What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-11-04 compared with 2021-08-06 · 190 added, 201 removed, 505 unchanged (44% of the section changed)

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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), including, without limitation:

● statements that are not historical in nature, and

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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 $1.7 billion in assets at June 30, 2021, provides a broad range of commercial and personal banking services.

Through the branch network of its subsidiary bank, Hawthorn Bank (the Bank), the Company, with $1.7 billion in assets at September 30, 2021, provides a broad range of commercial and personal banking services.

The Bank’s specialties include commercial banking for small and mid-sized businesses, including equipment, operating, commercial real estate, Small Business Administration (SBA) loans, and personal banking services including real estate mortgage lending, installment and consumer loans, certificates of deposit, individual retirement and other time deposit accounts, checking accounts, savings accounts, and money market accounts.

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Significant Developments and Transactions

Each item listed below materially affects the comparability of our results of operations for the three and six months ended June 30, 2021 and 2020, respectively, and our financial condition as of June 30, 2021 and December 31, 2020, and may affect the comparability of financial information we report in future fiscal periods.

Each item listed below materially affects the comparability of our results of operations for the three and nine months ended September 30, 2021 and 2020, respectively, and our financial condition as of September 30, 2021 and December 31, 2020, and may affect the comparability of financial information we report in future fiscal periods.

Impact of COVID-19 .

The COVID-19 pandemic and related restrictive measures taken by governments, businesses and individuals caused unprecedented uncertainty, volatility and disruption in financial markets and in governmental, commercial and consumer activity in the United States and globally, including the markets that we serve.

Although many of the restrictive measures have been eased during 2020 and into 2021, and the U.S.

economy has begun to recover and with the availability and distribution of a COVID-19 vaccine, the extent of the impact of the COVID-19 pandemic on the Company’s business remains highly uncertain and difficult to predict.

If the COVID-19 pandemic subsides, we anticipate continued improvements in commercial and consumer activity and the U.S.

The continuing impact of the COVID-19 pandemic on the Company’s business will depend on a number of factors, including, but not limited to, the scope, severity and duration of any resurgence of the pandemic (including COVID-19 variants), the actions taken to contain the outbreak or any resurgence or mitigate their impacts, the distribution of vaccines and the efficacy of those vaccines, the ability of communities to achieve herd immunity, the public’s confidence in the health and safety measures implemented by the Company’s customers, the continuing direct and indirect economic effects of the outbreak and containment measures, and the ability of the Company’s customers to recover from the negative economic impacts of the pandemic as it subsides, all of which are uncertain and cannot be predicted.

Although many of the restrictive measures have been eased during 2020 and 2021, and the U.S.

economy has begun to recover and with the availability and distribution of COVID-19 vaccines, the extent of the ultimate impact of the COVID-19 pandemic on the Company’s business remains uncertain and difficult to predict.

If the COVID-19 pandemic continues to subside, we anticipate continued improvements in commercial and consumer activity and the U.S.

The continuing impact of the COVID-19 pandemic on the Company’s business will depend on a number of factors, including, but not limited to, the scope, severity and duration of any resurgence of the pandemic (including COVID-19 variants), the actions taken to contain the outbreak or any resurgence or mitigate their impacts, the continued supply and distribution of vaccines and the efficacy of those vaccines, the ability of communities to achieve herd immunity, the public’s confidence in the health and safety measures implemented by the Company’s customers, the continuing direct and indirect economic effects of the outbreak and containment measures, and the ability of the Company’s customers to recover from the negative economic impacts of the pandemic as it subsides, all of which are uncertain and cannot be predicted.

Effects on Our Market Areas.

Our commercial and consumer banking products and services are delivered primarily in Missouri, where individual and governmental responses to the COVID-19 pandemic have led to a broad curtailment of economic activity While positive tailwinds exist, we recognize that our business and consumer customers are experiencing varying degrees of financial distress, which is expected to continue into the third quarter of 2021, especially as new COVID-19 variant infections increase and new health and safety measures are implemented.

Our commercial and consumer banking products and services are delivered primarily in Missouri, where individual and governmental responses to the COVID-19 pandemic led to a broad curtailment of economic activity.

While positive tailwinds exist, we recognize that our business and consumer customers are continuing to experience varying degrees of financial distress, which is expected to continue into the fourth quarter of 2021.

Commercial activity has improved but has not returned to the levels existing prior to the outbreak of the pandemic.

In addition, the economic pressures and uncertainties related to the COVID-19 pandemic have resulted in changes in consumer spending behaviors,

which may negatively impact the demand for loans and other services we offer.

In addition, the economic pressures, materials supply chain disruptions and continuing uncertainties related to the COVID-19 pandemic have resulted in changes in consumer spending behaviors, which has negatively impacted the demand for loans and other

services we offer.

Our borrowing base includes customers in industries such as hotel/lodging, restaurants, entertainment, retail and commercial real estate, all of which have been significantly impacted by the COVID-19 pandemic.

We recognize that these industries may take longer to recover as consumers may be hesitant to return to full social interaction or may change their spending habits on a more permanent basis as a result of the pandemic.

We recognize that these industries take longer to recover as consumers may be hesitant to return to full social interaction or may change their spending habits on a more permanent basis as a result of the pandemic.

We continue to monitor these customers closely.

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These developments, together with economic conditions generally, are also expected to impact our commercial real estate portfolio, particularly with respect to real estate with exposure to these industries, our consumer loan business and loan portfolio, and the value of certain collateral securing our loans.

The Company continues to lend to qualified consumer and commercial customers.

We continue to participate in the SBA’s Small Business Paycheck Protection Program (PPP).

As of June 30, 2021, the net balance of the PPP loans totaled $49.6 million.

The Company is an active participant in the SBA’s Small Business Paycheck Protection Programs (PPP), and has been since their inception.

As of September 30, 2021, the net balance of the PPP loans totaled $26.0 million.

Beginning in 2020, as provided for by the CARES Act, the Company offered payment modifications to borrowers.

At December 31, 2020, these modifications totaled $86.7 million, or 6.7% of total loans.

At June 30, 2021, $42.8 million, or 3.3% of total loans, remained in some form of a modification.

These loan modifications include $11.4 million on interest only, $26.4 million on full deferral and $5.0 million with extended amortization.

At September 30, 2021, $11.3 million, or 0.9% of total loans, remained in some form of a modification.

These loan modifications include two remaining loans on interest only.

As permitted by the CARES Act and other regulatory guidance, the Company has elected to suspend accounting principles generally accepted in the United States of America (U.S.

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SELECTED CONSOLIDATED FINANCIAL DATA

The following table presents selected consolidated financial information for the Company as of and for each of the three and six months ended June 30, 2021 and 2020, respectively.

The following table presents selected consolidated financial information for the Company as of and for each of the three and nine months ended September 30, 2021 and 2020, respectively.

The selected consolidated financial data should be read in conjunction with the unaudited consolidated financial statements of the Company, including the related notes, presented elsewhere herein.

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Three Months Ended

Six Months Ended

Nine Months Ended

September 30,

(In thousands, except per share data)

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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.

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 June 30,

Six Months Ended June 30,

Three Months Ended September 30,

Nine Months Ended September 30,

(In thousands)

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Income tax expense

Consolidated net income of $4.9 million, or $0.74 per diluted share, for the three months ended June 30, 2021 increased $1.6 million compared to $3.3 million, or $0.49 per diluted share, for the three months ended June 30, 2020.

For the three months ended June 30, 2021, the return on average assets was 1.14%, the return on average stockholders’ equity was 14.64%, and the efficiency ratio was 64.5%.

Consolidated net income of $10.7 million, or $1.62 per diluted share, for the six months ended June 30, 2021 increased $6.6 million compared to $4.1 million, or $0.61 per diluted share, for the six months ended June 30, 2020.

For the six months ended June 30, 2021, the return on average assets was 1.26%, the return on average stockholders’ equity was 16.31%, and the efficiency ratio was 63.1%.

Net interest income was $13.7 million and $28.1 million for the three and six months ended June 30, 2021, respectively, compared to $13.3 million and $25.9 million for the three and six months ended June 30, 2020, respectively.

The net interest margin (expressed on a fully taxable equivalent basis) decreased to 3.40% for the three months ended June 30, 2021 compared to 3.46% for the three months ended June 30, 2020, and was consistent at 3.51% for both the six months ended June 30, 2021 and 2020.

Consolidated net income of $5.8 million, or $0.88 per diluted share, for the three months ended September 30, 2021 increased $0.8 million compared to $5.0 million, or $0.74 per diluted share, for the three months ended September 30, 2020.

For the three months ended September 30, 2021, the return on average assets was 1.33%, the return on average stockholders’ equity was 16.49%, and the efficiency ratio was 61.2%.

Consolidated net income of $16.5 million, or $2.50 per diluted share, for the nine months ended September 30, 2021 increased $7.4 million compared to $9.1 million, or $1.35 per diluted share, for the nine months ended September 30, 2020.

For the nine months ended September 30, 2021, the return on average assets was 1.28%, the return on average stockholders’ equity was 16.37%, and the efficiency ratio was 62.5%.

Net interest income was $15.4 million and $43.4 million for the three and nine months ended September 30, 2021, respectively, compared to $13.8 million and $39.7 million for the three and nine months ended September 30, 2020, respectively.

The net interest margin (expressed on a fully taxable equivalent basis) increased to 3.78% for the three months ended September 30, 2021 compared to 3.50% for the three months ended September 30, 2020 and increased to 3.60% for the nine months ended September 30, 2021 compared to 3.50% for the nine months ended September 30, 2020.

These changes are discussed in greater detail under the Average Balance Sheet Data and Rate and Volume Analysis section below.

A $0.4 million provision for loan losses was required for both the three and six months ended June 30, 2021 compared to a $0.9 million and $4.2 million provision for the three and six months ended June 30, 2020, respectively.

The decreased provision in the three and six months ended June 30, 2021 compared to the three and six months ended June 30, 2020 resulted primarily from the impact of net recoveries and improvement in the economic outlook as the economy begins to recover from the impacts of the COVID-19 pandemic.

A $0.3 million and $0.7 million provision for loan losses was required for the three and nine months ended September 30, 2021 compared to a $1.2 million and $5.4 million provision for the three and nine months ended September 30, 2020, respectively.

The decreased provision in the three and nine months ended September 30, 2021 compared to the three and nine months ended September 30, 2020 resulted primarily from the impact of net recoveries and improvement in the economic outlook as the economy begins to recover from the impacts of the COVID-19 pandemic.

Criticized loan levels remain elevated when compared to pre-pandemic levels due to the downgrade of loans to borrowers that have been impacted by the COVID-19 pandemic.

The Company’s net loan charge-offs (recoveries) were $26,000 and $(222,000) for the three and six months ended June 30, 2021, respectively, compared to net loan (recoveries) charge-offs of $(29,000) and $55,000 for the three and six months ended June 30, 2020, respectively.

Non-performing loans totaled $33.8 million, or 2.61% of total loans, at June 30, 2021 compared to $34.6 million, or 2.69% of total loans, at December 31, 2020, and $8.9 million, or 0.70% of total loans, at June 30, 2020.

The Company’s net loan charge-offs (recoveries) were $106,000 and $(116,000) for the three and nine months ended September 30, 2021, respectively, compared to net loan charge-offs of $58,000 and $113,000 for the three and nine months ended September 30, 2020, respectively.

Non-performing loans totaled $32.8 million, or 2.56% of total loans, at September 30, 2021 compared to $34.6 million, or 2.69% of total loans, at December 31, 2020, and $5.8 million, or 0.45% of total loans, at September 30, 2020.

These changes are discussed in greater detail under the Lending and Credit Management section below.

Non-interest income increased $1.7 million, or 60.7%, for the three months ended June 30, 2021 compared to the three months ended June 30, 2020, and increased $3.9 million, or 75.5%, for the six months ended June 30, 2021 compared to the six months ended June 30, 2020.

Non-interest income decreased $1.4 million, or 28.2%, for the three months ended September 30, 2021 compared to the three months ended September 30, 2020, and increased $2.4 million, or 23.8%, for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020.

These changes are discussed in greater detail under the Non-interest Income and Expense section below.

Non-interest expense increased $0.5 million, or 4.4%, for the three months ended June 30, 2021 compared to the three months ended June 30, 2020, and increased $1.7 million, or 7.6%, for the six months ended June 30, 2021 compared

to the six months ended June 30, 2020.

Non-interest expense increased $0.08 million, or 0.1%, for the three months ended September 30, 2021 compared to the three months ended September 30, 2020, and increased $1.7 million, or 5.0%, for the nine months ended September 30,

2021 compared to the nine months ended September 30, 2020.

These changes are discussed in greater detail under the Non-interest Income and Expense section below.

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It is affected by both changes in the level of interest rates and changes in the amounts and mix of interest earning assets and interest-bearing liabilities.

The following table presents average balance sheet data, net interest income, average yields of earning assets, average costs of interest bearing liabilities, net interest spread and net

interest margin on a fully taxable equivalent basis for each of the three and six month periods ended June 30, 2021 and 2020, respectively.

Three Months Ended June 30,

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, 2021 and 2020, respectively.

Three Months Ended September 30,

(In thousands)

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Net interest margin

Interest income and yields are presented on a fully taxable equivalent basis using the federal statutory income tax rate of 21%, net of nondeductible interest expense, for the three months ended June 30, 2021 and 2020.

Such adjustments totaled $424,000 and $214,000 for the three months ended June 30, 2021 and 2020, respectively.

Such adjustments totaled $0.5 million and $0.2 million for the three months ended September 30, 2021 and 2020, respectively.

Non-accruing loans are included in the average amounts outstanding.

Fees and costs on loans are included in interest income ($0.5 million and $0.4 million of PPP fees were included in commercial loan income for the three months ended June 30, 2021 and 2020, respectively).

Six Months Ended June 30,

Fees and costs on loans are included in interest income ($2.1 million and $0.7 million of PPP fees were included in commercial loan income for the three months ended September 30, 2021 and 2020, respectively).

Nine Months Ended September 30,

(In thousands)

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Net interest margin

Interest income and yields are presented on a fully taxable equivalent basis using the federal statutory income tax rate of 21%, net of nondeductible interest expense, for the six months ended June 30, 2021 and 2020.

Such adjustments totaled $755,000 and $385,000 for the six months ended June 30, 2021 and 2020, respectively.

Interest income and yields are presented on a fully taxable equivalent basis using the federal statutory income tax rate of 21%, net of nondeductible interest expense, for the nine months ended September 30, 2021 and 2020.

Such adjustments totaled $1.3 million and $0.6 million for the nine months ended September 30, 2021 and 2020, respectively.

Non-accruing loans are included in the average amounts outstanding.

Fees and costs on loans are included in interest income ($2.0 million and $0.4 million of PPP fees were included in commercial loan income for the six months ended June 30, 2021 and 2020, respectively).

Fees and costs on loans are included in interest income ($4.4 million and $1.2 million of PPP fees were included in commercial loan income for the nine months ended September 30, 2021 and 2020, respectively).

Rate and Volume Analysis

The following table summarizes the changes in net interest income on a fully taxable equivalent basis, by major category of interest earning assets and interest bearing liabilities, identifying changes related to volumes and rates for the three and six months ended June 30, 2021 compared to the three and six months ended June 30, 2020, 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 June 30,

Six Months Ended June 30,

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, 2021 compared to the three and nine months ended September 30, 2020, 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,

Change due to

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Net interest income on a fully taxable equivalent basis

Interest income and yields are presented on a fully taxable equivalent basis using the Federal statutory income tax rate of 21%, net of nondeductible interest expense, for the three and six months ended June 30, 2021 and 2020.

Such adjustments totaled $424,000 and $755,000 for the three and six months ended June 30, 2021, respectively, compared to $214,000 and $385,000 for the three and six months ended June 30, 2020, respectively.

Such adjustments totaled $0.5 million and $0.2 million for the three and nine months ended September 30, 2021, respectively, compared to $1.3 million and $0.6 million for the three and nine months ended September 30, 2020, respectively.

Non-accruing loans are included in the average amounts outstanding.

Fees and costs on loans are included in interest income ($0.5 million and $2.0 million of PPP fees for the three and six months ended June 30, 2021, respectively, compared to $0.4 million for both the three and six months ended June 30, 2020 were included in commercial loan income).

Financial results for the quarter ended June 30, 2021 compared to the quarter ended June 30, 2020 reflected an increase in net interest income, on a tax equivalent basis, of $0.5 million, or 4.0%, and the financial results for the six months ended June 30, 2021 compared to the six months ended June 30, 2020 reflected an increase of $2.6 million, or 9.8%.

Measured as a percentage of average earning assets, the net interest margin (expressed on a fully taxable equivalent basis) decreased to 3.40% for the quarter ended June 30, 2021 compared to 3.46% for the quarter ended June 30, 2020, and remained consistent at 3.51% for both the six months ended June 30, 2021 and 2020, respectively.

Net interest income increased primarily due to an increase in average earning assets and a decrease in rates paid on average interest bearing liabilities in both the three and six month comparative periods.

Although average earning assets increased for both the three and six

month comparative periods, net interest margin decreased quarter-over-quarter primarily due to a decrease in rates earned, while net interest margin remained consistent for the six months ended June 30, 2021 compared to the six months ended June 30, 2020 primarily due to $2.0 million in PPP income earned in 2021 compared to $0.4 million in 2020.

Average interest-earning assets increased $87.1 million, or 5.5%, to $1.66 billion for the quarter ended June 30, 2021 compared to $1.57 billion for the quarter ended June 30, 2020, and average interest bearing liabilities decreased $17.7 million, or 1.5%, to $1.14 billion for the quarter ended June 30, 2021 compared to $1.16 billion for the quarter ended June 30, 2020.

Average interest-earning assets increased $152.1 million, or 10.1%, to $1.66 billion for the six months ended June 30, 2021 compared to $1.50 billion for the six months ended June 30, 2020, average interest bearing liabilities increased $20.9 million, or 1.8%, to $1.16 billion for the six months ended June 30, 2021 compared to $1.14 billion for the six months ended June 30, 2020.

Total interest income (expressed on a fully taxable equivalent basis) was $15.6 million and $32.0 million for the three and six months ended June 30, 2021, respectively, compared to $15.9 million and $31.9 million for the three and six months ended June 30, 2020, respectively.

The Company’s rates earned on interest earning assets were 3.77% and 3.90% for the three and six months ended June 30, 2021, respectively, compared to 4.07% and 4.26% for the three and six months ended June 30, 2020, respectively.

Interest income on loans held for investment was $14.0 million and $29.2 million for the three and six months ended June 30, 2021, respectively, compared to $14.6 million and $29.1 million for the three and six months ended June 30, 2020, respectively.

Average loans outstanding increased $19.0 million, or 1.5%, to $1.28 billion for the quarter ended June 30, 2021 compared to $1.26 billion for the quarter ended June 30, 2020.

The average yield on loans decreased to 4.42% for the quarter ended June 30, 2021 compared to 4.68% for the quarter ended June 30, 2020.

Average loans outstanding increased $66.6 million, or 5.5%, to $1.28 billion for the six months ended June 30, 2021 compared to $1.21 billion for the six months ended June 30, 2020.

The average yield on loans decreased to 4.61% for the six months ended June 30, 2021 compared to 4.84% for the six months ended June 30, 2020.

Fees and costs on loans are included in interest income ($2.1 million and $4.4 million of PPP fees for the three and nine months ended September 30, 2021, respectively, compared to $0.7 million and $1.2 million for the three and nine months ended September 30, 2020 were included in commercial loan income).

Financial results for the quarter ended September 30, 2021 compared to the quarter ended September 30, 2020 reflected an increase in net interest income, on a tax equivalent basis, of $1.8 million, or 12.8%, and the financial results for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020 reflected an increase of $4.4 million, or 10.8%.

Measured as a percentage of average earning assets, the net interest margin (expressed on a fully taxable equivalent basis) increased to 3.78% for the quarter ended September 30, 2021 compared to 3.50% for the quarter ended September 30, 2020 and increased to 3.60% for the nine months ended September 30, 2021 compared to 3.50% for the nine months ended September 30, 2020.

Net interest income and net interest margin increased primarily due to an increase in PPP fees and interest income in both the three and nine month comparative periods.

The Company earned $2.1 million and $4.4 million in PPP income for the three and nine months ended September 30, 2021, respectively, compared to $0.7 million and $1.2 million for the three and nine months ended September 30, 2020, respectively.

Average interest-earning assets increased $65.8 million, or 4.1%, to $1.67 billion for the quarter ended September 30, 2021 compared to $1.60 billion for the quarter ended September 30, 2020, and average interest-bearing liabilities decreased $26.8 million, or 2.3%, to $1.13 billion for the quarter ended September 30, 2021 compared to $1.16 billion for the quarter ended September 30, 2020.

Average interest-earning assets increased $123.2 million, or 8.0%, to $1.66 billion for the nine months ended September 30, 2021 compared to $1.54 billion for the nine months ended September 30, 2020, and average interest-bearing liabilities increased $4.9 million, or 0.4%, to $1.15 billion for the nine months ended September 30, 2021 compared to $1.14 billion for the nine months ended September 30, 2020.

Total interest income (expressed on a fully taxable equivalent basis) was $17.3 million and $49.3 million for the three and nine months ended September 30, 2021, respectively, compared to $16.2 million and $48.1 million for the three and nine months ended September 30, 2020, respectively.

The Company’s rates earned on interest earning assets were 4.12% and 3.97% for the three and nine months ended September 30, 2021, respectively, compared to 4.03% and 4.18% for the three and nine months ended September 30, 2020, respectively.

Interest income on loans held for investment was $15.6 million and $44.8 million for the three and nine months ended September 30, 2021, respectively, compared to $14.9 million and $44.0 million for the three and nine months ended September 30, 2020, respectively.

Average loans outstanding increased $11.5 million, or 0.9%, to $1.29 billion for the quarter ended September 30, 2021 compared to $1.27 billion for the quarter ended September 30, 2020.

The average yield on loans increased to 4.81% for the quarter ended September 30, 2021 compared to 4.66% for the quarter ended September 30, 2020.

Average loans outstanding increased $48.1 million, or 3.9%, to $1.28 billion for the nine months ended September 30, 2021 compared to $1.23 billion for the nine months ended September 30, 2020.

The average yield on loans decreased to 4.68% for the nine months ended September 30, 2021 compared to 4.78% for the nine months ended September 30, 2020.

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 $1.4 million and $2.4 million for the three and six months ended June 30, 2021, respectively, compared to $1.1 million and $2.1 million for the three and six months ended June 30, 2020, respectively.

Average securities increased $59.7 million, or 30.1%, to $257.9 million for the quarter ended June 30, 2021 compared to $198.3 million for the quarter ended June 30, 2020.

The average yield on securities decreased to 2.10% for the quarter ended June 30, 2021 compared to 2.15% for the quarter ended June 30, 2020.

Average securities increased $46.2 million, or 24.3%, to $236.9 million for the six months ended June 30, 2021 compared to $190.7 million for the six months ended June 30, 2020.

The average yield on securities decreased to 2.08% for the six months ended June 30, 2021 compared to 2.23% for the six months ended June 30, 2020.

Management plans to continue to grow the investment portfolio based on available liquidity.

Interest income on available-for-sale securities was $1.5 million and $4.0 million for the three and nine months ended September 30, 2021, respectively, compared to $1.1 million and $3.2 million for the three and nine months ended September 30, 2020, respectively.

Average securities increased $84.4 million, or 43.2%, to $279.9 million for the quarter ended September 30, 2021 compared to $195.5 million for the quarter ended September 30, 2020.

The average yield on securities was consistent at 2.15% for both quarters ended September 30, 2021 and 2020, respectively.

Average securities increased $59.1 million, or 30.7%, to $251.4 million for the nine months ended September 30, 2021 compared to $192.3 million for the nine months ended September 30, 2020.

The average yield on securities decreased to 2.10% for the nine months ended September 30, 2021 compared to 2.20% for the nine months ended September 30, 2020.

See the Liquidity Management section for further discussion.

Total interest expense decreased to $1.5 million and $3.2 million for the three and six months ended June 30, 2021, respectively, compared to $2.4 million and $5.7 million for the three and six months ended June 30, 2020, respectively.

The Company’s rates paid on interest bearing liabilities were 0.53% and 0.56% for the three and six months ended June 30, 2021, respectively, compared to 0.82% and 1.0% for the three and six months ended June 30, 2020, respectively.

Total interest expense decreased to $1.4 million and $4.6 million for the three and nine months ended September 30, 2021, respectively, compared to $2.1 million and $7.8 million for the three and nine months ended September 30, 2020, respectively.

The Company’s rates paid on interest bearing liabilities were 0.50% and 0.54% for the three and nine months ended September 30, 2021, respectively, compared to 0.73% and 0.91% for the three and nine months ended September 30, 2020, respectively.

See the Liquidity Management section for further discussion.

Interest expense on deposits decreased to $0.8 million and $1.8 million for the three and six months ended June 30, 2021, respectively, compared to $1.3 million and $3.4 million for the three and six months ended June 30, 2020, respectively.

Average interest bearing deposits increased $18.5 million, or 2.0%, to $954.1 million for the quarter ended June 30, 2021 compared to $935.6 million for the quarter ended June 30, 2020.

The average cost of deposits decreased to 0.33% for the quarter ended June 30, 2021 compared to 0.57% for the quarter ended June 30, 2020.

Average interest bearing deposits increased $36.4 million, or 3.9%, to $967.9 million for the six months ended June 30, 2021 compared to $931.5 million for the six months ended June 30, 2020.

The average cost of deposits decreased to 0.37% for the six months ended June 30, 2021 compared to 0.74% for the six months ended June 30, 2020.

Although offering rates remain low in response to lower market interest rates, growth in deposits was positively impacted in part by customers who deposited both economic stimulus payments and PPP loan proceeds.

Interest expense on borrowings was $0.7 million and $1.5 million for the three and six months ended June 30, 2021, respectively, compared to $1.1 million and $2.2 million for the three and six months ended June 30, 2020, respectively.

Average borrowings decreased to $189.6 million for the quarter ended June 30, 2021 compared to $225.8 million for the quarter ended June 30, 2020.

The average cost of borrowings decreased to 1.52% for the quarter ended June 30, 2021 compared to 1.87% for the quarter ended June 30, 2020.

Average borrowings decreased to $189.4 million for the six months ended June 30, 2021 compared to $204.8 million for the six months ended June 30, 2020.

The average cost of borrowings decreased to 1.54% for the six months ended June 30, 2021 compared to 2.18% for the six months ended June 30, 2020.

Interest expense on deposits decreased to $0.7 million and $2.5 million for the three and nine months ended September 30, 2021, respectively, compared to $1.3 million and $4.7 million for the three and nine months ended September 30, 2020, respectively.

Average interest-bearing deposits increased $3.3 million, or 0.4%, to $958.2 million for the quarter ended September 30, 2021 compared to $954.9 million for the quarter ended September 30, 2020.

The average cost of deposits decreased to 0.30% for the quarter ended September 30, 2021 compared to 0.53% for the quarter ended September 30, 2020.

Average interest-bearing deposits increased $25.3 million, or 2.7%, to $964.6 million for the nine months ended September 30, 2021 compared to $939.4 million for the nine months ended September 30, 2020.

The average cost of deposits decreased to 0.34% for the nine months ended September 30, 2021 compared to 0.67% for the nine months ended September 30, 2020.

Interest expense on borrowings was $0.7 million and $2.2 million for the three and nine months ended September 30, 2021, respectively, compared to $0.9 million and $3.1 million for the three and nine months ended September 30, 2020, respectively.

Average borrowings decreased to $172.8 million for the quarter ended September 30, 2021 compared to $202.9 million for the quarter ended September 30, 2020.

The average cost of borrowings decreased to 1.62% for the quarter ended September 30, 2021 compared to 1.68% for the quarter ended September 30, 2020.

Average borrowings decreased to $183.8 million for the nine months ended September 30, 2021 compared to $204.2 million for the nine months ended September 30, 2020.

The average cost of borrowings decreased to 1.57% for the nine months ended September 30, 2021 compared to 2.01% for the nine months ended September 30, 2020.

The decrease in cost of funds primarily resulted from lower market interest rates.

6 unchanged sentences

Non-interest income for the periods indicated was as follows:

Three Months Ended June 30,

Six Months Ended June 30,

Three Months Ended September 30,

Nine Months Ended September 30,

(In thousands)

9 unchanged sentences

NM = Not meaningful

Total non-interest income increased $1.7 million, or 60.7%, to $4.6 million for the quarter ended June 30, 2021 compared to $2.9 million for the quarter ended June 30, 2020, and increased $3.9 million, or 75.5%, to $9.0 million for the six months ended June 30, 2021 compared to $5.1 million for the six months ended June 30, 2020.

Service charges and fees increased $0.2 million, or 35.2%, to $0.8 million for the quarter ended June 30, 2021 compared to $0.6 million for the quarter ended June 30, 2020, and increased $0.1 million, or 10.2%, to $1.5 million for the six months ended June 30, 2021, compared to $1.4 million for the six months ended June 30, 2020.

The Company experienced lower service charge income during 2020 primarily due to a decrease in nonsufficient fund service charges (NSF) collected resulting from both a decrease in volume, in addition to temporary fee waivers for customers related to the COVID-19 pandemic.

Bank Card and Credit card transaction fees increased $0.2 million, or 25.9%, to $1.0 million for the quarter ended June 30, 2021 compared to $0.8 million for the quarter ended June 30, 2020, and increased $0.4 million, or 25.0%, to $1.9 million for the six months ended June 30, 2021, compared to $1.5 million for the six months ended June 30, 2020.

Total non-interest income decreased $1.4 million, or 28.2%, to $3.7 million for the quarter ended September 30, 2021 compared to $5.1 million for the quarter ended September 30, 2020, and increased $2.4 million, or 23.8%, to $12.7 million for the nine months ended September 30, 2021 compared to $10.3 million for the nine months ended September 30, 2020.

The decrease in non-interest income for the quarter end September 30, 2021 compared to the quarter ended September 30, 2020 was primarily due to the decrease in gain on sale of real estate mortgages due to lower volumes of real estate mortgage loans sold as further discussed below.

Bank Card and Credit card transaction fees increased $0.2 million, or 23.3%, to $1.0 million for the quarter ended September 30, 2021 compared to $0.8 million for the quarter ended September 30, 2020, and increased $0.5 million, or 24.4%, to $2.9 million for the nine months ended September 30, 2021, compared to $2.4 million for the nine months ended September 30, 2020.

The increases were primarily related to increases in debit card usage and interchange fees.

As the economy began to recover from the COVID 19 pandemic, the Company began to see an increase in spending due to both stimulus income and a reduction of conservative savings due to the uncertainty of the pandemic.

Real estate servicing fees, net of the change in valuation of mortgage servicing rights (MSRs) increased $0.4 million to $0.4 million for the quarter ended June 30, 2021 compared to $(16,000) for the quarter ended June 30, 2020, and increased $0.5 million to $0.4 million for the six months ended June 30, 2021 compared to $(0.1) million for the six months ended June 30, 2020.

Mortgage loan servicing fees earned on loans sold were $0.2 million and $0.4 million for the three and six months ended June 30, 2021, respectively, compared to $0.2 million and $0.4 million for the three and six months ended June 30, 2020, respectively.

The current quarter's MSR valuation increased $0.3 million from the prior linked quarter primarily due to decreased prepayment assumptions.

Real estate servicing fees, net of the change in valuation of mortgage servicing rights (MSRs) increased $17,000 to $71,000 for the quarter ended September 30, 2021 compared to $54,000 for the quarter ended September 30, 2020 and increased $543,000 to $495,000 for the nine months ended September 30, 2021 compared to $(48,000) for the nine months ended September 30, 2020.

Mortgage loan servicing fees earned on loans sold were $0.2 million and $0.6 million for the three and nine months ended September 30, 2021, respectively, compared to $0.2 million and $0.6 million for the three and nine months ended September 30, 2020, respectively.

The current quarter's MSR valuation decreased $13,000 from the prior linked quarter primarily due to a decrease in the Company's servicing portfolio.

The dramatic drop in market interest rates created an economic incentive for borrowers to refinance their existing home mortgage loans during 2020 that has slowed down in 2021.

The Company was servicing $286.6 million of mortgage loans at June 30, 2021 compared to $292.7 million and $273.8 million at December 31, 2020 and June 30, 2020, respectively.

Gain on sales of mortgage loans increased $1.1 million to $2.0 million for the quarter ended June 30, 2021 compared to $0.9 million for the quarter ended June 30, 2020, and increased $3.2 million to $4.5 million for the six months ended June 30, 2021 compared to $1.3 million for the six months ended June 30, 2020.

The Company sold $61.9 million and $128.5 million of loans for the three and six months ended June 30, 2021, respectively, compared to $35.5 million and $47.7 million for the three and six months ended June 30, 2020, respectively.

The increase in loans sales is directly attributed to the formation of the mortgage loan group in the fourth quarter of 2019, and significant growth in 2020.

Other Income decreased $0.2 million, or 65.3%, to $0.1 million for the quarter ended June 30, 2021 compared to $0.3 million for the quarter ended June 30, 2020, and decreased $0.3 million, or 71.2%, to $0.1 million for the six months ended June 30, 2021 compared to $0.4 million for the six months ended June 30, 2020.

The decreases resulted from a decrease in net gains on sales of other real estate owned and net losses on disposal of fixed assets, and a reduction in rent received on foreclosed properties.

The Company was servicing $277.1 million of mortgage loans at September 30, 2021 compared to $292.7 million and $289.3 million at December 31, 2020 and September 30, 2020, respectively.

Gain on sales of mortgage loans decreased $1.6 million to $1.4 million for the quarter ended September 30, 2021 compared to $3.0 million for the quarter ended September 30, 2020 and increased $1.5 million to $5.9 million for the nine months ended September 30, 2021 compared to $4.4 million for the nine months ended September 30, 2020.

The Company sold $39.1 million and $167.6 million of loans for the three and nine months ended September 30, 2021, respectively, compared to $73.5 million and $133.2 million for the three and nine months ended September 30, 2020, respectively.

Loans sold to the secondary market were strong in the first six months but began to slow down in the third quarter of 2021.

Other Income decreased $12,000, or 10.5%, to $0.1 million for the quarter ended September 30, 2021 compared to $0.1 million for the quarter ended September 30, 2020, and decreased $0.3 million, or 57.2%, to $0.2 million for the nine months ended September 30, 2021 compared to $0.5 million for the nine months ended September 30, 2020.

The decreases primarily resulted from a decrease in net gains on sales of other real estate owned and a decrease in net gains on disposal of fixed assets.

In the quarter ended June 30, 2020, the Company sold an out-of-service branch building being held as other real estate owned (OREO) to a non-profit organization.

This transaction consisted of a $266,000 donation expense and the Company realized a net gain of $210,000.

These decreases were partially offset by an increase in brokerage income.

These decreases were partially offset by an increase in brokerage income and a forfeiture of an OREO escrow deposit.

The following table presents the gross realized gains and losses from sales and calls of available-for-sale securities, as well as gains and losses on equity securities from fair value adjustments which have been recognized in earnings:

Three Months Ended June 30,

Six Months Ended June 30,

Three Months Ended September 30,

Nine Months Ended September 30,

(in thousands)

8 unchanged sentences

Non-interest expense for the periods indicated was as follows:

Three Months Ended June 30,

Six Months Ended June 30,

Three Months Ended September 30,

Nine Months Ended September 30,

(In thousands)

12 unchanged sentences

Total revenue includes net interest income and non-interest income.

Total non-interest expense increased $0.5 million, or 4.4%, to $11.8 million for the quarter ended June 30, 2021 compared to $11.3 million for the quarter ended June 30, 2020, and increased $1.7 million, or 7.6%, to $23.4 million for the six months ended June 30, 2021 compared to $21.8 million for the six months ended June 30, 2020.

Salaries increased $0.2 million, or 3.2%, to $5.2 million for the quarter ended June 30, 2021 compared to $5.0 million for the quarter ended June 30, 2020, and increased $1.0 million, or 10.4%, to $10.5 million for the six months ended June 30, 2021 compared to $9.5 million for the six months ended June 30, 2020.

The increases were primarily due to adding additional personnel to the new mortgage loan department.

In addition, annual merit increases average approximately 4.0% each year and were awarded in the first quarter of each year.

Employee benefits increased $0.3 million, or 18.8%, to $1.8 million for the quarter ended June 30, 2021 compared to $1.5 million for the quarter ended June 30, 2020, and increased $0.5 million, or 15.3%, to $3.6 million for the six months ended June 30, 2021 compared to $3.1 million for the six months ended June 30, 2020.

The increases were primarily due to an

increase in 401(k) plan contributions, payroll taxes, medical premiums, and pension cost due to lower annual discount rate assumptions compared to the prior year's annual assumptions.

Processing, network, and bank card expense increased $0.3 million, or 28.4%, to $1.2 million for the quarter ended June 30, 2021 compared to $1.0 million for the quarter ended June 30, 2020, and increased $0.3 million, or 15.8%, to $2.2 million for the six months ended June 30, 2021 compared to $1.9 million for the six months ended June 30, 2020.

Total non-interest expense remained consistent at $11.7 million for both the quarters ended September 30, 2021 and 2020, respectively, and increased $1.7 million, or 5.0%, to $35.1 million for the nine months ended September 30, 2021 compared to $33.4 million for the nine months ended September 30, 2020.

Salaries decreased $0.2 million, or 3.1%, to $4.9 million for the quarter ended September 30, 2021 compared to $5.1 million for the quarter ended September 30, 2020 primarily due to reduced commissions due to a decrease in loan originations, and increased $0.8 million, or 5.7%, to $15.4 million for the nine months ended September 30, 2021 compared to $14.6 million for the nine months ended September 30, 2020 primarily due to an increase in commissions paid due to an increase in loan originations.

( See Gain on sales of mortgage loans discussion above ) In addition, annual merit increases averaged approximately 4.0% each year and were awarded in the first quarter of each year.

Employee benefits remained consistent at $1.7 million for both the quarters ended September 30, 2021 and 2020, respectively, and increased $0.5 million, or 11.1%, to $5.3 million for the nine months ended September 30, 2021 compared to $4.8 million for the nine months ended September 30, 2020.

The increases were primarily due to an increase in 401(k) plan contributions, payroll taxes, medical premiums, and pension cost due to lower annual discount rate assumptions compared to the prior year's annual assumptions.

Processing, network, and bank card expense increased $0.4 million, or 46.9%, to $1.3 million for the quarter ended September 30, 2021 compared to $0.9 million for the quarter ended September 30, 2020, and increased $0.7 million, or 25.4%, to $3.5 million for the nine months ended September 30, 2021 compared to $2.8 million for the nine months ended September 30, 2020.

These increases were primarily related to increases in network, processing, and debit card processing expenses, partially offset by decreases in credit card and ATM interchange expenses.

Loan expense decreased $74,000, or 24.4%, to $0.2 million for the quarter ended June 30, 2021 compared to $0.3 million for the quarter ended June 30, 2020, and decreased $24,000, or 5.6%, to $0.4 million for the six months ended June 30, 2021 compared to $0.4 million for the six months ended June 30, 2020.

Loan expense decreased $0.2 million, or 41.9%, to $0.2 million for the quarter ended September 30, 2021 compared to $0.4 million for the quarter ended September 30, 2020, and decreased $0.2 million, or 22.1%, to $0.6 million for the nine months ended September 30, 2021 compared to $0.8 million for the nine months ended September 30, 2020.

The decreases in loan expense primarily resulted from decreases in commercial and real estate third-party loan expenses.

The Company experienced a decrease in commercial loan growth during the three and six months ended June 30, 2021 compared to the three and six months ended June 30, 2020.

The Company experienced a decrease in commercial loan growth during the three and nine months ended September 30, 2021 compared to the three and nine months ended September 30, 2020.

Also during 2020, the Company experienced significant real estate mortgage refinancing activity and growth in loan volume sold to the secondary market.

Other non-interest expense decreased $0.2 million, or 13.1%, to $1.0 million for the quarter ended June 30, 2021 compared to $1.2 million for the quarter ended June 30, 2020, and decreased $92,000, or 4.5%, to $2.0 million for the six months ended June 30, 2021 compared to $2.1 million for the six months ended June 30, 2020.

The decreases were primarily related to a decrease in donations, pension net interest cost, and insurance reserves.

In the quarter ended June 30, 2020, the Company sold an out-of-service branch building being held as other real estate owned (OREO) to a non-profit organization.

Other non-interest expense decreased $0.2 million, or 14.6%, to $1.0 million for the quarter ended September 30, 2021 compared to $1.2 million for the quarter ended September 30, 2020, and decreased $0.3 million, or 8.2%, to $3.0 million for the nine months ended September 30, 2021 compared to $3.3 million for the nine months ended September 30, 2020.

The decreases were primarily related to a decrease in donations, pension net interest cost, and miscellaneous charged-off items related to teller differences and debit card fraud.

In the quarter ended September 30, 2020, the Company sold an out-of-service branch building being held as other real estate owned (OREO) to a non-profit organization.

This transaction consisted of a $266,000 donation expense and the Company realized a net gain of $210,000.

These decreases were partially offset by an increase in the FDIC assessment expense and software expense due to new mortgage loan software.

The increase in the FDIC assessment was due to the Company having received the remaining FDIC assessment credit during the first quarter of 2020 that reduced the overall assessment due in addition to an increase in deposits.

Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 19.7% and 19.2% for the three and six months ended June 30, 2021, respectively, compared to 18.6% and 17.9% for the three and six months ended June 30, 2020, respectively.

The increase in the effective tax rate for each of the three and six months ended June 30, 2021 compared to the three and six months ended June 30, 2020 was primarily attributable to the increase in earnings and an increase in state taxes attributed to elevated earnings.

The effective tax rate for each of the three and six months ended June 30, 2021 and 2020, respectively, is lower than the U.S.

These decreases were partially offset by an increase in the FDIC assessment expense, deposit product expense, and software expense due to new mortgage loan software.

Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 19.7% and 19.4% for the three and nine months ended September 30, 2021, respectively, compared to 18.9% and 18.4% for the three and nine months ended September 30, 2020, respectively.

The increase in the effective tax rate for each of the three and nine months ended September 30, 2021 compared to the three and nine months ended September 30, 2020 was primarily attributable to the increase in earnings and an increase in state taxes attributed to elevated earnings.

The effective tax rate for each of the three and nine months ended September 30, 2021 and 2020, respectively, is lower than the U.S.

federal statutory rate of 21% primarily due to tax-free revenues.

1 unchanged sentence

Interest earned on the loan portfolio is a primary source of interest income for the Company.

Net loans represented 74.6% of total assets as of June 30, 2021 compared to 73.2% as of December 31, 2020.

Net loans represented 72.7% of total assets as of September 30, 2021 compared to 73.2% as of December 31, 2020.

Lending activities are conducted pursuant to an established loan policy approved by the Bank’s Board of Directors.

3 unchanged sentences

Major classifications within the Company’s held for investment loan portfolio as of the dates indicated is as follows:

June 30, 2021

September 30, 2021

December 31, 2020

7 unchanged sentences

Total loans held for investment

(a) Includes $49.6 million and $63.3 million of SBA PPP loans, net as of June 30, 2021 and December 31, 2020, respectively.

(a) Includes $26.0 million and $63.3 million of SBA PPP loans, net as of September 30, 2021 and December 31, 2020, respectively.

The Company extends credit to its local community markets through traditional real estate mortgage products.

5 unchanged sentences

Fixed rate loans conforming to standards required by the secondary market are offered to qualified borrowers but are not funded until the Company has a non-recourse purchase commitment from the secondary market at a predetermined price.

During the six months ended June 30, 2021, the Company sold approximately $128.5 million of loans to investors compared to $47.7 million for the six months ended June 30, 2020.

At June 30, 2021, the Company was servicing approximately $286.6 million of loans sold to the secondary market compared to $292.7 million at December 31, 2020, and $273.8 million at June 30, 2020.

During the nine months ended September 30, 2021, the Company sold approximately $167.6 million of loans to investors compared to $133.2 million for the nine months ended September 30, 2020.

At September 30, 2021, the Company was servicing approximately $277.1 million of loans sold to the secondary market compared to $292.7 million at December 31, 2020, and $289.3 million at September 30, 2020.

Risk Elements of the Loan Portfolio

13 unchanged sentences

The following table summarizes non-performing assets at the dates indicated:

September 30,

(In thousands)

20 unchanged sentences

(b) Non-performing assets include non-performing loans and other real estate owned and repossessed assets.

Total non-performing assets were $45.7 million, or 3.53% of total loans, at June 30, 2021 compared to $46.9 million, or 3.64% of total loans, at December 31, 2020, and $21.4 million, or 1.67% of total loans, at June 30, 2020, respectively.

Total non-accrual loans at June 30, 2021 decreased $0.8 million, or 2.2%, to $33.8 million compared to $34.6 million at December 31, 2020.

Loans past due 90 days and still accruing interest at June 30, 2021 were $5,000 compared to $17,000 at December 31, 2020.

Other real estate and repossessed assets were $11.9 million and $12.3 million at June 30, 2021 and December 31, 2020, respectively.

During the six months ended June 30, 2021, $30,000 of non-accrual loans, net of charge-offs taken, moved to other real estate owned and repossessed assets compared to no such loan movements during the six months ended June 30, 2020.

As of June 30, 2021, approximately $6.9 million of loans classified as substandard, which include performing TDRs, and not included in the non-performing asset table, were identified as potential problem loans having more than normal risk which raised doubts as to the ability of the borrower to comply with present loan repayment terms compared to $6.0 million and $5.7 million at December 31, 2020 and June 30, 2020, respectively.

Management believes the allowance for loan losses was sufficient to cover the risks and probable losses related to such loans at June 30, 2021 and December 31, 2020, respectively.

Total non-performing assets were $44.4 million, or 3.46% of total loans, at September 30, 2021 compared to $46.9 million, or 3.64% of total loans, at December 31, 2020, and $18.4 million, or 1.44% of total loans, at September 30, 2020, respectively.

Total non-accrual loans at September 30, 2021 decreased $1.7 million, or 5.0%, to $32.8 million compared to $34.6 million at December 31, 2020.

There were no loans past due 90 days and still accruing interest at September 30, 2021 compared to $17,000 at December 31, 2020.

Other real estate and repossessed assets were $11.6 million and $12.3 million at September 30, 2021 and December 31, 2020, respectively.

During the nine months ended September 30, 2021, $142,000 of non-accrual loans, net of charge-offs taken, moved to other real estate owned and repossessed assets compared to $73,000 during the nine months ended September 30, 2020.

As of September 30, 2021, approximately $6.0 million of loans classified as substandard, which include performing TDRs, and not included in the non-performing asset table, were identified as potential problem loans having more than normal risk which raised doubts as to the ability of the borrower to comply with present loan repayment terms compared to $6.0 million and $4.7 million at December 31, 2020 and September 30, 2020, respectively.

Management believes the allowance for loan losses was sufficient to cover the risks and probable losses related to such loans at September 30, 2021 and December 31, 2020, respectively.

The following table summarizes the Company’s TDRs at the dates indicated:

June 30, 2021

September 30, 2021

December 31, 2020

10 unchanged sentences

Total non-performing TDRs

* Amounts less than $1,000 are not reported

At June 30, 2021, loans classified as TDRs totaled $3.1 million, with $154,000 of specific reserves compared to $3.7 million of loans classified as TDRs, with $214,000 of specific reserves at December 31, 2020.

Non-performing loans, included $0.8 million of loans classified as TDRs at June 30, 2021 compared to $0.9 million at December 31, 2020.

At September 30, 2021, loans classified as TDRs totaled $2.5 million, with $133,000 of specific reserves compared to $3.7 million of loans classified as TDRs, with $214,000 of specific reserves at December 31, 2020.

Non-performing loans, included $0.6 million of loans classified as TDRs at September 30, 2021 compared to $0.9 million at December 31, 2020.

Both performing and non-performing TDRs are considered impaired loans.

When an individual loan is determined to be a TDR, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the underlying collateral less applicable selling costs if the loan is collateral dependent.

The net decrease in total TDRs from December 31, 2020 to June 30, 2021 was primarily due to $620,000 of payments received on TDRs.

The net decrease in total TDRs from December 31, 2020 to September 30, 2021 was primarily due to $1.2 million of payments received on TDRs.

Allowance for Loan Losses and Provision

1 unchanged sentence

The following table is a summary of the allocation of the allowance for loan losses:

September 30,

(In thousands)

6 unchanged sentences

Installment and other consumer

The allowance for loan losses (ALL) was $18.7 million, or 1.45% of loans outstanding, at June 30, 2021 compared to $18.1 million, or 1.41%, at December 31, 2020, and $16.6 million, or 1.30% at June 30, 2020.

The ratio of the ALL to non-performing loans was 55.45% at June 30, 2021, compared to 52.39% at December 31, 2020, and 186.62% at June 30, 2020.

The allowance for loan losses (ALL) was $18.9 million, or 1.48% of loans outstanding, at September 30, 2021 compared to $18.1 million, or 1.41%, at December 31, 2020, and $17.8 million, or 1.39% at September 30, 2020.

The ratio of the ALL to non-performing loans was 57.65% at September 30, 2021, compared to 52.39% at December 31, 2020, and 305.49% at September 30, 2020.

The following table is a summary of the general and specific allocations of the ALL:

September 30,

(In thousands)

5 unchanged sentences

Once the impairment amount is calculated, a specific reserve allocation is recorded.

At June 30, 2021, $5.4 million of the Company’s ALL was allocated to impaired loans totaling approximately $36.1 million compared to $5.1 million of the Company’s ALL allocated to impaired loans totaling approximately $37.3 million at December 31, 2020.

Management determined that $12.4 million, or 34%, of total impaired loans required no reserve allocation at June 30, 2021 compared to $11.9 million, or 32%, at December 31, 2020, primarily due to adequate collateral values , acceptable payment history and adequate cash flow ability.

At September 30, 2021, $4.9 million of the Company’s ALL was allocated to impaired loans totaling approximately $34.7 million compared to $5.1 million of the Company’s ALL allocated to impaired loans totaling approximately $37.3 million at December 31, 2020.

Management determined that $11.9 million, or 34%, of total impaired loans required no reserve allocation at September 30, 2021 compared to $11.9 million, or 32%, at December 31, 2020, primarily due to adequate collateral values , acceptable payment history and adequate cash flow ability.

The incurred loss component of the general reserve, or loans collectively evaluated for impairment, is determined by applying loss rates to pools of loans by asset type.

10 unchanged sentences

Although the ALL is comprised of specific and general allocations, the entire ALL is available to absorb any credit losses.

The ALL changes from December 31, 2020 to June 30, 2021 primarily resulted from net recovery activity, in addition to organic loan growth.

The ALL changes from December 31, 2020 to September 30, 2021 primarily resulted from net recovery activity, in addition to organic loan growth.

The Company continues to monitor the risks associated with its non-performing loans and the remaining loans modified under the CARES Act.

The decreased provision in the three and six months ended June 30, 2021 compared to the three and six months ended June 30, 2020

resulted primarily from the impact of net recoveries and improvement in the economic outlook as the economy begins to recover from the impacts of the COVID-19 pandemic, which significantly impacted provision in 2020.

A $0.3 million and $0.7 million provision for loan losses was required for the three and nine months ended September 30, 2021, respectively, compared to a $1.2 million and $5.4 million provision for the three and nine months ended September 30, 2020, respectively.

Criticized loan levels remain elevated when compared to pre-pandemic levels due to the downgrade of loans to borrowers that have been impacted by the COVID-19 pandemic.

1 unchanged sentence

Three Months Ended

Six Months Ended

Nine Months Ended

September 30,

(In thousands)

16 unchanged sentences

Net Loan Charge-offs (recoveries)

The Company’s net charge-offs were $26,000 for the three months ended June 30, 2021 compared to net recoveries of $29,000 for the three months ended June 30, 2020, and net recoveries were $222,000 for the six months ended June 30, 2021 compared to net charge-offs of $55,000 for the six months ended June 30, 2020.

During the first quarter of 2021 the Company received commercial and a real estate mortgage recoveries primarily related to two loan relationships

The Company’s net charge-offs were $106,000 for the three months ended September 30, 2021 compared to net charge-offs of $58,000 for the three months ended September 30, 2020, and net recoveries were $116,000 for the nine months ended September 30, 2021 compared to net charge-offs of $113,000 for the nine months ended September 30, 2020.

The net recovery for the nine months ended September 30, 2021 was primarily related to a commercial and a real estate mortgage recovery received from two loan relationships in the first quarter of 2021.

Loans Held For Sale

1 unchanged sentence

The loans are primarily sold to Freddie Mac, Fannie Mae, and PennyMac and other various secondary market investors.

At June 30, 2021, the carrying amount of these loans was $2.5 million compared to $5.1 million at December 31, 2020.

In the fourth quarter of 2019 the Company expanded its current home mortgage loan program to better serve its customers.

This expansion began with hiring new mortgage lending personnel and expanding the Bank’s available loan products and upgrading the Company's operating systems.

New home loan programs for its customers include:

VA loans, designed for military families and veterans;

USDA loans for those buying homes in rural communities;

and FHA loans, which offer low down payments and flexible underwriting guidelines.

In addition, we have added several secondary market investors, allowing us to sell loans on the secondary market versus servicing them at the Company.

This provides us with the ability to offer clients more aggressive pricing and at the same time improve the Company's financial return.

At September 30, 2021, the carrying amount of these loans was $4.6 million compared to $5.1 million at December 31, 2020.

Liquidity and Capital Resources

9 unchanged sentences

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.

September 30,

(In thousands)

3 unchanged sentences

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 $276.0 million at June 30, 2021 and included an unrealized net gain of $2.9 million.

The fair value of the available-for-sale investment portfolio was $278.5 million at September 30, 2021 and included an unrealized net gain of $0.05 million.

The portfolio includes projected maturities and mortgage-backed securities pay-downs of approximately $4.8 million over the next twelve months, which offer resources to meet either new loan demand or reductions in the Company’s deposit base.

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 required by law.

At June 30, 2021 and December 31, 2020, the Company’s unpledged securities in the available-for-sale portfolio totaled approximately $66.6 million and $44.1 million, respectively.

At September 30, 2021 and December 31, 2020, the Company’s unpledged securities in the available-for-sale portfolio totaled approximately $73.7 million and $44.1 million, respectively.

Total investment securities pledged for these purposes were as follows:

September 30,

(In thousands)

5 unchanged sentences

Liquidity is available from the Company’s base of core customer deposits, defined as demand, interest checking, savings, money market deposit accounts, and time deposits less than $250,000, less all brokered deposits under $250,000.

At June 30, 2021, such deposits totaled $1.3 billion and represented 92.9% of the Company’s total deposits.

At September 30, 2021, such deposits totaled $1.3 billion and represented 93.1% 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.

Core deposits at June 30, 2021 and December 31, 2020 were as follows:

Core deposits at September 30, 2021 and December 31, 2020 were as follows:

September 30,

(In thousands)

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Other time deposits

Time deposits and certificates of deposit of $250,000 and greater at June 30, 2021 and December 31, 2020 were $66.6 million and $91.3 million, respectively.

The Company had brokered deposits totaling $30.2 million and $40.2 million at June 30, 2021 and December 31, 2020, respectively.

Time deposits and certificates of deposit of $250,000 and greater at September 30, 2021 and December 31, 2020 were $77.1 million and $91.3 million, respectively.

The Company had brokered deposits totaling $20.2 million and $40.2 million at September 30, 2021 and December 31, 2020, respectively.

Other components of liquidity are the level of borrowings from third-party sources and the availability of future credit.

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Federal funds purchased are overnight borrowings obtained mainly from upstream correspondent banks with which the Company maintains approved credit lines.

As of June 30, 2021, under agreements with these unaffiliated banks, the Bank may borrow up to $60.0 million in federal funds on an unsecured basis and $10.5 million on a secured basis.

There were no federal funds purchased outstanding at June 30, 2021.

As of September 30, 2021, under agreements with these unaffiliated banks, the Bank may borrow up to $60.0 million in federal funds on an unsecured basis and $10.3 million on a secured basis.

There were no federal funds purchased outstanding at September 30, 2021.

Securities sold under agreements to repurchase are generally borrowed overnight and are secured by a portion of the Company’s investment portfolio.

At June 30, 2021, there were $32.0 million in repurchase agreements.

The Company may periodically borrow additional short-term funds from the Federal Reserve Bank through the discount window, although no such borrowings were outstanding at June 30, 2021.

At September 30, 2021, there were $27.4 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, 2021.

The Bank is a member of the Federal Home Loan Bank of Des Moines (FHLB) and has access to credit products of the FHLB.

As of June 30, 2021, the Bank had $93.5 million in outstanding borrowings with the FHLB.

As of September 30, 2021, the Bank had $93.5 million in outstanding borrowings with the FHLB.

In addition, the Company has $49.5 million in outstanding subordinated notes issued to wholly-owned grantor trusts, funded by preferred securities issued by the trusts.

Borrowings outstanding at June 30, 2021 and December 31, 2020 were as follows:

Borrowings outstanding at September 30, 2021 and December 31, 2020 were as follows:

September 30,

(In thousands)

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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.

The Federal Reserve Bank also establishes a collateral value of assets pledged to support borrowings from the discount window.

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,

(In thousands)

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Total available

At June 30, 2021, loans of $537.1 million were pledged at the FHLB as collateral for borrowings and letters of credit.

At June 30, 2021, investments totaling $10.9 million were pledged to secure federal funds purchase lines and borrowing capacity at the Federal Reserve Bank.

At September 30, 2021, loans of $556.0 million were pledged at the FHLB as collateral for borrowings and letters of credit.

At September 30, 2021, investments totaling $10.8 million were pledged to secure federal funds purchase lines and borrowing capacity at the Federal Reserve Bank.

Based upon the above, management believes the Company has more than adequate liquidity, both on balance sheet and through the additional funding capacity with the FHLB, the Federal Reserve Bank and Federal funds purchased lines to meet future anticipated needs in both the short and long-term.

this includes accounting for the impact of the COVID-19 pandemic, which is difficult to currently measure.

Management believes the most significant impact to the Company’s liquidity position in the short-term may be related to the PPP as loans are expected to be forgiven and depositors may choose to redirect their funds.

The longer-term impact on the Company's liquidity from the pandemic will be closely monitored and addressed as needs arise.

The Company also has available additional liquidity having pledged the PPP loans to the FHLB as collateral for available advances.

Sources and Uses of Funds

Cash and cash equivalents were $76.4 million at June 30, 2021 compared to $180.4 million at December 31, 2020.

The $103.9 million decrease resulted from changes in the various cash flows produced by operating, investing, and financing activities of the Company, as shown in the accompanying consolidated statement of cash flows for the six months ended June 30, 2021.

Cash and cash equivalents were $113.3 million at September 30, 2021 compared to $180.4 million at December 31, 2020.

The $67.1 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, 2021.

Cash flow provided from operating activities consists mainly of net income adjusted for certain non-cash items.

Operating activities provided cash flow of $13.0 million for the six months ended June 30, 2021.

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 $84.2 million during the six months ended June 30, 2021.

The cash outflow primarily consisted of $114.5 million in purchases of investment securities partially offset by $34.3 million from maturities and calls of investment securities.

Management intends to continue to grow the investment portfolio based on available liquidity.

Financing activities used total cash of $32.7 million during the six months ended June 30, 2021, resulting primarily from a $53.4 million decrease in interest-bearing transaction accounts and time deposits, a $13.1 million decrease in securities sold under agreements to repurchase, and a $13.1 million repayment of FHLB advances, partially offset by a $50.8 million increase in demand deposits.

Operating activities provided cash flow of $19.5 million for the nine months ended September 30, 2021.

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 $78.4 million during the nine months ended September 30, 2021.

The cash outflow primarily consisted of $136.7 million in purchases of investment securities partially offset by $50.8 million from maturities and calls and sales of investment securities.

Financing activities used total cash of $8.2 million during the nine months ended September 30, 2021, resulting primarily from a $51.7 million decrease in interest-bearing transaction accounts and time deposits, a $17.7 million decrease in securities sold under agreements to repurchase, and a $13.2 million repayment of FHLB advances, partially offset by a $79.1 million increase in demand deposits.

The growth in demand deposits was positively impacted by customers who deposited both economic stimulus payments and PPP loan proceeds into demand accounts.

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Management considers both on-balance sheet and off-balance sheet transactions in its evaluation of the Company’s liquidity.

The Company had $297.2 million in unused loan commitments and standby letters of credit as of June 30, 2021.

The Company had $385.5 million in unused loan commitments and standby letters of credit as of September 30, 2021.

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.

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The Company’s ongoing liquidity needs primarily include funding its operating expenses, paying cash dividends to its shareholders and, to a lesser extent, repurchasing its shares of common stock.

The Company paid cash dividends to its shareholders totaling approximately $1.7 million and $1.5 million for the six months ended June 30, 2021 and 2020, respectively.

The Company paid cash

dividends to its shareholders totaling approximately $2.6 million and $2.3 million for the nine months ended September 30, 2021 and 2020, respectively.

A large portion of the Company’s liquidity is obtained from the Bank in the form of dividends.

The Bank declared and paid $4.5 million and $2.5 million in dividends to the Company during the six months ended June 30, 2021 and 2020, respectively.

At June 30, 2021 and December 31, 2020, the Company had cash and cash equivalents totaling $1.8 million and $2.0 million, respectively.

The Bank declared and paid $6.5 million and $2.5 million in dividends to the Company during the nine months ended September 30, 2021 and 2020, respectively.

At September 30, 2021 and December 31, 2020, the Company had cash and cash equivalents totaling $2.3 million and $2.0 million, respectively.

Subject to declaration by the Company's Board of Directors, the Company expects to continue paying quarterly cash dividends as a part of its current capital allocation strategy.

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During the second quarter of 2021, the Company's Board of Directors reauthorized the purchase of up to $5.0 million market value of the Company's common stock.

There were no shares repurchased during the second quarter of 2021.

There were no shares repurchased during the third quarter of 2021.

The repurchases under these authorizations may be effectuated in the open market, by block purchase, in privately negotiated transactions, or through other transactions managed by broker-dealers, or any combination thereof.

No time limit was set for the completion of these authorized share repurchases.

As of June 30, 2021, $5.0 million remained available for the repurchase of shares pursuant to the share repurchase authorizations.

As of September 30, 2021, $5.0 million remained available for the repurchase of shares pursuant to the share repurchase authorizations.

The Company may continue to repurchase shares under its share repurchase authorizations, but the amount and timing of such repurchases will be dependent on a number of factors, including the price of its common stock and other cash flow needs.

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Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of CET1, Tier 1 and total capital to risk-weighted assets, and of Tier 1 capital to average assets, each as defined in the regulations.

Management believes, as of June 30, 2021, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

Management believes, as of September 30, 2021, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

Financial institutions are categorized as well capitalized or adequately capitalized, based on minimum total risk-based, Tier 1 risk-based, CET1 and Tier 1 leverage ratios.

As shown in the table below, the Company’s capital ratios exceeded the regulatory definition of adequately capitalized as of June 30, 2021 and December 31, 2020.

Based upon the information in its most recently filed call report, the Bank met the capital ratios necessary to be well capitalized.

As shown in the table below, the Company’s capital ratios exceeded the regulatory definition of adequately capitalized as of September 30, 2021 and December 31, 2020.

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.

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In addition, bank holding companies generally are required to maintain a Tier 1 leverage ratio of at least 4%.

Because the Bank had less than $15.0 billion in total consolidated assets as of December 31, 2009, the Company is allowed to continue to classify our trust preferred securities, all of which were issued prior to May 19, 2010, as Tier 1 capital.

Under the Basel III requirements, at June 30, 2021 and December 31, 2020, 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:

Because the Bank had less than $15.0 billion in total consolidated assets as of December 31, 2009, the Company is allowed to continue to classify its trust preferred securities, all of which were issued prior to May 19, 2010, as Tier 1 capital.

Under the Basel III requirements, at September 30, 2021 and December 31, 2020, 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:

Minimum Capital

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(in thousands)

June 30, 2021

September 30, 2021

Total Capital (to risk-weighted assets):

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis