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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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For the fiscal year ended December 31, 2021.

OR

For the transition period from                    to

Commission file number 001-39285

Partners Bancorp

(Exact name of registrant as specified in its charter)

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

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 has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐

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 30, 2021, 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 $78,977,410 based on the closing price of $8.04 per share on the Nasdaq Capital Market on that date.

As of March 29, 2022, there were 17,961,699 shares outstanding of the registrant’s common stock, $0.01 par value.

Documents Incorporated by Reference:

Portions of the Proxy Statement for the 2022 Annual Meeting of Shareholders of the Registrant are incorporated by reference into Part III of this Form 10-K.

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Fairfax, Falls Church, Manassas, Manassas Park, and Reston, Virginia) and Anne Arundel County and the three counties of Southern Maryland (Charles County, Calvert County and St. Mary’s County).

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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’ five 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.

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Merger Agreement with OceanFirst

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On November 4, 2021, the Company announced the signing of a definitive Agreement and Plan of Merger (the “Merger Agreement”), dated as of November 4, 2021, pursuant to which the Company will be acquired by OceanFirst Financial Corp., a Delaware corporation (“OCFC”), and Delmarva and Partners will be merged with and into OceanFirst Bank N.A., the wholly owned national banking subsidiary of OCFC. Under the terms of the merger agreement, each share of Company common stock (other than Exception Shares, as defined in the merger agreement), will be converted into the right to receive either 0.4512 shares of common stock of OCFC or $10.00, in each case, at the election of the holder of Company common stock, subject to a maximum of forty percent (40%) of the shares of Company common stock being convertible into cash and the allocation and proration provisions of the merger agreement. For more information on this pending transaction refer to Note 22—Transaction with OceanFirst Financial Corporation to the audited consolidated financial statements in this Annual Report on Form 10-K and the Company’s Current Report on Form 8-K filed with the SEC on November 4, 2021.

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Business Strategy

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The Company is a multi-bank holding company, whose wholly owned subsidiaries are Delmarva and Partners. Combined, these banks make the Company a $1.6 billion in total assets company, serving customers from southern New Jersey and Delaware, into Maryland and Virginia.

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

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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.

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It has been a strategic goal of the Company to add additional affiliate banks to the Company, to create a connected marketplace in the greater mid-Atlantic region. While the pending transaction with OCFC pursuant to the Merger Agreement does not adhere to the Affiliate Bank model, the Company believes it will significantly accelerate and accomplish the larger goal of creating a connected mid-Atlantic region community bank for our customers.

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Market Area and Deposit Share

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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, 2021, Delmarva had the fourth 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, and Maryland MSA’s is less than 0.1%.

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In Greater Fredericksburg, Partners has two offices in the City of Fredericksburg, Virginia (including Partners’ headquarters) and one office in Spotsylvania County, Virginia. In Greater Washington, Partners has a full service branch and commercial lending office in Reston, Virginia.  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, with the exception of the Reston, Virginia location, have drive-thru facilities and ATMs. JMC has locations in Newport News, Williamsburg, and Fredericksburg, Virginia. The Fredericksburg, Virginia office is co-located within a branch of Partners.

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Partners has three distinct market areas for commercial banking: Greater Fredericksburg (Stafford County, Spotsylvania County, King George County, Caroline County, and the City of Fredericksburg, Virginia); Greater Washington (the District of Columbia, Arlington County, Clarke County, Fairfax County, Fauquier County, Loudoun County, Prince William County, Warren County, and the Cities of Alexandria, Fairfax, Falls Church, Manassas, Manassas Park, and Reston, Virginia); and, Anne Arundel County and the three counties of Southern Maryland (Charles County, Calvert County and St. Mary’s County). The markets for JMC include the Newport News/Williamsburg, Virginia markets, and Greater Fredericksburg.

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The Washington-Arlington-Alexandria, DC-VA-MD-WV MSA, where all of Partners branches are located, had a combined deposit market of $357 billion as of June 30, 2021. Partners was ranked 33^rd out of 72 financial institutions, with total deposits of $509 million as of June 30, 2021. In Fredericksburg City, Virginia, Partners was ranked 3^rd, with a 12.63% market share, as of June 30, 2021. In Spotsylvania County, Virginia, Partners was ranked 4^th, with a 8.71% market share, as of June 30, 2021. In Charles County, Maryland, Partners was ranked 9^th, with a 2.61% market share, as of June 30, 2021.

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Competition

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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.

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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. The Company 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.

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Risk Management

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The Company believes that effective risk management is of primary importance. Risk management refers to the activities by which the Company identifies, measures, monitors, evaluates and manages the risks it faces in the course of its banking activities. These include liquidity, interest rate, credit, operational, compliance, regulatory, strategic, financial and reputational risk exposures. The Company’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 the Company faces, as well as the changing regulatory and compliance landscape. The Company’s risk management approach employs comprehensive policies and processes to establish robust governance. The Company believes a disciplined and conservative underwriting approach has been the key to its strong asset quality.

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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.

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Through its Affiliate Banks, the Company’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 teams 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, the Company’s and Affiliate Banks’ boards of directors.

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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, 2021, Delmarva had a legal lending limit of $14.2 million. At December 31, 2021, Delmarva’s average funded loan size outstanding for commercial real estate (including commercial construction) and commercial loans was $571 thousand and $147 thousand, respectively. At December 31, 2021, Partners had a legal lending limit of $8.4 million. At December 31, 2021, Partners average funded loan size outstanding for commercial real estate (including commercial construction) and commercial loans was $583 thousand and $137 thousand, respectively.

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Concentrations of Credit Risk. Most of the Company’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, Reston, Virginia, Charles County, Maryland and Anne Arundel County, Maryland (through Partners). The Company’s loan portfolio consists primarily of commercial real estate loans, including construction and land loans, which totaled $750.2 million and constituted 67.2% of total loans as of December 31, 2021, and 1-4 family residential real estate loans, which totaled $201.2 million and constituted 18.0% of total loans as of December 31, 2021. The geographic concentration of the Company’s loans subjects its business to the general economic conditions within that market area. The risks created by such concentrations have been considered by management in the determination of the adequacy of the allowance for credit losses. The Company’s management believes the allowance for credit 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, 2021.

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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.

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Delmarva has a concentration in both non-owner-occupied commercial real estate and construction and land development loans. At December 31, 2021, Delmarva’s non-owner-occupied commercial real estate loan portfolio constituted 242.3% of capital and its construction, land development and land loans constituted 79.0% of capital.

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Partners has a concentration in both non-owner-occupied commercial real estate and construction and land development loans. At December 31, 2021, Partners’ non-owner-occupied commercial real estate loan portfolio constituted 205.5% of capital and its construction, land development and land loans constituted 62.7% of capital.

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Human Capital Resources

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The Company the Affiliate Banks aim to foster a culture of respect, teamwork, ownership, responsibility, initiative, integrity, and service. The Company’s people are critical to its performance and the achievement of its strategic goals. Accordingly, the Company provides a competitive compensation and benefits program to help meet the needs of our employees, including benefits that incentivize retention and reward longevity. The Company encourages and supports the growth and development of its 234 full-time equivalent employees (as of December 31, 2021) and, wherever possible, seek to fill positions by promotion and transfer from within the organization. The Company considers relations with its employees to be excellent. The Company’s selection and promotion processes are without bias and include the active recruitment of minorities and women.

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Supervision and Regulation

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The Company’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 the Company 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, the Company cannot forecast how federal and state regulation and supervision of financial institutions may change in the future and affect the operations of the Company 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 (“DIF”), 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 the Company 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. The EGRRCPA amended certain aspects of the regulatory framework for small depository institutions with assets of less than $10 billion and 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 agencies retain broad discretion to impose additional regulatory requirements on banking organizations based on safety and soundness and U.S. financial system stability considerations.

The Company continues to experience ongoing regulatory reform. These regulatory changes could have a significant effect on how the Company 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 the Company and the Affiliate Banks. The specific implications of 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.

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CARES Act and the PPP.  The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was enacted in March 2020 to provide economic relief in response to the public health and economic impacts of a novel strain of coronavirus disease (“COVID-19”). Many of the CARES Act’s programs are, and remain, dependent upon the direct involvement of U.S. financial institutions like the Company and the Affiliate Banks. These programs have been implemented through rules and guidance adopted by federal departments and agencies, including the U.S. Department of Treasury, the Small Business Administration (the “SBA”), the Federal Reserve, and other federal banking agencies, including those with direct supervisory jurisdiction over the Company and the Affiliate Banks. The Company continues to assess the impact of statutes, regulations, and supervisory guidance related to the COVID-19 pandemic.

The CARES Act amended the SBA’s 7(a) loan program, in which the Affiliate Banks participate, to create a guaranteed, unsecured loan program, the Paycheck Protection Program (the “PPP”), to fund operational costs of eligible businesses, organizations and self-employed persons during COVID-19. In December 2020, Congress revived the PPP and allocated additional PPP funds for 2021. The application deadline for PPP loans expired on May 31, 2021. As participating lenders in the PPP, the Affiliate Banks have continued to monitor legislative, regulatory, and supervisory developments related thereto, including updates to guidance on loan forgiveness.

The American Rescue Plan. On March 11, 2021, President Biden signed into law the American Rescue Plan Act of 2021 (the “American Rescue Plan”) to provide additional relief and address the ongoing COVID-19 pandemic.  The American Rescue Plan allocates $1.9 trillion in funding for a multitude of programs addressing the national economy, public health, state and local governments, individuals, and businesses.  These programs include, among others, (i) small business assistance, including modification and expansion of the PPP, (ii) extension of unemployment benefits and related services, (iii) tax relief related to unemployment compensation, (iv) a maximum tax recovery rebate of $1,400 per eligible individual, and (v) the expansion and modification of certain tax credits, including the child tax credit and the earned income tax credit. These programs have been implemented by the responsible federal agencies and the Company continues to monitor developments related to the American Rescue Plan.

The Company. The Company 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, the Company 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 the Company 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. The Federal Reserve has adopted a final rule codifying the presumptions used in determinations of whether a company has the ability to exercise a controlling influence over another company for purposes of the BHC Act, and providing greater transparency on the types of relationships that the Federal Reserve generally views as supporting a determination of control.

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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 the Company 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. The Company 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 the Company, 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.

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As a Maryland corporation, the Company 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 and a member of the Federal Reserve System (a “state member bank”) whose accounts are insured by the DIF 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 Federal Reserve.

Partners is a Virginia chartered commercial bank and also a state member bank whose accounts are insured by the DIF 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 DIF, 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.

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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.

As of December 31, 2021, the Affiliate Banks met all capital adequacy requirements under the Basel III Final Rules, including the capital conservation buffer on a fully phased-in basis.

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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 the Company. 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 became 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). Neither the Company nor the Affiliate Banks have elected to use the CBLRF.

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, the Company 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 remain 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 that 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, 2021, both Affiliate Banks were considered “well capitalized.”

Limits on Dividends.  The Company, as a Maryland corporation, is a legal entity that is separate and distinct from the Affiliate Banks. A significant portion of the revenues of the Company result from dividends paid to it by the Affiliate Banks. Both the Company and the Affiliate Banks remain subject to laws and regulations that limit the payment of dividends, including limits on the sources of dividends and requirements to maintain capital at or above regulatory minimums. In particular, Federal Reserve supervisory guidance indicates that the Federal Reserve may have safety and soundness concerns if a bank holding company pays dividends that exceed earnings for the period in which the dividend is being paid. Further, the FDIA prohibits insured depository institutions such as the Affiliate Banks from making capital distributions, including paying dividends, if, after making such distribution, the institution would become undercapitalized as defined in the statute. The Company does not expect that any of these laws, regulations or policies will materially affect the ability of the Company or the Affiliate Banks to pay dividends.

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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.

Congress, the federal bank agencies 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. 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 the Company’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 Consumer Financial Protection Bureau (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 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.

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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 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 FDIC may also suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance if the institution has no tangible capital. If deposit insurance is terminated, the deposits at the institution at the time of termination, less subsequent withdrawals, shall continue to be insured for a period from six months to two years, as determined by the FDIC. Management is aware of no existing circumstances that could result in termination of the Affiliate Banks’ deposit insurance.

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 billion in assets). At December 31, 2021, 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 billion in assets.

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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, 2021, the designated reserve ratio was 2.00 percent and the minimum designated reserve ratio was 1.35 percent.

In June 2020, the FDIC adopted a final rule that generally removes the effect of PPP lending when calculating a bank’s deposit insurance assessment by providing an offset to the bank’s total assessment amount for the increase in the assessment base attributable to the bank’s participation in the PPP. This final rule began applying to FDIC deposit insurance assessments during the second quarter of 2020.

Concentration and Risk Guidance. The federal banking 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 and Partners adhere to the practices recommended in this guidance.

Additionally, 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 that 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 has undertaken 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.” On December 15, 2020, the FDIC issued final rules that amend the FDIC’s methodology for calculating interest rate caps, provide a new process for banks that seek FDIC approval to offer a competitive rate on deposits when the prevailing rate in the bank’s local market exceeds the national rate cap, and provides specific exemptions and streamlined application and notice procedures for certain deposit-placement arrangements that are not subject to brokered deposit restrictions. These final rules became effective on April 1, 2021. There has been no material impact to the Company or the Affiliate Banks from the new rule.

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 USA PATRIOT Act or future anti-terrorist, homeland security or anti-money laundering legislation or regulation cannot be predicted with certainty.

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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’s Financial Crimes Enforcement Network (“FinCEN”). 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.

Corporate Transparency Act. On January 1, 2021, as part of the 2021 National Defense Authorization Act, Congress enacted the Corporate Transparency Act (“CTA”), which requires FinCEN to issue regulations implementing reporting requirements for “reporting companies” (as defined in the CTA) to disclose beneficial ownership interests of certain U.S. and foreign entities by January 1, 2022. The CTA imposes additional reporting requirements on entities not previously subject to such beneficial ownership disclosure regulations and also contains exemptions for several different types of entities, including among others, certain banks and bank holding companies. Non-compliance with FinCEN regulations promulgated under the CTA may result in civil fines as well as criminal penalties.

In December 2021, FinCEN proposed the first of three sets of rules to implement the beneficial ownership reporting requirements of the CTA, with subsequent rulemakings expected (i) to implement the CTA’s protocols for access to and disclosure of beneficial ownership information, and (ii) to revise the existing customer due diligence requirements that apply to the Company, the Affiliate Banks and many other financial institutions, to ensure consistency between these requirements and the beneficial ownership reporting rules. The Company is unable to determine the ultimate impact, if any, of FinCEN’s regulations on the Company and its subsidiaries, including the Affiliate Banks. The Company will continue to monitor developments related to the FinCEN rules, including future FinCEN rulemakings.

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.

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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 the Company, 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, the Company 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. On July 9, 2019,  the federal banking agencies along with the Commodity Futures Trading Commission and the SEC issued a final rule to exclude community banks, like the Affiliate Banks, from the application of the Volcker Rule.

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.

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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 the Company or the Affiliate Banks, 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, the Company 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 the Company, these laws and programs do not materially affect the Company’s 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.

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On November 18, 2021, the federal bank regulatory agencies issued a final rule to improve the sharing of information about cyber incidents that may affect the U.S. banking system. The rule requires a banking organization to notify its primary federal regulator of any significant computer-security incident as soon as possible and no later than 36 hours after the banking organization determines that a cyber incident has occurred. Notification is required for incidents that have materially affected—or are reasonably likely to materially affect—the viability of a banking organization’s operations, its ability to deliver banking products and services, or the stability of the financial sector. In addition, the rule requires a bank service provider to notify affected banking organization customers as soon as possible when the provider determines that it has experienced a computer-security incident that has materially affected or is reasonably likely to materially affect banking organization customers for four or more hours. Compliance with the final rule is required by May 1, 2022. The Company and the Affiliate Banks do not anticipate any material impact to their respective operations related to this rule at this time.

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If the Company fails to meet regulatory expectations, it could be subject to various regulatory sanctions, including financial penalties and may be required to perform remediation efforts that demand significant Company resources. To date, the Company 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 the Company 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 the Company and its customers.

Future Regulation.  From time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and the operating environment of the Company in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. The Company cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would have on the financial condition or results of operations of the Company or the Affiliate Banks. A change in statutes, regulations or regulatory policies applicable to the Company or any of its subsidiaries could have a material effect on our business.

Filings with the SEC

The Company 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 the Company’s investor relations website, partnersbancorp.com/investor-relations, as soon as reasonably practicable after the Company files such documents with the SEC. The information contained on the Company’s website is not a part of this Form 10-K or of any other filing with the SEC. The Company’s filings with the SEC are also available through the SEC’s website at http://www.sec.gov.

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Risks Related to Our Business

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Risks Related to Bank and Bank Holding Company Regulation

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Risks Related to the Company’s Common Stock

Risks Related to Information Technology

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General Risk Factors

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Risk Factors

An investment in the Company’s securities involves risks and uncertainties. Below are the material risks and uncertainties, of which the Company is currently aware, that could have a material adverse effect on the Company’s business, results of operations, financial condition, liquidity and capital position. These factors could cause the Company’s actual results to differ materially from its historical results or the results contemplated by the forward-looking statements contained in this Annual Report on Form 10-K, in which case the trading price of the Company’s common stock could decline. 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.

Risk’s Related to the Company’s Pending Merger with OCFC

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Because the market price of OCFC common stock will fluctuate, the value of the merger consideration to be received by our shareholders may change.

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On November 4, 2021, the Company announced the signing of the Merger Agreement, pursuant to which the Company will be acquired by OCFC. Under the terms of the Merger Agreement, each share of Company common stock (other than Exception Shares, as defined in the merger agreement), will be converted into the right to receive either 0.4512 shares of common stock of OCFC or $10.00, in each case, at the election of the holder of Company common stock, subject to a maximum of forty percent (40%) of the shares of Company common stock being convertible into cash and the allocation and proration provisions of the Merger Agreement. The closing price of OCFC common stock on the

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date that the merger is completed may vary from the closing price of OCFC common stock on the date OCFC and the Company announced the signing of the Merger Agreement and the date of the special meeting of Company shareholders regarding the merger. Because the stock portion of the merger consideration is determined by a fixed exchange ratio, at the time of the election with respect to the receipt of stock or cash consideration, Company shareholders will not know or be able to calculate the value of the shares of OCFC common stock they may receive upon completion of the merger. Any change in the market price of OCFC common stock prior to completion of the merger may affect the value of the stock portion of the merger consideration. Stock price changes may result from a variety of factors, including general market and economic conditions, changes in the companies’ respective businesses, operations and prospects, and regulatory considerations, among other things. Many of these factors are beyond the control of OCFC and the Company. Company shareholders should obtain current market quotations for shares of OCFC common stock and Company common stock before making their election with respect to the form of merger consideration they wish to receive.

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Company shareholders may receive a form of consideration different from what they elect with respect to the merger with OCFC.

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Although each holder of Company common stock may elect to receive as consideration shares of OCFC common stock, only cash or a combination of OCFC common stock and cash, such elections are subject to a maximum of forty percent (40%) of the shares of Company common stock being convertible into cash and the allocation and proration provisions of the Merger Agreement. As a result, if the aggregate cash elections exceed forty percent (40%) of the shares of Company common stock, Company shareholders who elected cash will receive some of their merger consideration in a form that they did not elect.

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Regulatory approvals may not be received, may take longer than expected or may impose conditions that are not presently anticipated or cannot be met.

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Before the transactions contemplated by the Merger Agreement may be completed, various approvals must be obtained from bank regulatory authorities. In determining whether to grant these approvals, the applicable regulatory authorities consider a variety of factors, including the competitive impact of the proposal in the relevant geographic markets; financial, managerial and other supervisory considerations of each party; convenience and needs of the communities to be served and the record of the insured depository institution subsidiaries under the Community Reinvestment Act of 1977 and the regulations promulgated thereunder; effectiveness of the parties in combating money laundering activities; any significant outstanding supervisory matters; and the extent to which the proposal would result in greater or more concentrated risks to the stability of the United States banking or financial system. These regulatory authorities may impose conditions on the granting of such approvals. Such conditions or changes and the process of obtaining regulatory approvals could have the effect of delaying completion of the merger or of imposing additional costs or limitations on the combined company following the merger. The regulatory approvals may not be received at all, may not be received in a timely fashion, or may contain conditions on the completion of the mergers that are not anticipated or cannot be met. Furthermore, such conditions or changes may constitute a burdensome condition that may allow OCFC to terminate the Merger Agreement and OCFC may exercise its right to terminate the Merger Agreement. If the consummation of the mergers is delayed, including by a delay in receipt of necessary regulatory approvals, the business, financial condition and results of operations of the Company may also be materially and adversely affected.

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Failure of the merger to be completed, the termination of the Merger Agreement or a significant delay in the consummation of the merger could negatively impact the Company.

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The Merger Agreement is subject to a number of conditions which must be fulfilled in order to complete the mergers. These conditions to the consummation of the merger may not be fulfilled and, accordingly, the merger may not be completed. In addition, if the merger is not completed by November 4, 2022, either OCFC or the Company may choose to terminate the Merger Agreement at any time after that date if the failure of the effective time to occur on or before that date is not caused by any breach of the Merger Agreement by the party electing to terminate the merger agreement. If the merger is not consummated, the ongoing business, financial condition and results of operations of the Company may be materially adversely affected and the market price of the Company’s common stock may decline

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significantly, particularly to the extent that the current market price reflects a market assumption that the merger will be consummated.

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In addition, the Company has incurred and will incur substantial expenses in connection with the negotiation and completion of the transactions contemplated by the Merger Agreement. If the merger is not completed, the Company would have to recognize these expenses without realizing the expected benefits of the merger. Any of the foregoing, or other risks arising in connection with the failure of or delay in consummating the merger, including the diversion of management attention from pursuing other opportunities and the constraints in the merger agreement on the ability to make significant changes to the Company’s ongoing business during the pendency of the merger, could have a material adverse effect on the Company’s business, financial condition and results of operations. If the Merger Agreement is terminated and the Company’s board of directors seeks another merger or business combination, Company shareholders cannot be certain that the Company will be able to find a party willing to engage in a transaction on more attractive terms than the merger with OCFC.

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The Company will be subject to business uncertainties and contractual restrictions while the merger is pending.

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Uncertainty about the effect of the merger on employees, customers (including depositors and borrowers), suppliers and vendors may have an adverse effect on the business, financial condition and results of operations of the Company. These uncertainties may impair the Company’s ability to attract, retain and motivate key personnel and customers (including depositors and borrowers) pending the consummation of the merger, as such personnel and customers may experience uncertainty about their future roles and relationships following the consummation of the merger. Additionally, these uncertainties could cause customers (including depositors and borrowers), suppliers, vendors and others who deal with the Company to seek to change existing business relationships with the Company or fail to extend an existing relationship with the Company. In addition, competitors may target the Company’s existing customers by highlighting potential uncertainties and integration difficulties that may result from the merger.

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The pursuit of the merger and the preparation for the integration may place a burden on the Company’s management and internal resources. Any significant diversion of management attention away from ongoing business concerns and any difficulties encountered in the transition and integration process could have a material adverse effect on the Company’s business, financial condition and results of operations. In addition, the Merger Agreement restricts each party from taking certain actions without the other party’s consent while the merger is pending. These restrictions could have a material adverse effect on the Company’s business, financial condition and results of operations.

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The Merger Agreement contains provisions that may discourage other companies from pursuing, announcing or submitting a business combination proposal to the Company that might result in greater value to Company shareholders.

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The Merger Agreement contains provisions that may discourage a third party from pursuing, announcing or submitting a business combination proposal to the Company that might result in greater value to Company shareholders than the merger with OCFC. These provisions include a general prohibition on the Company from soliciting, or, subject to certain exceptions, entering into discussions with any third party regarding any acquisition proposal or offers for competing transactions. Furthermore, if the merger agreement is terminated, under certain circumstances, the Company may be required to pay OCFC a termination fee equal to $7,400,000. The Company also has an obligation to submit its merger-related proposals to a vote by its shareholders, including if the Company receives an unsolicited proposal that the Company board of directors believes is superior to the merger, unless the merger agreement is terminated by the Company under certain conditions described in the merger agreement.

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Litigation against the Company or OCFC, or the members of the Company’s or OCFC’s board of directors, could prevent or delay the completion of the OCFC Merger.

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Purported shareholder plaintiffs may assert legal claims related to the OCFC merger. The results of any such potential legal proceeding would be difficult to predict and such legal proceedings could delay or prevent the merger from being completed in a timely manner. Moreover, any litigation could be time consuming and expensive, and could

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divert attention of the Company’s and OCFC’s respective management teams away from their companies’ regular business. Any lawsuit adversely resolved against the Company, OCFC or members of their respective boards of directors, could have a material adverse effect on each party’s business, financial condition and results of operations.

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One of the conditions to the consummation of the merger is the absence of any law, order, decree or injunction (whether temporary, preliminary or permanent) or other action taken by the governmental authority of competent jurisdiction that restricts, enjoins or prohibits or makes illegal the consummation of the transactions contemplated by the merger agreement, including the merger. Consequently, if a settlement or other resolution is not reached in any lawsuit that is filed or any regulatory proceeding and a claimant secures injunctive or other relief or a governmental authority issues an order or other directive restricting, prohibiting or making illegal the completion of the transactions contemplated by the merger agreement, including the merger, then such injunctive or other relief may prevent the merger from being completed in a timely manner or at all.

Risks Related to Our Business

The COVID-19 pandemic could adversely affect our business, financial condition and results of operations, the extent of which is not now known or predictable.

The ongoing COVID-19 global and national health emergency has caused significant disruption in the United States and international economies and financial markets. The spread of COVID-19 in the United States has caused, among other things, illness, quarantines, cancellation of events and travel, business and school shutdowns, reduction in commercial activity and financial transactions, supply chain interruptions, increased unemployment, rising prices, inflation, and overall economic and financial market instability.

The COVID-19 pandemic has caused disruptions to the Company’s business and could cause material disruptions to the Company’s business and operations in the future. Impacts to the Company’s business have included increases in costs and reductions in operating effectiveness due to additional health and safety precautions implemented at the Company’s branches and the transition of a portion of the Company’s workforce to home locations, decreases in customer traffic in branches, and increases in requests for and the making of loan modifications. To the extent that commercial and social restrictions increase, the Company’s expenses, delinquencies, charge-offs, foreclosures and credit losses may materially increase, and the Company could experience reductions in fee income. In addition, any declines in credit quality could significantly affect the adequacy of the Company’s allowance for credit losses, which would lead to increases in the provision for credit losses and related declines in the Company’s net income.

While the Company has taken and is continuing to take precautions to protect the safety and well-being of its employees and customers, no assurance can be given that the steps being taken will be deemed to be adequate or appropriate, nor can the Company predict the level of disruption which will occur to its employee's ability to provide customer support and service. The continued or renewed spread of COVID-19 could negatively impact the availability of key personnel necessary to conduct the Company’s business, the business and operations of the Company’s third-party service providers who perform critical services for the Company’s business, or the businesses of many of the Company’s customers and borrowers.

Among the factors outside the Company’s control that are likely to affect the impact the COVID-19 pandemic will ultimately have on the Company’s business are, without limitation:

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If the COVID-19 pandemic results in a continuation or worsening of current economic conditions and commercial environments, our business, financial condition and results of operations could be materially adversely affected. Additional ongoing and potential risks and effects related to the COVID-19 pandemic are discussed in the other risk factors contained in this report.

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

The Company’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 investment 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 the Company’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 the Company receives on loans and investment securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) the Company’s ability to originate loans and obtain deposits, (ii) the fair value of the Company’s financial assets and liabilities, and (iii) the average duration of the Company’s mortgage-backed investment 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, the Company’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 response to 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. On March 16, 2022, the Federal Reserve increased the targeted federal funds rates to 0.25-0.5%, and the Federal Reserve has suggested further increases are expected during the remainder of 2022. As a result, the Company expects overall interest rates to rise in 2022, which is expected to 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. Fluctuations in market interest rates could have a material adverse effect on the Company’s business, financial condition and results of operations.

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

The Company’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

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industry and finance, and the strength of the U.S. economy and the local economies in which the Company operates, all of which are beyond the Company’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 the Company’s products and services, among other things, any of which could have a material adverse impact on the Company’s business, financial condition and results of operations.

If the Company has higher credit losses than it has allowed for, the Company’s earnings could materially decrease.

The Company maintains an allowance for credit losses, which is a reserve established through a provision for credit 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 credit losses inherently involves a high degree of subjectivity and requires the Company 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 the Company’s control, may require an increase in the allowance for credit losses. In addition, bank regulatory agencies periodically review the allowance for credit losses and may require an increase in the provision for credit 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 credit losses, the Company will need additional provisions to increase the allowance for credit losses. Any increases in the allowance for credit losses will result in a decrease in net income, and possibly capital, and may have a material adverse effect on the Company’s business, financial condition and results of operations.

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

The Company’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, the Greater Washington 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. Like most states and local economies, these areas have been significantly impacted by the COVID-19 pandemic and related governmental and societal actions. A significant decline in general economic conditions caused by inflation, recession, acts of terrorism, outbreak of hostilities (including the recent hostilities between Russia and Ukraine) or other international or domestic occurrences, unemployment, changes in securities markets, or other factors, including the continuation of the COVID-19 pandemic, could impact these local economic conditions and, in turn, have a material adverse effect on the Affiliate Banks’, and therefore the Company’s, financial condition and results of operations.

Because the Company 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

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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 the Company’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 the Company’s future performance.

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

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

Although the Company evaluates every loan that it makes against its underwriting criteria, the Company 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 and the conflict between Russian and Ukraine, 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 the Company’s borrowers.

The Company determines the adequacy of its allowance for credit losses by considering various factors, including:

Local economic conditions could impact the Company’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 the Company serves. Weakness in the market areas served by the Company could depress its earnings and, consequently, its financial condition because:

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

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

A significant portion of the Company’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

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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 (such as the conflict between Russia and Ukraine), and public health crises (like the current COVID-19 pandemic). If real estate prices decline, particularly in the Company’s market area, the value of the real estate collateral securing the Company’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 the Company’s business, financial condition and results of operations.

The Company’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.

The Company is a bank holding company and its operations are conducted by its subsidiaries, Delmarva and Partners. The Company’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 the Company will generate adequate cash flow from Delmarva and Partners to pay dividends in the future. The Company’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 the Company’s profitability.

The banking business is highly competitive. The Company 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. The Company’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 the Company’s competitors have substantially greater resources and lending limits than the Company has, and offer certain services, such as extensive and established branch networks and trust services, that the Company 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 the Company. The Company’s failure to compete effectively in its markets could restrain the Company’s growth or cause it to lose market share, which could have a material adverse effect on the Company’s business, financial condition and results of operations.

The Company 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 the Company’s profitability.

The nature of the Company’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 the Company records and reports its financial condition and results of operations. In some instances, the Company 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 the Company 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 the Company calculate the allowance for credit 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 credit losses and future provisions for credit losses.

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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. The Company expects to recognize a one-time cumulative-effect adjustment to the allowance for credit 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. The Company 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, the Company expects that the adoption of the CECL model will materially affect how it determines its allowance for credit 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 credit losses. If the Company is required to materially increase the level of its allowance for credit 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 the Company’s business, financial condition, results of operations and stock price.

The soundness of other financial institutions may adversely affect the Company.

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. The Company 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 the Company 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 which could result in defaults and, as a result, impair the confidence of our counterparties and ultimately affect our ability to effect transactions. In addition, the Company’s credit risk may be exacerbated when the collateral held by the Company cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit exposure due to the Company. Any such losses could have a material adverse effect on the Company’s financial condition and results of operations.

Market volatility may have materially adverse effects on the Company’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 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 the COVID-19 pandemic continues, there can be no assurance that the Company will not experience adverse effects, which may be material, on its liquidity, financial condition, and profitability.

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

Various Maryland laws affecting business corporations may have the effect of discouraging offers to acquire the Company, even if the acquisition would be advantageous to shareholders. In addition, the Company 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 the Company 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 the Company common stock.

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

The Company 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, the Company is required to assess whether the decline is an other-than-temporary impairment. If the Company 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 the Company 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 the Company’s investment portfolio or a prolonged price decline may result in the Company’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 the Company’s ability to fund operations and meet its obligations as they become due and failure to maintain sufficient liquidity could materially adversely affect the Company’s growth, business, profitability and financial condition.

Liquidity is essential to the Company’s business. Liquidity risk is the potential that the Company 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. The Company 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 operating 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 COVID-19 pandemic and geopolitical events such as the conflict between Russia and Ukraine. 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 the Company, 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. The Company’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 the Company or either of the Affiliate Banks. The Company’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 the Company’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.

The Company relies on customer deposits, advances from the Federal Home Loan Bank and brokered deposits to fund its operations. Although the Company 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.

The Company is subject to environmental liability risk associated with lending activities.

A significant portion of the Company’s loan portfolio is secured by real property. During the ordinary course of business, the Company 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, the Company may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws

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may require the Company to incur substantial expense and may materially reduce the affected property’s value or limit the Company’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 the Company’s exposure to environmental liability. Although the Company 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 the Company’s financial condition and results of operations and in turn, the Company’s financial condition, results of operations and stock price.

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, the Company may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports, and other financial information. The Company 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 the Company’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 that would have historically been held as bank deposits in brokerage accounts, mutual funds, reloadable pre-paid cards, or other types of assets, including cryptocurrencies and other digital assets. 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 the Company’s business, financial condition and results of operations.

Risks Related to Bank and Bank Holding Company Regulation

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 the Company’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. The Company is subject to primary regulation and supervision by the Federal Reserve, Delmarva is subject to primary regulation and supervision by the Federal Reserve 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 federal, state and local 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 the Company and the Affiliate Banks, transactions between the Company and the Affiliate Banks, handling of nonpublic information, restrictions on dividends, establishment of new offices, and the monitoring and reporting of suspicious activity and customers who are perceived to present a heightened risk of money laundering or other illegal activity. The Company 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 the Company’s operations, and the adoption of new laws and changes to or repeal of existing laws may have a further impact on the Company’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. The Company’s failure

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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 the Company’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 the Company’s business, financial condition and results of operations.

Federal, state and local legislative bodies and regulatory agencies may adopt changes to their laws or 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 the Company to increase its regulatory capital, and limit its ability to pursue business opportunities in an efficient manner by requiring the Company 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 the Company’s ability to implement its strategy and could affect the Company in substantial and unpredictable ways, and could have a material adverse effect on the Company’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, investment 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 the Company’s business differs from the Company’s assessment, the Company may be required to take additional charges or undertake, or refrain from taking, actions that could have a material adverse effect on the Company’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 6.0%, a minimum total risk based capital ratio of 8.0%, and a minimum leverage ratio of 4.0%. 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 10.0% or greater and a leverage ratio of 5.0% 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.

The COVID-19 pandemic and other events continue to have 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

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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. Any new or revised standards adopted in the future 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. The Company 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 the Company’s business, financial condition and results of operations. For additional information, please see “Supervision and Regulation” in Item 1, Business.

The Company 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.

The Company’s regulators or market conditions may require it to increase its capital levels. If the Company 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 the Company’s stock price. New investors may also have rights, preferences and privileges senior to the Company’s shareholders, which may adversely impact its shareholders. The Company’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, the Company 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 the Company 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 the Company’s business, financial condition, and results of operations.

Risks Related to the Company’s Common Stock

The Company’s ownership is concentrated in one significant shareholder.

Kenneth R. Lehman beneficially owns approximately 41.2% of the Company’s common stock. As a result, Mr. Lehman has the ability to exercise significant control over the Company’s business policies and affairs, such as the composition of the Company’s board of directors and any action requiring the approval of the Company’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 Information Technology

The Company’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.

The Company 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 the Company’s customer relationship management, general ledger, deposit, loan and other systems. While the Company 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 the Company 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. The Company is exposed to the risk of cyber-attacks in the normal course of business. In addition, the Company is exposed to cyber-attacks on vendors and merchants that affect the Company and its customers. In general, cyber incidents can result from deliberate attacks or unintentional events. The Company 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

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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 the Company 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 the Company 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 the Company’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.

The Company’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. The Company’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 the Company’s operations. Many of the Company’s competitors have substantially greater resources to invest in technological improvements. The Company 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 and Partners’businesses and, in turn, the Company’s 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 the Company’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 the Company’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 the Company’s interests and/or may be inaccurate. The dissemination of information online could harm the Company’s business, prospects, financial condition, and results of operations, regardless of the information’s accuracy. The harm may be immediate without affording the Company an opportunity for redress or correction.

Other risks associated with the use of social media include improper disclosure of proprietary information, negative comments about the Company’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 the Company’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 the Company’s reputation adversely affecting customer or investor confidence.

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General Risk Factors

The Company’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. The Company’s stock price may fluctuate widely in response to a variety of factors including the risk factors described herein and, among other things:

In particular, the ongoing COVID-19 pandemic has resulted in severe volatility in the financial markets including with respect to the Company’s common stock. Depending on the extent and duration of the COVID-19 pandemic, the price of the Company’s common stock may continue to experience volatility and declines.

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

From time to time, the Company 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, the Company 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 (such as the military conflict between Russia and Ukraine), 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 the Company’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 the Company’s business, financial condition, and results of operations.

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

The Company may use its common stock to acquire other companies. The Company may issue additional shares of common stock to pay for future acquisitions, which would dilute current investors’ ownership interest in the

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Company. Future business acquisitions could be material to the Company, and the degree of success achieved in acquiring and integrating these businesses into the Company could have a material effect on the value of the Company’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, the Company could become more susceptible to economic downturns and competitive pressures.

The Company may not be able to attract and retain skilled people.

The Company’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 the Company can be intense, and the Company may not be able to hire people or to retain them. In 2021, in particular, the labor market in the U.S. experienced a significant increase in workers leaving their positions (often referred to as the “Great Resignation”), which has made the market to replace these individuals increasingly competitive and has resulted in significant wage inflation in response to labor shortages. In 2021, we experienced higher turnover rates and challenges in recruiting and retaining qualified employees at all levels of our organization. The unexpected loss of services of one or more of the Company’s key personnel could have a material adverse impact on the Company’s business.

Litigation and regulatory actions, including possible enforcement actions, could subject the Company 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, the Company 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, the Company 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 the Company 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 the Company’s business, financial condition and results of operations.

Severe weather, natural disasters, acts of war or terrorism, other external events, including the ongoing COVID-19 pandemic or the outbreak of another highly infectious or contagious disease, could significantly impact the Company’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 the Company’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, the Company could be materially adversely affected. Third parties with which the Company does business could also be sources of operational risk to the Company, including the risk that the third parties’ own network and information processing systems could fail. Any of these occurrences could materially diminish the Company’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 the Company. Such events could affect the stability of the Company’s deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, impair the Company’s liquidity, cause significant property damage, result in loss of revenue, and/or cause the Company to incur additional expenses.

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The Company 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 the Company’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, acts of war (such as the current military confict between Russia and Ukraine) or terrorist acts. The Company 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. The Company also reviews and evaluates the business continuity plans of critical third-party service providers. While the Company 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 the Company’s reputation, and loss or liability to the Company.

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

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

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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 the Company 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 of the Affiliate Banks 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.

Computershare is the transfer agent for the Company’s common stock:

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Shareholder Website: www.computershare.com/investor

Shareholder Online Inquiries: www.computershare.com/investor/contact

Telephone: 1 (800) 368-5948

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Computershare Inc. (Overnight Delivery)Computershare Inc. (Regular Mail)
462 South 4th Street Suite 1600P.O. Box 505000
Louisville, KY 40202Louisville, KY 40233-5000
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ISSUER PURCHASES OF EQUITY SECURITIES

In November 2020 the Company’s Board of Directors approved, and the Company announced, a stock repurchase program (the “Program”). Under the Program, the Company is authorized to repurchase up to 356,000 shares of its common stock, which represented approximately 2% of its outstanding shares of common stock at the time of the Board of Directors’ approval. The Program may be limited or terminated at any time without prior notice. During the year ended December 31, 2021, the Company repurchased 31,800 shares at a weighted average price of $6.53 per share under the Program. The Company did not repurchase any of its common stock during the quarter ended December 31, 2021.

The following table provides information with respect to purchases made by or on behalf of us or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Exchange Act) of the Company’s common stock during the fourth quarter of 2021.

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ITEM 6. RESERVED

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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 Item 1A. “Risk Factors.” All of the forward-looking statements made in this Annual Report are expressly qualified by the cautionary statements contained or referred to in this Annual Report. The actual results or developments anticipated may not be realized or, even if substantially realized, they may not have the expected consequences to or effects on the Company or its businesses or operations. Readers are cautioned not to place undue reliance on the forward-looking statements contained in this Annual Report. Forward-looking statements speak only as of the date they are made and the Company does not undertake any obligation to update, revise, or clarify these forward-looking statements whether as a result of new information, future events or otherwise.

Overview

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

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The Company 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 purchasing investment securities are deposits and secondarily, borrowings. Consequently, one of the key measures of the Company’s success is the amount of net interest income, or the difference between the income on interest earning assets, such as loans and investment securities, and the expense on interest bearing liabilities, such as deposits and borrowings. The resulting ratio of that difference as a percentage of average interest 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 investment securities, the Company 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 the Company maintains an allowance for credit losses to absorb probable losses on existing loans that may become uncollectible. The Company maintains this allowance for credit losses by charging a provision for credit losses as needed against our operating earnings for each period. The Company has included a detailed discussion of this process, as well as several tables describing its allowance for credit losses.

The Company plans to continue to grow organically, including potential expansion into new market areas, such as its recent expansion into the Greater Washington market. The Company 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 Company’s financial performance generally, and in particular the ability of its borrowers to repay their loans, the value of collateral securing those loans, as well as demand for loans and other products and services the Company offers, is highly dependent on the business environment in the Company’s primary markets where the Company operates and in the United States as a whole.

The ongoing COVID-19 pandemic has severely disrupted supply chains and adversely affected production, demand, sales and employee productivity across a range of industries, dramatically increased unemployment in the Company’s areas of operation and nationally, and previously resulted in orders directing the closing or limited operation of certain businesses and restrictions on public gatherings. These events affected the Company’s operations during 2020 and 2021, and are expected to impact the Company’s financial results continuing on into 2022. The extent of the impact of the COVID-19 pandemic on the Company’s operational and financial performance will depend on certain developments, including the duration and spread of the outbreak, the impact on the Company’s customers, employees and vendors and the nature and effect of past and future federal and state governmental and private sector responses to the pandemic, all of which are uncertain and cannot be predicted.

In connection with the ongoing COVID-19 pandemic, both Delmarva and Virginia Partners continue to follow their pandemic response plans, which were enacted in February 2020. To date, management believes that the plans have been implemented successfully. As of December 31, 2021, both Delmarva and Virginia Partners branch operations were operating under normal lobby and drive-thru hours. In addition, the majority of Delmarva’s and Virginia Partners’ employees, with a few exceptions, have shifted from remote work to returning to the office on either a full-time or hybrid basis. Delmarva and Virginia Partners continue to take necessary precautions in order to protect their staffs, customers and their families as well as their communities, and to limit the ongoing impact of the COVID-19 pandemic.

Future developments with respect to the COVID-19 pandemic are highly uncertain and cannot be predicted and new information may emerge concerning the severity of the outbreak and the actions to contain the outbreak or treat its impact, among others. Other national health concerns, including the outbreak of other contagious diseases or pandemics may adversely affect the Company in the future. Please refer to the “Provision and Allowance for Credit Losses” section of this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more information related to payment deferrals, concentrations in higher risk industries, and the impact on the allowance for credit losses.

The following discussion and analysis also identifies significant factors that have affected the Company'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.

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Critical Accounting Policies and Estimates

Certain critical accounting policies affect significant judgments and estimates used in the preparation of the Company'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 the Company follows and the methods of applying these principles conform to U.S. GAAP and general banking industry practices. The Company's most critical accounting policy relates to the determination of the allowance for credit losses, which reflects the estimated losses resulting from the inability of borrowers to make loan payments. The determination of the adequacy of the allowance for credit losses 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 credit losses may be required. See “Provision and Allowance for Credit Losses” and Note 1 and Note 3 of the consolidated financial statements for the year ended December 31, 2021.

Another of the Company’s critical accounting policies, with the acquisitions of Liberty in 2018 and Virginia Partners in 2019, relates to the valuation of goodwill and intangible assets. The Company accounted for the Liberty Merger and the Share Exchange in accordance with 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 Liberty Merger and the Share Exchange, which totaled approximately $5.2 million and $4.4 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, which is limited to the amount of goodwill allocated to that reporting unit. In evaluating the goodwill on its consolidated balance sheet for impairment after the consummation date of the Liberty Merger and the Share Exchange, the Company 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 ASU 2017-04. 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 Liberty Merger and the Share Exchange. This assessment was performed during the fourth quarter of 2021, and resulted in no impairment of goodwill. Depending on the severity of the economic consequences of the COVID-19 pandemic and their impact on the Company, management may determine that goodwill is required to be evaluated for impairment due to the presence of a triggering event, which may have a negative impact on the Company’s results of operations.

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In addition to the Company’s policies related to the valuation of goodwill, intangible assets and other acquisition accounting adjustments, ongoing accounting for acquired loans is considered a critical accounting policy. Acquired loans are classified as either purchased credit impaired (“PCI “) loans or purchased performing loans and are recorded at fair value on the date of acquisition. PCI loans are those for which there is evidence of credit deterioration since origination and for which it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the “nonaccretable difference.” Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the “accretable yield” and is recognized as interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows. Periodically, we evaluate our estimate of cash flows expected to be collected on PCI loans. Estimates of cash flows for PCI loans require significant judgment. Subsequent decreases to the expected cash flows will generally result in a provision for credit losses resulting in an increase to the allowance for credit losses. Subsequent significant increases in cash flows may result in a reversal of post-acquisition provision for credit losses or a transfer from nonaccretable difference to accretable yield that increases interest income over the remaining life of the loan, or pool(s) of loans. The Company accounts for purchased performing loans using the contractual cash flows method of recognizing discount accretion based on the acquired loans’ contractual cash flows. Purchased performing loans are recorded at fair value, including a credit discount. The fair value discount is accreted as an adjustment to yield over the estimated lives of the loans. There is no allowance for credit losses established at the acquisition date for purchased performing loans, but a provision for credit losses may be required for any deterioration in these loans in future periods. The Company evaluates purchased performing loans quarterly for deterioration and records any required additional provision for credit losses.

Another critical accounting policy relates to deferred tax assets and liabilities. The Company 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 fifty (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.

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Positive Impacts:

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Negative Impacts:

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As previously disclosed, on November 4, 2021, the Company and OCFC announced that they have entered into a definitive agreement and plan of merger pursuant to which the Company will merge into OCFC, with OCFC surviving, and following which Virginia Partners and Delmarva will each successively merge with and into OceanFirst Bank, N.A., with OceanFirst Bank surviving each bank merger. The mergers are subject to receiving the requisite approval of the Company’s stockholders, which was received on March 9, 2022, receipt of all required regulatory approvals and fulfillment of other customary closing conditions.

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For the twelve months ended December 31, 2021, the Company’s return on average assets, return on average equity and efficiency ratio were 0.46%, 5.43% and 76.97%, respectively, as compared to 0.40%, 4.24% and 71.96%, respectively, for the same period in 2020.

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The increase in net income attributable to the Company for the twelve months ended December 31, 2021, as compared to the same period in 2020, was driven by an increase in net interest income and a lower provision for credit losses, and was partially offset by a decrease in noninterest income and higher noninterest expenses and federal and state income taxes.

Financial Condition

Total assets as of December 31, 2021 were $1.64 billion, an increase of $130.8 million, or 8.6%, from December 31, 2020. Key drivers of this change were increases in cash and cash equivalents and total loans held for investment. Changes in key balance sheet components as of December 31, 2021 compared to December 31, 2020 were as follows:

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Delmarva's Tier 1 leverage capital ratio was 8.1% at both December 31, 2021 and 2020. At both December 31, 2021 and 2020, Delmarva's Tier 1 risk-weighted capital and total risk-weighted capital ratios were 11.6% and 12.9%, respectively.

Virginia Partners’ Tier 1 leverage capital ratio was 8.5% at December 31, 2021 as compared to 9.5% at December 31, 2020. At December 31, 2021, Virginia Partners’ Tier 1 risk-weighted capital and total risk-weighted capital ratios were 11.3% and 12.0%, respectively, as compared to Tier 1 risk-weighted capital and total risk-weighted capital ratios of 13.1% and 13.5%, respectively, at December 31, 2020.

As of December 31, 2021, all of the capital ratios of Delmarva and Virginia Partners continue to exceed regulatory requirements, with total risk-based capital substantially above well-capitalized regulatory requirements.

See “Capital” below for additional information about Delmarva’s and Virginia Partners’ capital ratios and requirements.

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At December 31, 2021, nonperforming assets totaled $9.8 million, an increase from December 31, 2020 balances of $7.6 million. Most of this increase was due to an increase in nonaccrual loans, which totaled $9.0 million at December 31, 2021 compared with a balance of $4.9 million at December 31, 2020. There were no loans past due 90 days or more and still accruing interest at the end of 2021, compared to one loan past due 90 days or more and still accruing interest at December 31, 2020 with a balance of $2 thousand. Other real estate owned as of December 31, 2021 was $837 thousand, as compared to $2.7 million at December 31, 2020. Nonperforming loans as a percentage of total assets was 0.5% at December 31, 2021 and 0.3% at December 31, 2020. Nonperforming assets to total assets as of December 31, 2021 was 0.6% compared to 0.5% at December 31, 2020. Loans classified as Troubled Debt Restructurings (“TDRs’) totaled $7.9 million at December 31, 2021 and $6.7 million at December 31, 2020, an increase of $1.2 million during the year. This increase was mainly due to the addition of one relationship with an aggregate balance of $2.9 million.

Net charge-offs were 0.08% of average total loans for the year ended December 31, 2021 and 0.10% for the year ended December 31, 2020. The allowance for credit losses to total loans ratio was 1.31% at December 31, 2021, compared to 1.28% at December 31, 2020. In addition to the allowance for credit losses, as of December 31, 2021 and December 31, 2020, the Company had $2.3 million and $4.0 million, respectively, in unamortized discounts on acquired loans related to the acquisitions of Liberty and Virginia Partners. This discount is amortized over the life of the remaining loans.

Earnings Analysis

The Company'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 investment securities, the Company 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, the Company also maintains a portion of its deposits in cash and cash equivalents, government securities, interest bearing deposits in other financial institutions, and overnight loans of excess reserves (known as “Federal Funds Sold”) to correspondent banks. The revenue which the Company earns (prior to deducting its overhead expenses) is essentially a function of the amount of the Company's loans and deposits, as well as the profit margin (“interest spread”) and fee income which can be generated on these amounts.

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Net income attributable to the Company was $7.4 million and $5.7 million for the years ended December 31, 2021 and 2020, respectively, as reported in its audited consolidated financial statements. The following discussion should be read in conjunction with the Company'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 and financial condition of the Company at and for the periods and at the dates indicated, respectively:

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Interest Income and Expense – Years Ended December 31, 2021 and 2020

Net Interest Income and Net Interest Margin

The largest component of net income for the Company is net interest income, which is the difference between the income earned on assets, such as loans and investment securities, and interest paid on liabilities, such as deposits and borrowings, used to support such assets. Net interest income is determined by the rates earned on the Company'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.

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Net interest income for the twelve months ended December 31, 2021 increased by $2.6 million, or 6.0%, when compared to the twelve months ended December 31, 2020.  The Company's net interest margin (tax equivalent basis) decreased to 3.02%, representing a decrease of 15 basis points for the twelve months ended December 31, 2021 as compared to the same period in 2020.  The decrease in the net interest margin (tax equivalent basis) was primarily due to a decrease in the yields earned on average loans and investment securities, and higher average balances of interest-bearing liabilities.  These margin pressures were offset by higher net loan fees earned related to the forgiveness of loans originated and funded under the PPP, increases in average loan and investment securities balances, and lower rates paid on average interest-bearing liabilities.  The Company’s net interest margin (tax equivalent basis) was also negatively impacted by higher average balances of cash and due from banks, interest bearing deposits in other financial institutions and federal funds sold, which are lower yielding interest-earning assets.  Total interest income decreased by $743 thousand, or 1.3%, for the twelve months ended December 31, 2021 while total interest expense decreased by $3.4 million, or 27.5%, both as compared to the same period in 2020.  The most significant factors impacting net interest income during the twelve months ended December 31, 2021 were as follows:

Positive Impacts:

Negative Impacts:

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Loans

Average loan balances increased by $45.4 million, or 4.3%, and average yields earned decreased by 0.18% to 4.85% for the twelve months ended December 31, 2021, as compared to the same period in 2020.  The increase in average loan balances was primarily due to organic loan growth, including average growth of approximately $24.7 million in loans related to Virginia Partners’ recent expansion into the Greater Washington market, and loans originated and funded under the PPP, which were partially offset by the forgiveness of loans originated and funded under the PPP.  Organic loan growth continued to be negatively impacted by higher pay-offs and tempered loan demand due to the uncertainty surrounding the COVID-19 pandemic.  The decrease in average yields earned was primarily due to pay-offs of higher yielding fixed rate loans, repricing of variable rate loans, and lower average yields on new loan originations, including loans originated under the PPP at an interest rate of 1%, which were partially offset by higher net loan fees earned related to the forgiveness of loans originated and funded under the PPP.  Total average loans were 70.5% of total average interest-earning assets for the twelve months ended December 31, 2021, compared to 75.4% for the twelve months ended December 31, 2020.

Investment securities

Average total investment securities balances increased by $1.7 million, or 1.3%, and average yields earned decreased by 0.62% to 1.89% for the twelve months ended December 31, 2021, as compared to the same period in 2020, primarily due to management of the investment securities portfolio in light of the Company's liquidity needs and lower interest rates over the comparable period.  In addition, the decrease in average yields earned was driven by accelerated prepayments on mortgage-backed investment securities in the low interest rate environment.  These prepayments have caused the premiums paid on these investment securities to be amortized into expense on an accelerated basis thereby reducing income and yield earned.  Total average investment securities were 8.4% of total average interest-earning assets for the twelve months ended December 31, 2021, compared to 9.3% for the twelve months ended December 31, 2020.  

Interest-bearing deposits

Average total interest-bearing deposit balances increased by $101.3 million, or 12.5%, and average rates paid decreased by 0.44% to 0.73% for the twelve months ended December 31, 2021, as compared to the same period in 2020, primarily due to organic deposit growth, including average growth of approximately $13.1 million in deposits related to Virginia Partners’ recent expansion into the Greater Washington market, and a decrease in the average rate paid on money market and time deposits due to the decline in interest rates beginning late in the first quarter of 2020.

Borrowings

Average total borrowings decreased by $76.7 million, or 56.7%, and average rates paid increased by 1.61% to 3.62% for the twelve months ended December 31, 2021, as compared to the same period in 2020.  The decrease in average total borrowings balances was primarily due to a decrease in the average balance of Federal Home Loan Bank advances resulting from maturities and payoffs of borrowings that were not replaced, a decrease in average borrowings at the Federal Reserve Bank Discount Window under the PPP Liquidity Facility in which the loans under the PPP originated by the Company were previously pledged as collateral, and the early redemption of $2.0 million in subordinated notes payable, net, in early July 2021, which were partially offset by the issuance of $18.1 million in subordinated notes payable, net, in late June 2020.  The increase in average rates paid was primarily due to the issuance of subordinated notes payable, which is a higher cost interest-bearing liability, and the decreases in the average balances of Federal Home Loan Bank advances and borrowings at the Federal Reserve Bank Discount Window under the PPP Liquidity Facility, which were both lower cost interest-bearing liabilities, partially offset by the early redemption of subordinated notes payable, which was a higher cost interest-bearing liability.

Interest earned on assets and interest paid on liabilities is significantly influenced by market factors, specifically interest rate targets established by the Federal Reserve.

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The Federal Open Markets Committee (“FOMC”) lowered Federal Funds target rates for the first time in 11 years on July 31, 2019 and then again in September 2019 and October 2019, for a combined decrease of 75 basis points during 2019. In response to market volatility related to the COVID-19 pandemic, the FOMC again lowered Federal Funds target rates twice in March 2020, for a combined decrease of 150 basis points. The FOMC’s current Federal Funds target rate range is currently 0% to 0.25%. As a consequence, long-term interest rates have decreased. While there have been indications that FOMC plans to raise interest rates in 2022, the Company anticipates that the current interest rate environment will continue to put downward pressure on the Company’s net interest margin. In general, the Company believes interest rate increases lead to improved net interest margins whereas interest rate decreases result in correspondingly lower net interest margins.

The following table depicts, for the periods indicated, certain information related to the average balance sheet and average yields earned on assets and average costs paid on liabilities for the Company. Such yields and costs 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.

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The level of net interest income is affected primarily by variations in the volume and mix of these interest-earning assets and interest-bearing liabilities, as well as changes in interest rates. The following table shows the effect that these factors had on the interest earned from the Company's interest-earning assets and interest paid on its interest-bearing liabilities for the year ended December 31, 2021 versus 2020.

Interest Sensitivity. The Company monitors and manages the pricing and maturity of its assets and liabilities in order to diminish the potential adverse impact that changes in interest rates could have on its net interest income. The Company also performs asset/liability modeling to assess the impact varying interest rates and balance sheet mix assumptions will have on net interest income. Interest rate sensitivity can be managed by repricing assets or liabilities, selling investment securities available-for-sale, replacing an asset or liability at maturity, or adjusting the interest rate during the life of an asset or liability. Managing the amount of assets and liabilities repricing in the same time interval helps to hedge the risk and minimize the impact on net interest income of rising or falling interest rates. The Company evaluates interest sensitivity risk and then formulates guidelines regarding asset generation and repricing, funding sources and pricing, and off-balance sheet commitments in order to decrease interest rate sensitivity risk.

At December 31, 2021, the Company was asset sensitive within the one-year time frame when looking at a repricing gap analysis. The cumulative gap, in an unchanged interest rate environment, as a percentage of total assets up to one year is 27.0%. A positive gap indicates more assets than liabilities are repricing within the indicated time frame. Management believes there is more upside potential than downside risk and, based on the current and projected interest rate environment, management expects to see net interest income rise in the future.

Provision and Allowance for Credit Losses

The Company has developed policies and procedures for evaluating the overall quality of its credit portfolio and for timely identifying potential problem loans. Management's judgment as to the adequacy of the allowance for credit losses is based upon a number of assumptions about future events which it believes to be reasonable, but which may not prove to be accurate. Thus, there can be no assurance that loan charge-offs in future periods will not exceed the allowance for credit losses or that additional increases in the allowance for credit losses will not be required.

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The Company's allowance for credit losses consists of two parts. The first part is determined in accordance with authoritative guidance issued by the Financial Accounting Standards Board (“FASB”) regarding the allowance for credit losses. The Company's determination of this part of the allowance for credit losses is based upon quantitative and qualitative factors. A loan loss history based upon the prior three years is utilized in determining the appropriate allowance for credit losses. Historical loss factors are determined by criticized and uncriticized loans by loan type. These historical loss factors are applied to the loans by loan type to determine an indicated allowance for credit losses. The historical loss factors may also be modified based upon other qualitative factors including, but not limited to, local and national economic conditions, trends of delinquent loans, changes in lending policies and underwriting standards, concentrations, and management's knowledge of the loan portfolio.

The second part of the allowance for credit losses is determined in accordance with guidance issued by the FASB regarding impaired loans. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis. Impaired loans not deemed collateral dependent are analyzed according to the ultimate repayment source, whether that is cash flow from the borrower, guarantor or some other source of repayment. Impaired loans are deemed collateral dependent if in the Company's opinion the ultimate source of repayment will be generated from the liquidation of collateral.

The sum of the two parts constitutes management's best estimate of an appropriate allowance for credit losses. When the estimated allowance for credit losses is determined, it is presented to the Company's Board of Directors for review and approval on a quarterly basis.

At December 31, 2021, the Company's allowance for credit losses was $14.7 million, or 1.31% of total outstanding loans. At December 31, 2020, the allowance for credit losses was $13.2 million, or 1.28% of total outstanding loans. The Company's provision for credit losses was $2.3 million for the year ended December 31, 2021, as compared to $6.9 million for the year ended December 31, 2020. The decrease in the provision for credit losses during the twelve months ended December 31, 2021, as compared to the same period of 2020, was primarily due to a reduction of qualitative adjustment factors that had previously been increased in the allowance for credit losses related to the COVID-19 pandemic and the uncertainty in the economic environment and the reversal of specific reserves on purchased credit impaired loans acquired in the Virginia Partners acquisition due to improved performance, which were partially offset by the deterioration in asset quality and increased specific reserves of two loan relationships, the deterioration in asset quality and the establishment of a specific reserve on one loan relationship that has been individually evaluated for impairment, an increase in historical loss rates, loans acquired in the Virginia Partners acquisition that have converted from acquired to originated status, and organic loan growth. The provision for credit losses during the twelve months ended December 31, 2021, as well as the allowance for credit losses as of December 31, 2021, represents management’s best estimate of the impact of the COVID-19 pandemic on the ability of the Company’s borrowers to repay their loans. Management continues to carefully assess the exposure of the Company’s loan portfolio to COVID-19 pandemic related factors, economic trends and their potential effect on asset quality. As of December 31, 2021, the Company’s delinquencies and nonperforming assets had not been materially impacted by the COVID-19 pandemic. In addition, as of December 31, 2021, all of the loan balances that were approved by the Company, on a consolidated basis, for loan payment deferrals or payments of interest only have either resumed regular payments or have been paid off.

The Company discontinues accrual of interest on loans when management believes, after considering economic and business conditions and collection efforts that a borrower's financial condition is such that the collection of interest is doubtful. Generally, the Company will place a delinquent loan in nonaccrual status when the loan becomes 90 days or more past due. At the time a loan is placed in nonaccrual status, all interest which has been accrued on the loan but remains unpaid is reversed and deducted from earnings as a reduction of reported interest income. No additional interest is accrued on the loan balance until the collection of both principal and interest becomes reasonably certain.

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The following tables illustrate the Company's past due and nonaccrual loans at December 31, 2021 and 2020: