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Item 7. Management’s Discussion and Analysis

2021-03-08 compared with 2020-03-10 · 443 added, 447 removed, 482 unchanged (65% of the section changed)

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion sets forth management’s discussion and analysis of our results of operations for the year ended December 31, 2019 and the comparable unaudited twelve month period ended December 31, 2018, the three month transition period from October 1, 2018 to December 31, 2018 and the comparable unaudited three-month period ended December 31, 2017, and our financial position as of December 31, 2019 and December 31, 2018 , respectively.

The following discussion sets forth management’s discussion and analysis of our results of operations for the year ended December 31, 2020 and December 31, 2019, and our financial position as of December 31, 2020 and December 31, 2019, respectively.

The MD&A should be read in conjunction with our consolidated financial statements, related notes, the selected financial data and the statistical information presented elsewhere in this Annual Report on Form 10-K for a more complete understanding of the following discussion and analysis.

Unless otherwise noted, years refer to the Company’s fiscal years ended December 31, 2019 and September 30, 2018 .

Historically, our fiscal years ended on September 30.

On September 25, 2018, the Board of Directors of the Company adopted a resolution to change the Company’s fiscal year end from September 30 to December 31.

The transition period began October 1, 2018 and ended December 31, 2018.

In addition, on September 25, 2018, the Board of Directors of the Bank also adopted resolutions to amend the Bank’s bylaws to change the Bank’s fiscal year end from September 30 to December 31, commencing December 31, 2018.

In connection with this change, we previously filed a Transition Report on Form 10-K to report the results of the three month transition period from October 1, 2018 to December 31, 2018.

Unless otherwise noted, years refer to the Company’s fiscal years ended December 31, 2020 and December 31, 2019.

PERFORMANCE SUMMARY

The following is a brief summary of some of the significant factors that affected our operating results for the twelve months ended December 31, 2019 .

These items include the impact of the United Bank and F&M acquisitions, merger charges related to the acquisitions, the sale of the Bank’s only branch in Michigan during the second quarter of 2019 and the impact of higher professional service charges due to the change in our fiscal year end.

In October 2018, we closed on the United Bank acquisition.

As such, the transition period ended December 31, 2018, included approximately two and one half months impact of United Bank performance results offset by the impact of merger charges.

The year ended December 31, 2019 included a full year of United Bank results and significantly lower merger charges.

The following is a brief summary of some of the significant factors that affected our operating results for the twelve months ended December 31, 2020 and 2019.

In 2020, net interest income was favorably impacted by the following:

(1) higher accretion of discounts associated with paydown of purchased credit impaired loans, (2) income realized from the origination of the Small Business Administration Paycheck Protection Program (“SBA PPP”) loans, (3) lower deposit costs due to the lower 2020 interest rate environment, (4) an additional six months of net interest income on the F&M acquisition, partially offset by (5) lower interest income on loans, securities and cash and cash equivalents due to the lower interest rate environment and (6) a partial year of interest expense on the Company’s issuance of subordinated debt in August 2020.

The Company recorded higher provision for loan losses in 2020 largely due to organic loan growth along with qualitative factor increases to reflect uncertainty in current general economic conditions.

In 2020’s lower interest rate environment, the Company realized higher mortgage loans originated for sale, which increased gain on sale and income recorded in loan servicing income from the capitalization of mortgage servicing rights, partially offset by higher mortgage servicing rights impairment and an increase in variable compensation tied to mortgage loan production.

On July 1, 2019, we closed on the F&M acquisition.

3 unchanged sentences

Fiscal 2019 also included $0.4 million of professional fees related to the change in our fiscal year end.

When comparing, year over year results, changes in net interest income, non-interest income and non-interest expense are primarily due to the items discussed above.

When comparing, year over year results, changes in net interest income, provision for loan losses, non-interest income and non-interest expense are primarily due to the items discussed above.

See the remainder of this section for a more thorough discussion.

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of Tomah Inc.

(“F&M”), which enhanced the composition of core community banking loans and increased our market presence in Wisconsin.

(“F&M”), which enhanced the composition of commercial and agricultural loans and increased our market presence in Wisconsin.

In connection with the acquisition, the Company merged F&M with and into the Bank, with the Bank surviving the merger.

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The return on average equity was 8.29% for the twelve months ended December 31, 2020 and 6.59% for the comparable period in 2019.

Management continues to execute its strategy to grow its commercial banking loan portfolios.

In addition, the growth has allowed us to reduce concentrations in certain other loan portfolio segments, primarily those with longer-term fixed rates.

We view our loan portfolio as follows:

the Community Banking loan portfolio reflects management’s strategy to grow its commercial banking business and consumer lending.

The Legacy loan portfolio reflects management’s planned reduction strategy to sell substantially all newly originated fixed rate one to four family residential real estate loans in the secondary market, and the discontinuation of originated and purchased indirect paper loans.

CRITICAL ACCOUNTING ESTIMATES

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

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

The impairment testing process is conducted by assigning net assets and goodwill to the Company’s reporting unit.

An initial qualitative evaluation is made to assess the likelihood of impairment and determine whether further quantitative testing to calculate the fair value is necessary.

When the qualitative evaluation indicates that impairment is more likely than not, quantitative testing is required whereby the fair value of the Company’s reporting unit is calculated and compared to the recorded book value, “step one.” If the calculated fair value of the Company’s reporting unit exceeds its carrying value, goodwill is not considered impaired and “step two” is not considered necessary.

If the carrying value of the company’s reporting unit exceeds its calculated fair value, the impairment test continues (“step two”) by comparing the carrying value of the Company’s reporting unit’s goodwill to the implied fair value of goodwill.

An impairment charge is recognized if the carrying value of goodwill exceeds the implied fair value of goodwill.

In March 2020, the Company determined that a quarterly review of goodwill impairment should be performed, and this review was performed in each quarter of 2020.

These quarterly reviews determined that goodwill was not impaired at any 2020 quarter-end, or as of December 31, 2020.

Fair Value Measurements and Valuation Methodologies.

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Twelve months ended December 31, 2019

Only as limited to the following sub-section of “Management’s Discussion and Analysis of Results of Operations” for the comparative twelve-month periods ended December 31, 2019 and December 31, 2018 (unaudited);

(“2019”) and (“2018”) shall refer to the twelve-month periods ended December 31, 2019 and 2018, respectively.

Net Interest Income.

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Net interest income was $50.3 million for 2020 compared to $43.5 million for 2019.

This increase was largely due to the increase in loan interest income resulting from the United Bank and F&M acquisitions and to a lesser extent, organic growth, partially offset higher deposit expense due to the increase in deposits from the United Bank and F&M acquisitions, and organic growth.

In addition, scheduled loan accretion increased $0.3 million to $0.9 million for 2019 from $0.6 million for 2018.

To fund the F&M acquisition, the Company increased debt resulting in interest expense of $0.3 million in 2019, which offset the benefit of increased scheduled accretion.

Accretion due to the payoffs of purchased credit loans increased to $0.4 million for 2019 from $0.2 million for 2018.

The increase in average balances is largely the reason for the increase in net interest income, due to both a full year of F&M balances and SBA PPP loan origination growth, with originated loan growth muted by acquired loan shrinkage.

The net interest margin for 2020 was 3.40% compared to 3.37% for 2019.

The decrease in net interest margin is due to higher deposit costs, partially offset by higher loan yields.

This increase in the net interest margin percentage was due to the following factors:

(1) increase in accretion of discounts associated with paydown of purchased credit impaired loans;

(2)income realized from the origination of the SBA PPP loans;

(3) lower deposit costs due to the lower 2020 interest rate environment;

(4) an additional six months of net interest income on the F&M acquisition.

These increases were partially offset by:

(1) lower interest income on loans, securities and cash and equivalents due to the lower interest rate environment and (2) a partial year of interest expense on the Company’s issuance of subordinated debt in August 2020.

Accretion on purchased credit impaired loans recognized due to loan payoffs or significant reductions in loan balances was $2.7 million in 2020, which was an increase of $2.3 million from accretion recognized in 2019 or $0.4 million.

In 2020, the SBA PPP program was initiated, and the Bank recognized $2.1 million of accretion of the net origination fees and contractual interest income of $0.973 million.

Remaining deferred SBA PPP fees were approximately $3 million at December 31, 2020.

Interest expense on liabilities decreased $2.6 million in 2020 due to the lower interest rate environment and actions taken by the Bank to reduce interest rates paid.

The Bank has approximately $207 million of certificates of deposit maturing in 2021, at a blended interest cost of approximately 1.38%.

These favorable items were offset by the negative impacts of a lower interest rate environment resulting in lower yields on loans, investments and cash and cash equivalents.

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

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Non-accruing loans average balances are included in the table with the loans carrying a zero yield.

Twelve months ended December 31, 2019

Twelve months ended December 31, 2018

Twelve months ended December 31, 2020 Twelve months ended December 31, 2019

Balance Interest

Expense Average

Balance Interest

Expense Average

Average interest earning assets:

Cash and cash equivalents $ 52,016 $ 162 0.31 % $ 29,948 $ 672 2.24 %

Loans 1,234,732 59,763 4.84 % 1,074,952 54,647 5.08 %

Interest-bearing deposits 3,914 96 2.45 % 5,841 137 2.35 %

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Demand deposits 268,311 1,065 0.40 % 204,296 1,677 0.82 %

Money market 244,632 1,446 0.59 % 182,103 1,988 1.09 %

CD’s 316,264 6,325 2.00 % 352,924 7,114 2.02 %

IRA’s 42,039 729 1.73 % 42,134 744 1.77 %

Total deposits $ 1,045,430 $ 10,000 0.96 % $ 937,305 $ 12,174 1.30 %

6 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% 2019 and the three months ended December 31, 2018 and 24.5% for the nine months ended September 30, 2018.

The FTE adjustment to net interest income included in the rate calculations totaled $120 and $201 for the twelve month periods ended December 31, 2019 and 2018 , respectively.

The average yield on tax exempt securities is computed on a tax equivalent basis using a tax rate of 21% for the twelve months ended December 31, 2020 and 2019.

The FTE adjustment to net interest income included in the rate calculations totaled $1 thousand and $120 thousand for the twelve month periods ended December 31, 2020 and 2019, respectively.

Rate/Volume Analysis.

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2019 Increase (decrease) due to

Volume (1) Rate (1) Total

Interest income:

Cash and cash equivalents $ 354 $ (864) $ (510)

Loans 7,839 (2,723) 5,116

Interest-bearing deposits (47) 6 (41)

6 unchanged sentences

Money market accounts 571 (1,113) (542)

CD’s (734) (55) (789)

IRA’s (2) (13) (15)

Total deposits 345 (2,519) (2,174)

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We recorded provisions for loan losses of $7.8 million for 2020 compared to $3.5 million for 2019.

For 2019, approximately $2.0 million of provision related to growth in the originated loan portfolio, $0.43 million related to net charge-offs in the legacy portfolios and approximately $1.0 million of provision growth was attributed to specific reserves.

In 2018, the provision was approximately $1.75 million primarily related to originated loan growth, and also, due to modest growth in the specific reserve and charge-offs of $0.4 million.

The increase in specific reserves largely relates to the $10.4 million increase in classified assets in the originated loan portfolio.

In 2019, the Bank provided $0.4 million specific reserves that were also charged off in 2019.

The specific reserve increase relates largely to $0.7 million specific reserve attributed to two commercial credits, with the remaining increase in specific reserves related to one- to four-family residential loans and smaller commercial relationships.

Also contributing to higher provision for loan losses was the impact of the remix of the loan portfolio to commercial lending and runoff of one to four residential and indirect loans, which will increase the allowance due to higher provision levels on commercial lending utilized by the Bank.

Management believes that the provision taken for the year ended December 31, 2019 is adequate in view of the present condition of the Bank’s loan portfolio and the sufficiency of collateral supporting non-performing loans.

In 2020, the provision allocated for originated loan growth was approximately $1.2 million compared to approximately $2.0 million for 2019.

In 2020, approximately $1.2 million of provision was related to charge-offs and changes in specific reserves compared to $1.4 million in 2019.

The remaining increase in provision related to qualitative factor increases to reflect uncertainty in current general economic conditions and a modest increase in unallocated ALL.

There was no provision on approximately $5.5 million lines of credit drawn in late December and subsequently repaid on January 4, 2021.

Management believes that the provision taken for the year ended December 31, 2020 and 2019, respectively is adequate in view of the present condition of the Bank’s loan portfolio and the sufficiency of collateral supporting non-performing loans.

We are continually monitoring non-performing loan relationships and will make provisions, as necessary, if the facts and circumstances change.

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The following table reflects the various components of non-interest income for 2020 and 2019, respectively.

Twelve months ended December 31,

Change from prior year

Twelve months ended December 31, Change from prior year

2020 2019 2020 over 2019

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Insurance commission income 475 734 (35.29)%

Gains (losses) on available for sale securities

Gain on sale of branch

Net gains on investment securities 110 271 (59.41)%

Net gain on sale of branch — 2,295 N/M

Net gain on sale of acquired business lines 432 — N/M

Settlement proceeds 131 — N/M

Other 1,205 1,291 (6.66)%

Total non-interest income $ 18,448 $ 14,975 23.19%

N/M means not meaningful

The higher level of non-interest income primarily relates to the impact of twelve months of United Bank and six months of F&M activity in 2019 compared to two and one half months of United Bank activity in 2018.

The increase in gains on sale of loans in 2019 reflects the impact of the merger discussed above, increased mortgage activity from the lower interest rate environment and $0.4 million of gain on sale of government guarantees of certain agricultural loans.

In addition to the merger activity, loan fees and service charges increase also reflected higher commercial customer activity.

Gain (losses) on available for sale securities reflects the municipal bond sale disclosed in more detail in the balance sheet analysis section.

The higher level of non-interest income primarily relates to the full-year impact of F&M on 2020 non-interest income since F&M’s, July 1, 2019 acquisition, unless noted below.

Service charges on deposit accounts decreased $536 thousand due to the impact of higher average balances in retail checking accounts.

Loan servicing income increased largely due to increased capitalized mortgage servicing rights due to higher mortgage loan origination sold volumes.

The increase in gain on sale of loans in 2020 is due to higher mortgage loan origination and sale volumes.

Net gains on investment securities reflects the 2020 sale of higher premium mortgage-backed securities and the 2019 municipal bond sale discussed in more detail in the balance sheet analysis section.

The Company sold the Rochester Hills, Michigan branch in the second quarter of 2019 for a $2.3 million gain, recorded in the gain on sale of branch line item above.

In addition to the merger activity increases in other non-interest income, we recorded the receipt of a one-time payment of approximately $0.2 million on a loan charged-off prior to the Company’s acquisition.

The net gain on sale of acquired business lines reflects the sale of Wells Insurance Agency in June 2020 at a net gain of $252 thousand and the Bank’s acquired wealth management business partner exercising their contractual call, which originated prior to the acquisition, resulting in the sale of the Bank’s right to receive income from the wealth management business.

The Company recognized $131 thousand of non-interest income related to a cash receipt related to a private mortgage-backed security claim.

The cash received represents a supplement to the proceeds received in fiscal 2015 from the 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 2020 and 2019.

Twelve months ended December 31,

% Change From prior year

Twelve months ended December 31, % Change From prior year

2020 2019 2020 over 2019

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Compensation and related benefits $ 22,321 $ 20,325 9.82%

Occupancy 3,915 3,697 5.90%

Office 2,152 2,188 (1.65)%

Data processing 4,375 3,938 11.10%

Amortization of intangible assets 1,622 1,496 8.42%

Amortization of mortgage servicing rights

Mortgage servicing rights expense 3,050 1,108 175.27%

Advertising, marketing and public relations 967 1,214 (20.35)%

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Professional services 1,829 2,457 (25.56)%

(Gains) losses on repossessed assets, net

Gains on repossessed assets, net (259) (125) 107.20%

Other 3,117 6,130 (49.15)%

Total non-interest expense $ 43,673 43673000 $ 42,686 2.31%

Non-interest expense (annualized) / Average assets 2.74 % 3.05 %

Amortization of mortgage servicing rights increase in 2019 from 2018 is due (1) a larger servicing portfolio primarily from the United Bank acquisition and lower interest rates which resulted in recording $0.3 million of MSR impairment which is included in amortization of mortgage servicing rights on the consolidated statement of operations and in the preceding table.

Advertising, marketing and public relations increase in expense in 2019 from 2018, reflects the 2019 Company branding of merged bank operations with two bank conversions in less than six months.

Fiscal 2020 advertising, marketing and public relations expense is expected to decrease to the run rates previously experienced by the Company when including the run rates of the acquired companies.

FDIC premium assessment decreased due to two quarters of FDIC application of the Small Bank Assessment Credits.

The Bank has approximately $0.05 million of remaining potential credits, whose application will be determined by the FDIC.

Professional fees related to merger expenses decreased $0.4 million to $0.5 million for 2019 compared to $0.9 million in 2018.

Other non-interest expense was largely due to an increase in merger expenses of $3.1 million to $3.3 million in 2019 from $0.2 million in 2018.

The higher level of non-interest expense primarily relates to the full-year impact of F&M on 2020 non-interest expense since F&M’s, July 1, 2019 acquisition, unless noted below.

Compensation expense increased in 2020 primarily due to the impact of the F&M acquisition and higher variable mortgage production compensation related to higher mortgage loan origination activity, partially offset by lower compensation from the reduction in Bank personnel throughout 2020.

Data processing increases were due to higher loan balances and larger deposit balances.

Mortgage servicing rights expense increased in 2020 from impairment charges of $1.755 million in 2020 compared to $259 thousand in 2019.

This increase is due to the impact of higher actual and forecasted prepayment rates.

The remaining increase is due to higher amortization based on the current interest rate environment and a modestly larger servicing book.

Advertising, marketing and public relations decreased in 2020 reflecting the Company’s 2019 branding campaign for recently merged bank operations.

Overall decreases were partially offset by higher contributions made to the communities in the Bank’s branch footprint to support community needs, due to increased economic pressures faced in 2020.

The FDIC premium assessment increased in 2020, as 2019 reflected the FDIC application of the Small Bank Assessment Credits.

Professional fees decreased in 2020 largely due to a reduction in merger expenses of $0.5 million.

Other non-interest expense decreased in 2020 due to lower merger and branch closure costs in 2020 of $165 thousand, a decrease of $3.1 million from 2019.

Income Taxes.

Income tax provision was $2.8 million for 2019 compared to $2.0 million for 2018.

Tax expense was favorably impacted by a Department of Treasury ruling in the fourth quarter of 2019 related to the continued non-taxable nature of certain acquired bank owned life insurance.

Income tax provision was $4.6 million in 2020 compared to $2.8 million for 2019.

Tax expense in 2019 was favorably impacted by a Department of Treasury ruling in the fourth quarter of 2019 related to the continued non-taxable nature of certain acquired bank owned life insurance.

This resulted in a $0.3 million reduction in tax expense related to certain United Bank acquired bank owned life insurance contracts due to the elimination of previously established deferred tax liability on these contracts.

In addition, the federal income tax rate was 21% in 2019 compared to 24.5% for 2018 due to the impact of the Tax Cuts and Jobs Act of 2017, enacted on December 22, 2017.

Applying the new accounting guidance for the Tax Act, resulted in additional income tax provision of $0.06 million for the year ended December 31, 2018.

See Note 1, “Nature of Business and Summary of Significant Accounting Policies” and Note 14, “Income Taxes” in the accompanying Notes to Consolidated Financial Statements for a further discussion of income tax accounting, and the impact of the Tax Cuts and Jobs Act of 2017.

Income tax expense recorded in the accompanying Consolidated Statements of Operations involves interpretation and application of certain accounting pronouncements and federal and state tax codes and is, therefore, considered a critical accounting policy.

We undergo examination by various taxing authorities.

Such taxing authorities may require that changes in the amount of tax expense or the amount of the valuation allowance be recognized when their interpretations differ from those of management, based on their judgments about information available to them at the time of their examinations.

Transition period ended December 31, 2018 vs.

three months ended December 31, 2017 (Unaudited)

Net Interest Income.

Net interest income represents the difference between the dollar amount of interest earned on interest bearing assets and the dollar amount of interest paid on interest bearing liabilities.

The interest income and expense of financial institutions are significantly affected by general economic conditions, competition, policies of regulatory authorities and other factors.

Interest rate spread and net interest margin are used to measure and explain changes in net interest income.

Interest rate spread is the difference between the yield on interest earning assets and the rate paid for interest bearing liabilities that fund those assets.

Net interest margin is expressed as the percentage of net interest income to average interest earning assets.

Net interest margin 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.

Net interest income on a tax-equivalent basis was $10,083 for the transition period ended December 31, 2018, compared to $7,580 for the transition period ended December 31, 2017.

Interest income on tax exempt securities is computed on a tax equivalent basis.

The net interest margin for the transition period ended December 31, 2018 was 3.56% compared to 3.42% for the transition period ended December 31, 2017.

The 14 basis point increase includes the favorable impact of payoffs of acquired credit impaired loans of 8 basis points, increased accretion of 2 basis points due to United Bank and the favorable impact of United Bank, partially offset by higher borrowing costs.

Besides the additional net interest income provided from the United Bank acquisition, the Company's net interest margin benefited from $235,000 of interest income realized on the payoff of classified loans.

These classified loans were related to loans acquired in a prior acquisition.

As shown in the rate/volume analysis table below, positive volume changes resulted in a $2,560 increase in net interest income for the transition period ended December 31, 2018.

Average loan volume increases primarily result in the 73 day impact of the United Bank acquisition.

Additionally, commercial real estate and non-real estate loan growth in the current three month period over the prior year three month period, resulted from management's strategy to continue to grow its Community Banking portfolio and allow runoff of its Legacy loan portfolio as discussed previously.

The increase and changes in the composition of interest earning assets resulted in a $2,674 increase in interest income for the transition period ended December 31, 2018, and a $114 increase in interest expense due partially to acquisition of United Bank assets and liabilities.

Rate changes on interest earning assets caused an increase in interest income by $961 and increased interest expense by $1,007, for a net impact of a $46 decrease in net interest income between the transition period ended December 31, 2018 and 2017.

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

The following table shows 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.

Also presented is the weighted average yield on interest earning assets on a tax-equivalent basis, rates paid on interest bearing liabilities and the resultant spread at December 31, 2018 and December 31, 2017.

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

Average interest earning assets were $1,123,040 for the transition period ended December 31, 2018 compared to $879,838 for the quarter ended December 31, 2017.

Average loans outstanding increased to $921,951 for the quarter ended December 31, 2018 from $733,203 for the transition period ended December 31, 2017.

Interest income on loans increased $3,118, of which $2,374 related to the increase in average outstanding balances, combined with an increase in interest income due to higher yields on such loans in the amount of $744.

Average interest bearing liabilities increased $134,126 for the transition period ended December 31, 2018 from their December 31, 2017 levels.

Average interest bearing deposits increased $150,890, or 22.7% to $815,838 for the transition period ended December 31, 2018.

Interest expense on interest bearing deposits increased $225 during the transition period ended December 31, 2018 from the volume and mix changes and increased $704 from the impact of the rate environment, resulting in an aggregate increase of $929 in interest expense on interest bearing deposits.

Three months ended December 31, 2018

Three months ended December 31, 2017

Average interest earning assets:

Cash and cash equivalents

Interest-bearing deposits

Investment securities (1)

Non-marketable equity securities, at cost

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% and 24.5% for the three months ended December 31, 2018 and December 31, 2017, respectively.

The FTE adjustment to net interest income included in the rate calculations totaled $43 and $53 for the three months ended December 31, 2018 and 2017, respectively.

Rate/Volume Analysis.

The following table presents the dollar amount of changes in interest income and interest expense for the components of interest earning assets and interest bearing liabilities that are presented in the preceding table.

For each category of interest earning assets and interest bearing liabilities, information is provided on changes attributable to:

(1) changes in volume, which are changes in the average outstanding balances multiplied by the prior period rate (i.e.

holding the initial rate constant);

and (2) changes in rate, which are changes in average interest rates multiplied by the prior period volume (i.e.

holding the initial balance constant).

Three months ended December 31, 2018 v.

2017 Increase (decrease) due to

Interest income:

Cash and cash equivalents

Interest-bearing deposits

Investment securities

Non-marketable equity securities, at cost

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

the change in interest due to both rate and volume has been allocated in proportion to the relationship to the dollar amounts of the change in each.

Provision for Loan Losses.

We determine our provision for loan losses (“provision”, or “PLL”) based on our desire to provide an adequate allowance for loan losses (“ALL”) to reflect probable and inherent credit losses in our loan portfolio.

We recorded provisions for loan losses of $950 for the transition period ended December 31, 2018 and $100 for the quarter ended December 31, 2017, respectively, largely impacted by reflecting strong organic loan growth charge-offs, and the remix of the loan portfolio discussed earlier.

Commercial lending, under our ALL methodology commercial loans have, has a higher ALLL percentage and therefore higher provision than those association with the runoff Legacy portfolio.

Management believes that the provision taken for the transition period ended December 31, 2018 is adequate in view of the present condition of the Bank's loan portfolio and the sufficiency of collateral supporting non-performing loans.

We are continually monitoring non-performing loan relationships and will make provisions, as necessary, if the facts and circumstances change.

In addition, a decline in the quality of our loan portfolio as a result of general economic conditions, factors affecting particular borrowers or our market areas, or other factors could all affect the adequacy of our ALL.

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 PLL in the future.

See Note 1, “Nature of Business and Summary of Significant Accounting Policies - Allowance for Loan Losses ” of "Notes to Consolidated Financial Statements and Supplementary Data" to this Form 10-K, for further analysis of the provision for loan losses.

Net loan charge-offs for the three months ended December 31, 2018 and 2017 were $94 and $183, respectively.

Net charge-offs to average loans were 0.04% for the transition period ended December 31, 2018 and 0.10% for the transition period ended December 31, 2017.

Non-Interest Income .

The following table reflects the various components of non-interest income for the transition periods ended December 31, 2018 and 2017, respectively.

Three months ended December 31,

% Change from prior year

2017 (unaudited)

2018 over 2017 (unaudited)

Non-interest Income:

Service charges on deposit accounts

Interchange income

Loan servicing income

Gain on sale of mortgage loans

Loan fees and service charges

Insurance commission income

Total non-interest income

N/M means not meaningful

The higher level of non-interest income primarily relates to the United Bank acquisition.

Non-Interest Expense.

The following table reflects the various components of non-interest expense for the transition periods ended December 31, 2018 and 2017, respectively.

Three months ended December 31,

% Change From prior year

2017 (unaudited)

2018 over 2017 (unaudited)

Non-interest Expense:

Compensation and related benefits

Data processing

Amortization of intangible assets

Amortization of mortgage servicing rights

Advertising, marketing and public relations

FDIC premium assessment

Professional services

Losses on repossessed assets, net

Total non-interest expense

Non-interest expense (annualized) / Average assets

N/M means not meaningful

The higher level of non-interest expense primarily relates to the United Bank acquisition and the impact of merger activity.

Merger related expenses incurred this quarter and included in the non-interest expense in the consolidated statement of operations consisted of the following:

(1) $352,000 recorded in compensation and benefits, (2) $580,000 recorded in professional services and (3) $215,000 recorded in other non-interest expense.

Branch closure costs incurred this quarter consisted of $9,000 recorded in professional services and $3,000 recorded in other non-interest expense in the consolidated statement of operations.

Audit and financial reporting expensed, related to our year end change, consisted of $135,000 recorded in professional services in the consolidated statement of operations during the quarter ended December 31,2018.

Professional fees increased over the quarter due to engaging third-party contractors associated with the United Bank acquisition, the F.

Bancorp acquisition, the sale of the Michigan branch office and expenses associated

with changing the fiscal year end to December 31 from September 30.

The Company recognized approximately $490,000 in professional fees related to the United Bank acquisition, approximately $90,000 in professional fees for the F.

Bancorp acquisition, approximately $9,000 in professional fees related to the Michigan branch sale and approximately $135,000 in professional fees associated with changing the fiscal year end.

Income Taxes.

Income tax provision was $561 for the transition period ended December 31, 2018, compared to $883 for the quarter ended December 31, 2017.

Our effective tax rate decreased from 39.7% for the three months ended December 31, 2017 to 30.8% for the three months ended December 31, 2018.

The Tax Cuts and Jobs Act of 2017 ("the Tax Act"), enacted on December 22, 2017, reduced the corporate Federal income tax rate for the Company from 24.5% for the quarter ended December 31, 2017, to 21% for the transition period ended December 31, 2018.

GAAP required the impact of the provisions of the Tax Act be accounted for in the period of enactment.

At December 31, 2017, the Company revalued its net deferred tax assets to account for the future impact of lower corporate taxes.

For the items for which we were able to determine a reasonable estimate, we recorded an increased provisional amount of income tax expense of $275 in December 2017, related to the revaluation of the deferred tax assets to both the revaluation of timing differences and the unrealized loss on securities.

See Income Taxes 2018 compare, to 2017 results of operations for more detail.

The tax rate rose approximately 1% due to the impact of the 2019 sale of municipal securities.

3 unchanged sentences

Total assets increased $117.8 million to $1.65 billion at December 31, 2020 from $1.53 billion at December 31, 2019.

The December 31, 2019 asset growth from December 31, 2018 included the impact of the F&M acquisition of $193.6 million and net organic loan growth of approximately $57 million.

This growth was primarily due to strong deposit growth, which funded the net loan portfolio growth from SBA PPP loans and increase in the Bank’s liquidity position.

Cash and Cash Equivalents.

Cash and cash equivalents increased from $55.8 million at December 31, 2019 to $119.4 million at December 31, 2020.

The increase is largely due to the impact of customer activity, primarily wires received later in the day at year-end.

This increase was due to strong deposit growth, which exceeded loan and security growth.

Investment Securities.

We manage our securities portfolio to provide liquidity, in an effort to improve interest rate risk, enhance income.

Our investment portfolio is comprised of securities available for sale (AFS) and securities held to maturity (HTM) We have not purchased any securities for our HTM portfolio in in the past year and as such, the HTM portfolio balances have decreased.

Securities AFS (recorded at fair value), which represent the majority of our investment portfolio, grew to $180.1 million at December 31, 2019 compared with $146.7 million at December 31, 2018.

The growth in the AFS portfolio was largely due to maintaining on-balance liquidity above the Company’s 10% target.

Part of this growth is due to impact of the F&M acquisition, as noted above, which increased total assets.

Additionally, during the year, we sold the vast majority of our obligations of state and local government agency (municipal) portfolio.

We manage our securities portfolio to provide liquidity, in an effort to improve interest rate risk, and enhance income.

Our investment portfolio is comprised of securities available for sale (AFS) and securities held to maturity (HTM).

Securities AFS (recorded at fair value), which represent the majority of our investment portfolio, decreased to $144.2 million at December 31, 2020 compared with $180.1 million at December 31, 2019.

This decrease was primarily due to the increased principal repayment and runoff in mortgage-backed certificates, along with a $10.7 million sale of higher premium MBS.

Additionally, during 2019, we sold the vast majority of our obligations of state and local government agency (municipal) portfolio.

The proceeds from the sale, along with the growth in available for sale securities balances, were largely reinvested in mortgage-backed securities, corporate debt securities and investments in trust preferred securities, resulting in their respective increases.

The trust preferred securities reprice based on LIBOR plus a spread, and current issuers of these securities are bank holding companies with assets of $50 billion or more.

In 2020, the Bank purchased additional trust preferred securities with similar characteristics as those purchased in 2019.

In 2020, the Bank purchased $45 million of HTM securities, consisting largely of U.S agency mortgage-backed securities which offset the decrease in the AFS portfolio and resulted in a modest growth of the net balance of the AFS and HTM portfolios.

The amortized cost and market values of our investment securities by asset categories as of the dates indicated below were as follows:

Available for sale securities

Available for sale securities Amortized

December 31, 2020

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Corporate debt securities 17,199 17,462

Corporate asset based securities

Corporate asset-backed securities 36,039 35,827

Trust preferred securities 16,297 16,448

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Mortgage-backed securities 70,806 71,331

Agency securities

Corporate debt securities 18,776 18,725

Corporate asset based securities

Corporate asset-backed securities 27,718 26,854

Trust preferred securities 11,167 11,123

Total available for sale securities $ 180,768 $ 180,119

Held to maturity securities

Held to maturity securities Amortized

December 31, 2020

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The amortized cost and fair values of our investment securities by maturity, as of December 31, 2020 were as follows:

Available for sale securities

Available for sale securities Amortized

Cost Estimated

Due in one year or less $ — $ —

5 unchanged sentences

Total available for sale securities $ 142,177 $ 144,233

Held to maturity securities

Held to maturity securities Amortized

Cost Estimated

Due in one year or less $ — $ —

Due after one year through five years 200 200

Due after five years through ten years 400 402

Total securities with contractual maturities 600 602

Mortgage-backed securities 42,951 43,182

1 unchanged sentence

The amortized cost and fair values of our investment securities by maturity, as of December 31, 2019 were as follows:

Available for sale securities

Available for sale securities Amortized

Cost Estimated

Due in one year or less $ 141 $ 141

4 unchanged sentences

Mortgage-backed securities 70,806 71,331

Securities without contractual maturities

Total available for sale securities $ 180,768 $ 180,119

Held to maturity securities

Held to maturity securities Amortized

Cost Estimated

Due in one year or less $ 300 $ 302

Due after one year through five years

Total securities with contractual maturities 300 302

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The following tables show the fair value and gross unrealized losses of securities with unrealized losses, as of the dates indicated below, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position:

Less than 12 Months

12 Months or More

Available for sale securities

Less than 12 Months 12 Months or More Total

Available for sale securities Fair

Value Unrealized

December 31, 2020

government agency obligations $ 7,654 $ 17 $ 6,834 $ 53 $ 14,488 $ 70

Obligations of states and political subdivisions

Mortgage-backed securities

Agency securities

Corporate debt securities 3,447 27 1,418 82 4,865 109

Corporate asset based securities

Corporate asset-backed securities — — 24,310 316 24,310 316

Trust preferred securities 5,612 38 — — 5,612 38

2 unchanged sentences

government agency obligations $ 14,593 $ 156 $ 10,540 $ 191 $ 25,133 $ 347

Obligations of states and political subdivisions

Mortgage-backed securities 22,537 62 5,883 48 28,420 110

Agency securities

Corporate debt securities 7,001 15 1,398 102 8,399 117

Corporate asset based securities

Corporate asset-backed securities 8,683 285 18,171 579 26,854 864

Trust preferred securities 7,420 79 — — 7,420 79

Total available for sale securities $ 60,234 $ 597 $ 35,992 $ 920 $ 96,226 $ 1,517

Less than 12 Months

12 Months or More

Held to maturity securities

Less than 12 Months 12 Months or More Total

Held to maturity securities Fair

Value Unrealized

December 31, 2020

Obligations of states and political subdivisions

Mortgage-backed securities 16,538 34 — — 16,538 34

1 unchanged sentence

December 31, 2019

Obligations of states and political subdivisions

Mortgage-backed securities — — — — — —

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The composition of our investment securities portfolio by credit rating as of the periods indicated below was as follows:

Available for sale securities

December 31, December 31,

Available for sale securities Amortized

Value Amortized

government agency $ 72,502 $ 74,356 $ 122,826 $ 123,136

AAA 11,142 11,088 4,383 4,245

AA 25,037 24,879 23,475 22,749

A 8,713 8,925 18,776 18,725

BBB 24,783 24,985 11,167 11,123

Below investment grade — — — —

Non-rated — — 141 141

Total available for sale securities $ 142,177 $ 144,233 $ 180,768 $ 180,119

Held to maturity securities

December 31, December 31,

Held to maturity securities Amortized

Value Amortized

government agency $ 42,951 $ 43,182 $ 2,551 $ 2,655

AA — — 125 126

A 600 602 — —

Below investment grade — — — —

Non-rated — — 175 176

Total $ 43,551 $ 43,784 $ 2,851 $ 2,957

At December 31, 2020, the Bank has pledged certain of its U.S.

Government Agency securities with a carrying value of $5,990 and mortgage-backed securities with a carrying value of $13,999 as collateral against specific municipal deposits.

Government Agency securities with a carrying value of $0.6 million and mortgage-backed securities with a carrying value of $3.0 million as collateral against specific municipal deposits.

At December 31, 2020, the Bank has pledged certain of its U.S.

Government Agency securities with a carrying value of $1,609 as collateral against a borrowing line of credit with the Federal Reserve Bank.

Government Agency securities with a carrying value of $1.2 million as collateral against a borrowing line of credit with the Federal Reserve Bank of Minneapolis.

However, at December 31, 2020, there were no borrowings outstanding on this Federal Reserve Bank line of credit.

At December 31, 2019 , the Bank also has mortgage backed securities with a carrying value of $696 pledged as collateral to the Federal Home Loan Bank of Des Moines.

Total loans outstanding, net of deferred loan fees and costs, increased to $1.18 billion at December 31, 2019 from $992.6 million at December 31, 2018,

Gross loans increased to $1.19 billion at December 31, 2019 from $999.4 million at December 31, 2018, due to $130.3 million from the F&M acquisition and net organic loan growth of approximately $57 million.

Approximately $12.7 million of the loan growth represented line of credit draws of a single customer taken on December 31, 2019, which were repaid on January 2, 2020.

At December 31, 2019, total gross Community Banking portfolio loans, consisting of commercial, agricultural and consumer loans was $971.3 million or 82% of total gross loans, compared to $717.9 million or 72% of total gross loans at December 31, 2018.

This mix change was primarily due to the impact of the F&M acquisition, and to a lesser extent, the continued mix shift to growing the community banking portfolio and the planned runoff of the legacy loan portfolio.

The legacy portfolio loans, consisting of indirect paper and one-to-four family loans totaled $215.9 million or 18% at December 31, 2019 compared to $281.5 million or 28% at December 31, 2018.

The following table reflects the composition, or mix, of our loan portfolio at December 31, 2019 and the transition period ended December 31, 2018:

December 31, 2019

December 31, 2018

Community Banking Loan Portfolios:

At December 31, 2020, the Bank also has mortgage-backed securities with a carrying value of $0.5 million pledged as collateral to the Federal Home Loan Bank of Des Moines.

During the year ended December 31, 2020, the Bank sold approximately $10.8 million of fixed rate mortgage-backed certificates with a net realized gain of $156 thousand, which is included in net gains on investment securities in the Consolidated Statements of Operations.

During the twelve months ended December 31, 2019, the Bank sold $35.4 million of mortgage-backed securities and obligations of state and political subdivisions with a net realized gain of $142 thousand.

Total loans outstanding, net of deferred loan fees and costs, increased to $1.24 billion at December 31, 2020 from $1.18 billion at December 31, 2019.

Gross loans were increased by the net origination of $123.7 million of SBA PPP loans.

Reductions in the acquired loan portfolio, including purchase credit impaired loans reductions of $20.3 million, exceeded growth in the Bank’s originated loan portfolio.

The reductions in the purchase credit impaired loans also resulted in lower non-performing and substandard loans.

In 2020, approximately $5.5 million of the loan growth was due to draws on lines of credit on December 31, 2020, with the proceeds deposited into the customer’s money market account at the Bank, and withdrawn to repay the lines on January 4, 2021.

The same customers executed similar transactions at the end of 2019, with the dollar amount being approximately $12.7 million.

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

December 31, 2020 December 31, 2019

Amount Percent Amount Percent

Real Estate Loans:

Commercial/agricultural real estate:

3 unchanged sentences

Construction and land development 98,517 8.0 % 86,410 7.3 %

Commercial/Agricultural non-real estate:

Commercial non-real estate

Agricultural non-real estate

Residential real estate:

Residential mortgage:

Residential mortgage 131,386 10.6 % 176,332 15.0 %

Purchased HELOC loans 6,260 0.5 % 8,407 0.7 %

Consumer non-real estate:

Other consumer

Total Community Banking Loan Portfolios

Legacy Loan Portfolios:

Residential real estate:

One to four family

Consumer non-real estate:

Total real estate loans 934,785 75.5 % 957,979 81.3 %

C&I/Agricultural operating and Consumer installment loans:

C&I/Agricultural operating:

Commercial and industrial ("C&I) 116,553 9.4 % 133,734 11.4 %

Agricultural operating 32,785 2.6 % 37,780 3.2 %

Consumer Installment:

Originated indirect paper 25,851 2.1 % 39,585 3.4 %

Purchased indirect paper

Total Legacy Loan Portfolios

Other Consumer 13,213 1.1 % 18,186 1.5 %

Total C&I/Agricultural operating and Consumer installment loans 188,402 15.2 % 229,285 19.5 %

Gross loans before SBA PPP loans 1,123,187 90.7 % 1,187,264 100.8 %

SBA PPP Loans 123,702 10.0 % — — %

Gross loans 1,246,889 100.7 % 1,187,264 100.8 %

Unearned net deferred fees and costs and loans in process (4,245) (0.3) % (393) — %

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Approximately 76% of our total gross loans are secured by real estate.

In September 2017, the Bank purchased, on a non-recourse basis, a 90% participation in $24 million of loans secured by second liens on certain residential real estate properties.

The seller retained servicing of the purchased loans, and is paid a 40bp servicing fee, based on the outstanding balance of the purchased loans.

The balance of the Bank’s share of the purchased loans decreased to $8.4 million at December 31, 2019 a decrease from $12.9 million at December 31, 2018.

The following table sets forth, as of December 31, 2020 and December 31, 2019 respectively the fixed and adjustable-rate loans in our loan portfolio:

December 31, 2019

December 31, 2018

December 31, 2020 December 31, 2019

Amount Percent Amount Percent

Fixed rate loans:

1 unchanged sentence

Commercial/Agricultural real estate $ 347,617 28.1 % $ 397,793 33.8 %

Residential real estate

Residential mortgage 90,105 7.3 % 124,993 10.6 %

Total fixed rate real estate loans 437,722 35.4 % 522,786 44.4 %

Non-real estate loans:

Commercial/Agricultural non-real estate

Consumer non-real estate

C&I/Agricultural Operating 237,062 19.2 % 135,264 11.5 %

Consumer installment 38,998 3.2 % 57,644 4.9 %

Total fixed rate non-real estate loans 276,060 22.3 % 192,908 16.4 %

1 unchanged sentence

Adjustable-rate loans:

Real estate loans:

Commercial/Agricultural real estate 449,523 36.3 % 375,446 31.9 %

Residential real estate

Residential mortgage 47,540 3.8 % 59,747 5.1 %

Total adjustable-rate real estate loans 497,063 40.2 % 435,193 37.0 %

Non-real estate loans:

Commercial/Agricultural non-real estate

Consumer non-real estate

C&I/Agricultural operating 35,978 2.9 % 36,251 3.1 %

Consumer installment 66 — % 126 — %

Total adjustable-rate non-real estate loans 36,044 2.9 % 36,377 3.1 %

Total adjustable-rate loans 533,107 43.1 % 471,570 40.1 %

Gross loans 1,246,889 1,187,264

Unearned net deferred fees and costs and loans in process (4,245) (0.3) % (393) — %

3 unchanged sentences

Total loans receivable, net $ 1,220,538 $ 1,167,060

Loan amounts and their contractual maturities at December 31, 2019 are as follows:

Non-real estate

Commercial/Agricultural real estate

Residential real estate

Commercial/Agricultural non-real estate

Consumer non-real estate

Loan amounts, their contractual maturities and weighted average interest rates at December 31, 2020 are shown below.

SBA PPP loans of $123.7 million at an interest rate of 1% are included in the one year to five-year amounts in the C&I/agricultural operating segment.

Real estate Non-real estate

Commercial/Agricultural real estate Residential mortgage C&I/Agricultural operating Consumer installment Total

Amount Weighted

Rate Amount Weighted

Due in one year or less (1) $ 90,573 4.31 % $ 13,216 4.40 % $ 65,008 3.82 % $ 1,083 8.54 % $ 169,880 4.16 %

1 unchanged sentence

Due after five years 497,549 4.28 % 101,278 4.71 % 39,847 4.31 % 23,461 5.34 % $ 662,135 4.39 %

$ 797,139 4.32 % $ 137,646 4.71 % $ 273,040 2.73 % $ 39,064 5.60 % $ 1,246,889 4.05 %

(1) Includes loans having no stated maturity and overdraft loans.

Loan amounts and their contractual maturities at December 31, 2018 are as follows:

Non-real estate

Commercial/Agricultural real estate

Residential real estate

Commercial/Agricultural non-real estate

Consumer non-real estate

Loan amounts, their contractual maturities and interest rates at December 31, 2019 are as follows:

Real estate Non-real estate

Commercial/Agricultural real estate Residential mortgage C&I/Agricultural operating Consumer installment Total

Amount Weighted

Rate Amount Weighted

Due in one year or less (1) $ 104,682 4.85 % $ 16,601 4.66 % $ 68,139 4.96 % $ 1,828 8.95 % $ 191,250 4.91 %

1 unchanged sentence

Due after five years 402,162 4.84 % 125,229 4.94 % 39,061 4.30 % 36,663 5.35 % $ 603,115 4.84 %

$ 773,239 4.79 % $ 184,739 4.97 % $ 171,515 4.67 % $ 57,771 5.61 % $ 1,187,264 4.78 %

(1) Includes loans having no stated maturity and overdraft loans.

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We currently segregate loans into pools based on common risk characteristics for purposes of determining the ALL.

The additional

segmentation of the portfolio is intended to provide a more effective basis for the determination of qualitative factors affecting our ALL.

The additional segmentation of the portfolio is intended to provide a more effective basis for the determination of qualitative factors affecting

In addition, management continually evaluates our ALL methodology to assess whether modifications in our methodology are appropriate in light of underwriting practices, market conditions, identifiable trends, regulatory pronouncements or other factors.

Changes in the ALL by loan portfolio segment for the periods presented were as follows:

Commercial/Agricultural Real Estate

Commercial/Agricultural Non-real Estate

Residential Real Estate

Consumer Non-real Estate

Commercial/Agricultural Real Estate C&I/Agricultural Operating Residential Mortgage Consumer Installment Unallocated Total

Year ended December 31, 2020:

1 unchanged sentence

Beginning balance, January 1, 2020 $ 6,205 $ 1,643 $ 879 $ 467 $ 357 $ 9,551

Charge-offs — (932) (5) (145) — (1,082)

Recoveries 75 8 7 69 — 159

Provision 3,991 1,393 160 98 549 6,191

Total Allowance on originated loans $ 10,271 $ 2,112 $ 1,041 $ 489 $ 906 $ 14,819

2 unchanged sentences

Beginning balance, January 1, 2020 $ 526 $ 27 $ 163 $ 53 $ — $ 769

Charge-offs — (159) (74) (3) — (236)

Recoveries 77 33 15 7 — 132

Provision 1,081 240 231 7 — 1,559

Total allowance on other acquired loans $ 1,684 $ 141 $ 335 $ 64 $ — $ 2,224

1 unchanged sentence

Ending balance, December 31, 2020 $ 11,955 $ 2,253 $ 1,376 $ 553 $ 906 $ 17,043

Commercial/Agricultural Real Estate

Commercial/Agricultural Non-real Estate

Residential Real Estate

Consumer Non-real Estate

Three months ended December 31, 2018:

Commercial/Agricultural Real Estate C&I/Agricultural operating Residential Mortgage Consumer Installment Unallocated Total

Year ended December 31, 2019:

Allowance for Loan Losses:

Beginning balance, October 1, 2018

Beginning balance, January 1, 2019 $ 4,019 $ 1,258 $ 1,048 $ 641 $ 153 $ 7,119

Charge-offs (355) — (120) (257) — (732)

Recoveries — — — 84 — 84

Provision 2,541 385 (49) (1) 204 3,080

Total Allowance on originated loans $ 6,205 $ 1,643 $ 879 $ 467 $ 357 $ 9,551

1 unchanged sentence

Other acquired loans:

Beginning balance, October 1, 2018

Beginning balance, January 1, 2019 $ 183 $ 32 $ 205 $ 65 $ — $ 485

Charge-offs (26) — (120) (33) — (179)

Recoveries 3 — 5 10 — 18

Provision 366 (5) 73 11 — 445

Total Allowance on other acquired loans $ 526 $ 27 $ 163 $ 53 $ — $ 769

3 unchanged sentences

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 December 31, 2019 , the Company has identified impaired loans of $63.2 million, consisting of $12.6 million TDR loans, the carrying amount of purchased credit impaired loans of $32 million and $18.6 million of substandard non-TDR loans.

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

At December 31, 2018, the Company has identified impaired loans of $47.3

million, consisting of $8.7 million TDR loans, the carrying amount of purchased credit impaired loans of $24.8 million and $13.8 million of substandard non-TDR loans.

At December 31, 2020, the Company had identified impaired loans of $43.4 million, consisting of $18.5 million of TDR loans, the carrying amount of purchased credit impaired loans of $16.9 million and $8.0 million of substandard non-TDR loans.

The $43.4 million total of impaired

loans includes $11.7 million of performing TDR loans.

At December 31, 2019, the Company had identified impaired loans of $63.2 million, consisting of $12.6 million TDR loans, the carrying amount of purchased credit impaired loans of $32 million and $18.6 million of substandard non-TDR loans.

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

At December 31, 2019 , the allowance for loan losses was $10.3 million or 0.88% of our total loan portfolio, compared to $7.6 million, or 0.77% of our total loan portfolio at December 31, 2018.

At December 31, 2020, the allowance for loan losses was $ 17.0 million or 1.38% of total loans compared to $10.3 million or 0.88% of our total loan portfolio at December 31, 2019.

This level was based on our analysis of the loan portfolio risk at each of December 31, 2020 and December 31, 2019, as discussed above.

This ratio is modestly impacted by the percentage of gross acquired loans to gross loans which decreased to 36% at December 31, 2019 compared to 38% at December 31, 2018.

The Bank had $424.7 million in gross loans at December 31, 2019, which were recorded at fair market value at acquisition.

At December 31, 2018, the Bank had $379.6 million in gross loans, which were recorded at fair market value at acquisition.

The Bank increased its commercial and agricultural loan portfolios from last year as part of its strategic plan.

The increased loan volume and introduction of new loan products carries an elevated level of risk as the Bank does not have a long history in these business lines.

However, we believe our current ALL is adequate to cover probable losses in our current loan portfolio.

The increase in the allowance for loan losses was primarily due to the impact the change in Q-Factor related to qualitative factor increases to reflect uncertainty in current general economic conditions.

To a lesser extent, the provision for growth in the originated loan portfolio contributed to the increase in the amount of allowance for loan losses.

The percentage of allowance for loan losses was also helped by a decrease in gross acquired loans.

The percentage of gross acquired loans to gross loans, excluding SBA PPP loans, decreased to 25% at December 31, 2020 compared to 36% at December 31, 2019.

At December 31, 2020, the Bank had $286.2 million in gross acquired loans, which were recorded at fair market value at acquisition.

The Bank had $424.7 million in gross acquired loans at December 31, 2019, which were recorded at fair market value at acquisition.

Allowance for Loan Losses to Loans, net of SBA PPP Loans

2020 September 30,

2020 June 30,

2020 December 31,

Loans, end of period $ 1,237,581 $ 1,230,139 $ 1,281,175 $ 1,177,380

SBA PPP loans, net of deferred fees (120,711) (135,177) (132,800) —

Loans, net of SBA PPP loans and deferred fees $ 1,116,870 $ 1,094,962 $ 1,148,375 $ 1,177,380

Allowance for loan losses $ 17,043 $ 14,836 $ 13,373 $ 10,320

ALL to loans net of SBA PPP loans and deferred fees 1.53 % 1.35 % 1.16 % 0.88 %

ALL to loans, end of period 1.38 % 1.21 % 1.04 % 0.88 %

All of 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.

10 unchanged sentences

The unallocated portion of the ALL is intended to account for imprecision in the estimation process or relevant current information that may not have been considered in the process.

The following table identifies the various components of non-performing assets as of the dates indicated below:

December 31, 2019 and twelve months ended

December 31, 2018 and twelve months ended

September 30, 2018 and twelve months ended

Loans 30-89 days or more past due increased $6.7 million at December 31, 2020 compared to December 31, 2019, largely related to increases in commercial real estate and construction and land development loans 30-59 days delinquent.

Nonaccrual loans decreased from $19.1 million to $10.7 million at December 31, 2020, primarily due to significant decreases in nonaccrual acquired loans, specifically in acquired commercial/agricultural real estate loans.

While agricultural loans make up approximately 8% of the Bank’s loan portfolio, nonaccrual loans secured by agricultural collateral account for 65% or $7.0 million of the Bank’s nonaccrual loans, largely due to loans acquired in bank acquisitions.

We believe our credit and underwriting policies continue to support more effective lending decisions by the Bank, which increases the likelihood of maintaining loan quality going forward.

Refer to the “Risk Management and the Allowance for Loan Losses” section below for more information related to non-performing loans.

For the year ended December 31, 2020, loan charge-offs were $1.318 million compared to $0.911 million for the year ended December 31, 2019, largely due to an increase in commercial and industrial loans.

Certain external factors may result in higher future losses but are not readily determinable at this time, including, but not limited to:

unemployment rates, increased taxes and continuing increased regulatory expectations with respect to ALL levels.

As a result, our analysis may show a need to increase our ALL as a percentage of total loans and nonperforming loans for the near future.

Loans charged-off are subject to periodic review and specific efforts are taken to achieve maximum recovery of principal, accrued interest and related expenses on the loans charged off.

COVID-19 Loan Modifications.

In response to COVID-19, our banking regulator issued an Interagency Statement encouraging financial institutions to work prudently with borrowers who are or may be unable to meet their contractual obligations due to COVID-19.

Additionally, Section 4013 of the CARES Act provides that a qualified loan modification is exempt by law from classification as a TDR as defined by GAAP, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 outbreak declared by the President of the United States under the National Emergencies Act is terminated.

Section 541 of the Consolidated Appropriations Act, 2021 extends this relief to the earlier of January 1, 2022 or 60 days after the national emergency termination date.

The Interagency Statement was subsequently revised in April 2020 to clarify the interaction of the original guidance with Section 4013 of the CARES Act.

In accordance with this guidance, the Bank instituted a plan to offer modifications to impacted borrowers.

The Bank continues to work with borrowers as the pandemic persists and is requiring additional support in exchange for additional modifications beyond the original term.

As of December 31, 2020, the Bank’s COVID-19 related modifications under Section 4013 of the CARES Act, totaled $61 million, or 5% of gross loans versus $126.7 million, or 10% of gross loans at September 30, 2020, and $197.3 million, or 15% of gross loans at June 30, 2020.

At December 31, 2020, hotel industry sector loans represented $51.6 million of the approved deferrals.

The Bank has approximately $2.4 million of total payment deferrals expiring in the first quarter of 2021.

Nonperforming Loans, Potential Problem Loans and Foreclosed Properties.

We employ early identification of non-accrual and problem loans in order to minimize the risk of loss.

Non-performing loans are defined as either 90 days or more past due or non-accrual.

The accrual of interest income is discontinued according to the following schedules:

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

• Commercial and industrial/agricultural operating loans past due 90 days or more;

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

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

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

If collection is in doubt, cash receipts on non-accrual loans are used to reduce principal rather than recorded as interest income.

Restructuring a loan typically involves the granting of some concession to the borrower involving a loan modification, such as modifying the payment schedule or making interest rate changes.

Restructured loans may involve loans that have had a charge-off taken against the loan to reduce the carrying amount of the loan to fair market value as determined pursuant to ASC 310-10.

Restructured loans that comply with the restructured terms are considered performing loans.

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:

December 31, 2020 and twelve months ended December 31, 2019 and twelve months ended

Nonperforming assets:

2 unchanged sentences

Agricultural real estate 5,084 7,568

Commercial non-real estate

Agricultural non-real estate

One to four family

Consumer non-real estate

Commercial and industrial (“C&I”) 357 1,850

Agricultural operating 1,872 1,702

Residential mortgage 2,451 2,063

Consumer installment 156 168

Total nonaccrual loans $ 10,747 $ 19,056

12 unchanged sentences

Commercial/Agricultural real estate — (381)

Commercial/Agricultural non-real estate

Residential real estate

Consumer non-real estate

C&I/Agricultural operating (1,091) —

Residential mortgage (78) (239)

Consumer installment (149) (291)

Total loans charged off (1,318) (911)

1 unchanged sentence

Commercial/Agricultural real estate 150 3

Commercial/Agricultural non-real estate

Residential real estate

Consumer non-real estate

C&I/Agricultural operating 44 1

Residential mortgage 20 5

Consumer installment 77 93

Total recoveries of loans previously charged off:

7 unchanged sentences

NPAs to total assets 0.70 % 1.41 %

Loans 30-89 days or more past due increased $2.3 million at December 31, 2019 compared to December 31, 2018, largely related to increases in commercial and one to four family real estate loans 30-59 days delinquent.

Nonaccrual loans increased from $7.3 million at December 31, 2018 to $19.1 million at December 31, 2019, primarily due to increases in agricultural nonaccrual acquired loans.

While agricultural loans make up approximately 10% of the Bank’s loan portfolio, nonaccrual loans secured by agricultural collateral account for 49% or $9.3 million of the Bank’s nonaccrual loans, largely due to loans acquired in acquisitions.

We believe our credit and underwriting policies continue to support more effective lending decisions by the Bank, which increases the likelihood of maintaining loan quality going forward.

Refer to the “Risk Management and the Allowance for Loan Losses” section below for more information related to non-performing loans.

For the year ended December 31, 2019 , loan charge-offs were $0.911 million, compared to $0.707 million for the year ended September 30, 2018, largely due to an increase in commercial and agricultural real estate loans.

During the transition period ended December 31, 2018, loan charge-offs were $0.122 million.