions in the ordinary course of business with its executive officers, directors, principal stockholders, their immediate families and affiliated companies (commonly referred to as related parties). Loans receivable from related parties totaled $2.0 million and $5.1 million at December 31, 2022 and 2021, respectively. Advances, repayments, and the effect of changes in composition of related parties during 2022 totaled $5.2 million, $6.1 million, and $2.2 million, respectively. Advances, repayments, and the effect of changes in composition of related parties during 2021 totaled $2.8 million, $1.3 million, and $284 thousand, respectively.
Deposits of related parties totaled $32.6 million and $34.7 million at December 31, 2022 and 2021, respectively. Subordinated debt held by related parties totaled $208 thousand and $409 thousand at December 31, 2022 and 2021, respectively.
The Corporation paid legal fees of $14 thousand and $22 thousand to a law firm of a director for the years ended December 31, 2022 and 2021, respectively. The director retired from the law firm in 2022.
(16) Financial Instruments with Off-Balance Sheet Risk, Commitments and Contingencies
The Corporation is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet.
The Corporation’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
A summary of the Corporation’s financial instrument commitments at December 31, 2022 and 2021 is as follows:
| (dollars in thousands) | December 31, 2022 | December 31, 2021 | |||||||||
| Commitments to fund loans and commitments under lines of credit | $ | 506,203 | $ | 486,632 | |||||||
| Letters of credit | 19,042 | 25,986 | |||||||||
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Corporation evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation upon extension of credit, is based on management’s credit evaluation. Collateral held varies but may include personal or commercial real estate, accounts receivable, inventory and equipment.
Outstanding letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. The majority of these are standby letters of credit that expire within the next twelve months. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending other loan commitments. The Corporation requires collateral supporting these letters of credit as deemed necessary. Management believes that the proceeds obtained through a liquidation of such collateral would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees.
Loans sold under FHA or investor programs are subject to indemnification or repurchase if they fail to meet the origination criteria of those programs or if the loan is two or three months delinquent during a set period that usually varies from the first six months to a year after the loan is sold. There was 2 indemnifications signed for the year ended December 31, 2022 for $734 thousand, and 1 indemnification signed for the year ended December 31, 2021 for $109 thousand. A repurchase reserve of $858 thousand was recorded at December 31, 2022, as compared to $3.2 million as of December 31, 2021. There were 8 loans repurchased for the year
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ended December 31, 2022 with a total unpaid principal balance of $1.8 million, as compared to six loans repurchased for the year ended December 31, 2021 with an unpaid principal balance of $1.3 million.
(17) Regulatory Matters
The Bank and the Corporation are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet the 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 Corporation’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank and the Corporation must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s and the Corporation’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk-weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank and the Corporation to maintain minimum amounts and ratios (set forth below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets, and of Tier 1 capital to average assets. Management believes, as of December 31, 2022, that the Bank and the Corporation meet all capital adequacy requirements to which it is subject.
Community banks have long raised concerns with bank regulators about the regulatory burden, complexity, and costs associated with certain provisions of the Basel III Rule. In response, Congress provided an “off-ramp” for institutions, like us, with total consolidated assets of less than $10 billion. Section 201 of the Regulatory Relief Act instructed the federal banking regulators to establish a single CBLR of between 8 and 10%. Under the final rule, a community banking organization is eligible to elect the new framework if it has: less than $10 billion in total consolidated assets, limited amounts of certain assets and off-balance sheet exposures, and a CBLR greater than 9%. The Bank’s CBLR ratio was 9.95% at December 31, 2022.
As of December 31, 2022, the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s category.
The Bank is subject to certain restrictions on the amount of dividends that it may declare and pay to the Corporation due to regulatory considerations. The Pennsylvania Banking Code provides that cash dividends may be declared and paid only out of accumulated net earnings.
The Corporation’s and the Banks’s actual and required capital amounts and ratios under the CBLR rules at December 31, 2022 and 2021 are presented below.
| Corporation | Bank | Well-capitalized minimum | |||||||||||||||||||||||||||
| December 31, 2022 | December 31, 2021 | December 31, 2022 | December 31, 2021 | ||||||||||||||||||||||||||
| Tier 1 leverage ratio | 8.13 | % | 9.39 | % | 9.95 | % | 11.51 | % | 5.00 | % | |||||||||||||||||||
| Common tier 1 risk-based capital ratio | 8.77 | % | 10.83 | % | 10.73 | % | 13.27 | % | 6.50 | % | |||||||||||||||||||
| Tier 1 risk-based capital ratio | 8.77 | % | 10.83 | % | 10.73 | % | 13.27 | % | 8.00 | % | |||||||||||||||||||
| Total risk-based capital ratio | 12.05 | % | 14.81 | % | 11.87 | % | 14.63 | % | 10.00 | % | |||||||||||||||||||
(18) Fair Value Measurements and Disclosures
The Corporation uses fair value measurements to record fair value adjustments to certain assets and liabilities. The fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Corporation’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation techniques or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.
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In accordance with this guidance, the Corporation groups its financial assets and financial liabilities 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 or liabilities that the reporting entity has the ability to access at the measurement date.
Level 2 – Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.
Level 3 – Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.
Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis.
Securities
The fair value of securities available-for-sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices.
Mortgage Loans Held for Sale
The fair value of loans held for sale is based on secondary market prices.
Mortgage Loans Held for Investment
The fair value of mortgage loans held for investment is based on the price secondary markets are currently offering for similar loans using observable market data.
Derivative Financial Instruments
The fair values of forward commitments and interest rate swaps are based on market pricing and therefore are considered Level 2. Derivatives classified as Level 3 consist of interest rate lock commitments related to mortgage loan commitments. The determination of fair value includes assumptions related to the likelihood that a commitment will ultimately result in a closed loan, which is a significant unobservable assumption. A significant increase or decrease in the external market price would result in a significantly higher or lower fair value measurement.
The following table presents the fair value of financial assets measured at fair value on a recurring basis by level within the fair value hierarchy at the dates indicated:
| December 31, 2022 | |||||||||||||||||||||||
| (dollars in thousands) | Total | Level 1 | Level 2 | Level 3 | |||||||||||||||||||
| Assets | |||||||||||||||||||||||
| Securities available for sale: | |||||||||||||||||||||||
| U.S. asset backed securities | $ | 15,281 | $ | — | $ | 15,281 | $ | — | |||||||||||||||
| U.S. government agency MBS | 11,739 | — | 11,739 | — | |||||||||||||||||||
| U.S. government agency CMO | 23,318 | — | 23,318 | — | |||||||||||||||||||
| State and municipal securities | 38,838 | — | 38,838 | — | |||||||||||||||||||
| U.S. Treasuries | 29,523 | 29,523 | — | — | |||||||||||||||||||
| Non-U.S. government agency CMO | 9,089 | — | 9,089 | — | |||||||||||||||||||
| Corporate bonds | 7,558 | — | 7,558 | — | |||||||||||||||||||
| Equity investments | 2,086 | — | 2,086 | — | |||||||||||||||||||
| Mortgage loans held for sale | 22,243 | — | 22,243 | — | |||||||||||||||||||
| Mortgage loans held for investment | 14,502 | — | 14,502 | — | |||||||||||||||||||
| Interest rate lock commitments | 87 | — | — | 87 | |||||||||||||||||||
| Forward commitments | — | — | — | — | |||||||||||||||||||
| Customer derivatives - interest rate swaps | 3,846 | — | 3,846 | — | |||||||||||||||||||
| Total | $ | 178,110 | $ | 29,523 | $ | 148,500 | $ | 87 | |||||||||||||||
| Liabilities | |||||||||||||||||||||||
| Interest rate lock commitments | $ | 79 | $ | — | $ | — | $ | 79 | |||||||||||||||
| Customer derivatives - interest rate swaps | 3,799 | — | 3,799 | — | |||||||||||||||||||
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| December 31, 2022 | |||||||||||||||||||||||
| (dollars in thousands) | Total | Level 1 | Level 2 | Level 3 | |||||||||||||||||||
| Risk Participation Agreements | 17 | — | 17 | — | |||||||||||||||||||
| Total | $ | 3,895 | $ | — | $ | 3,816 | $ | 79 | |||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||
| (dollars in thousands) | Total | Level 1 | Level 2 | Level 3 | |||||||||||||||||||
| Assets | |||||||||||||||||||||||
| Securities available for sale: | |||||||||||||||||||||||
| U.S. asset backed securities | $ | 16,837 | $ | — | $ | 16,837 | $ | — | |||||||||||||||
| U.S. government agency MBS | 9,813 | — | 9,813 | — | |||||||||||||||||||
| U.S. government agency CMO | 22,381 | — | 22,381 | — | |||||||||||||||||||
| State and municipal securities | 72,982 | — | 72,982 | — | |||||||||||||||||||
| U.S. Treasuries | 29,728 | 29,728 | — | — | |||||||||||||||||||
| Non-U.S. government agency CMO | 975 | — | 975 | — | |||||||||||||||||||
| Corporate bonds | 6,586 | — | 6,586 | — | |||||||||||||||||||
| Equity investments | 2,354 | — | 2,354 | — | |||||||||||||||||||
| Mortgage loans held for sale | 80,882 | — | 80,882 | — | |||||||||||||||||||
| Mortgage loans held for investment | 17,558 | — | 17,558 | — | |||||||||||||||||||
| Interest rate lock commitments | 1,122 | — | — | 1,122 | |||||||||||||||||||
| Forward commitments | 65 | — | 65 | — | |||||||||||||||||||
| Customer derivatives - interest rate swaps | 961 | — | 961 | — | |||||||||||||||||||
| Total | $ | 262,244 | $ | 29,728 | $ | 231,394 | $ | 1,122 | |||||||||||||||
| Liabilities | |||||||||||||||||||||||
| Interest rate lock commitments | $ | 203 | $ | — | $ | — | $ | 203 | |||||||||||||||
| Forward commitments | 106 | — | 106 | — | |||||||||||||||||||
| Customer derivatives - interest rate swaps | 1,018 | — | 1,018 | — | |||||||||||||||||||
| Total | $ | 1,327 | $ | — | $ | 1,124 | $ | 203 | |||||||||||||||
The following table presents assets measured at fair value on a nonrecurring basis at the dates indicated:
| (dollars in thousands) | December 31, 2022 | December 31, 2021 | |||||||||
| Mortgage servicing rights | $ | 9,942 | $ | 10,756 | |||||||
| SBA loan servicing rights | 2,404 | 2,009 | |||||||||
Impaired loans (1) | |||||||||||
| Commercial and industrial | — | 1,837 | |||||||||
| Small business loans | 2,281 | 290 | |||||||||
| Total | $ | 14,627 | $ | 14,892 | |||||||
(1) Impaired loans are those in which the Corporation has measured impairment generally based on the fair value of the loan’s collateral. Refer to the following page for further qualitative discussion around impaired loans.
The following table details the valuation techniques for Level 3 impaired loans.
| (dollars in thousands) | Fair Value | Valuation Technique | Significant Unobservable Input | Range of Inputs | |||||||||||||||||||||||||
| December 31, 2022 | $ | 2,281 | Appraisal of collateral | Management adjustments on appraisals for property type and recent activity | 2%-15% discount | ||||||||||||||||||||||||
| December 31, 2021 | 2,127 | Appraisal of collateral | Management adjustments on appraisals for property type and recent activity | 2%-15% discount | |||||||||||||||||||||||||
Below is management’s estimate of the fair value of all financial instruments, whether carried at cost or fair value on the Corporation’s balance sheet. The following information should not be interpreted as an estimate of the fair value of the entire Corporation since a fair value calculation is only provided for a limited portion of the Corporation’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Corporation’s disclosures and those
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of other companies may not be meaningful. The following methods and assumptions were used to estimate the fair value of the Corporation’s financial instruments:
Cash and Cash Equivalents
The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets’ fair values.
Loans Receivable
The fair value of loans receivable is estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair value below is reflective of an exit price.
Servicing Assets
The Corporation estimates the fair value of mortgage servicing rights and SBA loan servicing rights using discounted cash flow models that calculate the present value of estimated future net servicing income. The model uses readily available prepayment speed assumptions for the interest rates of the portfolios serviced. These servicing rights are classified within Level 3 in the fair value hierarchy based upon management’s assessment of the inputs. The Corporation reviews the servicing rights portfolios on a quarterly basis for impairment.
Impaired Loans
Impaired loans are those in which the Corporation has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third‑party appraisals of the properties, or discounted cash flows based upon the expected proceeds. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted in accordance with the Allowance policy.
Accrued Interest Receivable and Payable
The carrying amount of accrued interest receivable and accrued interest payable approximates its fair value.
Deposit Liabilities
The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered in the market on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Short-Term Borrowings
The carrying amounts of short-term borrowings approximate their fair values.
Long-Term Debt
Fair values of FHLB advances and the acquisition purchase note payable are estimated using discounted cash flow analysis, based on quoted prices for new FHLB advances with similar credit risk characteristics, terms and remaining maturity. These prices obtained from this active market represent a market value that is deemed to represent the transfer price if the liability were assumed by a third party.
Subordinated Debt
Fair values of junior subordinated debt are estimated using discounted cash flow analysis, based on market rates currently offered on such debt with similar credit risk characteristics, terms and remaining maturity.
Off-Balance Sheet Financial Instruments
Off-balance sheet instruments are primarily comprised of loan commitments, which are generally priced at market at the time of funding. Fees on commitments to extend credit and stand-by letters of credit are deemed to be immaterial and these instruments are expected to be settled at face value or expire unused. It is impractical to assign any fair value to these instruments and as a result they are not included in the table below. Fair values assigned to the notional value of interest rate lock commitments and forward sale contracts are based on market quotes.
Derivative Financial Instruments
The fair value of forward commitments and interest rate swaps is based on market pricing and therefore are considered Level 2. Derivatives classified as Level 3 consist of interest rate lock commitments related to mortgage loan commitments. The determination of fair value includes assumptions related to the likelihood that a commitment will ultimately result in a closed loan, which is a significant unobservable assumption. A significant increase or decrease in the external market price would result in a significantly higher or lower fair value measurement.
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The following table presents the estimated fair values of the Corporation’s financial instruments at the dates indicated:
| December 31, 2022 | December 31, 2021 | ||||||||||||||||||||||||||||
| (dollars in thousands) | Fair Value Hierarchy Level | Carrying amount | Fair value | Carrying amount | Fair value | ||||||||||||||||||||||||
| Financial assets: | |||||||||||||||||||||||||||||
| Cash and cash equivalents | Level 1 | $ | 38,391 | $ | 38,391 | $ | 23,480 | $ | 23,480 | ||||||||||||||||||||
| Mortgage loans held for sale | Level 2 | 22,243 | 22,243 | 80,882 | 80,882 | ||||||||||||||||||||||||
| Loans receivable, net of the allowance for loan and lease losses | Level 3 | 1,729,180 | 1,679,955 | 1,368,899 | 1,370,885 | ||||||||||||||||||||||||
| Mortgage loans held for investment | Level 2 | 14,502 | 14,502 | 17,558 | 17,558 | ||||||||||||||||||||||||
| Financial liabilities: | |||||||||||||||||||||||||||||
| Deposits | Level 2 | 1,712,479 | 1,575,600 | 1,446,413 | 1,549,100 | ||||||||||||||||||||||||
| Short-term borrowings | Level 2 | 122,082 | 122,082 | 41,344 | 41,344 | ||||||||||||||||||||||||
| Subordinated debentures | Level 2 | 40,346 | 40,020 | 40,508 | 40,803 | ||||||||||||||||||||||||
The following table includes a rollforward of interest rate lock commitments for which the Corporation utilized Level 3 inputs to determine fair value on a recurring basis for the periods indicated.
| Year Ended December 31, | ||||||||||||||
| (dollars in thousands) | 2022 | 2021 | ||||||||||||
| Balance at beginning of the period | $ | 1,122 | $ | 6,932 | ||||||||||
| Decrease in value | (1,035) | (5,810) | ||||||||||||
| Balance at end of the period | $ | 87 | $ | 1,122 | ||||||||||
The following table details the valuation techniques for Level 3 interest rate lock commitments.
| (dollars in thousands) | Fair Value | Valuation Technique | Significant Unobservable Input | Range of Inputs | Weighted Average | ||||||||||||||||||||||||
| December 31, 2022 | $ | 87 | Market comparable pricing | Pull through | 1% - 99% | 84.05% | |||||||||||||||||||||||
| December 31, 2021 | 1,122 | Market comparable pricing | Pull through | 1% - 99% | 87.66% | ||||||||||||||||||||||||
(19) Derivative Financial Instruments
Risk Management Objective of Using Derivatives
The Corporation is exposed to certain risk arising from both its business operations and economic conditions. The Corporation principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Corporation manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments. Specifically, the Corporation enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Corporation’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Corporation’s known or expected cash receipts and its known or expected cash payments principally related to the Corporation’s loan portfolio.
Mortgage Banking Derivatives
In connection with its mortgage banking activities, the Corporation enters into commitments to originate certain fixed rate residential mortgage loans for customers, also referred to as interest rate locks. In addition, the Corporation enters into forward commitments for the future sales or purchases of mortgage-backed securities to or from third-party counterparties to hedge the effect of changes in interest rates on the values of both the interest rate locks and mortgage loans held for sale. Forward sales commitments may also be in the form of commitments to sell individual mortgage loans or interest rate locks at a fixed price at a future date. The amount necessary to settle each interest rate lock is based on the price that secondary market investors would pay for loans with similar characteristics, including interest rate and term, as of the date fair value is measured. Interest rate lock commitments and forward commitments are recorded within other assets/liabilities on the consolidated balance sheets, with changes in fair values during the period recorded within net change in the fair value of derivative instruments on the consolidated statements of income.
Customer Derivatives – Interest Rate Swaps
Derivatives not designated as hedges are not speculative and result from a service the Corporation provides to certain customers to swap a fixed rate product for a variable rate product, or vice versa. The Corporation executes interest rate derivatives with commercial banking customers to facilitate their respective risk management strategies. Those interest rate derivatives are simultaneously hedged by offsetting derivatives that the Corporation executes with a third party, such that the Corporation minimizes its net interest rate risk
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exposure resulting from such transactions. As the interest rate derivatives associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting derivatives are recognized directly in earnings.
The following table presents a summary of notional amounts and fair values of derivative financial instruments at the dates indicated:
| December 31, 2022 | December 31, 2021 | ||||||||||||||||||||||||||||
| (dollars in thousands) | Balance Sheet Line Item | Notional Amount | Asset (Liability) Fair Value | Notional Amount | Asset (Liability) Fair Value | ||||||||||||||||||||||||
| Interest Rate Lock Commitments | |||||||||||||||||||||||||||||
| Positive fair values | Other assets | $ | 16,590 | $ | 87 | $ | 108,653 | $ | 1,122 | ||||||||||||||||||||
| Negative fair values | Other liabilities | 16,108 | (79) | 35,264 | (203) | ||||||||||||||||||||||||
| Total | $ | 32,698 | $ | 8 | $ | 143,917 | $ | 919 | |||||||||||||||||||||
| Forward Commitments | |||||||||||||||||||||||||||||
| Positive fair values | Other assets | $ | — | $ | — | $ | 30,500 | $ | 65 | ||||||||||||||||||||
| Negative fair values | Other liabilities | — | — | 45,500 | (106) | ||||||||||||||||||||||||
| Total | $ | — | $ | — | $ | 76,000 | $ | (41) | |||||||||||||||||||||
| Customer Derivatives - Interest Rate Swaps | |||||||||||||||||||||||||||||
| Positive fair values | Other assets | $ | 43,779 | $ | 3,846 | $ | 35,447 | $ | 961 | ||||||||||||||||||||
| Negative fair values | Other liabilities | 43,779 | (3,799) | 35,447 | (1,018) | ||||||||||||||||||||||||
| Total | $ | 87,558 | $ | 47 | $ | 70,894 | $ | (57) | |||||||||||||||||||||
| Risk Participation Agreements | |||||||||||||||||||||||||||||
| Positive fair values | Other assets | $ | — | $ | — | $ | — | $ | — | ||||||||||||||||||||
| Negative fair values | Other liabilities | 7,200 | (17) | — | — | ||||||||||||||||||||||||
| Total | $ | 7,200 | $ | (17) | $ | — | $ | — | |||||||||||||||||||||
| Total derivative financial instruments | $ | 127,456 | $ | 38 | $ | 290,811 | $ | 821 | |||||||||||||||||||||
Interest rate lock commitments are considered Level 3 in the fair value hierarchy, while the forward commitments and interest rate swaps are considered Level 2 in the fair value hierarchy.
The following table presents a summary of the fair value (losses) gains on derivative financial instruments:
| Year Ended December 31, | ||||||||||||||
| (dollars in thousands) | 2022 | 2021 | ||||||||||||
| Interest Rate Lock Commitments | $ | (911) | $ | (5,913) | ||||||||||
| Forward Commitments | 41 | 1,531 | ||||||||||||
| Customer Derivatives - Interest Rate Swaps | 105 | 44 | ||||||||||||
| Risk Participation Agreements | 62 | — | ||||||||||||
| Net fair value (losses) gains on derivative financial instruments | $ | (703) | $ | (4,338) | ||||||||||
Net realized gains on derivative hedging activities were $5.4 million and net realized gains were $3.0 million for the year ended December 31, 2022 and 2021, respectively, and are included in non-interest income in the consolidated statements of income.
(20) Segments
ASC Topic 280 – Segment Reporting identifies operating segments as components of an enterprise which are evaluated regularly by the Corporation’s Chief Operating Decision Maker, our Chief Executive Officer, in deciding how to allocate resources and assess performance. The Corporation has applied the aggregation criterion set forth in this codification to the results of its operations.
Our Banking segment (“Bank”) consists of commercial and retail banking. The Banking segment generates interest income from its lending (including leasing) and investing activities and is dependent on the gathering of lower cost deposits from its branch network or borrowed funds from other sources for funding its loans, resulting in the generation of net interest income. The Banking segment also derives revenues from other sources including gains on the sale of SBA loans, sales of available for sale investment securities, service charges on deposit accounts, cash sweep fees, overdraft fees, BOLI income, title insurance fees, and other less significant non-interest income.
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Meridian Wealth (“Wealth”), a registered investment advisor and wholly-owned subsidiary of the Bank, provides a comprehensive array of wealth management services and products and the trusted guidance to help its clients and our banking customers prepare for the future. The unit generates non-interest income through advisory fees.
Meridian’s mortgage banking segment (“Mortgage”) consists of 12 loan production offices throughout suburban Philadelphia and Maryland. The Mortgage segment originates 1 – 4 family residential mortgages and sells nearly all of its production to third party investors. The unit generates net interest income on the loans it originates and holds temporarily, then earns fee income (primarily gain on sales) at the time of the sale. The unit also recognizes income from document preparation fees, changes in portfolio pipeline fair values and related net hedging gains (losses).
The table below summarizes income and expenses, directly attributable to each business line, which has been included in the statement of operations. Total assets for each segment is also provided.
| Segment Information | |||||||||||||||||||||||||||||||||||||||||||||||
Year Ended December 31, 2022 | Year Ended December 31, 2021 | ||||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Bank | Wealth | Mortgage | Total | Bank | Wealth | Mortgage | Total | |||||||||||||||||||||||||||||||||||||||
| Net interest income | $ | 68,570 | $ | 697 | $ | 861 | $ | 70,128 | $ | 61,032 | $ | 15 | $ | 2,064 | $ | 63,111 | |||||||||||||||||||||||||||||||
| Provision for loan losses | 2,488 | — | — | 2,488 | 1,070 | — | — | 1,070 | |||||||||||||||||||||||||||||||||||||||
| Net interest income after provision | 66,082 | 697 | 861 | 67,640 | 59,962 | 15 | 2,064 | 62,041 | |||||||||||||||||||||||||||||||||||||||
| Non-interest Income | |||||||||||||||||||||||||||||||||||||||||||||||
| Mortgage banking income | 436 | — | 24,889 | 25,325 | 1,097 | — | 74,835 | 75,932 | |||||||||||||||||||||||||||||||||||||||
| Wealth management income | — | 4,733 | — | 4,733 | — | 4,801 | — | 4,801 | |||||||||||||||||||||||||||||||||||||||
| SBA income | 4,467 | — | — | 4,467 | 6,898 | — | — | 6,898 | |||||||||||||||||||||||||||||||||||||||
| Net change in fair values | 167 | — | (4,122) | (3,955) | 43 | — | (7,881) | (7,838) | |||||||||||||||||||||||||||||||||||||||
| Net gain on hedging activity | — | — | 5,439 | 5,439 | — | — | 2,961 | 2,961 | |||||||||||||||||||||||||||||||||||||||
| Other | 2,486 | (1) | 3,230 | 5,715 | 2,741 | 1 | 2,492 | 5,234 | |||||||||||||||||||||||||||||||||||||||
| Non-interest income | 7,556 | 4,732 | 29,436 | 41,724 | 10,779 | — | 4,802 | 72,407 | 87,988 | ||||||||||||||||||||||||||||||||||||||
| Non-interest expense | 45,122 | 3,399 | 32,923 | 81,444 | 40,392 | 3,496 | 59,839 | 103,727 | |||||||||||||||||||||||||||||||||||||||
| Income (loss) before income taxes | $ | 28,516 | $ | 2,030 | $ | (2,626) | $ | 27,920 | $ | 30,349 | — | $ | 1,321 | $ | 14,632 | $ | 46,302 | ||||||||||||||||||||||||||||||
| Total Assets | $ | 2,011,835 | $ | 8,142 | $ | 42,251 | $ | 2,062,228 | $ | 1,608,305 | $ | 6,355 | $ | 98,783 | $ | 1,713,443 | |||||||||||||||||||||||||||||||
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(21) Parent Company Financial Statements
The condensed financial statements of the Corporation (parent company only) are presented below. These statements should be read in conjunction with the notes to the consolidated financial statements. All share amounts have been adjusted to reflect the two-for-one stock split effective February 28, 2023.
A. Condensed Balance Sheets
| (dollars in thousands, except share data) | December 31, 2022 | December 31, 2021 | |||||||||
| Assets: | |||||||||||
| Cash and due from banks | $ | 4,839 | $ | 2,836 | |||||||
| Investments in subsidiaries | 186,686 | 200,410 | |||||||||
| Other assets | 1,382 | 1,382 | |||||||||
| Total assets | $ | 192,907 | $ | 204,628 | |||||||
| Liabilities: | |||||||||||
| Subordinated debentures | $ | 39,175 | $ | 39,057 | |||||||
| Accrued interest payable | 6 | 6 | |||||||||
| Other liabilities | 446 | 205 | |||||||||
| Total liabilities | $ | 39,627 | $ | 39,268 | |||||||
| Stockholders’ equity: | |||||||||||
Common stock, $1 par value: 25,000,000 shares authorized; 13,156,308 and 13,069,174 shares issued, respectively; and 11,465,572 and 12,215,788 shares outstanding, respectively. | 13,156 | 6,535 | |||||||||
| Surplus | 79,072 | 83,663 | |||||||||
Treasury Stock - 1,690,736 and 853,386 shares, respectively, at cost | (21,821) | (8,860) | |||||||||
| Unearned common stock held by employee stock ownership plan | (1,403) | (1,602) | |||||||||
| Retained earnings | 95,815 | 84,916 | |||||||||
| Accumulated other comprehensive income | (11,539) | 708 | |||||||||
| Total stockholders’ equity | $ | 153,280 | $ | 165,360 | |||||||
| Total liabilities and stockholders’ equity | $ | 192,907 | $ | 204,628 | |||||||
B. Condensed Statements of Income
Year Ended December 31, | |||||||||||
| (dollars in thousands) | 2022 | 2021 | |||||||||
| Dividends from Bank | $ | 27,813 | $ | 17,187 | |||||||
| Interest income | 8 | — | |||||||||
| Total operating income | 27,821 | 17,187 | |||||||||
| Interest expense | 2,268 | 2,303 | |||||||||
| Other expenses | 1,412 | 1,675 | |||||||||
| Income before equity in undistributed income of subsidiaries | 24,141 | 13,209 | |||||||||
| Equity in undistributed income of subsidiaries | (3,084) | 22,376 | |||||||||
| Income before income taxes | 21,057 | 35,585 | |||||||||
| Income tax benefit | (772) | — | |||||||||
| Net income | 21,829 | 35,585 | |||||||||
| Total other comprehensive (loss) income | (12,247) | (1,848) | |||||||||
| Total comprehensive income | $ | 9,582 | $ | 33,737 | |||||||
C. Condensed Statements of Cash Flows
Year Ended December 31, | |||||||||||
| (dollars in thousands) | 2022 | 2021 | |||||||||
| Cash flows from operating activities: | |||||||||||
| Net Income | $ | 21,829 | $ | 35,585 | |||||||
| Adjustments to reconcile net income to net cash provided by (used in) operating activities: | |||||||||||
| Equity in undistributed income of subsidiaries | 3,084 | (22,376) | |||||||||
| Share-based compensation | 1,475 | 1,607 | |||||||||
| Amortization of issuance costs on subordinated debt | 118 | 153 | |||||||||
| Other, net | (1,369) | (740) | |||||||||
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Year Ended December 31, | |||||||||||
| (dollars in thousands) | 2022 | 2021 | |||||||||
| Net cash provided by operating activities | 25,137 | 14,229 | |||||||||
| Cash flows from financing activities: | |||||||||||
| Net purchase of treasury stock | (12,961) | (3,032) | |||||||||
| Dividends paid | (10,926) | (9,679) | |||||||||
| Share based awards and exercises | 754 | 1,105 | |||||||||
| Net cash (used in) provided by financing activities | (23,133) | (11,606) | |||||||||
| Net change in cash and cash equivalents | 2,004 | 2,623 | |||||||||
| Cash and cash equivalents at beginning of period | 2,836 | 213 | |||||||||
| Cash and cash equivalents at end of period | $ | 4,840 | $ | 2,836 | |||||||
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
None.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Management, with the participation of the Corporation’s President/Chief Executive Officer and its Chief Financial Officer, evaluated the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures (as defined in Rule l3a-l5(e) and 15d-15(e) promulgated under the Exchange Act) as of December 31, 2022. Based on this evaluation, the Corporation’s President /Chief Executive Officer and Chief Financial Officer have concluded, as of and for the end of the period covered by this report, that such disclosure controls and procedures were effective.
Design and Evaluation of Internal Control Over Financial Reporting
Pursuant to Section 404 of Sarbanes-Oxley, the following is a report of management’s assessment of the design and effectiveness of our internal controls for the fiscal year ended December 31, 2022.
Management’s Report on Internal Control Over Financial Reporting
The Corporation is responsible for the preparation, integrity, and fair presentation of the consolidated financial statements included in this Annual Report on Form 10-K. The consolidated financial statements and notes included in this Annual Report on Form 10-K have been prepared in conformity with United States generally accepted accounting principles and necessarily include some amounts that are based on Management’s best estimates and judgments.
The Corporation’s Management is responsible for establishing and maintaining effective internal control over financial reporting that is designed to produce reliable financial statements in conformity with United States generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Corporation; provide reasonable assurance that the transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles; provide a reasonable assurance that receipts and expenditures of the Corporation are only being made in accordance with authorizations of Management and directors of the Corporation; and provide a reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Corporation’s assets that could have a material effect on the financial statements. The system of internal control over financial reporting as it relates to the financial statements is evaluated for effectiveness by Management and tested for reliability through a program of internal audits. Actions are taken to correct potential deficiencies as they are noted.
Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation.
The Corporation’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, assessed the Corporation’s system of internal control over financial reporting as of December 31, 2022, in relation to the criteria for effective control over financial reporting as described in “Internal Control – Integrated Framework,” issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013). Based on this assessment, Management concludes that, as of December 31, 2022, the Corporation’s system of internal control over financial reporting is effective.
Changes in Internal Control Over Financial Reporting
There was no change in the Corporation’s internal control over financial reporting identified during the fourth quarter ended December 31, 2022 that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
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Item 9B. Other Information
None.
Item 9C. Disclosure Regarding Foreign Jurisdictions That Prevent Inspections
None.
PART III
Item 10. Directors, Executive Officers and Corporate Governance
The information required by Item 10 is incorporated by reference to information appearing in Meridian Corporation’s definitive proxy statement to be used in connection with the 2023 Annual Meeting of Shareholders under the headings, “ELECTION OF DIRECTORS,” “EXECUTIVE OFFICERS,” “SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE,” “CODE OF ETHICS,” “CORPORATE GOVERNANCE,” and “AUDIT COMMITTEE.”
Item 11. Executive Compensation
The information required by Item 11 is incorporated by reference to the information appearing in Meridian Corporation’s definitive proxy statement to be used in connection with the 2023 Annual Meeting of Shareholders under the headings, “EXECUTIVE COMPENSATION,” “SUMMARY COMPENSATION TABLE,” “OUTSTANDING AWARDS AT FISCAL YEAR-END TABLE,” “EXECUTIVE INCENTIVE, EMPLOYMENT AND CHANGE IN CONTROL ARRANGEMENTS,” and “DIRECTOR COMPENSATION.”
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by Item 12 is incorporated by reference to the information appearing in Meridian Corporation’s definitive proxy statement to be used in connection with the 2023 Annual Meeting of Shareholders under the headings, “EQUITY COMPENSATION PLAN INFORMATION” and “SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.”
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by Item 13 is incorporated by reference to the information appearing in Meridian Corporation’s definitive proxy statement to be used in connection with the 2023 Annual Meeting of Shareholders under the headings, “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS” and “DIRECTOR INDEPENDENCE.”
Item 14. Principal Accounting Fees and Services
The information required by Item 14 is incorporated by reference to the information appearing in Meridian Corporation’s definitive proxy statement to be used in connection with the 2023 Annual Meeting of Shareholders under the heading, “PROPOSAL TO RATIFY THE APPOINTMENT OF CROWE LLP AS THE CORPORATION’S INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM FOR THE YEAR ENDING DECEMBER 31, 2023.”
PART IV
Item 15. Exhibits, Financial Statement Schedules
(a)(1) The following portions of the Corporation’s consolidated financial statements are set forth in Item 8 – “Financial Statements and Supplementary Data”:
◦Report of Crowe LLP, Independent Registered Public Accounting Firm (PCAOB ID 173)
◦Consolidated Balance Sheets
◦Consolidated Statements of Income
◦Consolidated Statements of Comprehensive Income
◦Consolidated Statements of Changes in Stockholders’ Equity
◦Consolidated Statements of Cash Flows
◦Notes to Consolidated Financial Statements
(a)(2) The financial statement schedules required by this Item are omitted because the information is either inapplicable, not required or is presented in the consolidated financial statements or notes thereto.
(a)(3) The following exhibits are incorporated by reference herein or filed with this Form 10-K:
Exhibit Number | Description | |||||||
2.1 | ||||||||
3.1 | ||||||||
3.2 | ||||||||
4.1 | ||||||||
85
4.2 | ||||||||
4.3 | ||||||||
10.1 | ||||||||
10.2 | ||||||||
10.3 | ||||||||
10.4 | ||||||||
10.5 | ||||||||
10.6 | ||||||||
10.7 | ||||||||
10.8 | ||||||||
21.1 | ||||||||
23.1 | ||||||||
31.1 | ||||||||
31.2 | ||||||||
32 | ||||||||
101.INS | Inline XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.* | |||||||
| 101.SCH | Inline XBRL Taxonomy Extension Schema Document.* | |||||||
| 101.CAL | Inline XBRL Taxonomy Calculation Linkbase Document.* | |||||||
| 101.LAB | Inline XBRL Taxonomy Label Linkbase Document.* | |||||||
| 101.PRE | Inline XBRL Taxonomy Presentation Linkbase Document.* | |||||||
| 101.DEF | Inline XBRL Taxonomy Definition Document.* | |||||||
| 104 | Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).* | |||||||
Item 16. Form 10-K Summary
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| Date: | March 16, 2023 | Meridian Corporation | |||||||||
| By: | /s/ Christopher J. Annas | ||||||||||
| Christopher J. Annas President and Chief Executive Officer (Principal Executive Officer) | |||||||||||
86
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
| Signature | Title | Date | ||||||
| /s/ Christopher J. Annas | Chairman of the Board | March 16, 2023 | ||||||
| Christopher J. Annas | ||||||||
| /s/ Denise Lindsay | Director, Executive Vice President and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) | March 16, 2023 | ||||||
| Denise Lindsay | ||||||||
| /s/ Robert M. Casciato | Director | March 16, 2023 | ||||||
| Robert M. Casciato | ||||||||
| /s/ George C. Collier | Director | March 16, 2023 | ||||||
| George C. Collier | ||||||||
| /s/ Robert T. Holland | Director | March 16, 2023 | ||||||
| Robert T. Holland | ||||||||
| /s/ Edward J. Hollin | Director | March 16, 2023 | ||||||
| Edward J. Hollin | ||||||||
| /s/ Anthony M. Imbesi | Director | March 16, 2023 | ||||||
| Anthony M. Imbesi | ||||||||
| /s/ Christine M. Helmig | Director | March 16, 2023 | ||||||
| Christine M. Helmig | ||||||||
87