SB FINANCIAL GROUP, INC. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. SB Financial Group, Inc. (“SB Financial”), is a financial holding company registered with the Federal Reserve Board and subject to regulation under the Bank Holding Company Act of 1956, as amended. Through its direct and indirect subsidiaries, including The State Bank and Trust Company (“State Bank”), SB Financial is engaged in commercial and retail banking, wealth management and private client financial services. The following discussion provides a review of the consolidated financial condition and results of operations of SB Financial and its subsidiaries (collectively, the “Company”). This discussion should be read in conjunction with the Company’s Consolidated Financial Statements and related Notes as of and for the years ended December 31, 2023 and 2022 included in this Annual Report on Form 10-K. Strategic Discussion The focus and strategic goal of the Company is to grow into and remain a top decile (>90 th percentile) independent financial services company. The Company intends to achieve and maintain that goal by executing our five key initiatives. Increase profitability through ongoing diversification of revenue streams: For the twelve months ended December 31, 2023, the Company generated $17.7 million in noninterest income, or 31.1 percent of total operating revenue, from fee-based products. These revenue sources include fees generated from saleable residential mortgage loans, retail deposit products, wealth management services, saleable business-based loans (small business and farm service) and title agency revenue. For the twelve months ended December 31, 2022, the Company generated $18.2 million in noninterest income, or 31.6 percent of total operating revenue from fee-based products. 32 Strengthen our penetration in all markets served: Over our 119-year history of continuous operation in Northwest Ohio, we have established a significant presence in our traditional markets in Defiance, Fulton, Paulding and Williams counties in Ohio. In our newer markets of Bowling Green, Columbus, Findlay, Toledo (Ohio) and Ft. Wayne (Indiana), our current market penetration is minimal but we believe our potential for growth is significant. Over the past few years, we have expanded and committed additional resources to our presence in the Findlay and Edgerton markets in particular; however, we continue to seek to expand the presence and penetration in all of our markets. Expand product utilization by new and existing customers: As of December 31, 2023, we operated in 14 counties in Northwest Ohio, Central Ohio and Northeast Indiana with 23 full service offices, 23 ATM’s and six loan production offices. Combined in the 14 counties of operation, we command 4.4 percent of the deposit market share, which has steadily grown. Deliver gains in operational excellence: Our management team believes that becoming and remaining a high-performance financial services company will depend upon seamlessly and consistently delivering operational excellence, as demonstrated by the Company’s leadership in the origination and servicing of residential mortgage loans. As of December 31, 2023, the Company serviced 8,549 residential mortgage loans with an aggregate principal balance of $1.37 billion. As of December 31, 2022, the Company serviced 8,514 loans with an aggregate principal balance of $1.35 billion. Sustain asset quality: As of December 31, 2023, the Company’s asset quality metrics remained strong. Specifically, total nonperforming assets were $3.3 million, or 0.25 percent of total assets. Total delinquent loans at December 31, 2023 were 0.15 percent of total loans. As of December 31, 2022, the Company had total nonperforming assets of $5.1 million, or 0.38 percent of total assets. Total delinquent loans at December 31, 2022 were 0.27 percent of total loans. The successful execution of these five strategies have enabled the Company to improve financial performance across a broad series of metrics. These metrics over the last five years are outlined in the following table. Specifically, the Company has increased total assets by $303.8 million, or 29.3 percent. The growth has been on both sides of the balance sheet over the five year period, with loans growing $174.7 million or 21.2 percent and deposits growing $230.0 million or 27.4 percent. During the prior five-year period, the Company has raised capital through the issuance of debt securities to the market, which has improved capital significantly and expanded liquidity for potential strategic expansion. Strategic expansion has also occurred during the period with the acquisition of a small community bank (The Edon State Bank of Edon, Ohio) in 2020, the opening of three branch offices and the acquisition of two full service title agencies. 33 Financial Highlights Year Ended December 31, ($ in thousands, except per share data) 2023 2022 2021 2020 2019 Earnings Interest income $ 58,152 $ 44,569 $ 41,904 $ 42,635 $ 44,400 Interest expense 18,879 5,170 4,020 6,705 9,574 Net interest income 39,273 39,399 37,884 35,930 34,826 Provision for loan losses 315 - 1,050 4,500 800 Noninterest income 17,721 18,231 30,697 30,096 18,016 Noninterest expense 41,962 42,314 44,808 43,087 37,410 Provision for income taxes 2,622 2,795 4,446 3,495 2,659 Net income 12,095 12,521 18,277 14,944 11,973 Preferred stock dividends - - - - 950 Net income available to common shareholders 12,095 12,521 18,277 14,944 11,023 Per Common Share Data Basic earnings $ 1.77 $ 1.79 $ 2.58 $ 1.96 $ 1.71 Diluted earnings 1.75 1.77 2.56 1.96 1.51 Cash dividends declared 0.52 0.48 0.44 0.40 0.36 Total equity per share 18.50 17.08 21.05 19.39 17.53 Average Balances Average total assets $ 1,334,644 $ 1,318,781 $ 1,322,253 $ 1,161,396 $ 1,027,932 Average equity 118,315 126,963 144,223 139,197 133,190 Ratios Return on average total assets 0.91 % 0.95 % 1.38 % 1.29 % 1.16 % Return on average equity 10.22 9.86 12.67 10.74 8.99 Cash dividend payout ratio 1 29.62 27.25 17.18 20.54 23.84 Average equity to average assets 8.86 9.63 10.91 11.99 12.96 Period End Totals Total assets $ 1,342,387 $ 1,335,633 $ 1,330,854 $ 1,257,839 $ 1,038,577 Available-for-sale securities 219,708 238,780 263,259 149,406 100,948 Loans held for sale 2,525 2,073 7,472 7,234 7,258 Total loans & leases 1,000,212 962,075 822,714 872,723 825,510 Allowance for credit losses 15,786 13,818 13,805 12,574 8,755 Total deposits 1,070,205 1,086,665 1,113,045 1,049,011 840,219 Advances from FHLB 83,600 60,000 5,500 8,000 16,000 Trust preferred securities 10,310 10,310 10,310 10,310 10,310 Subordinated debt, net 19,642 19,594 19,546 - - Total equity 124,342 118,428 144,929 142,923 136,094 1 Cash dividends on common shares divided by net income available to common. 34 Critical Accounting Policies and Estimates The accounting and reporting policies of the Company are in accordance with generally accepted accounting principles in the United States and conform to general practices within the banking industry. The Company’s significant accounting policies are described in detail in the Notes to the Company’s Consolidated Financial Statements for the years ended December 31, 2023 and 2022. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The Company’s financial position and results of operations can be affected by these estimates and assumptions and are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company’s financial condition and results, and they require management to make estimates that are difficult, subjective or complex. Allowance for Credit Losses: The Company believes the determination of the ACL involves a higher degree of judgment and complexity than its other significant accounting policies. The ACL is calculated with the objective of maintaining a reserve level believed by management to be sufficient to absorb estimated credit losses over the life of an asset or an off-balance sheet credit exposure. Management’s determination of the adequacy of the ACL is based on periodic evaluations of past events, including historical credit loss experience on financial assets with similar risk characteristics, current conditions, and reasonable and supportable forecasts that affect the collectability of the remaining cash flows over the contractual term of the financial assets. However, this evaluation has subjective components requiring material estimates, including expected default probabilities, the expected loss given default, the amounts and timing of expected future cash flows on individually evaluated loans, and estimated losses based on historical loss experience and forecasted economic conditions. All of these factors may be susceptible to significant change. To the extent that actual results differ from management estimates, additional provisions for credit losses may be required that would adversely impact earnings in future periods. Goodwill and Other Intangibles: The Company records all assets and liabilities acquired in purchase acquisitions, including goodwill and other intangibles, at fair value as required. Goodwill is subject, at a minimum, to annual tests for impairment. Other intangible assets are amortized over their estimated useful lives using straight-line and accelerated methods, and are subject to impairment if events or circumstances indicate a possible inability to realize the carrying amount. The initial goodwill and other intangibles recorded and subsequent impairment analysis requires management to make subjective judgments concerning estimates of how the acquired asset will perform in the future. Events and factors that may significantly affect the estimates include, among others, customer attrition, changes in revenue growth trends, specific industry conditions and changes in competition. Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. Realization of deferred tax assets is dependent upon the generation of a sufficient level of future taxable income and recoverable taxes paid in prior years. Although realization is not assured, management believes it is more likely than not that all of the deferred tax assets will be realized. The Company recognizes interest and/or penalties related to income tax matters in income tax expense. An effective tax rate of 21% is used to determine after-tax components of other comprehensive income (loss) included in the statements of shareholders’ equity. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. 35 Changes in Financial Condition Total assets at December 31, 2023, were $1.343 billion, compared to $1.335 billion at December 31, 2022. Loans (excluding loans held for sale) were $1.000 billion at December 31, 2023, compared to $962.1 million at December 31, 2022. Total deposits were $1.070 billion at December 31, 2023, compared to $1.087 billion at December 31, 2022. As client balance sheets and liquidity was utilized in the economy, deposit levels moderated and assets were reallocated from cash and securities into loans. The following are the condensed average balance sheets of the Company for the years ending December 31 and includes the interest earned or paid, and the average interest rate, on each asset and liability: 2023 2022 2021 ($ in thousands) Average Average Average Average Average Average Balance Interest Rate Balance Interest Rate Balance Interest Rate Assets Taxable securities/cash $ 254,133 $ 6,092 2.40 % $ 330,549 $ 5,798 1.75 % $ 380,770 $ 3,386 0.89 % Non-taxable securities 7,181 170 2.37 % 8,106 198 2.44 % 7,802 353 4.52 % Loans, net 1 985,217 51,890 5.27 % 888,116 38,573 4.34 % 854,521 38,165 4.47 % Total earning assets 1,246,531 58,152 4.67 % 1,226,771 44,569 3.63 % 1,243,093 41,904 3.37 % Cash and due from banks 4,035 7,296 7,290 Allowance for credit losses (15,478 ) (13,808 ) (13,422 ) Premises and equipment 22,990 24,137 24,710 Other assets 76,566 74,385 60,582 Total assets $ 1,334,644 $ 1,318,781 $ 1,322,253 Liabilities Savings and interest-bearing demand deposits $ 619,906 $ 7,599 1.23 % $ 693,271 $ 2,258 0.33 % $ 672,296 $ 1,813 0.27 % Time deposits 236,665 7,109 3.00 % 159,401 1,219 0.76 % 177,918 1,316 0.74 % Repurchase agreements & other 15,765 74 0.47 % 20,481 39 0.19 % 22,821 42 0.18 % Advances from FHLB 55,044 2,603 4.73 % 16,420 515 3.14 % 6,507 188 2.89 % Trust preferred securities 10,310 716 6.94 % 10,310 361 3.50 % 10,310 199 1.93 % Subordianted debt 19,616 778 3.97 % 19,570 778 3.98 % 12,057 462 3.83 % Total interest-bearing liabilities 957,306 18,879 1.97 % 919,453 5,170 0.56 % 901,909 4,020 0.45 % Demand deposits 237,976 252,899 255,908 Other liabilities 21,047 19,466 20,213 Total liabilities 1,216,329 1,191,818 1,178,030 Shareholders’ equity 118,315 126,963 144,223 Total liabilities and shareholders’ equity $ 1,334,644 $ 1,318,781 $ 1,322,253 Net interest income (tax equivalent basis) $ 39,273 $ 39,399 $ 37,884 Net interest income as a percent of average interest-earning assets - GAAP measure 3.15 % 3.21 % 3.05 % Net interest income as a percent of average interest-earning assets - Non-GAAP measure 2 3.16 % 3.22 % 3.06 % -- Computed on a fully tax equivalent basis (FTE) 1 Nonaccruing loans and loans held for sale are included in the average balances. 2 Interest on tax exempt securities and loans is computed on a tax equivalent basis using a 21 percent statutory tax rate, and added to the net interest income. The tax equivalent adjustment was $0.14, $0.11 and $0.15 million in 2023, 2022 and 2021, respectively. 36 The following tables set forth the effect of volume and rate changes on interest income and expense for the periods indicated. For purposes of these tables, changes in interest due to volume and rate were determined as follows: ● Volume variance - change in volume multiplied by the previous year’s rate. ● Rate variance - change in rate multiplied by the previous year’s volume. ● Rate/volume variance - change in volume multiplied by the change in rate. This variance allocates the volume variance and rate variance in proportion to the relationship of the absolute dollar amount of the change in each. Total Variance Variance Attributable To ($ in thousands) 2023/2022 Volume Rate Interest income Taxable securities $ 294 $ (1,340 ) $ 1,634 Non-taxable securities 1 (28 ) (23 ) (5 ) Loans, net of unearned income and deferred fees 1 13,317 4,217 9,100 Total interest income 13,583 2,853 10,730 Interest expense Savings and interest-bearing demand deposits 5,341 (239 ) 5,580 Time deposits 5,890 591 5,299 Repurchase agreements & other 35 (9 ) 44 Advances from FHLB 2,088 1,211 877 Trust preferred securities 355 - 355 Subordinated debt - - - Total interest expense 13,709 1,554 12,155 Net interest income $ (126 ) $ 1,299 $ (1,425 ) 1 Interest on non-taxable securities and loans has been adjusted to fully tax equivalent The maturity distribution and weighted-average interest rates of debt securities available-for-sale at December 31, 2023, are set forth in the table below. The weighted-average interest rates are based on coupon rates for securities purchased at par value and on effective interest rates considering amortization or accretion if the securities were purchased at a premium or discount: Maturing ($ in thousands) Within 1 Year Weighted Average Yield 1-5 Years Weighted Average Yield 5-10 Years Weighted Average Yield After 10 Years Weighted Average Yield Total Weighted Average Yield Available-for-sale: U.S. Treasury and Government agencies $ 539 3.79 % $ 1,559 3.33 % $ 4,419 1.46 % $ 6,517 1.84 % Mortgage-backed securities - 18,028 1.48 % 10,411 2.01 % 160,428 1.90 % 188,867 1.87 % State and political subdivisions 261 2.92 % 280 2.61 % 1,987 3.89 % 7,370 2.57 % 9,898 2.83 % Other corporate securities - - 14,426 3.69 % - 14,426 3.69 % Total securities by maturity $ 800 3.51 % $ 19,867 1.64 % $ 31,243 2.83 % $ 167,798 1.93 % $ 219,708 2.03 % 37 ($ in thousands) Years Ended December 31, Total loans 2023 2022 % Change Commercial business & agriculture $ 191,932 $ 192,478 -0.3 % Commercial real estate 424,041 412,635 2.8 % Residential real estate 318,123 291,512 9.1 % Consumer & other 65,673 65,005 1.0 % Total loans 999,769 961,630 4.0 % Net deferred costs (fees) 443 445 -0.4 % Total loans, net deferred costs (fees) 1,000,212 962,075 4.0 % Loans held for sale $ 2,525 $ 2,073 21.8 % Total deposits 2023 2022 % Change Noninterest bearing demand $ 228,713 $ 256,799 -10.9 % Interest-bearing demand 166,413 191,719 -13.2 % Savings & money market 419,570 447,267 -6.2 % Time deposits 255,509 190,880 33.9 % Total deposits 1,070,205 1,086,665 -1.5 % Total shareholders’ equity $ 124,342 $ 118,428 5.0 % Loans held for investment (“HFI”) increased $38.1 million, or 4.0 percent, to $1.0 billion at December 31, 2023, which was due to an increase in residential and commercial real estate lending during 2023. The Company booked a much higher portion of residential real estate production on the balance sheet as increases in rates moved customers to variable rate mortgage products. Concentrations of Credit Risk : The Company makes commercial, real estate and installment loans to customers located mainly in the Tri-State region of Ohio, Indiana and Michigan. Commercial loans include loans collateralized by commercial real estate, business assets and, in the case of agricultural loans, crops and farm equipment and the loans are expected to be repaid from cash flow from operations of businesses. As of December 31, 2023, commercial business and agricultural loans made up approximately 19.2 percent of the HFI loan portfolio while commercial real estate loans accounted for approximately 42.4 percent of the HFI loan portfolio. As of December 31, 2023, residential first mortgage loans, which are secured by first mortgages on residential real estate, made up approximately 31.8 percent of the HFI portfolio, while consumer loans to individuals, which are primarily secured by consumer assets, made up approximately 6.6 percent of the HFI loan portfolio. Maturities and Sensitivities of Loans to Changes in Interest Rates: The following table shows the maturity distribution of loans outstanding as of December 31, 2023. The amounts have been categorized between loans with a fixed or floating interest rate (floating rate loans have an adjustable interest rate that changes in accordance to a rate index). 38 Maturities and Sensitivities of Loans to Changes in Interest Rates As of December 31, 2023 ($ in thousands) Within one year After one, but within five years After five, but within fifteen years After fifteen years Total Loans with fixed interest rates: Commercial & industrial $ 1,255 $ 30,703 $ 18,994 $ 18 $ 50,970 Commercial real estate - owner occupied 1,532 5,370 7,838 99 14,839 Commercial real estate - nonowner occupied 4,508 25,358 12,929 124 42,919 Agricultural 217 4,367 8,556 2,232 15,372 Residential real estate 1 979 16,430 29,500 46,910 HELOC - - - - - Consumer 3,615 9,271 1,393 - 14,279 Total $ 11,128 $ 76,048 $ 66,140 $ 31,973 $ 185,289 Loans with floating interest rates: Commercial & industrial $ 30,311 $ 11,101 $ 33,638 $ 696 $ 75,746 Commercial real estate - owner occupied 2,498 10,904 43,427 55,049 111,878 Commercial real estate - nonowner occupied 7,035 37,860 87,968 121,541 254,404 Agricultural 773 4,410 20,140 24,964 50,287 Residential real estate 3,757 417 12,206 254,833 271,213 HELOC 32 260 33,859 13,694 47,845 Consumer 717 2,833 - - 3,550 Total $ 45,123 $ 67,785 $ 231,238 $ 470,777 $ 814,923 Total loans: Commercial & industrial $ 31,566 $ 41,804 $ 52,632 $ 714 $ 126,716 Commercial real estate - owner occupied 4,030 16,274 51,265 55,148 126,717 Commercial real estate - nonowner occupied 11,543 63,218 100,897 121,665 297,323 Agricultural 990 8,777 28,696 27,196 65,659 Residential real estate 3,758 1,396 28,636 284,333 318,123 HELOC 32 260 33,859 13,694 47,845 Consumer 4,332 12,104 1,393 - 17,829 Total loans $ 56,251 $ 143,833 $ 297,378 $ 502,750 $ 1,000,212 Deposits decreased $16.5 million, or 1.5 percent, to $1.07 billion at December 31, 2023. Increased inflation and interest rates resulted in clients seeking higher returns on their deposit accounts. As a result, during 2023, we experienced a shift in the mix of our deposit balances as more of our clients moved balances to long-term time deposit accounts. Specifically, during 2023, time deposits increased $64.6 million, or 34 percent, while other deposits decreased $81.1 million, or 6 percent. The average amount of deposits and weighted-average rates paid are summarized as follows for the years ended December 31: 2023 2022 2021 Average Average Average Average Average Average ($ in thousands) Amount Rate Amount Rate Amount Rate Savings and interest bearing demand deposits $ 619,906 1.23 % $ 693,271 0.33 % $ 672,296 0.27 % Time deposits 236,665 3.00 % 159,401 0.76 % 177,918 0.74 % Non interest bearing demand deposits 237,976 - 252,899 - 255,908 - Totals $ 1,094,547 1.35 % $ 1,105,571 0.31 % $ 1,106,122 0.28 % 39 Time deposits that exceeded the FDIC insurance limit of $250,000 are summarized as follows: ($ in thousands) 2023 2022 Three months or less $ 6,637 $ 6,992 Over three months through six months 1,599 102 Over six months and through twelve months 5,209 1,330 Over twelve months 8,935 6,949 Total $ 22,380 $ 15,373 Shareholders’ equity at December 31, 2023, was $124.3 million, or 9.3 percent of total assets compared to $118.4 million or 8.9 percent of total assets at December 31, 2022. Retained earnings increased during the year due to earnings of $12.1 million less dividends paid to common shareholders of $3.6 million and repurchases of Company common shares of $3.5 million. The fair market value of the bond portfolio improved slightly during 2023 due to the valuation adjustment on the portfolio, which resulted in accumulated other comprehensive income (“AOCI”) falling to $29.8 million from $32.1 million. The Company continued to repurchase its own common shares during the year under the Company’s repurchase program authorized by the Board of Directors on December 21, 2022. Specifically, the Company repurchased 244,325 shares during 2023 at an average price of $13.98 per share. As of December 31, 2023, the Company had 255,675 shares remaining of the 500,000 shares authorized for repurchase under the Company’s existing share repurchase program, which expires December 31, 2024. Asset Quality Years Ended December 31, ($ in thousands) 2023 2022 % Change Nonaccruing loans $ 2,818 $ 3,682 -23.5 % Foreclosed assets and other assets held for sale, net 511 777 -34.2 % Nonperforming assets 3,329 4,459 -25.3 % Net charge-offs/(recoveries) 92 (13 ) -807.7 % Provision for credit losses 315 - N/M Allowance for credit losses 15,786 13,818 14.2 % Nonaccruing loans/total loans 0.28 % 0.38 % -26.4 % Allowance/nonaccruing loans 560.18 % 375.29 % 49.3 % Nonperforming assets/total assets 0.25 % 0.33 % -25.7 % Net charge offs/average loans 0.01 % 0.00 % -1100.0 % Allowance/loans 1.58 % 1.44 % 9.9 % Allowance/nonperforming loans 560.18 % 375.29 % 49.3 % Nonperforming assets totaled $3.3 million, or 0.25 percent of total assets at December 31, 2023, a decrease of $1.1 million, or 25.3 percent from 2022. The Company had total net charge-offs on loans of $92,000 in 2023, as compared to net recoveries of $13,000 in 2022. The Company’s ACL at December 31, 2023, now covers nonperforming loans at 560 percent, up from 319 percent at December 31, 2022. 40 The following schedule presents an analysis of the ACL, average loan data and related ratios at December 31 for the years indicated: ($ in thousands) Provision for Credit Losses Net (Chargeoffs) Recoveries Average Loans Ratio of annualized net (chargeoffs) recoveries to average loans December 31, 2023 Commercial & industrial $ 110 $ - $ 124,435 0.00 % Commercial real estate - owner occupied 202 - 118,583 0.00 % Commercial real estate - nonowner occupied 119 - 301,072 0.00 % Agricultural 23 - 59,720 0.00 % Residential real estate 190 (52 ) 313,034 -0.02 % HELOC 39 - 46,576 0.00 % Consumer 5 (40 ) 15,470 -0.26 % Total $ 688 $ (92 ) $ 978,890 -0.01 % December 31, 2022 Commercial & industrial $ (227 ) $ - $ 126,496 0.00 % Commercial real estate - owner occupied (868 ) - 122,031 0.00 % Commercial real estate - nonowner occupied 367 - 276,805 0.00 % Agricultural 12 - 58,745 0.00 % Residential real estate 923 - 239,162 0.00 % HELOC (45 ) 13 43,210 0.03 % Consumer (162 ) - 14,039 0.00 % Total $ - $ 13 $ 880,488 0.00 % December 31, 2021 Commercial & industrial $ (1,411 ) $ 227 $ 160,267 0.14 % Commercial real estate - owner occupied 505 - 118,713 0.00 % Commercial real estate - nonowner occupied 825 - 264,980 0.00 % Agricultural 103 - 53,122 0.00 % Residential real estate 975 6 195,277 0.00 % HELOC (16 ) - 43,488 0.00 % Consumer 69 (52 ) 11,546 -0.45 % Total $ 1,050 $ 181 $ 847,393 0.02 % The ACL balance and the provision for credit losses are determined by management based upon periodic reviews of the loan portfolio. In addition, management considers the level of charge offs on loans, as well as the fluctuations of charge offs and recoveries on loans, in the factors which caused these changes. Estimating the risk of loss and the amount of loss is necessarily subjective. Accordingly, the allowance is maintained by management at a level considered adequate to cover losses that are currently anticipated based on past loss experience, economic conditions, information about specific borrower situations, including their financial position and collateral values, and other factors and estimates which are subject to change over time. The Company has substantially increased its reserve level over the last several years. Specifically, the Company’s ACL balance has increased from $8.8 million at December 31, 2019 to $15.8 million at December 31, 2023, which reflects an increase of $7.0 million, or 80 percent. This increase was the result of $6.7 million in provision expense during the period and minimal charge-offs, which were just $0.8 million over the four-year period. The reserve increased during 2023 due to the one-time CECL adjustment of $1.4 million taken in January of 2023 upon the Company’s adoption of the CECL methodology. 41 The following schedule provides a breakdown of the ACL allocated by type of loan and related ratios at December 31 for the years indicated: Allowance Amount Percentage of Loans In Each Category to Total Loans Allowance Amount Percentage of Loans In Each Category to Total Loans Allowance Amount Percentage of Loans In Each Category to Total Loans ($ in thousands) 2023 2022 2021 Commercial & industrial $ 2,003 12.7 % $ 1,663 12.0 % $ 1,890 14.9 % Commercial real estate - owner occupied 1,952 12.4 % 1,696 12.3 % 2,564 14.5 % Commercial real estate - nonowner occupied 5,718 36.2 % 4,584 33.2 % 4,217 31.9 % Agricultural 440 2.8 % 611 4.4 % 599 7.0 % Residential real estate 4,936 31.3 % 4,438 32.1 % 3,515 25.1 % HELOC 510 3.2 % 547 4.0 % 579 5.1 % Consumer 227 1.4 % 279 2.0 % 441 1.6 % $ 15,786 100.0 % $ 13,818 100.0 % $ 13,805 100.0 % As further detailed in ITEM 1A. RISK FACTORS, the CARES Act provided for significant consumer and small business relief due to the impact of the COVID-19 pandemic. The Company provided payment relief to a number of consumer and small business customers throughout 2020 and 2021, which we believe was successful and enabled our clients to weather the pandemic effectively. All such COVID-related payment deferrals had expired or been removed by December 31, 2021 and all clients were back to contractual terms at such date. Regulatory capital reporting is required for State Bank only, as the Company is currently exempt from quarterly regulatory capital level measurement pursuant to the Small Bank Holding Company Policy Statement. As of December 31, 2023, State Bank met all regulatory capital levels required to be considered well-capitalized (see Note 16 to the Consolidated Financial Statements). On May 27, 2021, the Company issued and sold $20.0 million in aggregate principal amount of its 3.65% Fixed to Floating Rate Subordinated Notes due 2031 in a private placement exempt from the registration requirements under the Securities Act. The Subordinated Notes bear interest at a fixed rate of 3.65% through May 31, 2026. From June 1, 2026 to the maturity date or earlier redemption of the Subordinated Notes, the interest rate will reset quarterly to an interest rate per annum, equal to the then-current-three-month Secured Overnight Financing Rate (“SOFR”) provided by the Federal Reserve Bank of New York plus 296 basis points. The Subordinated Notes have a maturity of 10 years. Earnings Summary – 2023 vs. 2022 Net income for 2023 was $12.1 million, or $1.75 per diluted share, compared with net income of $12.5 million, or $1.77 per diluted share, for 2022. State Bank reported net income for 2023 of $13.3 million, which was down slightly from the $13.4 million of net income in 2022. SBFG Title reported net income for 2023 of $0.24 million, which was down from net income of $0.39 million for 2022. Positive results for 2023 included loan growth of $38.1 million, while deposits were slightly lower by $16.5 million. The Company completed the final forgiveness in January of 2023 from the nearly 1,200 PPP loans processed during 2020 and 2021. The mortgage banking business line was impacted by the rapidly rising rates, which contributed to the reduction in both balance growth and gains on sale. For the full year of 2023, residential real estate loan production was $215.5 million, with $3.6 million of revenue from gains on sale. The level of mortgage origination was down from the $313.0 million in 2022. The Company’s loans serviced for others ended the year at $1.367 billion, up slightly from $1.352 billion at December 31, 2022. Operating revenue decreased just slightly by $0.6 million, or 1.1 percent, from $57.6 million in 2022 to $57.0 million in 2023 due to decreased originated mortgage servicing rights (“OMSR”) recapture, significantly lower mortgage gain revenue offset by a $1.4 million gain on the sale of equity securities. SBFG Title revenue decreased by $0.6 million to $1.6 million for 2023. Operating expense decreased by $0.35 million, or 0.8 percent, from $42.3 million in 2022 to $42.0 million in 2023, due to lower incentive and commission levels, which were partially offset by higher medical costs and increased spending on technology. 42 Results of Operations Years Ended December 31, ($ in thousands, except per share data) 2023 2022 % Change Total assets $ 1,343,249 $ 1,335,633 0.6 % Total investments 219,708 238,780 -8.0 % Loans held for sale 2,525 2,073 21.8 % Loans, net of unearned income 1,000,212 962,075 4.0 % Allowance for credit losses 15,786 13,818 14.2 % Total deposits 1,070,205 1,086,665 -1.5 % Total operating revenue 1 $ 56,994 $ 57,630 -1.1 % Net interest income 39,273 39,399 -0.3 % Loan loss provision 315 - N/M Noninterest income 17,721 18,231 -2.8 % Noninterest expense 41,962 42,314 -0.8 % Net income 12,095 12,521 -3.4 % Diluted earnings per share 1.75 1.77 -1.1 % 1 Operating revenue equals net interest income plus noninterest income. Net interest income was $39.3 million for 2023 and decreased slightly from net income of $39.4 million for 2022. Average earning assets increased slightly to $1.25 billion in 2023, compared to $1.23 billion in 2022, primarily due to the increase in our loan portfolio, partially offset by lower cash and securities. The consolidated 2023 full year net interest margin on an fully-taxable equivalent (“FTE”) basis decreased 6 basis points to 3.16 percent compared to 3.22 percent for the full year of 2022. Provision for credit losses was taken in 2023 in the amount of $0.32 million compared to zero provision taken during 2022. For 2023, net charge-offs totaled $0.1 million or 0.01 percent of average loans, compared to net recoveries of $0.01 million or (0.00) percent of average loans, for 2022. Noninterest Income Years Ended December 31, ($ in thousands) 2023 2022 % Change Wealth management fees $ 3,532 $ 3,728 -5.3 % Customer service fees 3,403 3,378 0.7 % Gains on sale of residential loans & OMSR’s 3,609 4,298 -16.0 % Mortgage loan servicing fees, net 2,101 2,964 29.1 % Gain on sale of non-mortgage loans 429 566 -24.2 % Title insurance income 1,635 2,229 -26.6 % Other 3,012 1,068 182.0 % Total noninterest income $ 17,721 $ 18,231 -2.8 % 43 Total noninterest income was $17.7 million for 2023 compared to $18.2 million for 2022, representing a decrease of $0.5 million, or 2.8 percent, year-over-year. Gains on sale of residential mortgage loans was down from 2022 by $0.7 million, or 16.0 percent. The Company sold $161.2 million of originated mortgages into the secondary market in 2023, which due to being slightly more than the amortization on the serviced portfolio, increased the size of our serviced loan portfolio to $1.367 billion at December 31, 2023 from $1.352 billion at December 31, 2022. Sales of non-mortgage loans (small business and farm credits) in 2023 was the same as in 2022 at $4.2 million. The Company saw its wealth management assets under management decline by $5.3 million to $501.8 million at December 31, 2023, with total wealth management fees declining $0.2 million to $3.5 million. Noninterest Expense Years Ended December 31, ($ in thousands) 2023 2022 % Change Salaries & employee benefits $ 22,777 $ 24,142 -5.7 % Net occupancy expense 3,096 2,993 3.4 % Equipment expense 4,078 3,616 12.8 % Data processing fees 2,659 2,510 5.9 % Professional fees 3,024 3,214 -5.9 % Marketing expense 782 911 -14.2 % Telephone and communications 501 474 5.7 % Postage and delivery expense 432 422 2.4 % State, local and other taxes 949 1,082 -12.3 % Employee expense 631 613 2.9 % Other expense 3,033 2,337 29.8 % Total noninterest expense $ 41,962 $ 42,314 -0.8 % Total noninterest expense was $42.0 million for 2023 compared to $42.3 million for 2022, representing a $0.3 million, or 0.8 percent, decrease year-over-year. Total full-time equivalent employees ended 2023 at 251, which was down 17 from year end 2022. Earnings Summary – 2022 vs. 2021 Net income for 2022 was $12.5 million, or $1.77 per diluted share, compared with net income of $18.3 million, or $2.56 per diluted share, for 2021. State Bank reported net income for 2022 of $13.4 million, which was down from the $18.6 million in net income in 2021. SBFG Title reported net income for 2022 of $0.4 million, which was down from net income of $0.5 million in 2021. Positive results for 2022 included loan growth of $135.9 million when excluding the impact of the PPP initiative, while total deposits declined in 2022 by $23.5 million. The mortgage banking business line contributed gain on sale revenues of $4.3 million, with residential real estate loan production of $312.6 million and sales of loans of $184.8 million for the year. The level of mortgage origination declined in 2022 to $313.0 million from the $600.0 million in 2021. Operating revenue decreased by $11.0 million, or 16.0 percent, from $68.6 million in 2021 to $57.6 million in 2022 due to decreased PPP fees, OMSR recapture and lower mortgage gain revenue. SBFG Title increased revenue by $0.2 million to $2.3 million for 2022. Operating expense decreased by $2.5 million, or 5.6 percent, from $44.8 million in 2021 to $42.3 million in 2022, due to compensation and fringe benefit cost decreases partially offset by higher spend on technology/digital initiatives. Goodwill, Intangibles and Capital Purchases The Company completed its most recent annual goodwill impairment review as of December 31, 2023. Due to declines in the Company’s share price, a quantitative evaluation of goodwill was completed as of September 30, 2023, which revealed that impairment was not warranted. No events have occurred since that assessment, which would warrant impairment. At December 31, 2023, the Company concluded that it was more likely than not that the fair value of the reporting unit exceeded its carrying value, resulting in no impairment. The Company’s goodwill is further discussed in Note 6 to the Consolidated Financial Statements. Management plans to continue from time to time to purchase additional premises and equipment and improve current facilities to meet the current and future needs of the Company’s customers. These purchases will include buildings, leasehold improvements, furniture and equipment. Management expects that cash on hand and cash generated from current operations will fund these capital expenditures and purchases. 44 Liquidity Liquidity relates primarily to the Company’s ability to fund loan demand, meet deposit customers’ withdrawal requirements and provide for operating expenses. Sources used to satisfy these needs consist of cash and due from banks, interest-bearing deposits in other financial institutions, securities available-for-sale, loans held for sale and borrowings from various sources. These assets, excluding the borrowings, are commonly referred to as liquid assets. Liquid assets were $246.7 million at December 31, 2023, which included pledged available-for-sale securities of $102.3 million, compared to liquid assets of $270.8 million at December 31, 2022. The Company does not have material cash requirements for capital expenditures over the next year. Any cash needs for capital requirements would be funded by cash existing at the Company. It is not anticipated that the Company will be required to initiate external borrowings in order to fund ongoing operations. The Company’s commercial real estate, first mortgage residential, agricultural and multi-family mortgage portfolio of $807.8 million at December 31, 2023, can and is readily used to collateralize borrowings, which is an additional source of liquidity. Management believes the Company’s current liquidity level, without these borrowings, is sufficient to meet its current and anticipated liquidity needs. At December 31, 2023, all eligible commercial real estate, residential first, multi-family mortgage and agricultural loans were pledged under a FHLB blanket lien. Significant additional off balance-sheet liquidity is available in the form of FHLB advances, unused federal funds lines from correspondent banks and the national certificate of deposit market. Management expects the risk of changes in off-balance-sheet arrangements to be immaterial to earnings. Based on the current collateralization requirements of the FHLB, approximately $81.9 million of additional borrowing capacity existed at December 31, 2023. At December 31, 2023 and 2022, the Company had $41.0 million and $56.0 million in federal funds lines available. The Company also had $105.5 million in unpledged securities at December 31, 2023 available for additional borrowings. The cash flow statements for the periods presented provide an indication of the Company’s sources and uses of cash as well as an indication of the ability of the Company to maintain an adequate level of liquidity. A discussion of the cash flow statements for 2023 and 2022 follows: The Company experienced positive cash flows from operating activities in 2023 and 2022. Net cash from operating activities was $14.0 million and $25.6 million for the years ended December 31, 2023 and 2022, respectively. Significant operating items for 2023 included gain on sale of loans of $4.0 million and net income of $12.1 million. Cash provided by the sale of loans held for sale were $161.2 million. Cash used in the origination of loans held for sale were $159.3 million. The Company experienced negative cash flows from investing activities in 2023 and 2022. Net cash used in investing activities was $17.4 million and $165.7 million for the years ended December 31, 2023 and 2022, respectively. A net increase in loans of $38.7 million was the primary change in 2023. The changes for 2022 include the purchase of available-for-sale securities of $50.6 million and net increase in loans of $139.7 million. The Company had proceeds from repayments, maturities, sales and calls of securities of $22.2 million and $35.9 million in 2023 and 2022, respectively. The Company experienced negative cash flows from financing activities in 2023 and positive cash flows in 2022. Net cash used in financing activities was $1.5 million and net cash provided by financing activities was $18.4 million for the years ended December 31, 2023 and 2022, respectively. Negative cash flows of $16.5 million and $26.4 million are attributable to the change in deposits for 2023 and 2022, respectively. 45 The Company uses an Economic Value of Equity (“EVE”) analysis to measure risk in the balance sheet incorporating all cash flows over the estimated remaining life of all balance sheet positions. The EVE analysis calculates the net present value of the Company’s assets and liabilities in rate shock environments that range from -400 basis points to +400 basis points. The results of this analysis are reflected in the following table, which reflects the Company’s neutral balance sheet that directionally is trending to a liability sensitive position: Economic Value of Equity December 31, 2023 ($ in thousands) Change in rates $ Amount $ Change % Change +400 basis points $ 206,660 $ (9,716 ) -4.49 % +300 basis points 211,240 (5,136 ) -2.37 % +200 basis points 211,639 (4,737 ) -2.19 % +100 basis points 213,900 (2,476 ) -1.14 % Base Case 216,376 - - -100 basis points 213,526 (2,850 ) -1.32 % -200 basis points 206,761 (9,616 ) -4.44 % -300 basis points 195,925 (20,452 ) -9.45 % -400 basis points 196,802 (19,574 ) -9.05 % Economic Value of Equity December 31, 2022 ($ in thousands) Change in rates $ Amount $ Change % Change +400 basis points $ 264,361 $ (61,360 ) -18.84 % +300 basis points 284,602 (41,120 ) -12.62 % +200 basis points 303,265 (22,457 ) -6.89 % +100 basis points 319,473 (6,249 ) -1.92 % Base Case 325,722 - - -100 basis points 321,550 (4,172 ) -1.28 % -200 basis points 305,242 (20,480 ) -6.29 % -300 basis points 293,718 (32,004 ) -9.83 % -400 basis points 271,404 (54,318 ) -16.68 %