What changed in this filing

/stocks — the workspaceLOADING

Item 2. Management’s Discussion and Analysis

2020-08-06 compared with 2020-05-11 · 274 added, 164 removed, 401 unchanged (52% of the section changed)

5 unchanged sentences

Such forward-looking statements are inherently subject to many uncertainties in the Company’s operations and business environment.

Factors that could affect actual results or outcomes include the matters described under the caption “Risk Factors” in Item 1A of our annual report on Form 10-K for the year ended December 31, 2019, filed with the SEC on March 10, 2020 (“2019 10-K”), the matters described in “Risk Factors” in Item 1A of this Form 10-Q, and the following:

conditions in the financial markets and economic conditions generally;

adverse impacts the the Company or Bank arising from the COVID-19 pandemic;

adverse impacts to the Company or Bank arising from the COVID-19 pandemic;

the possibility of a deterioration in the residential real estate markets;

26 unchanged sentences

The forward-looking statements made herein are only made as of the date of this filing and the Company undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances occurring after the date of this report.

The following discussion sets forth management’s discussion and analysis of our consolidated financial condition as of March 31, 2020 , and our consolidated results of operations for the three months ended March 31, 2020 , compared to the same period in the prior fiscal year for the three months ended March 31, 2019 .

The following discussion sets forth management’s discussion and analysis of our consolidated financial condition as of June 30, 2020 , and our consolidated results of operations for the three and six months ended June 30, 2020 , compared to the same period in the prior fiscal year for the three and six months ended June 30, 2019 .

This discussion should be read in conjunction with the interim consolidated financial statements and the condensed notes thereto included with this report and with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the financial statements and notes related thereto included in our 2019 10-K.

24 unchanged sentences

The Company does not amortize goodwill and any acquired intangible asset with an indefinite useful economic life, but reviews them for impairment at a reporting unit level on an annual basis, or when events or changes in circumstances indicate that the carrying amounts may be impaired.

A reporting unit is defined as any distinct, separately identifiable component of the Company’s one operating segment for which complete, discrete financial information is available and reviewed regularly by the segment’s management.

has one reporting unit as of March 31, 2020 which is related to its banking activities.

A reporting unit is defined as any distinct, separately identifiable component of the Company’s one operating segment

for which complete, discrete financial information is available and reviewed regularly by the segment’s management.

The Company has one reporting unit as of June 30, 2020 which is related to its banking activities.

The Company performed the required goodwill impairment test and determined that goodwill was not impaired as of December 31, 2019.

The Company performed a goodwill impairment analysis as of March 31, 2020, due to triggering events being identified, and determined that goodwill was not impaired.

The Company performed a goodwill impairment analysis as of June 30, 2020 , due to triggering events being identified, and determined that goodwill was not impaired.

Fair Value Measurements and Valuation Methodologies.

18 unchanged sentences

We believe that the deferred tax assets and liabilities are adequate and properly recorded in the accompanying consolidated financial statements.

As of March 31, 2020 , management does not believe a valuation allowance related to the realizability of its deferred tax assets is necessary.

As of June 30, 2020 , management does not believe a valuation allowance related to the realizability of its deferred tax assets is necessary.

STATEMENT OF OPERATIONS ANALYSIS

6 unchanged sentences

Net interest margin currently exceeds interest rate spread because non-interest-bearing sources of funds (“net free funds”), principally demand deposits and stockholders’ equity, also support interest earning assets.

The narrative below discusses net interest income, interest rate spread, and net interest margin for the three-month period ended March 31, 2020 and March 31, 2019, respectively.

Net interest income was $12.7 million for the three months ended March 31, 2020, compared to $10.1 million for the three months ended March 31, 2019.

The narrative below discusses net interest income, interest rate spread, and net interest margin for the three and six-month periods ended June 30, 2020 and June 30, 2019, respectively.

Net interest income was $12.3 million for the three months ended June 30, 2020 and $25.0 million for the six months ended June 30, 2020, compared to $10.1 million for the three months ended June 30, 2019 and $20.1 million of the six months ended June 30, 2019.

The growth in net interest income was due to the growth in average assets from the F&M acquisition, increase in accretion of purchase credit impaired loans and organic loan growth, partially offset by a decrease in net interest margin percentage.

For the quarter ended March 31, 2020, the Company’s net interest margin benefited from $1.042 million, or 30 basis points of the accretion of purchased credit impaired discounts, compared to $15 thousand, or one basis point for the first quarter of 2019.

Scheduled accretion on acquired loans, was $234 thousand for the quarter ended March 31, 2020 compared to $194 thousand for the quarter ended March 31, 2019, with the increase due to impact of the F&M acquisition.

The net interest margin for the three-month period ended March 31, 2020 was 3.64%, compared to 3.43% for the three-month period ended March 31, 2019.

In addition, the three months ended June 30, 2020 benefited from the margin related to the Bank’s origination of $137 million of SBA PPP loans.

The net interest margin for the three-month period ended June 30, 2020 was 3.34%, compared to 3.30% for the three-month period ended June 30, 2019.

The increase in net interest margin was due to the increase in the accretion of purchased credit impaired discounts.

The net interest margin, after subtracting the positive 30 basis point impact of accretion of purchased credit impaired loans and scheduled accretion of 7 basis points, was 3.27%.

For the quarter ended March 31, 2019, the net interest margin of 3.43%, after subtracting the positive two basis point impact of accretion of purchased credit impaired loans and scheduled accretion of seven basis points was 3.34%.

or a seven-basis point reduction in net interest margin.

This decrease is largely due to lower interest rate spreads between loans and deposits in 2019 due to the competitive market for deposits and higher cost wholesale funding required to replace deposits lost due to the May 2019 branch sale.

The net interest margin, after subtracting the positive 8 basis point impact of accretion due to the payoff of purchased credit impaired loans and scheduled accretion of 7 basis points, was 3.19%.

In addition, the impact of SBA PPP loans originated in the second quarter of 2020 was 4 basis points.

For the quarter ended June 30, 2019, the net interest margin of 3.30%, after subtracting the positive two basis point impact of accretion of purchased credit impaired loans and scheduled accretion of seven basis points was 3.21%.

The net interest margin for the six-months ended June 30, 2020 was 3.48%, compared to 3.36% for the six-month period ended June 30, 2019.

The increase in net interest margin was due to the increase in the accretion of purchased credit impaired discounts.

The net interest margin for the six-month period ending June 30, 2020, after subtracting the positive 18 basis point impact of accretion due to the payoff of purchased credit impaired loans and scheduled accretion of 7 basis points, was 3.23%.

For the six months ended June 30, 2019, the net interest margin of 3.36%, after subtracting the positive one basis point impact of accretion of purchased credit impaired loans and scheduled accretion of seven basis points was 3.28%.

Average Balances, Net Interest Income, Yields Earned and Rates Paid.

The following net interest income analysis table presents interest income from average interest earning assets, expressed in dollars and yields, and interest expense on average interest-bearing liabilities, expressed in dollars and rates on a tax equivalent basis.

Shown below is the weighted average tax equivalent yield on interest earning assets, rates paid on interest-bearing liabilities and the resultant spread at or during the three-month period ended March 31, 2020, and for the three-month period ended March 31, 2019.

Shown below is the weighted average tax equivalent yield on interest earning assets, rates paid on interest-bearing liabilities and the resultant spread at or during the three and six-month periods ended June 30, 2020, and for the three and six-month periods ended June 30, 2019.

Non-accruing loans have been included in the table as loans carrying a zero yield.

1 unchanged sentence

(Dollar amounts in thousands)

Three months ended March 31, 2020 compared to the three months ended March 31, 2019 :

Three months ended March 31, 2020

Three months ended March 31, 2019

Three months ended June 30, 2020 compared to the three months ended June 30, 2019 :

Three months ended June 30, 2020

Three months ended June 30, 2019

Average interest earning assets:

15 unchanged sentences

(1) Fully taxable equivalent (FTE).

The average yield on tax exempt securities is computed on a tax equivalent basis using a tax rate of 21.0% for the quarters ended March 31, 2020 and March 31, 2019 .

The FTE adjustment to net interest income included in the rate calculations totaled $0 and $42 thousand for the three months ended March 31, 2020 and March 31, 2019 , respectively.

The average yield on tax exempt securities is computed on a tax equivalent basis using a tax rate of 21.0% for the quarters ended June 30, 2020 and June 30, 2019 .

The FTE adjustment to net interest income included in the rate calculations totaled $0 and $35 thousand for the three months ended June 30, 2020 and June 30, 2019 , respectively.

NET INTEREST INCOME ANALYSIS ON A TAX EQUIVALENT BASIS

(Dollar amounts in thousands)

Six months ended June 30, 2020 compared to the six months ended June 30, 2019 :

Six months ended June 30, 2020

Six months ended June 30, 2019

Average interest earning assets:

Cash and cash equivalents

Interest-bearing deposits

Investment securities (1)

Other investments

Total interest earning assets (1)

Average interest-bearing liabilities:

Savings accounts

Demand deposits

Total deposits

FHLB Advances and other borrowings

Total interest-bearing liabilities

Net interest income

Interest rate spread

Net interest margin (1)

Average interest earning assets to average interest-bearing liabilities

(1) Fully taxable equivalent (FTE).

The average yield on tax exempt securities is computed on a tax equivalent basis using a tax rate of 21.0% for the quarters ended June 30, 2020 and June 30, 2019 .

The FTE adjustment to net interest income included in the rate calculations totaled $1 thousand and $77 thousand for the six months ended June 30, 2020 and June 30, 2019 , respectively.

Rate/Volume Analysis.

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holding the initial balance constant).

Volume changes are largely due to the F&M acquisition for the three-months ended March 31, 2020 compared to the three-months ended March 31, 2019 and to a lesser extent, the impact of organic loan growth.

Volume changes are largely due to the F&M acquisition for the three and six months ended June 30, 2020 compared to the three and six months ended June 30, 2019 and to a lesser extent, the impact of organic loan growth.

RATE / VOLUME ANALYSIS

(Dollar amounts in thousands)

Three months ended March 31, 2020 compared to the three months ended March 31, 2019 .

Three months ended June 30, 2020 compared to the three months ended June 30, 2019 .

Increase (decrease) due to

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Net interest income

Six months ended June 30, 2020 compared to the six months ended June 30, 2019 .

Increase (decrease) due to

Interest income:

Cash and cash equivalents

Interest-bearing deposits

Investment securities

Other investments

Total interest earning assets

Interest expense:

Savings accounts

Demand deposits

Money market accounts

Total deposits

FHLB Advances and other borrowings

Total interest bearing liabilities

Net interest income

Provision for Loan Losses.

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We continue to monitor adverse general economic conditions that could affect our commercial and agricultural portfolios in the future.

Total provision for loan losses expense for the quarter ended March 31, 2020 was $2,000.

In anticipation of a COVID 19-related economic slowdown, management recorded provision for loans losses of $750.

Various “Stay-at-Home Orders” resulted in temporary business closures, reduced operating capacity and uncertainty regarding potential future revenue and cash flows for certain business, including bank borrowers.

Approximately $600 of the provision was related to loan growth in the quarter.

The remaining provision was related to net loan charge-offs of $485 and necessary increases in specific and unallocated allowance of loan losses.

Provision expenses for the quarter ended March 31, 2019 was $1,225.

Approximately $600 of the provision was related to loan growth.

The remaining provision expenses was primarily due to approximately $500 of growth in specific reserves, the impact of net charge-offs of $122 and the growth in unallocated reserves

Total provision for loan losses expense for the three and six months ended June 30, 2020 was $1,750 and $3,750, respectively.

In continued anticipation of COVID-19 related adverse economic impacts, management recorded provision for loan losses of $1,250 and $2,000 for the three and six months ended June 30, 2020, respectively, related to COVID-19.

“Stay-at-Home Orders” continued to result in temporary business closures, reduced operating capacity and uncertainty regarding potential future revenue and cash flows for certain business, including bank borrowers.

Approximately $100 and $700 of the provision was related to loan growth in the three and six months ended June 30, 2020 The remaining provision was related to net loan charge-offs of $212 and $697 for the three and six months ended June 30, 2020, and necessary increases in unallocated and specific allowance for loan losses.

Management believes that the provision taken for the current year three-month period is adequate in view of the present condition of our loan portfolio and the sufficiency of collateral supporting our non-performing loans.

2 unchanged sentences

If there are significant charge-offs against the ALL, or we otherwise determine that the ALL is inadequate, we will need to record an additional provision in the future.

See the section below captioned “Allowance for Loan Losses” in this discussion for further analysis of our provision for loan losses.

Non-interest Income .

The following table reflects the various components of non-interest income for the three month periods ended March 31, 2020 and 2019, respectively.

Three months ended March 31,

The following table reflects the various components of non-interest income for the three and six month periods ended June 30, 2020 and 2019, respectively.

Three months ended June 30,

Six months ended June 30,

Non-interest Income:

5 unchanged sentences

Insurance commission income

Gains on available for sale securities

Net gains on investment securities

Net gain on sale of branch

Net gain on sale of insurance agency

Settlement proceeds

Total non-interest income

The growth in most line items, year over year, are due to the impact of the F&M acquisition on July 1, 2019.

The interchange income increase reflects both the F&M acquisition and the impact of a milder winter in 2020 compared to 2019.

In 2019, our schools were closed for inclement weather for half of the working days in the month of February.

The increase in loan servicing income is largely due to the impact of higher 1-4 family loan originations.

The increase in gains on the sale of loans for the three months ended March 31, 2020 reflected increased mortgage activity due to the lower interest rate environment and to a lesser extent, higher gains on the sale of commercial originated government-guaranteed loans.

The increase in loan fees for the quarter ended March 31, 2020 compared to the same three-month period in 2019 is largely due to higher commercial loan customer activity.

The increase in insurance income in 2020 from 2019 is largely due to higher new commission activity.

For the three months ended March 31, 2020, the gain on sale of securities is due to the sale of $10 million of higher-premium mortgage-backed certificates to reduce prepayment risk, partially offset by approximately $70 of decreased equity value of the Company’s required holding of Farmer Mac common stock.

For the three months ended March 31, 2019, the market value of the Company’s required holding of Farmer Mac stock increased $34.

Included in other non-interest income for the quarter ended March 31, 2020 is a $75 prepayment fee received on the payoff of a mortgage-backed security.

Service charges on deposit accounts decreased to $345 and $905 for the three and six months ended June 30, 2020, from $581 and $1,131 in the comparable prior year periods.

This decrease was due to lower retail customer activity and due to higher balances of retail checking accounts primarily in the three months ended June 30, 2020.

Loan servicing income increased largely due to increased capitalized mortgage servicing rights due to higher mortgage loan origination fees in both the current three and six-month periods.

Gain on sale of loans increased in both the current three and six-month periods due to higher mortgage loan origination sold volumes.

The increase in loan fees and service charges for the six months ended June 30, 2020, is largely due to higher commercial loan customer activity, which occurred primarily in the first quarter of 2020

The Company recognized a gain on sale of its Michigan branch of $2,295 in the second quarter of 2019.

The Company sold the Wells Insurance Agency in June 2020, realizing a net gain of $252.

During the quarter ended June 30, 2020, the Company recognized $131 of non-interest income related to a private mortgage-backed security claim.

This distribution represents a supplement to the proceeds received in March 2017 from this private mortgage-backed security, previously owned by the Bank, and sold in 2011.

Non-interest Expense.

The following table reflects the various components of non-interest expense for the three month periods ended March 31, 2020 and 2019, respectively.

Three months ended March 31,

The following table reflects the various components of non-interest expense for the three and six month periods ended June 30, 2020 and 2019, respectively.

Three months ended June 30,

Six months ended June 30,

Non-interest Expense:

Compensation and benefits

Occupancy - net

Compensation and related benefits

Data processing

4 unchanged sentences

Professional services

Gains (losses) on repossessed assets, net

Gains on repossessed assets, net

Total non-interest expense

Non-interest expense (annualized) / Average assets

The growth in most line items, year over year, includes the impact of the F&M acquisition on July1, 2019.

Compensation expense, for the quarter ended March 31, 2020, increased from March 31, 2019.

In addition to the impact of higher salaries paid due to the impact of the F&M acquisition, we incurred higher employee benefit costs.

Mortgage servicing rights expense increased during the quarter ended March 31, 2020 by $545 compared to the quarter ended March 31, 2019 largely due to the impact of higher forecasted prepayments, from the current lower interest rate environment, resulting in $480 of mortgage servicing rights impairment.

The growth in most line items, year over year, are due to the impact of the F&M acquisition on July 1, 2019.

Compensation expense, for both the three and six-month periods ended June 30, 2020 was higher than the comparable prior year period due primarily to the impact of the F&M acquisition, and to a lesser extent, higher variable mortgage production compensation related to all-time high mortgage loan origination activity, primarily in the second quarter of 2020.

Data processing expense increases were due primarily to higher loan origination activity and larger deposit balances.

Mortgage servicing rights expense increased during the three and six months ended June 30, 2020 by $685 and $1,230, respectively, compared to the comparable prior year periods.

The Company recognized related impairment charges of $650 and $1,130, respectively in 2020 compared to $110 for the three and six-months ended June 30, 2019, largely due to the impact of higher actual and forecasted prepayment rates.

The remaining increase is due to higher amortization based on the interest rate environment.

The first quarter ended March 31, 2020 was favorably impacted by the FDIC application of the Small Bank Assessment Credits to our current quarter deposit insurance charge totaling $56.

This was the Bank’s final quarterly insurance credit.

Professional fees for the quarter ended March 31, 2020 decreased compared to the quarter ended March 31, 2019, primarily due to lower audit costs.

Higher 2019 audit costs were largely due to the transition period audit required by the Company’s change in fiscal year-end.

Other expenses for the quarter ended March 31, 2020 decreased compared to March 31, 2019 largely due to lower merger-related expenses, partially offset by higher commercial loan and deposit costs.

Professional services expenses were lower during the three and six months ended June 30, 2020 compared to the comparable prior year periods, primarily due to lower audit costs.

Higher 2019 audit costs were largely due to the transition period audit required due to the change in the Company’s fiscal year-end.

Other expenses for the six-month period ended June 30, 2020 decreased compared to June 30, 2019 largely due to lower merger-related expenses, partially offset by higher commercial loan and deposit costs.

Income Taxes.

Income tax expense was $937 for the three months ended March 31, 2020 compared to $322 for the three months ended March 31, 2019.

Income tax expense was $1,105 and $2,042 for the three and six months ended June 30, 2020 compared to $1,500 and $1,822 for the three and six months ended June 30, 2019.

The impact of higher non-taxable municipal income in 2019 was offset by higher non-deductible merger costs, netting to approximately the same effective tax rates in both periods.

BALANCE SHEET ANALYSIS

Cash and Cash Equivalents.

During March 2019, the Federal Reserve issued a rule eliminating the required deposit at the local Federal Reserve Bank effective March 26, 2020.

The Bank was able to utilize a portion of the formerly required $22 million to reduce borrowings and decrease the balance on deposit at the Federal Reserve by approximately $12 million.

Investment Securities.

2 unchanged sentences

In the first quarter, the Bank sold approximately $10.7 million of fixed-rate mortgage-backed certificates, (“MBS”) and these were replaced with similar, lower premium MBS.

Securities available for sale, which represent the majority of our investment portfolio, were $163.4 million at March 31, 2020, compared with $180.1 million at December 31, 2019.

Securities held to maturity increased to $10.8 million at March 31, 2020, compared to $2.9 million at December 31, 2019.

Securities available for sale, which represent the majority of our investment portfolio, were $162.7 million at June 30, 2020, compared with $180.1 million at December 31, 2019.

Securities held to maturity increased to $10.5 million at June 30, 2020, compared to $2.9 million at December 31, 2019.

This increase was due to the purchase of agency mortgage-backed securities in the first quarter of 2020.

1 unchanged sentence

Securities available for sale

March 31, 2020

June 30, 2020

government agency obligations

13 unchanged sentences

Securities held to maturity

March 31, 2020

June 30, 2020

Obligations of states and political subdivisions

4 unchanged sentences

The composition of our available for sale portfolios by credit rating as of the dates indicated below was as follows:

March 31, 2020

June 30, 2020

December 31, 2019

2 unchanged sentences

The composition of our held to maturity portfolio by credit rating as of the dates indicated was as follows:

March 31, 2020

June 30, 2020

December 31, 2019

1 unchanged sentence

government agency

At March 31, 2020, securities with a market value of $1.5 million were pledged against a line of credit with the Federal Reserve Bank of Minneapolis.

As of March 31, 2020, this line of credit had a zero-outstanding balance.

At March 31, 2020, the Bank has pledged mortgage-backed securities with a market value of $4.575 million and U.S.

Government Agency securities with a market value of $633,000 as collateral against municipal deposits.

At March 31, 2020, the Bank also has mortgage-backed securities with a carrying value of $655,000 pledged as collateral to the Federal Home Loan Bank of Des Moines.

At March 31, 2020, the Bank’s unrealized loss on securities available for sale, net of tax, increased to $1.6 million compared to $471 thousand at December 31, 2019.

The decrease in interest rates benefitted the Bank’s mortgage-backed securities portfolio.

However, the flight to safety caused some temporary decreases in the valuation of the Banks investment in Trust Preferred Securities and Student Loan Paper.

The Bank has the ability and intent to hold these securities to maturity and expects to collect the principal owed at maturity.

Total loans outstanding, net of deferred loan fees and costs and unamortized discount on acquired loans, increased by $3.6 million, to $1.181 billion as of March 31, 2020, from $1.177 billion at December 31, 2019.

This $3.6 million growth includes the impact of related commercial borrowers drawing on $12.7 million of lines credit on December 30, 2019 and repayment of the lines of credit of $12.7 million.

The following table reflects the composition, or mix of our loan portfolio at March 31, 2020 and December 31, 2019:

March 31, 2020

At June 30, 2020, securities with a market value of $1.4 million were pledged against a line of credit with the Federal Reserve Bank of Minneapolis.

As of June 30, 2020, this line of credit had a zero-outstanding balance.

At June 30, 2020, the Bank has pledged mortgage-backed securities with a market value of $4.0 million and U.S.

Government Agency securities with a market value of $0.6 million as collateral against municipal deposits.

At June 30, 2020, the Bank also has mortgage-backed securities with a carrying value of $0.6 million pledged as collateral to the Federal Home Loan Bank of Des Moines.

Total loans outstanding, net of deferred loan fees and costs and unamortized discount on acquired loans, increased by $103.8 million, to $1.28 billion as of June 30, 2020, from $1.18 billion at December 31, 2019.

This was due to the impact of the growth in the SBA PPP origination of $137.3 million, partially offset by the net remaining deferred origination fees of $4.7 million.

This growth was partially offset by a reduction in acquired commercial loans and originated loan portfolio reductions in residential mortgage loans and indirect consumer loans of $13.0 million and $7.5 million, respectively.

The following table reflects the composition, or mix of our loan portfolio at June 30, 2020 and December 31, 2019:

June 30, 2020

December 31, 2019

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Construction and land development

Residential real estate

One to four family

Residential mortgage

Purchased HELOC loans

Total real estate loans

Non-real estate loans:

Commercial/agricultural loans

Commercial non-real estate

Agricultural non-real estate

Consumer non-real estate

C&I/Agricultural operating and Consumer Installment Loans:

C&I/Agricultural operating

Commercial and industrial (“C&I”)

Agricultural operating

Consumer installment

Originated indirect paper

Other Consumer

Total non-real estate loans

Total C&I/Agricultural operating and Consumer installment Loans

Gross loans before C&I SBA PPP loans

C&I SBA PPP loans

Unearned net deferred fees and costs and loans in process

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The specific credit allocation for the ALL is based on a regular analysis of all loans that are considered impaired.

In compliance with ASC 310-10, the fair value of the loan is determined based on either the present value of expected cash flows discounted at the loan’s effective interest rate, the market price of the loan, or, if the loan is collateral dependent, the fair value

of the underlying collateral less the expected cost of sale for such collateral.

At March 31, 2020, the Company had identified impaired loans of $56.0 million, consisting of $12.1 million TDR loans, the carrying amount of purchased credit impaired loans of $26.9 million and $17.0 million of substandard non-TDR loans.

At June 30, 2020, the Company had identified impaired loans of $51.7 million, consisting of $13.1 million TDR loans, the carrying amount of purchased credit impaired loans of $23.4 million and $15.1 million of substandard non-TDR loans.

The $51.7 million total of impaired loans includes $5.7 million of performing TDR loans.

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The $63.2 million total of impaired loans includes $5.4 million of performing TDR loans.

At March 31, 2020 and December 31, 2019, we had 363 and 389 such impaired loans, respectively, all secured by real estate or personal property.

At June 30, 2020 and December 31, 2019, we had 343 and 389 such impaired loans, respectively, all secured by real estate or personal property.

Of the impaired loans, there were 22 individual loans where estimated fair value was less than their book value (i.e.

we deemed impairment to exist) totaling $5.3 million for which $1.0 million in specific ALL was recorded as of March 31, 2020.

At March 31, 2020 ALL was $11.8 million, or 1.00% of our total loan portfolio, compared to ALL of $10.3 million, or 0.88% of the total loan portfolio at December 31, 2019.

This level was based on our analysis of the loan portfolio risk at March 31, 2020, considering the factors discussed above.

we deemed impairment to exist) totaling $5.2 million for which $1.1 million in specific ALL was recorded as of June 30, 2020.

The allowance for loan and lease losses increased to $13.4 million at June 30, 2020 representing 1.04% of loans receivable or 1.16% of loans receivable, less the 100% SBA guaranteed PPP loans.

A significant portion of the current loan portfolio includes loans purchased through whole bank acquisitions in recent years resulting in purchase credit impairments which are not included in the allowance for loan losses.

The allowance for loan and lease losses was $10.3 million at December 31, 2019, representing 0.88% of total loans.

The increase in the allowance was primarily due to loan loss provisions largely associated with anticipated COVID-19 related adverse economic impact of $2.0 million.

In addition, the allowance grew due to approximately $0.8 million of provision for loan growth, with the remaining growth largely due to growth in unallocated.

Allowance for Loan Losses to Loans, net of C&I SBA PPP Loans

(in thousands, except ratios)

June 30, 2019

Loans, end of period

C&I SBA PPP loans, net of deferred fees

Loans, net of C&I SBA PPP loans and deferred fees

Allowance for loan losses

ALL to loans net of C&I SBA PPP loans and deferred fees

ALL to loans, end of period

All the nine factors identified in the FFIEC’s Interagency Policy Statement on the Allowance for Loan and Lease Losses are taken into account in determining the ALL.

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These refinements could also cause increases or decreases in the ALL.

In anticipation of a COVID-19-related economic slowdown, management added an additional qualitative factor in the quarter ended March 31, 2020 and increased the ALL by $750,000 for this qualitative factor.

In anticipation of a COVID-19-related economic slowdown, management added an additional qualitative factor in the quarters ended March 31, 2020 and June 30, 2020 and increased the ALL by $750,000 and $1.25 million, respectively, for this qualitative factor.

See Provision for loan losses in the Consolidated Statements of Operations (unaudited) for further details.

5 unchanged sentences

• Commercial/agricultural real estate loans, past due 90 days or more;

• Commercial/agricultural non-real estate loans, past due 90 days or more;

• Closed ended consumer non-real estate loans past due 120 days or more;

• Residential real estate loans and open-ended consumer non-real estate loans past due 180 days or more.

• C&I/Agricultural operating loans, past due 90 days or more;

• Closed ended consumer installment loans past due 120 days or more;

• Residential mortgage loans and open-ended consumer installment loans past due 180 days or more.

When interest accruals are discontinued, interest credited to income is reversed.

3 unchanged sentences

The following table identifies the various components of non-performing assets and other balance sheet information as of the dates indicated below and changes in the ALL for the periods then ended:

March 31, 2020 and Three Months Then Ended

June 30, 2020 and Six Months Then Ended

December 31, 2019 and Twelve Months Then Ended

3 unchanged sentences

Agricultural real estate

Commercial non-real estate

Agricultural non-real estate

One to four family

Consumer non-real estate

Commercial and industrial

Agricultural operating

Residential mortgage

Consumer installment

Total nonaccrual loans

13 unchanged sentences

Commercial/Agricultural real estate

Commercial/Agricultural non-real estate

Residential real estate

Consumer non-real estate

C&I/Agricultural operating

Residential mortgage

Consumer installment

Total loans charged off

1 unchanged sentence

Commercial/Agricultural real estate

Commercial/Agricultural non-real estate

Residential real estate

Consumer non-real estate

C&I/Agricultural operating

Residential mortgage

Consumer installment

Total recoveries of loans previously charged off:

7 unchanged sentences

NPAs to total assets

Nonperforming assets decreased in the quarter by $2.4 million to $19.2 million, largely due to decreases in nonaccrual loans acquired in the F&M acquisition.

The following table shows the detail of non-performing assets by originated and acquired portfolios.

Nonperforming Originated / Acquired Assets

(in thousands, except ratios)

June 30, 2020 and Three Months Ended

March 31, 2020 and Three Months Ended

December 31, 2019 and Three Months Ended

June 30, 2019 and Three Months Ended

Nonperforming assets:

Originated nonperforming assets:

Nonaccrual loans

Accruing loans past due 90 days or more

Total originated nonperforming loans (“NPL”)

Other real estate owned (“OREO”)

Other collateral owned

Total originated nonperforming assets (“NPAs”)

Acquired nonperforming assets:

Nonaccrual loans

Accruing loans past due 90 days or more

Total acquired nonperforming loans (“NPL”)

Other real estate owned (“OREO”)

Other collateral owned

Total acquired nonperforming assets (“NPAs”)

Total nonperforming assets (“NPAs”)

Loans, end of period

Total assets, end of period

Originated NPLs to total loans

Acquired NPLs to total loans

Originated NPAs to total assets

Acquired NPAs to total assets

Nonperforming assets decreased by $4.2 million to $17.4 million at June 30, 2020 from December 31, 2019, largely due to decreases in nonaccrual loans acquired in the F&M acquisition.

In the quarter ended June 30, 2020, nonaccrual acquired loans of $1.7 million were returned to accrual status based on their current payment status and history, and in accordance with the Bank’s policy.

Refer to the “Allowance for Loan Losses” and “Nonperforming Loans, Potential Problem Loans and Foreclosed Properties” sections below for more information related to non-performing loans.

Classified assets decreased to $38.4 million at March 31, 2020, from $39.9 million at December 31, 2019 largely due to the reduction in nonperforming assets discussed above, with a modest increase in newly classified assets.

Total impaired loans, which included trouble debt restructured loans, purchased credit impaired loans and substandard non-performing loans, was $56.0 million at March 31, 2020 compared to $63.2 million at December 31, 2019.

This decrease was due to the decrease in classified assets and certain other acquired loan decreases, largely from the F&M acquisition.

Nonaccrual Loans Rollforward:

Quarter Ended

June 30, 2020

March 31, 2020

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June 30, 2019

March 31, 2019

Balance, beginning of period

4 unchanged sentences

Balance, end of period

Nonaccrual TDR loans increased $513,000 to $7.7 million at March 31, 2020 from $7.2 million at December 31, 2019, primarily due to restructuring of nonaccrual loans.

Nonaccrual TDR loans decreased $206,000 to $7.0 million at June 30, 2020 from $7.2 million at December 31, 2019.

June 30, 2020

March 31, 2020

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September 30, 2019

June 30, 2019

Modifications

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Commercial/Agricultural real estate

Commercial/Agricultural non-real estate

Residential real estate

Consumer non-real estate

C&I/Agricultural operating

Residential mortgage

Consumer installment

Classified assets decreased to $35.9 million at June 30, 2020, from $39.9 million at December 31, 2019 largely due to the reduction in nonperforming assets discussed above, with a modest increase in newly classified assets The table below shows a summary of the decrease in substandard loans by quarter since the first impact of the F&M acquisition on September 30, 2019 levels.

While special mention loans increased in the first quarter of 2020, the growth moderated in the second quarter of 2020.

See Note 3, “Loans, Allowance for Loan Losses and Impaired Loans” for additional information.

(in thousands)

September 30, 2019

Special mention loan balances

Substandard loan balances

Balances, end of period

Total impaired loans, which included trouble debt restructured loans, purchased credit impaired loans and substandard non-performing loans, was $51.7 million at June 30, 2020 compared to $63.2 million at December 31, 2019.

This decrease was largely due to payoff and reduction in acquired purchased credit impaired loans due to the decrease in classified assets and certain other acquired loan decreases, largely from the F&M acquisition.

COVID-19-related portfolio concentrations and modifications - Hotels and restaurants represent our portfolio’s two industry sectors most directly and adversely affected by the COVID-19 pandemic.

These sector loans totaled approximately $115 million and $30 million, respectively at March 31, 2020.

The weighted-average loan-to-value percentage and debt service coverage ratio on these hotel industry sector loans was 58.5% and 1.75 times.

These sector loans totaled approximately $109 million and $42 million, respectively at June 30, 2020.

The weighted-average loan-to-value percentage and debt service

coverage ratio on these hotel industry sector loans was 58.5% and 1.75 times.

Approximately $21 million of restaurant sector loans are to franchise quick-service restaurants.

As of March 31, 2020, the Bank had not yet completed any loan modifications due to COVID-19-related borrower requests.

However, by April 22, 2020, the Bank had approved $167.4 million of COVID-19-related modifications, primarily consisting of payment deferrals.

Hotel and restaurant industry sectors represent approximately $94 million of the approved deferrals.

As of June 30, 2020, the Bank had completed $197.3 million of loan modifications due to COVID-19-related borrower requests, all of which were done in the second quarter of 2020.

Approximately 55% of the deferrals were full payment deferrals.

The remaining 45% of deferrals require interest only payments.

Hotel and restaurant industry sectors represent approximately $784 million and $25 million, respectively of the approved deferrals.

While the Company has no indication that any of the modified credits are specifically impaired, additional risk and uncertainty inherent in the current COVID-19 pandemic-affected environment has been considered.

See “Allowance for Loan Losses” section above for discussion of COVID-19 qualitative factor, and related provision for loan losses.

Acquired loans represent much of the reduction in non-performing loans and classified loans.

The table below shows the changes in the Bank’s non-accretable differences on purchased credit impaired loans.

The Bank has transferred non-accretable difference on purchased credit impaired loans to accretable loan discounts as collateral coverage improved sufficiently, due to a combination of principal paydowns and/or improving collateral positions.

This transferred accretion is accreted over the remaining maturity of the loan or until payoff, whichever is shorter.

Non-accretable Differences:

(in thousands)

September 30, 2019

Non-accretable difference, beginning of period

Additions to non-accretable difference for acquired purchased credit impaired loans

Non-accretable difference realized as interest from payoffs of purchased credit impaired loans

Transfers from non-accretable difference to accretable discount.

Non-accretable difference used to reduce loan principal balance

Non-accretable difference transferred to OREO due to loan foreclosure

Non-accretable difference, end of period

Mortgage Servicing Rights.

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Although management believes that the assumptions used to evaluate the MSRs for impairment are reasonable, future adjustment may be necessary if future economic conditions differ substantially from the economic assumptions used to determine the value of MSRs.

The fair market value of the Company’s MSR asset decreased from $4.3 million at December 31, 2019 to $3.7 million at March 31, 2020, primarily due to increased amortization and $480,000 of impairment recorded on the MSR asset due to the impact of higher prepayment activity.

The unpaid balances of one- to four-family residential real estate loans serviced for others as of March 31, 2020 and December 31, 2019 were $521.6 million and $524.7 million, respectively.

The fair market value of the Company’s MSR asset as a percentage of its servicing portfolio at March 31, 2020 and December 31, 2019 was 0.72% and 0.82%, respectively.

Deposits decreased $15.6 million to $1.180 billion at March 31, 2020, from $1.196 billion at December 31, 2019.

The fair market value of the Company’s MSR asset decreased from $4.3 million at December 31, 2019 to $3.5 million at June 30, 2020, primarily due to $41.2 million of impairment recorded on the MSR asset due to the impact of higher prepayment activity, increased amortization and $1.2 million of impairment partially offset by capitalized servicing on newly sold mortgage originations.

The unpaid balances of one- to four-family residential real estate loans serviced for others as of June 30, 2020 and December 31, 2019 were $538.3 million and $524.7 million, respectively.

The fair market value of the Company’s MSR asset as a percentage of its servicing portfolio at June 30, 2020 and December 31, 2019 was 0.65% and 0.82%, respectively.

Deposits increased $76.5 million to $1.272 billion at June 30, 2020, from $1.196 billion at December 31, 2019.

Approximately $12.7 million of December 31, 2019 deposits represented draws on lines of credit by a single customer, taken on December 31, 2019, with the proceeds deposited into the customer’s money market accounts and subsequently repaid on January 2, 2020.

The following is a summary of deposits by type at March 31, 2020 and December 31, 2019 , respectively:

March 31, 2020

Retail non-maturity deposits increased $35 million, and commercial non-maturity deposits increased $91 million in the three months ended June 30, 2020.

Approximately $16 million of the commercial non-maturity deposits related to growth from customers who borrowed under the SBA PPP loan program and were depositors of the Bank.

Approximately $3 million of the commercial non-maturity deposit growth was growth in deposit accounts from SBA PPP loan customers with no previous lending or deposit relationship with the Bank prior to the pandemic.

The strong non-maturity deposit growth allowed

the Company to reduce reliance on higher cost brokered and institutional deposits.

This planned reduction in brokered and institutional deposits resulted in a reduction to $20 million at June 30, 2020 from $54 million at December 31, 2019.

Additionally, retail certificates of deposit decreased by $11 million as the Company chose not to match higher rate local retail certificate competition.

The following is a summary of deposits by type at June 30, 2020 and December 31, 2019, respectively:

June 30, 2020

December 31, 2019

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Total deposits

Deposits from closed branches, in markets that the Bank no longer competes in, decreased by $2.0 million during the three months ended March 31, 2020 , and total $23.5 million as of March 31, 2020 .

Brokered and listing services certificates decreased to $41 million at March 31, 2020 from $53 million at December 31, 2019.

Our objective is to grow deposits and build customer relationships in our core markets through our branch network, deposit product offerings, including Treasury Management, and providing excellent customer service.

Management expects to continue to place emphasis on both retaining and generating additional deposits in 2020 through competitive pricing of deposit products, our branch delivery systems that have already been established and electronic banking.

Management expects to continue to place emphasis on both retaining and generating additional deposits in 2020 through competitive pricing of deposit products, our established branch delivery systems and electronic banking.

Federal Home Loan Bank (FHLB) advances (borrowings) and Other Borrowings.

FHLB advances were $123.5 million as of March 31, 2020 and $131.0 million as of December 31, 2019, as we continue to utilize these advances, as necessary, to supplement core deposits to meet our funding and liquidity needs, and as we evaluate all options to manage the Bank’s cost of funds.

FHLB advances were $124.5 million as of June 30, 2020 and $131.0 million as of December 31, 2019, as we continue to utilize these advances, as necessary, to supplement core deposits to meet our funding and liquidity needs, and as we evaluate all options to manage the Bank’s cost of funds.

The Bank has an irrevocable Standby Letter of Credit Master Reimbursement Agreement with the Federal Home Loan Bank.

This irrevocable standby letter of credit (“LOC”) is supported by loan collateral as an alternative to directly pledging investment securities on behalf of a municipal customer as collateral for their interest-bearing deposit balances.

The Bank’s current unused borrowing capacity, supported by loan collateral as of March 31, 2020 is approximately $193.6 million.

The Bank’s current unused borrowing capacity, supported by loan collateral as of June 30, 2020 is approximately $189.2 million.

In the quarter ended June 30, 2020, the Bank’s origination of SBA PPP loans allowed the Bank to gain access to the Federal Reserve Bank Paycheck Protection Program Liquidity Facility (“PPPLF”), whereby the Bank can pledged SBA PPP loans, by day of origination, up to the contractual maturity of the Bank’s SBA PPP loans with no collateral haircut.

The Bank borrowed twice under this facility in the second quarter of 2020.

Due to the strong growth in non-maturity deposits discussed above, the Bank had no outstanding borrowings under this facility at June 30, 2020.

The Bank could borrow $137.3 million under this facility in 2020.

During the first quarter of 2020, the Bank added $12.5 million of 10-year maturity advances that can be called or replaced by the FHLB on a quarterly basis, beginning approximately three months from the initial advance.

At March 31, 2020 and December 31, 2019, the Bank had $55 million and $42.5 million, respectively, of these 10-year, three month callable advances.

At June 30, 2020 and December 31, 2019, the Bank had $55 million and $42.5 million, respectively, of these 10-year, three-month callable advances.

In the first quarter of 2020, the Bank extended overnight advances with $5 million maturing in each quarter of 2023, 2024 and $5 million maturing in the first quarter of 2025.

See Note 6, “Federal Home Loan Bank Advances and Other Borrowings” for more information.

At March 31, 2020, the Bank has pledged $812.4 million of loans to secure the current FHLB outstanding advances, letters of credit and to provide the unused borrowing capacity compared to $792.9 million of loans pledged at December 31, 2019

On June 26, 2019, the Company entered into a credit agreement consisting of a $29.9 million term note and a $5.0 million revolving note.

This term note included the refinancing of $10.1 million in existing debt and matures on June 26, 2031.

This revolving note became effective on August 1, 2019, at which time it replaced the Company’s existing revolving loan arrangement, and it matures on August 1, 2020.

The Revolving Loans and the Note each bear interest at a variable rate based on the U.S.

Prime Rate as published in the Wall Street Journal less 75 basis points, with a floor of 3.5% and are payable in accordance with the terms of the Loan Agreement and the Note, respectively.

The proceeds from the Business Note were used to refinance the existing senior note, pay transaction fees and expenses and for financing the acquisition, by merger, of F&M.

At March 31, 2020 and December 31, 2019, there were no borrowings outstanding on this revolving loan.

At June 30, 2020, the Bank has pledged $816.7 million of loans to secure the current FHLB outstanding advances, letters of credit and to provide the unused borrowing capacity compared to $792.9 million of loans pledged at December 31, 2019.

Stockholders’ Equity.

Total stockholders’ equity decreased to $147.9 million at March 31, 2020 from $150.6 million at December 31, 2019.

In the first quarter of 2020, the Company declared and paid its annual cash dividend to common stockholders which increased by 5% from $0.20 per share in 2019 to $0.21 per share or $2.4 million.

Additionally, during the quarter, the Company purchased 156,000 shares of its common stock at a cost of $1.8 million under the Company’s stock buyback authorization.

On March 20, 2020, the Company announced the Board of Directors has suspended this stock buyback authorization.

As noted in the investment portfolio section earlier, the unrealized loss on the securities available-for-sale portfolio decreased by $1.1 million in the first quarter of 2020.

These decreases to stockholders’ equity were partially offset by $2.6 million in net income.

Book value per share decreased to $13.27 at March 31, 2020, from $13.36 per share at December 31, 2019.

Tangible book value per share (non-GAAP) was $9.80 at March 31, 2020, compared to $9.89 December 31, 2019.

Total stockholders’ equity increased to $152.8 million at June 30, 2020 from $150.6 million at December 31, 2019, largely due to net income of $5.7 million.

This increase was offset by the annual cash dividend paid to common stockholders of $2.4 million during the first quarter of 2020.

Additionally, during the first quarter, the Company repurchased 156,000 shares of its common stock at a cost of $1.8 million under the Company’s stock buyback authorization.

On March 20, 2020, the Company announced the Board of Directors had suspended this stock buyback authorization and on July 27, 2020, the Board of Directors terminated the stock buyback authorization, which was previously scheduled to expire on September 30, 2020.

Book value per share increased to $13.70 at June 30, 2020, from $13.36 per share at December 31, 2019.

Tangible book value per share (non-GAAP) was $10.31 at June 30, 2020, compared to $9.89 December 31, 2019.

Tangible book value (non-GAAP) is calculated as total stockholders’ equity less goodwill and intangible assets divided by common shares outstanding.

As of June 30, 2020 and December 31, 2019, (1) stockholders’ equity was $152.8 million and $150.6 million, respectively, (2) goodwill was $31.5 million for both periods, (3) intangible assets were $6.3 million and $7.6 million, respectively and (4) common shares outstanding were 11,150,695 and 11,266,954, respectively.

Tangible book value per share

is a non-GAAP financial measure that management believes enhances investors’ ability to better understand the Company’s financial position.

Liquidity and Asset / Liability Management .

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We consider our interest-bearing cash and unpledged investment securities to be our sources of on-balance sheet liquidity.

At March 31, 2020, our on-balance sheet liquidity ratio was 12.2%.

At June 30, 2020, our on-balance sheet liquidity ratio was 12.2%.

While scheduled payments from the amortization of loans and maturing short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are influenced by factors partially outside of the Bank’s control, including general interest rates, economic conditions and competition.

Although $240.1 million of our $382.3 million (63%) CD portfolio as of March 31, 2020 will mature within the next 12 months, we have historically retained a majority of our maturing CD’s.

Although $227.5 million of our $350.2 million (65%) CD portfolio as of June 30, 2020 will mature within the next 12 months, we have historically retained a majority of our maturing CD’s.

However, due to strategic pricing decisions regarding rate matching and branch closures, our retention rate may decrease in the future.

3 unchanged sentences

Our borrowing arrangement with the FHLB calls for pledging certain qualified real estate loans and borrowing up to 75% of the value of those loans, not to exceed 35% of the Bank’s total assets.

As of March 31, 2020, we had approximately $193.6 million available under this arrangement, supported by loan collateral, as compared to $203.9 million at December 31, 2019.

As of June 30, 2020, we had approximately $189.2 million available under this arrangement, supported by loan collateral, as compared to $203.9 million at December 31, 2019.

In the quarter ended June 30, 2020, the Bank’s origination of SBA PPP loans allowed the Bank to gain access to the Federal Reserve’s PPPLF facility, whereby the Bank can pledge SBA PPP loans, by day of origination, up to the contractual maturity of the Bank’s SBA PPP loans with no collateral haircut.

The Bank borrowed twice under this facility in the second quarter of 2020.

Due to the strong growth in non-maturity deposits discussed above, the Bank had no outstanding borrowing under this facility at June 30, 2020.

The Bank could borrow $137.3 million under this facility in 2020.

We maintain a line of credit with the Federal Reserve Bank which has a $1.2 million capacity, based on our current pledged collateral position.

5 unchanged sentences

These instruments include unused commitments for lines of credit, overdraft protection lines of credit and home equity lines of credit, as well as commitments to extend credit.

As of March 31, 2020, the Company had $208.2 million in unused commitments, compared to $246.7 million in unused commitments as of December 31, 2019

As of June 30, 2020, the Company had $213.9 million in unused commitments, compared to $246.7 million in unused commitments as of December 31, 2019.

Capital Resources.

As of March 31, 2020, as shown in the table below, our Tier 1 and Risk-based capital levels exceeded levels necessary to be considered “Well Capitalized” under Prompt Corrective Action provisions for both the Bank and at the Company level.

As of June 30, 2020, as shown in the table below, our Tier 1 and Risk-based capital levels exceeded levels necessary to be considered “Well Capitalized” under Prompt Corrective Action provisions for both the Bank and at the Company level.

Below are the amounts and ratios for our capital levels as of the dates noted below for the Bank.

3 unchanged sentences

Action Provisions

As of March 31, 2020 (Unaudited)

As of June 30, 2020 (Unaudited)

Total capital (to risk weighted assets)

7 unchanged sentences

Tier 1 leverage ratio (to adjusted total assets)

At March 31, 2020 , the Bank was categorized as “Well Capitalized” under Prompt Corrective Action Provisions, as determined by the OCC, our primary regulator.

At June 30, 2020 , the Bank was categorized as “Well Capitalized” under Prompt Corrective Action Provisions, as determined by the OCC, our primary regulator.

Below are the amounts and ratios for our capital levels as of the dates noted below for the Company.

3 unchanged sentences

Action Provisions

As of March 31, 2020 (Unaudited)

As of June 30, 2020 (Unaudited)

Total capital (to risk weighted assets)

7 unchanged sentences

Tier 1 leverage ratio (to adjusted total assets)

At March 31, 2020 , the Company was categorized as “Well Capitalized” under Prompt Corrective Action Provisions.

At June 30, 2020 , the Company was categorized as “Well Capitalized” under Prompt Corrective Action Provisions.

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