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Item 2. Management’s Discussion and Analysis

2023-08-11 compared with 2023-05-12 · 231 added, 145 removed, 391 unchanged (49% of the section changed)

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FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Period Ended March 31, 2023

Period Ended June 30, 2023

The following discussion analyzes the consolidated financial condition of Community Bancorp.

and its wholly-owned subsidiary, Community National Bank, as of March 31, 2023 and December 31, 2022, and its consolidated results of operations for the three--month interim period and one year period presented.

and its wholly-owned subsidiary, Community National Bank, as of June 30, 2023 and December 31, 2022, and its consolidated results of operations for the three- and six-month interim periods and one year period presented.

The Company is considered a “smaller reporting company” and a “non-accelerated filer” under the disclosure rules of the SEC.

Accordingly, the Company has elected to provide its audited statements of income, comprehensive income, cash flows and changes in shareholders’ equity for a two year, rather than a three year, period and intends to provide smaller reporting company scaled disclosures where management deems it appropriate.

Accordingly, the Company has elected to provide its statements of income, comprehensive income, cash flows and changes in shareholders’ equity for a two-year, rather than a three-year, period and provide certain other smaller reporting company scaled disclosures where management deems it appropriate.

The following discussion should be read in conjunction with the Company’s audited consolidated financial statements and related notes contained in its 2022 Annual Report on Form 10-K filed with the SEC.

Please refer to Note 1 in the accompanying audited consolidated financial statements for a listing of acronyms and defined terms used throughout the following discussion.

Please refer to Note 1 in the accompanying consolidated financial statements for a listing of acronyms and defined terms used throughout the following discussion.

FORWARD-LOOKING STATEMENTS

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the geographic concentration of the Company’s loan portfolio and deposit base;

the planned phase out of three month LIBOR by June 30, 2023, which could adversely affect the Company’s interest costs in future periods on its $12,887,000 in principal amount of Junior Subordinated Debentures due December 12, 2037, which currently bear interest at a variable rate, adjusted quarterly, equal to 3-month LIBOR, plus 2.85%;

reductions in deposit levels, which necessitate increased borrowings to fund loans and sale of investment securities;

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However, that information should be considered supplemental in nature and not as a substitute for related financial information prepared in accordance with GAAP.

The Company’s consolidated assets on March 31, 2023 were $1.03 billion compared to $1.06 billion at December 31, 2022, a decrease of 2.4%.

Significant changes in the asset base were due to a decrease of $33.5 million, or 47.1%, in cash and cash equivalents, which was partially offset by an increase in net loans of $9.5 million, or 1.3%.

This demonstrates the Company’s efforts to deploy cash into higher earning assets.

The increase in the loan portfolio was primarily attributable to an increase of $5.9 million in commercial & industrial loans, $5.23 million in CRE loans and $1.8 million in municipal loans, which was partially offset by a decrease of $1.9 million in residential junior lien loans and $0.8 million in purchased BHG loans.

Total deposits on March 31, 2023 were $888.5 million compared to $923.0 million on December 31, 2022, a decrease of $34.4 million, or 3.7% and an increase of $11.2 million, or 1.28%, compared to March 31, 2022.

Year to date, demand and interest-bearing transaction accounts decreased in total by $29.9 million or 5.9%, followed by a decrease of $7.6 million, or 5.4% in money market funds.

The Company’s consolidated assets at June 30, 2023, were $1.03 billion compared to $1.06 billion at December 31, 2022, a decrease of 2.3%.

Significant changes in the asset base were due to a decrease of $51.8 million, or 72.8%, in cash and cash equivalents, which was partially offset by an increase in loans of $32.4 million, or 4.3%.

This change in the asset base reflects the Company’s efforts to deploy cash into higher earning assets.

The increase in the loan portfolio was primarily attributable to an increase of $13.3 million in commercial & industrial loans, $27.9 million in CRE loans and $1.4 million in residential first lien loans, which was partially offset by a decrease of $6.9 million in municipal loans and $1.7 million in residential junior lien loans and $1.4 million in purchased loans.

Total deposits at June 30, 2023, were $851.2 million compared to $923.0 million at December 31, 2022, a decrease of $71.8 million, or 7.8%.

Year to date, demand and interest-bearing transaction accounts decreased in total by $41.3 million or 8.1%, followed by a decrease of $31.1 million, or 22.2% in money market funds and $5.0 million, or 2.9% in savings accounts.

This was offset minimally by an increase of $5.6 million, or 5.5% in time deposits.

An increase of $5.0 million, or 15.1%, in repurchase agreements is also noted since year end and $9.3 million, or 32.4%, since March 31, 2022.

A decline in deposits in the first quarter is a normal occurrence for the Company primarily due to normal seasonal outflows.

Pricing pressures as depositors look for alternative products with higher interest rates in the current rate environment has resulted in deposit outflows as well.

Total interest income increased $2.5 million, or 30.5%, for the first three months of 2023 compared to the same period in 2022.

The increase in the loan portfolio, coupled with the increases in the fed funds rate throughout 2022 and in the first quarter of 2023 help to support the year over year increase in interest income.

Total interest expense increased $1.6 million, or 224.1%, for the first three months of 2023 compared to the same period in 2022.

An increase of $2.1 million, or 6.2%, in repurchase agreements is also noted since year end.

Although a decline in deposits in the first six months is a normal occurrence for the Company primarily due to normal seasonal outflows, the decline is augmented by the continued spend-down of Covid relief funds.

Pricing pressures, as depositors look for alternative products with higher interest rates in the current rate environment, resulted in deposit outflows as well.

The decrease in deposit balances combined with the loan growth, has required the use of borrowed funds as a supplemental funding source.

Total interest income increased $2.6 million, or 30.1%, for the second quarter of 2023, and $5.1 million, or 30.6%, for the first six months of 2023, compared to the same periods in 2022.

The increase in the loan portfolio, coupled with increases in the fed funds rate throughout 2022 and into 2023, helped to support the year over year increase in interest income.

Total interest expense increased $2.2 million, or 292.6% for the second quarter of 2023, and $3.7 million, or 259.7%, for the first six months of 2023, compared to the same periods in 2022.

The recent increases in the fed funds rate have put more pressure on competitive deposit pricing, resulting in an increase in the Company’s money market and time deposit rates.

Please refer to the interest rate sensitivity discussion in the Interest Rate Risk and Asset and Liability Management section for more information on the impact that the actions of the FRB’s FOMC in regulating interest rates, and changes in the yield curve, could have on net interest income.

The provision for credit losses for the quarter ended March 31, 2023 was determined under ASU No.

The provision for credit losses for the three and six months ended June 30, 2023, was determined under ASU No.

2016-13, Measurement of Credit Losses on Financial Instruments, commonly referenced as the Current Expected Credit Losses, or CECL, which the Company adopted effective January 1, 2023.

The provision for credit losses for the first three months of 2023 was $286,526 compared to $862,500 for the same period in 2022, a decrease of $575,974, or 66.8%.

This decrease to the provision was driven primarily by a write-down on a non-performing CRE loan totaling $667,474 during March 2022.

The provision for credit losses for the second quarter of 2023 was $281,142 compared to $337,500 for the same quarter in 2022 and for the first six months of 2023 was $567,668 compared to $1.2 million for the same period in 2022, a decrease of $632,332, or 52.7%.

This decrease to the provision year over year was driven primarily by a write-down on a non-performing CRE loan totaling $667,474 during the first quarter of 2022, which necessitated a substantial provision for that quarter.

Please refer to Note 5 of the unaudited consolidated financial statements as well as the ACL and provisions discussion in the Credit Risk section of this MD&A.

Consolidated net income for the first three months of 2023 increased $933,219 to $3.3 million compared to $2.4 million in the same period of 2022.

Year over year, a $2.5 million increase in interest income was offset in part by an increase of $1.6 million in interest expense, but a decrease of $575,974 in the provision for credit losses between periods resulted in an increase of $1.6 million in net interest income after provision for credit losses.

Consolidated net income for the second quarter of 2023 increased $175,187 to $3.2 million compared to $3.0 million for the same quarter of 2022, and for the first six months of 2023 increased $1.1 million to $6.5 million compared to $5.4 million in the same period of 2022.

Year over year, a $5.1 million increase in interest income was partially offset by an increase of $3.7 million in interest expense and coupled with a decrease of $632,332 in the provision for credit losses between periods, resulted in an increase of $2.0 million in net interest income after provision for credit losses.

These changes, along with other significant changes in non-interest income and non-interest expense are discussed in the appropriate sections of this MD&A.

Equity capital increased to $79.7 million, with a book value per share of $14.33 as of March 31, 2023, compared to $75.2 million and a book value of $13.55 as of December 31, 2022.

This increase in equity capital is partially related to the decrease of unrealized losses in the investment portfolio of $2.7 million, net of tax, in accumulated other comprehensive loss in the shareholders’ equity portion of the balance sheet.

This position is considered by management as temporary and does not impact the Company’s regulatory capital ratios.

On March 15, 2023, the Company's Board of Directors declared a quarterly cash dividend of $0.23 per common share, payable on May 1, 2023 to shareholders of record on April 15, 2023.

As of March 31, 2023, all of the Company’s capital ratios, and those of our subsidiary Bank, were in excess of applicable regulatory requirements.

While we believe that we have sufficient capital to withstand an economic downturn from any headwinds related to inflation or recessionary periods, should one occur, our equity capital and regulatory capital ratios could be adversely impacted, including as a result of credit losses and other adverse impacts of the pandemic, deteriorating economic conditions, or government monetary policy.

Equity capital increased to $80.5 million, with a book value per share of $14.44 as of June 30, 2023, compared to $75.2 million and a book value per share of $13.55 as of December 31, 2022.

Equity capital increased between periods despite a cumulative effect charge to retained earnings of $549,113 upon the transition to CECL effective on January 1, 2023.

The increase in equity capital is partially related to the decrease in unrealized losses in the investment portfolio of $1.2 million, net of tax, reflected in the accumulated other comprehensive loss component of the shareholders’ equity portion of the balance sheet.

This position is considered by management as temporary and, unlike the charge to retained earnings in connection with the transition to CECL, does not impact the Company’s regulatory capital ratios.

The week of July 10, 2023 brought heavy rainfall to the state of Vermont which caused extensive flooding across much of the state leading to Governor Phil Scott declaring a state of emergency.

Preliminary figures from self-reporting data released by Vermont Emergency Management suggest that the impact was considerable, and that the total damage will be at least comparable, if not greater, than what was suffered in 2011 during Tropical Storm Irene.

The State Emergency Operations Center has received reports of damage to over 4,000 residential units and over 800 businesses.

The portion of the Company’s service area most impacted was central Vermont, including one of the Bank’s branches which sustained extensive flooding.

The branch has been closed for restoration and repairs, anticipating reopening within a few weeks.

The impact to the Bank’s customers appears to be manageable with many having flood insurance coverage and or qualifying for the various assistance programs offered at the state and federal level.

On June 14, 2023, the Company's Board of Directors declared a quarterly cash dividend of $0.23 per common share, payable on August 1, 2023, to shareholders of record on July 15, 2023.

As of June 30, 2023, all the Company’s capital ratios, and those of our subsidiary Bank, were in excess of applicable regulatory requirements.

While we believe that we have sufficient capital to withstand an economic downturn from any headwinds related to inflation or recessionary periods, should one occur, our equity capital and regulatory capital ratios could be adversely impacted, including as a result of credit losses and other adverse impacts of deteriorating economic conditions, or government monetary policy.

CRITICAL ACCOUNTING POLICIES

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These policies are described in the Company’s 2022 Annual Report on Form 10-K in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” and in Note 1 (Significant Accounting Policies) to the audited consolidated financial statements.

With the exception of the ACL policy, there were no material changes during the first three months of 2023 in the Company’s critical accounting policies.

With the exception of the ACL policy, there were no material changes during the first six months of 2023 in the Company’s critical accounting policies.

ACL - Management believes that the calculation of the ACL is a critical accounting policy that requires the most significant judgments and estimates used in the preparation of its consolidated financial statements.

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This evaluation is inherently subjective and actual results could differ significantly from these estimates under different assumptions, judgments or conditions.

A modified version of these requirements applies to debt securities classified as available for sale, which eliminates OTTI impairment analysis and requires that if a decline in the fair value of debt securities AFS are deemed by management to be the result of credit losses rather than other factors, the credit losses on those securities will be recorded through an allowance for credit losses rather than a write-down of the security.

The Company estimates expected credit losses on OBS credit exposures over the contractual period in which the Company is exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company.

The ACL on OBS credit exposures is adjusted through credit loss expense.

A modified version of these requirements applies to debt securities classified as available for sale, which eliminates OTTI impairment analysis and requires that if a decline in the fair value of debt securities AFS is deemed by management to be the result of credit losses rather than other factors, the credit losses on those securities is recorded through an allowance for credit losses rather than a write-down of the security.

The Company’s securities portfolio is evaluated for impairment on a quarterly basis.

RESULTS OF OPERATIONS

The Company’s net income for the first three months of 2023 was $3.3 million or $0.61 per common share, compared to $2.4 million or $0.44 per common share for the same period of 2022.

Core earnings (NII) were $8.5 million for the first three months of 2023 compared to $7.6 million for the same period in 2022.

Interest and fees on loans, the major component of interest income, increased $1.9 million, or 25.2% for the first three months of 2023 compared to the same period in 2022.

Interest paid on deposits, which is the major component of total interest expense, increased $1.3 million, or 234.2%, year over year, driven primarily by the increases in the fed funds rate during 2022 and the first quarter of 2023.

The Company’s net income for the second quarter of 2023 was $3.2 million or $0.58 per common share, compared to $3.0 million or $0.56 per common share for the same quarter of 2022.

Net income for the first six months of 2023 was $6.5 million or $1.19 per common share, compared to $5.4 million or $1.00 per common share for the same period of 2022.

Core earnings (NII) were $8.3 million for the second quarter of 2023 compared to $7.8 million for the same quarter of 2022, and $16.8 million for the first six months of 2023 compared to $15.4 million for the same period in 2022.

Interest and fees on loans, the major component of interest income, increased $2.4 million, or 31.3% for the second quarter of 2023 compared to the same quarter of 2022, and $4.3 million, or 28.3% for the first six months of 2023 compared to the same period in 2022.

Interest paid on deposits, which is the major component of total interest expense, increased $1.6 million, or 279.9% for the second quarter of 2023 compared to the same quarter of 2022, and increased $2.9 million, or 257.8%, year over year, driven primarily by the increases in the fed funds rate during 2022 and into the first six months of 2023.

Return on average assets, which is net income divided by average total assets, measures how effectively a corporation uses its assets to produce earnings.

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The following tables show these ratios annualized, as well as other equity ratios monitored by management, for the comparison periods presented.

Three Months Ended March 31

Three Months Ended June 30,

Return on average assets

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Average equity to average assets

Six Months Ended June 30,

Return on average assets

Return on average equity

Dividend payout ratio (1)

Average equity to average assets

Dividends declared per common share divided by earnings per common share.

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therefore, to equalize tax-free and taxable income in the comparison, we divide the tax-free income by 79%, with the result that every tax-free dollar is equivalent to $1.27 in taxable income for the periods presented.

The Company’s tax-exempt interest income of $291,954 and $224,094 for the three months ended March 31, 2023 and 2022, respectively, was derived from loans to local municipalities of $36.5 million and $48.7 million, and tax-exempt municipal investments of $11.6 million and $4.3 million, at March 31, 2023 and 2022, respectively.

The Company’s tax-exempt interest income of $300,389 and $256,652 for the three months ended June 30, 2023 and 2022, respectively, and $592,343 and $492,695 for the six months ended June 30, 2023 and 2022, respectively, was derived from loans to local municipalities of $27.7 million and $32.4 million, and tax-exempt municipal investments of $11.4 million and $7.2 million at June 30, 2023 and 2022, respectively.

The following tables show the reconciliation between reported NII and tax equivalent NII for the comparison periods presented.

Three Months Ended March 31,

Three Months Ended June 30,

Net interest income as presented

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Net interest income, tax equivalent

The following tables present the daily average interest-earning assets and the daily average interest-bearing liabilities supporting earning assets for the respective comparison periods.

Six Months Ended June 30,

Net interest income as presented

Effect of tax-exempt income

Net interest income, tax equivalent

The following tables present the daily average assets and the daily average liabilities, including the yields on interest-earning assets and interest-bearing liabilities for the respective comparison periods.

Interest income (excluding interest on non-accrual loans) is expressed on a tax equivalent basis, both in dollars and as a yield/rate for the comparison periods presented.

Net interest income, net interest spread and net interest margin are also expressed on a tax equivalent basis.

Three Months Ended March 31,

Three Months Ended June 30,

Average Assets

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Total interest-earning assets

$ 966,153,183

$ 953,230,258

Cash and due from banks

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Total interest-bearing liabilities

$ 740,177,596

$ 722,630,663

Noninterest bearing deposits

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Net interest margin (4)

Included in net loans are non-accrual loans with average balances of $8,220,394 and $5,736,827 for the three months ended March 31 2023 and 2022, respectively.

Loans are stated net of unearned discount and ACL, and include loans held-for-sale and tax-exempt loans to local municipalities with average balances of $35,177,595 and $49,022,025 for the three months ended March 31 2023 and 2022, respectively.

Included in other investments is the Company’s FHLBB Stock with average balances of $713,330 and $714,250, respectively, with a dividend rate of approximately 6.67% and 2.66%, respectively, for the three months ended March 31 2023 and 2022, respectively.

Included in net loans are non-accrual loans with average balances of $8,586,182 and $5,014,853 for the three months ended June 30, 2023 and 2022, respectively.

Loans are stated net of unearned discount and ACL, plus loans held-for-sale and include tax-exempt loans to local municipalities with average balances of $35,117,182 and $47,565,225 for the three months ended June 30, 2023 and 2022, respectively.

Included in other investments is the Company’s FHLBB Stock with average balances of $815,824 and $712,800 for the three months ended June 30, 2023 and 2022, respectively, with a dividend rate of approximately 3.72% and 2.09%, respectively, per quarter.

Net interest spread is the difference between the average yield on average interest-earning assets and the average rate paid on average interest-bearing liabilities.

Net interest margin is net interest income divided by average earning assets.

The average volume of interest-earning assets for the three-month period ended March 31, 2023 increased 2.8% compared to the same period last year, while the average yield on interest-earning assets increased 96 bps.

The average volume of loans increased 8.9% over the three-month comparison period of 2023 versus 2022, and the average yield on loans increased 66 bps.

Loans accounted for 76.8% of the average interest-earning asset portfolio for the three-month period ended March 31, 2023 compared to 72.5% for the same period last year.

Interest earned on the loan portfolio as a percentage of total interest income was 86.9% for the first three months of 2023 compared to 90.8% for the same period in 2022.

The average volume of the taxable investment portfolio (classified as AFS) decreased 2.2% during the three-month period ended March 31, 2023, compared to the same period last year, and the average yield increased 68 bps between periods.

The average volume of the tax-exempt investment portfolio (classified as AFS) increased $9.2 million, or 5.0% for the three-month period ended March 31, 2023 and the tax equivalent yield increased 154 bps between periods.

The Company began investing in these tax-exempt bonds during December 2021, and currently carries an average volume of $11.5 million as of March 31, 2023.

The average volume of sweep and interest-earning accounts, which consists primarily of an interest-bearing account at the FRBB, decreased 56.3% for the three-month comparison period ended March 31, 2023 compared to the same period in 2022.

The decrease in average volume is attributable to the funding of investments in 2022 and loan growth throughout 2022 and into 2023.

The average yield on these funds increased 391 bps for the three-month period ended March 31, 2023 versus the same period in 2022.

The average volume of interest-bearing liabilities for the three-month period ended March 31, 2023 increased 3.8%, compared to the same period in 2022, and the average rate paid on interest-bearing liabilities increased 84 bps.

The average volume of interest-bearing transaction accounts increased 8.2% for the three-month period ended March 31, 2023 compared to the same period of 2022 and the average rate paid on these accounts increased 115 bps between comparison periods.

Interest paid on interest-bearing transaction accounts as a percentage of total interest expense was 42.9% for the three-month period ended March 31, 2023, compared to 23.1% for the same comparison period in 2022.

The average volume of money market accounts increased 3.7% for the three-month period ended March 31, 2023 compared to the same period of 2022, and the average rate paid on these deposits increased 114 bps.

The average volume of savings accounts decreased 1.1% for the three-month period ended March 31, 2023 compared to the same period in 2022, while the average rate paid on these accounts increased two bps year over year.

The average volume of time deposits decreased 4.1% for the three-month period ended March 31, 2023 compared to the same period in 2022, while the average rate paid increased 41 bps.

Historically, the average volume of time deposits included brokered deposits, which provided an alternate source of funding, but as the Company’s retail deposits increased over the last two years, the need for these funds diminished.

Management still considers the brokered deposit market to be a beneficial source of funding in appropriate circumstances to help smooth out the fluctuations in core deposit balances without the need to disrupt deposit pricing in the Company’s local markets.

These funds can be obtained relatively quickly on an as-needed basis, making them a valuable alternative to traditional term borrowings from the FHLBB.

Refer to the “Liquidity and Capital Resources” section for more discussion on this topic.

The average volume of borrowed funds increased 23.8% for the three-month period ended March 31, 2023 compared to the same period in 2022.

In 2022, borrowed funds consisted of only JNE funds at zero percent interest, however, during the first three months of 2023, as the Company’s balance at FRBB decreased, the need for overnight borrowings increased for a short period of time in February.

The average volume of repurchase agreements increased 25.3% for the three-month period ended March 31, 2023 compared to the same period in 2022 and the average rate paid increased 118 bps between comparison periods.

In summary, between the three-month periods ended March 31, 2023 and 2022, the average yield on interest-earning assets increased 96 bps and the average rate paid on interest-bearing liabilities increased 84 bps.

Net interest spread increased 12 bps for the first three months of 2023 versus 2022 and net interest margin increased 32 bps between periods, reflecting the rising interest rate environment.

Six Months Ended June 30,

Average Assets

Loans, net (1)

$ 754,033,422

$ 690,602,453

Taxable investment securities

Tax-exempt investment securities

Sweep and interest-earning accounts

Other investments (2)

Total interest-earning assets

Cash and due from banks

Premises and equipment

$ 1,028,569,914

$ 1,007,587,491

Average Liabilities and Shareholders' Equity

Interest-bearing transaction accounts

$ 275,463,700

$ 259,195,319

Money market funds

Savings deposits

Time deposits

Borrowed funds

Repurchase agreements

Finance lease obligations

Junior subordinated debentures

Total interest-bearing liabilities

Noninterest bearing deposits

Other liabilities

Total liabilities

Shareholders' equity

Total liabilities and shareholders' equity

$ 1,028,569,914

$ 1,007,587,491

Net interest income

Net interest spread (3)

Net interest margin (4)

Included in net loans are non-accrual loans with average balances of $8,137,701 and $5,375,840 for the six months ended June 30, 2023 and 2022, respectively.

Loans are stated net of unearned discount and ACL, and include loans held-for-sale and tax-exempt loans to local municipalities with average balances of $35,147,221 and $48,289,600 for the six months ended June 30, 2023 and 2022, respectively.

Included in other investments is the Company’s FHLBB Stock with average balances of $764,860 and $713,521, respectively, with a dividend rate of approximately 6.67% and 2.4%, respectively, for the six months ended June 30, 2023 and 2022, respectively.

Net interest spread is the difference between the average yield on average interest-earning assets and the average rate paid on average interest-bearing liabilities.

Net interest margin is net interest income divided by average earning assets.

The average volume of interest-earning assets for the three- and six-month periods ended June 30, 2023, increased 1.4% and 2.1%, respectively, compared to the same periods last year, and the average yield on interest-earning assets increased 105 bps and 101 bps, respectively.

The average volume of loans increased over the three- and six-month comparison periods of 2023 versus 2022 by 9.5% and 9.2%, respectively, and the average yield on loans increased 87 bps and 77 bps, respectively.

Loans accounted for 78.8% and 77.8%, respectively, of the average interest-earning asset portfolio for the three- and six- month periods ended June 30, 2023, compared to 73.0% and 72.7%, respectively, for the same periods last year.

Interest earned on the loan portfolio as a percentage of total interest income was 89.2% and 88.1%, respectively, for the three- and six-month periods in 2023 compared to 88.8% and 89.8%, respectively, for the same periods in 2022.

The average volume of the taxable investment portfolio (classified as AFS) decreased 1.9% and 2.0% during the three- and six-month periods ended June 30, 2023, compared to the same periods last year, while the average yield increased 47 bps and 57 bps, respectively, between periods.

There were no investment purchases during the first six months of 2023 accounting for the decrease in investments year over year.

The average volume of the tax-exempt investment portfolio (classified as AFS) for the three- and six-month periods ended June 30, 2023, increased $6.1 million and $7.7 million, respectively, and the tax equivalent yield increased 83 bps and 105 bps, respectively.

The Company began investing in these tax-exempt bonds during December 2021, and purchased several bonds during 2022, accounting for the increase in this portfolio.

The average volume of sweep and interest-earning accounts, which consists primarily of an interest-bearing account at the FRBB, decreased 81.6% for the three-months ended June 30, 2023, compared to the same period in 2022, and 69.0% for the six-months ended June 30, 2023, compared to the same period in 2022.

The decrease in average volume year over year is attributable to the funding of investment and loan growth, and also to a decrease in customer deposit accounts.

The average yield on these funds increased 361 bps and 372 bps for the three- and six-month periods ended June 30, 2023, versus the same periods in 2022, directly related to the increases in the fed funds rate throughout 2022 and into 2023.

The average volume of interest-bearing liabilities for the three- and six-month periods ended June 30, 2023, increased 2.4% and 3.1%, respectively, compared to the same periods in 2022, and the average rate paid on interest-bearing liabilities increased 118 bps and 101 bps, respectively.

The average volume of interest-bearing transaction accounts increased 4.4% and 6.3%, respectively for the three- and six-month periods ended June 30, 2023, compared to the same periods of 2022, reflecting deposit growth during the third and fourth quarters of 2022.

The average rate paid on these accounts increased 141 bps and 128 bps, respectively, between comparison periods.

Interest paid on these funds as a percentage of total interest expense accounts for 39.8% and 41.2% for the three- and six-month periods of 2023, respectively.

The average volume of money market accounts decreased 6.0% and 1.1%, respectively, for the three- and six-month periods ended June 30, 2023, compared to the same periods of 2022, while the average rate paid on these deposits increased 126 bps and 119 bps, respectively.

The average volume of savings accounts decreased 6.9% and 4.1%, respectively, for the three- and six-month periods ended June 30, 2023, compared to the same periods in 2022, while the average rate paid on these accounts increased two bps in both comparison periods.

The average volume of time deposits increased 0.4% and decreased 1.8%, respectively, for the three- and six-month periods ended June 30, 2023, compared to the same periods in 2022, and the average rate paid increased 113 bps and 78 bps, respectively.

As a result of the decrease in deposits, the Company has had to rely on borrowed funds during the first six months of 2023, particularly during the second quarter of 2023, accounting for the increase of $19.2 million for the three months ended June 30, 2023, and $9.8 million for the six months ended June 30, 2023, compared to the respective periods in 2022.

The average rate paid increased accordingly for the three- and six-month periods ended June 30, 2023, by 454 bps and 428 bps.

The average volume of repurchase agreements increased 22.4% and 23.8%, respectively, for the three- and six-month periods ended June 30, 2023, compared to the same periods in 2022 and the average rate paid increased 205 bps and 162 bps, respectively, between comparison periods.

In summary, between the three- and six-month periods ended June 30, 2023 and 2022, the average yield on interest-earning assets increased 105 bps and 101 bps, respectively, and the average rate paid on interest-bearing liabilities increased 118 and 101 bps, respectively.

Net interest spread decreased 13 bps for the three-month period ended June 30, 2023, versus 2022, with no change noted for the six-month period of 2023 versus 2022, while net interest margins increased 14 bps and 23 bps, respectively, between periods.

The following table summarizes the variances in interest income and interest expense on a fully tax-equivalent basis for the interim periods presented for 2023 and 2022 resulting from volume changes in daily average assets and daily average liabilities and fluctuations in average rates earned and paid.

Three Months Ended March 31

Three Months Ended June 30,

Six Months Ended June 30,

Average Interest-Earning Assets

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Three Months Ended

Six Months Ended

Income from sold loans

1 unchanged sentence

Income from CFS Partners

VISA card commission

Other miscellaneous income

Total non-interest income

Total non-interest income increased $72,348, or 4.3%, for the first three months of 2023 compared to the same period in 2022, with significant changes noted in the following:

The decrease in income from sold loans is due primarily to a lower volume of loans sold into the secondary market during the first three months of 2023 versus 2022, as the rising interest rate environment has adversely affected residential mortgage lending activity.

An increase in CRE loan volume in 2023 resulted in a significant increase in documentation fees collected at origination as well as commercial rate lock fees collected, accounting for the increase in other income from loans for the first three months of 2023 versus 2022.

Income from CFS Partners increased between periods due in part to the late rebound of market prices during the latter part of the first quarter of 2023.

Total non-interest income increased $204,135, or 12.5%, for the three months ended June 30, 2023, and $276,483, or 8.3% for the six months ended June 30, 2023, compared to the same periods in 2022, with significant changes noted in the following:

The decrease in income from sold loans is due primarily to a lower volume of loans sold into the secondary market during both comparison periods of 2023 versus 2022, as the rising interest rate environment has adversely affected residential mortgage lending activity.

Income from CFS Partners increased between periods due primarily to the late rebound of market prices during the latter part of the first quarter of 2023.

CFS Partners has a small portion of its equity capital invested in the stock market, and as a result is sensitive to general stock market conditions.

Included in other miscellaneous income for 2022 is a one-time payment totaling $23,400 associated with a renegotiated contract with the Company’s check printing vendor, accounting for a portion of the decrease for the first three months of 2023 versus 2022.

The increase in VISA card commission is attributable to additional income from a renegotiated contract in June of 2023.

Included in other miscellaneous income for 2022 is a one-time credit totaling $23,400 associated with a renegotiated contract with the Company’s check printing vendor, accounting for the decrease for the six months ended June 30, 2023, versus 2022.

Non-interest Expense

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Three Months Ended

Six Months Ended

Salaries and wages

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Service contracts - administrative

Travel, entertainment and meals expense

FDIC insurance

3 unchanged sentences

Total non-interest expense

Total non-interest expense increased $426,114, or 7.8% for the first three months of 2023 compared to the same period in 2022, with significant changes noted in the following:

In addition to normal salary increases, the increase in salaries and wages year over year is attributable to new hires in the area of commercial lending as well as the hiring of a new Executive Officer during the last quarter of 2022.

Total non-interest expense increased $429,459, or 7.9% for the three months ended June 30, 2023, and $855,574, or 7.9%, for the six months ended June 30, 2023, compared to the same periods in 2022, with significant changes noted in the following:

In addition to normal salary increases, the increase in salaries and wages year over year is attributable to new hires in the area of commercial lending and operations during the last quarter of 2022.

Also contributing to the increase was a one-time salary adjustment in November of 2022 of $2,000 to all employees below vice president status that impacted the year over year comparison by $57,500.

The increase in service contracts - administrative is due to a combination of an increase in pricing for contracts that transaction based and inflationary adjustment factors that are higher than historical increase adjustments.

The increase in employee benefits is attributable to an increase in health insurance claims year over year under the Company’s self-insured health insurance plan.

The increase in service contracts - administrative is due to a combination of an increase in transaction-based pricing for certain contracts and contractual inflationary adjustment factors that are higher than historical increase adjustments.

The increase in travel, entertainment and meals expenses is attributable to an increase in travel expenses as more seminars and training sessions return to in-person attendance.

The increase in audit fees reflects increased audit services due to additional audit requirements required by FDICIA due to the Company surpassing $1.0 billion asset size.

The Company increased the 2023 monthly accrual for FDIC insurance in anticipation of an increase in the assessment multiplier, as announced by the FDIC in late 2022.

Collection & non-accruing loan expense is lower year over year due to a decrease of expenses associated with properties in the Company’s non-accruing loan portfolio.

ATM fees are based on increased customer activity as well as annual contractual price adjustments.

Collection & non-accruing loan expenses were lower year over year due to a decrease in expenses associated with properties in the Company’s non-accruing loan portfolio.

ATM fees are transaction-based and reflect increased customer activity year over year, as well as annual contractual price adjustments.

State deposit tax increased year over year due primarily to the increase in deposits.

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APPLICABLE INCOME TAXES

The provision for income taxes increased $254,124, or 48.6%, for the first three months of 2023 compared to the same period in 2022 and is proportional to the increase in income before income taxes totaling $1.2 million.

Tax credits related to limited partnership investments amounted to $67,128 and $96,237, respectively, for the first three months of 2023 and 2022.

Amortization expense related to limited partnership investments is included as a component of income tax expense and amounted to $67,128 and $67,092, respectively, for the first three months of 2023 and 2022.

The provision for income taxes increased $87,525, or 12.9% for the second quarter of 2023 compared to the same quarter of 2022, and $341,649, or 28.4%, for the first six months of 2023 compared to the same period in 2022.

Tax credits related to limited partnership investments amounted to $80,529 and $96,237, respectively, for the second quarter of 2023 compared to the same quarter of 2022, and $161,058 and $192,474 for the first six months of 2023 and 2022.

Amortization expense related to limited partnership investments is included as a component of income tax expense and amounted to $67,128 and $67,092, respectively, for the second quarter of 2023 compared to the same quarter of 2022, and $134,256 and $134,184 for the first six months of 2023 and 2022, respectively.

These investments provide tax benefits, including tax credits, and are designed to provide a targeted effective annual yield between 7% and 10%.

CHANGES IN FINANCIAL CONDITION

The following table reflects the composition of the Company's major categories of assets and liabilities as a percentage of total assets or liabilities and shareholders’ equity, as the case may be, as of the balance sheet dates:

March 31, 2023

June 30, 2023

December 31, 2022

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Time deposits

Borrowed funds

Long-term advances

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Money market funds

(31,082,039 )

Savings deposits

Time deposits

The increase in the loan portfolio during the first three months of 2023 was attributable to increases totaling $13.0 million in commercial & industrial CRE and municipal loans, which was partially offset by decreases of $0.8 million in purchased BHG loans, $1.9 million in residential junior lien loans and $0.6 million in consumer loans.

Borrowed funds

Long-term advances

The increase in the loan portfolio during the first six months of 2023 was attributable to increases of $27.9 million in CRE loans, $13.3 million in commercial & industrial and $1.4 million in residential 1 st lien loans, which was partially offset by decreases of $6.9 million in municipal loans, $1.4 million in purchased loans, and $1.7 million in residential junior lien loans.

The Company has experienced strong loan activity among its commercial customers, but only minimal consumer loan activity.

There were no securities AFS purchased during the first three months of 2023.

The change in the securities AFS portfolio is attributable to maturities amounting to $0.6 million, as well as principal payments on various securities totaling $3.1 million.

These changes were almost totally offset by a decrease of $3.4 million in unrealized losses arising during the first three months of 2023, which is reflected in OCI.

There were no securities AFS purchased during the first six months of 2023.

The change in the securities AFS portfolio is attributable to maturities amounting to $1.2 million and principal payments on various securities totaling $6.6 million, which was partially offset by a decrease of $1.5 million in unrealized losses arising during the first six months of 2023, which is reflected in OCI.

In management’s view, the size of the securities AFS portfolio is appropriate and proportional to the overall asset base, as this portfolio serves an important role in the Company’s liquidity position.

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These decreases were partially offset by a combined increase of $9.6 million, or 21.6%, in health savings accounts and the deposit account of the Company’s trust and asset management affiliate, CFSG.

The decrease in money market funds was driven by decreases of $6.5 million, or 21.9% in ICS accounts and $4.6 million, or 4.5% in retail money market funds.

These decreases were partially offset by an increase in municipal accounts of $3.5 million or 39.6%.

The decrease in money market funds was driven by decreases of $16.8 million, or 56.9%, in ICS accounts, $8.3 million, or 8.2%, in retail money market funds, and $6.0 million, or 68.1%, in municipal deposits.

The increase in time deposits is attributable to customer response to periodic certificate of deposit specials that have been offered.

As a result of the year to date decrease in aggregate deposits, the Company had to rely on borrowed funds and long-term advances as a supplemental funding source, accounting for the significant increase in these funds.

CERTAIN TIME DEPOSITS

Increments of maturity of time CDs of $250,000 or more outstanding on March 31, 2023 are summarized as follows:

Increments of maturity of time CDs of $250,000 or more outstanding at June 30, 2023, are summarized as follows:

3 months or less

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The ALCO uses an outside consultant to perform rate shock simulations to the Company's net interest income, as well as a variety of other analyses.

It is the ALCO’s function to provide the assumptions used in the modeling process.

It is ALCO’s function to provide the assumptions used in the modeling process.

Assumptions used in prior period simulation models are regularly tested by comparing projected NII with actual NII.

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Under the Company’s interest rate sensitivity modeling, with the continued asset sensitive balance sheet, in a rising rate environment NII initially trends upward as the short-term asset base (cash and adjustable-rate loans) quickly cycle upward while the retail funding base (deposits) lags the market.

If rates paid on deposits have to be increased more and/or more quickly than projected due to competitive pressures, the expected benefit to rising rates would be reduced.

If rates paid on deposits must be increased more and/or more quickly than projected due to competitive pressures, the expected benefit to rising rates would be reduced.

In a falling rate environment, NII is expected to trend slightly downward compared with the current rate environment scenario for the first year of the simulation as asset yield erosion is not fully offset by decreasing funding costs.

Thereafter, net interest income is projected to experience sustained downward pressure as funding costs reach their assumed floors and asset yields continue to reprice into the lower rate environment.

The current rising rate environment has had a positive impact to the Company’s NII however market expectations for higher deposit rates are applying increasing pressure to the spread between interest income and interest expense.

The following table summarizes the estimated impact on the Company's NII over a twelve month period, assuming a gradual parallel shift of the yield curve beginning March 31, 2023:

Percent Change

The current rising rate environment has had a positive impact on the Company’s NII, however market expectations for higher deposit rates and increased borrowing costs are applying increasing pressure to the spread between interest income and interest expense.

The following table summarizes the estimated impact on the Company's NII over a twelve-month period, assuming a gradual parallel shift of the yield curve beginning June 30, 2023:

Percent Change in NII

The estimated amounts shown in the table above are within the ALCO Policy limits.

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As the market rates continue to increase, the impact of a falling rate environment is more pronounced, and the possibility more plausible than during the last several years of near zero short-term rates.

As of March 31, 2023, the Company had outstanding $12,887,000 in principal amount of Junior Subordinated Debentures due December 15, 2037, which bear a quarterly floating rate of interest equal to the 3-month London Interbank Offered Rate (LIBOR), plus 2.85%.

As previously announced by the Financial Conduct Authority in the United Kingdom, the entity that administers LIBOR, 3-month LIBOR for U.S.

dollar denominated deposits will be phased out as of June 30, 2023.

As of June 30, 2023, the Company had outstanding $12,887,000 in principal amount of Junior Subordinated Debentures due December 15, 2037, which previously bore a quarterly floating rate of interest equal to the 3-month London Interbank Offered Rate (LIBOR), plus 2.85%.

As previously announced, 3-month LIBOR for U.S.

dollar denominated deposits was phased out as of June 30, 2023.

The Indenture governing the terms of the Company’s Debentures contains detailed fallback provisions in the event 3-month LIBOR is not available, empowering the Trustee to obtain substitute quotations from other leading banks.

However, under the federal Adjustable Interest Rate (LIBOR) Act enacted in March 2022 (the “LIBOR Act”), fallback provisions like those in the Company’s Indenture that are based on a “determining person” (such as an indenture trustee) obtaining quotations of interbank lending or deposit rates are deemed “ineffective” and will be replaced as a matter of law, without need to amend contract documents, with a benchmark interest rate identified in regulations promulgated by the Federal Reserve.

However, under the federal Adjustable Interest Rate (LIBOR) Act enacted in March 2022 (the “LIBOR Act”), fallback provisions like those in the Company’s Indenture are deemed “ineffective” and were replaced as a matter of law, as of the first London banking day after June 30, 2023 (the “LIBOR Replacement Date”), without need to amend contract documents, with a benchmark interest rate identified in regulations promulgated by the Federal Reserve.

As required under the LIBOR Act, the Federal Reserve-identified benchmark rates specified in the final regulations for various tenors of LIBOR are based on the Secured Overnight Financing Rate (SOFR) published by the Federal Reserve Bank of New York and each includes an appropriate “tenor spread adjustment” to reflect historical spreads between LIBOR and SOFR.

The replacement benchmark rate for ineffective fallback provisions will take effect on the first London banking day after June 30, 2023, (the “LIBOR Replacement Date”).

The Indenture Trustee has informed the Company that it views the fallback provisions in the Indenture as ineffective under the LIBOR Act, and that, absent either an amendment to the Indenture and related Debenture documents to adopt a new interest rate or a change in applicable law, effective on and after the LIBOR Replacement Date, 3-month LIBOR will be replaced by 3-month CME SOFR, as adjusted by a spread adjustment factor of 0.26161 percent, in accordance with the LIBOR Act and FRB regulations.

The Company does not intend to seek an amendment of the Indenture or other Debenture documents.

Accordingly, as of the LIBOR Replacement Date, the Debentures will bear interest at a quarterly floating rate equal to 3-month CME SOFR, as adjusted by a spread adjustment of 0.26161 percent, plus 2.85%.

In accordance with the LIBOR Act and its implementing regulations, as of the LIBOR Replacement Date, the Company’s Junior Subordinated Debentures bear interest at a quarterly floating rate equal to 3-month CME SOFR, as adjusted by a spread adjustment of 0.26161 percent, plus 2.85%.

Aside from the Debentures, the Company does not have any other exposures to the phase out of LIBOR.

The Company has not generally utilized LIBOR as an interest rate benchmark for its variable rate commercial, residential or other loans and does not utilize derivatives or other financial instruments tied to LIBOR for hedging or investment purposes.

Accordingly, management expects that the Company’s exposure to the phase out of LIBOR will be limited to the effect on the interest rate paid on its Debentures.

The Company has not generally utilized LIBOR as an interest rate benchmark for its variable rate commercial, residential or other loans and has not utilized derivatives or other financial instruments tied to LIBOR for hedging or investment purposes.

Accordingly, the Company’s exposure to the phase out of LIBOR is limited to the effect on the interest rate paid on its Debentures.

Credit Risk - As a financial institution, one of the primary risks the Company manages is credit risk, the risk of loss stemming from borrowers’ failure to repay loans or inability to meet other contractual obligations.

4 unchanged sentences

Loans are reviewed periodically by an independent loan review firm to help ensure accuracy of the Company's internal risk ratings and compliance with various internal policies, procedures and regulatory guidance.

Residential mortgage loans represented 30.4% of the Company’s loan balances at March 31, 2023, compared to 31.2% at December 31, 2022.

Residential mortgage loans represented 29.7% of the Company’s loan balances at June 30, 2023, compared to 31.1% at December 31, 2022.

The Company maintains a residential mortgage loan portfolio of traditional mortgage products and does not offer higher risk loan products, such as option adjustable-rate mortgage products, high loan-to-value products, interest only mortgages, subprime loans and products with deeply discounted teaser rates.

1 unchanged sentence

A 90% loan-to-value residential mortgage product without PMI is only available to borrowers with excellent credit and low debt-to-income ratios and has not been widely originated.

As of March 31, 2023, junior lien home equity products made up 13.8% of the residential mortgage portfolio with maximum loan-to-value ratios (including prior liens) of 80%.

As of June 30, 2023, junior lien home equity products made up 13.8% of the residential mortgage portfolio with maximum loan-to-value ratios (including prior liens) of 80%.

The Company also originates some home equity loans greater than 80% under an insured loan program with stringent underwriting criteria.

Consistent with the strategic focus on commercial lending, the commercial & industrial and CRE loan portfolios have seen solid growth over recent years.

Commercial & industrial, purchased, CRE and municipal loans collectively comprised 69.1% of the Company’s loan portfolio at March 31, 2023, compared to 68.4% at December 31, 2022.

The largest components of the CRE portfolio were $99.4 million in owner-occupied CRE and $139.0 million in non-owner occupied CRE at March 31, 2023.

Commercial & industrial, purchased, CRE and municipal loans collectively comprised 69.8% of the Company’s loan portfolio at June 30, 2023, compared to 68.4% at December 31, 2022.

The largest components of the CRE portfolio were $105.2 million in owner-occupied CRE and $149.8 million in non-owner occupied CRE at June 30, 2023.

Risk in the Company’s commercial & industrial and CRE loan portfolios is mitigated in part by government guarantees issued by federal agencies such as the SBA and RD.

At March 31, 2023, the Company had $26.2 million in guaranteed loans with guaranteed balances of $17.0 million, compared to $27.0 million in guaranteed loans with guaranteed balances of $18.3 million at December 31, 2022.

PPP loans with outstanding balances of $116,299 and $199,664 at March 31, 2023 and December 31, 2022, respectively, are included in these totals, all of which carry a 100% guarantee through the SBA, subject to borrower eligibility requirements.

At June 30, 2023, the Company had $26.2 million in guaranteed loans with guaranteed balances of $17.0 million, compared to $27.0 million in guaranteed loans with guaranteed balances of $18.3 million at December 31, 2022.

PPP loans with outstanding balances of $106,910 at June 30, 2023, and $199,664 at December 31, 2022, are included in these totals, all of which carry a 100% guarantee through the SBA, subject to borrower eligibility requirements.

The Company works actively with customers early in the delinquency process to help them to avoid default and foreclosure.

2 unchanged sentences

Residential mortgages and home equity loans are considered for non-accrual status at 90 days past due and are evaluated on a case-by-case basis.

The Company obtains current property appraisals or market value analyses and considers the cost to carry and sell collateral in order to assess the level of specific allocations required.

The Company obtains current property appraisals or market value analyses and considers the cost of carrying and selling collateral in order to assess the level of specific allocations required.

Consumer loans are generally not placed in non-accrual but are charged off by the time they reach 120 days past due.

4 unchanged sentences

Three Months Ended

Provision for credit losses on loans

Provision for loan losses

Provision for credit losses on OBS credit exposure

Provision for credit losses

Six Months Ended

Provision for loan losses

Provision for credit losses on OBS credit exposure

Provision for credit losses

ACL and provisions – As stated in Note 2 of the accompanying notes to the Company’s unaudited interim consolidated financial statements, effective January 1, 2023, the Company was required to recognize credit losses under the guidance of ASU No.

2016-13, Financial Instruments—Credit Losses (Topic 326):

Measurement of Credit Losses on Financial Instruments , The new guidance, which is referred to as the current expected credit loss, or CECL model, requires that expected credit losses for financial assets held at the reporting date that are accounted for at amortized cost be measured and recognized based on historical experience and current and reasonably supportable forecasted conditions to reflect the full amount of expected credit losses over the life of the loans.

The adjustment from the adoption of CECL amounted to $549,113, net of tax and was recorded as an adjustment to retained earnings and will affect calculation of regulatory capital ratios.

Measurement of Credit Losses on Financial Instruments, rather than under the incurred loss model.

The new guidance, which is referred to as the current expected credit loss, or CECL model, requires that expected credit losses for financial assets held at the reporting date that are accounted for at amortized cost be measured and recognized based on historical experience and current and reasonably supportable forecasted conditions to reflect the full amount of expected credit losses over the life of the loans.

The adjustment from the adoption of CECL amounted to $549,113, net of tax and was recorded as an adjustment to retained earnings and affects calculation of regulatory capital ratios.

Changes in forecasts used in the model could produce different results, quarter to quarter.

3 unchanged sentences

Although the Company, in establishing the ACL, considers the inherent losses in individual loans and pools of loans, the ACL is a general reserve available to absorb all credit losses in the loan portfolio.

No part of the ACL is segregated to absorb losses from any particular loan or segment of loans.

When establishing the ACL each quarter, the Company applies a combination of significant key assumptions and methodologies, as discussed in the ACL section under Critical Accounting Policies in this MD&A, and also presented in Note 5 of the accompanying unaudited interim consolidated financial statements.

No part of the ACL is segregated to absorb losses from any loan or segment of loans.

When establishing the ACL each quarter, the Company applies a combination of significant key assumptions and methodologies, as discussed in the ACL section under Critical Accounting Policies in this MD&A and presented in Note 5 of the accompanying unaudited interim consolidated financial statements.

The following table summarizes the Company’s credit risk ratios for the balance sheet dates presented:

10 unchanged sentences

Non-accruing loans

The provision for credit losses for the three months ended March 31, 2023 was $286,526, compared to $862,500 for the same period in 2022.

The provision for credit losses for the three months ended June 30, 2023, was $281,142 compared to $337,500 for the same period in 2023, and $567,668 for first six months ended June 30, 2023, compared to $1.2 million for the same period in 2022.

The $632,332 year over year decrease was driven in part by a write-down totaling $667,474, on a single non-performing loan, in March of 2022.

The first quarter ACL analysis indicates that the reserve balance of $9.3 million at March 31, 2023 is sufficient to cover expected credit losses that are probable and estimable as of the measurement date.

The second quarter ACL analysis indicates that the reserve balance of $9.3 million at June 30, 2023, is sufficient to cover expected credit losses that are probable and estimable as of the measurement date.

Included in the ACL calculation for June 30, 2023, is a decrease to the qualitative factor adjustment for delinquencies and nonperforming loans.

Management feels that the economic forecasts adequately quantify the risk in this area.

Management believes the reserve balance continues to be directionally consistent with the overall risk profile of the Company’s loan portfolio and credit risk appetite.

1 unchanged sentence

The adequacy of the ACL is presented to the full Board for approval quarterly.

Net recoveries (charge-offs) during the periods presented to average loans outstanding were as follows:

For the Three Months Ended March 31

Net charge-offs during the periods presented to average loans outstanding were as follows:

For the Six Months Ended June 30,

Commercial & industrial

22 unchanged sentences

Average amount outstanding

Net recoveries (charge-offs) during the period

Net charge-offs during the period

Average amount outstanding

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The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

During the first three months of 2023, the Company did not engage in any activity that created any additional types of off-balance sheet risk.

During the first six months of 2023, the Company did not engage in any activity that created any additional types of off-balance sheet risk.

With the adoption of ASU 2016-13 (CECL), the Company is required to establish an allowance for expected credit losses on OBS credit exposures.

Expected credit losses are estimated by management over the contractual period during which the Company is exposed to credit risk under a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company.

The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life.

The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over the estimated lives of such commitments.

Upon adoption of ASU 2016-13, the Company recorded an adjustment to retained earnings of $451,704 to reflect an allowance for credit losses for unfunded commitments.

The allowance for credit losses for OBS credit exposures is presented in the "Accrued interest and other liabilities" line of the consolidated balance sheets.

There were no changes to the allowance for credit losses for OBS credit exposures during the three months ended March 31, 2023.

There was a decrease of $17,872 to the allowance for credit losses for OBS credit exposures during the six months ended June 30, 2023.

LIQUIDITY AND CAPITAL RESOURCES

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One-way deposits acquired through the CDARS program provide an alternative funding source when needed.

At March 31, 2023 and December 31, 2022, the Company had no one-way CDARS outstanding.

At June 30, 2023, and December 31, 2022, the Company had no one-way CDARS outstanding.

In addition, two-way (reciprocal) CDARS deposits, as well as reciprocal ICS money market and demand deposits, enhance the Company’s ability to retain larger deposit balances by allowing the Company to provide FDIC deposit insurance to its customers in excess of account coverage limits through the exchange of deposits with other participating FDIC-insured financial institutions.

At March 31, 2023 and December 31, 2022, the Company reported $2.8 million in reciprocal CDARS deposits.

The balance in ICS reciprocal money market deposits was $23.0 million at March 31, 2023, compared to $29.5 million at December 31, 2022, and the balance in ICS reciprocal demand deposits as of those dates was $74.3 million and $85.3 million, respectively.

At March 31, 2023 and December 31, 2022, borrowing capacity of $110.3 million and $112.3 million, respectively, was available through the FHLBB, secured by the Company's qualifying loan portfolio (generally, residential mortgage and commercial loans), reduced by outstanding advances and by collateral pledges securing FHLBB letters of credit collateralizing public unit deposits.

The Company also has an unsecured Federal Funds credit line with the FHLBB with an available balance of $500,000 and no outstanding advances during any of the respective comparison periods.

Interest is chargeable at a rate determined daily, approximately 25 bps higher than the rate paid on federal funds sold.

The Company has a BIC arrangement with the FRBB secured by eligible commercial & industrial loans, CRE loans and home equity loans, resulting in an available credit line of $52.8 million and $56.1 million, respectively, at March 31, 2023 and December 31, 2022.

Credit advances under this FRBB lending program are overnight advances with interest chargeable at the primary credit rate (generally referred to as the discount rate), currently 500 bps.

The Company had no outstanding advances through this facility at March 31, 2023 or December 31, 2022.

As of March 31, 2023, the Company had additional potential borrowing capacity, subject to pledging of required collateral, under the FRB’s Term Funding Program, which was established in March 2023 to provide banks with an additional source of liquidity.

The Company did not have any advances under the Term Funding Program at March 31, 2023.

The following table reflects the Company’s outstanding advances under the FHLBB’s JNE program as of the dates indicated:

Long-Term Advances(1)

At June 30, 2023 and December 31, 2022, the Company reported $2.5 million and $2.8 million, respectively, in reciprocal CDARS deposits.

The balance in ICS reciprocal money market deposits was $12.7 million at June 30, 2023, compared to $29.5 million at December 31, 2022, and the balance in ICS reciprocal demand deposits as of those dates was $76.7 million and $85.3 million, respectively.

On June 30, 2023 and December 31, 2022, borrowing capacity of $108.1 million and $112.3 million, respectively, was available through the FHLBB, secured by the Company's qualifying loan portfolio (generally, residential mortgage and commercial loans), reduced by outstanding advances and by collateral pledges securing FHLBB letters of credit collateralizing public unit deposits of $24.6 million and $52.4 million, respectively.

The following table reflects the Company’s outstanding advances with FHLBB as of the dates indicated:

FHLBB Advances (1)

FHLBB term advance, 0.00%, due September 22, 2023

1 unchanged sentence

FHLBB term advance, 0.00%, due November 13, 2028

Total FRBB Advances

Overnight borrowings at 5.27%

Under the JNE program, the FHLBB provides a subsidy, funded by the FHLBB’s earnings, to write down interest rates to zero percent on advances that finance qualifying loans to small businesses.

JNE advances must support small business in New England that create and/or retain jobs, or otherwise contribute to overall economic development activities.

The Company has unsecured lines of credit with two correspondent banks with aggregate available borrowing capacity totaling $20.5 million as of the balance sheet dates presented in this quarterly report.

The Company also has an unsecured Federal Funds credit line with the FHLBB with an available balance of $500,000 and no outstanding advances during any of the respective comparison periods.

Interest is chargeable at a rate determined daily, approximately 25 bps higher than the rate paid on federal funds sold.

The Company has a BIC arrangement with the FRBB secured by eligible commercial & industrial loans, CRE loans and home equity loans, resulting in an available credit line of $53.7 million and $56.1 million, respectively, at June 30, 2023 and December 31, 2022.

Credit advances under this FRBB lending program are overnight advances with interest chargeable at the primary credit rate (generally referred to as the discount rate), currently 500 bps.

The Company had no outstanding advances through this facility at June 30, 2023 or December 31, 2022.

As of June 30, 2023, the Company had additional potential borrowing capacity, subject to pledging of required collateral consisting of eligible U.S.

Agency and U.S.

Government Securities, under the FRB’s BTFP which was established in March 2023 to provide banks with an additional source of liquidity.

The Company’s advances under the BTFP were as follows:

FRBB Advances

FRB BTFP term advance, 4.92%, due April 26, 2024

FRB BTFP term advance, 4.71%, due May 13, 2024

FRB BTFP term advance, 4.91%, due May 17, 2024

Total BTFP Advances

As of June 30, 2023, the Company had an unsecured line of credit with one correspondent bank of $12.5 million, compared to unsecured lines of credit with two correspondent banks with aggregate available borrowing capacity totaling $20.5 million as of December 31, 2022.

The Company had no outstanding advances against these credit lines as of the balance sheet dates presented.

Management believes that the combination of high levels of potentially liquid assets, unencumbered securities, cash flows from operations, and additional borrowing capacity are sufficient to meet the Company’s liquidity and capital needs.

The following table illustrates the changes in shareholders' equity from December 31, 2022 to March 31, 2023:

The following table illustrates the changes in shareholders' equity from December 31, 2022 to June 30, 2023:

Balance at December 31, 2022 (book value $13.55 per common share)

4 unchanged sentences

Change in AOCI on AFS securities, net of tax

Balance at March 31 2023 (book value $14.33 per common share)

The primary objective of the Company’s capital planning process is to balance appropriately the retention of capital to support operations and future growth, with the goal of providing shareholders an attractive return on their investment.

Balance at June 30, 2023 (book value $14.44 per common share)

To that end, management monitors capital retention and dividend policies on an ongoing basis.

1 unchanged sentence

Capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

As of March 31, 2023, the Bank was considered well capitalized under the standard regulatory capital framework for Prompt Corrective Action and the Company exceeded currently applicable consolidated regulatory guidelines for capital adequacy.

As of June 30, 2023, the Bank was considered well capitalized under the standard regulatory capital framework for Prompt Corrective Action and the Company exceeded currently applicable consolidated regulatory guidelines for capital adequacy.

While we believe that the Company has sufficient capital to withstand an extended economic downturn, our regulatory capital ratios could be adversely impacted by future credit losses and other operational impacts of deteriorating economic conditions and inflation.

The following table shows the Company’s actual capital ratios and those of its subsidiary, as well as currently applicable regulatory capital requirements, as of the dates indicated.

The calculations as of March 31, 2023 reflect adoption of ASU 2016-13 (CECL), including the beginning period cumulative effect adjustment of $549,113, which reduced retained earnings.

The calculations as of June 30, 2023 reflect adoption of ASU 2016-13 (CECL), including the beginning period cumulative effect adjustment of $549,113, which reduced retained earnings.

Adequacy Purposes

4 unchanged sentences

(Dollars in Thousands)

March 31, 2023

June 30, 2023

Common equity tier 1 capital

18 unchanged sentences

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