SIERRA BANCORP 10-Q

ITEM 2 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS This Form 10- Q includes forward-looking statements that involve inherent risks and uncertainties. These forward-looking statements are within the meaning of Section 27A of the Securities Act of 1933 (“1933 Act”), as amended and Section 21E of the Securities Exchange Act of 1934 (“1934 Act”), as amended. Those sections of the 1933 Act and 1934 Act provide a “safe harbor” for forward-looking statements in order to encourage companies to provide prospective information about their financial performance as long as important factors that could cause actual results to differ significantly from projected results are identified with meaningful cautionary statements. Words such as “expects”, “anticipates”, “believes”, “projects”, “intends”, and “estimates” or variations of such words and similar expressions, as well as future or conditional verbs preceded by “will”, “would”, “should”, “could” or “may” are intended to identify forward-looking statements. These forward-looking statements are based on certain underlying assumptions and are not guarantees of future performance, as they could be impacted by several potential risks and developments that cannot be predicted with any degree of certainty. These statements are based on management’s current expectations regarding economic, legislative, regulatory and other environmental issues that may affect our earnings in future periods. Therefore, actual outcomes and results may differ materially from what is expressed, forecast in, or implied by such forward-looking statements. A variety of factors could have a material adverse impact on the Company’s financial condition or results of operations, and should be considered when evaluating the Company’s potential future financial performance. They include, but are not limited to: ● the risk of unfavorable economic conditions in the Company’s market areas; ● risks associated with the current national emergency with respect to COVID-19 and its variants, including the impact that national, state, and local responses, including limitations on business and personal activity as well as any stimulus or relief efforts have on customers’ continued ability to repay loans.; ● risks associated with fluctuations in interest rates; ● risks associated with inflation; ● liquidity risks, including the ability to effectively manage the additional liquidity from the significant increase in deposits during the COVID-19 pandemic including managing the potential loss of a portion of such deposits; ● increases in nonperforming assets and credit losses that could occur, particularly in times of weak economic conditions or rising interest rates; ● reductions in the market value of available-for-sale securities that could result if interest rates increase substantially or an issuer has real or perceived financial difficulties; ● the Company’s ability to diversify and grow its loan portfolio; ● the Company’s ability to attract and retain skilled employees; ● the Company’s ability to successfully deploy new technology; ● the Company’s ability to receive regulatory approval for acquisitions or branch expansion while having a less than satisfactory rating under the Community Reinvestment Act; 35 Table of Contents ● the outcome of any existing or future legal action for which the Company or Bank is a defendant; ● the success of acquisitions or branch expansions, closures or consolidations; and ● risks associated with the multitude of current and prospective laws and regulations to which the Company is and will be subject. Risk factors that could cause actual results to differ materially from results that might be implied by forward-looking statements include the risk factors detailed in the Company’s Form 10-K for the fiscal year ended December 31, 2021 and in Item 1A, herein. We do not update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events. CRITICAL ACCOUNTING POLICIES The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States. The financial information and disclosures contained within those statements are significantly impacted by Management’s estimates and judgments, which are based on historical experience and incorporate various assumptions that are believed to be reasonable under current circumstances. Actual results may differ from those estimates under divergent conditions. Critical accounting policies are those that involve the most complex and subjective decisions and assessments, and have the greatest potential impact on the Company’s stated results of operations. In Management’s opinion, the Company’s critical accounting policies deal with the following areas: ● the establishment of the allowance for credit losses, as explained in detail in Note 10 to the consolidated financial statements and in the “Provision for Credit Losses” and “Allowance for Credit Losses” sections of this discussion and analysis; ● the valuation of individually evaluated loans and foreclosed assets, as discussed in Notes 8 and 10 to the consolidated financial statements; ● income taxes and related deferred tax assets and liabilities, especially with regard to the ability of the Company to recover deferred tax assets as discussed in the “Provision for Income Taxes” and “Other Assets” sections of this discussion and analysis; and ● goodwill and other intangible assets, which are evaluated annually for impairment and for which we have determined that no impairment exists, as discussed in the “Other Assets” section of this discussion and analysis. Critical accounting areas are evaluated on an ongoing basis to ensure that the Company’s financial statements incorporate our most recent expectations regarding those areas. OVERVIEW OF THE RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS SUMMARY First Quarter 2022 compared to First Quarter 2021 First quarter 2022 net income was $7.4 million, or $0.49 per diluted share, compared to $11.1 million, or $0.72 per diluted share in the first quarter of 2021. The Company’s annualized return on average equity was 8.64% and annualized return on average assets was 0.88% for the quarter ended March 31, 2022, compared to 12.94% and 1.40%, respectively, for the same quarter in 2021. The primary drivers behind the variance in first quarter net income are as follows: ● Net interest income decreased by $3.8 million mostly due to a 67 bps decline in the yield on earning assets and a shift in mix due to higher levels of average cash invested overnight with the Federal Reserve Bank and lower average loan balances. In addition, there was a $0.4 million unfavorable increase in interest expense due to the issuance of subordinated debt during the third quarter of 2021. 36 Table of Contents ​ ● A $0.6 million provision for credit losses on loans and leases as compared to a provision for loan and lease losses of $0.3 million in the same quarter in 2021. This unfavorable impact was attributed to higher charge-offs partially offset by a reduction in the pooled allowance under the new current expected credit losses (“CECL”) methodology implemented on January 1, 2022. ​ ● Noninterest income decreased $0.8 million or 11% primarily due to a $1.2 million decrease in the change in the annual valuation change of restricted equity investments, as well as BOLI fluctuations associated with deferred compensation plans for $1.2 million. These negative variances were partially offset by a $1.0 million gain on the sale of investment securities in an effort to rebalance the portfolio by selling longer duration and higher price volatility securities as a hedge against rising interest rates, due to likely persistent inflationary pressures in the near-intermediate term environment. Service charges on customer deposit accounts declined by $0.1 million, or 4%, to $3.0 million in the first quarter of 2022 as compared to the fourth quarter of 2021. This same income was $0.3 million higher in the first quarter of 2022 as compared to the first quarter of 2021 due to higher transaction based fees, including analysis fee income. ● Total noninterest expense had a favorable decline of $0.2 million, or 1%, in the first quarter of 2022 as compared to the first quarter of 2021. Lower occupancy and legal expenses, partially offset by higher salaries and benefits were the primary drivers. ​ FINANCIAL CONDITION SUMMARY March 31, 2022 relative to December 31, 2021 The Company’s assets totaled $3.4 billion at March 31, 2022 unchanged from December 31, 2021. The following provides a summary of key balance sheet changes during the first three months of 2022: ​ ● Investment securities increased 5% to $1.0 billion from $973.3 million at December 31, 2021, primarily due to purchases of collateralized loan obligations. ​ ● Gross loan balances remained relatively flat during the first quarter of 2022 with an overall 0.3% change. The net change did have some offsetting components with the larger fluctuations being a $44.0 million decline in mortgage warehouse line utilization, a $25.8 million decrease in non-owner occupied commercial real estate, and a $16.8 million of decrease in PPP loans. These declines were mostly offset by a $109.4 million increase in 1-4 family mortgage loans due to purchases of high-quality jumbo mortgage loans. ● Deposits totaled $2.9 billion at March 31,2022, representing a year-to-date increase of $83.4 million, or 3%. The growth in deposits came primarily from core transaction and savings accounts. ​ ● Total shareholders’ equity of $325.7 million at March 31, 2022 reflects a decrease of $36.8 million, or 10%, relative to year-end 2021 due to net income of $7.4 million, offset by a $3.5 million dividend paid to shareholders, $4.9 million in share repurchases, a $28.9 million unfavorable swing in other comprehensive income/loss due principally to changes in investment securities' fair value, and a $7.3 million cumulative effect adjustment for the implementation of ASC 326. The remaining difference is related to stock options exercised and restricted stock compensation recognized during the quarter. ​ IMPACT OF CORONAVIRUS DISEASE 2019 (COVID-19) PANDEMIC ON THE COMPANY’S OPERATIONS Overview On January 31, 2020, the United States Department of Health and Human Services declared a public health emergency with respect to the Coronavirus Disease 2019 (COVID-19). Subsequent to this date, federal, state, and local governmental agencies, regulatory agencies, and the Federal Reserve Board took many actions impacting the Company. 37 Table of Contents These actions included, among other things, the Federal Open Market Committee (FOMC) reducing the federal funds rate; California issuing a state-wide shelter-in-place order and various other orders at the state and local levels restricting business operations, closing schools, and thereafter prescribing requirements for reopening; and various pieces of federal legislation were passed to attempt to address the impact of COVID-19 on the economy. ​ Impact of COVID-19 on the Company’s Operations ● Starting in April 2020, the Company took actions to mitigate the impact on credit losses including permitting short-term payment deferrals to current customers, as well as providing bridge loans and SBA Paycheck Protection Program (PPP) loans. The Company had no loans remaining on deferral, which were modified under the CARES Act, as amended. ● The uncertainty of national and local economic conditions had an impact on our provision for credit losses in early 2022 and on our provision for loan and lease losses in 2021. The Company implemented the Current Expected Credit Loss ("CECL") accounting method under Financial Accounting Standards Board (FASB) Accounting Standards Update 2016-03 and related amendments, Financial Instruments – Credit Losses (Topic 326) on January 1, 2022, after having elected under Section 4014 of the CARES Act and the Consolidated Appropriations Act, 2021 to defer earlier implementation. ● The Company expects that net interest income may continue to be adversely impacted given pressure on the net interest margin as a result of the current interest rate environment. Although the FOMC raised the fed funds rate by 25 bps on March 16, 2022, the overall rate environment is still at historical lows. The FOMC has indicated potential future increases to the overnight fed funds rate but uncertainty as to when and at what rate this may occur still remains. These lower rates have impacted our net interest margin. Our net interest margin for the three months ended March 31, 2022, was 3.21%, compared to a net interest margin of 3.93% for the same period in 2021. Additional liquidity from significant deposit growth in 2021 and the first three months of 2022, coupled with lower loan balances has negatively impacted our net interest margin. This additional liquidity was mostly deployed in overnight funding resulting in $194.8 million in average overnight cash during the first quarter of 2022. This overnight funding earned an average rate of 19 basis points, for the first quarter ending March 31, 2022. In addition, the Company had $1.0 billion in investment securities at average tax effective yield 210 basis points lower than that of current loan yields. ● The COVID-19 pandemic has not adversely affected our capital or financial resources as of March 31, 2022. During the first three months of 2022, total shareholders’ equity decreased by $36.8 million, or 10%, to $325.7 million. The Company earned $7.4 million in net income in the first three months of 2022, but had a $28.9 million decrease in accumulated other comprehensive income as a result of decreases in the value of our investment portfolio due to an uptick in interest rates. If interest rates continue to rise, this component of equity would be expected to further decline. The Company also paid dividends of $3.5 million and repurchased shares of stock for $4.9 million during the first quarter of 2022. On April 22, 2022, the Company declared a twenty-three cent per share dividend to be paid on May 12, 2022. Although presently not expected, if the Company were to incur significant credit losses as a result of COVID-19’s impact on our customers’ ability to repay loans, capital could be adversely impacted. With respect to liquidity, the Company maintains strong primary and secondary liquidity sources as further described under “Liquidity and Market Risk Management” below. ● The Company continues to serve its customers. Several of our branch locations were closed during the height of the pandemic, but have since re-opened. Five branch locations were permanently closed in June 2021. This decision to close these branches was made as a result of a change in customer behaviors brought about by the COVID-19 pandemic along with an efficiency review. All of the five closed locations were located outside of Tulare County, the Bank’s primary market area. Many of our customers have found an added convenience and ease of transacting business through online and mobile banking services which precipitated our decision to close locations where in-person transaction volumes no longer warranted a traditional brick-and-mortar branch. Overall deposits at these five closed branches increased during the period of time from announcement to closure and consolidation into a nearby branch. 38 Table of Contents ● As a financial institution providing essential services, the Company expects continued demand for loans and deposits. In addition, mortgage warehouse utilization that resulted from the low rate environment is expected to remain at a lower levels. Further, it is expected that SBA PPP loans will continue to be forgiven, with the remainder expected to be forgiven in 2022. EARNINGS PERFORMANCE The Company earns income from two primary sources. The first is net interest income, which is interest income generated by earning assets less interest expense on deposits and other borrowed money. The second is noninterest income, which primarily consists of customer service charges and fees but also comes from non-customer sources such as BOLI and investment gains. The majority of the Company’s noninterest expense is comprised of operating costs that facilitate offering a full range of banking services to our customers. . NET INTEREST INCOME AND NET INTEREST MARGIN Net interest income decreased $3.8 million to $24.8 million, for the first quarter of 2022 over the first quarter of 2021. For the first quarter of 2022 as compared to the same quarter in 2021, average loan balances decreased $415.3 million, or 18%, primarily due to $181.6 million, or a 75% decrease in the utilization of mortgage warehouse lines, a $126.0 million, or 7% decrease in real estate secured loans, and a $94.5 million, or 49% decrease in commercial loans, mostly from the forgiveness of SBA PPP loans. Ag production loans were also down $12.2 million or 26%. The average yield on the overall loan portfolio decreased 21 basis points, while there was a 8 bps unfavorable increase in the cost of interest-bearing liabilities for the first quarter of 2022 as compared to the same quarter in 2021. The level of net interest income we recognize in any given period depends on a combination of factors including the average volume and yield for interest earning assets, the average volume and cost of interest-bearing liabilities, and the mix of products which comprise the Company’s earning assets, deposits, and other interest-bearing liabilities. The following tables show average balances for significant balance sheet categories and the amount of interest income or interest expense associated with each category for the noted periods. The tables also display calculated yields on each major component of the Company’s investment and loan portfolios, average rates paid on each key segment of the Company’s interest-bearing liabilities, and our net interest margin for the noted periods . 39 Table of Contents Average Balances and Rates (dollars in thousands, unaudited) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ For the three months ended ​ For the three months ended ​ ​ March 31, 2022 ​ March 31, 2021 Assets Average Balance (1) Income/ Expense Average Rate/Yield (2) Average Balance (1) Income/ Expense Average Rate/Yield (2) Investments: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Interest-earning due from banks ​ $ 194,846 ​ $ 93 ​ 0.19% ​ $ 76,504 ​ $ 19 ​ 0.10% Taxable ​ ​ 744,599 ​ ​ 3,490 ​ 1.90% ​ 317,254 ​ ​ 1,578 ​ 2.02% Non-taxable ​ ​ 294,409 ​ ​ 1,726 ​ 3.01% ​ ​ 226,838 ​ ​ 1,449 ​ 3.28% Total investments ​ ​ 1,233,854 ​ ​ 5,309 ​ 1.90% ​ ​ 620,596 ​ ​ 3,046 ​ 2.24% ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Loans and leases: (3) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Real estate ​ ​ 1,753,394 ​ ​ 18,326 ​ 4.24% ​ ​ 1,879,359 ​ ​ 21,391 ​ 4.62% Agricultural ​ ​ 33,986 ​ ​ 302 ​ 3.60% ​ ​ 46,153 ​ ​ 419 ​ 3.68% Commercial ​ ​ 97,127 ​ ​ 1,398 ​ 5.84% ​ ​ 191,656 ​ ​ 2,451 ​ 5.19% Consumer ​ ​ 4,448 ​ ​ 206 ​ 18.78% ​ ​ 5,422 ​ ​ 196 ​ 14.66% Mortgage warehouse lines ​ ​ 61,255 ​ ​ 510 ​ 3.38% ​ ​ 242,865 ​ ​ 1,928 ​ 3.22% Other ​ ​ 1,485 ​ ​ 30 ​ 8.19% ​ ​ 1,588 ​ ​ 27 ​ 6.90% Total loans and leases ​ ​ 1,951,695 ​ ​ 20,772 ​ 4.32% ​ ​ 2,367,043 ​ ​ 26,412 ​ 4.53% Total interest earning assets (4) ​ 3,185,549 ​ ​ 26,081 ​ 3.38% ​ ​ 2,987,639 ​ ​ 29,458 ​ 4.05% Other earning assets ​ ​ 15,679 ​ ​ ​ ​ ​ ​ ​ 13,275 ​ ​ ​ ​ ​ Non-earning assets ​ ​ 210,724 ​ ​ ​ ​ ​ ​ ​ 201,114 ​ ​ ​ ​ ​ Total assets ​ $ 3,411,952 ​ ​ ​ ​ ​ ​ $ 3,202,028 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Liabilities and shareholders' equity ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Interest bearing deposits: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Demand deposits ​ $ 202,962 ​ $ 106 ​ 0.21% ​ $ 130,763 ​ $ 73 ​ 0.23% NOW ​ ​ 546,280 ​ ​ 82 ​ 0.06% ​ ​ 569,171 ​ ​ 101 ​ 0.07% Savings accounts ​ ​ 467,700 ​ ​ 67 ​ 0.06% ​ ​ 391,091 ​ ​ 53 ​ 0.05% Money market ​ ​ 151,339 ​ ​ 23 ​ 0.06% ​ ​ 136,422 ​ ​ 30 ​ 0.09% Time Deposits ​ ​ 293,684 ​ ​ 234 ​ 0.32% ​ ​ 412,416 ​ ​ 289 ​ 0.28% Brokered deposits ​ ​ 60,000 ​ ​ 48 ​ 0.32% ​ ​ 100,000 ​ ​ 62 ​ 0.25% Total interest bearing deposits ​ ​ 1,721,965 ​ ​ 560 ​ 0.13% ​ ​ 1,739,863 ​ ​ 608 ​ 0.14% Borrowed funds: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Federal funds purchased ​ ​ 170 ​ ​ — ​ — ​ ​ 5,822 ​ ​ 1 ​ 0.07% Repurchase agreements ​ ​ 105,067 ​ ​ 82 ​ 0.32% ​ ​ 46,097 ​ ​ 45 ​ 0.40% Short term borrowings ​ ​ 1 ​ ​ — ​ — ​ ​ 11,530 ​ ​ 2 ​ 0.07% Long-term debt ​ ​ 49,143 ​ ​ 428 ​ 3.53% ​ ​ — ​ ​ — ​ — Subordinated debentures ​ ​ 35,320 ​ ​ 255 ​ 2.93% ​ ​ 35,141 ​ ​ 247 ​ 2.85% Total borrowed funds ​ ​ 189,701 ​ ​ 765 ​ 1.64% ​ ​ 98,590 ​ ​ 295 ​ 1.21% Total interest bearing liabilities ​ ​ 1,911,666 ​ ​ 1,325 ​ 0.28% ​ ​ 1,838,453 ​ ​ 903 ​ 0.20% Demand deposits - noninterest bearing ​ ​ 1,093,709 ​ ​ ​ ​ ​ ​ ​ 977,137 ​ ​ ​ ​ ​ Other liabilities ​ ​ 59,026 ​ ​ ​ ​ ​ ​ ​ 39,199 ​ ​ ​ ​ ​ Shareholders' equity ​ ​ 347,551 ​ ​ ​ ​ ​ ​ ​ 347,239 ​ ​ ​ ​ ​ Total liabilities and shareholders' equity ​ $ 3,411,952 ​ ​ ​ ​ ​ ​ $ 3,202,028 ​ ​ ​ ​ ​ Interest income/interest earning assets ​ ​ ​ ​ ​ ​ ​ 3.38% ​ ​ ​ ​ ​ ​ ​ 4.05% Interest expense/interest earning assets ​ ​ ​ ​ ​ ​ ​ 0.17% ​ ​ ​ ​ ​ ​ ​ 0.12% Net interest income and margin (5) ​ ​ ​ ​ $ 24,756 ​ 3.21% ​ ​ ​ ​ $ 28,555 ​ 3.93% (1) Average balances are obtained from the best available daily or monthly data and are net of deferred fees and related direct costs. (2) Yields and net interest margin have been computed on a tax equivalent basis utilizing a 21% effective tax rate. (3) Loans are gross of the allowance for possible loan losses. Loan fees have been included in the calculation of interest income. Net loan fees and loan acquisition FMV amortization were $0.4 million and $1.4 million for the quarters ended March 31, 2022 and 2021, respectively. (4) Non-accrual loans have been included in total loans for purposes of computing total earning assets. (5) Net interest margin represents net interest income as a percentage of average interest earning assets. ​ 40 Table of Contents The Volume and Rate Variances table below sets forth the dollar difference for the comparative periods in interest earned or paid for each major category of interest earning assets and interest-bearing liabilities, and the amount of such change attributable to fluctuations in average balances (volume) or differences in average interest rates. Volume variances are equal to the increase or decrease in average balances multiplied by prior period rates, and rate variances are equal to the change in rates multiplied by prior period average balances. Variances attributable to both rate and volume changes, calculated by multiplying the change in rates by the change in average balances, have been allocated to the rate variance. Volume & Rate Variances (dollars in thousands, unaudited) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Three months ended March 31, ​ ​ 2022 over 2021 ​ ​ Increase (decrease) due to Assets: Volume Rate ​ Mix Net Investments: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Federal funds sold/due from time $ 29 $ 18 ​ $ 27 $ 74 Taxable ​ ​ 2,125 ​ ​ (91) ​ ​ (123) ​ ​ 1,912 Non-taxable ​ ​ 106 ​ ​ (119) ​ ​ 290 ​ ​ 277 Total investments (1) ​ ​ 2,260 ​ ​ (192) ​ ​ 194 ​ ​ 2,263 Loans and leases: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Real estate ​ ​ (1,434) ​ ​ (1,748) ​ ​ 117 ​ ​ (3,065) Agricultural ​ ​ (110) ​ ​ (9) ​ ​ 2 ​ ​ (117) Commercial ​ ​ (1,209) ​ ​ 308 ​ ​ (152) ​ ​ (1,053) Consumer ​ ​ (35) ​ ​ 55 ​ ​ (10) ​ ​ 10 Mortgage warehouse ​ ​ (1,442) ​ ​ 94 ​ ​ (70) ​ ​ (1,418) Other ​ ​ (2) ​ ​ 5 ​ ​ — ​ ​ 3 Total loans and leases (1) ​ ​ (4,232) ​ ​ (1,295) ​ ​ (113) ​ ​ (5,640) Total interest earning assets (1) ​ $ (1,972) ​ $ (1,487) ​ $ 81 ​ $ (3,377) Liabilities ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Interest bearing deposits: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Demand deposits ​ $ 41 ​ ​ (5) ​ ​ (3) ​ $ 33 NOW ​ ​ (4) ​ ​ (16) ​ ​ 1 ​ ​ (19) Savings accounts ​ ​ 10 ​ ​ 3 ​ ​ 1 ​ ​ 14 Money market ​ ​ 3 ​ ​ (9) ​ ​ (1) ​ ​ (7) Time Deposits ​ ​ (84) ​ ​ 40 ​ ​ (11) ​ ​ (55) Brokered deposits ​ ​ (25) ​ ​ 18 ​ ​ (7) ​ ​ (14) Total interest bearing deposits (1) ​ ​ (59) ​ ​ 31 ​ ​ (20) ​ ​ (48) Borrowed funds: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Federal funds purchased ​ ​ (1) ​ ​ (1) ​ ​ 1 ​ ​ (1) Repurchase agreements ​ ​ 58 ​ ​ (9) ​ ​ (12) ​ ​ 37 Short term borrowings ​ ​ (2) ​ ​ (2) ​ ​ 2 ​ ​ (2) Long-term debt ​ ​ — ​ ​ — ​ ​ 428 ​ ​ 428 Subordinated debt ​ ​ 1 ​ ​ 7 ​ ​ — ​ ​ 8 Total borrowed funds (1) ​ ​ 56 ​ ​ (5) ​ ​ 419 ​ ​ 470 Total interest bearing liabilities (1) ​ ​ (3) ​ ​ 26 ​ ​ 399 ​ ​ 422 Net interest income (1) ​ $ (1,969) ​ $ (1,513) ​ $ (318) ​ $ (3,799) (1) Subtotals are a sum of the categories above and are not recalculated on the portfolio totals. ​ The volume variance calculated for the first three months of 2022 relative to the first three months of 2021 was an unfavorable $2.0 million due to lower average balances of interest earning assets, resulting from a decrease in all categories of loans, partially offset by an increase in investment balances. There was an unfavorable rate variance of $1.5 million for the comparative quarters since the weighted average yield on interest earning assets decreased by 67 basis points and the weighted average cost of interest-bearing liabil­ities increased by 8 basis points. There was also an 41 Table of Contents unfavorable mix variance of $0.3 million primarily from the issuance of subordinated debentures issued at 3.25% in September of 2021. The rate variance was negatively impacted by the following factors: high average balances of cash and due from banks earning on average 19 bps, new loans and investments having lower yields overall, including low-yielding purchased 1-4 SFD mortgage loans. Increased costs on interest bearing liabilities also had a negative impact on the variance primarily from the issuance of subordinated debt mentioned above. The Company’s net interest margin for the first quarter of 2022 was 3.21%, as compared to 3.93% for the first quarter of 2021. At March 31, 2022, approximately 7% of our total portfolio, or $142.6 million, consists of variable rate loans. Of these variable rate loans, approximately $22.0 million have floors. At March 31, 2022, our outstanding fixed rate loans represented 28% of our loan portfolio. The remaining 65% of our loan portfolio at March 31, 2022 consists of adjustable-rate loans; 78% of these loans (approximately $1.0 billion) will not begin adjusting for at least another 3 years, but up to 10 years. These loans are typically adjustable every five years after the initial adjustment. Approximately $47.8 million of these adjustable-rate loans have the ability to reprice next quarter. Cash balances for the quarterly comparisons have increased and have a negative impact on our net interest margin since cash balances earn considerably lower yields than other earning assets. Average cash and due from banks was $194.8 million, an increase of $118.3 million for the first quarter of 2021. Overall average investment securities increased by $494.9 million for the first quarter of March 31, 2022 as compared to March 31, 2021. For the quarter ending March 31, 2022 over the same period for 2021, average non-taxable securities increased $67.6 million and taxable securities increased $427.3 million. The overall investment portfolio had a tax-equivalent yield of 2.22% at March 31, 2022, with an average life of 6.21 years. Interest expense was $1.3 million in the first quarter of 2022, an increase of $0.4 million, or 47%, compared to the first quarter of 2021. The increase in interest expense for the quarter is primarily attributable to the issuance of subordinated debentures in September of 2021 at 3.25%. The average cost of interest-bearing deposits decreased by 1 basis point to 13 basis points for the first quarter of 2022 compared to the first quarter of 2021, while the average cost of borrowed funds increased 43 basis points for the first quarter of 2022 as compared to the same period in 2021. Non-interest bearing demand deposits increased $116.6 million or 12% for the first quarter of 2022 as compared to the first quarter of 2021. ​ PROVISION FOR CREDIT LOSSES ON LOANS AND LEASES The Company implemented the Current Expected Credit Loss ("CECL") accounting method under Financial Accounting Standards Board (FASB) Accounting Standards Update 2016-03 and related amendments, Financial Instruments – Credit Losses (Topic 326) on January 1, 2022 . Upon implementation the Company recorded a $10.4 million increase in the allowance for credit losses, which included a $0.9 million reserve for unfunded commitments as an adjustment to equity, net of deferred taxes. Credit risk is inherent in the business of making loans. The Company sets aside an allowance for credit losses on loans and leases, a contra-asset account, through periodic charges to earnings which are reflected in the income statement as the provision for credit losses on loans and leases. The Company recorded an expense related to a credit loss provision for loans and leases of $0.6 million in the first quarter of 2022 relative to a provision for loan and lease losses of $0.3 million in the first quarter of 2021. The higher provision for credit losses in the first quarter of 2022 over the same quarter in 2021, was primarily due to the impact of a $1.8 million in net charge-offs in the first quarter of 2022, partially offset by a decrease in the allowance for credit losses for loans evaluated on a pool basis. The increase in net charge-offs in the first quarter of 2022 was primarily related to a single loan relationship that defaulted in late March 2022 upon the discovery of new information. No additional allowance was booked for this loan individually evaluated for expected losses. The first quarter of 2022 decrease in the allowance for credit losses evaluated on a pooled basis was primarily due to a decline in the qualitative factors resulting from improvements in regional economic factors. 42 Table of Contents Specifically identifiable and quantifiable credit losses are immediately charged off against the allowance, with subsequent recoveries reflected as an increase to the allowance. The Company recorded net charge-offs of $1.8 million in the first quarter of 2022 as compared to net recoveries of $0.3 million for the comparative period of 2021. The allowance for credit losses on loans and leases is at a level that, in Management’s judgment, is adequate to absorb probable credit losses on loans related to individually identified loans as well as probable incurred credit losses in the remaining loan portfolio. The Company’s policies for monitoring the adequacy of the allowance, determining loan balances that should be charged off, and other detailed information with regard to changes in the allowance are discussed in Note 10 to the consolidated financial statements, and below, under “Allowance for Credit Losses.” The process utilized to establish an appropriate credit allowance for losses on loans and leases can result in a high degree of variability in the Company’s credit loss provision, and consequently in our net earnings. 43 Table of Contents NONINTEREST INCOME AND NONINTEREST EXPENSE The following table provides details on the Company’s noninterest income and noninterest expense for the three and nine month periods ended March 31, 2022 and 2021: Noninterest Income/Expense (dollars in thousands, unaudited) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ For the three months ended March 31, Noninterest income: ​ 2022 ​ 2021 Service charges on deposit accounts $ 3,040 $ 2,767 Other service charges and fees ​ ​ 2,787 ​ ​ 2,560 Net gains on sale of securities available-for-sale ​ ​ 1,032 ​ ​ — Bank-owned life insurance ​ ​ (645) ​ ​ 583 Other ​ ​ (151) ​ ​ 920 Total noninterest income ​ $ 6,063 ​ $ 6,830 As a % of average interest earning assets (1) ​ ​ 0.77% ​ ​ 0.93% ​ ​ ​ ​ ​ ​ ​ Noninterest expense: ​ ​ ​ ​ ​ ​ Salaries and employee benefits ​ $ 11,805 ​ $ 11,151 Occupancy costs ​ ​ ​ ​ ​ ​ Furniture & equipment ​ ​ 454 ​ ​ 452 Premises ​ ​ 1,840 ​ ​ 2,034 Advertising and marketing costs ​ ​ 406 ​ ​ 321 Data processing costs ​ ​ 1,485 ​ ​ 1,426 Deposit services costs ​ ​ 2,245 ​ ​ 2,068 Loan services costs ​ ​ ​ ​ ​ ​ Loan processing ​ ​ 111 ​ ​ 169 Foreclosed assets ​ ​ (5) ​ ​ 107 Other operating costs ​ ​ ​ ​ ​ ​ Telephone & data communications ​ ​ 444 ​ ​ 380 Postage & mail ​ ​ 56 ​ ​ 84 Other ​ ​ 419 ​ ​ 462 Professional services costs ​ ​ ​ ​ ​ ​ Legal & accounting ​ ​ 546 ​ ​ 442 Other professional service ​ ​ 143 ​ ​ 897 Stationery & supply costs ​ ​ 85 ​ ​ 78 Sundry & tellers ​ ​ 139 ​ ​ 200 Total noninterest expense ​ $ 20,173 ​ $ 20,271 As a % of average interest earning assets (1) ​ ​ 2.57% ​ ​ 2.75% Efficiency ratio (2)(3) ​ ​ 67.08% ​ ​ 56.43% (1) Annualized (2) Tax equivalent (3) The efficiency ratio is a non-GAAP measure and is a calculation of noninterest expense as a percentage of the sum of net interest income and noninterest income excluding net gains (losses) from securities and bank owned life insurance income. ​ 44 Table of Contents Noninterest Income: Total noninterest income reflected a decrease of $0.8 million, or 11%, for the quarter ended March 31, 2022 as compared to the same quarter in 2021 due mostly to lower BOLI income and a decrease in the fair market value adjustment for an equity investment, partially offset by a gain on the sale of investment securities. Service charges on deposit accounts increased by $0.3 million or 10%, for the quarterly comparison. The variance was primarily due to increases in overdraft fees and analysis fees on treasury management customers. Other service charges and fees increased $0.2 million or 9% for the first quarter of 2022 as compared to the same period in 2021 mainly due to an increase in debit card interchange fees from higher usage. Gains of the sales of securities were $1.0 million for the first quarter of 2022. There were no sales in the comparable quarter of 2021. The sale in the first quarter of 2022 was a strategic effort to rebalance the portfolio by selling longer duration and higher price volatility securities as a hedge against rising interest rates, due to likely persistent inflationary pressures in the near-intermediate term environment. BOLI income decreased by $1.2 million for the first quarter of 2022 as compared to the first quarter of 2021. The variance is due mostly to fluctuations in underlying values of assets in the specific account BOLI policies that are designed to have similar assets to those in the deferred compensation plans. Thus, the lower quarterly values in BOLI policies are offset by lower deferred compensation expense reflected primarily in director fees expense. At March 31, 2022, there was $43.5 million in BOLI policies and $10.1 million in separate account BOLI policies associated with the deferred compensation plans. In the “other” category of noninterest income the Company reflected a $1.1 million decrease in the first quarter of 2022 as compared to the first quarter of 2021. The quarterly comparison includes a $1.2 million change in the valuation adjustment of the Company’s equity investment in Pacific Coast Bankers’ Bank. The valuation of restricted stock held by the Company is required under FASB ASU 2016-01. This stock is related to an equity investment in Pacific Coast Bankers’ Bank and is adjusted when financial information and an updated valuation report becomes available, generally in the late first quarter of each year. Noninterest Expense: Total noninterest expense had a favorable decline of $0.1 million in the first quarter of 2022 as compared to the first quarter of 2021. The tax-equivalent efficiency ratio was 67.08% in the first quarter of 2022 as compared to 56.43% in the same quarter of 2021. The efficiency ratio represents total noninterest expense divided by the sum of fully tax-equivalent net interest and noninterest income; the provision for credit losses on loans and leases and investment gains/losses are excluded from the equation. The ratio spiked higher in the first three months of 2022 despite lower noninterest expense because the denominator of the equation, net interest income and noninterest income was lower during the same period, mainly due to lower interest earning assets. Salaries and benefits were $0.7 million higher in the first quarter of 2022 as compared to the first quarter of 2021. The increase in the year-over-year quarterly comparison is due to several factors, including merit increases for employees due to annual performance evaluations during the period, higher payroll taxes in the first quarter, and the strategic hiring of lending and management staff. Overall full-time equivalent employees were 484 at March 31, 2022 as compared to 508 at March 31, 2021. Occupancy expense was $0.2 million lower for the first quarter of 2022 as compared to the same quarter last year. We closed five branch facilities in the second quarter of 2021 which impacted the decrease for the year over year quarterly comparison. 45 Table of Contents Further, other noninterest expense categories were $0.7 million lower for the first quarter 2022 as compared to the first quarter in 2021. The principal decreases were in loan services costs mostly from the write up of the provision for credit losses on unfunded commitments for $0.1 million, a favorable variance in foreclosed asset costs for $0.1 million as all but one OREO property was sold in 2021, thus our carrying costs have decreased and a $0.8 million decrease in professional services costs. The positive variance in professional services costs came mostly from a decrease in directors deferred compensation expense which is linked to the fluctuations in BOLI income. ​ PROVISION FOR INCOME TAXES The Company sets aside a provision for income taxes on a monthly basis. The amount of that provision is deter­mined by first applying the Company’s statutory income tax rates to estimated taxable income, which is pre-tax book income adjusted for permanent dif­ferences, and then subtracting available tax credits. Permanent differences include but are not limited to tax-exempt interest income, BOLI income, and certain book expenses that are not allowed as tax deductions. Our tax credits consist primarily of those generated by investments in low-income housing tax credit funds. The Company's provision for income taxes was 27.0% of pre-tax income in the first quarter of 2022 relative to 25.5% in the first quarter of 2021. The increase in effective tax rate in the first quarter of 2022 is due to tax credits and tax-exempt income representing a smaller percentage of total taxable income. ​ BALANCE SHEET ANALYSIS EARNING ASSETS The Company’s interest earning assets are comprised of loans and investments, including overnight investments and surplus balances held in interest earning accounts in our Federal Reserve Bank account. The composition, growth characteristics, and credit quality of both of those components are significant determinants of the Company’s financial condition. Investments are analyzed in the section immediately below, while the loan and lease portfolio and other factors affecting earning assets are discussed in the sections following investments. INVESTMENTS The Company’s investments may at any given time consist of debt securities and marketable equity securities (together, the “investment portfolio”), investments in the time deposits of other banks, surplus interest earning balances in our Federal Reserve Bank account, and overnight fed funds sold. The Company’s investments can serve several purposes, including the following: 1) they can provide liquidity for potential funding needs; 2) they provide a source of pledged assets for securing public deposits, bankruptcy deposits and certain borrowed funds which require collateral; 3) they constitute a large base of assets with structural characteristics that can be changed more readily than loan or deposit portfolios, as might be required for interest rate risk management purposes; 4) they are another interest earning option for the placement of surplus funds when loan demand is light; and 5) they can provide partially tax exempt income. The investment portfolio is reflected on the balance sheet as investment securities and totaled $1.03 billion, or 30% of total assets at March 31, 2022, and $973.3 million, or 29% of total assets at December 31, 2021. In addition, within the Cash and Due from Banks account on the balance sheet was $186.4 million of surplus interest earning balances in our Federal Reserve Bank account at March 31, 2022, as compared to $193.2 million at December 31, 2021. Surplus balances in our Federal Reserve Bank account and fed funds sold to correspondent banks typically represent the temporary investment of excess liquidity. The Company carries investments at their fair market values. We currently have the intent and ability to hold our investment securities to maturity, but the securities are all marketable and are classified as “available for sale” to allow maximum flexibility with regard to interest rate risk and liquidity management. The expected average duration was 3.0 years at March 31, 2022, as compared to an average effective duration of 3.2 years at year-end 2021. 46 Table of Contents The following table sets forth the amortized cost and fair market value of Company’s investment portfolio by investment type as of the dates noted: Investment Portfolio (dollars in thousands, unaudited) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ March 31, 2022 ​ December 31, 2021 ​ ​ Amortized ​ Fair Market ​ Amortized ​ Fair Market ​ Cost Value Cost Value Available for Sale ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ U.S. government agencies $ 9,695 $ 9,437 $ 1,546 ​ $ 1,574 Mortgage-backed securities ​ ​ 304,904 ​ ​ 293,418 ​ ​ 303,912 ​ ​ 306,727 State and political subdivisions ​ ​ 294,077 ​ ​ 286,380 ​ ​ 290,729 ​ ​ 304,268 Corporate bonds ​ ​ 44,755 ​ ​ 43,359 ​ ​ 28,436 ​ ​ 28,529 Collateralized loan obligations ​ ​ 396,741 ​ ​ 392,438 ​ ​ 332,836 ​ ​ 332,216 Total securities ​ $ 1,050,172 ​ $ 1,025,032 ​ $ 957,459 ​ $ 973,314 ​ The net unrealized loss on our investment portfolio, or the amount by which amortized cost exceeded aggregate fair market values, was $25.1 million at March 31, 2022, a $41.0 million swing relative to the net unrealized gain of $15.9 million at December 31, 2021. The change was caused by increased long-term market interest rates on fixed-rate bond values. Since the declines in market values were primarily attributable to changes in interest rates and volatility in the financial markets and not a result of an expected credit loss, no allowance for credit losses was recorded as of March 31, 2022. Municipal bond balances comprise 28% of our total securities portfolio (fair value) at March 31, 2022, and 31% at December 31, 2021. Municipal bonds purchased have strong underlying ratings, and we review all municipal bonds in our portfolio every quarter for potential impairment. The corporate bonds purchased in the first three months 2022 and throughout 2021 are exclusively subordinated debentures of bank holding companies. These bonds were subject to a credit review by the credit administration department prior to their purchase and are subject to quarterly potential impairment reviews. The purchases of collateralized loan obligations (“CLOs”) are exclusively AAA and AA rated tranches. Each purchase is subject to a credit, concentration, and structure review by the credit administration department prior to their purchase and are subject to quarterly potential impairment reviews. The AAA and AA-rated CLO purchases were primarily a balance sheet diversification strategy to utilize available liquidity without adding duration. In addition to providing asset class diversification given the high level of real estate backed earning assets on the balance sheet, these floating rate CLOs are more asset sensitive which complements the longer-term fixed-rate earning assets. Investment securities that were pledged as collateral for borrowings and/or potential borrowings from the Federal Home Loan Bank and the Federal Reserve Bank, customer repurchase agreements, and other purposes as required or permitted by law totaled $160.7 million at March 31, 2022 and $167.2 million at December 31, 2021, leaving $864.3 million in unpledged debt securities at March 31, 2022 and $806.1 million at December 31, 2021. Securities that were pledged in excess of actual pledging needs and were thus available for liquidity purposes, if needed, totaled $40.4 million at March 31, 2022 and $47.0 million at December 31, 2021. ​ LOAN AND LEASE PORTFOLIO A distribution of the Company’s loans showing the balance and percentage of loans by type is presented for the noted periods in the table below. The balances in the table are before deferred or unamortized loan origination, extension, or commitment fees, and deferred origination costs. While not reflected in the loan totals and not currently comprising a 47 Table of Contents material segment of our lending activities, the Company also occasionally originates and sells, or participates out portions of, loans to non-affiliated investors. Loan and Lease Distribution (dollars in thousands, unaudited) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ March 31, 2022 December 31, 2021 ​ ​ Amount ​ Percent ​ Amount ​ Percent Real estate: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ 1-4 family residential construction ​ $ 8,800 ​ 0.45% ​ $ 21,369 ​ 1.08% Other construction/land ​ ​ 24,532 ​ 1.25% ​ ​ 25,299 ​ 1.28% 1-4 family - closed-end ​ ​ 399,852 ​ 20.40% ​ ​ 289,457 ​ 14.65% Equity lines ​ ​ 23,690 ​ 1.21% ​ ​ 26,588 ​ 1.35% Multi-family residential ​ ​ 59,632 ​ 3.04% ​ ​ 53,458 ​ 2.71% Commercial real estate - owner occupied ​ ​ 331,800 ​ 16.93% ​ ​ 334,446 ​ 16.93% Commercial real estate - non-owner occupied ​ ​ 854,504 ​ 43.61% ​ ​ 882,888 ​ 44.69% Farmland ​ ​ 98,925 ​ 5.05% ​ ​ 106,706 ​ 5.40% Total real estate ​ ​ 1,801,735 ​ 91.94% ​ ​ 1,740,211 ​ 88.09% Agricultural ​ ​ 31,761 ​ 1.62% ​ ​ 33,990 ​ 1.72% Commercial and industrial ​ ​ 87,132 ​ 4.45% ​ ​ 109,791 ​ 5.56% Mortgage warehouse lines ​ ​ 57,178 ​ 2.92% ​ ​ 101,184 ​ 5.12% Consumer loans ​ ​ 4,325 ​ 0.22% ​ ​ 4,550 ​ 0.23% Total loans and leases ​ ​ 1,982,131 ​ 101.15% ​ ​ 1,989,726 ​ 100.72% Allowance for credit losses on loans ​ ​ (22,530) ​ (1.15)% ​ ​ (14,256) ​ (0.72)% Total loans and leases, net ​ $ 1,959,601 ​ 100.00% ​ $ 1,975,470 ​ 100.00% ​ Gross loans and leases at $2.0 billion, remained relatively flat during the first quarter of 2022 with an overall 0.3% change. The net change did have some offsetting components with the larger fluctuations being a $44.0 million decline on mortgage warehouse line utilization. There was also a $25.8 million decrease in non-owner occupied commercial real estate, and a $16.8 million of decrease in Small Business Administration’s Paycheck Protection Program (“PPP”) loans. These declines were mostly offset by a $109.4 million increase in 1-4 family mortgage loans due to purchases of high-quality jumbo mortgage loans designed as a bridge to organic loan growth as the Bank’s core pipeline continues to improve with the recent hiring of loan teams which will further diversify the loan portfolio by specializing in various categories of agricultural real estate and agricultural production loans. The Company’s regulatory commercial real estate concentration ratio decreased to 234% at March 31, 2022 as compared to 248% at December 31, 2021. Regarding line utilization, unused commitments, excluding mortgage warehouse and consumer overdraft lines, were $224.4 million at March 31, 2022, compared to $242.3 million at December 31, 2021. Total utilization excluding mortgage warehouse and consumer overdraft lines was 61% at March 31, 2022, compared to 61% at December 31, 2021. Mortgage warehouse utilization was 16% at March 31, 2022, as compared to 28% at December 31, 2021. Utilization of mortgage warehouse lines in the future could be impacted by fluctuations in interest rates, seasonality, and other factors affecting home purchasing or refinancing demand including economic uncertainty. As expected, PPP loans continue to decline as borrowers receive forgiveness on these loans. There were 160 loans for $15.0 million outstanding at March 31, 2022, compared to 438 loans for $31.8 million at December 31, 2021. ​ 48 Table of Contents NONPERFORMING ASSETS Nonperforming assets are comprised of loans for which the Company is no longer accruing interest, in addition to foreclosed assets which is primarily OREO, but can include other foreclosed assets. If the Company grants a concession to a borrower in financial difficulty, the loan falls into the category of a TDR, unless the modification was granted under section 4013 of the CARES Act or the April 7, 2020 Interagency Statement. TDRs may be classified as either nonperforming or performing loans depending on their underlying characteristics and circumstances. The following table presents comparative data for the Company’s nonperforming assets and performing TDRs as of the dates noted: Nonperforming assets and performing troubled debt restructurings (dollars in thousands, unaudited) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ March 31, 2022 December 31, 2021 March 31, 2021 NON-ACCRUAL LOANS: ​ ​ ​ ​ ​ ​ ​ ​ ​ Real estate: ​ ​ ​ ​ ​ ​ ​ ​ ​ 1-4 family - closed-end ​ ​ 1,713 ​ ​ 1,023 ​ ​ 1,530 Equity lines ​ ​ 845 ​ ​ 892 ​ ​ 2,176 Commercial real estate - owner occupied ​ ​ 399 ​ ​ 1,234 ​ ​ 1,574 Commercial real estate - non-owner occupied ​ ​ — ​ ​ — ​ ​ 563 Farmland ​ ​ 18,449 ​ ​ — ​ ​ 434 TOTAL REAL ESTATE ​ ​ 21,406 ​ ​ 3,149 ​ ​ 6,277 Agriculture ​ ​ 8,110 ​ ​ 378 ​ ​ 466 Commercial and industrial ​ ​ 912 ​ ​ 973 ​ ​ 1,835 Consumer loans ​ ​ 18 ​ ​ 22 ​ ​ 21 TOTAL NONPERFORMING LOANS ​ ​ 30,446 ​ ​ 4,522 ​ ​ 8,599 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Foreclosed assets ​ ​ 93 ​ ​ 93 ​ ​ 945 Total nonperforming assets ​ $ 30,539 ​ $ 4,615 ​ $ 9,544 Performing TDRs (1) ​ $ 4,568 ​ $ 4,910 ​ $ 10,596 Nonperforming loans as a % of total gross loans and leases ​ ​ 1.54% ​ ​ 0.23% ​ ​ 0.38% Nonperforming assets as a % of total gross loans and leases and foreclosed assets ​ ​ 1.54% ​ ​ 0.23% ​ ​ 0.42% (1) Performing TDRs are not included in nonperforming loans above, nor are they included in the numerators used to calculate the ratios disclosed in this table. ​ Total nonperforming assets increased by $25.9 million, to $30.6 million during the first three months of 2022, primarily as a result of one relationship in the dairy industry consisting of four separate loans. These loans were written down by $1.96 million in the first quarter of 2022 and no further allowance for credit losses was deemed necessary on these loans. The Company's ratio of nonperforming loans to gross loans increased to 1.54% at March 31, 2022 from 0.23% at December 31, 2021; due primarily to the loan relationship downgrade previously mentioned. All of the Company's nonperforming assets are periodically reviewed and are either well-reserved based on current loss expectations or are carried at the fair value of the underlying collateral, net of expected disposition costs. As shown in the table, we also had $4.6 million in loans classified as performing TDRs on which we were still accruing interest as of March 31, 2022, a decrease of $0.3 million, or 7%, relative to December 31, 2021. Foreclosed assets had a carrying value of $0.1 million at March 31, 2022 and December 31, 2021 comprised of one property classified as OREO. All foreclosed assets are periodically evaluated and written down to their fair value less expected disposition costs, if lower than the then-current carrying value. 49 Table of Contents An action plan is in place for each of our non-accruing loans and foreclosed assets and they are all being actively managed. Collection efforts are continuously pursued for all nonperforming loans, but we cannot provide assurance that they will be resolved in a timely manner or that nonperforming balances will not increase. The Company had $3.0 million in loans past due 30-59 days at March 31, 2022. This is an increase of $0.8 million over the balance at December 31, 2021. All of these past due loans are under management supervision and every effort is being taken to assist the borrowers and manage credit risk in this regard. As described above, the Company provided loan modifications to certain customers and took advantage of either Section 4013 of the CARES Act or the April 7, 2020 Interagency Statement, which provides that such modifications do not result in treatment of such loan as a TDR. Since April 2020, the Company modified approximately $426 million of its loans under this guidance. For the Company, these modifications typically provided a deferral of both principal and interest for 180 days. Interest continues to accrue during the deferral period. At the end of the deferral period, for term loans, payments will be applied to accrued interest first and after the accrued interest is paid in full, the loan will be re-amortized with the maturity extended. For lines of credit, the borrower must repay the accrued interest at the end of the deferral period or take out a second credit facility to repay the accrued interest. As of March 31, 2022, there were no loans remaining on deferral with the Company. ALLOWANCE FOR CREDIT LOSSES – LOANS AND LEASES RECEIVABLE The allowance for credit losses on loans and leases, a contra-asset, is established through periodic provisions for credit losses on loans and leases. It is maintained at a level that is considered adequate to measure expected losses on individually identified loans, as well as expected losses inherent in the remaining loan portfolio. Specifically identifiable and quantifiable losses are immediately charged off against the allowance; recoveries are generally recorded only when sufficient cash payments are received subsequent to the charge off. After deferring implementation of the CECL accounting method under Financial Accounting Standards Board (FASB) Accounting Standards Update 2016-03 and related amendments, Financial Instruments – Credit Losses (Topic 326) under section 4014 of the CARES Act, the Company implemented CECL on January 1, 2022 . Upon implementation the Company recorded a $10.4 million increase in the allowance for credit losses, which included a $0.9 million reserve for unfunded commitments as an adjustment to equity, net of deferred taxes. The Company's allowance for credit losses on loans and leases was $22.5 million at March 31, 2022, as compared to $14.3 million at December 31, 2021, and $18.3 million at March 31, 2021. The $8.3 million increase in the allowance for credit losses on loan and leases during the first quarter of 2022 is due to a $9.5 million one-time adjustment from the implementation of CECL on January 1, 2022, a $0.6 million provision for credit losses on loan and leases, and net loan charge-offs of $1.8 million. The allowance was 1.14% of total loans at March 31, 2022, 0.72% of total loans at December 31, 2021, and 0.80% of total loans at March 31, 2021. Management's detailed analysis indicates that the Company's allowance for credit losses on loan and leases should be sufficient to cover credit losses for the life of the loan and leases outstanding as of March 31, 2022, but no assurance can be given that the Company will not experience substantial future losses relative to the size of the loan and lease loss allowance. A separate allowance of $1.0 million for potential credit losses inherent in unused commitments is included in other liabilities at March 31, 2022, as compared to $0.2 million at December 31, 2021. As mentioned previously a $0.9 million one-time adjustment was recorded to the reserve for unfunded commitments on January 1, 2022 upon the implementation of CECL. ​ ​ 50 Table of Contents The following table summarizes activity in the credit allowance for losses on loans and leases for the noted periods: Allowance for Credit Losses on Loans and Leases (dollars in thousands, unaudited) ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ For the three months ended ​ For the three months ended ​ For the year ended ​ March 31, March 31, December 31, Balances: ​ 2022 ​ 2021 ​ 2021 Average gross loans and leases outstanding during period (1) ​ $ 1,951,695 ​ $ 2,367,043 ​ $ 2,169,582 Gross loans and leases outstanding at end of period ​ $ 1,983,331 ​ $ 2,288,468 ​ $ 1,989,726 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Allowance for credit losses on loans and leases: ​ ​ ​ ​ ​ ​ ​ ​ ​ Balance at beginning of period ​ $ 14,256 ​ $ 17,738 ​ $ 17,738 Adoption of ASC 326 ​ ​ 9,454 ​ ​ — ​ ​ — Provision charged to expense ​ ​ 600 ​ ​ 250 ​ ​ (3,650) Charge-offs ​ ​ ​ ​ ​ ​ ​ ​ ​ Real estate ​ ​ ​ ​ ​ ​ ​ ​ ​ 1-4 family residential construction ​ ​ — ​ ​ — ​ ​ — Other construction/land ​ ​ — ​ ​ — ​ ​ — 1-4 family - closed-end ​ ​ — ​ ​ — ​ ​ — Equity lines ​ ​ — ​ ​ — ​ ​ 12 Multi-family residential ​ ​ — ​ ​ — ​ ​ — Commercial real estate- owner occupied ​ ​ — ​ ​ 233 ​ ​ 233 Commercial real estate- non-owner occupied ​ ​ — ​ ​ — ​ ​ — Farmland ​ ​ 1,958 ​ ​ — ​ ​ — Total real estate ​ ​ 1,958 ​ ​ 233 ​ ​ 245 Agricultural ​ ​ — ​ ​ — ​ ​ 50 Commercial and industrial ​ ​ 74 ​ ​ 52 ​ ​ 159 Consumer loans ​ ​ 299 ​ ​ 163 ​ ​ 946 Total ​ $ 2,331 ​ $ 448 ​ $ 1,400 Recoveries ​ ​ ​ ​ ​ ​ ​ ​ ​ Real estate ​ ​ ​ ​ ​ ​ ​ ​ ​ 1-4 family residential construction ​ ​ — ​ ​ — ​ ​ — Other construction/land ​ ​ 260 ​ ​ 218 ​ ​ 328 1-4 family - closed-end ​ ​ 87 ​ ​ 3 ​ ​ (67) Equity lines ​ ​ — ​ ​ — ​ ​ 25 Multi-family residential ​ ​ — ​ ​ — ​ ​ — Commercial real estate- owner occupied ​ ​ — ​ ​ 233 ​ ​ 233 Commercial real estate- non-owner occupied ​ ​ — ​ ​ — ​ ​ 82 Farmland ​ ​ — ​ ​ — ​ ​ — Total real estate ​ ​ 347 ​ ​ 454 ​ ​ 601 Agricultural ​ ​ — ​ ​ — ​ ​ — Commercial and industrial ​ ​ 20 ​ ​ 110 ​ ​ 223 Consumer loans ​ ​ 184 ​ ​ 215 ​ ​ 744 Total ​ $ 551 ​ $ 779 ​ $ 1,568 Net loan charge offs (recoveries) ​ $ 1,780 ​ $ (331) ​ $ (168) Balance at end of period ​ $ 22,530 ​ $ 18,319 ​ $ 14,256 ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ RATIOS ​ ​ ​ ​ ​ ​ ​ ​ ​ Net charge-offs (recoveries) to average loans and leases (annualized) ​ ​ 0.37% ​ ​ (0.06)% ​ ​ (0.01)% Allowance for credit losses on loans and leases to gross loans and leases at end of period ​ ​ 1.14% ​ ​ 0.80% ​ ​ 0.72% Allowance for credit losses on loans and leases to nonperforming loans ​ ​ 74.00% ​ ​ 213.04% ​ ​ 315.26% Net loan charge-offs (recoveries) to allowance for credit losses on loans and leases at end of period ​ ​ 7.90% ​ ​ (1.81)% ​ ​ (1.18)% Net loan charge-offs (recoveries) to provision for credit losses on loans and leases ​ ​ 296.67% ​ ​ (132.40)% ​ ​ 4.60% ​ (1) Average balances are obtained from the best available daily or monthly data and are net of deferred fees and related direct costs. The Company’s credit allowance for losses on loans and leases at March 31, 2022 represents Management’s best estimate of expected losses in the loan portfolio as of that date, but no assurance can be given that the Company will not experience substantial losses relative to the size of the allowance. Furthermore, fluctuations in credit quality, changes in economic conditions, updated accounting or regulatory requirements, and/or other factors could induce us to augment or reduce the allowance. 51 Table of Contents OFF-BALANCE SHEET ARRANGEMENTS The Company maintains commitments to extend credit in the normal course of business, as long as there are no violations of conditions established in the outstanding contractual arrangements. It is unlikely that all unused commitments will ultimately be drawn down. Unused commitments to extend credit, which included standby letters of credit, totaled $582 million at March 31, 2022 and $561 million at December 31, 2021, representing approximately 29% of gross loans outstanding at March 31, 2022 and 28% at December 31, 2021. The decrease in unused commitments is due in large part to the decrease in loan balances with unfunded commitments. The Company also had undrawn letters of credit issued to customers totaling $3.6 million at March 31, 2022 and December 31, 2021. The effect on the Company’s revenues, expenses, cash flows and liquidity from the unused portion of commitments to provide credit cannot be reasonably predicted because there is no guarantee that the lines of credit will ever be used. However, the “Liquidity” section in this Form 10-Q outlines resources available to draw upon should we be required to fund a significant portion of unused commitments. In addition to unused commitments to provide credit, the Company is utilizing a $125 million letter of credit issued by the Federal Home Loan Bank on the Company’s behalf as security for certain local agency deposits which totaled $78.3 million at March 31, 2022. That letter of credit is backed by loans that are pledged to the FHLB by the Company. For more information on the Company’s off-balance sheet arrangements, see Note 7 to the consolidated financial statements located elsewhere herein. OTHER ASSETS Interest earning cash balances were discussed above in the “Investments” section, but the Company also maintains a certain level of cash on hand in the normal course of business as well as non-earning deposits at other financial institutions. Our balance of cash and due from banks depends on the timing of collection of outstanding cash items (checks), the amount of cash held at our branches, and our reserve requirement among other things, and it is subject to significant fluctuations in the normal course of business. While cash flows are normally predictable within limits, those limits are fairly broad and the Company manages its short-term cash position through the utilization of overnight loans to, and borrowings from, correspondent banks, including the Federal Reserve Bank and the Federal Home Loan Bank. Should a large “short” overnight position persist for any length of time, the Company typically raises money through focused retail deposit gathering efforts or by adding brokered time deposits. If a “long” position is prevalent, we could let brokered deposits or other wholesale borrowings roll off as they mature, or we might invest excess liquidity into investments or loans, subject to the bank’s risk tolerances. The Company’s balance of non-earning cash and due from banks was $66.0 million at March 31, 2022 relative to $63.1 million at December 31, 2021. Foreclosed assets are discussed above in the section titled “Nonperforming Assets.” Net premises and equipment decreased by $0.3 million during the first three months of 2022, to $23.2 million. This decline was primarily a result of normal depreciation during the quarter net of new purchases. Goodwill was $27.4 million at March 31, 2022, unchanged during the first three months of 2022. Goodwill is tested for impairment annually, unless events and circumstances exist which indicate that an impairment test should be performed. A Goodwill impairment test was last performed during the fourth quarter 2021 and determined that no impairment existed. There have been no triggering events in the first three months of 2022 that would require the Company to perform a Goodwill impairment test, however the Company will continue to monitor its Goodwill for potential impairment. Bank-owned life insurance, with a balance of $53.6 million at March 31, 2022, is discussed in detail above in the “Noninterest Income and Noninterest Expense” section. 52 Table of Contents DEPOSITS AND INTEREST BEARING LIABILITIES DEPOSITS Deposits represent another key balance sheet category impacting the Company’s net interest income and profitability metrics. Deposits provide liquidity to fund growth in earning assets, and the Company’s net interest margin is improved to the extent that growth in deposits is concentrated in less volatile and typically less costly non-maturity accounts such as demand deposit accounts, NOW accounts, savings accounts, and money market demand accounts. Information concerning average balances and rates paid by deposit type is included in the Average Balances and Rates tables appearing above, in the section titled “Net Interest Income and Net Interest Margin.” A distribution of the Company’s deposits by type, showing the period-end balance and percentage of total deposits, is presented as of the dates indicated in the following table. Deposit Distribution (dollars in thousands, unaudited) ​ ​ ​ ​ ​ ​ ​ ​ ​ March 31, 2022 December 31, 2021 Noninterest bearing demand deposits ​ $ 1,104,691 ​ $ 1,084,544 Interest bearing demand deposits ​ ​ 228,885 ​ ​ 129,783 NOW ​ ​ 547,572 ​ ​ 614,770 Savings ​ ​ 480,178 ​ ​ 450,785 Money market ​ ​ 149,918 ​ ​ 147,793 Time ​ ​ 293,699 ​ ​ 293,897 Brokered deposits ​ ​ 60,000 ​ ​ 60,000 Total deposits ​ $ 2,864,943 ​ $ 2,781,572 ​ ​ ​ ​ ​ ​ ​ Percentage of Total Deposits ​ ​ ​ ​ ​ ​ Noninterest bearing demand deposits ​ ​ 38.57% ​ ​ 38.99% Interest bearing demand deposits ​ ​ 7.99% ​ ​ 4.67% NOW ​ ​ 19.11% ​ ​ 22.10% Savings ​ ​ 16.76% ​ ​ 16.21% Money market ​ ​ 5.23% ​ ​ 5.31% Time ​ ​ 10.25% ​ ​ 10.57% Brokered deposits ​ ​ 2.09% ​ ​ 2.16% Total ​ ​ 100.00% ​ ​ 100.00% ​ Deposit balances reflect net growth of $83.4 million, or 3%, during the first three months of 2022. Time deposits were $293.7 million at March 31, 2022 as compared to $293.9 million at December 31, 2021. Brokered deposits were unchanged at $60.0 million at March 31, 2022 from December 31, 2021. Non-maturity deposit growth of $83.6 million for the first three months of 2022 was primarily the result of increases in balances of existing customers as the total number of customers was relatively unchanged. Management is of the opinion that a relatively high level of core customer deposits is one of the Company’s key strengths, and we continue to strive for core deposit retention and growth. In particular, the Company’s ratio of noninterest-bearing deposits to total deposits was 38.6% at March 31, 2022 as compared to 39.0% at December 31, 2021. OTHER INTEREST-BEARING LIABILITIES The Company’s non-deposit borrowings may, at any given time, include fed funds purchased from correspondent banks, borrowings from the Federal Home Loan Bank, advances from the Federal Reserve Bank, securities sold under agreements to repurchase, and/or junior subordinated debentures. The Company uses short-term FHLB advances and fed funds purchased on uncommitted lines to support liquidity needs created by seasonal deposit flows, to temporarily 53 Table of Contents satisfy funding needs from increased loan demand, and for other short-term purposes. The FHLB line is committed, but the amount of available credit depends on the level of pledged collateral. Total non-deposit interest-bearing liabilities increased by $0.9 million, during the first three months of 2022 primarily due to an increase in customer repurchase agreements. Repurchase agreements totaled $107.8 million at March 31,2022 relative to a balance of $106.9 million at year-end 2021. Repurchase agreements represent “sweep accounts”, where certain customers have elected to have their commercial deposit balances above a specified threshold transferred at the close of each business day into non-deposit investments accounts. The balance in the investment account is used to have the customer purchase securities or a perfected interest in specifically identified pledged securities from the bank, which are then repurchased by the bank from the customer the next business day. The Company had Long term debt totaling $49.2 million and $49.1 million at March 31, 2022 and December 31, 2021, respectively, in the form of 3.25% fixed – floating subordinated debt with a ten-year maturity and junior subordinated debentures totaling $35.3 million at both March 31, 2022 and December 31, 2021, in the form of long-term borrowings from trust subsidiaries formed specifically to issue trust preferred securities. OTHER NONINTEREST BEARING LIABILITIES Other liabilities are principally comprised of operating lease right-of-use liabilities, accrued interest payable, other accrued but unpaid expenses, and certain clearing amounts. The Company’s balance of other liabilities was $36.0 million at March 31, 2022 as compared to $35.6 million at December 31, 2021. LIQUIDITY AND MARKET RISK MANAGEMENT LIQUIDITY Liquidity management refers to the Company’s ability to maintain cash flows that are adequate to fund operations and meet other obligations and commitments in a timely and cost-effective manner. Detailed cash flow projections are reviewed by Management on a monthly basis, with various stress scenarios applied to assess our ability to meet liquidity needs under unusual or adverse conditions. Liquidity ratios are also calculated and reviewed on a regular basis. While those ratios are merely indicators and are not measures of actual liquidity, they are closely monitored, and we are committed to maintaining adequate liquidity resources to draw upon should unexpected needs arise. The Company, on occasion, experiences cash needs as the result of loan growth, deposit outflows, asset purchases or liability repayments. To meet these short-term needs, we can borrow overnight funds from other financial institutions, draw advances via Federal Home Loan Bank lines of credit, or solicit brokered deposits if customer deposits are not immediately obtainable from local sources. At March 31, 2022 and December 31, 2021, the Company had the following sources of primary and secondary liquidity (dollars in thousands): ​ ​ ​ ​ ​ ​ ​ Primary and secondary liquidity sources ​ ​ March 31, 2022 ​ ​ December 31, 2021 Cash and cash equivalents ​ $ 253,534 ​ $ 257,528 Unpledged investment securities ​ ​ 861,857 ​ ​ 806,132 Excess pledged securities ​ ​ 40,403 ​ ​ 47,024 FHLB borrowing availability ​ ​ 748,101 ​ ​ 787,519 Unsecured lines of credit ​ ​ 305,000 ​ ​ 305,000 Funds available through fed discount window ​ ​ 44,587 ​ ​ 50,608 Totals ​ $ 2,253,482 ​ $ 2,253,811 ​ In addition to the above sources, the Company could obtain brokered deposits, obtain deposits via deposit listing services, or offer higher rate time deposits within our market. ​ 54 Table of Contents Cash and cash equivalents during the first three months of 2022, declined $4.0 million due to increases in investment securities. Utilization of remaining excess liquidity is expected to come from a combination of new loans, including loan purchases, and new investment purchases. In addition, it is possible that a portion of the deposits built-up during the COVID-19 pandemic could be withdrawn by customers. When looking to reduce these low-yielding cash balances with earning assets, management considers interest rate risk, including duration and extension risk; credit risk; and the liquidity risk of such alternative assets. ​ The Company performs regular stress tests on its liquidity and at this time, believes that we have sufficient primary and secondary liquidity sources for operations. ​ The Company has a higher level of actual balance sheet liquidity than might otherwise be the case, since we utilize a letter of credit from the FHLB rather than investment securities for certain pledging requirements. That letter of credit, which is backed by loans pledged to the FHLB by the Company, totaled $125 million at March 31, 2022 and December 31, 2021. Other sources of liquidity include the brokered deposit market, deposit listing services, and the ability to offer local time-deposit campaigns. Management is of the opinion that available investments and other potentially liquid assets, along with standby funding sources it has arranged, are more than sufficient to meet the Company’s current and anticipated short-term liquidity needs and that its liquidity has not been adversely impacted by COVID-19. The Company’s primary liquidity ratio and net loans to deposits were 40.43% and 69.19%, respectively, at March 31, 2022, as compared to internal policy guidelines of “greater than 15%” and “less than 95%.” Ratios and sub-limits for the various components comprising wholesale funding, which were all well within policy guidelines at March 31, 2022, are also periodically reviewed by Management and the Board. The Company has been able to maintain a robust liquidity position in recent periods, but no assurance can be provided that our liquidity position will continue at current strong levels. The holding company’s primary uses of funds include operating expenses incurred in the normal course of business, interest on trust preferred securities and subordinated debt, shareholder dividends, and share repurchases. Its primary source of funds is dividends from the Bank since the holding company does not conduct regular banking operations. As of March 31, 2022, the holding company maintained a cash balance of $11.6 million. Management anticipates that the holding company has sufficient liquidity to meet its funding requirements for the foreseeable future. Both the holding company and the Bank are subject to legal and regulatory limitations on dividend payments, as outlined in Item 5(c) Dividends in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021 which was filed with the SEC. INTEREST RATE RISK MANAGEMENT Market risk arises from changes in interest rates, exchange rates, commodity prices and equity prices. The Company does not engage in the trading of financial instruments, nor does it have exposure to currency exchange rates. Our market risk exposure is primarily that of interest rate risk, and we have established policies and procedures to monitor and limit our earnings and balance sheet exposure to changes in interest rates. The principal objective of interest rate risk management is to manage the financial components of the Company’s balance sheet in a manner that will optimize the risk/reward equation for earnings and capital under a variety of interest rate scenarios. To identify areas of potential exposure to interest rate changes, we utilize commercially available modeling software to perform monthly earnings simulations and calculate the Company’s market value of portfolio equity under varying interest rate scenarios. The model imports relevant information for the Company’s financial instruments and incorporates Management’s assumptions on pricing, duration, and optionality for anticipated new volumes. Various rate scenarios consisting of key rate and yield curve projections are then applied in order to calculate the expected effect of a given interest rate change on interest income, interest expense, and the value of the Company’s financial instruments. The rate projections can be shocked (an immediate and parallel change in all base rates, up or down), ramped (an incremental increase or decrease in rates over a specified time period), economic (based on current trends and econometric models) or stable (unchanged from current actual levels). 55 Table of Contents In addition to a stable rate scenario, which presumes that there are no changes in interest rates, we typically use at least eight other interest rate scenarios in conducting our rolling 12-month net interest income simulations: upward shocks of 100, 200, 300, and 400 basis points, and downward shocks of 100, 200, and 300 basis points. Those scenarios may be supplemented, reduced in number, or otherwise adjusted as determined by Management to provide the most meaningful simulations considering economic conditions and expectations at the time. Given the current near zero interest rate environment it is unlikely that rates could decline much further beyond the downward shock of 100 basis points, therefore the downward shock scenarios of 200, 300, and 400 basis points are temporarily being suspended after concurrence by the Company’s Board of Directors. Pursuant to policy guidelines, we generally attempt to limit the projected decline in net interest income relative to the stable rate scenario to no more than 5% for a 100 basis point (bp) interest rate shock, 10% for a 200 bp shock, 15% for a 300 bp shock, and 20% for a 400 bp shock. ​ The Company had the following estimated net interest income sensitivity profiles over one-year, without factoring in any potential negative impact on spreads resulting from competitive pressures or credit quality deterioration: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ March 31, 2022 ​ March 31, 2021 Immediate change in Interest Rates (basis points) ​ % Change in Net Interest Income ​ $ Change in Net Interest Income ​ % Change in Net Interest Income ​ $ Change in Net Interest Income +400 ​ ​ 13.3% ​ $ 14,321 ​ ​ 7.2% ​ $ 7,726 +300 ​ ​ 10.9% ​ $ 11,684 ​ ​ 5.7% ​ $ 6,137 +200 ​ ​ 8.1% ​ $ 8,712 ​ ​ 4.4% ​ $ 4,741 +100 ​ ​ 4.3% ​ $ 4,624 ​ ​ 2.8% ​ $ 2,991 Base ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ -100 ​ ​ (9.2)% ​ $ (9,892) ​ ​ (7.6)% ​ $ (8,181) ​ For the periods ending March 31, 2022 and March 31, 2021, management believes that the Company was asset sensitive, with net income increasing in a rising rate environment in all scenarios but declining considerably in the down shocks. The change in the magnitude of the Company’s asset sensitivity based on its interest rate risk model at March 31, 2022 as compared to March 31, 2021, is due primarily to the change in the structure of the balance sheet with the addition of $392.4 million in variable rate collateralized loan obligations and cash on hand of $253.5 million. In the up 400 basis point shock scenario, expected net interest income over the next twelve months increases $14.3 million, or 13%, to $122.05 million at March 31, 2022 compared to a 7.2% increase or $7.7 million for the same period in 2021. Over the next twelve months, $253.5 million in surplus cash is projected to decline due to expected core loan growth as our pipelines begin to increase with the addition of several loan teams and the opening of the Templeton LPO mentioned earlier. Further, a portion of the significant increase in deposits during the COVID-19 pandemic could be withdrawn by customers. These expected changes in earnings assets, including overnight cash, are not modeled in the immediate rate shock model described above. Although the cost of interest-bearing liabilities will also increase in a rate shock, the deposit betas utilized in the interest rate model mitigate the magnitude of a deposit rate increase. If there was an immediate downward adjustment, it is anticipated that interest income would decline. The reason for the drop in net interest income is because many deposit products are at or below their modeled floors of 0.15% or 0.20 % and cannot be re-priced lower, while non-floored interest earning assets such as loans and securities can theoretically still be re-priced lower in a falling rate environment. Due to the historically low current rate environment, we view any material interest rate reductions as unlikely in the near term. If there was an immediate downward adjustment of 100 basis points in interest rates, net interest income would drop $8.3 million or a negative variance of 8%. The reason for the drop in net interest income is, most deposit products are at their floors of 0.10% and cannot be re-priced lower, while non-floored interest earning assets such as loans and securities can theoretically still be re-priced lower in a falling rate environment. Due to the historically low current rate environment, we view any material interest rate reductions as unlikely in the near term. However, the potential percentage drop in net interest income in the “down 100 basis points” interest rate scenario exceeds our internal policy guidelines and we will continue to monitor our interest rate risk profile and implement remedial changes if deemed appropriate. ​ ​ ​ ​ ​ ​ ​ ​ In addition to the net interest income simulations shown above, we run stress scenarios for the unconsolidated Bank where we model the possibility of no balance sheet growth, the potential runoff of “surge” core deposits which flowed into the Bank in the most recent economic cycle, and unfavorable movement in deposit rates relative to yields on earning assets (i.e., higher deposit betas). When a static balance sheet and a stable interest rate environ­ment are assumed, projected annual net interest income is $8.1 million lower than in our standard simulation. The modeled economic value (or “fair value”) of financial instruments on the Company’s balance sheet will also vary under the interest rate scenarios previously discussed. The difference between the projected fair value of the Company’s financial assets and the fair value of its financial liabilities is referred to as the economic value of equity (“EVE”), and changes in EVE under different interest rate scenarios are effectively a gauge of the Company’s longer-term exposure to 56 Table of Contents interest rate fluctuations. Fair values for financial instruments are estimated by discounting projected cash flows (principal and interest) at anticipated replacement interest rates for each account type, while the fair value of non-financial accounts is assumed to equal their book value for all rate scenarios. An economic value simulation is a static measure utilizing balance sheet accounts at a given point in time, and the measurement can change sub­stantially over time, as is evident in the tables below for the periods ending March 31, 2022 and 2021, respectively, as the Company’s balance sheet evolves and interest rate and yield curve assumptions are updated. The change in economic value under different interest rate scenarios depends on the characteristics of each class of financial instrument, including stated interest rates or spreads relative to current or projected market-level interest rates or spreads, the likelihood of principal prepayments, whether contractual interest rates are fixed or floating, and the average remaining time to maturity. As a general rule, fixed-rate financial assets become more valuable in declining rate scenarios and less valuable in rising rate scenarios, while fixed-rate financial liabilities gain in value as interest rates rise and lose value as interest rates decline. The longer the duration of the financial instrument, the greater the impact a rate change will have on its value. In our economic value simulations, estimated prepayments are factored in for financial instruments with stated maturity dates, and decay rates for non-maturity deposits are projected based on historical patterns and Management’s best estimates. ​ Our EVE decreased in the past twelve months due to asset composition changes. The tables below show estimated changes in the Company’s EVE as modeled under different interest rate scenarios relative to a base case of current interest rates: ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ March 31, 2022 ​ March 31, 2021 Immediate change in Interest Rates (basis points) ​ % Change in Fair Value of Equity ​ $ Change in Fair Value of Equity ​ % Change in Fair Value of Equity ​ $ Change in Fair Value of Equity +400 ​ ​ 25.8% ​ $ 171,796 ​ ​ 31.5% ​ $ 174,274 +300 ​ ​ 22.8% ​ $ 151,682 ​ ​ 28.0% ​ $ 155,182 +200 ​ ​ 18.4% ​ $ 122,257 ​ ​ 22.8% ​ $ 126,402 +100 ​ ​ 11.0% ​ $ 72,882 ​ ​ 13.7% ​ $ 76,032 Base ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ -100 ​ ​ (20.2)% ​ $ (134,598) ​ ​ (20.1)% ​ $ (111,586) ​ ​ The table shows that our EVE is modeled to deteriorate in moderate declining rate scenarios but should benefit from a paral­lel shift upward in the yield curve. The rate of increase in EVE accelerates the higher interest rates rise. This increase in sensitivity is caused by the increase in gross deposits, namely, an increase in noninterest bearing deposits which become more valuable as interest rates rise. We also run stress scenarios for the unconsolidated Bank’s EVE to simulate the possibility of adverse movement in loan prepay­ment rates, unfavorable changes in deposit rates, and higher deposit decay rates. Model results are highly sensitive to changes in assumed decay rates for non-maturity deposits, in particular, with material unfavorable variances occurring relative to the standard simulations shown above as decay rates are increased. Furthermore, while not as extreme as the variances produced by increasing non-maturity deposit decay rates, EVE also displays a relatively high level of sensitivity to unfavorable changes in deposit rate betas in rising interest rate scenarios. CAPITAL RESOURCES The Company had total shareholders’ equity of $325.7 million at March 31, 2022, comprised of $111.7 million in common stock, $4.3 million in additional paid-in capital, $227.4 million in retained earnings, and accumulated other comprehensive loss of $17.7 million. At the end of 2021, total shareholders’ equity was $362.5 million. The decrease in equity during the first quarter of 2022 is due to net income of $7.4 million, offset by a $3.5 million dividend paid to shareholders, $4.9 million in share repurchases, a $28.9 million unfavorable swing in other comprehensive income/loss due principally to changes in investment securities' fair value and a $7.3 million decrease in retained earnings due to the cumulative effect of a change in accounting principal from the implementation of CECL, topic 326. The remaining difference is related to stock options exercised and restricted stock compensation recognized during the quarter. The Company approved a new share repurchase program (the 2021 Share Repurchase Plan) on October 21, 2021 and authorized one million shares to be repurchased under this plan. The previous 2003 Share Repurchase Plan was cancelled and the 268,301 shares remaining in that plan were incorporated into the 2021 Share Repurchase Plan. There 57 Table of Contents were 182,562 shares repurchased in the first quarter of 2022, with 630,000 shares remaining to be repurchased under the 2021 Share Repurchase Plan. The Company uses a variety of measures to evaluate its capital adequacy, including the leverage ratio which is calculated separately for the Company and the Bank. Management reviews these capital measurements on a quarterly basis and takes appropriate action to help ensure that they meet or surpass established internal and external guidelines. As permitted by the regulators for financial institutions that are not deemed to be “advanced approaches” institutions, the Company has elected to opt out of the Basel III requirement to include accumulated other comprehensive income in risk-based capital. The following table sets forth the Bank’s regulatory capital ratios as of the dates indicated. ​ Regulatory Capital Ratios ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ ​ Minimum ​ Minimum ​ ​ ​ ​ ​ ​ ​ Requirement ​ Required ​ ​ ​ March 31, ​ December 31, ​ to be ​ Community Bank ​ ​ 2022 2021 Well Capitalized (1) ​ Leverage Ratio (2) ​ Bank of the Sierra ​ ​ ​ ​ ​ ​ ​ ​ ​ Tier 1 Capital to Adjusted Average Assets ("Leverage Ratio") (3) ​ 11.65 % 11.31 % 5.00 % 9.00 % Sierra Bancorp ​ ​ ​ ​ ​ ​ ​ ​ ​ Tier 1 Capital to Adjusted Average Assets ("Leverage Ratio") (3) ​ 10.48 % 10.43 % 5.00 % N/A ​ (1) The Company was subject to these minimum requirements under the regulatory framework for Prompt Corrective Action at December 31, 2019. (2) If the subsidiary bank’s Leverage Ratio exceeds the minimum ratio under the Community Bank Leverage Ratio Framework, it is deemed to be “well capitalized” under all other regulatory capital requirements. The Company may revert back to the regulatory framework for Prompt Corrective Action if the subsidiary bank’s Leverage Ratio falls below the minimum under the Community Bank Leverage Ratio Framework. (3) The Company has elected to phase in the impact of implementing CECL on regulatory capital over a three-year period. ​ The federal banking agencies published a final rule on November 13, 2019, that provided a simplified measure of capital adequacy for qualifying community banking organizations. A qualifying community banking organization that opts into the community bank leverage ratio framework and maintains a leverage ratio greater than 9 percent will be considered to have met the minimum capital requirements, the capital ratio requirements for the well capitalized category under the Prompt Corrective Action framework, and any other capital or leverage requirements to which the qualifying banking organization is subject. A qualifying community banking organization with a leverage ratio of greater than 9 percent may opt into the community bank leverage ratio framework if has average consolidated total assets of less than $10 billion, has off-balance-sheet exposures of 25% or less of total consolidated assets, and has total trading assets and trading liabilities of 5 percent or less of total consolidated assets. Further, the bank must not be an advance approaches banking organization. The final rule became effective January 1, 2020 and banks that meet the qualifying criteria can elect to use the community bank leverage framework starting with the quarter ended March 31, 2020. The CARES Act reduced the required community bank leverage ratio to 8% until the earlier of December 31, 2020, or the national emergency is declared over. Beginning in 2021 the CBLR was increased to 8.5% for the calendar year with the CBLR increasing to 9% on January 1, 2022. The federal bank regulatory agencies adopted an interim final rule to implement this change from the CARES Act. At September 30, 2021, the Company and the Bank met the criteria outlined in the final rule and the interim final rule and elected to measure capital adequacy under the CBLR framework. ​ 58 Table of Contents PART I – FINANCIAL INFORMATION ITEM 3 QUALITATIVE & QUANTITATIVE DISCLOSURES ABOUT MARKET RISK The information concerning quantitative and qualitative disclosures about market risk is included in Part I, Item 2 above. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Market Risk Management.” PART I – FINANCIAL INFORMATION