What changed in this filing

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Item 2. Management’s Discussion and Analysis

2024-08-05 compared with 2024-05-06 · 291 added, 202 removed, 411 unchanged (55% of the section changed)

13 unchanged sentences

● 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);

● risks associated with inflation (including efforts by the FOMC of the FRB 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;

27 unchanged sentences

RESULTS OF OPERATIONS SUMMARY

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.

Second Quarter 2024 compared to Second Quarter 2023

Second quarter 2024 net income was $10.3 million, a $0.3 million increase or 3%, from the second quarter of 2023 and $0.71 per diluted share in the second quarter of 2024 as compared to $0.67 per diluted share in the second quarter of 2023.

The Company’s annualized return on average equity was 11.95% and annualized return on average assets was 1.14% for

the quarter ended June 30, 2024, compared to 13.06% and 1.07%, respectively, for the same quarter in 2023.

The primary drivers behind the increase in second quarter net income are as follows:

● Net income increased by $0.3 million, or 3%, to $10.3 million due to higher net interest income and lower noninterest expenses partially offset by an increase in the provision for credit losses, and lower noninterest income.

● The $1.9 million, or 7%, increase in net interest income was driven by a 30 basis points increase in net interest margin.

A $180.9 million decrease in other borrowed funds due to the strategic securities transaction and balance sheet restructuring in early 2024 along with higher loan yields were the primary drivers of the net interest margin increase.

● Noninterest income decreased $0.4 million, primarily from nonrecurring gains on the sale of investments in the second quarter of 2023.

● Noninterest expense improved due to a strategic internal reorganization in the fourth quarter of 2023 which optimized our team structure, and better aligned our resources and processes.

First Half 2024 compared to First Half 2023

Net income for the first half of 2024 was $19.6 million, or $1.35 per diluted share, compared to $18.7 million, or $1.26 per diluted share for the same period in 2023.

The Company’s annualized return on average equity was 11.52% and annualized return on average assets was 1.10% for the six months ended June 30, 2024, compared to a return on equity of 12.30% and return on assets of 1.02% for the six months ended June 30, 2023.

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

● The provision for credit losses on loans was $1.0 million, an increase of $0.7 million, due to higher net charge-offs.

● Net interest income increased by $2.4 million, or 4%, due mostly to the strategic decision to sell off lower yielding bonds in the fourth quarter of 2023 and the first quarter of 2024, which generated cash used partially to pay off higher cost borrowed funds.

● Noninterest income increased $1.6 million, or 11%, primarily from an increase in service charges on deposit accounts, and a $0.9 million positive variance in Bank Owned Life Insurance (BOLI) income tied to our nonqualified deferred compensation plan.

● Noninterest expense increased $1.3 million, or 3% primarily due to increased rent expense from the sale/leaseback transactions in fourth quarter of 2023 and first quarter of 2024.

FINANCIAL CONDITION SUMMARY

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:

June 30, 2024 relative to December 31, 2023

The Company’s assets totaled $3.7 billion at June 30, 2024, a decrease of $48.6 million, or 1.0% from December 31, 2023.

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

● Investment securities decreased $309.6 million, or 23.0%, to $1.0 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.

● Gross loans increased $144.5 million, or 7%, due to a $158.1 million increase in mortgage warehouse loans, and a $13.5 million increase in farmland loans, partially offset by smaller declines in other categories.

Specifically, there was a $27.0 million decrease in non-agricultural real estate loans, a $0.4 million decline in other commercial loans and a $0.5 million reduction in consumer loans.

In addition to strong favorable growth in mortgage

warehouse, new credit extended, including new fundings on non-mortgage warehouse lines of credit, was $75.3 million YTD 2024 vs $89.6 million YTD 2023.

● Deposits increased by $181.2 million, or 7%.

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.

The growth in deposits came primarily from brokered deposits, as overall customer deposits decreased $30.4 million.

Brokered deposits added in 2024 had a term of one year or less and were used to fund increases in mortgage warehouse balances in 2024.

● Other interest-bearing liabilities decreased $239.6 million mostly from a decrease in overnight borrowings facilitated by the strategic balance sheet restructuring in the first quarter of 2024.

● Total capital of $350.0 million at June 30, 2024, reflects an increase of $11.9 million, or 4%, compared to December 31, 2023.

The increase in equity during the first half of 2024, is due to net income of $19.6 million, offset by a $6.7 million dividend paid to shareholders, $7.1 million in share repurchases and a $5.3 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 first half of 2024.

EARNINGS PERFORMANCE

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NET INTEREST INCOME AND NET INTEREST MARGIN

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.

Net interest income was $30.2 million for the second quarter of 2024, a $1.9 million increase, or 7% over the second quarter of 2023, and increased $2.4 million, or 4%, to $58.9 million for the first six months of 2024 relative to the same period in 2023.

This increase in interest income for the quarterly comparison was due primarily to an increase in interest income on loans of $4.2 million, augmented by a $0.8 million decrease in interest expense due to the reduction in borrowed funds facilitated by a balance sheet restructuring, partially offset by a related decline in interest income on investments of $1.6 million, or 10%, due to the sale of low yielding investments.

For the second quarter of 2024, although the balance of average interest-earning assets was $106.2 million lower, the yield was 71 basis points higher as compared to the same period in 2023.

There was a 23 basis point increase in the cost of our interest-bearing liabilities for the same period, which offset some of the higher yields on the asset side.

Net interest income for the comparative year-to-date periods increased $2.4 million, due to the strategic decision to change the mix on interest earning assets, selling off lower yielding bonds in the fourth quarter of 2023 and first quarter of 2024, moderated by an increase in interest rates paid on interest-bearing liabilities.

There was a $112.5 million, or 6%, increase in average loan balances yielding 41 basis points higher for the same period, while average investment balances decreased $229.1 million, yielding 69 basis points higher for the same period.

Average interest-bearing liabilities decreased $83.7 million, mostly in borrowed funds.

The cost of interest-bearing liabilities was 41 basis points higher for the comparative periods.

The favorable net impact of the mix and rate change was a 23 basis point increase in our net interest margin for the six-months ending June 30, 2024 as compared to the same period in 2023.

Interest expense was $13.3 million for the second quarter of 2024, an increase of $0.8 million, relative to the second quarter of 2023.

For the first six months of 2024, compared to the first six months of 2023, interest expense increased $3.7 million, to $25.6 million.

The increase in interest expense is primarily attributable to an increase in interest rates paid on certain time deposits, and a shift in deposits to higher interest rate accounts partially offset by lower balances on other borrowings.

There was an unfavorable shift in the deposit mix in the second quarter of 2024 as compared to the same period in 2023

due to increased demand from customers for higher rates.

Higher cost customer time deposits increased by $23.0 million, and wholesale brokered deposits increased by $129.3 million, while lower cost and noninterest bearing deposits decreased by $181.4 million.

A $128.9 million decrease in borrowed funds mitigated some of the unfavorable shift for the quarterly comparison.

For the first half of 2024, as compared to the same period in 2023, customer time deposits increased $61.6 million, and wholesale brokered deposits increased $85.9 million, while borrowed funds decreased $88.7 million, and other deposits decreased $218.7 million.

The Company had $1.5 billion in adjustable and variable rate loans and $519.9 million in floating rate bonds, as compared to $316.6 million in floating rate CDs and $35.7 million in floating rate trust preferred securities at June 30, 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, $610.7 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.

Our net interest margin was 3.69% for the second quarter of 2024, and 3.39% for the second quarter of 2023, an increase of 30 basis points, and 3.66% for the first half of 2024, as compared to 3.43% for the first half of 2023, an increase of 23 basis points.

While the yield of interest-earning assets increased 71 basis points for the second quarter of 2024, the cost of interest-bearing liabilities increased 23 basis points for the same period of comparison.

The average balance of interest-earning assets decreased $106.2 million, while the decrease in interest-bearing liabilities was $86.0 million for the same period.

The decrease in higher cost borrowed funds over the increase in yield on interest-earning assets improved the net interest margin in the second quarter of 2024 over the same period in 2023.

For the year-to-date comparison the increase in net interest margin of 23 basis points comes from an increase in yield on interest-earning assets of 50 basis points partially offset by an increase in interest rates paid on interest-bearing liabilities of 41 basis points.

The increase in yield on interest earning assets is over a much larger volume base than of interest-bearing liabilities reflecting the positive change in the net interest margin for the first half of 2024.

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.

5 unchanged sentences

For the three months ended

March 31, 2024

March 31, 2023

June 30, 2024

June 30, 2023

Rate/Yield (2)

31 unchanged sentences

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 March 31, 2024 and 2023, respectively.

Net loan (costs) fees and loan acquisition FMV amortization were $(0.3) million and $(0.3) million for the quarters ended June 30, 2024 and 2023, respectively.

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

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

Average Balances and Rates

(Dollars in Thousands, Unaudited)

For the six months ended

June 30, 2024

June 30, 2023

Rate/Yield (2)

Interest-earning due from banks

Total investments

Mortgage warehouse lines

Total interest-earning assets (4)

Other earning assets

Non-earning assets

Liabilities and shareholders' equity

Interest-bearing deposits:

Demand deposits

Savings accounts

Time Deposits

Brokered deposits

Total interest-bearing deposits

Borrowed funds:

Repurchase agreements

Other borrowings

Long-term debt

Subordinated debentures

Total borrowed funds

Total interest-bearing liabilities

Demand deposits - noninterest-bearing

Other liabilities

Shareholders' equity

Total liabilities and shareholders' equity

Interest income/interest-earning assets

Interest expense/interest-earning assets

Net interest income and margin (5)

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

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

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

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

Net loan fees and loan acquisition FMV amortization were $(0.7) million and $(0.4) million for the six months ended June 30, 2024 and 2023, respectively.

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

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

The Volume and Rate Variances table below sets forth the dollar difference for the comparative periods in interest earned or paid for each major category of interest-earning assets and interest-bearing liabilities, and the amount of such change attributable to fluctuations in average balances (volume) or differences in average interest rates.

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(dollars in thousands, unaudited)

Three months ended March 31,

Three months ended June 30,

Six months ended June 30,

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 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.

The volume variance calculated for the second quarter of 2024 relative to the second quarter of 2023 was a favorable $2.0 million;

this is primarily from a favorable loan volume variance of $4.0 million augmented by a favorable reduction in other borrowed funds.

There was a favorable rate variance of $0.8 million from the comparative quarter since the weighted average yield on interest-earning assets more than offset the increase in the average yield unfavorable variance on interest-bearing liabilities.

There was an unfavorable mix variance of $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.

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 combined with higher interest rates paid on customer time

and brokered deposits.

The Company’s net interest margin for the second quarter of 2024 was 3.69%, as compared to 3.39% for the second quarter of 2023.

The volume variance calculated for the first six months of 2024 relative to the first six months of 2023 reflects a favorable variance of $1.0 million, a favorable rate variance of $2.4 million, and an unfavorable mix variance of $0.9 million.

There were increases in loan balances for a favorable volume variance of $5.3 million which was mostly offset by a $4.6 million decrease in investments, due to the balance sheet restructure in 2023.

There was a $2.8 million decrease in borrowed funds, partially offset by a $2.6 million increase in interest-bearing deposits.

There was a positive rate variance on interest earning assets of $5.6 million for the first six months of 2024 partially offset by a $3.2 million rate increase in interest earning liabilities.

The Company’s net interest margin for the first half of 2024 was 3.66%, as compared to 3.43% in the first half of 2023.

At June 30, 2024, approximately 15% of our total portfolio, or $342.7 million, consists of variable rate loans.

At June 30, 2024, our outstanding fixed rate loans represented 31% of our loan portfolio.

The remaining 54% of our loan portfolio at June 30, 2024, consists of adjustable-rate loans;

30% of these loans (approximately $355.0 million) 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 $170.9 million of these adjustable-rate loans have the ability to reprice in 2024, which is expected to have a positive impact on earnings as most of these adjustable-rate loans were made when rates were lower.

Interest earning cash balances for the quarter and year-to-date comparisons have increased and have a positive impact on our net interest margin since cash balances have been earning approximately 5.5%.

Average cash and due from banks was $43.4 million, an increase of $26.4 million for the second quarter of 2024 as compared to the same period last year, and was $9.8 million higher for the first half of 2024 as compared to the same period in 2023.

Overall average investment securities decreased by $282.6 million for the second quarter of June 30, 2024, as compared to June 30, 2023, and decreased by $239.0 million for the first half of 2024, 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 5.43% at June 30, 2024, with an average life of 6.08 years and average effective duration of 0.8 years for available-for-sale securities.

Approximately $519.9 million of the investment securities reprice every 90 days and $49.3 million are subordinated debt with an initial fixed rate period of 5 years and floating thereafter.

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.

Interest expense was $13.3 million for the second quarter of 2024, an increase of $0.8 million, relative to the second quarter of 2023.

For the first six months of 2024, compared to the first six months of 2023, interest expense increased $3.7 million, to $25.6 million.

There was an unfavorable shift in the deposit mix in the second quarter of 2024 as compared to the same period in 2023 due to increased demand from customers for higher rates.

Mitigating some of the unfavorable shift there was also a $128.9 million decrease in borrowed funds for the quarterly comparison.

Average noninterest-bearing demand deposits decreased $72.1 million or 7% for the second quarter of 2024 as compared to the second quarter of 2023 and decreased $76.2 million or 7% for the first half of 2024 as compared to the first half of 2023.

PROVISION FOR CREDIT LOSSES ON LOANS

1 unchanged sentence

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 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 $0.5 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 Company recorded a provision for credit losses of $0.9 million in the second quarter of 2024, as compared to $0.1 million in the second quarter of 2023, and

a year-to-date provision for credit losses on loans of $1.0 million in 2024, as compared to $0.3 million in the same period for 2023.

The Company's $0.8 million increase in the provision for credit losses on loans in the second quarter of 2024, as compared to the second quarter of 2023, and the $0.7 million year to date increase in the provision for credit losses on loans, compared to the same period in 2023, was primarily due to the impact of $2.9 million in net charge-offs in the first six months of 2024, with only $0.4 million in net charge-offs for the first six months of 2023.

The increase in net charge-offs in the second quarter of 2024 was primarily related to a single office building which was subsequently foreclosed upon and sold.

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.

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

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

NONINTEREST INCOME AND NONINTEREST EXPENSE

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

The following table provides details on the Company’s noninterest income and noninterest expense for the three and six-month periods ended June 30, 2024, and 2023:

Noninterest Income/Expense

(dollars in thousands, unaudited)

For the three months ended March 31,

For the three months ended June 30,

For the six months ended June 30,

Noninterest income:

Service charges and fees on deposit accounts

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

Net gain (loss) 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

20 unchanged sentences

Noninterest Income:

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 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.

Total noninterest income decreased by $0.4 million, or 5%, for the quarter ended June 30, 2024, as compared to the same quarter in 2023 and increased $1.6 million, or 11% for the comparable year-to-date periods.

The quarterly comparison decrease primarily resulted from a $0.4 million non-recurring bond sale gain in 2023.

The year-to-date increase reflects a $2.9 million loss on the sale of investment securities in 2024, offset by a $3.8 million gain on the sale/leaseback of bank owned branch locations.

There were $0.5 million in life insurance proceeds in 2023, with no like amount in 2024.

These favorable variances to the year-to-date comparisons were augmented by a $1.2 million increase in the value of separate account corporate-owned life insurance assets tied to non-qualified deferred compensation plans.

The Company maintains a non-qualified deferred compensation plan for officers and directors, which allows the participant to defer a portion of their earnings tax-free.

Participants are allowed to choose different hypothetical investment alternatives to determine their individualized return on their deferred compensation.

The Company has chosen to offset the cost of this liability with a Corporate Owned Life Insurance Policy (“COLI”) which is funded based on deferral elections from the participants.

Although the COLI is not directly tied to the deferred compensation plan, the COLI is invested in similar fund types as those selected by the participants.

There is some inefficiency in net earnings of the COLI asset as compared to the deferred compensation liability created by the cost of insurance, differences in balances, and differences in individual fund performance.

During the second quarter, and first six-months of 2024, earnings from the COLI was $0.3 million, and $1.3 million, respectively while additional expense from the related deferred compensation liability was $0.3 million, and $1.4 million, respectively.

Most of such expense is reported as Professional Fees under Directors Fees as such expense is related to deferral of past directors’ fees.

Specifically, $0.3 million for the quarterly comparison, and $1.2 million for the year-to-date comparison, respectively, is reflected as directors’ fees as part of the overall Professional Fees expense line item.

The tax benefit of having tax-free earnings with tax-deductible expense was $0.2 million during the second quarter of 2024, and $0.8 million for the first six-months of 2024.

Service charges on customer deposit account income decreased by $0.5 million, or 9%, to $6.2 million in the second quarter of 2024 as compared to the second quarter of 2023 and $0.8 million higher, or 8%, in the first six months of 2024, as compared to the same period in 2023.

These increases in the quarterly and year-to-date comparisons are primarily a result of higher interchange and ATM fees, along with increased service charges on analysis accounts.

In the “other” category of noninterest income there was a $0.4 million decrease in the second quarter of 2024 as compared to the second quarter of 2023, and a $0.7 million decrease in the first six months of 2024 as compared to the same period in 2023.

The quarterly comparison was negatively impacted by a decrease in life insurance proceeds and a decrease in limited partnership income.

The year-to-date comparison was also negatively impacted by a decrease in life insurance proceeds as well as a decrease in OREO rental income, as all OREO properties were sold.

Noninterest Expense:

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.

Total noninterest expense favorably declined by $0.3 million, or 1%, in the second quarter of 2024 relative to the second quarter of 2023, but increased by $1.3 million, or 3%, in the first six months of 2024 as compared to the first six months of 2023.

Salaries and benefits were $0.1 million, or 1%, lower in the second quarter of 2024 as compared to the second quarter of 2023 and were $0.3 million, or 1% higher for the first six months of 2024, compared to the same period in 2023.

The reason for the decrease in the quarterly comparison is due to a strategic decision to improve operational efficiencies.

The increase in the year-over-year comparison is primarily due to increases related to annual performance evaluations.

Overall full-time equivalent employees were 501 at June 30, 2024, as compared to 489 at December 31, 2023, and 502 at June 30, 2023.

Included in full-time equivalent employees at June 30, 2024 were 18 summer interns and temporary employees.

Occupancy expenses increased by $0.7 million, and $1.4 million for the second quarter, and the first half of 2024 as compared to the same periods in 2023.

The reason for the increases in both comparisons is due to increased rent expense from the sale/leaseback transactions in the fourth quarter of 2023, and first quarter of 2024.

Other noninterest expense decreased $0.9 million, or 11%, for the second quarter 2024, as compared to the second quarter in 2023, and decreased $0.4 million, or 3% for the first half of 2024 as compared to the same period in 2023.

FDIC assessment costs decreased $0.2 million for the quarterly comparisons, but were flat for the year-to-date comparison.

Deferred compensation expense for directors decreased $0.1 million for the quarterly comparison but increased $0.9 million for the year-to-date comparison, which is linked to the changes in life insurance income as described in detail above.

There were decreases in debit card processing and ATM network costs of $0.6 million for both the quarterly and year-to-date comparisons due to a branding change from Mastercard to Visa and the subsequent conversion costs related to that change.

Additionally, we incurred a $0.3 million loss that is reflected in noninterest expense during the second quarter of 2023 with no such like event in 2024.

For the year-to-date comparison there was also elevated foreclosed assets costs for the first half of 2023, as compared to the same period in 2024, due to the foreclosure and subsequent sale of one large credit in the first quarter of 2023.

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 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.

The Company's provision for income taxes was 27.8% of pre-tax income in the second quarter of 2024 relative to 26.2% in the second quarter of 2023, and 27.1% of pre-tax income for the first half of 2024 relative to 25.0% for the same period in 2023.

The increase in effective tax rate for both the quarterly and year-to-date comparisons is due to the tax credits and tax-exempt income representing a smaller percentage of total taxable income.

BALANCE SHEET ANALYSIS

EARNING ASSETS

The Company’s interest-earning assets are comprised of loans and investments, including overnight investments and surplus balances held in interest-earning accounts in our Federal Reserve Bank account.

The Company’s interest-earning assets are comprised of loans and investments, including overnight investments and surplus balances held in interest-earning accounts in our FRB account.

The composition, growth characteristics, and credit quality of both of those components are significant determinants of the Company’s financial condition.

Investments are analyzed in the section immediately below, while the loan portfolio and other factors affecting earning assets are discussed in the sections following investments.

The Company’s investments may at any given time consist of debt securities and marketable equity securities (together, the “investment portfolio”), investments in the time deposits of other banks, surplus interest-earning balances in our Federal Reserve Bank account, and overnight fed funds sold.

The Company’s investments can serve several purposes, including the following:

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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 $1.1 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 investment portfolio is reflected on the balance sheet as investment securities and totaled $1.0 billion, or 28% of total assets at June 30, 2024, and $1.3 billion, or 36% of total assets at December 31, 2023.

The decrease 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%.

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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 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 expected effective duration was 0.8 years for available-for-sale

investments and 6.0 years for held-to-maturity investments at June 30, 2024, as compared to 1.4 years for available-for-sale investments and 5.9 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:

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(dollars in thousands, unaudited)

March 31, 2024

June 30, 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 $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.

Investment securities that were pledged as collateral for borrowings and/or potential borrowings from the FHLB and the FRB, customer repurchase agreements, and other purposes as required or permitted by law totaled $495.9 million at June 30, 2024, and $543.9 million at December 31, 2023, leaving $533.8 million in unpledged debt securities at June 30, 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 $272.9 million at June, 2024, and $383.0 million at December 31, 2023.

ALLOWANCE FOR CREDIT LOSSES – AFS INVESTMENT SECURITIES

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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 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.

The Company maintains that it has intent and ability to hold these securities until the amortized cost basis of each security is recovered and likewise concluded as of both June 30, 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 June 30, 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.

Federal Government and the management did not consider a default, much less a loss on these securities to be a reasonable possibility as of either June 30, 2024, or December 31, 2023.

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

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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 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.

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

As of both June 30, 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 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.

Following review of the financial metrics available for each of the underlying institutions as of June 30, 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.

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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 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.

Following review of financial metrics as of both June 30, 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

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(dollars in thousands, unaudited)

March 31, 2024

June 30, 2024

December 31, 2023

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Consumer loans

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.

Gross loans at $2.2 billion, increased $144.4 million or 7% during the first six months of 2024.

There was a $158.1 million favorable change in mortgage warehouse lines, a $13.5 million increase in agricultural real estate loans, offset by unfavorable loan variances in all other loan categories, the largest of which was a $27.0 million decrease in other non-agricultural real estate loans.

As indicated in the loan roll forward table below, new credit extended for the second quarter of 2024, increased $5.3 million, and increased $3.3 million year-to-date 2024, over the same period in 2023.

Loan growth, excluding mortgage warehouse lines, has been slower in 2024 due to competitive pressures in our market and lower loan demand in the current interest rate environment.

The increase of $70.5 million in mortgage warehouse line utilization, was due in part to a $186.0 million increase in mortgage warehouse commitments for the first half of 2024, and subsequent utilization of those lines.

LOAN ROLLFORWARD

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For the three months ended:

March 31, 2024

December 31, 2023

For the six months ended:

June 30, 2024

March 31, 2024

June 30, 2023

June 30, 2024

June 30, 2023

Gross loans beginning balance

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Gross loans ending balance

(1) Change does not include new balances on lines of credit extended during the respective periods as such balances are included as part of “New credit extended” line above.

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;

At June 30, 2024, the total regulatory CRE concentration ratio of total CRE over Tier 1 Capital plus allowance was 241% as compared to 243% at December 31, 2023 and 243% at June 30, 2023.

Further, the overall level of construction and land development lending had declined to 1% of regulatory capital plus allowance for credit losses at June 30, 2024.

At June 30, 2024, our non-owner occupied commercial real estate includes $303 million of retail;

$152 million of warehouse/industrial;

$177 million of office;

and $181 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.

Unused commitments, excluding mortgage warehouse and overdraft lines, were $247.1 million at June 30, 2024, compared to $203.6 million at December 31, 2023.

Total utilization excluding mortgage warehouse and overdraft lines was 57% at June 30, 2024, compared to 62% at December 31, 2023.

Mortgage warehouse utilization increased to 54% at June 30, 2024, compared to 36% at December 31, 2023.

The increase in mortgage warehouse utilization during the first half of 2024 was due to $186.0 million in new mortgage warehouse lines and subsequent utilization of those lines.

It should be noted that the mortgage warehouse lines were moved to repurchase agreement lines in 2022 and 2023.

The repurchase agreement structure provides stronger credit protection to the Company, as well as more favorable regulatory capital treatment as these repurchase lines are not considered off-balance sheet commitments as they are unconditionally cancellable.

NONPERFORMING ASSETS

Nonperforming assets are comprised of loans for which the Company is no longer accruing interest, in addition to foreclosed assets which is primarily OREO, but can include other foreclosed assets.

Nonperforming assets currently is comprised of loans for which the Company is no longer accruing interest, but can include OREO and other foreclosed assets.

Nonperforming assets

(dollars in thousands, unaudited)

March 31, 2024

June 30, 2024

December 31, 2023

March 31, 2023

June 30, 2023

Nonperforming Loans:

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Commercial real estate

Other construction/land

Total Real Estate nonperforming loans

Other commercial

Consumer loans

Total Nonperforming Loans

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

Total nonperforming assets, comprised of non-accrual loans and foreclosed assets, 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.

Total nonperforming assets, comprised of non-accrual loans, decreased by $1.5 million, or 19%, during the first half of 2024, due to the foreclosure and subsequent sale of one commercial real estate loan.

The balance of nonaccrual loans at June 30, 2024 is primarily one nonperforming dairy loan classified as farmland.

The Company's ratio of nonperforming assets to loans plus foreclosed assets decreased to 0.29% at June 30, 2024, from 0.38% at December 31, 2023.

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.

There were no foreclosed assets at June 30, 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 $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.

The Company had $3.2 million in loans past due 30-89 days at June 30, 2024.

This is an increase of $2.9 million over the balance at December 31, 2023.

All of these past due loans are under management supervision and every effort is being taken to assist the borrowers and manage credit risk in this regard.

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

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 Company's allowance for credit losses on loans was $21.6 million at June 30, 2024, and $23.5 million at December 31, 2023.

The allowance was 0.97% of total loans at June 30, 2024, and 1.12% of total loans at December 31, 2023.

The decreased allowance for credit losses on loans was primarily due to a $1.6 million reduction in the allowance on loans

individually evaluated for expected credit losses.

Management's detailed analysis indicates that the Company's allowance for credit losses on loans should be sufficient to cover credit losses for the life of the loans outstanding as of June 30, 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 $0.5 million for potential credit losses inherent in unused commitments is included in other liabilities at June 30, 2024, unchanged from December 31, 2023.

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

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

The Company’s 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.

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

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

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

Unused commitments to extend credit, which included standby letters of credit, totaled $554.2

million at June 30, 2024, and $487.1 million at December 31, 2023, representing approximately 25% of gross loans outstanding at June 30, 2024, and 23% 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.

Unused commitments on mortgage warehouse lines were $232.4 million at June 30, 2024, and $204.5 million at December 31, 2023, while utilization was 54% and 36% respectively.

The increase in utilization during the first half 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 $43.6 million or 21% for the first six months of 2024 and are due to an increase in new lines of credit and higher utilization on existing lines of credit.

The Company also had undrawn letters of credit issued to customers totaling $5.3 million at June 30, 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 $72.4 million at March 31, 2024.

In addition to unused commitments to provide credit, the Company is utilizing a $125 million letter of credit issued by the FHLB on the Company’s behalf as security for certain local agency deposits which totaled $95.0 million at June 30, 2024.

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

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Our balance of cash and due from banks depends on the timing of collection of outstanding cash items (checks), the amount of cash held at our branches, and our reserve requirement among other things, and it is subject to significant fluctuations in the normal course of business.

While cash flows are normally predictable within limits, those limits are fairly broad and the Company manages its short-term cash position through the utilization of overnight loans to, and borrowings from, correspondent banks, including the Federal Reserve Bank and the Federal Home Loan Bank.

Should a large “short” overnight position persist for any length of time, the Company typically raises money through focused retail deposit gathering efforts or by adding brokered time deposits.

If a “long” position is prevalent, we could let brokered deposits or other wholesale borrowings roll off as they mature, or we might invest excess liquidity into investments or loans, subject to the bank’s risk tolerances.

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

The Company’s balance of non-earning cash and due from banks was $96.0 million at June 30, 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 $0.8 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.

Net premises and equipment decreased by $0.9 million during the first half of 2024, to $16.0 million.

This decline was a result of the sale/leaseback of two bank-owned branch locations in the first quarter of 2024.

Goodwill was $27.4 million at June 30, 2024, unchanged during the first half 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 $53.0 million at March 31, 2024, is discussed in detail above in the “Noninterest Income and Noninterest Expense” section.

Bank-owned life insurance, with a balance of $53.4 million at June 30, 2024, is discussed in detail above in the “Noninterest Income and Noninterest Expense” section.

DEPOSITS AND INTEREST-BEARING LIABILITIES

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(dollars in thousands, unaudited)

March 31, 2024

June 30, 2024

December 31, 2023

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Total deposits

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.

Deposit balances grew by $181.2 million, or 7%, during the first half of 2024 to $2.9 billion at June 30, 2024.

Core non-maturity deposits decreased $41.4 million, or 2%, for the first half of 2024, while customer time deposits increased by $11.0 million, or 2% due mostly to an increase in variable rate CD accounts by existing customers seeking higher interest rates on their deposits.

Brokered deposits increased $211.6 million during the first half of 2024, or 157%.

This was a strategic decision to fund increased usage on mortgage warehouse lines.

Overall noninterest-bearing deposits as a percent of total deposits decreased to 33.5% at June, 2024, compared to 37.0% at December 31, 2023.

Overall uninsured deposits are estimated to be approximately $805.4 million, or 27% of total deposit balances, excluding public agency deposits that are subject to collateralization through a letter of credit issued by the FHLB.

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

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

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

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 .

In addition, uninsured deposits of the Company’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 $250 million of combined pass-through FDIC insurance which would more than cover each of the Company’s deposit customers if such customer desired to have such pass-through insurance.

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

At June 30, 2024, the Company had approximately 121,000 accounts and the 25 largest deposit balance customers had balances of less than 14% 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’s non-deposit borrowings may, at any given time, include fed funds purchased from correspondent banks, borrowings from the FHLB, advances from the FRB, 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 FHLB line consists of both a secured and unsecured component.

The secured component depends on the level of pledged collateral.

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

Total non-deposit interest-bearing liabilities decreased by $239.5 million, during the first half 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.

Customer repurchase agreements increased from $107.1 million at December 31, 2023, to $148.0 million at June 30, 2024.

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 repurchases the same bonds on the next business day.

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

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.

Overnight and short-term borrowings decreased $280.5.0 million and were paid in full at June 30, 2024, from $280.5 million at December 31, 2023, as mentioned previously as a result of a balance sheet restructure.

Long-term debt at June 30, 2024, consisted of $49.3 million of subordinated debt.

This remained relatively unchanged from December 31, 2023.

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

Subordinated debentures related to $35.7 million of trust preferred securities at both June 30, 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 $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.

The Company’s balance of other liabilities was $75.2 million at June 30, 2024, as compared to $77.4 million at December 31, 2023, a decrease of $2.2 million or 3%.

The decrease was primarily driven by accrued payables that settled as of June 30, 2024, that were accrued for 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 76% at both March 31, 2024, and December 31, 2023.

In addition, the Company’s loan-to-deposit ratio was 76% at both June 30, 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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The Company, on occasion, experiences cash needs as the result of loan growth, deposit outflows, asset purchases or liability repayments.

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

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

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

At June 30, 2024, and December 31, 2023, the Company had the following sources of primary and secondary liquidity (dollars in thousands):

Primary and secondary liquidity sources

March 31, 2024

June 30, 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.

Available funding sources detailed above of $2.5 billion represented 86% of total deposits and 312% of estimated uninsured and/or uncollateralized deposits as of June 30, 2024.

Unpledged investment securities include $266.4 million of CLOs.

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

As CLO’s 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.

The Company performs regular stress tests on its liquidity and at this time, believes that we have sufficient primary and secondary liquidity sources for operations.

The Company has a higher level of actual balance sheet liquidity than might otherwise be the case since we utilize a letter of credit from the FHLB rather than investment securities for certain pledging requirements.

That letter of credit, which is backed by loans pledged to the FHLB by the Company, totaled $125 million at March 31, 2024, and December 31, 2023.

That letter of credit, which is backed by loans pledged to the FHLB by the Company, totaled $125 million at June 30, 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 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’s primary liquidity ratio and gross loans to deposits were 23.45% and 75.95%, respectively, at June 30, 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 June 30, 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 March 31, 2024, the holding company maintained a cash balance of $24.6 million.

As of June 30, 2024, the holding company maintained a cash balance of $15.8 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.

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

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

Assumptions regarding

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

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

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The Company had the following estimated net interest income sensitivity profiles over one-year, without factoring in any potential negative impact on spreads resulting from competitive pressures or credit quality deterioration:

March 31, 2024

March 31, 2023

June 30, 2024

June 30, 2023

Immediate change in Interest Rates (basis points)

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$ Change in Net Interest Income

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.

For the period ending June 30, 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 June 30, 2023 to asset sensitive at June 30, 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.

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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.

Management also models other down rate scenarios that do not assume a simultaneous shock of all rate curves including short-term and long-term curves.

Given the current inverted rate curve, shocking all curves tends to overstate the sensitivity to a change in rate.

Management evaluates the part of the curve that is most sensitive to rate declines and is currently looking at various balance sheet management strategies to manage the highest risks.

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).

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CAPITAL RESOURCES

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.

The Company had total shareholders’ equity of $350.0 million at June 30, 2024, comprised of $107.9 million in common stock, $5.3 million in additional paid-in capital, $247.8 million in retained earnings, and accumulated other comprehensive loss of $30.7 million.

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

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 increase in equity during the first half of 2024 is due to net income of $19.6 million, offset by a $6.7 million dividend paid to shareholders, $7.0 million in share repurchases and a $5.3 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.

Under the 2023 Share Repurchase Program, there were 357,105 shares repurchased in the first half 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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As permitted by the regulators for financial institutions that are not deemed to be “advanced approaches” institutions, the Company has elected to opt out of the Basel III requirement to include accumulated other comprehensive income in risk-based capital.

The following table sets forth the Bank’s regulatory capital ratios as of the dates indicated.

The following table sets forth the Company’s regulatory capital ratios as of the dates indicated.

Regulatory Capital Ratios

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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.

This means that if the Company’s subsidiary maintains a leverage ratio greater than 9% , 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% 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% or less of total consolidated assets.

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

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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