ISABELLA BANK CORP 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. (Dollars in thousands except per share amounts and ratios) The following is management's discussion and analysis of our financial condition and results of operations for the unaudited three and nine months ended September 30, 2024 and 2023. This analysis should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2023 and with the unaudited interim condensed consolidated financial statements and notes, beginning on page 4 of this report. General Isabella Bank Corporation is a registered financial services holding company that was incorporated in September 1988 under Michigan law. The Corporation's wholly owned subsidiary, Isabella Bank, has 31 offices located throughout Bay, Clare, Gratiot, Isabella, Mecosta, Midland, Montcalm, and Saginaw counties. The area includes significant agricultural production, manufacturing, retail, gaming and tourism, and several colleges and universities. Forward-Looking Statements Information in this Quarterly Report on Form 10-Q contains certain forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended and Rule 3b-6 promulgated thereunder. We intend such forward looking statements to be covered by the safe harbor provisions for forward looking statements contained in the Private Securities Litigation Reform Act of 1995, and are included in this statement for purposes of these safe harbor provisions. Forward-looking statements generally relate to losses, impact of events, financial condition, plans, objectives, outlook for earnings, revenues, expenses, capital and liquidity levels and ratios, asset levels, asset quality, financial position, and other matters regarding or affecting the Corporation and its future business and operations. Forward-looking statements are typically identified by words or phrases such as “will likely result", “expect”, “plan”, “believe”, “estimate”, “anticipate”, “strategy”, “trend”, “forecast”, “outlook”, “project”, “intend”, “assume”, “outcome”, “continue”, “remain”, “potential”, “opportunity”, “comfortable”, “current”, “position”, “maintain”, “sustain”, “seek”,“achieve” and variations of such words and similar expressions, or future or conditional verbs such as will, would, should, could or may. Although we believe the assumptions upon which these forward-looking statements are based are reasonable, any of these assumptions could prove to be inaccurate and the forward-looking statements based on these assumptions could be incorrect. The matters discussed in these forward-looking statements are subject to various risks, uncertainties and other factors that could cause actual results and trends to differ materially from those made, projected, or implied in or by the forward-looking statements depending on a variety of uncertainties or other factors described in Corporation’s Annual Report on Form 10-K for the year ended December 31, 2023, or included in any subsequent filing by the Corporation with the Securities and Exchange Commission. Forward-looking statements are based on beliefs and assumptions using information available at the time the statements are made. The Corporation cautions you not to unduly rely on forward-looking statements because the assumptions, beliefs, expectations and projections about future events may, and often do, differ materially from actual results. Any forward-looking statement speaks only as to the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect developments occurring after the statement is made. Non-GAAP Financial Measures Our accounting and reporting policies conform to GAAP and the prevailing practices in the financial services industry. However, we also evaluate our performance by reference to certain additional financial measures discussed in this Quarterly Report on Form 10-Q that we identify as being “non-GAAP financial measures.” In accordance with SEC rules, we classify a financial measure as being a non-GAAP financial measure if that financial measure excludes or includes amounts, or is subject to adjustments that have the effect of excluding or including amounts, as the case may be, in the most directly comparable measure calculated and presented in accordance with GAAP as in effect from time to time in the United States in our statements of income, balance sheets or statements of cash flows. Non-GAAP financial measures do not include operating and other statistical measures or ratios, or statistical measures calculated using exclusively either financial measures calculated in accordance with GAAP, operating measures or other measures that are not non-GAAP financial measures or both. The non-GAAP financial measures that we discuss in this Quarterly Report on Form 10-Q should not be considered in isolation or as a substitute for the most directly comparable or other financial measures calculated in accordance with GAAP. Moreover, the manner in which we calculate the non-GAAP financial measures that we discuss in this report may differ from that of other companies reporting measures with similar names. 41 Table of Contents Executive Summary Comparison of Operating Results for the three and nine months ended September 30, 2024, and 2023, unless otherwise noted Net income in the third quarter of 2024 was $3,281, or $0.44 per diluted share, compared with $4,413, or $0.58 per diluted share, in the same quarter 2023. The non-GAAP measure of adjusted net income in the third quarter 2024 totaled $4,559, or $0.61 per diluted share, compared to $4,354 or $0.58 per diluted share, in the same quarter of 2023. Adjusted net income in the current year quarter excludes a $1,622 charge-off related to overdrawn deposit accounts from a single customer. Net income for the year-to-date period of 2024 was $9,893, or $1.32 per diluted share, compared with $14,364, or $1.89 per diluted share, in the same period of 2023. Adjusted net income was $11,112, or $1.48 per diluted share, compared with $14,193, or $1.87 per diluted share, for the respective periods. The decrease in adjusted net income primarily reflects lower net interest income due to slower repricing of earning assets as compared to the rising costs of interest bearing liabilities. The decrease in net income for the comparative periods also included an increase in provision and compensation expenses. Net interest income was $14,488 in the third quarter of 2024 and $14,302 in the same quarter of 2023 representing 2.98% and 2.99% of earning assets, or NIM on an FTE basis, respectively. The current year quarter NIM included a 6 basis point benefit due to the recovery of the contractual interest of two previously charged-off commercial loans. The book yield from securities was 2.21% and 2.23% during the third quarters of 2024 and 2023, respectively. The weighted average maturity of our U.S. Treasury portfolio is less than two years, and the future proceeds are expected to be reinvested in market rate loans and securities, or to pay off borrowed funds. Our yield on loans expanded to 5.73% in the third quarter 2024, up from 5.17% in the same quarter of 2023, which includes an increase of 8 basis points due to the recovery of previously charged-off loans. Overall, our loan yields continued to expand due to higher rates on new loans and fixed rate commercial loans that have and continue repricing to variable rates. At the end of the third quarter 2024, approximately 41% of commercial loans are fixed at rates that are lower than current market rates. Most of those fixed rate loans will contractually reprice to variable rates over the next three to five years. Our cost of interest bearing liabilities increased to 2.43% from 1.77% in the third quarter 2023 due to several interest rate hikes throughout 2023 and the associated remix from noninterest bearing deposits into higher tier money market and certificate of deposit accounts. While we have experienced a downward trend in our NIM over the past several quarters, we are seeing a reversal of this trend as NIM has expanded 19 basis points over the last two quarters of 2024 as loans reprice and the cost of interest bearing liabilities stabilize. For the first nine months of 2024, net interest income was $41,280 compared with $44,332 in the same period of 2023. The comparison of NIM and yield on interest earning assets for the first nine months of 2024 were 2.87% and 4.62% compared to 3.13%, and 4.11% for the same period 2023. The yield on loans expanded to 5.55%, from 4.95%, and our cost of interest bearing liabilities increased to 2.37% from 1.39% for the nine months of 2024 and 2023, respectively. The explanations for the improvement in NIM are consistent with those provided in the year-over-year three-month comparison above. The provision for credit losses was $946 in the third quarter of 2024, compared to a credit of $292 for the same period in 2023. The provision for the current year quarter includes the impact from the recovery of the contractual principal of two previously charged-off commercial loans totaling $314. Given the loan recoveries, our historical loss rate experience improved which provided a benefit of $435 during the quarter. The benefits were offset by a $1,622 charge-off related to overdrawn deposit accounts from a single customer. The loans to the customer and related parties are well collateralized, and no additional credit provisioning was necessary in the third quarter. The credit in the prior year quarter mostly reflects loan recoveries in excess of charge-offs during the period. For the first nine months of 2024, provision for credit losses was $1,508 and a reversal of $55 in the same period of 2023. The reasons for the increase in provision for the nine month comparison are the same as the three month comparison. Net loan charge-offs have been at historic lows for the past five years due to our disciplined underwriting standards. Noninterest income for the three months ended September 30, 2024 and 2023 was $3,528 and $3,414, respectively. Wealth management fees grew $145, or 17%, due to an increase in new accounts and higher market valuations. Customer service fees increased $99 compared to the same quarter of 2023 based on a higher number of transaction accounts. For the nine months of 2024, noninterest income was $10,604, compared to $10,311 in the same period of 2023. The reasons for the increase in income for the nine month comparison are the same as the three month comparison. Noninterest expenses for the three-month period ended September 30, 2024 increased $570, or 4.5%, in comparison to the same period in 2023. Compensation and benefit expenses increased $612 reflecting annual merit increases in 2024, and higher incentive compensation as compared to the third quarter of 2023. For the first nine months of 2024, noninterest expenses were $38,799, compared to $37,395 in the same period of 2023. Annual merit increases and medical claims resulted in a $1,447 increase in compensation and benefit expenses for the first nine months of 2024. Our year-to-date efficiency ratio is 73.65% in 2024 compared to 67.56% in 2023, which primarily reflects lower NIM and a relatively stable base of noninterest expense. 42 Table of Contents Financial Condition (September 30, 2024 to December 31, 2023 comparison) Total assets increased $47,933 to $2,106,901 as of September 30, 2024 due to loan growth funded by growth in deposits during the third quarter. Excess cash generated during the first nine months of 2024 was used to pay off wholesale borrowings totaling $19,633. Our AFS securities portfolio totaled $506,806 at September 30, 2024, declining $21,342 due to municipal maturities and principal paydowns on mortgage-related securities. Net unrealized losses at September 30, 2024 totaled $20,968, or 3.97%, of the portfolio. The unrealized loss position on our AFS securities portfolio resulted from increases in short-term and intermediate-term benchmark interest rates. Our bond portfolio has a very short remaining life with $220,000 of the U.S. Treasury portfolio maturing by the end of 2026. The $169,339 Collateral Mortgage Obligation portfolio has a projected weighted-average life of 3.5 years and most bonds are bulleted in structure. Nearly half of the tax-exempt municipal portfolio will mature over the next five years. Loans outstanding as of September 30, 2024 totaled $1,424,283. Since December 31, 2023, gross loans have increased $74,820 as a result of growth in commercial loans and increased participation in advances to mortgage brokers. Additional loan growth came from the residential real estate portfolio due to the slowing of prepayments on steady new volume. At the end of September, $12.6 million of commercial real estate construction loans were closed and are expected to be funded early in the fourth quarter. The ACL was $12,635 at September 30, 2024, a decrease of $473 from $13,108 at December 31, 2023. Most of the decrease is due to improvement in historical loss experience, which was driven by the recovery of two previously charged-off loans during the quarter totaling $314. Nonaccrual loans were $547 as of September 30, 2024 compared to $926 at December 31, 2023. Past due and accruing accounts between 30 to 89 days as a percentage of total loans was 0.16% at September 30, 2024, compared to 0.29% at year-end 2023. Overall, credit quality remains strong, and there are no negative trends. Total deposits increased $58,137 since December 31, 2023, to $1,781,832 at the end of the third quarter 2024. Consumer demand for retail certificates of deposit accounts continues based on the rate environment, resulting in a $37,223 increase in the balance during the first nine months of 2024. Interest bearing demand deposits increased $55,855, while savings and demand deposits declined $27,929 and $7,012, respectively. Total equity was $212,985 at September 30, 2024 compared to $202,402 at year-end 2023. Our tangible book value per share was $22.14 as of September 30, 2024, compared to $20.59 on December 31, 2023. Net unrealized losses on AFS securities reduced tangible book value per share by $2.23 and $3.37 for the respective periods. Share repurchases totaled 124,969 during the first nine months of 2024 for a value of $2,419 at an average price of $19.36. We continue to have robust liquidity levels and capital. As of September 30, 2024, we had $797,818 of unencumbered sources of liquidity and strong capital ratios; the Tier 1 Leverage Ratio was 8.77%, Tier 1 risk-based capital was 12.08%, and Total risk-based capital was 14.90%. Reclassifications Certain amounts reported in the interim 2023 consolidated financial statements have been reclassified to conform to the 2024 presentation. Subsequent Events We evaluated subsequent events after September 30, 2024 through the date our interim condensed consolidated financial statements were issued for potential recognition and disclosure. No subsequent events require financial statement recognition or disclosure between September 30, 2024 and the date our interim condensed consolidated financial statements were issued. 43 Table of Contents Selected Financial Data (Unaudited) The following table outlines our results of operations and provides certain performance measures as of, and for the: Three Months Ended Nine Months Ended September 30 2024 June 30 2024 March 31 2024 December 31 2023 September 30 2023 September 30 2024 September 30 2023 PER SHARE Basic earnings $ 0.44 $ 0.47 $ 0.42 $ 0.51 $ 0.59 $ 1.32 $ 1.91 Diluted earnings 0.44 0.46 0.42 0.51 0.58 1.32 1.89 Adjusted diluted earnings (2) 0.61 0.46 0.41 0.50 0.58 1.48 1.87 Dividends 0.28 0.28 0.28 0.28 0.28 0.84 0.84 Book value (1) 28.63 27.06 26.80 27.04 24.71 28.63 24.71 Tangible book value (1) 22.14 20.60 20.35 20.59 18.27 22.14 18.27 Market price (1) 21.21 18.20 19.40 21.50 21.05 21.21 21.05 PERFORMANCE RATIOS Return on average total assets 0.62 % 0.68 % 0.61 % 0.73 % 0.86 % 0.64 % 0.94 % Adjusted return on average total assets (2) 0.87 % 0.68 % 0.60 % 0.73 % 0.85 % 0.71 % 0.93 % Return on average shareholders' equity 6.26 % 6.97 % 6.19 % 7.98 % 9.17 % 6.47 % 10.04 % Adjusted return on average shareholders' equity (2) 8.70 % 6.96 % 6.08 % 7.97 % 9.05 % 7.27 % 9.92 % Return on average tangible shareholders' equity 8.15 % 9.19 % 8.12 % 10.73 % 12.27 % 8.48 % 13.42 % Adjusted return on average tangible shareholders' equity (2) 11.32 % 9.17 % 7.97 % 10.71 % 12.11 % 9.52 % 13.26 % Net interest margin yield (FTE) (2) 2.98 % 2.85 % 2.79 % 2.83 % 2.99 % 2.87 % 3.13 % Efficiency ratio (2) 72.30 % 73.93 % 74.84 % 68.41 % 70.56 % 73.65 % 67.56 % Gross loan to deposit ratio (1) 79.93 % 80.22 % 77.22 % 78.29 % 75.43 % 79.93 % 75.43 % Shareholders' equity to total assets (1) 10.11 % 9.82 % 9.75 % 9.83 % 8.74 % 10.11 % 8.74 % Tangible shareholders' equity to tangible assets (1) 8.00 % 7.65 % 7.58 % 7.66 % 6.61 % 8.00 % 6.61 % FINANCIAL DATA (in millions) Total assets (1) 2,107 2,060 2,058 2,059 2,118 2,107 2,118 AFS securities (1) 507 506 518 528 517 507 517 Gross loans (1) 1,424 1,382 1,366 1,349 1,335 1,424 1,335 ACL (1) 13 13 13 13 13 13 13 Deposits (1) 1,782 1,722 1,768 1,724 1,769 1,782 1,769 Borrowed funds (1) 97 119 72 116 147 97 147 Shareholders' equity (1) 213 202 201 202 185 213 185 Wealth assets under management (1) 680 648 661 641 591 680 591 Net income 3 3 3 4 4 10 14 Interest income 23 22 21 21 20 67 59 Interest expense 9 9 8 7 6 26 14 Net interest income 14 14 13 14 14 41 44 Provision for credit losses 1 — — 1 — 2 — Noninterest income 4 4 3 4 3 11 10 Noninterest expenses 13 13 13 12 13 39 37 (1) At end of period (2) Non-GAAP financial measure; refer to the "Recconcilation of Non-GAAP Financial Measures" section 44 Table of Contents 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. 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 restricted equity holdings are included in other interest earning assets. Three Months Ended September 30, 2024 June 30, 2024 September 30, 2023 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) $ 1,403,810 $ 20,230 5.73 % $ 1,375,523 $ 18,863 5.52 % $ 1,325,455 $ 17,270 5.17 % AFS securities (2) 536,379 2,981 2.21 % 545,827 3,041 2.24 % 572,038 3,213 2.23 % FHLB stock 12,762 168 5.24 % 12,762 158 4.98 % 12,762 91 2.83 % Fed funds sold 4 — 5.55 % 7 — 5.51 % 13 — 5.47 % Other (3) 14,597 194 5.29 % 14,054 263 7.53 % 17,638 161 3.62 % Total interest earning assets 1,967,552 23,573 4.77 % 1,948,173 22,325 4.61 % 1,927,906 20,735 4.27 % NONEARNING ASSETS Allowance for credit losses (13,125) (13,431) (12,937) Cash and demand deposits due from banks 25,903 23,931 25,287 Premises and equipment 27,868 27,999 26,629 Other assets 87,002 80,539 74,244 Total assets $ 2,095,200 $ 2,067,211 $ 2,041,129 INTEREST BEARING LIABILITIES Interest bearing demand deposits $ 358,383 $ 295 0.33 % $ 342,931 $ 334 0.39 % $ 342,175 $ 242 0.28 % Savings 599,679 3,437 2.28 % 613,601 3,321 2.18 % 595,372 2,156 1.44 % Certificates of deposit 375,936 3,899 4.13 % 366,440 3,658 4.01 % 324,399 2,617 3.20 % Short-term borrowings 48,151 384 3.17 % 40,593 321 3.18 % 46,574 284 2.42 % FHLB advances 40,588 571 5.60 % 45,510 638 5.64 % 44,429 617 5.51 % Subordinated debt, net of unamortized issuance costs 29,388 267 3.61 % 29,365 266 3.64 % 29,298 267 3.62 % Total interest bearing liabilities 1,452,125 8,853 2.43 % 1,438,440 8,538 2.39 % 1,382,247 6,183 1.77 % NONINTEREST BEARING LIABILITIES AND SHAREHOLDERS' EQUITY Demand deposits 418,973 411,282 451,123 Other liabilities 15,658 16,755 16,802 Shareholders’ equity 208,444 200,734 190,957 Total liabilities and shareholders’ equity $ 2,095,200 $ 2,067,211 $ 2,041,129 Net interest income (FTE) $ 14,720 $ 13,787 $ 14,552 Net yield on interest earning assets (FTE) (4) 2.98 % 2.85 % 2.99 % (1) Includes loans HFS and nonaccrual loans (2) Average balances for AFS securities are based on amortized cost (3) Includes average interest-bearing deposits with other banks, net of Federal Reserve daily cash letter (4) Non-GAAP financial measure; refer to the "Non-GAAP Financial Measures" section 45 Table of Contents Nine Months Ended September 30, 2024 September 30, 2023 Average Balance Tax Equivalent Interest Average Yield/Rate Average Balance Tax Equivalent Interest Average Yield/Rate INTEREST EARNING ASSETS Loans (1) $ 1,376,122 $ 57,150 5.55 % $ 1,298,316 $ 48,090 4.95 % AFS securities (2) 546,376 9,153 2.24 % 588,796 10,007 2.27 % FHLB stock 12,762 472 4.94 % 12,762 226 2.37 % Fed funds sold 6 — 5.59 % 11 — 5.08 % Other (3) 17,941 750 5.58 % 30,005 1,029 4.59 % Total interest earning assets 1,953,207 67,525 4.62 % 1,929,890 59,352 4.11 % NONEARNING ASSETS Allowance for credit losses (13,216) (12,786) Cash and demand deposits due from banks 24,623 25,043 Premises and equipment 27,962 26,300 Other assets 83,878 75,239 Total assets $ 2,076,454 $ 2,043,686 INTEREST BEARING LIABILITIES Interest bearing demand deposits $ 349,086 $ 1,042 0.40 % $ 356,608 $ 582 0.22 % Savings 615,668 10,091 2.19 % 623,157 5,471 1.17 % Certificates of deposit 366,672 10,974 4.00 % 298,535 5,900 2.64 % Short-term borrowings 43,197 1,026 3.17 % 40,707 604 1.98 % FHLB advances 37,883 1,597 5.63 % 21,685 887 5.47 % Subordinated debt, net of unamortized issuance costs 29,365 799 3.63 % 29,275 799 3.65 % Total interest bearing liabilities 1,441,871 25,529 2.37 % 1,369,967 14,243 1.39 % NONINTEREST BEARING LIABILITIES AND SHAREHOLDERS' EQUITY Demand deposits 414,179 466,725 Other liabilities 16,183 15,619 Shareholders’ equity 204,221 191,375 Total liabilities and shareholders’ equity $ 2,076,454 $ 2,043,686 Net interest income (FTE) $ 41,996 $ 45,109 Net yield on interest earning assets (FTE) (4) 2.87 % 3.13 % (1) Includes loans HFS and nonaccrual loans (2) Average balances for AFS securities are based on amortized cost (3) Includes average interest-bearing deposits with other banks, net of Federal Reserve daily cash letter (4) Non-GAAP financial measure; refer to the "Non-GAAP Financial Measures" section 46 Table of Contents Loans The following table displays loan balances as of: September 30 2024 June 30 2024 March 31 2024 December 31 2023 September 30 2023 Annualized Growth % Quarter to Date Annualized Growth % Year to Date Commercial and industrial $ 240,589 $ 238,245 $ 226,281 $ 209,738 $ 195,814 3.94 % 19.61 % Commercial real estate 547,038 547,005 561,123 564,244 566,639 0.02 % (4.07) % Advances to mortgage brokers 76,187 39,300 29,688 18,541 24,807 N/M N/M Agricultural 96,794 94,996 93,695 99,994 99,233 7.57 % (4.27) % Total commercial loans 960,608 919,546 910,787 892,517 886,493 17.86 % 10.17 % Residential real estate 369,846 365,188 356,658 356,418 348,196 5.10 % 5.02 % Consumer 93,829 96,902 98,063 100,528 99,985 (12.68) % (8.89) % Total $ 1,424,283 $ 1,381,636 $ 1,365,508 $ 1,349,463 $ 1,334,674 12.35 % 7.39 % The following table presents the composition of our commercial real estate portfolio by industry as of: September 30, 2024 December 31, 2023 Balance Percent of Total Balance Percent of Total Real estate Non-owner occupied $ 129,595 23.69 % $ 129,016 22.87 % 1-4 family investor 92,154 16.85 % 89,208 15.81 % Multifamily 69,624 12.73 % 78,108 13.84 % Owner occupied 25,395 4.64 % 27,758 4.92 % Hotels 79,397 14.51 % 82,650 14.65 % Health care 35,812 6.55 % 40,249 7.13 % Retail trade 34,087 6.23 % 34,622 6.14 % Manufacturing 11,687 2.14 % 12,341 2.19 % Accommodation services 11,547 2.11 % 11,277 2.00 % Educational services 11,188 2.05 % 11,589 2.05 % Wholesale trade 11,007 2.01 % 10,308 1.83 % Construction 4,056 0.74 % 5,079 0.90 % Other 31,489 5.75 % 32,039 5.67 % Total commercial real estate $ 547,038 100.00 % $ 564,244 100.00 % Commercial real estate loans are subject to a varying degree of risk from changes in interest rates and economic conditions. To control these risks, we maintain 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. Our practices also include appropriate loan reviews, and monitoring of past due levels, concentrations, industry trends, and other qualitative factors. 47 Table of Contents Deposits The following table displays deposit balances as of: September 30 2024 June 30 2024 March 31 2024 December 31 2023 September 30 2023 Annualized Growth % Quarter to Date Annualized Growth % Year to Date Noninterest bearing demand deposits $ 421,493 $ 412,193 $ 413,272 $ 428,505 $ 445,043 9.02 % (2.18) % Interest bearing demand deposits 376,592 338,329 349,401 320,737 363,558 45.24 % 23.22 % Savings 600,150 603,328 639,491 628,079 628,795 (2.11) % (5.93) % Certificates of deposit 383,597 368,449 366,143 346,374 332,078 16.45 % 14.33 % Total $ 1,781,832 $ 1,722,299 $ 1,768,307 $ 1,723,695 $ 1,769,474 13.83 % 4.50 % 48 Table of Contents Asset Quality Analysis The following table outlines our quarter-to-date asset quality analysis as of, and for the three-month periods ended: September 30 2024 June 30 2024 March 31 2024 December 31 2023 September 30 2023 NONPERFORMING ASSETS Commercial and industrial $ 120 $ 271 $ 567 $ 491 $ 17 Commercial real estate — — 234 — — Agricultural — 167 189 205 208 Residential real estate 427 556 293 286 295 Consumer — — — — — Total nonaccrual loans 547 994 1,283 982 520 Accruing loans past due 90 days or more 64 15 — 87 — Total nonperforming loans 611 1,009 1,283 1,069 520 Foreclosed assets 546 629 579 406 509 Debt securities 12 12 12 12 77 Total nonperforming assets $ 1,169 $ 1,650 $ 1,874 $ 1,487 $ 1,106 Nonperforming loans to gross loans 0.04 % 0.07 % 0.09 % 0.08 % 0.04 % Nonperforming assets to total assets 0.06 % 0.08 % 0.09 % 0.07 % 0.05 % ACL as a % of nonaccrual loans 2,309.87 % 1,317.40 % 1,043.65 % 1,334.83 % 2,455.19 % ALLOWANCE FOR CREDIT LOSSES Allowance at beginning of period $ 13,095 $ 13,390 $ 13,108 $ 12,767 $ 12,833 Charge-offs 1,767 527 191 452 179 Recoveries 408 134 145 71 433 Net loan charge-offs (recoveries) 1,359 393 46 381 (254) Provision for credit losses - loans 899 98 328 722 (320) Allowance at end of period $ 12,635 $ 13,095 $ 13,390 $ 13,108 $ 12,767 ACL to gross loans 0.89 % 0.95 % 0.98 % 0.97 % 0.96 % Reserve for unfunded commitments 498 450 379 315 352 Provision for credit losses - unfunded commitments 47 72 64 (38) 28 Reserve to unfunded commitments 0.15 % 0.14 % 0.11 % 0.10 % 0.11 % NET LOAN CHARGE-OFFS (RECOVERIES) Commercial and industrial $ (6) $ 334 $ (2) $ 242 $ (41) Commercial real estate (318) (29) (6) (3) (3) Agricultural — — (2) (6) — Residential real estate (20) (19) (63) (14) (266) Consumer 1,703 107 119 162 56 Total $ 1,359 $ 393 $ 46 $ 381 $ (254) Net (recoveries) charge-offs (Quarter to Date annualized to average loans) 0.39 % 0.11 % 0.01 % 0.11 % (0.08) % Net (recoveries) charge-offs (Year to Date annualized to average loans) 0.17 % 0.00 % 0.00 % 0.00 % (0.03) % DELINQUENT AND NONACCRUAL LOANS Accruing loans 30-89 days past due $ 2,226 $ 1,484 $ 7,938 $ 3,895 $ 715 Accruing loans past due 90 days or more 64 15 — 87 — Total accruing past due loans 2,290 1,499 7,938 3,982 715 Nonaccrual loans 547 994 1,283 982 520 Total past due and nonaccrual loans $ 2,837 $ 2,493 $ 9,221 $ 4,964 $ 1,235 49 Table of Contents 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 61,560 shares or $1,190 of common stock during the first nine months of 2024, as compared to 55,456 shares or $1,208 of common stock during the same period in 2023. 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 $332 and $477 during the nine-month periods ended September 30, 2024 and 2023, respectively. We also grant restricted stock awards pursuant to the RSP. Pursuant to this plan, we increased shareholders’ equity by $71 during the first nine months of 2024, as compared to $219 during the same period in 2023. We have publicly announced a common stock repurchase plan. Pursuant to this plan, we repurchased 124,969 shares or $2,419 of common stock during the first nine months of 2024 and 124,320 shares or $2,906 during the first nine months of 2023. As of September 30, 2024, we were authorized to repurchase up to an additional 145,837 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. The following table sets forth our ratios as of: September 30 2024 June 30 2024 March 31 2024 December 31 2023 September 30 2023 Common equity tier 1 capital 12.08 % 12.37 % 12.36 % 12.54 % 12.43 % Tier 1 capital 12.08 % 12.37 % 12.36 % 12.54 % 12.43 % Total capital 14.90 % 15.29 % 15.31 % 15.52 % 15.39 % Tier 1 leverage 8.77 % 8.83 % 8.80 % 8.76 % 8.77 % 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 $340,365, or 16.15% of assets, as of September 30, 2024, compared to $381,417, or 18.52%, as of December 31, 2023. The decrease 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 September 30, 2024, we had available lines of credit of $360,440. We monitor our daily liquidity position to meet our cash flow needs. We also forecast anticipated funding needs for changes in interest rates and economic conditions, the scheduled maturity and interest rate sensitivity of the investment and loan portfolios and deposits, and regulatory capital requirements. Our liquidity stress testing is designed with consideration of these and other factors that could pose undue risk to liquidity. 50 Table of Contents Our liquidity position remained strong at September 30, 2024, which is illustrated in the following table: September 30 2024 June 30 2024 March 31 2024 December 31 2023 September 30 2023 Total cash and cash equivalents $ 27,378 $ 23,559 $ 25,218 $ 33,672 $ 115,879 Brokered CD capacity 120,000 120,000 120,000 120,000 120,000 Available lines of credit Fed funds lines with correspondent banks 93,000 93,000 93,000 93,000 73,000 FHLB borrowings 233,552 194,403 248,624 211,860 182,125 FRB Discount Window 28,888 28,148 28,083 28,220 27,785 Other lines of credit 5,000 5,000 5,000 5,000 5,000 Total available lines of credit 360,440 320,551 374,707 338,080 287,910 Unencumbered lendable value of FRB collateral, estimated (1) 290,000 290,000 310,000 320,000 320,000 Total cash and liquidity $ 797,818 $ 754,110 $ 829,925 $ 811,752 $ 843,789 Uninsured deposits $ 687,990 $ 623,245 $ 658,564 $ 600,381 $ 615,633 Coverage ratio of uninsured deposits with total cash and liquidity 116 % 121 % 126 % 135 % 137 % (1) In cludes estimated unencumbered lendable value of FHLB collateral of $200,000 as of September 30, 2024. 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, collateral dependent 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 7 – Fair Value” of our interim condensed consolidated financial statements. 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 yield curves, 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. 51 Table of Contents The following table summarizes our interest rate sensitivity for 12 and 24 months as of September 30, 2024. The results displayed in the table reflect the modeling of immediate shifts in the yield curve and a flat balance sheet and may not reflect actual or expected changes. September 30, 2024 12 Months 24 Months Immediate basis point change assumption (short-term) -200 -100 100 200 -200 -100 100 200 Percent change in net interest income vs. constant rate (3.64) % (1.23) % 4.15 % 4.86 % (9.34) % (3.64) % 6.44 % 0.66 % 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 marketplace. Generally, a decrease in interest rates will result in an increase in cash flows from these assets. 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. 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. 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 represent our future cash requirements. We are party to credit related financial instruments with off-balance-sheet risk. These financial instruments are entered into in the normal course of business to meet the financing needs of our customers. These financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The contractual or notional amounts of these instruments reflect the extent of involvement we have in a particular class of financial instrument. Our exposure to credit-related loss in the event of nonperformance by the counterparties to the financial instruments for commitments to extend credit and standby letters of credit could be up to the contractual notional amount of those instruments. We use the same credit policies when analyzing the creditworthiness of counterparties as we do for extending loans to customers. No significant losses are anticipated as a result of these commitments. 52 Table of Contents Reconciliation of Non-GAAP Financial Measures The following tables provide a detailed analysis, and reconciliation for, our non-GAAP financial measures as of, and for the: Three Months Ended Nine Months Ended September 30 2024 June 30 2024 March 31 2024 December 31 2023 September 30 2023 September 30 2024 September 30 2023 Net income $ 3,281 $ 3,481 $ 3,131 $ 3,803 $ 4,413 $ 9,893 $ 14,364 Nonrecurring items: Net gains on sale of AFS securities — — — — — — 67 Net gains (losses) on foreclosed assets 4 6 69 8 75 79 150 Other (1) (1,622) — — — — (1,622) — Income tax impact 340 (1) (14) (2) (16) 324 (46) Total nonrecurring items (1,278) 5 55 6 59 (1,219) 171 Adjusted net income (A) $ 4,559 $ 3,476 $ 3,076 $ 3,797 $ 4,354 $ 11,112 $ 14,193 Noninterest expenses $ 13,228 $ 12,895 $ 12,676 $ 11,915 $ 12,658 $ 38,799 $ 37,395 Amortization of acquisition intangibles — 1 — 1 — 1 2 Adjusted noninterest expense (B) $ 13,228 $ 12,894 $ 12,676 $ 11,914 $ 12,658 $ 38,798 $ 37,393 Net interest income $ 14,488 $ 13,550 $ 13,242 $ 13,612 $ 14,302 $ 41,280 $ 44,332 Tax equivalent adjustment for net interest margin 232 237 246 246 250 716 777 Net interest income (FTE) (C) 14,720 13,787 13,488 13,858 14,552 41,996 45,109 Noninterest income 3,528 3,608 3,468 3,516 3,414 10,604 10,311 Tax equivalent adjustment for efficiency ratio 53 53 51 50 48 157 143 Adjusted revenue (FTE) 18,301 17,448 17,007 17,424 18,014 52,757 55,563 Nonrecurring items Net gains on sale of AFS securities — — — — — — 67 Net gains (losses) on foreclosed assets 4 6 69 8 75 79 150 Total nonrecurring items 4 6 69 8 75 79 217 Adjusted revenue (D) $ 18,297 $ 17,442 $ 16,938 $ 17,416 $ 17,939 $ 52,678 $ 55,346 Efficiency ratio (B/D) 72.30 % 73.93 % 74.84 % 68.41 % 70.56 % 73.65 % 67.56 % Average earning assets (E) 1,967,552 1,948,173 1,943,758 1,943,937 1,927,906 1,953,207 1,929,890 Net yield on interest earning assets (FTE) (C/E) 2.98 % 2.85 % 2.79 % 2.83 % 2.99 % 2.87 % 3.13 % (1) Provision for credit losses impact of a $1,622 charge-off related to overdrawn deposit accounts from a single customer. 53 Table of Contents Three Months Ended Nine Months Ended September 30 2024 June 30 2024 March 31 2024 December 31 2023 September 30 2023 September 30 2024 September 30 2023 Average assets (F) 2,095,200 2,067,211 2,066,757 2,053,437 2,041,129 2,076,454 2,043,686 Average shareholders' equity (G) 208,444 200,734 203,434 188,958 190,957 204,221 191,375 Average tangible shareholders' equity (H) 160,161 152,451 155,150 140,674 142,672 155,938 143,089 Average diluted shares outstanding (2) (I) 7,473,184 7,494,828 7,507,739 7,526,515 7,570,374 7,492,404 7,591,664 Adjusted diluted earnings per share (A/I) $ 0.61 $ 0.46 $ 0.41 $ 0.50 $ 0.58 $ 1.48 $ 1.87 Adjusted return on average assets (A/F) 0.87 % 0.68 % 0.60 % 0.73 % 0.85 % 0.71 % 0.93 % Adjusted return on average shareholders' equity (A/G) 8.70 % 6.96 % 6.08 % 7.97 % 9.05 % 7.27 % 9.92 % Adjusted return on average tangible shareholders' equity (A/H) 11.32 % 9.17 % 7.97 % 10.71 % 12.11 % 9.52 % 13.26 % (2) Whole shares Item 3. Quantitative and Qualitative Disclosures about Market Risk. The information presented in the section captioned “Market Risk” in Management's Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference.