What changed in this filing

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Item 7. Management’s Discussion and Analysis

2023-03-10 compared with 2022-03-16 · 155 added, 166 removed, 714 unchanged (31% of the section changed)

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It is a member of the Federal Reserve, and is regulated by the OCC.

Including its headquarters in Manitowoc, Wisconsin, the Bank has 21 banking locations in Manitowoc, Outagamie, Brown, Winnebago, Sheboygan, Waupaca, Ozaukee, Monroe, and Jefferson counties in Wisconsin.

Including its headquarters in Manitowoc, Wisconsin, the Bank has 28 banking locations in Brown, Columbia, Dane, Fond du Lac, Jefferson, Manitowoc, Monroe, Outagamie, Ozaukee, Shawano, Sheboygan, Waupaca, Waushara, and Winnebago counties in Wisconsin.

The Bank offers loan, deposit and treasury management products at each of its banking locations.

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Recent acquisitions

Partnership Community Bancshares, Inc .

On July 12, 2019, the Company completed a merger with Partnership, a bank holding company headquartered in Cedarburg, Wisconsin, pursuant to the Agreement and Plan of Bank Merger, dated as of January 22, 2019 and as amended on April 30, 2019, by and among the Company and Partnership, whereby Partnership merged with and into the Company, and Partnership Bank, Partnership’s wholly-owned banking subsidiary, merged with and into the Bank.

Partnership’s principal activity was the ownership and operation of Partnership Bank, a state-chartered banking institution that operated four (4) branches in Wisconsin at the time of closing.

The merger consideration totaled approximately $49.6 million.

Pursuant to the terms of the Merger Agreement, Partnership shareholders had the option to receive either 0.34879 shares of the Company’s common stock or $17.3001 in cash for each outstanding share of Partnership common stock, and cash in lieu of any remaining fractional share.

The stock versus cash elections by the Partnership shareholders were subject to final consideration being made up of approximately $14.3 million in cash and 534,659 shares of Company common stock, valued at approximately $35.3 million (based on a value of $66.03 per share on the closing date).

Timberwood Bancshares, Inc .

On May 15, 2020, the Company completed a merger with Timberwood, a bank holding company headquartered in Tomah, WI, pursuant to the Agreement and Plan of Bank Merger, dated as of November 20, 2019, by and among the Company and Timberwood, whereby Timberwood was merged with and into the Company, and Timberwood Bank, Timberwood's wholly owned banking subsidiary, was merged with and into the Bank.

Tomah Bancshares, Inc .

On May 15, 2020, the Company completed a merger with Timberwood, a bank holding company headquartered in Tomah, WI, pursuant to the Agreement and Plan of Bank Merger dated as of November 20, 2019, by and between the Company and Timberwood, whereby Timberwood was merged with and into the Company, and Timberwood Bank, Timberwood's wholly owned banking subsidiary, was merged with and into the Bank.

Timberwood's principal activity was the ownership and operation of Timberwood Bank, a state-chartered banking institution that operated one (1) branch in Wisconsin at the time of closing.

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Denmark Bancshares, Inc.

On January 18, 2022, the Company entered into an Agreement and Plan of Merger with Denmark Bancshares, Inc.

(“Denmark”), a Wisconsin Corporation, pursuant to which Denmark will merge with and into the Company and Denmark’s banking subsidiary, Denmark State Bank, will merge with and into the Bank.

The transaction is expected to close during the third quarter of 2022 and is subject to, among other items, approval by the shareholders of both institutions and regulatory agencies.

Merger consideration will consist of up to 20% cash and no less than 80% of the common stock of the Company, and will total approximately $119 million, subject to the fair market value of the Company’s common stock on the date of closing.

Based on results as of December 31, 2021, the combined company would have total assets of approximately $3.6 billion, loans of approximately $2.7 billion, and deposits of approximately $3.1 billion.

On August 12, 2022, the Company completed a merger with Denmark, a bank holding company headquartered in Denmark, Wisconsin, pursuant to the merger agreement, dated as of January 18, 2022 by and between the Company and Denmark, whereby Denmark merged with and into the Company, and Denmark State Bank, Denmark’s wholly-owned banking subsidiary, merged with and into the Bank.

Denmark’s principal activity was the ownership and operation of Denmark State Bank, a state-chartered banking institution that operated seven (7) branches in Wisconsin at the time of closing.

The merger consideration totaled approximately $128.8 million.

Pursuant to the terms of the merger agreement, Denmark shareholders could elect to receive either 0.5276 of a share of the Company’s common stock or $38.10 in cash for each outstanding share of Denmark common stock, subject to a maximum of 20% cash consideration in total, with cash paid in lieu of any remaining fractional share.

Company stock issued totaled 1,579,530 shares valued at approximately $124.8 million, with cash of $4.0 million comprising the remainder of merger consideration.

Hometown Bancorp, Ltd.

On February 10, 2023, the Company completed a merger with Hometown Bancorp, Ltd.

("Hometown"), a bank holding company headquartered in Fond Du Lac, Wisconsin, pursuant to the Agreement and Plan of Bank Merger, dated as of July 25, 2022, by and between the Company and Hometown, whereby Hometown merged with and into the Company, and Hometown Bank, Hometown's wholly-owned banking subsidiary, merged with and into the Bank.

Hometown's principal activity was the ownership and operation of Hometown Bank, a state-chartered banking institution that operated ten (10) branches in Wisconsin at the time of closing.

The merger consideration totaled approximately $130.5 million.

Pursuant to the terms of the merger agreement, Hometown shareholders could elect to receive either 0.3962 of a share of the Company’s common stock or $29.16 in cash for each outstanding share of Hometown common stock, subject to a maximum of 30% cash consideration in total, and cash in lieu of any remaining fractional share.

Company stock issued totaled 1,450,272 shares valued at approximately $115.1 million, with cash of $15.4 million comprising the remainder of merger consideration.

At close, the combined company had total assets of approximately $4.2 billion, loans of approximately $3.3 billion and deposits of approximately $3.5 billion.

These values are based on initial fair value estimates and are subject to change.

The Company accounts for these transactions under the acquisition method of accounting, and thus, the financial position and results of operations of acquired institutions prior to the consummation date are not included in the accompanying consolidated financial statements.

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The estimated fair values are subject to refinement for up to one year after the consummation as additional information becomes available relative to the closing date fair values.

COVID-19 and Recent Events

economy contracted in the first half of 2020, ending the longest expansionary period in U.S.

history, due to the COVID-19 pandemic.

During March 2020, in an effort to lessen the impact of COVID-19 on consumers and businesses, the Federal Reserve reduced the federal funds rate 1.5 percentage points to 0.00 to 0.25 percent and the U.S.

government enacted the CARES Act, the largest economic stimulus package in the nation’s history.

The Company responded to the pandemic, beginning in March 2020, by supporting our clients, employees, and communities with such measures as remote work capabilities and branch service enhancements, loan payment deferrals, and accelerated investments in several technology initiatives that provided more convenience and a better digital experience as clients adapted to this highly virtual environment.

The Company participated in the PPP and funded approximately 2,998 loans totaling approximately $377.5 million under the programs available in both 2020 and 2021.

Additional government spending measures and the availability of vaccines improved consumer confidence and demand, and the economy largely reopened in 2021, leading to a reduction in the unemployment rate and accelerated GDP growth.

While 2021 has seen a recovery in the U.S.

economy compared to 2020, uncertainty and market disruptions such as additional coronavirus variants, pandemic-related supply chain issues and labor shortages persist.

The economic expansion has been met with inflationary pressures that are expected to result in the Federal Open Market Committee policy-tightening in 2022, likely including multiple interest rate hikes.

With a strong asset-sensitive balance sheet and our strong position in our markets, we expect increases in loan demand and interest rates should improve returns going forward.

CRITICAL ACCOUNTING POLICIES

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If the present value of the expected cash flows for a loan is greater than its carrying value, any previously established ALLL is reversed and any remaining difference increases the accretable yield which will be taken into income over the remaining life of the loan.

Loans which were considered TDRs by the acquired institution prior to the acquisition are not required to be classified as TDRs in our consolidated financial statements unless or until such loans would subsequently meet our criteria to be classified as such, since acquired loans were recorded at their estimated fair values at the time of the acquisition.

Loans which were considered TDRs by the acquired institution prior to the acquisition are not required to be

classified as TDRs in our consolidated financial statements unless or until such loans would subsequently meet our criteria to be classified as such, since acquired loans were recorded at their estimated fair values at the time of the acquisition.

Impaired Investment Securities

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This delay applies to the Company as it was classified as a “Smaller reporting company” as defined in Rule 12b-2 of the Exchange Act as of the date ASU 2019-10 was enacted.

We are currently evaluating the impact of ASU 2016-13 on the consolidated financial statements, although the general expectation in the banking industry is that the implementation of this standard will result in higher required balances in the ALLL.

During the first half of 2019 the Company engaged a third-party partner to assist in its implementation of this standard.

Over the last three years significant progress has been made working through the assumptions, drivers, documentation and other mechanics for the calculation of the Company’s ALL under ASU 2016-13.

Throughout 2022, management ran a calculation of its allowance under ASU 2016-13 parallel to its current modeling to assess the functioning of the ASU 2016-13 model while also documenting the controls that will be in place around the process when the Company implements this standard.

Results of these parallel runs indicate that the Bank’s ALL to total loans coverage ratio will increase from 0.78% as of December 31, 2022, to 1.10% - 1.20% upon implementation of ASU 2016-13 on January 1, 2023.

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848):

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It provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met.

The updated guidance is effective for all entities from March 12, 2020 through December 31, 2022.

The updated guidance was originally effective for all entities from March 12, 2020 through December 31, 2022.

In December 2022, the FASB issued ASU 2022-06 which deferred the sunset date of Topic 848 from December 31, 2022 to December 31, 2024.

The Corporation has been diligent in responding to reference rate reform and does not anticipate a significant impact to its financial statements as a result.

In October 2020, the FASB issued ASU 2020-08, Codification Improvements to Subtopic 310-20, Receivables – Nonrefundable Fees and Other Costs.

This ASU clarifies the requirements for entities to reevaluate whether a callable debt security is within the scope of paragraph 310-20-35-33 of the stated subtopic for each reporting period.

The ASU was published to clarify the Codification and correct its unintended application and will be effective for fiscal years, and interim periods within those fiscal years, beginning within those fiscal years, beginning after December 31, 2020.

The adoption of this guidance is not expected to have an impact on our consolidated financial statements as all premiums within our securities portfolio were already being amortized to the earliest call date prior to the implementation as required under subtopic 310-20.

In March 2022, the FASB issued ASU 2022-02, Financial Instruments - Credit Losses (Topic 326):

Troubled Debt Restructurings and Vintage Disclosures.

This ASU provides guidance on eliminating the requirement for classification of and disclosures around troubled debt restructurings.

The purpose of this guidance is to eliminate unnecessary and overly-complex disclosures of loans that are already incorporated into the allowance for credit losses and related disclosures.

This ASU further requires the disclosure of current-period gross charge-offs by year of origination.

The updated guidance is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, for all entities which have implemented ASU 2016-13.

The Company has historically had very few credit relationships classified as troubled debt restructurings, and as such does not anticipate that the elimination of accounting for and disclosure of these types of credit relationships will have a significant impact to its financial statements upon implementation of ASU 2016-13 beginning with the first quarter of 2023.

RESULTS OF OPERATIONS

Results of Operations for the Years Ended December 31, 2022 and 2021

Net income increased $7.4 million, or 19.4%, to $45.4 million for the year ended December 31, 2021, from $38.0 million for the year ended December 31, 2020.

The primary reasons for the increase in profitability were increased net interest, a reduced provision for loan losses during 2021, robust retail mortgage lending which led to a large increase in gains on sales of mortgage loans to the secondary market, reduced losses on sales and valuations of OREO and a significant penalty for the early extinguishment of debt during 2020 that did not recur during 2021.

This was offset by a small loss on sales of securities during 2021 that compared unfavorably to a gain of $3.2 million on these sales during 2020 as well as a $1.7 million gain on the sale of a branch location during 2020 with no similar gain during 2021.

Net income decreased $0.2 million, or 0.1%, to $45.2 million for the year ended December 31, 2022, from $45.4 million for the year ended December 31, 2021.

During 2022, the Company experienced increased net interest income, a reduced provision for loan losses, a slowdown in retail mortgage lending which led to a large decrease in gains on sales of mortgage loans to the secondary market, and a significant increase in many noninterest expense areas as a result of the acquisition of Denmark which occurred during August 2022.

Net Interest Income.

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We seek to maximize net interest income without exposing the Company to an excessive level of interest rate risk through our asset and liability policies.

Interest rate risk is managed by monitoring the pricing, maturity and repricing options of all classes of interest-bearing assets and liabilities.

Interest rate risk is managed by monitoring the

pricing, maturity and repricing options of all classes of interest-bearing assets and liabilities.

Our net interest margin can also be adversely impacted by the reversal of interest on nonaccrual loans and the reinvestment of loan payoffs into lower yielding investment securities and other short-term investments.

Net interest income after provision for loan losses increased by $14.9 million to $101.9 million for the year ended December 31, 2022, from $87.0 million for the year ended December 31, 2021.

Interest income on loans decreased by $1.9 million, or 1.9%, from 2020 to 2021.

Interest income on loans increased by $13.5 million, or 14.5%, from 2021 to 2022.

Total average interest-earning assets increased to $3.09 billion for the year ended December 31, 2022 from $2.63 billion for the year ended December 31, 2021.

The Bank’s net interest margin decreased 37 basis points to 3.47% for the year ended December 31, 2021, down from 3.84% for the year ended December 31, 2020.

The Bank’s net interest margin decreased six basis points to 3.41% for the year ended December 31, 2022, down from 3.47% for the year ended December 31, 2021.

Interest Income.

Total interest income decreased $2.3 million, or 2.30%, to $98.4 million for the year ended December 31, 2021, down from $100.7 million for the year ended December 31, 2020.

This decrease was primarily due to yield on loans decreasing by 50 basis points from 4.75% during 2020 to 4.25% during 2021, which more than offset the $185.1 million increase in average balances of loans during 2021.

Total interest income increased $18.1 million, or 18.4%, to $116.5 million for the year ended December 31, 2022, up from $98.4 million for the year ended December 31, 2021.

This increase was primarily due to the $455.2 million increase in average earning assets during 2022 when compared to 2021.

Most of this growth was the result of the acquisition of Denmark in August 2022.

Interest Expense.

Interest expense decreased $5.6 million, or 40.1%, to $8.3 million for the year ended December 31, 2021, down from $13.9 million for the year ended December 31, 2020.

The decrease was driven by declines in the average cost of interest-bearing liabilities, falling 39 basis points from 0.87% to 0.48%.

This decline was primarily the result of a significantly lower interest rate environment that developed through the first half of 2020 and continued throughout 2021.

Interest expense on interest-bearing deposits decreased by $4.9 million to $7.5 million for the year ended December 31, 2021, from $12.5 million for the year ended December 31, 2020.

This decrease was primarily due to the aforementioned lower interest rate environment, allowing the Company to significantly reduce crediting interest rates on non-time, interest-bearing deposit accounts.

Interest expense increased $4.1 million, or 49.9%, to $12.4 million for the year ended December 31, 2022, up from $8.3 million for the year ended December 31, 2021.

The increase was driven by a combination of increases in the average cost of interest-bearing liabilities, rising 12 basis points from 0.48% to 0.60%, and a $362.4 million increase in average interest-bearing liabilities.

Interest expense on interest-bearing deposits increased by $2.7 million to $10.3 million for the year ended December 31, 2022, from $7.5 million for the year ended December 31, 2021.

This increase was due to the aforementioned higher interest rate environment and growth in average interest-bearing deposits totaling $240.6 million year-over-year.

The average cost of interest-bearing deposits was 0.54% for the year ended December 31, 2022, compared to 0.45% for the year ended December 31, 2021.

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We recorded a provision for loan losses of $2.2 million for the year ended December 31, 2022, compared to $3.1 million for the year ended December 31, 2021.

Provision expense was elevated during 2020 in response to uncertainty created by COVID-19 and society’s response to it.

Actual asset quality metrics during the course of 2021 remained strong, however, and allowed for a reduction in provision expense during that year.

Our asset quality metrics during the course of 2022 continued the trend of remaining strong from 2021 and allowed for a further reduction in provision expense during 2022.

The ALLL was $22.7 million, or 0.78% of total loans, at December 31, 2022 compared to $20.3 million, or 0.91% of total loans at December 31, 2021.

The increase in ALLL coverage to total loans from December 31, 2020, to December 31, 2021, was primarily due to a smaller percentage of the Company’s loan portfolio accounted for under purchase accounting year-over-year.

The decrease in ALLL coverage to total loans from December 31, 2021, to December 31, 2022, was primarily due to a significant increase in the percentage of the Company’s loan portfolio accounted for under purchase accounting year-over-year as a result of the Denmark acquisition.

Under the Company’s current allowance methodology, loans which are accounted for under purchase accounting do not require an ALLL reserve allocation.

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Other sources of noninterest income include loan servicing fees and gains on sales of mortgage loans.

Noninterest income was $23.5 million for 2021, matching non-interest income during 2020.

Service charges increased by $1.1 million, or 22.5%, from 2020 to 2021, as a result of new markets and added scale from three acquisitions during the previous four years.

Loan servicing income and net gain on sales of mortgage loans increased by $2.4 million and $2.1 million from 2020 to 2021, respectively, as a result of a robust residential mortgage lending environment during 2021 spurred by historically low mortgage interest rates.

Due to uncertainty about liquidity needs in financial markets during the early days of the COVID-19 pandemic, the Company sold approximately $34.0 million in U.S.

Treasury Securities during the second quarter of 2020, resulting in a gain on sale of securities of $3.2 million.

This compared favorably to small losses on sales of securities during 2021.

Finally, the Company recorded a $1.7 million gain on the sale of a branch location during December 2020.

There was no similar sale during 2021, causing other noninterest income to decrease year-over-year.

Noninterest income decreased by $3.7 million, or 15.7% to $19.8 million for 2022, down from $23.5 million during 2021.

The primary driver of the decrease in noninterest income was the slowdown in the retail mortgage lending market, which drove a $5.8 million decline in gains on sales of mortgage loans to the secondary market.

This same slowdown positively impacted the valuation of the Company’s mortgage servicing rights (“MSR”) as certain assumptions in the calculation of fair value of these rights adjusted to the new market conditions, leading to $1.6 more in positive valuation adjustments to MSRs in 2022 compared to 2021.

Finally, income from the Company’s investment in UFS saw a significant increase year-over-year as they continue to increase market share.

The major components of our noninterest income are listed in the table below:

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Service charges

Income from Ansay & Associates, LLC

Income from UFS, LLC

Income from Ansay

Income from UFS

Loan servicing income

Valuation adjustment on MSR

Net gain on sales of mortgage loans

Net gain on sales of securities

Net gain on sales and valuation of ORE

Total noninterest income

Noninterest Expense.

Noninterest expense decreased $2.8 million to $50.5 million for the year ended December 31, 2021, down from $53.4 million for the year ended December 31, 2020.

Personnel expense increased $1.2 million, or 4.6%, primarily as a result of customary annual salary increases.

Occupancy expense decreased $0.5 million, or 11.0%, data processing decreased $0.2 million, or 3.1%, and outside service fees decreased $1.0 million, or 25.2%, primarily as a result of the Company completing an acquisition of another institution during 2020 with no corresponding acquisition during 2021.

Noninterest expense increased $11.5 million to $62.1 million for the year ended December 31, 2022, up from $50.6 million for the year ended December 31, 2021.

Personnel expense increased $4.6 million, or 16.3%, primarily as a result of the severance payments and the added scale from the Denmark acquisition that occurred during 2022.

Occupancy expense increased $1.3 million, or 30.2%, data processing increased $1.0 million, or 18.3%, and outside service fees increased $3.7 million, or 118.7%, primarily as a result of the Company completing the Denmark acquisition during 2022 with no corresponding acquisition during 2021.

These areas of noninterest expense are typically elevated during years where acquisitions occur.

The Company had sales of two large foreclosed properties scheduled to close late in the first quarter of 2020 which would have resulted in modest losses.

Due to the economic turmoil that resulted during the last several weeks of the first quarter of 2020, terms of these sales were negatively impacted.

Rather than hold these properties heading into this time of uncertainty, the Company chose to accept the reduced terms, causing significant losses on these sales that were the primary components of $1.4 million in total losses on sales and valuations of other real estate owned during 2020.

During 2021 the Company experienced a small overall gain on these types of transactions, creating a very favorable year-over-year comparison.

Finally, during the second quarter of 2020 the Company paid off $30.0 million in borrowings from the Federal Home Loan Bank of Chicago which had contractual maturities ranging from August 2022 through August 2024, resulting in prepayment penalties of $1.3 million, but saving the Company $1.7 million in interest over the next four years.

There was no similar action during 2021.

Amortization of intangibles increased by $0.9 million, or 65.0%, as the acquisition of Denmark led to a core deposit intangible of $15.1 million which began amortizing during August 2022.

The major components of our noninterest expense are listed in the table below:

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Postage, stationary, and supplies

Net loss (gain) on sales and valuation of ORE

Net loss on sales of securities

Charitable contributions

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Amortization of intangibles

Penalty for early extinguishment of debt

Total noninterest expenses

Income Tax Expense.

We recorded a provision for income taxes of $14.5 million for the year ended December 31, 2021, compared to $11.8 million for the year ended December 31, 2020, reflecting effective tax rates of 24.2% and 23.7%, respectively.

We recorded a provision for income taxes of $14.4 million for the year ended December 31, 2022, compared to $14.5 million for the year ended December 31, 2021, reflecting effective tax rates of 24.2% for both 2022 and 2021, respectively.

Results of Operations for the Years Ended December 31, 2021 and 2020

Net income increased $7.4 million, or 19.4%, to $45.4 million for the year ended December 31, 2021, from $38.0 million for the year ended December 31, 2020.

The primary reasons for the increase in profitability were increased net interest and service charge income from the added scale as a result of the acquisitions of Partnership and Timberwood, significant growth in our loan portfolio through participation in PPP, and robust retail mortgage lending which led to a large increase in gains on sales of mortgage loans to the secondary market.

This was offset by larger provisions for loan losses during 2020, as well as increased expenses related to personnel, facilities and data processing as part of the same added scale from the aforementioned acquisitions.

2020 profitability was further negatively impacted by higher losses on sales of foreclosed properties and a penalty related to the early extinguishment of long-term debt.

Net Interest Income.

Net interest income after provision for loan losses increased by $7.3 million to $87.0 million for the year ended December 31, 2021, from $79.7 million for the year ended December 31, 2020.

Interest income on loans increased by $12.3 million, or 14.9%, from 2019 to 2020.

Interest income on loans decreased by $1.9 million, or 1.9%, from 2020 to 2021.

Total average interest-earning assets increased to $2.63 billion for the year ended December 31, 2021 from $2.31 billion for the year ended December 31, 2020.

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Interest Income.

Total interest income increased $11.5 million, or 12.9%, to $100.7 million for the year ended December 31, 2020, up from $89.2 million for the year ended December 31, 2019.

As noted, the increase was primarily due to loan growth from the acquisitions of Partnership and Timberwood, as well as participation in PPP.

The average balance of loans increased by $466.9 million during 2020.

Total interest income decreased $2.3 million, or 2.30%, to $98.4 million for the year ended December 31, 2021, down from $100.7 million for the year ended December 31, 2020.

Interest Expense.

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The decrease was driven by declines in the average cost of interest-bearing liabilities, falling 39 basis points from 0.87% to 0.48%.

This decline was primarily the result of a significantly lower interest rate environment that developed through the first half of 2020.

This decline was primarily the result of a significantly lower interest rate environment that developed through the first half of 2020 and continued throughout 2021.

Interest expense on interest-bearing deposits decreased by $4.9 million to $7.5 million for the year ended December 31, 2021, from $12.5 million for the year ended December 31, 2020.

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We recorded a provision for loan losses of $3.1 million for the year ended December 31, 2021, compared to $7.1 million for the year ended December 31, 2020.

Significant charge-offs occurring during the third quarter of 2019 necessitated increased provisions for loan losses during 2019.

These charge-offs were the result of exiting certain relationships during that quarter which were originally acquired as part of the Waupaca transaction.

Despite having significantly reduced charge-offs during 2020, economic uncertainties as a result of the COVID-19 pandemic required a build-up of our ALLL, resulting in higher provision expense.

Provision expense was elevated during 2020 in response to uncertainty created by COVID-19 and society’s response to it.

Actual asset quality metrics during the course of 2021 remained strong, however, and allowed for a reduction in provision expense during that year.

The ALLL was $20.3 million, or 0.91% of total loans, at December 31, 2021 compared to $17.7 million, or 0.81% of total loans, at December 31, 2020.

Under the Company’s current allowance methodology, loans which are accounted for under purchase accounting do not require an ALLL reserve allocation.

Noninterest Income.

Noninterest income increased $10.9 million to $23.5 million in 2020 compared to $12.6 million in 2019.

Service charges increased by $1.5 million, or 42.7%, from 2019 to 2020, the result of new markets and added scale from three acquisitions in slightly more than three years.

Income from Ansay increased by $0.9 million as a result of modestly higher profitability at that organization as well as the increase in our ownership during October 2019.

Loan servicing income and net gain on sales of mortgage loans increased by $0.9 and $3.9 million from 2019 to 2020, the result of a robust residential mortgage lending environment during 2020 spurred by historically low mortgage interest rates.

Due to uncertainty about liquidity needs in financial markets during the early days of the COVID-19 pandemic, the Company sold approximately $34.0 million in U.S.

Treasury Securities during the second quarter of 2020, resulting in a gain on sale of securities of $3.2 million, an increase of $2.6 million over 2019.

Finally, the Company recorded a $1.7 million gain on the sale of a branch location during December 2020, causing other noninterest income to increase year-over-year.

Noninterest income was $23.5 million for 2021, compared to $18.9 million during 2020.

Service charges increased by $1.1 million, or 22.5%, from 2020 to 2021, as a result of new markets and added scale from three acquisitions during the previous four years.

Net gain on sales of mortgage loans increased by $2.1 million from 2020 to 2021 as a result of a robust residential mortgage lending environment during 2021 spurred by historically low mortgage interest rates.

The Company had sales of two large foreclosed properties scheduled to close late in the first quarter of 2020 which would have resulted in modest losses.

Due to the economic turmoil that resulted during the last several weeks of the first quarter of 2020, terms of these sales were negatively impacted.

During 2021 the Company experienced a small overall gain on these types of transactions, creating a very favorable year-over-year comparison.

Finally, the Company recorded a $1.7 million gain on the sale of a branch location during December

There was no similar sale during 2021, causing other noninterest income to decrease year-over-year.

The major components of our noninterest income are listed in the table below:

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Service Charges

Income from Ansay & Associates, LLC

Income from UFS, LLC

Income from Ansay

Income from UFS

Loan Servicing income

Valuation adjustment on mortgage servicing rights

Net gain on sales of mortgage loans

Net gain on sales of securities

Noninterest income from strategic alliances

Net gain (loss) on other real estate owned

Total noninterest income

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Noninterest expense increased $1.8 million to $50.6 million for the year ended December 31, 2021, up from $48.7 million for the year ended December 31, 2020.

Year-over-year, personnel expense increased $4.4 million, or 19.1%, occupancy expense increased $0.9 million, or 22.3%, data processing increased $1.0 million, or 22.3%, outside service fees increased $1.1 million, or 35.2%, and amortization of intangibles increased $0.6 million, or 53.0% the result of added scale and expenses from acquisitions of Partnership and Timberwood during 2019 and 2020.

Postage, stationary, and supplies increased by $0.3 million, or 47.6%, from 2019 to 2020 as a result of costs associated with the Company’s response to the COVID-19 pandemic.

The Company had sales of two large foreclosed properties scheduled to close late in the first quarter of 2020 which would have resulted in modest losses.

Due to the economic turmoil that resulted during the last several weeks of that quarter, terms of these sales were negatively impacted.

Personnel expense increased $1.2 million, or 4.6%, primarily as a result of customary annual salary increases.

These areas of noninterest expense are typically elevated during years where acquisitions occur.

Due to uncertainty about liquidity needs in financial markets during the early days of the COVID-19 pandemic, the Company sold approximately $34.0 million in U.S.

Treasury Securities during the second quarter of 2020, resulting in a gain on sale of securities of $3.2 million.

This compared favorably to small losses on sales of securities during 2021.

There was no similar action during 2021.

The major components of our noninterest expense are listed in the table below.

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Postage, stationary, and supplies

Net loss (gain) on sales and valuation of ORE

Charitable Contributions

Outside service fees

Net loss on sales of securities

Amortization of intangibles

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The effective tax rate for 2020 increased due to the fact that tax- exempt interest remained consistent year-over-year while other taxable components of income increased significantly.

NET INTEREST MARGIN

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Total assets increased $722.9 million, or 24.6%, to $3.66 billion at December 31, 2022 from $2.94 billion at December 31, 2021.

The primary driver of this increase, as with most of the categories below, was our acquisition of Denmark, consisting of $685.8 million in assets, during 2022.

Cash and Cash Equivalents.

Cash and cash equivalents increased by $126.6 million, or 74.4%, to $296.9 million at December 31, 2021 from $170.2 million at December 31, 2020.

Cash and cash equivalents decreased by $177.5 million, or 59.8%, to $119.4 million at December 31, 2022 from $296.9 million at December 31, 2021.

Investment Securities.

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FHLB borrowings totaled $1.9 million and $8.0 million at December 31, 2022 and 2021, respectively.

Subordinated debt totaled at $17.5 million at December 31, 2021 and 2020.

Subordinated debt increased $6.0 million, or 34.3% to $23.5 million at December 31, 2022 from $17.5 million at December 31, 2021.

Stockholders’ Equity.

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Total loans increased $658.5 million, or 29.4%, to $2.89 billion as of December 31, 2022 as compared to $2.24 billion as of December 31, 2021.

Our loan growth during the year ended December 31, 2021 has been comprised of an decrease of $78.8 million or 17.7% in commercial and industrial loans, an increase of $119.2 million or 12.0% in commercial real estate loans, a decrease of $7.6 million or 5.4% in construction and development loans, an increase of $26.0 million or 4.8% in residential 1-4 family loans and a decrease of $14.7 million or 21.6% in consumer and other loans.

Total loans increased $455.1 million, or 26.2%, to $2.19 billion as of December 31, 2020 as compared to $1.74 billion as of December 31, 2019.

Our loan growth during the year ended December 31, 2022 has been comprised of an increase of $126.3 million, or 34.5%, in commercial and industrial loans, an increase of $287.1 million, or 25.8%, in commercial real estate loans, an increase of $67.3 million, or 50.8%, in construction and development loans, an increase of $167.7 million, or 29.3%, in residential 1-4 family loans and an increase of $10.1 million, or 18.9%, in consumer and other loans.

The significant increase in loans during the year ended December 31, 2020 is attributable to loans purchased as part of the Timberwood transaction along with significant commercial and industrial loan growth as a result of participating in the PPP loan program.

Total loans increased $44.1 million, or 2.0%, to $2.24 billion as of December 31, 2021 as compared to $2.19 billion as of December 31, 2020.

Our loan growth during the year ended December 31, 2021 has been comprised of a decrease of $78.8 million, or 17.7%, in commercial and industrial loans, an increase of $119.2 million, or 12.0%, in commercial real

estate loans, a decrease of $7.6 million, or 5.4%, in construction and development loans, an increase of $26.0 million, or 4.8%, in residential 1-4family loans and a decrease of $14.7 million, or 21.6%, in consumer and other loans.

The following table presents the balance and associated percentage of each major category in our loan portfolio at December 31, 2022, 2021, and 2020:

(In thousands)

Commercial & industrial

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Our C&I portfolio totaled $492.5 million, $366.2 million and $445.0 million at December 31, 2022, 2021 and 2020, respectively, and represented 17%, 16% and 20% of our total loans, respectively.

C&I loans decreased 17.7% during 2021, primarily the result of significant levels of PPP loans being forgiven during the year.

C&I loans increased 47.2% during 2020, primarily as a result of loans made through PPP and secondarily as a result of the Timberwood acquisition.

C&I loans increased 1.7% in 2019.

C&I loans increased 34.5% during 2022, primarily as a result of loans acquired from Denmark during 2022, slightly offset by significant levels of PPP loans being forgiven during the year.

C&I loans decreased 17.7% during 2021, primarily as a result of significant levels of PPP loans being forgiven during the year.

C&I loans increased 47.2% in 2020, primarily as a result of loans made through PPP and secondarily as a result of the Timberwood acquisition.

Our C&I loan customers represent various small and middle-market established businesses involved in professional services, accommodation and food services, health care, financial services, wholesale trade, manufacturing, distribution, retailing and non-profits.

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Commercial Real Estate (CRE).

Our CRE loan portfolio totaled $1.11 billion, $992.2 million and $813.1 million at December 31, 2021, 2020 and 2019, respectively, and represented 50%, 45% and 47% of our total loans, respectively.

Our CRE loan portfolio totaled $1.40 billion, $1.11 billion and $992.2 million at December 31, 2022, 2021 and 2020, respectively, and represented 48%, 50% and 45% of our total loans, respectively.

Our CRE loans increased 25.8% during 2022, primarily as a result of loans acquired from Denmark during 2022.

Our CRE loans increased 12.0% during 2021, primarily as a result of a backlog from 2020 when developers were cautious to start projects during the early stages of COVID-19.

Our CRE loans increased 22.0% during 2020, primarily as a result of the Timberwood acquisition.

Our CRE loans increased 21.7% during 2019 due primarily to the Partnership acquisition.

Our CRE loans increased 22.0% during 2020 due primarily to the Timberwood acquisition.

Our CRE loans are secured by a variety of property types including multifamily dwellings, retail facilities, office buildings, commercial mixed use, lodging and industrial and warehouse properties.

We do not have any specific industry or customer concentrations in our CRE portfolio.

Our commercial real estate loans are generally for terms up to twenty years, with loan-to-values that generally do not exceed 85%.

Amortization schedules are long term and thus a balloon payment is generally

due at maturity.

Our commercial real estate loans are generally for terms up to twenty years, with loan-

to-values that generally do not exceed 85%.

Amortization schedules are long term and thus a balloon payment is generally due at maturity.

Under most circumstances, the Bank will offer to rewrite or otherwise extend the loan at prevailing interest rates.

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Our C&D loan portfolio totaled $199.7 million, $132.5 million and $140.1 million at December 31, 2022, 2021 and 2020, respectively, and represented 7%, 6% and 6% of our total loans, respectively.

C&D loans decreased 5.4% during 2021.

C&D loans increased 6.0% during 2020.

C&D loans increased 117.4% during 2019 due to a combination of loans acquired in the Partnership acquisition and strong development in both owner-occupied and multifamily developments in our markets due to a continued strong economy.

C&D loans increased 50.8% during 2022, primarily as a result of loans acquired from Denmark during 2022.

C&D loans decreased 5.4% during 2021 and increased 6.0% during 2020.

Our C&D loans are generally for the purpose of creating value out of real estate through construction and development work, and also include loans used to purchase recreational use land.

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Our residential 1-4 family loan portfolio totaled $739.5 million, $571.8 million and $545.8 million at December 31, 2022, 2021 and 2020, respectively, and represented 25%, 26% and 25% of our total loans, respectively.

Residential 1-4 family loans increased 29.3% during 2022, primarily as a result of loans acquired from Denmark during 2022.

Residential 1-4 family loans increased 4.8% during 2021.

Residential 1-4 family loans increased 21.7% during 2020 primarily as a result of the Timberwood transaction.

Residential 1-4 family loans increased 21.7% during 2019 primarily as a result of the Partnership transaction.

We offer fixed and adjustable rate residential mortgage loans with maturities up to 30 years.

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Loans sold with the retention of servicing assets result in the capitalization of servicing rights.

Loan servicing rights are included in other assets and are subsequently amortized as an offset to other income over the estimated period of servicing.

Loan servicing rights are subsequently amortized as an offset to other income over the estimated period of servicing.

The net balance of capitalized servicing rights amounted to $9.6 million, $5.0 million and $3.7 million at December 31, 2022, 2021 and 2020, respectively.

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As of December 31,

(dollars in thousands)

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Total nonperforming assets ("NPAs")

Accruing troubled debt resructured loans

Accruing troubled debt restructured loans

Nonaccrual loans to total loans

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NPAs to total assets

ALLL to Nonaccrual loans

ALLL to total loans

ALL to nonaccrual loans

ALL to total loans

At December 31, 2022, 2021 and 2020, impaired loans had specific reserves of $8,000, $964,000 and $900,000, respectively.

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Management has evaluated the aforementioned loans and other loans classified as nonperforming and believes that all nonperforming loans have been adequately reserved for in the allowance for loan losses at December 31, 2022.

Our nonperforming assets were elevated during the years ended December 31, 2018 and 2017, primarily due to the acquisition of a troubled institution during 2017, which included $19.4 million of loans which were considered nonperforming.

This increase in nonperforming assets was anticipated in conjunction with the acquisition, and management actively managed these relationships out of the Bank through pay downs, refinances with or sales of loans to other institutions, or foreclosure actions.

As a result of these actions nonperforming assets declined sharply during 2019.

Nonperforming assets trended back up slightly during 2020 primarily due to one commercial real estate loan totaling approximately $7.3 million which was moved to nonaccrual status when a major tenant declared bankruptcy and vacated the facility.

Payments continued to be made timely on this loan, and it returned to performing status during 2021, causing a decline in nonperforming assets.

Nonaccrual Loans

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If a TDR is placed on nonaccrual status, which would occur based on the same criteria as non-TDR loans, it remains there until a sufficient period of performance under the restructured terms has occurred at which it returned to accrual status, generally 6 months.

In response to the COVID-19 pandemic, the CARES Act was signed into law.

Under the CARES Act, banks may elect to deem that loan modifications do not result in TDRs if they are (1) related to COVID-19;

(2) executed on a loan that was not more than 30 days past due as of December 31, 2019;

and (3) executed between March 1, 2020 and the earlier of (A) 60 days after the date of termination of the national emergency declaration or (B) December 31, 2021.

Additionally, in accordance with the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (Revised), other short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs under ASC Subtopic 310-40.

This includes short-term (e.g.

up to six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant.

Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented.

Loans modified under this guidance are not considered TDRs and as such are not identified in the table below.

During 2020, the Company granted payment deferrals to over 625 customers on loans totaling over $271 .5 million.

These deferrals were primarily for lengths in the range of 60 to 180 days, and were a combination of deferrals of principal payments only or both principal and interest payments.

As of December 31, 2020, these totals had decreased to fewer than 20 loans with total balances less than $20.0 million.

As of December 31, 2021, only one loan remained with payment deferrals under the CARES Act, totaling $1.1 million.

As of December 31, 2022 and 2021, the Company had specific reserves of $8,000 and $7,000 for TDRs, respectively, and none of them have subsequently defaulted.

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The following table summarizes the changes in our ALLL for the years indicated:

Year ended December 31,

(dollars in thousands)

Balance of ALLL at the beginning of period

Balance of ALL at the beginning of period

Net loans charged-off (recovered):

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Provision charged to operating expense

Balance of ALLL at end of period

Balance of ALL at end of period

Ratio of net charge-offs (recoveries) to average loans by loan composition

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The following table summarizes an allocation of the ALLL and the related percentage of loans outstanding in each category for the periods below.

As of December 31

(in thousands, except %)

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The following tables set forth the average balances of our deposits for the periods indicated:

December 31, 2022

December 31, 2021

December 31, 2020

(dollars in thousands)

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Securities sold under repurchase agreements at period end

Weighted average interest rate on short-term borrowing at period end

Weighted average interest rate on securities sold under repurchase agreements at period end

Lines of credit and other borrowings

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There were $1.9 million, $8.0 million and $23.3 million of advances outstanding from the FHLB at December 31, 2022, 2021, and 2020.

The total loans pledged as collateral were $915.5 million, $825.3 million and $815.2 million at December 31, 2021, 2020 and 2019, respectively.

Outstanding letters of credit from the FHLB totaled $0.8 million and $14.4 million at December 31, 2020 and 2019, respectively.

There were no outstanding letters of credit from the FHLB at December 31, 2021.

The total loans pledged as collateral were $1.15 billion, $915.5 million and $825.3 million at December 31, 2022, 2021 and 2020, respectively.

There were no outstanding letters of credit from the FHLB at December 31, 2022 and December 31, 2021, respectively.

Outstanding letters of credit from the FHLB totaled $0.8 million at December 31, 2020.

The following table summarizes short-term borrowings (borrowings with maturities of one year or less), which consist of borrowings from the FHLB, and the weighted average interest rates paid:

1 unchanged sentence

(dollars in thousands)

Average daily amount of short-term borrowings outstanding during the period

Weighted average interest rate on average daily short-term borrowing

Maximum outstanding short-term borrowings outstanding at any month-end

Short-term borrowing outstanding at period end

Weighted average interest rate on short-term borrowing at period end

Average daily amount of borrowings outstanding during the period

Weighted average interest rate on average daily borrowing

Maximum outstanding borrowings at any month-end

Borrowing outstanding at period end

Weighted average interest rate on borrowing at period end

The Corporation maintains a $7.5 million line of credit with a commercial bank, which was entered into on May 15, 2021, and renewed on May 15, 2022.

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The Company had outstanding balances of $6.0 million under these agreements at December 31, 2022 and 2021.

During August 2022, the Company entered into subordinated note agreements with an individual.

The Company had outstanding balances of $6.0 million under these agreements as of December 31, 2022.

These notes were issued with 10-year maturities, carry interest at a fixed rate of 5.25% through August 6, 2027, and at a variable rate thereafter, payable quarterly.

These notes are callable on or after August 6, 2027 and qualify for Tier 2 capital for regulatory purposes.

The individual associated with these subordinated note agreements is not a related party of the Company.

INVESTMENT SECURITIES

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Securities available for sale consist of U.S.

Treasury securities, obligations of states and political subdivision, mortgage-backed securities, and corporate notes.

Securities classified as available for sale, which management has the intent and ability to hold for an indefinite period of time, but not necessarily to maturity, are carried at fair value, with unrealized gains and losses, net of related deferred income taxes, included in stockholders’ equity as a separate component of other comprehensive income.

Treasury securities, obligations of states and political subdivision, agency mortgage-backed securities, corporate notes, and certificates of deposits.

Securities classified as available for sale, which

management has the intent and ability to hold for an indefinite period of time, but not necessarily to maturity, are carried at fair value, with unrealized gains and losses, net of related deferred income taxes, included in stockholders’ equity as a separate component of other comprehensive income.

The fair value of securities available for sale totaled $304.6 million and included gross unrealized gains of $0.5 million and gross unrealized losses of $21.8 million at December 31, 2022.

At December, 31 2021, the fair value of securities available for sale totaled $212.7 million and included gross unrealized gains of $5.6 million and gross unrealized losses of $0.7 million.

Securities classified as held to maturity consist of obligations of states and political subdivisions.

Securities classified as held to maturity consist of U.S.

Treasury securities and obligations of states and political subdivisions.

These securities, which management has the intent and ability to hold to maturity, are reported at amortized cost.

Securities held to maturity as of December 31, 2022 and 2021, are carried at their amortized cost of $45.1 million and $5.9 million, respectively.

The Company did not sell any securities in 2022.

The Company recognized a net loss on sale of investment securities of $3,000 during the year ended December 31, 2021.

The Company recognized a net gain on sale of investment securities of $3.2 million during the year ended December 31, 2020.

The Company recognized a net gain of $0.2 million on the sale of an investment previously classified as an “other investment” and also a net gain on sale of investment securities of $0.6 million during the year ended December 31, 2019.

The following tables set forth the composition and maturities of investment securities as of December 31, 2022 and December 31, 2021.

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Held to maturity securities

Treasury securities

Obligations of states and political subdivisions

Total held to maturity securities

After One, But

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Available for sale securities

Treasury securities

Obligations of U.S.

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The largest unrealized loss percentage of any single security was 30.37% (or $606,000) of its amortized cost.

This was also the largest unrealized dollar loss of any single security.

As of December 31, 2020, six debt securities had gross unrealized losses, with an aggregate depreciation of 0.08% from our amortized cost basis.

The largest unrealized dollar loss of any single security was $1.49 million (or 15.4%).

As of December 31, 2021, 26 debt securities had gross unrealized losses, with an aggregate depreciation of 0.98% from our amortized cost basis.

The largest unrealized loss percentage of any single security was 5.31% (or $256,000) of its amortized cost.

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Borrowings and brokered deposits are considered short-term supplements to our overall liquidity but are not intended to be relied upon for long-term needs.

We believe that our present position is adequate to meet our current and future liquidity needs, and management knows of no trend or event that will have a material impact on the Company’s ability to maintain liquidity at satisfactory levels.

We believe that our present position is adequate

to meet our current and future liquidity needs, and management knows of no trend or event that will have a material impact on the Company’s ability to maintain liquidity at satisfactory levels.

Capital Adequacy.

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Our total shareholders’ equity increased during 2022, 2021 and 2020 as a result of our profitability, reduced by dividends paid and common share repurchases.

Growth in shareholders’ equity during 2020 and 2019 was further stimulated by the acquisitions of Timberwood and Partnership in these years, respectively.

Growth in shareholders’ equity during 2022 and 2020 was further stimulated by the acquisitions of Denmark and Timberwood in these years, respectively.

Our capital management consists of providing adequate equity to support our current and future operations.

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Failure to meet minimum capital requirements may prompt certain actions by regulators that, if undertaken, could have a direct material adverse effect on our financial condition and results of operations.

Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measure of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices.

Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank and Company must meet specific capital guidelines that involve quantitative measure of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices.

The capital amounts and the classifications are also subject to qualitative judgment by the regulator in regards to risk weighting and other factors.

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Total capital (to risk-weighted assets)

Tier I capital (to risk-weighted)

Tier I capital (to risk-weighted assets)

Common equity tier I capital (to risk-weighted assets)

Tier I capital (to average assets)

As previously mentioned, the Company carried $17.5 million of subordinated debt as of December 31, 2021 and 2020, respectively, which is included in total capital for the Company in the tables above.

As previously mentioned, the Company carried $23.5 million of subordinated debt as of December 31, 2022 and $17.5 million of subordinated debt as of December 31, 2021, which is included in total capital for the Company in the tables above.

FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

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The effect of inflation on a financial institution differs significantly from the effect on an industrial company.

While a financial institution’s operating expenses, particularly salary and employee benefits, are affected by general inflation, the asset and liability structure of a financial institution consists largely of monetary items.

While a financial institution’s operating expenses, particularly salary and employee benefits, are affected by general inflation, the asset and

liability structure of a financial institution consists largely of monetary items.

Monetary items, such as cash, investments, loans, deposits and other borrowings, are those assets and liabilities which are or will be converted into a fixed number of dollars regardless of changes in prices.

3 unchanged sentences

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis