PARTNERS BANCORP - Quarter Report: 2023 March (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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Commission File Number: 001-39285

Partners Bancorp

(Exact name of registrant as specified in its charter)

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410-548-1100

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer”, "accelerated filer", "smaller reporting company" and “emerging growth company” in Rule 12b-2 of the Exchange Act.

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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of May 15, 2023, there were 17,985,577 shares of the registrant’s Common Stock, par value $0.01 per share, outstanding.

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TABLE OF CONTENTS

PART I

FINANCIAL INFORMATION

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PART I – FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS.

PARTNERS BANCORP

CONSOLIDATED BALANCE SHEETS

* Derived from audited consolidated financial statements.

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The Notes to the Unaudited Consolidated Financial Statements are an integral part of these consolidated financial statements.

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PARTNERS BANCORP

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

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The Notes to the Unaudited Consolidated Financial Statements are an integral part of these consolidated financial statements.

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PARTNERS BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

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The Notes to the Unaudited Consolidated Financial Statements are an integral part of these consolidated financial statements.

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PARTNERS BANCORP

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(Unaudited)

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The Notes to the Unaudited Consolidated Financial Statements are an integral part of these consolidated financial statements.

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PARTNERS BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

The Notes to the Unaudited Consolidated Financial Statements are an integral part of these consolidated financial statements.

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PARTNERS BANCORP

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Nature of Business and Its Significant Accounting Policies

Partners Bancorp (the “Company”) is a multi-bank holding company with two wholly owned subsidiaries (the “Subsidiaries”), The Bank of Delmarva (“Delmarva”), a commercial bank headquartered in Seaford, Delaware that operates primarily in Wicomico and Worcester counties in Maryland, Sussex County in Delaware, and Camden and Burlington counties in New Jersey, and Virginia Partners Bank (“Partners”), a commercial bank headquartered in Fredericksburg, Virginia that operates in and around the greater Fredericksburg, Virginia area (Stafford County, Spotsylvania County, King George County, Caroline County, and the City of Fredericksburg, Virginia), the Greater Washington area (the District of Columbia, Arlington County, Clarke County, Fairfax County, Fauquier County, Loudoun County, Prince William County, Warren County, and the Cities of Alexandria, Fairfax, Falls Church, Manassas, Manassas Park, and Reston, Virginia) and Anne Arundel County and the three counties of Southern Maryland (Charles County, Calvert County and St. Mary’s County).  The Subsidiaries engage in general banking business and provide a broad range of financial services to individual and corporate customers, and are subject to competition from other financial institutions. The Subsidiaries are also subject to the regulations of certain federal and state agencies and undergo periodic examinations by those regulatory authorities. The accounting and reporting policies of the Company and its Subsidiaries conform to accounting principles generally accepted in the United States of America (“U.S. GAAP”) and practices within the banking industry.

Significant accounting policies not disclosed elsewhere in the consolidated financial statements are as follows:

Principles of Consolidation:

The consolidated financial statements include the accounts of the Company; the Subsidiaries, along with their consolidated subsidiaries: Delmarva Real Estate Holdings, LLC, a wholly owned subsidiary of Delmarva, which is a real estate holding company; Davie Circle, LLC, a wholly owned subsidiary of Delmarva, which is a real estate holding company; Delmarva BK Holdings, LLC, a wholly owned subsidiary of Delmarva, which is a real estate holding company; DHB Development, LLC, of which Delmarva holds a 40.55% interest, and which is a real estate holding company; and FBW, LLC, of which Delmarva holds a 50% interest, and which is a real estate holding company; Bear Holdings, Inc., a wholly owned subsidiary of Partners, which is a real estate holding company; Johnson Mortgage Company, LLC (“JMC”), of which Partners owns a 51% interest, and which is a residential mortgage company; and 410 William Street, LLC, a wholly owned subsidiary of Partners, which holds investment property. All significant intercompany accounts and transactions have been eliminated in consolidation.

Financial Statement Presentation:

The unaudited interim consolidated financial statements do not include all information and notes necessary for a complete presentation of financial position, results of operations, changes in stockholder's equity, and cash flows in conformity with U.S. GAAP. In the opinion of management, the unaudited interim consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the consolidated financial position at March 31, 2023 and December 31, 2022, the results of its operations for three months and its cash flows for the three months ended March 31, 2023 and 2022 in conformity with U.S. GAAP.

Operating results for the three months ended March 31, 2023 are not necessarily indicative of the results that may be expected for the year ending December 31, 2023, or for any other period.

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Use of Estimates:

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Certain of the critical accounting estimates are more dependent on such judgment and in some cases may contribute to volatility in the Company’s reported financial performance should the assumptions and estimates used change over time due to changes in circumstances. Actual results could differ from those estimates.  The more significant areas in which management of the Company applies critical assumptions and estimates that are most susceptible to change in the short term include the calculation of the allowance for credit losses and the unrealized gain or loss on investment securities available for sale.

Adoption of New Accounting Standard in 2023:

Effective January 1, 2023, the Company adopted Accounting Standards Update (“ASU”) 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”), which replaced the prior incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (“CECL” or the “CECL Standard”). The measurement of expected credit losses under the CECL Standard is applicable to financial assets measured at amortized cost, including portfolio loans and investment securities classified as held-to-maturity (“HTM”). It also applies to off-balance-sheet credit exposures including loan commitments, standby letters of credit, financial guarantees and other similar instruments. In addition, the CECL Standard changes the accounting for investment securities classified as available for sale ("AFS"), including a requirement that estimated credit losses on AFS investment securities be presented as an allowance rather than as a direct write-down of the carrying balance of investment securities which the Company does not currently intend to sell or does not believe, based on current conditions, that it is likely that the Company will be required to sell.

The Company adopted the CECL Standard using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Upon adoption, we recognized an after-tax cumulative effect reduction to retained earnings totaling $1.4 million, as detailed in the table below. As discussed further below, purchased credit deteriorated assets (“PCD”) were measured on a prospective basis in accordance with the CECL Standard and all purchased credit impaired (“PCI”) loans as of December 31, 2022 were considered PCD loans upon adoption. Results for reporting periods beginning after January 1, 2023 are presented under the CECL Standard while prior period amounts continue to be reported in accordance with previously applicable accounting guidance. The adoption of the CECL Standard resulted in the following adjustments to our financial statements as of January 1, 2023:

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(1) Represents a gross-up of the balance sheet related to PCD loans resulting from the adoption of ASU 2016-13 on January 1, 2023.

Loans designated as PCI and accounted for under Accounting Standards Codification (“ASC”) 310-30 were designated as PCD loans. In accordance with the CECL Standard, the Company did not reassess whether PCI loans met the criteria of PCD loans as of the date of adoption and determined all PCI loans were PCD loans. The Company recorded an increase to the balance of PCD loans and an increase to the allowance for credit losses for loans of $9 thousand, which represented the expected credit losses for PCD loans. The remaining non-credit discount (based on the adjusted amortized

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cost basis) will be accreted into interest income at the effective interest rate as of January 1, 2023 over the remaining estimated life of the loans.

On January 1, 2023, the Company adopted ASU 2022-02, “Financial Instruments-Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures” (“ASU 2022-02”).  ASU 2022-02 addresses areas identified by the Financial Accounting Standards Board (“FASB”) as part of its post-implementation review of the credit losses standard (ASU 2016-13) that introduced the CECL Standard. The amendments eliminate the accounting guidance for troubled debt restructurings (“TDRs”) by creditors that have adopted the CECL Standard and enhance the disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. In addition, the amendments require that the Company disclose current-period gross write-offs for financing receivables and net investment in leases by year of origination in the vintage disclosures. The Company adopted the standard prospectively and it did not have a material impact on the financial statements.

In December 2018, the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Federal Deposit Insurance Corporation (“FDIC”) and the Office of Comptroller of the Currency (“OCC”) approved a final rule to address changes to credit loss accounting under U.S. GAAP, including banking organizations’ adoption of the CECL Standard. The final rule provides banking organizations the option to phase-in, over a three-year period, the day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard. The Company has elected to phase in the impact of the adoption of this standard on the Company’s regulatory capital over the three-year transition period. See Note 10 – Regulatory Capital Requirements for further information.

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Investment Securities Available for Sale (“AFS”):

Management evaluates all AFS investment securities in an unrealized loss position on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. If the Company has the intent to sell the investment security or it is more likely than not that the Company will be required to sell the investment security, the investment security is written down to fair value and the entire loss is recorded in earnings.

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If either of the above criteria is not met, the Company evaluates whether the decline in fair value is the result of credit losses or other factors. In making the assessment, the Company may consider various factors including the extent to which fair value is less than amortized cost, downgrades in the ratings of the investment security by a rating agency, the failure of the issuer to make scheduled interest or principal payments and adverse conditions specific to the investment security. If the assessment indicates that a credit loss exists, the present value of cash flows expected to be collected are compared to the amortized cost basis of the investment security and any deficiency is recorded as an allowance for credit losses, limited by the amount that the fair value is less than the amortized cost basis. Any amount of unrealized loss that has not been recorded through an allowance for credit loss is recognized in other comprehensive income (loss), net of tax.

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Changes in the allowance for credit losses are recorded as a provision for (or recovery of) credit losses in the Consolidated Statements of Income. Losses are charged against the allowance for credit losses when management believes an AFS investment security is confirmed to be uncollectible or when either of the criteria regarding intent or requirement to sell is met. At March 31, 2023, there was no allowance for credit losses related to the AFS investment securities portfolio.

Impairment may result from credit deterioration of the issuer or collateral underlying the investment security.  In performing an assessment of recoverability, all relevant information is considered, including the length of time and extent to which fair value has been less than the amortized cost basis, the cause of the price decline, credit performance of the issuer and underlying collateral, and recoveries or further declines in fair value subsequent to the balance sheet date.

Restricted Stock, Equity Securities and Other Investments:

Federal Reserve Bank (“FRB”) stock, at cost, Federal Home Loan Bank (“FHLB”) stock, at cost, Atlantic Central Bankers Bank (“ACBB”) stock, at cost, and Community Bankers Bank (“CBB”) stock, at cost, are equity interests in the FRB, FHLB, ACBB, and CBB, respectively. These securities do not have a readily determinable fair value for purposes

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of ASC 321 Investments-Equity Securities (“ASC 321”) because their ownership is restricted and they lack an active market. As there is no readily determinable fair value for these securities, they are carried at cost less any impairment.

Equity securities with readily determinable fair values are carried at fair value, with changes in fair value reported in net income. Any equity securities without readily determinable fair values are carried at cost, minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments. The entirety of any impairment on equity securities is recognized in earnings.  Equity securities are included in “Other investments” on the Consolidated Balance Sheets.

Other investments includes an equity ownership of Solomon Hess SBA Loan Fund LLC, for which the value is adjusted for its pro rata share of assets in the fund.  Other investments also includes equity securities the Company holds with Community Capital Management in their Community Reinvestment Act (“CRA”) Qualified Investment Fund.

Bank Owned Life Insurance:

The Company has purchased life insurance policies on certain key executives.  Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other changes or amounts due that are probable at settlement.  

Loans and the Allowance for Credit Losses:

Loans are generally carried at the amount of unpaid principal, adjusted for unearned loan fees and costs, which are amortized over the term of the loan using the effective interest rate method. Interest on loans is accrued based on the principal amounts outstanding. It is the Company’s policy to discontinue the accrual of interest when a the borrower is determined to be experiencing financial difficulty or when principal or interest on the loan is delinquent for ninety days or more. When a loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Cash collections on loans classified as nonaccrual are applied as reductions of the loan principal balance and no interest income is recognized on those loans until the principal balance has been collected. As a general rule, a nonaccrual loan may be restored to accrual status when (1) none of its principal and interest is due and unpaid, and the Company expects repayment of the remaining contractual principal and interest, or (2) when it otherwise becomes well secured and in the process of collection.  

The allowance for credit losses is maintained at a level believed to be adequate by management to absorb expected losses inherent in the loan portfolio and is based on the size and current risk characteristics of the loan portfolio, the concentration of credits within each segment, the effects of any changes in lending policies, procedures, including underwriting standards and collections, charge off and recovery practices, the effects of changes in the experience, depth and ability of management, the quality of the Company’s loan review system and the degree of oversight by the Company’s Board of Directors, an assessment of individually evaluated loans and actual loss experience, the value of the underlying collateral, the condition of various market segments, both locally and nationally, and current and reasonable and supportable forecasts of economic events in specific industries and geographical areas, including unemployment levels, and other pertinent factors, including regulatory guidance and general economic conditions, along with external factors such as competition and the legal environment. The Company’s allowance for credit losses incorporates forward-looking information and applies a reversion methodology beyond the reasonable and supportable forecast period of twelve months.  After the forecast period, the Company’s model immediately reverts back to the historical loss rate adjusted for the quantitative factors described above for the remaining contractual life of the financial assets.  Determination of the allowance for credit losses is inherently subjective, as it requires significant estimates, which may be susceptible to significant change. Loan losses are charged off against the allowance for credit losses, while recoveries of amounts previously charged off are credited to the allowance for credit losses. A provision for credit losses is charged to operations based on management's periodic evaluation of the factors previously mentioned, as well as other pertinent factors. Evaluations are conducted at least quarterly and more often if deemed necessary.  Expected credit losses are estimated over the contractual term of the loans, and are adjusted for expected prepayments.  

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The Company’s allowance for credit losses measures the expected lifetime loss using pooled assumptions and loan-level details for loans that share common risk characteristics and evaluates an individual reserve in instances where the loans do not share the same risk characteristics.

Loans that share common risk characteristics are considered collectively assessed. Loss estimates within the collectively assessed population are based on a combination of pooled assumptions and loan-level characteristics. Quantitative loss estimation models have been developed based largely on internal and peer historical data at the loan and portfolio levels and the economic conditions during the same time period.

Expected losses for the Company’s collectively assessed loan segments are estimated using the average charge-off method, which calculates an estimate of losses based upon historical experience and is applied prospectively across the life of each loan. This method calculates future cash flows at the individual note level based upon note characteristics. Life calculations for each loan grouping incorporates future cash flows at the note level, in addition to prepayment assumptions.

Loans that do not share risk characteristics are evaluated on an individual basis. The individual reserve component relates to loans that have shown substantial credit deterioration as measured by risk rating and/or delinquency status. In addition, the Company has elected the practical expedient that would include loans for individual assessment consideration if the repayment of the loan is expected substantially through the operation or sale of collateral because the borrower is experiencing financial difficulty. Where the source of repayment is the sale of collateral, the specific reserve is based on the fair value of the underlying collateral, less selling costs, compared to the amortized cost basis of the loan. If the specific reserve is based on the operation of the collateral, the reserve is calculated based on the fair value of the collateral calculated as the present value of expected cash flows from the operation of the collateral, compared to the amortized cost basis. If the Company determines that the value of a collateral dependent loan is less than the recorded investment in the loan, the Company charges off the deficiency if it is determined that such amount is deemed uncollectible.

The Company obtains appraisals from a pre-approved list of independent, third party appraisers located in the market in which the collateral is located. At a minimum, it is ascertained that the appraiser is currently licensed in the state in which the property is located, experienced in the appraisal of properties similar to the property being appraised, has knowledge of current real estate market conditions and financing trends, and is reputable. Independent appraisals or valuations are obtained on all individually assessed loans, as well as updated every twelve months for all individually assessed loans. External valuation sources are the primary source to value collateral dependent loans; however, the Company may also utilize values obtained through other valuation sources. These alternative sources of value are used only if deemed to be more representative of value based on updated information regarding collateral resolution. The specific reserve on loans individually assessed is updated, reviewed, and approved on a quarterly basis at or near the end of each reporting period.

The Company performs regular credit reviews of the loan portfolio to review the credit quality and adherence to its underwriting standards. Upon origination, each commercial loan is assigned a risk rating, with loans closer to one having less risk. This risk rating scale is the Company’s primary credit quality indicator.

Loan Charge-off Policies

Loans are generally fully or partially charged down to the fair value of securing collateral when:

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Acquired Loans

Loans acquired in connection with acquisitions are recorded at their acquisition-date fair value with no carryover of related allowance for credit losses. Acquired loans are classified into two categories - purchased financial instruments with more than insignificant credit deterioration (“PCD”) loans, and loans with insignificant credit deterioration (“non-PCD”). PCD loans are defined as a loan or group of loans that have experienced more than insignificant credit deterioration since origination. Non-PCD loans will have an allowance for credit losses established on the acquisition date, which is recognized in the current period provision for credit losses. For PCD loans, an allowance for credit losses is recognized on day 1 by adding it to the fair value of the loan, which is the “Day 1 amortized cost basis”. There is no provision for credit losses recognized on PCD loans because the initial allowance for credit losses is established by grossing-up the amortized cost of the PCD loan. Determining the fair value of the acquired loans involves estimating the principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest. Management considers a number of factors in evaluating the acquisition-date fair value including the remaining life of the acquired loans, delinquency status, estimated prepayments, payment options and other loan features, internal risk grade, estimated value of the underlying collateral and interest rate environment.

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PCD loans are accounted for in accordance with ASC 326-20, Financial Instruments- Credit Losses- Measured at Amortized Cost (“ASC 326-20”), if, at acquisition, the loan or pool of loans has experienced more-than-insignificant credit deterioration since origination. At acquisition, the Company considers several factors as indicators that an acquired loan or pool of loans has experienced more-than-insignificant credit deterioration. These factors include loans 30 days or more past due, loans with an internal risk grade of below average or lower, loans classified as non-accrual by the acquired institution, and the materiality of the credit.

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Under ASC 326-20, a group of loans with similar risk characteristics can be assessed to determine if the pool of loans is PCD. However, if a loan does not have similar risk characteristics as any other acquired loan, the loan is individually assessed to determine if it is PCD. In addition, the initial allowance for credit losses related to acquired loans can be estimated for a pool of loans if the loans have similar risk characteristics. Even if the loans were individually assessed to determine if they were PCD, they can be grouped together in the initial allowance for credit losses calculation if they share similar risk characteristics. If a PCD loan has an unfunded commitment at acquisition, the initial allowance for credit losses calculation reflects only the expected credit losses associated with the funded portion of the PCD loan. Expected credit losses associated with the unfunded commitment are included in the initial measurement of the commitment. For PCD loans, the non-credit discount or premium is allocated to individual loans as determined by the difference between the loan’s amortized cost basis and the unpaid principal balance. The non-credit premium or discount is recognized into interest income on a level yield basis over the remaining expected life of the loan. For non-PCD loans, the interest and credit discount or premium is allocated to individual loans as determined by the difference between the loan’s amortized cost basis and the unpaid principal balance. The premium or discount is recognized into interest income on a level yield basis over the remaining expected life of the loan.

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TDRs prior to the Adoption of ASU 2022-02

Prior to the adoption of  ASU 2022-02, a loan was accounted for and reported as a TDR when, for economic or legal reasons, the Company granted a concession to a borrower experiencing financial difficulty that it would not otherwise consider.  Management would work with borrowers identified as being in financial difficulty to modify to more affordable terms before their loan would reach nonaccrual status.  These modified terms may have included rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral.  A restructuring that resulted in only an insignificant delay in payment was not considered a concession.  A delay may have been considered insignificant if the payments subject to the delay were insignificant relative to the unpaid principal or collateral value and the contractual amount due, or the delay in timing of the restructured payment period was insignificant relative to the frequency of the payments, the debt’s original contractual maturity or original expected duration.

TDRs were designated as impaired loans because interest and principal payments would not be received in accordance with the original contract terms.  TDRs that were performing and on accrual status as of the date of the modification remained on accrual status.  TDRs that were nonperforming as of the date of modification generally remained

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as nonaccrual until the prospect of future payments in accordance with the modified loan agreement was reasonably assured, generally demonstrated when the borrower maintained compliance with the restructured terms for a predetermined period, normally at least six months.  TDRs that had temporary below-market concessions remained designated as a TDR and impaired regardless of the accrual or performance status until the loan was paid off.  However, if the TDR was modified in a subsequent restructure with market terms and the borrower was not currently experiencing financial difficulty, then the loan was no longer designated as a TDR.  See “Adoption of New Accounting Standards in 2023” as discussed previously for further discussion related to accounting for modifications of loans to borrowers experiencing financial difficulty subsequent to the adoption of ASU 2022-02 as of January 1, 2023.

Loans Held for Sale:

These loans consist of loans made through Partners’ majority owned subsidiary JMC.

JMC is engaged in the mortgage brokerage business in which JMC originates, closes, and immediately sells mortgage loans and related servicing rights to permanent investors in the secondary market.  JMC has written commitments from several permanent investors (large financial institutions) and only closes loans that meet the lending requirements of the permanent investors.  Loans are made in connection with the purchase or refinancing of existing and new one-to-four family residences primarily in southeastern and northern Virginia.  Loans are initially funded primarily by JMC’s lines of credit.  With the concurrent sale and delivery of mortgage loans to the permanent investors, JMC records receivables for mortgage loans sold and recognizes the related gains and losses on such sales.  The receivables for mortgage loans sold are usually satisfied within 30 days of sale, whereupon the related borrowings on the lines of credit are repaid.  Because of the short holding period, these loans are carried at the lower of cost or market and no market adjustments were deemed necessary in the first quarter of 2023 or 2022.  JMC’s agreements with its permanent investors include provisions that could require JMC to repurchase loans under certain circumstances, and also provide for the assessment of fees if loans go into default or are refinanced within specified periods of time.  JMC has never been required to repurchase a loan and no indemnification reserve has been recorded as of March 31, 2023 or December 31, 2022 for possible repurchases.  Management does not believe that a provision for early default or refinancing cost is necessary at March 31, 2023 or December 31, 2022.

JMC enters into commitments with its customers to originate loans where the interest rate on the loans is determined (locked) prior to funding.  While this subjects JMC to the risk that interest rates may change from the commitment date to the funding date, JMC simultaneously enters into financial agreements (best efforts forward sales commitments) with its permanent investors giving JMC the right to deliver (put) loans to the investors at specified yields, thus enabling JMC to manage its exposure to changes in interest rates such that JMC is not subject to fluctuations in fair values of these agreements due to changes in interest rates.  However, a default by a permanent investor required to purchase loans under such an agreement would expose JMC to potential fluctuation in selling prices of loans due to changes in interest rate.  The fair value of rate lock commitments and forward sales commitments was considered immaterial at March 31, 2023 and December 31, 2022 and an adjustment was not recorded.  Gains and losses on the sale of mortgages as well as origination fees, brokerage fees, interest rate lock-in fees and other fees paid by mortgagors are included in “Mortgage banking income, net” on the Company’s Consolidated Statements of Income.

Other Real Estate Owned (“OREO”):

OREO comprises properties acquired in partial or total satisfaction of problem loans. The properties are recorded at the lower of cost or fair value, net of estimated selling costs, at the date acquired creating a new cost basis. Losses arising at the time of acquisition of such properties are charged against the allowance for credit losses. Subsequent write-downs that may be required, and expenses of operation and gains and losses realized from the sale of OREO are included in “Other expenses” on the Company’s Consolidated Statements of Income. At March 31, 2023 and December 31, 2022 there were no properties included in OREO.

Intangible Assets and Amortization:

During the fourth quarter of 2019, the Company acquired Partners, and during the first quarter of 2018, the Company acquired Liberty Bell Bank (“Liberty”).   ASC 350, Intangibles-Goodwill and Other (“ASC 350”) prescribes

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accounting for intangible assets subsequent to initial recognition. Acquired intangible assets (such as core deposit intangibles) are separately recognized if the benefit of the assets can be sold, transferred, licensed, rented, or exchanged, and amortized over their useful lives. Intangible assets related to the acquisitions of Partners and Liberty are being amortized over their remaining useful life. See Note 13 – Goodwill and Intangible Assets for further information.

Goodwill:

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The Company’s goodwill was recognized in connection with the acquisitions of Partners and Liberty. The Company reviews the carrying value of goodwill at least annually during the fourth quarter or more frequently if certain impairment indicators exist. In testing goodwill for impairment, the Company may first consider qualitative factors to determine whether the existence of events or circumstances lead to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events and circumstances, we conclude that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then no further testing is required and the goodwill of the reporting unit is not impaired. If the Company elects to bypass the qualitative assessment or if we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the fair value of the reporting unit is compared with its carrying amount to determine whether an impairment exists. No impairment of goodwill was required for the three months ended March 31, 2023 or for the year ended December 31, 2022 based on management’s assessment.

Accounting for Stock Based Compensation:

The Company follows ASC 718-10, Compensation—Stock Compensation (“ASC 718-10”) for accounting and reporting for stock-based compensation plans. ASC 718-10 defines a fair value at grant date to be used for measuring compensation expense for stock-based compensation plans to be recognized in the statement of income.

Earnings Per Share:

Basic earnings per common share are determined by dividing net income by the weighted average number of shares outstanding for each period, giving retroactive effect to stock splits and dividends. Weighted average common shares outstanding were 17,984,953 and 17,958,104 for the three months ended March 31, 2023 and 2022, respectively. Calculations of diluted earnings per common share include the average dilutive common stock equivalents outstanding during the period, unless they are anti-dilutive. Dilutive common equivalent shares consist of stock options calculated using the treasury stock method and restricted stock awards. See Note 9 – Earnings Per Share for further information.  

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Note 2. Investment Securities

The Company’s AFS investment securities portfolio, other than subordinated debt investment securities, is either covered by the explicit or implied guarantee of the United States government or one of its agencies or are generally rated investment grade or higher. Subordinated debt investments, which are not rated, are issued by financial institutions within the geographic region of the Company. In addition, the Company performs a quarterly credit review on the majority of its municipal bonds issued by states and political subdivisions. All AFS investment securities were current with no investment securities past due or on nonaccrual as of March 31, 2023 or December 31, 2022. As such, the Company has recorded no allowance for credit losses related to available-for-sale securities as of March 31, 2023.

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The following tables summarize the amortized cost and fair value of investment securities AFS and the corresponding amounts of gross unrealized gains and losses at March 31, 2023 and December 31, 2022, respectively.

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Gross unrealized losses and fair values, aggregated by investment security category and length of time that individual investment securities have been in a continuous unrealized loss position, at March 31, 2023 and December 31, 2022, are as follows:

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At March 31, 2023, there were twelve mortgage-backed investment securities (“MBS”), eight agency investment securities, two subordinated debt investment securities and seventeen municipal investment securities that have been in a continuous unrealized loss position for less than twelve months. At March 31, 2023, there were fifty-nine MBS investment securities, nine agency investment securities, two subordinated debt investment securities, and thirty-four municipal investment securities that had been in a continuous unrealized loss position for more than twelve months.  

The Company has evaluated AFS investment securities in an unrealized loss position for credit related impairment at March 31, 2023 and concluded no impairment existed based on several factors which included: (1) the majority of these investment securities are of high credit quality, (2) unrealized losses are primarily the result of market volatility and increases in market interest rates, (3) the contractual terms of the investments do not permit the issuer(s) to settle the investment securities at a price less than the cost basis of each investment, (4) issuers continue to make timely principal and interest payments, and (5) the Company does not intend to sell any of the investment securities and the accounting standard of “more likely than not” has not been met for the Company to be required to sell any of the investment securities before recovery of their amortized cost basis. As such, the Company has recorded no allowance for credit losses related to AFS securities as of March 31, 2023.

During the three months ended March 31, 2023 and 2022, the Company did not sell any investment securities.  

During the three months ended March 31, 2023, no investment securities either matured or were called.  During the three months ended March 31, 2022, one investment security was called, resulting in no gain or loss during the period.  

The Company has pledged certain investment securities as collateral for qualified customers’ deposit accounts at March 31, 2023 and December 31, 2022.  The amortized cost and fair value of these pledged investment securities was $10.3 million and $9.1 million, respectively, at March 31, 2023.  The amortized cost and fair value of these pledged investment securities was $10.4 million and $9.1 million, respectively, at December 31, 2022.

The Company realized a gain of $27 thousand and a loss of $89 thousand on equity securities during the three months ended March 31, 2023 and 2022, respectively, which are included in “Other expenses” in the Consolidated Statements of Income.

Contractual maturities of investment securities at March 31, 2023 are shown below. Actual maturities may differ from contractual maturities because debtors may have the right to call or prepay obligations with or without call or prepayment penalties. MBS investment securities have no stated maturity and primarily reflect investments in various Pass-through and Participation Certificates issued by the Federal National Mortgage Association and the Government National Mortgage Association. Repayment of MBS is affected by the contractual repayment terms of the underlying mortgages collateralizing these obligations and the current level of interest rates.  

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The following is a summary of maturities, calls, or repricing of AFS investment securities:

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Note 3. Loans and Allowance for Credit Losses

Major categories of loans as of March 31, 2023 and December 31, 2022 are as follows:

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