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 credit 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, • the effects of the COVID-19 pandemic, or any resurgence thereof, or other external events may adversely affect the Company, • changes may occur in the securities markets, • changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for credit losses, including after implementation of the credit impairment model for Current Expected Credit Losses (CECL), • the continued use, availability, and reliability of the London Interbank Offered Rate (LIBOR) and the risks related to the transition from LIBOR to any alternate reference rate we may use, and • our ability to maintain sufficient liquidity, primarily through deposits, in light of recent events in the banking industry. 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, 2022, and in other reports filed with the Securities Exchange Commission (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. 36 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 $1.9 billion in assets at March 31, 2023, 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 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 a 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. CRITICAL ACCOUNTING POLICIES AND ESTIMATES 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. 37 Allowance for Credit Losses Management has identified the accounting policy related to the allowance for credit 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 for credit losses and the impact of any associated risks related to these policies and estimates 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 expected losses, 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. 38 Executive Summary The Company has prepared all of the consolidated financial information in this report in accordance with United States (U.S.) generally accepted accounting principles (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. The Three Months Ended (Dollars in thousands, except per share data) March 31, 2023 December 31, 2022 March 31, 2022 Net interest income $ 13,948 $ 14,990 $ 14,145 Provision for (release of) credit losses on loans & unfunded commitments 680 100 (2,500) Non-interest income 3,182 3,119 3,726 Investment securities gains (losses), net 8 (2) (4) Non-interest expense 12,478 12,576 12,227 Income before income taxes 3,980 5,431 8,140 Income tax expense 709 705 1,531 Net income $ 3,271 $ 4,726 $ 6,609 Basic earnings per share $ 0.48 $ 0.70 $ 0.97 Diluted earnings per share $ 0.48 $ 0.70 $ 0.97 Efficiency ratio (1) 72.84% 69.46% 68.42% Net interest spread 2.57% 3.00% 3.36% Net interest margin 3.16% 3.43% 3.50% (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. 39 The Three Months Ended March 31, 2023 December 31, 2022 March 31, 2022 Key Financial Ratios Book value per share $ 18.96 $ 18.76 $ 19.58 Market price per share $ 23.38 $ 21.77 $ 24.31 Cash dividends paid on common stock $ 1,150 $ 1,151 $ 993 Return on total assets 0.70% 1.01% 1.51% Return on stockholders' equity 10.14% 15.72% 18.41% Average stockholders' equity to total assets 6.87% 6.45% 8.22% Capital Ratios Stockholders' equity to assets 6.77% 6.62% 7.74% Total risk-based capital ratio 13.81% 13.85% 14.66% Tier 1 risk-based capital ratio 12.47% 12.52% 13.44% Common equity Tier 1 capital 9.77% 9.89% 10.36% Tier 1 leverage ratio (1) 10.43% 10.76% 10.99% Asset Quality Net-charge-offs (recoveries) $ 52 $ 17 $ 124 Non-performing loans $ 19,599 $ 18,701 $ 17,099 Classified assets $ 91,640 $ 95,137 $ 104,073 Non-performing loans to total loans 1.27% 1.23% 1.28% Non-performing assets to total assets 1.47% 1.43% 1.55% Allowance for credit and loan losses to total loans 1.43% 1.02% 1.07% (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 $3.3 million for the first quarter of 2023 (current quarter) decreased $1.5 million, or 30.8%, compared to the fourth quarter of 2022 (linked quarter) and decreased $3.3 million, or 50.5%, from the first quarter of 2022 (the prior-year quarter). Earnings per diluted share were $0.48 for the current quarter compared to $0.70 and $0.97 for the linked quarter and prior-year quarter, respectively. For the current quarter, the return on average assets was 0.70%, the return on average stockholders’ equity was 10.14%, and the efficiency ratio was 72.8%. Net interest income of $13.9 million for the first quarter 2023, decreased $1.0 million from the linked quarter, and decreased $0.2 million from the prior year quarter. Net interest margin, on a fully taxable equivalent basis (FTE) basis, was 3.16% for the first quarter, a decrease from 3.43% and 3.50% for the linked quarter and the prior year quarter, respectively. 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 current quarter was $3.2 million, an increase of $0.1 million, or 2.0%, from the linked quarter, and a decrease of $0.5 million, or 14.6%, from the prior-year quarter. The change in the current quarter compared to the prior-year quarter was primarily due to the decrease in the gain on sale of real estate mortgages of $0.4 million, or 44.1%. Non-interest expense for the current quarter was $12.5 million, a decrease of $0.1 million, or 0.8%, from the linked quarter, and an increase of $0.3 million, or 2.1%, from the prior-year quarter. 40 Balance Sheet Highlights: Cash and cash equivalents – Cash and cash equivalents decreased by $49.9 million, or 59.7%, to $33.8 million at the end of the current quarter as compared to the end of the linked quarter. Year-over-year, cash and cash equivalents decreased $16.7 million, or 33.1%, from $50.5 million at the end of the prior-year quarter. See Liquidity Management for further discussion. Loans – Loans held for investment increased by $20.8 million, or 1.4%, to $1.5 billion at the end of the current quarter as compared to the end of the linked quarter. Year-over-year, loans held for investment increased $208.2 million, or 15.6%, from $1.3 billion at the end of the prior-year quarter. Asset quality – Non-performing loans totaled $19.6 million at the end of the current quarter, an increase of $0.9 million from $18.7 million at the end of the linked quarter, and an increase of $2.5 million from $17.1 million at the end of the prior-year quarter. The increase in non-performing loans in the current quarter as compared to the prior-year quarter was primarily due to four large non-accrual loan relationships. The allowance for credit losses to total loans was 1.43% at March 31, 2023, compared to the allowance for loan losses to total loans of 1.02% at December 31, 2022 and 1.07% at March 31, 2022. These changes are discussed in greater detail under the Lending and Credit Management section below. Deposit s – Total deposits decreased by $24.1 million, or 1.5%, equal to $1.6 billion at the end of the current quarter as compared to the end of the linked quarter. Year-over-year deposits increased $151.9 million, or 10.4%, from $1.5 billion as of the end of the prior-year quarter. Capital – On January 1, 2023, the Company adopted Accounting Standard Update (ASU) 2016-13 and recorded a one-time cumulative effect adjustment to retained earnings totaling $5.6 million. Total stockholders' equity was $128.4 million and the common equity to assets ratio was 6.77% at the end of the current quarter as compared to 6.62% and 7.74% at the end of the linked quarter and the prior-year quarter, respectively. Regulatory capital ratios remain “well-capitalized”, with a tier 1 leverage ratio of 10.43% and a total risk-based capital ratio of 13.81% at the end of the current quarter. 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 FTE basis for each of the three month ended March 31, 2023 and 2022, respectively. The average balances used in this table and other statistical data were calculated using average daily balances. 41 Three Months Ended March 31, 2023 2022 (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) Commercial $ 232,467 $ 3,371 5.88% $ 220,888 $ 2,832 5.20% Real estate construction - residential 36,875 608 6.69 23,455 256 4.43 Real estate construction - commercial 147,848 1,862 5.11 95,935 996 4.21 Real estate mortgage - residential 361,853 4,509 5.05 281,824 2,837 4.08 Real estate mortgage - commercial 720,102 8,314 4.68 670,713 6,933 4.19 Installment and other consumer 23,097 227 3.99 22,342 206 3.74 Total loans $ 1,522,242 $ 18,891 5.03% $ 1,315,157 $ 14,060 4.34% Loans held for sale 2,751 27 3.98 2,288 20 3.55 Investment securities: U.S. Treasury 3,189 28 3.56 4,010 5 0.51 U.S. government and federal agency obligations 25,056 99 1.60 27,371 89 1.32 Obligations of states and political subdivisions 110,840 897 3.28 126,577 1,020 3.27 Mortgage-backed securities 103,821 522 2.04 132,922 510 1.56 Other debt securities 12,123 172 5.75 13,456 156 4.70 Total investment securities $ 255,029 $ 1,718 2.73% $ 304,336 $ 1,780 2.37% Other investment securities 6,291 93 6.00 5,412 75 5.62 Federal funds sold 50 — — 6,232 1 0.07 Interest bearing deposits in other financial institutions 48,304 537 4.51 70,824 60 0.34 Total interest earning assets $ 1,834,667 $ 21,266 4.70% $ 1,704,249 $ 15,996 3.81% All other assets 87,239 83,294 Allowance for credit losses (15,783) (16,926) Total assets $ 1,906,123 $ 1,770,617 LIABILITIES AND STOCKHOLDERS' EQUITY Savings $ 172,574 $ 15 0.04% $ 176,648 $ 15 0.03% NOW accounts 208,582 531 1.03 265,542 187 0.29 Interest checking 180,735 1,939 4.35 29,398 28 0.39 Money market 307,682 1,369 1.80 289,140 86 0.12 Time deposits 310,347 1,698 2.22 260,628 389 0.61 Total interest bearing deposits $ 1,179,920 $ 5,552 1.91% $ 1,021,356 $ 705 0.28% Federal funds purchased and securities sold under agreements to repurchase 5,236 21 1.63 13,792 10 0.29 Federal Home Loan Bank advances and other borrowings 96,728 540 2.26 77,397 252 1.32 Subordinated notes 49,486 872 7.15 49,486 324 2.66 Total borrowings $ 151,450 $ 1,433 3.84% $ 140,675 $ 586 1.69% Total interest bearing liabilities $ 1,331,370 $ 6,985 2.13% $ 1,162,031 $ 1,291 0.45% Demand deposits 432,639 449,175 Other liabilities 11,247 13,849 Total liabilities $ 1,775,256 $ 1,625,055 Stockholders' equity 130,867 145,562 Total liabilities and stockholders' equity $ 1,906,123 $ 1,770,617 Net interest income (FTE) $ 14,281 $ 14,705 Net interest spread 2.57% 3.36% Net interest margin 3.16% 3.50% (1) Interest income and yields are presented on a FTE basis using the federal statutory income tax rate of 21%, net of nondeductible interest expense, for both the three months ended March 31, 2023 and 2022. Such adjustments totaled $0.3 million and $0.6 million for the three months ended March 31, 2023 and 2022, respectively. (2) Non-accruing loans are included in the average amounts outstanding. 42 Rate and Volume Analysis The following table summarizes the changes in net interest income on a FTE basis, by major category of interest-earning assets and interest-bearing liabilities, identifying changes related to volumes and rates for the three months ended March 31, 2023 compared to the three months ended March 31, 2022. 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 March 31, 2023 vs. 2022 Change due to (in thousands) Total Change Average Volume Average Rate Interest income on a fully taxable equivalent basis: (1) Loans: (2) Commercial $ 539 $ 154 $ 385 Real estate construction - residential 352 186 166 Real estate construction - commercial 866 621 245 Real estate mortgage - residential 1,672 909 763 Real estate mortgage - commercial 1,381 533 848 Installment and other consumer 21 7 14 Loans held for sale 7 4 3 Investment securities: U.S. Treasury 23 (1) 24 U.S. government and federal agency obligations 10 (8) 18 Obligations of states and political subdivisions (123) (127) 4 Mortgage-backed securities 12 (126) 138 Other debt securities 16 (17) 33 Other investment securities 18 13 5 Federal funds sold (1) (1) — Interest bearing deposits in other financial institutions 477 (25) 502 Total interest income $ 5,270 $ 2,122 $ 3,148 Interest expense: Savings $ — $ — $ — NOW accounts 344 (49) 393 Interest checking 1,911 643 1,268 Money market 1,283 6 1,277 Time deposits 1,309 88 1,221 Federal funds purchased and securities sold under agreements to repurchase 11 (9) 20 Federal Home Loan Bank advances and other borrowings 288 75 213 Subordinated notes 548 — 548 Total interest expense $ 5,694 $ 754 $ 4,940 Net interest income on a fully taxable equivalent basis $ (424) $ 1,368 $ (1,792) (1) Interest income and yields are presented on a FTE basis using the federal statutory income tax rate of 21%, net of nondeductible interest expense, for both the three months ended March 31, 2023 and 2022. Such adjustments totaled $0.3 million for the three months ended March 31, 2023 compared to $0.6 million for the three months ended March 31, 2022. (2) Non-accruing loans are included in the average amounts outstanding. 43 Financial results for the three months ended March 31, 2023 compared to the three months ended March 31, 2022 reflected a decrease in net interest income, on a tax equivalent basis, of $0.4 million, or 2.9%. Measured as a percentage of average earning assets, the net interest margin (expressed on a FTE basis) decreased to 3.16% for the three months ended March 31, 2023 compared to 3.50% for the three months ended March 31, 2022. While interest income increased $5.3 million in the current quarter compared to the prior year quarter, which was driven primarily by higher yields on interest-earning assets and growth in loans, interest expense increased $5.7 million resulting in a $0.4 million decrease in net interest income. Average interest-earning assets increased $130.4 million, or 7.7%, to $1.83 billion for the three months ended March 31, 2023 compared to $1.70 billion for the three months ended March 31, 2022, and average interest-bearing liabilities increased $169.3 million, or 14.6%, to $1.33 billion for the three months ended March 31, 2023 compared to $1.16 billion for the three months ended March 31, 2022. Total interest income (expressed on a FTE basis) was $21.3 million for the three months ended March 31, 2023 compared to $16.0 million for the three months ended March 31, 2022. The Company’s rates earned on interest-earning assets were 4.70% for the three months ended March 31, 2023 compared to 3.81% for the three months ended March 31, 2022. Interest income on loans held for investment was $18.9 million for the three months ended March 31, 2023 compared to $14.1 million for the three months ended March 31, 2022. Average loans outstanding increased $207.1 million, or 15.7%, to $1.52 billion for the three months ended March 31, 2023 compared to $1.32 billion for the three months ended March 31, 2022. The average yield on loans increased to 5.03% for the three months ended March 31, 2023 compared to 4.34% for the three months ended March 31, 2022. 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 $1.7 million for the three months ended March 31, 2023 compared to $1.8 million for the three months ended March 31, 2022. Average securities decreased $49.3 million, or 16.2%, to $255.0 million for the three months ended March 31, 2023 compared to $304.3 million for the three months ended March 31, 2022. The average yield on securities increased to 2.73% for the three months ended March 31, 2023 compared to 2.37% for the three months ended March 31, 2022. See the Liquidity Management section for further discussion. Total interest expense increased to $7.0 million for the three months ended March 31, 2023 compared to $1.3 million for the three months ended March 31, 2022. The Company’s rates paid on interest-bearing liabilities were 2.13% for the three months ended March 31, 2023 compared to 0.45% for the three months ended March 31, 2022. See the Liquidity Management section for further discussion. Interest expense on deposits increased to $5.6 million for the three months ended March 31, 2023 compared to $0.7 million for the three months ended March 31, 2022. Average interest-bearing deposits increased $158.6 million, or 15.5%, to $1.18 billion for the three months ended March 31, 2023 compared to $1.02 billion for the three months ended March 31, 2022. The average cost of deposits increased to 1.91% for the three months ended March 31, 2023 compared to 0.28% for the three months ended March 31, 2022. Interest expense on borrowings increased $1.4 million for the three months ended March 31, 2023 compared to $0.6 million for the three months ended March 31, 2022. Average borrowings increased to $151.5 million for the three months ended March 31, 2023 compared to $140.7 million for the three months ended March 31, 2022. The average cost of borrowings increased to 3.84% for the three months ended March 31, 2023 compared to 1.69% for the three months ended March 31, 2022. The increase in cost of funds primarily resulted from higher market interest rates. 44 Non-Interest Income and Expense Non-interest income for the periods indicated was as follows: Three Months Ended March 31, (Dollars in thousands) 2023 2022 $ Change % Change Non-interest income Service charges and other fees $ 684 $ 793 $ (109) (13.7) % Bank card income and fees 960 961 (1) (0.1) % Trust department income 271 340 (69) (20.3) % Real estate servicing fees, net 193 231 (38) (16.5) % Gain on sales of mortgage loans, net 496 888 (392) (44.1) % Other 578 513 65 12.7 % Total non-interest income $ 3,182 $ 3,726 $ (544) (14.6) % Non-interest income as a % of total revenue * 18.6 % 20.8 % * Total revenue is calculated as net interest income plus non-interest income. Total non-interest income decreased $0.5 million, or 14.6%, to $3.2 million for the three months ended March 31, 2023 compared to $3.7 million for the three months ended March 31, 2022. 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) remained relatively flat at $0.2 million for the quarter ended March 31, 2023 compared to the quarter ended March 31, 2022. Mortgage loan servicing fees earned on loans sold were $0.2 million for the three months ended March 31, 2023, compared to $0.3 million for the three months ended March 31, 2022. The current quarter's MSR valuation increased $29,000 from December 31, 2022 primarily due to an increase in market rates. Mortgage rates have increased significantly to over 6.0% for a new thirty-year conforming mortgage. The Company was servicing $235.2 million of mortgage loans at March 31, 2023 compared to $240.5 million and $261.5 million at December 31, 2022 and March 31, 2022, respectively. Gain on sales of mortgage loans decreased $0.4 million to $0.5 million for the three months ended March 31, 2023 compared to $0.9 million for the three months ended March 31, 2022. The Company sold $20.2 million of loans for the three months ended March 31, 2023, compared to $29.1 million for the three months ended March 31, 2022. 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 were recognized in earnings: Three Months Ended March 31, (in thousands) 2023 2022 Investment securities gains (losses), net Available-for-sale securities: Gross realized gains $ — $ — Gross realized losses — — Other-than-temporary impairment recognized — — Other investment securities: Fair value adjustments, net 8 (4) Investment securities gains (losses), net $ 8 $ (4) 45 Non-interest expense for the periods indicated was as follows: Three Months Ended March 31, (Dollars in thousands) 2023 2022 $ Change % Change Non-interest expense Salaries $ 5,484 $ 5,156 $ 328 6.4% Employee benefits 1,519 1,730 (211) (12.2) Occupancy expense, net 795 786 9 1.1 Furniture and equipment expense 752 755 (3) (0.4) Processing, network and bank card expense 1,157 1,142 15 1.3 Legal, examination, and professional fees 505 440 65 14.8 Advertising and promotion 357 293 64 21.8 Postage, printing, and supplies 193 190 3 1.6 Loan expense 385 145 240 165.5 Other 1,331 1,590 (259) (16.3) Total non-interest expense $ 12,478 $ 12,227 $ 251 2.1% Efficiency ratio* 72.8 % 68.4 % Number of full-time equivalent employees 315 306 * 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 increased $0.3 million to $12.5 million for the three months ended March 31, 2023 compared to $12.2 million for the three months ended March 31, 2022. Salaries increased $0.3 million, or 6.4%, to $5.5 million for the three months ended March 31, 2023 compared to $5.2 million for the three months ended March 31, 2022. The increase was primarily due to annual merit increases. Employee benefits decreased $0.2 million, or 12.2%, to $1.5 million for the three months ended March 31, 2023 compared to $1.7 million for the three months ended March 31, 2022. The decrease was primarily due to a decrease in 401(k) plan contributions, medical premiums, and pension cost due to higher annual discount rate assumptions compared to the prior year's annual assumptions. Loan expense increased $0.2 million, or 165.5%, to $0.4 million for the three months ended March 31, 2023 compared to $0.1 million for the three months ended March 31, 2022. The increase was primarily due to recognition of adjustment to dealers reserve that was related to prior years' activity. Other non-interest expense decreased $0.3 million, or 16.3%, to $1.3 million for the three months ended March 31, 2023 compared to $1.6 million for the three months ended March 31, 2022. The decreases 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. Income Taxes Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 17.8% for the three months ended March 31, 2023 compared to 18.8% for the three months ended March 31, 2022. The decrease in the effective tax rate for the three months ended March 31, 2023 compared to the three months ended March 31, 2022 was primarily attributable to the decrease in earnings,and an increase in tax-exempt income and additional tax planning initiatives. The effective tax rate for each of the three months ended March 31, 2023 and 2022 is lower than the U.S. federal statutory rate of 21%, primarily due to tax-free revenues. Included in the effective tax rate is a $13,000 benefit associated with a historic tax credit investment for the three months ended March 31, 2023. 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. 46 Lending and Credit Management Interest earned on the loan portfolio is a primary source of interest income for the Company. Net loans represented 80.2% of total assets as of March 31, 2023 compared to 78.3% as of December 31, 2022. 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 the 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 were as follows: March 31, 2023 December 31, 2022 (Dollars in thousands) Amount % of Loans Amount % of Loans Commercial, financial, and agricultural $ 227,992 14.8 % $ 244,549 16.1 % Real estate construction − residential 44,467 2.9 32,095 2.1 Real estate construction − commercial 157,860 10.2 137,235 9.0 Real estate mortgage − residential 363,634 23.6 361,025 23.7 Real estate mortgage − commercial 725,573 47.1 722,729 47.5 Installment and other consumer 22,548 1.5 23,619 1.6 Total loans held for investment $ 1,542,074 100.0 % $ 1,521,252 100.0 % The Company extends credit to its local community markets through traditional real estate mortgage products. The Company does not participate in credit extension 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 three months ended March 31, 2023, the Company sold approximately $20.2 million of loans to investors compared to $29.1 million for the three months ended March 31, 2022. At March 31, 2023, the Company was servicing approximately $235.2 million of loans sold to the secondary market compared to $240.5 million at December 31, 2022, and $261.5 million at March 31, 2022. Risk Elements of the Loan Portfolio Management, internal loan review and the senior loan committee formally review all loans in excess of certain dollar amounts (periodically established) at least annually. Loans in excess of $2.0 million in the 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 will evaluate individual loans for expected credit losses when those loans do not share similar risk characteristics with loans evaluated using a collective (pooled) basis. Management follows the guidance provided in the Financial Accounting Standards Board's (FASB) Accounting Standards Codification (ASC) Topic 326-20-30-2. 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 individually analyzed and in conjunction with current economic conditions and loss experience, reserves are estimated as further discussed below. Loans not individually evaluated are aggregated and collectively analyzed. Under ASC 326-20-30-2 and ASC 326-20-55-5, the Company should aggregate financial assets based on similar risk characteristics. Management determined that segmenting loans not individually analyzed by the federal call report codes represents the most prudent way to consolidate loans by their associated risk qualities. 47 General reserves are recorded for collectively analyzed loans using a consistent methodology. Two different models are used for calculating the general reserve. The Discounted Cash Flow model considers quantitative peer group historic loss experience, forecasts over the estimated life of the loan pools, industry data, and qualitative or environmental factors, such as: lending policies and procedures; economic conditions; the nature, volume and terms of the portfolio; lending staff and management; past due loans; the loan review system; collateral values; concentrations of credit; and external factors. The Remaining Life model applies a long-term average loss rate calculated using peer data that is adjusted for qualitative or environmental factors such as those previously noted. The model used depends on the loan portfolio segment. 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 credit losses are adjusted to maintain the allowance at a level considered necessary by management to provide for expected losses inherent in the loan portfolio. Non-Performing Assets The following table summarizes non-performing assets at the dates indicated: March 31, December 31, (Dollars in thousands) 2023 2022 Non-accrual loans (c): Commercial, financial, and agricultural $ 166 $ 121 Real estate construction − commercial 83 87 Real estate mortgage − residential 914 685 Real estate mortgage − commercial 18,355 17,801 Installment and other consumer 80 6 Total $ 19,598 $ 18,700 Loans contractually past - due 90 days or more and still accruing: Installment and other consumer $ 1 $ 1 Total $ 1 $ 1 Total non-performing loans (a) 19,599 18,701 Other real estate owned and repossessed assets 8,247 8,795 Total non-performing assets $ 27,846 $ 27,496 Loans held for investment $ 1,542,074 $ 1,521,252 Allowance for credit losses on loans 21,979 15,588 Restructured loans accruing 1,571 1,661 Allowance for credit and loan losses to loans, respectively 1.43 % 1.02 % Non-accrual loans to total loans 1.27 % 1.23 % Non-performing loans to loans (a) 1.27 % 1.23 % Non-performing assets to loans (b) 1.81 % 1.81 % Non-performing assets to assets (b) 1.47 % 1.43 % Allowance for credit and loan losses to non-accrual loans, respectively 112.15 % 83.36 % Allowance for credit and loan losses to non-performing loans, respectively 112.14 % 83.35 % (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. (c) Non-accrual loans include $0.3 million of restructured loans as of both March 31, 2023 and December 31, 2022. Total non-performing assets were $27.8 million, or 1.81% of total loans, at March 31, 2023 compared to $27.5 million, or 1.81% of total loans, at December 31, 2022. Total non-accrual loans at March 31, 2023 increased $0.9 million, or 4.8%, to $19.6 million compared to $18.7 million at December 31, 2022. There were $1,000 in loans past due 90 days and still accruing interest at both March 31, 2023 and 48 December 31, 2022. Other real estate and repossessed assets were $8.2 million and $8.8 million at March 31, 2023 and December 31, 2022, respectively. During the three months ended March 31, 2023, there were no non-accrual loans, net of charge-offs taken, added to other real estate owned and repossessed assets. During the three months ended March 31, 2022, an additional $0.1 million 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 March 31, 2023, approximately $10.7 million of loans classified as substandard, which include accruing restructured loans, 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 $12.8 million at December 31, 2022. Management believes the allowance for credit losses was sufficient to cover the risks and expected / probable losses related to such loans at March 31, 2023 and December 31, 2022, respectively. Provision and Allowance for Credit Losses on Loans and Liability for Unfunded Commitments Allowance for Credit Losses On January 1, 2023, the Company adopted ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) which provides for the CECL credit loss model. The adoption of the standard resulted in an increase to the allowance for credit losses of $5.8 million and a new liability for unfunded commitments totaling $1.3 million. These one-time cumulative adjustments resulted in a $5.6 million tax-effected decrease to retained earnings. The following table is a summary of the allocation of the allowance for credit losses: March 31, 2023 December 31, 2022 (in thousands) Amount % of loans in each category to total loans Amount % of loans in each category to total loans Allocation of allowance for credit losses at end of period: Commercial, financial, and agricultural $ 1,921 14.8 % $ 2,735 16.1 % Real estate construction − residential 631 2.9 157 2.1 Real estate construction − commercial 4,464 10.2 875 9.0 Real estate mortgage − residential 5,262 23.6 3,329 23.7 Real estate mortgage − commercial 9,487 47.1 8,000 47.5 Installment and other consumer 222 1.5 326 1.6 Unallocated (8) — 166 — Total $ 21,979 100.0 % $ 15,588 100.0 % The allowance for credit losses was $22.0 million, or 1.43%, of loans outstanding at March 31, 2023 compared to $15.6 million, or 1.02%, of loans outstanding at December 31, 2022. The ratio of the allowance for credit losses to non-performing loans was 112.14% at March 31, 2023, compared to the allowance for loan losses of 83.35% at December 31, 2022. 49 Provision for (Release of) Credit Losses Three Months Ended March 31, (In thousands) 2023 2022 Provision for (release of) credit losses on loans $ 650 $ (2,500) Provision for available-for-sale securities — — Provision for credit losses for off-balance sheet commitments 30 — Total Provision for (release of) credit losses $ 680 $ (2,500) The Company recognized a provision for credit losses of $0.7 million for the three months ended March 31, 2023, compared to a release of provision for loan losses of $2.5 million for the three months ended March 31, 2022. The release of provision expense primarily resulted from the release of specific reserves totaling $2.8 million in the first quarter of 2022 due to returning the balances related to one loan relationship to accrual status from non-accrual status. The following table summarizes credit loss experience for the periods indicated: Three Months Ended March 31, 2023 2022 (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 $ 21 $ 232,467 0.01 % $ 15 $ 220,888 0.01 % Real estate construction − residential — 36,875 — — 23,455 — Real estate construction − commercial — 147,848 — — 95,935 — Real estate mortgage − residential (2) 361,853 — (3) 281,824 — Real estate mortgage − commercial 3 720,102 — 73 670,713 0.01 Installment and other consumer 30 23,097 0.13 39 22,342 0.17 Total $ 52 $ 1,522,242 — % $ 124 $ 1,315,157 0.01 % Net Loan Charge-Offs (Recoveries) The Company’s net charge-offs were $0.1 million, for the three months ended March 31, 2023 compared to $0.1 million, or 0.01% of average loans, for the three months ended March 31, 2022. Loans Held for Sale The Company designates certain long-term fixed rate personal real estate loans as held for sale. These loans are initially measured at fair value under the fair value option election with subsequent changes in fair value recognized in mortgage banking income. The loans are primarily sold to Freddie Mac, Fannie Mae, and PennyMac and other various secondary market investors. At March 31, 2023, the carrying amount of these loans was $1.8 million compared to $0.6 million at December 31, 2022. Liquidity and Capital Resources Liquidity Management The role of liquidity management is to ensure that 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 50 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) March 31, 2023 December 31, 2022 Federal funds sold $ 47 $ 46 Other interest-bearing deposits 15,425 65,013 Certificates of deposit in other banks 2,215 2,955 Available-for-sale investment securities 259,653 250,747 Total $ 277,340 $ 318,761 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 $259.7 million at March 31, 2023 and included an unrealized net loss of $40.7 million. The portfolio includes projected maturities and mortgage-backed securities pay-downs of approximately $10.3 million over the next 12 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 March 31, 2023 and December 31, 2022, the Company’s unpledged securities in the available-for-sale portfolio totaled approximately $54.4 million and $139.2 million, respectively. Total investment securities pledged for these purposes were as follows: (in thousands) March 31, 2023 December 31, 2022 Investment securities pledged for the purpose of securing: Federal Reserve Bank borrowings $ 8,846 $ 8,563 Federal funds purchased and securities sold under agreements to repurchase 8,807 8,601 Other deposits 187,641 94,432 Total pledged, at fair value $ 205,294 $ 111,596 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 March 31, 2023, such deposits totaled $1.4 billion and represented 86.6% 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. 51 Core deposits at March 31, 2023 and December 31, 2022 were as follows: (in thousands) March 31, 2023 December 31, 2022 Core deposit base: Non-interest bearing demand $ 444,437 $ 453,443 Interest checking 338,223 440,611 Savings and money market 438,838 442,856 Other time deposits 171,141 160,174 Total $ 1,392,639 $ 1,497,084 Estimated uninsured deposits totaled $463.7 million, including $175.3 million of certificates of deposit, at March 31, 2023, compared to $420.3 million, including $94.9 million of certificates of deposit, at December 31, 2022. The Company had brokered deposits totaling $40.1 million at both March 31, 2023 and December 31, 2022. Included within in the uninsured deposits at March 31, 2023 and December 31, 2022 are public funds deposits greater than $250,000 which are collateralized by the Company totaling $183.3 million and $111.6 million, respectively. The estimated uninsured and uncollateralized deposits ratio to total deposits at March 31, 2023 and December 31, 2022 was 17% and 19%, 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, advances from the Federal Home Loan Bank (FHLB) 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 March 31, 2023, under agreements with these unaffiliated banks, the Bank may borrow up to $35.0 million in federal funds on an unsecured basis and $8.3 million on a secured basis. There were no federal funds purchased outstanding at March 31, 2023. Securities sold under agreements to repurchase are generally borrowed overnight and are secured by a portion of the Company’s investment portfolio. At March 31, 2023, there were $5.1 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 March 31, 2023. The Bank is a member of the FHLB and has access to credit products of the FHLB. As of March 31, 2023, the Bank had $93.0 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 March 31, 2023 and December 31, 2022 were as follows: (in thousands) March 31, 2023 December 31, 2022 Borrowings: Federal funds purchased and securities sold under agreements to repurchase $ 5,115 $ 5,187 Federal Home Loan Bank advances 93,000 98,000 Subordinated notes 49,486 49,486 Total $ 147,601 $ 152,673 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 to 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. 52 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: March 31, 2023 December 31, 2022 (in thousands) FHLB Federal Reserve Bank Federal Funds Purchased Lines Total FHLB Federal Reserve Bank Federal Funds Purchased Lines Total Advance equivalent $ 370,125 $ 8,334 $ 35,000 $ 413,459 $ 355,391 $ 8,058 $ 60,000 $ 423,449 Letters of credit (19,500) — — (19,500) (47,500) — — (47,500) Advances outstanding (93,000) — — (93,000) (98,000) — — (98,000) Total available $ 257,625 $ 8,334 $ 35,000 $ 300,959 $ 209,891 $ 8,058 $ 60,000 $ 277,949 At March 31, 2023, loans of $598.1 million were pledged to the FHLB as collateral for borrowings and letters of credit. At March 31, 2023, 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 liquidity needs in both the short and long-term. Sources and Uses of Funds Cash and cash equivalents were $33.8 million at March 31, 2023 compared to $83.7 million at December 31, 2022. The $49.9 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 three months ended March 31, 2023. Cash flow provided from operating activities consists mainly of net income adjusted for certain non-cash items. Operating activities provided cash flow of $3.4 million for the three months ended March 31, 2023. 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 $23.1 million during the three months ended March 31, 2023. The cash outflow primarily consisted of a net increase in loans held for investment of $20.9 million and $8.5 million in purchases of investment securities, partially offset by $5.0 million from maturities, calls and sales of investment securities. Financing activities used total cash of $30.3 million during the three months ended March 31, 2023, resulting primarily from a $115.4 million decrease in demand deposits and interest-bearing transaction accounts. These decreases were partially offset by a $91.4 million increase in time deposits. 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 $417.6 million in unused loan commitments and standby letters of credit as of March 31, 2023. 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 $1.2 million and $1.0 million for the three months ended March 31, 2023 and 2022, respectively. A large portion of the Company’s liquidity is obtained from the Bank in the form of dividends. The Bank declared and paid $1.5 million and $3.5 million in dividends to the Company during the three months ended March 31, 2023 and 2022, respectively. At March 31, 2023 and December 31, 2022, the Company had cash and cash equivalents totaling $2.8 million and $2.5 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. 53 Pursuant to the Company's 2019 Repurchase Plan, management is 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 did not repurchase any shares during the three months ended March 31, 2023. As of March 31, 2023, $2.1 million remained available for share repurchases pursuant to the plan. Repurchases under the plan 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 completion of share repurchases under the plan. 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. In July 2013, the federal banking agencies issued final rules to implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act (the "Basel III Rules"). The phase-in period for the Company began on January 1, 2015. The Federal Reserve System's capital adequacy guidelines require that bank holding companies maintain a common equity Tier 1 risk-based capital ratio equal to at least 4.5% of its risk-weighted assets, a Tier 1 risk-based capital ratio equal to at least 6% of its risk-weighted assets and a total risk-based capital ratio equal to at least 8% of its risk-weighted assets. In addition, bank holding companies generally are required to maintain a Tier 1 leverage ratio of at least 4%. In addition to the higher requirements, the Basel III Rules established that bank holding companies are required to maintain a common equity Tier 1 capital conservation buffer of at least 2.5% of risk-weighted assets over and above the minimum risk-based capital requirements. Institutions that do not maintain the required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management. The capital conservation buffer requirement was phased in over four years beginning in 2016. On January 1, 2016, the first phase of the requirement went into effect at 0.625% of risk-weighted assets, and increased each subsequent year by an additional 0.625 percentage points, to reach its final level of 2.5% of risk-weighted assets on January 1, 2019. At December 31, 2019, the capital conservation buffer requirement of 2.5% effectively raised the minimum required risk-based capital ratios to 7% common equity Tier 1 capital, 8.5% Tier 1 capital and 10.5% total capital on a fully phased-in basis. Because the Bank had less than $15.0 billion in total consolidated assets as of December 31, 2009, the Company is allowed to continue its trust preferred securities, all of which were issued prior to May 19, 2010, as Tier 1 capital. 54 Under the Basel III Rules, at March 31, 2023 and December 31, 2022, 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 March 31, 2023 Total Capital (to risk-weighted assets): Company $ 225,994 13.81 % $ 171,862 10.50 % $ — N.A% Bank 224,411 13.76 % 171,305 10.50 % 163,148 10.00 % Tier 1 Capital (to risk-weighted assets): Company $ 204,030 12.47 % $ 139,127 8.50 % $ — N.A% Bank 206,268 12.64 % 138,676 8.50 % 130,518 8.00 % Common Equity Tier 1 Capital (to risk-weighted assets): Company $ 159,851 9.77 % $ 114,575 7.00 % $ — N.A% Bank 206,268 12.64 % 114,203 7.00 % 106,046 6.50 % Tier 1 leverage ratio (to adjusted average assets): Company $ 204,030 10.43 % $ 78,225 4.00 % $ — N.A% Bank 206,268 10.60 % 77,832 4.00 % 97,290 5.00 % December 31, 2022 Total Capital (to risk-weighted assets): Company $ 222,873 13.85 % $ 169,025 10.50 % $ — N.A% Bank 221,066 13.78 % 168,431 10.50 % 160,410 10.00 % Tier 1 Capital (to risk-weighted assets): Company $ 201,595 12.52 % $ 136,830 8.50 % $ — N.A% Bank 205,318 12.80 % 136,349 8.50 % 128,328 8.00 % Common Equity Tier 1 Capital (to risk-weighted assets): Company $ 159,125 9.89 % $ 112,684 7.00 % $ — N.A% Bank 205,318 12.80 % 112,287 7.00 % 104,267 6.50 % Tier 1 leverage ratio: Company $ 201,595 10.76 % $ 74,936 4.00 % $ — N.A% Bank 205,318 10.85 % 75,678 4.00 % 94,598 5.00 % 55