ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The following discussion sets forth management’s discussion and analysis of our results of operations for the year ended December 31, 2022 and December 31, 2021, and our financial position as of December 31, 2022 and December 31, 2021, respectively. The MD&A should be read in conjunction with our consolidated financial statements, related notes, the selected financial data and the statistical information presented elsewhere in this Annual Report on Form 10-K for a more complete understanding of the following discussion and analysis. Unless otherwise noted, years refer to the Company’s fiscal years ended December 31, 2022 and December 31, 2021.
PERFORMANCE SUMMARY
The following is a brief summary of some of the significant factors that affected our operating results for the twelve months ended December 31, 2022 and 2021.In 2022, net interest income was favorably impacted by the following: (1)growth in the loan portfolio and related growth in loan interest income; (2) the positive impact of higher interest rates on loan yields on new, renewing and repricing loans, which was more than offset by a reduction in the accretion of the Small Business Administration Paycheck Protection Program (“SBA PPP”) loan fees of $5.9 million;and (3) growth in the investment securities portfolio.These positive additions were offset by higher interest expense on subordinated debt due to (a) the issuance of $35 million with a coupon of 4.75%, partially offset by the call and redemption of $15 million of 6.75% subordinated debt issued in 2017 and (b) the impact of higher interest rates on FHLB advances and deposits. The Company recorded $1.5 million of provision for loan losses in 2022, largely due to loan growth and net charge-offs, partially offset by a reduction in specific reserves.No provision for loan losses was recorded in 2021 largely due to qualitative factor decreases to reflect greater certainty and improvement in current general economic conditions, offsetting the impact of organic loan growth. In 2022’s higher interest rate and tight housing supply environment, the Company experienced fewer mortgage loans originated for sale, which decreased gain on sale and income recorded in loan servicing income from the capitalization of mortgage servicing rights. Non-interest expense increased modestly in 2022, largely due to the cost of closing branches.
When comparing year-over-year results, changes in net interest income, provision for loan losses, non-interest income and non-interest expense are primarily due to the items discussed above. See the remainder of this section for a more thorough discussion. 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.
We reported net income of $17.76 million for the twelve months ended December 31, 2022, compared to net income of $21.27 million for the twelve months ended December 31, 2021. Diluted earnings per share were $1.69 for the twelve months ended December 31, 2022, compared to $1.98 for the twelve months ended December 31, 2021.Return on average assets for the twelve months ended December 31, 2022, was 1.00%, compared to 1.23% for the twelve months ended December 31, 2021. The return on average equity was 10.70% for the twelve months ended December 31, 2022, and 12.97% for the comparable period in 2021.
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CRITICAL ACCOUNTING ESTIMATES
Our consolidated financial statements have been prepared in conformity with U.S. Generally Accepted Accounting Principles (“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 the related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends, and other factors that management believes to be relevant at the time our consolidated financial statements are prepared. Some of these estimates are more critical than others. Below is a discussion of our critical accounting estimates.
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 losses, 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 the Federal 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 the 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
Loans acquired in connection with acquisitions are recorded at their acquisition-date fair value with no carryover of related allowance for loan losses. Any allowance for loan loss on these pools reflects only losses incurred after the acquisition (meaning the present value of all cash flows expected at acquisition that ultimately are not to be collected).
Goodwill and Other Intangible Assets.
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 of December 31, 2022, which is related to its banking activities.The impairment testing process is conducted by assigning net assets and goodwill to the Company’s reporting unit.An initial qualitative evaluation is made to assess the likelihood of impairment and determine whether further quantitative testing to calculate the fair value is necessary. When the qualitative evaluation indicates that impairment is more likely than not, quantitative testing is required whereby the fair value of the Company’s reporting unit is calculated and compared to the recorded book value, “step one.” If the calculated fair value of the Company’s reporting unit exceeds its carrying value, goodwill is not considered impaired, and “step two” is not considered necessary.If the carrying value of the company’s reporting unit exceeds its calculated fair value, the impairment test continues
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(“step two”) by comparing the carrying value of the Company’s reporting unit’s goodwill to the implied fair value of goodwill.An impairment charge is recognized if the carrying value of goodwill exceeds the implied fair value of goodwill.
In 2022, the Company performed quarterly reviews to determine if a triggering event had occurred that would require impairment testing. These quarterly reviews determined that no triggering event occurred during 2022. The Company performed its required annual goodwill impairment test as of December 31, 2022, and determined that goodwill was not impaired.
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, 5, 6, 13 and 14 of 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 of December 31, 2022, management does not believe a valuation allowance related to the realizability of its deferred tax assets is necessary.
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STATEMENT OF OPERATIONS ANALYSIS
Twelve months ended December 31, 2022 vs. Twelve months ended December 31, 2021
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 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 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.
Net interest income was $56.4 million for 2022 compared to $53.7 million for 2021. The increase is largely due to the positive loan volume variance due to growth in loans outstanding. Negative loan rate variances are due to a decrease in SBA PPP accretion of $5.9 million, which was partially offset by the impact of higher interest rates on newly originated, renewed and repricing loans. The positive rate variance on investment securities was largely due to the repricing of variable rate securities and the impact of new purchases above the portfolio rate. This positive rate variance was partially offset by higher interest expense on subordinated debt of $35 million issued in March 2022, with a coupon rate of 4.75%. In August 2022, interest expense was partially reduced by the call and redemption of $15 million of 6.75% subordinated debt issued in 2017. In addition, the impact of higher interest rates on liability costs reduced net interest income.
The net interest margin for 2022 was 3.39% compared to 3.34% for 2021. The increase in the net interest margin was due to the following factors: (1) the impact of higher interest rates on new, maturing, and repricing loans; (2) the impact of higher interest rates on the variable rate investment portfolio; and (3) a reduction in the balance of low yielding cash as a percentage of total assets. These positive impacts were partially offset by: (1) a decrease in SBA PPP loan accretion income of $5.9 million; (2) higher interest expense on subordinated debt, due to the issuance of $35 million with a coupon rate of 4.75%, partially offset by the call and redemption of $15 million of 6.75% subordinated debt issued in 2017; and (3) the impact of higher interest rates on liability costs.
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Average Balances, Net Interest Income, Yields Earned and Rates Paid. The following table shows 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. Also presented is the weighted average yield on interest earning assets on a tax-equivalent basis, rates paid on interest bearing liabilities and the resultant spread at December 31, 2022 and December 31, 2021.Non-accruing loans average balances are included in the table with the loans carrying a zero yield.
Twelve months ended December 31, 2022 Twelve months ended December 31, 2021
Average interest earning assets:
Average interest bearing liabilities:
Interest rate spread 3.19 % 3.18 %
Net interest margin (1) 3.39 % 3.34 %
(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% for the twelve months ended December 31, 2022 and 2021. The FTE adjustment to net interest income included in the rate calculations totaled $1 thousand and $3 thousand for the twelve month periods ended December 31, 2022 and 2021, respectively.
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Rate/Volume Analysis. The following table presents 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).
Twelve months ended December 31, 2022 v. 2021 increase (decrease) due to
Volume (1) Rate (1) TotalIncrease /(Decrease)
Interest income:
Cash and cash equivalents $ (353) $ 434 $ 81
Interest-bearing deposits (20) (1) (21)
Interest expense:
(1)the change in interest due to both rate and volume has been allocated in proportion to the relationship to the dollar amounts of the change in each.
Provision for Loan Losses. We determine our provision for loan losses (“provision,” or “PLL”) to provide an adequate allowance for loan losses (“ALL”) to reflect probable and inherent credit losses in our loan portfolio.
The provision for loan losses recorded in 2022 was $1.5 million compared to no provision for 2021. In 2022, the provision allocated for originated loan growth was approximately $1.3 million for 2022 and the provision related to charge-offs, reduced by decreases in changes in specific reserves, was approximately $0.2 million. The remaining provision in 2022 was related to qualitative factor increases to reflect uncertainty in current general economic conditions and a modest increase in unallocated ALL. In 2021, the impact of growth in the originated loan portfolio and modest charge-offs were offset by a reduction in Q-Factors related to economic qualitative factor decreases to reflect reduced uncertainty in current general economic conditions and a modest reduction in the unallocated reserve.
Management believes that the provisions for the years ended December 31, 2022, and 2021, are both adequate in view of the condition of the Bank’s loan portfolio and the sufficiency of collateral supporting non-performing loans as of the respective year-end dates. We are continually monitoring non-performing loan relationships and will make provisions, as necessary, if the facts and circumstances change. 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 other factors 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 PLL in the future. See Note 1, “Nature of Business and Summary of Significant Accounting Policies - Allowance for Loan Losses” of “Notes to Consolidated Financial Statements and Supplementary Data” to this Form 10-K, for further analysis of the provision for loan losses.
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Non-Interest Income. The following table reflects the various components of non-interest income for 2022 and 2021, respectively.
Twelve months ended December 31, Change from prior year
Non-interest Income:
N/M means not meaningful
Service charges on deposit accounts increased $292 thousand due to an increase in customer spending activity.
Loan servicing income decreased largely due to decreased capitalized mortgage servicing rights as a result of lower mortgage loan origination sold volumes.
The decrease in gain on sale of loans in 2022 is due to fewer mortgage loan originations and lower related sale volumes and a decrease in SBA loans sold.
Net gains on investment securities decreased in 2022 due to no realized gains on sale of AFS securities in 2022, compared to a $573 thousand net gain on sale in 2021. The sales in 2021 consisted of senior debt of large bank holding companies and lower yielding trust preferred securities. Both helped fund loan growth and decrease 100% risk weighted AFS securities. The net gains on investment securities were also impacted by smaller increases in the market value of our investment in Farmer Mac and Bankers’ Bank stock and the recognition of $367 thousand of net unrealized gain on investments recorded at Net Asset Value (“NAV”).
Other income decreased largely due to the cash receipt of $131 thousand in 2021 related to a private mortgage-backed security claim. This cash receipt represents a supplement to the proceeds received in fiscal 2015 from the private mortgage-backed security previously owned by the Bank and sold in 2011.
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Non-Interest Expense. The following table reflects the various components of non-interest expense for 2022 and 2021.
Twelve months ended December 31, % Change From prior year
Non-interest Expense:
Mortgage servicing rights expense, net 222 191 16.23%
Advertising, marketing and public relations 1,017 986 3.14%
Gains on repossessed assets, net (395) (199) 98.49%
New market tax credit depletion 650 — N/M
Non-interest expense (annualized) / Average assets 2.32 % 2.35 %
Compensation expense decreased in 2022 primarily due to lower salaries due to lower headcount and a decrease in incentives based on performance.
Professional fees increased slightly in 2022 largely due to a modest increase in utilization of third parties in completing one-time and ongoing projects.
Gains on repossessed assets increased largely due to the sale of a former branch sold in 2022, partially offset by limited gains on sales of repossessed assets due to foreclosure compared to 2021.
In the first quarter of 2022, the Bank invested $4.1 million in a New Markets Tax Credit (“NMTC”). 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 the Financial 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 NMTC recognized, which is seven years.
Other non-interest expense increased in 2022 primarily due to branch closure costs in 2022 of $1.0 million and $0.3 million of increased origination costs and deposit product costs.
Income Taxes. Income tax provision was $5.8 million in 2022 compared to $7.7 million for 2021 primarily due to the impact of lower pre-tax income and the impact of the new market tax credit purchased in 2022 discussed above. The 2022 effective tax rate was 24.7% compared to 26.6% in 2021. This difference is primarily due to the impact of the NMTC.
Income tax expense recorded in the accompanying Consolidated Statements of Operations involves interpretation and application of certain accounting pronouncements and federal and state tax codes and is, therefore, considered a critical accounting policy. We undergo examination by various taxing authorities. Such taxing authorities may require that changes in the amount of tax expense or the amount of the valuation allowance be recognized when their interpretations differ from those of management, based on their judgments about information available to them at the time of their examinations.
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BALANCE SHEET ANALYSIS
Total assets increased $76.8 million to $1.82 billion at December 31, 2022, from $1.74 billion at December 31, 2021. Strong originated loan growth was funded by the utilization of excess asset liquidity, resulting in a decrease in cash and cash equivalents, net deposit growth, and the utilization of FHLB advances.
Cash and Cash Equivalents. Cash and cash equivalents decreased from $47.7 million at December 31, 2021, to $35.4 million at December 31, 2022. As noted above, this decrease, along with deposit growth and FHLB advances, funded loan portfolio growth.
Investment Securities. We manage our securities portfolio to provide liquidity, in an effort to improve interest rate risk, and enhance income. Our investment portfolio is comprised of securities available for sale (“AFS”) and securities held to maturity (“HTM”).
Securities AFS (recorded at fair value), which represent the majority of our investment portfolio, decreased to $166.0 million at December 31, 2022, compared with $203.1 million at December 31, 2021. This decrease is due to the change in unrealized losses of $24.6 million in 2022, along with principal repayments and maturities. These reductions were partially offset primarily by purchases of bank holding company issued capital instruments, which are classified as corporate debt securities.
In 2021, the sale of trust preferred securities issued by bank holding companies with an amortized cost of $17.4 million and $10.6 million of non-CDFI bank holding company senior debt, reduced the portfolio of these securities to zero. The weighted average coupon of these sales was 2.2%. The sale of these 100% risk-weighted assets partially offset the impact of loan growth on risk-weighted assets and increased the overall yield of interest-earning assets. In addition, the bank sold $9.7 million of other AFS securities, largely U.S. agency mortgage-backed securities. These 2021 sales resulted in net realized gains of $573 thousand, which is included in net gains on investment securities in the Consolidated Statements of Operations
Securities held to maturity increased to $96.4 million at December 31, 2022, compared to $71.1 million at December 31, 2021. The increase was largely due to the purchase of agency mortgage-backed securities, net of principal repayments. The unrealized loss on the held to maturity portfolio increased by $17.6 million during the year to $19.6 million at December 31, 2022.
The amortized cost and market values of our investment securities by asset categories as of the dates indicated below were as follows:
Available for sale securities AmortizedCost FairValue
U.S. government agency obligations $ 18,373 $ 18,313
Obligations of states and political subdivisions — —
U.S. government agency obligations $ 25,826 $ 26,265
Obligations of states and political subdivisions 140 140
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Held to maturity securities AmortizedCost FairValue
Obligations of states and political subdivisions $ 600 $ 546
Total held to maturity securities $ 96,379 $ 76,779
Obligations of states and political subdivisions $ 4,600 $ 4,593
Total held to maturity securities $ 71,141 $ 69,177
The amortized cost and fair values of our investment securities by maturity, as of December 31, 2022 were as follows:
Available for sale securities AmortizedCost EstimatedFair Value
Due in one year or less $ — $ —
Due after one year through five years 8,525 8,184
Due after five years through ten years 45,622 41,427
Total securities with contractual maturities 92,886 87,381
Held to maturity securities AmortizedCost EstimatedFair Value
Due after one year through five years $ 450 $ 415
Due after five years through ten years 150 131
Total securities with contractual maturities 600 546
Total held to maturity securities $ 96,379 $ 76,779
The amortized cost and fair values of our investment securities by maturity, as of December 31, 2021 were as follows:
Available for sale securities AmortizedCost EstimatedFair Value
Due in one year or less $ 140 $ 140
Due after one year through five years 4,903 4,971
Due after five years through ten years 40,410 40,818
Total securities with contractual maturities 95,210 95,901
Held to maturity securities AmortizedCost EstimatedFair Value
Due after one year through five years $ 4,300 $ 4,298
Due after five years through ten years 300 295
Total securities with contractual maturities 4,600 4,593
Total held to maturity securities $ 71,141 $ 69,177
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The following tables show the fair value and gross unrealized losses of securities with unrealized losses, as of the dates indicated below, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position:
Less than 12 Months 12 Months or More Total
U.S. government agency obligations $ 1,169 $ 1 $ — $ — $ 1,169 $ 1
Less than 12 Months 12 Months or More Total
Obligations of states and political subdivisions $ — $ — $ 546 $ 54 $ 546 $ 54
Obligations of states and political subdivisions $ 593 $ 7 $ — $ — $ 593 $ 7
Unrealized losses reflected in the preceding tables have not been included in results of operations because the unrealized loss was not deemed other-than-temporary. Management has determined that more likely than not, the Company neither intends to sell, nor will it be required to sell each debt security before its anticipated recovery, and therefore recovery of cost will occur.
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The composition of our investment securities portfolio by credit rating as of the periods indicated below was as follows:
December 31, December 31,
Available for sale securities AmortizedCost FairValue AmortizedCost FairValue
Below investment grade — — — —
Non-rated — — — —
December 31, December 31,
Held to maturity securities AmortizedCost FairValue AmortizedCost FairValue
AAA — — — —
BBB — — — —
Below investment grade — — — —
Non-rated — — — —
At December 31, 2022, the Bank pledged certain of its mortgage-backed securities with a carrying value of $5.4 million as collateral to secure a line of credit with the Federal Reserve Bank. As of December 31, 2022, there were no borrowings outstanding on this Federal Reserve Bank line of credit. As of December 31, 2022, the Bank has pledged certain of its U.S. Government Agency securities with a carrying value of $2.6 million and mortgage-backed securities with a carrying value of $2.2 million as collateral against specific municipal deposits. As of December 31, 2022, the Bank also has mortgage-backed securities with a carrying value of $0.1 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. As of December 31, 2021, there were no borrowings outstanding on this Federal Reserve Bank 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.
Loans. Total loans outstanding, net of deferred loan fees and costs, increased to $1.41 billion at December 31, 2022, from $1.31 billion at December 31, 2021.
Gross loan growth consisted largely of $27.5 million in commercial real estate loans, $30.6 million of multi-family real estate loans, $23.0 of construction and land development loans, and $13.8 million of commercial and industrial loan growth. In addition, the growth in residential mortgage and agricultural real estate portfolios of $23.8 million exceeded the reduction in the remaining loan portfolios of $19.6 million. Included in the shrink numbers above is 100% of the of SBA PPP loans of $8.8 million at December 31, 2021.
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The following table reflects the composition, or mix, of our loan portfolio at December 31, 2022 and December 31, 2021:
Amount Percent Amount Percent
Real Estate Loans:
Commercial/Agricultural real estate:
Residential mortgage:
C&I/Agricultural operating and Consumer installment loans:
C&I/Agricultural operating:
Consumer installment:
SBA PPP Loans — — % 8,755 0.7 %
Unamortized discount on acquired loans (1,766) (0.1) % (3,600) (0.3) %
Our loan portfolio is diversified by types of borrowers and industry groups within the market areas that we serve. Significant loan concentrations are considered to exist for a financial entity when the amounts of loans to multiple borrowers engaged in similar activities cause them to be similarly impacted by economic or other conditions. As illustrated above, at December 31, 2022, the largest loan concentration we identified was commercial real estate loans which comprised 52% of our total loan portfolio. Approximately 88% of our total gross loans are secured by real estate.
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The following table sets forth, as of December 31, 2022 and December 31, 2021 respectively the fixed and adjustable-rate loans in our loan portfolio:
Amount Percent Amount Percent
Fixed rate loans:
Real estate loans:
Non-real estate loans:
Adjustable-rate loans:
Real estate loans:
Non-real estate loans:
Consumer installment 16 — % 17 — %
Unamortized discount on acquired loans (1,766) (0.1) % (3,600) (0.3) %
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Loan amounts, their contractual maturities and weighted average interest rates at December 31, 2022 are shown below.
Real estate Non-real estate
(1)Includes loans having no stated maturity and overdraft loans.
Loan amounts, their contractual maturities and weighted average interest rates at December 31, 2021, are shown below. SBA PPP loans at an interest rate of 1% are included in the C&I/agricultural operating segment amounts as follows: (1) $2.1 million is included in the one year or less amounts and (2) $6.7 million is included in the one year to five-year amounts.
Real estate Non-real estate
(1)Includes loans having no stated maturity and overdraft loans.
We believe that the critical factors in the overall management of credit or loan quality are sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, recording an adequate allowance to provide for incurred loan losses, and reasonable non-accrual and charge-off policies.
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The following table summarizes SBA PPP loans by origination year as of December 31, 2022 and December 31, 2021, respectively.
2020 Originations 2021 Originations Total
SBA PPP loans, December 31, 2022 $ — $ — $ — $ — $ — $ —
Risk Management and the 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 accompanying Consolidated Statements of Operations as Provision for Loan Losses. See “Statement of Operations Analysis - Provision for Loan Losses” above. 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 on the affected loan.
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 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.
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Changes in the ALL by loan portfolio segment for the periods presented were as follows:
Allowance for Loan Losses:
Other acquired loans:
Total allowance on other acquired loans 534 63 25 8 — 630
Allowance for Loan Losses:
Other acquired loans:
The specific credit allocation for the ALL is based on a regular analysis of all originated 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. At December 31, 2022, the Company had evaluated loans for impairment with a recorded investment of $26.8 million, consisting of $7.0 million PCI loans, with a carrying amount of $6.9 million, $7.0 million of TDR loans, net of TDR PCI loans and $12.9 million of substandard non-TDR non-PCI loans. The $26.8 million total of loans individually evaluated for impairment includes $5.2 million of performing TDR loans. At December 31, 2021, the Company had evaluated loans for impairment with a recorded investment of $31.7 million, consisting of $11.2 million PCI loans, with a carrying amount of $10.6 million, $9.9 million of TDR loans, net of TDR PCI loans and $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.
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At December 31, 2022, the allowance for loan losses was $17.9 million or 1.27% of total loans compared to $16.9 million or 1.29% of our total loan portfolio at December 31, 2021. This level was based on our analysis of the loan portfolio risk at each of December 31, 2022, and December 31, 2021, as discussed above.
Allowance for Loan Losses to Loans, net of SBA PPP Loans
SBA PPP loans, net of deferred fees — (8,457)
ALL to loans, end of period 1.27 % 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 of our ALL-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. 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.
Accruing loans 30-89 days or more past due increased $7.5 million at December 31, 2022, compared to December 31, 2021, largely related to increases in agricultural real estate and construction and land development loans 30-59 days delinquent.
Nonaccrual loans decreased modestly to $11.2 million at December 31, 2022, from $11.7 million at December 31, 2021.
We believe our credit and underwriting policies continue to support more effective lending decisions by the Bank, which increases the likelihood of maintaining loan quality going forward. Refer to the “Risk Management and the Allowance for Loan Losses” section below for more information related to non-performing loans.
For the year ended December 31, 2022, net loan charge-offs were $0.449 million compared to $0.130 million for the year ended December 31, 2021.
Certain external factors may result in higher future losses but are not readily determinable at this time, including, but not limited to: unemployment rates, increased taxes and continuing increased regulatory expectations with respect to ALL levels. As a result, our analysis may show a need to increase our ALL as a percentage of total loans and nonperforming loans for the near future. Loans charged-off are subject to periodic review and specific efforts are taken to achieve maximum recovery of principal, accrued interest and related expenses on the loans charged-off.
COVID-19 Loan Modifications. In response to COVID-19, our banking regulator issued an Interagency Statement encouraging financial institutions to work prudently with borrowers who are or may be unable to meet their contractual obligations due to COVID-19. Additionally, Section 4013 of the CARES Act provides that a qualified loan modification is exempt by law from classification as a TDR as defined by GAAP, from the period beginning March 1, 2020, until the earlier of December 31, 2020, or the date that is 60 days after the date on which the national emergency concerning the COVID-19 outbreak declared by the President of the United States under the National Emergencies Act is terminated. Section 541 of the Consolidated Appropriations Act, 2021 extends this relief to the earlier of January 1, 2022, or 60 days after the national emergency termination date. The President of the United States has announced that the national emergency declaration will end on May 11, 2023. The Interagency Statement was subsequently revised in April 2020 to clarify the interaction of the original guidance with Section 4013 of the CARES Act. In accordance with this guidance, the Bank instituted a plan to offer modifications to impacted borrowers. The Bank continues to work with borrowers as the pandemic persists and is requiring additional support in exchange for additional modifications beyond the original term. As of December 31, 2022, the Bank has $0.1 million of remaining residential mortgage COVID-19 related modifications under Section 4013 of the CARES Act. All
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previously deferred commercial loans have exited deferral status. At December 31, 2021, COVID-19 related modifications under Section 4013 of the CARES Act totaled $6.6 million, or 0.5% of gross loans.
Nonperforming Loans, Potential Problem Loans and Foreclosed Properties. We employ early identification of non-accrual and problem loans in order to minimize the risk of loss. Non-performing loans are defined as either 90 days or more past due or non-accrual. The accrual of interest income is discontinued according to the following schedules:
•Commercial/agricultural real estate loans, past due 90 days or more;
•Commercial and industrial/agricultural operating loans past due 90 days or more;
•Closed ended consumer installment loans past due 120 days or more; and
•Residential mortgage 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 recorded as interest income. Restructuring a loan 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. Restructured 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. Restructured loans that comply with the restructured terms are considered performing loans.
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The following table identifies the various components of non-performing assets and other balance sheet information as of the dates indicated below and changes in the ALL for the periods then ended:
Nonperforming assets:
Nonaccrual loans
Commercial and industrial (“C&I”) 552 298
Consumer installment 31 77
Accruing loans past due 90 days or more 246 160
Other collateral owned 6 2
Total nonperforming assets (“NPAs”) $ 12,721 $ 13,233
Troubled Debt Restructurings (“TDRs”) $ 7,788 $ 12,523
Loans charged off:
Commercial/Agricultural real estate (205) (251)
C&I/Agricultural operating (346) (7)
Residential mortgage (68) —
Consumer installment (48) (81)
Total loans charged off (667) (339)
Recoveries of loans previously charged off:
Commercial/Agricultural real estate 102 28
C&I/Agricultural operating 36 123
Residential mortgage 29 13
Consumer installment 51 45
Total recoveries of loans previously charged off: 218 209
Net loans charged off (“NCOs”) (449) (130)
Additions to ALL via provision for loan losses charged to operations 1,475 —
Ratios:
NCOs (annualized) to average loans 0.03 % 0.01 %
ALL to total loans 1.27 % 1.29 %
NPLs to total loans 0.81 % 0.90 %
NPAs to total assets 0.70 % 0.76 %
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The following table shows the detail of non-performing assets by originated and acquired portfolios.
Nonperforming Originated and Acquired Assets
Nonperforming assets:
Originated nonperforming assets:
Accruing loans past due 90 days or more 213 63
Total originated nonperforming loans (“NPL”) 9,160 6,511
Other real estate owned (“OREO”) 1,041 —
Other collateral owned 6 2
Total originated nonperforming assets (“NPAs”) $ 10,207 $ 6,513
Acquired nonperforming assets:
Accruing loans past due 90 days or more 33 97
Total acquired nonperforming loans (“NPL”) 2,290 5,314
Other real estate owned (“OREO”) 224 1,406
Other collateral owned — —
Total acquired nonperforming assets (“NPAs”) $ 2,514 $ 6,720
Total nonperforming assets (“NPAs”) $ 12,721 $ 13,233
Ratios:
Originated NPLs to total loans 0.65 % 0.50 %
Acquired NPLs to total loans 0.16 % 0.41 %
Originated NPAs to total assets 0.56 % 0.37 %
Acquired NPAs to total assets 0.14 % 0.39 %
Non-performing assets include non-performing loans, other real estate owned, and other collateral owned. Our non-performing assets were $12.7 million, or 0.70% of total assets, at December 31, 2022, compared to $13.2 million, or 0.76% of total assets, at December 31, 2021. The decrease was largely due to a decrease in acquired nonaccrual loans and sale of a former branch asset transferred to OREO in 2021, partially offset by an increase in acquired nonaccrual loans and the transfer to OREO of two former branch assets in 2022.
Nonaccrual Loans Roll Forward
Year Ended
Transfers to OREO (92) (64)
Return to accrual status (168) (1,017)
Repurchase of government guaranteed loans 517
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The table below shows the totals of accruing troubled debt restructurings as of December 31, 2022, and December 31, 2021. The decrease in troubled debt restructurings from 2021 to 2022 in dollars was largely due to one commercial real estate loan of $3.5 million that paid in full in 2022.
Troubled Debt Restructurings in Accrual Status
Troubled debt restructurings: Accrual Status
Consumer installment — — 6 36
The table below shows the totals of special mention, substandard and the total of these, known as criticized loans as of December 31, 2022, and 2021.The increase in criticized loans in 2022 was largely due to the addition of two loans in the second quarter of 2022. One was a commercial real estate loan secured by a hotel, and the other was a fully secured C&I working capital loan. This increase was partially offset by a reduction in originated accruing TDR loans, nonperforming and other substandard loans.
Special mention loan balances $ 12,170 $ 4,536
Accretable difference:
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 table below shows $1.16 million of accretable discount from purchased impaired loans with the original non-accretable discount transferred to accretable discount. The accretion on this balance is scheduled to be approximately $80 in 2023; however, large balance payoffs, as seen in 2022, 2021 and 2020, would accelerate this accretion.
Fiscal years ending December 31, Purchase Accounting Accretable Discount
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Mortgage Servicing Rights. The Company continues to sell loans to investors in the secondary market and generally retains the rights to service mortgage loans sold to others. MSR assets are initially measured at fair value by a third party; 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 to $5.7 million at December 31, 2022, compared to $4.3 million at December 31, 2021. Impairment reversals of $0.6 million were recorded in 2022 on the MSR impairment which reduced the impairment to zero at December 31, 2022. This was partially offset by a reduction in the gross MSR balance of $0.5 million, which was due to amortization of $0.8 million and additions from originations of $0.3 million. In 2021, amortization was $1.6 million and additions from originations were $1.1 million for a reduction in the gross asset of $0.5 million The unpaid balances of one- to four-family residential real estate loans serviced for others as of December 31, 2022, and December 31, 2021, were $523.7 million and $556.1 million, respectively. The fair market value of the Company’s MSR asset as a percentage of its servicing portfolio at December 31, 2022, and December 31, 2021 was 1.08% and 0.78%, respectively.
Intangible Assets. We have intangible assets of $2.4 million at December 31, 2022, compared to $3.9 million at December 31, 2021. The intangible assets are comprised of core deposit intangible assets arising from various acquisitions from 2016 through 2019. Amortization of these intangibles was $1.4 million in 2022.
Foreclosed and repossessed assets. Included in foreclosed and repossessed assets, net are two closed branch locations that are being held for sale. These properties are being held at $1,041 and $130, respectively, which represent their estimated fair market values less the cost to sell. In 2022, a loss of $666 was recognized on the reclassification of these properties from fixed assets to foreclosed assets.
The bank closed on the sale of the property valued at $130 in January 2023 to a non-financial institution at the carrying value.
Deposits. Deposits are our largest source of funds. Total deposits increased to $1.42 billion at December 31, 2022, from $1.39 billion at December 31, 2021. The increase in deposits was largely due to the addition of $39.8 million of broker certificates in the third and fourth quarter. Based on current market conditions, the brokered CD markets are available to the Bank for supplemental additions. Growth in non-interest bearing demand deposits and money market accounts was partially offset by a $25.0 million reduction in interest bearing demand deposits as customers sought higher yields and a reduction in CD’s of $17.5 million before the impact of brokered CD additions.
The following is a summary of deposits by type at December 31, 2022 and December 31, 2021, respectively:
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Federal Home Loan Bank (FHLB) advances and other borrowings. A summary of Federal Home Loan Bank (FHLB) advances and other borrowings at December 31, 2022 and December 31, 2021 is as follows:
Unamortized discount on acquired notes — (3)
Other borrowings:
Unamortized debt issuance costs (841) (430)
(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 pledged balances of $984,878 and $861,900 at December 31, 2022 and 2021, respectively. At December 31, 2022, the Bank’s available and unused portion under the FHLB borrowing arrangement was approximately $256,773 compared to $204,271 as of December 31, 2021.
(2) Maximum month-end borrowed amounts outstanding under this borrowing agreement were $157,530 and $123,530, during the twelve months ended December 31, 2022 and December 31, 2021, respectively.
(3) The weighted-average interest rates on FHLB borrowings, with maturities less than twelve months, outstanding as of December 31, 2022 and December 31, 2021 were 4.09% and 2.45%, respectively.
(4) At December 31, 2022, no FHLB term notes can be called by the FHLB. At December 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 June 2019 consist of the following:
(a) A term note, which was subsequently refinanced in March 2022, requiring quarterly interest-only payments through March 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 $5,000 line of credit, maturing in August 2023, that remains undrawn upon.
(6) Subordinated notes resulted from the following:
(a) The Company’s private sale in August 2017, which bore a fixed interest rate of 6.75% for five years. In August 2022, they converted to a three-month LIBOR plus 4.90% rate, and the interest rate will reset quarterly thereafter. The note was
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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 in June 2022, and this subordinated note was called and repaid in full on August 10, 2022.
(b) The Company’s Subordinated Note Purchase Agreement entered into with certain purchasers in August 2020, which bears a fixed interest rate of 6.00% for five years. In September 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 in March 2022, which bears a fixed interest rate of 4.75% for five years. In April 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.
Federal Home Loan Bank (FHLB) advances and other borrowings
We utilize advances and other borrowings, as necessary, to supplement core deposits to meet our funding and liquidity needs and we evaluate all options for funding securities.
FHLB advances increased $31.0 million to $142.5 million as of December 31, 2022, compared to $111.5 million as of December 31, 2021. The Bank terminated $15.0 million of advances in the quarter ended March 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 ended June 30, 2022, and September 30, 2022. The Bank added a $5 million advance maturing in the second quarter of 2023. The Bank had $12 million of FHLB advances maturing overnight as of December 31, 2022, and an additional $95.0 million maturing in January of 2023. The Bank has an irrevocable Standby Letter of Credit Master Reimbursement Agreement with the Federal 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 of December 31, 2022, is approximately $256.8 million.
The Bank maintains three unsecured federal funds purchased lines of credit with its banking partners which total $75.0 million. These lines bear interest at the lender bank’s 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 of December 31, 2022, or December 31, 2021.
At December 31, 2022 and 2021, the Bank had the ability to borrow $4.1 million and $0.8 from the Federal Reserve Bank of Minneapolis. The ability to borrow is based on mortgage-backed securities pledged with a carrying value of $5.4 million and $0.9 million as of December 31, 2022 and 2021, respectively. There were no Federal Reserve borrowings outstanding as of December 31, 2022 and 2021.
Stockholders’ Equity. Total stockholders’ equity was $167.1 million at December 30, 2022, compared to $170.9 million at December 31, 2021. The increases in stockholders’ equity included the Company’s net income of $17.8 million and restricted stock amortization of $0.9 million. These increases were more than offset by: (1) the repurchase of approximately 129 thousand shares of its common stock, which reduced equity by $1.8 million; (2) the payment of the annual cash dividend, paid in February 2022, to common stockholders at $0.26 per share or $2.7 million; and (3) an increase in the unrealized loss on available for sale securities of $17.8 million.
In November 2020, the Board of Directors authorized a 5% or 557 thousand share repurchase program. The Company repurchased all remaining authorized shares of the Company’s stock under the November 2020 share repurchase program not previously repurchased in 2020 during the year ended December 31, 2021. On July 23, 2021, the Board of Directors adopted a new share repurchase program. Under this new share repurchase program, approximately 129 thousand shares were repurchased during the year ended December 31, 2022. The Company is authorized to repurchase an additional 243 thousand shares under this July 2021 share repurchase program. On August 16, 2022, the Inflation Reduction Act was signed into law, which includes a 1% excise tax on stock repurchases. We do not expect the 1% excise tax on stock repurchases under the Inflation Reduction Act will have a material impact to our financial statements for the fiscal years after December 31, 2022.
Liquidity and Asset / Liability Management. Liquidity management refers to our ability to ensure cash is available in a timely manner to meet loan demand, depositors’ needs, and meet other financial obligations as they become due without undue
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cost, risk, or disruption to normal operating activities. We manage and monitor our short-term and long-term liquidity positions and needs through a regular review of maturity profiles, funding sources, and loan and deposit forecasts to minimize funding risk. A key metric we monitor is our liquidity ratio, calculated as cash and securities portfolio divided by total assets. At December 31, 2022, our liquidity ratio decreased to 13.0% percent from 17.0% at December 31, 2021. This was largely due to a reduction in interest-bearing cash.
Our primary sources of funds are deposits, amortization, prepayments and maturities on the investment and loan portfolios and funds provided from operations. We use our sources of funds primarily to meet ongoing commitments, to pay maturing certificates of deposit and savings withdrawals, and to fund loan commitments. While scheduled payments from the amortization of loans and maturing short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. Although $128.5 million of our $225.3 million (57%) CD portfolio will mature within the next 12 months, we have historically retained a majority of our maturing CD’s. However, due to strategic pricing decisions regarding rate matching and branch closures, our retention rate decreased in 2022 and may remain at lower than historical levels in 2023 based on management’s current pricing strategy, which reflects the Bank’s current strong on-balance sheet liquidity ratio. 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. Based on interest rates on scheduled maturities and lower current market interest rates, this should also improve our cost of funds.
We maintain access to additional sources of funds including FHLB borrowings and lines of credit with the Federal Reserve Bank, and our 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, commercial and industrial loans, and borrowing up to 75% of the value of those loans, not to exceed 35% of the Bank’s total assets. Currently, we have approximately $256.8 million available to borrow under this arrangement, supported by loan collateral as of December 31, 2022. At December 31, 2021, the Bank had no borrowing capacity under the Federal Reserve SBA PPP Liquidity Facility, as the program expired on July 30, 2021. We also had borrowing capacity of $4.1 million at the Federal Reserve Bank and $75 million of uncommitted federal funds purchased lines with correspondent banks as part of our contingency funding plan. In addition, the Company maintains a $5.0 million revolving line of credit which is available as needed for general liquidity purposes. While the Bank does not have formal brokered certificate lines of credit with counter parties at December 31, 2022, we believe that the Bank could access this market, which provides an additional potential source of liquidity as evidenced by third and fourth quarter 2022 new brokered deposits. See Note 9, “Federal Home Loan Bank and Other Borrowings” of “Notes to Consolidated Financial Statements” which are included in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K, for further detail.
In reviewing the adequacy of our 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, and 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 Arrangements. In the ordinary course of business, the Bank has entered into off-balance sheet financial instruments, issued to meet customer financial needs. Such financial instruments are recorded in the financial statements when they become payable. 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 of December 31, 2022, the Company had approximately $243.0 million in unused loan commitments, compared to approximately $271.0 million in unused commitments as of December 31, 2021. In addition, there are $4.7 million of commitments for contributions of capital to an SBIC and an investment company at December 31, 2022. These commitments totaled $5.0 million at December 31, 2021. See Note 11, “Commitments and Contingencies”; “Financial Instruments with Off-Balance Sheet Risk” of “Notes to Consolidated Financial Statements” which are included in Part II, Item 8, “Financial Statements and Supplementary Data” of this Form 10-K, for further detail.
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Capital Resources. As of the dates indicated below, our Tier 1 and Risk-based capital levels exceeded levels necessary to be considered “Well Capitalized” under Prompt Corrective Action provisions for the Bank.
Below are the amounts and ratios for our capital levels as of the dates noted below for the Bank.
Amount Ratio Amount Ratio Amount Ratio
At December 31, 2022, 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.
Actual For Capital AdequacyPurposes
Amount Ratio Amount Ratio
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Selected Quarterly Financial Data
The following is selected financial data summarizing the results of operations for each quarter as of the periods indicated below:
Year ended December 31, 2022:
Dividends paid $ 0.26 $ — $ — $ —
Year ended December 31, 2021:
Provision for loan losses — — — —
Dividends paid $ 0.23 $ — $ — $ —
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our Risk When Interest Rates Change. The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time. Market interest rates change over time and are not predictable or controllable. Accordingly, our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities. Like other financial institutions, our interest income and interest expense are affected by general economic conditions and policies of regulatory authorities, including the monetary policies of the Federal Reserve. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk.
How We Measure Our Risk of Interest Rate Changes. As part of our attempt to manage our exposure to changes in interest rates and comply with applicable regulations, we monitor our interest rate risk through several means including through the use of third party reporting software. In monitoring interest rate risk, we continually analyze and manage assets and liabilities based on their payment streams and interest rates, the timing of their maturities, and their sensitivity to actual or potential changes in market interest rates.
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In order to manage the potential for adverse effects of material and prolonged increases in interest rates on our results of operations, we adopted asset and liability management policies to better align the maturities and re-pricing terms of our interest earning assets and interest-bearing liabilities. These policies are implemented by our Asset and Liability Management Committee (ALCO). The ALCO is comprised of members of the Bank’s senior management and a member from the Board of Directors. The ALCO establishes guidelines for and monitors the volume and mix of our assets and funding sources, taking into account relative costs and spreads, interest rate sensitivity and liquidity needs. The Committee’s objectives are to manage assets and funding sources to produce results that are consistent with liquidity, cash flow, capital adequacy, growth, risk and profitability goals for the Bank. The ALCO meets on a regularly scheduled basis to review, among other things, economic conditions and interest rate outlook, current and projected liquidity needs and capital position, anticipated changes in the volume and mix of assets and liabilities and interest rate risk exposure limits versus current projections pursuant to net present value of portfolio equity analysis. At each meeting, the Committee recommends strategy changes, as appropriate, based on this review. The Committee is responsible for reviewing and reporting on the effects of the policy implementations and strategies to the Bank’s Board of Directors on a regularly scheduled basis.
In order to manage our assets and liabilities and achieve desired levels of liquidity, credit quality, cash flow, interest rate risk, profitability and capital targets, we have focused our strategies on:
•originating shorter-term secured commercial, agricultural and consumer loan maturities;
•originating variable rate commercial and agricultural loans;
•the sale of a vast majority of longer-term fixed-rate residential loans in the secondary market with retained servicing;
•managing our funding needs by growing core deposits;
•utilizing brokered certificate of deposits and borrowings as appropriate, which may have fixed rates with varying maturities;
•purchasing investment securities to modify our interest rate risk profile
At times, depending on the level of general interest rates, the relationship between long- and short-term interest rates, market conditions and competitive factors, the ALCO may determine to increase the Bank’s interest rate risk position somewhat in order to maintain or improve its net interest margin.
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The following table sets forth, at December 31, 2022 and December 31, 2021, an analysis of our interest rate risk as measured by the estimated changes in Economic Value of Equity (EVE) resulting from an immediate and permanent shift in the yield curve with the results of the scenarios shown in the table below. As of December 31, 2021, due to the level of interest rates, EVE estimates for decreases in interest rates greater than 100 basis points were not meaningful. The reduction in risk in the up-interest rate shocks from December 31, 2021 in the percentage of change in economic value of equity is largely due to the increased value of non-maturity deposits.
Percent Change in Economic Value of Equity (EVE)
(1)Assumes an immediate and parallel shift in the yield curve at all maturities.
Our overall interest rate sensitivity is demonstrated by net interest income shock analysis which measures the change in net interest income in the event of an immediate and permanent shift in the yield curve. This analysis assesses the risk of change in our net interest income over the next 12 months in the event of an immediate and parallel shift in the yield curve and the results of the scenarios are shown in the table below. As of December 31, 2021, due to the level of interest rates, projected changes in net interest income for rate shock level decreases greater than 100 basis points were not meaningful. The decrease in the reduction of the percent change in net interest income rate shocks in the up-interest scenarios is largely due to the impact of the actual results and changes in the balance sheet compared to a flat balance sheet used in the simulation.
Percent Change in Net Interest Income Over One Year Horizon
(1)Assumes an immediate and parallel shift in the yield curve at all maturities.
Note: The table above may not be indicative of future results.
The assumptions used to measure and assess interest rate risk include interest rates, loan prepayment rates, deposit decay (runoff) rates, and the market values of certain assets under differing interest rate scenarios. Actual values may differ from those projections set forth above should market conditions vary from the assumptions used in preparing the analysis. Further, the computations do not contemplate any actions we may undertake in response to changes in interest rates.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm (Eide Bailly LLP; Phoenix, Arizona; PCAOB ID 286)
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Income
Consolidated Statements of Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
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Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of
Citizens Community Bancorp, Inc. and Subsidiary
Eau Claire, Wisconsin
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Citizens Community Bancorp, Inc. and Subsidiary (the Company) as of December 31, 2022 and 2021, and the related consolidated statements of operations, comprehensive income, changes in stockholders’ equity, and cash flows for the years then ended, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2022 and 2021, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with auditing standards generally accepted in the United States of America, the Company’s internal control over financial reporting as of December 31, 2022, based on criteria established in 2013 Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 7, 2023, expressed an unmodified opinion.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risk of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks.Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements.Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements.We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
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Allowance for Loan Losses
As discussed in Notes 1 and 3 to the Company’s consolidated financial statements, the Company has a gross loan portfolio of $1.4 billion and related allowance for loan losses of $17.9 million as of December 31, 2022. The Company’s allowance for loan losses is a material and complex estimate requiring significant management’s judgment in the evaluation of the credit quality and the estimation of inherent losses within the loan portfolio. The allowance for loan losses includes a general reserve which is determined based on the results of a quantitative and a qualitative analysis of all loans not measured for impairment at the reporting date.
The Company’s general reserves cover non-impaired loans and is based on historical loss rates and qualitative loss factors for each portfolio. In calculating the allowance for loan losses, the Company considers relevant credit quality indicators for each loan segment, and estimates losses for each loan type based upon their nature and risk profile. This process requires significant management judgment in the review of the loan portfolio and assignment of risk ratings based upon the characteristics of loans. In addition, estimation of losses inherent within the portfolio requires significant management judgment, particularly where the Company has not incurred sufficient historical losses and has utilized industry data in forming its estimate.
Auditing these complex judgments and assumptions involves especially challenging auditor judgment due to the nature and extent of audit evidence and effort required to address these matters, including the extent of specialized skill or knowledge needed.
The primary procedures we performed to address this critical audit matter included:
•Obtaining an understanding of the Company’s process for determining the allowance for loan losses, which includes management’s determination of and changes to qualitative adjustments as of the balance sheet date.
•Evaluating the design and testing the operating effectiveness of controls relating to the development and approval of the allowance for loan loss methodology, controls around the reliability and accuracy of the information used in the calculation and management’s review and approval of the allowance for loan losses.
•Evaluating the reasonableness of assumptions and reasonableness, accuracy and completeness of data used by management in forming the loss factors by performing retrospective review of historic loan loss experience and analyzing historical data used in developing the assumptions.
•Evaluating the appropriateness of inputs and factors that the Company used in forming the qualitative loss factors and assessing whether such inputs and factors were relevant, reliable, and reasonable for the purpose used.
•Testing the mathematical accuracy and computation of the allowance for loan losses.
•Evaluated the period to period consistency with which qualitative loss factors are determined and applied. Evaluate the qualitative adjustments year over year for directional consistency and testing the reasonableness, including the qualitative adjustments attributed to the estimated impact of the COVID-19 pandemic on the Company’s loan portfolio.
/s/ Eide Bailly, LLP
We have served as the Company’s auditor since 2020.
Phoenix, Arizona
March 7, 2023
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CITIZENS COMMUNITY BANCORP, INC.
Consolidated Balance Sheets
(in thousands, except share data)
Assets
Other interest bearing deposits 249 1,511
Loans held for sale — 6,670
Mortgage servicing rights, net 4,262 4,161
Foreclosed and repossessed assets, net 1,271 1,408
Liabilities and Stockholders’ Equity
Liabilities:
Stockholders’ Equity:
Accumulated other comprehensive (loss) income (17,656) 161
See accompanying notes to audited consolidated financial statements.
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CITIZENS COMMUNITY BANCORP, INC.
Consolidated Statements of Operations
(in thousands, except per share data)
For the year ended December 31, 2022 For the year ended December 31, 2021
Interest and dividend income:
Interest expense:
Interest on FHLB borrowed funds 2,303 1,572
Interest on other borrowed funds 4,296 2,946
Net interest income before provision for loan losses 56,369 53,667
Provision for loan losses 1,475 —
Net interest income after provision for loan losses 54,894 53,667
Non-interest income:
Service charges on deposit accounts 2,018 1,726
Loan fees and service charges 679 705
Net gains on investment securities 541 1,224
Non-interest expense:
Amortization of intangible assets 1,449 1,596
Mortgage servicing rights expense, net 222 191
Advertising, marketing and public relations 1,017 986
FDIC premium assessment 470 551
Gain on repossessed assets, net (395) (199)
New market tax credit depletion 650 —
Income before provision for income taxes 23,581 28,959
Net income attributable to common stockholders $ 17,761 $ 21,266
Per share information:
Cash dividends paid $ 0.26 $ 0.23
See accompanying notes to audited consolidated financial statements.
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CITIZENS COMMUNITY BANCORP, INC.
Consolidated Statements of Comprehensive (Loss) Income
(in thousands)
For the year ended December 31, 2022 For the year ended December 31, 2021
Net income attributable to common stockholders $ 17,761 $ 21,266
Other comprehensive loss, net of tax:
Securities available for sale
Net unrealized losses arising during period, net of tax (17,817) (909)
Other comprehensive loss, net of tax (17,817) (1,329)
Comprehensive (loss) income $ (56) $ 19,937
See accompanying notes to audited consolidated financial statements.
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CITIZENS COMMUNITY BANCORP, INC.
Consolidated Statements of Changes in Stockholders’ Equity
(in thousands, except Shares)
Shares Amount
Other comprehensive income, net of tax — — — — (1,329) (1,329)
Forfeiture of unvested shares (1,500) — — — — —
Surrender of restricted shares of common stock (2,409) — (30) — — (30)
Restricted common stock awarded under the equity incentive plan 64,399 — — — — —
Common stock options exercised 5,800 — 52 — — 52
Stock option expense — — 8 — — 8
Amortization of restricted stock — — 797 — — 797
Cash dividends ($0.23 per share) — — — (2,511) — (2,511)
Other comprehensive income, net of tax — — — — (17,817) (17,817)
Forfeiture of unvested shares (2,626) — — — — —
Surrender of restricted shares of common stock (10,730) — (150) — — (150)
Restricted common stock awarded under the equity incentive plan 45,222 — — — — —
Common stock options exercised 7,900 — 71 — — 71
Stock option expense — — 3 — — 3
Amortization of restricted stock — — 860 — — 860
Cash dividends ($0.26 per share) — — — (2,742) — (2,742)
See accompanying notes to audited consolidated financial statements.
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CITIZENS COMMUNITY BANCORP, INC.
Consolidated Statements of Cash Flows
(in thousands)
For the year ended December 31, 2022 For the year ended December 31, 2021
Cash flows from operating activities:
Net income attributable to common stockholders $ 17,761 $ 21,266
Premium amortization, net of discount accretion on investment securities 41 103
Provision for loan losses 1,475 —
Net valuation gain on equity securities (541) (651)
Net realized gain on debt securities — (573)
Mortgage servicing rights amortization and impairment reversal, net 222 191
Amortization of intangible assets 1,449 1,596
Amortization of restricted stock 860 797
Net stock based compensation expense 3 8
Loss on sale of office properties and equipment — 31
Loss on closure of branch facilities 736 —
Decrease deferred income taxes 506 930
Increase in cash surrender value of life insurance (642) (628)
Net gain from disposals of foreclosed and repossessed assets (395) (199)
Gain on sale of loans held for sale, net (1,474) (5,399)
New market tax credit depletion 650 —
Net change in:
Accrued interest receivable and other assets 79 1,241
Net cash provided by operating activities 29,288 21,599
Cash flows from investing activities:
Net decrease in other interest bearing deposits 1,262 2,241
Purchase of available for sale securities (13,315) (130,545)
Purchase of held to maturity securities (35,342) (39,784)
Proceeds from sales of available for sale securities — 38,239
Proceeds from principal payments of available for sale securities 25,815 32,218
Proceeds from calls of held to maturity securities — 3,500
Purchase of equity investments (300) (960)
Equity investment capital distribution 136 —
Net (purchases) sales of other investments (290) 126
Proceeds from sales of foreclosed and repossessed assets 1,797 557
Proceeds from disposal of office properties and equipment 14 38
New market tax credit investment (4,056) —
Cash flows from financing activities:
Federal Home Loan Bank advances 112,000 —
Federal Home Loan Bank advances called (55,000) —
Federal Home Loan Bank advance termination payments (15,015) (8,113)
Federal Home Loan Bank maturities (11,000) (4,000)
Amortization of debt issuance costs 398 98
Proceeds from other borrowings, net of origination costs 34,191 —
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Other borrowings principal reductions (5,606) —
Other borrowings called and repaid (15,000) —
Repurchase shares of common stock (1,764) (7,951)
Surrender of restricted shares of common stock (150) (30)
Common stock options exercised 71 52
Net cash provided by financing activities 77,571 69,853
Net decrease in cash and cash equivalents (12,328) (71,749)
Cash and cash equivalents at beginning of period 47,691 119,440
Cash and cash equivalents at end of period $ 35,363 $ 47,691
Supplemental cash flow information:
Cash paid during the period for:
Supplemental noncash disclosure:
Transfers from loans receivable to foreclosed and repossessed assets $ 92 $ 84
See accompanying notes to audited consolidated financial statements.
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CITIZENS COMMUNITY BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements of Citizens Community Federal N.A. (the “Bank”) included herein have been included by its parent company, Citizens Community Bancorp, Inc. (the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). As used in this annual report, the terms “we”, “us”, “our”, and “Citizens Community Bancorp, Inc.” mean the Company and its wholly owned subsidiary, the Bank, unless the context indicates other meaning.
The Bank is a national banking association (a “National Bank”) and operates under the title of Citizens Community Federal National Association (“Citizens Community Federal N.A.” or “Bank”). The Company is a bank holding company, supervised by the Federal Reserve Bank of Minneapolis (the “FRB”), and operates under the title of Citizens Community Bancorp, Inc. The Office of the Comptroller of the Currency (the “OCC”), is the primary federal regulator for the Bank.
The consolidated income of the Company is principally derived from the income of the Bank, the Company’s wholly owned subsidiary, serving customers primarily in Wisconsin and Minnesota through 23 branch locations. Its primary markets include the Chippewa Valley Region in Wisconsin, Mankato and Twin Cities markets in Minnesota, and various rural communities around these areas. The Bank offers traditional community banking services to businesses, agricultural operators and consumers, including one-to-four family residential mortgages.
The Bank is subject to competition from other financial institutions and non-financial institutions providing financial products. Additionally, the Bank is subject to the regulations of certain regulatory agencies and undergoes periodic examination by those regulatory agencies.
In preparing these consolidated financial statements, we evaluated the events and transactions occurring subsequent to the balance sheet date of December 31, 2022 through the date on which the consolidated financial statements were available to be issued on March 7, 2023, for items that should potentially be recognized or disclosed in these consolidated financial statements.
Unless otherwise stated herein, and except for share and per share amounts, all amounts are in thousands.
Principles of Consolidation – The accompanying consolidated financial statements include the accounts of the Company and the Bank. All significant inter-company accounts and transactions have been eliminated.
Use of Estimates—Preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying disclosures. These estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Estimates are used in accounting for, among other items, fair value of financial instruments, the allowance for loan losses, mortgage servicing rights, foreclosed and repossessed assets, valuation of intangible assets arising from acquisitions, useful lives for depreciation and amortization, valuation of goodwill and long-lived assets, stock based compensation, deferred tax assets, uncertain income tax positions and contingencies. Management does not anticipate any material changes to estimates made herein in the near term. Factors that may cause sensitivity to the aforementioned estimates include but are not limited to: those items described under the caption “Risk Factors” in Item 1A of the accompanying annual report on Form 10-K for the year ended December 31, 2022 and external market factors such as market interest rates and unemployment rates, changes to operating policies and procedures, and changes in applicable banking regulations. Actual results may ultimately differ from estimates, although management does not generally believe such differences would materially affect the consolidated financial statements in any individual reporting period.
Cash and Cash Equivalents—For purposes of reporting cash flows in the consolidated financial statements, cash and cash equivalents include cash, due from banks, and interest bearing deposits with original maturities of three months or less.
Other Interest Bearing Deposits—Other interest bearing deposits are certificate of deposit investments made by the Bank with other financial institutions that are carried at cost. The weighted average months to maturity of the interest bearing deposits is 3.00 months. Balances over $250 in those institutions are not insured by the FDIC and therefore pose a potential risk in the event the institution were to fail. As of December 31, 2022 and December 31, 2021, there were no certificate of deposit accounts with a balance greater than $250.
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Investment Securities; Held to Maturity and Available for Sale – Management determines the appropriate classification of investment securities at the time of purchase and reevaluates such designation as of the date of each balance sheet. Securities are classified as held to maturity when the Company has the positive intent and ability to hold the securities to maturity. Held to maturity securities are stated at amortized cost. Investment securities not classified as held to maturity are classified as available for sale. Available for sale securities are stated at fair value, with unrealized holding gains and losses being reported in other comprehensive income (loss), net of tax. Unrealized losses deemed other-than-temporary due to credit issues are reported in the Company’s net income in the period in which the losses arise. Realized gains or losses on sales of available for sale securities are calculated with the specific identification method and are included in the consolidated statements of operations under net gains on investment securities. Interest income includes amortization of purchase premium or accretion of purchase discount. Amortization of premiums and accretion of discounts are recognized in interest income using the interest method over the estimated lives of the securities.
The Company evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. As part of such monitoring, the credit quality of individual securities and their issuer is assessed. Significant inputs used to measure the amount of other-than-temporary impairment related to credit loss include, but are not limited to: the Company’s intent and ability to sell the debt security prior to recovery, that it is more likely than not that the Company will not sell the security prior to recovery, default and delinquency rates of the underlying collateral, remaining credit support, and historical loss severities. Adjustments to market value of available for sale securities that are considered temporary are recorded in other comprehensive income or loss as separate components of stockholders’ equity, net of tax. If the unrealized loss of a security is identified as other-than-temporary based on information available, such as the decline in the creditworthiness of the issuer, external market ratings, or the anticipated or realized elimination of associated dividends, such impairments are further analyzed to determine if credit loss exists. If there is a credit loss, it will be recorded in the Company’s consolidated statement of operations. Non-credit components of the unrealized losses on available for sale securities will continue to be recognized in other comprehensive income (loss), net of tax.
Equity investments - The Company is required to maintain an investment in Federal Agricultural Mortgage Corporation (“Farmer Mac”) equity securities. Farmer Mac equity securities are carried at their fair market value, which is readily determinable. Changes in fair value are recognized as net gains (losses) on investment securities in the consolidated Statement of Operations.
Also included in equity investments are the Company’s investments in a Volcker Rule-compliant Small Business Investment Company (SBIC) and an investment fund. The SBIC and investment fund meet the definition of investment companies, as defined in ASC 946, Financial Services - Investment Companies. These investments seek returns by investing in various small businesses and do not have redemption rights. Distributions from the investments will be received as the underlying investments, which generally have a life of 10 years, are liquidated. We elected the practical expedient available in Topic 820, Fair Value Measurements, which permits the use of net asset value ("NAV") per share or equivalent to value investments in entities that are or are similar to investment companies. SBICs and investment funds report their investments at estimated fair value. We record the unrealized gains and losses resulting from changes in the fair value of these investments as gains or losses on equity securities in our consolidated statements of operations. The carrying value of these investments is equal to the capital account balance as provided by the investee and adjusted as necessary.
Other investments - As a member of the Federal Reserve Bank System and the Federal Home Loan Bank (“FHLB”) System, the Bank is required to maintain an investment in the capital stock of these entities. These securities are “restricted” in that they can only be sold back to the respective institutions or another member institution at par. Therefore, they are less liquid than other exchange traded equity securities. As no ready market exists for these stocks, and they have no quoted market value, these investments are carried at cost and periodically evaluated for impairment based on the ultimate recovery of par value. Cash dividends are reported as interest on investments in the consolidated statement of operations.
Also included in other investments is stock of our correspondent bank, Bankers’ Bank, without readily determinable fair value. This stock is carried at cost plus or minus changes resulting from observable price changes in orderly transactions for this stock, less other-than-temporary impairment charges, if any.
Management’s evaluation for impairment of these other investments includes consideration of the financial condition and other available relevant information of the issuer. Based on management’s quarterly evaluation, no impairment has been recorded on these securities. Other investments totaling $15,834 at December 31, 2022 consisted of $7,652 of FHLB stock, $5,674 of Federal Reserve Bank stock and $2,508 of Bankers’ Bank stock. Other investments totaling $15,305 at December 31, 2021 consisted of $7,877 of FHLB stock, $5,200 of Federal Reserve Bank stock, and $2,228 of Bankers’ Bank stock.
Loans receivable – Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs, accretable yield on acquired
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loans, and non-accretable discount on purchased credit impaired (PCI) loans. Interest income is accrued on the unpaid principal balance of these loans. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the interest method over the contractual life of the loan with no prepayments assumed. If the loan is prepaid, any amortized net fee is recognized at that time. Late charge fees are recognized into income when collected.
Interest income on commercial, mortgage and consumer loans is discontinued according to the following schedules:
•Commercial/agricultural real estate loans past due 90 days or more;
•Commercial and industrial/agricultural operating loans past due 90 days or more;
•Closed end 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.
Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual status or charged off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not received for a loan placed on nonaccrual status is reversed against interest income. Interest received on such loans is accounted for on the cash basis or cost recovery method until qualifying for return to accrual status. Loans are returned to accrual status when payments are made that bring the loan account current with the contractual term of the loan and a six month payment history has been established. Interest on accruing troubled debt restructured (“TDR”) loans, less than 90 days delinquent, is recognized as income as it accrues based on the revised terms of the loan over an established period of continued payment.
Residential mortgage loans and open ended consumer installment loans are charged off to estimated net realizable value less estimated selling costs at the earlier of when (a) the loan is deemed by management to be uncollectible, or (b) the loan becomes past due 180 days or more. Closed ended consumer installment loans are charged off to net realizable value at the earlier of when (a) the loan is deemed by management to be uncollectible, or (b) the loan becomes past due 120 days or more. Commercial/agricultural real estate, commercial and industrial and agricultural operating loans are charged off to net realizable value at the earlier of when (a) the loan is deemed by management to be uncollectible, or (b) the loan becomes past due 90 days or more.
Allowance for Loan Losses – The allowance for loan losses (“ALL”) is a valuation allowance for probable and inherent credit losses in our loan portfolio. Loan losses are charged against the ALL when management believes that the collectability of a loan balance is unlikely. Subsequent recoveries, if any, are credited to the ALL. Management estimates the required ALL balance taking into account the following factors: past loan loss experience; the nature, volume and composition of our loan portfolio; known and inherent risks in our portfolio; information about specific borrowers’ ability to repay; estimated collateral values; current economic conditions; and other relevant factors determined by management. The ALL consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component covers non-impaired loans and is based on historical loss experience adjusted for certain qualitative factors. The entire ALL balance is available for any loan that, in management’s judgment, should be charged off.
A loan is impaired when full payment under the loan terms is not expected. Impaired loans consist of all TDRs, as well as individual loans not considered a TDR, that are either (1) rated substandard or worse, (2) on nonaccrual status or (3) PCI loans which are impaired at the time of acquisition. Substandard loans, as defined by the OCC, our primary banking regulator, are loans that are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. All TDRs are individually evaluated for impairment. See Note 3, “Loans, Allowance for Loan Losses and Impaired Loans” for more information on what we consider to be a TDR. For TDR’s or substandard loans deemed to be impaired, a specific ALL allocation may be established so that the loan is reported, net, at the lower of (a) its outstanding principal balance; (b) the present value of the loan’s estimated future cash flows using the loan’s existing rate; or (c) at the fair value of any loan collateral, less estimated disposal costs, if repayment is expected solely from the underlying collateral of the loan. For TDRs less than 90+ days past due, and certain substandard loans that are less than 90+ days delinquent, the likelihood of the loan migrating to over 90 days past due is also taken into account when determining the specific ALL allocation for these particular loans. Large groups of smaller balance homogeneous loans, such as non-TDR commercial, consumer and residential real estate loans, are collectively evaluated for ALL purposes, and accordingly, are not separately identified for ALL disclosures.
Acquired Loans— Loans acquired in connection with acquisitions are recorded at their acquisition-date fair value with no carryover of related allowance for credit losses. Any allowance for loan loss on these pools reflect only losses incurred after the acquisition (meaning the present value of all cash flows expected at acquisition that ultimately are not to be received). Determining the fair value of the acquired loans involves estimating the principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest. Management considers a number of factors in evaluating the acquisition-date fair value including: the remaining life of the acquired loans, delinquency status, estimated
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prepayments, payment options and other loan features, internal risk grade, estimated value of the underlying collateral and interest rate environment.
Acquired loans that met the criteria for nonaccrual of interest prior to the acquisition may be considered performing upon acquisition, regardless of whether the customer is contractually delinquent, if we can reasonably estimate the timing and amount of the expected cash flows on such loans and if we expect to fully collect the new carrying value of the loans. As such, we may no longer consider the loan to be nonaccrual or nonperforming and may accrue interest on these loans, including the impact of any accretable yield.
Loans acquired with deteriorated credit quality are accounted for in accordance with Accounting Standards Codification (“ASC”) 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (ASC 310-30) if, at acquisition, the loans have evidence of credit quality deterioration since origination and it is probable that all contractually required payments will not be collected. At acquisition, the Company considers several factors as indicators that an acquired loan has evidence of deterioration in credit quality. These factors include, but are not limited to: loans 90 days or more past due, loans with an internal risk grade of substandard or below, loans classified as non-accrual by the acquired institution, and loans that have been previously modified in a troubled debt restructuring.
Under the ASC 310-30 model, the excess of cash flows expected to be collected at acquisition over recorded fair value is referred to as the accretable yield and is the interest component of expected cash flow. The accretable discount is recognized into income over the remaining life of the loan if the timing and/or amount of cash flows expected to be collected can be reasonably estimated (the accretion method). If the timing or amount of cash flows expected to be collected cannot be reasonably estimated, the cost recovery method of income recognition is used. The difference between the loan’s total scheduled principal and interest payments over all cash flows expected to be collected at acquisition, considering the impact of prepayments, is referred to as the non-accretable difference. The non-accretable difference represents contractually required principal and interest payments which the Company does not expect to collect.
Over the life of the loan, management continues to estimate cash flows expected to be collected. Decreases in expected cash flows are recognized as impairments through a charge to the provision for loan losses resulting in an increase in the allowance for loan losses. Subsequent improvements in cash flows result in first, reversal of existing valuation allowances recognized subsequent to acquisition, if any, and next, an increase in the amount of accretable discount to be subsequently recognized in interest income on a prospective basis over the loan’s remaining life.
Acquired loans that were not individually determined to be purchased with deteriorated credit quality are accounted for in accordance with ASC 310-20, Nonrefundable Fees and Other Costs (ASC 310-20), whereby the premium or discount derived from the fair market value adjustment, on a loan-by-loan or pooled basis, is recognized into interest income on a level yield basis over the remaining expected life of the loan or pool.
For all acquired loans, the outstanding loan balances less any related accretable discount and/or non-accretable difference is referred to as the loans’ carrying amount.
Loans Held for Sale — Loans held for sale are those loans the Company has the intent to sell in the foreseeable future. They are carried at the lower of aggregate cost or fair value. Gains and losses on sales of loans are recognized at settlement dates, and are determined by the difference between the sales proceeds and the carrying value of the loans after allocating costs to servicing rights retained. Such gains and losses are included as non-interest income in the consolidated statement of operations. All sales are made without recourse. Interest rate lock commitments on mortgage loans to be funded and sold are valued at fair value, and are included in other assets or liabilities, if material.
Transfers of financial assets—Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the entity, (2) the transferee obtains the right, free of conditions that constrain it from taking advantage of that right, to pledge or exchange the transferred assets, and (3) the entity does not maintain effective control over the transferred assets through an agreement to repurchase them before maturity.
Mortgage Servicing Rights— Mortgage servicing rights (“MSR”) assets result as the Company sells loans to investors in the secondary market and retains the rights to service mortgage loans sold to others. MSR assets are initially measured at fair value; assessed for impairment at least annually; 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, included in mortgage servicing rights expense in the consolidated statements of operations, thereon are based on numerous factors, assumptions and judgments, such as those for: changes in the
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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.
Servicing fee income, which is reported on the consolidated statements of operations in non-interest income as loan servicing fee income, is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of outstanding principal; or a fixed amount per loan and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income.
Office Properties and Equipment—Premises and equipment are stated at cost less accumulated depreciation. Land is carried at cost. Maintenance and repair costs are charged to expense as incurred. Gains or losses on disposition of office properties and equipment are reflected in income. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 10 to 40 years. Furniture, fixtures and equipment are depreciated using the straight-line (or accelerated) method with useful lives ranging from 3 to 10 years. Leasehold improvements are depreciated using the straight-line (or accelerated) method with useful lives based on the lesser of (a) the estimated life of the lease, or (b) the estimated useful life of the leasehold improvement.Depreciation expense is included in non-interest expense on the consolidated statements of operations.
Goodwill and other intangible assets—The Company accounts 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, primarily Core Deposit Intangibles (CDI) with definite useful economic lives over their useful economic lives originally ranging from 48 to 111 months 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. Goodwill is not amortized but, instead, is subject to impairment tests on at least an annual basis, and more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. 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 of December 31, 2022 which is related to its banking activities. The impairment testing process is conducted by assigning net assets and goodwill to the Company’s reporting unit. An initial qualitative evaluation is made to assess the likelihood of impairment and determine whether further quantitative testing to calculate the fair value is necessary. When the qualitative evaluation indicates that impairment is more likely than not, quantitative testing is required whereby the fair value of the Company’s reporting unit is calculated and compared to the recorded book value, “step one.” If the calculated fair value of the Company’s reporting unit exceeds its carrying value, goodwill is not considered impaired and “step two” is not considered necessary. If the carrying value of the company’s reporting unit exceeds its calculated fair value, the impairment test continues (“step two”) by comparing the carrying value of the Company’s reporting unit’s goodwill to the implied fair value of goodwill. An impairment charge is recognized if the carrying value of goodwill exceeds the implied fair value of goodwill. The Company has performed the required goodwill impairment test and has determined that goodwill was not impaired as of December 31, 2022. See Note 6 for additional information on goodwill and other intangible assets.
Foreclosed and Repossessed Assets – Assets acquired through foreclosure or repossession are initially recorded at fair value, less estimated costs to sell, which establishes a new cost basis. If the fair value declines subsequent to foreclosure or repossession, a write-down is recorded through expense. Costs incurred after acquisition are expensed and are included in non-interest expense, other in the consolidated statements of operations.
Bank Owned Life Insurance (BOLI)—The Bank invests in bank-owned life insurance (BOLI) as a source of funding for employee benefit expenses. BOLI involves the purchasing of life insurance by the Bank on a select group of employees. The Bank is the owner and beneficiary of the policies. Income from the increase in cash surrender value of the policies as well as the receipt of death benefits is included in non-interest income on the consolidated statements of operations.
New Markets Tax Credits - As a part of its commitment to the communities it serves, in the first quarter of 2022, the Company made an investment in an LLC that is sponsoring a community development project that has been awarded a New Markets Tax Credit (“NMTC”) through the U.S. Department of the Treasury’s Community Development Financial Institutions Fund. This investment is Community Reinvestment Act eligible and is designed to generate a return primarily through the realization of the tax credit. This LLC is considered a Variable Interest Entity (“VIE”), as the Company represents the holder of the equity investment at risk. However, the Company does not have the ability to direct the activities that most significantly affect the performance of the LLC. As such, the Company is not the primary beneficiary of the VIE and the LLC has not been consolidated. The investment is accounted for using the equity method of accounting and is amortized through non-interest
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expense as the related tax credits are utilized. The utilization of the tax credit is recognized as a reduction in income tax expense.
As of December 31, 2022, the carrying amount of this investment, which is included in other assets in the consolidated balance sheets, was $3,350. The risk of loss with this investment is limited to its carrying value and is tied to its ability to operate in compliance with the rules and regulations necessary for the qualification of the tax credit generated by the investment. As of December 31, 2022, there were no known instances of noncompliance associated with the investment.
Leases - We determine if an arrangement is a lease at inception. All of our existing leases have been determined to be operating leases under ASC 842. Right-of-use (“ROU”) assets are included in other assets in our consolidated balance sheets. Operating lease liabilities are included in other liabilities in our consolidated balance sheets. Lease expense is included in non-interest expense, occupancy in the consolidated statements of operations.
ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at commencement date, based on the present value of lease payments over the lease term. As none of our existing leases provide an implicit rate, we use our incremental borrowing rate, based on information available at commencement date, in determining the present value of lease payments. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Our lease terms may include options to extend or terminate the lease, when it is reasonably certain that we will exercise that option. Lease expense is recognized based on the total contractually required lease payments, over the term of the lease, on a straight-line basis. Some of the Bank’s leases require it to make variable payments for the Bank’s share of property taxes, insurance, common area maintenance and other costs. These variable costs are recognized when incurred and are also included in lease expense.
Debt and equity issuance costs—Debt issuance costs, which consist primarily of fees paid to note lenders, are deferred and included in other borrowings in the consolidated balance sheets. Debt issuance costs with a Company call option that originated prior to 2020 and senior note debt issuance costs, are amortized over the contractual term of the corresponding debt, as a component of interest expense on other borrowed funds in the consolidated statements of operations. Debt issuance costs that originated in 2020 and thereafter, are amortized through the first Company call option date of the corresponding debt, as a component of interest expense on other borrowed funds in the consolidated statements of operations. Specific costs associated with the issuance of shares of the Company’s common or preferred stock are netted against proceeds and recorded in stockholders’ equity, as additional paid in capital, on the consolidated balance sheets, in the period of the share issuance.
Advertising, Marketing and Public Relations Expense—The Company expenses all advertising, marketing and public relations costs as they are incurred.
Income Taxes – The Company accounts for income taxes in accordance with the Financial Accounting Standards Board (FASB) Accounting Standards Codification (“ASC”) Topic 740, “Income Taxes.” Under this guidance, deferred taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates that will apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date. See Note 14, “Income Taxes” for details on the Company’s income taxes.
The Company regularly reviews the carrying amount of its net deferred tax assets to determine if the establishment of a valuation allowance is necessary. If based on the available evidence, it is more likely than not that all or a portion of the Company’s net deferred tax assets will not be realized in future periods, a deferred tax valuation allowance would be established. Consideration is given to various positive and negative factors that could affect the realization of the deferred tax assets. In evaluating this available evidence, management considers, among other things, historical performance, expectations of future earnings, the ability to carry back losses to recoup taxes previously paid, the length of statutory carry forward periods, any experience with utilization of operating loss and tax credit carry forwards not expiring, tax planning strategies and timing of reversals of temporary differences. Significant judgment is required in assessing future earnings trends and the timing of reversals of temporary differences. Accordingly, the Company’s evaluation is based on current tax laws as well as management’s expectations of future performance.
Revenue Recognition - The Company’s primary source of revenue is interest income from interest earning assets, which is recognized on the accrual basis of accounting using the effective interest method. The recognition of revenues from interest earning assets is based upon formulas from underlying loan agreements, securities contracts or other similar contracts.
The company accounts for revenue from contracts with customers in accordance with ASC Topic 606, “Revenue from Contracts with Customers.” Topic 606 provides that revenue from contracts with customers be recognized when performance
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obligations under the terms of a contract are satisfied. Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring goods or providing service. The company does not have any materially significant payment terms as payment is received shortly after the satisfaction of the performance obligation. The statement of operations line items recognized under the scope of Topic 606 are as follows: