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 on September 30, 2022 as compared to December 31, 2021, and the consolidated results of operations for the three and nine months ended September 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 increased to $1.16 billion at September 30, 2022 compared to $1.14 billion December 31, 2021. During the nine months ended September 30, 2022, securities increased $88 million, net loans increased $61 million, and cash and cash equivalents decreased $136 million. Deposits and short-term borrowings increased $24 million. Net loans increased $61 million, or 11%, as construction loans increased $12 million, or 27%, and residential real estate loans increased $22 million, or 13%, from December 31, 2021. Commercial and commercial real estate loans increased $30 million compared to December 31, 2021 including $4 million in PPP loan forgiveness from year end. PPP loans outstanding on September 30, 2022, were $392 thousand 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 nine months of 2022, and home equity line balances increased by $7 million. Residential mortgage loan originations for the nine months ended September 30, 2022 totaled $61 million, a decrease from $85 million in originations during the nine months ended September 30, 2021. As interest rates rose in 2022, more variable rate residential mortgage loans were originated for the portfolio, with nine-month originations of $48 million in 2022 and $38 million in 2021. Originations sold into the secondary market were $8 million and $36 million, respectively during the nine months ended September 30, 2022 and September 30, 2021. The Bank originates and sells primarily fixed rate thirty-year mortgages into the secondary market. The allowance for loan losses decreased $637 thousand from the year ago quarter to $7.0 million. The Company has not early adopted CECL which has been delayed for smaller reporting companies. Net recoveries were $285 thousand, or an annualized -0.07% of average loans, in the current nine-month period compared to net recoveries of $26 thousand, or -0.01% of average loans in the year-ago nine-month period. At September 30, 2022, the allowance for total loans was 1.15%. 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 $ 402 thousand to $ 6 86 thousand , or 0. 1 1 % , of total loans from $ 1.1 million, or 0. 20 %, on December 31, 202 1 . For the nine months ended September 30, 2022 , $ 82 thousand in loans were placed on n onaccrual status , $ 4 70 thousand in paydowns were received , and $ 10 thousand in personal loans were charged-off due to non-payment . September 30, December 31, September 30, (Dollars in thousands) 2022 2021 2021 Non-performing loans $ 686 $ 1,088 $ 1,320 Other real estate — — — Repossessed assets — — 33 Allowance for loan losses 7,008 7,618 7,645 Total loans $ 609,971 $ 549,154 $ 546,095 Allowance for loan losses as a percentage of total loans 1.15 % 1.39 % 1.40 % Allowance for loan losses to total nonperforming loans 10.2X 7.0X 5.8X The ratio of gross loans to deposits was 59.3% at September 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 $53.7 million within the available-for-sale and held-to-maturity portfolios as of September 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 September 30, 2022, are considered temporary and no impairment loss relating to these securities has been recognized. Deposits increased $27 million, or 3%, from December 31, 2021 with noninterest-bearing deposits increasing approximately $4 million, or 1%, and interest-bearing deposit accounts increasing approximately $23 million, or 3%. Total deposits as of September 30, 2022 are $1.03 billion, or 6%, greater than September 30, 2021 deposit balances. On a year over year comparison, increases were recognized in noninterest-bearing demand deposits of $34 million, money market accounts of $25 million, savings of $12 million, and declines in interest-bearing demand deposits of $2 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 $2 million, or 6%, to $34 million at September 30, 2022 as compared to December 31, 2021 and other borrowings decreased $879 thousand as the Company repaid FHLB advances. Total shareholders’ equity amounted to $92 million, or 7.9%, of total assets at September 30, 2022, a decrease of $5 million, or 5.5%, from $97 million December 31, 2021. The decrease in shareholders’ equity during the nine months ended September 30, 2022 was due to accumulated other comprehensive loss (“AOCL”) of $11.9 million, which was partially offset by net income of $9.6 million, less cash dividends of $2.6 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 September 30, 2022. RESULTS OF OPERATIONS Three months ended September 30, 2022, and 2021 For the quarters ended September 30, 2022 and 2021, the Company recorded net income of $3.7 million and $2.9 million and $1.35 and $1.06 per share, respectively. The $749 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 $232 thousand, and a decrease of $93 thousand in noninterest income. The recovery of provision for loan losses was $250 thousand in 2022 compared to $210 thousand for the three-month period in 2021, and the federal income tax provision increased $201 thousand. Return on average assets and return on average equity were 1.25% and 15.24%, respectively, for the three-month period of 2022, compared to 1.03% and 11.79%, 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 September 30, 2022 2021 (Dollars in thousands) Average balance 1 Interest Average rate 2 Average balance 1 Interest Average rate 2 ASSETS Interest-earning deposits $ 101,460 $ 586 2.29 % $ 277,168 $ 114 0.16 % Taxable securities 373,290 1,780 1.89 207,459 677 1.29 Tax-exempt securities 4 24,627 139 2.24 26,377 148 2.23 Loans 3,4 594,820 6,687 4.46 545,420 6,905 5.02 Total interest-earning assets 1,094,197 9,192 3.33 % 1,056,424 7,844 2.95 % Noninterest-earning assets 65,326 59,390 TOTAL ASSETS $ 1,159,523 $ 1,115,814 LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing demand deposits $ 243,343 $ 151 0.25 % $ 253,190 $ 78 0.12 % Savings deposits 323,033 183 0.22 290,544 74 0.10 Time deposits 115,899 225 0.77 124,479 298 0.95 Borrowed funds 37,479 37 0.39 42,043 30 0.28 Total interest-bearing liabilities 719,754 596 0.33 % 710,256 480 0.27 % Noninterest-bearing demand deposits 340,576 304,196 Other liabilities 4,150 3,778 Shareholders' Equity 95,043 97,584 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,159,523 $ 1,115,814 Taxable equivalent net interest income, (Non-GAAP) $ 8,596 $ 7,364 Tax equivalent adjustment 4 (36 ) (39 ) Net interest income, (GAAP) $ 8,560 $ 7,325 Net interest margin, (GAAP) 3.10 % 2.75 % Tax equivalent adjustment 4 0.02 0.02 Net interest margin-taxable equivalent, (Non-GAAP) 3.12 % 2.77 % Taxable equivalent net interest spread 3.00 % 2.68 % 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 September 30, 2022, was $9.2 million representing a $1.4 million increase, or 17%, 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 56 basis points for the quarter ended September 30, 2022 as compared to the same period in 2021, primarily from PPP recognized loan fees declining from $909 thousand in 2021 to $24 thousand in 2022. Interest expense for the quarter ended September 30, 2022 was $596 thousand, an increase of $116 thousand, or 24%, from the same quarter in 2021. The increase in interest expense occurred primarily due to the increase in interest rates on savings and interest-bearing demand deposits as well as an increase in volume of savings accounts for the quarter ended September 30, 2022. 26 CSB BANCORP, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS For the quarter ended September 30, 2022, with improving credit quality and net loan recoveries, the bank recognized a recovery for loan losses of $250 thousand to the provision for loan losses, compared to a recovery for loan losses of $210 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. 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 September 30, 2022, was $1.7 million, a decrease of $93 thousand, or 5%, compared to the same quarter in 2021. The gain on the sale of mortgage loans into the secondary market decreased by $221 thousand, or 82%, for the quarter ended September 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 $216 thousand for the third quarter 2022, a decrease of $36 thousand, or 14%, as compared to the same quarter in 2021. Credit card fee income increased $43 thousand, or 34%, as improvements to the card program have resulted in increased customer usage. Service charges on deposit accounts increased $71 thousand, or 28%, compared to the same quarter in 2021, primarily from increased customer overdraft fees. Debit card interchange income increased $15 thousand, or 3%, with greater fees generated from usage in the third quarter 2022 . Earnings on bank owned life insurance increased $7 thousand, or 4%, for the third quarter 2022. Noninterest expenses for the quarter ended September 30, 2022 increased $232 thousand, or 4%, compared to the third quarter 2021. Salaries and employee benefits decreased $29 thousand, or less than 1%, a result of fewer FTE’s due to open positions which was partially offset by reduced credits from loan originations compared to third quarter 2021. Occupancy and equipment expense increased $25 thousand, or 6%, in 2022 over the third quarter 2021, primarily due to increases in depreciation related to facility improvements and increased cost of building and equipment repairs and maintenance. Professional and director fees increased $375 thousand, or 208%, for the quarter ended September 30, 2022 as compared to the third quarter 2021, primarily due to consulting fees to renegotiate the renewal of the core data processing software contract, loan legal and collection expenses as compared to a recovery of loan collection expenses in 2021, and an increase in audit fees. Software expense increased $79 thousand due to additional software purchases. The Ohio Financial institutions tax increased $7 thousand, or 4%, in the third quarter due to the Company’s increased capital base . FDIC assessment amounted to $93 thousand as compared to $130 thousand in the third quarter 2021 due to improvement within nonperforming loans . Marketing and public relations expense declined $6 thousand, or 4%. Federal income tax expense increased $201 thousand, or 29%, for the quarter ended September 30, 2022 as compared to the third quarter 2021 . The provision for income taxes was $890 thousand (effective rate of 19.6%) for the quarter ended September 30, 2022, compared to $689 thousand (effective rate of 19.2%) for the same quarter ended 2021. RESULTS OF OPERATIONS Nine months ended September 30, 2022, and 2021 For the nine months ended September 30, 2022, and 2021, the Company recorded net income of $9.6 million and $8.5 million and $3.52 and $3.12 per share, respectively. The $1.0 million increase in net income for the nine-month period was primarily the result of an increase in net interest income of $2.3 million, which was partially offset by a reduction in noninterest income of $390 thousand and an increase in noninterest expenses of $803 thousand. A negative loan loss provision of $895 thousand for the period as compared to a smaller negative loss provision of $655 thousand for the same period in 2021 also contributed to increased net income for the nine months. The federal income tax provision was $269 thousand higher during the nine-month period in 2022. Return on average assets and return on average equity were 1.12% and 13.41%, respectively, for the nine months ended September 30, 2022, compared to 1.03% and 11.91%, 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 Nine Months Ended September 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 119,373 863 0.97 % 257,590 228 0.12 % Taxable securities 360,774 4,721 1.75 192,528 1,840 1.28 Tax-exempt securities 4 24,705 416 2.25 26,284 429 2.18 Loans 3,4 576,821 18,510 4.29 568,726 20,018 4.71 Total earning assets 1,081,673 24,510 3.03 % 1,045,128 22,515 2.88 % Other assets 63,217 57,579 TOTAL ASSETS $ 1,144,890 $ 1,102,707 LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing demand deposits $ 239,679 $ 257 0.14 % $ 262,213 $ 258 0.13 % Savings deposits 313,172 325 0.14 276,808 214 0.10 Time deposits 117,999 670 0.76 123,886 1,024 1.11 Other borrowed funds 41,032 94 0.31 43,432 100 0.31 Total interest bearing liabilities 711,882 1,346 0.25 % 706,339 1,596 0.30 % Non-interest bearing demand deposits 333,715 296,789 Other liabilities 3,956 3,803 Shareholders' Equity 95,337 95,776 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,144,890 $ 1,102,707 Taxable equivalent net interest income, (Non-GAAP) $ 23,164 $ 20,919 Tax equivalent adjustment 4 (109 ) (115 ) Net interest income, (GAAP) $ 23,055 $ 20,804 Net interest margin, (GAAP) 2.85 % 2.66 % Tax equivalent adjustment 4 0.01 0.02 Net interest margin-taxable equivalent, (Non-GAAP) 2.86 % 2.68 % Taxable equivalent net interest spread 2.78 % 2.58 % 28 CSB BANCORP, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Interest income for the nine months ended September 30, 2022, was $24.4 million representing a $2.0 million thousand increase, or 9%, compared to the same period in 2021. This increase was primarily due to volume and yield increases on taxable securities, yield increases on overnight deposits in other banks, and volume increases in average loan balances for the period ended September 30, 2022, as compared to the same period in 2021 . Offsetting these increases was a yield decrease on loans, primarily from PPP fees declining from $2.4 million in 2021 to $173 thousand in 2022. Year-to-date average PPP loan balances decreased from $26 million on September 30, 2021, to $1.8 million on September 30, 2022 , as loans were forgiven by the SBA. Interest expense for the nine months ended September 30, 2022, was $1.3 million, a decrease of $250 thousand, or 16%, from the same period in 2021. The decrease in interest expense occurred primarily due to a decrease in rates on time deposits for the nine months ended September 30, 2022, partially offset by an increase in the average balances and rates on savings deposits in 2022. For the nine months ended September 30, 2022, the provision for loan losses was a credit (reversal) of provision of $895 thousand, compared to a smaller credit provision of $655 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 nine months ended September 30, 2022, was $5.1 million, a decrease of $390 thousand, or 7%, compared to the same period in 2021. The gain on the sale of mortgage loans to the secondary market decreased $860 thousand, or 73%, to $314 thousand for the nine months ended September 30, 2022, as increases in interest rates slowed mortgage loan refinancing. Debit card interchange income increased $56 thousand, or 4%. Earnings on bank owned life insurance policies increased $47 thousand, or 10%, for the period. Service charges on deposit accounts increased $199 thousand, or 29%, 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 $175 thousand, or 51% with growth in business credit card customers and interchange income. Fees from trust and brokerage services decreased $65 thousand for the period. Noninterest expenses for the nine months ended September 30, 2022, increased $803 thousand, or 5%, compared to the same period in 2021. Salaries and employee benefits increased $465 thousand, or 5%, a result of increased salaries, with additions to lending staff, and reduced credits on deferred loan costs with less volume originated in commercial and mortgage loans. Occupancy and equipment expenses increased $134 thousand over the same period in 2021 with an increase in depreciation and maintenance expense. Professional and director fees increased $330 thousand, or 40%, for the nine months ended September 30, 2022, as compared to the same period in 2021, see three months ended results of operation. Software expense rose, $102 thousand, or 11%, with the addition of software. Marketing and public relations expense increased $38 thousand, or 12%, 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. Federal income tax expense increased $269 thousand, or 13%, for the nine months ended September 30, 2022, as compared to the same period in 2021. The provision for income taxes was $2.3 million (effective rate of 19.4%) for the nine months ended September 30, 2022, compared to $2.0 million (effective rate of 19.2%) for the same period ended 2021. CAPITAL RESOURCES The Company maintained a strong capital position with tangible common equity to tangible assets of 7.5% at September 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 29 CSB BANCORP, INC. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 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 September 30, 2022, the Company and the Bank met all capital adequacy requirements to which they were subject. Capital Ratios September 30, 2022 December 31, 2021 Common Equity Tier 1 Capital To Risk Weighted Assets Consolidated 14.6 % 16.3 % Bank 14.5 % 16.0 % Tier 1 Capital To Risk Weighted Assets Ratio Consolidated 14.6 % 16.3 % Bank 14.5 % 16.0 % Total Capital To Risk Weighted Assets Ratio Consolidated 15.7 % 17.5 % Bank 15.5 % 17.3 % Tier 1 Leverage Ratio Consolidated 8.7 % 8.3 % Bank 8.6 % 8.2 % LIQUIDITY (Dollars in thousands) September 30, 2022 December 31, 2021 Change Cash and cash equivalents $ 107,516 $ 243,657 $ (136,141 ) Available from FHLB 115,780 107,054 8,726 Unpledged AFS securities at fair market value 123,600 108,158 15,442 $ 346,896 $ 458,869 $ (111,973 ) Net deposits and short-term liabilities $ 1,044,431 $ 1,016,821 $ 27,610 Liquidity ratio 33.2 % 45.1 % (11.9 ) % 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 Nine Months Ended September 30, September 30, (Dollars in thousands, except per share data) 2022 2021 2022 2021 Basic Earnings Per Share Net income $ 3,650 $ 2,901 $ 9,560 $ 8,531 Weighted average common shares 2,712,686 2,729,410 2,716,225 2,737,336 Basic Earnings Per Share 1.35 1.06 3.52 3.12 Diluted Earnings Per Share Net income $ 3,650 $ 2,901 $ 9,560 $ 8,531 Weighted average common shares 2,712,686 2,729,410 2,716,225 2,737,336 Diluted Earnings Per Share 1.35 1.06 3.52 3.12 31 CSB BANCORP, INC. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK