KBRA affirms the deposit and senior unsecured debt ratings of A-, the subordinated debt rating of BBB+, and the short-term deposit and debt ratings of K2 for Portsmouth, Virginia-based TowneBank (NASDAQ: TOWN, "the bank"). The Outlook for all long-term ratings is revised to Stable from Positive.

Key Credit Considerations

The change to a Stable Outlook primarily considers the heightened uncertainty in the macroeconomic environment and broad headwinds within the CRE and mortgage banking sectors, which make it less likely that TOWN's ratings will be upgraded within the next 12 months. With that said, KBRA considers the bank as firmly positioned in the current rating category, anchored by a durable earnings profile (core ROA in the 1.10%-1.20% range over time), solid capital protection, and strong long term asset quality performance. The bank's earnings are underpinned by highly diverse fee revenue streams with noninterest income historically producing 40%-50% of total revenues, which in KBRA's view, affords the bank greater discretion to maintain a more conservative lending risk appetite. Additionally, a meaningful proportion of fee revenues are derived from verticals that are less correlated to lending activities, further reinforcing earnings durability. While we recognize that mortgage banking revenues will continue to exhibit softness, noninterest income contributions excluding mortgage banking-related income (~30% of total revenues) would still outperform most peers. Regulatory capital is conservatively managed, with the CET1 ratio (11.7% at 1Q23) tracking slightly above the peer average over time (TOWN's CET1 ratio averaged ~12% since 2015), with TOWN demonstrating quick capital rebuild following acquisitions. Further reinforcing capital strength is a comparatively strong TCE ratio (8.8% at 1Q23), which if excluding AOCL (~9.5%), would track closer in line with the pre-pandemic average. Additionally, share repurchases have historically been limited. Credit quality has been strong with the NPA ratio and classified loan measures tracking better than many peers over the past year. Although partly attributed to a benign credit environment, solid credit performance has been underpinned by disciplined underwriting and manageable concentration limits, particularly in office CRE, as well as a market footprint anchored in industries that we view as more economically stable with minimal exposure to urban central business districts. That said, the bank's investor CRE concentration, while not outsized, has tracked slightly higher than many peers in recent periods. The funding profile is solid, characterized by a highly granular core deposit base, amassed by leading market share in its heritage VA markets and competitive rankings in the contemporary VA market as well as economically attractive NC MSAs. Supported by a strong NIB deposit base (38% of total deposits at 1Q23), total deposit costs (~1.00% at 1Q23) have been sustained below peers in recent periods and over time. While the proportion of uninsured/uncollateralized deposits (45% of total deposits at 1Q23) represented a higher proportion of deposits compared to the KBRA average, it is adequately mitigated by sufficient liquidity coverage of 106%, which includes significant on-balance sheet sources (cash of ~$1.2 billion and unencumbered securities of ~$1.8 billion), a low loan-to-deposit ratio (83% at 1Q23), and highly granular deposit relationships.

Rating Sensitivities

While a rating upgrade is unlikely in the near term, sustaining better than peer through-the-cycle asset quality measures along with stable earnings (including maintaining above peer noninterest income to total revenue contributions), while managing the CET1 ratio near 12% or higher could lead to positive rating momentum over time. Conversely, significant deterioration in asset quality, substantial and sustained earnings contraction, or a meaningful decline in the CET1 ratio, especially in conjunction with material RWA density growth, could pressure the ratings.

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Methodologies

Financial Institutions: Bank & Bank Holding Company Global Rating Methodology

ESG Global Rating Methodology

A description of all substantially material sources that were used to prepare the credit rating and information on the methodology(ies) (inclusive of any material models and sensitivity analyses of the relevant key rating assumptions, as applicable) used in determining the credit rating is available in the Information Disclosure Form(s) located here.

Information on the meaning of each rating category can be located here.

Further disclosures relating to this rating action are available in the Information Disclosure Form(s) referenced above. Additional information regarding KBRA policies, methodologies, rating scales and disclosures are available at www.kbra.com.

About KBRA

Kroll Bond Rating Agency, LLC (KBRA) is a full-service credit rating agency registered with the U.S. Securities and Exchange Commission as an NRSRO. Kroll Bond Rating Agency Europe Limited is registered as a CRA with the European Securities and Markets Authority. Kroll Bond Rating Agency UK Limited is registered as a CRA with the UK Financial Conduct Authority. In addition, KBRA is designated as a designated rating organization by the Ontario Securities Commission for issuers of asset-backed securities to file a short form prospectus or shelf prospectus. KBRA is also recognized by the National Association of Insurance Commissioners as a Credit Rating Provider.

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