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Item 7. Management’s Discussion and Analysis

2024-03-14 compared with 2023-03-15 · 525 added, 505 removed, 518 unchanged (67% of the section changed)

Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is intended to provide a comprehensive review of the Company’s operating results and financial condition.

The information contained in this section should be read in

conjunction with the Audited Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements in this Annual Report on Form 10-K.

Information related to the comparison of the results of operations for the years

December 31, 2021 to 2020 is found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the 2021 Annual Report on Form 10-K filed with the SEC on March 15, 2022.

FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K may contain certain forward-looking statements within the meaning of Section 27A of the Securities Act, as amended, and Section 21E of the Exchange Act.

These forward-looking

statements reflect our current views and are not historical facts.

These statements may include statements regarding projected performance for periods following the date of this report.

These statements can generally be identified by use of

phrases such as “believe,” “expect,” “will,” “seek,” “should,” “anticipate,” “estimate,” “intend,” “plan,” “target,” “project,” “commit” or other words of similar import.

Similarly, statements that describe our future financial condition, results

of operations, objectives, strategies, plans, goals or future performance and business are also forward-looking statements.

Statements that project future financial conditions, results of operations and shareholder value are not guarantees of

performance and many of the factors that will determine these results and values are beyond our ability to control or predict.

For those statements, we claim the protection of the safe harbor for forward-looking statements contained in the

Private Securities Litigation Reform Act of 1995.

These forward-looking statements involve known and unknown risks, uncertainties and other factors, including, but not limited to, those described in the “Risk Factors” and “Management’s Discussion

and Analysis of Financial Condition and Results of Operations” sections and other parts of this Annual Report on Form 10-K that could cause our actual results to differ materially from those anticipated in these forward-looking statements.

following is a non-exclusive list of factors, that could cause our actual results to differ materially from our forward-looking statements in this Annual Report on Form 10-K:

changes in general economic conditions, either nationally, in California, or in our local markets;

inflation, changes in interest rates, securities market volatility and monetary fluctuations;

increases in competitive pressures among financial institutions and businesses offering similar products and services;

the future impact of the COVID-19 virus;

higher defaults in our loan portfolio than we expect;

changes in management’s estimate of the adequacy of the allowance for credit losses;

risks associated with our growth and expansion strategy and related costs;

increased lending risks associated with our high concentration of real estate loans;

legislative or regulatory changes or changes in accounting principles, policies or guidelines;

technological changes;

failure to raise the debt limit on U.S.

regulatory or judicial proceedings;

other factors and risks including those described under “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report on Form 10-K.

Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected, projected, intended,

committed or believed.

Additional factors that could cause actual results to differ materially from those expressed in the forward-looking statements are discussed in “Item 1A.

Risk Factors” in this Annual Report on Form 10-K.

Please take into

account that forward-looking statements speak only as of the date of this Annual Report on Form 10-K (or documents incorporated by reference, if applicable).

The Company does not undertake any obligation to publicly correct or update any forward-looking statement if it later becomes aware that actual results are likely to differ materially from those expressed in such

forward-looking statement, except as required by law.

Farmers & Merchants Bancorp (the “Company”, “FMCB”, or “we”) is the holding company for Farmers & Merchants Bank of Central California (the “Bank” or “FMB).

The Bank is a full-service community bank

providing loans, deposit and cash management services to individuals and businesses.

Our primary clients are small to medium-sized businesses that require highly personalized commercial banking products and services.

The Bank has 29 branch

locations and 3 ATMs that have been serving communities in the mid-Central Valley and East Bay of California for over 100 years.

The primary source of funding for our asset growth has been the generation of core deposits, which we raise through our existing branch locations, newly opened branch locations, or through acquisitions.

loan growth is primarily the result of organic growth generated by our seasoned relationship managers and supporting associates who provide outstanding service and responsiveness to our clients or through acquisitions.

Our results of operations are largely dependent on net interest income.

Net interest income is the difference between interest income we earn on interest earning assets, which are comprised of loans, investment

securities and short-term investments, and the interest we pay on our interest bearing liabilities, which are primarily deposits, and, to a lesser extent, other borrowings.

Management strives to match the re-pricing characteristics of the

interest earning assets and interest bearing liabilities to protect net interest income from changes in market interest rates and changes in the shape of the yield curve.

We measure our performance by calculating our net interest margin, return on average assets, and return on average equity.

Net interest margin is calculated by dividing net interest income, which is the difference

between interest income on interest earning assets and interest expense on interest bearing liabilities, by average interest earning assets.

Net interest income is our largest source of revenue.

Interest rate fluctuations, as well as changes in

the amount and type of earning assets and liabilities, combine to affect net interest income.

We also measure our performance by our efficiency ratio, which is calculated by dividing non-interest expense by the sum of net interest income and

non-interest income.

The following discussion is intended to provide a comprehensive review of the Company’s operating results and financial condition.

The information contained in this section should be read in conjunction with the

Audited Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements in this Form 10-K.

Information related to the comparison of the results of operations for the years December 31, 2022 to 2021 is found in

“Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the 2022 Annual Report on Form 10-K filed with the SEC on March 15, 2023.

Farmers & Merchants Bancorp (the “Company” or “FMCB”) is a Delaware registered bank holding company organized in 1999.

As a registered bank holding company, FMCB is subject to regulation, supervision, and

examination by the Federal Reserve and by the California Department of Financial Protection and Innovation (“DFPI”).

The Company’s principal business is to serve as a holding company for Farmers & Merchants Bank of Central California (the

“Bank” or “F&M Bank”) and for other banking or banking related subsidiaries, which the Company may establish or acquire.

Over 107 years ago, August 1, 1916, marked the first day of business for Farmers & Merchants Bank (the “Bank”).

Bank was incorporated under the laws of the State of California and licensed as a state-chartered bank.

The Bank’s first venture out of Lodi occurred when the Galt office opened in 1948.

Since then the Bank has opened full-service branches in

Linden, Manteca, Riverbank, Modesto, Sacramento, Elk Grove, Turlock, Hilmar, Stockton, Merced, Walnut Creek, Concord, Walnut Grove, Oakland and Napa.

As a legal entity separate and distinct from its subsidiary, the Company’s principal source of

funds is, and will continue to be, dividends paid by and other funds received from the Bank.

Legal limitations are imposed on the amount of dividends that may be paid and loans that may be made by the Bank to the Company.

In March 2002, F & M Bancorp, Inc.

was created to protect the name “F & M Bank.” During 2002, the Company completed a fictitious name filing in California to begin using the streamlined name, “F & M

Bank,” as part of a larger effort to enhance the Company’s image and build brand name recognition.

Since 2002, the Company has converted all of its daily operating and image advertising to the “F & M Bank” name and the Company’s logo, slogan

and signage were redesigned to incorporate the trade name, “F & M Bank.”

The Company’s outstanding common stock as of December 31, 2023, consisted of 747,971 shares of common stock, $0.01 par value.

No shares of preferred stock were issued or outstanding as of December 31, 2023.

common stock of the Company is not widely held or listed on any exchange.

However, trades are reported on the OTCQX under the symbol “FMCB.”

The primary source of funding for the Company’s growth has been the generation of core deposits, which the Company raises through its existing branch locations, newly opened branch locations, or through

acquisitions.

Loan growth over the years is the result of organic growth generated by the Company’s seasoned relationship managers and supporting associates who provide outstanding service and responsiveness to the Company’s clients.

The Company’s results of operations are largely dependent on net interest income.

Net interest income is the difference between interest income earned on interest earning assets, which are comprised of loans and

leases, investment securities, short-term investments and interest bearing deposits at other banks, and the interest the Company pays on interest bearing liabilities, which are primarily deposits, and, to a lesser extent, other borrowings.

Management strives to match the re-pricing characteristics of the interest earning assets and interest bearing liabilities to protect net interest income from changes in market interest rates and changes in the shape of the yield curve.

The Company measures its performance by calculating the net interest margin, return on average assets, return on average equity and the efficiency ratio.

Net interest margin is calculated by dividing net interest

income, which is the difference between interest income on interest earning assets and interest expense on interest bearing liabilities, by average interest earning assets.

Net interest income is the Company’s largest source of revenue.

rate fluctuations, as well as changes in the amount and type of earning assets and liabilities, combine to affect net interest income.

The return on average assets is calculated by dividing the Company’s net income by its total average assets and

the return on average equity is calculated by dividing the Company’s net income by its shareholder equity.

The efficiency ratio is calculated by dividing non-interest expense by the sum of net interest income and non-interest income.

Selected Financial Data

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Cash dividends per common share

Dividend ratio

Net interest margin

Dividend payout ratio

Net interest margin (tax equivalent)

Non-interest income to average assets

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Capital ratios:

Tier 1 leverage capital

Total risk-based capital

Average equity to average assets

Tangible common equity to tangible assets

Common equity tier 1 capital to risk-weighted assets

Tier 1 capital to risk-weighted assets

Risk-based capital to risk-weighted assets

Tier 1 leverage capital ratio

Tangible common equity ratio(1)

(1) See "Non-GAAP Measurements"

Summary of Critical Accounting Policies and Estimates

In the opinion of management, the accompanying Consolidated Statements of Financial Condition and related Consolidated Statements of Operations, Comprehensive Income, Changes in Shareholders’ Equity and Cash Flows

In the opinion of management, the accompanying Consolidated Statements of Financial Condition and related Consolidated Statements of Income, Comprehensive Income, Changes in Shareholders’ Equity and Cash Flows

reflect all adjustments (which include reclassification and normal recurring adjustments) that are necessary for a fair presentation in conformity with GAAP.

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operating results in future periods.

For additional information concerning critical accounting policies, see the Selected Notes to the Consolidated Financial Statements and the following:

For additional information concerning critical accounting policies, see Note 1 located in Item 8:

“Financial Statements and Supplementary Data” in this Form 10-K and the following:

Use of Estimates — The preparation of our financial statements requires management to make estimates and judgments that affect the reported amount of

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The allowance for credit losses, deferred income taxes, and fair values of financial instruments are estimates, which are particularly subject to

Allowance for Credit Losses — The Company recognizes there is risk of credit losses with financial instruments, to include loans, and unfunded loan

Allowance for Credit Losses — The Company recognizes there is risk of credit losses with financial instruments, such as loans and unfunded loan

commitments, where the Company advances funds to a counterparty.

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The allowance for credit losses represents our

estimate of probable losses inherent in our existing loan portfolio.

estimate of current expected credit losses inherent in our existing loan portfolio.

The allowance for credit losses is increased by charging a provision for credit losses against income and reduced by charge-offs, net of recoveries.

Under the guidance of Financial Accounting Standards Board Accounting Standards Update 2016-13, Financial Instruments – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments (“CECL”), we

evaluate our allowance for credit losses quarterly based on a number of quantitative and qualitative factors, including levels and trends of past due and non-accrual loans, asset classifications, loan grades and internal loan reviews, change in

volume and mix of loans, collateral value, historical loss experience, size and complexity of individual credits, loan concentrations and economic conditions.

evaluate our allowance for credit losses quarterly based on a number of quantitative and qualitative factors.

Allowance for credit losses is provided on both a specific and general basis.

allowances are provided for impaired credits for which the expected/anticipated loss is measurable.

General valuation allowances are based on a portfolio segmentation based on risk grading, with a further evaluation of various quantitative and

qualitative factors.

The Company begins its determination of credit losses by evaluating historical credit loss experience by loan segment.

Historical loss information may be adjusted based on specific risk characteristics by loan

Such risk characteristics may include, but are not necessarily limited to, changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered

elsewhere in estimating credit losses;

Specific allowances are provided for impaired credits for

which the expected/anticipated loss is measurable.

General valuation allowances are based on a portfolio segmentation based on risk grading, with a further evaluation of various quantitative and qualitative factors.

The Company uses the Weighted Average Remaining Maturity (“WARM”) method to calculate the ACL, as this method is deemed the most appropriate given the Company’s current size and complexity.

The Company begins its

determination of credit losses by evaluating historical credit loss experience by loan segment.

The Company analyzes historical credit loss criteria over a fifteen-year history for both the Company’s loss history and its peers.

Due to a growth

cycle that has expanded the Company’s geographical service area and product mix as it has expanded into the San Francisco Bay Area, the Company’s peer group losses have been determined to better align with the Company’s loss profile in loans

related to commercial, industrial, and personal segments.

However, given the low concentration in agricultural industry related loans in the peer group, the Company’s own loss history in agricultural loans is more suitable.

These loss factors are

analyzed in conjunction with weighted average duration calculations in order to assess the loss factors over the life of the loan segment.

Historical loss information may be adjusted based on specific risk characteristics by loan segment.

Such risk characteristics may include, but are not necessarily limited to, changes in lending policies and

procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses;

changes in national and local economic conditions and forecasts;

changes in the nature and volume of the loans and in the terms of such instruments;

changes in the experience, ability, and depth of lending

management and other relevant staff;

changes in the volume and severity of past due status, the volume of non-accrual loans, and the volume and severity of adversely classified or graded loans;

changes in the quality of the institution’s loan

review system;

changes in the

nature and volume of the loans and in the terms of such instruments;

changes in the experience, ability, and depth of lending management and other relevant staff;

changes in the volume and severity of past due status, the volume of non-accrual

loans, and the volume and severity of adversely classified or graded loans;

changes in the quality of the institution’s loan review system;

changes in the value of underlying collateral for collateral-dependent loans;

the existence and effect of any concentrations of credit, and changes in the level of such concentrations;

and the effect of other external factors such

as competition and legal and regulatory requirements on the level of estimated credit losses.

the existence and effect of

any concentrations of credit, and changes in the level of such concentrations;

and the effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses.

While the Company utilizes a systematic methodology in determining its allowance, the allowance is based on estimates, and ultimate losses may vary from current estimates.

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For additional information, see Note 4, located in Item 8.

Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.

“Financial Statements and Supplementary Data” in this Form 10-K.

The allowance for credit losses on unfunded loan commitments is classified in other liabilities on the Consolidated Statements of Financial Condition.

The allowance for credit losses on unfunded loan commitments

is increased by charging a provision for credit losses on unfunded commitments, which was reported in other non-interest expenses for 2022 and prior.

We believe that our allowance for credit losses was adequate to absorb probable losses inherent in the loan portfolio as of December 31, 2022 and 2021.

The Company analyzes the unfunded loan commitments utilizing

historical utilization rates from the prior 12 months to predict losses.

The allowance for credit losses on unfunded loan commitments is increased by charging the provision for credit losses.

The provision for credit-losses – unfunded loan

commitments was recognized in non-interest expense in 2022.

We believe that our allowance for credit losses was adequate to absorb probable losses inherent in the loan and lease portfolio as of December 31, 2023 and 2022.

Investment Securities — Investment securities are classified as held-to-maturity (“HTM”) when the Company has the positive intent and ability to hold the

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Investment securities classified at HTM are carried at amortized cost.

Investment securities classified at AFS are reported at fair value.

Investment securities classified as AFS are reported at fair value.

Purchase premiums and

discounts are recognized in interest income using the interest method over the terms of the securities.

Debt securities classified as held-to-maturity are carried at cost, net of the allowance for credit losses - securities, adjusted for

amortization of premiums and discounts to the earliest callable date.

Debt securities classified as available-for-sale are measured at fair value.

Unrealized holding gains and losses on debt securities classified as available-for-sale are

excluded from earnings and are reported net of tax as accumulated other comprehensive income (AOCI), a component of shareholders’ equity, until realized.

When AFS securities, specifically identified, are sold, the unrealized gain or loss is

reclassified from AOCI to non-interest income.

Management measures expected credit losses on held-to-maturity debt securities on a collective basis by major security type.

Debt securities classified as HTM are carried at cost, net of the allowance for credit losses - securities, adjusted for amortization of

premiums and discounts to the earliest callable date.

Debt securities classified as AFS are measured at fair value.

Unrealized holding gains and losses on debt securities classified as AFS are excluded from earnings and are reported net of tax as

accumulated other comprehensive income (“AOCI”), a component of shareholders’ equity, until realized.

When AFS securities, specifically identified, are sold, the unrealized gain or loss is reclassified from AOCI to non-interest income.

Management measures expected credit losses on HTM debt securities on a collective basis by major security type.

The Company’s HTM portfolio contains securities issued by U.S.

government entities and

agencies and municipalities.

government entities and agencies and

municipalities.

The Company uses industry historical credit loss information adjusted for current conditions to establish the allowance for credit losses on its HTM municipal bond portfolio.

For available-for-sale debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or is more likely than not that it will be required to sell the security before recovery

of its amortized cost basis.

If the Company intends to sell the security or it is more likely than not that the Company will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in

If the Company does not intend to sell the security, and it is not more likely than not that the Company will be required to sell the security, the Company evaluates whether the decline in fair value has resulted from credit losses or

For AFS debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or is more likely than not that it will be required to sell, the security before recovery of its

amortized cost basis.

If the Company intends to sell the security, or it is more likely than not that the Company will be required to sell the security, before recovering its cost basis, the entire impairment loss would be recognized in earnings.

In making this assessment, management considers the extent to which fair value is less than amortized costs, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among

other factors.

among other factors.

If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security.

Projected cash flows are discounted

by the current effective interest rate.

If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the

amount that the fair value is less than the amortized cost basis.

The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge

Projected cash flows are discounted by the

current effective interest rate.

that the fair value is less than the amortized cost basis.

The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to

Changes in the allowance for credit losses-securities are recorded as provision for (or reversal of) credit losses.

Losses are charged against the allowance when management believes the non-collectability of an

available-for-sale security is confirmed or when either criteria regarding intent of requirement to sell is met.

At December 31, 2022, we had no investment securities that were impaired.

Goodwill — Goodwill represents the excess of the purchase considerations paid over the fair value of the assets acquired, net of the fair values of

liabilities assumed in a business combination it is not amortized but is reviewed annually, or more frequently as current circumstances and conditions warrant, for impairment.

An assessment of qualitative factors is completed to determine if it

is more likely than not that, the fair value of a reporting unit is less than its carrying amount.

If the qualitative analysis concludes that further analysis is required, then a quantitative impairment test would be completed.

The quantitative

goodwill impairment compares the reporting unit's estimated fair values, including goodwill, to its carrying amount.

If the carrying amount exceeds its reporting unit’s fair value, then an impairment loss would be recognized as a charge to

earnings, but is limited by the amount of goodwill allocated to that reporting unit.

Other Intangible Assets — Other intangible assets consists primarily of core deposit intangibles (“CDI”), which are amounts recorded in business

combinations or deposit purchase transactions related to the value of transaction-related deposits and the value of the client relationships associated with the deposits.

Core deposit intangibles are amortized over the estimated useful lives of

such deposits.

These assets are reviewed at least annually for events or circumstances that could affect their recoverability.

These events could include loss of the underlying core deposits, increased competition or adverse changes in the

The amortization of our CDI is recorded in other non-interest expense.

To the extent other identifiable intangible assets are deemed unrecoverable;

impairment losses are recorded in other non-interest expense to reduce the carrying

amount of the assets.

Losses are charged against the allowance when management believes the non-collectability of an AFS

security is confirmed or when either criteria regarding intent or requirement to sell is met.

At December 31, 2023, the Company had no investment securities that were impaired.

Fair Value Measurements — The Company discloses the fair value of financial instruments and the methods and significant assumptions used to estimate those

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“Quantitative and Qualitative Disclosures about Market Risk” and Note 11 located in Item 8.

Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.

Income Taxes — Income taxes are filed on a consolidated basis with our subsidiaries and allocate income tax expense (benefit) based on each entity’s

“Financial Statements and

Supplementary Data” in this Form 10-K.

Income Taxes — Income taxes are filed on a consolidated basis with our subsidiaries and we allocate income tax expense (benefit) based on each entity’s

proportionate share of the consolidated provision for income taxes.

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Only tax positions that meet the “more likely than not” recognition threshold are recognized.

The benefit of a tax position is recognized in the financial statements in the period during which, based on all available

evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any.

Tax positions taken are not offset or aggregated with other

Tax positions that meet the more likely than not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority.

portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying consolidated statements of financial condition along

with any associated interest and penalties that would be payable to the taxing authorities upon examination.

Interest expense and penalties associated with unrecognized tax benefits are classified as income tax expense in the consolidated

statements of income.

The benefit of a tax position is recognized in the financial statements in the period during which, based on all

available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any.

Tax positions taken are not offset or aggregated with

other positions.

Tax positions that meet the “more likely than not” recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing

The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying consolidated statements of financial

condition along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

Interest expense and penalties associated with unrecognized tax benefits are classified as income tax expense in the

consolidated statements of income.

Impact of Recently Issued Accounting Standards

“Summary of Significant Accounting Policies” to the Consolidated Financial Statements in “Item 8.

Financial Statements and Supplementary Data” in this Annual Report on Form 10-K.

Financial Statements and Supplementary Data” in this Form 10-K.

Non-GAAP Measurements

We use certain non-GAAP financial measures to provide meaningful supplemental information regarding the Company’s operational performance and to enhance investors’ overall understanding of such financial

The methodology for determining these non-GAAP measures may differ among companies.

We used the following non-GAAP measures in this Form 10-K:

Tangible common equity ratio and tangible book value per common share:

Given that the use of these measures is prevalent among banking regulators, investors, and analysts, we disclose them in

addition to the related GAAP measures of return on average equity and book value per common share.

The reconciliations of these non-GAAP measurements to the GAAP measurements are presented in the following tables for and as of the periods

Tangible Common Equity Ratio and

Tangible Book Value Per Common Share

(Dollars in thousands, except per share data)

Shareholders' equity

Intangible assets

Tangible common equity

Intangible assets

Tangible assets

Tangible common equity ratio (1)

Book value per common share (2)

Tangible book value per common share (3)

Common shares outstanding

Tangible common equity divided by tangible assets

Total common equity divided by common shares outstanding.

Tangible common equity divided by common shares outstanding.

Results of Operations

The following discussion and analysis is intended to provide a better understanding of Farmers & Merchants Bancorp and its subsidiaries’ performance during each of the years in the two-year period ended

December 31, 2022 and the material changes in financial condition, operating income, and expense of the Company and its subsidiaries as shown in the accompanying consolidated financial statements.

Information related to the comparison of the

results of operations for the years December 31, 2021 and 2020 can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the 2021 Annual Report on Form 10-K filed with the SEC on March 15, 2022.

The following discussion and analysis is intended to provide a better understanding of the Company’s performance during each of the years in the two-year period ended December 31, 2023 and the material changes in

financial condition, operating income, and expense of the Company and its subsidiaries as shown in the accompanying consolidated financial statements.

Information related to the comparison of the results of operations for the years ended December

31, 2022 and 2021 can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the 2022 Annual Report on Form 10-K filed with the SEC on March 15, 2023.

Factors that determine the level of net income include the volume of earning assets and interest bearing liabilities, yields earned and rates paid, fee income, non-interest expense, the level of non-performing

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Non-interest income includes card processing fees, service charges on deposit accounts, bank-owned life insurance income,

gains/losses on the sale of investment securities, and gains/losses on deferred compensation investments.

gains/losses on the sale of investment securities, and gains/losses on deferred compensation plan investments.

Non-interest expense consists primarily of salaries and employee benefits, cost of deferred compensation benefits, occupancy, data

processing, FDIC insurance, marketing, legal and other expenses.

processing, deposit insurance, marketing, professional services, and other expenses.

Earnings Performance

The following table presents performance metrics for the periods indicated:

(dollars in thousands, except per share amounts)

Earnings Summary:

Interest income

Interest expense

Net interest income

Provision for credit losses

Non-interest income

Non-interest expense

Income before taxes

Income tax expense

Per Common Share Data:

Diluted earnings per common share

Book value per common share

Tangible book value per common share (1)

Performance Ratios:

Return on average assets

Return on average equity

Net interest margin (tax equivalent)

Yield on average loans and leases (tax equivalent)

Cost of average total deposits

Efficiency ratio

Loan-to-deposit ratio

Percentage of checking deposits to total deposits

Capital Ratios Bancorp:

Common equity tier 1 capital to risk-weighted assets

Tier 1 capital to risk-weighted assets

Risk-based capital to risk-weighted assets

Tier 1 leverage capital ratio

Tangible common equity ratio (1)

See "Non-GAAP Measurements"

Average Balance and Yields

The following table sets forth a summary of average balances with corresponding interest income and interest expense as well as average yield,

cost and net interest margin information for the periods presented.

The following table sets forth a summary of average balances with corresponding interest income and interest expense as well as average yield, cost and net interest margin information for the periods presented.

Average balances are derived from daily balances.

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(Dollars in thousands)

Average Balance

Income / Expense

Average Balance

Income / Expense

Interest earnings deposits in other banks and federal

Interest earnings deposits in other banks and federal funds sold

Investment securities:

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Total average liabilities and shareholders' equity

Net interest income

Net interest income and margin (4)

Interest rate spread

Net interest margin (4)

Excludes average unrealized (losses) gains of ($24.5) million and $3.4 million for the years ended December 31, 2022, and 2021, respectively, which are included in non-interest earning assets.

The average yield does not include the federal tax benefits at an assumed effective yield of 26% related to income earned on tax-exempt municipal securities totaling $415,000 and $436,000 for the years ended December 31, 2022, and

2021, respectively.

Tax Equivalent Adjustment

Net interest income

Excludes average unrealized (losses) of ($25.8) million and $(24.5) million for the years ended December 31, 2023, and 2022, respectively, which are included in non-interest earning assets.

Yields and interest income are calculated on a fully taxable equivalent basis using the current statutory federal tax rate.

Loan interest income includes loan fees of $6.1 million and $11.6 million for the years ended December 31, 2023 and 2022, respectively.

Net interest margin is computed by dividing net interest income by average interest earning assets.

Interest-bearing deposits with banks and Federal Reserve balances are additional earning assets available to the Company.

Average interest-bearing deposits with banks consisted

primarily of FRB deposits.

Interest-bearing deposits with banks and FRB balances are earning assets available to the Company.

Average interest-bearing deposits with banks consisted primarily of FRB

Balances with the FRB earned an average interest rate of 5.17% and 1.72% for the years ended December 31, 2023 and 2022, respectively.

The increase was primarily the result of

the FRB increasing rates by 425 basis points during 2022.

Average interest-bearing deposits was $704 million and $666 million for the years ended December 31, 2022 and 2021, respectively.

Interest income on

interest-bearing deposits with banks was $12.1 million and $902,000 for the years ended December 31, 2022 and 2021, respectively.

The investment portfolio is another main component of the Company’s earning assets.

The increase was primarily the result of the Federal

Reserve increasing rates by 425 basis points from March 2022 to December 2022 and 100 basis points from February 2023 to July 2023.

Average interest-bearing deposits with banks was $519.3 million and $704.1

million for the years ended December 31, 2023 and 2022, respectively and decreased primarily to fund loan growth.

Interest income on interest-bearing deposits with banks was $26.9 million and $12.1 million for the years ended December 31, 2023

and 2022, respectively.

The investment portfolio is also a component of the Company’s earning assets.

Historically, the Company invested primarily in:

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and (3) investment grade bank-qualified municipal bonds.

However, at certain times the Company selectively added investment grade corporate securities

(floating rate and fixed rate with maturities less than 5 years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity.

Since the risk factor for these types of investments is generally lower

than that of loans and leases, the yield earned on investments is generally less than that of loans and leases.

Average total investment securities were $1.1 billion and $891 million for the years ended December 31, 2022 and 2021, respectively.

The average yield on total investment securities were 1.94% and 1.83 % for the

However, at certain times the Company has selectively added investment grade corporate

securities (floating rate and fixed rate with maturities less than 7 years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity.

Since the risk factor for these types of investments is

generally lower than that of loans and leases, the yield earned on investments is generally less than that of loans and leases.

Average total investment securities were $990.5 million and $1.1 billion for the years ended December 31, 2023 and 2022, respectively.

The average yield on total investment securities was 2.20% and 1.98% for the

years ended December 31, 2023 and 2022, respectively.

See “Investment Securities and Federal Reserve balances” for a discussion of the Company’s investment strategy in 2022.

See “Investment Securities” for a discussion of the Company’s investment strategy in 2023.

Average loans and leases held for investment were $3.5 billion and $3.3 billion for the years ended December 31, 2023 and 2022, respectively.

The yield on the loan & lease portfolio was 5.00% and 4.77% for the

The average yield on the loan and lease portfolio was 5.84% and 5.00%

for the years ended December 31, 2023 and 2022, respectively.

The increase in the loan yield reflects the increase in market interest rates over the prior year.

Average interest-bearing deposits were $3.1 billion and $3.0 billion for the years ended December 31, 2023 and 2022, respectively.

The average rate paid on interest-bearing deposits was 1.20% and 0.14% for the

years ended December 31, 2023 and 2022, respectively.

The Company continues to experience aggressive competitor pricing for loans and leases to which it may need to respond in order to retain key customers.

This could continue to place negative

pressure on future loan & lease yields and net interest margin.

Average interest-bearing liabilities was $3.0 billion and $2.8 billion for the years ended December 31, 2022 and 2021, respectively.

Total interest expense on interest-bearing liabilities was $4.8 million, $4.3

million for the years ended December 31, 2022 and 2021, respectively.

The average rate paid on interest-bearing liabilities was 0.16% and 0.16% for the years ended December 31, 2022 and 2021, respectively.

Total interest expense on interest-bearing deposits was $37.5 million and $4.3 million for the years ended December 31, 2023 and 2022, respectively, with the increase driven by increases in

short-term market interest rates during 2023.

The average rate paid on total funding costs was 0.82% and 0.10% for the years ended December 31, 2023 and 2022, respectively.

Rate/Volume Analysis

The following table shows the change in interest income and interest expense and the amount of change attributable to variances in volume, rates and

the combination of volume and rates based on the relative changes of volume and rates.

For purposes of this table, the change in interest due to both volume and rate has been allocated to change due to volume and rate in proportion to the

relationship of absolute dollar amounts of change in each.

The following table shows the change in interest income and interest expense and the amount of change attributable to variances in volume, rates and the combination of volume and rates based on the relative changes

of volume and rates.

For purposes of this table, the change in interest due to both volume and rate has been allocated to change due to volume and rate in proportion to the relationship of absolute dollar amounts of change in each.

Year Ended December 31, 2023

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Net interest income

(1) Consumer and other - These decreases respresent the end of the PPP loans which were $0 and $70,765 as of December 31, 2022 and 2021 respectively.

Net interest income was $193.6 million and $160.9 million for the two years ended December 31, 2022 and 2021, respectively.

The increase in net interest income was driven primarily by increased interest rates and

deposit growth, which we were able to partially deploy into growing our loan portfolio.

The remaining increase in interest was held in interest earning deposits and investment securities.

Comparison of Results of Operations for the Years Ended December 31, 2023 and 2022

(Dollars in thousands)

$ Better / (Worse)

% Better / (Worse)

Selected Income Statement Information:

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For the years ended December 31, 2023 and 2022, net income was $88.3 million compared with $75.1 million, respectively.

The increase in net income was primarily

the result of higher net interest income of $32.6 million.

This increase was offset by a decrease in non-interest income of $14.9 million, higher provision for credit losses of $4.5 million, higher income tax expense of $2.7 million and an

increase in non-interest expense of $1.8 million.

The increase in net income was primarily the result of higher net interest income of $21.8

million and an increase in non-interest income of $8.7 million, which included a $4.3 million death benefit gain on bank-owned life insurance (“BOLI”) that was not present during 2022.

This increase was offset by an increase in non-interest

expense of $10.8 million, higher income tax expense of $3.6 million and a higher provision for credit losses of $3.0 million.

Net Interest Income and Net Interest Margin

For the year ended December 31, 2022, net interest income increased $32.6 million, or 20.28%, to $193.6 million compared with

$160.9 million for the same period a year earlier.

The increase is the result of:

(1) average interest earning assets increasing $435.4 million, or 9.35%, to $5.1 billion compared with $4.7 billion for the same period a year earlier;

net interest margin increasing 34 basis points to 3.80% for all of 2022 compared with 3.46% for the same period a year earlier.

The increase in the net interest margin was primarily the result of the FRB increasing the federal funds rate over

the past year.

For the year ended December 31, 2023, net interest income increased $21.8 million, or 11.27%, to $215.4 million compared with $193.6 million for the same period a year earlier.

The increase is primarily the result

of the net interest margin (tax equivalent basis) increasing 49 basis points to 4.30% compared with 3.81% for the same period a year earlier.

The increase in the net interest margin was primarily the result of the Federal Reserve increasing the

federal funds rate by 425 basis points from March 2022 to December 2022 and 100 basis points from February 2023 to July 2023.

The loan yield for the year ended December 31, 2023, increased 84 basis points from 5.00% to 5.84% compared to the same

period a year earlier.

The cost of funds for the year ended December 31, 2023, increased by 72 basis points from 0.10% to 0.82% compared to the same period a year earlier.

Provision for Credit Losses.

The provision for credit losses in each period is a charge against earnings in that period.

The provision is the amount required to maintain the

allowance for credit losses at a level that, in management’s judgment, is adequate to absorb expected losses over the life of the loan and HTM securities portfolios.

The provision for credit losses for the year ended December 31, 2022, was $6.5 million compared with $1.9 million for the same period a year ago.

For the year ended December 31, 2022, the Company incurred net

charge-offs of $0.2 million compared with net recoveries of $0.2 million for the same period a year earlier.

The provision is the amount

required to maintain the allowance for credit losses at a level that, in management’s judgment, is adequate to absorb expected losses, over the life of the loans and leases, unfunded loan commitments and HTM securities portfolios.

The provision for credit losses for the year ended December 31, 2023, was $9.4 million compared with $6.5 million for the same period a year earlier.

The increase in 2023 was primarily due to higher estimated

losses inherent in the loan and lease portfolio directly related to quantitative and qualitative factors associated with the current economic environment.

For the year ended December 31, 2023, the Company incurred net recoveries of $0.3 million

compared with net charge-offs of $0.2 million for the same period a year earlier.

Non-interest Income

Non-interest income decreased $14.9 million, or 70.66%, to $6.2 million for 2022 compared with $21.1 million for the same period a year earlier.

year-over-year decrease in non-interest income was primarily due to:

(1) a $10.7 million loss on the sale of investment securities versus a $2.6 gain for the same period a year earlier;

and (2) $2.2 million decline in gains/(losses) on deferred

compensation plan investments.

(Dollars in thousands)

Non-interest Income:

Card processing

Gain on BOLI death benefit

Net gain on deferred compensation benefits

Service charges on deposit accounts

Increase in cash surrender value of BOLI

Net loss on sale of securities available-for-sale

Total non-interest income

Non-interest income increased $8.7 million to $14.9 million for 2023 compared with $6.2 million for the same period a year earlier.

The year-over-year increase in non-interest income was primarily due to a $4.3

million BOLI death benefit gain, a $2.5 million increase in net gains on deferred compensation plan investments and a $2.5 million decrease in net losses on the sale of investment securities during 2023 for interest rate risk management purposes

to reposition the balance sheet.

The Company recorded net gains on deferred compensation plan investments of $3.0 million in 2023 compared to net gains of $0.5 million in 2022.

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Non-interest Expense

Non-interest expense increased $1.8 million, or 1.96%, to $93.6 million for 2022 compared with $91.8 million for the same period a year ago.

year-over-year increase was primarily comprised of:

(1) a $0.4 million increase in salaries and employee benefits;

(2) a $0.6 million increase in legal expenses;

(3) a $0.2 million increase in FDIC insurance;

(4) a $0.2 million increase in

marketing expenses;

and (5) an increase of $2.5 million in other miscellaneous expenses ($1.0 million of which was a provision for unused commitments).

These increases were partially off-set by a $2.2 million decline in gain/(losses) on deferred

compensation plan investments.

For the year ended December 31, 2022, the Company’s efficiency ratio was 46.84% compared with 50.42% for the same period a year ago.

(Dollars in thousands)

$ Better / (Worse)

% Better / (Worse)

Non-interest Expense:

Salaries and employee benefits

Data Processing

Net gain on deferred compensation benefits

Deposit insurance

Professional services

Total non-interest expense

Non-interest expense increased $10.8 million to $104.3 million for 2023 compared with $93.6 million for the same period a year earlier.

The year-over-year increase was primarily comprised of a $6.6 million increase

in salaries and employee benefits, a $2.5 million increase in net gains on deferred compensation plan investments, a $1.0 million increase in deposit insurance and a $0.6 million increase in marketing expenses.

For the year ended December 31,

2023, the Company’s expense efficiency ratio was 45.31% compared with 46.84% for the same period a year earlier as the increase in revenues outpaced the increase in expenses.

Net gains on deferred compensation plan obligations were $3.0 million in 2023 compared to net gains of $0.5 million in 2022.

See Note 11, located in “Item 8.

See Note 10, located in “tem 8.

“Financial Statements and Supplementary Data” for a

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For the year ended December 31, 2023, income tax expense was $28.2 million, compared with $24.7 million for the same period a year earlier.

ended December 31, 2022, the effective tax rate was 24.72% compared with 24.89% for the same period a year ago.

Financial Condition

Total assets grew $149.7 million, or 2.89%, to $5.3 billion at December 31, 2022 compared with $5.2 billion at December 31, 2021.

For the year ended December 31, 2023, the effective tax rate was 24.23%

compared with 24.72% for the same period a year earlier.

The Company’s effective tax rate for 2023 was lower, primarily due to a non-taxable BOLI death benefit gain of $4.3 million recognized during the year.

The Company’s effective tax rate can

fluctuate from year to year due primarily to changes in the mix of taxable and tax-exempt earning sources.

The effective rates were lower than the combined Federal and State statutory rate of 30% due primarily to BOLI death benefits, the cash

surrender value of life insurance, credits associated with low income housing tax credit investments (“LIHTC”), and tax-exempt interest income on municipal securities and loans.

Balance Sheet Analysis

Total assets were $5.3 billion at December 31, 2023, a decrease of $18.5 million or 0.35% compared to December 31, 2022.

Loans held for investment grew $142.3 million or 4.05% to $3.7 billion at December 31, 2023,

compared with $3.5 billion at December 31, 2022.

Exclusive of SBA PPP loans, the loan portfolio grew $346 million, or 10.69%, over December 31, 2021.

This data constitutes non-GAAP financial data.

The Company believes that excluding

the temporary effect of the PPP loans furnishes useful information regarding the Company’s growth.

Total deposits increased $119.1 million, or 2.57%, to $4.8 billion at December 31, 2022 compared with $4.6 billion at December 31, 2021.

increase in total assets and deposits was primarily the result of continued strong organic deposit growth.

Investment Securities and Federal Reserve Balances

The Company’s investment portfolio decreased by less than 1.0%, to $1.0 billion at December 31, 2022.

This decrease is net of the impact of $47.7 million that the Company sold for interest rate risk management

The Company uses its investment portfolio to manage interest rate and liquidity risks.

The Company's total investment portfolio as of December 31, 2022 represents 18.72% of the Company’s total assets as compared to 19.45% at December

Not included in the investment portfolio are interest bearing deposits with banks and overnight investments in Federal Reserve balances.

Interest bearing deposits with banks consisted primarily of FRB deposits.

The FRB currently pays interest on the deposits that banks maintain in their FRB accounts, whereas historically banks had to sell these Federal Funds to other banks in order to earn interest.

Since balances at the

FRB are effectively risk free, the Company elected to maintain its excess cash at the FRB.

Total deposits were $4.7 billion at December 31, 2023 compared with $4.8 billion at December 31, 2022, a decrease of $91.2 million, or 1.92%.

Cash and Cash Equivalents

The Company’s cash and cash equivalents consist of interest bearing deposits with banks and overnight investments in Federal Reserve balances.

Interest bearing deposits with banks consisted primarily of FRB

Since balances at the FRB are effectively risk free, the Company elected to maintain its excess cash at the FRB.

Interest bearing deposits with banks totaled $338.4 million at December 31, 2023 and $514.9 million at December 31, 2022.

The Company classifies its investment securities as either held-to-maturity (“HTM”) or available-for-sale (“AFS”).

Securities are classified as held-to-maturity and are carried at amortized cost, net of an

allowance for credit losses, when the Company has the intent and ability to hold the securities to maturity.

See Note 2 “Investment Securities” to the Consolidated Financial Statements in “Item 8.

Financial Statements and Supplementary Data” in

this Annual Report on Form 10-K.

Securities classified as AFS include securities, which may be sold to effectively manage interest rate risk exposure, prepayment risk, satisfy liquidity demands and other factors.

These securities are reported at

fair value with aggregate, unrealized gains or losses excluded from income and included as a separate component of shareholders’ equity, net of related income taxes.

As of December 31, 2022, the Company held no investment securities from any

issuer (other than the U.S.

Treasury or an agency of the U.S.

government or a government-sponsored entity) that totaled over 10% of our shareholders’ equity.

The decrease was primarily due to funding loan growth during the year.

The Company’s total cash and cash equivalents as of December 31, 2023 represented 7.7% of the Company’s total assets as compared to 11.0% as of December 31, 2022.

Investment Securities

The Company’s net investment portfolio increased slightly by $2.0 million to $1.0 billion at December 31, 2023 compared to $998.2 million at December 31, 2022.

During 2023, the Company purchased $85.3 million of`

investment securities and sold $39.9 million for interest rate risk management purposes to reposition the balance sheet.

The Company uses its investment portfolio to manage interest rate and liquidity risks.

The Company's total investment

portfolio as of December 31, 2023 represented 18.84% of the Company’s total assets as compared to 18.74% at December 31, 2022.

The carrying value of our portfolio of investment securities was as follows:

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Total held-to-maturity securities

(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S.

(2) Municipal securities are net of allowance for credit losses of $393 and $0, respectively.

(1) All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government

What changed 10-K

Item 7. Management’s Discussion and Analysis