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Item 2. Management’s Discussion and Analysis

2023-08-03 compared with 2023-05-05 · 297 added, 224 removed, 464 unchanged (53% of the section changed)

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They include, but are not limited to:

● risks associated with fluctuations in interest rates, including the impact on other comprehensive income (loss), the ability for customers to repay on floating or adjustable rates loans, and the impact on costs of funding and interest income on earning assets;

● risks associated with inflation (including efforts by the Federal Open Market Committee of the Federal Reserve Bank to control the same);

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● 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;

● reductions in the market value of available-for-sale securities that could result if interest rates increase, or an issuer has real or perceived financial difficulties;

● the impact of adverse developments at other banks, including bank failures, that impact general sentiment regarding the stability and liquidity of banks;

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● the Company’s ability to maintain a satisfactory rating under the Community Reinvestment Act;

● the risk to the Company’s operations and ability to serve customers due to the inability of a vendor to meet its service level agreements;

● the outcome of any existing or future legal action for which the Company or Bank is a defendant;

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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.

Critical accounting policies are those that involve the most complex and subjective decisions and assessments which 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:

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● 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;

● income taxes and related deferred tax assets and liabilities, regarding 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;

● 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.

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RESULTS OF OPERATIONS SUMMARY

First Quarter 2023 compared to First Quarter 2022

First quarter 2023 net income was $8.8 million, or $0.58 per diluted share, compared to $7.4 million, or $0.49 per diluted share in the first quarter of 2022.

The Company’s annualized return on average equity was 11.53% and annualized return on average assets was 0.97% for the quarter ended March 31, 2023, compared to 8.64% and 0.88%, respectively, for the same quarter in 2022.

Second Quarter 2023 compared to Second Quarter 2022

Second quarter 2023 net income was $9.9 million, or $0.67 per diluted share, an increase of $0.7 million, or 7.6%, as compared to $9.2 million, or $0.61 per diluted share in the second quarter of 2022.

The Company’s annualized return on average equity was 13.06% and annualized return on average assets was 1.07% for the quarter ended June 30, 2023, compared to 11.68% and 1.07%, respectively, for the same quarter in 2022.

The primary drivers behind the variance in first quarter net income are as follows:

● Net interest income increased $1.7 million or 7%.

This was due mostly to an $11.3 million increase in interest income partially offset by an $8.0 million increase in interest expense.

This was due to a $12.7 million increase in interest income partially offset by a $10.9 million increase in interest expense.

There was an increase in investment securities which contributed $10.0 million to the favorable interest income variance.

This increase in investments primarily consisted of floating rate collateralized loan obligations (CLOs), which contributed to $7.3 million or 57.5% of the interest income favorable variance, partially offset by an unfavorable increase in interest expense due to a shift of deposit balances into higher cost time certificates and an increase in borrowed funds.

● Noninterest income increased $0.5 million or 9% primarily due to $0.3 million gain on life insurance proceeds, $0.3 million in other foreclosed assets income, combined with favorable BOLI fluctuations associated with deferred compensation plans for $0.8 million.

The provision for credit losses at $0.3 million declined by $0.2 million, or 49% as a result of lower net loan charge-offs recognized in the first quarter of 2023.

● Total noninterest expense increased $2.8 million, or 14%, in the first quarter of 2023 as compared to the first quarter of 2022.

Salaries and benefits costs increased $1.0 million as we added new lending teams, and other noninterest expense increased $1.8 million mostly due to a $0.8 million increase in foreclosed asset expense, and a $0.5 million in directors deferred compensation expense, linked to favorable changes in BOLI income described above.

● Noninterest income decreased $2.4 million primarily from nonrecurring gains on the sale of other assets in the second quarter of 2022.

There was a benefit for credit losses of $0.1 million as compared to a $2.4 million provision for credit losses for the same period in 2022.

The benefit for the 2nd quarter of 2023 was comprised of a $.15 million benefit for credit losses on unfunded commitments and HTM securities offset by a $.1 million provision for credit losses on loans and leases.

The positive variance for the 2nd quarter of 2023 as compared to the same period in 2022 was primarily a result of lower net loan charge-offs recognized in the second quarter of 2023.

● Total noninterest expense increased $0.9 million, or 4%, in the second quarter of 2023 as compared to the second quarter of 2022.

Salaries and Benefits were $0.4 million, or 3%, higher in the second quarter of 2023 as compared to the second quarter of 2022 as we added new lending teams and certain management staff, and other noninterest expense increased $0.4 million due a $0.9 million increase in deferred compensation expense for directors, which is linked to $1.2 million in favorable changes in BOLI income.

There were also non-recurring increases in debit card processing and ATM network cost for the second quarter due to a branding change from Mastercard to Visa and the subsequent conversion costs related to that change.

Additionally, we incurred a $0.3 million loss from a 2017 event that is reflected in noninterest expense.

The unfavorable variances were partially offset by decreases in recruitment costs associated with new hires in 2022, decreased postage costs and other costs declined due to restitution payments made to customers in 2022 due to updated guidance from the Federal Deposit Insurance Corporation related to customers charged nonsufficient fund fees on represented items.

First Half 2023 compared to First Half 2022

Net income for the first half of 2023 was $18.7 million, or $1.26 per diluted share, compared to $16.6 million, or $1.10 per diluted share for the same period in 2022.

The Company’s annualized return on average equity was 12.30% and annualized return on average assets was 1.02% for the six months ended June 30, 2023, compared to a return on equity of 10.10% and return on assets of 0.98% for the six months ended June 30, 2022.

The primary drivers behind the variance in year-to-date net income are as follows:

● The provision for credit losses on loans and leases declined by $2.7 million to $0.2 million due to lower net charge-offs.

● Net interest income increased by $5.1 million, or 10%, due mostly to higher interest income on floating rate investments as well as both the average loan and investment balances increasing.

Partially offsetting the benefit from increased net interest income, the cost of interest-bearing liabilities increased due to time deposit balances and rates increasing, as well as higher balances of borrowed funds at increased borrowing rates.

● Noninterest income decreased $1.9 million, or 12%, for the same reasons as noted above in the quarterly comparison, combined with a $1.0 million gain on the sale of investment securities in 2022, partially offset by a $2.0 million positive variance in BOLI income tied to our nonqualified deferred compensation plan.

● Noninterest expense increased $3.7 million, or 9% for the same reasons as outlined in the quarterly comparison above;

however, there were also elevated foreclosed assets costs for the first half of 2023 of $0.7 million as compared to the same period in 2022, due to the foreclosure and then subsequent sale of one large credit in the first quarter of 2023.

FINANCIAL CONDITION SUMMARY

March 31, 2023 relative to December 31, 2022

The Company’s assets totaled $3.7 billion at March 31, 2023, an increase of $85.4 million, or 2% from December 31, 2022.

The following provides a summary of key balance sheet changes during the first three months of 2023:

● Investment securities increased by $101.8 million, or 8%, to $1.4 billion primarily due to strategic purchases of U.S.

government agency securities and CLOs.

● Gross loan balances declined by $19.0 million, due mostly to the foreclosure of $18.1 million of loans related to one dairy relationship in January 2023.

Further commercial real estate secured loans increased $8.7 million, and mortgage warehouse lines increased by $3.0 million.

June 30, 2023 relative to December 31, 2022

The Company’s assets totaled $3.8 billion at June 30, 2023, an increase of $153.9 million, or 4.3% from December 31, 2022.

The following provides a summary of key balance sheet changes during the first six months of 2023:

● Investment securities increased $84.2 million, or 7%, which consisted mostly of variable rate collateralized loan obligations.

● Gross loans increased $41.5 million, or 2% due mostly to a $45.2 million increase in mortgage warehouse utilization and an $18.6 million increase in commercial and industrial loans.

These increases were offset by a $25.4 million decrease in real estate loans.

Organic loan production for the first half of 2023 was $89.6 million, a 37% decrease, as compared to $142.1 million for the comparative period in 2022, as the current interest rate environment is slowing loan demand and creating competitive pressures on new credits.

This lower production was offset by a decrease in prepayments and curtailments of loans of $127.6 million compared to 2022.

● Deposits increased by $72.6 million, or 3%.

The growth in deposits came primarily from customer time and brokered deposits.

● Other short-term borrowings declined $42.2 million to $176.8 million at March 31, 2023 from $219.0 million at December 31, 2022 and consisted of overnight borrowings from correspondent banks and the FHLB.

Customer repurchase agreements, which are considered short-term as well, declined from $109.2 million at December 31, 2022 to $94.1 million at March 31, 2023.

● Long-term debt at March 31, 2023 consisted of $40.0 million of long-term FHLB advances and $49.2 million of subordinated debt.

This was an increase of $40.0 million from December 31, 2022 due to the $40.0 million in long-term FHLB advances, taken out as a partial hedge on longer term adjustable rate loans.

● Total capital of $307.0 million at March 31, 2023 reflects an increase of $3.4 million, or 1%, relative to year-end 2022.

The Company’s leverage ratio was 10.13% at March 31, 2023 as compared to 10.30% at December 31, 2022.

The increase in equity during the first three months of 2023 was due to the addition of $8.8 million in net income, a $0.5 million favorable swing in accumulated other comprehensive income/loss, due principally to changes in investment securities’ fair value, net of $2.7 million in share repurchases, and $3.5 million in

dividends paid.

The remaining difference is related to stock options exercised and restricted stock granted during the first three months.

The growth in deposits came primarily from higher-cost time deposits and brokered deposits.

Noninterest bearing or low-cost transaction and savings accounts decreased $135.2 million.

● Other short-term borrowings declined $9.2 million to $318.9 million at June 30, 2023 from $328.2 million at December 31, 2022 while long-term borrowings in the form of long-term FHLB advances increased $80.0 million for the first half of 2023, taken out as a partial on-balance sheet match against longer term production loans.

● Total capital of $309.6 million at June 30, 2023 reflects an increase of $6.0 million, or 2%, relative to year-end 2022.

The Company’s leverage ratio was 10.03% at June 30, 2023 as compared to 10.30% at December 31, 2022.

The increase in equity during the first half of 2023 was due to the addition of $18.7 million in net income, a $0.07 million favorable swing in accumulated other comprehensive income/loss due principally to changes in investment securities’ fair value, $3.8 million in share repurchases and net of $7.0 million in dividends paid.

The remaining difference is related to stock options exercised and restricted stock granted during the first three months of 2023.

EARNINGS PERFORMANCE

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NET INTEREST INCOME AND NET INTEREST MARGIN

Net interest income was $28.1 million, for the first quarter of 2023, a $3.4 million increase, or 14% over the first quarter of 2022.

For the first quarter of 2023 as compared to the same quarter in 2022, the $3.4 million increase in net interest income came from a $186.9 million increase in average earning asset balances, which consisted of increases of $104.8 million in average investment balances and $82.1 million in average loan balances.

In addition, there was a favorable rate variance on average earning assets of 121 basis points.

Offsetting these favorable interest income variances, average deposit balances increased $128.6 million, with all of the increase in higher cost time deposits.

Average borrowed funds increased $175.2 million, primarily for the purchase of floating rate collateralized loan obligations.

Deposit costs increased 118 basis points in the first quarter of 2023 as compared to the same quarter in 2022, along with a 201 basis point increase in the cost of borrowed funds.

Interest expense was $9.3 million for the first quarter of 2023, an increase of $8.0 million, relative to the first quarter of 2022.

The significant increase in interest expense is attributable to an unfavorable shift in deposit mix and the impact of interest rate increases, as the average balance of higher cost time deposits, including variable rate time deposits and borrowed funds increased by $270.1 million and $175.2 million respectively in the first quarter of 2023 as compared to the first quarter of 2022.

The Company had $1.3 billion in adjustable and variable rate loans and $561.0 million in floating rate collateralized loan obligations, as compared to $464.7 million in floating rate CDs and $35.5 million in floating rate trust preferred securities at March 31, 2023.

Net interest income was $28.3 million, for the second quarter of 2023, a $1.7 million increase, or 7% over the second quarter of 2022, and increased $5.1 million, or 10%, to $56.4 million for the first six months of 2023 relative to the same period in 2022.

Net interest income for the comparative year-to-date periods increased $5.1 million due to the change in mix on interest earning assets, moderated by an increase in interest rates paid on interest-bearing liabilities.

There was a $62.4 million, or 3% increase in average loan and lease balances yielding 31 basis points higher for the same period, while average investment balances increased $153.1 million yielding 273 basis points higher for the same period as many investments are floating rate.

Average interest-bearing liabilities increased $332.2 million, of which $68.3 million is an increase in deposit balances, $174.6 million is overnight or short-term borrowings, while $36.5 million is longer term FHLB borrowings.

The cost of interest bearing liabilities was 164 bps higher for the comparative periods.

The net impact of the mix and rate change was a 12 basis point increase in our net interest margin for the six-months ending June 30, 2023 as compared to the same period in 2022.

Interest expense was $12.6 million for the second quarter of 2023, an increase of $10.9 million, relative to the second quarter of 2022.

For the first six months of 2023, compared to the first six months of 2022, interest expense increased $18.9 million, to $21.8 million.

The increase in interest expense is primarily attributable to an increase in interest rates paid on certain time deposits and higher cost overnight borrowed funds.

There was an unfavorable shift in the deposit mix in the second quarter of 2023 as compared to the same period in 2022 that amplified the increase in interest expense.

Higher cost customer time deposits increased by $244.7 million, wholesale brokered deposits increased by $118.7 million and other borrowed funds increased $167.3 million, while lower cost and noninterest bearing deposits decreased by $332.1 million.

For the first half of 2023 as compared to the same period in 2022, customer time deposits increased $206.3 million, wholesale brokered deposits increased $110.7 million and borrowed funds increased $211.3 million, while lower cost or no cost deposits decreased $248.7 million.

The Company had $1.3 billion in adjustable and variable rate loans and $563.0 million in floating rate collateralized loan obligations, as compared to $430.8 million in floating rate CDs and $35.6 million in floating rate trust preferred securities at June 30, 2023.

$245.1 million of the Company’s adjustable and variable rate loans have the ability to reprice in the next twelve months.

The Company continues to offer floating rate CDs which are indexed to prime.

These floating rate CDs increased $135.4 million or 41%, to $464.7 million at March 31, 2023, as compared to $329.3 million at December 31, 2022.

Due to the increases in the prime rate during 2022 and 2023, interest expense on floating rate CDs has increased $4.1 million for the first quarter of 2023 over the first quarter of 2022.

These floating rate CDs increased $100.8 million or 31%, to $430.8 million at June 30, 2023, as compared to $329.3 million at December 31, 2022.

Due to the increases in the prime rate during 2022 and 2023, interest expense on floating rate CDs has increased $4.6 million for the first half of 2023 over the first half of 2022.

These CD’s require a minimum balance and pay a rate that is 325 – 400 basis points below the Wall Street Journal Prime rate, with a 20 basis point minimum rate.

Our net interest margin was 3.39% for the second quarter of 2023, as compared to 3.47% for the linked quarter and 3.40% for the second quarter of 2022.

While the yield of interest-earning assets increased 26 basis points for the second quarter of 2023 as compared to the linked quarter, the cost of interest-bearing liabilities increased 48 basis points for the same period of comparison.

The average balance of interest-earning assets increased $66.4 million for the linked quarter while the increase in interest-bearing liabilities was $98.3 million for the same period.

The increase in interest rates on a larger volume of interest-bearing liabilities over interest-earning assets, combined with a shift in deposit balances from lower cost transaction accounts to higher cost time certificates exacerbates the margin compression in the linked quarter.

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.

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For the three months ended

March 31, 2023

March 31, 2022

June 30, 2023

June 30, 2022

Rate/Yield (2)

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Loan fees have been included in the calculation of interest income.

Net loan (costs) fees and loan acquisition FMV amortization were $(0.1) million and $0.4 million for the quarters ended March 31, 2023 and 2022, respectively.

(4) Non-accrual loans have been included in total loans for purposes of computing total earning assets.

Net loan (costs) fees and loan acquisition FMV amortization were $(0.3) million and $0.4 million for the quarters ended June 30, 2023 and 2022, respectively.

(4) Nonaccrual 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.

Average Balances and Rates

(Dollars in Thousands, Unaudited)

For the six months ended

June 30, 2023

June 30, 2022

Rate/Yield (2)

Interest-earning due from banks

Total investments

Mortgage warehouse lines

Total interest earning assets (4)

Other earning assets

Non-earning assets

Liabilities and shareholders' equity

Interest bearing deposits:

Demand deposits

Savings accounts

Time Deposits

Brokered deposits

Total interest bearing deposits

Borrowed funds:

Repurchase agreements

Other borrowings

Long-term debt

Subordinated debentures

Total borrowed funds

Total interest bearing liabilities

Demand deposits - noninterest bearing

Other liabilities

Shareholders' equity

Total liabilities and shareholders' equity

Interest income/interest earning assets

Interest expense/interest earning assets

Net interest income and margin (5)

(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 federal 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 $0.8 million for the six months ended June 30, 2023 and 2022, respectively.

(4) Nonaccrual 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.

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.

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(dollars in thousands, unaudited)

Three months ended March 31,

Three months ended June 30,

Six months ended June 30,

2023 over 2022

Increase (decrease) due to

Federal funds sold/due from time

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(1) Subtotals are a sum of the categories above and are not recalculated on the portfolio totals.

The volume variance calculated for the first quarter of 2023 relative to the first quarter of 2022 was a favorable $1.6 million;

this is primarily from a favorable volume variance of $1.8 million in interest earning assets, as the average balance of interest earning assets increased $186.9 million from the comparative quarters.

There was a favorable rate variance of $6.3 million from the comparative quarters since the weighted average yield on interest earning assets more than offset the increase in the average yield unfavorable variance on interest bearing liabilities.

The volume variance calculated for the second quarter of 2023 relative to the second quarter of 2022 was a favorable $1.4 million;

this is primarily from a favorable volume variance of $1.8 million in interest earning assets, as the average balance of interest earning assets increased $243.8 million from the comparative quarter.

There was a favorable rate variance of $5.3 million from the comparative quarter since the weighted average yield on interest earning assets more than offset the increase in the average yield unfavorable variance on interest bearing liabilities.

There was an unfavorable mix variance of $5.0 million primarily from the shift in customer deposit transaction accounts into higher

cost variable rate time certificates combined with a higher level of borrowed funds.

The Company’s net interest margin for the first quarter of 2023 was 3.47%, as compared to 3.21% for the first quarter of 2022.

At March 31, 2023, approximately 4% of our total portfolio, or $89.5 million, consists of variable rate loans.

At March 31, 2023, our outstanding fixed rate loans represented 36% of our loan portfolio.

The remaining 60% of our loan portfolio at March 31, 2023 consists of adjustable-rate loans;

The Company’s net interest margin for the second quarter of 2023 was 3.39%, as compared to 3.40% for the second quarter of 2022.

The volume variance calculated for the first six months of 2023 relative to the first six months of 2022 reflects a favorable variance of $2.7 million, a favorable rate variance of $11.3 million, and an unfavorable mix variance of $8.8 million.

There were increases in loan and investment security balances for a favorable volume variance of $4.5 million which was partially offset by a $1.9 million increase in interest bearing liabilities.

There was a positive rate variance on interest earning assets of $18.7 million for the first six months of 2023 partially offset by a $7.5 million rate increase in interest earning liabilities.

The Company’s net interest margin for the first half of 2023 was 3.43%, as compared to 3.31% in the first half of 2022.

At June 30, 2023, approximately 5% of our total portfolio, or $95.5 million, consists of variable rate loans.

At June 30, 2023, our outstanding fixed rate loans represented 37% of our loan portfolio.

The remaining 58% of our loan portfolio at June 30, 2023 consists of adjustable-rate loans;

69% of these loans (approximately $836.3 million) will not have the ability to reprice for at least another 3 years.

These loans are typically adjustable every five years after the initial adjustment.

Approximately $68.1 million of these adjustable-rate loans have the ability to reprice next quarter, which will have a positive impact on earnings.

Cash balances for the quarterly comparisons have decreased and have a positive impact on our net interest margin since cash balances earn considerably lower yields than other earning assets.

Average cash and due from banks was $83.1 million, a decrease of $188.5 million for the first three months of 2023 as compared to the same period last year.

Overall average investment securities increased by $294.4 million for the first quarter of March 31, 2023 as compared to March 31, 2022.

For the quarter ending March 31, 2023 over the same period for 2022, average non-taxable securities increased $66.9 million and taxable securities increased $227.5 million.

The overall investment portfolio had a tax-equivalent yield of 4.65% at March 31, 2023, with an average life of 6.41 years.

Interest expense was $9.3 million in the first quarter of 2023, an increase of $8.0 million compared to the first quarter of 2022.

The increase is attributable to a shift from being a net seller of Federal Funds at March 31, 2022, to a net purchaser of funds at March 31, 2023 coupled with a 380 to 450 basis point increase to the rate on the Prime Index Certificate of Deposit accounts offered by the bank.

Approximately $92.2 million of these adjustable-rate loans have the ability to reprice in the third quarter of 2023, which will have a positive impact on earnings.

Cash balances for the quarter and year-to-date comparisons have decreased and have a positive impact on our net interest margin since cash balances earn considerably lower yields than other earning assets.

Average cash and due from banks was $115.0 million, a decrease of $112.6 million for the second quarter of 2023 as compared to the same period last year, and was $150.3 million lower for the first half of 2023 as compared to the same period in 2022.

Overall average investment securities increased by $200.9 million for the second quarter of June 30, 2023, as compared to June 30, 2022, and increased by $153.1 million for the first half of 2023 as compared to the same period in 2022.

For the quarter ending June 30, 2023, over the same period for 2022, average non-taxable securities increased $68.5 million and taxable securities increased $243.4 million.

For the first half of 2032 over the same period in 2022, average non-taxable securities increased $75.1 million and taxable securities increased $228.1million.

The overall investment portfolio had a tax-equivalent yield of 4.86% at June 30, 2023, with an average life of 6.70 years and average effective duration of 1.6 years for available for available-for-sale securities.

Approximately $563.0 million of the investment securities reprice every 90 days and $52.3 million are subordinated debt with an initial fixed rate period of 5 years and floating thereafter.

Interest expense was $12.6 million in the second quarter of 2023, an increase of $10.9 million compared to the second quarter of 2022, and increased $18.9 million for the first six-months of 2023 as compared to the same period in 2022.

The increase is attributable to an increase in borrowed fund balances and rates, as well as a 275 basis point increase to the rate on the Prime Index Certificate of Deposit accounts offered by the bank.

The rate on the Prime Index account is tied to a spread to the Wall Street Journal Prime Rate and varies from Prime minus 400 basis points to Prime minus 325 basis points.

The average cost of interest-bearing deposits increased by 118 basis points to 131 basis points for the first quarter of 2023 compared to the first quarter of 2022.

The average cost of interest-bearing deposits increased by 153 basis points to 170 basis points for the second quarter of 2023 compared to the second quarter of 2022, and by 136 basis points for the first half of 2023 as compared to the same period in 2022.

This increase is almost entirely due to the prime-based certificate of deposit account that adjusts with each change in the Wall Street Journal Prime rate.

As described above, this certificate of deposit product pays between 325 and 400 basis points below the Wall Street Journal Prime rate.

The Wall Street Journal Prime rate has increased by 450 basis points for the twelve month period between March 31, 2023 and March 31, 2022.

The average cost of borrowed funds increased 201 basis points for the first quarter of 2023 as compared to the same period in 2022.

Non-interest-bearing demand deposits decreased $22.9 million or 2% for the first quarter of 2023 as compared to the first quarter of 2022.

The Wall Street Journal Prime rate has increased by 275 basis points for the twelve month period between June 30, 2023 and June 30, 2022.

The average cost of borrowed funds increased 246 basis points for the second quarter of 2023 as compared to the same period in 2022 and increased 342 basis points for the first half of 2023 as compared to the same period in 2022.

Average noninterest-bearing demand deposits decreased $81.9 million or 7% for the second quarter of 2023 as compared to the second quarter of 2022, and decreased $52.6 million or 5% for the first half of 2023 as compared to the first half of 2022.

PROVISION FOR CREDIT LOSSES ON LOANS

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The Company sets aside an allowance for credit losses on loans, a contra-asset account, through periodic charges to earnings which are reflected in the income statement as the provision for credit losses on loans.

The Company recorded an expense related to a credit loss provision for loans of $0.3 million in the first quarter of 2023 relative to a provision for credit losses on loans of $0.6 million in the first quarter of 2022.

The Company's $0.3 million decrease in the provision for credit losses on loans in the first quarter of 2023 as compared to the first quarter of 2022 was primarily due to the impact of reduced net loan charge-offs in the first quarter of 2023.

The Company recorded an expense related to a credit loss provision for loans of $0.1 million in the second quarter of 2023 relative to a provision for credit losses on loans of $2.5 million in the second quarter of 2022 and a $0.3 million provision for credit losses on loans in the first half of 2023 as compared to $3.1 million in the same period in 2022.

The Company's $2.5 million decrease in the provision for credit losses on loans in the second quarter of 2023 as compared to the second quarter of 2022, and the $2.8 million decrease for the first six months of 2023 as compared to the same period in 2022 was favorably impacted by an improvement in the qualitative reserve rate component on the allowance for credit losses calculation as well as continued lower charge-offs of loans.

Specifically identifiable and quantifiable loan losses are immediately charged off against the allowance, with subsequent recoveries reflected as an increase to the allowance.

The Company recorded net loan charge-offs of $0.2 million in the first quarter of 2023 as compared to $1.8 million for the first quarter of 2022.

The Company recorded net loan charge-offs of $0.2 million in the second quarter of 2023 as compared to $2.3 million for the second quarter of 2022 and $.04 million in the first half of 2023 as compared to $4.1 million for the comparative period in 2022.

The allowance for credit losses on loans 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 credit losses in the remaining loan portfolio.

financial statements, and below, under “Allowance for Credit Losses.” The process utilized to establish an appropriate credit allowance for losses on loans can result in a high degree of variability in the Company’s credit loss provision, and consequently in our net earnings.

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 can result in a high degree of variability in the Company’s credit loss provision, and consequently in our net earnings.

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, 2023 and 2022:

The following table provides details on the Company’s noninterest income and noninterest expense for the three and six-month periods ended June 30, 2023, and 2022:

Noninterest Income/Expense

(dollars in thousands, unaudited)

For the three months ended March 31,

For the three months ended June 30,

For the six months ended June 30,

Noninterest income:

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Noninterest Income:

Total noninterest income increased $0.5 million, or 9%, for the quarter ended March 31, 2023 as compared to the same quarter in 2022.

A favorable swing in the income on BOLI offset by lower service charges on deposits and lower gains on the sale of investment securities accounts for most of the positive variance.

Other service charges and fees on deposit accounts decreased $0.2 million or 3% for the first quarter of 2023 as compared to the same period in 2022.

Effective in the third quarter of 2022, the Company made several changes to its NSF fees (i.e.

returned item) and overdraft fees for customers.

In particular, NSF fees are no longer charged, and overdraft fees are limited to 4 per day and no continuous overdraft fee will be charged.

In addition, the amount of overdraft privilege (i.e.

the amount to which the Company will pay overdrafts for customers) was increased by $250.

There were de minimis gains of the sales of securities for the first quarter of 2023, but there was a $1.0 million gain on the sale of securities in the first quarter of 2022.

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 increased by $0.8 million for the first quarter of 2023 as compared to the first quarter of 2022.

Total noninterest income decreased by $2.4 million, or 23%, for the quarter ended June 30, 2023 as compared to the same quarter in 2022 and decreased $1.9 million, or 12% for the comparable year-to-date periods.

These declines were due mostly to a decline in gains and recoveries recognized in 2022 as compared to 2023.

Other service charges and fees on deposit accounts decreased by $0.2 million, or 4%, to $5.7 million in the second quarter of 2023 as compared to the second quarter of 2022.

This service charge income was $0.4 million lower, or 13% in the first six months of 2023, as compared to the same period in 2022.

These decreases in the quarterly and year-to-date comparisons are primarily a result of decreased overdraft income and lower interchange fees.

BOLI income increased by $1.2 million for the second quarter of 2023 as compared to the second quarter of 2022, and $2.0 million for the first half of 2023 as compared to the same period in 2022.

The variance is due mostly to fluctuations in underlying values of assets in the separate 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, 2023, there was $43.2 million in traditional BOLI policies and $9.1 million in separate account BOLI policies associated with the deferred compensation plans.

In the “other” category of noninterest income the Company there was a $0.9 million increase in the first quarter of 2023 as compared to the first quarter of 2022.

The primary reason for the favorable variance was the receipt of $0.3 million in life insurance proceeds, $0.3 million in income on foreclosed assets and a $0.3 million increase in variable rate SBA loan fund income.

Thus, the higher values in BOLI policies are offset by higher deferred compensation expense reflected primarily in director fees expense.

At June 30, 2023, there was $43.3 million in traditional BOLI policies and $9.4 million in separate account BOLI policies associated with the deferred compensation plans.

In the “other” category of noninterest income there was a $3.8 million decrease in the second quarter of 2023 as compared to the second quarter of 2022, and a $2.8 million decrease in the first six months of 2023 as compared to the same period in 2022.

The quarterly and year-to-date comparison includes $3.2 million in non-recurring gains in 2022 resulting from the sale of Visa B stock of $2.6 million and a small business investment company fund investment of $0.6 million, as well as $0.4 million in life insurance proceeds, a $1.0 million recovery of prior year legal expenses, and a $0.2 million gain from a recovery on an acquired loan.

In 2023 for the quarterly and year-to-date period the Company did recognize non-recurring gains of $0.2 million and $.5 million respectively in life insurance proceeds and $0.4 million and $0.7 million respectively in variable rate SBA loan fund income.

Noninterest Expense:

Total noninterest expense increased by $2.8 million, or 14%, in the first quarter of 2023 relative to the first quarter of 2022.

Salaries and Benefits were $1.0 million, or 9%, higher in the first quarter of 2023 as compared to the first quarter of 2022.

The reason for this increase is primarily due to several factors, including merit increases for employees due to annual performance evaluations during the first quarter of 2023, and the strategic hiring of lending and management staff to support expected loan growth.

There were 500 full-time equivalent employees at March 31, 2023 as compared to 484 at March 31, 2022.

Occupancy expenses were flat for the first quarter of 2023 as compared to the same quarter in 2022.

Other noninterest expense increased $1.8 million, or 29% for the first quarter 2023 as compared to the first quarter in 2022.

The variances for the first quarter of 2023 compared to the same period in 2022 was primarily driven by a $0.8 million increase in foreclosed asset expenses related to a foreclosed Dairy relationship that was sold during the quarter and an increase in directors deferred compensation expense for $0.5 million which is linked to the fluctuation in BOLI income.

Total noninterest expense increased by $0.9 million, or 4%, in the second quarter of 2023 relative to the second quarter of 2022, and by $3.7 million, or 9%, in the first six months of 2023 as compared to the first six months of 2022.

The higher costs for the first six months of 2023 as compared to 2022 are primarily due to higher salary and benefit costs, an increase in deferred compensation (although this was mostly offset by a corresponding decrease in noninterest income), and higher foreclosure costs in 2023.

Salaries and Benefits were $0.4 million, or 3%, higher in the second quarter of 2023 as compared to the second quarter of 2022 and $1.4 million, or 6% higher for the first six months of 2023 compared to the same period in 2022.

The reason for this increase is primarily due to increased salary expense and benefit costs associated with those salaries for new lending teams and certain management staff for both the quarterly and year-to-date comparisons.

Furthermore, health insurance costs increased in 2023 for the Company and are trending 13% higher in the year-to-date comparisons.

Overall full-time equivalent employees were 501 at June 30, 2023, as compared to 491 at December 31, 2022 and 504 at June 30, 2022.

Occupancy expenses were relatively unchanged for the second quarter and were up $0.1 million or 1% for the first half of 2023 as compared to the same periods in 2022.

Other noninterest expense increased $0.4 million, or 6% for the second quarter 2023 as compared to the second quarter in 2022, and increased $2.2 million, or 16% for the first half of 2023 as compared to the same period in 2022.

FDIC assessment costs increased for the both the quarterly and year-to-date comparisons by $0.4 million;

there were increases in deferred compensation expense for directors of $0.9 million for the quarterly comparison and $1.4 million for the year-to-date comparison, which is linked to the changes in life insurance income, increasing $1.2 million for the quarterly comparison and $2.0 million for the year-to-date comparison.

There were also increases in debit card processing and ATM network costs for both the quarterly and year-to-date comparisons due to a branding change from Mastercard to Visa and the subsequent conversion costs related to that change.

Those conversion charges are estimated

to be $0.5 million for both the quarterly and year-to-date comparisons.

Additionally, we incurred a $0.3 million loss from a 2017 event that is reflected in noninterest expense.

These increases were partially offset in both the quarterly and year-to-date comparisons by decreases in recruitment costs associated with new hires in 2022, decreased postage costs, and costs associated with restitution payments made to customers in 2022 for customers charged nonsufficient fund fees on represented items due to a change in the rules related to such items by the Federal Deposit Insurance Corporation.

For the year-to-date comparison there was also elevated foreclosed assets costs for the first half of 2023 as compared to the same period in 2022, due to the foreclosure and then subsequent sale one large credit in the first quarter of 2023.

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.

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 23.6% of pre-tax income in the first quarter of 2023 relative to 27.0% in the first quarter of 2022.

The decrease in effective tax rate is due to the volatility in the Corporate Owned Life Insurance asset value associated with our non-qualified deferred compensation plans.

In the first quarter of 2023, the investments associated with the non-qualified deferred compensation plans increased in value, resulting in a non-taxable income as compared to a decrease in value generating non-tax deductible expense for the first quarter of 2022.

The Company's provision for income taxes was 26.2% of pre-tax income in the second quarter of 2023 relative to 26.3% in the second quarter of 2022, and 25.0% of pre-tax income for the first half of 2023 relative to 26.6% for the same period in 2022.

The changes in effective tax rate for both the quarterly and year-to-date comparisons is due to the volatility in the Corporate Owned Life Insurance asset value associated with our non-qualified deferred compensation plans.

In the second quarter and first half of 2023, the investments associated with the non-qualified deferred compensation plans increased in value, generating non-taxable income for the second quarter, and first half of 2023 while decreasing in value in the second quarter and first half of 2022 resulting in a non-deductible expense.

BALANCE SHEET ANALYSIS

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and 5) they can provide partially tax exempt income.

The investment portfolio is reflected on the balance sheet as investment securities and totaled $1.4 billion, or 37% of total assets at March 31, 2023, and $1.3 billion, or 35% of total assets at December 31, 2022.

The investment portfolio is reflected on the balance sheet as investment securities and totaled $1.4 billion, or 36% of total assets at June 30, 2023, and $1.3 billion, or 35% of total assets at December 31, 2022.

The increase was primarily due to purchases of U.S.

government agency securities and AAA and AA tranches of collateralized loan obligations.

government agency securities and AAA and AA tranches of adjustable rate collateralized loan obligations.

The Company carries “available for sale” investments at their fair market values and “held to maturity” investments at amortized cost net of allowance for credit losses.

We currently have the intent and ability to hold our investment securities to maturity, but the securities are all marketable.

The expected effective duration was 1.6 years for available-for-sale investments and 6.3 years for held-to-maturity investments at March 31, 2023, as compared to 1.8 years for available-for-sale investments and 6.4 years for held-to-maturity investments at December 31, 2022.

The expected effective duration was 1.6 years for available-for-sale investments and 6.3 years for held-to-maturity investments at June 30, 2023, as compared to 1.8 years for available-for-sale investments and 6.4 years for held-to-maturity investments at December 31, 2022.

In the second and fourth quarters of 2022 the Company transferred $162.1 million and $198.3 million, respectively of “available for sale” investments to “held to maturity”.

5 unchanged sentences

(dollars in thousands, unaudited)

March 31, 2023

June 30, 2023

December 31, 2022

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Total securities

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 $186.3 million at March 31, 2023 and $183.5 million at December 31, 2022, leaving $1.2 billion in unpledged debt securities at March 31, 2023 and $1.1 billion at December 31, 2022.

Securities that were pledged in excess of actual pledging needs and were thus available for liquidity purposes, if needed, totaled $58.3 million at March 31, 2023 and $43.1 million at December 31, 2022.

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 $482.0 million at June 30, 2023 and $183.5 million at December 31, 2022, leaving $0.9 million in unpledged debt securities at June 30, 2023 and $1.1 billion at December 31, 2022.

Securities that were pledged in excess of actual pledging needs and were thus available for liquidity purposes, if needed, totaled $359.5 million at June 30, 2023 and $43.1 million at December 31, 2022.

ALLOWANCE FOR CREDIT LOSSES – AFS INVESTMENT SECURITIES

1 unchanged sentence

It is maintained at a level that is considered adequate to measure expected losses across the classes of major investment security types related to fluctuations in market conditions, primarily interest rates, and not reflective of a deterioration in credit value.

The Company maintains that it has intent and ability to hold these securities until the amortized cost basis of each security is recovered and likewise concluded as of both January 1, 2022 and March 31, 2023 that it was not more likely than not that any of the securities in an unrealized loss position would be required to be sold.

The following bullets outline additional support for management’s conclusion that no amount of the unrealized loss of the securities in an unrealized loss position as of January 1, 2022 and March 31, 2023 was attributable to credit deterioration and a risk of loss, requiring an allowance for credit losses.

The Company maintains that it has intent and ability to hold these securities until the amortized cost basis of each security is recovered and likewise concluded as of both June 30, 2023 and December 31, 2022 that it was not more likely than not that any of the securities in an unrealized loss position would be required to be sold.

The following bullets outline additional support for management’s conclusion that

no amount of the unrealized loss of the securities in an unrealized loss position as of June 30, 2023 and December 31, 2022 was attributable to credit deterioration and a risk of loss, requiring an allowance for credit losses.

● US Government Agencies are supported by the full faith and credit-worthiness of the U.S.

Federal Government and the management did not consider a default, much less a loss on these securities to be a reasonable possibility as of either January 1, 2022 or March 31, 2023.

Federal Government and the management did not consider a default, much less a loss on these securities to be a reasonable possibility as of either June 30, 2023 or December 31, 2022.

● Mortgage-backed securities issued by government sponsored entities (“GSEs”) carry an implicit guarantee by the U.S.

1 unchanged sentence

Federal Government up to a limit, with an implied ability to draw funds beyond the limit.

Management did not consider a default, much less a loss on these securities to be a reasonable possibility as of either January 1, 2022 or March 31, 2023.

● Management routinely monitors third party credit grades of the municipal issuers in the Company’s state and political subdivisions portfolio and as of both January 1, 2022 and March 31, 2023 noted that all municipal securities in an unrealized loss position were either investment grade rated or guaranteed.

Management did not consider a default, much less a loss on these securities to be a reasonable possibility as of either June 30, 2021 or December 31, 2022.

● Management routinely monitors third party credit grades of the municipal issuers in the Company’s state and political subdivisions portfolio and as of both June 30, 2023 and December 31, 2022 noted that all municipal securities in an unrealized loss position were either investment grade rated or guaranteed.

On a quarterly basis management receives financial information from a third-party service in order to monitor the underlying issuer’s financial stability.

In addition, management performs annual reviews of the underlying municipal issuers financial statements in order to evaluate stability and repayment capacity and has noted no concerns with any of the bonds in the Company’s State and Local portfolio.

As of both January 1, 2022 and March 31, 2023 management concluded that no allowance for credit losses was warranted on any of the Company’s municipal securities and the unrealized loss position of each of the securities reflected fluctuations in market conditions, primarily interest rates, since the time of purchase.

As of both June 30, 2023 and December 31, 2022 management concluded that no allowance for credit losses was warranted on any of the Company’s municipal securities and the unrealized loss position of each of the securities reflected fluctuations in market conditions, primarily interest rates, since the time of purchase.

● The Company has invested in corporate debt issuances of other financial institutions.

Various financial metrics of each of the issuing financial institutions are reviewed by management quarterly, these metrics include credit quality, reserve adequacy, profitability and capital.

Following review of the financial metrics available for each of the underlying institutions as of January 1, 2022 and March 31, 2023 management concluded that the unrealized loss position of these securities related exclusively to the fluctuation in market conditions, primarily interest rates, from the date of purchase, and were not reflective of any credit concerns with the issuing financial institution.

Following review of the financial metrics available for each of the underlying institutions as of June 30, 2023 and December 31, 2022 management concluded that the unrealized loss position of these securities related exclusively to the fluctuation in market conditions, primarily interest rates, from the date of purchase, and were not reflective of any credit concerns with the issuing financial institution.

These bonds were subject to a credit review by the credit administration department prior to their purchase and are subject to ongoing quarterly reviews.

2 unchanged sentences

Management monitors the credit rating of these investments on a quarterly basis in addition to various performance metrics available through a third-party informational service.

Following review of financial metrics as of both January 1, 2022 and March 31, 2023 management concluded that the unrealized loss position of these securities related exclusively to the fluctuation in market conditions, primarily interest rate spreads, from the date of purchase, and were not reflective of any credit concerns with the tranches comprising the Company’s investments.

Following review of financial metrics as of both June 30, 2023 and December 31, 2022 management concluded that the unrealized loss position of these securities related exclusively to the fluctuation in market conditions, primarily interest rate spreads due to changes in supply or demand, from the date of purchase, and were not reflective of any credit concerns with the tranches comprising the Company’s investments.

LOAN PORTFOLIO

4 unchanged sentences

(dollars in thousands, unaudited)

March 31, 2023

June 30, 2023

December 31, 2022

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Total loans, net

Net loans at $2.0 billion, decreased $18.9 million during the first three months of 2023 with an overall 1% change.

The net change did have offsetting components with the larger fluctuations being a $3.0 million increase in mortgage warehouse line utilization, and an $18.7 million increase in non-owner occupied commercial real estate.

Unfavorable larger loan variances include a $20.5 million decrease in farmland, and a $10.0 million decrease in owner-occupied commercial real estate.

As indicated in the loan roll forward below, new credit extended for the first quarter of 2023 increased $30.1 million over the same period in 2022 but decreased $14.6 million for the linked quarter comparisons.

For the first three months ended 2023 we had $48.8 million in loan paydowns and maturities, along with a $3.0 million increase in mortgage warehouse line utilization and a $25.8 million decrease in line of credit utilization.

Net loans at $2.1 billion, increased $41.7 million during the first six months of 2023 with an overall 2% change year-to-date.

The net change did have offsetting components with the larger fluctuations being a $45.2 million increase in mortgage warehouse line utilization, a $19.8 million increase in non-owner occupied commercial real estate and an $18.6 million increase in commercial and industrial loan.

Unfavorable larger loan variances include a $20.7 million decrease in farmland, and an $11.2 million decrease in owner-occupied commercial real estate.

As indicated in the loan roll forward below, new credit extended for the second quarter of 2023 decreased $82.5 million and for the first half of 2023 decreased $52.5 million over the same periods in 2022.

For the six months ended 2023, we had $74.2 million in loan paydowns and maturities, along with a $45.2 million increase in mortgage warehouse line utilization and a $19.2 million decrease in line of credit utilization.

LOAN ROLLFORWARD

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For the three months ended:

March 31, 2023

December 31, 2022

For the six months ended:

June 30, 2023

March 31, 2023

June 30, 2022

June 30, 2023

June 30, 2022

Gross loans beginning balance

5 unchanged sentences

Gross loans ending balance

Over the past two years, the Company has strategically focused on reducing concentrations in commercial real estate, especially amongst areas management deemed to be higher risk such as construction, office real estate, and hospitality.

At March 31, 2021, the total regulatory CRE ratio of total CRE over Tier 1 Capital plus allowance was 359%.

At March 31, 2023, this ratio had declined to 249% which positions us well for growth.

Further, the overall level of construction and land development lending had declined from 25% of regulatory capital plus allowance for credit losses at March 31, 2021, to 4% of regulatory capital plus allowance for credit losses at March 31, 2023.

Further, overall committed office

real estate is 8.4% of total commitments at March 31, 2023.

At June 30, 2023 the total regulatory CRE ratio of total CRE over Tier 1 Capital plus allowance was 243%, compared to 249% for the linked quarter and 246% at December 31, 2022 which positions us well for growth.

Further, the overall level of construction and land development lending had declined from 18% of regulatory capital plus allowance for credit losses

at June 30, 2021, to 4% of regulatory capital plus allowance for credit losses at June 30, 2023.

Overall committed non-owner occupied office real estate is 8.5% of total commitments at June 30, 2023.

The office real estate loans are adjustable rates with most rate adjustments occurring beyond two years.

2 unchanged sentences

Over the past two years, noting the affect the pandemic had on the office building sector, new production of commercial real estate loans in this segment have been discouraged, resulting in reduced loan originations.

Regarding line utilization, unused commitments, excluding mortgage warehouse and overdraft lines, were $223.6 million at March 31, 2023, compared to $219.7 million at December 31, 2022.

Total utilization excluding mortgage warehouse and overdraft lines was 57% at March 31, 2023, compared to 59% at December 31, 2022.

Mortgage warehouse utilization was 15% at March 31, 2023, compared to 10% at December 31, 2022.

It should be noted that the majority of the mortgage warehouse lines were moved to repurchase agreement lines that provide stronger credit protection to the Company, as well as more favorable regulatory capital treatment as these repurchase lines are not considered off-balance sheet commitments.

As expected, PPP loans continue to decline as borrowers receive forgiveness on these loans.

There were eleven loans for $0.8 million outstanding at March 31, 2023, compared to fourteen loans for $1.8 million at December 31, 2022.

Regarding line utilization, unused commitments, excluding mortgage warehouse and overdraft lines, were $216.0 million at June 30, 2023, compared to $219.7 million at December 31, 2022.

Total utilization excluding mortgage warehouse and overdraft lines was 59% at both June 30, 2023 and December 31, 2022.

Mortgage warehouse utilization was 26% at June 30, 2023, compared to 10% at December 31, 2022.

It should be noted that the mortgage warehouse lines were moved to repurchase agreement lines that provide stronger credit protection to the Company, as well as more favorable regulatory capital treatment as these repurchase lines are not considered off-balance sheet commitments.

PPP loans continue to decline as borrowers receive forgiveness on these loans.

There were ten loans for $0.5 million outstanding at June 30, 2023, compared to fourteen loans for $1.8 million at December 31, 2022.

NONPERFORMING ASSETS

2 unchanged sentences

(dollars in thousands, unaudited)

March 31, 2023

June 30, 2023

December 31, 2022

March 31, 2022

NON-ACCRUAL LOANS:

June 30, 2022

Nonperforming Loans:

1-4 family - closed-end

Commercial real estate - owner occupied

TOTAL REAL ESTATE

Total Real Estate nonperforming loans

Commercial and industrial

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Nonperforming assets as a % of total gross loans and foreclosed assets

Total nonperforming assets, comprised of non-accrual loans and foreclosed assets, decreased by $18.6 million, or 95% during the first quarter of 2023.

The significant decrease resulted from a decrease in non-accrual loans, primarily as a result of one relationship in the dairy industry consisting of four separate loans that were foreclosed on and subsequently sold in the first quarter of 2023.

These loans were written down by $8.7 million during 2022 and no further allowance for credit losses was deemed necessary on these loans.

The Company's ratio of nonperforming assets to loans plus foreclosed assets decreased to 0.05% at March 31, 2023, from 0.95% at December 31, 2022 due primarily to the resolution of the loan relationship previously mentioned.

All of the Company's nonperforming assets are individually

evaluated for credit loss quarterly and management believes the established allowance for credit loss on such loans are appropriate.

There were no foreclosed assets at March 31, 2023 and December 31, 2022., however when the Company does own foreclosed assets, they are periodically evaluated and written down to their fair value less expected disposition costs, if lower than the then-current carrying value.

Total nonperforming assets, comprised of nonaccrual loans and foreclosed assets, decreased by $18.4 million to $1.1 million for the first half of 2023.

The Company's ratio of nonperforming loans to gross loans decreased to 0.05% at June 30, 2023 from 0.95% at December 31, 2022.

The significant decrease resulted from a decrease in nonaccrual loan balances, primarily as a result of the foreclosure and sale of one loan relationship in the dairy industry consisting of four separate loans in the first quarter of 2023.

All the Company's nonperforming assets are individually evaluated for credit loss quarterly and management believes the established allowance for credit loss on such loans is appropriate.

There were no foreclosed assets at June 30, 2023 and December 31, 2022, however when the Company does own foreclosed assets, they are periodically evaluated and written down to their fair value less expected disposition costs, if lower than the then-current carrying value.

In January 2023, the Company foreclosed on $18.1 million of loans and the properties were sold prior to March 31, 2023.

An action plan is in place for each of our non-accruing loans 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 $1.5 million in loans past due 30-59 days at March 31, 2023.

The Company had $1.9 million in loans past due 30-89 days at June 30, 2023.

This is a decrease of $0.3 million over the balance at December 31, 2022.

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.

ALLOWANCE FOR CREDIT LOSSES – LOANS RECEIVABLE

ALLOWANCE FOR CREDIT LOSSES – LOANS

The allowance for credit losses on loans, a contra-asset, is established through periodic provisions for credit losses on loans.

4 unchanged sentences

The Company implemented CECL on January 1, 2022, and 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 was $23.1 million at both March 31, 2023, and December 31, 2022, and $22.5 million at March 31, 2022.

The allowance was 1.14% of total loans at March 31, 2023, 1.12% of total loans at December 31, 2022, and 1.14% of total loans at March 31, 2022.

Management's detailed analysis indicates that the Company's allowance for credit losses on loan should be sufficient to cover credit losses for the life of the loans outstanding as of March 31, 2023, but no assurance can be given that the Company will not experience substantial future losses relative to the size of the credit loss allowance for loans.

A separate allowance of $0.9 million for potential credit losses inherent in unused commitments is included in other liabilities at March 31, 2023, unchanged from December 31, 2022.

The Company's allowance for credit losses on loans was $23.0 million at June 30, 2023, and $23.1 million at December 31, 2022, and $22.8 million at June 30, 2022.

The allowance was 1.10% of total loans at June 30, 2023, 1.12% of total loans at December 31, 2022, and 1.13% of total loans at June 30, 2022.

Management's detailed analysis indicates that the Company's allowance for credit losses on loan should be sufficient to cover credit losses for the life of the loans outstanding as of June 30, 2023, but no assurance can be given that the Company will not experience substantial future losses relative to the size of the credit loss allowance for loans.

A separate allowance of $0.8 million for potential credit losses inherent in unused commitments is included in other liabilities at June 30, 2023, unchanged from December 31, 2022.

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.

11 unchanged sentences

Provision charged to expense

1-4 family residential construction

Other construction/land

1-4 family - closed-end

Multi-family residential

Commercial real estate- owner occupied

Commercial real estate- non-owner occupied

2 unchanged sentences

Consumer loans

1-4 family residential construction

Other construction/land

1-4 family - closed-end

Multi-family residential

Commercial real estate- owner occupied

Commercial real estate- non-owner occupied

Total real estate

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(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 at March 31, 2023 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.

The Company’s credit allowance for losses on loans at June 30, 2023 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.

2 unchanged sentences

It is unlikely that all unused commitments will ultimately be drawn down.

Unused commitments to extend credit, which included standby letters of credit, totaled $705.2 million at March 31, 2023 and $895.6 million at December 31, 2022, representing approximately 35% of gross loans outstanding at March 31, 2023 and 44% at December 31, 2022.

Included in unused commitments are mortgage warehouse lines which are mostly in the form of repo lines and are unconditionally cancellable.

Unused commitments on mortgage warehouse lines were $401.5 million at March 31, 2023 and $594.6 million at December 31, 2022.

The increase in unused commitments on mortgage warehouse lines is due in large part to the decrease in funded commitments due to the impact of recent interest rate increases.

Unused commitments exclusive of mortgage warehouse lines have increased $2.7 million or 1% for the first three months of 2023 and are due to an increase in new lines of credit.

The Company also had undrawn letters of credit issued to customers totaling $6.1 million at March 31, 2023 and $6.0 million at December 31, 2022.

Unused commitments to extend credit, which included standby letters of credit, totaled $613.8 million at June 30, 2023 and $895.6 million at December 31, 2022, representing approximately 29% of gross loans outstanding at June 30, 2023 and 44% at December 31, 2022.

Included in unused commitments are

mortgage warehouse lines which are mostly in the form of repo lines and are unconditionally cancellable.

Unused commitments on mortgage warehouse lines were $319.4 million at June 30, 2023 and $594.6 million at December 31, 2022.

The decline in unused commitments during 2023 is primarily due to a decline in mortgage warehouse lines as the Company strategically reduced availability under the lines while increasing the number of lines outstanding.

Unused commitments exclusive of mortgage warehouse lines and overdraft lines of credit, have decreased $3.7 million or 2% for the first six months of 2023 and are due to a decrease in new lines of credit.

The Company also had undrawn letters of credit issued to customers totaling $6.0 million at both June 30, 2023 and December 31, 2022.

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 $73.0 million at March 31, 2023.

That letter of credit is backed by loans that are pledged to the FHLB by the Company.

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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 $81.7 million at March 31, 2023 relative to $72.8 million at December 31, 2022.

The Company’s balance of non-earning cash and due from banks was $100.4 million at June 30, 2023 relative to $72.8 million at December 31, 2022.

Foreclosed assets are discussed above in the section titled “Nonperforming Assets.”

Net premises and equipment decreased by $0.2 million during the first three months of 2023, to $22.3 million.

Net premises and equipment decreased by $0.4 million during the first half of 2023, to $22.1 million.

This decline was primarily a result of normal depreciation, the disposal of obsolete equipment, net of new purchases.

Goodwill was $27.4 million at March 31, 2023, unchanged during the first three months of 2023.

Goodwill was $27.4 million at June 30, 2023, unchanged during the first half of 2023.

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 2022 and determined that no impairment existed.

During the first three months of 2023, overall bank stock prices declined significantly after the liquidity events that led to the voluntary liquidation of one California bank, the failure of a $200 billion California Bank (second largest bank failure in history) and the failure of a $100 billion bank in New York.

Given the recent events management felt it prudent to perform a current valuation in light of the recent slide in the Company’s stock price relative to the entire banking sector.

During the first half of 2023, overall bank stock prices declined significantly after the liquidity events that led to the voluntary liquidation of one California bank, the failure of a $200 billion California Bank (second largest bank failure in history) and the failure of a $100 billion bank in New York.

Given those events management felt it prudent to perform a valuation in the first quarter of 2023 in light of the slide in the Company’s stock price relative to the entire banking sector.

After performing such valuation, management concluded that no impairment of the Company existed at March 31, 2023.

Management will continue to evaluate whether or not a triggering event occurs, or circumstances

change that would more likely than not reduce the fair value of the Company below its carrying amount before the next annual test.

Bank-owned life insurance, with a balance of $52.3 million at March 31, 2023, is discussed in detail above in the “Noninterest Income and Noninterest Expense” section.

Management will continue to evaluate whether or not a triggering event occurs, or circumstances change that would more likely than not reduce the fair value of the Company below its carrying amount before the next annual test.

Bank-owned life insurance, with a balance of $52.7 million at June 30, 2023, is discussed in detail above in the “Noninterest Income and Noninterest Expense” section.

DEPOSITS AND INTEREST-BEARING LIABILITIES

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(dollars in thousands, unaudited)

March 31, 2023

June 30, 2023

December 31, 2022

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Total deposits

Deposit balances grew by $102.8 million, or 4%, during the first quarter of 2023 to $2.9 billion at March 31, 2023.

Core non-maturity deposits decreased $82.3 million, or 4%, for the first three months of 2023, while customer time deposits increased by $120.2 million.

Brokered deposits increased $65.0 million during the quarter;

Deposit balances grew by $72.6 million, or 3%, during the first half of 2023 to $2.9 billion at June 30, 2023.

Core non-maturity deposits decreased $135.2 million, or 6%, for the first half of 2023, while customer time deposits increased by $152.8 million, or 38%.

Brokered deposits increased $55.0 million during the first half of 2023, or 45%;

to take advantage of preferential pricing over other forms of borrowed funds.

Overall noninterest-bearing deposits as a percent of total deposits decreased to 35.3% at March 31, 2023, compared to 38.2% at December 31, 2022, and from 38.6% at March 31, 2022.

From March 10, 2023 to March 31, 2023, overall deposits decreased by less than 0.04%.

Overall noninterest-bearing deposits as a percent of total deposits decreased to 36.5% at June 30, 2023, compared to 38.2% at December 31, 2022, and from 39.3% at June 30, 2022.

Overall uninsured deposits are estimated to be approximately $799.7 million, or 27% of total deposit balances, excluding public agency deposits that are subject to collateralization through a letter of credit issued by the FHLB.

In addition, uninsured deposits of the bank’s customers are eligible for FDIC pass-through insurance if the customer opens an IntraFi Insured Cash Sweep account or a reciprocal time deposit through the Certificate of Deposit Account Registry System (CDARS).

IntraFi allows for up to $150 million of combined pass-through FDIC insurance which would more than cover each of the Bank’s deposit customers if such customer desired to have such pass-through insurance.

IntraFi allows for up to $225 million of combined pass-through FDIC insurance per customer which would more than cover each of the Bank’s deposit customers if such customer desired to have such pass-through insurance.

The Bank maintains a diversified deposit base with no significant customer concentrations and does not bank any cryptocurrency companies.

At March 31, 2023, the Company had approximately 122,000 accounts and the 25 largest deposit balance customers had balances of less than 9% of overall deposits .

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 35.3% at March 31, 2023 as compared to 38.2% at December 31, 2022.

At June 30, 2023, the Company had approximately 121,000 accounts and the 25 largest deposit balance customers had balances of less than 11% of overall deposits .

During the second quarter of 2023, except for seasonality fluctuations in the normal course of business there has been no change in the composition of our 25 largest deposit balance customers.

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, subordinated notes 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 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 decreased by $17.2 million, during the first three months of 2023.

primarily due to a decrease in customer repurchase agreements and overnight borrowings.

Customer repurchase agreements declined from $109.2 million at December 31, 2022 to $94.1 million at March 31, 2023.

The Company uses short-term FHLB advances and fed funds purchased on unsecured lines to support liquidity needs created by seasonal deposit flows, to temporarily satisfy funding needs from increased loan demand, and for other short-term purposes.

The FHLB line consists of both a secured and unsecured component.

The secured component depends on the level of pledged collateral.

Total non-deposit interest-bearing liabilities decreased by $70.9 million, during the first half of 2023 primarily due to an overnight increase in long term FHLB borrowings.

This was a strategic decision to take advantage of longer term pricing as a partial on-balance sheet match to longer term loans due to the current inverted yield curve and to provide longer-term interest rate risk mitigation.

Customer repurchase agreements declined from $109.2 million at December 31, 2022 to $73.7 million at June 30, 2023.

Customer repurchase agreements provide collateral for customers that sweep excess deposit balances each day into a separate repurchase agreement account where the Company effectively sells certain government bonds to customers daily and then repurchase the same bonds on the next business day.

Although these accounts are not deposits and are not FDIC insured, they provide customers with larger account balances the ability to have their account secured with collateral.

Other borrowings declined $2.2 million to $216.8 million at March 31, 2022 from $219.0 million at December 31, 2022 and consist of overnight borrowings from correspondent banks and FHLB advances.

Overall borrowings from the FHLB and correspondent banks remained relatively unchanged during the first quarter of 2023.

Long-term debt at March 31, 2023 consisted of $49.2 million of subordinated debt.

This remained unchanged from December 31, 2022.

Subordinated debentures related to $35.5 million of trust preferred securities at both March 31, 2023 and December 31, 2022.

Other borrowings increased $106.2 million to $325.2 million at June 30, 2023 from $219.0 million at December 31, 2022 and consist of overnight borrowings from correspondent banks and the FHLB.

Long-term debt at June 30, 2023 consisted of $49.3 million of subordinated debt.

This remained relatively unchanged from December 31, 2022.

Subordinated debentures related to $35.6 million of trust preferred securities at June 30, 2023 and $35.5 million at December 31, 2022.

Trust preferred securities are variable rate instruments which were benchmarked against the London Interbank Offered Rate (LIBOR) plus a spread until LIBOR was phased out on June 30, 2023.

These instruments are benchmarked against the Secured Overnight Financing Rate (SOFR), effective June 30, 2023.

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 $41.5 million at March 31, 2023 as compared to $45.1 million at December 31, 2022, a decrease of $3.6 million or 8%.

The decrease was primarily driven a reduced in accrued expenses.

The Company’s balance of other liabilities was $49.6 million at June 30, 2023 as compared to $45.1 million at December 31, 2022, an increase of $4.5 million or 10%.

The increase was primarily driven by investment securities that have not settled as of June 30, 2023.

LIQUIDITY AND MARKET RISK MANAGEMENT

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The Company continues to have substantial liquidity though unencumbered assets and available borrowings.

In addition, the Company’s loan-to-deposit ratio declined from 72% at December 31, 2022 to 69% at March 31, 2023.

At March 31, 2023, and December 31, 2022, the Company had the following sources of primary and secondary liquidity (dollars in thousands):

In addition, the Company’s loan-to-deposit ratio was flat at 72% at both June 30, 2023 and December 31, 2022.

At June 30, 2023, and December 31, 2022, the Company had the following sources of primary and secondary liquidity (dollars in thousands):

Primary and secondary liquidity sources

March 31, 2023

June 30, 2023

December 31, 2022

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As CLOs have a rate that resets every 90 days to current rates, the volatility of pricing of these securities is limited and the Company could sell such securities for liquidity at a significantly lower loss than selling lower rate fixed term securities such as US government bonds or municipal bonds.

During the first quarter of 2023, the Bank sold a few CLOs at a modest gain and expects to continue to utilize the CLO portfolio for both interest rate risk management and liquidity purposes.

During the first half of 2023, the Bank sold a few CLOs at a modest gain and expects to continue to utilize the CLO portfolio for both interest rate risk management and liquidity purposes.

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, 2023 and December 31, 2022.

Other sources of liquidity include the brokered deposit market, deposit listing services, and the ability to offer local time-deposit campaigns.

That letter of credit, which is backed by loans pledged to the FHLB by the Company, totaled $125 million at June 30, 2023 and December 31, 2022.

Other sources of liquidity include the brokered deposit market, deposit listing services, Intrafi, 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.

The Company’s primary liquidity ratio and net loans to deposits were 32.4% and 69.0%, respectively, at March 31, 2023, 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, 2023, are also periodically reviewed by Management and the Board.

The Company’s primary liquidity ratio and net loans to deposits were 32.2% and 71.8%, respectively, at June 30, 2023, 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 June 30, 2023, 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.

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Its primary source of funds is dividends from the Bank since the holding company does not conduct regular banking operations.

As of March 31, 2023, the holding company maintained a cash balance of $27.8 million.

As of June 30, 2023, the holding company maintained a cash balance of $18.7 million.

Management anticipates that the holding company has sufficient liquidity to meet its funding requirements for the foreseeable future.

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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.

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.

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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, 2023

March 31, 2022

June 30, 2023

June 30, 2022

Immediate change in Interest Rates (basis points)

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$ Change in Net Interest Income

For the periods ending March 31, 2023 and March 31, 2022, management believes that the Company was liability sensitive, with net income decreasing in a rising and declining rate scenarios.

The shift from being asset sensitive at March 31, 2022 to slightly liability sensitive at March 31, 2023, is primarily due to the change in assumption regarding low cost deposits.

At March 31, 2023, it was assumed that over twelve months, a small portion of low-cost deposits would shift into higher cost deposits thus making the company slightly liability sensitive.

Further, the Company has more variable rate liabilities at March 31, 2023 including overnight borrowings both in Fed Funds purchased and overnight FHLB borrowings and in customer time deposits tied to the prime interest rate.

For the period ending June 30, 2023, management believes that the Company was liability sensitive, with net income decreasing in a rising and declining rate scenarios.

The shift from being asset sensitive at June 30, 2022 to slightly liability sensitive at June 30, 2023, is primarily due to the change in assumption regarding low cost deposits and loan betas.

At June 30, 2023, it was assumed that over twelve months, a small portion of low-cost deposits would shift into higher cost deposits thus making the company slightly liability sensitive.

In addition, based on the magnitude of rate changes, interest rates on new loans did not increase at the rates modeled in 2022 and therefore, the beta on loan yields was lowered in modeling interest rate risk in 2023.

Further, the Company has more variable rate liabilities at June 30, 2023 including overnight borrowings both in Fed Funds purchased and overnight FHLB borrowings and in customer time deposits tied to the prime interest rate.

Any change in interest rate in the model would expect to decrease net interest income.

At March 31, 2023, the Company had $176.8

million in overnight borrowings as compared to none at March 31, 2022.

At March 31, 2022, the Company had $186.4 million in overnight cash held with the Federal Reserve bank as compared to $0.7 million at March 31, 2023.

At June 30, 2023, the Company had $245.2 million in overnight borrowings as compared to none at June 30, 2022.

At June 30, 2022, the Company had $78.7 million in overnight cash held with the Federal Reserve bank as compared to $2.2 million at June 30, 2023.

The change in net interest income is similar for the up 100, 200, 300, and 400 basis point scenarios.

If there were an immediate and sustained upward adjustment of 100 basis points in interest rates, all else being equal, net interest income over the next 12 months is projected to decline by $6.5 million, or 6%, relative to a stable interest rate scenario, with the favorable variance increasing marginally as interest rates rise higher.

If there were an immediate and sustained upward adjustment of 100 basis points in interest rates, all else being equal, net interest income

over the next 12 months is projected to decline by $0.4 million, or .4%, relative to a stable interest rate scenario, with the unfavorable variance increasing as interest rates rise higher.

If there was an immediate downward adjustment of 100 basis points in interest rates, net interest income would drop $2.5 million or a negative variance of 2%.

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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 $2.9 million lower than in our standard simulation.

The most significant impact to net interest income in the net interest income simulations is the reduction or migration of low-cost deposits.

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.

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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, 2023 and 2022, respectively, as the Company’s balance sheet evolves and interest rate and yield curve assumptions are updated.

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 June 30, 2023 and 2022, 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.

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The tables below show estimated changes in the Company’s EVE as modeled under different interest rate scenarios relative to the base case:

March 31, 2023

March 31, 2022

June 30, 2023

June 30, 2022

Immediate change in Interest Rates (basis points)

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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.

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.

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CAPITAL RESOURCES

The Company had total shareholders’ equity of $307.0 million at March 31, 2023, comprised of $111.8 million in common stock, $4.6 million in additional paid-in capital, $246.7 million in retained earnings, and accumulated other comprehensive loss of $56.1 million.

The Company had total shareholders’ equity of $309.6 million at June 30, 2023, comprised of $110.1 million in common stock, $4.9 million in additional paid-in capital, $251.1 million in retained earnings, and accumulated other comprehensive loss of $56.5 million.

At the end of 2022, total shareholders’ equity was $303.6 million.

The increase in equity during the first three months of 2022 is due to net income of $8.8 million, offset by a $3.5 million dividend paid to shareholders, $2.7 million in share repurchases, and a $0.5 million favorable swing in other comprehensive income/(loss) due principally to changes in investment securities' fair value.

The remaining difference is related to stock options exercised and restricted stock compensation recognized during the quarter.

The increase in equity during the first half of 2023 is due to net income of $18.7 million, offset by a $7.0 million dividend paid to shareholders, $6.5 million in share repurchases, and a $0.1 million favorable swing in other comprehensive income/(loss) due principally to changes in investment securities' fair value.

The remaining difference is related to stock options exercised and restricted stock compensation recognized during the first half of 2023.

The Company approved a new share repurchase program on October 20, 2022 (the 2023 Share Repurchase Plan) that was effective upon the expiration of the prior 2021 Share Repurchase Plan on October 31, 2022.

The 2023 Share Repurchase Plan authorizes 630,000 shares to be repurchased and expires on October 31, 2023.

Under the 2023 Share Repurchase Program, there were 146,418 shares repurchased in the first three months of 2023.

Under the 2023 Share Repurchase Program, there were 381,566 shares repurchased in the first half of 2023.

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.

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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.

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.

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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-Q

Item 2. Management’s Discussion and Analysis