Bank7 Corp. 10-Q

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Quarterly Report and in our Annual Report on Form 10-K for the year ended December 31, 2022. Unless the context indicates otherwise, references in this management’s discussion and analysis to “we”, “our”, and “us,” refer to Bank7 Corp. and its consolidated subsidiaries. All references to “the Bank” refer to Bank7, our wholly owned subsidiary. General We are Bank7 Corp., a bank holding company headquartered in Oklahoma City, Oklahoma. Through our wholly-owned subsidiary, Bank7, we operate twelve locations in Oklahoma, the Dallas/Fort Worth, Texas metropolitan area and Kansas. We are focused on serving business owners and entrepreneurs by delivering fast, consistent and well-designed loan and deposit products to meet their financing needs. We intend to grow organically by selectively opening additional branches in our target markets and pursuing strategic acquisitions. As a bank holding company, we generate most of our revenue from interest income on loans and from short-term investments. The primary source of funding for our loans and short-term investments are deposits held by our subsidiary, Bank7. We measure our performance by our return on average equity, earnings per share, capital ratios, efficiency ratio (calculated by dividing noninterest expense by the sum of net interest income on a tax equivalent basis) and noninterest income. As of September 30, 2023, we had total assets of $1.77 billion, gross loans of $1.39 billion, total deposits of $1.59 billion and total shareholders’ equity of $167.9 million. Results of Operations Performance Summary. For the third quarter of 2023, we reported a pre-tax income of $10.2 million, compared to pre-tax income of $10.4 million for the third quarter of 2022. For the first nine months of 2023, we reported a pre-tax income of $35.7 million, compared to pre-tax income of $27.9 million for the same period in 2022. For the third quarter of 2023, interest income increased by $10.0 million, or 46.2%, compared to the third quarter of 2022. For the first nine months of 2023, interest income increased by $35.9 million, or 67.3%, compared to the same period in 2022. For the third quarter of 2023, average total loans were $1.34 billion with loan yields of 8.52% as compared to average total loans of $1.21 billion with loan yields of 6.69% for the third quarter of 2022. For the first nine months of 2023, average total loans were $1.30 billion with loan yields of 8.34% as compared to average total loans of $1.10 billion with loan yields of 6.13% for the same period in 2022. Our provision for credit losses for the third quarter of 2023 was $4.2 million, compared to $2.4 million for the same period of 2022. Our provision for credit losses for the first nine months of 2023 was $5.7 million, compared to $2.8 million for the same period in 2022. During the third quarter 2023, we had a single loan customer file for bankruptcy, and as a result, we increased nonaccrual loans by $40.1 million and recorded an additional allowance for credit losses and provision for loan losses of $3.0 million. See Note (6) and (13) for further disclosure and discussion. Return on average equity was 18.89% for the third quarter of 2023, as compared to 23.72% for the third quarter of 2022. Return on average equity was 23.29% for first nine months of 2023, as compared to 21.54% for the same period in 2022. 40 Table of Contents Net Interest Income and Net Interest Margin. The following table presents, for the periods indicated, information about: (i) weighted average balances, the total dollar amount of interest income from interest-earning assets, and the resultant average yields; (ii) average balances, the total dollar amount of interest expense on interest-bearing liabilities, and the resultant average rates; (iii) net interest income; and (iv) the net interest margin. Net Interest Margin For the Three Months Ended September 30, 2023 2022 Average Balance Interest Income/ Expense Average Yield/ Rate Average Balance Interest Income/ Expense Average Yield/ Rate (Dollars in thousands) Interest-Earning Assets: Short-term investments $ 176,589 $ 2,062 4.63 % $ 99,751 $ 445 1.77 % Debt securities, taxable 151,174 699 1.83 163,699 690 1.67 Debt securities, tax exempt (1) 19,430 81 1.65 21,811 90 1.64 Loans held for sale 232 - - 1,281 - - Total loans (2) 1,344,038 28,880 8.52 1,213,080 20,466 6.69 Total interest-earning assets 1,691,463 31,722 7.44 1,499,622 21,691 5.74 Noninterest-earning assets 23,407 23,197 Total assets $ 1,714,870 $ 1,522,819 Funding sources: Interest-bearing liabilities: Deposits: Transaction accounts $ 823,331 7,733 3.73 % $ 761,927 2,338 1.22 % Time deposits 292,235 3,243 4.40 152,910 308 0.80 Total interest-bearing deposits 1,115,566 10,976 3.90 914,837 2,646 1.15 Total interest-bearing liabilities $ 1,115,566 10,976 3.90 $ 914,837 2,646 1.15 Noninterest-bearing liabilities: Noninterest-bearing deposits $ 422,691 $ 463,882 Other noninterest-bearing liabilities 11,649 8,132 Total noninterest-bearing liabilities 434,340 472,014 Shareholders' equity 164,964 135,968 Total liabilities and shareholders' equity $ 1,714,870 $ 1,522,819 Net interest income $ 20,746 $ 19,045 Net interest spread 3.54 % 4.59 % Net interest margin 4.87 % 5.04 % (1) Taxable-equivalent yield of 2.15% as of September 30, 2023, applying a 23.0% effective tax rate (2) Non-accrual loans of $41.2 million and $8.2 million as of September 30, 2023 and September 30, 2022, respectively, are included in loans. For the third quarter of 2023 compared to the third quarter of 2022: - Interest income on total loans totaled $28.9 million, an increase of $8.4 million or 41.1%, due to an increase in average loans of $131.0 million, or 10.8%, and increased loan yields; - Loan yields totaled 8.52% compared to 6.69% for the same period in 2022, primarily due to the continued fed rate hikes; and - Net interest margin for the third quarter of 2023 was 4.87% compared to 5.04% for the third quarter of 2022. 41 Table of Contents Net Interest Margin For the Nine Months Ended September 30, 2023 2022 Average Balance Interest Income/ Expense Average Yield/ Rate Average Balance Interest Income/ Expense Average Yield/ Rate (Dollars in thousands) Interest-Earning Assets: Short-term investments $ 162,432 $ 5,668 4.67 % $ 139,133 $ 793 0.76 % Debt securities, taxable 152,702 2,106 1.84 142,913 1,625 1.52 Debt securities, tax exempt (1) 19,828 253 1.71 22,087 273 1.65 Loans held for sale 115 - - 686 - - Total loans (2) 1,299,754 81,117 8.34 1,103,114 50,597 6.13 Total interest-earning assets 1,634,831 $ 89,144 7.29 1,407,933 53,288 5.06 Noninterest-earning assets 22,560 24,069 Total assets $ 1,657,391 $ 1,432,002 Funding sources: Interest-bearing liabilities: Deposits: Transaction accounts $ 812,962 20,346 3.35 % $ 699,670 3,351 0.64 % Time deposits 257,418 7,548 3.92 168,608 890 0.71 Total interest-bearing deposits 1,070,380 27,894 3.48 868,278 4,241 0.65 Total interest-bearing liabilities $ 1,070,380 27,894 3.48 868,278 4,241 0.65 Noninterest-bearing liabilities: Noninterest-bearing deposits $ 420,356 424,720 Other noninterest-bearing liabilities 10,496 7,128 Total noninterest-bearing liabilities 430,852 431,848 Shareholders' equity 156,159 131,876 Total liabilities and shareholders' equity $ 1,657,391 $ 1,432,002 Net interest income $ 61,250 $ 49,047 Net interest spread 3.81 % 4.41 % Net interest margin 5.01 % 4.66 % (1) Taxable-equivalent yield of 2.24% as of September 30, 2023, applying a 23.7% effective tax rate (2) Non-accrual loans of $41.2 million and $8.2 million as of September 30, 2023 and September 30, 2022, respectively, are included in loans. For the first nine months of 2023 compared to the same period in 2022: - Interest income on total loans totaled $81.2 million, an increase of $30.5 million or 60.3%, due to an increase in average loans of $196.6 million, or 17.8%, and increased loan yields; - Loan yields totaled 8.3% compared to 6.1% for the same period in 2022, primarily due to the continued fed rate hikes; - Interest income on debt securities totaled $2.4 million an increase of $461,000 or 24.3%, as a result of debt securities purchased during the first quarter of 2022; and - Net interest margin for the first nine months of 2023 was 5.01% compared to 4.66% for the same period in 2022. 42 Table of Contents Increases and decreases in interest income and interest expense result from changes in average balances, or volume, of interest-earning assets and interest-bearing liabilities, as well as changes in average interest rates. The following tables set forth the effects of changing rates and volumes on our net interest income during the period shown. Information is provided with respect to (i) effects on interest income attributable to changes in volume (change in volume multiplied by prior rate) and (ii) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume). Analysis of Changes in Interest Income and Expenses For the Three Months Ended September 30, 2023 vs 2022 Change due to: Volume (1) Rate (1) Interest Variance (Dollars in thousands) Increase (decrease) in interest income: Short-term investments $ 343 $ 1,274 $ 1,617 Debt securities (63 ) 63 - Total loans 2,208 6,206 8,414 Total increase (decrease) in interest income 2,488 7,543 10,031 Increase (decrease) in interest expense: Deposits: Transaction accounts 189 5,206 5,395 Time deposits 281 2,654 2,935 Total interest-bearing deposits 470 7,860 8,330 Total increase (decrease) in interest expense 470 7,860 8,330 Increase (Decrease) in net interest income $ 2,018 $ (317 ) $ 1,701 Analysis of Changes in Interest Income and Expenses For the Nine Months Ended September 30, 2023 vs 2022 Change due to: Volume (1) Rate (1) Interest Variance (Dollars in thousands) Increase (decrease) in interest income: Short-term investments $ 45 $ 4,830 $ 4,875 Debt securities 29 432 461 Total loans 3,038 27,482 30,520 Total increase (decrease) in interest income 3,112 32,744 35,856 Increase (decrease) in interest expense: Deposits: Transaction accounts 183 16,812 16,995 Time deposits 159 6,499 6,658 Total interest-bearing deposits 342 23,311 23,653 Total increase (decrease) in interest expense 342 23,311 23,653 Increase (Decrease) in net interest income $ 2,770 $ 9,433 $ 12,203 (1) Variances attributable to both volume and rate are allocated on a consistent basis between rate and volume based on the absolute value of the variances in each category. 43 Table of Contents Securities Our investment portfolio consists entirely of securities classified as available for sale. As a result, the carrying values of our investment securities are adjusted for unrealized gain or loss, and any gain or loss is reported on an after-tax basis as a component of other comprehensive income in shareholders’ equity. We evaluate our available for sale securities portfolio on a quarterly basis for potential credit-related impairment. We assess potential credit impairment by comparing the fair value of a debt security to its amortized cost basis. If the fair value of a debt security is greater than the amortized cost basis, no impairment is recognized. If the fair value is less than the amortized cost basis, we review the factors to determine if the impairment is credit-related or noncredit-related. For debt securities we intend to sell or are more likely than not required to sell, before the recovery of their amortized cost basis, the difference between fair value and amortized cost is impaired and is recognized through earnings. For debt securities we do not intend to sell or are more likely than not required to sell, prior to expected recovery of amortized cost basis, the credit portion of the impairment is recognized through earnings, with a corresponding entry to an allowance for credit losses, and the noncredit portion is recognized through accumulated other comprehensive income. The following table summarizes the maturity distribution schedule with corresponding weighted average taxable equivalent yields of the debt securities portfolio at September 30, 2023. The following table presents securities at their expected maturities, which may differ from contractual maturities. The Company manages its debt securities portfolio for liquidity, as a tool to execute its asset/liability management strategy, and for pledging requirements for public funds: As of September 30, 2023 Within One Year After One Year But Within Five Years After Five Years But Within Ten Years After Ten Years Total Amount Yield * Amount Yield * Amount Yield * Amount Yield * Amount Yield * Available-for-sale (Dollars in thousands) U.S. Federal agencies $ 32 2.39 % $ 108 2.93 % $ - 0 % $ - 0 % $ 140 2.81 % Mortgage-backed securities - 1.22 10,403 1.31 2,359 1.54 21,318 1.70 34,080 1.57 State and political subdivisions 4,032 1.20 13,017 1.24 8,046 1.54 129 1.66 25,224 1.33 U.S. Treasuries 98,352 1.19 1,750 1.01 3,336 1.54 - - 103,438 1.18 Corporate debt securities - - - - 4,256 1.54 - - 4,256 3.36 Total $ 102,416 1.19 % $ 25,278 1.26 % $ 17,997 1.91 % $ 21,447 1.70 % $ 167,138 1.36 % Percentage of total 61.28 % 15.12 % 10.77 % 12.83 % 100.00 % *Yield is on a taxable-equivalent basis using 21% tax rate Provision for Credit Losses Credit risk is inherent in the business of making loans. We establish an Allowance for credit losses (“Allowance”) through charges to earnings, which are shown in the statements of income as the provision for credit losses. Specifically identifiable and quantifiable known losses are charged off against the Allowance. The provision for credit losses is determined by conducting a quarterly evaluation of the adequacy of our Allowance and applying the shortfall or excess, if any, to the current quarter’s expense. Any shortfall between the liquidation value of the underlying collateral and the recorded investment value of the loan is considered the required specific reserve amount. See the discussion under “—Critical Accounting Policies and Estimates—Allowance for Credit and Lease Losses” and see Note (1) for discussion of methodology changes in the allowance related to implementation of ASC 326. This has the effect of creating variability in the amount and frequency of charges to our earnings. The provision for credit losses and level of Allowance for each period are dependent upon many factors, including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, management’s assessment of the quality of the loan portfolio, the valuation of problem loans and the general economic conditions in our market areas. The Allowance as a percentage of loans was 1.48% at September 30, 2023 and 1.16% at December 31, 2022. 44 Table of Contents Noninterest Income Noninterest income for the three months ended September 30, 2023 was $1.0 million compared to $840,000 for the same period in 2022, an increase of $167,000, or 19.9%. The following table sets forth the major components of our noninterest income for the three months ended September 30, 2023 and 2022: For the Three Months Ended September 30, 2023 2022 $ Increase (Decrease) % Increase (Decrease) (Dollars in thousands) Noninterest income: Mortgage lending income $ 6 $ 134 $ (128 ) -95.52 % Loss on sales of available-for-sale debt securities (7 ) (10 ) 3 -30.00 % Service charges on deposit accounts 213 210 3 1.43 % Other income and fees 795 506 289 57.11 % Total noninterest income $ 1,007 $ 840 $ 167 19.88 % Noninterest income for the nine months ended September 30, 2023 was $2.5 million compared to $2.2 million for the same period in 2022, an increase of $265,000, or 12.0%. The following table sets forth the major components of our noninterest income for the nine months ended September 30, 2023 and 2022: For the Nine Months Ended September 30, 2023 2022 $ Increase (Decrease) % Increase (Decrease) (Dollars in thousands) Noninterest income: Mortgage lending income $ 172 $ 395 $ (223 ) -56.46 % Loss on sales of available-for-sale debt securities (15 ) (127 ) 112 -88.19 % Service charges on deposit accounts 647 678 (31 ) -4.57 % Other income and fees 1,668 1,261 407 32.28 % Total noninterest income $ 2,472 $ 2,207 $ 265 12.01 % 45 Table of Contents Noninterest Expense Noninterest expense for the three months ended September 30, 2023 was $7.4 million compared to $7.1 million for the same period in 2022, an increase of $257,000, or 3.6%. The following table sets forth the major components of our noninterest expense for the three months ended September 30, 2023 and 2022: For the Three Months Ended September 30, 2023 2022 $ Increase (Decrease) % Increase (Decrease) (Dollars in thousands) Noninterest expense: Salaries and employee benefits $ 4,910 $ 3,996 $ 914 22.87 % Furniture and equipment 254 390 (136 ) -34.87 % Occupancy 662 614 48 7.82 % Data and item processing 424 522 (98 ) -18.77 % Accounting, marketing, and legal fees 14 340 (326 ) -95.88 % Regulatory assessments 279 551 (272 ) -49.36 % Advertising and public relations 74 83 (9 ) -10.84 % Travel, lodging and entertainment 85 94 (9 ) -9.57 % Other expense 688 543 145 26.70 % Total noninterest expense $ 7,390 $ 7,133 $ 257 3.60 % Salaries and employee benefits totaled $4.9 million for the third quarter of 2023 compared to $4.0 million for the same period in 2022, an increase of $914,000 or 22.9%. This increase was attributable to overall increases in compensation to remain competitive. Noninterest expense for the nine months ended September 30, 2023 was $22.4 million compared to $20.5 million for the same period in 2022, an increase of $1.9 million, or 9.3%. The following table sets forth the major components of our noninterest expense for the nine months ended September 30, 2023 and 2022: For the Nine Months Ended September 30, 2023 2022 $ Increase (Decrease) % Increase (Decrease) (Dollars in thousands) Noninterest expense: Salaries and employee benefits $ 14,299 $ 12,148 $ 2,151 17.71 % Furniture and equipment 755 1,134 (379 ) -33.42 % Occupancy 1,980 1,736 244 14.06 % Data and item processing 1,280 1,468 (188 ) -12.81 % Accounting, marketing, and legal fees 491 782 (291 ) -37.21 % Regulatory assessments 1,013 973 40 4.11 % Advertising and public relations 273 314 (41 ) -13.06 % Travel, lodging and entertainment 255 216 39 18.06 % Other expense 2,068 1,745 323 18.51 % Total noninterest expense $ 22,414 $ 20,516 $ 1,898 9.25 % Salaries and employee benefits totaled $14.3 million for the first nine months of 2023 compared to $12.1 million for the same period in 2022, an increase of $2.2 million or 17.7%. This increase was attributable to overall increases in compensation to remain competitive. 46 Table of Contents Financial Condition The following discussion of our financial condition compares September 30, 2023 and December 31, 2022. Total Assets Total assets increased $188.2 million, or 11.9%, to $1.77 billion as of September 30, 2023, compared to $1.58 billion as of December 31, 2022. The increase in total assets is primarily attributable to continued organic growth within our major metropolitan markets in Oklahoma City, Tulsa, and Texas. Loan Portfolio The following table presents the balance and associated percentage of each major category in our loan portfolio as of September 30, 2023 and December 31, 2022: As of September 30, As of December 31 2023 2022 Amount % of Total Amount % of Total (Dollars in thousands) Construction & development $ 139,053 10.0 % $ 163,203 12.8 % 1-4 family real estate 91,540 6.6 % 76,928 6.0 % Commercial real estate - other 516,975 37.0 % 439,001 34.5 % Total commercial real estate 747,568 53.6 % 679,132 53.3 % Commercial & industrial 568,684 40.7 % 513,011 40.3 % Agricultural 64,688 4.6 % 66,145 5.2 % Consumer 14,993 1.1 % 14,949 1.2 % Gross loans 1,395,933 100.0 % 1,273,237 100.0 % Less: unearned income, net (3,156 ) (2,781 ) Total Loans, net of unearned income 1,392,777 1,270,456 Less: Allowance for credit losses (20,649 ) (14,734 ) Net loans $ 1,372,128 $ 1,255,722 Our loans represent the largest portion of our earning assets. The quality and diversification of the loan portfolio is an important consideration when reviewing our financial condition. As of September 30, 2023 and December 31, 2022, our gross loans were $1.40 billion and $1.27 billion, respectively. Included in the commercial & industrial loan balances at September 30, 2023 and December 31, 2022, respectively, are $2.0 million and $2.6 million of loans that were originated under the SBA PPP program. We have established internal concentration limits in the loan portfolio for Commercial Real Estate (CRE) loans, hospitality loans, energy loans, and construction loans, among others. All loan types are within our established limits. We use underwriting guidelines to assess each borrower’s historical cash flow to determine debt service capabilities, and we further stress test the customer’s debt service capability under higher interest rate scenarios as well as other underlying macro-economic factors. Financial and performance covenants are used in commercial lending to allow us to react to a borrower’s deteriorating financial condition, should that occur. 47 Table of Contents The following tables show the contractual maturities of our gross loans as of the periods below: As of September 30, 2023 Due in One Year or Less Due after One Year Through Five Years Due after Five Years Through Fifteen Years Due after Fifteen Years Fixed Rate Adjustable Rate Fixed Rate Adjustable Rate Fixed Rate Adjustable Rate Fixed Rate Adjustable Rate Total (Dollars in thousands) Construction & development $ 7,306 $ 68,731 $ 6,742 $ 42,350 $ - $ 13,589 $ 335 $ - $ 139,053 1-4 family real estate 10,760 11,164 39,491 19,148 28 5,435 5,514 - 91,540 Commercial real estate - other 46,278 77,209 153,640 206,163 137 21,946 11,602 - 516,975 Total commercial real estate 64,344 157,104 199,873 267,661 165 40,970 17,451 - 747,568 Commercial & industrial 15,460 331,247 41,492 166,400 3,452 10,013 620 - 568,684 Agricultural 13,063 25,091 9,185 13,165 59 1,254 2,871 - 64,688 Consumer 2,388 17 5,897 110 582 2,908 3,091 - 14,993 Gross loans $ 95,255 $ 513,459 $ 256,447 $ 447,336 $ 4,258 $ 55,145 $ 24,033 $ - $ 1,395,933 As of December 31, 2022 Due in One Year or Less Due after One Year Through Five Years Due after Five Years Through Fifteen Years Due after Fifteen Years Fixed Rate Adjustable Rate Fixed Rate Adjustable Rate Fixed Rate Adjustable Rate Fixed Rate Adjustable Rate Total (Dollars in thousands) Construction & development $ 11,749 $ 81,002 $ 7,556 $ 57,439 $ - $ 1,160 $ - $ 4,297 $ 163,203 1-4 family real estate 10,550 12,664 24,741 15,782 314 6,606 - 6,271 76,928 Commercial real estate - other 2,680 59,870 131,105 207,819 6,635 17,146 - 13,746 439,001 Total commercial real estate 24,979 153,536 163,402 281,040 6,949 24,912 - 24,314 679,132 Commercial & industrial 43,823 234,573 60,275 159,571 3,745 10,390 - 634 513,011 Agricultural 1,798 17,514 8,767 33,270 469 980 140 3,207 66,145 Consumer 1,683 22 6,310 156 587 2,860 82 3,249 14,949 Gross loans $ 72,283 $ 405,645 $ 238,754 $ 474,037 $ 11,750 $ 39,142 $ 222 $ 31,404 $ 1,273,237 Allowance for Credit and Lease Losses The allowance is based on management’s estimate of potential losses inherent in the loan portfolio. In the opinion of management, the allowance is adequate to absorb estimated losses in the portfolio as of each balance sheet date. While management uses available information to analyze losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance. In analyzing the adequacy of the allowance, a comprehensive loan grading system to determine risk potential in loans is utilized together with the results of internal credit reviews. To determine the adequacy of the allowance, the loan portfolio is broken into segments based on loan type. Historical loss experience factors by segment, adjusted for changes in trends and conditions, are used to determine an indicated allowance for each portfolio segment. These factors are evaluated and updated based on the composition of the specific loan segment. Other considerations include volumes and trends of delinquencies, nonaccrual loans, levels of bankruptcies, criticized and classified loan trends, expected losses on real estate secured loans, new credit products and policies, economic conditions, concentrations of credit risk and the experience and abilities of our lending personnel. See Note (1) for discussion of methodology changes to the allowance related to implementation of ASC 326. The allowance was $20.6 million at September 30, 2023, compared to $14.7 million at December 31, 2022. 48 Table of Contents The following table provides an analysis of the activity in our allowance for the periods indicated: For the Nine Months Ended September 30, 2023 2022 (Dollars in thousands) Balance at beginning of the period $ 14,734 $ 10,316 Impact of CECL adoption 250 - Provision for credit losses for loans 5,681 2,843 Charge-offs: Construction & development - - 1-4 family real estate - - Commercial real estate - other - - Commercial & industrial - - Agricultural (7 ) - Consumer (16 ) (20 ) Total charge-offs (23 ) (20 ) Recoveries: Construction & development - - 1-4 family real estate - - Commercial real estate - other - - Commercial & industrial - - Agricultural 2 - Consumer 5 14 Total recoveries 7 14 Net recoveries (charge-offs) (16 ) (6 ) Balance at end of the period $ 20,649 $ 13,153 Net recoveries (charge-offs) to average loans 0.00 % 0.00 % While the entire allowance is available to absorb losses from any and all loans, the following table represents management’s allocation of the allowance by loan category, and the percentage of allowance in each category, for the periods indicated: As of September 30, As of December 31, 2023 2022 Amount Percent Amount Percent (Dollars in thousands) Construction & development $ 1,481 7.2 % $ 1,889 12.8 % 1-4 family real estate 1,146 5.5 % 890 6.0 % Commercial real estate - Other 6,729 32.6 % 5,080 34.5 % Commercial & industrial 10,430 50.6 % 5,937 40.3 % Agricultural 609 2.9 % 765 5.2 % Consumer 254 1.2 % 173 1.2 % Total $ 20,649 100.0 % $ 14,734 100.0 % 49 Table of Contents Nonperforming Assets Loans are considered delinquent when principal or interest payments are past due 30 days or more. Delinquent loans may remain on accrual status between 30 days and 90 days past due. Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. Typically, the accrual of interest on loans is discontinued when principal or interest payments are past due 90 days or when, in the opinion of management, there is a reasonable doubt as to collectability of the obligation. When loans are placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Income on a nonaccrual loan is subsequently recognized only to the extent that cash is received and the loan’s principal balance is deemed collectible. Loans are restored to accrual status when loans become well-secured and management believes full collectability of principal and interest is probable. A loan is considered impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans include loans on nonaccrual status. Income from a loan on nonaccrual status is recognized to the extent cash is received and when the loan’s principal balance is deemed collectible. Depending on a particular loan’s circumstances, we measure impairment of a loan based upon either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the fair value of the collateral less estimated costs to sell if the loan is collateral dependent. A loan is considered collateral dependent when repayment of the loan is based solely on the liquidation of the collateral. Fair value, where possible, is determined by independent appraisals, typically on an annual basis. Between appraisal periods, the fair value may be adjusted based on specific events, such as if deterioration of quality of the collateral comes to our attention as part of our problem loan monitoring process, or if discussions with the borrower lead us to believe the last appraised value no longer reflects the actual market for the collateral. The impairment amount on a collateral dependent loan is charged off to the allowance if deemed not collectible and the impairment amount on a loan that is not collateral dependent is set up as a specific reserve. Real estate we acquire as a result of foreclosure or by deed-in-lieu of foreclosure is classified as other real estate owned, or OREO, until sold, and is initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. 50 Table of Contents The following table presents information regarding nonperforming assets as of the dates indicated. As of September 30, As of December 31, 2023 2022 (Dollars in thousands) Nonaccrual loans $ 41,243 $ 8,039 Accruing loans 90 or more days past due 9,856 9,941 Total nonperforming assets $ 51,099 $ 17,980 Ratio of nonperforming loans to total loans 3.67 % 1.42 % Ratio of nonaccrual loans to total loans 2.96 % 0.63 % Ratio of allowance for credit losses to total loans 1.48 % 1.16 % Ratio of allowance for credit losses to nonaccrual loans 50.07 % 183.28 % Ratio of nonperforming assets to total assets 2.88 % 1.13 % The following tables present an aging analysis of loans as of the dates indicated. As of September 30, 2023 Loans 30-59 days past due Loans 60-89 days past due Loans 90+ days past due Loans 90+ days past due and accruing Total past due loans Current Total loans (Dollars in thousands) Construction & development $ - $ - $ - $ - $ - $ 139,053 $ 139,053 1-4 family real estate - - - - - 91,540 91,540 Commercial real estate 134 - - - 134 516,841 516,975 Commercial & industrial 58 - 9,776 9,776 9,834 558,850 568,684 Agricultural - - - - - 64,688 64,688 Consumer 123 - 80 80 203 14,790 14,993 Total $ 315 $ - $ 9,856 $ 9,856 $ 10,171 $ 1,385,762 $ 1,395,933 As of December 31, 2022 Loans 30-59 days past due Loans 60-89 days past due Loans 90+ days past due Loans 90+ days past due and accruing Total Past Due Loans Current Total loans (Dollars in thousands) Construction & development $ - $ - $ - $ - $ - $ 163,203 $ 163,203 1-4 family real estate - - - - - 76,928 76,928 Commercial real estate - 617 - - 617 438,384 439,001 Commercial & industrial 21 - 9,923 9,923 9,944 503,067 513,011 Agricultural 4 - - - 4 66,141 66,145 Consumer 291 82 22 18 395 14,554 14,949 Total $ 316 $ 699 $ 9,945 $ 9,941 $ 10,960 $ 1,262,277 $ 1,273,237 51 Table of Contents In addition to the past due and nonaccrual criteria, we also evaluate loans according to our internal risk grading system. Loans are segregated between pass, watch, special mention, and substandard categories. The definitions of those categories are as follows: Pass : These loans generally conform to Bank policies, are characterized by policy-conforming advance rates on collateral, and have well-defined repayment sources. In addition, these credits are extended to borrowers and guarantors with a strong balance sheet and either substantial liquidity or a reliable income history. Watch : These loans are still considered “Pass” credits; however, various factors such as industry stress, material changes in cash flow or financial conditions, or deficiencies in loan documentation, or other risk issues determined by the lending officer, Commercial Loan Committee or Credit Quality Committee warrant a heightened sense and frequency of monitoring. Special mention : These loans have observable weaknesses or evidence of imprudent handling or structural issues. The weaknesses require close attention, and the remediation of those weaknesses is necessary. No risk of probable loss exists. Credits in this category are expected to quickly migrate to “Watch” or “Substandard” as this is viewed as a transitory loan grade. Substandard : These loans are not adequately protected by the sound worth and debt service capacity of the borrower, but may be well-secured. The loans have defined weaknesses relative to cash flow, collateral, financial condition or other factors that might jeopardize repayment of all of the principal and interest on a timely basis. There is the possibility that a future loss will occur if weaknesses are not remediated. Outstanding loan balances categorized by internal risk grades as of the periods indicated are summarized as follows: As of September 30, 2023 Pass Watch Special mention Substandard Total (Dollars in thousands) Construction & development $ 138,260 $ - $ 793 $ - $ 139,053 1-4 family real estate 91,540 - - - 91,540 Commercial real estate - Other 501,009 - 15,832 134 516,975 Commercial & industrial 503,770 - 11,785 53,129 568,684 Agricultural 64,581 107 - - 64,688 Consumer 14,913 - - 80 14,993 Total $ 1,314,073 $ 107 $ 28,410 $ 53,343 $ 1,395,933 As of December 31, 2022 Pass Watch Special mention Substandard Total (Dollars in thousands) Construction & development $ 163,203 $ - $ - $ - $ 163,203 1-4 family real estate 76,928 - - - 76,928 Commercial real estate - Other 397,295 14,976 24,747 1,983 439,001 Commercial & industrial 493,412 - 584 19,015 513,011 Agricultural 65,857 288 - - 66,145 Consumer 14,927 - - 22 14,949 Total $ 1,211,622 $ 15,264 $ 25,331 $ 21,020 $ 1,273,237 52 Table of Contents Deposits We gather deposits primarily through our twelve branch locations and online through our website. We offer a variety of deposit products including demand deposit accounts and interest-bearing products, such as savings accounts and certificates of deposit. We put continued effort into gathering noninterest-bearing demand deposit accounts through loan production cross-selling, customer referrals, marketing efforts and various involvement with community networks. Some of our interest-bearing deposits are obtained through brokered transactions. We participate in the CDARS and ICS programs, where customer funds are placed into multiple deposit accounts, each in an amount under the standard FDIC insurance maximum of $250,000, and placed at a network of banks across the United States. Total deposits as of September 30, 2023 and December 31, 2022 were $1.59 billion and $1.43 billion, respectively. The following table sets forth deposit balances by certain categories as of the dates indicated and the percentage of each deposit category to total deposits. As of September 30, December 31, 2023 2022 Amount Percentage of Total Amount Percentage of Total (Dollars in thousands) Noninterest-bearing demand $ 480,827 30.1 % $ 441,509 30.9 % Interest-bearing transaction deposits 722,301 45.3 % 669,852 46.8 % Savings deposits 133,198 8.4 % 136,537 9.5 % Time deposits ($250,000 or less) 168,371 10.6 % 140,929 9.8 % Time deposits (more than $250,000) 88,875 5.6 % 42,573 3.0 % Total interest-bearing deposits 1,112,745 69.9 % 989,891 69.1 % Total deposits $ 1,593,572 100.0 % $ 1,431,400 100.0 % The following tables set forth the maturity of time deposits as of the dates indicated below: As of September 30, 2023 Maturity Within: Three Months Three to Six Months Six to 12 Months After 12 Months Total (Dollars in thousands) Time deposits ($250,000 or less) $ 64,130 $ 44,202 $ 45,618 $ 14,421 $ 168,371 Time deposits (more than $250,000) 26,218 30,753 10,404 21,500 88,875 Total time deposits $ 90,348 $ 74,955 $ 56,022 $ 35,921 $ 257,246 As of December 31, 2022 Maturity Within: Three Months Three to Six Months Six to 12 Months After 12 Months Total (Dollars in thousands) Time deposits ($250,000 or less) $ 58,184 $ 25,333 $ 38,844 $ 18,568 $ 140,929 Time deposits (more than $250,000) 12,292 5,579 17,001 7,701 42,573 Total time deposits $ 70,476 $ 30,912 $ 55,845 $ 26,269 $ 183,502 53 Table of Contents Liquidity Liquidity refers to our ability to meet the cash flow requirements of depositors and borrowers, while at the same time meeting our operating, capital and strategic cash flow needs, all at a reasonable cost. We continuously monitor our liquidity position to ensure that assets and liabilities are managed in a manner that will meet all short-term and long-term cash requirements. We manage our liquidity position to meet the daily cash flow needs of customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of our shareholders. Our liquidity position is supported by the management of liquid assets and access to alternative sources of funds. Our liquid assets include cash, interest-bearing deposits in correspondent banks and fed funds sold. Other available sources of liquidity include wholesale deposits and borrowings from correspondent banks and FHLB advances. Our short-term and long-term liquidity requirements are primarily met through cash flow from operations, redeployment of prepaying and maturing balances in our loan portfolios, and increases in customer deposits. Other alternative sources of funds will supplement these primary sources to the extent necessary to meet additional liquidity requirements on either a short-term or long-term basis. As of September 30, 2023, we had no unsecured fed funds lines with correspondent depository institutions with no amounts advanced. In addition, based on the values of loans pledged as collateral, we had borrowing availability with the FHLB of $146.6 million as of September 30, 2023 and $129.2 million as of December 31, 2022. Capital Requirements The Bank is subject to various regulatory capital requirements administered by the federal and state banking regulators. Failure to meet regulatory capital requirements may result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for “prompt corrective action” (described below), We must meet specific capital guidelines that involve quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting policies. The capital amounts and classifications are subject to qualitative judgments by the federal banking regulators about components, risk weightings and other factors. Qualitative measures established by regulation to ensure capital adequacy require us to maintain minimum amounts and ratios of Common Equity Tier 1 (“CET1”) capital, Tier 1 capital, total capital to risk-weighted assets, and Tier 1 capital to average consolidated assets, referred to as the “leverage ratio.” As of September 30, 2023, the Bank was in compliance with all applicable regulatory requirements and categorized as “well-capitalized” under the prompt corrective action frame work. There have been no conditions or events since September 30, 2023 that management believes would change this classification. The table below presents our applicable capital requirements, as well as our capital ratios as of September 30, 2023 and December 31, 2022. The Company exceeded all regulatory capital requirements and the Bank was considered to be “well-capitalized” as of the dates reflected in the tables below. Basel III Capital Rules Under the Basel III Capital Rules, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of CET1 capital above its minimum risk-based capital requirements. As of September 30, 2023, the Company and the Bank met all capital adequacy requirements under the Basel III Capital Rules. 54 Table of Contents Actual With Capital Conservation Buffer Minimum to be "Well-Capitalized" Under Prompt Corrective Action Amount Ratio Amount Ratio Amount Ratio (Dollars in thousands) As of September 30, 2023 Total capital (to risk-weighted assets) Company $ 185,826 12.64 % $ 154,381 10.50 % N/A N/A Bank 185,773 12.64 % 154,273 10.50 % $ 146,927 10.00 % Tier 1 capital (to risk-weighted assets) Company 167,419 11.39 % 124,975 8.50 % N/A N/A Bank 167,379 11.39 % 124,888 8.50 % 117,542 8.00 % CET 1 capital (to risk-weighted assets) Company 167,419 11.39 % 102,921 7.00 % N/A N/A Bank 167,379 11.39 % 102,849 7.00 % 95,503 6.50 % Tier 1 capital (to average assets) Company 167,419 9.76 % N/A N/A N/A N/A Bank 167,379 9.75 % N/A N/A 85,805 5.00 % Actual With Capital Conservation Buffer Minimum to be "Well-Capitalized" Under Prompt Corrective Action Amount Ratio Amount Ratio Amount Ratio (Dollars in thousands) As of December 31, 2022 Total capital (to risk-weighted assets) Company $ 158,158 12.41 % $ 133,862 10.50 % N/A N/A Bank 158,158 12.42 % 133,756 10.50 % $ 127,387 10.00 % Tier 1 capital (to risk-weighted assets) Company 143,424 11.25 % 108,365 8.50 % N/A N/A Bank 143,424 11.26 % 108,279 8.50 % 101,909 8.00 % CET 1 capital (to risk-weighted assets) Company 143,424 11.25 % 89,241 7.00 % N/A N/A Bank 143,424 11.26 % 89,171 7.00 % 82,801 6.50 % Tier 1 capital (to average assets) Company 143,424 9.19 % N/A N/A N/A N/A Bank 143,424 9.18 % N/A N/A 78,111 5.00 % Shareholders’ equity provides a source of permanent funding, allows for future growth and provides a cushion to withstand unforeseen adverse developments. Total shareholders’ equity increased $23.8 million as of September 30, 2023 to $167.9 million, compared to $144.1 million as of December 31, 2022. 55 Table of Contents Contractual Obligations The following tables contain supplemental information regarding our total contractual obligations as of September 30, 2023, and December 31, 2022: Payments Due as of September 30, 2023 Within One Year One to Three Years Three to Five Years After Five Years Total (Dollars in thousands) Deposits without a stated maturity $ 1,336,326 $ - $ - $ - $ 1,336,326 Time deposits 221,325 34,753 1,168 - 257,246 Operating lease commitments 380 768 369 1,088 2,605 Total contractual obligations $ 1,558,031 $ 35,521 $ 1,537 $ 1,088 $ 1,596,177 Payments Due as of December 31, 2022 Within One Year One to Three Years Three to Five Years After Five Years Total (Dollars in thousands) Deposits without a stated maturity $ 1,245,798 $ - $ - $ - $ 1,245,798 Time deposits 157,233 26,002 267 - 183,502 Operating lease commitments 532 815 453 530 2,330 Total contractual obligations $ 1,403,563 $ 26,817 $ 720 $ 530 $ 1,431,630 We believe that we will be able to meet our contractual obligations as they come due through the maintenance of adequate cash levels. We expect to maintain adequate cash levels through profitability, loan repayment and maturity activity and continued deposit gathering activities. We have in place various borrowing mechanisms for both short-term and long-term liquidity needs. Off-Balance Sheet Arrangements We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The contractual or notional amounts of those instruments reflect the extent of involvement we have in particular classes of financial instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if we deemed necessary upon extension of credit, is based on management’s credit evaluation of the counterparty. The Company also estimates a reserve for potential losses associated with off-balance sheet commitments and letters of credit. It is included in other liabilities in the Company’s consolidated statements of condition, with any related provisions to the reserve included in non-interest expense in the consolidated statement of income. In determining the reserve for unfunded lending commitments, a process similar to the one used for the allowance is employed. Based on historical experience, loss factors, adjusted for expected funding, are applied to the Company’s off-balance sheet commitments and letters of credit to estimate the potential for losses. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of the customer to a third party. They are intended to be disbursed, subject to certain conditions, upon request of the borrower. 56 Table of Contents The following table summarizes commitments as of the dates presented. September 30, December 31, 2023 2022 (Dollars in thousands) Commitments to extend credit $ 245,079 $ 198,027 Standby letters of credit 2,148 1,043 Total $ 247,227 $ 199,070 Critical Accounting Policies and Estimates Our accounting and reporting policies conform to GAAP and conform to general practices within the industry in which we operate. To prepare financial statements in conformity with GAAP, management makes estimates, assumptions and judgments based on available information. These estimates, assumptions and judgments affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements and, as this information changes, actual results could differ from the estimates, assumptions and judgments reflected in the financial statement. In particular, management has identified several accounting policies that, due to the estimates, assumptions and judgments inherent in those policies, are critical in understanding our financial statements. The JOBS Act permits us an extended transition period for complying with new or revised accounting standards affecting public companies. We have elected to take advantage of this extended transition period, which means that the financial statements included in this Form 10-Q, as well as any financial statements that we file in the future, will not be subject to all new or revised accounting standards generally applicable to public companies for the transition period for so long as we remain an emerging growth company or until we affirmatively and irrevocably opt out of the extended transition period under the JOBS Act. Effective January 1, 2023, the Company adopted ASU 2016-13, Financial Instrument – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments related to the impairment of financial instruments. This guidance, commonly referred to as Current Expected Credit Loss (“CECL”), changes impairment recognition to a model that is based on expected losses rather than incurred losses. The allowance for credit losses is considered a critical accounting policy and a critical accounting estimate. The allowance for credit losses is established for current expected credit losses on the Company’s loan portfolio, including unfunded credit commitments. Prior to January 1, 2023, the allowance for credit losses was established based on an incurred loss model. Upon the adoption of CECL, certain loan classification and segmentation categories were changed to align with the requirements of the standard and more effectively model the CECL estimate. The updated CECL segmentation is reflected in the disclosures beginning January 1, 2023, and prior period classifications have been adjusted to reflect CECL segmentations. Results from periods prior to January 1, 2023, are presented using the previously applicable GAAP. For more information see Note 1 and Note 6 to the consolidated financial statements contained in this report. The following is a discussion of the critical accounting policies and significant estimates that we believe require us to make the most complex or subjective decisions or assessments. Additional information about these policies can be found in Note 1 of our unaudited condensed consolidated financial statements as of September 30, 2023. Allowance for Credit Losses The allowance is based on management’s estimate of probable losses inherent in the loan portfolio. In the opinion of management, the allowance is adequate to absorb estimated losses in the portfolio as of each balance sheet date. While management uses available information to analyze losses on loans, future additions to the allowance may be necessary based on changes in economic conditions and changes in the composition of the loan portfolio. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance. In analyzing the adequacy of the allowance, a comprehensive loan grading system to determine risk potential in loans is utilized together with the results of internal credit reviews. To determine the adequacy of the allowance, the loan portfolio is broken into segments based on loan type and risk characteristics. Historical loss experience factors by segment, adjusted for changes in trends and conditions, are used to determine an indicated allowance for each portfolio segment. These factors are evaluated and updated based on the composition of the specific loan segment. Other considerations include volumes and trends of delinquencies, nonaccrual loans, levels of bankruptcies, criticized and classified loan trends, expected losses on real estate secured loans, new credit products and policies, economic conditions, concentrations of credit risk and the experience and abilities of our lending personnel. In addition to the segment evaluations, impaired loans with a balance of $250,000 or more are individually evaluated based on facts and circumstances of the loan to determine if a specific allowance amount may be necessary. Specific allowances may also be established for loans whose outstanding balances are below the $250,000 threshold when it is determined that the risk associated with the loan differs significantly from the risk factor amounts established for its loan segment. 57 Table of Contents Goodwill and Intangibles Intangible assets totaled $1.1 million and goodwill, net of accumulated amortization, totaled $8.5 million for the nine months ended September 30, 2023, compared to intangible assets of $1.3 million and goodwill of $8.6 million for the year ended December 31, 2022. Goodwill resulting from a business combination represents the excess of the fair value of the consideration transferred over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill is tested annually for impairment or more frequently if other impairment indicators are present. If the implied fair value of goodwill is lower than its carrying amount, a goodwill impairment is indicated and goodwill is written down to its implied fair value. Subsequent increases in goodwill value are not recognized in the accompanying consolidated financial statements. Other intangible assets consist of core deposit intangible assets and are amortized on a straight-line basis based on an estimated useful life of 10 years. Such assets are periodically evaluated as to the recoverability of their carrying values. Income Taxes We file a consolidated income tax return. Deferred taxes are recognized under the balance sheet method based upon the future tax consequences of temporary differences between the carrying amounts and tax basis of assets and liabilities, using the tax rates expected to apply to taxable income in the periods when the related temporary differences are expected to be realized. The amount of accrued current and deferred income taxes is based on estimates of taxes due or receivable from taxing authorities either currently or in the future. Changes in these accruals are reported as tax expense, and involve estimates of the various components included in determining taxable income, tax credits, other taxes and temporary differences. Changes periodically occur in the estimates due to changes in tax rates, tax laws and regulations and implementation of new tax planning strategies. The process of determining the accruals for income taxes necessarily involves the exercise of considerable judgment and consideration of numerous subjective factors. Management performs an analysis of our tax positions annually and believes it is more likely than not that all of its tax positions will be utilized in future years.