CITIZENS COMMUNITY BANCORP, INC. FORWARD-LOOKING STATEMENTS
Certain matters discussed in this report contain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 and the Company intends that these forward-looking statements be covered by the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. These statements may be identified by the use of forward-looking words or phrases such as "anticipate," "believe," "could," "expect," "estimates," "intend," "may," "preliminary," "planned," "potential," "should," "will," "would," or the negative of those terms or other words of similar meaning. Similarly, statements that describe the Company's future plans, objectives or goals are also forward-looking statements. Such forward-looking statements are inherently subject to many uncertainties in the Company's operations and business environment. Factors that could affect actual results or outcomes include the matters described under the caption "Risk Factors" in Item 1A of our annual report on Form 10-K for the year endedDecember 31, 2021 , filed with theSEC onMarch 2, 2022 ("2021 10-K"), the matters described in "Risk Factors" in Item 1A for the quarters endedMarch 31, 2022 andJune 30, 2022 , and in Item 1A of this Form 10-Q, and the following: •conditions in the financial markets and economic conditions generally; •adverse impacts to the Company or Bank arising from the COVID-19 pandemic; •acts of terrorism and political or military actions bythe United States or other governments; •the possibility of a deterioration in the residential real estate markets; •interest rate risk; •lending risk; •higher lending risks associated with our commercial and agricultural banking activities; •the sufficiency of loan allowances; •changes in the fair value or ratings downgrades of our securities; •competitive pressures among depository and other financial institutions; •disintermediation risk; •our ability to maintain our reputation; •our ability to maintain or increase our market share; •our ability to realize the benefits of net deferred tax assets; •our inability to obtain needed liquidity; •our ability to raise capital needed to fund growth or meet regulatory requirements; •our ability to attract and retain key personnel; •our ability to keep pace with technological change; •prevalence of fraud and other financial crimes; •cybersecurity risks; •the possibility that our internal controls and procedures could fail or be circumvented; •our ability to successfully execute our acquisition growth strategy; •risks posed by acquisitions and other expansion opportunities, including difficulties and delays in integrating the acquired business operations or fully realizing the cost savings and other benefits; •restrictions on our ability to pay dividends; •the potential volatility of our stock price; •accounting standards for loan losses; •legislative or regulatory changes or actions, or significant litigation, adversely affecting the Company or Bank; •public company reporting obligations; •changes in federal or state tax laws; and •changes in accounting principles, policies or guidelines and their impact on financial performance. Stockholders, potential investors, and other readers are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements made herein are only made as of the date of this filing and the Company undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances occurring after the date of this report. 58 --------------------------------------------------------------------------------
GENERAL The following discussion sets forth management's discussion and analysis of our consolidated financial condition as ofSeptember 30, 2022 , and our consolidated results of operations for the three and nine months endedSeptember 30, 2022 , compared to the same periods in the prior fiscal year for the three and nine months endedSeptember 30, 2021 . This discussion should be read in conjunction with the interim consolidated financial statements and the condensed notes thereto included with this report and with Management's Discussion and Analysis of Financial Condition and Results of Operations and the financial statements and notes related thereto included in our 2021 10-K. Unless otherwise stated, all monetary amounts in this Management's Discussion and Analysis of Financial Condition and Results of Operations, other than share, per share and capital ratio amounts, are stated in thousands.
CRITICAL ACCOUNTING ESTIMATES
Our consolidated financial statements are prepared in accordance with GAAP. In connection with the preparation of our financial statements, we are required to make assumptions and estimates about future events and apply judgments that affect the reported amount of assets, liabilities, revenue, expenses, and their related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that our management believes to be relevant at the time our consolidated financial statements are prepared. Some of these estimates are more critical than others. In addition to the policies included in Note 1, "Nature of Business and Summary of Significant Accounting Policies," to the Consolidated Financial Statements included as an exhibit in our annual report on our 2021 10-K, our critical accounting estimates are as follows: Allowance for Loan Losses. We maintain an allowance for loan losses to absorb probable and inherent losses in our loan portfolio. The allowance is based on ongoing, quarterly assessments of the estimated probable incurred losses in our loan portfolio. In evaluating the level of the allowance for loan loss, we consider the types of loans and the amount of loans in our loan portfolio, historical loss experience, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, prevailing economic conditions and other relevant factors determined by management. We follow all applicable regulatory guidance, including the "Interagency Policy Statement on the Allowance for Loan and Lease Losses," issued by theFederal Financial Institutions Examination Council (FFIEC). We believe that the Bank's Allowance for Loan Losses Policy conforms to all applicable regulatory requirements. However, based on periodic examinations by regulators, the amount of the allowance for loan losses recorded during a particular period may be adjusted. Our determination of the allowance for loan losses is based on (1) specific allowances for specifically identified and evaluated impaired loans and their corresponding estimated loss based on likelihood of default, payment history, and net realizable value of underlying collateral. Specific allocations for collateral dependent loans are based on fair value of the underlying collateral relative to the unpaid principal balance of individually impaired loans. For loans that are not collateral dependent, the specific allocation is based on the present value of expected future cash flows discounted at the loan's original effective interest rate through the repayment period; and (2) a general allowance on loans not specifically identified in (1) above, based on historical loss ratios, which are adjusted for qualitative and general economic factors. We continue to refine our allowance for loan losses methodology, with an increased emphasis on historical performance adjusted for applicable economic and qualitative factors. Assessing the allowance for loan losses is inherently subjective as it requires making material estimates, including the amount, and timing of future cash flows expected to be received on impaired loans, any of which estimates may be susceptible to significant change. In our opinion, the allowance, when taken as a whole, reflects estimated probable loan losses in our loan portfolio.
We will adopt ASU 2016-13, Financial Instruments-Credit Losses (Topic 326),
"Measurement of Credit Losses on Financial Instruments" through a
cumulative-effect adjustment on
59
--------------------------------------------------------------------------------We account for goodwill and other intangible assets in accordance with ASC Topic 350, "Intangibles -Goodwill and Other." The Company records the excess of the cost of acquired entities over the fair value of identifiable tangible and intangible assets acquired, less liabilities assumed, as goodwill. The Company amortizes acquired intangible assets with definite useful economic lives over their useful economic lives utilizing the straight-line method. On a periodic basis, management assesses whether events or changes in circumstances indicate that the carrying amounts of the intangible assets may be impaired. The Company does not amortize goodwill, but reviews goodwill for impairment at a reporting unit level on an annual basis, or when events or changes in circumstances indicate that the carrying amounts may be impaired. A reporting unit is defined as any distinct, separately identifiable component of the Company's one operating segment for which complete, discrete financial information is available and reviewed regularly by the segment's management. The Company has one reporting unit as ofSeptember 30, 2022 , which is related to its banking activities. The Company performed the required goodwill impairment test and determined that goodwill was not impaired as ofDecember 31, 2021 .
Fair Value Measurements and Valuation Methodologies.
We apply various valuation methodologies to assets and liabilities which often involve a significant degree of judgment, particularly when liquid markets do not exist for the particular items being valued. Quoted market prices are referred to when estimating fair values for certain assets, such as most investment securities. However, for those items for which an observable liquid market does not exist, management utilizes significant estimates and assumptions to value such items. Examples of these items include loans, deposits, borrowings, goodwill, core deposit intangible assets, other assets and liabilities obtained or assumed in business combinations, and certain other financial instruments. These valuations require the use of various assumptions, including, among others, discount rates, rates of return on assets, repayment rates, cash flows, default rates, and liquidation values. The use of different assumptions could produce significantly different results, which could have material positive or negative effects on the Company's results of operations, financial condition or disclosures of fair value information. In addition to valuation, the Company must assess whether there are any declines in value below the carrying value of assets that should be considered other than temporary or otherwise require an adjustment in carrying value and recognition of a loss in the consolidated statement of operations. Examples include but are not limited to: loans, investment securities, goodwill, core deposit intangible assets and deferred tax assets, among others. Specific assumptions, estimates and judgments utilized by management are discussed in detail herein in management's discussion and analysis of financial condition and results of operations and in notes 1, 2, 3, 4 and 10 of Condensed Notes to Consolidated Financial Statements. Income Taxes. Amounts provided for income tax expenses are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws. Deferred income tax assets and liabilities, which arise principally from temporary differences between the amounts reported in the financial statements and the tax basis of certain assets and liabilities, are included in the amounts provided for income taxes. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income and tax planning strategies which will create taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and if necessary, tax planning strategies in making this assessment. The assessment of tax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgments concerning certain accounting pronouncements and application of specific provisions of federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management's current assessment, the impact of which could be material to our consolidated results of operations and reported earnings. We believe that the deferred tax assets and liabilities are adequate and properly recorded in the accompanying consolidated financial statements. As ofSeptember 30, 2022 , management does not believe a valuation allowance related to the realizability of its deferred tax assets is necessary. 60 --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS ANALYSIS
Net Interest Income. Net interest income represents the difference between the
dollar amount of interest earned on interest-bearing assets and the dollar
amount of interest paid on interest-bearing liabilities. The interest income and
expense of financial institutions (including those of the Bank) are
significantly affected by general economic conditions, competition, policies of
regulatory authorities and other factors.
Interest rate spread and net interest margin are used to measure and explain
changes in net interest income. Interest rate spread is the difference between
the yield on interest earning assets and the rate paid for interest-bearing
liabilities that fund those assets. Net interest margin is expressed as the
percentage of net interest income to average interest earning assets. Net
interest margin currently exceeds interest rate spread because
non-interest-bearing sources of funds ("net free funds"), principally demand
deposits and stockholders' equity, also support interest earning assets. The
narrative below discusses net interest income, interest rate spread, and net
interest margin for the three and nine-month periods ended September 30, 2022 ,
and September 30, 2021 , respectively.
Net interest income was $14.5 million for the three months ended September 30,
2022 , and $41.9 million for the nine months ended September 30, 2022 , compared
to $13.7 million for the three months ended September 30, 2021 , and $39.3
million for the nine months ended September 30, 2021 . Net interest income for
the three and nine months ended September 30, 2022 , increased from the same
period one year ago due to: 1) both organic loan and investment growth from
September 30, 2021 ; 2) the positive impact of nonaccrual loan payoffs and
purchased loan credit impairment accretion; 3) increases in loan and investment
yields due to both contractual repricing and higher coupons on new loans in
excess of portfolio yield; and 4) lower liability costs. This was partially
offset by $1.9 million and $4.9 million decreases in the accretion of deferred
fees related to SBA Paycheck Protection Program ("SBA PPP") loans for the three
and nine months ended September 30, 2022 , respectively, compared to the prior
year periods.
The net interest margin for the three-month period ended September 30, 2022 , was
3.43%, compared to 3.34% for the three-month period ended September 30, 2021 .
The net interest margin increase was due to: 1) increases in loan and investment
yields due to both contractual repricing and higher coupons on new loans in
excess of portfolio yield and 2) lower deposit costs, partially offset by: 1) a
46-basis point decrease in SBA PPP deferred loan fee accretion in loan yields
and 2) the impact of additional interest expense on the subordinated debt issued
in March of 2022.
The net interest margin for the nine-month period ended September 30, 2022 , was
3.38%, compared to 3.29% for the nine-month period ended September 30, 2021 . The
net interest margin increase was due to: 1) increases in loan and investment
yields due to both contractual repricing and higher coupons on new loans in
excess of portfolio yield; 2) the positive impact of nonaccrual loan payoffs
with purchased loan credit impairment accretion and interest income recognition
of 3 basis points; 3) lower deposit costs; and 4) the positive impact of
investing lower yield cash into investment securities. This was partially offset
by a 39-basis point decrease in SBA PPP deferred loan fee accretion and the
impact of additional interest expense due to subordinated debt issued in March
2022 .
61-------------------------------------------------------------------------------- Average Balances, Net Interest Income, Yields Earned and Rates Paid. The following net interest income analysis table presents interest income from average interest earning assets, expressed in dollars and yields, and interest expense on average interest-bearing liabilities, expressed in dollars and rates on a tax equivalent basis. Shown below is the weighted average tax equivalent yield on interest earning assets, rates paid on interest-bearing liabilities and the resultant spread at or during the three and nine-month periods endedSeptember 30, 2022 , andSeptember 30, 2021 . Non-accruing loans have been included in the table as loans carrying a zero yield. NET INTEREST INCOME ANALYSIS ON A TAX EQUIVALENT BASIS (Dollar amounts in thousands) Three months endedSeptember 30, 2022 compared to the three months ended September 30, 2021: Three months ended September 30, 2022 Three months ended September 30, 2021 Interest Average Interest Average Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate (1) Balance Expense Rate (1) Average interest earning assets: Cash and cash equivalents$ 11,043 $ 60 2.16 %$ 111,192 $ 50 0.18 % Loans 1,370,897 15,937 4.61 % 1,192,636 14,537 4.84 % Interest-bearing deposits 1,079 7 2.57 % 1,512 8 2.10 % Investment securities (1) 274,868 1,768 2.57 % 303,325 1,412 1.85 % Other investments 14,910 187 4.98 % 14,961 168 4.46 % Total interest earning assets (1)$ 1,672,797 $ 17,959 4.26 %$ 1,623,626 $ 16,175 3.95 % Average interest-bearing liabilities: Savings accounts$ 227,985 $ 204 0.36 %$ 216,304 $ 95 0.17 % Demand deposits 413,033 575 0.55 % 392,080 280 0.28 % Money market 331,469 519 0.62 % 276,582 193 0.28 % CD's 136,624 335 0.97 % 207,494 682 1.30 % IRA's 34,446 48 0.55 % 39,525 104 1.04 % Total deposits$ 1,143,557 $ 1,681 0.58 %$ 1,131,985 $ 1,354 0.47 % FHLB Advances and other borrowings 192,338 1,821 3.76 % 169,891 1,133 2.65 % Total interest-bearing liabilities$ 1,335,895 $ 3,502 1.04 %$ 1,301,876 $ 2,487 0.76 % Net interest income$ 14,457 $ 13,688 Interest rate spread 3.22 % 3.19 % Net interest margin (1) 3.43 % 3.34 % Average interest earning assets to average interest-bearing liabilities 1.25
1.25
(1) Fully taxable equivalent (FTE). The average yield on tax exempt securities is computed on a tax equivalent basis using a tax rate of 21.0% for the quarters endedSeptember 30, 2022 , andSeptember 30, 2021 . The FTE adjustment to net interest income included in the rate calculations totaled$0 and$1 thousand for the three months endedSeptember 30, 2022 , andSeptember 30, 2021 , respectively. 62
--------------------------------------------------------------------------------
NET INTEREST INCOME ANALYSIS ON A TAX EQUIVALENT BASIS
(Dollar amounts in thousands)
Nine months ended September 30, 2022 compared to the nine months ended
September 30, 2021:
Nine months ended September 30, 2022 Nine months ended September 30, 2021
Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate (1) Balance Expense Rate (1)
Average interest earning assets:
Cash and cash equivalents $ 23,727 $ 116 0.65 % $ 118,064 $ 107 0.12 %
Loans 1,334,811 44,598 4.47 % 1,197,469 43,014 4.80 %
Interest-bearing deposits 1,365 22 2.15 % 2,227 37 2.22 %
Investment securities (1) 282,771 4,777 3.38 % 263,655 3,606 1.83 %
Other investments 15,044 525 4.67 % 15,006 510 4.54 %
Total interest earning assets (1) $ 1,657,718 $ 50,038 4.04 % $ 1,596,421 $ 47,274 3.96 %
Average interest bearing liabilities:
Savings accounts $ 227,787 $ 424 0.25 % $ 211,320 $ 277 0.18 %
Demand deposits 411,471 1,045 0.34 % 361,248 788 0.29 %
Money market 318,246 1,011 0.42 % 263,195 577 0.29 %
CD's 143,965 1,079 1 % 237,706 2,592 1.46 %
IRA's 35,729 175 0.65 % 40,119 355 1.18 %
Total deposits $ 1,137,198 $ 3,734 0.44 % $ 1,113,588 $ 4,589 0.55 %
FHLB Advances and other borrowings 181,598 4,413 3.25 % 173,889 3,400 2.61 %
Total interest bearing liabilities $ 1,318,796 $ 8,147 0.83 % $ 1,287,477 $ 7,989 0.83 %
Net interest income $ 41,891 $ 39,285
Interest rate spread 3.21 % 3.13 %
Net interest margin (1) 3.38 % 3.29 %
Average interest earning assets to
average interest bearing liabilities 1.26 1.24
(1) Fully taxable equivalent (FTE). The average yield on tax exempt securities is computed on a tax equivalent basis using a tax rate of 21.0% for the nine months endedSeptember 30, 2022 , andSeptember 30, 2021 . The FTE adjustment to net interest income included in the rate calculations totaled$1 and$3 thousand for the nine-month periods endedSeptember 30, 2022 , andSeptember 30, 2021 , respectively. 63
-------------------------------------------------------------------------------- Rate/Volume Analysis. The following tables present the dollar amount of changes in interest income and interest expense for the components of interest earning assets and interest-bearing liabilities that are presented in the preceding table. For each category of interest earning assets and interest-bearing liabilities, information is provided on changes attributable to: 1) changes in volume, which are changes in the average outstanding balances multiplied by the prior period rate (i.e., holding the initial rate constant) and 2) changes in rate, which are changes in average interest rates multiplied by the prior period volume (i.e., holding the initial balance constant). Rate changes have been discussed previously in the net interest income section above. For the three and nine months endedSeptember 30, 2022 , compared to the same periods in 2021, the loan volume increased due to strong organic growth. The decrease in certificate volumes is due to CD shrinkage, with some of this decrease moving to money markets. Investment securities volume decreases for the three months endedSeptember 30, 2022 , compared to the three months endedSeptember 30, 2021 , are primarily due to: 1) principal repayments and 2) unrealized losses in the available for sale securities portfolio, partially offset by purchases. Investment securities volume increases for the nine months endedSeptember 30, 2022 , compared to the same period in the prior year are due to an increase in portfolio balances, largely due to purchases of mortgage-backed securities. RATE / VOLUME ANALYSIS (Dollar amounts in thousands) Three months endedSeptember 30, 2022 compared to the three months endedSeptember 30, 2021 . Increase (decrease) due to Volume Rate Net Interest income: Cash and cash equivalents$ (270) $ 280 $ 10 Loans 2,099
(699) 1,400
Interest-bearing deposits (3) 2 (1)
Investment securities (144) 500 356
Other investments (1) 20 19
Total interest earning assets 1,681 103 1,784
Interest expense:
Savings accounts 5 104 109
Demand deposits 16 279 295
Money market accounts 44 282 326
CD's (193) (154) (347)
IRA's (12) (44) (56)
Total deposits (140) 467 327
FHLB Advances and other borrowings 163 525 688
Total interest bearing liabilities 23 992 1,015
Net interest income $ 1,658 $ (889) $ 769
64
--------------------------------------------------------------------------------
Nine months ended September 30, 2022 compared to the nine months ended
September 30, 2021 .
Increase (decrease) due to
Volume Rate Net
Interest income:
Cash and cash equivalents $ (264) $ 273 $ 9
Loans 4,728 (3,144) 1,584
Interest-bearing deposits (14) (1) (15)
Investment securities 278 893 1,171
Other investments 1 14 15
Total interest earning assets 4,729 (1,965) 2,764
Interest expense:
Savings accounts 23 124 147
Demand deposits 117 140 257
Money market accounts 136 298 434
CD's (806) (707) (1,513)
IRA's (35) (145) (180)
Total deposits (565) (290) (855)
FHLB Advances and other borrowings 156 857 1,013
Total interest bearing liabilities (409) 567 158
Net interest income $ 5,138 $ (2,532) $ 2,606 Provision for Loan Losses. We determine our provision for loan losses ("provision") based on our desire to provide an adequate allowance for loan losses ("ALL") to reflect probable and inherent credit losses in our loan portfolio. We continue to monitor adverse general economic conditions that could affect our commercial and agricultural portfolios in the future.
Total provision for loan losses for the three and nine months endedSeptember 30, 2022 , was$0.4 million and$0.8 million , respectively, compared to no provision for the three and nine months endedSeptember 30, 2021 . Based on loan growth alone, the provision would have been$0.5 million for the third quarter and$0.95 million in the second quarter. However, payments on, and improved collateral position on substandard loans reduced specific reserves, reducing the provision. In addition, approximately$0.3 million of second quarter 2022 charge-offs had been provided for in previous quarters and the related charge-offs reduced second quarter 2022 specific reserves. There were no loan loss provisions for the quarters endedMarch 31, 2022 ,September 30, 2021 ,June 30, 2021 , orMarch 31, 2021 . Continued improving economic conditions in our markets, as evidenced by unemployment rates below the national average in our two largest population centers, have resulted in improving overall economic trends for businesses.
Note that in discussing ALL allocations, the entire ALL balance is available for any loan that, in management's judgment, should be charged off.
Management believes that the provision recorded for the current year three and
nine-month period is adequate in view of the present condition of our loan
portfolio and the sufficiency of collateral supporting our non-performing loans.
We continually monitor non-performing loan relationships and will adjust our
provision, as necessary, if changing facts and circumstances require a change in
the ALL. In addition, a decline in the quality of our loan portfolio as a result
of general economic conditions, factors affecting particular borrowers or our
market areas, or otherwise, could all affect the adequacy of our ALL. If there
are significant charge-offs against the ALL, or we otherwise determine that the
ALL is inadequate, we will need to record an additional provision in the future.
65
--------------------------------------------------------------------------------
Non-interest Income. The following table reflects the various components of
non-interest income for the three and nine- month periods ended
Three months ended September Nine months ended September
30, 30,
2022 2021 % Change 2022 2021 % Change
Non-interest Income:
Service charges on deposit accounts $ 535 $ 463 15.55 % $ 1,505 $ 1,256 19.82 %
Interchange income 597 600 (0.50) % 1,760 1,776 (0.90) %
Loan servicing income 611 842 (27.43) % 1,912 2,560 (25.31) %
Gain on sale of loans 194 1,014 (80.87) % 1,330 4,131 (67.80) %
Loan fees and service charges 267 118 126.27 % 500 547 (8.59) %
Net gains (losses) on investment
securities (55) 73 N/M (167) 344 N/M
Other 323 338 (4.44) % 717 801 (10.49) %
Total non-interest income $ 2,472 $ 3,448 (28.31) % $ 7,557 $ 11,415 (33.80) %
Service charges on deposit accounts increased to $535 for the three months ended
September 30, 2022 , from $463 for the prior year quarter. For the nine months
ended September 30, 2022 , service charges increased to $1,505 , compared to
$1,256 in the comparable prior year period. The increase for both periods is due
to higher customer spending activity.
Loan servicing income decreased with reduced capitalization of mortgage
servicing rights due to lower mortgage loan origination volume in both the three
and nine-month periods ended September 30, 2022 , compared to the same periods in
the prior year.
Gain on sale of loans decreased in the current three and nine-month periods
ended
The increase in loan fees and service charges for the three-month period endedSeptember 30, 2022 , compared to the three-month period endedSeptember 30, 2021 , is largely due to a loan prepayment on an acquired loan. For the nine-month periodSeptember 30, 2022 , the decrease in loan fees and service charges from the nine-month period endingSeptember 30, 2021 , is due to net decreases in commercial loan-related customer activity. The change in net gains (losses) on investment securities between the three and nine months endedSeptember 30, 2022 , and the three and nine months endedSeptember 30, 2021 , respectively, is primarily due to: 1) net unrealized losses on equity securities with readily determinable fair value in 2022, compared to net unrealized gains on equity securities with readily determinable fair value in 2021 and 2) modest net realized gains on sale of available for sale securities in the second quarter of 2021 of$36 and third quarter of 2021 of$42 primarily due to sales of trust-preferred securities. 66
-------------------------------------------------------------------------------- Non-interest Expense. The following table reflects the various components of non-interest expense for the three and nine-month periods endedSeptember 30, 2022 and 2021, respectively. Three months ended September 30, Nine months ended September 30, 2022 2021 % Change 2022 2021 % Change Non-interest Expense: Compensation and related benefits$ 5,900 $ 5,718 3.18 %$ 16,887 $ 16,736 0.90 % Occupancy 1,429 1,313 8.83 % 4,137 3,943 4.92 % Data processing 1,382 1,582 (12.64) % 4,098 4,374 (6.31) % Amortization of intangible assets 399 399 - % 1,197 1,197 - % Mortgage servicing rights expense, net 197 37 432.43 % 65 28 132.14 % Advertising, marketing and public relations 300 220 36.36 % 762 577 32.06 % FDIC premium assessment 119 148 (19.59) % 352 395 (10.89) % Professional services 382 328 16.46 % 1,152 1,192 (3.36) % Gains on repossessed assets, net (8) (3) (166.67) % (17) (149) 88.59 % New market tax credit depletion 163 - N/M 488 - N/M Other 1,014 578 75.43 % 2,286 1,714 33.37 % Total non-interest expense$ 11,277 $ 10,320 9.27 %$ 31,407 $ 30,007 4.67 % Non-interest expense (annualized) / Average assets 2.51 % 2.34 % 7.36 % 2.38 % 2.34 % 1.71 % Compensation expense for the three-month and nine-month periods endedSeptember 30, 2022 , were higher than the comparable prior year periods primarily due to merit and benefit increases in late March of 2022, partially offset by lower variable mortgage compensation related to lower mortgage activity. Net mortgage servicing rights expense increased during the three and nine months endedSeptember 30, 2022 , compared to the comparable prior year periods. While amortization expense decreased in the current three month period due to the impact of lower forecasted prepayments, this decrease was more than offset by$382 thousand of impairment reversal in the comparable prior year period. Amortization expense decreased in the nine months endedSeptember 30, 2022 , compared to the nine months endedSeptember 30, 2021 , by$691 thousand . This was partially offset by a decrease in MSR impairment reversals for the nine months endedSeptember 30, 2022 , of$566 thousand , compared to the comparable prior year period reversal of$1,294 thousand . TheFDIC insurance premium decreased for the three-month and nine-month periods endedSeptember 30, 2022 , from the comparable prior year periods due to the favorable impact of increased bank capital ratios, largely due to both a$15 million capital injection following the Company's subordinated debt issuance in March of 2022 and the impact of growth in the Bank's retained earnings. Professional services costs increased during the three months endedSeptember 30, 2022 , from the comparable prior year period due to the use of outside professionals who finished projects on behalf of the Company. Despite the increase in the third quarter compared to the prior year third quarter, the current year nine-month period professional fees decreased compared to the same period in 2021. This decrease was largely due to the need for fewer outside professionals and lower fees from our independent registered public accounting firm and other costs to prepare our Form 10-K in the first quarter of 2022 compared to the first quarter of 2021.
Net gains on repossessed assets decreased for the nine month period ended
In the first quarter of 2022, the Bank invested$4.1 million in a New Market Tax Credit. Based on current accounting guidance, the related non-tax-deductible asset depletion will occur over a 5-year period in lockstep with the recognition of the tax credit.The Emerging Issues Task Force of theFinancial Accounting Standards Board has issued guidance that, if implemented in its current proposal, would change the depletion expense from equal to the tax credit until the asset is depleted, to being proportional with the new market tax credit recognized, which is seven years. 67 --------------------------------------------------------------------------------
The increase in other expenses during the three and nine months ended
Income Taxes. Income tax expense was$1.3 and$4.2 million for the three and nine months endedSeptember 30, 2022 , respectively, compared to$1.8 and$5.5 million for the three and nine months endedSeptember 30, 2021 . The effective tax rate was 24.3% for both the three and nine-month periods endedSeptember 30, 2022 , compared to 26.7% and 26.5% for the comparable prior year periods. The lower effective tax rate is due to the impact of the New Market Tax Credit. The lower tax expense is due to both the lower effective tax rate and lower pre-tax income. 68
--------------------------------------------------------------------------------
BALANCE SHEET ANALYSIS
Cash and Cash Equivalents. Our cash balances decreased$18.3 million to$29.4 million in the first three quarters of 2022 as we deployed cash to support loan growth.
Securities available for sale, which represent the majority of our investment portfolio, were$167.8 million atSeptember 30, 2022 , compared with$203.1 million atDecember 31, 2021 . The decrease in the available for sale portfolio is due to unrealized losses of$24.0 million arising during the period and principal repayments, partially offset by purchases of corporate debt securities and mortgage-backed certificates. Securities held to maturity increased to$97.6 million atSeptember 30, 2022 , compared to$71.1 million atDecember 31, 2021 . This increase was largely due to the purchase of agency mortgage-backed securities, net of repayments. The unrealized loss on the held to maturity portfolio increased by$18.4 million in the first three quarters of 2022, to$20.4 million .
The amortized cost and market values of our available for sale securities by asset categories as of the dates indicated below were as follows:
Amortized Fair
Available for sale securities Cost Value
U.S. government agency obligations $ 19,357 $ 19,314
Mortgage-backed securities 99,198 79,927
Corporate debt securities 41,861 38,110
Corporate asset-backed securities 31,149
30,413
Totals $ 191,565 $ 167,764
December 31, 2021
U.S. government agency obligations $ 25,826 $ 26,265
Obligations of states and political subdivisions 140
140
Mortgage-backed securities 107,636 107,167
Corporate debt securities 35,342 35,588
Corporate asset-backed securities 33,902
33,908
Totals $ 202,846 $ 203,068
69--------------------------------------------------------------------------------
The amortized cost and fair value of our held to maturity securities by asset categories as of the dates noted below were as follows:
Amortized Fair
Held to maturity securities Cost Value
September 30, 2022 Obligations of states and political subdivisions$ 600 $ 546 Mortgage-backed securities 97,010
76,687
Totals $ 97,610 $77,233
Obligations of states and political subdivisions
Mortgage-backed securities 66,541
64,584
Totals $ 71,141 $ 69,177 The composition of our available for sale portfolios by credit rating as of the dates indicated below was as follows:
September 30, 2022
Amortized Fair Amortized Fair
Available for sale securities Cost Value Cost Value
U.S. government agency $ 115,150 $ 95,941 $ 131,115 $ 131,008
AAA 8,717 8,442 9,662 9,710
AA 25,837 25,272 26,727 26,762
A 5,700 5,218 5,700 5,720
BBB 36,161 32,891 29,642 29,868
Non-rated - - - -
Total available for sale securities
The composition of our held to maturity portfolio by credit rating as of the dates indicated was as follows:
September 30, 2022 December 31, 2021
Amortized Fair Amortized Fair
Held to maturity securities Cost Value Cost Value
U.S. government agency $ 97,010 $ 76,687 $ 66,541 $ 64,584
AAA - - - -
AA - - 4,000 4,000
A 600 546 600 593
Total $ 97,610 $ 77,233 $ 71,141 $ 69,177
At September 30, 2022 , the Bank has pledged mortgage-backed securities with a
carrying value of $5.5 million as collateral against a borrowing line of credit
with the Federal Reserve Bank with no borrowings outstanding on this line of
credit. As of September 30, 2022 , the Bank has pledged U.S. Government Agency
securities with a carrying value of $2.8 million and mortgage-backed securities
with a carrying value of $2.3 million as collateral against specific municipal
deposits. As of September 30, 2022 , the Bank also has mortgage-backed securities
with a carrying value of $0.2 million pledged as collateral to the Federal Home
Loan Bank of Des Moines .
At December 31, 2021 , the Bank has pledged certain of its mortgage-backed
securities with a carrying value of $0.9 million as collateral to secure a line
of credit with the Federal Reserve Bank with no borrowings outstanding on this
line of credit. As of December 31, 2021 , the Bank has pledged certain of its
U.S. Government Agency securities with a carrying value of $3.9 million and
mortgage-backed securities with a carrying value of $2.9 million as collateral
against specific municipal deposits. As of December 31, 2021 , the Bank also has
mortgage-backed securities with a carrying value of $0.3 million pledged as
collateral to the Federal Home Loan Bank of Des Moines .
70
--------------------------------------------------------------------------------
Loans. Total loans outstanding, net of deferred loan fees and costs and
unamortized discount on acquired loans, increased by $64.9 million , to $1.38
billion as of September 30, 2022 , from $1.31 billion at December 31, 2021 . The
originated loan portfolio, before SBA PPP loans, increased $116.9 million in the
nine-month period ended September 30, 2022 . Total SBA PPP loans decreased $8.8
million , entirely due to debt forgiveness. Acquired loans decreased by $44.8
million . The following table reflects the composition, or mix, of our loan
portfolio at September 30, 2022 , and December 31, 2021 :
September 30, 2022 December 31, 2021
Amount Percent Amount Percent
Real estate loans:
Commercial/Agricultural real estate
Commercial real estate $ 701,688 51.1 % $ 698,465 53.3 %
Agricultural real estate 81,707 5.9 % 78,495 6.0 %
Multi-family real estate 197,672 14.4 % 178,349 13.6 %
Construction and land development 117,850 8.6 % 79,520 6.1 %
Residential mortgage
Residential mortgage 98,733 7.2 % 90,990 6.9 %
Purchased HELOC loans 3,357 0.2 % 3,871 0.3 %
Total real estate loans 1,201,007 87.4 % 1,129,690 86.2 %
C&I/Agricultural operating and Consumer Installment
Loans:
C&I/Agricultural operating
Commercial and industrial ("C&I") 134,815 9.8 % 122,167 9.3 %
Agricultural operating 26,033 1.9 % 31,588 2.4 %
Consumer installment - %
Originated indirect paper 11,234 0.8 % 15,971 1.2 %
Other consumer 7,310 0.5 % 8,874 0.7 %
Total C&I/Agricultural operating and Consumer
installment Loans 179,392 13.0 % 178,600 13.6 %
Gross loans before C&I SBA PPP loans 1,380,399 100.4 % 1,308,290 99.8 %
SBA PPP loans - - % 8,755 0.7 %
Gross loans $ 1,380,399 100.4 % $ 1,317,045 100.5 %
Unearned net deferred fees and costs and loans in
process (2,447) (0.2) % (2,482) (0.2) %
Unamortized discount on acquired loans (2,076) (0.2) % (3,600) (0.3) %
Total loans (net of unearned income and deferred
expense) 1,375,876 100.0 % 1,310,963 100.0 %
Allowance for loan losses (17,442) (16,913)
Total loans receivable, net $ 1,358,434 $ 1,294,050
71-------------------------------------------------------------------------------- The following table summarizes SBA PPP loans by origination year atSeptember 30, 2022 : 2020 Originations 2021 Originations Total Net Deferred Net Deferred Fee Net Deferred Balance Fee Income Balance Income Balance Fee Income SBA PPP loans, January 1, 2021$ 123,702 $ 2,991 $ - $ -$ 123,702 $ 2,991 2021 SBA PPP loan originations - - 55,854 3,494 55,854
3,494
Less: 2021 SBA PPP loan forgiveness and fee accretion (121,574) (2,987) (49,227) (3,201) (170,801)
(6,188)
SBA PPP loans, December 31, 2021 2,128 4 6,627 293 8,755 297 Less: 2022 SBA PPP loan forgiveness and fee accretion (2,128) (4) (6,627) (293) (8,755) (297) SBA PPP loans, September 30, 2022 $ - $ - $ - $ - $ -
$ -
Allowance for Loan Losses. The loan portfolio is our primary asset subject to credit risk. To address this credit risk, we maintain an ALL for probable and inherent credit losses through periodic charges to our earnings. These charges are shown in our consolidated statements of operations as provision for loan losses. See "Provision for Loan Losses" earlier in this quarterly report. We attempt to control, monitor, and minimize credit risk through the use of prudent lending standards, a thorough review of potential borrowers prior to lending and ongoing and timely review of payment performance. Asset quality administration, including early identification of loans performing in a substandard manner, as well as timely and active resolution of problems, further enhances management of credit risk and minimization of loan losses. Any losses that occur and that are charged off against the ALL are periodically reviewed with specific efforts focused on achieving maximum recovery of both principal and interest. At least quarterly, we review the adequacy of the ALL. Based on an estimate computed pursuant to the requirements of ASC 450-10, "Accounting for Contingencies" and ASC 310-10, "Accounting by Creditors for Impairment of a Loan", the analysis of the ALL consists of three components: (i) specific credit allocation established for expected losses relating to specific impaired loans for which the recorded investment in the loan exceeds its fair value; (ii) general portfolio allocation based on historical loan loss experience for significant loan categories; and (iii) general portfolio allocation based on qualitative factors such as economic conditions and other relevant factors specific to the markets in which we operate. We continue to refine our ALL methodology by introducing a greater level of granularity to our loan portfolio. We currently segregate loans into pools based on common risk characteristics for purposes of determining the ALL. The additional segmentation of the portfolio is intended to provide a more effective basis for the determination of qualitative factors affecting our ALL. In addition, management continually evaluates our ALL methodology to assess whether modifications in our methodology are appropriate in light of underwriting practices, market conditions, identifiable trends, regulatory pronouncements or other factors. We believe that any modifications or changes to the ALL methodology would be to enhance the ALL. However, any such modifications could result in materially different ALL levels in future periods. The specific credit allocation for the ALL is based on a regular analysis of all loans that are considered impaired. In compliance with ASC 310-10, the fair value of the loan is determined based on either the present value of expected cash flows discounted at the loan's effective interest rate, the market price of the loan, or, if the loan is collateral dependent, the fair value of the underlying collateral less the expected cost of sale for such collateral. AtSeptember 30, 2022 , the Company individually evaluated loans for impairment with a recorded investment of$29.7 million , consisting of (1)$7.3 million purchased credit impaired ("PCI") loans, with a carrying amount of$7.1 million ; (2)$8.5 million TDR loans, net of TDR PCI loans; and (3)$14.1 million of substandard non-TDR, non-PCI loans. The$29.7 million total of loans individually evaluated for impairment includes$6.9 million of performing TDR loans. AtDecember 31, 2021 , the Company individually evaluated loans for impairment with a recorded investment of$31.7 million , consisting of (1)$11.2 million PCI loans, with a carrying amount of$10.6 million ; (2)$9.9 million TDR loans, net of TDR PCI loans; and (3)$11.3 million of substandard non-TDR, non-PCI loans. The$31.7 million total of loans individually evaluated for impairment includes$8.0 million of performing TDR loans. AtSeptember 30, 2022 , andDecember 31, 2021 , we had$29.7 million and 192 loans individually evaluated for impairment, respectively, all secured by real estate or personal property. Of the originated loans individually evaluated for impairment, there were 5 loans where the estimated fair value was less than their book value (i.e., we deemed impairment to exist) totaling$6.7 million for which$0.7 million in specific ALL was recorded as ofSeptember 30, 2022 . The allowance for loan losses modestly increased$0.3 million to$17.2 million atSeptember 30, 2022 , representing 1.25% of loans receivable. A portion of the current loan portfolio includes loans purchased through whole bank acquisitions in recent years resulting in purchased credit impairments which are not included in the allowance for loan losses. As the originated portfolio grows and the acquired portfolio shrinks, the percentage of originated loans to total loans grows, as does the overall 72 -------------------------------------------------------------------------------- percentage of the allowance to total loans. The allowance for loan losses was$16.9 million atDecember 31, 2021 , representing 1.30% of loans receivable, less the 100% SBA guaranteed PPP loans. The increase in the allowance atSeptember 30, 2022 , was due to a provision of$0.8 million , partially offset by net loan charge-offs. Approximately$0.3 million of the charge-offs in the second quarter had specific reserves previously established, so there was no impact on the provision for loan losses.
Allowance for Loan Losses to Loans, net of SBA PPP Loans
(in thousands, except ratios)
September 30, December 31,
2022 2021
Loans, end of period $ 1,375,876 $ 1,310,963
SBA PPP loans, net of deferred fees - (8,457)
Loans, net of SBA PPP loans and deferred fees $ 1,375,876 $ 1,302,506
Allowance for loan losses $ 17,217 $ 16,913
ALL to loans net of SBA PPP loans and deferred fees 1.25 % 1.30 %
ALL to loans, end of period 1.25 % 1.29 %
All of the nine factors identified in the FFIEC's Interagency Policy Statement
on the Allowance for Loan and Lease Losses are taken into account in determining
the ALL. The impact of the factors in general categories are subject to change;
thus, the allocations are management's estimate of the loan loss categories in
which the probable and inherent loss has occurred as of the date of our
assessment. Of the nine factors, we believe the following have the greatest
impact on our customers' ability to repay loans and our ability to recover
potential losses through collateral sales: (1) lending policies and procedures;
(2) economic and business conditions; and (3) the value of the underlying
collateral. As loan balances and estimated losses in a particular loan type
decrease or increase and as the factors and resulting allocations are monitored
by management, changes in the risk profile of the various parts of the loan
portfolio may be reflected in the allocated allowance. The general component
covers non-impaired loans and is based on historical loss experience adjusted
for these and other qualitative factors. In addition, management continues to
refine the ALL estimation process as new information becomes available. These
refinements could also cause increases or decreases in the ALL. See Provision
for loan losses in the Consolidated Statements of Operations (unaudited) for
further details. The unallocated portion of the ALL is intended to account for
imprecision in the estimation process or relevant current information that may
not have been considered in the process.
Nonperforming Loans, Potential Problem Loans and Foreclosed Properties . We
practice early identification of nonaccrual and problem loans in order to
minimize the Bank's risk of loss. Nonperforming loans are defined as nonaccrual
loans and restructured loans that were 90 days or more past due at the time of
their restructure, or when management determines that such classification is
warranted. The accrual of interest income is discontinued on our loans according
to the following schedule:
•Commercial/agricultural real estate loans, past due 90 days or more;
•C&I/Agricultural operating loans, past due 90 days or more;
•Closed ended consumer installment loans, past due 120 days or more; and
•Residential mortgage loans and open-ended consumer installment loans, past due 180 days or more.
When interest accruals are discontinued, interest credited to income is
reversed. If collection is in doubt, cash receipts on non-accrual loans are used
to reduce principal rather than being recorded as interest income. A TDR
typically involves the granting of some concession to the borrower involving a
loan modification, such as modifying the payment schedule or making interest
rate changes. TDR loans may involve loans that have had a charge-off taken
against the loan to reduce the carrying amount of the loan to fair market value
as determined pursuant to ASC 310-10.
73
--------------------------------------------------------------------------------
The following table identifies the various components of nonperforming assets
and other balance sheet information as of the dates indicated below and changes
in the ALL for the periods then ended:
December 31, 2021 and
September 30, 2022 and Twelve Months Then
Nine Months Then Ended Ended
Nonperforming assets:
Nonaccrual loans
Commercial real estate $ 5,848 $ 5,374
Agricultural real estate 2,729 3,490
Construction and land development 43 -
Commercial and industrial 188 298
Agricultural operating 668 993
Residential mortgage 1,246 1,433
Consumer installment 50 77
Total nonaccrual loans $ 10,772 $ 11,665
Accruing loans past due 90 days or more 248 160
Total nonperforming loans ("NPLs") 11,020 11,825
Other real estate owned 1,584 1,406
Other collateral owned - 2
Total nonperforming assets ("NPAs") $ 12,604 $ 13,233
Troubled Debt Restructurings ("TDRs") $ 9,336 $ 12,523
Accruing TDRs $ 6,910 $ 7,984
Nonaccrual TDRs $ 2,426 $ 4,539
Average outstanding loan balance $ 1,334,811 $ 1,216,244
Loans, end of period $ 1,375,876 $ 1,310,963
Total assets, end of period $ 1,780,202 $ 1,739,628
ALL, at beginning of period $ 16,913 $ 17,043
Loans charged off:
Commercial/Agricultural real estate (205) (251)
C&I/Agricultural operating (310) (7)
Residential mortgage (68) -
Consumer installment (34) (81)
Total loans charged off (617) (339)
Recoveries of loans previously charged off:
Commercial/Agricultural real estate 41 28
C&I/Agricultural operating 27 123
Residential mortgage 29 13
Consumer installment 49 45
Total recoveries of loans previously charged off: 146 209
Net loans charged off ("NCOs") (471) (130)
Additions to ALL via provision for loan losses charged to
operations 775 -
ALL, at end of period $ 17,217 $ 16,913
Ratios:
ALL to NCOs (annualized) 2,734.05 % 13,010.00 %
NCOs (annualized) to average loans 0.05 % 0.01 %
ALL to total loans 1.25 % 1.29 %
NPLs to total loans 0.80 % 0.90 %
NPAs to total assets 0.71 % 0.76 %
74--------------------------------------------------------------------------------
The following table shows the detail of non-performing assets by originated and acquired portfolios:
Nonperforming Originated / Acquired Assets
(in thousands, except ratios)
September 30, 2022 December 31, 2021
Nonperforming assets:
Originated nonperforming assets:
Nonaccrual loans $ 8,294 $ 6,448
Accruing loans past due 90 days or more 169 63
Total originated nonperforming loans ("NPL") 8,463 6,511
Other real estate owned ("OREO") - -
Other collateral owned - 2
Total originated nonperforming assets ("NPAs") $ 8,463 $ 6,513
Acquired nonperforming assets:
Nonaccrual loans $ 2,478 $ 5,217
Accruing loans past due 90 days or more 79 97
Total acquired nonperforming loans ("NPL") 2,557 5,314
Other real estate owned ("OREO") 1,584 1,406
Other collateral owned - -
Total acquired nonperforming assets ("NPAs") $ 4,141 $ 6,720
Total nonperforming assets ("NPAs") $ 12,604 $ 13,233
Loans, end of period $ 1,375,876 $ 1,310,963
Total assets, end of period $ 1,780,202 $ 1,739,628 Ratios:
Originated NPLs to total loans 0.61 % 0.50 %
Acquired NPLs to total loans 0.19 % 0.41 %
Originated NPAs to total assets 0.48 % 0.37 %
Acquired NPAs to total assets 0.23 % 0.39 %
75--------------------------------------------------------------------------------
Nonaccrual Loans Roll Forward:
Quarter Ended
September 30, December 31, September 30,
2022 June 30, 2022 March 31, 2022 2021 2021
Balance, beginning of period
$ 11,665 $ 11,706 $ 8,075 Additions 257 1,918 720 428 4,859 Acquired nonaccrual loans - - - - - Charge offs (4) (437) (15) (1) (24) Transfers to OREO (27) (65) - (19) - Return to accrual status (117) - (51) (30) - Repurchases of government guaranteed loans 517 - - - - Payments received (288) (2,830) (461) (422) (1,202) Other, net - (10) - 3 (2) Balance, end of period$ 10,772 $ 10,434 $ 11,858 $ 11,665 $ 11,706 Nonperforming loans decreased by$0.8 million to$11.0 million atSeptember 30, 2022 , fromDecember 31, 2021 . This decrease is largely due to payoffs of acquired nonaccrual loans, partially offset by increases in originated nonaccrual loans, the repurchase of a government guaranteed loan and increases in originated accruing loans past due 90 days or more. Nonperforming assets decreased to$12.6 million or 0.71% of total assets atSeptember 30, 2022 , compared to$13.2 million , or 0.76% of total assets atDecember 31, 2021 . Included in nonperforming assets atSeptember 30, 2022 , are$4.1 million of nonperforming assets acquired during recent whole-bank acquisitions. Refer to the "Allowance for Loan Losses" and "Nonperforming Loans,Potential Problem Loans and Foreclosed Properties " sections above for more information related to nonperforming loans. Included in the above table are nonaccrual TDR loans. Nonaccrual TDR loans decreased to$2.4 million atSeptember 30, 2022 , from$4.5 million atDecember 31, 2021 . September 30, 2022 December 31, 2021 Number of Recorded Number of Recorded Modifications Investment Modifications Investment Troubled debt restructurings: Accrual Status Commercial/Agricultural real estate 10$ 1,363 11$ 4,618 C&I/Agricultural operating 6 2,505 3 649 Residential mortgage 37 3,033 36 2,681 Consumer installment 2 9 6 36 Total loans 55$ 6,910 56$ 7,984 Accruing troubled debt restructurings decreased$1.1 million to$6.9 million largely due to the payoff of a$3.3 million loan in the first quarter, partially offset by modest additions. The table below shows a summary of criticized loans for the past five quarters. In the second quarter of 2022, two loans became categorized as special mention. One is a commercial real estate loan secured by a hotel and has rebounded more slowly from the pandemic due to reliance on seasonal events and company meetings. Performance year to date and current bookings show good progress. The second special mention loan is a$10.4 million fully secured working capital C&I loan. Negotiations are ongoing with the borrower to improve the loan structure and performance of the business. In the third quarter of 2022, this loan increased its outstanding balance by$2.4 million with a draw on a secured line of credit. The loan was categorized as special mention atJune 30, 2022 and is projected to decrease toJune 2022 levels by mid-first quarter 2023. See Note 3, "Loans, Allowance for Loan Losses and Impaired Loans" for additional information. 76 --------------------------------------------------------------------------------
(in thousands)
September 30, June 30, March 31, December 31, September 30,
2022 2022 2022 2021 2021
Special mention loan balances
$ 1,849 $ 4,536 $ 2,548 Substandard loan balances 20,227 20,680 24,822 22,817 27,137 Criticized loans, end of period$ 40,405 $ 37,954 $ 26,671 $ 27,353 $ 29,685 Classified assets decreased to$20.2 million atSeptember 30, 2022 , from$22.8 million atDecember 31, 2021 , largely due to non-accruing loan payoffs, along with the first quarter payoff of a substandard accruing troubled debt restructuring loan of$3.3 million partially offset by the new classification of$3.8 million of five agricultural relationships in the first quarter. Special mention loans increased$15.7 million in the first nine months of 2022, primarily due to the addition of two loans in the second quarter of 2022 and a draw on a line of credit on one of the loans in the third quarter. One is a commercial real estate loan for$5.4 million secured by a hotel (50% LTV at origination) and has rebounded more slowly from the pandemic due to reliance on seasonal events and company meetings. Performance year to date and bookings show good progress. The second special mention loan is a$10.4 million C&I fully secured working capital loan. Negotiations are ongoing with the borrower to improve the loan structure and cash flow of the business. Hotels and restaurants represent our portfolio's two industry sectors most directly and adversely affected by the recent pandemic and related government actions. These sector loans totaled approximately$93 million and$48 million , respectively, atSeptember 30, 2022 . The weighted-average loan-to-value percentage on these hotel industry sector loans was 57%. Approximately$35.6 million of restaurant sector loans are to franchise quick-service restaurants. As ofSeptember 30, 2022 , the Bank had$0.2 million of remaining residential mortgage loan modifications, due to pandemic-related borrower requests. As ofSeptember 30, 2022 , all previously deferred commercial loans have exited deferral status. While the Company has no indication that any of the modified credits are specifically impaired, additional risk and uncertainty inherent in the current pandemic-affected environment have been considered. See "Allowance for Loan Losses" section above for discussion of pandemic-related qualitative factor, and related provision for loan losses. The table below shows scheduled accretion by year for the accretable difference recognized due to fair value purchase accounting on recent whole bank acquisitions. In addition, the Company has$1.21 million of accretable discount from purchased impaired loans with the original non-accretable discount transferred to accretable discount. The scheduled accretion on this balance is estimated to be approximately$100 thousand per year; however, large balance payoffs, as seen in 2022, 2021 and 2020, would accelerate this accretion. Fiscal years ending December 31, Purchase Accounting Accretable Difference 2022 $ 148 2023 279 2024 131 2025 95 Total $ 653 Mortgage Servicing Rights. Mortgage servicing rights ("MSR") assets are initially measured at fair value; assessed at least quarterly for impairment; carried at the lower of the initial capitalized amount, net of accumulated amortization, or estimated fair value. MSR assets are amortized in proportion to and over the period of estimated net servicing income, with the amortization recorded in non-interest expense in the consolidated statement of operations. The valuation of MSRs and related amortization thereon are based on numerous factors, assumptions, and judgments, such as those for: changes in the mix of loans, interest rates, prepayment speeds, and default rates. Changes in these factors, assumptions and judgments may have a material effect on the valuation and amortization of MSRs. Although management believes that the assumptions used to evaluate the MSRs for impairment are reasonable, future adjustment may be necessary if future economic conditions differ substantially from the economic assumptions used to determine the value of MSRs.
The fair market value of the Company's MSR asset increased from
77
--------------------------------------------------------------------------------
result,
The unpaid balances of one- to four-family residential real estate loans serviced for others as ofSeptember 30, 2022 , andDecember 31, 2021 , were$531.8 million and$556.1 million , respectively. The fair market value of the Company's MSR asset as a percentage of its servicing portfolio atSeptember 30, 2022 , andDecember 31, 2021 , was 1.09% and 0.78%, respectively. Deposits. Deposits increased$46.8 million to$1.43 billion atSeptember 30, 2022 , from$1.39 billion atDecember 31, 2021 . Retail certificate of deposit account balances decreased by$33.6 million fromDecember 31, 2021 , as the Company chose not to match higher rate local retail certificate competition in the first and second quarters of 2022. Retail certificates have grown approximately$16 million since the low point in late second quarter of 2022. In late third quarter of 2022, the Bank added$19.9 million of brokered CDs. In addition, some of the decrease in retail certificates has moved to money market accounts, which increased almost$40 million from year-end.
The following is a summary of deposits by type at
September 30, 2022
Non-interest bearing demand deposits $ 285,670 $ 276,631 Interest bearing demand deposits 394,924 396,231 Savings accounts 236,107 222,674 Money market accounts 328,544 288,985 Certificate accounts 189,123 203,014 Total deposits $ 1,434,368$ 1,387,535 78
--------------------------------------------------------------------------------
September 30, 2022 December 31 ,
2021
Stated Maturity Amount Range of Stated Rates Amount Range of Stated Rates
Federal Home Loan Bank
advances (1), (2), (3), (4) 2022 $ 67,000 3.08 % 3.13 % $ 11,000 2.45 % 2.45 %
2023 10,000 1.43 % 2.01 % 20,000 1.43 % 1.44 %
2024 20,530 0.00 % 1.45 % 20,530 0.00 % 1.45 %
2025 5,000 1.45 % 1.45 % 5,000 1.45 % 1.45 %
2029 - - % - % 42,500 1.00 % 1.13 %
2030 - - % - % 12,500 0.52 % 0.86 %
Subtotal 102,530 111,530
Unamortized discount on
acquired notes - (3)
Federal Home Loan Bank
advances, net $ 102,530 $ 111,527
Senior Notes (5) 2034 $ 23,250 3.00 % 5.50 % $ 28,856 3.00 % 3.50 %
Subordinated Notes (6) 2027 $ - - % - % $ 15,000 6.75 % 6.75 %
2030 15,000 6.00 % 6.00 % 15,000 6.00 % 6.00 %
2032 35,000 4.75 % 4.75 % - - % - %
$ 50,000 $ 30,000
Unamortized debt issuance
costs (899) (430)
Total other borrowings $ 72,351 $ 58,426
Totals $ 174,881 $ 169,953
(1) The FHLB advances bear fixed rates, require interest-only monthly payments,
and are collateralized by a blanket lien on pre-qualifying first mortgages, home
equity lines, multi-family loans and certain other loans which had a pledged
balance of $960,192 and $861,900 at September 30, 2022 and December 31, 2021 ,
respectively. At September 30, 2022 , the Bank's available and unused portion
under the FHLB borrowing arrangement was approximately $277,959 compared to
$204,271 as of December 31, 2021 .
(2) Maximum month-end borrowed amounts outstanding under this borrowing
agreement were
(3) The weighted-average interest rate on FHLB borrowings maturing within twelve
months as of
(4) AtSeptember 30, 2022 , no FHLB term notes can be called by the FHLB. AtDecember 31, 2021 , FHLB term notes totaling$55,000 could be called by the FHLB on a quarterly basis, and if not called, would mature at various dates in 2029 and 2030. These notes were called by the FHLB in 2022.
(5) Senior notes, entered into by the Company in
(a) A term note, which was subsequently refinanced inMarch 2022 , requiring quarterly interest-only payments throughMarch 2025 , and quarterly principal and interest payments thereafter. Interest is variable, based on US Prime rate minus 75 basis points with a floor rate of 3.00%.
(b) A
79
--------------------------------------------------------------------------------(6) Subordinated notes resulted from the following:
(a) The Company's private sale inAugust 2017 , which bore a fixed interest rate of 6.75% for five years. InAugust 2022 , they converted to a three-month LIBOR plus 4.90% rate, and the interest rate will reset quarterly thereafter. The note was callable by the Bank when, and anytime after, the floating rate is initially set. Interest-only payments were due quarterly. The Company sent the required redemption notice to the note holders inJune 2022 , and this subordinated note was called and repaid in full onAugust 10, 2022 . (b) The Company's Subordinated Note Purchase Agreement entered into with certain purchasers inAugust 2020 , which bears a fixed interest rate of 6.00% for five years. InSeptember 2025 , the fixed interest rate will be reset quarterly to equal the three-month term Secured Overnight Financing Rate plus 591 basis points. The note is callable by the Bank when, and anytime after, the floating rate is initially set. Interest-only payments are due semi-annually each year during the fixed interest period and quarterly during the floating interest period. (c) The Company's Subordinated Note Purchase Agreement entered into with certain purchasers inMarch 2022 , which bears a fixed interest rate of 4.75% for five years. InApril 2027 , the fixed interest rate will be reset quarterly to equal the three-month term Secured Overnight Financing Rate plus 329 basis points. The note is callable by the Bank when, and anytime after, the floating rate is initially set. Interest-only payments are due semi-annually each year during the fixed interest period and quarterly during the floating interest period. FHLB advances decreased$9.0 million to$102.5 million as ofSeptember 30, 2022 , compared to$111.5 million as ofDecember 31, 2021 . The Bank terminated$15.0 million of advances in the quarter endedMarch 31, 2022 , incurring a$0.002 million prepayment penalty, as we modestly reduced excess liquidity.$27.5 million of FHLB advances were called by the FHLB in each of the quarters endedJune 30, 2022 , andSeptember 30, 2022 . The Bank added a$5 million advance maturing in the second quarter of 2023 and the Bank had$67 million of FHLB advances maturing overnight as ofSeptember 30, 2022 . The Bank has an irrevocable Standby Letter of Credit Master Reimbursement Agreement with theFederal Home Loan Bank . This irrevocable standby letter of credit ("LOC") is supported by loan collateral as an alternative to directly pledging investment securities on behalf of a municipal customer as collateral for their interest-bearing deposit balances. The Bank's current unused borrowing capacity, supported by loan collateral as ofSeptember 30, 2022 , is approximately$278.0 million . The Bank maintains three unsecured federal funds purchased lines of credit with banking partners which total$75 million . These lines bear interest at the lender banks announced daily federal funds rate, mature daily, and are revocable at the discretion of the lending institution. There were no borrowings outstanding on these lines of credit as ofSeptember 30, 2022 , orDecember 31, 2021 .
See Note 7, "
AtSeptember 30, 2022 , the Bank has pledged$960.2 million of loans to secure the current FHLB outstanding advances and letters of credit and to provide the unused borrowing capacity, compared to$861.9 million of loans pledged atDecember 31, 2021 . Stockholders' Equity. Total stockholders' equity was$163.3 million atSeptember 30, 2022 , compared to$170.9 million atDecember 31, 2021 . The decrease in stockholder's equity was attributable to: 1) the$17.4 million decrease in accumulated other comprehensive (loss) income due to an increase in unrealized loss on available for sale securities; 2) the payment of the annual cash dividend paid in February to common stockholders of$0.26 per share or$2.7 million ; and 3) the repurchase of approximately 71 thousand shares of the Company's common stock, which reduced equity by$1.0 million . These reductions to equity were largely offset by net income of$13.1 million , and amortization of restricted stock of$0.6 million . OnJuly 23, 2021 , the Board of Directors adopted a new share repurchase program. Under this new share repurchase program, fifty-three thousand shares were repurchased during the current quarter and approximately seventy-one thousand shares were repurchased during the nine months endedSeptember 30, 2022 . The Company is authorized to repurchase an additional 301 thousand shares under thisJuly 2021 share repurchase program. Liquidity and Asset / Liability Management. Our primary sources of funds are deposits; contractual amortization, prepayments, and maturities of outstanding loans and investment securities; and borrowings. We use our sources of funds primarily to meet ongoing commitments, to pay non-renewing, maturing certificates of deposit and savings withdrawals, and to fund loan commitments. We have enhanced our liquidity monitoring and updated what we consider to be sources of on-balance sheet cash. We consider our interest-bearing cash and unpledged investment securities to be our sources of on-balance sheet liquidity. AtSeptember 30, 2022 , our on-balance sheet liquidity ratio was 13.6%. While scheduled payments from the amortization of loans and investment securities and maturing short-term investments are relatively predictable sources of funds, 80 -------------------------------------------------------------------------------- deposit flows and loan prepayments are influenced by factors partially outside of the Bank's control, including general interest rates, economic conditions, and competition. Although$93.8 million of our$189.1 million (49.6%)September 30, 2022 , CD portfolio matures within the next 12 months, we have historically retained a majority of our maturing CDs. Due to strategic pricing decisions regarding rate matching based on currently liquidity levels, our retention rate may decrease in the future, although some deposits may be retained and moved to money market accounts. Through new deposit product offerings to our branch and commercial customers, we are currently attempting to strengthen customer relationships to attract additional non-rate sensitive deposits. In our present interest rate environment, and based on maturing yields, this is intended to also reduce our cost of funds. We maintain access to additional sources of funds including FHLB borrowings and lines of credit with theFederal Reserve Bank and correspondent banks. We utilize FHLB borrowings to leverage our capital base, to provide funds for our lending and investment activities, and to manage our interest rate risk. Our borrowing arrangement with the FHLB calls for pledging certain qualified real estate loans and borrowing up to 75% of the value of those loans, not to exceed 35% of the Bank's total assets. As ofSeptember 30, 2022 , we had approximately$278.0 million available under this arrangement, supported by loan collateral, as compared to$204.2 million atDecember 31, 2021 .
We maintain a line of credit with the
We have
In reviewing our adequacy of liquidity, we review and evaluate historical financial information, including information regarding general economic conditions, current ratios, management goals and the resources available to meet our anticipated liquidity needs. Management believes that our liquidity is adequate. To management's knowledge, there are no known events or uncertainties that will result, or are likely to reasonably result, in a material increase or decrease in our liquidity. Off-Balance Sheet Liabilities. Some of our financial instruments have off-balance sheet risk. These instruments include unused commitments for lines of credit, overdraft protection lines of credit and home equity lines of credit, as well as commitments to extend credit. As ofSeptember 30, 2022 , the Company had$265.1 million in unused commitments, compared to$271.0 million in unused commitments as ofDecember 31, 2021 . 81 -------------------------------------------------------------------------------- Capital Resources. As ofSeptember 30, 2022 , andDecember 31, 2021 , as shown in the table below, the Bank's Tier 1 and Risk-based capital levels exceeded levels necessary to be considered "Well Capitalized" under Prompt Corrective Action provisions. Below are the amounts and ratios for our capital levels as of the dates noted below for the Bank: To Be Well Capitalized For Capital Adequacy Under Prompt Corrective Actual Purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio As ofSeptember 30, 2022 (Unaudited) Total capital (to risk weighted assets)$ 219,988 14.4 %$ 122,333 > = 8.0 %$ 152,916 > = 10.0 % Tier 1 capital (to risk weighted assets) 202,771 13.3 % 91,750 > = 6.0 % 122,333 > = 8.0 % Common equity tier 1 capital (to risk weighted assets) 202,771 13.3 % 68,812 > = 4.5 % 99,396 > = 6.5 % Tier 1 leverage ratio (to adjusted total assets) 202,771 11.6 % 69,913 > = 4.0 % 87,391 > = 5.0 % As ofDecember 31, 2021 (Audited) Total capital (to risk weighted assets)$ 187,783 13.4 %$ 111,694 > = 8.0 %$ 139,618 > = 10.0 % Tier 1 capital (to risk weighted assets) 170,870 12.2 % 83,771 > = 6.0 % 111,694 > = 8.0 % Common equity tier 1 capital (to risk weighted assets) 170,870 12.2 % 62,828 > = 4.5 % 90,752 > = 6.5 % Tier 1 leverage ratio (to adjusted total assets) 170,870 10.0 % 68,323 > = 4.0 % 85,403 > = 5.0 % AtSeptember 30, 2022 , andDecember 31, 2021 , the Bank was categorized as "Well Capitalized" under Prompt Corrective Action Provisions, as determined by the OCC, our primary regulator.
Below are the amounts and ratios for our capital levels as of the dates noted below for the Company:
For Capital Adequacy
Actual Purposes
Amount Ratio Amount Ratio
As of September 30, 2022 (Unaudited)
Total capital (to risk weighted assets) $ 213,594 14.0 % $ 122,333 > = 8.0 %
Tier 1 capital (to risk weighted
assets) 146,337 9.6 % 91,750 > = 6.0 %
Common equity tier 1 capital (to risk
weighted assets) 146,337 9.6 % 68,812 > = 4.5 %
Tier 1 leverage ratio (to adjusted
total assets) 146,337 8.4 % 69,913 > = 4.0 %
As of December 31, 2021 (Audited)
Total capital (to risk weighted assets) $ 182,242 13.1 % $ 111,694 > = 8.0 %
Tier 1 capital (to risk weighted
assets) 135,329 9.7 % 83,771 > = 6.0 %
Common equity tier 1 capital (to risk
weighted assets) 135,329 9.7 % 62,828 > = 4.5 %
Tier 1 leverage ratio (to adjusted
total assets) 135,329 7.9 % 68,323 > = 4.0 %
82--------------------------------------------------------------------------------
© Edgar Online, source
