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Item 2. Management’s Discussion and Analysis

2023-11-02 compared with 2023-08-03 · 255 added, 268 removed, 493 unchanged (51% of the section changed)

30 unchanged sentences

● risks associated with the multitude of or changes to current and prospective laws and regulations, and related interpretations, to which the Company is and will be subject;

● Our ability to remediate, on a timely basis, our material weakness in our control over financial reporting relating to the call report classification of loans for certain real estate secured loans miscoded.

Risk factors that could cause actual results to differ materially from results that might be implied by forward-looking statements include the risk factors detailed in the Company’s Form 10-K for the fiscal year ended December 31, 2022, and in Item 1A, herein.

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RESULTS OF OPERATIONS SUMMARY

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 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 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.

Third Quarter 2023 compared to Third Quarter 2022

Third quarter 2023 net income was $9.9 million, unchanged from the third quarter of 2022 and $0.68 per diluted share in the third quarter of 2023 as compared to $0.66 per diluted share in the third quarter of 2022.

The Company’s annualized return on average equity was 12.62% and annualized return on average assets was 1.04% for the quarter ended September 30, 2023, compared to 12.84% and 1.13%, respectively, for the same quarter in 2022.

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

● Net interest income decreased $0.8 million or 3%.

This was mostly due to a 33 bp decrease in net interest margin.

There was a $231.9 million increase in average interest-earning assets with an increased yield of 94 bps, however this was more than offset by a $335.4 million increase in interest-bearing liabilities at 184 bps higher cost.

● Noninterest income increased $1.2 million or 17% primarily due to a $0.6 million increase in bank-owned life insurance, $0.3 million in life insurance proceeds and a $0.2 million increase in service charges on deposit accounts.

● Total noninterest expense increased $1.6 million, or 7%, in the third quarter of 2023 as compared to the third quarter of 2022.

Salaries and Benefits were $1.1million, or 10%, higher in the third quarter of 2023 as compared to the third quarter of 2022 as we added new lending teams and certain management staff, and other noninterest expense increased $0.5 million, primarily driven by a $0.6 million unfavorable variance in directors deferred compensation expense, linked to the changes in BOLI income, higher FDIC assessment costs, increased marketing costs associated with a deposit acquisition campaign and elevated debit card losses.

These increased expenses were partially offset by lower costs in core processing, debit card processing and ATM network costs.

First Nine Months 2023 compared to First Nine Months of 2022

Net income for the first nine months of 2023 was $28.6 million, or $1.93 per diluted share, compared to $26.5 million, or $1.76 per diluted share for the same period in 2022.

The Company’s annualized return on average equity was 12.41% and annualized return on average assets was 1.03% for the nine months ended September 30, 2023, compared to a return on equity of 10.98% and return on assets of 1.03% for the nine months ended September 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.

● The provision for credit losses was $0.2 million, a decrease of $4.0 million due to a decrease in specific reserves on individual loans as well as lower net loan charge-offs.

● Net interest income increased $4.3 million or 5%.

The increase is primarily due to rate increases on interest-earning assets which were partially offset by rate increases on both existing and new interest-bearing liabilities.

● Noninterest income decreased by $0.8 million, or 3%.

In 2022 there was a $1.0 million recovery of prior year legal expenses, a $1.0 million gain on the sale of investment securities, and a $3.2 million gain on the sale of other assets with no like corresponding event in 2023.

Positively impacting the first nine months of 2023 there was a $2.8 million positive variance in deferred compensation BOLI and a $0.4 million increase in life insurance proceeds.

● Noninterest expense increased $5.2 million, or 8%, due mostly to the increases in salary expense from annual performance increases along with new commercial and ag loan production teams and a negative variance in

director’s deferred compensation expense which is linked to the favorable changes in bank-owned life insurance income described above.

FINANCIAL CONDITION SUMMARY

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.

September 30, 2023 relative to December 31, 2022

The Company’s assets totaled $3.7 billion at September 30, 2023, an increase of $130.3 million, or 3.8% from December 31, 2022.

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

● Investment securities increased $62.1 million, or 5%, to $1.3 billion primarily due to strategic purchases of high quality AAA and AA rated, collateralized loan obligations and government agency securities.

● Gross loans increased $47.9 million predominantly due to a $42.2 million increase in mortgage warehouse line utilization.

In addition, C&I loans increased, but were partially offset by a decline in Farmland loans due to a foreclosure of a single dairy relationship in early 2023.

● Deposits increased by $23.6 million, or 1%.

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.

The growth in deposits came mostly from a $45.0 million increase in brokered deposits primarily acquired prior to March 2023 as part of the Company’s interest rate risk management and liquidity strategy.

● Short-term borrowings increased $3.7 million to $331.9 million at September 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 nine months of 2023, taken out as a partial on-balance sheet match against longer term production loans.

Total capital of $308.9 million at September 30, 2023 reflects an increase of $5.3 million, or 2%, relative to year-end 2022.

The Company’s regulatory Tier 1 leverage ratio was 10.12% at September 30, 2023 as compared to 10.30% at December 31, 2022.

The increase in equity during the first nine months of 2023 was due to the addition of $28.6 million in net income, offset by a $5.3 million unfavorable swing in accumulated other comprehensive income/loss, due principally to changes in investment securities’ fair value, $8.5 million in share repurchases, and $10.4 million in dividends paid.

The remaining difference is related to the impact of restricted stock.

EARNINGS PERFORMANCE

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The first is net interest income, which is interest income generated by earning assets less interest expense on deposits and other borrowed money.

The second is noninterest income, which primarily consists of customer service charges and fees but also comes from non-customer sources such as BOLI and investment gains.

The second is noninterest income, which primarily consists of customer service charges and fees but also comes from non-customer sources such as BOLI, equity investments, and investment gains.

The majority of the Company’s noninterest expense is comprised of operating costs that facilitate offering a full range of banking services to our customers.

NET INTEREST INCOME AND NET INTEREST MARGIN

Net interest income 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.

Net interest income was $28.1 million, for the third quarter of 2023, a $0.8 million decrease, or 3% over the third quarter of 2022, but increased $4.3 million, or 5%, to $84.5 million for the first nine months of 2023 relative to the same period in 2022.

Net interest income for the comparative year-to-date periods increased $4.3 million due primarily to the change in mix of interest-earning assets, moderated by an increase in interest rates paid on interest-bearing liabilities.

There was a $64.0 million, or 3% increase in average loan and lease balances yielding 36 basis points higher for the same period, while average investment balances increased $157.0 million yielding 239 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.

Average interest-bearing liabilities increased $333.3 million, of which $47.1 million is an

increase in deposit balances, $174.3 million is overnight or short-term borrowings, while $51.1 million is long term FHLB borrowings.

The cost of interest-bearing liabilities was 171 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.

The net impact of the mix and rate change was a 2 basis point decrease in our net interest margin for the nine-months ending September 30, 2023 as compared to the same period in 2022.

Interest expense was $14.3 million for the third quarter of 2023, an increase of $11.3 million, relative to the third quarter of 2022.

For the first nine months of 2023, compared to the same period in 2022, interest expense increased $30.2 million to $36.1 million.

The significant increase in interest expense is attributable to an unfavorable shift in interest-bearing liabilities and the impact of recent interest rate increases, as the average balance of deposits, including lower cost core deposits decreased $93.2 million while higher cost borrowed funds and wholesale brokered deposits increased by $352.7 million in the third quarter of 2023 as compared to the third quarter of 2022.

For the year-to-date comparisons the increase is attributable to a shift from lower cost transaction accounts to higher cost time accounts as well as an increase in borrowed funds.

For the first nine months of 2023, higher cost customer time deposits increased $218.9 million, wholesale brokered deposits increased $106.6 million and borrowed funds increased $247.5 million, while lower cost or no cost deposits decreased $278.4 million.

Future interest expense could be adversely affected if the shift from lower cost transaction accounts to higher cost accounts continues in the current interest rate environment.

The Company had $1.3 billion in adjustable and variable rate loans and $569.8 million in floating rate collateralized loan obligations, as compared to $414.7 million in floating rate CDs and $35.6 million in floating rate trust preferred securities at September 30, 2023.

$245.3 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 $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 Company continues to offer variable rate CDs which are indexed to prime.

These variable rate CDs increased $85.4 million or 26%, to $414.7 million at September 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 variable rate CDs has increased $14.0 million for the first nine months of 2023 over the first nine months of 2022.

These CDs require a minimum balance and pay a rate that is 375 – 600 basis points below the Wall Street Journal Prime rate, with a 20 basis point minimum rate.

Our net interest margin was 3.30% for the third quarter of 2023, as compared to 3.39% for the linked quarter and 3.63% for the third quarter of 2022.

While the yield of interest-earning assets increased 21 basis points for the third quarter of 2023 as compared to the linked quarter, the cost of interest-bearing liabilities increased 27 basis points for the same period of comparison.

The average balance of interest-earning assets increased $24.7 million for the linked quarter while the increase in interest-bearing liabilities was $9.0 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 shift in deposit balances from lower cost transaction accounts to higher cost time certificates and overnight borrowed funds 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

June 30, 2023

June 30, 2022

September 30, 2023

September 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 $(0.3) million and $0.4 million for the quarters ended June 30, 2023 and 2022, respectively.

Net loan (costs) fees and loan acquisition FMV amortization were $(0.3) million and $0.1 million for the quarters ended September 30, 2023 and 2022, respectively.

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

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(Dollars in Thousands, Unaudited)

For the six months ended

June 30, 2023

June 30, 2022

For the nine months ended

September 30, 2023

September 30, 2022

Rate/Yield (2)

31 unchanged sentences

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.

Net loan (costs) fees and loan acquisition FMV amortization were $(0.7) million and $0.9 million for the nine months ended September 30, 2023 and 2022, respectively.

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

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(dollars in thousands, unaudited)

Three months ended June 30,

Six months ended June 30,

Three months ended September 30,

Nine months ended September 30,

2023 over 2022

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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 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.

The volume variance calculated for the third quarter of 2023 relative to the third quarter of 2022 was an unfavorable $0.8 million;

this is primarily from an unfavorable volume variance of $3.1 million in interest-bearing liabilities, as the average balance of interest-bearing liabilities increased $335.4 million from the comparative quarter.

There was a favorable rate variance of $2.8 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 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;

There was an unfavorable mix variance of $2.8 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 third quarter of 2023 was 3.30%, as compared to 3.63% for the third quarter of 2022.

The volume variance calculated for the first nine months of 2023 relative to the first nine months of 2022 reflects a favorable variance of $0.2 million, a favorable rate variance of $14.6 million, and an unfavorable mix variance of $10.5 million.

There were increases in loan and investment security balances for a favorable volume variance of $6.9 million

which was mostly offset by a $6.7 million increase in interest-bearing liabilities.

There was a positive rate variance on interest-earning assets of $26.1 million for the first nine months of 2023 partially offset by a $11.5 million rate increase in interest-earning liabilities.

The Company’s net interest margin for the first nine months of 2023 was 3.39%, as compared to 3.41% in the first nine months of 2022.

At September 30, 2023, approximately 4% of our total portfolio, or $81.3 million, consists of variable rate loans.

At September 30, 2023, our outstanding fixed rate loans represented 38% of our loan portfolio.

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

67% of these loans (approximately $819.2 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 $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 $100.6 million of these adjustable-rate loans have the ability to reprice in the fourth quarter of 2023, which will have a positive impact on earnings.

Cash balances for the quarterly comparisons have stabilized but for the year-to-date comparison have decreased, which had 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 $23.8 million, an increase of $1.9 million for the third quarter of 2023 as compared to the same period last year, and was $98.9 million lower for the first nine months of 2023 as compared to the same period in 2022.

Overall average investment securities increased by $162.8 million for the third quarter of September 30, 2023, as compared to September 30, 2022, and increased by $255.9 million for the first nine months of 2023 as compared to the same period in 2022.

For the quarter ending September 30, 2023, over the same period for 2022, average non-taxable securities increased $9.1 million and taxable securities increased $153.7 million.

For the first nine months of 2023 over the same period in 2022, average non-taxable securities increased $48.0 million and taxable securities increased $207.9 million.

The overall investment portfolio had a tax-equivalent yield of 5.07% at September 30, 2023, with an average life of 7.07 years and average effective duration of 1.6 years for available-for-sale securities.

Approximately $569.8 million of the investment securities reprice every 90 days and $52.2 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 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 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.

Interest expense was $14.3 million for the third quarter of 2023, an increase of $11.3 million, relative to the third quarter of 2022.

For the first nine months of 2023, compared to the same period in 2022, interest expense increased $30.2 million to $36.1 million.

The significant increase in interest expense is attributable to an unfavorable shift in interest-bearing liabilities and the impact of interest rate increases, as the average balance of deposits, including lower cost core deposits decreased $93.2 million while higher cost borrowed funds and wholesale brokered deposits increased by $352.7 million in the third quarter of 2023 as compared to the third quarter of 2022.

For the year-to-date comparisons the increase is attributable to a shift from lower cost transaction accounts to higher cost time accounts, as well as an increase in borrowed funds.

For the first nine months of 2023, higher cost customer time deposits increased $218.9 million wholesale brokered deposits increased $106.6 million and borrowed funds increased $247.5 million, while lower cost or no cost deposits decreased $278.4 million.

Average noninterest-bearing demand deposits decreased $75.9 million or 7% for the third quarter of 2023 as compared to the third quarter of 2022 and decreased $60.4 million or 5% for the first nine months of 2023 as compared to the first nine months 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 $0.1 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.

The Company recorded a benefit related to a credit loss provision for loans of $0.03 million in the third quarter of 2023 relative to a provision for credit losses on loans of $1.3 million in the third quarter of 2022 and a $0.2 million provision for credit losses on loans in the first nine months of 2023 as compared to $4.2 million in the same period in 2022.

The Company's $1.3 million decrease in the provision for credit losses on loans in the third quarter of 2023 as compared to the third quarter of 2022, and the $4.0 million decrease for the first nine months of 2023 as

compared to the same period in 2022 was favorably impacted by lower charge-offs of loans.

The decrease in net charge-offs in the first nine months of 2023 was primarily related to a single office building loan relationship that was sold at a discount due to an increased risk of default that would have likely led to a prolonged collection period and a single dairy loan relationship.

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 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 Company recorded net loan charge-offs of $0.1 million in the third quarter of 2023 as compared to $0.2 million for the third quarter of 2022 and $0.4 million in the first nine months of 2023 as compared to $4.3 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.

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NONINTEREST INCOME AND NONINTEREST EXPENSE

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:

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

Noninterest Income/Expense

(dollars in thousands, unaudited)

For the three months ended June 30,

For the six months ended June 30,

For the three months ended September 30,

For the nine months ended September 30,

Noninterest income:

24 unchanged sentences

Noninterest Income:

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.

Total noninterest income increased $1.2 million, or 17%, for the quarter ended September 30, 2023, as compared to the same quarter in 2022, and decreased $.08 million, or 3% for the year-to-date period ended September 30, 2023 as compared to the same period in 2022.

Service charges and fees on deposit accounts increased by $0.1 million, or 1%, to $6.1 million in the third quarter of 2023 as compared to the third quarter of 2022.

This service charge income was $0.3 million lower, or 2% in the first nine months of 2023, as compared to the same period in 2022.

These decreases in the quarterly and year-to-date comparisons are primarily due to decreases in ATM and debit card income.

BOLI income increased by $0.6 million for the third quarter of 2023 as compared to the third quarter of 2022, and $2.6 million for the first nine months 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 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.

At September 30, 2023, there was $41.5 million in traditional BOLI policies and $9.9 million in separate account BOLI policies associated with the deferred compensation plans.

In the “other” category of noninterest income there was a $0.5 million increase in the third quarter of 2023 as compared to the third quarter of 2022, and a $2.4 million decrease in the first nine months of 2023 as compared to the same period in 2022.

The quarterly comparison was positively impacted by an increase in life insurance proceeds for $0.3 million, and $0.4 million in quarterly income from an equity investment in an SBA loan fund.

The year-to-date increases were unfavorably impacted by a $1.0 million gain on the sale of debt securities, $3.6 million from gains on the sale of other assets, and the recovery of prior period legal expenses in 2022 with no like sales or recoveries in 2023.

Partially offsetting these 2022 events was year-to-date income from an equity investment in an SBA Loan fund for $1.0 million.

Noninterest Expense:

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.

Total noninterest expense increased by $1.6 million, or 7%, in the third quarter of 2023 relative to the third quarter of 2022, and by $5.2 million, or 8%, for the first nine months of 2023 as compared to the same period in 2022.

Salaries and Benefits were $1.1 million, or 10%, higher in the third quarter of 2023 as compared to the third quarter of 2022 and $2.5 million, or 7%, higher for the first nine months of 2023 compared to the same period in 2022.

The reason for this increase is primarily due to increased salary expense due to the hiring of new lending teams and management staff for both the quarterly and year-to-date comparisons.

There were 487 full-time equivalent employees at September 30, 2023 as compared to 491 at December 31, 2022 and 500 at September 30, 2022.

Occupancy expenses were relatively unchanged for the third quarter and the first nine-months of 2023 as compared to the same periods in 2022.

Other noninterest expense increased $0.5 million, or 6%, for the third quarter 2023 as compared to the third quarter in 2022, and increased $2.7 million, or 13% for the first nine months of 2023 as compared to the same period in 2022.

The variances for the third quarter of 2023 compared to the same period in 2022 was primarily driven by a $0.6 million unfavorable variance in directors deferred compensation expense, linked to the changes in BOLI income, higher FDIC assessment costs, increased marketing costs associated with a deposit acquisition campaign and elevated debit card losses due to a conversion of debit card systems.

These increased expenses were partially offset by lower costs in core processing, debit card processing and ATM network costs.

For the year-over-year comparison, the categories of increase were the same as with the quarterly comparison, along with a $0.2 million decrease in deposit statement costs offset by increased foreclosed asset costs related to the foreclosure and subsequent sale of one large loan relationship in the first quarter of 2023.

PROVISION FOR INCOME TAXES

3 unchanged sentences

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 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.

The Company's provision for income taxes was 25.8% of pre-tax income in the third quarter of 2023 relative to 25.1% in the third quarter of 2022, and 25.3% of pre-tax income for the first nine months of 2023 relative to 26.1% for the same period in 2022.

The change in the effective tax rate for the quarter ended September 30, 2023 as compared to the same quarter in 2022 was due to a decrease in available tax credits.

The change in effective tax rate for the 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 third quarter and first nine months of 2023, the investments associated with the non-qualified deferred compensation plans increased in value, generating non-taxable income for the third quarter, and first nine months of 2023 while decreasing in value in the third quarter and first nine months 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 36% of total assets at June 30, 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 $1.3 billion, or 36% of total assets at September 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.

2 unchanged sentences

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 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.

The expected effective duration was 1.6 years for available-for-sale investments and 6.7 years for held-to-maturity investments at September 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”.

Those securities were transferred at fair market value on the date of the transfer.

The transfer was initiated to reduce the effect of potential future rate increases on the available-for-sale portfolio, mark-to-market, other comprehensive income and equity.

The transfer was initiated to reduce the effect of potential future rate increases on the available-for-sale

portfolio, mark-to-market, other comprehensive income and equity.

See Note 9, Investment Securities for additional information.

2 unchanged sentences

(dollars in thousands, unaudited)

June 30, 2023

September 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 $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.

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 $477.4 million at September 30, 2023 and $183.5 million at December 31, 2022, leaving $0.9 million in unpledged debt securities at September 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 $326.3 million at September 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 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.

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 September 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 September 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 June 30, 2023 or December 31, 2022.

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 September 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 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.

Management did not consider a default, much less a loss on these securities to be a reasonable possibility as of either September 30, 2023 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 September 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 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.

As of both September 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 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.

Following review of the financial metrics available for each of the underlying institutions as of September 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 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.

Following review of financial metrics as of both September 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)

June 30, 2023

September 30, 2023

December 31, 2022

Residential real estate

Commercial real estate

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

Commercial and industrial

Other commercial

Mortgage warehouse lines

2 unchanged sentences

Total loans, net

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.

Gross loans at $2.1 billion, increased $48.2 million during the first nine months of 2023 with an overall 2% change year-to-date.

The net change did have offsetting components with the larger fluctuations being a $42.1 million increase in mortgage warehouse line utilization, a $22.7 million increase in commercial real estate, and a $35.5 million increase in other commercial loans.

Unfavorable larger loan variances include an $18.7 million decrease in residential real estate, a $22.4 million decrease in farmland and an $11.0 million decrease in other construction.

As indicated in the loan roll forward below, new credit extended for the third quarter of 2023 decreased $14.0 million and for the first nine months of 2023 decreased $66.4 million over the same periods in 2022.

For the nine months ended 2023, we had $111.2 million in loan paydowns and maturities, along with a $42.1 million increase in mortgage warehouse line utilization and a $41.7 million decrease in line of credit utilization.

LOAN ROLLFORWARD

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For the three months ended:

For the six months ended:

June 30, 2023

March 31, 2023

June 30, 2022

June 30, 2023

For the nine months ended:

September 30, 2023

June 30, 2023

September 30, 2022

September 30, 2023

September 30, 2022

Gross loans beginning balance

5 unchanged sentences

Gross loans ending balance

(1) Includes $1.6 million from the sale of a performing loan during the second quarter of 2022.

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 and office real estate.

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.

At September 30, 2023 the total regulatory CRE ratio of total CRE over Tier 1 Capital plus allowance was 243%, compared to 243% 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 to 2% of regulatory capital plus allowance for credit losses at September 30, 2023.

Overall committed non-owner occupied commercial real estate is 253% of regulatory capital plus allowance for credit losses and is 13.6% of total commitments at September 30, 2023.

Office real estate loans are 48% of regulatory capital plus allowance for credit losses and are adjustable rates with most rate adjustments occurring beyond two years.

During the next twenty-four months, we have 43 office commercial real estate loans totaling $40.9 million that have scheduled interest rate resets.

1 unchanged sentence

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 $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.

Regarding line utilization, unused commitments, excluding mortgage warehouse and overdraft lines, were $216.8 million at September 30, 2023, compared to $219.7 million at December 31, 2022.

Total utilization excluding mortgage warehouse and overdraft lines was 60% at September 30, 2023 and 59% at December 31, 2022.

Mortgage warehouse utilization was 30% at September 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.

There were nine loans for $0.4 million outstanding at September 30, 2023, compared to fourteen loans for $1.8 million at December 31, 2022.

NONPERFORMING ASSETS

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(dollars in thousands, unaudited)

June 30, 2023

September 30, 2023

December 31, 2022

June 30, 2022

September 30, 2022

Nonperforming Loans:

1-4 family - closed-end

Commercial real estate - owner occupied

Residential real estate

Total Real Estate nonperforming loans

Commercial and industrial

Other commercial

Consumer loans

4 unchanged sentences

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

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.

Total nonperforming assets, comprised of nonaccrual loans and foreclosed assets, decreased by $18.8 million to $0.8 million for the first nine months of 2023.

The Company's ratio of nonperforming loans to gross loans decreased to 0.4% at September 30, 2023 from 0.95% at December 31, 2022.

The decrease resulted from a decrease in non-accrual 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.

There were no foreclosed assets at September 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.

1 unchanged sentence

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

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

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

7 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 $23.0 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.

The Company's allowance for credit losses on loans was $23.1 million both at September 30, 2023, and December 31, 2022, and $23.8 million at September 30, 2022.

The allowance was 1.10% of total loans at September 30, 2023, 1.12% of total loans at December 31, 2022, and 1.18% of total loans at September 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 September 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 $0.6 million for potential credit losses inherent in unused commitments is included in other liabilities at September 30, 2023, down $0.2 million 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.

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For the year ended

September 30,

Average gross loans outstanding during period (1)

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Provision charged to expense

Commercial real estate- non-owner occupied

Commercial real estate

Total real estate

Commercial and industrial

Other commercial

Consumer loans

Residential real estate

Commercial real estate

Other construction/land

1-4 family - closed-end

Commercial real estate- owner occupied

Total real estate

Commercial and industrial

Other commercial

Consumer loans

Net loan charge offs (recoveries)

Net loan charge offs

Balance at end of period

Net charge-offs (recoveries) to average Loans (annualized)

Net charge-offs to average Loans (annualized)

Allowance for credit losses on Loans to gross Loans at end of period

Net loan charge-offs (recoveries) to allowance for credit losses on Loans at end of period

Net loan charge-offs (recoveries) to provision for credit losses on Loans

Net loan charge-offs to allowance for credit losses on Loans at end of period

Net loan charge-offs to provision for credit losses on Loans

(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 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.

The Company’s credit allowance for losses on loans at September 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.

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

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.

Unused commitments to extend credit, which included standby letters of credit, totaled $548.8 million at September 30, 2023 and $895.6 million at December 31, 2022, representing approximately 44% of gross loans outstanding at September 30, 2023 and 44% at December 31, 2022.

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 $254.4 million at September 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 existing lines while increasing the number of lines outstanding.

Unused commitments exclusive of mortgage warehouse lines and overdraft lines of credit, have decreased $2.9 million or 1% for the first nine 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 September 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 $100.8 million at June 30, 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 $100.4 million at June 30, 2023 relative to $72.8 million at December 31, 2022.

The Company’s balance of non-earning cash and due from banks was $88.5 million at September 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 $0.4 million during the first half of 2023, to $22.1 million.

Net premises and equipment decreased by $0.6 million during the first nine months of 2023, to $21.9 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 June 30, 2023, unchanged during the first half of 2023.

Goodwill was $27.4 million at September 30, 2023, unchanged during the first nine months 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 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 $52.7 million at June 30, 2023, is discussed in detail above in the “Noninterest Income and Noninterest Expense” section.

The annual goodwill impairment test was last performed on October 1, 2023, and it was determined that no impairment existed.

Management continues 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 in 2024.

Bank-owned life insurance, with a balance of $51.3 million at September 30, 2023, is discussed in detail above in the “Noninterest Income and Noninterest Expense” section.

DEPOSITS AND INTEREST-BEARING LIABILITIES

Deposits represent another key balance sheet category impacting the Company’s net interest income and profitability metrics.

Deposits provide liquidity to fund growth in earning assets, and the Company’s net interest margin is improved to the extent that growth in deposits is concentrated in less volatile and typically less costly non-maturity accounts such as demand deposit accounts, NOW accounts, savings accounts, and money market demand accounts.

Deposits provide liquidity to fund growth in earning assets, and the Company’s net interest margin is improved

to the extent that growth in deposits is concentrated in less volatile and typically less costly non-maturity accounts such as demand deposit accounts, NOW accounts, savings accounts, and money market demand accounts.

Information concerning average balances and rates paid by deposit type is included in the Average Balances and Rates tables appearing above, in the section titled “Net Interest Income and Net Interest Margin.” A distribution of the Company’s deposits by type, showing the period-end balance and percentage of total deposits, is presented as of the dates indicated in the following table.

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(dollars in thousands, unaudited)

June 30, 2023

September 30, 2023

December 31, 2022

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Total deposits

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%;

Deposit balances grew by $23.6 million, or 1%, during the first nine months of 2023 to $2.9 billion at September 30, 2023.

Core non-maturity deposits decreased $173.6 million, or 7%, for the first nine months of 2023, while customer time deposits increased by $152.1 million, or 38% due mostly to an increase in variable rate CD accounts by existing customers seeking higher interest rates on their deposits.

Brokered deposits increased $45.0 million during the first nine months of 2023, or 38%;

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

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 noninterest-bearing deposits as a percent of total deposits decreased to 36.9% at September 30, 2023, compared to 38.2% at December 31, 2022, and from 38.8% at September 30, 2022.

Overall uninsured deposits are estimated to be approximately $830.3 million, or 29% of total deposit balances, excluding public agency deposits that are subject to collateralization through a letter of credit issued by the FHLB.

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

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.

At September 30, 2023, the Company had approximately 121,000 accounts and the 25 largest deposit balance customers had balances of approximately 12% of overall deposits .

During the second and third quarters 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

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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.

Total non-deposit interest-bearing liabilities increased by $83.9 million, during the first nine months of 2023 primarily due to an 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 declined from $109.2 million at December 31, 2022 to $94.9 million at September 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 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.

Overnight and short-term borrowings increased $18.0 million to $237.0 million at September 30, 2023 from $219.0 million at December 31, 2022 and consist of overnight borrowings from correspondent banks and the FHLB, and short-term FHLB borrowings.

Long-term debt at September 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.

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

Trust preferred securities are variable rate instruments benchmarked against the Secured Overnight Financing Rate (SOFR).

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 $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.

The Company’s balance of other liabilities was $62.9 million at September 30, 2023 as compared to $45.1 million at December 31, 2022, an increase of $17.8 million or 39%.

The increase was primarily driven by ICS transactions that have not settled as of September 30, 2023.

LIQUIDITY AND MARKET RISK MANAGEMENT

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

In addition, the Company’s loan-to-deposit ratio was 73% at September 30, 2023 and 72% at December 31, 2022.

Liquidity management refers to the Company’s ability to maintain cash flows that are adequate to fund operations and meet other obligations and commitments in a timely and cost-effective manner.

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The Company, on occasion, experiences cash needs as the result of loan growth, deposit outflows, asset purchases or liability repayments.

To meet these short-term needs, we can borrow overnight funds from other financial institutions,

draw advances via Federal Home Loan Bank lines of credit, or solicit brokered deposits if customer deposits are not immediately obtainable from local sources.

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

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):

To meet these short-term needs, we can borrow overnight funds from other financial institutions, draw advances via Federal Home Loan Bank lines of credit, or solicit brokered deposits if customer deposits are not immediately obtainable from local sources.

At September 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

June 30, 2023

September 30, 2023

December 31, 2022

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Funds available through fed discount window

The Company did not participate in the new Federal Reserve Bank Term Funding Program.

The Company did not participate in the Federal Reserve Bank Term Funding Program in 2023.

Unpledged investment securities include $290.5 million of CLOs.

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 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.

During the first nine months 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 June 30, 2023 and December 31, 2022.

That letter of credit, which is backed by loans pledged to the FHLB by the Company, totaled $125 million at September 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 32.2% 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’s primary liquidity ratio and net loans to deposits were 31.5% and 71.8%, respectively, at September 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 September 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 June 30, 2023, the holding company maintained a cash balance of $18.7 million.

As of September 30, 2023, the holding company maintained a cash balance of $14.7 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.

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.

Our market risk exposure is primarily that of interest rate risk, and we have established policies and procedures to monitor and limit our earnings and balance sheet exposure to changes in interest rates.

The principal objective of interest rate risk management is to manage the financial components of the Company’s balance sheet in a manner that will optimize the risk/reward equation for earnings and capital under a variety of interest rate scenarios.

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The model imports relevant information for the Company’s financial instruments and incorporates Management’s assumptions on pricing, duration, and optionality for anticipated new volumes.

Assumptions regarding deposit betas in the up cycles can range from 25 to 100% and from 0 to 50% in the down cycles depending on the deposit type.

Deposit decay rate assumptions range from 5 to 10% and are based on historical averages.

Prepayment speeds are based on three year historical averages.

Various rate scenarios consisting of key rate and yield curve projections are then applied in order to calculate the expected effect of a given interest rate change on interest income, interest expense, and the value of the Company’s financial instruments.

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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:

June 30, 2023

June 30, 2022

September 30, 2023

September 30, 2022

Immediate change in Interest Rates (basis points)

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$ Change in Net Interest Income

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.

For the period ending September 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 September 30, 2022 to slightly liability sensitive at September 30, 2023, is primarily due to the change in assumptions regarding low cost deposits and loan betas.

The base scenarios utilize a dynamic balance sheet based on expected growth.

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

Thus, as rates increase, more deposits will shift into higher-cost deposits.

In addition, based on the magnitude of rate changes, interest rates on new loans did not increase at the rates modeled in 2022.

To address this, the beta on loan yields was lowered in modeling interest rate risk in 2023, which has the impact of lowering the effect of future rate increases on interest income.

Further, the Company has more variable rate liabilities at September 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 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.

At September 30, 2023, the Company had $331.9 million in overnight and short term borrowings as compared to $215.1 million at September 30, 2022.

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 $0.4 million, or .4%, relative to a stable interest rate scenario, with the unfavorable variance increasing 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 $0.5 million, or 0.4%, 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 $3.9 million or a negative variance of 3%.

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As a significant portion of the Company’s deposits remain in noninterest-bearing accounts or low-cost deposit accounts, in a down rate scenario, these rates would not change or only change slightly.

However, floating rate earning assets (loans and deposits) would reprice downward more than the decline in floating rate liabilities.

All interest rate shock scenarios are within our internal policy guidelines, and we will continue to monitor our interest rate risk profile and implement remedial changes if deemed appropriate.

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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 June 30, 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 September 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 longer the duration of the financial instrument, the greater the impact a rate change will have on its value.

In our economic value simulations, estimated prepayments are factored in for financial instruments with stated maturity dates, and decay rates for non-maturity deposits are projected based on historical patterns and Management’s best estimates.

Our EVE decreased in the past twelve months primarily from an increase in decay rates on certain non-maturity deposit accounts which significantly lowered the deposit values.

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

June 30, 2023

June 30, 2022

September 30, 2023

September 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 $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.

The Company had total shareholders’ equity of $308.9 million at September 30, 2023, comprised of $109.6 million in common stock, $4.9 million in additional paid-in capital, $227.6 million in retained earnings, and accumulated other comprehensive loss of $61.9 million.

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

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 increase in equity during the first nine months of 2023 is due to net income of $28.6 million, offset by a $10.4 million dividend paid to shareholders, $8.5 million in share repurchases, and a $5.3 million unfavorable swing in other comprehensive income/(loss) due principally to changes in investment securities' fair value.

The remaining difference is related to stock options and restricted stock during the first nine months 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 381,566 shares repurchased in the first half of 2023.

Under the 2023 Share Repurchase Program, there were 481,094 shares repurchased in the first nine months 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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Regulatory Capital Ratios

September 30,

Community 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.

A qualifying community banking organization that opts into

the community bank leverage ratio framework and maintains a leverage ratio greater than 9 percent will be considered to have met the minimum capital requirements, the capital ratio requirements for the well capitalized category under the Prompt Corrective Action framework, and any other capital or leverage requirements to which the qualifying banking organization is subject.

A qualifying community banking organization with a leverage ratio of greater than 9 percent may opt into the community bank leverage ratio framework if has average consolidated total assets of less than $10 billion, has off-balance-sheet exposures of 25% or less of total consolidated assets, and has total trading assets and trading liabilities of 5 percent or less of total consolidated assets.

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The final rule became effective January 1, 2020 and banks that meet the qualifying criteria can elect to use the community bank leverage framework starting with the quarter ended March 31, 2020.

The CARES Act reduced the required community bank leverage ratio to 8% until the earlier of December 31, 2020, or the national emergency is declared over.

Beginning in 2021 the CBLR was increased to 8.5% for the calendar year with the CBLR increasing to 9% on January 1, 2022.

The federal bank regulatory agencies adopted an interim final rule to implement this change from the CARES Act.

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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