Item 2. Management’s Discussion and Analysis
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,
• economic or other disruptions caused by acts of terrorism, war or other conflicts, including the Russia-Ukraine conflict, natural disasters, such as hurricanes, freezes, flooding and other man-made disasters, such as oil spills or power outages, health emergencies, epidemics or pandemics, climate changes or other catastrophic events,
• 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),
• technological changes, including potential cyber-security incidents and other disruptions, or innovations to the financial services industry, including as a result of the increased telework environment,
• 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 and 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.
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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 September 30, 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, financial and agricultural 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.
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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.
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.
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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) and the rules of the SEC. 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
(In thousands, except per share data) September 30, 2023 June 30, 2023 September 30, 2022
Net interest income $ 15,147 $ 14,202 $ 15,067
Provision for credit losses on loans & unfunded commitments 110 — 300
Non-interest income 606 1,596 3,485
Investment securities gains, net 3 7 1
Non-interest expense 12,569 12,725 12,195
Income before income taxes 3,077 3,080 6,058
Income tax expense 498 531 1,131
Net income $ 2,579 $ 2,549 $ 4,927
Basic earnings per share $ 0.36 $ 0.36 $ 0.70
Diluted earnings per share $ 0.36 $ 0.36 $ 0.70
Efficiency ratio (1) 79.79% 80.55% 65.73%
Net interest margin 3.35% 3.19% 3.56%
Nine Months Ended
September 30,
(Dollars in thousands, except per share data) 2023 2022
Net interest income $ 43,297 $ 43,773
Provision for (release of) credit losses on loans & unfunded commitments 790 (1,000)
Non-interest income 5,384 10,859
Investment securities (losses) gains, net 18 (12)
Non-interest expense 37,772 35,962
Income before income taxes 10,137 19,658
Income tax expense 1,738 3,633
Net income $ 8,399 $ 16,025
Basic earnings per share $ 1.19 $ 2.27
Diluted earnings per share $ 1.19 $ 2.27
Efficiency ratio (1) 77.59% 65.83%
Net interest margin 3.23% 3.57%
(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.
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As of and for the Three Months Ended For the Nine Months Ended
(Dollars in thousands, except per share data) September 30, 2023 June 30, 2023 September 30, 2022 September 30, 2023 September 30, 2022
Key financial ratios
Book value per share $ 16.82 $ 17.97 $ 16.32
Market price per share $ 16.25 $ 17.95 $ 20.50
Cash dividends paid on common stock $ 1,151 $ 1,151 $ 1,105 $ 3,452 $ 3,088
Return on total assets 0.54% 0.54% 1.08% 0.59% 1.21%
Return on stockholders' equity 8.05% 7.99% 15.30% 8.73% 16.00%
Average stockholders' equity to total assets 6.73% 6.75% 7.06% 6.78% 7.55%
Capital Ratios
Stockholders' equity to assets 6.30% 6.65% 6.25%
Total risk-based capital ratio 14.20% 13.99% 13.84%
Tier 1 risk-based capital ratio 12.54% 12.51% 12.25%
Common equity Tier 1 capital 10.09% 9.92% 9.82%
Tier 1 leverage ratio (1) 10.43% 10.46% 10.60%
Asset Quality
Net-charge-offs (recoveries) $ 74 $ (92) $ 148 $ 34 $ 398
Non-performing loans $ 3,847 $ 3,847 $ 17,348
Classified assets $ 79,022 $ 88,488 $ 96,705
Non-performing loans to total loans 0.25% 0.25% 1.16%
Non-performing assets to total assets 0.39% 0.54% 1.44%
Allowance for loan losses to total loans 1.44% 1.42% 1.04%
(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 $2.6 million for the third quarter 2023 increased $0.03 million, or 1.2%, compared to the second quarter 2023 ("linked quarter") and decreased $2.3 million, or 47.7%, from the third quarter 2022 (the "prior year quarter"). Earnings per diluted share was consistent at $0.36 for each of the third quarter 2023 and linked quarter compared to $0.70 for the prior year quarter. For the third quarter 2023, the return on average assets was 0.54%, the return on average stockholders’ equity was 8.05%, and the efficiency ratio was 79.8%.
Consolidated net income of $8.4 million, or $1.19 per diluted share, for the nine months ended September 30, 2023 decreased $7.6 million, or 47.6%, compared to $16.0 million, or $2.27 per diluted share, for the nine months ended September 30, 2022. For the nine months ended September 30, 2023, the return on average assets was 0.59%, the return on average stockholders’ equity was 8.73%, and the efficiency ratio was 77.6%.
Net interest income of $15.1 million for the third quarter 2023, increased $0.9 million from the linked quarter, and increased $0.1 million from the prior year quarter. Net interest margin, on a fully taxable equivalent ("FTE") basis, was 3.35% for the third quarter compared to 3.19% and 3.56% for the linked quarter and the prior year quarter, respectively.
Net interest income of $43.3 million for the nine months ended September 30, 2023 decreased $0.5 million compared to $43.8 million for the nine months ended September 30, 2022. Net interest margin, on a fully taxable equivalent basis, was 3.23% for the nine months ended September 30, 2023, a decrease from 3.57% for the nine months ended September 30, 2022. The change to net interest margin on a fully taxable equivalent basis is discussed in greater detail under the Average Balance Sheet Data and Rate and Volume Analysis sections below.
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Non-interest income for the third quarter 2023 was $0.6 million, a decrease of $1.0 million, or 62.0%, from the linked quarter, and a decrease of $2.9 million, or 82.6%, from the prior year quarter. The change in the current quarter compared to the prior year quarter is primarily due to the recognition of a $2.8 million valuation allowance on property in other real estate owned.
Non-interest income of $5.4 million for the nine months ended September 30, 2023 decreased $5.5 million, or 50.4%, compared to $10.9 million for the nine months ended September 30, 2022. The decrease is primarily due to the recognition of a $4.6 million valuation allowance in the second and third quarter 2023 on property in other real estate owned, a decrease in real estate servicing fees, and the gains on sales of real estate mortgages. These changes are discussed in greater detail under the Non-interest Income and Expense section below.
Non-interest expense for the third quarter 2023 was $12.6 million, a decrease of $0.2 million, or 1.2%, from the linked quarter, and an increase of $0.4 million, or 3.1%, from the prior year quarter.
Non-interest expense for the nine months ended September 30, 2023 was $37.8 million, an increase of $1.8 million, or 5.0%, from the nine months ended September 30, 2022. These changes are discussed in greater detail under the Non-interest Income and Expense section below.
Balance Sheet Highlights:
Cash and cash equivalents – Cash and cash equivalents increased $3.2 million, or 13.0%, to $27.9 million at the end of the current quarter compared to the end of the linked quarter. Year-over-year, cash and cash equivalents decreased $13.5 million, or 32.7%, from $41.4 million at the end of the prior-year quarter. See the Liquidity Management section for further discussion.
Loans – Loans held for investment decreased by $6.2 million, or 0.4%, to $1.6 billion as of September 30, 2023 compared to the end of the linked quarter. Year-over-year, loans held for investment increased $65.0 million, or 4.4%, from $1.5 billion as of September 30, 2022. The yield earned on average loans held for investment was 5.67%, on an FTE basis, for the third quarter 2023 compared to 5.23% for the linked quarter and 4.51% for the prior year quarter.
Asset quality – Non-performing loans remained steady at $3.8 million at September 30, 2023 and at the end of the linked quarter, compared to $17.3 million at the end of the prior year quarter. The decrease in non-performing loans in the current quarter as compared to the prior year quarter was primarily due to three large non-accrual loan relationships returning to accruing status. The allowance for credit losses to total loans was 1.44% at September 30, 2023, compared to the allowance for loan losses to total loans of 1.02% at December 31, 2022 and 1.04% at September 30, 2022. These changes are discussed in greater detail under the Lending and Credit Management section below.
Deposit s – Total deposits increased $37.1 million, or 2.4%, to $1.6 billion as of September 30, 2023 compared to the end of the linked quarter. Year-over-year deposits decreased $12.4 million, or 0.8%, from $1.6 billion as of September 30, 2022. The yield earned on average deposits was 2.32%, on an FTE basis, for the third quarter 2023 compared to 2.07% for the linked quarter and 0.73% for the prior year quarter.
Federal Home Loan Bank advances and other borrowings – FHLB advances and other borrowings decreased $52.3 million, or 31.8%, to $112.0 million as of September 30, 2023 compared to the end of the linked quarter. Year-over-year FHLB advances and other borrowing increased $39.0 million, or 53.4%, from $73.0 million as of September 30, 2022. The Company utilized funding capacity with the FHLB to meet its short-term liquidity needs.
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 $118.4 million and the common equity to assets ratio was 6.30% at September 30, 2023 compared to 6.65% and 6.25% 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 14.20% at September 30, 2023.
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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 nine month periods ended September 30, 2023 and 2022, respectively. The average balances used in this table and other statistical data were calculated using average daily balances.
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Three Months Ended September 30,
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 $ 232,516 $ 3,761 6.42% $ 245,877 $ 3,211 5.18%
Real estate construction - residential 55,289 1,028 7.38 24,249 333 5.45
Real estate construction - commercial 129,284 1,899 5.83 127,594 1,522 4.73
Real estate mortgage - residential 376,209 5,185 5.47 323,158 3,570 4.38
Real estate mortgage - commercial 739,225 10,054 5.40 702,139 7,608 4.30
Installment and other consumer 22,176 279 4.99 23,738 206 3.44
Total loans $ 1,554,699 $ 22,206 5.67% $ 1,446,755 $ 16,450 4.51%
Loans held for sale 6,351 59 3.69 1,560 23 5.85
Investment securities:
U.S. Treasury 4,861 52 4.24 3,586 12 1.33
U.S. government and federal agency obligations 25,498 103 1.60 25,440 87 1.36
Obligations of states and political subdivisions 108,022 814 2.99 113,003 1,040 3.65
Mortgage-backed securities 97,274 514 2.10 111,616 493 1.75
Other debt securities 11,566 176 6.04 12,781 163 5.06
Total investment securities 247,221 1,659 2.66 266,426 1,795 2.67
Other investment securities 7,713 121 6.22 5,431 64 4.68
Federal funds sold 42 — — 46 — —
Interest bearing deposits in other financial institutions 7,029 85 4.80 15,462 76 1.95
Total interest earning assets $ 1,823,055 $ 24,130 5.25% $ 1,735,680 $ 18,408 4.21%
All other assets 89,159 88,350
Allowance for loan losses (22,356) (15,431)
Total assets $ 1,889,858 $ 1,808,599
LIABILITIES AND STOCKHOLDERS' EQUITY
Savings $ 178,564 $ 229 0.51% $ 182,364 $ 16 0.03%
NOW accounts 182,487 464 1.01 268,780 646 0.95
Interest checking 187,732 2,252 4.76 47,788 264 2.19
Money market 273,655 1,521 2.21 302,773 456 0.60
Time deposits 315,332 2,173 2.73 273,550 584 0.85
Total interest bearing deposits $ 1,137,770 $ 6,639 2.32% $ 1,075,255 $ 1,966 0.73%
Federal funds purchased and securities sold under agreements to repurchase 6,137 38 2.46 6,181 13 0.83
Federal Home Loan Bank advances and other borrowings 129,758 1,075 3.29 75,262 277 1.46
Subordinated notes 49,486 989 7.93 49,486 570 4.57
Total borrowings 185,381 2,102 4.50 130,929 860 2.61
Total interest bearing liabilities $ 1,323,151 $ 8,741 2.62% $ 1,206,184 $ 2,826 0.93%
Demand deposits 426,052 464,377
Other liabilities 13,502 10,291
Total liabilities $ 1,762,705 $ 1,680,852
Stockholders' equity 127,153 127,747
Total liabilities and stockholders' equity $ 1,889,858 $ 1,808,599
Net interest income (FTE) $ 15,389 $ 15,582
Net interest spread 2.63% 3.28%
Net interest margin 3.35% 3.56%
(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 September 30, 2023 and 2022. Such adjustments totaled $0.2 million and $0.5 million for the three months ended September 30, 2023 and 2022, respectively.
(2) Non-accruing loans are included in the average amounts outstanding.
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Nine Months Ended September 30, 2023
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 $ 231,691 $ 10,702 6.18% $ 233,076 $ 8,860 5.08%
Real estate construction - residential 47,265 2,514 7.11 23,627 865 4.89
Real estate construction - commercial 137,776 5,586 5.42 110,540 3,683 4.45
Real estate mortgage - residential 368,702 14,524 5.27 300,518 9,461 4.21
Real estate mortgage - commercial 735,539 27,257 4.95 685,041 21,743 4.24
Installment and other consumer 22,622 763 4.51 22,987 614 3.57
Total loans $ 1,543,595 $ 61,346 5.31% $ 1,375,789 $ 45,226 4.40%
Loans held for sale 3,837 119 4.15 1,841 69 5.01
Investment securities:
U.S. Treasury 4,391 133 4.05 3,909 29 0.99
U.S. government and federal agency obligations 25,406 305 1.61 26,235 271 1.38
Obligations of states and political subdivisions 109,994 2,587 3.14 118,845 3,152 3.55
Mortgage-backed securities 101,126 1,565 2.07 120,806 1,503 1.66
Other debt securities 11,826 520 5.88 13,080 476 4.87
Total investment securities 252,743 5,110 2.70 282,875 5,431 2.57
Other investment securities 7,015 321 6.12 5,430 204 5.02
Federal funds sold 51 2 5.24 2,285 5 0.29
Interest bearing deposits in other financial institutions 20,551 724 4.71 34,210 179 0.70
Total interest earning assets $ 1,827,792 $ 67,622 4.95% $ 1,702,430 $ 51,114 4.01%
All other assets 89,524 86,062
Allowance for loan losses (20,124) (15,575)
Total assets $ 1,897,192 $ 1,772,917
LIABILITIES AND STOCKHOLDERS' EQUITY
Savings $ 172,639 $ 259 0.20% $ 179,952 $ 45 0.03%
NOW accounts 196,084 1,485 1.01 267,266 1,196 0.60
Interest checking 170,057 5,741 4.51 34,404 346 1.34
Money market 293,842 4,476 2.04 295,105 688 0.31
Time deposits 325,002 6,208 2.55 260,610 1,297 0.67
Total interest bearing deposits $ 1,157,624 $ 18,169 2.10% $ 1,037,337 $ 3,572 0.46%
Federal funds purchased and securities sold under agreements to repurchase 5,525 83 2.01 8,812 32 0.49
Federal Home Loan Bank advances and other borrowings 113,167 2,430 2.87 76,278 778 1.36
Subordinated notes 49,486 2,769 7.48 49,486 1,316 3.56
Total borrowings 168,178 5,282 4.20 134,576 2,126 2.11
Total interest bearing liabilities $ 1,325,802 $ 23,451 2.36% $ 1,171,913 $ 5,698 0.65%
Demand deposits 429,859 455,689
Other liabilities 12,911 11,408
Total liabilities $ 1,768,572 $ 1,639,010
Stockholders' equity 128,620 133,907
Total liabilities and stockholders' equity $ 1,897,192 $ 1,772,917
Net interest income (FTE) $ 44,171 $ 45,416
Net interest spread 2.59% 3.36%
Net interest margin 3.23% 3.57%
(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 the nine months ended September 30, 2023 and 2022. Such adjustments totaled $0.9 million and $1.6 million for the nine months ended September 30, 2023 and 2022, respectively.
(2) Non-accruing loans are included in the average amounts outstanding.
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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 nine months ended September 30, 2023 compared to the three and nine months ended September 30, 2022, respectively. 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 September 30, Nine Months Ended September 30,
2023 vs. 2022 2023 vs. 2022
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)
Commercial $ 550 $ (182) $ 732 $ 1,842 $ (53) $ 1,895
Real estate construction - residential 695 544 151 1,649 1,135 514
Real estate construction - commercial 377 20 357 1,903 1,012 891
Real estate mortgage - residential 1,615 644 971 5,063 2,403 2,660
Real estate mortgage - commercial 2,446 419 2,027 5,514 1,685 3,829
Installment and other consumer 73 (14) 87 149 (10) 159
Loans held for sale 36 47 (11) 50 64 (14)
Investment securities:
U.S. Treasury 40 6 34 104 4 100
U.S. government and federal agency obligations 16 — 16 34 (9) 43
Obligations of states and political subdivisions (226) (44) (182) (565) (224) (341)
Mortgage-backed securities 21 (68) 89 62 (269) 331
Other debt securities 13 (16) 29 44 (49) 93
Other investment securities 57 32 25 117 67 50
Federal funds sold — — — (3) (9) 6
Interest bearing deposits in other financial institutions 9 (58) 67 545 (98) 643
Total interest income $ 5,722 $ 1,330 $ 4,392 $ 16,508 $ 5,649 $ 10,859
Interest expense:
Savings $ 213 $ — $ 213 $ 214 $ (2) $ 216
NOW accounts (182) (218) 36 289 (380) 669
Interest checking 1,988 1,420 568 5,395 3,377 2,018
Money market 1,065 (48) 1,113 3,788 (3) 3,791
Time deposits 1,589 102 1,487 4,911 393 4,518
Federal funds purchased and securities sold under agreements to repurchase 25 — 25 51 (16) 67
Federal Home Loan Bank advances and other borrowings 798 293 505 1,652 503 1,149
Subordinated notes 419 — 419 1,453 — 1,453
Total interest expense $ 5,915 $ 1,549 $ 4,366 $ 17,753 $ 3,872 $ 13,881
Net interest income on a fully taxable equivalent basis $ (193) $ (219) $ 26 $ (1,245) $ 1,777 $ (3,022)
(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 the three and nine months ended September 30, 2023 and 2022, respectively. Such adjustments totaled $0.2 million and $0.9 million for the three and nine months ended September 30, 2023, respectively, compared to $0.5 million and $1.6 million for the three and nine months ended September 30, 2022, respectively.
(2) Non-accruing loans are included in the average amounts outstanding.
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Financial results for the quarter ended September 30, 2023 compared to the quarter ended September 30, 2022 reflected a decrease in net interest income, on a fully taxable equivalent basis, of $0.2 million, or 1.2%, and financial results for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022 reflected a decrease of $1.2 million, or 2.7%. Measured as a percentage of average earning assets, the net interest margin (expressed on a fully taxable equivalent basis) decreased to 3.35% for the quarter ended September 30, 2023 compared to 3.56% for the quarter ended September 30, 2022, and decreased to 3.23% for the nine months ended September 30, 2023 compared to 3.57% for the nine months ended September 30, 2022. The increase in margin for the third quarter of 2023 compared to the linked quarter was due to $0.6 million of interest accreted into income on three loans returning to accruing status in June 2023, representing approximately 14 basis points.
Interest income on a fully taxable equivalent basis increased $5.7 million in the current quarter compared to the prior year quarter, and increased $16.5 million for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022, while interest expense increased $5.9 million and $17.8 million for the three and nine months ended September 30, 2023, respectively, resulting in a decrease in net interest income on an FTE basis.
Average interest-earning assets increased $87.4 million, or 5.0%, to $1.82 billion for the quarter ended September 30, 2023 compared to $1.74 billion for the quarter ended September 30, 2022, and average interest-bearing liabilities increased $117.0 million, or 9.7%, to $1.32 billion for the quarter ended September 30, 2023 compared to $1.21 billion for the quarter ended September 30, 2022.
Average interest-earning assets increased $125.4 million, or 7.4%, to $1.83 billion for the nine months ended September 30, 2023 compared to $1.70 billion for the nine months ended September 30, 2022, and average interest-bearing liabilities increased $153.9 million, or 13.1%, to $1.33 billion for the nine months ended September 30, 2023 compared to $1.17 billion for the nine months ended September 30, 2022.
Total interest income (expressed on a fully taxable equivalent basis) was $24.1 million and $67.6 million for the three and nine months ended September 30, 2023, respectively, compared to $18.4 million and $51.1 million for the three and nine months ended September 30, 2022, respectively. The Company’s rates earned on interest earning assets were 5.25% and 4.95% for the three and nine months ended September 30, 2023, respectively, compared to 4.21% and 4.01% for the three and nine months ended September 30, 2022, respectively.
Interest income on loans held for investment was $22.2 million and $61.3 million for the three and nine months ended September 30, 2023, respectively, compared to $16.5 million and $45.2 million for the three and nine months ended September 30, 2022, respectively.
Average loans outstanding increased $107.9 million, or 7.5%, to $1.55 billion for the quarter ended September 30, 2023 compared to $1.45 billion for the quarter ended September 30, 2022. The average yield on loans increased to 5.67% for the quarter ended September 30, 2023 compared to 4.51% for the quarter ended September 30, 2022. The increase in yield was due to $0.6 million of interest accreted into income on three loans returning to accruing status in June 2023, representing approximately 16 basis points.
Average loans outstanding increased $167.8 million, or 12.2%, to $1.54 billion for the nine months ended September 30, 2023 compared to $1.38 billion for the nine months ended September 30, 2022. The average yield on loans increased to 5.31% for the nine months ended September 30, 2023 compared to 4.40% for the nine months ended September 30, 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 and $5.1 million for the three and nine months ended September 30, 2023, respectively, compared to $1.8 million and $5.4 million for the three and nine months ended September 30, 2022, respectively.
Average securities decreased $19.2 million, or 7.2%, to $247.2 million for the quarter ended September 30, 2023 compared to $266.4 million for the quarter ended September 30, 2022. The average yield on securities decreased to 2.66% for the quarter ended September 30, 2023 compared to 2.67% for the quarter ended September 30, 2022.
Average securities decreased $30.1 million, or 10.7%, to $252.7 million for the nine months ended September 30, 2023 compared to $282.8 million for the nine months ended September 30, 2022. The average yield on securities increased to
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2.70% for the nine months ended September 30, 2023 compared to 2.57% for the nine months ended September 30, 2022. See the Liquidity Management section for further discussion.
Total interest expense increased to $8.7 million and $23.5 million for the three and nine months ended September 30, 2023, respectively, compared to $2.8 million and $5.7 million for the three and nine months ended September 30, 2022, respectively. The Company’s rates paid on interest bearing liabilities were 2.62% and 2.36% for the three and nine months ended September 30, 2023, respectively, compared to 0.93% and 0.65% for the three and nine months ended September 30, 2022, respectively. See the Liquidity Management section for further discussion.
Interest expense on deposits increased to $6.6 million and $18.2 million for the three and nine months ended September 30, 2023, respectively, compared to $2.0 million and $3.6 million for the three and nine months ended September 30, 2022, respectively.
Average interest-bearing deposits increased $62.5 million, or 5.8%, to $1.14 billion for the quarter ended September 30, 2023 compared to $1.08 billion for the quarter ended September 30, 2022. The average cost of deposits increased to 2.32% for the quarter ended September 30, 2023 compared to 0.73% for the quarter ended September 30, 2022.
Average interest-bearing deposits increased $120.3 million, or 11.6%, to $1.16 billion for the nine months ended September 30, 2023 compared to $1.04 billion for the nine months ended September 30, 2022. The average cost of deposits increased to 2.10% for the nine months ended September 30, 2023 compared to 0.46% for the nine months ended September 30, 2022.
Interest expense on borrowings increased to $2.1 million and $5.3 million for the three and nine months ended September 30, 2023, respectively, compared to $0.9 million and $2.1 million for the three and nine months ended September 30, 2022, respectively.
Average borrowings increased $54.5 million, or 41.6%, to $185.4 million for the quarter ended September 30, 2023 compared to $130.9 million for the quarter ended September 30, 2022. The average cost of borrowings increased to 4.50% for the quarter ended September 30, 2023 compared to 2.61% for the quarter ended September 30, 2022.
Average borrowings increased $33.6 million, or 25.0%, to $168.2 million for the nine months ended September 30, 2023 compared to $134.6 million for the nine months ended September 30, 2022. The Company utilized funding capacity with the FHLB to meet its short-term liquidity needs. The average cost of borrowings increased to 4.20% for the nine months ended September 30, 2023 compared to 2.11% for the nine months ended September 30, 2022. 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 September 30, Nine Months Ended September 30,
(Dollars in thousands) 2023 2022 $ Change % Change 2023 2022 $ Change % Change
Service charges and other fees $ 760 $ 693 $ 67 9.7 % $ 2,180 $ 2,322 $ (142) (6.1) %
Bank card income and fees 1,029 1,030 (1) (0.1) % 3,044 3,054 (10) (0.3) %
Trust department income 283 287 (4) (1.4) % 820 924 (104) (11.3) %
Real estate servicing fees, net 125 383 (258) (67.4) % 417 861 (444) (51.6) %
Gain on sales of mortgage loans, net 851 628 223 35.5 % 2,014 2,322 (308) (13.3) %
Losses (gains) on other real estate owned, net (2,809) — (2,809) NM (4,592) 30 (4,622) NM
Other 367 464 (97) (20.9) % 1,501 1,346 155 11.5 %
Total non-interest income $ 606 $ 3,485 $ (2,879) (82.6) % $ 5,384 $ 10,859 $ (5,475) (50.4) %
Non-interest income as a % of total revenue * 3.8 % 18.8 % 11.1 % 19.9 %
* Total revenue is calculated as net interest income plus non-interest income.
NM = not meaningful
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Total non-interest income decreased $2.9 million, or 82.6%, to $0.6 million for the third quarter ended September 30, 2023 compared to $3.5 million for the third quarter ended September 30, 2022, and decreased $5.5 million, or 50.4%, to $5.4 million for the nine months ended September 30, 2023 compared to $10.9 million for the nine months ended September 30, 2022. The Company recognized a $2.8 million and $4.6 million valuation allowance for other real estate owned in the quarter and nine months ended September 30, 2023, respectively.
Real estate servicing fees, net of the change in valuation of mortgage servicing rights (MSRs) decreased to $0.1 million for the quarter ended September 30, 2023 compared to $0.4 million for the quarter ended September 30, 2022, and decreased to $0.4 million for the nine months ended September 30, 2023 compared to $0.9 million for the nine months ended September 30, 2022.
The Company was servicing $226.3 million of mortgage loans at September 30, 2023 compared to $240.5 million and $247.6 million at December 31, 2022 and September 30, 2022, respectively.
Gain on sales of mortgage loans increased to $0.9 million for the third quarter ended September 30, 2023 compared to $0.6 million for the third quarter ended September 30, 2022, and decreased to $2.0 million for the nine months ended September 30, 2023 compared to $2.3 million for the nine months ended September 30, 2022.
The Company sold $37.2 million and $84.4 million of loans for the three and nine months ended September 30, 2023, respectively, compared to $21.4 million and $76.1 million for the three and nine months ended September 30, 2022, respectively.
Investment Security Gains (Losses)
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 September 30, Nine Months Ended September 30,
(in thousands) 2023 2022 2023 2022
Gross realized gains $ — $ — $ — $ —
Gross realized losses — — — —
Other-than-temporary impairment recognized — — — —
Other investment securities:
Fair value adjustments, net 3 1 18 (12)
Investment securities gains (losses), net $ 3 $ 1 $ 18 $ (12)
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Non-interest expense for the periods indicated was as follows:
Three Months Ended September 30, Nine Months Ended September 30,
(Dollars in thousands) 2023 2022 $ Change % Change 2023 2022 $ Change % Change
Salaries $ 5,719 $ 5,153 $ 566 11.0% $ 16,763 $ 15,315 $ 1,448 9.5%
Employee benefits 1,405 1,597 (192) (12.0) 4,215 4,936 (721) (14.6)
Occupancy expense, net 842 789 53 6.7 2,437 2,339 98 4.2
Furniture and equipment expense 768 774 (6) (0.8) 2,236 2,301 (65) (2.8)
Processing, network and bank card expense 1,320 1,261 59 4.7 3,797 3,545 252 7.1
Legal, examination, and professional fees 499 395 104 26.3 1,447 1,210 237 19.6
Advertising and promotion 375 430 (55) (12.8) 1,084 1,027 57 5.6
Postage, printing, and supplies 248 237 11 4.6 621 653 (32) (4.9)
Loan expense 147 123 24 19.5 771 426 345 81.0
Other 1,246 1,436 (190) (13.2) 4,401 4,210 191 4.5
Total non-interest expense $ 12,569 $ 12,195 $ 374 3.1% $ 37,772 $ 35,962 $ 1,810 5.0%
Efficiency ratio* 79.8 % 65.7 % 77.6 % 65.8 %
Number of full-time equivalent employees 312 299 312 299
* 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 $0.4 million to $12.6 million for the quarter ended September 30, 2023 compared to $12.2 million for the quarter ended September 30, 2022 and increased $1.8 million to $37.8 million for the nine months ended September 30, 2023 compared to $36.0 million for the nine months ended September 30, 2022.
Salaries increased $0.5 million, or 11.0%, to $5.7 million for the quarter ended September 30, 2023 compared to $5.2 million for the quarter ended September 30, 2022, and increased $1.5 million, or 9.5%, to $16.8 million for the nine months ended September 30, 2023 compared to $15.3 million for the nine months ended September 30, 2022. The increase was primarily due to annual merit increases and an increase in full-time equivalent employees.
Employee benefits decreased $0.2 million, or 12.0%, to $1.4 million for the quarter ended September 30, 2023 compared to $1.6 million for the quarter ended September 30, 2022, and decreased $0.7 million, or 14.6%, to $4.2 million for the nine months ended September 30, 2023 compared to $4.9 million for the nine months ended September 30, 2022. The decrease was primarily due to a decrease in 401(k) plan contributions and pension cost due to higher annual discount rate assumptions compared to the prior year's annual assumptions.
Loan expense increased $0.02 million, or 19.5%, to $0.1 million for the quarter ended September 30, 2023 compared to $0.1 million for the quarter ended September 30, 2022, and increased $0.4 million, or 81.0%, to $0.8 million for the nine months ended September 30, 2023 compared to $0.4 million for the nine months ended September 30, 2022. The increase was primarily due to recognition of an adjustment to an unearned dealers reserve related to prior years' activity in the first quarter of 2023.
Income Taxes
Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 16.2% and 17.1% for the three and nine months ended September 30, 2023, respectively, compared to 18.7% and 18.5% for the three and nine months ended September 30, 2022, respectively.
The decrease in the effective tax rate for the three and nine months ended September 30, 2023 compared to the three and nine months ended September 30, 2022 was primarily attributable to the decrease in earnings, an increase in tax-exempt income and a return to provision adjustment resulting in a net benefit related to the 2022 tax return. The effective tax rate for each of the three and nine months ended September 30, 2023 and 2022, respectively, 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 and $40,000 benefit associated with a historic tax credit investment for the three and nine months ended September 30, 2023, respectively. The investment is expected to generate a $0.3 million tax benefit over the life of the project and is being recognized under the deferral method of accounting.
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Lending and Credit Management
Interest earned on the loan portfolio is a primary source of interest income for the Company. Net loans represented 81.7% of total assets as of September 30, 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 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:
September 30, 2023 December 31, 2022
(Dollars in thousands) Amount % of Loans Amount % of Loans
Commercial, financial, and agricultural $ 227,372 14.6 % $ 244,549 16.1 %
Real estate construction − residential
58,774 3.7 32,095 2.1
Real estate construction − commercial
130,572 8.4 137,235 9.0
Real estate mortgage − residential
379,514 24.4 361,025 23.7
Real estate mortgage − commercial
739,413 47.5 722,729 47.5
Installment and other consumer 21,324 1.4 23,619 1.6
Total loans held for investment $ 1,556,969 100.0 % $ 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 nine months ended September 30, 2023, the Company sold approximately $84.4 million of loans to investors compared to $76.1 million for the nine months ended September 30, 2022. At September 30, 2023, the Company was servicing approximately $226.3 million of loans sold to the secondary market compared to $240.5 million at December 31, 2022, and $247.6 million at September 30, 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.
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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:
September 30, December 31,
(Dollars in thousands) 2023 2022
Non-accrual loans (c):
Commercial, financial, and agricultural $ 88 $ 121
Real estate construction − commercial 74 87
Real estate mortgage − residential 773 685
Real estate mortgage − commercial 2,874 17,801
Installment and other consumer 1 6
Total $ 3,810 $ 18,700
Loans contractually past - due 90 days or more and still accruing:
Real estate mortgage − residential $ 31 $ —
Installment and other consumer 6 1
Total $ 37 $ 1
Total non-performing loans (a) 3,847 18,701
Other real estate owned and repossessed assets 3,564 8,795
Total non-performing assets $ 7,411 $ 27,496
Loans held for investment $ 1,556,969 $ 1,521,252
Allowance for credit losses on loans 22,462 15,588
Restructured loans accruing 1,435 1,661
Allowance for credit and loan losses to loans, respectively 1.44 % 1.02 %
Non-accrual loans to total loans 0.24 % 1.23 %
Non-performing loans to loans (a) 0.25 % 1.23 %
Non-performing assets to loans (b) 0.48 % 1.81 %
Non-performing assets to assets (b) 0.39 % 1.43 %
Allowance for credit and loan losses to non-accrual loans, respectively 589.55 % 83.36 %
Allowance for credit and loan losses to non-performing loans, respectively 583.88 % 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 September 30, 2023 and December 31, 2022.
Total non-performing assets were $7.4 million, or 0.48% of total loans, at September 30, 2023 compared to $27.5 million, or 1.81% of total loans, at December 31, 2022.
Total non-accrual loans at September 30, 2023 decreased $14.9 million, or 79.6%, to $3.8 million compared to $18.7 million at December 31, 2022 primarily due to three large non-accrual loan relationships returning to accruing status. There
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were $37,000 in loans past due 90 days and still accruing interest at September 30, 2023 compared to $1,000 at December 31, 2022. Other real estate and repossessed assets were $3.6 million and $8.8 million at September 30, 2023 and December 31, 2022, respectively. During the nine months ended September 30, 2023, there were $44,000 of non-accrual loans, net of charge-offs taken, added to other real estate owned and repossessed assets compared to $3,000 during the nine months ended September 30, 2022.
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 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:
September 30, 2023 December 31, 2022
(Dollars 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 $ 1,936 14.6 % $ 2,735 16.1 %
Real estate construction − residential 873 3.7 157 2.1
Real estate construction − commercial 3,265 8.4 875 9.0
Real estate mortgage − residential 5,314 24.4 3,329 23.7
Real estate mortgage − commercial 10,733 47.5 8,000 47.5
Installment and other consumer 244 1.4 326 1.6
Unallocated 97 — 166 —
Total $ 22,462 100.0 % $ 15,588 100.0 %
The allowance for credit losses was $22.5 million, or 1.44%, of loans outstanding at September 30, 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 583.88% at September 30, 2023, compared to the allowance for loan losses of 83.35% at December 31, 2022.
Provision for (Release of) Credit Losses / Loan Losses
Three Months Ended September 30, Nine Months Ended September 30,
(In thousands) 2023 2022 2023 2022
Provision for (release of) credit / loan losses on loans, respectively $ 300 $ 300 $ 1,115 $ (1,000)
Provision for available-for-sale securities — — — —
Provision for (release of) credit losses for off-balance sheet commitments (190) — (325) —
Total Provision for (release of) credit losses $ 110 $ 300 $ 790 $ (1,000)
The Company recognized a provision for credit losses of $0.1 million and $0.8 million for the three and nine months ended September 30, 2023, respectively, compared to a $0.3 million provision and a $1.0 million release of provision for loan losses for the three and nine months ended September 30, 2022, respectively. 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.
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The following table summarizes credit loss experience for the periods indicated:
Three Months Ended September 30,
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 $ 7 $ 232,516 — % $ 33 $ 245,877 0.01 %
Real estate construction − residential
— 55,289 — — 24,249 —
Real estate construction − commercial
— 129,284 — — 127,594 —
Real estate mortgage − residential
(2) 376,209 — (4) 323,158 —
Real estate mortgage − commercial
2 739,225 — (6) 702,139 —
Installment and other consumer 67 22,176 0.30 125 23,738 0.53
Total $ 74 $ 1,554,699 — % $ 148 $ 1,446,755 0.01 %
Nine Months Ended September 30,
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 $ (124) $ 231,691 (0.05) % $ 57 $ 233,076 0.02 %
Real estate construction − residential
— 47,265 — — 23,627 —
Real estate construction − commercial
— 137,776 — — 110,540 —
Real estate mortgage − residential
(6) 368,702 — (27) 300,518 (0.01)
Real estate mortgage − commercial
25 735,539 — 169 685,041 0.02
Installment and other consumer 139 22,622 0.61 199 22,987 0.87
Total $ 34 $ 1,543,595 — % $ 398 $ 1,375,789 0.03 %
Net Loan Charge-Offs (Recoveries)
The Company’s net charge-offs were $0.1 million and $34,000 for the three and nine months ended September 30, 2023, respectively, compared to net charge-offs of $0.1 million and $0.4 million for the three and nine months ended September 30, 2022, respectively.
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 September 30, 2023, the carrying amount of these loans was $3.0 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
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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) September 30, 2023 December 31, 2022
Federal funds sold $ — $ 46
Other interest-bearing deposits 10,061 65,013
Certificates of deposit in other banks 735 2,955
Available-for-sale investment securities 233,516 250,747
Total $ 244,312 $ 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 $233.5 million at September 30, 2023 and included an unrealized net loss of $56.5 million. The portfolio includes projected maturities and mortgage-backed securities pay-downs of approximately $9.1 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 September 30, 2023 and December 31, 2022, the Company’s unpledged securities in the available-for-sale portfolio totaled approximately $116.1 million and $139.2 million, respectively.
Total investment securities pledged for these purposes were as follows:
(in thousands) September 30, 2023 December 31, 2022
Investment securities pledged for the purpose of securing:
Federal Reserve Bank borrowings $ 8,035 $ 8,563
Federal funds purchased and securities sold under agreements to repurchase 8,505 8,601
Other deposits 100,887 94,432
Total pledged, at fair value $ 117,427 $ 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 September 30, 2023, such deposits totaled $1.4 billion and represented 90.0% 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.
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Core deposits at September 30, 2023 and December 31, 2022 were as follows:
(in thousands) September 30, 2023 December 31, 2022
Core deposit base:
Non-interest bearing demand $ 425,105 $ 453,443
Interest checking 348,840 440,611
Savings and money market 451,235 442,856
Other time deposits 197,445 160,175
Total $ 1,422,625 $ 1,497,085
Estimated uninsured deposits totaled $358.7 million, including $115.2 million of certificates of deposit, at September 30, 2023, compared to $420.3 million, including $94.9 million of certificates of deposit, at December 31, 2022. The Company had brokered deposits totaling $42.5 million and $40.1 million at September 30, 2023 and December 31, 2022, respectively.
Included in the uninsured deposits at September 30, 2023 and December 31, 2022 are public fund deposits greater than $250,000, which are collateralized by the Company totaling $96.6 million and $111.6 million, respectively. The estimated uninsured and uncollateralized deposits ratio to total deposits at September 30, 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), 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 September 30, 2023, under agreements with these unaffiliated banks, the Bank may borrow up to $35.0 million in federal funds on an unsecured basis and $7.5 million on a secured basis. There were no federal funds purchased outstanding at September 30, 2023. Securities sold under agreements to repurchase are generally borrowed overnight and are secured by a portion of the Company’s investment portfolio. At September 30, 2023, there were $6.2 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 September 30, 2023.
The Bank is a member of the FHLB and has access to credit products of the FHLB. As of September 30, 2023, the Bank had $112.0 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 September 30, 2023 and December 31, 2022 were as follows:
(in thousands) September 30, 2023 December 31, 2022
Borrowings:
Federal funds purchased and securities sold under agreements to repurchase $ 6,196 $ 5,187
Federal Home Loan Bank advances 112,000 98,000
Subordinated notes 49,486 49,486
Total $ 167,682 $ 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.
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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:
September 30, 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 $ 431,021 $ 7,532 $ 35,000 $ 473,553 $ 355,391 $ 8,058 $ 60,000 $ 423,449
Letters of credit (14,500) — — (14,500) (47,500) — — (47,500)
Advances outstanding (112,000) — — (112,000) (98,000) — — (98,000)
Total available $ 304,521 $ 7,532 $ 35,000 $ 347,053 $ 209,891 $ 8,058 $ 60,000 $ 277,949
At September 30, 2023, loans of $719.9 million were pledged to the FHLB as collateral for borrowings and letters of credit. At September 30, 2023, investments with a market value of $8.0 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 $27.9 million at September 30, 2023 compared to $83.7 million at December 31, 2022. The $55.8 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 nine months ended September 30, 2023. Cash flow provided from operating activities consists mainly of net income adjusted for certain non-cash items. Operating activities provided cash flow of $12.3 million for the nine months ended September 30, 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 $28.0 million during the nine months ended September 30, 2023. The cash outflow primarily consisted of a net increase in loans held for investment of $35.5 million and $9.5 million in purchases of investment securities, partially offset by $15.9 million from maturities and calls of investment securities.
Financing activities used total cash of $40.2 million during the nine months ended September 30, 2023, resulting primarily from a $149.3 million decrease in demand deposits and interest-bearing transaction accounts. These decreases were partially offset by a $97.6 million increase in time deposits. The Company utilized funding capacity with the FHLB by drawing advances of $342.9 million and repaying $328.9 million to meet its short-term liquidity needs during the year.
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 $339.8 million in unused loan commitments and standby letters of credit as of September 30, 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 $3.5 million and $3.1 million for the nine months ended September 30, 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 $9.0 million in dividends to the Company during each of the nine months ended September 30, 2023 and 2022, respectively. At September 30, 2023 and December 31, 2022, the Company had cash and cash equivalents totaling $5.9 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
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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.
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 September 30, 2023. As of September 30, 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.
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Under the Basel III Rules, at September 30, 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
September 30, 2023
Total Capital (to risk-weighted assets):
Company $ 228,901 14.20 % $ 169,202 10.50 % $ — N.A%
Bank 223,912 13.92 % 168,842 10.50 % 160,802 10.00 %
Tier 1 Capital (to risk-weighted assets):
Company $ 201,998 12.54 % $ 136,973 8.50 % $ — N.A%
Bank 205,641 12.79 % 136,682 8.50 % 128,642 8.00 %
Common Equity Tier 1 Capital (to risk-weighted assets):
Company $ 162,630 10.09 % $ 112,802 7.00 % $ — N.A%
Bank 205,641 12.79 % 112,562 7.00 % 104,521 6.50 %
Tier 1 leverage ratio (to adjusted average assets):
Company $ 201,998 10.43 % $ 77,435 4.00 % $ — N.A%
Bank 205,641 10.63 % 77,366 4.00 % 96,708 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 %
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.