Note 1 – Summary of Significant Accounting Policies
Nature of business and organization – FinWise Bancorp is a Utah Corporation headquartered in Murray, Utah and operates all business activities through its wholly-owned banking subsidiaries FinWise Investments, LLC and FinWise Bank, f/k/a Utah Community Bank. FinWise Bank was incorporated in the state of Utah on May 7, 1999. FinWise Bancorp, f/k/a All West Bancorp, was incorporated in the state of Utah on October 22, 2002, after which, it acquired 100% of FinWise Bank. As of March 4, 2016, FinWise Bank’s articles of incorporation were amended to rename the entity FinWise Bank. As of March 15, 2021, FinWise Bancorp’s articles of incorporation were amended and restated to rename the entity FinWise Bancorp. References herein to “FinWise Bancorp,” “Bancorp” or the “holding company,” refer to FinWise Bancorp on a standalone basis. The word “Company” refers to FinWise Bancorp, FinWise Investments, LLC, and FinWise Bank collectively and on a consolidated basis. References to the “Bank” refer to FinWise Bank on a standalone basis.
The Bank provides a full range of banking services to individual and commercial customers. The Bank’s primary source of revenue is from loans including consumer, Small Business Administration (SBA), commercial, commercial real estate, and residential real estate. The Bank also has established Strategic Programs with various third-party loan origination platforms that use technology to streamline the origination of unsecured consumer and secured or unsecured business loans to borrowers within certain approved credit profiles. The Bank earns monthly program fees based on the volume of loans originated in these Strategic Programs, as well as interest during the time the Bank holds the loans.
The Company is subject to competition from other financial institutions and to the regulations of certain federal and state agencies and undergoes periodic examinations by those agencies.
Basis of Presentation – The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and with rules and regulations of the Securities and Exchange Commission ("SEC") and include the activity of the Company and its wholly owned subsidiaries, FinWise Investments, LLC and the Bank. The statements do not include all of the information and footnotes required by GAAP for complete financial statements. All significant inter-company transactions have been eliminated in consolidation. In the opinion of management, all the adjustments (consisting of normal and recurring adjustments) necessary for the fair presentation of the consolidated financial condition and the consolidated results of operations for the periods presented have been included. The results of operations and other data presented for the three months ended March 31, 2023 are not necessarily indicative of the results of operations that may be expected for subsequent periods or the full year results. The unaudited consolidated financial statements presented should be read in conjunction with the Company’s audited consolidated financial statements and notes to the audited consolidated financial statements included in the Company’s December 31, 2022 Annual Report on Form 10-K. Certain prior period amounts have been reclassified to conform to current period presentation.
The Company has evaluated subsequent events for potential recognition and/or disclosure in this Quarterly Report on Form 10-Q through the date these consolidated financial statements were issued.
Out-of-period adjustments – During the first quarter of 2022, we recognized a $(0.8) million ($(0.6) million net of tax) reduction of interest and fees on loans and loans receivable, net as an out-of-period adjustment. The impact associated with this correction was not considered material to the interim unaudited consolidated financial statements for the three months ended March 31, 2022, year ended December 31, 2022, or the financial statements of any previously filed interim or annual periods.
During the third quarter of 2022, the Company identified an error in the calculation of the Company’s tax provision which understated income tax expense for previously reported financial statements. The error was related to an incorrect application of Section 162(m) of the Internal Revenue Code, which limits tax deductions relating to executive compensation of certain executives of publicly held companies. The Company recorded an out-of-period adjustment during the third quarter of 2022 to correct the previously understated income tax expense. The adjustment resulted in a decrease to after-tax income of $(0.9) million for the year ended December 31, 2022. The impact associated with this correction was not considered material to the interim unaudited consolidated financial statements for the three months ended September 30, 2022, year ended December 31, 2022, or the financial statements of any previously filed interim or annual periods.
During the fourth quarter of 2022, the Company established a new loan trailing fee asset which is included in “Other assets” on the Consolidated Balance Sheets of approximately $2.3 million and recognized $2.1 million in gain on sale of loans ($1.5 million net of tax) as an out-of-period adjustment of which $1.2 million ($0.9 million net of tax) would have been recorded in the first three quarters of 2022 with the remaining $0.9 million ($0.6 million net of tax) associated with
years prior to 2022. Before this correction, the loan trailing fees had been recognized in revenue during the month payment was owed by the Strategic Program rather than as a gain to be recognized upon sale of the loan receivables. The impact associated with this correction was not considered material to the interim unaudited consolidated financial statements for the three months ended December 31, 2022, year ended December 31, 2022, or the financial statements of any previously filed interim or annual periods.
Cash and Cash Equivalents – For purposes of reporting cash flows, the Company defines cash and cash equivalents as cash, cash due from banks, interest-bearing deposits in other banks, other interest-bearing deposits, and federal funds sold.
Loans Receivable – Loans receivable are reported at their outstanding principal adjusted for any charge-offs, the allowance for credit losses, and deferred fees and costs. Loan origination fees, net of certain direct origination costs, if any, are deferred and recognized on an adjustment of the related loan yield using an effective-yield method over the contractual life of the loan. Interest income on loans is recognized on an accrual basis commencing in the month of origination using the interest method. Delinquency fees are recognized in income when chargeable and when collectability is reasonably assured.
The Company requires most loans to be substantially collateralized by real estate, equipment, vehicles, accounts receivable, inventories or other tangible or intangible assets. Real estate collateral is in the form of first and second mortgages on various types of property. The Company also originates unsecured loans to consumers and businesses.
The Company may change its intent from holding loans for investment and reclassify them as held-for-sale. Loans held-for-sale are carried at the lower of aggregate cost and fair value. Gains and losses are recorded in non-interest income based on the difference between sales proceeds and carrying value.
Nonaccrual Loans – The Company's policy is to place loans on a nonaccrual status when: 1) payment is in default for 90 days or more unless the loan is well secured and in the process of collection; or 2) full repayment of principal and interest is not foreseen. When a loan is placed on nonaccrual status, all accrued and uncollected interest on that loan is reversed. Past-due interest received on nonaccrual loans is not recognized in interest income but is applied as a reduction of the outstanding principal of the loan. A loan is relieved of its nonaccrual status when all principal and interest payments are brought current, the loan is well secured, and an analysis of the borrower's financial condition provides reasonable assurance that the borrower can repay the loan as scheduled.
Stock Repurchase Program – On August 18, 2022, the Company announced that its Board of Directors (the “Board”) has authorized, effective August 16, 2022, a common stock repurchase program to purchase up to 644,241 shares of the Company’s common stock in the aggregate. The repurchase program expires on August 31, 2024, but may be limited or terminated at any time without prior notice. The repurchase program authorizes the repurchase by the Company of its common stock in open market transactions, including pursuant to a trading plan in accordance with Rule 10b-18 promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), or privately negotiated transactions. The authorization permits management to repurchase shares of the Company’s common stock from time to time at management’s discretion. Repurchases may also be made pursuant to a trading plan under Rule 10b5-1 under the Exchange Act, which would permit shares to be repurchased when the Company might otherwise be precluded from doing so because of self-imposed trading blackout periods or other regulatory restrictions. The actual means and timing of any shares purchased under the program will depend on a variety of factors, including the market price of the Company’s common stock, general market and economic conditions, and applicable legal and regulatory requirements. The repurchase program does not obligate the Company to purchase any particular number of shares. Since commencement of the repurchase program, the Company has repurchased 143,573 shares for approximately $1.4 million as of March 31, 2023 and retired them at cost.
Revenue from Contracts with Customers – The Company applies the provisions of ASC 606, Revenue from Contracts with Customers (“ASC 606”). The core principle of this standard is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. Services that the Company reports as part of non-interest income are subject to ASC 606 and include fees from its deposit customers for transaction-based activities, account maintenance charges and overdraft services. Transaction-based fees, such as ACH and wire transfer fees, overdraft, return and stop payment charges, are recognized at the time such transactions are executed and the services have been fulfilled by the Company. The fees are typically withdrawn from the customer’s deposit account balance. The Company also receives fees from third-parties in its Strategic Programs for setting up systems and procedures to efficiently originate loans in a convenient, compliant and safe manner. Because the third-party simultaneously receives and benefits from the services,
revenue is recognized evenly over the term of the loan program. Program Fees received in connection with the Company’s Strategic Programs are recorded at the time services are provided.
Segment Reporting – Operating segments are components of a business where separate financial information is available and evaluated regularly by the chief operating decision makers ("CODMs") in deciding how to allocate resources and in assessing performance. ASC Topic 280, Segment Reporting, requires information to be reported about a company's operating segments using a "management approach", meaning it is based on the way management organizes segments internally to make operating decisions and assess performance. Based on this guidance, the Company has one reportable operating segment, the Bank.
Recently adopted accounting pronouncements
Allowance for Credit Losses: On January 1, 2023, the Company adopted ASU 2016-13, Topic 326 which replaced the incurred loss methodology with CECL for financial instruments measured at amortized cost and other commitments to extend credit. CECL requires the immediate recognition of estimated credit losses expected to occur over the estimated remaining life of the asset. The forward-looking concept of CECL requires loss estimates to consider historical experience, current conditions and reasonable and supportable economic forecasts of future events and circumstances.
The allowance for credit losses (“ACL”) on loans held for investment is the combination of the allowance for loan losses and the reserve for unfunded loan commitments. The allowance for loan losses is reported as a reduction of the amortized cost basis of loans, while the reserve for unfunded loan commitments is included within "other liabilities" on the Consolidated Balance Sheets. The estimate of credit loss incorporates assumptions for both the likelihood and amount of funding over the estimated life of the commitments, including adjustments for current conditions and reasonable and supportable forecasts. Management periodically reviews and updates its assumptions for estimated funding rates. The amortized cost basis of loans does not include accrued interest receivable, which is included in "accrued interest receivable" on the Consolidated Balance Sheets. The "Provision for credit losses" on the Consolidated Statements of Income is a combination of the provision for credit losses and the provision for unfunded loan commitments.
ACL in accordance with CECL methodology
With respect to the Bank's core portfolio which consists of SBA 7(a), local lending, retail point of sale, and equipment finance and leasing, the Bank pools similar loans that are collectively evaluated and determines an appropriate level of general allowance by portfolio segment using a non discounted cash flow model, with use of probability of default, loss given default, and prepayment speed estimates derived from industry specific collected data. The model captures losses over the historical charge-off and prepayment cycle and applies those losses at a loan level over the remaining maturity of the loan. The model then calculates a historical loss rate using the average losses over the reporting period, which is then applied to each segment utilizing a standard reversion rate. With respect to the Bank's active retained Strategic Program loan portfolio, the Bank is using a methodology that compares the actual loan performance of a vintage to the worst performing loans within that vintage, known as the high-water mark. The Bank records the expected credit losses based on the high-water mark loss rate. With respect to the Bank's inactive retained Strategic Program loan portfolio, performance data at the summary level provided by the Strategic Programs is banded by credit profile and original loan term and compared to actual loan performance on a quarterly basis. The expected loss rate is supplemented with adjustments for reasonable and supportable forecasts of relevant economic indicators, including but not limited to national unemployment rate forecasts. Expected credit losses are estimated over the contractual term of the loans, adjusted for expected prepayments when appropriate. Also included in the ACL are qualitative factors based on the risks present for each portfolio segment. These qualitative factors include the following that are derived from the Interagency Policy Statement on Allowance for Credit Losses: changes in lending policies and procedures; changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the loan portfolio; changes in the nature and volume of the loan portfolio and in the terms of loans; changes in the experience, ability, and depth of lending management and staff; changes in the volume and severity of past due loans, nonaccrual loans, and classified or graded loans; changes in the quality of the Bank's loan review system; changes in the value of underlying collateral for loans that are not collateral-dependent; changes in the level of concentration of credit; changes in the effect of competition, legal, and regulatory requirements on the level of estimated credit losses; and, if applicable, changes in the composition and volume of the loan portfolio due to mergers, acquisitions, and other significant transactions not considered elsewhere. The Bank also considers a custom qualitative factor that explores the lingering "ripple" effects of the Covid-19 pandemic, including lasting changes to consumer behavior, lending, and society at large. It is also possible that these factors could include social, political, economic, and terrorist events or activities. All of these factors are susceptible to change, which may be significant.
When management identifies loans that do not share common risk characteristics (i.e., are not similar to other loans within a pool) they are evaluated on an individual basis. These loans are not included in the collective evaluation. For loans identified as having a likelihood of foreclosure or that the borrower is experiencing financial difficulty, a collateral dependent approach is used. These are loans for which the repayment is expected to be provided substantially through the operation or sale of the collateral. Under CECL, for collateral dependent loans, the Company has adopted the practical expedient method to measure the allowance for credit losses based on the fair value of collateral. The allowance for credit losses is calculated on an individual loan basis based on the shortfall between the fair value of the loan's collateral, which is adjusted for liquidation costs/discounts, and amortized cost. If the fair value of the collateral exceeds the amortized cost, no allowance is required.
The CECL methodology requires a significant amount of management judgment in determining the appropriate allowance for credit losses. Several of the steps in the methodology involve judgment and are subjective in nature including, among other things: segmenting the loan portfolio; determining the amount of loss history to consider; selecting predictive econometric regression models that use appropriate macroeconomic variables; determining the methodology to forecast prepayments; selecting the most appropriate economic forecast scenario; determining the length of the reasonable and supportable forecast and reversion periods; estimating expected utilization rates on unfunded loan commitments; and assessing relevant and appropriate qualitative factors. In addition, the CECL methodology is dependent on economic forecasts, which are inherently imprecise and will change from period to period. Although the allowance for credit losses is considered appropriate, there can be no assurance that it will be sufficient to absorb future losses.
In determining an appropriate amount for the allowance, the Bank segments and aggregates the loan portfolio based on common characteristics. The following segments have been identified:
Commercial Real Estate. These loans are generally secured by owner-occupied nonfarm, nonresidential properties, or by other nonfarm, nonresidential properties. Owner-occupied commercial real estate loans are typically repaid first by the cash flows generated by the underlying business and its ability to generate sustainable profitability and resulting positive cash flows. Factors that may influence a business' profitability include, but are not limited to, demand for its products or services, quality and depth of management, degree of competition, regulatory changes, and general economic conditions. Non-owner occupied commercial real estate loans are generally considered to have a higher degree of credit risk as they may be dependent on the ongoing success and operating viability of a fewer number of tenants who are occupying the property and who may have a greater degree of exposure to economic conditions.
Commercial and Industrial. These loans are generally secured by business assets such as furniture, fixtures, equipment. accounts receivable, inventory, business vehicles, and other business personal property. Commercial and industrial loans are typically repaid first by the cash flows generated by the borrower's business operations. The primary risk characteristics are specific to the underlying business and its ability to generate sustainable profitability and resulting positive cash flows. Factors that may influence a business' profitability include, but are not limited to, demand for its products or services, quality and depth of management, degree of competition, regulatory changes, and general economic conditions.
Lease Financing Receivables. Equipment financing and leasing typically involve the use of equipment as collateral for the loan. If the borrower defaults on the loan, the Bank may need to repossess and sell the equipment to recover the outstanding debt. However, the value of the equipment may depreciate over time, or disappear, making it difficult for the Bank to recover the full amount of the loan. In equipment leasing, the residual value of the equipment is an important consideration. The residual value is the estimated value of the equipment at the end of the lease term. If the actual value of the equipment is lower than the residual value, the lessor may not be able to recover the full amount of the lease payments.
Construction and Land Development. Risks common to construction loans are cost overruns, changes in market demand for property, supply chain interruption affecting construction materials, inadequate long-term financing arrangements and declines in real estate values. Changes in market demand for property could lead to longer marketing times resulting in higher carrying costs, declining values, and higher interest rates. Risks common to residential lot loans are those similar to other types of real estate construction loans, as many customers finance the purchase of improved lots in anticipation of constructing a 1 to 4 family residence. Accordingly, common risks are changes in market demand for property, supply chain interruption affecting construction materials, inadequate long-term financing arrangements and declines in real estate values. Changes in market demand for property could lead to longer marketing times resulting in higher carrying costs, declining values and higher interest rates.
Consumer. These are loans to individuals for household, family, and other personal expenditures. Consumer loans generally have higher interest rates and shorter terms than residential loans but tend to have higher credit risk due to the type of collateral securing the loan or in some cases the absence of collateral.
Residential Real Estate. These loans are generally secured by 1 to 4 family residential properties. The primary risk characteristics associated with residential mortgage loans typically involve: major living or lifestyle changes to the borrower, including unemployment or other loss of income; unexpected significant expenses, such as for major medical issues or catastrophic events; and divorce or death. In addition, residential mortgage loans that have adjustable rates could expose the borrower to higher debt service requirements in a rising interest rate environment. Further, real estate values could drop significantly and cause the value of the property to fall below the loan amount, creating additional potential loss exposure for the Bank.
Residential Real Estate Multifamily. Risks common to multifamily loans are poor management, high vacancy rates and regulatory changes. The value of multi-family properties can be impacted by changes in the local real estate market. If property values decline, the Bank may not be able to recover the full amount of the loan if the property needs to be foreclosed.
Strategic Program Loans. Unsecured consumer loans and secured or unsecured business loans issued by the Company through these programs generally follow and are limited to specific predetermined underwriting criteria. Strategic Program loans cover a wide range of borrower credit profiles, loan terms and interest rates. Strategic Program loans generally have higher interest rates and shorter terms similar to consumer loans and tend to have higher credit risk due to the type of collateral securing the loan or in most cases the absence of collateral.
In March 2022, the FASB issued ASU 2022-02, Financial Instruments-Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures. ASU 2022-02 addresses areas identified by the FASB as part of its post-implementation review of the credit losses standard (ASU 2016-13) that introduced the CECL model. The amendments eliminate the accounting guidance for troubled debt restructurings by creditors that have adopted the CECL model and enhance the disclosure requirements for loan refinancings and modifications. The Company adopted ASU 2022-02 on January 1, 2023. Effective January 1, 2023 loan modifications to borrowers experiencing financial difficulty are required to be disclosed by type of modification and by type of loan. Prior accounting guidance classified loans which were modified as troubled debt restructurings only if the modification reflected a concession from the lender in the form of a below market interest rate or other concession in addition to borrower financial difficulty. Under the new guidance, loans with modifications will be reported whether a concession is made or not. In the first quarter of 2023, there were no loan modifications which were subject to the new reporting.
Enactment of the Inflation Reduction Act of 2022
On August 16, 2022, the U.S. government enacted the Inflation Reduction Act (IRA) which, among other changes, created a new corporate alternative minimum tax (AMT) based on adjusted financial statement income and imposes a 1% excise tax on corporate stock repurchases. The effective date of these provisions is January 1, 2023. The Company is aware of the effects that the enactment of the IRA will have on its consolidated financial statements. If expected stock repurchases are likely to be more than the exemption threshold, we will account for them in our tax provision.
Note 2 – Investments
Investment securities held-to-maturity, at cost
The Company's held-to-maturity ("HTM") investment portfolio consists of Agency mortgage-backed securities and Agency collateralized mortgage obligations. The Company reports HTM securities on the Company's Consolidated Balance Sheets at carrying value which is amortized cost. The amortized cost, unrealized gains and losses, and estimated
fair values of the Company’s held-to-maturity securities at March 31, 2023 and December 31, 2022, are summarized as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| March 31, 2023 |
($ in thousands) | Amortized Cost | | Unrealized Gain | | Unrealized Loss | | Estimated Fair Value |
Mortgage-backed securities | $ | 7,809 | | | $ | — | | | $ | (850) | | | $ | 6,960 | |
Collateralized mortgage obligations | 6,071 | | | — | | | (730) | | | 5,340 | |
Total securities held-to-maturity | $ | 13,880 | | | $ | — | | | $ | (1,580) | | | $ | 12,300 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2022 |
($ in thousands) | Amortized Cost | | Unrealized Gain | | Unrealized Loss | | Estimated Fair Value |
Mortgage-backed securities | $ | 8,087 | | | $ | 5 | | | $ | (825) | | | $ | 7,268 | |
Collateralized mortgage obligations | 6,205 | | | — | | | (744) | | | 5,461 | |
Total securities held-to-maturity | $ | 14,292 | | | $ | 5 | | | $ | (1,569) | | | $ | 12,728 | |
Credit Quality Indicators & Allowance for Credit Losses - HTM
On January 1, 2023, the Company adopted ASU 2016-13, which replaced the legacy GAAP other-than-temporary impairment ("OTTI") model with a credit loss model. ASU 2016-13 requires an allowance on lifetime expected credit losses on HTM debt securities but retains the concept from the OTTI model that credit losses are recognized once securities become impaired. For HTM securities, the Company evaluates the credit risk of its securities on at least a quarterly basis. The Company estimates expected credit losses on HTM debt securities on a collective basis by major security type. Accrued interest receivable on HTM debt securities is excluded from the estimate of credit losses. At March 31, 2023 and at adoption of CECL on January 1, 2023, there was no ACL related to HTM securities due to the composition of the portfolio which is generally considered not to have credit risk given the government guarantee associated with these agencies.
The Company had eighteen securities, consisting of eight collateralized mortgage obligations and ten mortgage-backed securities, in an unrealized loss position at March 31, 2023 and seventeen securities, consisting of eight collateralized mortgage obligations and nine mortgage-backed securities, in an unrealized loss position at December 31, 2022, as summarized in the following tables:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| March 31, 2023 |
| Less than 12 months | | 12 Months or More | | Total |
($ in thousands) | Fair Value | | Unrealized Losses | | Fair Value | | Unrealized Losses | | Fair Value | | Unrealized Losses |
Mortgage-backed securities | $ | 1,684 | | | $ | (66) | | | $ | 5,275 | | | $ | (783) | | | $ | 6,960 | | | $ | (850) | |
Collateralized mortgage obligations | 2,676 | | | (100) | | | 2,665 | | | (631) | | | 5,340 | | | (730) | |
Total securities held-to-maturity | $ | 4,360 | | | $ | (166) | | | $ | 7,940 | | | $ | (1,414) | | | $ | 12,300 | | | $ | (1,580) | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2022 |
| Less than 12 months | | 12 Months or More | | Total |
($ in thousands) | Fair Value | | Unrealized Losses | | Fair Value | | Unrealized Losses | | Fair Value | | Unrealized Losses |
Mortgage-backed securities | $ | 2,374 | | | $ | (190) | | | $ | 3,962 | | | $ | (635) | | | $ | 6,336 | | | $ | (825) | |
Collateralized mortgage obligations | 2,752 | | | (96) | | | 2,709 | | | (648) | | | 5,461 | | | (744) | |
Total securities held-to-maturity | $ | 5,126 | | | $ | (286) | | | $ | 6,671 | | | $ | (1,283) | | | $ | 11,797 | | | $ | (1,569) | |
The amortized cost and estimated market value of debt securities at March 31, 2023 and December 31, 2022, by contractual maturity are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
| | | | | | | | | | | | | | | | | | | | | | | |
| March 31, 2023 | | December 31, 2022 |
($ in thousands) | Amortized Cost | | Estimated Fair Value | | Amortized Cost | | Estimated Fair Value |
Securities held-to-maturity | | | | | | | |
Due in one year or less | $ | — | | | $ | — | | | $ | — | | | $ | — | |
Due after one year through five years | — | | | — | | | — | | | — | |
Due after five years through ten years | 3,236 | | | 3,050 | | | 3,388 | | | 3,202 | |
Due after ten years | 10,644 | | | 9,250 | | | 10,904 | | | 9,526 | |
Total Securities held-to-maturity | $ | 13,880 | | | $ | 12,300 | | | $ | 14,292 | | | $ | 12,728 | |
At March 31, 2023, held-to-maturity securities in the amount of $12.1 million were pledged as collateral for a credit line held by the Bank. There were no sales or transfers of investment securities and no realized gains or losses on these securities during the three months ended March 31, 2023 or 2022.
FHLB stock
The Bank is a member of the FHLB system. Members are required to own FHLB stock of at least the greater of 1% of FHLB membership asset value or 2.70% of outstanding FHLB advances. At March 31, 2023 and December 31, 2022, the Bank owned $0.4 million, respectively, of FHLB stock, which is carried at cost. The Company evaluated the carrying value of its FHLB stock investment at March 31, 2023 and determined that it was not impaired. This evaluation considered the long-term nature of the investment, the current financial and liquidity position of the FHLB, repurchase activity of excess stock by the FHLB at its carrying value, the return on the investment from recurring and special dividends, and the Company’s intent and ability to hold this investment for a period of time sufficient to recover our recorded investment.
Note 3 – Loans and Allowance for Credit Losses
Loans outstanding by general ledger classification as of March 31, 2023 and December 31, 2022, consisted of the following:
| | | | | | | | | | | |
| March 31, | | December 31, |
| 2023 | | 2022 |
($ in thousands) | | | |
SBA | $ | 178,663 | | | $ | 145,172 | |
Commercial, non-real estate | 17,890 | | | 11,484 | |
Residential real estate | 30,994 | | | 37,815 | |
Strategic Program loans | 46,806 | | | 47,848 | |
Commercial real estate | 17,022 | | | 12,063 | |
Consumer | 6,351 | | | 5,808 | |
Total loans | $ | 297,726 | | | $ | 260,190 | |
Loans held-for-sale | (25,413) | | | (23,589) | |
Total loans held for investment | $ | 272,313 | | | $ | 236,601 | |
Deferred loan fees, net | (58) | | | (399) | |
Allowance for loan losses | (12,034) | | | (11,985) | |
Net loans | $ | 260,221 | | | $ | 224,217 | |
Strategic Program Loans – In 2016, the Company began originating loans with various third-party loan origination platforms that use technology and other innovative systems to streamline the origination of unsecured consumer and secured or unsecured business loans to a wide array of borrowers within certain approved credit profiles. Loans issued by the Company through these programs generally follow and are limited to specific predetermined underwriting criteria. The Company earns monthly minimum program fees from these third parties. Based on the volume of loans originated by the Company related to each Strategic Program, an additional fee equal to a percentage of the loans generated under the Strategic Program may be collected. The program fee is included within non-interest income on the Consolidated Statements of Income.
The Company generally retains the loans and/or receivables for a number of business days after origination before selling the loans and/or receivables to the Strategic Program platform or another investor. Interest income is recognized by the Company while holding the loans. These loans are classified as held-for-sale on the balance sheet.
The Company may also hold a portion of the loans or receivable and sell the remainder directly to the Strategic Programs or other investors. The Company generally services the loans originated through the Strategic Programs in consideration of servicing fees equal to a percentage of the loans generated under the Strategic Programs. In turn, the Strategic Program service providers, subject to the Company’s approval and oversight, serve as sub-servicer and perform typical primary servicing duties including loan collections, modifications, charging-off, reporting and monitoring.
Each Strategic Program establishes a “reserve” deposit account with the Company. The agreements generally require that the reserve account deposit balance does not fall below an agreed upon dollar or percentage threshold related to the total loans currently outstanding as held for sale by the Company for the specific Strategic Program. If necessary, the Company has the right to withdraw amounts from the reserve account to fulfill loan purchaser obligations created under the program agreements. Total cash held in reserve by Strategic Programs at the Company at March 31, 2023 and December 31, 2022, was $18.7 million and $16.6 million, respectively.
Strategic Program loans retained and held-for-sale as of March 31, 2023 and December 31, 2022, are summarized as follows:
| | | | | | | | | | | |
| March 31, | | December 31, |
| 2023 | | 2022 |
($ in thousands) | | | |
Retained Strategic Program loans | $ | 21,393 | | | $ | 24,259 | |
Strategic Program loans held-for-sale | 25,413 | | | 23,589 | |
Total Strategic Program loans | $ | 46,806 | | | $ | 47,848 | |
Allowance for Credit Losses
In determining an appropriate amount for the allowance, the Bank segmented and aggregated the loan portfolio based on Call Report codes. The following pool segments identified as of March 31, 2023 are based on the CECL methodology:
| | | | | |
($ in thousands) | |
Construction and land development | $ | 24,996 | |
Residential real estate | 31,262 | |
Residential real estate multifamily | 495 | |
Commercial real estate | 157,358 | |
Commercial and industrial | 16,071 | |
Consumer | 5,681 | |
Lease financing receivables | 15,057 | |
Strategic Program loans | 21,393 | |
Total loans | $ | 272,313 | |
The portfolio classes identified as of December 31, 2022 are based on the incurred loss methodology and are segmented by general ledger classification as detailed below.
| | | | | |
($ in thousands) | |
SBA | $ | 145,172 | |
Commercial, non-real estate | 11,484 | |
Residential real estate | 37,815 | |
Strategic Program loans | 24,259 | |
Commercial real estate | 12,063 | |
Consumer | 5,808 | |
Total loans | $ | 236,601 | |
Activity in the ACL by common characteristic loan pools based on the CECL methodology was as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, 2023 |
($ in thousands) | Beginning Balance | | Impact of ASU 2016-13 adoption | | Provision (Reversal) of Credit Losses | | Charge-Offs | | Recoveries | | Ending Balance |
Construction and land development | $ | 424 | | | $ | (67) | | | $ | (72) | | | $ | — | | | $ | — | | | $ | 285 | |
Residential real estate | 876 | | | (58) | | | (22) | | | — | | | 3 | | | 799 | |
Residential real estate multifamily | 3 | | | 1 | | | 1 | | | — | | | — | | | 5 | |
Commercial real estate | 3,238 | | | (574) | | | 492 | | | (122) | | | — | | | 3,034 | |
Commercial and industrial | 339 | | | (85) | | | 39 | | | (18) | | | 2 | | | 277 | |
Consumer | 65 | | | 14 | | | 3 | | | — | | | — | | | 82 | |
Lease financing receivables | 339 | | | (105) | | | 91 | | | — | | | — | | | 325 | |
Strategic Program loans | 6,701 | | | 1,131 | | | 2,136 | | | (3,025) | | | 284 | | | 7,227 | |
Total allowance for loan losses | $ | 11,985 | | | $ | 257 | | | $ | 2,668 | | | $ | (3,165) | | | $ | 289 | | | $ | 12,034 | |
| | | | | | | | | | | |
Unfunded lending commitments | — | | | 26 | | | 3 | | | — | | | — | | | 29 | |
Total allowance for credit losses | $ | 11,985 | | | $ | 283 | | | $ | 2,671 | | | $ | (3,165) | | | $ | 289 | | | $ | 12,063 | |
Activity in the allowance for loan losses by general ledger classification based on the incurred loss methodology was as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, 2022 |
($ in thousands) | Beginning Balance | | Provision (Reversal) of Credit Losses | | Charge-Offs | | Recoveries | | Ending Balance |
SBA | $ | 2,739 | | | $ | 356 | | | $ | (31) | | | $ | — | | | $ | 3,064 | |
Commercial, non-real estate | 132 | | | (26) | | | — | | | 1 | | | 107 | |
Residential real estate | 352 | | | 59 | | | — | | | — | | | 411 | |
Strategic Program loans | 6,549 | | | 2,558 | | | (2,878) | | | 93 | | | 6,322 | |
Commercial real estate | 21 | | | — | | | — | | | — | | | 21 | |
Consumer | 62 | | | — | | | — | | | — | | | 62 | |
Total allowance for loan losses | $ | 9,855 | | | $ | 2,947 | | | $ | (2,909) | | | $ | 94 | | | $ | 9,987 | |
The following table presents the loan balances by portfolio class, based on impairment method, and the corresponding balances in the allowance as of December 31, 2022. For the year ended December 31, 2022, the allowance was calculated based on the incurred loss methodology.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Allowance for Loan Losses | | Portfolio Loan Balances |
($ in thousands) | Individually | | Collectively | | Total | | Individually | | Collectively | | Total |
SBA | $ | — | | | $ | 4,294 | | | $ | 4,294 | | | $ | 450 | | | $ | 144,722 | | | $ | 145,172 | |
Commercial, non-real estate | — | | | 401 | | | 401 | | | — | | | 11,484 | | | 11,484 | |
Residential real estate | — | | | 497 | | | 497 | | | — | | | 37,815 | | | 37,815 | |
Strategic Program loans | — | | | 6,701 | | | 6,701 | | | — | | | 24,259 | | | 24,259 | |
Commercial real estate | — | | | 27 | | | 27 | | | — | | | 12,063 | | | 12,063 | |
Consumer | — | | | 65 | | | 65 | | | — | | | 5,808 | | | 5,808 | |
Total loans | $ | — | | | $ | 11,985 | | | $ | 11,985 | | | $ | 450 | | | $ | 236,151 | | | $ | 236,601 | |
The following table presents, under previously applicable GAAP, loans individually evaluated for impairment as of December 31, 2022:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Recorded Investment | | Unpaid Principal Balance | | Related Allowance | | Average Recorded Investment | | Interest Income Recognized |
($ in thousands) | | | | | | | | | |
With no related allowance recorded | | | | | | | | | |
SBA | $ | 450 | | | $ | 450 | | | $ | — | | | $ | 711 | | | $ | 36 | |
Commercial, non-real estate | — | | | — | | | — | | | — | | | — | |
Residential real estate | — | | | — | | | — | | | — | | | — | |
Strategic Program loans | — | | | — | | | — | | | — | | | — | |
Commercial real estate | — | | | — | | | — | | | — | | | — | |
Consumer | — | | | — | | | — | | | — | | | — | |
Total | $ | 450 | | | $ | 450 | | | $ | — | | | $ | 711 | | | $ | 36 | |
Nonaccrual and past due loans are summarized below as of March 31, 2023 and December 31, 2022:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
March 31, 2023 | | | | | | | | | | | | | |
($ in thousands) | Current | | 30-59 Days Due Due | | 60-89 Days Due Due | | 90+ Days Past Due & Still Accruing | | Total Past Due | | Non- Accrual | | Total |
| | | | | | | | | | | | | |
Construction and land development | $ | 24,996 | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | — | | | $ | 24,996 | |
Residential real estate | 31,249 | | | 13 | | | — | | | — | | | 13 | | | — | | | 31,262 | |
Residential real estate multifamily | 495 | | | — | | | — | | | — | | | — | | | — | | | 495 | |
Commercial real estate | 156,618 | | | — | | | — | | | — | | | — | | | 740 | | | 157,358 | |
Commercial and industrial | 16,055 | | | 16 | | | — | | | — | | | 16 | | | — | | | 16,071 | |
Consumer | 5,637 | | | 44 | | | — | | | — | | | 44 | | | — | | | 5,681 | |
Lease financing receivables | 15,057 | | | — | | | — | | | — | | | — | | | — | | | 15,057 | |
Strategic Program loans | 19,647 | | | 851 | | | 704 | | | 191 | | | 1,746 | | | — | | | 21,393 | |
Total | $ | 269,754 | | | $ | 924 | | | $ | 704 | | | $ | 191 | | | $ | 1,819 | | | $ | 740 | | | $ | 272,313 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
December 31, 2022 | | | | | | | | | | | | | |
($ in thousands) | Current | | 30-59 Days Due Due | | 60-89 Days Due Due | | 90+ Days Past Due & Still Accruing | | Total Past Due | | Non- Accrual | | Total |
SBA | $ | 144,803 | | | $ | 369 | | | $ | — | | | $ | — | | | $ | 369 | | | $ | — | | | $ | 145,172 | |
Commercial, non-real estate | 11,484 | | | — | | | — | | | — | | | — | | | — | | | 11,484 | |
Residential real estate | 37,387 | | | 428 | | | — | | | — | | | 428 | | | — | | | 37,815 | |
Strategic Program loans | 22,080 | | | 1,184 | | | 802 | | | 193 | | | 2,179 | | | — | | | 24,259 | |
Commercial real estate | 12,063 | | | — | | | — | | | — | | | — | | | — | | | 12,063 | |
Consumer | 5,776 | | | 32 | | | — | | | — | | | 32 | | | — | | | 5,808 | |
Total | $ | 233,593 | | | $ | 2,013 | | | $ | 802 | | | $ | 193 | | | $ | 3,008 | | | $ | — | | | $ | 236,601 | |
The amount of interest income for the three months ended March 31, 2023 and 2022, that was not recorded on nonaccrual loans was de minimis.
In addition to past due and nonaccrual status criteria, the Company also evaluates loans using a loan grading system. Internal loan grades are based on current financial information, historical payment experience, and credit documentation, among other factors. Performance-based grades are summarized below:
Pass – A Pass asset is higher quality and does not fit any of the other categories described below. The likelihood of loss is believed to be remote.
Watch – A Watch asset may be a larger loan or one that places a heavier reliance on collateral due to the relative financial strength of the borrower. The assets may be maintenance intensive requiring closer monitoring. The obligor is believed to have an adequate primary source of repayment.
Special Mention – A Special Mention asset has potential weaknesses that may be temporary or, if left uncorrected, may result in a loss. While concerns exist, the Company believes that it is currently protected against a default and loss is considered unlikely and not imminent.
Substandard – A Substandard asset is believed to be inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified have identified weaknesses and are characterized by the possibility that the Company may sustain some loss if deficiencies are not corrected.
Not Rated – For certain Strategic Program and consumer loans, the Company does not evaluate and risk rate the loans in the same manner as other loans in the Company’s portfolio. The Not Rated loans are typically homogenous, smaller dollar balances approved using abridged underwriting methods that allow the Company to streamline the loan approval process and increase efficiency. Credit quality for Strategic Program loans is highly correlated with delinquency levels.
The following table presents the ending balances of the Company's loan and lease portfolio including non-performing loans by class of receivable and originating year and considering certain credit quality indicators as of the date indicated along with gross chargeoffs for the three months ended March 31, 2023:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
March 31, 2023 | 2023 | | 2022 | | 2021 | | Prior | | Revolving Loans | | Total |
($ in thousands) | | | | | | | | | | | |
| | | | | | | | | | | |
Construction and land development | | | | | | | | | | | |
Pass | $ | 1,138 | | | $ | 19,349 | | | $ | 4,298 | | | $ | 211 | | | $ | — | | | $ | 24,996 | |
Watch | — | | | — | | | — | | | — | | | — | | | — | |
Special Mention | — | | | — | | | — | | | — | | | — | | | — | |
Substandard | — | | | — | | | — | | | — | | | — | | | — | |
Total | 1,138 | | | 19,349 | | | 4,298 | | | 211 | | | — | | | 24,996 | |
Current period gross writeoff | — | | | — | | | — | | | — | | | — | | | — | |
| | | | | | | | | | | |
Residential real estate | | | | | | | | | | | |
Pass | 1,009 | | | 9,933 | | | 1,464 | | | 3,308 | | | 1,424 | | | 17,138 | |
Watch | 336 | | | 8,256 | | | 2,120 | | | 3,399 | | | — | | | 14,111 | |
Special Mention | — | | | — | | | — | | | 13 | | | — | | | 13 | |
Substandard | — | | | — | | | — | | | — | | | — | | | — | |
Total | 1,345 | | | 18,189 | | | 3,584 | | | 6,720 | | | 1,424 | | | 31,262 | |
Current period gross writeoff | — | | | — | | | — | | | — | | | — | | | — | |
| | | | | | | | | | | |
Residential real estate multifamily | | | | | | | | | | | |
Pass | 121 | | | 267 | | | 81 | | | — | | | — | | | 469 | |
Watch | — | | | — | | | — | | | 26 | | | — | | | 26 | |
Special Mention | — | | | — | | | — | | | — | | | — | | | — | |
Substandard | — | | | — | | | — | | | — | | | — | | | — | |
Total | 121 | | | 267 | | | 81 | | | 26 | | | — | | | 495 | |
Current period gross writeoff | — | | | — | | | — | | | — | | | — | | | — | |
| | | | | | | | | | | |
Commercial real estate | | | | | | | | | | | |
Pass | 26,697 | | | 39,395 | | | — | | | 12,015 | | | — | | | 78,107 | |
Watch | 10,072 | | | 35,290 | | | 17,030 | | | 15,642 | | | — | | | 78,034 | |
Special Mention | — | | | — | | | — | | | 477 | | | — | | | 477 | |
Substandard | — | | | 356 | | | — | | | 384 | | | — | | | 740 | |
Total | 36,769 | | | 75,041 | | | 17,030 | | | 28,518 | | | — | | | 157,358 | |
Current period gross writeoff | — | | | — | | | — | | | (122) | | | — | | | (122) | |
| | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial and industrial | | | | | | | | | | | |
Pass | 2,596 | | | 5,401 | | | 848 | | | 1,919 | | | 1 | | | 10,765 | |
Watch | 595 | | | 2,731 | | | 1,071 | | | 792 | | | — | | | 5,189 | |
Special Mention | — | | | — | | | — | | | 23 | | | — | | | 23 | |
Substandard | — | | | — | | | — | | | 94 | | | — | | | 94 | |
Total | 3,191 | | | 8,132 | | | 1,919 | | | 2,828 | | | 1 | | | 16,071 | |
Current period gross writeoff | — | | | — | | | — | | | (18) | | | — | | | (18) | |
| | | | | | | | | | | |
Consumer | | | | | | | | | | | |
Pass | 985 | | | 2,721 | | | 984 | | | 933 | | | 2 | | | 5,625 | |
Watch | 3 | | | — | | | 8 | | | 3 | | | — | | | 14 | |
Special Mention | — | | | — | | | — | | | — | | | — | | | — | |
Substandard | — | | | — | | | — | | | — | | | — | | | — | |
Not Rated | 29 | | | 13 | | | — | | | — | | | — | | | 42 | |
Total | 1,017 | | | 2,734 | | | 992 | | | 936 | | | 2 | | | 5,681 | |
Current period gross writeoff | — | | | — | | | — | | | — | | | — | | | — | |
| | | | | | | | | | | |
Lease financing receivables | | | | | | | | | | | |
Pass | 6,378 | | | 8,326 | | | — | | | 353 | | | — | | | 15,057 | |
Watch | — | | | — | | | — | | | — | | | — | | | — | |
Special Mention | — | | | — | | | — | | | — | | | — | | | — | |
Substandard | — | | | — | | | — | | | — | | | — | | | — | |
Total | 6,378 | | | 8,326 | | | — | | | 353 | | | — | | | 15,057 | |
Current-period gross writeoffs | — | | | — | | | — | | | — | | | — | | | — | |
| | | | | | | | | | | |
Strategic Program loans | | | | | | | | | | | |
Pass | 4,092 | | | 2,822 | | | 51 | | | 1 | | | — | | | 6,966 | |
Watch | 89 | | | 86 | | | 8 | | | — | | | — | | | 183 | |
Special Mention | — | | | 5 | | | 3 | | | — | | | — | | | 8 | |
Substandard | — | | | 2 | | | 3 | | | — | | | — | | | 5 | |
Not Rated | 2,432 | | | 8,957 | | | 2,841 | | | 1 | | | — | | | 14,231 | |
Total | 6,613 | | | 11,872 | | | 2,906 | | | 2 | | | — | | | 21,393 | |
Current-period gross writeoffs | (19) | | | (2,628) | | | (376) | | | (2) | | | — | | | (3,025) | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | |
Total Portfolio loans receivable, gross | 56,572 | | | 143,910 | | | 30,810 | | | 39,594 | | | 1,427 | | | 272,313 | |
The following table presents the ending balances of the Company's loan and lease portfolio including non-performing loans by class of receivable and considering certain credit quality indicators as of the date indicated:
| | | | | | | | | | | | | | | | | | | | | | | |
December 31, 2022 | | | | | | | |
($ in thousands) | Pass Grade 1-4 | | Special Mention Grade 5 | | Classified/ Doubtful/Loss Grade 6-8 | | Total |
SBA | $ | 144,149 | | | $ | 573 | | | $ | 450 | | | $ | 145,172 | |
Commercial, non-real estate | 11,484 | | | — | | | — | | | 11,484 | |
Residential real estate | 37,815 | | | — | | | — | | | 37,815 | |
Commercial real estate | 12,063 | | | — | | | — | | | 12,063 | |
Consumer | 5,808 | | | — | | | — | | | 5,808 | |
Not Risk Graded | | | | | | | |
Strategic Program loans | | | | | | | 24,259 | |
Total | $ | 211,319 | | | $ | 573 | | | $ | 450 | | | $ | 236,601 | |
Effective January 1, 2023 loan modifications to borrowers experiencing financial difficulty are required to be disclosed by type of modification and by type of loan. Prior accounting guidance classified loans which were modified as troubled debt restructurings only if the modification reflected a concession from the lender in the form of a below market interest rate or other concession in addition to borrower financial difficulty. Under the new guidance (ASU 2022-02), loans with modifications made after January 1, 2023, will be reported under the new loan modification guidance whether a concession is made or not. As of January 1, 2023, the Company has ceased to recognized or measure new TDRs but those existing at December 31, 2022 will remain until settled.
In the quarter ended March 31, 2023 there were no material loan modifications reportable under the new guidance.
The table below provides information as to the amount of outstanding loans previously classified as TDRs that remain as of March 31, 2023:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
($ in thousands) | | Loans with Adjusted Interest Rates | | Loans with Extended Maturity Dates (Months) | | Loans with Principal Deferment (Months) | | Outstanding Balance |
SBA | | $ | — | | | 0 | | 15 months | | $ | 94 | |
Total | | $ | — | | | | | | | $ | 94 | |
Loans modified and recorded as TDR’s at December 31, 2022, consist of the following:
| | | | | | | | | | | | | | | | | |
($ in thousands) | Number of Contracts | | Pre- Modification Outstanding Recorded Investment | | Post- Modification Outstanding Recorded Investment |
December 31, 2022 | | | | | |
SBA | 1 | | $ | 94 | | | $ | 94 | |
Total at December 31, 2022 | 1 | | $ | 94 | | | $ | 94 | |
At December 31, 2022, there were no commitments to lend additional funds to debtors whose loan terms have been modified in a TDR. There was one principal charge-off recorded related to TDRs during the three months ended March 31, 2022 for $0.01 million.
During the three months ended March 31, 2022, there were no loan modifications to TDRs. Separately, one restructured loan incurred a default within 12 months of the restructure date during the three months ended March 31, 2022. This same loan was paid in full with interest on June 2, 2022.
Collateral-Dependent Financial Loans
A collateral-dependent financial loan relies substantially on the operation or sale of the collateral for repayment. In evaluating the overall risk associated with a loan, the Company considers (1) character, overall financial condition and resources, and payment record of the borrower; (2) the prospects for support from any financially responsible guarantors; and (3) the nature and degree of protection provided by the cash flow and value of any underlying collateral. The loan may become collateral-dependent when foreclosure is probable or the borrower is experiencing financial difficulty and its sources of repayment become inadequate over time. At such time, the Company develops an expectation that repayment will be provided substantially through the operation or sale of the collateral.
The following tables present the amortized cost basis of collateral-dependent loans by class of loans as of the dates indicated:
| | | | | | | | | | | | | | | | | | | | |
($ in thousands) | | Collateral Type |
As of March 31, 2023 | | Real Estate | | Personal Property | | Total |
Commercial real estate | | $ | 1,809 | | | $ | — | | | $ | 1,809 | |
| | | | | | | | | | | | | | | | | | | | |
($ in thousands) | | Collateral Type |
As of December 31, 2022 | | Real Estate | | Personal Property | | Total |
Commercial real estate | | $ | 356 | | | $ | — | | | $ | 356 | |
Note 4 – Lease Liabilities
The Company includes commercial operating leases of $2.8 million within premises and equipment, net issued during the year ended 2022. Net book value of the operating leases as of March 31, 2023 was $2.5 million. Rental income from operating leases for the three months ended March 31, 2023 was $0.1 million and for the three months ended March 31, 2022 was a de minimis amount. Depreciation expense was $0.5 million and $0.1 million for the three months ended March 31, 2023 and 2022, respectively.
The Company leases its facilities under noncancelable operating leases. Rent expense for the three months ended March 31, 2023 and 2022 was $0.2 million and $0.2 million, respectively. Future minimum annual undiscounted rental payments for these operating leases are as follows ($ in thousands):
| | | | | |
Nine Months Ended December 31, 2023 | $ | 579 | |
Year Ended December 31, 2024 | 1,104 |
Year Ended December 31, 2025 | 1,086 |
Year Ended December 31, 2026 | 1,118 |
Year Ended December 31, 2027 | 1,152 |
Thereafter | 2,203 |
Total | 7,242 |
Less present value discount | (461) |
Operating lease liabilities | $ | 6,781 | |
The Company entered into one lease during the three months ended March 31, 2022 to provide additional space while the Murray office construction was completed. ASC 842 does not apply due to the short-term period of this lease and immateriality. The tables below present information regarding the Company’s lease assets and liabilities.
| | | | | | | | | | | |
| Three Months Ended |
| March 31, 2023 | | March 31, 2022 |
| | | |
Weighted-average remaining lease term – operating leases (in years) | 6.5 | | 7.4 |
Weighted-average discount rate – operating leases | 1.9 | % | | 1.9 | % |
Supplemental cash flow information related to leases were as follows (in thousands):
| | | | | | | | | | | |
| Three Months Ended March 31, | | Three Months Ended March 31, |
| 2023 | | 2022 |
($ in thousands) | | | |
Operating cash flows from operating leases | $ | 271 | | | $ | 28 | |
Right-of-use assets obtained in exchange for operating lease liabilities | — | | | 7,380 | |
The components of lease expense were as follows (in thousands):
| | | | | | | | | | | |
| Three Months Ended March 31, 2023 | | Three Months Ended March 31, 2022 |
(in thousands) | | | |
Operating leases | | | |
Operating lease cost | $ | 219 | | | $ | 236 | |
Variable lease cost | 9 | | | 4 | |
Operating lease expense | 228 | | | 240 | |
Short-term lease rent expense | — | | | — | |
Net rent expense | $ | 228 | | | $ | 240 | |
Note 5 – SBA Servicing Asset
The Company periodically sells portions of SBA loans and retains rights to service the loans. Loans serviced for others are not included in the accompanying balance sheet. The unpaid principal balances of SBA loans serviced for others was $312.9 million and $318.6 million at March 31, 2023 and December 31, 2022, respectively.
The following table summarizes SBA servicing asset activity for the periods indicated:
| | | | | | | | | | | | | | |
| | For the Three Months Ended March 31, |
($ in thousands) | | 2023 | | 2022 |
Beginning balance | | $ | 5,210 | | | $ | 3,938 | |
Additions to servicing asset | | — | | | 1,408 | |
Recovery of SBA servicing asset | | 253 | | | 59 | |
Amortization of servicing asset | | (179) | | | (180) | |
Ending balance | | $ | 5,284 | | | $ | 5,225 | |
The fair market value of the SBA servicing asset as of March 31, 2023 and December 31, 2022, was $5.3 million and $5.2 million, respectively. Recovery or impairment adjustments to servicing rights are mainly due to market-based assumptions associated with discounted cash flows, loan prepayment speeds, and changes in interest rates. A significant change in prepayments of the loans in the servicing portfolio could result in significant changes in the valuation adjustments, thus creating potential volatility in the carrying amount of servicing rights.
The Company assumed a weighted average prepayment rate of 14.54%, weighted average term of 4.43 years, and a weighted average discount rate of 16.26% at March 31, 2023.
The Company assumed a weighted average prepayment rate of 14.24%, weighted average term of 4.45 years, and a weighted average discount rate of 18.79% at December 31, 2022.
Note 6 – Capital Requirements
The Bank is subject to various regulatory capital requirements administered by federal and State of Utah banking agencies (the regulators). Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off -balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk -weighting, and other factors. Prompt corrective action provisions are not applicable to the bank holding company.
Beginning January 1, 2020, the bank qualified and elected to use the community bank leverage ratio (CBLR) framework for quantitative measures which requires the Bank to maintain minimum amounts and ratios of Tier 1 capital to average total consolidated assets. Management believes, as of March 31, 2023 and December 31, 2022, that the Bank meets all capital adequacy requirements to which it is subject.
As of March 31, 2023 and December 31, 2022, the most recent notification from the FDIC 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 following table sets forth the actual capital amounts and ratios for the Bank and the minimum ratio and amount of capital required to be categorized as well-capitalized and adequately capitalized as of the dates indicated.
The Bank’s actual capital amounts and ratios are presented in the following table:
| | | | | | | | | | | | | | | | | | | | | | | |
| Actual | | Well-Capitalized Requirement |
($ in thousands) | Amount | | Ratio | | Amount | | Ratio |
March 31, 2023 | | | | | | | |
Leverage ratio (CBLR election) | $ | 96,738 | | | 24.0 | % | | $ | 36,357 | | | 9.0 | % |
December 31, 2022 | | | | | | | |
Leverage ratio (CBLR election) | $ | 91,674 | | | 25.1 | % | | $ | 32,898 | | | 9.0 | % |
Federal Reserve Board Regulations require maintenance of certain minimum reserve balances based on certain average deposits. The Bank had no reserve requirements as of March 31, 2023 and December 31, 2022.
The Federal Reserve’s policy statement and supervisory guidance on the payment of cash dividends by a Bank Holding Company (“BHC”), such as FinWise Bancorp, expresses the view that a BHC should generally pay cash dividends on common stock only to the extent that (1) the BHC’s net income available over the past year is sufficient to cover the cash dividend, (2) the rate of earnings retention is consistent with the organization’s expected future needs and financial condition, and (3) the minimum regulatory capital adequacy ratios are met. Should an insured depository institution controlled by a bank holding company be “significantly undercapitalized” under the applicable federal bank capital ratios, or if the bank subsidiary is “undercapitalized” and has failed to submit an acceptable capital restoration plan or has materially failed to implement such a plan, federal banking regulators (in the case of the Bank, the FDIC) may choose to require prior Federal Reserve approval for any capital distribution by the BHC.
In addition, since FinWise Bancorp is a legal entity separate and distinct from the Bank and does not conduct stand-alone operations, an ability to pay dividends depends on the ability of the Bank to pay dividends to FinWise Bancorp and the FDIC and the Utah Department of Financial Institutions (“UDFI”) may, under certain circumstances, prohibit the payment of dividends to FinWise Bancorp from the Bank. Utah corporate law also requires that dividends can only be paid out of funds legally available.
The Company has not paid any cash dividends on its common stock since inception and it currently has no plans to pay cash dividends in the foreseeable future. However, the Company’s Board of Directors may declare a cash or stock dividend out of retained earnings provided the regulatory minimum capital ratios are met. The Company plans to maintain capital ratios that meet the well-capitalized standards per the regulations and, therefore, would limit dividends to amounts that are appropriate to maintain those well-capitalized regulatory capital ratios.
Note 7 – Commitments and Contingent Liabilities
Federal Home Loan Bank Secured Line of Credit
As of March 31, 2023 and December 31, 2022, the Bank’s available line of credit with the FHLB to borrow in overnight funds was $2.5 million and $2.6 million, respectively. All borrowings are short-term and the interest rate is equal to the correspondent bank’s daily federal funds purchase rate. As of March 31, 2023 and December 31, 2022, no amounts were outstanding under the line of credit. Loans totaling $3.8 million and $4.0 million were pledged to secure the FHLB line of credit as of March 31, 2023 and December 31, 2022, respectively.
Lines of Credit
At March 31, 2023 and December 31, 2022, we had the ability to access $10.6 million and $10.6 million from the Federal Reserve Bank’s Discount Window on a collateralized basis. Through Zions Bank, the Bank had an available unsecured line available of $1.0 million at March 31, 2023 and December 31, 2022. The Bank had an available line of credit with Bankers’ Bank of the West to borrow up to $1.05 million in overnight funds at March 31, 2023 and December 31, 2022. We had no outstanding balances on such unsecured or secured lines of credit as of March 31, 2023 and December 31, 2022.
In April of 2023, the Bank was notified that due to the current banking industry disruptions, Zions Bank was limiting its Fed Funds line advances to secured arrangements and would continue to do so for the foreseeable future thereby eliminating the unsecured line the Bank had previously maintained with Zions Bank.
Paycheck Protection Program Liquidity Facility
On April 20, 2020, the Bank was approved by the Federal Reserve to access its SBA Paycheck Protection Program Liquidity Facility (“PPPLF”) through the discount window. The PPPLF enables the Company to fund Paycheck Protection Program ("PPP") loans without taking on additional liquidity or funding risks because the Company is able to pledge PPP loans as collateral to secure extensions of credit under the PPPLF on a non-recourse basis. Borrowings under the PPPLF have a fixed-rate of 0.35%, with a term that matches the underlying loans. The Bank pledged $0.3 million of PPP loans as eligible collateral under the PPPLF borrowing arrangement at March 31, 2023. The Bank pledged $0.3 million of PPP loans as eligible collateral under the PPPLF borrowing arrangement at December 31, 2022. The average outstanding borrowings were $0.3 million during the three months ended March 31, 2023 and $1.0 million during the three months ended March 31, 2022.
Commitments to Extend Credit
In the ordinary course of business, the Bank has entered into commitments to extend credit to customers which have not yet been exercised. These financial instruments include commitments to extend credit in the form of loans. Those instruments involve to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets.
At March 31, 2023 and December 31, 2022, financial instruments with off-balance-sheet risk were as follows:
| | | | | | | | | | | |
| March 31, | | December 31, |
($ in thousands) | 2023 | | 2022 |
Revolving, open-end lines of credit | $ | 1,932 | | | $ | 1,683 | |
Commercial real estate | 17,817 | | | 17,886 | |
Other unused commitments | 264 | | | 253 | |
| $ | 20,013 | | | $ | 19,822 | |
Allowance for Credit Losses on Unfunded Commitments
The Company estimates expected credit losses over the contractual period in which the Company is exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancelable by the Company. The allowance for credit losses on unfunded commitments is included in other liabilities on the consolidated balance sheets and is adjusted through a charge to provision for credit loss expense on the consolidated statements of income. The allowance for credit losses on unfunded commitments estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life. The allowance for credit losses on unfunded commitments was $29.5 thousand as of March 31, 2023.
Note 8 – Investment in Business Funding Group, LLC
On December 31, 2019, the Company purchased from certain members of BFG a 10% membership interest in exchange for an aggregate of 950,784 shares of par value $0.001 Common Stock of the Company. The exchange was accounted for at fair value based on the fair value of the Company’s shares of approximately $3.5 million.
The Company’s 10% membership interests of BFG are comprised of Class A Voting Units representing 4.96% of the aggregate membership interests of BFG and Class B Non-Voting Units representing 5.04% of the aggregate membership interests of BFG. The other existing members of BFG jointly own the remaining 90% of the outstanding membership interests, on a fully-diluted basis – all of which membership interests are Class A Voting Units. Based on the Company’s accounting policy with respect to investments in limited liability companies, the Company concluded that its level of ownership was indicative of significant influence and, as a result, the investment would be accounted for using the equity method. However, the Company elected the fair value option for its investment due to cost-benefit considerations. The Company received distributions from BFG in the amounts of $0.2 million and $0.1 million for the three months ended March 31, 2023 and 2022, respectively. These distributions were recorded in the Consolidated Balance Sheets as decreases in the investment in BFG.
On March 31, 2020, the Company entered into an agreement with BFG whereby the Company has the right of first refusal to purchase additional interests in BFG from any selling members. Additionally, the Company was granted an option to purchase all, but not less than all, of the interests in BFG from the remaining members for an earnings multiple between 10 times and 15 times net profit based on the fiscal year ended immediately prior to the exercise of the option. The option period begins on January 1, 2021 and expires on January 1, 2028. In consideration of granting the first right of refusal and the option, BFG members received 270,000 warrants in the aggregate. The warrants have an exercise price of $6.67 per share and the warrants expire on March 31, 2028. The warrants are free-standing equity instruments and, as a result, are classified within equity at the fair value on the issuance date. The fair value of the warrants was determined by our board of directors with input from management, relying in part upon valuation reports prepared by a third-party valuation firm using a Black-Scholes option pricing model adjusted for a lack of marketability since the Company’s stock is not publicly traded. The resulting fair value of the warrants was $0.19 per share.
For further discussion on the Company’s investment in BFG, see Note 13 Related Parties.
Note 9 – Stock-Based Compensation
Stock option plans
The Company utilizes stock-based compensation plans, as well as discretionary grants, for employees, directors and consultants to attract and retain the best available personnel for positions of substantial responsibility, to provide additional incentives and to promote the success of the Company’s business.
The 2019 Stock Option Plan (“2019 Plan”) was adopted on June 20, 2019 following approval by the Company’s Board of Directors and shareholders. The 2019 Plan provides for the issuance of non-statutory stock options and restricted stock to employees, directors and consultants. The 2019 Plan also provides for the issuance of incentive stock options only to employees.
The 2019 Plan will terminate as to future awards 10 years from the later of the effective date or the earlier of the most recent Board or stockholder approval of an increase in the number of shares reserved for issuance under the 2019 Plan. At March 31, 2023, 623,489 shares are available for future issuance.
The 2016 Stock Option Plan (“2016 Plan”) was adopted on April 20, 2017 following approval by the Company’s Board of Directors and shareholders. The 2016 Plan provides for the issuance of non-statutory stock options and restricted stock to employees, directors and consultants. The 2016 Plan also provides for the issuance of incentive stock options only to employees. The 2016 Plan authorizes the issuance of 299,628 common shares. The 2016 Plan will terminate as to future awards 10 years from the later of the effective date or the earlier of the most recent Board or stockholder approval of an increase in the number of shares reserved for issuance under the 2016 Plan. At March 31, 2023, 273 shares under 2016 Plan are available for future issuance.
The stock-based incentive awards for both the 2019 Plan and the 2016 Plan (collectively, the “Plans”) are granted at an exercise price not less than the fair market value of the shares on the date of grant, which is based on a Black-Scholes valuation model, in the case of options, or based on the fair value of the stock at the grant date, in the case of restricted stock. Vesting of the options vary by employee or director and can have a term no more than 10 years, with the options generally having vesting periods ranging from 1 to 5 years. No shares had been granted under the 2016 Plan prior to 2018.
Under both Plans, if an award expires or becomes un-exercisable without having been exercised in full, or is surrendered pursuant to an exchange program, the unpurchased shares that were subject thereto shall become available for future grant or sale under the Plans. However, shares that have actually been issued under the Plans, upon exercise of an award, shall not be returned to the Plans and shall not become available for future distribution under the Plans, except that if unvested shares of restricted stock are repurchased by the Company at their original purchase price, such shares shall become available for future grant under the Plans.
Stock options
The grant date fair value is determined using the Black-Scholes option valuation model.
The assumptions for expected life reflected management’s judgment and include consideration of historical experience. Expected volatility is based on data from comparable public companies for the expected option term. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the option. Expected forfeitures are estimated based on the Company’s historical forfeiture experience. Management believes that the assumptions used in the option-pricing model are highly subjective and represent only one estimate of possible value, as there is no active market for the options granted. The table below summarizes the assumptions used for the options granted during the first quarter of 2023. No options were granted during the first three months of 2022.
| | | | | |
| For the Three Months Ended March 31, |
| 2023 |
Risk-free interest rate | 3.9% - 4.0% |
Expected term in years | 5.5 – 7.5 |
Expected volatility | 44.0% – 44.9% |
Expected dividend yield | — | |
The following summarizes stock option activity for the three months and three months ended March 31, 2023:
| | | | | | | | | | | | | | | | | | | | | | | |
| Stock Options | | Weighted Average Exercise Price | | Weighted Average Contractual Life (in years) | | Aggregate Intrinsic Value |
Outstanding at December 31, 2022 | 881,625 | | $ | 5.27 | | | 7.5 | | $ | 3,871,667 | |
Options granted | 1,100 | | 9.46 | | 9.9 | | — | |
Options exercised | (16,800) | | 2.37 | | 0.0 | | 11,369 | |
Options forfeited | (2,496) | | 9.96 | | 0.0 | | 100,711 | |
Outstanding at March 31, 2023 | 863,429 | | $ | 5.32 | | | 7.3 | | $ | 3,407,917 | |
Options vested and exercisable at March 31, 2023 | 648,774 | | $ | 4.43 | | | 7.0 | | $ | 2,846,076 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Stock Options | | Weighted Average Exercise Price | | Weighted Average Contractual Life (in years) | | Aggregate Intrinsic Value |
Outstanding at December 31, 2021 | 862,488 | | $ | 4.41 | | | 8.2 | | $ | 8,088,660 | |
Options exercised | (16,800) | | 2.37 | | | 0 | | 248,312 | |
Options forfeited | (6,660) | | 3.28 | | | 0 | | 92,357 | |
Outstanding at March 31, 2022 | 839,028 | | $ | 4.46 | | | 8.0 | | $ | 10,645,951 | |
Options vested and exercisable at March 31, 2023 | 592,632 | | $ | 4.58 | | | 8.0 | | $ | 7,447,226 | |
The weighted average grant-date fair value of options per share granted during the three months ended March 31, 2023 was $4.74. The aggregate intrinsic value of options exercised during the three months ended March 31, 2023 was a de minimis amount. During the three months ended March 31, 2023, the Company received de minimis proceeds from the exercise of stock options and recognized a de minimis tax benefit from the exercise of stock options. Upon exercise of the stock options, the Company will issue new authorized shares.
The weighted average grant-date fair value of options per share granted during the three months ended March 31, 2022 was $1.55. The aggregate intrinsic value of options exercised during the three months ended March 31, 2022 was $0.2 million. During the three months ended March 31, 2022, the Company received de minimis proceeds from the exercise of stock options and recognized a de minimis tax benefit from the exercise of stock options.
Stock-based compensation expense
The following tables present pre-tax and after-tax stock-based compensation expense recognized:
| | | | | | | | | | | |
| For the Three Months Ended March 31, |
($ in thousands) | 2023 | | 2022 |
Pre-tax | | | |
Stock options | $ | 95 | | | $ | 39 | |
Restricted shares | 326 | | | — | |
Total | $ | 421 | | | $ | 39 | |
After-tax | | | |
Stock options | $ | 92 | | | $ | 38 | |
Restricted shares | 245 | | | — | |
Total | $ | 337 | | | $ | 38 | |
As of March 31, 2023, the Company had unrecognized stock-based compensation expense related to stock options and restricted stock of approximately $0.4 million and $0.7 million, respectively, which is expected to be recognized over the remaining weighted average recognition period of 1.7 years and 1.4 years.
Note 10 – Fair Value of Financial Instruments
The Company measures and discloses certain assets and liabilities at fair value. Fair value is defined as 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 (that is, not a forced liquidation or distressed sale). GAAP establishes a consistent framework for measuring fair value and disclosure requirements about fair value measurements. Among other things, the standard requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s estimates for market assumptions. These two types of inputs create the following fair value hierarchy.
Level 1 – Quoted prices in active markets for identical instruments. An active market is a market in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.
Level 2 – Observable inputs other than Level 1 including quoted prices in active markets for similar instruments, quoted prices in less active markets for identical or similar instruments, or other observable inputs that can be corroborated by observable market data.
Level 3 – Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation also includes observable inputs from nonbinding single dealer quotes not corroborated by observable market data. In developing Level 3 measurements, management incorporates whatever market data might be available and uses discounted cash flow models where appropriate. These calculations include projections of future cash flows, including appropriate default and loss assumptions, and market-based discount rates.
The estimated fair value amounts of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize at a future date. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. In addition, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates that must be made given the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values. Transfers between levels of the fair value hierarchy are deemed to occur at the end of the reporting period.
The following methods were used to estimate the fair value of each class of financial instruments:
Cash and cash equivalents: The carrying amount of these items is a reasonable estimate of their fair value.
Investment securities held-to-maturity: The estimated fair values of investment securities are priced using current active market quotes, if available, which are considered Level 1 measurements. For most of the portfolio, matrix pricing based on the securities’ relationship to other benchmark quoted prices is used to establish the fair value. These measurements are considered Level 2.
Investment in Federal Home Loan Bank stock: The fair value is based upon the redemption value of the stock, which equates to the carrying value.
Strategic Program loans held-for-sale: The carrying amount of these items is a reasonable estimate of their fair value.
Loans held for investment: The fair value is estimated by discounting the future cash flows and estimated prepayments using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining term. Some loan types’ fair value approximated carrying value because of their floating rate or expected maturity characteristics.
SBA servicing asset: The fair value of servicing assets is based on, in part, third -party valuations that project estimated future cash inflows that include servicing fees and outflows that include market rates for costs of servicing. The present value of the future cash flows are calculated utilizing market-based discount rates. The market-based discount rates represent risk spreads based on secondary market transactions utilizing calculated prepayment curves. Due to the fact that observable loan transactions are used to determine the risk spreads, the Company considers the measurement to be Level 2.
Investment in BFG: The Company purchased its ownership interest in BFG on December 31, 2019. The Company’s valuation technique utilized the average of the discounted cash flow method and the Guideline Public Company method. A 20% lack of marketability discount was applied to the valuation as well as a 4.50% discount to non-voting shares to arrive at fair value as of March 31, 2023 and December 31, 2022. The calculation of fair value utilized significant unobservable inputs, including projected cash flows, growth rates, and discount rates. The fair value of the investment in BFG was $4.5 million and $4.8 million as of March 31, 2023 and December 31, 2022, respectively. The following table summarizes investment in BFG activity for the periods indicated:
| | | | | | | | | | | |
| For the Three Months Ended March 31, |
($ in thousands) | 2023 | | 2022 |
Beginning balance | $ | 4,800 | | | $ | 5,900 | |
Distributions from BFG | (215) | | | (102) | |
Change in fair value of BFG | (85) | | | (398) | |
Ending balance | $ | 4,500 | | | $ | 5,400 | |
Deposits: The carrying amount of deposits with no stated maturity, such as savings and checking accounts, is a reasonable estimate of their fair value. The market value of certificates of deposit is based upon the discounted value of contractual cash flows. The discount rate is determined using the rates currently offered on comparable instruments.
Accrued interest receivable and payable: The fair value of accrued interest receivable and payable approximates their carrying amount.
PPP Liquidity Facility: The fair value of PPPLF is estimated using a discounted cash flow based on the remaining contractual term and current borrowing rates for similar terms.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | March 31, 2023 | | December 31, 2022 |
($ in thousands) | Level | | Carrying Amount | | Estimated Fair Value | | Carrying Amount | | Estimated Fair Value |
Financial assets: | | | | | | | | | |
Cash and cash equivalents | 1 | | $ | 105,609 | | | $ | 105,609 | | | $ | 100,567 | | | $ | 100,567 | |
Investment securities held-to-maturity | 2 | | 13,880 | | | 12,300 | | | 14,292 | | | 12,728 | |
Investment in FHLB stock | 2 | | 449 | | | 449 | | | 449 | | | 449 | |
Loans held for investment | 3 | | 260,221 | | | 276,140 | | | 224,217 | | | 237,225 | |
Loans held-for-sale | 2 | | 25,413 | | | 25,409 | | | 23,589 | | | 23,586 | |
Accrued interest receivable | 2 | | 2,174 | | | 2,174 | | | 1,818 | | | 1,818 | |
SBA servicing asset | 2 | | 5,284 | | | 5,284 | | | 5,210 | | | 5,210 | |
Investment in BFG | 3 | | 4,500 | | | 4,500 | | | 4,800 | | | 4,800 | |
Financial liabilities: | | | | | | | | | |
Total deposits | 2 | | 283,192 | | | 260,107 | | | 242,998 | | | 221,287 | |
Accrued interest payable | 2 | | 117 | | | 117 | | | 54 | | | 54 | |
PPP Liquidity Facility | 2 | | 283 | | | 283 | | | 314 | | | 314 | |
Assets measured at fair value on a nonrecurring basis are summarized as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
($ in thousands) | | | | Fair Value Measurements Using |
Description of Financial Instrument | | Fair Value | | Level 1 | | Level 2 | | Level 3 |
March 31, 2023 | | | | | | | | |
Nonrecurring assets | | | | | | | | |
Individually evaluated loans | | $ | 834 | | | $ | — | | | $ | — | | | $ | 834 | |
December 31, 2022 | | | | | | | | |
Nonrecurring assets | | | | | | | | |
Individually evaluated loans | | $ | 450 | | | $ | — | | | $ | — | | | $ | 450 | |
Individually evaluated loans – The loan amount above represents loans individually evaluated as of year-end that have been adjusted to fair value. When collateral dependent loans are individually evaluated, they are measured using the current fair value of the collateral securing these loans, less selling costs. The fair value of real estate collateral is determined using collateral valuations or a discounted cash flow analysis using inputs such as discount rates, sale prices of similar assets, and term of expected disposition. Some appraised values are adjusted based on management’s review and analysis, which may include historical knowledge, changes in market conditions, estimated selling and other anticipated costs, and/or expertise and knowledge. The loss represents charge-offs on loans for adjustments made based on the fair value of the collateral.
Quantitative information for Level 3 fair value measurements – The range and weighted average of the significant unobservable inputs used to fair value Level 3 nonrecurring assets as of March 31, 2023 and as of December 31, 2022, along with the valuation techniques used, are shown in the following table:
| | | | | | | | | | | | | | | | | | | | |
($ in thousands) | Fair Value | | Valuation Technique | Unobservable Input | | Range (Weighted Average) |
March 31, 2023 | | | | | | |
Individually evaluated loans | $ | 834 | | | Market comparable | Adjustment to appraisal value | | 0.32 | % |
| | | | | | |
December 31, 2022 | | | | | | |
Individually evaluated loans | $ | 450 | | | Market comparable | Adjustment to appraisal value | | 0.20 | % |
The range and weighted average of the significant unobservable inputs used to fair value the investment in BFG Level 3 recurring asset as of March 31, 2023 and as of December 31, 2022 are shown in the following table:
| | | | | | | | | | | |
($ in thousands) | March 31, 2023 Range (Weighted Average) | | December 31, 2022 Range (Weighted Average) |
Discounted Cash Flows | | | |
Revenue growth rate | 10.8 | % | | 10.8 | % |
Expense growth rate | 11.5 | % | | 11.5 | % |
Discount rate | 25.0 | % | | 25.0 | % |
| | | |
Guideline Public Company | | | |
Multiples of enterprise value | 3.5x to 5.0x | | 3.0x to 5.0x |
Note 11 – Income Taxes
The Company accounts for income taxes by recognizing deferred tax assets and liabilities based upon temporary differences between the amounts for financial reporting purposes and tax basis of its assets and liabilities. Deferred tax assets increased $0.2 million during the three months ended March 31, 2023 as a result of changes to temporary timing differences associated with accounting for bad debts. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more-likely-than-not that some portion, or all, of the deferred tax asset will not be realized. In assessing the realization of deferred tax assets, management evaluates both positive and negative evidence, including the forecasts of future income, applicable tax planning strategies, and assessments of current and future economic and business conditions. This analysis is updated quarterly and adjusted as necessary. Based on this analysis, management has determined that a valuation allowance for deferred tax assets was not required at March 31, 2023.
For the three months ended March 31, 2023 and 2022, income tax expense was $1.4 million and $3.2 million, respectively, resulting in an effective income tax rate of 26.1% and 25.4%, respectively. The effective tax rate differs from the statutory rate of 24.9% during the three months ended March 31, 2023 due primarily to nondeductible wages, state taxes and the tax effect of stock-based compensation. The effective tax rate differs from the statutory rate of 24.9% during the three months ended March 31, 2022 due primarily to the tax effect of stock-based compensation.
The Company had no unrecognized tax benefits at March 31, 2023.
Note 12 – Related Parties
In the ordinary course of business, the Company may grant loans to certain executive officers and directors and the companies with which they are associated. The Company had de minimis loans outstanding to related parties as of March 31, 2023 and December 31, 2022. Total deposits from certain executive officers and directors and the companies with which they are associated were $1.9 million and $1.2 million as of March 31, 2023 and December 31, 2022, respectively.
On October 21, 2022, Mr. Alan Weichselbaum, who was elected as a director of the Company on October 6, 2022, repaid in full the $0.1 million aggregate principal amount plus interest owed under a secured promissory note, dated as of June 1, 2022 (the “2022 Note”), between the Company and Mr. Weichselbaum in accordance with the terms of the 2022 Note. As such, the obligations of the parties under the 2022 Note and a related security agreement were discharged and the 2022 Note and the security agreement were terminated.
BFG is a small business loan broker, primarily under the SBA’s 7(a) loan program. As noted in Note 9 Investments above, the Company has a 10% ownership in the outstanding membership units of BFG. The Company underwrites loans sourced by BFG in its normal course of business. If approved and funded, the Company pays BFG a commission fee based on the amount funded. There is no guarantee or commitment made by the Company to BFG to approve or fund loans referred by BFG. The Company is able to use its sole discretion in deciding to approve and fund loans referred by BFG.
Note 13 – Earnings per Share
The following table is a reconciliation of the components used to derive basic and diluted EPS for the three months ended March 31, 2023 and 2022 ($ in thousands, except share and per share amounts):
| | | | | | | | | | | |
| For the Three Months Ended March 31, |
($ in thousands) | 2023 | | 2022 |
Numerator: | | | |
Net income | $ | 3,861 | | | $ | 9,434 | |
Amount allocated to participating common shareholders(1) | (37) | | | — | |
Net income allocate to common shareholders | $ | 3,824 | | | $ | 9,434 | |
Denominator: | | | |
Weighted average shares outstanding, basic | 12,708,326 | | 12,777,237 |
Weighted average effect of dilutive securities: | | | |
Stock options | 391,477 | | 619,516 |
Warrants | 72,485 | | 170,558 |
Weighted average shares outstanding, diluted | 13,172,288 | | 13,567,311 |
Earnings per share, basic | $ | 0.30 | | | $ | 0.74 | |
Earnings per share, diluted | $ | 0.29 | | | $ | 0.70 | |
(1)Represents earnings attributable to holders of unvested restricted stock issued outside of the Plan to the Company’s employees.
There were 471,952 and 219,512 anti-dilutive options for the three months ended March 31, 2023 and 2022, respectively, reported in the table above. There were 197,515 shares and 99,442 anti-dilutive warrants for the three months ended March 31, 2023 and 2022, respectively, reported in the table above.