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, strategy, 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, and the Israel-Hamas 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, and • 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 Company has 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 Item 1A. of the Company’s Annual Report on Form 10-K for the year ended December 31, 2023 (the "2023 Form 10-K"), and in other reports filed by us 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. 34 Overview Crucial to the Company’s community banking strategy is growth in its commercial banking services, retail mortgage lending and retail banking services. Through the branch network of its subsidiary bank, Hawthorn Bank (the "Bank"), the Company, with $1.8 billion in assets at September 30, 2024, 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, a comprehensive suite of cash management services, 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. The geographic areas in which the Company provides products and services include the Missouri communities in and surrounding Jefferson City, Columbia, Clinton, Warsaw, Springfield, 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 deposit accounts of the Bank are insured by the Federal Deposit Insurance Corporation ("FDIC") to the extent provided by law. The Bank is supervised and regulated by the FDIC and the Missouri Division of Finance. Regular examinations are conducted by representatives of these regulatory bodies. Such regulations, supervision and examinations are principally for the benefit of depositors, rather than for the benefit of shareholders. The Company is also subject to supervision and examination by the Board of Governors of the Federal Reserve System. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Certain accounting policies are considered most critical to the understanding of the Company’s financial condition and results of operations. These critical accounting policies and estimates 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 Company has identified certain accounting policies as "critical accounting policies and estimates," consisting of those related to the allowance for credit losses, as described in the section captioned "Critical Accounting Policies and Estimates" incorporated by reference in Item 7, Management's Discussion and Analysis of Financial Condition and results of Operations included in the 2023 Form 10-K. There have been no changes in the Company's application of critical accounting policies and estimates since December 31, 2023. 35 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. Three Months Ended September 30, Nine Months Ended September 30, (dollars in thousands, except per share data) 2024 2023 2024 2023 Net interest income $ 14,327 $ 15,147 $ 43,246 $ 43,297 Provision for credit losses on loans & unfunded commitments 500 110 726 790 Non-interest income 3,783 606 10,798 5,384 Investment securities gains (losses), net 8 3 (7) 18 Non-interest expense 11,994 12,569 36,603 37,772 Income before income taxes 5,624 3,077 16,708 10,137 Income tax expense 1,050 498 3,049 1,738 Net income $ 4,574 $ 2,579 $ 13,659 $ 8,399 Basic earnings per share $ 0.66 $ 0.36 $ 1.95 $ 1.19 Diluted earnings per share $ 0.66 $ 0.36 $ 1.95 $ 1.19 Efficiency ratio (1) 66.23% 79.79% 67.73% 79.79% Net interest margin (FTE) 3.36% 3.35% 3.36% 3.23% (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. As of and for the Three Months Ended As of and for the Nine Months Ended September 30, September 30, (dollars in thousands, except per share data) 2024 2023 2024 2023 Key financial ratios Book value per share (2) $ 20.91 $ 16.82 Market price per share $ 25.03 $ 16.25 Cash dividends paid on common stock $ 1,194 $ 1,151 $ 3,720 $ 3,452 Return on total assets 1.00% 0.54% 1.00% 0.59% Return on stockholders' equity 12.87% 8.05% 13.24% 8.73% Average stockholders' equity to total assets 7.80% 6.73% 7.54% 6.78% Capital Ratios Stockholders' equity to assets 8.09% 6.30% Total risk-based capital ratio 14.91% 14.20% Tier 1 risk-based capital ratio 13.66% 12.54% Common equity Tier 1 capital 10.53% 10.09% Tier 1 leverage ratio (1) 11.33% 10.43% Asset Quality Net loan charge-offs $ 636 $ 74 $ 2,682 $ 34 Non-performing assets $ 8,451 $ 7,411 Classified assets $ 13,496 $ 33,342 Non-performing loans to total loans 0.28% 0.25% Non-performing assets to total loans 0.58% 0.48% Allowance for credit losses to total loans 1.50% 1.44% (1) Tier 1 leverage ratio is calculated by dividing Tier 1 capital by average total consolidated assets 36 (2) Book value per share is calculated using weighted average shares Results of Operations Highlights: Consolidated net income of $4.6 million, or $0.66 per diluted share, for the third quarter ended September 30, 2024 increased $2.0 million, or 77.4%, compared to $2.6 million, or $0.36 per diluted share, for the third quarter ended September 30, 2023. For the third quarter 2024, the return on average assets was 1.00%, the return on average stockholders’ equity was 12.87%, and the efficiency ratio was 66.2%. For the nine months ended September 30, 2024 consolidated net income increased $5.3 million, or 62.6%, to $13.7 million, or $1.95 per diluted share, compared to $8.4 million, or $1.19 per diluted share, for the nine months ended September 30, 2023. For the nine months ended September 30, 2024, the return on average assets was 1.00%, the return on average stockholders’ equity was 13.24%, and the efficiency ratio was 67.7%. The Company continues to see a positive impact from focusing on the core business of the Bank and remains committed to expanding our products and services to the core customer base, while managing operating expenses. Net interest income was $14.3 million for the third quarter ended September 30, 2024 decreased $0.8 million compared to and $15.1 million for the third quarter ended September 30, 2023. Net interest margin, on a fully taxable equivalent basis ("FTE"), was 3.36% for the third quarter 2024, an increase from 3.35% for the third quarter 2023. Net interest income was $43.2 million for the nine months ended September 30, 2024 decreased $0.1 million compared to $43.3 million for the nine months ended September 30, 2023. Net interest margin, on a FTE basis, was 3.36% for the nine months ended September 30, 2024, an increase from 3.23% for the nine months ended September 30, 2023. 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. Non-interest income was $3.8 million and $10.8 million for the three and nine months ended September 30, 2024, respectively, compared to $0.6 million and $5.4 million for the three and nine months ended September 30, 2023, respectively. The increases were primarily due to earnings on bank-owned life insurance and the gain on sale of other real estate. These changes are discussed in greater detail under the Non-interest Income and Expense section. Non-interest expense was $12.0 million and $36.6 million for the three and nine months ended September 30, 2024, respectively, compared to $12.6 million and $37.8 million for the three and nine months ended September 30, 2023, respectively. The decreases are primarily due to operating within a unified company culture, focusing on core business lines and improving operational efficiencies. These changes are discussed in greater detail under the Non-interest Income and Expense section. Balance Sheet Highlights: Cash and cash equivalents – Cash and cash equivalents decreased $39.2 million to $54.2 million as of September 30, 2024 compared to $93.4 million as of December 31, 2023 and increased $26.4 million compared to $27.9 million as of September 30, 2023. The Company purchased $32.9 million securities and $35.0 million in bank-owned life insurance during the nine months ended September 30, 2024. See the Liquidity Management section for further discussion. Loans – Loans held for investment decreased $72.4 million to $1.47 billion as of September 30, 2024 compared to $1.54 billion as of December 31, 2023 and decreased $90.2 million compared to $1.56 billion as of September 30, 2023. Normal amortizing payments, unscheduled payoffs and a weaker demand for loans have contributed to the variance. Asset quality – Non-performing assets to total loans was 0.58% at September 30, 2024, compared to 0.53% and 0.48% at December 31, 2023 and September 30, 2023, respectively. Non-performing assets totaled $8.5 million at September 30, 2024, compared to $8.2 million and $7.4 million at December 31, 2023 and September 30, 2023, respectively. The increase in non-performing assets in the current quarter is primarily due to a $2.0 million commercial loan relationship moving to non-accrual status and a $1.1 million commercial real estate loan that went to foreclosure during the current quarter. In the third quarter 2024, the Company had net loan charge-offs of $0.6 million, or 0.04% of average loans, compared to net loan charge-offs $0.1 million, or 0.00% of average loans, in the prior year quarter. The charge-offs in the current 37 quarter primarily related to one commercial real estate loan and one commercial loan relationship that were adequately reserved for in the prior quarter. The allowance for credit losses was $21.9 million, or 1.50%, of loans outstanding at September 30, 2024 compared to $23.7 million, or 1.54%, of loans outstanding at December 31, 2023, and $22.5 million, or 1.44%, of loans outstanding at September 30, 2023. These changes are discussed in greater detail under the Lending and Credit Management section. Deposit s – Total deposits decreased $67.3 million to $1.50 billion as of September 30, 2024 compared to $1.57 billion as of December 31, 2023, and decreased $76.9 million compared to $1.58 billion as of September 30, 2023. The decrease in deposits at September 30, 2024 as compared to December 31, 2023 was primarily a result of a decrease in public funds partially offset by an increase in savings accounts. Federal Home Loan Bank ("FHLB") advances and other borrowings – Total FHLB advances and other borrowings decreased $10.5 million to $96.5 million as of September 30, 2024 compared to $107.0 million as of December 31, 2023, and decreased $15.5 million compared to $112.0 million as of September 30, 2023 Capital – The Company maintains its “well capitalized” regulatory capital position. At September 30, 2024, capital ratios were as follows: total risk-based capital to risk-weighted assets 14.91%; tier 1 capital to risk-weighted assets 13.66%; tier 1 leverage 11.33%; and common equity to assets 8.09%. 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 and nine month periods ended September 30, 2024 and 2023, respectively. The average balances used in this table and other statistical data were calculated using average daily balances. 38 Three Months Ended September 30, 2024 2023 (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 $ 210,783 $ 3,592 6.78% $ 232,516 $ 3,761 6.42% Real estate construction - residential 35,611 717 8.01 55,289 1,028 7.38 Real estate construction - commercial 61,546 1,269 8.20 129,284 1,899 5.83 Real estate mortgage - residential 369,068 5,235 5.64 376,209 5,185 5.47 Real estate mortgage - commercial 792,668 10,727 5.38 739,225 10,054 5.40 Installment and other consumer 15,977 235 5.85 22,176 279 4.99 Total loans $ 1,485,653 $ 21,775 5.83% $ 1,554,699 $ 22,206 5.67% Loans held for sale 610 13 8.48 6,351 59 3.69 Investment securities: U.S. Treasury — — — 4,861 52 4.24 U.S. government and federal agency obligations 13,218 140 4.21 25,498 103 1.60 Obligations of states and political subdivisions 103,790 745 2.86 108,022 814 2.99 Mortgage-backed securities 61,907 530 3.41 97,274 514 2.10 Other debt securities 13,335 191 5.70 11,566 176 6.04 Total investment securities $ 192,250 $ 1,606 3.32% $ 247,221 $ 1,659 2.66% Other investment securities 5,844 141 9.60 7,713 121 6.22 Interest bearing deposits in other financial institutions 34,099 469 5.47 7,071 85 4.77 Total interest earning assets $ 1,718,456 $ 24,004 5.56% $ 1,823,055 $ 24,130 5.25% All other assets 117,429 89,017 Allowance for credit losses (21,923) (22,356) Total assets $ 1,813,962 $ 1,889,716 LIABILITIES AND STOCKHOLDERS' EQUITY Savings $ 273,470 $ 1,612 2.35% $ 178,564 $ 229 0.51% NOW accounts 190,084 677 1.42 182,487 464 1.01 Interest checking 121,423 1,372 4.50 187,732 2,252 4.76 Money market 221,794 1,249 2.24 273,655 1,521 2.21 Time deposits 319,279 2,834 3.53 315,332 2,173 2.73 Total interest bearing deposits $ 1,126,050 $ 7,744 2.74% $ 1,137,770 $ 6,639 2.32% Federal funds purchased and securities sold under agreements to repurchase 29 — — 6,136 38 2.46 Federal Home Loan Bank advances and other borrowings 99,293 759 3.04 129,758 1,075 3.29 Subordinated notes 49,486 989 7.95 49,486 989 7.93 Total borrowings $ 148,808 $ 1,748 4.67% $ 185,380 $ 2,102 4.50% Total interest bearing liabilities $ 1,274,858 $ 9,492 2.96% $ 1,323,150 $ 8,741 2.62% Demand deposits 385,298 426,052 Other liabilities 12,375 13,361 Total liabilities $ 1,672,531 $ 1,762,563 Stockholders' equity 141,431 127,153 Total liabilities and stockholders' equity $ 1,813,962 $ 1,889,716 Net interest income (FTE) $ 14,512 $ 15,389 Net interest spread (FTE) 2.59% 2.63% Net interest margin (FTE) 3.36% 3.35% (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, 2024 and 2023. Such adjustments totaled $0.19 million and $0.24 million for the three months ended September 30, 2024 and 2023, respectively. (2) Non-accruing loans are included in the average amounts outstanding. 39 Nine Months Ended September 30, 2024 2024 2023 (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 $ 217,576 $ 10,847 6.66% $ 231,691 $ 10,702 6.18% Real estate construction - residential 46,247 2,705 7.81 47,265 2,514 7.11 Real estate construction - commercial 70,452 3,788 7.18 137,776 5,586 5.42 Real estate mortgage - residential 371,072 15,716 5.66 368,702 14,524 5.27 Real estate mortgage - commercial 783,960 31,328 5.34 735,539 27,257 4.95 Installment and other consumer 17,916 780 5.82 22,622 763 4.51 Total loans $ 1,507,223 $ 65,164 5.78% $ 1,543,595 $ 61,346 5.31% Loans held for sale 1,841 80 5.80 3,837 119 4.15 Investment securities: U.S. Treasury 656 26 5.29 4,391 133 4.05 U.S. government and federal agency obligations 14,994 502 4.47 25,406 305 1.61 Obligations of states and political subdivisions 103,687 2,256 2.91 109,994 2,587 3.14 Mortgage-backed securities 54,356 1,270 3.12 101,126 1,565 2.07 Other debt securities 12,640 550 5.81 11,826 520 5.88 Total investment securities $ 186,333 $ 4,604 3.30% $ 252,743 $ 5,110 2.70% Other investment securities 6,126 428 9.33 7,015 321 6.12 Interest bearing deposits in other financial institutions 41,149 1,732 5.62 20,602 726 4.71 Total interest earning assets $ 1,742,672 $ 72,008 5.52% $ 1,827,792 $ 67,622 4.95% All other assets 109,477 89,524 Allowance for credit losses (23,132) (20,124) Total assets $ 1,829,017 $ 1,897,192 LIABILITIES AND STOCKHOLDERS' EQUITY Savings $ 249,594 $ 3,912 2.09% $ 172,639 $ 259 0.20% NOW accounts 197,898 2,084 1.41 196,084 1,485 1.01 Interest checking 128,420 4,359 4.53 170,057 5,741 4.51 Money market 226,115 3,679 2.17 293,842 4,476 2.04 Time deposits 333,923 8,744 3.50 325,002 6,208 2.55 Total interest bearing deposits $ 1,135,950 $ 22,778 2.68% $ 1,157,624 $ 18,169 2.10% Federal funds purchased and securities sold under agreements to repurchase 10 1 13.36 5,525 83 2.01 Federal Home Loan Bank advances and other borrowings 105,050 2,438 3.10 113,167 2,430 2.87 Subordinated notes 49,486 2,964 8.00 49,486 2,769 7.48 Total borrowings $ 154,546 $ 5,403 4.67% $ 168,178 $ 5,282 4.20% Total interest bearing liabilities $ 1,290,496 $ 28,181 2.92% $ 1,325,802 $ 23,451 2.36% Demand deposits 389,003 429,859 Other liabilities 11,690 12,911 Total liabilities $ 1,691,189 $ 1,768,572 Stockholders' equity 137,828 128,620 Total liabilities and stockholders' equity $ 1,829,017 $ 1,897,192 Net interest income (FTE) $ 43,827 $ 44,171 Net interest spread (FTE) 2.60% 2.58% Net interest margin (FTE) 3.36% 3.23% (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, 2024 and 2023. Such adjustments totaled $0.6 million and $0.9 million for the nine months ended September 30, 2024 and 2023, respectively. (2) Non-accruing loans are included in the average amounts outstanding. 40 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 and nine months ended September 30, 2024 compared to the three and nine months ending ended September 30, 2023, 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, 2024 vs. 2023 2024 vs. 2023 Change due to Change due to (dollars 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 $ (169) $ (363) $ 194 $ 145 $ (673) $ 818 Real estate construction - residential (311) (389) 78 191 (55) 246 Real estate construction - commercial (630) (1,219) 589 (1,798) (3,255) 1,457 Real estate mortgage - residential 50 (99) 149 1,192 94 1,098 Real estate mortgage - commercial 673 721 (48) 4,071 1,854 2,217 Installment and other consumer (44) (86) 42 17 (178) 195 Loans held for sale (46) (82) 36 (39) (76) 37 Investment securities: U.S. Treasury (52) (26) (26) (107) (138) 31 U.S. government and federal agency obligations 37 (68) 105 197 (166) 363 Obligations of states and political subdivisions (69) (31) (38) (331) (143) (188) Mortgage-backed securities 16 (229) 245 (295) (897) 602 Other debt securities 15 26 (11) 30 35 (5) Other investment securities 20 (34) 54 107 (45) 152 Interest bearing deposits in other financial institutions 384 369 15 1,006 840 166 Total interest income $ (126) $ (1,510) $ 1,384 $ 4,386 $ (2,803) $ 7,189 Interest expense: Savings $ 1,383 $ 178 $ 1,205 $ 3,653 $ 164 $ 3,489 NOW accounts 213 20 193 599 14 585 Interest checking (880) (754) (126) (1,382) (1,409) 27 Money market (272) (291) 19 (797) (1,083) 286 Time deposits 661 27 634 2,536 174 2,362 Federal funds purchased and securities sold under agreements to repurchase (38) (19) (19) (82) (153) 71 FHLB advances and other borrowings (316) (237) (79) 8 (180) 188 Subordinated notes — — — 195 — 195 Total interest expense $ 751 $ (1,076) $ 1,827 $ 4,730 $ (2,473) $ 7,203 Net interest income on a FTE basis $ (877) $ (434) $ (443) $ (344) $ (330) $ (14) (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, 2024 and 2023, respectively. Such adjustments totaled $0.2 million and $0.6 million for the three and nine months ended September 30, 2024, respectively, compared to $0.2 million and $0.9 million for the three and nine months ended September 30, 2023, respectively. (2) Non-accruing loans are included in the average amounts outstanding. 41 Financial results for the quarter ended September 30, 2024 compared to the quarter ended September 30, 2023 reflected a decrease in net interest income, on a FTE basis, of $0.9 million, or 5.7%, and financial results for the the nine months ended September 30, 2024 compared to the nine months ended September 30, 2023 reflected a decrease of $0.3 million, or 0.8%. Measured as a percentage of average earning assets, the net interest margin (expressed on a FTE basis) increased to 3.36% for the quarter ended September 30, 2024 compared to 3.35% for the quarter ended September 30, 2023, and increased to 3.36% for the nine months ended September 30, 2024 compared to 3.23% for the nine months ended September 30, 2023. Average interest-earning assets decreased $104.6 million, or 5.7%, to $1.72 billion for the quarter ended September 30, 2024 compared to $1.82 billion for the quarter ended September 30, 2023, and average interest-bearing liabilities decreased $48.3 million, or 3.6%, to $1.27 billion for the quarter ended September 30, 2024 compared to $1.32 billion for the quarter ended September 30, 2023. Average interest-earning assets decreased $85.1 million, or 4.7%, to $1.74 billion for the nine months ended September 30, 2024 compared to $1.83 billion for the nine months ended September 30, 2023, and average interest-bearing liabilities decreased $35.3 million, or 2.7%, to $1.29 billion for the nine months ended September 30, 2024 compared to $1.33 billion for the nine months ended September 30, 2023. Total interest income (expressed on a FTE basis) was $24.0 million and $72.0 million for the three and nine months ended September 30, 2024, respectively, compared to $24.1 million and $67.6 million for the three and nine months ended September 30, 2023, respectively. The Company’s rates earned on interest earning assets were 5.56% and 5.52% for the three and nine months ended September 30, 2024, respectively, compared to 5.25% and 4.95% for the three and nine months ended September 30, 2023, respectively. Interest income on loans held for investment was $21.8 million and $65.2 million for the three and nine months ended September 30, 2024, respectively, compared to $22.2 million and $61.3 million for the three and nine months ended September 30, 2023, respectively. Average loans outstanding decreased $69.0 million, or 4.4%, to $1.49 billion for the quarter ended September 30, 2024 compared to $1.55 billion for the quarter ended September 30, 2023. The average yield on loans increased to 5.83% for the quarter ended September 30, 2024 compared to 5.67% for the quarter ended September 30, 2023. Average loans outstanding decreased $36.4 million, or 2.4%, to $1.51 billion for the nine months ended September 30, 2024 compared to $1.54 billion for the nine months ended September 30, 2023. The average yield on loans increased to 5.78% for the nine months ended September 30, 2024 compared to 5.31% for the nine months ended September 30, 2023. 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 $1.6 million and $4.6 million for the three and nine months ended September 30, 2024, respectively, compared to $1.7 million and $5.1 million for the three and nine months ended September 30, 2023, respectively. Average securities decreased $55.0 million, or 22.2%, to $192.3 million for the quarter ended September 30, 2024 compared to $247.2 million for the quarter ended September 30, 2023. The average yield on securities increased to 3.32% for the quarter ended September 30, 2024 compared to 2.66% for the quarter ended September 30, 2023 Average securities decreased $66.4 million, or 26.3%, to $186.3 million for the nine months ended September 30, 2024 compared to $252.7 million for the nine months ended September 30, 2023. The average yield on securities increased to 3.30% for the nine months ended September 30, 2024 compared to 2.70% for the nine months ended September 30, 2023. During the fourth quarter of 2023, the Company repositioned its balance sheet by selling $83.7 million in book value of investment securities, with an average yield of 1.57%. See the Liquidity Management section for further discussion. Total interest expense was $9.5 million and $28.2 million for the three and nine months ended September 30, 2024, respectively, compared to $8.7 million and $23.5 million for the three and nine months ended September 30, 2023, respectively. The Company’s rates paid on interest bearing liabilities were 2.96% and 2.92% for the three and nine months ended September 30, 2024, respectively, compared to 2.62% and 2.36% for the three and nine months ended September 30, 2023, respectively. See the Liquidity Management section for further discussion. 42 Interest expense on deposits was $7.7 million and $22.8 million for the three and nine months ended September 30, 2024, respectively, compared to $6.6 million and $18.2 million for the three and nine months ended September 30, 2023, respectively. Average interest-bearing deposits decreased $11.7 million, or 1.0%, to $1.13 billion for the quarter ended September 30, 2024 compared to $1.14 billion for the quarter ended September 30, 2023. The average cost of deposits increased to 2.74% for the quarter ended September 30, 2024 compared to 2.32% for the quarter ended September 30, 2023. Average interest-bearing deposits decreased $21.7 million, or 1.9%, to $1.14 billion for the nine months ended September 30, 2024 compared to $1.16 billion for the nine months ended September 30, 2023. The average cost of deposits increased to 2.68% for the nine months ended September 30, 2024 compared to 2.10% for the nine months ended September 30, 2023. Interest expense on borrowings was $1.7 million and $5.4 million for the three and nine months ended September 30, 2024, respectively, compared to $2.1 million and $5.3 million for the three and nine months ended September 30, 2023, respectively. Average borrowings decreased $36.6 million, or 19.7%, to $148.8 million for the quarter ended September 30, 2024 compared to $185.4 million for the quarter ended September 30, 2023. The average cost of borrowings increased to 4.67% for the quarter ended September 30, 2024 compared to 4.50% for the quarter ended September 30, 2023. Average borrowings decreased $13.6 million, or 8.1%, to $154.5 million for the nine months ended September 30, 2024 compared to $168.2 million for the nine months ended September 30, 2023. The average cost of borrowings increased to 4.67% for the nine months ended September 30, 2024 compared to 4.20% for the nine months ended September 30, 2023. The increase in average cost of borrowings 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) 2024 2023 $ Change % Change 2024 2023 $ Change % Change Service charges and other fees $ 870 $ 760 $ 110 14.5 % $ 2,464 $ 2,180 $ 284 13.0 % Bank card income and fees 1,037 1,029 8 0.8 % 3,084 3,044 40 1.3 % Earnings on bank-owned life insurance 520 14 506 NM 1,162 43 1,119 NM Trust department income 341 283 58 20.5 % 960 820 140 17.1 % Real estate servicing fees, net 81 125 (44) (35.2) % 33 417 (384) (92.1) % Gain on sales of mortgage loans, net 111 851 (740) (87.0) % 786 2,014 (1,228) (61.0) % Gains (losses) on other real estate owned, net 262 (2,809) 3,071 (109.3) % 751 (4,592) 5,343 (116.4) % Other 561 353 208 58.9 % 1,558 1,458 100 6.9 % Total non-interest income $ 3,783 $ 606 $ 3,177 524.3 % $ 10,798 $ 5,384 $ 5,414 100.6 % Non-interest income as a % of total revenue * 20.9 % 3.8 % 20.0 % 11.1 % * Total revenue is calculated as net interest income plus non-interest income. NM = not meaningful Total non-interest income increased $3.2 million, or 524.3%, to $3.8 million for the third quarter ended September 30, 2024 compared to $0.6 million for the third quarter ended September 30, 2023, and increased $5.4 million, or 100.6%, to $10.8 million for the nine months ended September 30, 2024 compared to $5.4 million for the nine months ended September 30, 2023. The increases were primarily due to earnings on bank-owned life insurance and the gain on sale of other real estate owned during the current periods. Earnings on bank-owned life insurance increased to $0.5 million for the third quarter ended September 30, 2024 compared to $0.01 million for the third quarter ended September 30, 2023, and increased to $1.2 million for the nine months ended September 30, 2024 compared to $0.04 million for the nine months ended September 30, 2023. The 43 Company purchased $35.0 million in bank-owned life insurance policies in the first quarter of 2024. The earnings generated from these polices are primarily derived from the investment returns on the cash value component. Real estate servicing fees, net of the change in valuation of mortgage servicing rights (MSRs) decreased to $0.08 million for the third quarter ended September 30, 2024 compared to $0.1 million for the third quarter ended September 30, 2023, and decreased to $0.03 million for the nine months ended September 30, 2024 compared to $0.4 million for the nine months ended September 30, 2023. On January 31, 2024, the Company sold its servicing portfolio and the balance of the serviced loans transferred on April 30, 2024. The remaining servicing fees and costs were settled during the second and third quarter of 2024. Gain on sales of mortgage loans decreased to $0.1 million for the third quarter ended September 30, 2024 compared to $0.9 million for the third quarter ended September 30, 2023, and decreased to $0.8 million for the nine months ended September 30, 2024 compared to $2.0 million for the nine months ended September 30, 2023. The Company sold $7.4 million and $45.0 million of mortgage loans for the three and nine months ended September 30, 2024, respectively, compared to $37.2 million and $84.4 million for the three and nine months ended September 30, 2023, respectively. Gains (losses) on other real estate owned increased to a $0.3 million gain for the third quarter ended September 30, 2024 compared to a $2.8 million loss for the third quarter ended September 30, 2023, and increased to a $0.8 million gain for the nine months ended September 30, 2024 compared to a $4.6 million loss for the nine months ended September 30, 2023. During the second and third quarter of 2023, the Company recognized $1.8 million and $2.8 million in valuation write-downs, respectively, on foreclosed property in other real estate owned based on current appraisals. The Company sold the remaining parcel related to one of these properties in the second quarter of 2024, and the Company recognized a $0.4 million release of the valuation write-down. Moreover, the Company sold land previously intended for a new branch, resulting in a gain of $0.3 million in the third quarter of 2024. Non-interest expense for the periods indicated was as follows: Three Months Ended September 30, Nine Months Ended September 30, (dollars in thousands) 2024 2023 $ Change % Change 2024 2023 $ Change % Change Salaries $ 5,115 $ 5,719 $ (604) (10.6)% $ 15,756 $ 16,763 $ (1007) (6.0)% Employee benefits 1,424 1,405 19 1.4 4,237 4,215 22 0.5 Occupancy expense, net 843 842 1 0.1 2,364 2,437 (73) (3.0) Furniture and equipment expense 787 768 19 2.5 2,266 2,236 30 1.3 Processing, network and bank card expense 1,480 1,320 160 12.1 4,212 3,797 415 10.9 Legal, examination, and professional fees 378 499 (121) (24.2) 1,713 1,447 266 18.4 Advertising and promotion 198 375 (177) (47.2) 711 1,084 (373) (34.4) Postage, printing, and supplies 215 248 (33) (13.3) 571 621 (50) (8.1) Loan expense 126 147 (21) (14.3) 515 771 (256) (33.2) Other 1,428 1,246 182 14.6 4,258 4,401 (143) (3.2) Total non-interest expense $ 11,994 $ 12,569 $ (575) (4.6)% $ 36,603 $ 37,772 $ (1,169) (3.1)% Efficiency ratio* 66.2 % 79.8 % 67.7 % 77.6 % Number of full-time equivalent employees 268 312 268 312 * Efficiency ratio is calculated as non-interest expense as a percent of revenue. Total revenue is calculated as net interest income plus non-interest income. Total non-interest expense decreased $0.6 million, or 4.6%, to $12.0 million for the third quarter ended September 30, 2024 compared to $12.6 million for the third quarter ended September 30, 2023, and decreased $1.2 million, or 3.1%, to $36.6 million for the nine months ended September 30, 2024 compared to $37.8 million for the nine months ended September 30, 2023. Salaries decreased $0.6 million, or 10.6%, to $5.1 million for the third quarter ended September 30, 2024 compared to $5.7 million for the third quarter ended September 30, 2023, and decreased $1.0 million, or 6.0%, to $15.8 million for the nine months ended September 30, 2024 compared to $16.8 million for the nine months ended September 30, 2023. The decrease was primarily due to planned reductions of full-time employees during the fourth quarter of 2023 and second quarter of 2024. 44 Legal, examination and professional fees decreased $0.1 million, or 24.2%, to $0.4 million for the third quarter ended September 30, 2024 compared to $0.5 million for the third quarter ended September 30, 2023, and increased $0.3 million, or 18.4%, to $1.7 million for the nine months ended September 30, 2024 compared to $1.4 million for the nine months ended September 30, 2023. The increase was primarily due to legal fees related loan workouts. Advertising and promotion decreased $0.2 million, or 47.2%, to $0.2 million for the third quarter ended September 30, 2024 compared to $0.4 million for the third quarter ended September 30, 2023, and decreased $0.4 million, or 34.4%, to $0.7 million for the nine months ended September 30, 2024 compared to $1.1 million for the nine months ended September 30, 2023. The decrease in expenses was the result of a strategic decision to discontinue the Company's outsourced marketing efforts. The Company has hired internal marketing resources and by transitioning to an in-house marketing team, the Company has reduced costs. Income Taxes Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements was 18.7% and 18.2% for the three and nine months ended September 30, 2024, respectively, compared to 16.2% and 17.1% for the three and nine months ended September 30, 2023, respectively. The effective tax rate for each of the three and nine months ended September 30, 2024 and 2023, respectively, is lower than the U.S. federal statutory rate of 21% primarily due to tax-free revenues. Lending and Credit Management Interest earned on the loan portfolio is a primary source of interest income for the Company. Net loans represented 79.8% of total assets as of September 30, 2024 compared to 80.8% as of December 31, 2023. 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 market 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, 2024 December 31, 2023 (dollars in thousands) Amount % of Loans Amount % of Loans Commercial, financial, and agricultural $ 202,341 13.8 % $ 226,275 14.7 % Real estate construction − residential 32,344 2.2 58,347 3.8 Real estate construction − commercial 65,432 4.5 130,296 8.5 Real estate mortgage − residential 369,103 25.2 372,391 24.2 Real estate mortgage − commercial 782,487 53.3 731,024 47.5 Installment and other consumer 15,044 1.0 20,814 1.3 Total loans held for investment $ 1,466,751 100.0 % $ 1,539,147 100.0 % Commercial Real Estate Loans Commercial real estate loans ("CRE") consist primarily of income-producing investment property loans. Additionally, CRE loans include 1-4 family property loans as well as land and development loans. The following table shows the categories of the Company's non-owner occupied CRE loan portfolio at September 30, 2024 and December 31, 2023: 45 September 30, 2024 December 31, 2023 (dollars in thousands) Amount % of Loans Amount % of Loans Multi Family $ 198,237 31.9 % $ 144,254 22.4 % Retail 162,205 26.0 157,890 24.6 Hotel & Food Service 71,283 11.5 66,244 10.3 Office Buildings 47,957 7.7 49,991 7.8 1-4 Family Construction 32,344 5.2 58,347 9.0 Other Construction 31,642 5.0 33,807 5.3 Other Real Estate 26,392 4.2 21,445 3.3 Industrial 18,589 3.0 14,741 2.3 Residential Building Construction 18,390 3.0 29,149 4.5 Commercial and Institutional Building Construction 10,332 1.7 24,778 3.9 Land Subdivision 5,068 0.8 42,561 6.6 Total Commercial Real Estate - Non Owner Occupied $ 622,439 100.0 % $ 643,207 100.0 % 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. 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, special mention, 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. 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. 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. 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. 46 Non-Performing Assets The following table summarizes non-performing assets at the dates indicated: September 30, December 31, (dollars in thousands) 2024 2023 Non-accrual loans: Commercial, financial, and agricultural $ 1,879 $ 2,228 Real estate construction − residential 454 432 Real estate construction − commercial 55 69 Real estate mortgage − residential 1,113 587 Real estate mortgage − commercial 179 2,978 Installment and other consumer 11 — Total $ 3,691 $ 6,294 Loans contractually past - due 90 days or more and still accruing: Real estate mortgage − residential $ 373 $ 115 Installment and other consumer 2 4 Total $ 375 $ 119 Total non-performing loans (a) 4,066 6,413 Other real estate owned and repossessed assets 4,385 1,744 Total non-performing assets (b) $ 8,451 $ 8,157 Loans held for investment $ 1,466,751 $ 1,539,147 Allowance for credit losses on loans $ 21,937 $ 23,744 Allowance for credit losses to loans 1.50 % 1.54 % Non-accrual loans to total loans 0.25 % 0.41 % Non-performing loans to loans (a) 0.28 % 0.42 % Non-performing assets to loans (b) 0.58 % 0.53 % Non-performing assets to assets (b) 0.47 % 0.43 % Allowance for credit losses to non-accrual loans 594.34 % 377.25 % Allowance for credit losses to non-performing loans 539.52 % 370.25 % (a) Non-performing loans include loans 90 days past due and accruing and non-accrual loans. (b) Non-performing assets include non-performing loans and other real estate owned and repossessed assets. Total non-performing assets were $8.5 million, or 0.58% of total loans, at September 30, 2024 compared to $8.2 million, or 0.53% of total loans, at December 31, 2023. Total non-accrual loans at September 30, 2024 decreased $2.6 million, or 41.4%, to $3.7 million compared to $6.3 million at December 31, 2023. The decrease in non-accrual loans was primarily due to a $1.8 million charged off commercial loan relationship and $3.5 million in commercial real estate loans that went to non-accrual status in the first quarter and proceeded to foreclosure in the second quarter and third quarter of 2024. In addition, $2.0 million in commercial loans moved to non-accrual status in the third quarter of 2024. There were $0.4 million in loans past due 90 days and still accruing interest at September 30, 2024 compared to $0.1 million at December 31, 2023. Other real estate and repossessed assets were $4.4 million and $1.7 million at September 30, 2024 and December 31, 2023, respectively. There were $3.5 million and $0.04 million in non-accrual loans added to other real estate owned and repossessed assets during the nine months ended September 30, 2024 and 2023, respectively. 47 Provision and Allowance for Credit Losses on Loans and Liability for Unfunded Commitments Allowance for Credit Losses The following table is a summary of the allocation of the allowance for credit losses: September 30, 2024 December 31, 2023 (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 $ 1,630 13.8 % $ 3,208 14.7 % Real estate construction − residential 586 2.2 1,043 3.8 Real estate construction − commercial 1,824 4.5 3,273 8.5 Real estate mortgage − residential 5,282 25.2 5,264 24.2 Real estate mortgage − commercial 12,634 53.3 10,537 47.5 Installment and other consumer 146 1.0 232 1.3 Unallocated (165) — 187 — Total $ 21,937 100.0 % $ 23,744 100.0 % The allowance for credit losses was $21.9 million, or 1.50%, of loans outstanding at September 30, 2024 compared to $23.7 million, or 1.54%, of loans outstanding at December 31, 2023. The ratio of the allowance for credit losses to non-performing loans was 539.52% at September 30, 2024, compared to 370.25% at December 31, 2023. Provision for Credit Losses Three Months Ended September 30, Nine Months Ended September 30, (dollars in thousands) 2024 2023 2024 2023 Provision for credit losses on loans $ 593 $ 300 $ 875 $ 1,115 Provision for (release of) credit losses for off-balance sheet commitments (93) (190) (149) (325) Total provision for credit losses $ 500 $ 110 $ 726 $ 790 The Company recognized a provision for credit losses of $0.5 million and $0.7 million for the three and nine months ended September 30, 2024, respectively, compared to a $0.1 million and $0.8 million provision for credit losses for the three and nine months ended September 30, 2023, respectively. 48 The following table summarizes credit loss experience for the periods indicated: Three Months Ended September 30, 2024 2023 (dollars in thousands) (Net Charge-offs) Recoveries Average Loans Net (Charge-offs) Recoveries / Average Loans (Net Charge-offs) Recoveries Average Loans Net (Charge-offs) Recoveries / Average Loans Commercial, financial, and agricultural $ (254) $ 210,783 (0.12) % $ (7) $ 232,516 — % Real estate construction − residential — 35,611 — — 55,289 — Real estate construction − commercial — 61,546 — — 129,284 — Real estate mortgage − residential 7 369,068 — 2 376,209 — Real estate mortgage − commercial (343) 792,668 (0.04) (2) 739,225 — Installment and other consumer (46) 15,977 (0.29) (67) 22,176 (0.30) Total $ (636) $ 1,485,653 (0.04) % $ (74) $ 1,554,699 — % Nine Months Ended September 30, 2024 2023 (dollars in thousands) (Net Charge-offs) Recoveries Average Loans Net (Charge-offs) Recoveries / Average Loans (Net Charge-offs) Recoveries Average Loans Net (Charge-offs) Recoveries / Average Loans Commercial, financial, and agricultural $ (2,122) $ 217,576 (0.98) % $ 124 $ 231,691 0.05 % Real estate construction − residential — 46,247 — — 47,265 — Real estate construction − commercial — 70,452 — — 137,776 — Real estate mortgage − residential (11) 371,072 — 6 368,702 — Real estate mortgage − commercial (433) 783,960 (0.06) (25) 735,539 — Installment and other consumer (116) 17,916 (0.65) (139) 22,622 (0.61) Total $ (2,682) $ 1,507,223 (0.18) % $ (34) $ 1,543,595 — % Net Loan Charge-Offs The Company’s net charge-offs were $0.6 million and $2.7 million for the three and nine months ended September 30, 2024 compared to $0.1 million and $0.03 million for the three and nine months ended September 30, 2023, respectively. The charge-offs in the current quarter primarily related to one commercial and one commercial real estate loan relationship that was adequately reserved for in the prior quarter. Loans Held for Sale The Company designates certain long-term fixed rate personal real estate loans as held for sale. Prior to September 30, 2024, these loans were initially measured at fair value under the fair value option election with subsequent changes in fair value recognized in mortgage banking income. As of September 30, 2024, loans held for sale are being carried at the lower of cost or estimated fair value. The loans are primarily sold to Freddie Mac, Fannie Mae, and PennyMac and various other secondary market investors. At September 30, 2024, the carrying amount of these loans was $0.3 million compared to $3.9 million at December 31, 2023. 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, 2024, the Company sold approximately $45.0 million of loans to investors compared to $84.4 million for the nine months ended September 30, 2023. On January 31, 2024, the Company sold its servicing portfolio and 49 the balance of the serviced loans transferred on April 30, 2024. The Company was servicing approximately $226.3 million of loans sold to the secondary market at September 30, 2023. 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 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. (dollars in thousands) September 30, 2024 December 31, 2023 Other interest-bearing deposits $ 34,813 $ 77,775 Certificates of deposit in other banks 1,000 — Available-for-sale investment securities 203,292 188,742 Total $ 239,105 $ 266,517 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 $203.3 million at September 30, 2024 and included an unrealized net loss of $24.7 million. The portfolio includes projected maturities and mortgage-backed securities pay-downs of approximately $4.3 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, 2024 and December 31, 2023, the Company’s unpledged securities in the available-for-sale portfolio totaled approximately $118.4 million and $99.5 million, respectively. Total investment securities pledged for these purposes were as follows: (dollars in thousands) September 30, 2024 December 31, 2023 Federal Reserve Bank borrowings $ 9,001 $ 9,048 Other deposits 75,885 80,175 Total pledged, at fair value $ 84,886 $ 89,223 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, 2024, such deposits totaled $1.4 billion and represented 93.5% 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. 50 Core deposits at September 30, 2024 and December 31, 2023 were as follows: (dollars in thousands) September 30, 2024 December 31, 2023 Non-interest bearing demand $ 390,639 $ 402,241 Interest checking 313,557 387,242 Savings and money market 498,387 459,049 Other time deposits 203,135 214,004 Total $ 1,405,718 $ 1,462,536 Estimated uninsured deposits totaled $325.2 million, including $97.8 million of certificates of deposit, at September 30, 2024, compared to $387.1 million, including $108.1 million of certificates of deposit, at December 31, 2023. The Company had brokered deposits totaling $10,000 and $0.2 million at September 30, 2024 and December 31, 2023, respectively. Included in the uninsured deposits at September 30, 2024 and December 31, 2023 are public fund deposits greater than $250,000 which are collateralized by the Company totaling $95.1 million and $137.7 million, 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 federal funds purchased, 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, 2024, under agreements with these unaffiliated banks, the Bank may borrow up to $35.0 million in federal funds on an unsecured basis and $8.5 million on a secured basis. There were no federal funds purchased outstanding at September 30, 2024. 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, 2024. The Bank is a member of the FHLB and has access to credit products of the FHLB. As of September 30, 2024, the Bank had $96.4 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, 2024 and December 31, 2023 were as follows: (dollars in thousands) September 30, 2024 December 31, 2023 Federal Home Loan Bank advances $ 96,425 $ 107,000 Other borrowings 100 — Subordinated notes 49,486 49,486 Total $ 146,011 $ 156,486 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. 51 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: September 30, 2024 December 31, 2023 (dollars in thousands) FHLB Federal Reserve Bank Federal Funds Purchased Lines Total FHLB Federal Reserve Bank Federal Funds Purchased Lines Total Advance equivalent $ 421,917 $ 8,530 $ 35,000 $ 465,447 $ 425,367 $ 8,563 $ 35,000 $ 468,930 Letters of credit (44,500) — — (44,500) (107,500) — — (107,500) Advances outstanding (96,425) — — (96,425) (107,000) — — (107,000) Total available $ 280,992 $ 8,530 $ 35,000 $ 324,522 $ 210,867 $ 8,563 $ 35,000 $ 254,430 At September 30, 2024, loans of $720.7 million were pledged to the FHLB as collateral for borrowings and letters of credit. At September 30, 2024, investments with a market value of $9.0 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 $54.2 million at September 30, 2024 compared to $93.4 million at December 31, 2023. The $39.2 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, 2024. Cash flow provided by operating activities consists mainly of net income adjusted for certain non-cash items. Operating activities provided total cash of $23.7 million for the nine months ended September 30, 2024. Investing activities, consisting mainly of purchases, sales and maturities of available-for-sale securities, and changes in the level of the loan portfolio, provided total cash of $19.8 million during the nine months ended September 30, 2024. The cash flow primarily consisted of a $66.2 million net decrease in loans held for investment and $20.3 million proceeds from maturities and calls of available-for-sale securities, partially offset by $32.9 million in purchases of securities and $35.0 million in purchases of bank owned life insurance policies. During the fourth quarter of 2023, the Company repositioned its balance sheet by selling $83.7 million in book value of investment securities, with an average yield of 1.57%. Financing activities used total cash of $82.6 million during the nine months ended September 30, 2024, resulting primarily from a $34.5 million decrease in interest-bearing transaction accounts, $21.2 million decrease in time deposits, $11.6 million decrease in demand deposits and a $10.5 million net decrease in FHLB advances. 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 $335.0 million in unused loan commitments and standby letters of credit as of September 30, 2024. 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 $3.7 million and $3.5 million during the nine months ended September 30, 2024 and 2023, respectively. A large portion of the Company’s liquidity is obtained from the Bank in the form of dividends. The Bank declared $15.0 million and $9.0 million in dividends to the Company during the nine months ended September 30, 2024 and 2023, respectively. At September 30, 2024 and December 31, 2023, the Company had cash and cash equivalents totaling $13.8 million and $6.8 million, respectively. Subject to declaration by the Company's Board of Directors, the Company expects to continue paying quarterly cash dividends as a part of its current capital allocation 52 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 repurchased under the plan, as well as the timing of any such repurchases. The Company repurchased 56,692 common shares under the repurchase plan during the first nine months of 2024 at an average cost of $19.51 per share totaling $1.1 million. As of September 30, 2024, $3.9 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. The Basel III regulatory capital reforms adopted by U.S. federal regulatory authorities (the "Basel III Capital Rules"), among other things, (i) establish the capital measure called "Common Equity Tier 1" ("CET1"), (ii) specify that Tier 1 capital consists of CET1 and "Additional Tier 1 Capital" instruments meeting stated requirements, (iii) require that most deductions/adjustments to regulatory capital measures be made to CET1 and not to other components of capital and (iv) define the scope of the deductions/adjustments to the capital measures. Additionally, the Basel III Capital Rules require that the Company maintain a 2.50% capital conservation buffer with respect to each of CET1, Tier 1 and total capital to risk-weighted assets, which provides for capital levels that exceed the minimum risk-based capital adequacy requirements. A financial institution with a conservation buffer of less than the required amount is subject to limitations on capital distributions, including dividend payments and stock repurchases, and certain discretionary bonus payments to executive officers. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of CET1, Tier 1 and total capital to risk-weighted assets, and of Tier 1 capital to average assets, each as defined in the regulations. Management believes, as of September 30, 2024, that the Company and the Bank meet all capital adequacy requirements to which they are subject. Financial institutions are categorized as well capitalized or adequately capitalized, based on minimum total risk-based, Tier 1 risk-based, CET1 and Tier 1 leverage ratios. As shown in the table below, the Company’s capital ratios exceeded the regulatory definition of adequately capitalized as of September 30, 2024 and December 31, 2023. Based upon the information in its most recently filed call report, the Bank met the capital ratios necessary to be well-capitalized. The regulatory authorities can apply changes in classification of assets and such changes may retroactively subject the Company to changes in capital ratios. Any such change could reduce one or more capital ratios below well-capitalized status. In addition, a change may result in imposition of additional assessments by the FDIC or could result in regulatory actions that could have a material effect on our condition and results of operations. In addition, bank holding companies generally are required to maintain a Tier 1 leverage ratio of at least 4%. Because the Bank had less than $15.0 billion in total consolidated assets as of December 31, 2009, the Company is allowed to continue its trust preferred securities, all of which were issued prior to May 19, 2010, as Tier 1 capital. 53 Under the Basel III Capital Rules, at September 30, 2024 and December 31, 2023, 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 the dates 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, 2024 Total Capital (to risk-weighted assets): Company $ 228,627 14.91 % $ 160,988 10.50 % $ — N.A% Bank 218,513 14.14 % 162,284 10.50 % 154,557 10.00 % Tier 1 Capital (to risk-weighted assets): Company $ 209,459 13.66 % $ 130,324 8.50 % $ — N.A% Bank 199,193 12.89 % 131,373 8.50 % 123,645 8.00 % Common Equity Tier 1 Capital (to risk-weighted assets): Company $ 161,459 10.53 % $ 107,326 7.00 % $ — N.A% Bank 199,193 12.89 % 108,190 7.00 % 100,462 6.50 % Tier 1 leverage ratio (to adjusted average assets): Company $ 209,459 11.33 % $ 73,924 4.00 % $ — N.A% Bank 199,193 10.84 % 73,517 4.00 % 91,896 5.00 % December 31, 2023 Total Capital (to risk-weighted assets): Company $ 221,586 13.99 % $ 166,266 10.50 % $ — N.A% Bank 219,043 13.91 % 165,369 10.50 % 157,494 10.00 % Tier 1 Capital (to risk-weighted assets): Company $ 199,395 12.59 % $ 134,596 8.50 % $ — N.A% Bank 199,490 12.67 % 133,870 8.50 % 125,995 8.00 % Common Equity Tier 1 Capital (to risk-weighted assets): Company $ 154,033 9.73 % $ 110,844 7.00 % $ — N.A% Bank 199,490 12.67 % 110,246 7.00 % 102,371 6.50 % Tier 1 leverage ratio: Company $ 199,395 10.29 % $ 77,492 4.00 % $ — N.A% Bank 199,490 10.31 % 77,411 4.00 % 96,763 5.00 % 54