What changed in this filing

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Item 7. Management’s Discussion and Analysis

2023-03-07 compared with 2022-03-02 · 156 added, 157 removed, 757 unchanged (29% of the section changed)

6 unchanged sentences

In 2022, net interest income was favorably impacted by the following:

(1) income realized from the origination of the Small Business Administration Paycheck Protection Program (“SBA PPP”) loans;

(2) loan growth and related growth in loan interest income;

(3) growth in the investment securities portfolio;

(4) lower deposit costs due to the lower interest rate environment, and partially offset by;

(5) lower accretion of discounts associated with the paydown of purchased credit impaired loans;

and (6) lower interest income on loans and cash and cash equivalents due to the lower interest rate environment.

The Company recorded no provision for loan losses in 2021 largely due to qualitative factor decreases to reflect greater certainty and improvement in current general economic conditions, offsetting the impact of organic loan growth.

In 2021’s higher interest rate and tight housing supply environment, the Company experienced fewer mortgage loans originated for sale, which decreased gain on sale and income recorded in loan servicing income from the capitalization of mortgage servicing rights, partially offset by a reversal of mortgage servicing rights impairment and a decrease in variable compensation tied to mortgage loan production.

(1)growth in the loan portfolio and related growth in loan interest income;

(2) the positive impact of higher interest rates on loan yields on new, renewing and repricing loans, which was more than offset by a reduction in the accretion of the Small Business Administration Paycheck Protection Program (“SBA PPP”) loan fees of $5.9 million;

and (3) growth in the investment securities portfolio.

These positive additions were offset by higher interest expense on subordinated debt due to (a) the issuance of $35 million with a coupon of 4.75%, partially offset by the call and redemption of $15 million of 6.75% subordinated debt issued in 2017 and (b) the impact of higher interest rates on FHLB advances and deposits.

The Company recorded $1.5 million of provision for loan losses in 2022, largely due to loan growth and net charge-offs, partially offset by a reduction in specific reserves.

No provision for loan losses was recorded in 2021 largely due to qualitative factor decreases to reflect greater certainty and improvement in current general economic conditions, offsetting the impact of organic loan growth.

In 2022’s higher interest rate and tight housing supply environment, the Company experienced fewer mortgage loans originated for sale, which decreased gain on sale and income recorded in loan servicing income from the capitalization of mortgage servicing rights.

Non-interest expense increased modestly in 2022, largely due to the cost of closing branches.

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.

20 unchanged sentences

Our determination of the allowance for loan losses is based on (1) specific allowances for specifically identified and evaluated impaired loans and their corresponding estimated loss based on likelihood of default, payment history and net realizable value of underlying collateral.

Specific allocations for collateral dependent loans are based on fair value of the underlying collateral relative to the unpaid principal balance of individually impaired loans.

Specific allocations for collateral dependent loans are based on the fair value of the underlying collateral relative to the unpaid principal balance of individually impaired loans.

For loans that are not collateral dependent, the specific allocation is based on the present value of expected future cash flows discounted at the loan’s original effective interest rate through the repayment period;

15 unchanged sentences

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.

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.

35 unchanged sentences

Net interest income was $56.4 million for 2022 compared to $53.7 million for 2021.

The increase is largely due to an increase in SBA PPP accretion, which increased $4.1 million.

The increase is largely due to the positive loan volume variance due to growth in loans outstanding.

Negative loan rate variances are due to a decrease in SBA PPP accretion of $5.9 million, which was partially offset by the impact of higher interest rates on newly originated, renewed and repricing loans.

The positive rate variance on investment securities was largely due to the repricing of variable rate securities and the impact of new purchases above the portfolio rate.

This positive rate variance was partially offset by higher interest expense on subordinated debt of $35 million issued in March 2022, with a coupon rate of 4.75%.

In August 2022, interest expense was partially reduced by the call and redemption of $15 million of 6.75% subordinated debt issued in 2017.

In addition, the impact of higher interest rates on liability costs reduced net interest income.

The net interest margin for 2022 was 3.39% compared to 3.34% for 2021.

The decrease in the net interest margin percentage was due to the following factors:

1) a decrease in the accretion of discounts associated with the paydown of purchased credit impaired loans;

2) a full year of interest expense on the Company’s issuance of 6% subordinated debt in August 2020;

3) the increase in lower yielding cash and investment securities as a percentage of interest-earning assets;

and 4) lower interest income on loans, securities and cash and cash equivalents due to the lower interest rate environment.These decreases were partially offset by:

1) higher income SBA PPP accretion and 2) lower deposit costs due to a decrease in interest rates in 2020 and the Company’s action to reduce higher costing certificates of deposits.

Accretion on purchased credit impaired loans recognized due to loan payoffs or significant reductions in loan balances was $0.4 million in 2021, which was a decrease of $2.3 million from accretion recognized in 2020 or $2.7 million.

In 2021, the Bank recognized $6.2 million of accretion of net origination fees and contractual interest income of $0.7 million in 2021 and $2.1 million of accretion of net origination fees and contractual interest income of $1.0 million in 2020.

Remaining deferred SBA PPP fees were approximately $0.3 million at December 31, 2021.

Interest expense on liabilities decreased $3.9 million in 2021 due to the lower interest rate environment and actions taken by the Bank to reduce interest rates paid.

The Bank has approximately $179 million of certificates of deposit maturing in 2022, at a weighted average cost of approximately 1.35%.

Of these, $64 million mature in the first quarter of 2022, with a weighted average cost of 1.50%.

$73 million mature in the second quarter of 2022 with a weighted average cost of approximately 1.50%.

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.

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

(1) the impact of higher interest rates on new, maturing, and repricing loans;

(2) the impact of higher interest rates on the variable rate investment portfolio;

and (3) a reduction in the balance of low yielding cash as a percentage of total assets.

These positive impacts were partially offset by:

(1) a decrease in SBA PPP loan accretion income of $5.9 million;

(2) higher interest expense on subordinated debt, due to the issuance of $35 million with a coupon rate of 4.75%, partially offset by the call and redemption of $15 million of 6.75% subordinated debt issued in 2017;

and (3) the impact of higher interest rates on liability costs.

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

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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);

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).

22 unchanged sentences

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

There was no provision for loan losses recorded in 2021 compared to $7.8 million for 2020.

The provision for loan losses recorded in 2022 was $1.5 million compared to no provision for 2021.

In 2022, the provision allocated for originated loan growth was approximately $1.3 million for 2022 and the provision related to charge-offs, reduced by decreases in changes in specific reserves, was approximately $0.2 million.

The remaining provision in 2022 was related to qualitative factor increases to reflect uncertainty in current general economic conditions and a modest increase in unallocated ALL.

In 2021, the impact of growth in the originated loan portfolio and modest charge-offs were offset by a reduction in Q-Factors related to economic qualitative factor decreases to reflect reduced uncertainty in current general economic conditions and a modest reduction in the unallocated reserve.

In 2020, the provision allocated for originated loan growth was approximately $1.2 million for 2020 and provision related to charge-offs and changes in specific reserves was approximately $1.2 million.

The remaining provision in 2020 related to qualitative factor increases to reflect uncertainty in current general economic conditions and a modest increase in unallocated ALL.

Management believes that the provisions for the year ended December 31, 2021 and 2020, are both adequate in view of the present condition of the Bank’s loan portfolio and the sufficiency of collateral supporting non-performing loans.

Management believes that the provisions for the years ended December 31, 2022, and 2021, are both adequate in view of the condition of the Bank’s loan portfolio and the sufficiency of collateral supporting non-performing loans as of the respective year-end dates.

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

12 unchanged sentences

Loan fees and service charges 679 705 (3.69)%

Insurance commission income — 475 N/M

Net gains on investment securities 541 1,224 (55.80)%

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

Settlement proceeds — 131 N/M

Other 936 1,094 (14.44)%

1 unchanged sentence

N/M means not meaningful

Service charges on deposit accounts decreased $106 thousand due to fewer overdrafts attributable to the impact of higher average balances in retail checking accounts.

Interchange income increased due to an increase in our customer spending utilizing debit cards.

Service charges on deposit accounts increased $292 thousand due to an increase in customer spending activity.

Loan servicing income decreased largely due to decreased capitalized mortgage servicing rights as a result of lower mortgage loan origination sold volumes.

The decrease in gain on sale of loans in 2021 is due to lower mortgage loan origination and sale volumes, partially offset by an increase in SBA loans sold.

Net gains on investment securities increased in 2021 due to the $573 thousand net gain on sale of primarily senior debt of large bank holding companies and lower yielding trust preferred securities, which helped fund loan growth and decrease 100% risk weighted AFS securities compared to a $156 thousand gain on sale of high premium mortgage-backed certificates in 2020.

The net gains on investment securities remaining increase was due to the increase in the market value of our investment in Farmer Mac and Bankers’ Bank stock .

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.

The decrease in gain on sale of loans in 2022 is due to fewer mortgage loan originations and lower related sale volumes and a decrease in SBA loans sold.

Net gains on investment securities decreased in 2022 due to no realized gains on sale of AFS securities in 2022, compared to a $573 thousand net gain on sale in 2021.

The sales in 2021 consisted of senior debt of large bank holding companies and lower yielding trust preferred securities.

Both helped fund loan growth and decrease 100% risk weighted AFS securities.

The net gains on investment securities were also impacted by smaller increases in the market value of our investment in Farmer Mac and Bankers’ Bank stock and the recognition of $367 thousand of net unrealized gain on investments recorded at Net Asset Value (“NAV”).

Other income decreased largely due to the cash receipt of $131 thousand in 2021 related to a private mortgage-backed security claim.

This cash receipt 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.

12 unchanged sentences

Gains on repossessed assets, net (395) (199) 98.49%

New market tax credit depletion 650 — N/M

Other 3,552 2,255 57.52%

1 unchanged sentence

Non-interest expense (annualized) / Average assets 2.32 % 2.35 %

Compensation expense increased in 2021 primarily due to an increase in incentives based on performance, such as commercial loan growth origination.

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

Mortgage servicing rights expense, net benefited from the reversal of previously recorded impairment charges of $1.4 million in 2021 compared to impairment charges of $1.8 million in 2020.

This decrease is due to the impact of lower actual and forecasted prepayment rates.

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

Professional fees decreased in 2021 largely due to less utilization of third parties in completing one-time and ongoing projects.

Other non-interest expense decreased in 2021 due to lower origination and branch closure costs in 2020 of $165 thousand.

Compensation expense decreased in 2022 primarily due to lower salaries due to lower headcount and a decrease in incentives based on performance.

Professional fees increased slightly in 2022 largely due to a modest increase in utilization of third parties in completing one-time and ongoing projects.

Gains on repossessed assets increased largely due to the sale of a former branch sold in 2022, partially offset by limited gains on sales of repossessed assets due to foreclosure compared to 2021.

In the first quarter of 2022, the Bank invested $4.1 million in a New Markets Tax Credit (“NMTC”).

Based on current accounting guidance, the related non-tax-deductible asset depletion will occur over a 5-year period in lockstep with the recognition of the tax credit.

The Emerging Issues Task Force of the Financial Accounting Standards Board has issued guidance that, if implemented in its current proposal, would change the depletion expense from equal to the tax credit until the asset is depleted, to being proportional with the NMTC recognized, which is seven years.

Other non-interest expense increased in 2022 primarily due to branch closure costs in 2022 of $1.0 million and $0.3 million of increased origination costs and deposit product costs.

Income Taxes.

Income tax provision was $7.7 million in 2021 compared to $4.6 million for 2020 primarily due to the impact of higher pre-tax income.

The tax rate remained nearly flat at 26.6% in 2021 and 26.4% in 2020.

Income tax provision was $5.8 million in 2022 compared to $7.7 million for 2021 primarily due to the impact of lower pre-tax income and the impact of the new market tax credit purchased in 2022 discussed above.

The 2022 effective tax rate was 24.7% compared to 26.6% in 2021.

This difference is primarily due to the impact of the NMTC.

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.

3 unchanged sentences

Total assets increased $76.8 million to $1.82 billion at December 31, 2022, from $1.74 billion at December 31, 2021.

Strong originated loan growth and net purchases in the Bank’s investment portfolio were funded by strong deposit growth and a reduction in cash and cash equivalents.

Strong originated loan growth was funded by the utilization of excess asset liquidity, resulting in a decrease in cash and cash equivalents, net deposit growth, and the utilization of FHLB advances.

Cash and Cash Equivalents.

Cash and cash equivalents decreased from $47.7 million at December 31, 2021, to $35.4 million at December 31, 2022.

As noted above, this decrease, along with deposit growth, funded loan and investment portfolio growth.

As noted above, this decrease, along with deposit growth and FHLB advances, funded loan portfolio growth.

Investment Securities.

1 unchanged sentence

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, increased to $203.1 million at December 31, 2021, compared with $144.2 million at December 31, 2020.

This increase was primarily due to purchases of $99 million of agency mortgage-backed securities and purchases of debt issued by bank holding companies, largely subordinated debt of $27 million.

Securities AFS (recorded at fair value), which represent the majority of our investment portfolio, decreased to $166.0 million at December 31, 2022, compared with $203.1 million at December 31, 2021.

This decrease is due to the change in unrealized losses of $24.6 million in 2022, along with principal repayments and maturities.

These reductions were partially offset primarily by purchases of bank holding company issued capital instruments, which are classified as corporate debt securities.

In 2021, the sale of trust preferred securities issued by bank holding companies with an amortized cost of $17.4 million and $10.6 million of non-CDFI bank holding company senior debt, reduced the portfolio of these securities to zero.

4 unchanged sentences

These 2021 sales resulted in net realized gains of $573 thousand, which is included in net gains on investment securities in the Consolidated Statements of Operations

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 gain on investment securities in the Consolidated Statement of Operations.

In 2021, the Bank purchased $39 million of HTM securities, consisting largely of U.S.

agency mortgage-backed securities.

This growth was offset by principal repayments.

Securities held to maturity increased to $96.4 million at December 31, 2022, compared to $71.1 million at December 31, 2021.

The increase was largely due to the purchase of agency mortgage-backed securities, net of principal repayments.

The unrealized loss on the held to maturity portfolio increased by $17.6 million during the year to $19.6 million at December 31, 2022.

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

6 unchanged sentences

Corporate asset-backed securities 29,877 28,817

Trust preferred securities — —

Total available for sale securities $ 190,344 $ 165,991

5 unchanged sentences

Corporate asset-backed securities 33,902 33,908

Trust preferred securities 16,297 16,448

Total available for sale securities $ 202,846 $ 203,068

20 unchanged sentences

Cost Estimated

Due in one year or less $ — $ —

Due after one year through five years $ 450 $ 415

15 unchanged sentences

Cost Estimated

Due in one year or less $ — $ —

Due after one year through five years $ 4,300 $ 4,298

11 unchanged sentences

government agency obligations $ 3,169 $ 138 $ 1,138 $ 95 $ 4,307 $ 233

Mortgage-backed securities 9,654 896 68,907 17,952 78,561 18,848

Corporate debt securities 21,547 1,688 18,704 2,697 40,251 4,385

Corporate asset-backed securities 7,955 221 20,862 839 28,817 1,060

Trust preferred securities — — — — — —

Total available for sale securities $ 42,325 $ 2,943 $ 109,611 $ 21,583 $ 151,936 $ 24,526

1 unchanged sentence

government agency obligations $ 1,169 $ 1 $ — $ — $ 1,169 $ 1

Mortgage-backed securities 89,010 878 — — 89,010 878

Corporate debt securities 17,240 142 735 15 17,975 157

Corporate asset-backed securities 19,296 127 — — 19,296 127

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

Total available for sale securities $ 126,715 $ 1,148 $ 735 $ 15 $ 127,450 $ 1,163

9 unchanged sentences

December 31, 2021

Obligations of states and political subdivisions $ 593 $ 7 $ — $ — $ 593 $ 7

Mortgage-backed securities 46,969 1,346 14,716 715 61,685 2,061

23 unchanged sentences

Total $ 96,379 $ 76,779 $ 71,141 $ 69,177

At December 31, 2021, the Bank has pledged certain of its U.S.

At December 31, 2022, the Bank pledged certain of its mortgage-backed securities with a carrying value of $5.4 million as collateral to secure a line of credit with the Federal Reserve Bank.

As of December 31, 2022, there were no borrowings outstanding on this Federal Reserve Bank line of credit.

As of December 31, 2022, the Bank has pledged certain of its U.S.

Government Agency securities with a carrying value of $2.6 million and mortgage-backed securities with a carrying value of $2.2 million as collateral against specific municipal deposits.

At December 31, 2021, the Bank has pledged certain of its U.S.

Government Agency securities with a carrying value of $0.9 million as collateral against a borrowing line of credit with the Federal Reserve Bank of Minneapolis.

However, at December 31, 2021, there were no borrowings outstanding on this Federal Reserve Bank line of credit.

At December 31, 2021, the Bank also has mortgage-backed securities with a carrying value of $0.3 million pledged as collateral to the Federal Home Loan Bank of Des Moines.

As of December 31, 2022, the Bank also has mortgage-backed securities with a carrying value of $0.1 million pledged as collateral to the Federal Home Loan Bank of Des Moines.

At December 31, 2021, the Bank has pledged certain of its mortgage-backed securities with a carrying value of $0.9 million as collateral to secure a line of credit with the Federal Reserve Bank.

As of December 31, 2021, there were no borrowings outstanding on this Federal Reserve Bank line of credit.

As of December 31, 2021, the Bank has pledged certain of its U.S.

Government Agency securities with a carrying value of $3.9 million and mortgage-backed securities with a carrying value of $2.9 million as collateral against specific municipal deposits.

As of December 31, 2021, the Bank also has mortgage-backed securities with a carrying value of $0.3 million pledged as collateral to the Federal Home Loan Bank of Des Moines.

Total loans outstanding, net of deferred loan fees and costs, increased to $1.41 billion at December 31, 2022, from $1.31 billion at December 31, 2021.

Gross loan growth consisted largely of $191 million in commercial real estate loans and, $56 million of multi-family real estate loans.

The portfolio shrinkage in construction and development was largely offset by agricultural and commercial and industrial growth.

We also experienced net forgiveness of $115 million of SBA PPP loans.

The planned runoff of the residential mortgage portfolio of $43 million and indirect loans of $10 million contributed to reduced growth in the loan portfolio.

Gross loan growth consisted largely of $27.5 million in commercial real estate loans, $30.6 million of multi-family real estate loans, $23.0 of construction and land development loans, and $13.8 million of commercial and industrial loan growth.

In addition, the growth in residential mortgage and agricultural real estate portfolios of $23.8 million exceeded the reduction in the remaining loan portfolios of $19.6 million.

Included in the shrink numbers above is 100% of the of SBA PPP loans of $8.8 million at December 31, 2021.

The following table reflects the composition, or mix, of our loan portfolio at December 31, 2022 and December 31, 2021:

61 unchanged sentences

Loan amounts, their contractual maturities and weighted average interest rates at December 31, 2022 are shown below.

SBA PPP loans at an interest rate of 1% are included in the C&I/agricultural operating segment amounts as follows:

(1) $2.1 million is included in the one year or less amounts and (2) $6.7 million is included in the one year to five-year amounts.

Real estate Non-real estate

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

Loan amounts, their contractual maturities and 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.

Loan amounts, their contractual maturities and weighted average interest rates at December 31, 2021, are shown below.

SBA PPP loans at an interest rate of 1% are included in the C&I/agricultural operating segment amounts as follows:

(1) $2.1 million is included in the one year or less amounts and (2) $6.7 million is included in the one year to five-year amounts.

Real estate Non-real estate

18 unchanged sentences

SBA PPP loans, December 31, 2021 2,128 4 6,627 293 8,755 297

2021 SBA PPP loan originations — — 55,854 3,494 55,854 3,494

2022 SBA PPP loan forgiveness and fee accretion (2,128) (4) (6,627) (293) (8,755) (297)

53 unchanged sentences

The $26.8 million total of loans individually evaluated for impairment includes $5.2 million of performing TDR loans.

At December 31, 2020, the Company had evaluated loans for impairment with a recorded investment of $42.3 million, consisting of $17.9 million of PCI loans with a carrying amount of $16.9 million, $15.6 million TDR loans, net of TDR PCI loans and $9.8 million of substandard non-TDR, non-PCI loans.

At December 31, 2021, the Company had evaluated loans for impairment with a recorded investment of $31.7 million, consisting of $11.2 million PCI loans, with a carrying amount of $10.6 million, $9.9 million of TDR loans, net of TDR PCI loans and $11.3 million of substandard non-TDR non-PCI loans.

The $31.7 million total of loans individually evaluated for impairment includes $8.0 million of performing TDR loans.

1 unchanged sentence

This level was based on our analysis of the loan portfolio risk at each of December 31, 2022, and December 31, 2021, as discussed above.

The decrease in allowance dollars is due to modest net charge-offs in 2021.

The slight decrease in the allowance for loan losses to total loan portfolio percentage was primarily due to the impact of growth in the originated loan portfolio, largely offset by a reduction in Q-Factors related to economic qualitative factor decreases to reflect reduced uncertainty in current general economic conditions.

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 15% at December 31, 2021, compared to 25% at December 31, 2020.

At December 31, 2021, the Bank had $198.6 million in gross acquired loans, which were recorded at fair market value at acquisition.

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

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

4 unchanged sentences

Allowance for loan losses $ 17,939 $ 16,913

ALL to loans net of SBA PPP loans and deferred fees 1.30 % 1.53 %

ALL to loans, end of period 1.27 % 1.29 %

11 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.

Loans 30-89 days or more past due decreased $16.7 million at December 31, 2021, compared to December 31, 2020, largely related to decreases in commercial real estate and construction and land development loans 30-59 days delinquent.

Nonaccrual loans increased modestly to $11.7 million at December 31, 2021, from $10.7 million at December 31, 2020, primarily due to an increase in commercial real estate due to a $4.5 million loan.

Nonaccrual loans related to acquisitions decreased to $5.2 million at December 31, from $7.3 million at December 31, 2020.

Accruing loans 30-89 days or more past due increased $7.5 million at December 31, 2022, compared to December 31, 2021, largely related to increases in agricultural real estate and construction and land development loans 30-59 days delinquent.

Nonaccrual loans decreased modestly to $11.2 million at December 31, 2022, from $11.7 million at December 31, 2021.

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, 2021, loan charge-offs were $0.339 million compared to $1.318 million for the year ended December 31, 2020, largely due to a decrease in commercial and industrial loans.

For the year ended December 31, 2022, net loan charge-offs were $0.449 million compared to $0.130 million for the year ended December 31, 2021.

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

3 unchanged sentences

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.

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 President of the United States has announced that the national emergency declaration will end on May 11, 2023.

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

1 unchanged sentence

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, 2021, the Bank’s COVID-19 related modifications under Section 4013 of the CARES Act, totaled $6.6 million, or 0.5% of gross loans versus $61 million, or 5.0% of gross loans at December 31, 2020.

At December 31, 2021, hotel industry sector loans represented $6.0 million of the approved deferrals, compared to $51.6 million at December 31, 2020.

The Bank has approximately $6.0 million of total payment deferrals expiring in the first quarter of 2022.

As of December 31, 2022, the Bank has $0.1 million of remaining residential mortgage COVID-19 related modifications under Section 4013 of the CARES Act.

previously deferred commercial loans have exited deferral status.

At December 31, 2021, COVID-19 related modifications under Section 4013 of the CARES Act totaled $6.6 million, or 0.5% of gross loans.

Nonperforming Loans, Potential Problem Loans and Foreclosed Properties.

80 unchanged sentences

Our non-performing assets were $12.7 million, or 0.70% of total assets, at December 31, 2022, compared to $13.2 million, or 0.76% of total assets, at December 31, 2021.

The increase was largely due to an increase in originated nonaccrual loans and the transfer of $1.4 million of a former branch asset to OREO, partially offset by a decrease in acquired nonaccrual loans.

The decrease was largely due to a decrease in acquired nonaccrual loans and sale of a former branch asset transferred to OREO in 2021, partially offset by an increase in acquired nonaccrual loans and the transfer to OREO of two former branch assets in 2022.

Nonaccrual Loans Roll Forward

5 unchanged sentences

Return to accrual status (168) (1,017)

Repurchase of government guaranteed loans 517

Payments received (4,140) (4,271)

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The table below shows the totals of accruing troubled debt restructurings as of December 31, 2022, and December 31, 2021.

The 2021 decrease in troubled debt restructurings in dollars was largely due to one C&I loan of $3.0 million that paid in full in 2021.

The decrease in troubled debt restructurings from 2021 to 2022 in dollars was largely due to one commercial real estate loan of $3.5 million that paid in full in 2022.

Troubled Debt Restructurings in Accrual Status

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The table below shows the totals of special mention, substandard and the total of these, known as criticized loans as of December 31, 2022, and 2021.

The decrease in criticized loans in 2021 was largely due to decreases in acquired substandard loans and a reduction in originated accruing TDR loans, nonperforming and other substandard loans.

The increase in criticized loans in 2022 was largely due to the addition of two loans in the second quarter of 2022.

One was a commercial real estate loan secured by a hotel, and the other was a fully secured C&I working capital loan.

This increase was partially offset by a reduction in originated accruing TDR loans, nonperforming and other substandard loans.

December 31, 2022 December 31, 2021

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Criticized loans, end of period $ 29,489 $ 27,353

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

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

This transferred non-accretable difference to accretable discount is accreted over the remaining maturity of the loan or until payoff, whichever is shorter.

Non-accretable difference:

December 31, 2021 December 31, 2020

Non-accretable difference, beginning of period $ 1,087 $ 6,290

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

Non-accretable difference realized as interest from payoffs of purchased credit impaired loans (105) (1,693)

Transfers from non-accretable difference to accretable discount.

(329) (2,754)

Non-accretable difference used to reduce loan principal balance — (505)

Non-accretable difference transferred to OREO due to loan foreclosure — (251)

Non-accretable difference, end of period $ 653 $ 1,087

Accretable difference:

The table below shows scheduled accretion by year for the accretable difference recognized due to fair value purchase accounting on recent whole bank acquisitions.

In addition, the Company has $1.61 million of accretable discount from purchased impaired loans with the original non-accretable discount transferred to accretable discount.

The scheduled accretion on this balance is estimated to be $100 per year;

In addition, the table below shows $1.16 million of accretable discount from purchased impaired loans with the original non-accretable discount transferred to accretable discount.

The accretion on this balance is scheduled to be approximately $80 in 2023;

however, large balance payoffs, as seen in 2022, 2021 and 2020, would accelerate this accretion.

Fiscal years ending December 31, Purchase Accounting Accretable Discount

Thereafter 751

Total $ 1,670

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 increased to $4.3 million at December 31, 2021, from $3.3 million at December 31, 2020.

This increase was primarily due to $1.4 million of impairment reversal recorded in 2021 on the MSR impairment which reduced the impairment to $0.6 million at December 31, 2021.

The fair market value of the Company’s MSR asset increased to $5.7 million at December 31, 2022, compared to $4.3 million at December 31, 2021.

Impairment reversals of $0.6 million were recorded in 2022 on the MSR impairment which reduced the impairment to zero at December 31, 2022.

This was partially offset by a reduction in the gross MSR balance of $0.5 million, which was due to amortization of $0.8 million and additions from originations of $0.3 million.

The unpaid balances of one- to four-family residential real estate loans serviced for others as of December 31, 2021, and December 31, 2020, were $556.1 million and $553.7 million, respectively.

In 2021, amortization was $1.6 million and additions from originations were $1.1 million for a reduction in the gross asset of $0.5 million The unpaid balances of one- to four-family residential real estate loans serviced for others as of December 31, 2022, and December 31, 2021, were $523.7 million and $556.1 million, respectively.

The fair market value of the Company’s MSR asset as a percentage of its servicing portfolio at December 31, 2022, and December 31, 2021 was 1.08% and 0.78%, respectively.

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Foreclosed and repossessed assets.

Included in foreclosed and repossessed assets, net is a closed branch location that is being held for sale.

The excess property was created when the Bank constructed a new, smaller facility on a portion of the site that better supports the Bank’s needs.

The property is being held at $1,360, which was its carrying value prior to its reclassification as held for sale, as the bank has a signed purchase agreement from a non-financial institution in excess of its carrying value.

As such, no gain or loss was recognized on the reclassification.

The Bank expects to complete the sale in the first half of 2022.

Included in foreclosed and repossessed assets, net are two closed branch locations that are being held for sale.

These properties are being held at $1,041 and $130, respectively, which represent their estimated fair market values less the cost to sell.

In 2022, a loss of $666 was recognized on the reclassification of these properties from fixed assets to foreclosed assets.

The bank closed on the sale of the property valued at $130 in January 2023 to a non-financial institution at the carrying value.

Deposits are our largest source of funds.

Total deposits increased to $1.42 billion at December 31, 2022, from $1.39 billion at December 31, 2021.

The increase in deposits, largely attributable to the growth in non-maturity deposits, allowed the Company to reduce reliance on higher cost certificates of deposit.

This non-maturity deposit growth was partially offset by a $110.2 million reduction of retail certificates of deposits, as the Company chose not to match higher rates offered by local retail certificate of deposit competitors.

Brokered and institutional deposits decreased to $0.0 million at December 31, 2021, from $2.5 million at December 31, 2020.

The Bank believes these markets are available to the Bank if the need arises.

The increase in deposits was largely due to the addition of $39.8 million of broker certificates in the third and fourth quarter.

Based on current market conditions, the brokered CD markets are available to the Bank for supplemental additions.

Growth in non-interest bearing demand deposits and money market accounts was partially offset by a $25.0 million reduction in interest bearing demand deposits as customers sought higher yields and a reduction in CD’s of $17.5 million before the impact of brokered CD additions.

The following is a summary of deposits by type at December 31, 2022 and December 31, 2021, respectively:

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A summary of Federal Home Loan Bank (FHLB) advances and other borrowings at December 31, 2022 and December 31, 2021 is as follows:

Stated Maturity Amount Range of Stated Rates Amount Range of Stated Rates

December 31, 2022 December 31, 2021

Stated Maturity Amount Range of Stated Rates Stated Maturity Amount Range of Stated Rates

Federal Home Loan Bank advances (1), (2), (3), (4) 2022 $ — — % — % 2022 $ 11,000 2.45 % 2.45 %

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2030 — — % — % 2030 12,500 0.52 % 0.86 %

2030 12,500 0.52 % 0.86 % 12,500 0.52 % 0.86 %

Subtotal 142,530 111,530

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2032 35,000 4.75 % 4.75 % 2032 — — % — %

$ 50,000 $ 30,000

Unamortized debt issuance costs (841) (430)

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(3) The weighted-average interest rates on FHLB borrowings, with maturities less than twelve months, outstanding as of December 31, 2022 and December 31, 2021 were 4.09% and 2.45%, respectively.

(4) FHLB term notes totaling $55,000, with various maturity dates in 2029 and 2030, can be called or replaced by the FHLB on a quarterly basis.

(4) At December 31, 2022, no FHLB term notes can be called by the FHLB.

At December 31, 2021, FHLB term notes totaling $55,000 could be called by the FHLB on a quarterly basis, and if not called, would mature at various dates in 2029 and 2030.

These notes were called by the FHLB in 2022.

(5) Senior notes, entered into by the Company in June 2019 consist of the following:

(a) A term note which was subsequently refinanced in October 2020 and modified in 2021, requiring quarterly interest-only payments through June 2022, and quarterly principal and interest payments thereafter.

Interest is variable, based on US Prime rate with a floor rate of 3.00%, due to the modification in October 2021.

(a) A term note, which was subsequently refinanced in March 2022, requiring quarterly interest-only payments through March 2025, and quarterly principal and interest payments thereafter.

Interest is variable, based on US Prime rate minus 75 basis points with a floor rate of 3.00%.

(b) A $5,000 line of credit, maturing in August 2023, that remains undrawn upon.

(6) Subordinated notes resulted from the following:

(a) The Company’s private sale in August 2017, which bears a fixed interest rate of 6.75% for five years.

In August 2022, they convert to a three-month LIBOR plus 4.90% rate, and the interest rate will reset quarterly thereafter.

The note is callable by the Bank when, and anytime after, the floating rate is initially set.

Interest-only payments are due quarterly.

(a) The Company’s private sale in August 2017, which bore a fixed interest rate of 6.75% for five years.

In August 2022, they converted to a three-month LIBOR plus 4.90% rate, and the interest rate will reset quarterly thereafter.

callable by the Bank when, and anytime after, the floating rate is initially set.

Interest-only payments were due quarterly.

The Company sent the required redemption notice to the note holders in June 2022, and this subordinated note was called and repaid in full on August 10, 2022.

(b) The Company’s Subordinated Note Purchase Agreement entered into with certain purchasers in August 2020, which bears a fixed interest rate of 6.00% for five years.

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Interest-only payments are due semi-annually each year during the fixed interest period and quarterly during the floating interest period.

(c) The Company’s Subordinated Note Purchase Agreement entered into with certain purchasers in March 2022, which bears a fixed interest rate of 4.75% for five years.

In April 2027, the fixed interest rate will be reset quarterly to equal the three-month term Secured Overnight Financing Rate plus 329 basis points.

The note is callable by the Bank when, and anytime after, the floating rate is initially set.

Interest-only payments are due semi-annually each year during the fixed interest period and quarterly during the floating interest period.

Federal Home Loan Bank (FHLB) advances and other borrowings

We utilize advances and other borrowings, as necessary, to supplement core deposits to meet our funding and liquidity needs and we evaluate all options for funding securities.

FHLB advances decreased to $111.5 million at December 31, 2021, from $123.5 million at December 31, 2020.

An $11 million advance matures in 2022, with additional fixed-rate advances of $45.5 million maturing in 2023 through 2025.

There are $55 million of advances with a stated maturity in 2029 and 2030, that are callable quarterly by the Federal Home Loan Bank.

In the first quarter of 2021, the Bank terminated $8 million of advances at a pre-tax cost of approximately $100 thousand.

FHLB advances increased $31.0 million to $142.5 million as of December 31, 2022, compared to $111.5 million as of December 31, 2021.

The Bank terminated $15.0 million of advances in the quarter ended March 31, 2022, incurring a $0.002 million prepayment penalty, as we modestly reduced excess liquidity.

$27.5 million of FHLB advances were called by the FHLB in each of the quarters ended June 30, 2022, and September 30, 2022.

The Bank added a $5 million advance maturing in the second quarter of 2023.

The Bank had $12 million of FHLB advances maturing overnight as of December 31, 2022, and an additional $95.0 million maturing in January of 2023.

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 December 31, 2022, is approximately $256.8 million.

The Bank maintains three unsecured federal funds purchased lines of credit with its banking partners which total $75.0 million.

These lines bear interest at the lender bank’s announced daily federal funds rate, mature daily and are revocable at the discretion of the lending institution.

There were no borrowings outstanding on these lines of credit as of December 31, 2022, or December 31, 2021.

At December 31, 2022 and 2021, the Bank had the ability to borrow $4.1 million and $0.8 from the Federal Reserve Bank of Minneapolis.

The ability to borrow is based on mortgage-backed securities pledged with a carrying value of $5.4 million and $0.9 million as of December 31, 2022 and 2021, respectively.

There were no Federal Reserve borrowings outstanding as of December 31, 2022 and 2021.

Stockholders’ Equity.

Total stockholders’ equity was $167.1 million at December 30, 2022, compared to $170.9 million at December 31, 2021.

The increase in stockholders’ equity was due to the Company’s net income of $21.3 million and restricted stock amortization of $0.8 million.

This increase was partially offset by 1) the repurchase of approximately 620 thousand shares of its common stock, which reduced equity by $8.0 million;

2) the payment of the annual cash dividend, paid in February 2021, to common stockholders of $0.23 per share or $2.5 million;

and 3) a decrease in the unrealized gain on available for sale securities of $1.3 million.

The increases in stockholders’ equity included the Company’s net income of $17.8 million and restricted stock amortization of $0.9 million.

These increases were more than offset by:

(1) the repurchase of approximately 129 thousand shares of its common stock, which reduced equity by $1.8 million;

(2) the payment of the annual cash dividend, paid in February 2022, to common stockholders at $0.26 per share or $2.7 million;

and (3) an increase in the unrealized loss on available for sale securities of $17.8 million.

In November 2020, the Board of Directors authorized a 5% or 557 thousand share repurchase program.

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The Company is authorized to repurchase an additional 243 thousand shares under this July 2021 share repurchase program.

On August 16, 2022, the Inflation Reduction Act was signed into law, which includes a 1% excise tax on stock repurchases.

We do not expect the 1% excise tax on stock repurchases under the Inflation Reduction Act will have a material impact to our financial statements for the fiscal years after December 31, 2022.

Liquidity and Asset / Liability Management.

Liquidity management refers to our ability to ensure cash is available in a timely manner to meet loan demand, depositors’ needs, and meet other financial obligations as they become due without undue cost, risk or disruption to normal operating activities.

cost, risk, or disruption to normal operating activities.

We manage and monitor our short-term and long-term liquidity positions and needs through a regular review of maturity profiles, funding sources, and loan and deposit forecasts to minimize funding risk.

A key metric we monitor is our liquidity ratio, calculated as cash and investments with maturities less than one-year divided by deposits with maturities less than or equal to one-year.

At December 31, 2021, our liquidity ratio increased to 17.0% percent from 16.5% at December 31, 2020.

This was largely due to the growth in AFS and HTM securities portfolio, which was mostly offset by a reduction in interest-bearing cash.

Our primary sources of funds are deposits;

amortization, prepayments and maturities of outstanding loans;

other short-term investments;

and funds provided from operations.

A key metric we monitor is our liquidity ratio, calculated as cash and securities portfolio divided by total assets.

At December 31, 2022, our liquidity ratio decreased to 13.0% percent from 17.0% at December 31, 2021.

This was largely due to a reduction in interest-bearing cash.

Our primary sources of funds are deposits, amortization, prepayments and maturities on the investment and loan portfolios and funds provided from operations.

We use our sources of funds primarily to meet ongoing commitments, to pay maturing certificates of deposit and savings withdrawals, and to fund loan commitments.

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Currently, we have approximately $256.8 million available to borrow under this arrangement, supported by loan collateral as of December 31, 2022.

At December 31, 2021, the Bank had no borrowing capacity under the Federal Reserve SAB PPP Liquidity Facility, as the program expired on July 30, 2021.

We also maintain lines of credit of $0.9 million with the Federal Reserve Bank and $25 million of uncommitted federal funds purchased lines

with correspondent banks as part of our contingency funding plan.

At December 31, 2021, the Bank had no borrowing capacity under the Federal Reserve SBA PPP Liquidity Facility, as the program expired on July 30, 2021.

We also had borrowing capacity of $4.1 million at the Federal Reserve Bank and $75 million of uncommitted federal funds purchased lines with correspondent banks as part of our contingency funding plan.

In addition, the Company maintains a $5.0 million revolving line of credit which is available as needed for general liquidity purposes.

While the Bank does not have formal brokered certificate lines of credit with counter parties at December 31, 2021, we believe that the Bank could access this market, which provides an additional potential source of liquidity.

While the Bank does not have formal brokered certificate lines of credit with counter parties at December 31, 2022, we believe that the Bank could access this market, which provides an additional potential source of liquidity as evidenced by third and fourth quarter 2022 new brokered deposits.

See Note 9, “Federal Home Loan Bank and Other Borrowings” of “Notes to Consolidated Financial Statements” which are included in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K, for further detail.

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As of December 31, 2022, the Company had approximately $243.0 million in unused loan commitments, compared to approximately $271.0 million in unused commitments as of December 31, 2021.

In addition, there are $5.0 million in contribution of capital for SBIC and an investment company at December 31, 2021, with no such commitments at December 31, 2020.

In addition, there are $4.7 million of commitments for contributions of capital to an SBIC and an investment company at December 31, 2022.

These commitments totaled $5.0 million at December 31, 2021.

See Note 11, “Commitments and Contingencies”;

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Income before income tax expense 6,212 5,777 5,277 6,315

Provision (benefit) for income tax 1,945 1,720 1,819 2,209

Provision for income tax 1,506 1,411 1,284 1,619

Net income $ 4,706 $ 4,366 $ 3,993 $ 4,696

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Income before income tax expense 7,451 6,426 6,816 8,266

Provision (benefit) for income tax 937 1,105 1,267 1,246

Provision for income tax 1,945 1,720 1,819 2,209

Net income $ 5,506 $ 4,706 $ 4,997 $ 6,057

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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-K

Item 7. Management’s Discussion and Analysis