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Item 2. Management’s Discussion and Analysis

2024-05-06 compared with 2023-11-02 · 213 added, 348 removed, 400 unchanged (58% of the section changed)

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They include, but are not limited to:

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

● risks associated with fluctuations in interest rates, including the impact on other comprehensive income, the ability for customers to repay on floating or adjustable rates loans, and the impact on costs and demand of deposits and funding, the impact on interest income on earning assets, the impact on valuations of collateral on our loans, and the impact on fair value of longer-term assets;

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

● the risk of unfavorable economic conditions in the Company’s market areas, or the impact on the Company’s market areas of national or international economic conditions;

● liquidity risks, including the ability to effectively manage the potential loss of deposits, the ability to maintain funding lines of credit;

and the loss of value of unencumbered investment securities;

● liquidity risks, including the ability to effectively manage the potential loss of deposits, the ability to maintain funding lines of credit, and the loss of value of unencumbered investment securities;

● increases in nonperforming assets and credit losses that could occur, particularly in times of weak economic conditions or rising interest rates;

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

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

● operational risks including the ability to detect and prevent errors and fraud;

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

● operational risks including the ability to detect and prevent financial reporting errors, operations errors, and fraud;

● the Company’s ability to diversify and grow its loan portfolio;

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● the Company’s ability to successfully deploy new technology and manage cyber security risks;

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

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

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● the success of acquisitions or branch expansions, closures or consolidations.

● 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, 2023, and in Item 1A, herein.

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RESULTS OF OPERATIONS SUMMARY

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 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.

First Quarter 2024 compared to First Quarter 2023

First quarter 2024 net income was $9.3 million, a $0.6 million increase or 7%, from the first quarter of 2023 and $0.64 per diluted share in the first quarter of 2024 as compared to $0.58 per diluted share in the first quarter of 2023.

The Company’s annualized return on average equity was 11.09% and annualized return on average assets was 1.06% for the

quarter ended March 31, 2024, compared to 11.53% and 0.97%, respectively, for the same quarter in 2023.

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

● Net income for the first quarter of 2024 increased $0.6 million, or 7%, to $9.3 million due primarily to an increase in net interest income of $0.6 million.

Additionally, the favorable change in the credit loss expense on loans and improvements in noninterest income, were mostly offset by higher noninterest expenses.

● The $0.6 million increase in net interest income for the quarter was driven by a 15 basis point increase in the net interest margin due to higher yields on investments and lower costs of borrowings, partially offset by higher deposit costs.

● Noninterest income for the first quarter of 2024 as compared to the same period in 2023 increased $2.0 million or 31%.

There was a favorable variance of $1.0 million in bank owned life insurance (BOLI), a gain on the sale/leaseback of two bank owned branch buildings for $3.8 million, increases in service charges and fees on deposit accounts for $0.3 million or 6%, offset by a loss on the sale of bonds from a balance sheet restructure for $2.9 million.

● Total noninterest expense increased $1.5 million, or 7%, in the first quarter of 2024 as compared to the first quarter of 2023.

Salaries and Benefits were $0.4 million, or 3%, higher in the first quarter of 2024 as compared to the first quarter of 2023 due to several factors, including merit increases for employees due to annual performance evaluations during the first quarter of 2024, higher payroll taxes in the first quarter.

Occupancy expense was up $0.7 million for the first quarter of 2024 as compared to the same quarter last year, due to increased rent expense from the sale/leaseback transaction in December 2023.

Other noninterest expense increased $0.5 million, or 6%, in the first quarter of 2024 as compared to the first quarter of 2023.

The primary reason for the negative variance was increased directors deferred compensation expense which is linked to the fluctuation in BOLI income although lower advertising expenses in the comparative period mitigated some of this negative variance.

FINANCIAL CONDITION SUMMARY

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.

March 31, 2024 relative to December 31, 2023

The Company’s assets totaled $3.6 billion at March 31, 2024, a decrease of $176.7 million, or 5.0% from December 31, 2023.

The following provides a summary of key balance sheet changes during the first three months of 2024:

● Investment securities decreased $281.1 million, or 21.0%, to $1.1 billion primarily due to the sale of bonds from the strategic securities transaction and balance sheet restructuring.

● Gross loans increased $66.8 million due to an $87.6 million increase in mortgage warehouse line utilization.

● Deposits increased by $85.8 million, or 3%.

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.

The growth in deposits came from brokered deposits, as overall customer deposits decreased $50.9 million.

● Other borrowings decreased $280.5 million to $80.0 million at March 31, 2024, from $360.5 million at December 31, 2023, and consists of term FHLB advances.

The decline in other borrowings is due mostly to a balance sheet restructuring in which the Company sold bonds with an average book yield of 2.61% to paydown borrowed funds at an average rate of 5.52%.

Total capital of $345.1 million at March 31, 2024, reflects an increase of $7.0 million, or 2%, compared to December 31, 2023.

The increase in equity during the first quarter of 2024 is due to net income of $9.3 million, offset by a $3.4 million dividend paid to shareholders, $3.3 million in share repurchases and a $4.1 million favorable swing in other comprehensive income due principally to changes in investment securities’ fair value.

The remaining difference is related to equity compensation recognized during the quarter.

EARNINGS PERFORMANCE

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NET INTEREST INCOME AND NET INTEREST MARGIN

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 $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 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 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 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.

Net interest income was $28.7 million for the first quarter of 2024 an increase of $0.6 million, or 2%, as compared to the first quarter of 2023.

For the first quarter of 2024 as compared to the same quarter in 2023, the $3.5 million improvement in interest income is due primarily to a $56.8 million increase in average loan balances, as well as a 39 basis point increase in yield.

However, this was partially offset by a $3.0 million increase in interest expense due to the movement of deposits from lower cost transaction accounts to higher cost time deposits including wholesale brokered deposits.

Deposit costs increased 82 basis points in the first quarter of 2024 as compared to the same quarter in 2023, while there was a 35 basis points decrease in the cost borrowed funds.

The net impact of the mix and rate change was a 15 basis point increase in our net interest margin for the quarterly comparison.

Interest expense was $12.2 million for the first quarter of 2024, an increase of $3.0 million, or 32% from the same period in 2023.

The unfavorable change in the quarterly comparison was primarily due an increase in rates paid on customer variable rate Certificates of Deposits.

The rate on the variable account is tied to a spread to the Wall Street Journal Prime Rate and varies from Prime minus 600 basis points to Prime minus 375 basis points.

During the twelve-month period from March 31, 2023, to March 31, 2024, the Prime rate increased 50 basis points.

The Company had $1.5 billion in adjustable and variable rate loans and $563.6 million in floating rate collateralized loan obligations, as compared to $332.3 million in floating rate CDs and $35.7 million in floating rate trust preferred securities at March 31, 2024.

The adjustable rate loans have repricing frequencies ranging from 30-days to 10-years.

Of the $1.5 billion in adjustable and variable rate loans, $471.8 million of such adjustable and variable rate loans reprice in the next twelve months.

Our net interest margin was 3.62% for the first quarter of 2024, as compared to 3.47% for the quarter ending March 31, 2023.

While the yield on interest-earning assets increased 55 basis points for the first quarter of 2024 as compared to the same period in 2023, the cost of interest-bearing liabilities increased 61 basis points for the same period of comparison.

Since the change in rate on interest-bearing assets is applied to a larger base than that of interest-bearing liabilities, the result is favorable to the net interest margin even though the increase on the interest-earning asset side is six basis points lower than the increase on the interest bearing liability side.

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

September 30, 2023

September 30, 2022

March 31, 2024

March 31, 2023

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 $0.1 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.

(5) Net interest margin represents net interest income as a percentage of average interest-earning assets.

Average Balances and Rates

(Dollars in Thousands, Unaudited)

For the nine months ended

September 30, 2023

September 30, 2022

Rate/Yield (2)

Interest-earning due from banks

Total investments

Mortgage warehouse lines

Total interest-earning assets (4)

Other earning assets

Non-earning assets

Liabilities and shareholders' equity

Interest-bearing deposits:

Demand deposits

Savings accounts

Time Deposits

Brokered deposits

Total interest-bearing deposits

Borrowed funds:

Repurchase agreements

Other borrowings

Long-term debt

Subordinated debentures

Total borrowed funds

Total interest-bearing liabilities

Demand deposits - noninterest-bearing

Other liabilities

Shareholders' equity

Total liabilities and shareholders' equity

Interest income/interest-earning assets

Interest expense/interest-earning assets

Net interest income and margin (5)

(1) Average balances are obtained from the best available daily or monthly data and are net of deferred fees and related direct costs.

(2) Yields and net interest margin have been computed on a tax equivalent basis utilizing a 21% effective federal tax rate.

(3) Loans are gross of the allowance for possible loan losses.

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

Net loan (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.

Net loan (costs) fees and loan acquisition FMV amortization were $(0.3) million and $(0.1) million for the quarters ended March 31, 2024 and 2023, 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 September 30,

Nine months ended September 30,

2023 over 2022

Three months ended March 31,

2024 over 2023

Increase (decrease) due to

Federal funds sold/due from time

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

The volume variance calculated for the 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.

The volume variance calculated for the first quarter of 2024 relative to the first quarter of 2023 was an unfavorable $0.2 million;

this is primarily from an unfavorable volume variance of $0.6 million in interest-bearing liabilities, as the average balance of time deposits increased $143.3 million from the comparative quarter.

There was a favorable rate variance of $1.7 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 $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 $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.

There was an unfavorable mix variance of $0.9 million primarily from the sale of bonds with lower yields that has yet to be deployed into higher yielding assets.

The Company’s net interest margin for the first quarter of 2024 was 3.62%, as compared to 3.47% for the first quarter of 2023.

At March 31, 2024, approximately 13% of our total portfolio, or $276.0 million, consists of variable rate loans.

At March 31, 2024, our outstanding fixed rate loans represented 32% of our loan portfolio.

The remaining 55% of our loan portfolio at March 31, 2024, consists of adjustable-rate loans;

63% of these loans (approximately $1.2 billion) will not have the ability to reprice for at least another 3 years.

Our adjustable rate loans have maturities up to 25 years and are generally adjustable every five years after the initial adjustment, which can vary from 5 to 10 years to initial adjustment.

Approximately $165.8 million of these adjustable-rate loans have the ability to reprice in 2024, which is expected to have a positive impact on earnings.

Interest earning cash balances for the quarterly comparisons have increased, which had a positive impact on our net interest margin since cash balances have yielded 5.75%.

Average interest earning cash and due from banks was $17.0 million, an increase of $11.7 million for the first quarter of 2024 as compared to the same period last year.

Overall average investment securities decreased by $195.2 million for the first quarter of March 31, 2024, as compared to March 31, 2023, from the sale of lower yielding bonds from a strategic securities transaction, the proceeds of which were used to paydown higher cost borrowings.

The overall investment portfolio had a tax-equivalent yield of 5.48% at March 31, 2024, with an average life of 5.85 years and average effective duration of 0.6 years for available-for-sale securities.

Approximately $563.6 million of the investment securities reprice every 90 days and $54.7million are subordinated debt with an initial fixed rate period of 5 years and floating thereafter.

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.

Interest expense was $12.2 million for the first quarter of 2024, an increase of $3.0 million, or 32% from the same period in 2023.

The unfavorable variance in the quarterly comparison was primarily due an increase in rates paid on customer variable rate Certificates of Deposits.

The rate on the variable account is tied to a spread to the Wall Street Journal Prime Rate and varies from Prime minus 600 basis points to Prime minus 375 basis points.

During the twelve-month period from March 31, 2023, to March 31, 2024, the Prime rate increased 50 basis points.

Average noninterest-bearing demand deposits decreased $80.4 million or 8% for the first quarter of 2024 as compared to the first quarter of 2023.

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 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.

The Company recorded a provision for credit losses of $0.1 million in the first quarter of 2024, as compared to $0.3 million in the first quarter of 2023.

The decrease in provision in the first quarter of 2024 as compared to the same quarter in 2023 was a result of reduced quantitative reserves from an improved economic forecast coupled with lower loan balances in most categories.

Some of the calculated reserve reduction was offset by higher net loan charge-offs;

however the overall reserve for credit losses was $0.05 million higher at March 31, 2024, as compared to March 31, 2023.

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 $0.1 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 Company recorded net loan charge-offs of $0.5 million in the first quarter of 2024 as compared to $0.2 million for the first quarter of 2023.

The Company's $0.2 million decrease in the provision for credit losses on loans in the first quarter of 2024 as compared to the first quarter of 2023 was primarily due to the impact of reduced net loan charge-offs in the first quarter of 2023.

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.

The Company’s policies for monitoring the adequacy of the allowance, determining loan balances that should be charged off, and other detailed information with regard to changes in the allowance are discussed in Note 10 to the consolidated financial statements, and below, under “Allowance for Credit Losses.” The process utilized to establish an appropriate credit allowance for losses on loans can result in a high degree of variability in the Company’s credit loss provision, and consequently in our net earnings.

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

NONINTEREST INCOME AND NONINTEREST EXPENSE

The following table provides details on the Company’s noninterest income and noninterest expense for the three and nine-month periods ended September 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 March 31, 2024, and 2023:

Noninterest Income/Expense

(dollars in thousands, unaudited)

For the three months ended September 30,

For the nine months ended September 30,

For the three months ended March 31,

Noninterest income:

Service charges and fees on deposit accounts

Net gains on sale of securities available-for-sale

Net (loss) gain on sale of securities available-for-sale

Gain on sale of fixed assets

Bank-owned life insurance

Realized gain on available-for-sale securities

Total noninterest income

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Noninterest Income:

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.

Total noninterest income increased by $2.0 million, or 31%, in the first quarter of 2024 as compared to the same quarter in 2023.

The variance was due to a $3.8 million gain on the sale of branch properties that were a part of our sale/leaseback transaction, a $1.0 million increase in BOLI income, a $0.3 million increase in service charges and fees on deposit accounts partially offset by a $2.9 million loss on the sale of lower yielding bonds that were part of a balance sheet restructure.

BOLI income increased by $1.0 million for the first quarter of 2024 as compared to the first quarter of 2023.

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 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.

At March 31, 2024, there was $41.9 million in traditional BOLI policies and $11.0 million in separate account BOLI policies associated with the deferred compensation plans.

In the “other” category of noninterest income there was a $0.3 million decrease in the first quarter of 2024 as compared to the first quarter of 2023.

The quarterly comparison was negatively impacted by a decrease in life insurance proceeds and a decrease in OREO rental income, as all OREO properties were sold.

Noninterest Expense:

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.

Total noninterest expense increased $1.5 million, or 7%, compared to the first quarter of 2023.

The primary driver of higher expense in the first quarter of 2024 is deferred directors’ fees as part of the Company’s deferred compensation plan.

The higher deferred compensation expense was offset by higher bank-owned life insurance income.

Salaries and Benefits were $0.4 million, or 3%, higher in the first quarter of 2024 as compared to the first quarter of 2023.

The reason for this increase is primarily due to several factors, including merit increases for employees due to annual performance evaluations during the first quarter of 2024, higher payroll taxes in the first quarter.

There were 487 full-time equivalent employees at March 31, 2024, as compared to 500 at March 31, 2023.

Occupancy expense was up $0.7 million for the first quarter of 2024 as compared to the same quarter last year.

The reason for the increase is mostly due to increased rent expense from the sale/leaseback transaction in December 2023.

Other noninterest expense increased $0.5 million, or 6%, in the first quarter of 2024 as compared to the first quarter of 2023.

The primary reason for the negative variance was increased directors deferred compensation expense which is linked to the fluctuation in BOLI income and increased FDIC assessment costs, although lower foreclosed asset operating costs and lower advertising expenses in mitigated some of this negative variance.

PROVISION FOR INCOME TAXES

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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 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.

The Company's provision for income taxes was 26.3% of pre-tax income in the first quarter of 2024 relative to 23.6% in the first quarter of 2023.

The change in the effective tax rate for the quarter ended March 31, 2024, as compared to the same quarter in 2023 was due to tax credits and tax-exempt income representing a smaller percentage of total taxable income.

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 $1.3 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.

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

The investment portfolio is reflected on the balance sheet as investment securities and totaled $1.1 billion, or 30% of total assets at March 31, 2024, and $1.3 billion, or 36% of total assets at December 31, 2023.

The increase was due to the sale of bonds from the strategic securities transaction.

The bonds sold had an average book yield of 2.61% and were used to paydown borrowed funds at an average rate of 5.52%.

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

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

The expected effective duration was 1.6 years for available-for-sale investments and 6.7 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.

See Note 9, Investment Securities for additional information.

The expected effective duration was 0.6 years for available-for-sale investments and 6.0 years for held-to-maturity investments at March 31, 2024, as compared to 1.6 years for available-for-sale investments and 6.7 years for held-to-maturity investments at December 31, 2023.

The following table sets forth the carrying amount for available-for-sale securities, at fair value, and held-to-maturity securities, at amortized cost, net of the allowance for credit losses of the Company’s investment portfolio by investment type as of the dates noted:

1 unchanged sentence

(dollars in thousands, unaudited)

September 30, 2023

March 31, 2024

December 31, 2023

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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 $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.

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 $492.5 million at March 31, 2024, and $543.9 million at December 31, 2023, leaving $555.8 million in unpledged debt securities at March 31, 2024, and $793.0 million at December 31, 2023.

Securities that were pledged in excess of actual pledging needs and were thus available for liquidity purposes, if needed, totaled $316.9 million at March 31, 2024, and $383.0 million at December 31, 2023.

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 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 September 30, 2023 or December 31, 2022.

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 March 31, 2024 and December 31, 2023 that it was not more likely than not that any of the securities in an unrealized loss position would be required to be sold.

The following bullets outline additional support for management’s conclusion that no amount of the unrealized loss of the securities in an unrealized loss position as of March 31, 2024 and December 31, 2023, 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 creditworthiness 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 March 31, 2024, or December 31, 2023.

● 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 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.

Management did not consider a default, much less a loss on these securities to be a reasonable possibility as of either March 31, 2024, or December 31, 2023.

● Management routinely monitors third party credit grades of the municipal issuers in the Company’s state and political subdivisions portfolio and as of both March 31, 2024, or December 31, 2023 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 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.

As of both March 31, 2024 or December 31, 2023 management concluded that no allowance for credit losses was warranted on any of the Company’s municipal securities and the unrealized loss position of each of the securities reflected fluctuations in market conditions, primarily interest rates, since the time of purchase.

● 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 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.

Following review of the financial metrics available for each of the underlying institutions as of March 31, 2024 or December 31, 2023 management concluded that the unrealized loss position of these securities related exclusively to the fluctuation in market conditions, primarily interest rates, from the date of purchase, and were not reflective of any credit concerns with the issuing financial institution.

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 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.

Following review of financial metrics as of both March 31, 2024 or December 31, 2023 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)

September 30, 2023

March 31, 2024

December 31, 2023

6 unchanged sentences

Consumer loans

Allowance for credit losses on loans

Total loans, net

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.

Gross loans at $2.2 billion, increased $66.8 million or 3% during the first three months of 2024.

There was an $87.6 million increase in mortgage warehouse line utilization, offset by unfavorable loan variances in all other loan categories, the largest of which were a $12.8 million decrease in other commercial loans and $5.6 million decrease in residential real estate.

As indicated in the loan rollforward below, new credit extended for the first quarter of 2024 decreased $17.6 million over the same period in 2023 but increased $8.3 million for the linked quarter comparisons.

For the first three months ended 2024 we had $30.8 million in loan paydowns and maturities, along with a $24.9 million decrease in line of credit utilization, counterbalanced by an $87.6 million increase in mortgage warehouse utilization.

LOAN ROLLFORWARD

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For the three months ended:

For the nine months ended:

September 30, 2023

June 30, 2023

September 30, 2022

September 30, 2023

September 30, 2022

March 31, 2024

December 31, 2023

March 31, 2023

Gross loans beginning balance

New credit extended

Loan purchases

Changes in line of credit utilization

2 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 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.

The Bank’s practice is to make commercial real estate loans with an “at origination” loan-to-value of 65% or lower using conservative underwriting standards.

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 $216.8 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.

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

At March 31, 2024, the total regulatory CRE concentration ratio of total CRE over Tier 1 Capital plus allowance was 248%.

Further, the overall level of construction and land development lending had declined to 1% of regulatory capital plus allowance for credit losses at March 31, 2024.

At March 31, 2024, our non-owner occupied commercial real estate includes $304 million of retail;

$155 million of warehouse/industrial, $186 million of office;

and $182 million of hospitality.

Approximately 5% of the office real estate matures in less than two years.

Line utilization, unused commitments, excluding mortgage warehouse and overdraft lines, were $234.4 million at March 31, 2024, compared to $203.6 million at December 31, 2023.

Total utilization excluding mortgage warehouse and overdraft lines was 58% at March 31, 2024, compared to 53% at December 31, 2023.

Mortgage warehouse utilization was 50% at March 31, 2024, compared to 36% at December 31, 2023.

The increase in mortgage warehouse utilization during the first quarter of 2024 was due to new customers in the mortgage warehouse product that ramped up their utilization.

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 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

2 unchanged sentences

(dollars in thousands, unaudited)

September 30, 2023

March 31, 2024

December 31, 2023

September 30, 2022

March 31, 2023

Nonperforming Loans:

Residential real estate

Commercial real estate

Other construction/land

Total Real Estate nonperforming loans

6 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 $18.8 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 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.

Total nonperforming assets, comprised of non-accrual loans and foreclosed assets, increased by $6.2 million, or 78%, during the first quarter of 2024.

The increase resulted from an increase in non-accrual loans, primarily as a result of one dairy industry real estate secured loan.

This loan was written down by $0.4 million and no further allowance for credit losses was deemed necessary on this loan.

The Company's ratio of nonperforming assets to loans plus foreclosed assets increased to 0.66% at March 31, 2024, from 0.38% at December 31, 2023, due primarily to the one dairy loan previously mentioned.

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

There were no foreclosed assets at March 31, 2024, and December 31, 2023, 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.

An action plan is in place for each of our non-accruing loans and they are all being actively managed.

Collection efforts are continuously pursued for all nonperforming loans, but we cannot provide assurance that they will be resolved in a timely manner or that nonperforming balances will not increase.

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

The Company had $0.8 million in loans past due 30-89 days at March 31, 2024.

This is a decrease of $1.3 million over the balance at December 31, 2023.

5 unchanged sentences

recoveries are generally recorded only when sufficient cash payments are received subsequent to the charge off.

Due to the uncertainty of national and local economic conditions, the Company deferred implementation of the CECL accounting method under Financial Accounting Standards Board (FASB) Accounting Standards Update 2016-03 and related amendments, Financial Instruments – Credit Losses (Topic 326) under section 4014 of the CARES Act.

The Company implemented CECL on January 1, 2022, and recorded a $10.4 million increase in the allowance for credit losses, which included a $0.9 million reserve for unfunded commitments as an adjustment to equity, net of deferred taxes.

The Company's allowance for credit losses on loans was $23.1 million 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.

The Company's allowance for credit losses on loans was $23.1 million at March 31, 2024, and $23.5 million at December 31, 2023.

The allowance was 1.07% of total loans at March 31, 2024, and 1.12% of total loans at December 31, 2023.

Management's detailed analysis indicates that the Company's allowance for credit losses on loan should be sufficient to cover credit losses for the life of the loans outstanding as of March 31, 2024, 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 March 31, 2024, down $0.1 million from December 31, 2023.

The following table summarizes activity in the credit allowance for losses on loans for the noted periods:

4 unchanged sentences

For the year ended

September 30,

Average gross loans outstanding during period (1)

2 unchanged sentences

Balance at beginning of period

Adoption of ASC 326

Provision charged to expense

Residential real estate

Commercial real estate

4 unchanged sentences

Commercial real estate

Other construction/land

Total real estate

8 unchanged sentences

(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 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.

The Company’s allowance for credit losses on loans at March 31, 2024 represents Management’s best estimate of expected losses in the loan portfolio as of that date, but no assurance can be given that the Company will not experience substantial

losses relative to the size of the allowance.

Furthermore, fluctuations in credit quality, changes in economic conditions, updated accounting or regulatory requirements, and/or other factors could induce us to augment or reduce the allowance.

2 unchanged sentences

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

Unused commitments to extend credit, which included standby letters of credit, totaled $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.

Unused commitments to extend credit, which included standby letters of credit, totaled $440.9 million at March 31, 2024, and $408.1 million at December 31, 2023, representing approximately 21% of gross loans outstanding at March 31, 2024, and 20% at December 31, 2023.

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

Unused commitments on mortgage warehouse lines were $206.4 million at March 31, 2024, and $204.5 million at December 31, 2023, while utilization was 50% and 36% respectively.

The increase in utilization during the first quarter of 2024 was due to new customers in the mortgage warehouse product that ramped up their utilization.

Unused commitments exclusive of mortgage warehouse lines and overdraft lines of credit, have increased $30.9 million or 15% for the first three months of 2024 and are due to an increase in new lines of credit.

The Company also had undrawn letters of credit issued to customers totaling $4.8 million at March 31, 2024, and $5.0 million at December 31, 2023.

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 $72.6 million at September 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 $88.5 million at September 30, 2023 relative to $72.8 million at December 31, 2022.

The Company’s balance of non-earning cash and due from banks was $70.9 million at March 31, 2024, relative to $73.7 million at December 31, 2023.

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

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 September 30, 2023, unchanged during the first nine months of 2023.

Net premises and equipment decreased by $0.8 million during the first three months of 2024, to $16.1 million.

This decline was a result of the sale/leaseback of two bank-owned branch locations at a gain of $3.8 million.

Goodwill was $27.4 million at March 31, 2024, unchanged during the first three months of 2024.

Goodwill is tested for impairment annually, unless events and circumstances exist which indicate that an impairment test should be performed.

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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.

Bank-owned life insurance, with a balance of $53.0 million at March 31, 2024, 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)

September 30, 2023

March 31, 2024

December 31, 2023

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Total deposits

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 36.9% at September 30, 2023, compared to 38.2% at December 31, 2022, and from 38.8% at September 30, 2022.

Deposit balances grew by $85.8 million, or 3%, during the first three months of 2024 to $2.9 billion at March 31, 2024.

Core non-maturity deposits decreased $56.7 million, or 3%, for the first three months of 2024, while customer time deposits increased by $5.9 million, or 1% due mostly to an increase in variable rate CD accounts by existing customers seeking higher interest rates on their deposits.

Brokered deposits increased $136.6 million during the first three months of 2024, or 101%.

This was a strategic decision to take advantage of preferential pricing over other forms of borrowed funds.

Overall noninterest-bearing deposits as a percent of total deposits decreased to 34.0% at March 31, 2024, compared to 37.0% at December 31, 2023.

Overall uninsured deposits are estimated to be approximately $784.4 million, or 28% of total deposit balances, excluding public agency deposits that are subject to collateralization through a letter of credit issued by the FHLB.

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

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

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

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

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.

At March 31, 2024, the Company had approximately 121,000 accounts and the 25 largest deposit balance customers had balances of less than 13% of overall deposits .

OTHER INTEREST-BEARING LIABILITIES

The Company’s non-deposit borrowings may, at any given time, include fed funds purchased from correspondent banks, borrowings from the Federal Home Loan Bank, advances from the Federal Reserve Bank, securities sold under agreements to repurchase, subordinated notes and/or junior subordinated debentures.

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

The Company uses short-term FHLB advances

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

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

The secured component depends on the level of pledged collateral.

Total non-deposit interest-bearing liabilities 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 $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.

Total non-deposit interest-bearing liabilities decreased by $265.7 million, during the first three months of 2024 primarily due to a decrease in overnight fed funds and short term FHLB borrowings.

This was a result of a balance sheet restructure in which bonds with a book yield of 2.61% were sold to pay off higher cost borrowed funds at an average rate of 5.52%.

Customer repurchase agreements increased from $107.1 million at December 31, 2023, to $121.9 million at March 31, 2024.

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.

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.

Overnight and short-term borrowings decreased $280.0 million and were paid in full at March 31, 2024, from $280.0 million at December 31, 2023, as mentioned previously as a result of a balance sheet restructure.

Long-term debt at March 31, 2024, consisted of $49.2 million of subordinated debt.

This remained relatively unchanged from December 31, 2023.

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

Subordinated debentures related to $35.7 million of trust preferred securities at both March 31, 2024, and December 31, 2023.

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

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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 $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.

The Company’s balance of other liabilities was $73.6 million at March 31, 2024, as compared to $77.4 million at December 31, 2023, a decrease of $3.8 million or 5%.

The decrease was primarily driven by Insured Cash Sweep (“ICS”) transactions that settled as of March 31, 2024, that were in process at December 31, 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.

In addition, the Company’s loan-to-deposit ratio was 76% at both March 31, 2024, and December 31, 2023.

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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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):

At March 31, 2024, and December 31, 2023, the Company had the following sources of primary and secondary liquidity (dollars in thousands):

Primary and secondary liquidity sources

September 30, 2023

March 31, 2024

December 31, 2023

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Funds available through fed discount window

Available funding sources detailed above of $2.6 billion represented 90% of total deposits and 325% of estimated uninsured and/or uncollateralized deposits as of March 31, 2024.

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

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

During the first 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 September 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 March 31, 2024, and December 31, 2023.

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 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’s primary liquidity ratio and gross loans to deposits were 24.09% and 75.8%, respectively, at March 31, 2024, as compared to internal policy guidelines of “greater than 15%” and “less than 95%.” Ratios and sub-limits for the various components comprising wholesale funding, which were all well within policy guidelines at March 31, 2024, 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 September 30, 2023, the holding company maintained a cash balance of $14.7 million.

As of March 31, 2024, the holding company maintained a cash balance of $24.6 million.

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

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

To identify areas of potential exposure to interest rate changes, we utilize commercially available modeling software to perform monthly earnings simulations and calculate the Company’s market value of portfolio equity under varying interest rate scenarios.

rate scenarios.

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

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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:

September 30, 2023

September 30, 2022

March 31, 2024

March 31, 2023

Immediate change in Interest Rates (basis points)

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$ Change in Net Interest Income

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 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.

For the period ending March 31, 2024, management believes that the Company was asset sensitive, with net income increasing in a rising rate scenario and decreasing in declining rate scenarios.

The shift from being liability sensitive at March 31, 2023 to asset sensitive at March 31, 2024, is due mostly to the decrease in the level of overnight borrowings both in Fed Funds purchased and overnight FHLB borrowings, a decrease in fixed rate bonds (which were sold to payoff higher cost borrowings that reprice daily), combined with an increase in mortgage warehouse line utilization which is very short-term.

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 $0.5 million, or 0.4%, 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 increase by $2.8 million, or 2.3%, relative to a stable interest rate scenario, with the favorable 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 $6.8 million or a negative variance of 5.5%.

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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.

If there was an immediate downward adjustment of 100 basis points in interest rates, net interest income would drop $8.3 million or a negative variance of 8%.

The reason for the drop in net interest income is, most deposit products are at their floors of 0.10% and cannot be re-priced lower, while non-floored interest earning assets such as loans and securities can theoretically still be re-priced lower in a falling rate environment.

Due to the historically low current rate environment, we view any material interest rate reductions as unlikely in the near term.

However, the potential percentage drop in net interest income in the “down 100 basis points” interest rate scenario exceeds our internal policy guidelines and we will continue to monitor our interest rate risk profile and implement remedial changes if deemed appropriate.

All interest rate downward shock scenarios are outside of internal policy guidelines, and all upward rate shock scenarios are within internal policy guidelines.

Although interest rate downward shock scenarios are outside of internal policy guidelines, the starting point has also increased as a result of the aforementioned balance sheet restructuring.

Management is currently looking at various balance sheet management strategies to bring our net interest income at risk to a more neutral position which would lower asset sensitivity overall and would lower the negative impact of down rate shocks.

In addition to the net interest income simulations shown above, we run stress scenarios for the unconsolidated Bank where we model the possibility of no balance sheet growth, the potential runoff of “surge” core deposits which flowed into the Bank in the most recent economic cycle, and unfavorable movement in deposit rates relative to yields on earning assets (i.e., higher deposit betas).

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

The modeled economic value (or “fair value”) of financial instruments on the Company’s balance sheet will also vary under the interest rate scenarios previously discussed.

The difference between the projected fair value of the Company’s financial assets and the fair value of its financial liabilities is referred to as the economic value of equity (“EVE”), and changes in EVE under different interest rate scenarios are effectively a gauge of the Company’s longer-term exposure to interest rate fluctuations.

Fair values for financial instruments are estimated by discounting projected cash flows (principal and interest) at anticipated replacement interest rates for each account type, while the fair value of non-financial accounts is assumed to equal their book value for all rate scenarios.

An economic value simulation is a static measure utilizing balance sheet accounts at a given point in time, and the measurement can change substantially over time, as is evident in the tables below for the periods ending 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.

As a general rule, fixed-rate financial assets become more valuable in declining rate scenarios and less valuable in rising rate scenarios, while fixed-rate financial liabilities gain in value as interest rates rise and lose value as interest rates decline.

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

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

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:

September 30, 2023

September 30, 2022

Immediate change in Interest Rates (basis points)

% Change in Fair Value of Equity

$ Change in Fair Value of Equity

% Change in Fair Value of Equity

$ Change in Fair Value of Equity

The table shows that our EVE is modeled to deteriorate in declining rate scenarios but should benefit from a parallel shift upward in the yield curve.

The rate of increase in EVE accelerates the higher interest rates rise.

This increase in sensitivity is caused by the increase in gross deposits, namely, an increase in noninterest-bearing deposits which become more valuable as interest rates rise.

We also run stress scenarios for the unconsolidated Bank’s EVE to simulate the possibility of adverse movement in loan prepayment rates, unfavorable changes in deposit rates, and higher deposit decay rates.

Model results are highly sensitive to changes in assumed decay rates for non-maturity deposits, in particular, with material unfavorable variances occurring relative to the standard simulations shown above as decay rates are increased.

Furthermore, while not as extreme as the variances produced by increasing non-maturity deposit decay rates, EVE also displays a relatively high level of sensitivity to unfavorable changes in deposit rate betas in rising interest rate scenarios.

The potential percentage change in EVE in all rate shock interest rate scenarios is within our internal policy guidelines.

We continue to monitor our interest rate risk profile and implement remedial changes if deemed appropriate.

CAPITAL RESOURCES

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.

The Company had total shareholders’ equity of $345.1 million at March 31, 2024, comprised of $109.3 million in common stock, $4.8 million in additional paid-in capital, $262.9 million in retained earnings, and accumulated other comprehensive loss of $31.9 million.

At the end of 2023, total shareholders’ equity was $338.1 million.

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 481,094 shares repurchased in the first nine months of 2023.

The increase in equity during the first quarter of 2024 is due to net income of $9.3 million, offset by a $3.4 million dividend paid to shareholders, $3.3 million in share repurchases and a $4.1 million favorable swing in other comprehensive income/loss due principally to changes in investment securities’ fair value.

The remaining difference is related to equity compensation recognized during the quarter.

The Company approved a new share repurchase program in October 2023 that authorized 1,000,000 shares of common stock for repurchase beginning at the end of the expiration of the share repurchase program on October 31, 2023, and expiring on October 31, 2024.

Under the 2023 Share Repurchase Program, there were 178,937 shares repurchased in the first three months of 2024 under a Rule 10b5-1 Plan.

The Company uses a variety of measures to evaluate its capital adequacy, including the leverage ratio which is calculated separately for the Company and the Bank.

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Regulatory Capital Ratios

September 30,

Community Bank

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Bank of the Sierra

Tier 1 Capital to Adjusted Average Assets ("Leverage Ratio") (3)

Sierra Bancorp

Tier 1 Capital to Adjusted Average Assets ("Leverage Ratio") (3)

(1) The Company was subject to these minimum requirements under the regulatory framework for Prompt Corrective Action at December 31, 2019.

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(3) The Company has elected to phase in the impact of implementing CECL on regulatory capital over a three-year period.

The federal banking agencies published a final rule on November 13, 2019, that provided a simplified measure of capital adequacy for qualifying community banking organizations.

A qualifying community banking organization that opts into

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

The federal banking agencies provide a simplified measure of capital adequacy for qualifying community banking organizations by allowing such banking organizations to opt into the community bank leverage ratio framework.

The Company’s subsidiary has opted into the community bank leverage ratio framework.

This means that if the Company’s subsidiary maintains a leverage ratio greater than 9 percent, it will be considered to have met the minimum capital requirements, the capital ratio requirements for the well capitalized category under the Prompt Corrective Action framework, and any other capital or leverage requirements to which the qualifying banking organization is subject.

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

Further, the bank must not be an advance approaches banking organization.

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

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

At September 30, 2021, the Company and the Bank met the criteria outlined in the final rule and the interim final rule and elected to measure capital adequacy under the CBLR framework.

PART I – FINANCIAL INFORMATION

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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