HAWTHORN BANCSHARES, INC. 10-Q

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements This report contains certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of Hawthorn Bancshares, Inc., and its subsidiaries (collectively, the Company, we, our, or us), including, without limitation: • statements that are not historical in nature, and • statements preceded by, followed by or that include the words believes , expects, may, will, should, could, anticipates, estimates, intends, plans, hopes or similar expressions. Forward-looking statements are not guarantees of future performance or results. They involve risks, uncertainties and assumptions. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors: • competitive pressures among financial services companies may increase significantly, • changes in the interest rate environment may reduce interest margins, • general economic conditions, either nationally or in Missouri, may be less favorable than expected and may adversely affect the quality of our loans and other assets, • increases in non-performing assets in the Company’s loan portfolios and adverse economic conditions may necessitate increases to our provisions for loan losses, • costs or difficulties related to any integration of any business of the Company and its acquisition targets may be greater than expected, • legislative, regulatory or tax law changes may adversely affect the business in which the Company and its subsidiaries are engaged, • credit and market risks relating to increasing inflation, • changes may occur in the securities markets, and • the COVID-19 pandemic, or any resurgence thereof, or other external events may adversely affect the Company. We have described additional factors that could cause actual results to be materially different from those described in the forward-looking statements under the caption Risk Factors in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, and in other reports filed with the SEC from time to time. Other factors that have not been identified in this report could also have this effect. You are cautioned not to put undue reliance on any forward-looking statement, which speak only as of the date they were made. Except as required by law, the Company undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events, or changes in its business, results of operations or financial condition over time. 35 Overview Crucial to the Company’s community banking strategy is growth in its commercial banking services, retail mortgage lending and retail banking services. Through the branch network of its subsidiary bank, Hawthorn Bank (the Bank), the Company, with $1.8 billion in assets at June 30, 2022, provides a broad range of commercial and personal banking services. The Bank’s specialties include commercial banking for small and mid-sized businesses, including equipment, operating, commercial real estate, Small Business Administration (SBA) loans, and personal banking services including real estate mortgage lending, installment and consumer loans, certificates of deposit, individual retirement and other time deposit accounts, checking accounts, savings accounts, and money market accounts. Other financial services that the Company provides include trust services that include estate planning, investment and asset management services and a comprehensive suite of cash management services. The geographic areas in which the Company provides products and services include the Missouri communities in and surrounding Jefferson City, Columbia, Clinton, Warsaw, Springfield, St. Louis, and the greater Kansas City metropolitan area. The Company’s primary source of revenue is net interest income derived primarily from lending and deposit taking activities. Much of the Company’s business is commercial, commercial real estate development, and residential mortgage lending. The Company’s income from mortgage brokerage activities is directly dependent on mortgage rates and the level of home purchases and refinancing activity. The success of the Company’s growth strategy depends primarily on the ability of the Bank to generate an increasing level of loans and deposits at acceptable risk levels and on acceptable terms without significant increases in non-interest expenses relative to revenues generated. The Company’s financial performance also depends, in part, on its ability to manage various portfolios and to successfully introduce additional financial products and services by expanding new and existing customer relationships, utilizing improved technology, and enhancing customer satisfaction. Furthermore, the success of the Company’s growth strategy depends on its ability to maintain sufficient regulatory capital levels during periods in which general economic conditions are unfavorable and despite economic conditions being beyond its control. The Bank is a full-service bank that conducts general banking business, offering its customers checking and savings accounts, debit cards, certificates of deposit, safety deposit boxes and a wide range of lending services, including commercial and industrial loans, residential real estate loans, single payment personal loans, installment loans and credit card accounts. In addition, the Bank provides trust services. The deposit accounts of the Bank are insured by the Federal Deposit Insurance Corporation (FDIC) to the extent provided by law. The operations of the Bank are supervised and regulated by the FDIC and the Missouri Division of Finance. Periodic examinations of the Bank are conducted by representatives of the FDIC and the Missouri Division of Finance. Such regulations, supervision and examinations are principally for the benefit of depositors, rather than for the benefit of shareholders. The Company is subject to supervision and examination by the Board of Governors of the Federal Reserve System. Significant Developments and Transactions The item listed below materially affects the comparability of our results of operations for the three and six months ended June 30, 2022 and 2021, and our financial condition as of June 30, 2022 and December 31, 2021, and may affect the comparability of financial information we report in future fiscal periods. COVID-19 Pandemic The Coronavirus Disease 2019 (COVID-19) pandemic (the pandemic) has impacted the Company and may continue to do so, as uncertainty remains about the duration of the pandemic and the timing and strength of the global and national economic recovery. In conjunction with our efforts to support clients affected by the pandemic, the Company has cumulatively originated $136.0 million in loans under the Paycheck Protection Program (PPP) with amounts outstanding of $1.1 million and $8.4 million at June 30, 2022 and December 31, 2021, respectively. For more information on PPP loans, see Note 2 – Loans and Allowance for Loan Losses in the Notes to Consolidated Financial Statements (unaudited) . The future direct and indirect impact of the pandemic on our businesses, results of operations and financial condition remains uncertain. Should current economic conditions deteriorate or if the pandemic worsens due to various factors, including through the spread of more easily communicable variants of COVID-19, such conditions could have an adverse effect on our businesses and results of operations and could adversely affect our financial condition. 36 CRITICAL ACCOUNTING POLICIES The following accounting policies are considered most critical to the understanding of the Company’s financial condition and results of operations. These critical accounting policies require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. Because these estimates and judgments are based on current circumstances, they may change over time or prove to be inaccurate based on actual experiences. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of a materially different financial condition and/or results of operations could reasonably be expected. The impact and any associated risks related to the critical accounting policies on the business operations are discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations , where such policies affect the reported and expected financial results. Allowance for Loan Losses Management has identified the accounting policy related to the allowance for loan losses as critical to the understanding of the Company’s results of operations, since the application of this policy requires significant management assumptions and estimates that could result in materially different amounts to be reported if conditions or underlying circumstances were to change. Further discussion of the methodology used in establishing the allowance and the impact of any associated risks related to these policies on the Company’s business operations is provided in Note 1 - Summary of Significant Accounting Policies and is also discussed in the Lending and Credit Management section below. Many of the loans are deemed collateral dependent for purposes of the measurement of the impairment loss, thus the fair value of the underlying collateral and sensitivity of such fair values due to changing market conditions, supply and demand, condition of the collateral and other factors can be volatile over periods of time. Such volatility can have an impact on the financial performance of the Company. 37 Executive Summary The Company has prepared all of the consolidated financial information in this report in accordance with U.S. GAAP. In preparing the consolidated financial statements in accordance with U.S. GAAP, the Company makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurances that actual results will not differ from those estimates. Three Months Ended (Dollars in thousands, except per share data) June 30, 2022 March 31, 2022 June 30, 2021 Net interest income $ 14,561 $ 14,145 $ 13,671 Provision for (release of) loan losses 1,200 (2,500) 400 Non-interest income 3,648 3,726 4,661 Investment securities (losses) gains, net (9) (4) — Non-interest expense 11,540 12,227 11,841 Income before income taxes 5,460 8,140 6,091 Income tax expense 971 1,531 1,199 Net income $ 4,489 $ 6,609 $ 4,892 Basic earnings per share $ 0.66 $ 0.97 $ 0.71 Diluted earnings per share $ 0.66 $ 0.97 $ 0.71 Efficiency ratio (1) 63.38% 68.42% 64.59% Net interest spread 3.47% 3.36% 3.24% Net interest margin 3.64% 3.50% 3.40% Six Months Ended June 30, (Dollars in thousands, except per share data) 2022 2021 Net interest income $ 28,706 $ 28,062 (Release of) provision for loan losses (1,300) 400 Non-interest income 7,374 9,233 Investment securities (losses) gains, net (13) 15 Non-interest expense 23,767 23,622 Income before income taxes 13,600 13,288 Income tax expense 2,502 2,557 Net income $ 11,098 $ 10,731 Basic earnings per share $ 1.63 $ 1.56 Diluted earnings per share $ 1.63 $ 1.56 Efficiency ratio (1) 65.87% 63.34% Net interest spread 3.41% 3.34% Net interest margin 3.57% 3.51% (1) Efficiency ratio is calculated as non-interest expense as a percentage of revenue. Total revenue is calculated as net interest income plus non-interest income. 38 As of and for the Three and Six Months Ended June 30, 2022 March 31, 2022 June 30, 2021 Key financial ratios Book value per share $ 18.20 $ 19.58 $ 19.85 Market price per share $ 25.49 $ 24.31 $ 22.05 Quarter Cash dividends paid on common stock $ 990 $ 993 $ 828 Return on total assets 1.04% 1.51% 1.14% Return on stockholders' equity 14.00% 18.41% 14.64% Average stockholders' equity to total assets 7.40% 8.22% 7.76% Year-to-date Cash dividends paid on common stock $ 1,983 $ 993 $ 1,670 Return on total assets 1.28% 1.51% 1.26% Return on stockholders' equity 16.33% 18.41% 16.31% Average stockholders' equity to total assets 7.81% 8.22% 7.70% Capital Ratios Stockholders' equity to assets 6.93% 7.74% 7.99% Total risk-based capital ratio 13.97% 14.66% 14.66% Tier 1 risk-based capital ratio 12.53% 13.44% 13.20% Common equity Tier 1 capital 9.85% 10.36% 9.91% Tier 1 leverage ratio (1) 10.98% 10.99% 10.49% Asset Quality Net-charge-offs (recoveries) (Qtr) $ 126 $ 124 $ 26 Net-charge-offs (recoveries) (Ytd) $ 250 $ 124 $ (222) Non-performing loans $ 17,817 $ 17,099 $ 33,788 Classified assets $ 99,200 $ 104,073 $ 136,599 Non-performing loans to total loans 1.25% 1.28% 2.61% Non-performing assets to total assets 1.51% 1.55% 2.68% Allowance for loan losses to total loans 1.08% 1.07% 1.45% (1) Tier 1 leverage ratio is calculated by dividing Tier 1 capital by average total consolidated assets Results of Operations Highlights: Consolidated net income of $4.5 million for the second quarter 2022 decreased $2.1 million compared to the first quarter 2022 ("linked quarter") and decreased $0.4 million from the second quarter 2021 (the "prior year quarter"). Earnings per diluted share were $0.66 for the second quarter 2022 compared to $0.97 and $0.71 for the linked quarter and prior year quarter, respectively. For the second quarter 2022, the return on average assets was 1.04%, the return on average stockholders’ equity was 14.00%, and the efficiency ratio was 63.4%. Consolidated net income of $11.1 million, or $1.63 per diluted share, for the six months ended June 30, 2022 increased $0.4 million compared to $10.7 million, or $1.56 per diluted share, for the six months ended June 30, 2021. For the six months ended June 30, 2022, the return on average assets was 1.28%, the return on average stockholders’ equity was 16.33%, and the efficiency ratio was 65.9%. Net interest income of $14.6 million for the second quarter 2022, increased $0.4 million from the linked quarter, and increased $0.9 million from the prior year quarter. Net interest margin, on a fully taxable equivalent basis ("FTE") basis, was 3.64% for the second quarter, an increase from 3.50% for the linked quarter, and an increase from 3.40% for the prior year quarter. 39 Net interest income of $28.7 million, for the six months ended June 30, 2022, increased $0.6 million compared to $28.1 million for the six months ended June 30, 2021. Net interest margin, on a fully taxable equivalent basis ("FTE") basis, was 3.57% for the six months ended June 30, 2022, an increase from 3.51% for the six months ended June 30, 2021. These changes are discussed in greater detail under the Average Balance Sheet Data and Rate and Volume Analysis section below. Non-interest income for the second quarter 2022 was $3.6 million, a decrease of $0.1 million, or 2.1%, from the linked quarter, and a decrease of $1.0 million, or 21.7%, from the prior year quarter. The change in the current quarter compared to the prior year quarter is primarily due to the decrease in the gain on sale of real estate mortgages of $1.2 million, or 60.5%. Non-interest income of $7.4 million, for the six months ended June 30, 2022 decreased $1.9 million, or 20.1%, compared to $9.2 million for the six months ended June 30, 2021. The change was primarily due to the decrease in the gain on sale of real estate mortgages of $2.8 million, or 62.4%. These changes are discussed in greater detail under the Non-interest Income and Expense section below. Non-interest expense for the second quarter 2022, was $11.5 million, a decrease of $0.7 million, or 5.6%, from the linked quarter, and a decrease of $0.3 million, or 2.5%, from the prior year quarter. The change in the current quarter compared to the linked quarter is primarily due to the decrease in salary and benefits expenses and the change in the fair value adjustment for mortgage banking derivative liabilities. Non-interest expense for the six months ended June 30, 2022 was $23.8 million, an increase of $0.1 million, or 0.6%, from the six months ended June 30, 2021. The change was primarily due to the new software maintenance agreements and the change in the fair value adjustment for mortgage banking derivatives, partially offset by a decrease in salary and benefits. These changes are discussed in greater detail under the Non-interest Income and Expense section below. Balance Sheet Highlights: Loans – Loans held for investment increased by $93.9 million, or 7.0%, equal to $1.4 billion as of June 30, 2022 as compared to the end of the linked quarter. Year-over-year, loans held for investment grew $133.9 million, or 10.4%, from $1.3 billion as of June 30, 2021. Asset quality – Non-performing loans totaled $17.8 million at June 30, 2022, an increase of $0.7 million from $17.1 million at the end of the linked quarter, and a decrease of $16.0 million from $33.8 million at the end of the prior year quarter. The reduction in non-performing loans in the current quarter as compared to the prior year quarter was primarily due to several large non-accrual loans returning to accrual status. The allowance for loan losses to total loans was 1.08% at June 30, 2022, compared to 1.30% at December 31, 2021 and 1.45% at June 30, 2021. These changes are discussed in greater detail under the Lending and Credit Management section below. Deposit s – Total deposits increased by $74.7 million, or 5.1%, equal to $1.5 billion as of June 30, 2022 as compared to the end of the linked quarter. Year-over-year deposits grew $149.8 million, or 10.8%, from $1.4 billion as of June 30, 2021. Capital – Total shareholder’s equity was $124.1 million and the common equity to assets ratio was 6.93% at June 30, 2022 as compared to 7.74% and 7.99% at the end of the linked quarter and the prior year quarter, respectively. Regulatory capital ratios remain “well-capitalized,” with tier 1 leverage ratio of 10.98% and a total risk-based capital ratio of 13.97% at June 30, 2022. Average Balance Sheet Data Net interest income is the largest source of revenue resulting from the Company’s lending, investing, borrowing, and deposit gathering activities. It is affected both by changes in the level of interest rates and changes in the amounts and mix of interest earning assets and interest-bearing liabilities. The following table presents average balance sheet data, net interest income, average yields of earning assets, average costs of interest-bearing liabilities, net interest spread and net interest margin on a fully taxable equivalent basis for each of the three and six month periods ended June 30, 2022 and 2021, respectively. The average balances used in this table and other statistical data were calculated using average daily balances. 40 Three Months Ended June 30, 2022 2022 2021 (Dollars in thousands) Average Balance Interest Income/ Expense (1) Rate Earned/ Paid (1) Average Balance Interest Income/ Expense (1) Rate Earned/ Paid (1) ASSETS Loans: (2) (3) Commercial $ 232,187 $ 2,816 4.86% $ 256,557 $ 2,999 4.69% Real estate construction - residential 23,167 276 4.78 35,005 427 4.89 Real estate construction - commercial 107,744 1,165 4.34 77,726 912 4.71 Real estate mortgage - residential 296,119 3,048 4.13 263,477 2,843 4.33 Real estate mortgage - commercial 681,926 7,208 4.24 618,126 6,620 4.30 Installment and other consumer 22,865 202 3.54 24,794 243 3.93 Total loans $ 1,364,008 $ 14,715 4.33% $ 1,275,685 $ 14,044 4.42% Loans held for sale 1,682 26 6.20 4,222 29 2.76 Investment securities: U.S. Treasury 4,135 11 1.07 3,039 8 1.06 U.S. government and federal agency obligations 25,917 93 1.44 22,729 100 1.76 Obligations of states and political subdivisions 117,103 1,091 3.74 88,153 670 3.05 Mortgage-backed securities 118,113 501 1.70 131,134 416 1.27 Other debt securities 13,012 159 4.90 12,887 157 4.89 Total investment securities 278,280 1,855 2.67 257,942 1,351 2.10 Other investment securities 5,446 66 4.86 6,070 81 5.35 Federal funds sold 645 4 2.49 5,980 1 0.07 Interest bearing deposits in other financial institutions 16,953 43 1.02 110,674 87 0.32 Total interest earning assets $ 1,667,014 $ 16,709 4.02% $ 1,660,573 $ 15,593 3.77% All other assets 86,474 85,372 Allowance for loan losses (14,383) (18,467) Total assets $ 1,739,105 $ 1,727,478 LIABILITIES AND STOCKHOLDERS' EQUITY Savings $ 180,781 $ 15 0.03% $ 156,943 $ 14 0.04% NOW accounts 267,441 363 0.54 227,179 134 0.24 Interest checking 25,823 54 0.84 41,336 47 0.46 Money market 293,251 146 0.20 281,832 81 0.12 Time deposits 247,511 324 0.53 246,862 504 0.82 Total interest bearing deposits $ 1,014,807 $ 902 0.36% $ 954,152 $ 780 0.33% Federal funds purchased and securities sold under agreements to repurchase 6,548 9 0.55 45,261 26 0.23 Federal Home Loan Bank advances and other borrowings 76,198 248 1.31 94,823 385 1.63 Subordinated notes 49,486 422 3.42 49,486 307 2.49 Total borrowings 132,232 679 2.06 189,570 718 1.52 Total interest bearing liabilities $ 1,147,039 $ 1,581 0.55% $ 1,143,722 $ 1,498 0.53% Demand deposits 453,348 433,878 Other liabilities 10,110 15,878 Total liabilities $ 1,610,497 $ 1,593,478 Stockholders' equity 128,608 134,000 Total liabilities and stockholders' equity $ 1,739,105 $ 1,727,478 Net interest income (FTE) $ 15,128 $ 14,095 Net interest spread 3.47% 3.24% Net interest margin 3.64% 3.40% (1) Interest income and yields are presented on a fully taxable equivalent basis using the federal statutory income tax rate of 21%, net of nondeductible interest expense, for the three months ended June 30, 2022 and 2021. Such adjustments totaled $0.6 million and $0.4 million for the three months ended June 30, 2022 and 2021, respectively. (2) Non-accruing loans are included in the average amounts outstanding. (3) Fees and costs on loans are included in interest income ($0.1 million and $0.5 million of PPP fees were included in commercial loan income for the three months ended June 30, 2022 and 2021, respectively) 41 Six Months Ended June 30, 2022 2022 2021 (Dollars in thousands) Average Balance Interest Income/ Expense (1) Rate Earned/ Paid (1) Average Balance Interest Income/ Expense (1) Rate Earned/ Paid (1) ASSETS Loans: (2) (3) Commercial $ 226,569 $ 5,648 5.03% $ 257,087 $ 7,156 5.61% Real estate construction - residential 23,311 532 4.60 34,252 822 4.84 Real estate construction - commercial 101,872 2,161 4.28 78,150 1,791 4.62 Real estate mortgage - residential 289,011 5,880 4.10 261,768 5,684 4.38 Real estate mortgage - commercial 676,350 14,146 4.22 619,991 13,219 4.30 Installment and other consumer 22,605 408 3.64 25,390 508 4.03 Total loans $ 1,339,718 $ 28,775 4.33% $ 1,276,638 $ 29,180 4.61% Loans held for sale 1,983 46 4.68 4,857 54 2.24 Investment securities: U.S. Treasury 4,073 16 0.79 3,023 16 1.07 U.S. government and federal agency obligations 26,640 184 1.39 23,473 201 1.73 Obligations of states and political subdivisions 121,814 2,113 3.50 74,878 1,121 3.02 Mortgage-backed securities 125,476 1,010 1.62 123,351 798 1.30 Other debt securities 13,233 313 4.77 12,216 302 4.99 Total investment securities 291,236 3,636 2.52 236,941 2,438 2.07 Other investment securities 5,429 141 5.24 6,026 165 5.52 Federal funds sold 3,423 5 0.29 13,089 5 0.08 Interest bearing deposits in other financial institutions 43,740 102 0.47 119,811 185 0.31 Total interest earning assets $ 1,685,529 $ 32,705 3.91% $ 1,657,362 $ 32,027 3.90% All other assets 84,893 84,893 Allowance for loan losses (15,648) (18,467) Total assets $ 1,754,774 $ 1,723,788 LIABILITIES AND STOCKHOLDERS' EQUITY Savings $ 178,726 $ 30 0.03% $ 149,879 $ 26 0.03% NOW accounts 266,497 550 0.42 229,234 272 0.24 Interest checking 27,601 81 0.59 51,373 122 0.48 Money market 291,207 232 0.16 280,539 164 0.12 Time deposits 254,033 714 0.57 256,899 1,176 0.92 Total interest bearing deposits $ 1,018,064 $ 1,607 0.32% $ 967,924 $ 1,760 0.37% Federal funds purchased and securities sold under agreements to repurchase 10,149 19 0.38 43,394 52 0.24 Federal Home Loan Bank advances and other borrowings 76,795 501 1.32 96,479 781 1.63 Subordinated notes 49,486 745 3.04 49,486 617 2.51 Total borrowings 136,430 1,265 1.87 189,359 1,450 1.54 Total interest bearing liabilities $ 1,154,494 $ 2,872 0.50% $ 1,157,283 $ 3,210 0.56% Demand deposits 451,273 416,749 Other liabilities 11,969 17,070 Total liabilities $ 1,617,736 $ 1,591,102 Stockholders' equity 137,038 132,686 Total liabilities and stockholders' equity $ 1,754,774 $ 1,723,788 Net interest income (FTE) $ 29,833 $ 28,817 Net interest spread 3.41% 3.34% Net interest margin 3.57% 3.51% (1) Interest income and yields are presented on a fully taxable equivalent basis using the federal statutory income tax rate of 21%, net of nondeductible interest expense, for the six months ended June 30, 2022 and 2021. Such adjustments totaled $1.1 million and $0.8 million for the six months ended June 30, 2022 and 2021, respectively. (2) Non-accruing loans are included in the average amounts outstanding. (3) Fees and costs on loans are included in interest income ($0.3 million and $2.0 million of PPP fees were included in commercial loan income for the six months ended June 30, 2022 and 2021, respectively). 42 Rate and Volume Analysis The following table summarizes the changes in net interest income on a fully taxable equivalent basis, by major category of interest earning assets and interest-bearing liabilities, identifying changes related to volumes and rates for the three and six months ended June 30, 2022 compared to the three and six months ended June 30, 2021. The change in interest due to the combined rate/volume variance has been allocated to rate and volume changes in proportion to the absolute dollar amounts of change in each. Three Months Ended June 30, Six Months Ended June 30, 2022 vs. 2021 2022 vs. 2021 Change due to Change due to (in thousands) Total Change Average Volume Average Rate Total Change Average Volume Average Rate Interest income on a fully taxable equivalent basis: (1) Loans: (2) (3) Commercial $ (183) $ (292) $ 109 $ (1,508) $ (802) $ (706) Real estate construction - residential (151) (141) (10) (290) (251) (39) Real estate construction - commercial 253 329 (76) 370 511 (141) Real estate mortgage - residential 205 341 (136) 196 568 (372) Real estate mortgage - commercial 588 676 (88) 927 1183 (256) Installment and other consumer (41) (18) (23) (100) (53) (47) Loans held for sale (3) (25) 22 (8) (44) 36 Investment securities: U.S. Treasury 3 3 — 0 5 (5) U.S. government and federal agency obligations (7) 13 (20) (17) 25 (42) Obligations of states and political subdivisions 421 250 171 992 792 200 Mortgage-backed securities 85 (44) 129 212 14 198 Other debt securities 2 2 — 11 24 (13) Other investment securities (15) (8) (7) (24) (16) (8) Federal funds sold 3 (2) 5 0 (6) 6 Interest bearing deposits in other financial institutions (44) (120) 76 (83) (150) 67 Total interest income $ 1,116 $ 964 $ 152 $ 678 $ 1,800 $ (1,122) Interest expense: Savings $ 1 $ 2 $ (1) $ 4 $ 4 $ — NOW accounts 229 28 201 278 50 228 Interest checking 7 (22) 29 (41) (65) 24 Money market 65 4 61 68 7 61 Time deposits (180) 1 (181) (462) (13) (449) Federal funds purchased and securities sold under agreements to repurchase (17) (34) 17 (33) (53) 20 Federal Home Loan Bank advances and other borrowings (137) (68) (69) (280) (143) (137) Subordinated notes 115 — 115 128 — 128 Total interest expense $ 83 $ (89) $ 172 $ (338) $ (213) $ (125) Net interest income on a fully taxable equivalent basis $ 1,033 $ 1,053 $ (20) $ 1,016 $ 2,013 $ (997) (1) Interest income and yields are presented on a fully taxable equivalent basis using the federal statutory income tax rate of 21%, net of nondeductible interest expense, for the six months ended June 30, 2022 and 2021. Such adjustments totaled $1.1 million and $0.8 million for the six months ended June 30, 2022 and 2021, respectively. (2) Non-accruing loans are included in the average amounts outstanding. (3) Fees and costs on loans are included in interest income ($0.3 million and $2.0 million of PPP fees were included in commercial loan income for the six months ended June 30, 2022 and 2021, respectively). 43 Financial results for the quarter ended June 30, 2022 compared to the quarter ended June 30, 2021 reflected an increase in net interest income, on a tax equivalent basis, of $1.0 million, or 7.3%, and the financial results for the six months ended June 30, 2022 compared to the six months ended June 30, 2021 reflected an increase of $1.0 million, or 3.5%. Measured as a percentage of average earning assets, the net interest margin (expressed on a fully taxable equivalent basis) increased to 3.64% for the quarter ended June 30, 2022 compared to 3.40% for the quarter ended June 30, 2021, and increased to 3.57% for the six months ended June 30, 2022 compared to 3.51% for the six months ended June 30, 2021. Driving the increase in net interest income in the quarter compared to the prior year quarter was higher interest income, resulting from growth in both loans and investments securities of 6.9% and 7.9%, respectively. The increase in net interest income for the current year verses the prior year, on a year-to-date basis was higher interest income resulting from growth in both the balance and yield for the investment securities portfolio, in addition to lower interest expense for interest bearing liabilities. Average interest-earning assets increased $6.4 million, or 0.4%, to $1.67 billion for the quarter ended June 30, 2022 compared to $1.66 billion for the quarter ended June 30, 2021, and average interest-bearing liabilities increased $3.3 million, or 0.3%, to $1.15 billion for the quarter ended June 30, 2022 compared to $1.14 billion for the quarter ended June 30, 2021. Average interest-earning assets increased $28.2 million, or 1.7%, to $1.69 billion for the six months ended June 30, 2022 compared to $1.66 billion for the six months ended June 30, 2021, and average interest-bearing liabilities decreased $2.8 million, or 0.2%, to $1.15 billion for the six months ended June 30, 2022 compared to $1.16 billion for the six months ended June 30, 2021. Total interest income (expressed on a fully taxable equivalent basis) was $16.7 million and $32.7 million for the three and six months ended June 30, 2022, respectively, compared to $15.6 million and $32.0 million for the three and six months ended June 30, 2021, respectively. The Company’s rates earned on interest earning assets were 4.02% and 3.91% for the three and six months ended June 30, 2022, respectively, compared to 3.77% and 3.90% for the three and six months ended June 30, 2021, respectively. Interest income on loans held for investment was $14.7 million and $28.8 million for the three and six months ended June 30, 2022, respectively, compared to $14.0 million and $29.2 million for the three and six months ended June 30, 2021, respectively. Average loans outstanding increased $88.3 million, or 6.9%, to $1.36 billion for the quarter ended June 30, 2022 compared to $1.28 billion for the quarter ended June 30, 2021. The average yield on loans decreased to 4.33% for the quarter ended June 30, 2022 compared to 4.42% for the quarter ended June 30, 2021. Average loans outstanding increased $63.1 million, or 4.9%, to $1.34 billion for the six months ended June 30, 2022 compared to $1.28 billion for the six months ended June 30, 2021. The average yield on loans decreased to 4.33% for the six months ended June 30, 2022 compared to 4.61% for the six months ended June 30, 2021. See the Lending and Credit Management section for further discussion of changes in the composition of the lending portfolio. Interest income on available-for-sale securities was $1.9 million and $3.6 million for the three and six months ended June 30, 2022, respectively, compared to $1.4 million and $2.4 million for the three and six months ended June 30, 2021, respectively. Average securities increased $20.3 million, or 7.9%, to $278.3 million for the quarter ended June 30, 2022 compared to $257.9 million for the quarter ended June 30, 2021. The average yield on securities increased to 2.67% for the quarter ended June 30, 2022 compared to 2.10% for the quarter ended June 30, 2021. See the Liquidity Management section for further discussion. Average securities increased $54.3 million, or 22.9%, to $291.2 million for the six months ended June 30, 2022 compared to $236.9 million for the six months ended June 30, 2021. The average yield on securities increased to 2.52% for the six months ended June 30, 2022 compared to 2.07% for the six months ended June 30, 2021. See the Liquidity Management section for further discussion. Total interest expense increased to $1.6 million for the quarter ended June 30, 2022 compared to $1.5 million for the quarter ended June 30, 2021, and decreased to $2.9 million for the six months ended June 30, 2022 compared to $3.2 million for the six months ended June 30, 2021. The Company’s rates paid on interest bearing liabilities were 0.55% and 44 0.50% for the three and six months ended June 30, 2022, respectively, compared to 0.53% and 0.56% for the three and six months ended June 30, 2021, respectively. See the Liquidity Management section for further discussion. Interest expense on deposits increased to $0.9 million for the quarter ended June 30, 2022 compared to $0.8 million for the quarter ended June 30, 2021, and decreased to $1.6 million for the six months ended June 30, 2022 compared to $1.8 million for the six months ended June 30, 2021. Average interest-bearing deposits increased $60.7 million, or 6.4%, to $1.01 billion for the quarter ended June 30, 2022 compared to $0.95 billion for the quarter ended June 30, 2021. The average cost of deposits increased to 0.36% for the quarter ended June 30, 2022 compared to 0.33% for the quarter ended June 30, 2021. Average interest-bearing deposits increased $50.1 million, or 5.2%, to $1.02 billion for the six months ended June 30, 2022 compared to $0.97 billion for the six months ended June 30, 2021. The average cost of deposits decreased to 0.32% for the six months ended June 30, 2022 compared to 0.37% for the six months ended June 30, 2021. Interest expense on borrowings decreased to $0.7 million and $1.3 million for the three and six months ended June 30, 2022, respectively, compared to $0.7 million and $1.5 million for the three and six months ended June 30, 2021, respectively. Average borrowings decreased to $132.2 million for the quarter ended June 30, 2022 compared to $189.6 million for the quarter ended June 30, 2021. The average cost of borrowings increased to 2.06% for the quarter ended June 30, 2022 compared to 1.52% for the quarter ended June 30, 2021. The increase in cost of funds primarily resulted from higher market interest rates. Average borrowings decreased to $136.4 million for the six months ended June 30, 2022 compared to $189.4 million for the six months ended June 30, 2021. The average cost of borrowings increased to 1.87% for the six months ended June 30, 2022 compared to 1.54% for the six months ended June 30, 2021. The increase in cost of funds primarily resulted from higher market interest rates. Non-interest Income and Expense Non-interest income for the periods indicated was as follows: Three Months Ended June 30, Six Months Ended June 30, (Dollars in thousands) 2022 2021 $ Change % Change 2022 2021 $ Change % Change Non-interest income Service charges and other fees $ 835 $ 765 $ 70 9.2 % $ 1,628 $ 1,504 $ 124 8.2 % Bank card income and fees 1,063 1,022 41 4.0 % 2,024 1,882 142 7.5 % Trust department income 296 308 (12) (3.9) % 636 602 34 5.6 % Real estate servicing fees, net 248 351 (103) (29.3) % 478 424 54 12.7 % Gain on sales of mortgage loans, net 806 2,041 (1,235) (60.5) % 1,695 4,511 (2,816) (62.4) % Other 400 174 226 129.9 % 913 310 603 194.5 % Total non-interest income $ 3,648 $ 4,661 $ (1,013) (21.7) % $ 7,374 $ 9,233 $ (1,859) (20.1) % Non-interest income as a % of total revenue * 20.0 % 25.4 % 20.4 % 24.8 % * Total revenue is calculated as net interest income plus non-interest income. Total non-interest income decreased $1.0 million, or 21.7%, to $3.6 million for the second quarter ended June 30, 2022 compared to $4.7 million for the second quarter ended June 30, 2021, and decreased $1.9 million, or 20.1%, to $7.4 million for the six months ended June 30, 2022 compared to $9.2 million for the six months ended June 30, 2021. The decrease was primarily due to the decrease in gain on sale of real estate mortgages due to lower volumes of real estate mortgage loans sold as further discussed below. Real estate servicing fees, net of the change in valuation of mortgage servicing rights (MSRs) decreased to $0.2 million for the quarter ended June 30, 2022 compared to $0.4 million for the quarter ended June 30, 2021, and increased to $0.5 million for the six months ended June 30, 2022 compared to $0.4 million for the six months ended June 30, 2021. 45 Mortgage loan servicing fees earned on loans sold were $0.2 million and $0.4 million for the three and six months ended June 30, 2022, respectively, compared to $0.2 million and $0.4 million for the three and six months ended June 30, 2021, respectively. The current quarter's MSR valuation increased $160,000 and $190,000 from the linked quarter and December 31, 2021, respectively, primarily due to an increase in market rates. The Company was servicing $252.3 million of mortgage loans at June 30, 2022 compared to $270.0 million and $286.6 million at December 31, 2021 and June 30, 2021, respectively. Gain on sales of mortgage loans decreased $1.2 million to $0.8 million for the second quarter ended June 30, 2022 compared to $2.0 million for the second quarter ended June 30, 2021, and decreased $2.8 million to $1.7 million for the six months ended June 30, 2022 compared to $4.5 million for the six months ended June 30, 2021. The Company sold $25.7 million and $54.7 million of loans for the three and six months ended June 30, 2022, respectively, compared to $62.1 million and $128.2 million for the three and six months ended June 30, 2021, respectively. Loans sold to the secondary market slowed after strong sales during the first six months of 2021. Other Income increased $0.2 million to $0.4 million for the quarter ended June 30, 2022 compared to $0.2 million for the quarter ended June 30, 2021, and increased $0.6 million to $0.9 million for the six months ended June 30, 2022 compared to $0.3 million for the six months ended June 30, 2021. The increase primarily resulted from mortgage banking derivative income, interest component of net pension cost, net gain on sale of property in other real estate owned, and income received from the Missouri Department of Transportation related to a land easement. During the fourth quarter of 2021, the Company elected to record the fair value of derivatives related to interest rate lock commitments and mandatory commitments and the related changes due to volume and rates through non-interest income and non-interest expense. The following table presents the gross realized gains and losses from sales and calls of available-for-sale securities, as well as gains and losses on equity securities from fair value adjustments which have been recognized in earnings: Three Months Ended June 30, Six Months Ended June 30, (in thousands) 2022 2021 2022 2021 Investment securities (losses) gains, net Available-for-sale securities: Gross realized gains $ — $ — $ — $ 2 Gross realized losses — — — — Other-than-temporary impairment recognized — — — — Other investment securities: Fair value adjustments, net (9) — (13) 13 Investment securities (losses) gains, net $ (9) $ — $ (13) $ 15 46 Non-interest expense for the periods indicated was as follows: Three Months Ended June 30, Six Months Ended June 30, (Dollars in thousands) 2022 2021 $ Change % Change 2022 2021 $ Change % Change Non-interest expense Salaries $ 5,008 $ 5,151 $ (143) (2.8)% $ 10,163 $ 10,493 $ (330) (3.1)% Employee benefits 1,608 1,804 (196) (10.8) 3,339 3,608 (269) (7.5) Occupancy expense, net 765 719 46 6.4 1,550 1,490 60 4.0 Furniture and equipment expense 771 753 18 2.4 1,526 1,497 29 1.9 Processing, network and bank card expense 1,142 1,224 (82) (6.7) 2,284 2,232 52 2.3 Legal, examination, and professional fees 375 385 (10) (2.6) 815 789 26 3.3 Advertising and promotion 304 309 (5) (1.6) 597 552 45 8.2 Postage, printing, and supplies 226 186 40 21.5 416 390 26 6.7 Loan expense 157 229 (72) (31.4) 303 403 (100) (24.8) Other 1,184 1,081 103 9.5 2,774 2,168 606 28.0 Total non-interest expense $ 11,540 $ 11,841 $ (301) (2.5)% $ 23,767 $ 23,622 $ 145 0.6% Efficiency ratio* 63.4 % 64.6 % 65.9 % 63.3 % Number of full-time equivalent employees 300 306 300 306 * Efficiency ratio is calculated as non-interest expense as a percent of revenue. Total revenue is calculated as net interest income plus non-interest income. Total non-interest expense decreased $0.3 million to $11.5 million for the quarter ended June 30, 2022 compared to $11.8 million for the quarter ended June 30, 2021, and increased $0.1 million to $23.8 million for the six months ended June 30, 2022 compared to $23.6 million for the six months ended June 30, 2021. Salaries decreased $0.1 million, or 2.8%, to $5.0 million for the quarter ended June 30, 2022 compared to $5.2 million for the quarter ended June 30, 2021, and decreased $0.3 million, or 3.1%, to $10.2 million for the six months ended June 30, 2022 compared to $10.5 million for the six months ended June 30, 2021. The decreases were primarily due to reduced commissions based on lower loan volume. See Gains on sales of mortgage loans discussion above. Employee benefits decreased $0.2 million, or 10.8%, to $1.6 million for the quarter ended June 30, 2022 compared to $1.8 million for the quarter ended June 30, 2021, and decreased $0.3 million, or 7.5%, to $3.3 million for the six months ended June 30, 2022 compared to $3.6 million for the six months ended June 30, 2021. The decreases were primarily due to a decrease in 401(k) plan contributions, medical premiums, and pension cost due to lower annual discount rate assumptions compared to the prior year's annual assumptions. Other non-interest expense increased $0.1 million, or 9.5%, to $1.2 million for the quarter ended June 30, 2022 compared to $1.1 million for the quarter ended June 30, 2021, and increased $0.6 million, or 28.0%, to $2.8 million for the six months ended June 30, 2022 compared to $2.2 million for the six months ended June 30, 2021. The increases were primarily related to the change in the fair value adjustment for mortgage banking derivatives, telephone and software expense related to network upgrades and maintenance agreements. During the fourth quarter of 2021, the Company elected to record the fair value of derivatives related to interest rate lock commitments and mandatory commitments and the related changes due to volume and rates through non-interest income and non-interest expense. Income taxes Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 17.8% and 18.4% for the three and six months ended June 30, 2022, respectively, compared to 19.7% and 19.2% for the three and six months ended June 30, 2021, respectively. The decrease in the effective tax rate for the three months ended June 30, 2022 compared to the three months ended June 30, 2021 was primarily attributable to the decrease in earnings and the benefit recorded pertaining to the historical tax credit. The decrease in the effective tax rate for the six months ended June 30, 2022 compared to the six months ended June 30, 2021 was primarily attributable to the increase in earnings and an increase in state taxes attributed to elevated earnings partially offset by the benefit recorded pertaining to the historical tax credit. The effective tax rate for each of the three and six months ended June 30, 2022 and 2021, respectively, is lower than the U.S. federal statutory rate of 21% primarily due to tax-free revenues. 47 Included in the effective tax rate is a $14,000 and $27,000 benefit associated with a historic tax credit investment for the three and six months ended June 30, 2022, respectively. The investment is expected to generate a $331,000 tax benefit over the life of the project and is being recognized under the deferral method of accounting. Lending and Credit Management Interest earned on the loan portfolio is a primary source of interest income for the Company. Net loans represented 78.9% of total assets as of June 30, 2022 compared to 70.2% as of December 31, 2021. Lending activities are conducted pursuant to an established loan policy approved by the Bank’s Board of Directors. The Bank’s credit review process is overseen by regional loan committees with established loan approval limits. In addition, a senior loan committee reviews all credit relationships in aggregate over an established dollar amount. The senior loan committee meets weekly and is comprised of senior managers of the Bank. Major classifications within the Company’s held for investment loan portfolio as of the dates indicated is as follows: June 30, 2022 December 31, 2021 (Dollars in thousands) Amount % of Loans Amount % of Loans Commercial, financial, and agricultural (a) $ 242,701 17.0 % $ 217,214 16.7 % Real estate construction − residential 23,629 1.7 27,920 2.1 Real estate construction − commercial 119,079 8.3 91,369 7.0 Real estate mortgage − residential 312,086 21.9 279,346 21.5 Real estate mortgage − commercial 706,700 49.5 663,256 50.9 Installment and other consumer 23,633 1.7 23,028 1.8 Total loans held for investment $ 1,427,828 100.0 % $ 1,302,133 100.0 % (a) Includes $1.1 million and $8.4 million of SBA PPP loans, net as of June 30, 2022 and December 31, 2021, respectively. The Company extends credit to its local community markets through traditional real estate mortgage products. The Company does not participate in credit extensions to sub-prime residential real estate markets. The Company does not lend funds for transactions defined as “highly leveraged” by bank regulatory authorities or for foreign loans. Additionally, the Company does not have any concentrations of loans exceeding 10% of total loans that are not otherwise disclosed in the loan portfolio composition table. The Company does not have any interest-earning assets that would have been included in non-accrual, past due, or restructured loans if such assets were loans. The Company generally does not retain long-term fixed rate residential mortgage loans in its portfolio. Fixed rate loans conforming to standards required by the secondary market are offered to qualified borrowers but are not funded until the Company has a non-recourse purchase commitment from the secondary market at a predetermined price. During the six months ended June 30, 2022, the Company sold approximately $54.7 million of loans to investors compared to $128.2 million for the six months ended June 30, 2021. At June 30, 2022, the Company was servicing approximately $252.3 million of loans sold to the secondary market compared to $270.0 million at December 31, 2021, and $286.6 million at June 30, 2021. Risk Elements of the Loan Portfolio Management, the senior loan committee, and internal loan review, formally review all loans in excess of certain dollar amounts (periodically established) at least annually. Loans in excess of $2.0 million in aggregate and all adversely classified credits identified by management are reviewed by the senior loan committee. In addition, all other loans are reviewed on a risk weighted selection process. The senior loan committee reviews and reports to the Board of Directors, at scheduled meetings: past due, classified, and watch list loans in order to classify or reclassify loans as loans requiring attention, substandard, doubtful, or loss. During this review, management also determines which loans should be considered impaired. Management follows the guidance provided in the Financial Accounting Standards Board's (FASB) ASC Topic 310-10-35 in identifying and measuring loan impairment. If management determines that it is probable that all amounts due on a loan will not be collected under the original terms of the loan agreement, the loan is considered impaired. These loans are evaluated individually for impairment, and in conjunction with current economic conditions and loss experience, specific reserves are estimated as further discussed below. Loans not individually evaluated are aggregated and reserves are recorded using a consistent methodology that considers historical loan loss experience by loan type, 48 delinquencies, current economic conditions, loan risk ratings and industry concentration. Management believes, but there can be no assurance, that these procedures keep management informed of potential problem loans. Based upon these procedures, both the allowance and provision for loan losses are adjusted to maintain the allowance at a level considered necessary by management to provide for probable losses inherent in the loan portfolio. Non-performing Assets The following table summarizes non-performing assets at the dates indicated: June 30, December 31, (Dollars in thousands) 2022 2021 Non-accrual loans: Commercial, financial, and agricultural $ 131 $ 153 Real estate construction − commercial 96 105 Real estate mortgage − residential 1,129 1,129 Real estate mortgage − commercial 16,097 24,029 Installment and other consumer 195 43 Total $ 17,648 $ 25,459 Loans contractually past - due 90 days or more and still accruing: Real estate mortgage − residential $ 167 $ 14 Installment and other consumer 2 — Total $ 169 $ 14 Total non-performing loans (a) 17,817 25,473 Other real estate owned and repossessed assets 9,155 10,525 Total non-performing assets $ 26,972 $ 35,998 Loans held for investment $ 1,427,828 $ 1,302,133 Allowance for loan losses to loans 1.08 % 1.30 % Non-accrual loans to total loans 1.24 % 1.96 % Non-performing loans to loans (a) 1.25 % 1.96 % Non-performing assets to loans (b) 1.89 % 2.76 % Non-performing assets to assets (b) 1.51 % 1.97 % Allowance for loan losses to non-accrual loans 87.00 % 66.39 % Allowance for loan losses to non-performing loans 86.17 % 66.36 % (a) Non-performing loans include loans 90 days past due and accruing, non-accrual loans, and non-performing TDRs included in non-accrual loans and 90 days past due. (b) Non-performing assets include non-performing loans and other real estate owned and repossessed assets. Total non-performing assets were $27.0 million, or 1.89% of total loans, at June 30, 2022 compared to $36.0 million, or 2.76% of total loans, at December 31, 2021. Total non-accrual loans at June 30, 2022 decreased $7.8 million, or 30.7%, to $17.6 million compared to $25.5 million at December 31, 2021. There were $169,000 in loans past due 90 days and still accruing interest at June 30, 2022 compared to $14,000 at December 31, 2021. Other real estate and repossessed assets were $9.2 million and $10.5 million at June 30, 2022 and December 31, 2021, respectively. During the six months ended June 30, 2022, there were no additions to other real estate owned compared to $30,000 of non-accrual loans, net of charge-offs taken, during the six months ended June 30, 2021. During the first quarter ended June 30, 2022, an additional $52,000 charge-off was recorded related to a property that moved into other real estate owned at the end of the fourth quarter of 2021. As of June 30, 2022, approximately $13.2 million of loans classified as substandard, which include performing TDRs, and were not included in the non-performing asset table, were identified as potential problem loans having more than normal risk which raised doubts as to the ability of the borrower to comply with present loan repayment terms, compared to $13.8 49 million at December 31, 2021. Management believes the allowance for loan losses was sufficient to cover the risks and probable losses related to such loans at June 30, 2022 and December 31, 2021, respectively. The following table summarizes the Company’s TDRs at the dates indicated: June 30, 2022 December 31, 2021 (Dollars in thousands) Number of contracts Recorded Investment Specific Reserves Number of contracts Recorded Investment Specific Reserves Performing TDRs Commercial, financial and agricultural 3 $ 182 $ 23 2 $ 188 $ 24 Real estate mortgage − residential 5 1,154 47 6 1,262 56 Real estate mortgage − commercial 2 316 37 2 328 38 Installment and other consumer 2 14 1 2 17 2 Total performing TDRs 12 $ 1,666 $ 108 12 $ 1,795 $ 120 Non-performing TDRs Real estate mortgage − residential 5 $ 462 $ 59 5 $ 561 $ 39 Total non-performing TDRs 5 $ 462 $ 59 5 $ 561 $ 39 Total TDRs 17 $ 2,128 $ 167 17 $ 2,356 $ 159 At June 30, 2022, loans classified as TDRs totaled $2.1 million, with $0.2 million of specific reserves, compared to $2.4 million of loans classified as TDRs, with $0.2 million of specific reserves, at December 31, 2021. Non-performing loans, included $0.5 million of loans classified as TDRs at June 30, 2022 compared to $0.6 million at December 31, 2021. Both performing and non-performing TDRs are considered impaired loans. When an individual loan is determined to be a TDR, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the underlying collateral less applicable selling costs if the loan is collateral dependent. The net decrease in total TDRs from December 31, 2021 to June 30, 2022 was primarily due to $229,000 of payments received on TDRs. Allowance for Loan Losses and Provision Allowance for Loan Losses The following table is a summary of the allocation of the allowance for loan losses: June 30, 2022 December 31, 2021 (in thousands) Amount % of loans in each category to total loans Amount % of loans in each category to total loans Allocation of allowance for loan losses at end of period: Commercial, financial, and agricultural $ 3,005 17.0 % $ 2,717 16.7 % Real estate construction − residential 66 1.7 137 2.1 Real estate construction − commercial 762 8.3 588 7.0 Real estate mortgage − residential 2,747 21.9 2,482 21.5 Real estate mortgage − commercial 8,410 49.5 10,662 50.9 Installment and other consumer 312 1.7 256 1.8 Unallocated 51 — 61 — Total $ 15,353 100.0 % $ 16,903 100.0 % The allowance for loan losses was $15.4 million, or 1.08%, of loans outstanding at June 30, 2022 compared to $16.9 million, or 1.30%, of loans outstanding at December 31, 2021. The ratio of the allowance for loan losses to non-performing loans was 86.17% at June 30, 2022, compared to 66.36% at December 31, 2021. 50 The following table is a summary of the general and specific allocations of the allowance for loan losses: (in thousands) June 30, 2022 December 31, 2021 Allocation of allowance for loan losses: Individually evaluated for impairment − specific reserves $ 307 $ 3,044 Collectively evaluated for impairment − general reserves 15,046 13,859 Total $ 15,353 $ 16,903 The specific reserve component applies to loans evaluated individually for impairment. The net carrying value of impaired loans is generally based on the fair values of collateral obtained through independent appraisals and/or internal evaluations, or by discounting the total expected future cash flows. Once the impairment amount is calculated, a specific reserve allocation is recorded. At June 30, 2022, $0.3 million of the Company’s ALL was allocated to impaired loans totaling approximately $19.3 million compared to $3.0 million of the Company’s ALL allocated to impaired loans totaling approximately $27.3 million at December 31, 2021. Management determined that $16.0 million, or 83%, of total impaired loans required no reserve allocation at June 30, 2022 compared to $16.6 million, or 61%, at December 31, 2021, primarily due to adequate collateral values , acceptable payment history and adequate cash flow ability. The incurred loss component of the general reserve, or loans collectively evaluated for impairment, is determined by applying loss rates to pools of loans by asset type. Loans not individually evaluated are aggregated by risk characteristics and reserves are recorded using a consistent methodology that considers historical loan loss experience by loan type. The look-back period begins with loss history in the first quarter 2012 as the starting point through the current quarter and it will continue to include this starting point going forward. Management determined that the look-back period should be expanded until a loss producing downturn is recognized. This would be accomplished by allowing the look-back period to shift forward by eliminating the earliest loss period and replenishing it with losses from the most recent period. The look-back period is consistently evaluated for relevance given the current facts and circumstances. These historical loss rates for each risk group are used as the starting point to determine loss rates for measurement purposes. The historical loan loss rates are multiplied by loss emergence periods (LEP) which represent the estimated time period between a borrower first experiencing financial difficulty and the recognition of a loss. The Company’s methodology includes qualitative risk factors that allow management to adjust its estimates of losses based on the most recent information available and to address other limitations in the quantitative component that is based on historical loss rates. Such risk factors are generally reviewed and updated quarterly, as appropriate, and are adjusted to reflect changes in national and local economic conditions and developments, the nature, volume and terms of loans in the portfolio, including changes in volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified or graded loans, loan concentrations, assessment of trends in collateral values, assessment of changes in the quality of the Company’s internal loan review department, and changes in lending policies and procedures, including underwriting standards and collections, charge-off and recovery practices. The specific and general reserve allocations represent management’s best estimate of probable losses inherent in the loan portfolio at the evaluation date. Although the ALL is comprised of specific and general allocations, the entire ALL is available to absorb any credit losses. The decrease in the allowance for loan losses from December 31, 2021 as compared to June 30, 2022 primarily resulted from transitioning loans impacted by COVID-19 from non-accrual status back to performing status. This transition was made according to the Company’s established internal loan policies regarding loan performance as well as consultation with industry experts. This transition back to performing status also reduced specific reserves based on the attributes of the individual loan collateral, to the general allocations method described above. The Company continues to monitor the risks associated with its non-performing loans. Partially offsetting this decrease in the allowance for loan losses was an increase in the reserve due to the significant loan growth that occurred during the first six months of 2022. Provision The Company recognized a provision expense and a negative provision expense for loan losses of $1.2 million and $1.3 million for the three and six months ended June 30, 2022, respectively, compared to $0.4 million provision expense for both the three and six months ended June 30, 2021, respectively. The negative provision expense primarily resulted 51 from the release of specific reserves totaling $2.8 million in the first quarter of 2022 due to returning significant loan balances to accrual from non-accrual status or other collateral valuation adjustments. The following table summarizes loan loss experience for the periods indicated: Three Months Ended June 30, 2022 2022 2021 (Dollars in thousands) Net Charge-offs (Recoveries) Average Loans Net (Recoveries) Charge-offs / Average Loans Net Charge-offs (Recoveries) Average Loans Net (Recoveries) Charge-offs / Average Loans Commercial, financial, and agricultural $ 9 $ 232,187 — % $ (5) $ 256,557 — % Real estate construction − residential — 23,167 — — 35,005 — Real estate construction − commercial — 107,744 — — 77,726 — Real estate mortgage − residential (20) 296,119 (0.01) (3) 263,477 — Real estate mortgage − commercial 103 681,926 0.02 3 618,126 — Installment and other consumer 34 22,865 0.15 31 24,794 0.13 Total $ 126 $ 1,364,008 0.01 % $ 26 $ 1,275,685 — % Six Months Ended June 30, 2022 2021 (Dollars in thousands) Net Charge-offs (Recoveries) Average Loans Net (Recoveries) Charge-offs / Average Loans Net Charge-offs (Recoveries) Average Loans Net (Recoveries) Charge-offs / Average Loans Commercial, financial, and agricultural $ 24 $ 226,569 0.01 % $ (128) $ 257,087 (0.05) % Real estate construction − residential — 23,311 — (13) 34,252 (0.04) Real estate construction − commercial — 101,872 — — 78,150 — Real estate mortgage − residential (23) 289,011 (0.01) (172) 261,768 (0.07) Real estate mortgage − commercial 175 676,350 0.03 26 619,991 — Installment and other consumer 74 22,605 0.33 65 25,390 0.26 Total $ 250 $ 1,339,718 0.02 % $ (222) $ 1,276,638 (0.02) % Net Loan Charge-offs (recoveries) The Company’s net charge-offs were $0.1 million, or 0.01% of average loans, for the quarter ended June 30, 2022 compared to $26,000, or approximately 0.00% of average loans, for the quarter ended June 30, 2021, and net charge-offs were $0.3 million, or 0.02% of average loans, for the six months ended June 30, 2022 compared to net recoveries of $0.2 million, or (0.02)% of average loans, for the six months ended June 30, 2021. Loans Held For Sale The Company designates certain long-term fixed rate personal real estate loans as held for sale. In the fourth quarter of 2021, the Company elected the fair value option for all newly originated long-term personal real estate loans held for sale. As of December 31, 2021, all loans held for sale were carried at fair value. The loans are primarily sold to Freddie Mac, Fannie Mae, and PennyMac and other various secondary market investors. At June 30, 2022, the carrying amount of these loans was $1.7 million compared to $2.2 million at December 31, 2021. 52 Liquidity and Capital Resources Liquidity Management The role of liquidity management is to ensure funds are available to meet depositors’ withdrawal and borrowers’ credit demands while at the same time maximizing profitability. This is accomplished by balancing changes in demand for funds with changes in the supply of those funds. Liquidity to meet these demands is provided by maturing assets, short-term liquid assets that can be converted to cash and the ability to attract funds from external sources, principally depositors. Due to the nature of services offered by the Company, management prefers to focus on transaction accounts and full service relationships with customers as the primary sources of funding. The Company’s Asset/Liability Committee (ALCO), primarily made up of senior management, has direct oversight responsibility for the Company’s liquidity position and profile. A combination of daily, weekly, and monthly reports provided to management detail the following: internal liquidity metrics, composition and level of the liquid asset portfolio, timing differences in short-term cash flow obligations, available pricing and market access to the financial markets for capital, and exposure to contingent draws on the Company’s liquidity. The Company has a number of sources of funds to meet liquidity needs on a daily basis. The Company’s most liquid assets are comprised of available-for-sale investment securities, not including other debt securities, federal funds sold, and excess reserves held at the Federal Reserve. (in thousands) June 30, 2022 December 31, 2021 Federal funds sold $ 45 $ 7,122 Other interest-bearing deposits 8,159 135,500 Certificates of deposit in other banks 4,201 5,193 Available-for-sale investment securities 267,274 310,870 Total $ 279,679 $ 458,685 Federal funds sold and resale agreements normally have overnight maturities and are used for general daily liquidity purposes. The fair value of the available-for-sale investment portfolio was $267.3 million at June 30, 2022 and included an unrealized net loss of $38.8 million. The portfolio includes projected maturities and mortgage-backed securities pay-downs of approximately $5.0 million over the next twelve months, which offer resources to meet either new loan demand or reductions in the Company’s borrowings. The Company pledges portions of its investment securities portfolio to secure public fund deposits, federal funds purchase lines, securities sold under agreements to repurchase, borrowing capacity at the Federal Reserve Bank, and for other purposes as required or permitted by law. At June 30, 2022 and December 31, 2021, the Company’s unpledged securities in the available-for-sale portfolio totaled approximately $46.9 million and $35.5 million, respectively. Total investment securities pledged for these purposes were as follows: (in thousands) June 30, 2022 December 31, 2021 Investment securities pledged for the purpose of securing: Federal Reserve Bank borrowings $ 8,799 $ 10,778 Federal funds purchased and securities sold under agreements to repurchase 9,000 28,769 Other deposits 202,586 235,829 Total pledged, at fair value $ 220,385 $ 275,376 Liquidity is available from the Company’s base of core customer deposits, defined as demand, interest checking, savings, money market deposit accounts, and time deposits less than $250,000, less all brokered deposits under $250,000. At June 30, 2022, such deposits totaled $1.4 billion and represented 91.2% of the Company’s total deposits. These core deposits are normally less volatile and are often tied to other products of the Company through long lasting relationships. 53 Core deposits at June 30, 2022 and December 31, 2021 were as follows: (in thousands) June 30, 2022 December 31, 2021 Core deposit base: Non-interest bearing demand $ 471,762 $ 453,066 Interest checking 314,772 357,825 Savings and money market 447,264 440,331 Other time deposits 162,859 175,827 Total $ 1,396,657 $ 1,427,049 Estimated uninsured deposits totaled $503.5 million, including $99.9 million of certificates of deposit, at June 30, 2022, compared to $513.5 million, including $69.1 million of certificates of deposit, at December 31, 2021. The Company had brokered deposits totaling $34.0 million and $20.2 million at June 30, 2022 and December 31, 2021, respectively. Other components of liquidity are the level of borrowings from third-party sources and the availability of future credit. The Company’s outside borrowings are comprised of securities sold under agreements to repurchase, Federal Home Loan Bank advances, and subordinated notes. Federal funds purchased are overnight borrowings obtained mainly from upstream correspondent banks with which the Company maintains approved credit lines. As of June 30, 2022, under agreements with these unaffiliated banks, the Bank may borrow up to $60.0 million in federal funds on an unsecured basis and $8.3 million on a secured basis. There were no federal funds purchased outstanding at June 30, 2022. Securities sold under agreements to repurchase are generally borrowed overnight and are secured by a portion of the Company’s investment portfolio. At June 30, 2022, there were $6.9 million in repurchase agreements. The Company may periodically borrow additional short-term funds from the Federal Reserve Bank through the discount window, although no such borrowings were outstanding at June 30, 2022. The Bank is a member of the Federal Home Loan Bank of Des Moines (FHLB) and has access to credit products of the FHLB. As of June 30, 2022, the Bank had $68.0 million in outstanding borrowings with the FHLB. In addition, the Company has $49.5 million in outstanding subordinated notes issued to wholly-owned grantor trusts, funded by preferred securities issued by the trusts. Borrowings outstanding at June 30, 2022 and December 31, 2021 were as follows: (in thousands) June 30, 2022 December 31, 2021 Borrowings: Federal funds purchased and securities sold under agreements to repurchase $ 6,935 $ 23,829 Federal Home Loan Bank advances 68,000 77,418 Subordinated notes 49,486 49,486 Total $ 124,421 $ 150,733 The Company pledges certain assets, including loans and investment securities to the Federal Reserve Bank, FHLB, and other correspondent banks as security to establish lines of credit and borrow from these entities. Based on the type and value of collateral pledged, the FHLB establishes a collateral value from which the Company may draw advances against this collateral. This collateral is also used to enable the FHLB to issue letters of credit in favor of public fund depositors of the Company. The Federal Reserve Bank also establishes a collateral value of assets pledged to support borrowings from the discount window. 54 The following table reflects collateral value of assets pledged, borrowings, and letters of credit outstanding, in addition to the estimated future funding capacity available to the Company as follows: June 30, 2022 December 31, 2021 (in thousands) FHLB Federal Reserve Bank Federal Funds Purchased Lines Total FHLB Federal Reserve Bank Federal Funds Purchased Lines Total Advance equivalent $ 293,908 $ 8,258 $ 60,000 $ 362,166 $ 273,479 $ 10,384 $ 60,000 $ 343,863 Letters of credit (3,000) — — (3,000) (31,000) — — (31,000) Advances outstanding (68,000) — — (68,000) (77,418) — — (77,418) Total available $ 222,908 $ 8,258 $ 60,000 $ 291,166 $ 165,061 $ 10,384 $ 60,000 $ 235,445 At June 30, 2022, loans of $585.5 million were pledged to the Federal Home Loan Bank as collateral for borrowings and letters of credit. At June 30, 2022, investments with a market value of $8.8 million were pledged to secure federal funds purchase lines and borrowing capacity at the Federal Reserve Bank. Based upon the above, management believes the Company has more than adequate liquidity, both on balance sheet and through the additional funding capacity with the FHLB, the Federal Reserve Bank and Federal funds purchased lines to meet future anticipated needs in both the short and long-term. Sources and Uses of Funds Cash and cash equivalents were $28.2 million at June 30, 2022 compared to $159.9 million at December 31, 2021. The $131.7 million decrease resulted from changes in the various cash flows produced by operating, investing, and financing activities of the Company, as shown in the accompanying consolidated statement of cash flows for the six months ended June 30, 2022. Cash flow provided from operating activities consists mainly of net income adjusted for certain non-cash items. Operating activities provided cash flow of $6.5 million for the six months ended June 30, 2022. Investing activities, consisting mainly of purchases, sales and maturities of available-for-sale securities, and changes in the level of the loan portfolio, used total cash of $121.0 million during the six months ended June 30, 2022. The cash outflow primarily consisted of a net increase in loans held for investment of $125.8 million and $17.2 million in purchases of investment securities partially offset by $20.8 million from maturities and calls and sales of investment securities. Financing activities used total cash of $17.2 million during the six months ended June 30, 2022, resulting primarily from a $22.3 million decrease in interest-bearing transaction accounts, a $16.9 million decrease in securities sold under agreements to repurchase, and a $9.4 million net repayment of Federal Home Loan Bank advances. These decreases were partially offset by an increase in demand deposits. The decrease in interest-bearing accounts was due primarily to reductions in deposits for public funds customers, resulting from the distribution of prior year tax collections. In the normal course of business, the Company enters into certain forms of off-balance sheet transactions, including unfunded loan commitments and letters of credit. These transactions are managed through the Company’s various risk management processes. Management considers both on-balance sheet and off-balance sheet transactions in its evaluation of the Company’s liquidity. The Company had $408.7 million in unused loan commitments and standby letters of credit as of June 30, 2022. Although the Company’s current liquidity resources are adequate to fund this commitment level, the nature of these commitments is such that the likelihood of such a funding demand is very low. The Company is a legal entity, separate and distinct from the Bank, which must provide its own liquidity to meet its operating needs. The Company’s ongoing liquidity needs primarily include funding its operating expenses, paying cash dividends to its shareholders and, to a lesser extent, repurchasing its shares of common stock. The Company paid cash dividends to its shareholders totaling approximately $2.0 million and $1.7 million for the six months ended June 30, 2022 and 2021, respectively. A large portion of the Company’s liquidity is obtained from the Bank in the form of dividends. The Bank declared and paid $7.5 million and $4.5 million in dividends to the Company during the six months ended June 30, 2022 and 2021, respectively. At June 30, 2022 and December 31, 2021, the Company had cash and cash equivalents totaling $3.3 million and $1.8 million, respectively. Subject to declaration by the Company's Board of Directors, the Company expects to continue paying quarterly cash dividends as a part of its current capital allocation strategy. Future dividends will be subject to the determination, declaration and discretion of the Company's Board of Directors and compliance with applicable regulatory capital requirements. 55 The Company's 2019 Repurchase Plan was amended during the second quarter 2021 to authorize the purchase of up to an additional $5.0 million in market value of the Company's common stock. Management was given discretion to determine the number and pricing of the shares to be purchased, as well as the timing of any such purchases. The Company repurchased 23,536 and 85,188 common shares under the plan during the first and second quarter of 2022, respectively, at an average cost of $26.60 per share totaling $2.9 million. The repurchases under these authorizations may be effectuated in the open market, by block purchase, in privately negotiated transactions, or through other transactions managed by broker-dealers, or any combination thereof. No time limit was set for the completion of these authorized share repurchases. As of June 30, 2022, $2.1 million remained available for the repurchase of shares pursuant to the share repurchase authorizations. The Company may continue to repurchase shares under its share repurchase authorizations, but the amount and timing of such repurchases will be dependent on a number of factors, including the price of its common stock and other cash flow needs. There is no assurance that the Company will repurchase up to the full amount remaining under its share repurchase authorizations. Capital Management The Company and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification of the Company and the Bank are subject to qualitative judgments by the regulators about components, risk-weightings, and other factors. The Basel III regulatory capital framework (the "Basel III Capital Rules") adopted by U.S. federal regulatory authorities, among other things, (i) establishes the capital measure called "Common Equity Tier 1" ("CET1"), (ii) specifies that Tier 1 capital consist of CET1 and "Additional Tier 1 Capital" instruments meeting stated requirements, (iii) requires that most deductions/adjustments to regulatory capital measures be made to CET1 and not to other components of capital and (iv) defines the scope of the deductions/adjustments to the capital measures. Additionally, the Basel III Capital Rules require that the Company maintain a 2.5% capital conservation buffer with respect to each of CET1, Tier 1 and total capital to risk-weighted assets, which provides for capital levels that exceed the minimum risk-based capital adequacy requirements. A financial institution with a conservation buffer of less than the required amount is subject to limitations on capital distributions, including dividend payments and stock repurchases, and certain discretionary bonus payments to executive officers. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of CET1, Tier 1 and total capital to risk-weighted assets, and of Tier 1 capital to average assets, each as defined in the regulations. Management believes, as of June 30, 2022, that the Company and the Bank meet all capital adequacy requirements to which they are subject. Financial institutions are categorized as well capitalized or adequately capitalized, based on minimum total risk-based, Tier 1 risk-based, CET1 and Tier 1 leverage ratios. As shown in the table below, the Company’s capital ratios exceeded the regulatory definition of adequately capitalized as of June 30, 2022 and December 31, 2021. Based upon the information in its most recently filed call report, the Bank met the capital ratios necessary to be well-capitalized. The regulatory authorities can apply changes in classification of assets and such changes may retroactively subject the Company to changes in capital ratios. Any such change could reduce one or more capital ratios below well-capitalized status. In addition, a change may result in imposition of additional assessments by the FDIC or could result in regulatory actions that could have a material effect on our condition and results of operations. In addition, bank holding companies generally are required to maintain a Tier 1 leverage ratio of at least 4%. Because the Bank had less than $15.0 billion in total consolidated assets as of December 31, 2009, the Company is allowed to continue to classify its trust preferred securities, all of which were issued prior to May 19, 2010, as Tier 1 capital. 56 Under the Basel III requirements, at June 30, 2022 and December 31, 2021, the Company met all capital adequacy requirements and had regulatory capital ratios in excess of the levels established for well-capitalized institutions, as shown in the following table as of periods indicated: Actual Minimum Capital Required - Basel III Fully Phased-In Required to be Considered Well- Capitalized (Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio June 30, 2022 Total Capital (to risk-weighted assets): Company $ 215,286 13.97 % $ 161,837 10.50 % $ — N.A% Bank 212,948 13.85 % 161,494 10.50 % 153,803 10.00 % Tier 1 Capital (to risk-weighted assets): Company $ 193,126 12.53 % $ 131,011 8.50 % $ — N.A% Bank 197,435 12.84 % 130,733 8.50 % 123,043 8.00 % Common Equity Tier 1 Capital (to risk-weighted assets): Company $ 151,773 9.85 % $ 107,892 7.00 % $ — N.A% Bank 197,435 12.84 % 107,662 7.00 % 99,972 6.50 % Tier 1 leverage ratio (to adjusted average assets): Company $ 193,126 10.98 % $ 70,352 4.00 % $ — N.A% Bank 197,435 11.20 % 70,532 4.00 % 88,165 5.00 % December 31, 2021 Total Capital (to risk-weighted assets): Company $ 210,726 14.79 % $ 149,640 10.50 % $ — N.A% Bank 210,148 14.78 % 149,339 10.50 % 142,228 10.00 % Tier 1 Capital (to risk-weighted assets): Company $ 193,663 13.59 % $ 121,137 8.50 % $ — N.A% Bank 193,085 13.58 % 120,894 8.50 % 113,782 8.00 % Common Equity Tier 1 Capital (to risk-weighted assets): Company $ 145,663 10.22 % $ 99,760 7.00 % $ — N.A% Bank 193,085 13.58 % 99,559 7.00 % 92,448 6.50 % Tier 1 leverage ratio: Company $ 193,663 11.01 % $ 70,342 4.00 % $ — N.A% Bank 193,085 11.04 % 69,959 4.00 % 87,449 5.00 % 57