CSB Bancorp, Inc. 10-Q

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following management’s discussion and analysis focuses on the consolidated financial condition of the Company at June 30, 2022 as compared to December 31, 2021, and the consolidated results of operations for the three and six months ended June 30, 2022 compared to the same periods in 2021. The purpose of this discussion is to provide the reader with a more thorough understanding of the Consolidated Financial Statements. This discussion should be read in conjunction with the interim condensed Consolidated Financial Statements and related footnotes contained in Part I, Item 1 of this Quarterly Report. FORWARD-LOOKING STATEMENTS Certain statements contained in this Quarterly Report are not historical facts but rather are forward-looking statements that are subject to certain risks and uncertainties. When used herein, the terms “anticipates”, “plans”, “expects”, “believes”, and similar expressions as they relate to the Company or its management are intended to identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The Company’s actual results, performance or achievements may materially differ from those expressed or implied in the forward-looking statements. Risks and uncertainties that could cause or contribute to such material differences include, but are not limited to, general economic conditions, interest rate environment, competitive conditions in the financial services industry, changes in law, governmental policies and regulations, and rapidly changing technology affecting financial services. Other factors not currently anticipated may also materially and adversely affect the Company’s results of operations, cash flows, and financial position. There can be no assurance that future results will meet expectations. While the Company believes that the forward-looking statements in this report are reasonable, the reader should not place undue reliance on any forward-looking statement. The Company does not undertake, and specifically disclaims any obligation, to publicly revise any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events, except as may be required by applicable law. FINANCIAL CONDITION Total assets remained constant at $1.1 billion at June 30, 2022 compared to December 31, 2021. During the six months ended June 30, 2022, securities increased $86 million, net loans increased $33 million, and cash and cash equivalents decreased $140 million. Deposits and short-term borrowings decreased $12 million. Net loans increased $33 million, or 6%, as construction loans increased $22 million, or 47%, and residential real estate loans increased $12 million, or 7% from December 31, 2021. Commercial and commercial real estate loans were flat compared to December 31, 2021 including $3 million in PPP loan forgiveness from year end. PPP loans outstanding at June 30, 2022 were $1.6 million after the bank originated $129 million in PPP loans during 2020 and 2021. Consumer refinance activity slowed significantly on mortgage loans, home purchase activity remained stable despite limited inventory through the first six months of 2022, and home equity line originations increased by $5 million. Residential mortgage loan originations for the six months ended June 30, 2022 totaled $44 million, a decrease from $59 million in originations during the six months ended June 30, 2021. Originations sold into the secondary market were $7 million and $27 million, respectively during the six months ended June 30, 2022 and June 30, 2021. The Bank originates and sells primarily fixed rate thirty-year mortgages into the secondary market. The allowance for loan losses decreased $607 thousand from the year ago quarter to $7.3 million. The Company has not early adopted CECL which has been delayed for smaller reporting companies. Net recoveries were $295 thousand, or an annualized 0.21% of average loans, in the current six-month period compared to net recoveries of $46 thousand, or 0.01% of average loans in the year-ago six-month period. At June 30, 2022, the allowance for total loans was 1.25%. We believe the allowance level is appropriate given the low level of problem loans and composition of the overall loan portfolio in the current economic environment. 24 CSB BANCORP, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Non performing loans de creased $ 3 9 8 thousand to $ 690 thousand , or 0. 12 % , of total loans from $ 1.1 million, or 0. 20 %, on December 31, 202 1 . For the six months ended June 30, 2022, $50 thousand in loans were placed on n onaccrual status , $ 436 thousand in paydowns were received , and $ 10 thousand in personal loans were charged-off due to non-payment . June 30, December 31, June 30, (Dollars in thousands) 2022 2021 2021 Non-performing loans $ 690 $ 1,088 $ 2,786 Other real estate — — — Repossessed assets — — — Allowance for loan losses 7,268 7,618 7,875 Total loans $ 582,185 $ 549,154 $ 552,030 Allowance for loan losses as a percentage of total loans 1.25 % 1.39 % 1.43 % Allowance for loan losses to total nonperforming loans 10.5X 7.0X 2.8X The ratio of gross loans to deposits was 58.6% at June 30, 2022, compared to 54.8% at December 31, 2021. The Company has no exposure to government-sponsored enterprise preferred stocks, collateralized debt obligations, or trust preferred securities. Management has considered industry analyst reports, sector credit reports, and the volatility within the bond market in concluding that the gross unrealized losses of $35.4 million within the available-for-sale and held-to-maturity portfolios as of June 30, 2022, was primarily the result of current market yields compared to the yields at the time the investments were purchased by the Company and not due to credit quality. As a result, all embedded security losses on June 30, 2022, are considered temporary and no impairment loss relating to these securities has been recognized. Deposits decreased $10 million, or less than 1%, from December 31, 2021 with noninterest-bearing deposits decreasing approximately $6 million, or 2%, and interest-bearing deposit accounts decreasing approximately $4 million, or less than 1%. Total deposits as of June 30, 2022 are $993 million, or less than 1%, greater than June 30, 2021 deposit balances. On a year over year comparison, increases were recognized in noninterest-bearing demand deposits of $26 million, money market accounts of $17 million, savings of $12 million, and declines in interest-bearing demand deposits of $41 million and time deposits by $8 million. Deposit growth has normalized following the Bank’s customers increasing deposits through stimulus payments and cash conservation as a result of the COVID-19 pandemic. Short-term borrowings consisting of overnight repurchase agreements with retail customers decreased $3 million, or 7%, to $34 million at June 30, 2022 as compared to December 31, 2021 and other borrowings decreased $813 thousand as the Company repaid FHLB advances. Total shareholders’ equity amounted to $94 million, or 8.3%, of total assets at June 30, 2022, a decrease of $4 million, or 3.8%, from $97 million December 31, 2021. The decrease in shareholders’ equity during the six months ended June 30, 2022 was due to accumulated other comprehensive loss (“AOCL”) of $8 million, which was partially offset by net income of $5.9 million, less cash dividends of $1.7 million. Rapidly rising interest rates during 2022 have caused the AOCL to increase as AFS securities are marked to fair market value. As interest rates rise, the fair value of AFS fixed-rate securities decline with a corresponding net of tax decline recorded in the AOCL portion of equity. This unrealized loss in securities is temporary and is adjusted monthly for additional interest rate fluctuations, principal paydowns, calls, and maturities. The Company and the Bank met all regulatory capital requirements at June 30, 2022. RESULTS OF OPERATIONS Three months ended June 30, 2022 and 2021 For the quarters ended June 30, 2022 and 2021, the Company recorded net income of $3.2 million and $2.7 million and $1.18 and $1.00 per share, respectively. The $464 thousand increase in net income for the period was primarily the result of a $1.2 million increase in net interest income, offset by an increase in noninterest expenses of $384 thousand, and a decrease of $61 thousand in noninterest income. The recovery of provision for loan losses was $345 thousand in 2022 compared to $475 thousand for the three-month period in 2021, and the federal income tax provision increased $120 thousand. Return on average assets and return on average equity were 1.13% and 13.73%, respectively, for the three-month period of 2022, compared to 0.97% and 11.62%, respectively for the same quarter in 2021. 25 CSB BANCORP, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Average Balance Sheets and Net Interest Margin Analysis For the Three Months Ended June 30, 2022 2021 (Dollars in thousands) Average balance 1 Interest Average rate 2 Average balance 1 Interest Average rate 2 ASSETS Interest-earning deposits $ 99,122 $ 203 0.82 % $ 291,587 $ 68 0.09 % Taxable securities 374,246 1,660 1.78 193,252 604 1.25 Tax-exempt securities 4 24,184 137 2.27 24,029 141 2.35 Loans 3,4 574,824 6,039 4.21 564,997 6,239 4.43 Total interest-earning assets 1,072,376 8,039 3.01 % 1,073,865 7,052 2.63 % Noninterest-earning assets 63,942 57,386 TOTAL ASSETS $ 1,136,318 $ 1,131,251 LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing demand deposits $ 237,950 $ 56 0.09 % $ 281,376 $ 94 0.13 % Savings deposits 307,234 75 0.10 276,746 70 0.10 Time deposits 118,232 213 0.72 124,436 345 1.11 Borrowed funds 41,663 29 0.28 44,956 34 0.30 Total interest-bearing liabilities 705,079 373 0.21 % 727,514 543 0.30 % Noninterest-bearing demand deposits 333,692 305,459 Other liabilities 3,797 3,492 Shareholders' Equity 93,750 94,786 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,136,318 $ 1,131,251 Taxable equivalent net interest income, (Non-GAAP) $ 7,666 $ 6,509 Tax equivalent adjustment 4 (36 ) (38 ) Net interest income, (GAAP) $ 7,630 $ 6,471 Net interest margin, (GAAP) 2.86 % 2.42 % Tax equivalent adjustment 4 0.01 0.01 Net interest margin-taxable equivalent, (Non-GAAP) 2.87 % 2.43 % Taxable equivalent net interest spread 2.80 % 2.33 % 1 Average balances have been computed on an average daily basis. 2 Average rates have been computed based on the amortized cost of the corresponding asset or liability. 3 Average loan balances include nonaccrual loans. 4 Interest income is shown on a fully tax-equivalent basis, which is a Non-GAAP measure and is reconciled to the GAAP measure at the bottom of the table. Interest income for the quarter ended June 30, 2022, was $8 million representing a $989 thousand increase, or 14%, compared to the same period in 2021. This increase was primarily due to the additional volume and increased rates on taxable securities, as well as an increase in the rate earned on interest-earning deposits, partially offset by the decrease in loan interest rates in the comparable periods. Average loan rates decreased 22 basis points for the quarter ended June 30, 2022 as compared to the same period in 2021, primarily from PPP fees declining from $552 thousand in 2021 to $17 thousand in 2022. Interest expense for the quarter ended June 30, 2022 was $373 thousand, a decrease of $170 thousand, or 31%, from the same quarter in 2021. The decrease in interest expense occurred primarily due to the decrease in interest rates and the volume of time deposit accounts along with the decrease in rates on interest-bearing demand deposits for the quarter ended June 30, 2022. 26 CSB BANCORP, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS For the quarter ended June 30, 2022, with improving credit quality and net loan recoveries, the bank recognized a recovery for loan losses of $345 thousand to the provision for loan losses, compared to a recovery for loan losses of $475 thousand for the same quarter in 2021. The recapture of provision for loan losses for the current quarter primarily reflects the sustained improvement in credit quality including the increase in loans graded as pass as well as a reduction of impaired loans, along with net recoveries during the quarter of $308 thousand. Economic indicators reflect improvement in residential real estate prices and low unemployment. The provision for loan losses is determined based on management’s calculation of the adequacy of the allowance for loan losses, which includes provisions for classified loans as well as for the remainder of the portfolio based on historical data, including past charge-offs and current economic trends. Noninterest income for the quarter ended June 30, 2022, was $1.8 million, a decrease of $61 thousand, or 3%, compared to the same quarter in 2021. The gain on the sale of mortgage loans into the secondary market decreased by $270 thousand, or 65%, for the quarter ended June 30, 2022 as fewer loans were sold into the secondary market due to decreasing demand for mortgage refinancing as interest rates increased and inventories of homes available for sale declined. Fees from trust and brokerage services amounted to $253 thousand for the second quarter 2022, a decrease of $11 thousand, or 4%, as compared to the same quarter in 2021. Service charges on deposit accounts increased $70 thousand, or 32%, compared to the same quarter in 2021, primarily from increased customer overdraft fees. Debit card interchange income increased $17 thousand, or 3%, with greater fees generated from usage in the second quarter 2022. Credit card fee income increased $81 thousand, or 74% as improvements to the card program have resulted in increased customer usage. Earnings on bank owned life insurance increased $24 thousand, or 17%, for the second quarter 2022. Noninterest expenses for the quarter ended June 30, 2022 increased $384 thousand, or 7%, compared to the second quarter 2021. Salaries and employee benefits increased $368 thousand, or 12%, a result of increases in base wages and retirement accruals recognized in second quarter 2022 as compared to second quarter 2021. FDIC assessment amounted to $75 thousand as compared to $120 thousand in the second quarter 2021 due to improvement within nonperforming loans. Marketing and public relations expense increased $12 thousand, or 12%, primarily due to new opportunities and more events taking place after being cancelled due to COVID-19. Occupancy and equipment expense increased $54 thousand, or 13%, in 2022 over the second quarter 2021, primarily due to increases in depreciation related to facility improvements and increased cost of building and equipment repairs and maintenance. The Ohio financial institutions tax increased $7 thousand, or 4%, in the second quarter due to the Company’s increased capital base. Professional and director fees decreased $26 thousand, or 7%, for the quarter ended June 30, 2022 as compared to the second quarter 2021, as a result of fewer loan collection expenses. Federal income tax expense increased $120 thousand, or 18%, for the quarter ended June 30, 2022 as compared to the second quarter 2021. The provision for income taxes was $774 thousand (effective rate of 19.4%) for the quarter ended June 30, 2022, compared to $654 thousand (effective rate of 19.2%) for the same quarter ended 2021. RESULTS OF OPERATIONS Six months ended June 30, 2022, and 2021 For the six months ended June 30, 2022, and 2021, the Company recorded net income of $5.9 million and $5.6 million and $2.17 and $2.05 per share, respectively. The $280 thousand increase in net income for the six-month period was primarily the result of an increase in net interest income of $1.0 million, which was partially offset by a reduction in noninterest income of $297 thousand and an increase in noninterest expenses of $571 thousand. A negative loan loss provision of $645 thousand for the period as compared to a smaller negative loss provision of $445 thousand for the same period in 2021 also contributed to increased net income for the six months. The federal income tax provision was $68 thousand higher during the six-month period in 2022. Return on average assets and return on average equity were 1.05% and 12.48%, respectively, for the six months ended June 30, 2022, compared to 1.04% and 11.97%, respectively for the same period in 2021. 27 CSB BANCORP, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS For the Six Months Ended June 30, 2022 2021 (Dollars in thousands) Average balance 1 Interest Average rate 2 Average balance 1 Interest Average rate 2 ASSETS Interest-earning deposits in other banks 128,478 277 0.43 % 247,638 114 0.09 % Taxable securities 354,411 2,941 1.67 187,476 1,163 1.25 Tax-exempt securities 4 24,745 277 2.26 23,700 281 2.39 Loans 3,4 567,671 11,823 4.20 580,572 13,113 4.55 Total earning assets 1,075,305 15,318 2.87 % 1,039,386 14,671 2.85 % Other assets 62,147 56,692 TOTAL ASSETS $ 1,137,452 $ 1,096,078 LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing demand deposits $ 237,816 $ 106 0.09 % $ 266,799 $ 180 0.14 % Savings deposits 308,159 142 0.09 269,826 140 0.10 Time deposits 119,067 445 0.75 123,584 726 1.18 Other borrowed funds 42,838 57 0.27 44,138 70 0.32 Total interest bearing liabilities 707,880 750 0.21 % 704,347 1,116 0.32 % Non-interest bearing demand deposits 330,228 293,024 Other liabilities 3,857 3,850 Shareholders' Equity 95,487 94,857 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,137,452 $ 1,096,078 Taxable equivalent net interest income, (Non-GAAP) $ 14,568 $ 13,555 Tax equivalent adjustment 4 (73 ) (76 ) Net interest income, (GAAP) $ 14,495 $ 13,479 Net interest margin, (GAAP) 2.72 % 2.61 % Tax equivalent adjustment 4 0.01 0.02 Net interest margin-taxable equivalent, (Non-GAAP) 2.73 % 2.63 % Taxable equivalent net interest spread 2.66 % 2.53 % 28 CSB BANCORP, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Interest income for the six months ended June 30, 2022, was $15.2 million representing a $650 thousand increase, or 4%, compared to the same period in 2021. This increase was primarily due to volume and yield increases on taxable securities along with yield increases on overnight deposits in other banks for the period ended June 30, 2022, as compared to the same period in 2021. Offsetting these increases was the decrease in average loan balances and the average interest earned on loans, primarily from PPP fees declining from $1.5 million in 2021 to $150 thousand in 2022. Average PPP loan balances decreased from $39 million at June 30 2021 to $1.6 million on June 30, 2022 as loans were forgiven by the SBA. Interest expense for the six months ended June 30, 2022, was $750 thousand, a decrease of $366 thousand, or 33%, from the same period in 2021. The decrease in interest expense occurred primarily due to a decrease in rates on all interest-bearing liabilities for the six months ended June 30, 2022, partially offset by an increase in the average balances of savings deposits in 2022. For the six months ended June 30, 2022, the provision for loan losses was a credit (reversal) of provision of $645 thousand, compared to a smaller credit provision of $445 thousand for the same period in 2021. For more discussion see Results of Operations, three months. The provision for loan losses is determined based on management’s calculation of the adequacy of the allowance for loan losses, which includes provisions for classified loans as well as for the remainder of the portfolio based on historical data, including past charge-offs and current economic trends. Noninterest income for the six months ended June 30, 2022, was $3.4 million, a decrease of $297 thousand, or 8%, compared to the same period in 2021. The gain on the sale of mortgage loans to the secondary market decreased $639 thousand to $265 thousand for the six months ended June 30, 2022, as increases in interest rates slowed mortgage loan refinancing. Debit card interchange income increased $41 thousand, or 4%. Earnings on bank owned life insurance policies increased $40 thousand for the period. Service charges on deposit accounts increased $128 thousand, or 30%, compared to the same period in 2021 primarily from increases in overdraft fees, as well as increases in business service charges on deposit accounts. Credit card fee income increased $132 thousand, or 62% with growth in business credit card customers and interchange income. Fees from trust and brokerage services decreased $29 thousand for the period. Noninterest expenses for the six months ended June 30, 2022, increased $571 thousand, or 5%, compared to the same period in 2021. Salaries and employee benefits increased $494 thousand, or 8%, a result of increased salaries, with additions to lending staff, and reduced credits on deferred loan costs with less volume originated in commercial loans. Marketing and public relations expense increased $44 thousand, or 25%, with marketing, brand recognition initiatives, and community support in the company’s market slowly increasing in volume due to increasing opportunities presenting after previous cancellations due to COVID-19. Occupancy and equipment expenses increased $109 thousand over the same period in 2021 with an increase in depreciation and maintenance expense. Professional and director fees decreased $45 thousand for the six months ended June 30, 2022, as compared to the same period in 2021. Federal income tax expense increased $68 thousand, or 5%, for the six months ended June 30, 2022, as compared to the same period in 2021. The provision for income taxes was $1.4 million (effective rate of 19.3%) for the six months ended June 30, 2022, compared to $1.3 million (effective rate of 19.3%) for the same period ended 2021. CAPITAL RESOURCES The Company maintained a strong capital position with tangible common equity to tangible assets of 7.9% at June 30, 2022 compared with 8.1% at December 31, 2021. Consistent with the Board of Director’s commitment to public confidence and safe and sound banking operations, capital targets and minimum risk-based capital ratios for CSB were established to maintain excess capital to well-capitalized standards. To be considered well-capitalized, an institution must have a total risk-based capital ratio of at least 10%, a tier 1 capital ratio of at least 8%, a leverage capital ratio of at least 5%, a common equity tier 1 (“CET1”) ratio of at least 6.5% and must not be subject to any order or directive requiring the institution to improve its capital level. An adequately capitalized institution has a total risk-based capital 29 CSB BANCORP, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ratio of at least 8%, a tier 1 capital ratio of at least 6%, a CET1 ratio of at least 4.5%, and a leverage ratio of at least 4%. Failure to meet specified minimum capital requirements could result in regulatory actions by the Federal Reserve or Ohio Division of Financial Institutions that could have a material effect on the Company’s financial condition or results of operations. Management believes there were no material changes to capital resources as presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021. As of June 30, 2022, the Company and the Bank met all capital adequacy requirements to which they were subject. Capital Ratios June 30, 2022 December 31, 2021 Common Equity Tier 1 Capital To Risk Weighted Assets Consolidated 15.0 % 16.3 % Bank 14.8 % 16.0 % Tier 1 Capital To Risk Weighted Assets Ratio Consolidated 15.0 % 16.3 % Bank 14.8 % 16.0 % Total Capital To Risk Weighted Assets Ratio Consolidated 16.1 % 17.5 % Bank 15.9 % 17.3 % Tier 1 Leverage Ratio Consolidated 8.7 % 8.3 % Bank 8.5 % 8.2 % LIQUIDITY (Dollars in thousands) June 30, 2022 December 31, 2021 Change Cash and cash equivalents $ 103,366 $ 243,657 $ (140,291 ) Available from FHLB 110,470 107,054 3,416 Unpledged AFS securities at fair market value 127,099 108,158 18,941 $ 340,935 $ 458,869 $ (117,934 ) Net deposits and short-term liabilities $ 1,010,376 $ 1,016,821 $ (6,445 ) Liquidity ratio 33.7 % 45.1 % (11.4 ) % Minimum board approved liquidity ratio 20.0 20.0 Liquidity refers to the Company’s ability to generate sufficient cash to fund current loan demand, meet deposit withdrawals, pay operating expenses, and meet other obligations. Liquidity is monitored by the Company’s Asset Liability Committee. Other sources of liquidity include, but are not limited to, purchases of federal funds, advances from the FHLB, adjustments of interest rates to attract deposits, brokered deposits, and borrowing at the Federal Reserve discount window. Management believes that its sources of liquidity are adequate to meet cash flow obligations for the foreseeable future. Off-Balance Sheet Arrangements The Company does not have any off-balance sheet arrangements (as such term is defined in applicable Securities and Exchange Commission (the “Commission”) rules) that are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures, or capital resources. 30 CSB BANCORP, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS PER SHARE DATA Earnings per share is computed based on the weighted average number of shares of common stock outstanding during each year. The company currently maintains a simple capital structure, thus, there are no dilutive effects on earnings per share. The weighted average number of common shares outstanding for earnings per share computations was as follows: Three Months Ended Six Months Ended June 30, June 30, (Dollars in thousands, except per share data) 2022 2021 2022 2021 Basic Earnings Per Share Net income $ 3,209 $ 2,745 $ 5,910 $ 5,630 Weighted average common shares 2,718,024 2,740,390 2,718,024 2,741,365 Basic Earnings Per Share $ 1.18 $ 1.00 $ 2.17 $ 2.05 Diluted Earnings Per Share Net income $ 3,209 $ 2,745 $ 5,910 $ 5,630 Weighted average common shares 2,718,024 2,740,390 2,718,024 2,741,365 Diluted Earnings Per Share $ 1.18 $ 1.00 $ 2.17 $ 2.05 31 CSB BANCORP, INC. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK