UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

 

☒ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2019.

OR

☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                    to

Commission file number 033-21202

Delmar Bancorp

(Exact name of registrant as specified in its charter)

 

Registrant's telephone number, including area code (410)‑548‑1100

Securities registered pursuant to Section 12(b) of the Act: None.

Securities registered pursuant to Section 12(g) of the Act: None.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒

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

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

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

 

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

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

As of June 28, 2019, which was the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $42,679,746 based on the closing price of $7.60 per share on the OTCQX market on that date.

As of March 27, 2020, there were 17,807,639 shares outstanding of the registrant’s common stock, $0.01 par value..

Documents Incorporated by Reference:

None.

 

 

 

 

TABLE OF CONTENTS

 

PART I

 

Item 1. Business.

 

General Information

 

Delmar Bancorp. Delmar Bancorp (“Delmar”) is a Maryland chartered corporation and a bank holding company registered with and supervised by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). Delmar holds all of the issued and outstanding shares of common stock of The Bank of Delmarva (“Delmarva”) and Virginia Partners Bank (“Partners” and, together with Delmarva, the “Affiliate Banks”). Delmar was incorporated on January 6, 1988 under the general corporation law of Maryland for the purpose of becoming a bank holding company for Delmarva. Partners is a commercial bank which was organized under the laws of the Commonwealth of Virginia and commenced regular operations on July 8, 2008. Delmar acquired Partners on November 15, 2019 through an exchange of shares in an all-stock transaction (the “Share Exchange”) pursuant to which each share of Partners common stock was exchanged for 1.7179 shares of Delmar common stock.  Options and warrants to acquire Partners common stock were assumed by Delmar and converted into options and warrants to acquire shares of Delmar common stock.

 

Delmar has no direct subsidiaries other than Delmarva and Partners. The principal executive office of Delmar is located at 2245 Northwood Drive, Salisbury, Maryland 21801.

 

Since commencing operations, Delmar’s business has consisted primarily of managing and supervising Delmarva and its principal source of income has been revenues generated by Delmarva. Delmar anticipates that going forward its business will continue to consist primarily of managing and supervising the Affiliate Banks and that its principal source of income will be revenues generated by the Affiliate Banks.

 

Delmar provides various services to the Affiliate Banks which include, but are not limited to, management assistance, internal auditing services, compliance management, financial reporting and training, and vendor management support.

 

The Bank of Delmarva. Delmarva, a community oriented financial institution, was established in Maryland in 1896, reorganized as a national bank in 1996, and reorganized as a Delaware state chartered bank in 2003. Delmarva provides a broad range of commercial and consumer banking services to individuals, small and medium-sized businesses and professionals in Southern New Jersey and the eastern shore regions of Maryland and Delaware, including Sussex County, Delaware, Wicomico County, Maryland and Worcester County, Maryland. Delmarva currently operates 14 full service banking offices, located in Delmar, Salisbury and Ocean City, Maryland and Laurel, Dagsboro Rehoboth, Delaware, and Cherry Hill, Evesham and Moorestown, New Jersey, along with 16 automated teller machines (“ATMs”). In March 2018, Delmar completed its acquisition of Liberty Bell Bank through a merger with Delmarva, with Delmarva being the surviving entity. Through the merger, Delmarva gained the branches in Cherry Hill, Evesham and Moorestown, New Jersey, which are operated under the name Liberty Bell Bank, a Division of The Bank of Delmarva. Delmarva’s main office is located at 910 Norman Eskridge Highway, Seaford, Delaware.

 

Delmarva has five consolidated subsidiaries, three of which are wholly owned, organized to hold foreclosed real estate.

 

Virginia Partners Bank. Partners is headquartered in Fredericksburg, Virginia, which is also the location of an operations center. Partners has three branches in Fredericksburg, Virginia. In Maryland, Partners trades under the name Maryland Partners Bank (a division of Virginia Partners Bank), and operates a full service branch and commercial banking office in La Plata, Maryland and a Loan Production Office in Annapolis, Maryland. Partners engages in the general banking business and provides financial services to the communities in and around the Greater Fredericksburg, Virginia area (Stafford County, Spotsylvania County, King George County, Caroline County, and the City of Fredericksburg, Virginia), and Anne Arundel County and the three counties of Southern Maryland (Charles County, Calvert County and St. Mary’s County).

 

Partners has two wholly owned subsidiaries and one majority owned subsidiary. Bear Holdings, Inc. was established in 2011 for the purpose of holding properties acquired through foreclosure that are classified as other real estate owned. In 2012, 410 William Street, LLC was formed for the purpose of acquiring and holding an interest in the property at 410 William Street, which houses one of Partners’ four branches, including the executive offices. On January 1, 2018, Partners acquired a 51% ownership interest in Johnson Mortgage Company, LLC (“JMC”), which is a residential mortgage company headquartered in Newport News, Virginia, with branch offices in Fredericksburg and Williamsburg, Virginia. JMC is engaged in the mortgage banking business in which JMC originates, closes, and immediately sells mortgage loans and related servicing rights to permanent investors in the secondary market. The financial position and operating results of these subsidiaries are included in Partners consolidated financial statements. For JMC, Partners reflects the issued and outstanding interest not held by Partners in its consolidated financial statements as noncontrolling interest.

 

Business Strategy

 

Delmar is a multi-bank holding company, whose wholly-owned subsidiaries are The Bank of Delmarva and Virginia Partners Bank.  Combined, these banks make Delmar a $1.2 billion company, serving customers from southern New Jersey and Delaware, into Maryland and Virginia.

 

As member banks of the "Affiliate Bank" model, Delmar’s Affiliate Banks employ hundreds of people and invest millions of dollars into their local economies. Ultimately, Delmar’s community banks put families into homes, send kids to college, and provide critical financial support to allow "Main Street businesses" to prosper.  

 

The Affiliate Bank model offers other community banks the best of both worlds: keep what is best about community banking, while enjoying the benefits of a larger, stronger parent company with better access to technology and  capital, and improved shareholder liquidity. Affiliate banks keep their own charters, names, boards, and management. Affiliate bank customers experience better service through the combined branch network of the affiliates and the larger lending capacity created by the affiliation.

 

It is a strategic goal of Delmar to add additional affiliate banks to the Company, to create a connected marketplace in the greater mid-Atlantic region.

 

Products and Services

 

Each Affiliate Bank is a full service community bank, and offers a comprehensive array of deposit products, loan services, and other services to its customers, filling both retail and commercial needs. These products and services include:

 

 

Market Area and Deposit Share

 

Delmarva’s primary market area consists of Sussex County, Delaware, Wicomico County, Maryland, Worcester County, Maryland, Camden County, New Jersey and Burlington County, New Jersey and contiguous counties in Maryland, Delaware and New Jersey. As of June 30, 2019, Delmarva had the third highest level of deposits of banks active in the Salisbury MD-DE MSA, excluding a large credit card bank which reports all of its deposits in the market. Delmarva’s market share in the Philadelphia—Camden—Wilmington, Pennsylvania, New Jersey, Delaware, Maryland is less than 0.1%.

 

In Greater Fredericksburg, Partners has two offices in the City of Fredericksburg (including Partners’ headquarters) and one office in Spotsylvania County. In Maryland, Partners has a full service branch and commercial lending office in La Plata, Maryland, and a Loan Production Office in Annapolis, Maryland. All branch locations have drive-thru facilities and ATMs. JMC has locations in Newport News, Williamsburg, and Spotsylvania, Virginia. The Spotsylvania office is co-located with a branch of Partners.

 

Partners has two distinct market areas for commercial banking: Greater Fredericksburg (Stafford County, Spotsylvania County, King George County, Caroline County, and the City of Fredericksburg, Virginia); and, Anne Arundel County and the three counties of Southern Maryland (Charles County, Calvert County and St. Mary’s County). The markets for JMC include the Newport News/Williamsburg, Virginia markets, and Greater Fredericksburg.

 

The Washington-Arlington-Alexandria, DC-VA-MD-WV MSA, where all of Partners branches are located, had a combined deposit market of $261 billion as of June 30, 2019. Partners was ranked 37th out of 75 financial institutions, with total deposits of $334 million as of June 30, 2019. In Fredericksburg City, Virginia, Partners was ranked 3rd, with a 17.76% market share, as of June 30, 2019. In Spotsylvania County, Virginia, Partners was ranked 8th, with a 2.76% market share, as of June 30, 2019. In Charles County, Maryland, Partners was ranked 10th, with a 2.28% market share, as of June 30, 2019.

 

Competition

 

Both Delmarva and Partners face significant competition for the attraction of deposits and the origination of loans from other community banks and larger banks with regional or national footprints.  The Affiliate Banks also face

competition from other financial services companies such as brokerage firms, credit unions and insurance companies, mortgage companies, insurance companies and nonbank and online depositories and lenders. Larger bank competitors may have many offices operating over a wide geographic area. Among the advantages such large banks have over Delmarva and Partners is their ability to finance wide-ranging advertising campaigns, and by virtue of their greater total capitalization, to have substantially higher lending limits than Delmarva and Partners. Factors such as interest rates offered, the number and location of branches and the types of products offered, as well as the reputation of the institution, affect competition for deposits and loans.

 

Both Delmarva and Partners differentiate themselves from their competitors through superior customer service and responsiveness with accountability to a local management team, board of directors and advisory board. Delmar believes that its multi-bank model permits its Affiliate Banks to maintain their character as community banks and the close relationships they maintain with their customers and communities, while affiliating with a larger organization that can provide more sophisticated technology and products, access to capital and support and guidance from partnered institutions.

 

Risk Management

 

Delmar believes that effective risk management is of primary importance. Risk management refers to the activities by which Delmar identifies, measures, monitors, evaluates and manages the risks its faces in the course of its banking activities. These include liquidity, interest rate, credit, operational, compliance, regulatory, strategic, financial and reputational risk exposures. Delmar’s and the Affiliate Banks’ boards of directors and management teams have created a risk-conscious culture that is focused on quality growth, which starts with capable and experienced risk management teams and infrastructure capable of addressing the evolving risks Delmar faces, as well as the changing regulatory and compliance landscape. Delmar’s risk management approach employs comprehensive policies and processes to establish robust governance. Delmar believes a disciplined and conservative underwriting approach has been the key to its strong asset quality.

 

The lending activities in which the Affiliate Banks engage carry the risk that the borrowers will be unable to perform on their obligations. As such, interest rate policies of the Federal Reserve and general economic conditions, nationally and in Delmarva’s and Partners’ market areas, could have a significant impact on Delmarva’s and Partners’ results of operations, respectively. To the extent that economic conditions deteriorate, business and individual borrowers may be less able to meet their obligations in full, in a timely manner, resulting in decreased earnings or losses. Economic conditions may also adversely affect the value and liquidity of property pledged as security for loans.

 

Through its Affiliate Banks, Delmar’s goal is to mitigate risks in the event of unforeseen threats to the loan portfolio as a result of economic downturn or other negative influences. Plans for mitigating inherent risks in managing loan assets include: carefully enforcing loan policies and procedures, evaluating each borrower’s business plan during the underwriting process and throughout the loan term, identifying and monitoring primary and alternative sources for loan repayment, and obtaining collateral to mitigate economic loss in the event of liquidation. Specific loan reserves are established based upon credit and/or collateral risks on an individual loan basis. A risk rating system is employed to proactively estimate loss exposure and provide a measuring system for setting general and specific reserve allocations. The Affiliate Bank’s management, lending officers and credit administration team emphasize a strong risk management culture supported by comprehensive policies and procedures for credit underwriting, funding and administration that the Affiliate Banks believe have enabled them to maintain sound asset quality. The underwriting methodology emphasizes establishing and monitoring strong overall cash flow throughout a customer’s business operations, appropriate loan-to-value ratios, full or partial guarantors when deemed necessary, and/or strong tertiary sources of re-payment. The Affiliate Banks’ tiered underwriting structure includes progressive levels of individual loan authority, concurrent authority and senior loan committee approval. The Affiliate Banks’ loan review function performs regular internal loan reviews and identifies early warning indicators to proactively monitor the loan portfolio. Asset quality is regularly reported to, and monitored by, Delmar’s board.

 

Each of the Affiliate Banks’ lending activities are subject to a variety of lending limits imposed by state and federal law. These limits will increase or decrease in response to increases or decreases in its level of capital. At December 31, 2019, Delmarva had a legal lending limit of $11.8 million. At December 31, 2019, Delmarva’s average

funded loan size outstanding for commercial real estate (including commercial construction) and commercial loans was $491 thousand and $126 thousand, respectively. At December 31, 2019, Partners had a legal lending limit of $7.1 million. At December 31, 2019, Partner’s average funded loan size outstanding for commercial real estate (including commercial construction) and commercial loans was $592 thousand and $104 thousand, respectively.

 

Concentrations of Credit Risk. Most of Delmar’s lending is conducted with businesses and individuals in eastern shore regions of Maryland and Delaware and in southern New Jersey (through Delmarva) and Fredericksburg, Virginia, Charles County, Maryland and Anne Arundel County, Maryland (through Partners). Delmar’s loan portfolio consists primarily of commercial real estate loans, including construction and land loans, which totaled $577.3 million and constituted 57.8% of total loans as of December 31, 2019, and 1-4 family residential real estate loans, which totaled $247.0 million and constituted 24.8% of total loans as of December 31, 2019. The geographic concentration of Delmar’s loans subjects its business to the general economic conditions within that market area. The Share Exchange with Partners somewhat reduced the geographic concentration of Delmarva’s loans, but Delmarva’s current and prospective market areas are largely affected by the same general economic factors that affect Partners. The risks created by such concentrations have been considered by management in the determination of the adequacy of the allowance for loan losses. Delmar’s management believes the allowance for loan losses of each Affiliate Bank is adequate to cover probable incurred losses in the loan portfolios of each respective Affiliate Bank as of December 31, 2019.

 

Comprehensive risk management practices and appropriate capital levels are essential elements of a sound commercial real estate lending program. A concentration in commercial real estate adds a dimension of risk that compounds the risk inherent in individual loans. The federal banking agencies have issued guidance governing financial institutions with concentrations in commercial real estate lending. The guidance provides that institutions that have (i) total reported loans for construction, land development, and other land which represent 100% or more of an institution’s total risk-based capital; or (ii) total reported commercial real estate loans, excluding loans secured by owner-occupied commercial real estate, representing 300% or more of the institution’s total risk-based capital and the institution’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months, are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital.

 

Delmarva has a concentration in both non-owner-occupied commercial real estate and construction and land development loans. At December 31, 2019, Delmarva’s non-owner-occupied commercial real estate loan portfolio constituted 207.9% of capital and its construction, land development and land loans constituted 71.4% of capital.

 

Partners has a concentration in both non-owner-occupied commercial real estate and construction and land development loans. At December 31, 2019, Partners’ non-owner-occupied commercial real estate loan portfolio constituted 201.0% of capital and its construction, land development and land loans constituted 54.6% of capital.

 

 

Employees

As of December 31, 2019, Delmar had approximately 218 full-time equivalent employees. Delmar believes that its employee relations are good.

 

Supervision and Regulation

 

Delmar’s and the Affiliate Banks’ business and operations are subject to extensive federal and state governmental regulation and supervision. The following is a brief summary of certain statutes and rules and regulations that affect or will affect us. This summary is not complete, and Delmar refers you to the particular statutory or regulatory provisions or proposals for more information. Because regulation of financial institutions changes regularly and is the subject of constant legislative and regulatory debate, Delmar cannot forecast how federal and state regulation and supervision of financial institutions may change in the future and affect the operations of Delmar and the Affiliate Banks.

 

Supervision, regulation, and examination by the regulatory agencies are intended primarily for the protection of depositors and the Deposit Insurance Fund, rather than shareholders.

 

Regulatory Reform. The financial crisis of 2008, including the downturn of global economic, financial and money markets and the threat of collapse of numerous financial institutions, and other events led to the adoption of numerous laws and regulations that apply to, and focus on, financial institutions. The most significant of these laws is the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which was enacted on July 21, 2010 and, in part, was intended to implement significant structural reforms to the financial services industry.

 

The Dodd-Frank Act implemented far-reaching changes across the financial regulatory landscape, including changes that have significantly affected the business of all bank holding companies and banks, including Delmar and the Affiliate Banks.  Some of the rules that have been proposed and, in some cases, adopted to comply with the Dodd-Frank Act's mandates are discussed further below. In May 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the “EGRRCPA”) was enacted to reduce the regulatory burden on certain banking organizations, including community banks, by modifying or eliminating certain federal regulatory requirements. While the EGRRCPA maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain aspects of the regulatory framework for small depository institutions with assets of less than $10 billion as well as for larger banks with assets above $50 billion. In addition, the EGRRCPA included regulatory relief for community banks regarding regulatory examination cycles, call reports, application of the Volcker Rule (proprietary trading prohibitions), mortgage disclosures, qualified mortgages, and risk weights for certain high-risk commercial real estate loans. However, federal banking regulators retain broad discretion to impose additional regulatory requirements on banking organizations based on safety and soundness and U.S. financial system stability considerations.

 

Delmar continues to experience ongoing regulatory reform. These regulatory changes could have a significant effect on how Delmar and the Affiliate Banks conduct their businesses, including increased compliance costs and other adverse effects on the business, financial condition and results of operations of Delmar and the Affiliate Banks. The specific implications of the Dodd-Frank Act, the EGRRCPA, and other potential regulatory reforms cannot yet be fully predicted and will depend to a large extent on the specific regulations that are to be adopted in the future.  Certain aspects of the Dodd-Frank Act and the EGRRCPA are discussed in more detail below.

 

Delmar. Delmar is a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the “BHC Act”) and subject to regulation and supervision by the Federal Reserve. The BHC Act and other federal laws subject bank holding companies to restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations and unsafe and unsound banking practices. As a bank holding company, Delmar is required to file with the Federal Reserve an annual report and such other additional information as the Federal Reserve may require pursuant to the BHC Act. The Federal Reserve may also examine Delmar and each of its subsidiaries.

 

The BHC Act requires approval of the Federal Reserve for, among other things, a bank holding company’s direct or indirect acquisition of control of more than 5% of the voting shares, or substantially all the assets, of any bank or the merger or consolidation by a bank holding company with another bank holding company. The BHC Act generally permits the acquisition by a bank holding company of control or substantially all the assets of any bank located in a state other than the home state of the bank holding company, except where the bank has not been in existence for the minimum period of time required by state law; but if the bank is at least five years old, the Federal Reserve may approve the acquisition.

 

With limited exceptions, a bank holding company is prohibited from acquiring control of any voting shares of any company which is not a bank or bank holding company and from engaging directly or indirectly in any activity other than banking or managing or controlling banks or furnishing services to or performing service for its authorized subsidiaries. A bank holding company may, however, engage in, or acquire an interest in, a company that engages in activities which the Federal Reserve has determined by order or regulation to be so closely related to banking or managing or controlling banks as to be properly incident thereto. In making such a determination, the Federal Reserve is required to consider whether the performance of such activities can reasonably be expected to produce benefits to the public, such as convenience, increased competition or gains in efficiency, which outweigh possible adverse effects, such

as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. The Federal Reserve is also empowered to differentiate between activities commenced de novo and activities commenced by the acquisition, in whole or in part, of a going concern.

 

The Federal Reserve may order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company’s continued ownership, activity or control constitutes a serious risk to the financial safety, soundness, or stability of it or any of its bank subsidiaries.

 

Subsidiary banks of a bank holding company are subject to restrictions imposed by the Federal Reserve Act on any extensions of credit to a bank holding company or any of its subsidiaries, or investments in the stock or other securities thereof, and on the taking of such stock or securities as collateral for loans to any borrower. Further, a bank holding company and any subsidiary bank are prohibited from engaging in tie-in arrangements in connection with the extension of credit. A subsidiary bank may not extend credit, lease or sell property, or furnish any services, or fix or vary the consideration for any of the foregoing on the condition that: (i) the customer obtain or provide some additional credit, property or services from or to such bank other than a loan, discount, deposit or trust service; (ii) the customer obtain or provide some additional credit, property or service from or to Delmar or any of its subsidiaries; or (iii) the customer not obtain some other credit, property or service from competitors, except for reasonable requirements to assure the soundness of credit extended.

 

The Gramm-Leach-Bliley Act (the “GLB Act”) allows a bank holding company or other company to elect to become a financial holding company, which would allow that company to engage in activities that are financial in nature, that are incidental to such activities, or are complementary to such activities. The GLB Act enumerates certain activities that are deemed financial in nature, such as underwriting insurance or acting as an insurance principal, agent or broker, underwriting, dealing in or making markets in securities, and engaging in merchant banking under certain restrictions. It also authorizes the Federal Reserve to determine by regulation what other activities are financial in nature, or incidental or complementary thereto. Delmar has not elected financial holding company status.

 

The Federal Deposit Insurance Act (the “FDIA”) and Federal Reserve policy require a bank holding company to serve as a source of financial and managerial strength to its bank subsidiaries. In addition, where a bank holding company has more than one FDIC-insured bank or thrift subsidiary, like Delmar, each of the bank holding company’s subsidiary FDIC-insured depository institutions is responsible for any losses to the FDIC as a result of an affiliated depository institution’s failure. As a result of a bank holding company’s source of strength obligation, a bank holding company may be required to provide funds to a bank subsidiary in the form of subordinate capital or other instruments which qualify as capital under bank regulatory rules. Any loans from the holding company to such subsidiary banks likely would be unsecured and subordinated to such bank’s depositors and perhaps to other creditors of Delmarva and Partners.

 

A bank holding company is generally required to give the Federal Reserve prior written notice of any purchase or redemption of its own then outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the company’s consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, Federal Reserve order or directive, or any condition imposed by, or written agreement with, the Federal Reserve. The Federal Reserve has adopted an exception to this approval requirement for well-capitalized bank holding companies that meet certain conditions.

 

As a Maryland corporation, Delmar is subject to limitations on and requirements for its activities. For example, state law restrictions include limitations and restrictions relating to indemnification of directors, distributions to shareholders, transactions involving directors, officers or interested shareholders, maintenance of books, records, minutes, borrowing and the observance of corporate formalities.

 

 

The Affiliate Banks. Delmarva is a Delaware chartered commercial bank which is not a member of the Federal Reserve System (a “state nonmember bank”) whose accounts are insured by the Deposit Insurance Fund of the FDIC up to the maximum legal limits. Delmarva is subject to regulation, supervision and regular examination by the State Bank Commissioner of the State of Delaware (the “Delaware Commissioner”) and the FDIC.

 

Partners is a Virginia chartered commercial bank which is a member of the Federal Reserve System (a “state member bank”) whose accounts are insured by the Deposit Insurance Fund of the FDIC up to the maximum legal limits. Partners is subject to regulation, supervision and regular examination by the Bureau of Financial Institutions of the State Corporation Commission of the Commonwealth of Virginia (the “Virginia Bureau”) and the Federal Reserve.

 

The regulations of these various agencies govern most aspects of Delmarva’s and Partners’ businesses, including required reserves against deposits, loans, investments, mergers and acquisitions, borrowing, dividends and location and number of branch offices. The laws and regulations governing the Affiliate Banks generally have been promulgated to protect depositors and the Deposit Insurance Fund, and not for the purpose of protecting shareholders. Competition among commercial banks, savings and loan associations, and credit unions has increased following enactment of legislation, which greatly expanded the ability of banks and bank holding companies to engage in interstate banking or acquisition activities.

Banking is a business that depends on interest rate differentials. In general, the differences between the interest paid by a bank on its deposits and its other borrowings and the interest received by a bank on loans extended to its customers and securities held in its investment portfolio constitute the major portion of Delmarva’s and Partners’ earnings. Thus, the earnings and growth of both Affiliate Banks will be subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve, which regulates the supply of money through various means including open market dealings in United States government securities. The nature and timing of changes in such policies and their impact on Delmarva and Partners cannot be predicted.

 

Branching and Interstate Banking. The federal banking agencies are authorized to approve interstate bank merger transactions without regard to whether such transaction is prohibited by the law of any state, unless the home state of one of the banks has opted out of the interstate bank merger provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Riegle-Neal Act”) by adopting a law after the date of enactment of the Riegle-Neal Act and prior to June 1, 1997 which applies equally to all out-of-state banks and expressly prohibits merger transactions involving out-of-state banks. Interstate acquisitions of branches are permitted only if the law of the state in which the branch is located permits such acquisitions. Such interstate bank mergers and branch acquisitions are also subject to the nationwide and statewide insured deposit concentration limitations described in the Riegle-Neal Act. The Dodd-Frank Act authorizes national and state banks to establish de novo branches in other states to the same extent as a bank chartered by that state would be permitted to branch.

 

Capital Requirements.

 

Basel III Capital Framework. The Federal Reserve and the FDIC have adopted rules to implement the Basel III capital framework as outlined by the Basel Committee on Banking Supervision and standards for calculating risk-weighted assets and risk-based capital measurements (collectively, the “Basel III Final Rules”) that apply to banking institutions they supervise. For the purposes of these capital rules, (i) common equity tier 1 capital (“CET1”) consists principally of common stock (including surplus) and retained earnings; (ii) Tier 1 capital consists principally of CET1 plus non-cumulative preferred stock and related surplus, and certain grandfathered cumulative preferred stocks and trust preferred securities; and (iii) Tier 2 capital consists of other capital instruments, principally qualifying subordinated debt and preferred stock, and limited amounts of an institution’s allowance for loan losses. Each regulatory capital classification is subject to certain adjustments and limitations, as implemented by the Basel III Final Rules. The Basel III Final Rules also establish risk weightings that are applied to many classes of assets held by community banks, importantly including applying higher risk weightings to certain commercial real estate loans.

 

The Basel III Final Rules and minimum capital ratios required to be maintained by banks were effective January 1, 2015. The Basel III Final Rules also include a requirement that banks maintain additional capital (the “capital conservation buffer”), which was phased in beginning January 1, 2016 and was fully phased in effective January 1,

2019. The Basel III Final Rules and fully phased in capital conservation buffer require banks to maintain (i) a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% capital conservation buffer (which is added to the minimum CET1 ratio, effectively resulting in a required ratio of CET1 to risk-weighted assets of at least 7%), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (effectively resulting in a required Tier 1 capital ratio of 8.5%), (iii) a minimum ratio of total (that is, Tier 1 plus Tier 2) capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (effectively resulting in a required total capital ratio of 10.5%) and (iv) a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average total assets, subject to certain adjustments and limitations.

 

The Basel III Final Rules provide deductions from and adjustments to regulatory capital measures, primarily to CET1, including deductions and adjustments that were not applied to reduce CET1 under historical regulatory capital rules. For example, mortgage servicing rights, deferred tax assets dependent upon future taxable income, and significant investments in non-consolidated financial entities must be deducted from CET1 to the extent that any one such category exceeds 10.0% of CET1 or all such categories in the aggregate exceed 15.0% of CET1.

 

The capital ratios described above are the minimum levels that the federal banking agencies expect. State and federal regulators have the discretion to require an institution to maintain higher capital levels based upon its concentrations of loans, the risk of its lending or other activities, the performance of its loan and investment portfolios and other factors. Failure to maintain such higher capital expectations could result in a lower composite regulatory rating, which would impact the institution’s deposit insurance premiums and could affect its ability to borrow and costs of borrowing, and could result in additional or more severe enforcement actions. In respect of institutions with high concentrations of loans in areas deemed to be higher risk, or during periods of significant economic stress, regulators may require an institution to maintain a higher level of capital, and/or to maintain more stringent risk management measures, than those required by these regulations.

Community Bank Leverage Ratio. As a result of the EGRRCPA, the federal banking agencies were required to develop

a Community Bank Leverage Ratio (the ratio of a bank’s tangible equity capital to average total consolidated assets) for banking organizations with assets of less than $10 billion, such as either of the Affiliate Banks or Delmar. On October 29, 2019, the federal banking agencies  issued a final rule that implements the Community Bank Leverage Ratio Framework (the “CBLRF”).  To qualify for the CBLRF, a bank must have less than $10 billion in total consolidated assets, limited amounts of off-balance sheet exposures and trading assets and liabilities, and a leverage ratio greater than 9.0%. A bank that elects the CBLRF and has a leverage ratio greater than 9.0% will be considered to be in compliance with Basel III capital requirements and exempt from the complex Basel III calculations and will also be deemed “well capitalized” under Prompt Corrective Action regulations, discussed below.  A bank that falls out of compliance with the CBLRF will have a two-quarter grace period to come back into full compliance, provided its leverage ratio remains above 8.0% (a bank will be deemed “well capitalized” during the grace period).  The CBLRF will be available for banking organizations to use as of March 31, 2020 (with the flexibility for banking organizations to subsequently opt into or out of the CBLRF, as applicable).

 

Small Bank Holding Company. The EGRRCPA also expanded the category of bank holding companies that may rely on the Federal Reserve’s Small Bank Holding Company Policy Statement by raising the maximum amount of assets a qualifying bank holding company may have from $1 billion to $3 billion. In addition to meeting the asset threshold, a bank holding company must not engage in significant nonbanking activities, not conduct significant off-balance sheet activities, and not have a material amount of debt or equity securities outstanding and registered with the Securities and Exchange Commission (the “SEC”) (subject to certain exceptions). The Federal Reserve may, in its discretion, exclude any bank holding company from the application of the Small Bank Holding Company Policy Statement if such action is warranted for supervisory purposes.

 

In August 2018, the Federal Reserve issued an interim final rule to apply the Small Bank Holding Company Policy Statement to bank holding companies with consolidated total assets of less than $3 billion. The policy statement, which, among other things, exempts certain bank holding companies from minimum consolidated regulatory capital ratios that apply to other bank holding companies. As a result of the interim final rule, which was effective August 30, 2018, Delmar expects that it will be treated as a small bank holding company and will not be subject to regulatory capital requirements. The comment period on the interim final rule closed on October 29, 2018 and, to date, the Federal Reserve

has not issued a final rule to replace the interim final rule. The Affiliate Banks remains subject to the regulatory capital requirements described above.

 

Prompt Corrective Action. Under Section 38 of the FDIA, each federal banking agency is required to implement a system of prompt corrective action for institutions which it regulates. The federal banking agencies have promulgated substantially similar regulations to implement the system of prompt corrective action established by Section 38 of the FDIA. The federal banking agencies have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institution in question is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” These terms are defined under uniform regulations issued by each of the federal banking agencies regulating these institutions. An insured depository institution which is less than adequately capitalized must adopt an acceptable capital restoration plan, is subject to increased regulatory oversight and is increasingly restricted in the scope of its permissible activities. As of December 31, 2019, both Affiliate Banks were considered “well capitalized.”

 

Regulatory Enforcement Authority. Federal banking law grants substantial enforcement powers to federal banking agencies. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions against banking organizations and institution-affiliated parties. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities. In addition, the FDIC could terminate the institution’s deposit insurance if it determines that the institution’s financial condition is unsafe or unsound or that the institution engaged in unsafe or unsound practices that violated an applicable rule, regulation, order or condition enacted or imposed by the institution’s regulators.

 

As a result of the volatility and instability in the financial system in recent years, Congress, the bank regulatory authorities and other government agencies have called for or proposed additional regulation and restrictions on the activities, practices and operations of banks and their holding companies. The Congress and the federal banking agencies have broad authority to require all banks and holding companies to adhere to more rigorous or costly operating procedures, corporate governance procedures, or to engage in activities or practices which they would not otherwise elect. Any such requirement could adversely affect Delmar’s business and results of operations.

 

Community Reinvestment Act. The Community Reinvestment Act (the “CRA”) requires that, in connection with examinations of financial institutions within their respective jurisdictions, the federal banking agencies will evaluate the record of each financial institution in meeting the needs of its local community, including low- and moderate-income neighborhoods. A bank’s CRA performance is also considered in evaluating applications seeking approval for mergers, acquisitions, and new offices or facilities. Failure to adequately meet these criteria could result in additional requirements and limitations being imposed. Additionally, banks must publicly disclose the terms of certain CRA-related agreements. These factors also are considered in evaluating share exchanges, mergers, acquisitions and applications to open a branch or facility. In their most recent CRA evaluations, each Affiliate Bank received a “Satisfactory” CRA rating.

Fair and Responsible Banking. Banks and other financial institutions are subject to numerous laws and regulations intended to promote fair and responsible banking and prohibit unlawful discrimination and unfair, deceptive or abusive practices in banking. These laws include, among others, the Dodd-Frank Act, Section 5 of the Federal Trade Commission Act, the Equal Credit Opportunity Act, and the Fair Housing Act. Many states and local jurisdictions have consumer protection laws analogous, and in addition, to those listed above. These federal, state and local laws regulate the manner in which financial institutions deal with customers taking deposits, making loans or conducting other types of transactions. Failure to comply with these laws and regulations could give rise to regulatory sanctions, and actions by the U.S. Department of Justice and state attorneys general.

 

Consumer Financial Protection Bureau. The Dodd-Frank Act created the CFPB, an independent federal agency within the Federal Reserve System having broad rulemaking, supervisory and enforcement powers under various

federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Practices Act, the consumer financial privacy provisions of the GLB Act and certain other statutes. The CFPB has examination and primary enforcement authority with respect to depository institutions with more than $10.0 billion in assets. Smaller institutions, including Delmarva and Partners, are subject to rules promulgated by the CFPB but continue to be examined and supervised by federal banking agencies for compliance with federal consumer protection laws and regulations. The CFPB also has authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.

 

The CFPB has proposed or issued a number of important rules affecting a wide range of consumer financial products. The changes resulting from the Dodd-Frank Act and CFPB rulemakings and enforcement policies may impact the profitability of our business activities, limit our ability to make, or the desirability of making, certain types of loans, require us to change our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect our business or profitability.

 

The CFPB has concentrated much of its rulemaking efforts on reforms related to residential mortgage transactions. The CFPB has issued rules related to a borrower’s ability to repay and qualified mortgage standards, mortgage servicing standards, loan originator compensation standards, requirements for high cost mortgages, appraisal and escrow standards and requirements for higher-priced mortgages. The CFPB has also issued rules establishing integrated disclosure requirements for lenders and settlement agents in connection with most closed end, real estate secured consumer loans; and rules which, among other things, expand the scope of information lenders must report in connection with mortgage and other housing-related loan applications under the Home Mortgage Disclosure Act. These rules include significant regulatory and compliance changes and are expected to have a broad impact on the financial services industry.

 

The rule implementing the Dodd-Frank Act requirement that lenders determine whether a consumer has the ability to repay a mortgage loan, established certain minimum requirements for creditors when making ability to pay determinations, and established certain protections from liability for mortgages meeting the definition of “qualified mortgages.” Generally, the rule applies to all consumer-purpose, closed-end loans secured by a dwelling including home-purchase loans, refinances and home equity loans—whether first or subordinate lien. The rule does not cover, among other things, home equity lines of credit or other open-end credit; temporary or “bridge” loans with a term of 12 months or less, such as a loan to finance the initial construction of a dwelling; a construction phase of 12 months or less of a construction-to-permanent loan; and business-purpose loans, even if secured by a dwelling. The rule afforded greater legal protections for lenders making qualified mortgages that are not “higher priced.” Qualified mortgages must generally satisfy detailed requirements related to product features, underwriting standards, and a points and fees requirement whereby the total points and fees on a mortgage loan cannot exceed specified amounts or percentages of the total loan amount. Mandatory features of a qualified mortgage include: (i) a loan term not exceeding 30 years; and (ii) regular periodic payments that do not result in negative amortization, deferral of principal repayment, or a balloon payment. Further, the rule clarified that qualified mortgages do not include “no-doc” loans and loans with negative amortization, interest-only payments, or balloon payments. The rule created special categories of qualified mortgages originated by certain smaller creditors. Under the EGRRCPA, most residential mortgage loans originated and held in portfolio by a bank with less than $10 billion in assets will be designated as “qualified mortgages.”  Higher-priced qualified mortgages (e.g., sub-prime loans) receive a rebuttable presumption of compliance with ability-to-repay rules, and other qualified mortgages (e.g., prime loans) are deemed to comply with the ability-to-repay rules.

 

FDIC Insurance. The deposits of the Affiliate Banks are insured by the Deposit Insurance Fund (the “DIF”) of the FDIC up to the standard maximum insurance amount for each deposit insurance ownership category. The basic limit on FDIC deposit insurance coverage is $250,000 per depositor. Under the FDIA, the FDIC may terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations as an insured institution, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC, subject to administrative and potential judicial hearing and review processes.

 

The DIF is funded by assessments on banks and other depository institutions calculated based on average consolidated total assets minus average tangible equity (defined as Tier 1 capital). As required by the Dodd-Frank Act, the FDIC has adopted a large-bank pricing assessment scheme, set a target “designated reserve ratio” (described in more detail below) of 2.0% for the DIF and, in lieu of dividends, provides for a lower assessment rate schedule when the reserve ratio reaches 2.0% and 2.5%. An institution's assessment rate is based on a statistical analysis of financial ratios that estimates the likelihood of failure over a three-year period, which considers the institution’s weighted average CAMELS component rating, and is subject to further adjustments including those related to levels of unsecured debt and brokered deposits (not applicable to banks with less than $10.0 billion in assets).  At December 31, 2019, total base assessment rates for institutions that have been insured for at least five years range from 1.5 to 30 basis points applying to banks with less than $10.0 billion in assets.

 

The Dodd-Frank Act transferred to the FDIC increased discretion with regard to managing the required amount of reserves for the DIF, or the “designated reserve ratio.” The FDIA requires that the FDIC consider the appropriate level for the designated reserve ratio on at least an annual basis. As of December 31, 2019, the designated reserve ratio was 2.00 percent and the minimum designated reserve ratio was 1.35 percent.

 

At September 30, 2019, the reserve ratio was 1.41 percent. Banks with less than $10 billion in total consolidated assets are eligible for credits to offset the portion of their assessments that helped to raise the reserve ratio to 1.35 percent. The FDIC automatically applies these credits to reduce an eligible bank’s regular DIF assessment up to the entire amount of the assessment.  The FDIC will remit any such remaining credits in a lump sum to the appropriate bank following application to the bank’s regular DIF assessment for four quarterly assessment periods. Delmarva was awarded credits of $176 thousand, all of which was used to offset its DIF assessment in the third and fourth quarters of 2019; Partners was awarded credits of $94 thousand, of which $55 thousand was used to offset its DIF assessment in the third and fourth quarters of 2019

 

Delmar expects that the remainder of the credits will be utilized to offset the Affiliate Banks’ DIF assessments during 2020.

 

Concentration and Risk Guidance. The federal banking regulatory agencies promulgated joint interagency guidance regarding material direct and indirect asset and funding concentrations. The guidance defines a concentration as any of the following: (i) asset concentrations of 25% or more of Total Capital (loan related) or Tier 1 Capital (non-loan related) by individual borrower, small interrelated group of individuals, single repayment source or individual project; (ii) asset concentrations of 100% or more of Total Capital (loan related) or Tier 1 Capital (non-loan related) by industry, product line, type of collateral, or short-term obligations of one financial institution or affiliated group; (iii) funding concentrations from a single source representing 10% or more of Total Assets; or (iv) potentially volatile funding sources that when combined represent 25% or more of Total Assets (these sources may include brokered, large, high-rate, uninsured, internet-listing-service deposits, Federal funds purchased or other potentially volatile deposits or borrowings). If a concentration is present, management must employ heightened risk management practices including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing, third party review and increasing capital requirements. Delmarva adheres to the practices recommended in this guidance.

 

Additionally, the federal bank regulatory agencies have issued guidance governing financial institutions with concentrations in commercial real estate lending. The guidance provides that institutions that have: (i) total reported loans for construction, land development, and other land which represent 100% or more of an institution’s total risk-based capital; or (ii) total reported commercial real estate loans, excluding loans secured by owner-occupied commercial real estate, representing 300% or more of the institution’s total risk-based capital and the institution’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months, are identified as having potential commercial real estate concentration risk. Institutions, which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital.

 

Brokered Deposits. Section 29 of the FDIA and FDIC regulations generally limit the ability of any bank to accept, renew or roll over any brokered deposit unless it is “well capitalized” or, with the FDIC’s approval, “adequately

capitalized.” However, as a result of the EGRRCPA, the FDIC is undertaking a comprehensive review of its regulatory approach to brokered deposits, including reciprocal deposits, and interest rate caps applicable to banks that are less than “well capitalized.” In December 2019, the FDIC issued a notice of proposed rulemaking to modernize its brokered deposit regulations. At this time, it is difficult to predict what changes, if any, to the brokered deposit regulations will actually be implemented or the effect of such changes on Delmar.

 

USA Patriot Act. Under the USA Patriot Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships, as well as enhanced due diligence standards intended to detect, and prevent, the use of the United States financial system for money laundering and terrorist financing activities. The Patriot Act requires financial institutions, including banks, to establish anti-money laundering programs, including employee training and independent audit requirements, meet minimum standards specified by the act, follow minimum standards for customer identification and maintenance of customer identification records, and regularly compare customer lists against lists of suspected terrorists, terrorist organizations and money launderers. The costs or other effects of the compliance burdens imposed by the Patriot Act or future anti-terrorist, homeland security or anti-money laundering legislation or regulation cannot be predicted with certainty.

 

Bank Secrecy Act. The Bank Secrecy Act (the “BSA”), which is intended to require financial institutions to develop policies, procedures and practices to prevent and deter money laundering, mandates that every bank have a written, board-approved program that is reasonably designed to assure and monitor compliance with the BSA. The program must, at a minimum: (i) provide for a system of internal controls to assure ongoing compliance; (ii) provide for independent testing for compliance; (iii) designate an individual responsible for coordinating and monitoring day-to-day compliance; and (iv) provide training for appropriate personnel. In addition, banks are required to adopt a customer identification program as part of its BSA compliance program. Financial institutions are generally required to report cash transactions involving more than $10,000 to the U.S. Treasury Department. In addition, financial institutions are required to file suspicious activity reports for transactions that involve more than $5,000 and which the financial institution knows, suspects or has reason to suspect involves illegal funds, is designed to evade the requirements of the BSA or has no lawful purpose. The regulations implementing the BSA explicitly include risk-based procedures for conducting ongoing customer due diligence, to include understanding the nature and purpose of customer relationships for the purpose of developing a customer risk profile. In addition, banks must identify and verify the identity of the beneficial owners of all legal entity customers (other than those that are excluded) at the time a new account is opened (other than accounts that are exempted).

 

Office of Foreign Assets Control. The United States has imposed economic sanctions that affect transactions with designated foreign countries, foreign nationals and others, which are administered by the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”). The OFAC-administered sanctions targeting countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on a “U.S. person” engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of a sanctioned country have an interest by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g. property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences.

 

Increased Focus on Lending to Members of the Military. The federal banking agencies and the U.S. Department of Justice have recently increased their focus on financial institution compliance with the Servicemembers Civil Relief Act (the “SCRA”). The SCRA requires a bank to cap the interest rate at 6% for any loan to a member of the military who goes on active duty after taking out the loan. It also limits the actions Delmarva or Partners can take when a servicemember is in foreclosure. The EGRRCPA also adds certain protections for consumers, including veterans and active duty military personnel, expanded credit freezes and creation of an identity theft protection database.

 

Incentive Compensation. The Federal Reserve, the Office of the Comptroller of the Currency and the FDIC have issued regulatory guidance intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The Federal

Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as Delmar and Partners, that are not “large, complex banking organizations.” The findings will be included in reports of examination, and deficiencies will be incorporated into the organization’s supervisory ratings. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

 

In 2016, the SEC and the federal banking agencies proposed rules that prohibit covered financial institutions (including bank holding companies and banks) from establishing or maintaining incentive-based compensation arrangements that encourage inappropriate risk taking by providing covered persons (consisting of senior executive officers and significant risk takers, as defined in the rules) with excessive compensation, fees or benefits that could lead to material financial loss to the financial institution. The proposed rules outline factors to be considered when analyzing whether compensation is excessive and whether an incentive-based compensation arrangement encourages inappropriate risks that could lead to material loss to the covered financial institution, and establishes minimum requirements that incentive-based compensation arrangements must meet to be considered to not encourage inappropriate risks and to appropriately balance risk and reward. The proposed rules also impose additional corporate governance requirements on the boards of directors of covered financial institutions and impose additional record-keeping requirements. The comment period for these proposed rules has closed and a final rule has not yet been published. At this time, Delmar cannot predict what impact, if any, the final rule will have on its operations. 

Volcker Rule. The Volcker Rule under the Dodd-Frank Act prohibits bank holding companies and their subsidiary banks from engaging in proprietary trading except in limited circumstances, and places limits on ownership of equity investments in private equity and hedge funds.  The EGRRCPA exempted all banks with less than $10 billion in assets (including their holding companies and affiliates) from the Volcker Rule, provided that the institution has total trading assets and liabilities of 5.0% or less of total assets, subject to certain limited exceptions. In December 2018, the federal banking agencies invited public comment on a proposal to exclude community banks from the application of the Volcker Rule. Delmar believes that its financial condition and its operations are not and will not be significantly affected by the Volcker Rule, amendments thereto, or its implementing regulations.

Call Reports and Examination Cycle. All institutions, regardless of size, submit a quarterly call report that includes data used by federal banking agencies to monitor the condition, performance, and risk profile of individual institutions and the industry as a whole. The EGRRCPA contained provisions expanding the number of regulated institutions eligible to use streamline call report forms. In November 2018, the federal banking agencies issued a proposal to permit insured depository institutions with total assets of less than $5 billion that do not engage in certain complex or international activities to file the most streamlined version of the quarterly call report, and to reduce data reportable on certain streamlined call report submissions.

In December 2018, consistent with the provisions of the EGRRCPA, the federal banking agencies jointly adopted final rules that permit banks with up to $3 billion in total assets, that received a composite CAMELS rating of “1” or “2,” and that meet certain other criteria (including not having undergone any change in control during the previous 12-month period, and not being subject to a formal enforcement proceeding or order), to qualify for an 18-month on-site examination cycle.

Stress Testing. As required by the Dodd-Frank Act, the federal banking agencies implemented stress testing requirements for certain financial institutions, including bank holding companies and state-chartered banks, with more than $10 billion in total consolidated assets. The EGRRCPA subsequently raised the asset thresholds for company-run stress testing and mandatory stress testing conducted by the Federal Reserve to $50 billion and $100 billion, respectively. Although these requirements do not apply to Delmar or Partners, the federal banking agencies emphasize that all banking organizations, regardless of size, should have the capacity to analyze the potential effect of adverse market conditions or outcomes on the organization’s financial condition. Based on existing regulatory guidance, Delmar and Partners will be expected to consider the institution’s interest rate risk management, commercial real estate loan concentrations and other credit-related information, and funding and liquidity management during this analysis of adverse market conditions or outcomes.

Confidentiality and Required Disclosures of Customer Information. Under the Federal Right to Privacy Act of 1978, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records, financial institutions are required to disclose their policies for collecting and protecting confidential information. The Affiliate Banks are also subject to various laws and regulations that address the privacy of nonpublic personal financial information of consumers. The GLB Act and certain regulations issued thereunder protect against the transfer and use by financial institutions of consumer nonpublic personal information. A financial institution must provide to its customers, at the beginning of the customer relationship and annually thereafter, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. These privacy provisions generally prohibit a financial institution from providing a customer’s personal financial information to unaffiliated third parties unless the institution discloses to the customer that the information may be so provided and the customer is given the opportunity to opt out of such disclosure.

In August 2018, the CFPB published its final rule to update Regulation P pursuant to the amended GLB Act. Under this rule, certain qualifying financial institutions are not required to provide annual privacy notices to customers. To qualify, a financial institution must not share nonpublic personal information about customers except as described in certain statutory exceptions which do not trigger a customer’s statutory opt-out right. In addition, the financial institution must not have changed its disclosure policies and practices from those disclosed in its most recent privacy notice. The rule sets forth timing requirements for delivery of annual privacy notices in the event that a financial institution that qualified for the annual notice exemption later changes its policies or practices in such a way that it no longer qualifies for the exemption.

Although these laws and programs impose compliance costs and create privacy obligations and, in some cases, reporting obligations, and compliance with all of the laws, programs, and privacy and reporting obligations may require significant resources of Partners, these laws and programs do not materially affect Partners’ products, services or other business activities.

Cybersecurity. The federal banking agencies have adopted guidelines for establishing information security standards and cybersecurity programs for implementing safeguards under the supervision of a financial institution’s board of directors. These guidelines, along with related regulatory materials, increasingly focus on risk management and processes related to information technology and the use of third parties in the provision of financial products and services.

In particular, in March 2015, federal regulators issued two related statements regarding cybersecurity. One statement indicates that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institution. The other statement indicates that a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving destructive malware. A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack. If Delmar fails to observe the regulatory guidance, it could be subject to various regulatory sanctions, including financial penalties. To date, Delmar has not experienced a significant compromise, significant data loss or any material financial losses related to cybersecurity attacks, but its systems and those of its customers and third-party service providers are under constant threat and it is possible that Delmar could experience a significant event in the future. Risks and exposures related to cybersecurity attacks are expected to remain high for the foreseeable future due to the rapidly evolving nature and sophistication of these threats, as well as due to the expanding use of Internet banking, mobile banking and other technology-based products and services by Delmar and its customers. If Delmar fails to meet the expectations set forth in the federal banking agencies’ regulatory guidance, it could be subject to various regulatory actions and any remediation efforts may require significant resources of Delmar.

Filings with the SEC

Delmar files annual, quarterly, and current reports under the Exchange Act with the SEC. These reports and this Form 10-K are posted and available at no cost on Delmar’s investor relations website, http://www.bankofdelmarvahb.com/home/about-us/investor-relations, as soon as reasonably practicable after Delmar files such documents with the SEC. The information contained on Delmar’s website is not a part of this Form 10-K or of any other filing with the SEC. Delmar’s filings with the SEC are also available through the SEC’s website at http://www.sec.gov.

 

Item 1A. Risk Factors.

Delmar’s business is influenced by many factors that are difficult to predict, involve uncertainties that may materially affect actual results and are often beyond its control. A number of these factors have been identified below. For other factors that may cause actual results to differ materially from those indicated in any forward-looking statement or projection contained in this Annual Report on Form 10-K, please see “Forward-Looking Statements” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Risks Related to Our Business

Changes in interest rates could adversely impact Delmar’s financial condition and results of operations.

Delmar’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets, such as loans and securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond Delmar’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the amount of interest Delmar receives on loans and securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) Delmar’s ability to originate loans and obtain deposits, (ii) the fair value of Delmar’s financial assets and liabilities, and (iii) the average duration of Delmar’s mortgage-backed securities portfolio. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, Delmar’s net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.

In an emergency measure aimed at blunting the economic impact of the novel coronavirus pandemic (“COVID-19”), the Federal Reserve lowered the target for the federal funds rate to a range of between 0%-0.25% on March 15, 2020. This action by the Federal Reserve followed a prior reduction of the targeted federal funds rates to a range of 1% to 1.25% on March 3, 2020.  If the Federal Reserve decreases the targeted federal funds rates further in response to the economic effects of COVID-19, overall interest rates will likely decline, which may negatively impact our net interest income. Alternatively, if the COVID-19 outbreak abates and general economic conditions improve, the Federal Reserve may determine to increase the targeted federal funds rates and overall interest rates will likely rise, which will positively impact our net interest income, but may negatively impact the housing market by reducing refinancing activity, new home purchases, commercial lending activity, and the U.S. economy.

Any substantial, unexpected or prolonged change in market interest rates could have a material adverse effect on Delmar’s business, financial condition and results of operations.

The earnings of financial services companies are significantly affected by general business and economic conditions.

Delmar’s operations and profitability are impacted by general business and economic conditions in the United States and abroad. These conditions include short-term and long-term interest rates, inflation, money supply, political issues, legislative and regulatory changes, fluctuations in both debt and equity capital markets, broad trends in industry and finance, and the strength of the U.S. economy and the local economies in which Delmar operates, all of which are beyond Delmar’s control. In addition, geopolitical developments, international trade disputes, public health crises, such

as the COVID-19 pandemic, and other events beyond our control, can increase levels of political and economic unpredictability globally and increase the volatility of economic conditions on a local, national, and global scale. Deterioration in economic conditions could result in an increase in loan delinquencies and non-performing assets, decreases in loan collateral values, and a decrease in demand for Delmar’s products and services, among other things, any of which could have a material adverse impact on Delmar’s business, financial condition and results of operations.

If Delmar has higher loan losses than it has allowed for, Delmar’s earnings could materially decrease.

Delmar maintains an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, that represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The level of the allowance reflects management’s continuing evaluation of the following: industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions; and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires Delmar to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, and other factors, both within and outside of Delmar’s control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review the allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. Further, if charge-offs in future periods exceed the allowance for loan losses, Delmar will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income, and possibly capital, and may have a material adverse effect on Delmar’s business, financial condition and results of operations.

Delmar’s profitability will depend significantly on economic conditions in the States of Delaware, New Jersey, Maryland and the Commonwealth of Virginia.

Delmar’s success depends primarily on the general economic conditions of the States of Delaware, New Jersey and Maryland and the Commonwealth of Virginia, and the specific local markets in which Delmarva and Partners operate. Unlike larger national or other regional banks that are more geographically diversified, the Affiliate Banks have relatively compact geographic footprints. Delmarva provides banking and financial services to customers primarily in the eastern regions in Delaware and Maryland and in the Camden and Burlington counties of New Jersey. Partners serves the communities in and around the Greater Fredericksburg, Virginia area and Anne Arundel County and the three counties of Southern Maryland. The local economic conditions in these areas have a significant impact on the demand for the Affiliate Banks’ products and services, as well as the ability of the Affiliate Banks’ customers to repay loans, the value of the collateral securing the loans, and the stability of the Affiliate Banks’ deposit funding sources. A significant decline in general economic conditions caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences, unemployment, changes in securities markets, or other factors, including the on-going COVID-19 pandemic, could impact these local economic conditions and, in turn, have a material adverse effect on the Affiliate Banks’, and therefore Delmar’s, financial condition and results of operations.

Because Delmar emphasizes commercial real estate and commercial loan originations, its credit risk may increase and future downturns in the local real estate market or economy could adversely affect its earnings.

Commercial real estate and commercial loans generally have more inherent risk than residential real estate loans. Because the repayment of commercial real estate and commercial loans depends on the successful management and operation of the borrower’s properties or related businesses, repayment of such loans can be affected by adverse conditions in the local real estate market or economy. Commercial real estate and commercial loans also may involve relatively large loan balances to individual borrowers or groups of related borrowers. A future downturn in the local economy could adversely affect the value of properties securing the loan or the revenues from the borrower’s business, thereby increasing the risk of nonperforming loans. As Delmar’s commercial real estate and commercial loan portfolios increase, the corresponding risks and potential for losses from these loans may also increase. Furthermore, it may be

difficult to assess the future performance of newly originated commercial loans, as such loans may have delinquency or charge-off levels above our historical experience, which could adversely affect Delmar’s future performance.

The severity and duration of a future economic downturn and the composition of Delmar’s loan portfolio could impact the level of loan charge-offs and provision for loan losses and may adversely affect Delmar’s net income or loss.

Lending money is a substantial part of Delmar’s businesses. However, every loan that Delmar makes carries a certain risk of non-payment. Delmar cannot assure that its allowance for loan losses will be sufficient to absorb actual loan losses. Delmar also cannot assure that it will not experience significant losses in its loan portfolio that may require significant increases to the allowance for loan losses in the future.

Although Delmar evaluates every loan that it makes against its underwriting criteria, Delmar may experience losses by reasons of factors beyond its control, including from occurrences and circumstances unrelated to the underwriting criteria applied to a particular borrower, such as the current COVID-19 outbreak, which has a high potential for negative impact on financial markets generally as well as the local markets in which we conduct business.. Some of these factors include changes in market conditions affecting the value of real estate and unexpected problems affecting the creditworthiness of Delmar’s borrowers.

Delmar determines the adequacy of its allowance for loan losses by considering various factors, including:

 

Local economic conditions could impact Delmar’s loan portfolio. For example, an increase in unemployment, a decrease in real estate values, or increases in interest rates, as well as other factors, could weaken the economies of the communities that Delmar serves. Weakness in the market areas served by Delmar could depress its earnings and, consequently, its financial condition because:

 

Although, based on the aforementioned procedures implemented by Delmar, management believes the current allowance for loan losses is adequate, Delmar may have to increase its provision for loan losses should local economic conditions deteriorate which could negatively impact Delmar’s business, financial condition and results of operations.

Changes in real estate values may adversely impact Delmar’s loans that are secured by real estate.

A significant portion of Delmar’s loan portfolio consists of residential and commercial mortgages, as well as consumer loans, secured by real estate. These properties are concentrated within the local markets served by Delmarva

and Partners. Real estate values and real estate markets generally are affected by, among other things, changes in national, regional or local economic conditions, fluctuations in interest rates, the availability of loans to potential purchasers, changes in the tax laws and other government statutes, regulations and policies, as well as other factors outside of our control such as natural disasters, geopolitical events, and public health crises (like the current COVID-19 pandemic).  If real estate prices decline, particularly in Delmar’s market area, the value of the real estate collateral securing Delmar’s loans could be reduced. This reduction in the value of the collateral could increase the number of non-performing loans and could have a material adverse impact on Delmar’s business, financial condition and results of operations.

Delmar’s ability to pay dividends depends primarily on receiving dividends from the Affiliate Banks, which is subject to regulatory limits on such bank’s performance.

Delmar is a bank holding company and its operations are conducted by its subsidiaries, Delmarva and Partners. Delmar’s ability to pay dividends depends on its receipt of dividends from Delmarva and Partners. Dividend payments from Delmarva and Partners are subject to legal and regulatory limitations, generally based on net profits and retained earnings, imposed by the various banking regulatory agencies. The ability of Delmarva or Partners to pay dividends is also subject to their profitability, financial condition, capital requirements, and their respective cash flow requirements. There is no assurance that Delmarva or Partners will be able to pay dividends in the future or that Delmar will generate adequate cash flow from Delmarva and Partners to pay dividends in the future. Delmar’s failure to pay dividends on its common stock could have a material adverse effect on the market price of its common stock.

For additional information, please see Item 5, Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Competition from other traditional and nontraditional financial institutions and service providers may adversely affect Delmar’s profitability.

The banking business is highly competitive. Delmar competes as a financial intermediary with commercial banks, savings banks, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds and other financial institutions operating in their respective markets, as well as nontraditional competitors such as fintech companies and internet-based lenders, depositories and payment systems. Delmar’s profitability depends upon its continued ability to successfully compete with traditional and new financial services providers, some of which maintain a physical presence in its market areas and others of which maintain only a virtual presence.

Many of Delmar’s competitors have substantially greater resources and lending limits than Delmar has, and offer certain services, such as extensive and established branch networks and trust services, that Delmar does not currently provide or currently expect to provide in the near future. Moreover, larger institutions operating in their respective market areas have access to borrowed funds at lower cost than will be available to Delmar. Delmar’s failure to compete effectively in its markets could restrain Delmar’s growth or cause it to lose market share, which could have a material adverse effect on Delmar’s business, financial condition and results of operations.

Regulatory initiatives regarding bank capital requirements may require heightened capital.

Regulatory capital rules adopted in July 2013 implemented higher minimum capital requirements for bank holding companies and banks. These rules, which implement the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision, include a common equity Tier 1 capital requirement and establish criteria that instruments must meet to be considered common equity Tier 1 capital, additional Tier 1 capital or Tier 2 capital. These enhancements were intended to both improve the quality and increase the quantity of capital required to be held by banking organizations, and to better equip the U.S. banking system to deal with adverse economic conditions. The capital rules require bank holding companies and banks to maintain a common equity Tier 1 capital ratio of 4.5%, a minimum total Tier 1 risk based capital ratio of 6%, a minimum total risk based capital ratio of 8%, and a minimum leverage ratio of 4%. Bank holding companies and banks are also required to hold a capital conservation buffer of common equity Tier 1 capital of 2.5% to avoid limitations on capital distributions and discretionary executive

compensation payments. The revised capital rules will also require banks to maintain a common equity Tier 1 capital ratio of 6.5% or greater, a Tier 1 capital ratio of 8% or greater, a total capital ratio of 10% or greater and a leverage ratio of 5% or greater to be deemed “well-capitalized” for purposes of certain rules and prompt corrective action requirements.

The Federal Reserve may also set higher capital requirements for holding companies whose circumstances warrant it. For example, holding companies experiencing significant internal growth or making acquisitions are expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. Our regulatory capital ratios currently are in excess of the levels established for “well-capitalized” institutions. Future regulatory change could impose higher capital standards.

As a result of the Economic Growth, Regulatory Relief and Consumer Protection Act (the “EGRRCPA”), the federal banking agencies were required to develop a Community Bank Leverage Ratio (the ratio of a bank’s tangible equity capital to average total consolidated assets) for banking organizations with assets of less than $10 billion, such as the Bank. On October 29, 2019, the federal banking agencies  issued a final rule that implements the Community Bank Leverage Ratio Framework (the “CBLRF”).  To qualify for the CBLRF, a bank must have less than $10 billion in total consolidated assets, limited amounts of off-balance sheet exposures and trading assets and liabilities, and a leverage ratio greater than 9.0%. A bank that elects the CBLRF and has a leverage ratio greater than 9.0% will be considered to be in compliance with Basel III capital requirements and exempt from the complex Basel III calculations and will also be deemed “well capitalized” under Prompt Corrective Action regulations, discussed below.  A bank that falls out of compliance with the CBLRF will have a two-quarter grace period to come back into full compliance, provided its leverage ratio remains above 8.0% (a bank will be deemed “well capitalized” during the grace period).  The CBLRF will be available for banking organizations to use as of March 31, 2020 (with the flexibility for banking organizations to subsequently opt into or out of the CBLRF, as applicable). If Delmar, Delmarva and Partners qualify for this simplified capital regime, there can be no assurance that satisfaction of the CBLRF will provide adequate capital for their operations and growth, or an adequate cushion against increase levels of nonperforming assets or weakened economic conditions.

The current COVID-19 pandemic is having a significant impact on financial markets, which has resulted in a volatile environment for banks and bank holding companies. As a result, there is the potential for new laws and regulations regarding lending and funding practices and capital and liquidity standards, and bank regulatory agencies have been (and are expected to continue to be) very proactive in responding to both market and supervisory concerns arising from the COVID-19 pandemic. Any new or revised standards adopted in the future – whether in response to the COVID-19 pandemic or other events – may require us to maintain materially more capital, with common equity as a more predominant component, or manage the configuration of our assets and liabilities to comply with formulaic liquidity requirements. Delmar may not be able to raise additional capital at all, or on terms acceptable to it. Failure to maintain capital to meet current or future regulatory requirements could have a significant material adverse effect on Delmar’s business, financial condition and results of operations.

For additional information, please see “Supervision and Regulation” in Item 1, Business.

Delmar may need or be compelled to raise additional capital in the future which could dilute shareholders or be unavailable when needed or at unfavorable terms.

Delmar’s regulators or market conditions may require it to increase its capital levels. If Delmar raises capital through the issuance of additional shares of its common stock or other securities, it would likely dilute the ownership interests of shareholders and may dilute the per share book value and earnings per share of its common stock. Furthermore, it may have an adverse impact on Delmar’s stock price. New investors may also have rights, preferences and privileges senior to Delmar’s shareholders, which may adversely impact its shareholders. Delmar’s ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside its control, and on its financial performance. Accordingly, Delmar cannot be assured of its ability to raise additional capital on terms and time frames acceptable to it or to raise additional capital at all. If Delmar cannot raise additional capital in sufficient amounts when needed, its ability to comply with regulatory capital requirements could be materially impaired. Additionally, the

inability to raise capital in sufficient amounts may adversely affect Delmar’s business, financial condition, and results of operations.

The banking industry is highly regulated, and the regulatory framework, together with any future legislative or regulatory changes, may have a materially adverse effect on Delmar’s operations.

The banking industry is highly regulated and supervised under both federal and state laws and regulations that are intended primarily for the protection of depositors, customers, the public, the banking system as a whole or the FDIC Deposit Insurance Fund, not for the protection of our shareholders and creditors. Delmar is subject to primary regulation and supervision by the Federal Reserve, Delmarva is subject to primary regulation and supervision by the FDIC and the Delaware Commissioner and Partners is subject to primary regulation by the Federal Reserve and the Virginia Bureau. Compliance with these laws and regulations can be difficult and costly, and changes to laws and regulations can impose additional compliance costs. The Dodd-Frank Act, which imposes significant regulatory and compliance changes on financial institutions, is an example of this type of federal regulation. The laws and regulations applicable to the Affiliate Banks govern a variety of matters, including permissible types, amounts and terms of loans and investments it may make, the maximum interest rate that may be charged, the amount of reserves it must hold against deposits it takes, the types of deposits it may accept and the rates it may pay on such deposits, maintenance of adequate capital and liquidity, changes in control of Delmar and the Affiliate Banks, transactions between Delmar and the Affiliate Banks, handling of nonpublic information, restrictions on dividends and establishment of new offices. Delmar and the Affiliate Banks must obtain approval from their regulators before engaging in certain activities, and there is risk that such approvals may not be granted, either in a timely manner or at all. These requirements may constrain Delmar’s operations, and the adoption of new laws and changes to or repeal of existing laws may have a further impact on Delmar’s business, financial condition and results of operations. Also, the burden imposed by those federal and state regulations may place banks in general, including the Affiliate Banks in particular, at a competitive disadvantage compared to non-bank competitors. Delmar’s failure to comply with any applicable laws or regulations, or regulatory policies and interpretations of such laws and regulations, could result in sanctions by regulatory agencies, civil money penalties or damage to our reputation, all of which could have a material adverse effect on Delmar’s business, financial condition and results of operations.

Bank holding companies and financial institutions currently face an uncertain regulatory environment. Applicable laws, regulations, interpretations, enforcement policies and accounting principles have been subject to significant changes in recent years, and may be subject to significant future changes. Future changes may have a material adverse effect on Delmar’s business, financial condition and results of operations.

Federal and state regulatory agencies may adopt changes to their regulations or change the manner in which existing regulations are applied. We cannot predict the substance or effect of pending or future legislation or regulation or the application of laws and regulations to us. Compliance with current and potential regulation, as well as regulatory scrutiny, may significantly increase our costs, impede the efficiency of our internal business processes, require Delmar to increase its regulatory capital, and limit its ability to pursue business opportunities in an efficient manner by requiring Delmar to expend significant time, effort and resources to ensure compliance and respond to any regulatory inquiries or investigations.

In addition, given the current economic and financial environment, including the adverse effects thereto as a result of the current COVID-19 pandemic, regulators may elect to alter standards or the interpretation of the standards used to measure regulatory compliance or to determine the adequacy of liquidity, risk management or other operational practices for financial service companies in a manner that impacts Delmar’s ability to implement its strategy and could affect Delmar in substantial and unpredictable ways, and could have a material adverse effect on Delmar’s business, financial condition and results of operations. Furthermore, the regulatory agencies have extremely broad discretion in their interpretation of laws and regulations and their assessment of the quality of our loan portfolio, securities portfolio and other assets. If any regulatory agency’s assessment of the quality of our assets, operations, lending practices, investment practices, capital structure or other aspects of Delmar’s business differs from Delmar’s assessment, Delmar may be required to take additional charges or undertake, or refrain from taking, actions that could have a material adverse effect on Delmar’s business, financial condition and results of operations.

Litigation and regulatory actions, including possible enforcement actions, could subject Delmar to significant fines, penalties, judgments or other requirements resulting in increased expenses or restrictions on its business activities.

In the normal course of business, from time to time, Delmar or the Affiliate Banks may be named as a defendant in various legal actions, arising in connection with their current and/or prior business activities. Legal actions could include claims for substantial compensatory or punitive damages or claims for indeterminate amounts of damages. Further, Delmar or the Affiliate Banks may in the future be subject to consent orders or other formal or informal enforcement agreements with their regulators. They may also, from time to time, be the subject of subpoenas, requests for information, reviews, investigations and proceedings (both formal and informal) by governmental agencies regarding current and/or prior business activities. Any such legal or regulatory actions may subject Delmar to substantial compensatory or punitive damages, significant fines, penalties, obligations to change business practices or other requirements resulting in increased expenses, diminished income and damage to their reputation. Involvement in any such matters, whether tangential or otherwise and even if the matters are ultimately determined in their favor, could also cause significant harm to their reputation and divert management attention from the operation of their business. Further, any settlement, consent order, other enforcement agreement or adverse judgment in connection with any formal or informal proceeding or investigation by government agencies may result in litigation, investigations or proceedings as other litigants and government agencies begin independent reviews of the same activities. As a result, the outcome of legal and regulatory actions could have a material adverse effect on Delmar’s business, financial condition and results of operations.

New lines of business or new products and services may subject Delmar to additional risks.

From time to time, Delmar may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services, Delmar may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, shifting market preferences, natural disasters, geopolitical events, and public health crises (such as the current COVID-19 pandemic) may also impact the successful implementation of a new line of business and/or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of Delmar’s system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business and new products or services could have a material adverse effect on Delmar’s business, financial condition, and results of operations.

Delmar may not be able to attract and retain skilled people.

Delmar’s success depends, in large part, on its ability to attract and retain key people. Competition for the best people in most activities engaged in by Delmar can be intense, and Delmar may not be able to hire people or to retain them. The unexpected loss of services of one or more of Delmar’s key personnel could have a material adverse impact on Delmar’s business because it would no longer have the benefit of their skills, knowledge of Delmar’s markets, as well as years of industry experience, and it would be difficult to promptly find qualified replacement personnel.

Delmar operates in a highly regulated environment and may be adversely affected by changes in federal, state and local laws and regulations.

Delmar and the Affiliate Banks are subject to extensive regulation, supervision and/or examination by federal and state banking authorities. Any change in applicable regulations or federal, state or local legislation could have a substantial impact on Delmar and its operations. Additional legislation and regulations that could significantly affect Delmar’s powers, authority and operations may be enacted or adopted in the future, which could have a material adverse effect on its financial condition and results of operations. Further, regulators have significant discretion and authority to prevent or remedy unsafe or unsound practices or violations of laws by banks and bank and financial holding companies in the performance of their supervisory and enforcement duties.

In particular, the current COVID-19 pandemic is ongoing, and its dynamic nature, including uncertainties relating to the ultimate geographic spread of the virus, the severity of the disease, the duration of the outbreak, and actions that may be taken by governmental authorities to contain the outbreak or to treat its impact (both economic and health-related), is not fully known at this time. The Federal Reserve has publicly stated that it is closely monitoring development of COVID-19 and its effects on the economic outlook, and would act appropriately to support the economy and the financial industry. Other federal and state regulators are likewise monitoring the effects that COVID-19 has on the financial industry and the economy.  The exercise of regulatory authority by these federal and state regulatory authorities may have a negative impact on Delmar’s business, financial condition and results of operations.

Like other bank holding companies and financial institutions, Delmar must comply with significant anti-money laundering and anti-terrorism laws. Under these laws, Delmar is required, among other things, to enforce a customer identification program and file currency transaction and suspicious activity reports with the federal government. Government agencies have substantial discretion to impose significant monetary penalties on institutions which fail to comply with these laws or make required reports. While Delmar has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur.

Delmar is subject to an extensive body of accounting rules and best practices. Periodic changes to such rules may change the treatment and recognition of critical financial line items and affect Delmar’s profitability.

The nature of Delmar’s business makes them sensitive to the large body of accounting rules in the U.S. From time to time, the governing bodies that oversee changes to accounting rules and reporting requirements may release new guidance for the preparation of our financial statements. These changes can materially impact how Delmar records and reports its financial condition and results of operations. In some instances, Delmar could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements. Recently implemented changes include requirements that Delmar record the value of and liabilities relating to operating leases on its balance sheet. Changes which have been approved for future implementation, or which are currently proposed or expected to be proposed or adopted include requirements that Delmar calculate the allowance for loan losses on the basis of the current expected credit losses over the lifetime of our loans, or the CECL model, which is expected to be applicable to us beginning in 2023, and may result in increases in its allowance for loan losses and future provisions for loan losses. 

Under the CECL model, banks will be required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model required under current accounting principles generally accepted in the United States (“GAAP”), which delays recognition until it is probable a loss has been incurred. Delmar expects to recognize a one-time cumulative-effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, consistent with regulatory expectations set forth in interagency guidance issued at the end of 2016. Delmar cannot yet determine the magnitude of any such one-time cumulative adjustment or of the overall impact of the new standard on its financial condition or results of operations. Accordingly, Delmar expects that the adoption of the CECL model will materially affect how it determines its allowance for loan losses, and could require it to significantly increase its allowance. Moreover, the CECL model may create more volatility in the level of the allowance for loan losses. If Delmar is required to materially increase the level of its allowance for loan losses for any reason, such increase could adversely affect its capital, regulatory capital ratios, ability to make larger loans, earnings and performance metrics. Any such changes could have a material adverse effect on Delmar’s business, financial condition, results of operations and stock price.

The soundness of other financial institutions may adversely affect Delmar.

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. Delmar has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and institutional clients. Many of these transactions expose Delmar to credit risk in the event of a default by a counterparty or client. In

the past, defaults by, or even speculation about, one or more financial services institutions or the financial services industry generally during moments of economic crisis have led to market-wide liquidity problems.  The economic volatility resulting from the current COVID-19 pandemic could, as similar events in the past have, result in similar defaults and, as a result, impair the confidence of our counterparties and ultimately affect our ability to effect transactions. In addition, Delmar’s credit risk may be exacerbated when the collateral held by Delmar cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit exposure due to Delmar. Any such losses could have a material adverse effect on Delmar’s financial condition and results of operations.

Market volatility may have materially adverse effects on Delmar’s liquidity and financial condition.

The capital and credit markets have experienced extreme volatility and disruption. Over the last several years, in some cases, the markets have exerted downward pressure on stock prices, security prices, and credit capacity for certain issuers without regard to those issuers’ underlying financial strength. Moreover, the current COVID-19 pandemic is disrupting supply chains and affecting production and sales across a range of industries (including businesses and industries in the geographies served by our Affiliate Banks) and has caused a significant amount of market disruption and volatility. The extent of the impact of the current COVID-19 pandemic on our liquidity and financial condition will depend on certain developments, including the duration and spread of the outbreak, the impact to our customers, employees and vendors, and the impact to the financial services and banking industry and the economy as a whole – all of which are uncertain and cannot be predicted at this time. If the market disruption and volatility associated with COVID-19 continues, there can be no assurance that Delmar will not experience adverse effects, which may be material, on its liquidity, financial condition, and profitability. 

Any future acquisitions by Delmar could dilute shareholder ownership and may cause it to become more susceptible to adverse economic events.

Delmar may use its common stock to acquire other companies. Delmar may issue additional shares of common stock to pay for future acquisitions, which would dilute current investors’ ownership interest in Delmar. Future business acquisitions could be material to Delmar, and the degree of success achieved in acquiring and integrating these businesses into Delmar could have a material effect on the value of Delmar’s common stock. In addition, any acquisition could require it to use substantial cash or other liquid assets or to incur debt. In those events, Delmar could become more susceptible to economic downturns and competitive pressures.

Maryland business corporation law and various anti-takeover provisions under Delmar’s articles could impede the takeover of Delmar.

Various Maryland laws affecting business corporations may have the effect of discouraging offers to acquire Delmar, even if the acquisition would be advantageous to shareholders. In addition, Delmar has various anti-takeover measures in place under its articles of incorporation and bylaws, including a staggered board of directors, and the absence of cumulative voting. Any one or more of these measures may impede the takeover of Delmar without the approval of the board of directors and may prevent shareholders from taking part in a transaction in which they could realize a premium over the current market price of Delmar common stock.

If Delmar concludes that the decline in value of any of its investment securities is an other-than-temporary impairment, Delmar is required to write down the value of that security through a charge to earnings.

Delmar reviews its investment securities portfolio at each quarter-end to determine whether the fair value is below the current carrying value. When the fair value of any of its investment securities has declined below its carrying value, Delmar is required to assess whether the decline is an other-than-temporary impairment. If Delmar determines that the decline is an other-than-temporary impairment, it is required to write down the value of that security through a charge to earnings for credit related impairment. Non-credit related reductions in the value of a security do not require a write down of the value through earnings unless Delmar intends to, or is required to, sell the security. Changes in the expected cash flows related to the credit related piece of the investment of a security in Delmar’s investment portfolio or a prolonged price decline may result in Delmar’s conclusion in future periods that an impairment is other than temporary, which would require a charge to earnings to write down the security to fair value. Due to the complexity of

the calculations and assumptions used in determining whether an asset has an impairment that is other than temporary, the impairment disclosed may not accurately reflect the actual impairment in the future.

Liquidity risk could impair Delmar’s ability to fund operations and meet its obligations as they become due and failure to maintain sufficient liquidity could materially adversely affect Delmar’s growth, business, profitability and financial condition.

Liquidity is essential to Delmar’s business. Liquidity risk is the potential that Delmar will be unable to meet its obligations as they become due because of an inability to liquidate assets or obtain adequate funding at a reasonable cost, in a timely manner and without adverse conditions or consequences. Delmar requires sufficient liquidity to fund asset growth, meet customer loan requests, customer deposit maturities and withdrawals, payments on its debt obligations as they come due and other cash commitments under both normal operations conditions and other unpredictable circumstances, including events causing industry or general financial market stress. Liquidity risk can increase due to a number of factors, including an over-reliance on a particular source of funding or market-wide phenomena such as market dislocation and major disasters, including public health crises such as the current COVID-19 pandemic. Factors that could detrimentally impact access to liquidity sources include, but are not limited to, a decrease in the level of its business activity as a result of a downturn in the markets in which its loans are concentrated, adverse regulatory actions against Delmar, or changes in the liquidity needs of depositors. Market conditions or other events could also negatively affect the level or cost of funding, affecting its ongoing ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations, and fund asset growth and new business transactions at a reasonable cost, in a timely manner, and without adverse consequences. Delmar’s inability to raise funds through deposits, borrowings, the sale of loans, and other sources could have a substantial negative effect on its business, and could result in the closure of Delmar or either of the Affiliate Banks. Delmar’s access to funding sources in amounts adequate to finance its activities or on acceptable terms could be impaired by factors that affect its organization specifically or the financial services industry or economy in general. Any substantial, unexpected, and/or prolonged change in the level or cost of liquidity could impair Delmar’s ability to fund operations and meet its obligations as they become due and could have a material adverse effect on its business, financial condition and results of operations.

Delmar relies on customer deposits, advances from the Federal Home Loan Bank and brokered deposits to fund its operations. Although Delmar has historically been able to replace maturing deposits and advances if desired, including throughout the most recent recession, it may not be able to replace such funds in the future if its financial condition, the financial condition of the Federal Home Loan Bank or market conditions were to change. Federal Home Loan Bank borrowings and other current sources of liquidity may not be available or, if available, sufficient to provide adequate funding for operations.

Delmar’s operations of its business, including its transactions with customers, are increasingly done via electronic means, and this has increased its risks related to cybersecurity.

Delmar relies heavily on communications and information systems to conduct its business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in Delmar’s customer relationship management, general ledger, deposit, loan and other systems. While Delmar has policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of its information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. Although Delmar maintains insurance coverage that may, subject to policy terms and conditions including significant self-insured deductibles, cover certain aspects of cyber risks, such insurance coverage may be insufficient to cover all losses. Delmar is exposed to the risk of cyber-attacks in the normal course of business. In addition, Delmar is exposed to cyber-attacks on vendors and merchants that affect Delmar and its customers. In general, cyber incidents can result from deliberate attacks or unintentional events. Delmar has observed an increased level of attention in the industry focused on cyber-attacks that include, but are not limited to, gaining unauthorized access to digital systems for purposes of misappropriating assets or sensitive information, corrupting data, or causing operational disruption. To combat against these attacks, policies and procedures are in place to prevent or limit the effect of the possible security breach of its information systems. While Delmar maintains insurance coverage that may, subject to policy terms and conditions including significant self-insured deductibles, cover certain aspects of cyber risks, such insurance coverage may be insufficient to cover all losses. While Delmar has not incurred any material losses related to

cyber-attacks, nor is it aware of any specific or threatened cyber incidents as of the date of this report, it may incur substantial costs and suffer other negative consequences if it falls victim to successful cyber-attacks. Such negative consequences could include remediation costs that may include liability for stolen assets or information and repairing system damage that may have been caused; deploying additional personnel and protection technologies, training employees, and engaging third-party experts and consultants; lost revenues resulting from unauthorized use of proprietary information or the failure to retain or attract customers following an attack; disruption or failures of physical infrastructure, operating systems or networks that support Delmar’s business and customers resulting in the loss of customers and business opportunities; additional regulatory scrutiny and possible regulatory penalties; litigation; and, reputational damage adversely affecting customer or investor confidence.

Delmar’s controls and procedures may fail or be circumvented and have a material adverse effect on its business, financial condition, and results of operations.

Management regularly reviews and updates Delmar’s internal controls, disclosure controls and procedures, as well as corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of Delmar’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on its business, financial condition, and results of operations.

Delmar is subject to environmental liability risk associated with lending activities.

A significant portion of Delmar’s loan portfolio is secured by real property. During the ordinary course of business, Delmar may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, Delmar may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require Delmar to incur substantial expense and may materially reduce the affected property’s value or limit Delmar’s ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase Delmar’s exposure to environmental liability. Although Delmar has policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on Delmar’s financial condition and results of operations and in turn, Delmar’s financial condition, results of operations and stock price.

Delmar’s financial performance may suffer if its information technology is unable to keep pace with growth or industry developments.

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Delmar’s future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in Delmar’s operations. Many of Delmar’s competitors have substantially greater resources to invest in technological improvements. Delmar may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on Delmarva’s business and, in turn, Delmar’s business, financial condition and results of operations.

Financial services companies depend on the accuracy and completeness of information about customers and counterparties.

In deciding whether to extend credit or enter into other transactions, Delmar may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports, and other financial information. Delmar may also rely on representations of those customers, counterparties or other third parties, such as

independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports, or other financial information could have a material adverse impact on Delmar’s business, financial condition and results of operations.

Consumers may decide not to use banks to complete their financial transactions.

Technology and other changes are allowing parties to complete financial transactions that historically have involved banks through alternative methods. For example, consumers can now maintain funds in brokerage accounts or mutual funds that would have historically been held as bank deposits. Consumers can also complete transactions such as obtaining loans, paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of loans, customer deposits and the related income generated from those transactions. The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on Delmar’s business, financial condition and results of operations.

Severe weather, natural disasters, acts of war or terrorism, other external events, including the COVID-19 pandemic or the outbreak of another highly infectious or contagious disease, could significantly impact Delmar’s business.

The unpredictable nature of events such as severe weather, natural disasters, pandemics or other public health issues, acts of war or terrorism, other adverse external events, including the COVID-19 pandemic or the outbreak of another highly infectious or contagious disease could have a significant impact on Delmar’s ability to conduct business. If any of its financial, accounting, network or other information processing systems fail or have other significant shortcomings due to such external events, Delmar could be materially adversely affected. Third parties with which Delmar does business could also be sources of operational risk to Delmar, including the risk that the third parties’ own network and information processing systems could fail. Any of these occurrences could materially diminish Delmar’s ability to operate its business, or result in potential liability to clients, reputational damage, and regulatory intervention, any of which could materially adversely affect Delmar. Such events could affect the stability of Delmar’s deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, impair Delmar’s liquidity, cause significant property damage, result in loss of revenue, and/or cause Delmar to incur additional expenses.

Delmar may be subject to disruptions or failures of the financial, accounting, network and other information processing systems arising from events that are wholly or partially beyond Delmar’s control, which may include, for example, computer viruses, electrical or telecommunications outages, natural disasters, public health crises and disease pandemics (including the current COVID-19 pandemic), damage to property or physical assets, or terrorist acts. Delmar has developed a comprehensive business continuity plan which includes plans to maintain or resume operations in the event of an emergency, such as a power outage or disease pandemic, and contingency plans in the event that operations or systems cannot be resumed or restored. The business continuity plan is updated as needed, periodically reviewed, and components are regularly tested. Delmar also reviews and evaluates the business continuity plans of critical third-party service providers. While Delmar believes its business continuity plan and efforts to evaluate the business continuity plans of critical third-party service providers help mitigate risks, disruptions or failures affecting any of these systems may cause interruptions in service to customers, damage to Delmar’s reputation, and loss or liability to Delmar.

The outbreak COVID-19, or the outbreak of another highly infectious or contagious disease, could adversely affect Delmar’s business, financial condition and results of operations.

Delmar’s business (and the business of our Affiliate Banks) is dependent upon the willingness and ability of its customers to conduct banking and other financial transactions. The spread of a highly infectious or contagious disease, such as COVID-19, could cause severe disruptions in the national economy, which could in turn disrupt the business, activities, and operations of our customers, as well our business and operations. Since the beginning of January 2020, the coronavirus outbreak has caused significant disruption in the financial markets both globally and in the U.S. The continuing spread of COVID-19 is likely to result in a significant decrease in commercial activity nationally, and may cause our customers, vendors, and counterparties to be unable to meet existing payment or other obligations to Delmar.

Moreover, the national public health crisis arising from the COVID-19 pandemic (and public expectations about it), combined with certain pre-existing factors, including, but not limited to, international trade disputes, inflation risks, and oil price volatility, could further destabilize the financial markets and geographies in which we operate.  The resulting economic pressure on consumers and uncertainty regarding the sustainability of economic improvements may result in changes in consumer and business spending, borrowing and saving habits, which may affect the demand for loans and other products and services we offer, as well as the creditworthiness of potential and current borrowers.  Borrower loan defaults that adversely affect our earnings correlate with deteriorating economic conditions (such as the unemployment rate), which, in turn, may impact our borrowers' creditworthiness and our ability to make loans.

We also could be adversely affected if our key personnel, a significant number of our employees, or our access to branch facilities and other physical offices, were to become unavailable (or curtailed) due to a widening or unresolved public health crisis arising from the current COVID-19 pandemic.  Although Delmar and our Affiliate Banks maintain business continuity plans, the continuing spread of COVID-19, or an outbreak of another highly infectious or contagious disease, could negatively impact the availability of our personnel and facilities. For example, the use of quarantines and social distancing methods to curtail the spread of COVID-19 – whether mandated by governmental authorities or recommended as a public health practice – may adversely affect our operations as key personnel, employees and customers avoid physical interaction.  The continued spread of COVID-19 (or an outbreak of a similar highly contagious disease) could also negatively impact the business and operations of third party service providers who perform critical services for our business.

As a result, if COVID-19 continues to spread or the response to contain the current COVID-19 pandemic is unsuccessful, Delmar could experience a material adverse effect on its business, financial condition, and results of operations.

The increasing use of social media platforms presents new risks and challenges and the inability or failure to recognize, respond to, and effectively manage the accelerated impact of social media could materially adversely impact Delmar’s business.

There has been a marked increase in the use of social media platforms, including weblogs (blogs), social media websites, and other forms of Internet-based communications which allow individuals access to a broad audience of consumers and other interested persons. Social media practices in the banking industry are evolving, which creates uncertainty and risk of noncompliance with regulations applicable to Delmar’s business. Consumers value readily available information concerning businesses and their goods and services and often act on such information without further investigation and without regard to its accuracy. Many social media platforms immediately publish the content their subscribers and participants post, often without filters or checks on accuracy of the content posted. Information posted on such platforms at any time may be adverse to Delmar’s interests and/or may be inaccurate. The dissemination of information online could harm Delmar’s business, prospects, financial condition, and results of operations, regardless of the information’s accuracy. The harm may be immediate without affording Delmar an opportunity for redress or correction.

Other risks associated with the use of social media include improper disclosure of proprietary information, negative comments about Delmar’s business, exposure of personally identifiable information, fraud, out-of-date information, and improper use by employees and customers. The inappropriate use of social media by Delmar’s customers or employees could result in negative consequences such as remediation costs including training for employees, additional regulatory scrutiny and possible regulatory penalties, litigation, or negative publicity that could damage Delmar’s reputation adversely affecting customer or investor confidence.

Risks Relating to Delmar’s Common Stock

An active public market for Delmar’s common stock does not currently exist, and therefore Partners shareholders may not be able to easily sell their shares of Delmar common stock.

Delmar’s common stock is not listed on a national exchange and trades on the OTCQX market maintained by OTC Market Groups, Inc. under the symbol “DBCP.” Delmar’s common stock is thinly traded, and daily trading volume

in Delmar’s common stock is low. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of Delmar’s common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which Delmar has no control. As a result, an investment in Delmar’s common stock may be relatively illiquid, and the market price for Delmar’s common stock may be volatile. While Delmar anticipates that it will apply to list its common stock on The Nasdaq Stock Market (“Nasdaq”) in the future, Delmar cannot be certain that such an application will be approved or that an active trading market will ever develop, or if one develops, that it will continue. Delmar also cannot be sure whether the trading price of its common stock in the future will be higher or lower than it is as of the filing of this Annual Report on Form 10-K.

Delmar’s stock price may be volatile, and you could lose part or all of your investment as a result.

Stock price volatility may negatively impact the price at which our common stock may be sold, and may also negatively impact the timing of any sale. Delmar’s stock price may fluctuate widely in response to a variety of factors including the risk factors described herein and, among other things:

 

 

Delmar’s ownership is Concentrated in one significant shareholder.

Kenneth R. Lehman beneficially owns approximately 41.5% of Delmar’s common stock. As a result, Mr. Lehman has the ability to exercise significant control over Delmar’s business policies and affairs, such as the composition of Delmar’s board of directors and any action requiring the approval of Delmar’s shareholders, including the adoption of amendments to its articles of incorporation and the approval of a merger, share exchange or sale of substantially all of its assets. Mr. Lehman is able to vote his shares in favor of his interests that may not always coincide with the interests of the other shareholders.

For additional information, please see Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

Risks Related to Our Recent Share Exchange

Delmar may fail to achieve expected results from the share exchange if integration of the operations of Delmar and Partners is not handled successfully.

The success of the transaction depends on a smooth integration and post-share exchange operations of Delmar and Partners. Benefits of the transaction to shareholders may not be realized if the post-share exchange integration is not well executed or well received by each company’s historical customers.

Delmar may fail to realize the cost savings it expects to achieve from the share exchange.

While Delmar and Partners will continue to be separate entities following the share exchange, the success of the share exchange will depend, in part, on Delmar’s ability to realize the estimated cost savings from combining the businesses of Delmar and Partners. While Delmar believes that the cost savings estimates are achievable, it is possible that the potential cost savings could be more difficult to achieve than Delmar anticipates. If Delmar’s estimates are incorrect or it is unable to combine the businesses of Delmar and Partners successfully, the anticipated cost savings may not be realized fully or at all, or may take longer to realize than expected.

Combining the businesses of Delmar and Partners may be more difficult, costly or time-consuming than expected.

The process of integrating the businesses of Delmar and Partners could result in the loss of key employees, the disruption of each company’s ongoing business, inconsistencies in standards, controls, procedures and policies that adversely affect either company’s ability to maintain relationships with clients and employees or achieve the anticipated benefits of the share exchange, despite that both Delmar and Partners will continue to be separate entities following the share exchange. As with any affiliation of financial institutions, there also may be disruptions that cause Delmar and Partners to lose customers or cause customers to withdraw their deposits from Delmarva or Partners, or other unintended consequences that could have a material adverse effect on Delmar’s results of operations or financial condition. 

 

ITEM 1B.     UNRESOLVED STAFF COMMENTS.

Delmar has no unresolved staff comments to report.

ITEM 2.       PROPERTIES.

Delmarva currently maintains 14 branches and other facilities as set forth in the table below.

 

Partners currently maintains five branches and other facilities as set forth in the table below.

 

All of the foregoing properties are used by Delmarva and Partners in the normal course of their businesses. Delmar believes all of these properties are in good operating condition and are adequate for Delmar’s present and anticipated future needs. Delmar maintains comprehensive general liability and casualty loss insurance covering its properties and activities conducted in or about its properties. Delmar believes this insurance provides adequate protection for liabilities or losses that might arise out of the ownership and use of such properties. 

 

ITEM 3.       LEGAL PROCEEDINGS.

From time to time Delmar, Delmarva and Partners are a party to various litigation matters incidental to the conduct of their respective businesses. Delmar and the Affiliate Banks are not presently party to any legal proceedings the resolution of which Delmar believes would have a material adverse effect on their respective businesses, prospects, financial condition, liquidity, results of operation, cash flows or capital levels.

 

ITEM 4.      MINE SAFETY DISCLOSURES.

None.

PART II

ITEM 5.      MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

 

As of February 28, 2020, there were 17,790,181 shares of Delmar common stock outstanding which were held by approximately 700 holders of record, which number does not reflect the number of individuals or institutional investors holding stock in nominee name through banks, brokerage firms, and others.

Delmar’s common stock is quoted on the OTCQX market maintained by OTC Market Groups, Inc. under the symbol “DBCP. On February 28, 2020, the closing price of Delmar’s common stock on the OTCQX was $7.85 per share. There is a limited public trading market for Delmar common stock. While Delmar anticipates that it will file an application to list its common stock on the Nasdaq stock market Delmar cannot be certain that such application will be approved or that an active trading market will ever develop, or if one develops, that it will continue.

Delmar currently pays a quarterly dividend of $0.025 per share. The most recent quarterly dividend was declared on February 5, 2020 and is payable on April 10, 2020 to holders of record as of March 30, 2020. When declaring dividends, the Board of Directors considers, among other things, the Delmar’s long-term outlook, Delmar’s financial conditions and results of operations during recent financial periods, and trends in the investment and financing markets.

There can be no assurance that future earnings will be sufficient to allow Delmar to maintain or increase the amount of the cash dividend. Substantially all of Delmar's income from which it can pay dividends is the receipt of dividends from Delmarva and Partners. The availability of dividends from the Affiliate Banks is limited by various statutes and regulations. It also is possible, depending on the financial condition of the Affiliate Banks, and other factors, that the applicable regulatory authorities could assert that payment of dividends or other payments is an unsafe or unsound banking practice. In the event that either Delmarva or Partners is unable to pay dividends to Delmar, Delmar may not be able to pay dividends on its common stock. As of the date of filing this Annual Report on Form 10-K, Delmar has no such restrictions.

Under Maryland law, dividends may only be paid out of retained earnings. State and federal bank regulatory agencies also have authority to prohibit a bank from paying dividends if such payment is deemed to be an unsafe or unsound practice, and the Federal Reserve has the same authority over bank holding companies. At December 31, 2019, each of Delmarva and Partners could pay dividends to Delmar to the extent of its retained earnings so long as it maintained required capital ratios.

The Federal Reserve has established requirements with respect to the maintenance of appropriate levels of capital by registered bank holding companies. Compliance with such standards, as presently in effect, or as they may be amended from time to time, could possibly limit the amount of dividends that Delmar may pay in the future. In 1985, the Federal Reserve issued a policy statement on the payment of cash dividends by bank holding companies. In the statement, the Federal Reserve expressed its view that a holding company experiencing earnings weaknesses should not pay cash dividends exceeding its net income, or which could only be funded in ways that weaken the holding company’s financial health, such as by borrowing. As depository institutions, the deposits of which are insured by the FDIC, neither Delmarva nor Partners may pay dividends or distribute any of its capital assets while it remains in default on any assessment due the FDIC. The Affiliate Banks currently are not in default under any of their obligations to the FDIC.

 

 

ITEM 6.      SELECTED FINANCIAL DATA.

The following summary presents Selected Consolidated Financial Data of Delmar as of and for the periods indicated. The financial data as of and for the years ended December 31, 2019 through 2015 has been derived from Delmar's audited financial statements.

 

NON‑GAAP FINANCIAL MEASURES

Some of the financial measures discussed in Delmar's selected historical financial data are “non‑GAAP financial measures.” In accordance with SEC rules, Delmar classifies a financial measure as being a non‑GAAP financial measure if that financial measure excludes or includes amounts, or is subject to adjustments that have the effect of excluding or including amounts, that are included or excluded, as the case may be, in the most directly comparable measure calculated and presented in accordance with GAAP in Delmar's statements of income, balance sheets or statements of cash flows. The following unaudited reconciliation tables provide a more detailed analysis of these non‑GAAP financial measures.

 

ITEM 7.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion compares the Company’s financial condition at December 31, 2019 to its financial condition at December 31, 2018 and the results of operations for the years ended December 31, 2019 and 2018. This discussion should be read in conjunction with the Consolidated Financial Statements and the Notes thereto appearing in Item 8 of Part II of this Annual Report on Form 10-K.

Forward-Looking Statements

Portions of this Annual Report on Form 10-K contain forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. Statements that are not historical in nature, including statements that include the words “anticipate”, “estimate”, “should”, “expect”, “believe”, “intend”, and similar expressions, are expressions about our confidence, policies, and strategies, the adequacy of capital levels, and liquidity and are not guarantees of future performance. Such forward-looking statements involve certain risks and uncertainties, including economic conditions, competition in the geographic and business areas in which we operate, inflation, fluctuations in interest rates, legislation, and governmental regulation, as well as other factors outside of our control such as natural disasters, geopolitical events and public health crises (like the current COVID-19 pandemic). These factors should not be considered exhaustive and should be read together with other cautionary statements that are included in this Annual Report on Form 10-K including those discussed in the section entitled Item 1A. “Risk Factors.”  If one or more of the factors affecting our forward-looking information and statements proves incorrect, then our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements contained in this report. Therefore, we caution you not to place undue reliance on our forward-looking information and statements. We will not update the forward-looking statements to reflect actual results or changes in the factors affecting the forward-looking statements. New risks and uncertainties may emerge from time to time, and it is not possible for us to predict their occurrence or how they will affect us.

Overview

Delmar, a bank holding corporation, through its wholly owned subsidiaries, The Bank of Delmarva (“Delmarva”) and Virginia Partners Bank (“Partners”), commercial banking corporations, engages in general commercial banking operations, with eighteen branches throughout Wicomico, Charles, Anne Arundel, and Worcester Counties in Maryland, Sussex County in Delaware, Camden and Burlington Counties in New Jersey, the city of Fredericksburg, Virginia, and Spotsylvania County, Virginia.

Delmar derives the majority of its income from interest received on our loans and investment securities. The primary source of funding for making these loans and investments are deposits and secondarily, borrowings. Consequently, one of the key measures of Delmar's success is the amount of net interest income, or the difference between the income on interest‑earning assets, such as loans and investments, and the expense on interest‑bearing liabilities, such as deposits and borrowings. The resulting ratio of that difference as a percentage of average earning assets represents the net interest margin. Another key measure is the spread between the yield earned on interest‑earning assets and the rate paid on interest‑bearing liabilities, which is called the net interest spread. In addition to earning interest on loans and investments, Delmar earns income through fees and other charges to customers. Also included is a discussion of the various components of this noninterest income, as well as of noninterest expense.

There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We maintain this allowance by charging a provision for loan losses as needed against our operating earnings for each period. We have included a detailed discussion of this process, as well as several tables describing our allowance for loan losses.

Delmar plans to continue to grow both organically and possibly through future acquisitions, including potential expansion into new market areas. Delmar believes its current financial condition, coupled with its scalable operational capabilities, will allow it to act upon growth opportunities in the current banking environment.

The following discussion and analysis also identifies significant factors that have affected Delmar's financial position and operating results during the periods included in the consolidated financial statements accompanying this report. You are encouraged to read this management's discussion and analysis in conjunction with the consolidated financial statements and the notes thereto included in Item 8 in this Annual Report on Form 10-K, and the other statistical information included in this Form 10-K.

Critical Accounting Policies

Certain critical accounting policies affect significant judgments and estimates used in the preparation of Delmar's consolidated financial statements. These significant accounting policies are described in the notes to the consolidated financial statements included in Item 8 in this Annual Report on Form 10-K. The accounting principles Delmar follows and the methods of applying these principles conform to GAAP and general banking industry practices. Delmar's most critical accounting policy relates to the determination of the allowance for loan losses, which reflects the estimated losses resulting from the inability of borrowers to make loan payments. The determination of the adequacy of the allowance involves significant judgment and complexity and is based on many factors. If the financial condition of our borrowers were to deteriorate, resulting in an impairment of their ability to make payments, the estimates would be updated and additional provisions for loan losses may be required. See “Provision and Allowance for Loan Losses” and Note 1 and Note 3 of the consolidated financial statements for the year ended December 31, 2019.

Another of Delmar's critical accounting policies, with the acquisitions of Liberty in 2018 and Partners in 2019, relates to the valuation of goodwill, intangible assets and other acquisition accounting adjustments. Delmar accounted for the acquisitions of Liberty and Partners in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic No. 805, which requires the use of the acquisition method of accounting. Under this method, assets acquired, including intangible assets, and liabilities assumed, are recorded at their fair value. Determination of fair value involves estimates based on internal valuations of discounted cash flow analyses performed, third party valuations, or other valuation techniques that involve subjective assumptions. Additionally, the term of the useful lives and appropriate amortization periods of intangible assets is subjective. Resulting goodwill from the acquisition of Liberty and Partners, which totaled approximately $5.2 million and $4.2 million, respectively, under the acquisition method of accounting represents the excess of the purchase price over the fair value of net assets acquired. Goodwill is not amortized, but is evaluated for impairment annually or more frequently if deemed necessary. If the fair value of an asset exceeds the carrying amount of the asset, no charge to goodwill is made. If the carrying amount exceeds the fair value of the asset, goodwill will be adjusted through a charge to earnings. In evaluating the goodwill on its consolidated balance sheet for impairment after the consummation date of the acquisitions of Liberty and Partners, Delmar will first assess qualitative factors to determine whether it is more likely than not that the fair value of our acquired assets is less than the carrying amount of the acquired assets, as allowed under Accounting Standards Update (“ASU”) 2011‑08, Intangibles—Goodwill and Other (Topic 350): Testing Goodwill for Impairment. After making the assessment based on several factors, which will include, but is not limited to, the current economic environment, the economic outlook in our markets, our financial performance and common stock value as compared to our peers, we will determine if it is more likely than not that the fair value of our assets is greater than their carrying amount and, accordingly, will determine whether impairment of goodwill should be recorded as a charge to earnings in years subsequent to the acquisitions of Liberty and Partners. This assessment was performed at the end of 2019, and resulted in no impairment of goodwill. See Note 18, Note 20 and Note 21 in the consolidated financial statements for the year ended December 31, 2019 for more information related to the fair value of assets acquired in the acquisitions of Liberty and Partners, including goodwill and intangible assets.

Another critical accounting policy relates to deferred tax assets and liabilities. Delmar records deferred tax assets and deferred tax liabilities for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Future tax benefits, such as net operating loss carry forwards available from the Liberty acquisition, are recognized to the extent that realization of such benefits is more likely than not. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the assets and liabilities are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date. In the event the future tax consequences of differences between the financial reporting bases and the tax bases of our assets and liabilities results in deferred tax assets, an evaluation of the probability of being able to

realize the future benefits indicated by such assets is required. A valuation allowance is provided when it is more likely than not that a portion or the full amount of the deferred tax asset will not be realized. In assessing the ability to realize the deferred tax assets, management considers the scheduled reversals of deferred tax liabilities, projected future taxable income, and tax planning strategies. Such a deferred tax liability will only be recognized when it becomes apparent that those temporary differences will reverse in the foreseeable future. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50 percent more likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

Results of Operations

Net income for the year ended December 31, 2019 totaled $5.9 million compared to $5.5 million for the year ended December 31, 2018, or an increase of $401 thousand. Basic earnings per share were $0.54 for the year ended December 31, 2019, as compared to $0.57 for the year ended December 31, 2018. The increase of $401 thousand in net earnings for the year ended December 31, 2019 included an increase in net interest income of $3.3 million, due mainly to the increase in loan balances. In the fourth quarter, Delmar acquired Partners, which increased loan balances by $357.1 million as of the acquisition date.  These acquired loan balances contributed $2.4 million in loan interest, including fees.  The increase of $6.2 million in interest income was partially offset by an increase in interest expense of $2.9 million.  This was attributable to a significant increase in deposit balances during the year, of which $348.6 million was due to the acquisition of Partners.  Partners deposit balances contributed an increase of $500 thousand in interest expense during the fourth quarter.  Delmarva’s deposits increased by $48.9 million, or almost 8.0% during 2019.  The increase in net interest income was reduced by an increase in noninterest expenses of $2.7 million. Noninterest expense for the year ended December 31, 2019 increased, as compared to the year ended December 31, 2018 due to an increase in salaries and employee benefits of $2.6 million. This increase was partially related to the additional expense of Partners employees during the fourth quarter, which contributed $881 thousand to expenses.  In addition, an additional $1.2 million was paid in bonuses related to the transaction with Partners during the year ended December 31, 2019.

Financial Condition

Consolidated assets totaled $1,252.7 million at December 31, 2019, a 69.4% increase as compared to $739.4 million at December 31, 2018. The fair value of the assets acquired in the Partners transaction, which closed in November 2019, was $454.2 million. The remaining increase in consolidated assets of $59.1 million, or 8.0% from December 31, 2018 to December 31, 2019, was due to increased cash balances related to organic deposit growth. Deposits totaled $1,006.8 million at December 31, 2019, an increase of 63.7% compared to $614.9 million at December 31, 2018. The fair value of deposits assumed in the Partners transaction was $348.6 million, with the remaining increase of $43.3 million or 7.0% attributable to organic growth. Non‑interest bearing demand grew $76.2 million for the year ended December 31, 2019. NOW accounts and savings and money market accounts increased from $54.5 million and $123.9 million, respectively, at December 31, 2018 to $76.9 million and $223.0 million at December 31, 2019, an increase of 41.2% and 79.9%, respectively. Time deposits of $100,000 or more increased $159.4 million for the year ended December 31, 2019 as compared to December 31, 2018. Net loans grew $361.2 million, or 57.7%, for the year ended December 31, 2019. The fair value of loans acquired in the Partners transaction was $357.1 million, with the remaining increase of $4.0 million, or 0.6%, attributable to organic growth.

Delmarva's Tier 1 leverage capital ratio was 9.1% at December 31, 2019 as compared to 8.7% at December 31, 2018. At December 31, 2019, Delmarva's Tier 1 risk‑weighted capital and total‑risk-weighted capital were 11.6% and 12.7%, respectively, as compared to Tier 1 risk‑weighted capital and total risk‑weighted capital ratios of 10.5% and 11.7%, respectively, at December 31, 2018. Partners’ Tier 1 leverage capital ratio was 10.4% at December 31, 2019, while its Tier 1 risk‑weighted capital and total risk‑weighted capital ratios were 12.4% and 12.5%, respectively, at December 31, 2019.  See “Capital” below for additional information about Delmar's, Delmarva’s and Partners’ capital ratios and requirements.

Adversely classified assets totaled $16.6 million at December 31, 2019 as compared to $18.7 million at December 31, 2018. OREO properties totaled $2.4 million at December 31, 2019 as compared to $3.7 million at

December 31, 2018. Nonaccrual loans totaled $4.5 million at December 31, 2019 as compared to $9.1 million at December 31, 2018. Nonaccrual loans as a percentage of total loans was 0.45% at December 31, 2019 and 1.4% as of December 31, 2018. There was one loan past due 90 days or more and still accruing interest at December 31, 2019 with an aggregate balance of $5 thousand, as compared to three loans greater than 90 days past due still accruing interest with a balance of $606 thousand at December 31, 2018. Adversely classified assets were 13.2% of Delmar’s total capital at December 31, 2019 compared to 28.9% at December 31, 2018. Loans classified as troubled debt restructurings (“TDRs”) totaled $10.3 million at December 31, 2019, a 42.2% decline compared to $17.8 million at December 31, 2018.

Net charge‑offs were 0.2% of average total loans for the year ended December 31, 2019 and .01% for the year ended December 31, 2018. The allowance for loan losses to total loans ratio was 0.7% at December 31, 2019, compared to 1.1% at December 31, 2018. In addition to the allowance for loan losses, there was an unamortized discount of $6.1 million related to the loans acquired in the Liberty and Partners transactions. This discount is amortized over the life of the remaining loans.

Stockholders' equity increased from $66.0 million at December 31, 2018 to approximately $130.9 million at December 31, 2019, or year over year growth of approximately 98.3%. Of this growth, $52.3 million related to the value of common stock issued to shareholders of Partners in the Partners acquisition. The remaining increase was mainly due to income earned during the year, net of dividends of $1.2 million paid to shareholders, the increase in unrealized holding losses on securities available for sale during the period, and exercise of warrants.

Summary of Return on Equity and Assets

 

Earnings Analysis

Delmar's primary source of revenue is interest income and fees, which it earns by lending and investing the funds which are held on deposit. Because loans generally earn higher rates of interest than investments, Delmar seeks to deploy as much of its deposit funds as possible in the form of loans to individuals, businesses, and other organizations. To ensure sufficient liquidity, Delmar also maintains a portion of its deposits in cash, government securities, deposits with other financial institutions, and overnight loans of excess reserves (known as “Federal Funds Sold”) to correspondent banks. The revenue which Delmar earns (prior to deducting its overhead expenses) is essentially a function of the amount of Delmar's loans and deposits, as well as the profit margin (“interest spread”) and fee income which can be generated on these amounts.

Delmar reported net income of $5.9 million and $5.5 million for the years ended December 31, 2019 and 2018, respectively, in its audited financial statements. The following discussion should be read in conjunction with Delmar's consolidated financial statements and the notes to the consolidated financial statements included at Item 8 of this Annual Report on Form 10-K.

The following is a summary of the results of operations by Delmar for the years ended December 31, 2019 and 2018.

 

 

Net Interest Income

The largest component of net income for Delmar is net interest income, which is the difference between the income earned on assets and interest paid on deposits and borrowings used to support such assets. Net interest income is determined by the rates earned on Delmar's interest‑earning assets and the rates paid on its interest‑bearing liabilities, the relative amounts of interest‑earning assets and interest‑bearing liabilities, and the degree of mismatch and the maturity and repricing characteristics of its interest‑earning assets and interest‑bearing liabilities.

Net interest income was approximately $31.1 million for the year ended December 31, 2019, compared to $27.8 million for the year ended December 31, 2018. This increase is the direct result of increased loan volumes during 2019, mainly, the increase in balances as a result of the acquisition of Partners in November 2019.

In addition to the primary interest earning assets and interest bearing liabilities held at Delmarva and Partners, Delmar has additional borrowings with a balance of $6.5 million at December 31, 2019 and 2018. During 2015, $2.0 million was advanced to fund the repurchase of preferred shares, and the remaining $4.5 million was advanced during the first quarter of 2018 to fund the cash portion of the payment to Liberty shareholders. Interest expense on these borrowings, which is included in consolidated net income, was approximately $450 thousand for the year ended December 31, 2019 and $428 thousand for the year ended December 31, 2018.

For the year ended December 31, 2019, the consolidated net interest spread, the difference between the yield earned on interest earning assets and the rates paid on interest‑bearing liabilities, was 3.5% compared to 3.8% for the year ended December 31, 2018. The consolidated net interest margin (which is net interest income divided by average interest earning assets), calculated on a tax equivalent basis, was 4.0% for the year ended December 31, 2019 compared to 4.2% for the year ended December 31, 2018. Rates paid on average interest‑bearing liabilities were 1.5% for the year ended December 31, 2019, and 1.2% for the year ended December 31, 2018. Interest earned on assets and interest accrued on liabilities is significantly influenced by market factors, specifically interest rate targets established by

the Federal Reserve. Average loans net of the allowance comprised 88.0% of average earning assets for the year ended December 31, 2019, compared to 88.2% for the year ended December 31, 2018.

The following tables depict, for the periods indicated, certain information related to the average balance sheet and average yields on assets and average costs of liabilities for Delmar. Such yields are derived by dividing income or expense by the average balance of the corresponding assets or liabilities. Average balances have been derived from daily averages.