Item 7. Management’s Discussion and Analysis
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
ISABELLA BANK CORPORATION FINANCIAL REVIEW
(Dollars in thousands except per share amounts)
The following is management’s discussion and analysis of our financial condition and results of operations. This discussion and analysis is intended to provide a better understanding of the consolidated financial statements and statistical data included elsewhere in this Annual Report on Form 10-K.
Executive Summary
We reported net income of $18,167 and earnings per common share of $2.42 for the year ended December 31, 2023. Net income and earnings per common share for the same period of 2022 were $22,238 and $2.95, respectively. Net interest income decreased $2,537, or 4.19%, during 2023 compared to 2022. Rising interest rates and growth in core loans led to a $13,833, or 21.02%, increase in gross interest income during 2023 compared to 2022. Conversely, rising interest rates on deposits and an increase in borrowings led to a $16,370 increase in interest expense for the year ended December 31, 2023 when compared to the same period in 2022.
The provision for credit losses during the year ended December 31, 2023 was $629, compared to $483 for the same period in 2022. Credit quality remained strong at December 31, 2023, as evidenced by total past due and nonaccrual loans which were $4,964, or 0.37%, of gross loans. While maintaining strong credit quality, the ACL and provision for loan losses increased during 2023 as a result of core loan growth and economic related risk factors.
Noninterest income increased $161 during 2023 compared to the same period in 2022. This increase was driven by wealth management fees and ATM and debit card fee income, offset by a decrease in OMSR income and gain on sale of loans, as residential mortgages sold to the secondary market declined. Noninterest expenses increased $2,490 in 2023, when compared to the same period in 2022, and was primarily a result of increased compensation, equipment expense, other losses, and FDIC insurance premiums.
As of December 31, 2023, total assets and assets under management were $2,058,968 and $2,948,751, respectively. Assets under management include loans sold and serviced of $248,756 and investment and trust assets managed by Isabella Wealth of $641,027, in addition to assets on our consolidated balance sheet. Loans outstanding as of December 31, 2023 totaled $1,349,463. During 2023, gross loans grew $85,290 driven by growth in nearly all loan categories. Total deposits were $1,723,695 as of December 31, 2023, declining $20,580, or 1.2%, during the year as competition for deposits remained strong throughout 2023. All regulatory capital ratios for the Bank exceeded the minimum thresholds to be considered a "well capitalized" institution.
Our securities portfolio decreased $52,333 during 2023, predominantly due to maturities and principal paydowns. Unrealized losses on our AFS securities portfolio were $31,826 at December 31, 2023, improving $13,298 since December 31, 2022. Unrealized losses on our AFS securities portfolio resulted from increased short-term and intermediate-term benchmark interest rates throughout 2023. As a result, the higher level of unrealized losses has reduced our balance of shareholders' equity and negatively impacted our tangible book value. Management does not anticipate the need to sell securities and incur a loss as a result of the sale.
Our net yield on interest earning assets (FTE) was 3.05% for 2023, which decreased from 3.18% in 2022. To maintain a competitive edge in a rising interest rate environment, we increased most of our deposit rates beginning in the fourth quarter of 2022 and in recent periods, increased our level of borrowings to fund loan growth. As a result, this has negatively impacted our net yield on interest earning assets and further increases may slow improvement in our net yield on interest earning assets.
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Recent Events and Legislation
2023 Bank Failures and the Condition of the Banking Industry: In March 2023, disruptions in the industry resulted in FDIC seizures of three banking institutions. Each bank had its own unique balance sheet issues, none of which exist at Isabella Bank. Shortly after the FDIC takeovers, the Federal Reserve Bank and the Department of Treasury announced enhanced insurance coverage and a borrowing program to help banks in need of funding. Isabella Bank continues to monitor such events, as well as industry and regulatory responses, to assure we are prepared for any changes that might affect the bank, including the ability to timely address economic uncertainty.
Impact of the Adoption of ASC 326 (CECL): We adopted ASU No. 2016-13, as subsequently updated for certain clarifications, targeted relief and codification improvements, as of January 1, 2023. Based on portfolio characteristics and economic conditions and expectations as of January 1, 2023, we recorded a combined pre-tax increase of $3,059 to the ACL and reserve for unfunded commitments on January 1, 2023 upon the adoption of ASU 2016-13; this implementation resulted in a reduction to retained earnings of $2,417, net of tax, as of January 1, 2023. In connection with the adoption of ASC 326, we revised certain accounting policies and implemented certain accounting policy elections, which are included in “Note 1 – Significant Accounting Policies” of our interim condensed consolidated financial statements.
Reclassifications
Certain amounts reported in management's discussion and analysis of financial condition and results of operations for 2022 and 2021 have been reclassified to conform with the 2023 presentation.
Operating results for periods after January 1, 2023 are presented in accordance with ASC 326 while prior period amounts continue to be reported in accordance with previously applicable standards and the accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2022. In addition, the adoption of ASC 326 requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses.
Subsequent Events
We evaluated subsequent events after December 31, 2023 through the date our condensed consolidated financial statements were issued for potential recognition and disclosure. No subsequent events require financial statement recognition or disclosure between December 31, 2023 and the date our condensed consolidated financial statements were issued.
Other
We have not received, nor are aware of, any notices of regulatory actions as of March 6, 2024.
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Results of Operations
(Dollars in thousands except per share amounts)
The following table outlines the results of operations and provides certain key performance measures as of, and for the years ended, December 31:
2023 2022 2021
INCOME STATEMENT DATA
Interest income $ 79,631 $ 65,798 $ 60,113
Interest expense 21,687 5,317 7,412
Net interest income 57,944 60,481 52,701
Provision for credit losses 629 483 (518)
Noninterest income 13,827 13,666 13,822
Noninterest expenses 49,310 46,820 43,694
Federal income tax expense 3,665 4,606 3,848
Net income $ 18,167 $ 22,238 $ 19,499
PER SHARE
Basic earnings $ 2.42 $ 2.95 $ 2.48
Diluted earnings $ 2.40 $ 2.91 $ 2.45
Dividends $ 1.12 $ 1.09 $ 1.08
Tangible book value (1)
$ 20.59 $ 18.25 $ 21.61
Quoted market value
High $ 26.00 $ 26.25 $ 29.00
Low $ 19.13 $ 21.00 $ 19.45
Close (1)
$ 21.50 $ 23.50 $ 25.50
Common shares outstanding (1)
7,485,889 7,559,421 7,532,641
PERFORMANCE RATIOS
Return on average total assets 0.89 % 1.08 % 0.96 %
Return on average shareholders' equity 9.52 % 11.41 % 8.83 %
Return on average tangible shareholders' equity 12.75 % 15.17 % 11.31 %
Net interest margin yield (FTE) 3.05 % 3.18 % 2.87 %
BALANCE SHEET DATA (1)
Gross loans $ 1,349,463 $ 1,264,173 $ 1,301,037
AFS securities $ 528,148 $ 580,481 $ 490,601
Total assets $ 2,058,968 $ 2,030,267 $ 2,032,158
Deposits $ 1,723,695 $ 1,744,275 $ 1,710,339
Borrowed funds $ 116,136 $ 87,016 $ 99,320
Shareholders' equity $ 202,402 $ 186,210 $ 211,048
Gross loans to deposits 78.29 % 72.48 % 76.07 %
ASSETS UNDER MANAGEMENT (1)
Loans sold with servicing retained $ 248,756 $ 264,206 $ 278,844
Assets managed by Isabella Wealth $ 641,027 $ 513,918 $ 516,243
Total assets under management $ 2,948,751 $ 2,808,391 $ 2,827,245
ASSET QUALITY (1)
Nonperforming loans to gross loans 0.08 % 0.04 % 0.10 %
Nonperforming assets to total assets 0.07 % 0.05 % 0.08 %
ACL to gross loans 0.97 % 0.78 % 0.70 %
CAPITAL RATIOS (1)
Shareholders' equity to assets 9.83 % 9.17 % 10.39 %
Tier 1 leverage 8.76 % 8.61 % 7.97 %
Common equity tier 1 capital 12.54 % 12.91 % 12.07 %
Tier 1 risk-based capital 12.54 % 12.91 % 12.07 %
Total risk-based capital 15.52 % 15.79 % 14.94 %
(1) At end of year
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The following table outlines our interim results of operations and key performance measures as of, and for the unaudited periods ended:
Quarter to Date
December 31
2023 September 30
2023 June 30
2023 March 31
2023
INCOME STATEMENT DATA
Total interest income $ 21,056 $ 20,485 $ 19,495 $ 18,595
Total interest expense 7,444 6,183 4,816 3,244
Net interest income 13,612 14,302 14,679 15,351
Provision for loan losses 684 (292) 196 41
Noninterest income 3,516 3,414 3,604 3,293
Noninterest expenses 11,915 12,658 12,539 12,198
Federal income tax expense 726 937 918 1,084
Net income $ 3,803 $ 4,413 $ 4,630 $ 5,321
PER SHARE
Basic earnings $ 0.51 $ 0.59 $ 0.62 $ 0.70
Diluted earnings $ 0.51 $ 0.58 $ 0.61 $ 0.70
Dividends $ 0.28 $ 0.28 $ 0.28 $ 0.28
Quoted market value (1)
$ 21.50 $ 21.05 $ 20.50 $ 24.80
Tangible book value (1)
$ 20.59 $ 18.27 $ 18.69 $ 19.24
Quarter to Date
December 31
2022 September 30
2022 June 30
2022 March 31
2022
INCOME STATEMENT DATA
Total interest income $ 17,915 $ 17,019 $ 16,102 $ 14,762
Total interest expense 1,643 1,216 1,175 1,283
Net interest income 16,272 15,803 14,927 13,479
Provision for loan losses (57) 18 485 37
Noninterest income 3,272 3,252 3,595 3,547
Noninterest expenses 11,922 11,917 11,661 11,320
Federal income tax expense 1,357 1,233 1,081 935
Net income $ 6,322 $ 5,887 $ 5,295 $ 4,734
PER SHARE
Basic earnings $ 0.84 $ 0.78 $ 0.70 $ 0.63
Diluted earnings $ 0.83 $ 0.77 $ 0.69 $ 0.62
Dividends $ 0.28 $ 0.27 $ 0.27 $ 0.27
Quoted market value (1)
$ 23.50 $ 21.40 $ 24.80 $ 25.85
Tangible book value (1)
$ 18.25 $ 16.96 $ 18.85 $ 19.56
(1) At end of period
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CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are set forth in “Note 1 – Significant Accounting Policies” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data. Of these significant accounting policies, we consider our policies regarding the ACL, acquisition intangibles and goodwill, and the determination of the fair value and assessment of credit related impairments of investment securities to be our most critical accounting policies.
The ACL requires our most subjective and complex judgment. Changes in economic conditions and other external factors can have a significant impact on the ACL and, therefore, the allowance for credit losses and results of operations. We have developed policies and procedures for assessing the appropriateness of the ACL, recognizing that this process requires a number of assumptions and estimates with respect to our loan portfolio. Our assessments may be impacted in future periods by changes in economic conditions, and the discovery of information with respect to borrowers which is not known to us at the time of the issuance of the consolidated financial statements. For additional discussion concerning our ACL and related matters, see “ACL - Loans” and “Note 4 – Loans and ACL” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
U.S. generally accepted accounting principles require that we determine the fair value of the assets and liabilities of an acquired entity, and record the fair value on the date of acquisition. We employ a variety of measures in the determination of the fair value, including the use of discounted cash flow analysis, market appraisals, and projected future revenue streams. For certain items that we believe we have the appropriate expertise to determine the fair value, we may choose to use our own calculations of the value. In other cases, where the value is not easily determined, we consult with independent experts to determine the fair value of the identified asset or liability. Once valuations have been determined, the net difference between the price paid for the acquired entity and the net value of assets acquired on our balance sheet, including identifiable intangibles, is recorded as goodwill. Acquisition intangibles and goodwill are qualitatively evaluated to determine if it is more likely than not that the carrying balance is impaired on at least an annual basis.
AFS securities are carried at fair value with changes in the fair value included as a component of other comprehensive income. Declines in the fair value of AFS securities below their cost that are other-than-temporary are reflected as realized losses in the consolidated statements of income. The market values for most AFS investment securities are typically obtained from outside sources and applied to individual securities within the portfolio. Municipal securities for which no readily determinable market values are available are priced using fair value curves which most closely match the securities' characteristics. AFS securities are reviewed quarterly for possible credit impairment. In determining whether a credit-related impairment exists for debt securities, we assess whether: (a) we do not have the intent to sell the security; and (b) it is more likely than not we will not have to sell the security before recovery of its cost basis. If either of these conditions are met, any previously recognized allowances are charged-off and the security's amortized cost is written down to fair value through income. If these conditions are not met, the security is evaluated to determine whether the decline in fair value has resulted from credit losses or other factors.
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Average Balances, Interest Rates, and Net Interest Income
The following schedules present the daily average amount outstanding for each major category of interest earning assets, non-earning assets, interest bearing liabilities, and noninterest bearing liabilities for the last three years. These schedules also present an analysis of interest income and interest expense for the periods indicated. All interest income is reported on a FTE basis using a federal income tax rate of 21%. Loans in nonaccrual status, for the purpose of the following computations, are included in the average loan balances. FRB and FHLB restricted equity holdings are included in other interest earning assets.
Year Ended December 31
2023 2022 2021
Average
Balance Tax
Equivalent
Interest Average
Yield /
Rate Average
Balance Tax
Equivalent
Interest Average
Yield /
Rate Average
Balance Tax
Equivalent
Interest Average
Yield /
Rate
INTEREST EARNING ASSETS
Loans (1)
$ 1,308,891 $ 65,670 5.02 % $ 1,249,634 $ 53,283 4.26 % $ 1,208,141 $ 51,410 4.26 %
Taxable investment securities 485,718 9,399 1.94 % 477,159 8,294 1.74 % 297,357 4,920 1.65 %
Nontaxable investment securities 96,845 3,780 3.90 % 107,158 3,933 3.67 % 117,997 4,235 3.59 %
Fed funds sold 12 1 5.04 % 10 — 2.42 % 5 — 0.02 %
Other 41,965 1,804 4.30 % 99,301 1,344 1.35 % 255,246 706 0.28 %
Total earning assets 1,933,431 80,654 4.17 % 1,933,262 66,854 3.46 % 1,878,746 61,271 3.26 %
NONEARNING ASSETS
Allowance for credit losses (12,784) (9,477) (9,396)
Cash and demand deposits due from banks 24,592 24,708 29,139
Premises and equipment 26,589 24,648 24,760
Accrued income and other assets 74,319 81,823 109,625
Total assets $ 2,046,147 $ 2,054,964 $ 2,032,874
INTEREST BEARING LIABILITIES
Interest bearing demand deposits $ 346,875 1,086 0.31 % $ 374,623 274 0.07 % $ 345,015 216 0.06 %
Savings deposits 626,027 8,290 1.32 % 630,574 1,135 0.18 % 558,102 616 0.11 %
Time deposits 308,699 8,976 2.91 % 270,296 2,612 0.97 % 336,094 4,610 1.37 %
Federal funds purchased and repurchase agreements 43,061 961 2.23 % 49,974 79 0.16 % 57,453 53 0.09 %
FHLB advances 23,699 1,309 5.52 % 7,863 152 1.93 % 69,342 1,302 1.88 %
Subordinated debt, net of unamortized issuance costs
29,287 1,065 3.64 % 29,200 1,065 3.65 % 17,000 615 3.62 %
Total interest bearing liabilities 1,377,648 21,687 1.57 % 1,362,530 5,317 0.39 % 1,383,006 7,412 0.54 %
NONINTEREST BEARING LIABILITIES
Demand deposits 461,689 482,781 416,247
Other 16,043 14,695 12,858
Shareholders’ equity 190,767 194,958 220,763
Total liabilities and shareholders’ equity $ 2,046,147 $ 2,054,964 $ 2,032,874
Net interest income (FTE) $ 58,967 $ 61,537 $ 53,859
Net yield on interest earning assets (FTE) 3.05 % 3.18 % 2.87 %
(1) Includes loans and mortgage loans AFS
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Net interest income is the amount by which interest income on earning assets exceeds the interest expense on interest bearing liabilities. Net interest income is influenced by changes in the balance and mix of assets and liabilities, as well as market interest rates. We exert some control over these factors; however, FRB monetary policy and competition have a significant impact. For analytical purposes, net interest income is adjusted to an FTE basis by including the income tax savings from interest on tax exempt loans and nontaxable investment securities, thus making year to year comparisons more meaningful. The FTE adjustment is based on a federal income tax rate of 21%.
Volume and Rate Variance Analysis
The following table sets forth the effect of volume and rate changes on interest income and expense for the periods indicated. For the purpose of this table, changes in interest due to volume and rate were determined as follows:
Volume—change in volume multiplied by the previous period's FTE rate.
Rate—change in the FTE rate multiplied by the previous period's volume.
All interest income presented in the table below is reported on a FTE basis using a federal income tax rate of 21%. The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
2023 Compared to 2022
Increase (Decrease) Due to 2022 Compared to 2021
Increase (Decrease) Due to
Volume Rate Net Volume Rate Net
Changes in interest income
Loans $ 2,621 $ 9,766 $ 12,387 $ 1,769 $ 104 $ 1,873
Taxable investment securities 151 954 1,105 3,114 260 3,374
Nontaxable investment securities (393) 240 (153) (396) 94 (302)
Fed Funds Sold — 1 1 — — —
Other (1,130) 1,590 460 (659) 1,297 638
Total changes in interest income 1,249 12,551 13,800 3,828 1,755 5,583
Changes in interest expense
Interest bearing demand deposits (22) 834 812 20 38 58
Savings deposits (8) 7,163 7,155 89 430 519
Time deposits 420 5,944 6,364 (796) (1,202) (1,998)
Federal funds purchased and repurchase agreements (12) 894 882 (8) 34 26
FHLB advances 602 555 1,157 (1,187) 37 (1,150)
Subordinated debt, net of unamortized issuance costs
3 (3) — 445 5 450
Total changes in interest expense 983 15,387 16,370 (1,437) (658) (2,095)
Net change in interest margin (FTE) $ 266 $ (2,836) $ (2,570) $ 5,265 $ 2,413 $ 7,678
Over the past several quarters, rising rates on deposit accounts and an increase in borrowed funds have reversed the improvement in our net interest margin. The higher interest rate environment is expected to continue to place pressure and slow improvement on our net yield on interest earning assets.
Average Yield / Rate for the Three-Month Periods Ended:
December 31
2023 September 30
2023 June 30
2023 March 31
2023 December 31
2022
Total earning assets 4.38 % 4.30 % 4.11 % 3.89 % 3.77 %
Total interest bearing liabilities 2.13 % 1.79 % 1.41 % 0.95 % 0.49 %
Net yield on interest earning assets (FTE) 2.85 % 3.02 % 3.11 % 3.22 % 3.43 %
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Quarter to Date Net Interest Income (FTE)
December 31
2023 September 30
2023 June 30
2023 March 31
2023 December 31
2022
Total interest income (FTE) $ 21,302 $ 20,735 $ 19,750 $ 18,867 $ 18,183
Total interest expense 7,444 6,183 4,816 3,244 1,643
Net interest income (FTE) $ 13,858 $ 14,552 $ 14,934 $ 15,623 $ 16,540
Past Due and Nonaccrual Loans
Fluctuations in past due and nonaccrual loans can have a significant impact on the ACL. To determine the potential impact, and corresponding estimated losses, we analyze our historical loss trends on loans past due greater than 30 days and nonaccrual loans for indications of additional deterioration.
Total Past Due and Nonaccrual Loans as of December 31
2023 2022 2021 2020 2019
Commercial and industrial $ 656 $ 617 $ 203 $ 1,790 $ 1,936
Commercial real estate — 6,887 358 358 559
Agricultural 205 234 987 3,786 4,285
Residential real estate 3,910 3,333 2,287 3,580 4,554
Consumer 193 59 196 96 71
Total $ 4,964 $ 11,130 $ 4,031 $ 9,610 $ 11,405
Total past due and nonaccrual loans to gross loans 0.37 % 0.88 % 0.31 % 0.78 % 0.96 %
The increase in past due and nonaccrual loans within the commercial real estate and residential loan portfolios at the end of 2022 was the result of one past due relationship, which has since improved. The accrual of interest on commercial and agricultural loans, as well as residential real estate loans, is discontinued at the time a loan is 90 days or more past due unless the credit is well-secured and in the process of short-term collection. Upon transferring a loan to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if a charge-off is necessary. Consumer loans are typically charged-off no later than 180 days past due. Loans may be placed back on accrual status after six months of continued performance and achievement of current payment status.
The following table summarizes nonaccrual loans as of:
December 31
2023 September 30
2023 June 30
2023 March 31
2023 December 31
2022
Commercial and industrial $ 491 $ 17 $ 17 $ 20 $ 82
Commercial real estate — — — 57 14
Agricultural 205 208 218 232 234
Residential real estate 286 295 179 179 127
Total $ 982 $ 520 $ 414 $ 488 $ 457
Nonaccrual loans as a % of loans at end of period 0.07 % 0.04 % 0.03 % 0.04 % 0.04 %
A summary of loans past due by type and information related to nonaccrual status loans are included in “Note 4 – Loans and ACL” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
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Nonperforming Assets
The following table summarizes our nonperforming assets as of December 31:
2023 2022 2021 2020 2019
Nonaccrual loans $ 982 $ 457 $ 1,245 $ 5,313 $ 6,535
Accruing loans past due 90 days or more 87 — 97 — —
Total nonperforming loans 1,069 457 1,342 5,313 6,535
Foreclosed assets 406 439 211 527 456
Debt securities 12 77 131 230 230
Total nonperforming assets $ 1,487 $ 973 $ 1,684 $ 6,070 $ 7,221
Nonperforming loans as a % of total loans 0.08 % 0.04 % 0.10 % 0.43 % 0.55 %
Nonperforming assets as a % of total assets 0.07 % 0.05 % 0.08 % 0.31 % 0.40 %
ACL - Loans
The viability of any financial institution is ultimately determined by its management of risk. Loans represent our single largest concentration of risk. The ACL is our estimation of expected credit losses within the existing loan portfolio. We allocate the ACL throughout the loan portfolio based on our assessment of the underlying risks associated within each loan segment. Our assessments include allocations based on specific valuation allowances, historical charge-offs, internally assigned credit risk ratings, past due and nonaccrual balances, historical loss percentages, and other credit trends and risk characteristics, including current conditions and reasonable and supportable forecasts about the future.
Upon the adoption of ASC 326 on January 1, 2023, the total amount of the allowance for credit losses on loans estimated using the CECL methodology increased $2,744 compared to the total amount of the allowance for credit losses on loans estimated as of December 31, 2022 using the prior incurred loss methodology. The manner in which credit loss allowances are allocated to the individual portfolio segments was partly impacted by a change in the way the underlying loans within each segment are pooled for modeling purposes. The impact of varying economic conditions and portfolio risk factors are now a component of the credit loss models applied to each modeling pool. In that regard, the amounts allocated to the underlying pools of loans within each portfolio segment more directly reflect the economic variables and portfolio stress factors that correlate with credit losses within each portfolio. Under the prior methodology, allocations in excess of those derived from historical loss rates were recognized as unallocated. Nonetheless, despite fluctuations in the allocation of portions of the overall allowance to the various portfolio segments, the entire allowance is available to absorb any credit losses within the entire loan portfolio.
The following table summarizes our charge-offs, recoveries, provision for credit losses, and ACL balances as of, and for the unaudited three month periods ended:
December 31
2023 September 30
2023 June 30
2023 March 31
2023 December 31
2022
Total charge-offs $ 452 $ 179 $ 92 $ 101 $ 249
Total recoveries 71 433 95 110 479
Net loan charge-offs (recoveries) 381 (254) (3) (9) (230)
Net loan charge-offs (recoveries) to average loans outstanding 0.03 % (0.02) % 0.00 % 0.00 % (0.02) %
Provision for credit losses - loans $ 684 $ (320) $ 190 $ 37 $ (57)
Provision for credit losses to average loans outstanding 0.05 % (0.02) % 0.01 % 0.00 % 0.00 %
ACL $ 13,108 $ 12,767 $ 12,833 $ 12,640 $ 9,850
ACL as a % of loans at end of period 0.97 % 0.96 % 0.96 % 0.99 % 0.78 %
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The following table summarizes charge-off and recovery activity by loan segment for the year ended December 31, 2023:
Commercial and Industrial Commercial Real Estate Agricultural Residential Real Estate Consumer Total
Charge-offs $ 276 $ — $ 4 $ 2 $ 542 $ 824
Recoveries 79 26 12 329 263 709
Net loan charge-offs (recoveries) $ 197 $ (26) $ (8) $ (327) $ 279 $ 115
Average loans outstanding $ 203,390 $ 547,166 $ 96,967 $ 345,630 $ 97,485 $ 1,290,638
Net loan charge-offs (recoveries) to average loans outstanding 0.10 % — % (0.01) % (0.09) % 0.29 % 0.01 %
The following table summarizes charge-offs, recoveries, and provision for credit loss activity for the years ended December 31:
2023 2022 2021 2020 2019
Allowance at beginning of period $ 9,850 $ 9,103 $ 9,744 $ 7,939 $ 8,375
Adoption of ASC 326 2,744 — — — —
Charge-offs 824 619 607 381 948
Recoveries 709 883 484 521 482
Provision for credit losses - loans 629 483 (518) 1,665 30
Allowance at end of period $ 13,108 $ 9,850 $ 9,103 $ 9,744 $ 7,939
Net loan charge-offs (recoveries) $ 115 $ (264) $ 123 $ (140) $ 466
Net loan charge-offs (recoveries) to average loans outstanding 0.01 % (0.02) % 0.01 % (0.01) % 0.04 %
ACL as a % of loans at end of period 0.97 % 0.78 % 0.70 % 0.79 % 0.67 %
ACL as a % of nonaccrual loans 1334.83 % 2155.36 % 731.16 % 183.40 % 121.48 %
The following table illustrates the two main components of the ACL as of:
December 31
2023 September 30
2023 June 30
2023 March 31
2023 December 31
2022
ACL
Individually evaluated $ 84 $ — $ — $ — $ 451
Collectively evaluated 13,024 12,767 12,833 12,640 9,399
Total $ 13,108 $ 12,767 $ 12,833 $ 12,640 $ 9,850
ACL to gross loans
Individually evaluated 0.01 % 0.00 % 0.00 % 0.00 % 0.04 %
Collectively evaluated 0.96 % 0.96 % 0.96 % 0.99 % 0.74 %
Total 0.97 % 0.96 % 0.96 % 0.99 % 0.78 %
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The following table illustrates the amounts of the ACL and ALLL allocated to each loan segment and the percentage of these loan segments to gross loans as of December 31:
2023 2022 2021 2020 2019
ACL Allocation % of Gross Loans ALLL Allocation % of Gross Loans ALLL Allocation % of Gross Loans ALLL Allocation % of Gross Loans ALLL Allocation % of Gross Loans
Commercial and industrial $ 968 15.54 $ 860 14.11 $ 680 13.91 $ 704 17.37 $ 644 14.25
Commercial real estate 5,878 41.82 461 44.78 1,060 42.89 1,458 39.99 1,270 42.22
Advances to mortgage brokers — 1.37 — — — 5.53 — 4.06 — 2.99
Agricultural 270 7.41 577 8.30 289 7.27 311 8.12 634 9.87
Residential real estate 4,336 26.41 617 26.64 747 24.77 1,363 24.51 2,047 24.76
Consumer 1,656 7.45 961 6.17 908 5.63 798 5.95 922 5.91
Total Allocated 13,108 100.00 3,476 100.00 3,684 100.00 4,634 100.00 5,517 100.00
Unallocated — — 6,374 — 5,419 — 5,110 — 2,422 —
Total $ 13,108 100.00 $ 9,850 100.00 $ 9,103 100.00 $ 9,744 100.00 $ 7,939 100.00
While we utilize our best judgment and information available, the ultimate adequacy of the ACL is dependent upon a variety of factors beyond our control, including the performance of our borrowers, the economy, and changes in interest rates. We closely monitor overall credit quality indicators and our policies and procedures related to the analysis of the ACL to ensure that the ACL remains at an appropriate level.
For further discussion of the allocation of the ACL, see “Note 4 – Loans and ACL” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
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Noninterest Income and Noninterest Expenses
Significant noninterest income balances are highlighted in the following table for the years ended December 31:
Change Change
2023 2022 $ % 2021 $ %
Service charges and fees
ATM and debit card fees $ 5,051 $ 4,774 $ 277 5.80 % $ 4,600 $ 174 3.78 %
Service charges and fees on deposit accounts 2,413 2,566 (153) (5.96) % 2,139 427 19.96 %
Freddie Mac servicing fee 630 669 (39) (5.83) % 747 (78) (10.44) %
Net OMSR income (loss) (137) 435 (572) (131.49) % (184) 619 336.41 %
Other fees for customer services 340 286 54 18.88 % 312 (26) (8.33) %
Total service charges and fees 8,297 8,730 (433) (4.96) % 7,614 1,116 14.66 %
Wealth management fees 3,557 3,005 552 18.37 % 3,071 (66) (2.15) %
Earnings on corporate owned life insurance policies 920 884 36 4.07 % 800 84 10.50 %
Net gain on sale of mortgage loans 317 631 (314) (49.76) % 1,694 (1,063) (62.75) %
Other 736 416 320 76.92 % 643 (227) (35.30) %
Total noninterest income $ 13,827 $ 13,666 $ 161 1.18 % $ 13,822 $ (156) (1.13) %
During 2022, we experienced an increase in service charges and fees on deposit accounts mainly due to an increase in the number of deposit accounts. Although deposit accounts continued to grow in 2023, we experienced a decline in fees due to the discontinuation of NSF fees. Although we expect a continuation in deposit account growth in 2024, fee levels may not exceed 2023 due to continued regulatory discussions around the practice of service charges and fees.
OMSR income results are driven, in part, by changes in offering rates on residential mortgage loans, anticipated prepayments in the servicing-retained portfolio, and the volume of loans within the servicing-retained portfolio. During 2022, prepayment speeds declined as a result of an increase in interest rates, resulting in income recognized during 2022. During 2023 the volume of loans serviced decreased, resulting in the recognition of losses. OMSR income during 2024 may continue to experience fluctuations and could vary from 2023 levels.
During 2023, we experienced an increase in wealth management fees driven by a combination of the growth in the stock market and increased new business activity. During 2022, there was strong growth in assets managed by Isabella Wealth, however the decline in the market offset the increase in fees related to growth in new business. We expect wealth management fees to exceed 2023 levels in 2024 as a result of new business activity.
The amount of loans sold is driven by customer demand and balance sheet management strategies. We experienced a significant increase in loan demand in early 2021 which led to an increase in the number and dollar amount of loans sold; as such, net gain on sale of mortgage loans increased significantly. In mid-2021, we decided to retain more loan originations on the balance sheet, due to our liquidity position, thereby decreasing the number of mortgage loans sold, which had an impact on the net gain on loans sold. As a result of this change in strategy, coupled with a decline in loan demand due to increased interest rates, net gain on sale of mortgage loans declined in the second half of 2021 and during 2022. During 2023, we experienced a decrease in gain on sale of mortgage loans as loan demand continued to decline. As demand is expected to remain at reduced levels in 2024, gain on sale of mortgage loans is not expected to exceed 2023 levels during 2024.
The fluctuations in all other income are spread throughout various categories, none of which is individually significant.
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Significant noninterest expense balances are highlighted in the following table for the years ended December 31:
Change Change
2023 2022 $ % 2021 $ %
Compensation and benefits $ 25,905 $ 24,887 $ 1,018 4.09 % $ 23,749 $ 1,138 4.79 %
Furniture and equipment 6,519 6,006 513 8.54 % 5,462 544 9.96 %
Occupancy 3,778 3,691 87 2.36 % 3,661 30 0.82 %
Other
Audit, consulting, and legal fees 2,340 2,358 (18) (0.76) % 2,066 292 14.13 %
ATM and debit card fees 1,767 1,909 (142) (7.44) % 1,810 99 5.47 %
Marketing costs 1,159 1,056 103 9.75 % 939 117 12.46 %
Memberships and subscriptions 1,042 876 166 18.95 % 877 (1) (0.11) %
Loan underwriting fees 927 1,004 (77) (7.67) % 849 155 18.26 %
FDIC insurance premiums 922 537 385 71.69 % 690 (153) (22.17) %
Donations and community relations 915 923 (8) (0.87) % 705 218 30.92 %
Other losses 871 546 325 59.52 % 194 352 181.44 %
Director fees 764 790 (26) (3.29) % 703 87 12.38 %
All other 2,401 2,237 164 7.33 % 1,989 248 12.47 %
Total other noninterest expenses 13,108 12,236 872 7.13 % 10,822 1,414 13.07 %
Total noninterest expenses $ 49,310 $ 46,820 $ 2,490 5.32 % $ 43,694 $ 3,126 7.15 %
The increase in compensation and benefits has been driven by merit increases and our employee incentive plans. We closely monitor compensation levels to ensure we attract and retain talent in a competitive labor market. While expenses related to our employee incentive plans fluctuate based on financial performance, compensation and benefits expense in 2024 is expected to continue to increase as a result of anticipated merit increases and insurance related benefits.
The decrease in ATM and debit card fees is primarily the result of a cost savings related to vendor reporting services. While the savings in the service fees will continue, ATM and debit card fees are expected to exceed 2023 levels in 2024 as a result of the continuation of increased card usage.
The increase in FDIC insurance premiums is due to the FDIC adopting a final rule, applicable to all insured depository institutions, to increase initial base deposit insurance assessment rate schedules uniformly by 2 basis points, beginning in the first quarterly assessment period of 2023. The increase in assessment rate schedules is intended to increase the likelihood that the reserve ratio of the Deposit Insurance fund reaches the statutory minimum of 1.35 percent by the statutory deadline of September 30, 2028. FDIC premiums are expected to maintain 2023 levels into 2024.
Donations and community relations increased during 2022 as a result of initiatives designed to deepen and strengthen our relationship with the communities in which we operate and serve, which includes an expanded footprint. During 2023 we maintained the same level of community support as in 2022. In 2024 we do not expect donations and community relations to exceed 2023 levels.
During the second quarter of 2023, we recognized a loss related to the settlement of a business matter. No further losses are anticipated related to this matter. As such, other losses are expected to decline during 2024 when compared to 2023 levels.
The fluctuations in all other noninterest expenses are spread throughout various categories, none of which is individually significant.
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Analysis of Changes in Financial Condition
The following table shows the composition and changes in our balance sheet as of December 31:
Change
2023 2022 $ %
ASSETS
Cash and cash equivalents $ 33,672 $ 38,924 $ (5,252) (13.49) %
AFS securities
Amortized cost of AFS securities 559,974 625,605 (65,631) (10.49) %
Unrealized gains (losses) on AFS securities (31,826) (45,124) 13,298 N/M
AFS securities 528,148 580,481 (52,333) (9.02) %
Mortgage loans AFS — 379 (379) (100.00) %
Loans 1,349,463 1,264,173 85,290 6.75 %
Less allowance for credit losses 13,108 9,850 3,258 33.08 %
Net loans 1,336,355 1,254,323 82,032 6.54 %
Premises and equipment 27,639 25,553 2,086 8.16 %
Corporate owned life insurance policies 33,892 32,988 904 2.74 %
Equity securities without readily determinable fair values 15,848 15,746 102 0.65 %
Goodwill and other intangible assets 48,284 48,287 (3) (0.01) %
Accrued interest receivable and other assets 35,130 33,586 1,544 4.60 %
TOTAL ASSETS $ 2,058,968 $ 2,030,267 $ 28,701 1.41 %
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits $ 1,723,695 $ 1,744,275 $ (20,580) (1.18) %
Borrowed funds 116,136 87,016 29,120 33.47 %
Accrued interest payable and other liabilities 16,735 12,766 3,969 31.09 %
Total liabilities 1,856,566 1,844,057 12,509 0.68 %
Shareholders’ equity 202,402 186,210 16,192 8.70 %
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $ 2,058,968 $ 2,030,267 $ 28,701 1.41 %
A discussion of changes in balance sheet amounts by major categories follows:
Cash and cash equivalents
Included in cash and cash equivalents are funds held with the FRB which fluctuate from period to period. Cash levels declined slightly during 2023 driven by funding for loan growth.
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AFS securities
The primary objective of our investing activities is to manage our overall exposure to changes in interest rates. Secondary considerations include ensuring ample access to liquidity, generating returns, and providing current income. The following is a schedule of the carrying value of AFS securities as of December 31:
2023 2022 2021
U.S. Treasury $ 214,801 $ 208,701 $ 209,703
States and political subdivisions 92,876 117,512 121,205
Auction rate money market preferred 2,931 2,342 3,242
Mortgage-backed securities 32,815 39,070 56,148
Collateralized mortgage obligations 177,775 205,728 92,301
Corporate 6,950 7,128 8,002
Total $ 528,148 $ 580,481 $ 490,601
Excluding those holdings in government sponsored enterprises and municipalities within the State of Michigan, there were no investments in securities of any one issuer that exceeded 10% of shareholders’ equity during 2023, 2022, and 2021. We have a policy prohibiting investments in securities that we deem unsuitable due to their inherent credit or market risks. Prohibited investments include stripped mortgage-backed securities, zero coupon bonds, non-government agency asset-backed securities, and structured notes. Our holdings in mortgage-backed securities and collateralized mortgage obligations include only government agencies and government sponsored agencies as we hold no investments in private label mortgage-backed securities or collateralized mortgage obligations.
The following is a schedule of maturities of AFS securities and their weighted average yields as of December 31, 2023. Weighted average yields have been computed on an FTE basis using a tax rate of 21%. Our auction rate money market preferred investments are long-term floating rate instruments. The issuers of auction rate securities generally have the right to redeem or refinance the debt. Because of their lack of contractual maturities, auction rate money market preferred stocks are not reported by a specific maturity group. Mortgage-backed securities and collateralized mortgage obligations are not reported by a specific maturity group due to their variable monthly payments. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.
Maturing
Within
One Year After One
Year But
Within
Five Years After Five
Years But
Within
Ten Years After
Ten Years Securities with
Variable Monthly
Payments or
Noncontractual
Maturities
Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%)
U.S. Treasury $ — — $ 214,801 0.98 $ — — $ — — $ — —
States and political subdivisions 15,907 3.65 28,197 3.13 19,450 2.93 29,322 3.58 — —
Mortgage-backed securities — — — — — — — — 32,815 2.36
Collateralized mortgage obligations — — — — — — — — 177,775 2.91
Auction rate money market preferred — — — — — — — — 2,931 7.78
Corporate — — — — 6,950 3.78 — — — —
Total $ 15,907 3.65 $ 242,998 0.27 $ 26,400 3.15 $ 29,322 3.58 $ 213,521 2.90
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Loans
Loans are the largest component of earning assets. The proper management of credit and market risk inherent in the loan portfolio is critical to our financial stability. To control these risks, we have adopted strict underwriting standards, lending limits to a single borrower, loan to collateral value limits, and a defined market area. We also monitor and limit loan concentrations to specific industries. We have no foreign loans and there were no concentrations greater than 10% of total loans that are not disclosed as a separate category in the following table.
The following table presents the composition of the loan portfolio for the years ended December 31:
2023 2022 2021 2020 2019
Commercial and industrial $ 209,738 $ 178,428 $ 180,975 $ 215,101 $ 169,116
Commercial real estate 564,244 566,012 557,905 495,232 500,876
Advances to mortgage brokers 18,541 — 72,001 50,258 35,523
Agricultural 99,994 104,985 94,634 100,600 117,136
Residential real estate 356,418 336,694 322,239 303,500 293,779
Consumer 100,528 78,054 73,283 73,620 70,140
Total $ 1,349,463 $ 1,264,173 $ 1,301,037 $ 1,238,311 $ 1,186,570
The following table presents the change in the loan portfolio categories for the years ended December 31:
2023 2022 2021
$ Change % Change $ Change % Change $ Change % Change
Commercial and industrial $ 31,310 17.55 % $ (2,547) (1.41) % $ (34,126) (15.87) %
Commercial real estate (1,768) (0.31) % 8,107 1.45 % 62,673 12.66 %
Advances to mortgage brokers 18,541 100.00 % (72,001) (100.00) % 21,743 43.26 %
Agricultural (4,991) (4.75) % 10,351 10.94 % (5,966) (5.93) %
Residential real estate 19,724 5.86 % 14,455 4.49 % 18,739 6.17 %
Consumer 22,474 28.79 % 4,771 6.51 % (337) (0.46) %
Total $ 85,290 6.75 % $ (36,864) (2.83) % $ 62,726 5.07 %
We've experienced an increase in the commercial loan portfolio in recent periods as demand has increased. With the increased activity in mortgage lending in the second quarter of 2023, we elected to resume participation in a mortgage purchase program. Our participation in this program paused during most of 2022 and the first quarter of 2023 due to low mortgage volume. Residential mortgage lending activities continues to increase despite increased interest rates. As interest rates are expected to remain high throughout 2024, growth in residential loans is anticipated to continue, but at a slower pace. We've experienced growth in the consumer portfolio and expect this trend to continue in 2024.
Accrued interest receivable and other assets
Other assets consist primarily of prepaid expenses, OMSR, and net deferred tax assets. For more information related to estimates and deferred taxes, refer to “Note 1 – Significant Accounting Policies” and “Note 15 – Federal Income Taxes” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
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Deposits
Deposits are our primary source of funding. The following table presents the composition of the deposit portfolio as of December 31:
2023 2022 2021
Noninterest bearing demand deposits $ 428,505 $ 494,346 $ 448,352
Interest bearing demand deposits 320,737 372,155 364,563
Savings deposits 628,079 625,734 596,662
Certificates of deposit 346,125 251,541 297,696
Internet certificates of deposit 249 499 3,066
Total $ 1,723,695 $ 1,744,275 $ 1,710,339
The following table presents the change in the deposit categories for the years ended December 31:
2023 2022
$ Change % Change $ Change % Change
Noninterest bearing demand deposits $ (65,841) (13.32) % $ 45,994 10.26 %
Interest bearing demand deposits (51,418) (13.82) % 7,592 2.08 %
Savings deposits 2,345 0.37 % 29,072 4.87 %
Certificates of deposit 94,584 37.60 % (46,155) (15.50) %
Internet certificates of deposit (250) (50.10) % (2,567) (83.72) %
Total $ (20,580) (1.18) % $ 33,936 1.98 %
Total deposits have decreased over the past 12 months driven by a decline in demand deposits. We have experienced significant growth in certificates of deposit accounts during 2023 as a result of increased interest rates. We expect interest rates on deposits to continue to rise into 2024 due to competitive pressures, and anticipate a continuation in the shift of customers moving to higher interest earning products.
The following table presents estimated balances of uninsured deposits as of December 31:
2023 2022 2021 2020 2019
Uninsured deposits $ 600,381 $ 585,901 $ 548,213 $ 461,859 $ 336,399
Uninsured deposits are the portion of deposit accounts in U.S. offices that exceed the FDIC insurance limits. The balance provided above are estimates and reflect the methodologies and assumptions used for regulatory reporting of uninsured deposits. The remaining maturity of estimated uninsured certificates of deposit, by account, as of December 31, 2023 is presented in the table below. Estimated uninsured certificates of deposit is based on individual accounts and does not reflect uninsured balances by account owner.
Maturity
Within 3 months $ 13,396
Within 3 to 6 months 14,383
Within 6 to 12 months 23,555
Over 12 months 8,350
Total $ 59,684
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Borrowed Funds
Borrowed funds include FHLB advances, securities sold under agreements to repurchase, subordinated debt, and federal funds purchased. The balance of borrowed funds fluctuates from period to period based on our funding needs that arise from changes in loans, investments, and deposits. To provide balance sheet growth, we may utilize borrowings and brokered deposits to fund earning assets.
The following table presents borrowed funds balances as of December 31:
2023 2022 2021
Securities sold under agreements to repurchase without stated maturity dates $ 46,801 $ 57,771 $ 50,162
FHLB advances 40,000 — 20,000
Subordinated debt, net of unamortized issuance costs 29,335 29,245 29,158
Total $ 116,136 $ 87,016 $ 99,320
FHLB advances outstanding as of December 31, 2023 were short-term, with maturities within a week after December 31, 2023. In 2021, we completed a private placement of $30,000 in aggregate principal amount of 3.25% Fixed-to-Floating Rate Subordinated Notes due 2031 (the "Notes"). The Notes will initially bear a fixed interest rate of 3.25% until June 15, 2026, after which time until maturity on June 15, 2031, the interest rate will reset quarterly to an annual floating rate equal to the then-current 3-month SOFR plus 256 basis points. The Notes are redeemable by us at our option, in whole or in part, on or after June 15, 2026. The Notes are not subject to redemption at the option of the holders. For additional disclosure related to borrowed funds, see “Note 8 – Borrowed Funds” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
Accrued interest payable and other liabilities
Included in accrued interest payable and other liabilities are obligations related to our defined benefit pension plan and other employee benefits. For more information on the defined benefit pension plan and other employee benefits, see “Note 12 – Benefit Plans” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
Contractual Obligations and Loan Commitments
We have various financial obligations, including contractual obligations and commitments related to deposits and borrowings, which may require future cash payments. We also have loan related commitments that may impact liquidity. The commitments include unused lines of credit, commercial and standby letters of credit, and commitments to grant loans. These commitments to grant loans include residential mortgage loans with the majority committed to be sold to the secondary market. Many of these commitments historically have expired without being drawn upon and do not necessarily indicate our future cash requirements.
For additional disclosure related to Contractual Obligations and Loan Commitments, see “Note 9 – Off-Balance-Sheet Activities, Commitments and Other Matters” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
Capital
Capital consists solely of common stock, retained earnings, and accumulated other comprehensive income (loss). We are authorized to raise capital through dividend reinvestment, employee and director stock purchases, and shareholder stock purchases. Pursuant to these authorizations, we issued 75,488 shares or $1,617 of common stock during 2023, and 74,445 shares or $1,762 of common stock in 2022. We offer the Directors Plan in which participants purchase stock units through deferred fees, in lieu of cash payments. Pursuant to this plan, we increased shareholders’ equity by $529 and $463 during 2023 and 2022, respectively. We also grant restricted stock awards pursuant to the RSP, effective June 24, 2020. Pursuant to this plan, we increased shareholders’ equity by $253 and $147 during 2023 and 2022.
We have publicly announced a common stock repurchase plan. Pursuant to this plan, we repurchased 149,020 shares or $3,415 of common stock during 2023 and 47,665 shares or $1,124 during 2022. As of December 31, 2023, we were authorized to repurchase up to an additional 270,806 shares of common stock.
The FRB has established minimum risk-based capital guidelines. Pursuant to these guidelines, a framework has been established that assigns risk weights to each category of on and off-balance-sheet items to arrive at risk adjusted total assets. Regulatory capital is divided by the risk adjusted assets with the resulting ratio compared to the minimum standard to determine whether a corporation has adequate capital.
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The common equity tier 1 capital ratio has a minimum requirement of 4.50%. The minimum standard for primary, or Tier 1 capital is 6.00% and the minimum standard for total capital is 8.00%. The minimum requirements presented below include the minimum required capital levels based on the Basel III Capital Rules. Capital requirements to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. The following table sets forth these requirements and our ratios as of December 31:
2023 2022
Actual Minimum Required - BASEL III Required to be Considered Well Capitalized Actual Minimum Required - BASEL III Required to be Considered Well Capitalized
Common equity tier 1 capital 12.54 % 7.00 % 6.50 % 12.91 % 7.00 % 6.50 %
Tier 1 capital 12.54 % 8.50 % 8.00 % 12.91 % 8.50 % 8.00 %
Total capital 15.52 % 10.50 % 10.00 % 15.79 % 10.50 % 10.00 %
Tier 1 leverage 8.76 % 4.00 % 5.00 % 8.61 % 4.00 % 5.00 %
Total capital includes Tier 1 capital and Tier 2 capital. Tier 2 capital includes a permissible portion of the allowances for credit losses and subordinated debt, net of unamortized issuance costs. There are no significant regulatory constraints placed on our capital. At December 31, 2023, the Bank exceeded minimum capital requirements. For further information regarding the Bank’s capital requirements, see “Note 10 – Minimum Regulatory Capital Requirements” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
Liquidity
Liquidity is monitored regularly by our ALCO, which consists of members of senior management. The committee reviews projected cash flows, key ratios, and liquidity available from both primary and secondary sources.
Our primary sources of liquidity are cash and cash equivalents and unencumbered AFS securities. These categories totaled $381,417 or 18.52% of assets as of December 31, 2023, compared to $488,981 or 24.08% as of December 31, 2022. The decline in the amount and percentage of primary liquidity is a direct result of an increase in loans and a decrease in unencumbered AFS securities collateralizing non-market funding. Liquidity is important for financial institutions because of their need to meet loan funding commitments, depositor withdrawal requests, and various other commitments including expansion of operations, investment opportunities, and payment of cash dividends. Based on these same factors, daily liquidity could vary significantly.
Deposit accounts are our primary source of funds. Our secondary sources include the ability to borrow from the FHLB, from the FRB, and through various correspondent banks in the form of federal funds purchased and a line of credit. These funding methods typically carry a higher interest rate than traditional market deposit accounts. Some borrowed funds, including FHLB advances, FRB Discount Window advances, and repurchase agreements, require us to pledge assets, typically in the form of AFS securities or loans, as collateral. As of December 31, 2023, we had available lines of credit of $338,080.
The frequency and complexity of our liquidity stress testing has increased due to economic uncertainly and changes within the interest rate and economic environment. Our liquidity position remained strong at the end of 2023, which is illustrated in the following table:
December 31
2023
Total cash and cash equivalents $ 33,672
Available lines of credit
Fed funds lines with correspondent banks 93,000
FHLB borrowings 211,860
FRB Discount Window 28,220
Other lines of credit 5,000
Total available lines of credit 338,080
Unencumbered lendable value of FRB collateral, estimated 1
320,000
Total cash and liquidity $ 691,752
(1) Includes estimated unencumbered lendable value of FHLB collateral of $230,000
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The following table summarizes our sources and uses of cash for the years ended December 31:
2023 2022 $ Variance
Net cash provided by (used in) operating activities $ 23,715 $ 26,937 $ (3,222)
Net cash provided by (used in) investing activities (25,779) (106,255) 80,476
Net cash provided by (used in) financing activities (3,188) 12,912 (16,100)
Increase (decrease) in cash and cash equivalents (5,252) (66,406) 61,154
Cash and cash equivalents January 1 38,924 105,330 (66,406)
Cash and cash equivalents December 31 $ 33,672 $ 38,924 $ (5,252)
Fair Value
We utilize fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. AFS securities, cash flow hedge derivative instruments and certain liabilities are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other assets on a nonrecurring basis, such as mortgage loans AFS, impaired loans, goodwill, foreclosed assets, OMSR, and certain other assets and liabilities. These nonrecurring fair value adjustments typically involve the application of lower of cost or market accounting or write downs of individual assets.
For further information regarding fair value measurements, see “Note 1 – Significant Accounting Policies” and “Note 17 – Fair Value” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data .
Market Risk
Our primary market risks are interest rate risk and liquidity risk. IRR is the exposure of our net interest income to changes in interest rates. IRR results from the difference in the maturity or repricing frequency of a financial institution's interest earning assets and its interest bearing liabilities. Managing IRR is the fundamental method by which financial institutions earn income and create shareholder value. Excessive exposure to IRR could pose a significant risk to our earnings and capital.
The FRB has adopted a policy requiring banks to effectively manage the various risks that can have a material impact on safety and soundness. The risks include credit, interest rate, liquidity, operational, and reputational. We have policies, procedures, and internal controls for measuring and managing these risks. Specifically, our ALCO policy and procedures include defining acceptable types and terms of investments and funding sources, liquidity requirements, limits on investments in long-term assets, limiting the mismatch in repricing opportunities of assets and liabilities, and the frequency of measuring and reporting to our Board of Directors.
The primary technique to measure IRR is simulation analysis. Simulation analysis forecasts the effects on the balance sheet structure and net interest income under a variety of scenarios that incorporate changes in interest rates, the shape of the yield curve, interest rate relationships, loan prepayments, and funding sources. These forecasts are compared against net interest income projected in a stable interest rate environment. While many assets and liabilities reprice either at maturity or in accordance with their contractual terms, several balance sheet components demonstrate characteristics that require an evaluation to more accurately reflect their repricing behavior. Key assumptions in the simulation analysis include prepayments on loans, probable calls of investment securities, changes in market conditions, loan volumes and loan pricing, deposit sensitivity, and customer preferences. These assumptions are inherently uncertain as they are subject to fluctuation and revision in a dynamic rate environment. As a result, the simulation analysis cannot precisely forecast the impact of rising and falling interest rates on net interest income. Actual results will differ from simulated results due to many other factors, including changes in balance sheet components, interest rate changes, changes in market conditions, and management strategies. We regularly monitor our projected net interest income sensitivity to ensure that it remains within established limits.
Gap analysis, the secondary method to measure IRR, measures the cash flows and/or the earliest repricing of our interest bearing assets and liabilities. This analysis is useful for measuring trends in the repricing characteristics of the balance sheet. Significant assumptions are required in this process because of the embedded repricing options contained in assets and liabilities. Residential real estate and consumer loans allow the borrower to repay the balance prior to maturity without penalty, while commercial and agricultural loans may have prepayment penalties. The amount of prepayments is dependent upon many factors, including the interest rate of a given loan in comparison to the current offering rates, the level of home sales, and the overall availability of credit in the market place. Generally, a decrease in interest rates will result in an increase in cash flows from these assets. A significant portion of our securities are callable or have prepayment options. The call and prepayment options are more likely to be exercised in a period of decreasing interest rates. Savings and demand accounts may generally be withdrawn on request without prior notice. The timing of cash flows from these deposits is estimated based on historical experience. Certificates of deposit have penalties that discourage early withdrawals.
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We do not believe there has been a material change in the nature or categories of our primary market risk exposure, or the particular markets that present the primary risk of loss. We do not know of or expect there to be any material change in the general nature of our primary market risk exposure in the near term, and we do not expect to make material changes to our market risk methods in the near term. We may change those methods in the future to adapt to changes in circumstances or to implement new techniques.
Gap analysis is also utilized as a method to measure interest rate sensitivity. Interest rate sensitivity is determined by the amount of earning assets and interest bearing liabilities repricing within a specific time period, and their relative sensitivity to a change in interest rates. We strive to achieve reasonable stability in the net interest margin through periods of changing interest rates. One specific focus of interest rate sensitivity is the loan portfolio, primarily with commercial and agricultural loans.
The following table shows the maturity of loans outstanding at December 31, 2023 based on contractual terms. Also provided are the amounts classified according to the sensitivity to changes in interest rates.
1 Year
or Less 1 to 5
Years 5 to 15
Years Over 15
Years Total
Commercial and industrial $ 33,643 $ 94,909 $ 40,710 $ 40,476 $ 209,738
Commercial real estate 28,478 70,347 148,297 317,122 564,244
Advances to mortgage brokers 18,541 — — — 18,541
Agricultural 9,195 24,821 29,919 36,059 99,994
Residential real estate 4,165 17,302 130,237 204,714 356,418
Consumer 2,547 40,303 57,079 599 100,528
Total $ 96,569 $ 247,682 $ 406,242 $ 598,970 $ 1,349,463
Fixed interest rates
Commercial and industrial $ 5,300 $ 67,963 $ 15,781 $ 78 $ 89,122
Commercial real estate 23,068 58,228 21,030 593 102,919
Advances to mortgage brokers 18,541 — — — 18,541
Agricultural 3,126 8,710 4,514 634 16,984
Residential real estate 2,417 8,529 93,303 23,870 128,119
Consumer 2,289 39,912 57,035 599 99,835
Total $ 54,741 $ 183,342 $ 191,663 $ 25,774 $ 455,520
Variable interest rates
Commercial and industrial $ 28,343 $ 26,946 $ 24,929 $ 40,398 $ 120,616
Commercial real estate 5,410 12,119 127,267 316,529 461,325
Advances to mortgage brokers — — — — —
Agricultural 6,069 16,111 25,405 35,425 83,010
Residential real estate 1,748 8,773 36,934 180,844 228,299
Consumer 258 391 44 — 693
Total $ 41,828 $ 64,340 $ 214,579 $ 573,196 $ 893,943
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The information presented in the section captioned “Market Risk” in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference.
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