ITEM 1A. RISK FACTORS
The risks described below are not the only risks we face. Additional risks that we do not yet know of or that we currently believe are immaterial may also impair our future business operations. If any of the events or circumstances described in the
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following risks actually occurs, our business, financial condition or results of operations could be materially adversely affected. In such cases, the trading price of our common stock could decline.
RISKS RELATED TO ECONOMIC CONDITIONS
Our business may be adversely affected by conditions in the financial markets and economic conditions generally. We operate primarily in the Wisconsin and Minnesota markets. As a result, our financial condition, results of operations and cash flows are significantly impacted by changes in the economic conditions in those areas. In addition, our business is susceptible to broader economic trends within the United States economy. Economic conditions have a significant impact on the demand for our products and services, as well as the ability of our customers to repay loans, the value of the collateral securing loans and the stability of our deposit funding sources. A significant decline in general economic conditions caused by inflation, recession, tariffs, unemployment, changes in securities markets, changes in housing market prices, geopolitical uncertainties, natural disasters, pandemics and election outcomes or other factors could impact economic conditions and, in turn, could have a material adverse effect on our financial condition and results of operations.
Inflation may have an adverse impact on our business and on our customers. Inflation risk is the risk that the value of assets or income from investments will be worth less in the future as inflation decreases the value of money. The annual inflation rate as of December 2023 was 3.4% measured by consumer price index. Inflation increases the cost of goods and services we use in our business operations, such as electricity and other utilities, which increases our non-interest expenses. Furthermore, our customers are also affected by inflation and the rising costs of goods and services used in their households and businesses, which could have a negative impact on their ability to repay their loans with us.
Geopolitical tensions, including current or anticipated impact of military conflicts, could adversely affect general economic industry conditions. Geopolitical tensions may affect our earnings. Adverse economic conditions may result from a variety of factors including domestic and global economic and political developments, including civil unrest, terrorism, foreign investment restrictions, or military action, such as the armed conflict between Ukraine and Russia and corresponding sanctions imposed by the United States and other countries or the conflict in Israel and the surrounding areas, and new or evolving legal and regulatory requirements on business investment, hiring, migration, labor supply and global supply chains.
We are subject to higher lending risks with respect to our commercial and agricultural banking activities which could adversely affect our financial condition and results of operations. Our loans include commercial and agricultural loans, which include loans secured by real estate as well as loans secured by personal property. Commercial real estate lending, including agricultural loans, typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. Agricultural operating loans carry significant risks as they may involve larger balances concentrated with a single borrower or group of related borrowers. In addition, repayment of such loans depends on the successful operation or management of the farm property securing the loan for which an operating loan is utilized. Farming operations may be affected by factors outside of the borrower’s control, including adverse weather conditions, such as drought, hail or floods that can severely limit crop yields and declines in market prices for agricultural products. Although the Bank manages lending risks through its underwriting and credit administration policies, no assurance can be given that such risks will not materialize, in which event, our financial condition, results of operations, cash flows and business prospects could be materially adversely affected.
Future pandemics (including new variants of COVID-19), could materially affect our results of operations, financial position and/or liquidity. COVID-19 presented, and any future pandemics (including new variants of COVID-19) could present, the following risks, among others: inflation; increased unemployment levels; disruptions in global supply chains and financial markets; adverse legislative or regulatory actions; operational disruptions; increased general and administrative expenses; financial market disruption; and an economic downturn. These risks could materially and adversely impact our results of operations, financial position and/or liquidity. For a further discussion of risks that can impact us as a result of financial market disruption or an economic downturn, see “Our business may be adversely affected by conditions in the financial markets and economic conditions generally.”
RISKS RELATED TO OUR BUSINESS AND OPERATIONS
We rely on network and information systems and other technologies, and, as a result, we are subject to various Cybersecurity risks. Cybersecurity refers to the combination of technologies, processes and procedures established to protect information technology systems and data from unauthorized access, attack, or damage. Our business involves the storage and transmission of customers’ personal information. While we have internal policies and procedures designed to prevent or limit the effect of a failure, interruption or security breach of our information systems, as well as contracts and service agreements with applicable outside vendors, we cannot be assured that any such failures, interruptions or security breaches will not occur or, if they do, that they will be addressed adequately. Any failure or interruption of these systems could result in failures or disruptions in our loan, deposit, general ledger and other systems. We rely on the secure processing, storage and transmission of confidential and other information on our computer systems and networks. Unauthorized disclosure of sensitive or confidential
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client or customer information, whether through a breach of our computer systems or otherwise, could severely harm our business. Although we have implemented measures to prevent security breaches, cyber incidents and other security threats, our facilities and systems, and those of third party service providers, may be vulnerable to security breaches, acts of vandalism, computer viruses, misplaced or lost data, programming and/or human error, or other similar events that could have a material adverse effect on our business.
Although, to date, we have not experienced any material losses relating to cyber-attacks or other information security breaches, there can be no assurance that we will not suffer such losses in the future. Our risk and exposure to these matters remains heightened because of, among other things, the evolving nature of these threats, the outsourcing of some of our business operations and the continued uncertain global economic environment. As cyber threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities. Furthermore, the storage and transmission of such data is regulated at the federal and state level. Privacy information security laws and regulation changes, and compliance therewith, may result in cost increases due to system changes and the development of new administrative processes. If we fail to comply with applicable laws and regulations or experience a data security breach involving the misappropriation, loss or other unauthorized disclosure of confidential information, whether by us or our vendors, our reputation could be damaged, possibly resulting in lost future business, and we could be subject to fines, penalties, administrative orders and other legal risks as a result of a breach or non-compliance.
The impact of larger or similar-sized financial institutions encountering financial difficulties may adversely affect the Company's business, earnings and financial condition.
The Company is exposed to the risk that when a peer financial institution experiences financial difficulties, there could be an adverse impact on the regional banking industry and the business environment in which it operates. The bank failures of Silicon Valley Bank in California, Signature Bank in New York, and First Republic Bank in California during the first and second quarters of 2023 have caused a degree of concern and uncertainty in the investor community and among bank customers generally. Uncertainty may be compounded by the reach and depth of media attention and its ability to disseminate concerns about these types of events. This public uncertainty and concern could potentially affect the Bank despite its relatively high percentage of deposits (82% as of December 31, 2023) that are either insured or collateralized and its balance sheet liquidity and collateralized borrowing capacity being well in excess of the uninsured deposit balances. While the Company does not believe that the circumstances of these three banks' failures are indicators of broader issues with the banking system, the failures may reduce customer confidence, affect sources of funding and liquidity, increase regulatory requirements and costs, adversely affect financial markets and/or have a negative reputational ramification for the banking industry, including the Company. The Company will continue to monitor the ongoing events concerning these three banks as well as any future potential bank failures and volatility within the banking industry generally, together with any responsive measures taken by the banking regulators to mitigate or manage potential turmoil in the banking industry.
We are subject to interest rate risk. Through our banking subsidiary, the Bank, our profitability depends in large part on our net interest income, which is the difference between interest earned from interest earning assets, such as loans and mortgage-backed securities, and interest paid on interest bearing liabilities, such as deposits and borrowings. Our net interest income will be adversely affected if market interest rates change such that the interest we pay on deposits and borrowings increase faster than the interest earned on loans and investments. 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 due to many factors that are beyond our control, including but not limited to: general economic conditions and government policy decisions, especially policies of the Federal Reserve Bank. 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. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk. In particular, reduced interest rates negatively impact our results of operations.
We are subject to lending risk. There are inherent risks associated with our lending activities. These risks include the impact of changes in interest rates and changes in the economic conditions in the markets we serve, as well as those across the United States. Our exposure to lending risk is managed through the use of consistent underwriting standards, and we avoid highly leveraged transactions as well as excessive industry and other concentrations, but there can be no assurance that our risk mitigation measures will be effective in avoiding undue credit risk. An increase in interest rates or weakening economic conditions (such as high levels of unemployment) could further adversely impact the ability of borrowers to repay outstanding loans, or could substantially weaken the value of collateral securing those loans. Downward pressure on real estate values could increase the potential for problem loans and thus have a direct impact on our consolidated results of operations. In addition, we may purchase real estate, or we may foreclose on and take title to real estate. Although we exercise prudent due diligence when making loans, we could be subject to environmental liabilities with respect to these properties. See also “The COVID-19 pandemic may continue to impact economic conditions and affect our financial condition, our results of operations and other aspects of our business.”
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Changes in the fair value or ratings downgrades of our securities may reduce our stockholders’ equity, net earnings, or regulatory capital ratios. At December 31, 2023, $155.7 million of our securities, were classified as available for sale (AFS) and $91.2 million were classified as held to maturity (HTM). The estimated fair value of our AFS securities portfolio may increase or decrease depending on market conditions. Our AFS securities portfolio is comprised of fixed-rate, and to a lesser extent, floating rate securities. We increase or decrease stockholders’ equity by the amount of the change in unrealized gain or loss (the difference between the estimated fair value and amortized cost) of our AFS securities portfolio, net of the related tax benefit or provision, under the category of accumulated other comprehensive income/loss. Therefore, a decline in the estimated fair value of this portfolio due to interest rate changes will result in a decline in our reported stockholders’ equity, as well as our book value per common share and tangible book value per common share. This decrease will occur even though the securities are not sold. In the case of debt securities, if these securities are never sold, the decrease will be recovered over the life of the securities.
We conduct a periodic review and evaluation of our securities portfolio to determine if the decline in the fair value of any security below its cost basis is other-than-temporary. Factors which we consider in our analysis include, but are not limited to, the severity and duration of the decline in fair value of the security, the financial condition and near-term prospects of the issuer, whether the decline appears to be related to issuer conditions or general market or industry conditions, our intent and ability to retain the security for a period of time sufficient to allow for any anticipated recovery in fair value and the likelihood of any near-term fair value recovery. We generally view changes in fair value caused by changes in interest rates as temporary, which is consistent with our experience. If we deem such decline to be other-than-temporary related to credit losses, an allowance for credit losses(“ACL”) will be established. At December 31, 2023, no ACL was established for available for sale securities or held to maturity securities.At December 31, 2023, U.S. government issued or U.S. agency issued securities were carried at $181.3 million or 73.4% of the combined AFS and HTM portfolio.
The capital that we are required to maintain for regulatory purposes is impacted by, among other factors, the securities ratings on our portfolio. Therefore, ratings downgrades on our securities may also have a material adverse effect on our risk-based regulatory capital levels.
Our allowance for credit losses - loans may be insufficient. To address risks inherent in our loan portfolio, we maintain an allowance for credit losses that represents the Company’s best estimate of the reserve necessary to adequately account for probable losses expected over the remaining life of the assets. Factors considered by the Company in evaluating the overall adequacy of the allowance include historical net loan losses, the level and composition of nonaccrual, past due and modifications, trends in volumes and terms of loans, effects of changes in risk selection and underwriting standards or lending practices, lending staff changes, concentrations of credit, industry conditions and the current economic conditions in the region where the Company operates. The Company estimates the appropriate level of allowance for credit losses by evaluating loans collectively on a pooled basis when similar risk characteristics exist, and on an individual basis when management determines that a loan does not share similar risk characteristics with other loans. In evaluating our impaired loans, we assess repayment expectations and determine collateral values based on all information that is available to us. However, we must often make subjective decisions based on our assumption about the creditworthiness of the borrowers and the values of collateral securing these loans.
Deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, and other factors, both within and outside of our control, may require an increase in our allowance for credit losses. In addition, bank regulatory agencies periodically examine our allowance for credit losses and may require an increase in the allowance or the recognition of further loan charge-offs, based on judgments different from those of our management.
If charge-offs in future periods exceed our allowance for credit losses, we will need to take additional credit loss provisions to increase our allowance for credit losses. Any additional provision for credit losses will reduce our net income or increase our net loss, which could have a direct material adverse effect on our financial condition and results of operations.
Competition may affect our results. Competition in the banking and financial services industry is intense. Our profitability depends upon our continued ability to compete in our primary market area. We face strong competition in originating loans, in seeking deposits and in offering other banking services. We compete with commercial banks, trust companies, mortgage banking firms, credit unions, finance companies, mutual funds, insurance companies and brokerage and investment banking firms. Our market area is also served by commercial banks and savings associations that are substantially larger than us in terms of deposits and loans, have greater human and financial resources, and may offer certain services that we do not or cannot provide. This competitive climate can make it difficult to establish, maintain and retain relationships with new and existing customers and can lower the rate we are able to charge on loans, increase the rates we must offer on deposits, and affect our charges for other services. Those factors can, in turn, adversely affect our results of operations and profitability.
Customers may decide not to use banks to complete their financial transactions, which could result in a loss of income to us. Technology and other changes are allowing customers to complete financial transactions that historically have involved banks at one or both ends of the transaction. For example, customers can now pay bills and transfer funds directly without
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going through a bank. The process of eliminating banks as intermediaries, known as disintermediation, could result in the loss of fee income, as well as the loss of customer deposits.
We are a community bank and our ability to maintain our reputation is critical to the success of our business and the failure to do so may materially adversely affect our performance. We are a community bank, and our reputation is one of the most valuable components of our business. A key component of our business strategy is to rely on our reputation for customer service and knowledge of local markets to expand our presence by capturing new business opportunities from existing and prospective customers in our market area and contiguous areas. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering superior service to our customers and caring about our customers and associates. If our reputation is negatively affected by the actions of our employees, by our inability to conduct our operations in a manner that is appealing to current or prospective customers, or otherwise, our business and, therefore, our operating results may be materially adversely affected.
Maintaining or increasing our market share may depend on lowering prices and market acceptance of new products and services. Our success depends, in part, on our ability to adapt our products and services to evolving industry standards and customer demands. We face increasing pressure to provide products and services at lower prices, which can reduce our net interest margin and revenues from our fee-based products and services. In addition, the widespread adoption of new technologies, including internet and mobile banking services, could require us to make substantial expenditures to modify or adapt our existing products and services. Also, these and other capital investments in our business may not produce expected growth in earnings anticipated at the time of the expenditure. We may not be successful in introducing new products and services, achieving market acceptance of our products and services, or developing and maintaining loyal customers, which in turn, could adversely affect our results of operations and profitability.
We may not have sufficient pre-tax net income in future periods to fully realize the benefits of our net deferred tax assets. Assessing the need for, or the sufficiency of, a valuation allowance requires management to evaluate all available evidence. Based on future pre-tax net income projections and the planned execution of existing tax planning strategies, we believe that it is more likely than not that we will fully realize the benefits of our net deferred tax assets. However, our current assessment is based on assumptions and judgments that may or may not reflect actual future results. If a valuation allowance becomes necessary, it could have a material adverse effect on our consolidated results of operations and financial condition.
We could experience an unexpected inability to obtain needed liquidity. Liquidity measures the ability to meet current and future cash flow needs as they become due. The liquidity of a financial institution reflects its ability to meet loan requests, to accommodate possible outflows in deposits, and to take advantage of interest rate market opportunities. The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets and its access to alternative sources of funds. We seek to ensure our funding needs are met by maintaining an appropriate level of liquidity through asset/liability management. If we become unable to obtain funds when needed, it could have a material adverse effect on our business and, in turn, our consolidated financial condition and results of operations. Moreover, it could limit our ability to take advantage of what we believe to be good market opportunities for expanding our loan portfolio.
Future growth, operating results or regulatory requirements may require us to raise additional capital but that capital may not be available. We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. To the extent our future operating results erode capital or we elect to expand through loan growth or acquisition, we may be required to raise additional capital.
Our ability to raise capital will depend on conditions in the capital markets, which are outside of our control, and on our financial performance. Accordingly, we cannot be assured of our ability to raise capital when needed or on favorable terms. If we cannot raise additional capital when needed or if we are subject to material unfavorable terms for such capital, we may be subject to increased regulatory supervision and the imposition of restrictions on our growth and business. These actions could negatively impact our ability to operate or further expand our operations and may result in increases in operating expenses and reductions in revenues that could have a material adverse effect on our consolidated financial condition and results of operations.
We may not be able to attract or retain key people. Our success depends, in part, on our ability to attract and retain key people. We depend on the talents and leadership of our executive team, including Stephen M. Bianchi, our Chief Executive Officer, and James S. Broucek, our Chief Financial Officer. Competition for the best people in most activities engaged in by us can be intense, and we may not be able to hire people or retain them. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our local markets, years of industry experience and the difficulty of promptly finding qualified replacement personnel.
We continually encounter technological change. The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology driven by new or modified products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs.
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Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.
Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes. As a bank, we are susceptible to fraudulent activity that may be committed against us or our customers which may result in financial losses or increased costs to us or our customers, disclosure or misuse of our information or our customers' information, misappropriation of assets, privacy breaches against our customers, litigation or damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other dishonest acts.Consistent with industry trends, we have also experienced an increase in attempted electronic fraudulent activity in recent periods. Given such increase in electronic fraudulent activity and the growing level of use of electronic, internet-based and networked systems to conduct business directly or indirectly with our clients, certain fraud losses may not be avoidable regardless of the preventative and detection systems in place. Nationally, reported incidents of fraud and other financial crimes have increased. While we have policies and procedures designed to prevent such losses, there can be no assurance that such losses will not occur.
Our internal controls and procedures may fail or be circumvented. Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well-designed and operated, is based in part on certain assumptions and can provide only reasonable assurances that the objectives of the system are met. Any (a) failure or circumvention of our controls and procedures, (b) failure to adequately address any internal control deficiencies, or (c) failure to comply with regulations related to controls and procedures could have a material effect on our business, consolidated financial condition and results of operations. See Item 9A “Controls and Procedures” for further discussion of our internal controls.
Our growth strategy includes selectively acquiring businesses through acquisitions of other banks, and our ability to consummate these acquisitions on economically advantageous terms acceptable to us in the future is unknown. Our growth strategy includes acquisitions of other banks that serve customers or markets we find desirable, including our acquisitions of Community Bank of Northern Wisconsin (“CBN”), WFC, United Bank and F&M. The market for acquisitions remains highly competitive, and we may be unable to find satisfactory acquisition candidates in the future that fit our acquisition and growth strategy. This competition could increase prices for potential acquisitions that we believe are attractive. Any such acquisitions could be funded through cash from operations, the issuance of equity and/or the incurrence of additional indebtedness, which amount may be material, or a combination thereof. Any acquisition could be dilutive to our earnings and stockholders’ equity per share of our common stock. Also, acquisitions are subject to various regulatory approvals. If we fail to receive the appropriate regulatory approvals, we will not be able to consummate an acquisition that we believe is in our best interests. Among other things, our regulators consider our capital, liquidity, profitability, regulatory compliance and levels of goodwill and intangibles when considering acquisition and expansion proposals. To the extent that we are unable to find suitable acquisition candidates, an important component of our growth strategy may be lost.
Acquisition and expansion activities may disrupt our business, dilute existing stockholders and adversely affect our operating results. We acquired F&M in July 2019, United Bank in October 2018, WFC in August 2017 and CBN in May 2016. We intend to continue to evaluate potential acquisitions and expansion opportunities inthe normal course of our business. Although the integration of F&M, United Bank, WFC and CBN have been successfully completed, we cannot assure you that we will be able to adequately or profitably manage the ongoing integration of any future acquisitions. Acquiring other banks or financial service companies, as well as othergeographic and product expansion activities, involve various risks including:
•risks of unknown or contingent liabilities;
•unanticipated costs and delays;
•risks that acquired new businesses do not perform consistent with our growth and profitability expectations;
•risks of entering new markets or product areas where we have limited experience;
•risks that growth will strain our infrastructure, staff, internal controls and management, which may require additional personnel, time and expenditures;
•exposure to potential asset quality issues with acquired institutions;
•difficulties, expenses and delays of integrating the operations and personnel of acquired institutions, and start-up delays and costs of other expansion activities;
•potential disruptions to our business;
•possible loss of key employees and customers of acquired institutions;
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•potential short-term decreases in profitability; and
•diversion of our management’s time and attention from our existing operations and business.
Our failure to execute our acquisition strategy could adversely affect our business, results of operations, financial condition and future prospects.
Our ability to pay dividends depends primarily on dividends from our banking subsidiary, the Bank, which is subject to regulatory and other limitations. We are a bank holding company and our operations are conducted primarily by our banking subsidiary, the Bank. Since we receive substantially all of our revenue from dividends from the Bank, our ability to pay dividends on our common stock depends on our receipt of dividends from the Bank.
The Company is a legal entity separate and distinct from the Bank. As a bank holding company, the Company is subject to certain restrictions on its ability to pay dividends under applicable banking laws and regulations. Federal bank regulators are authorized to determine under certain circumstances relating to the financial condition of a bank holding company or a bank that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. In particular, federal bank regulators have stated that paying dividends that deplete a banking organization’s capital base to an inadequate level would be an unsafe and unsound banking practice and that banking organizations should generally pay dividends only out of current operating earnings. In addition, the Federal Reserve has indicated that bank holding companies should carefully review their dividend policy and has discouraged payment ratios that are at maximum allowable levels unless both asset quality and capital are very strong.
The ability of the Bank to pay dividends to us is also subject to its profitability, financial condition, capital expenditures and other cash flow requirements. The Bank may not be able to generate adequate cash flow to pay us dividends in the future. The Company’s ability to pay dividends is also subject to the terms of its Subordinated Note Purchase Agreements dated August 27, 2020 and March 11, 2022 and Business Note Agreement dated June 26, 2019 each of which prohibits the Company from declaring or paying dividends while an event of default has occurred and is continuing under each respective agreement. The Company has pledged 100% of Bank stock as collateral for the loan and credit facilities provided for by the Business Note Agreement. The inability to receive dividends from the Bank could have an adverse effect on our business and financial condition.
Furthermore, holders of our common stock are only entitled to receive the dividends as our Board of Directors may declare out of funds legally available for such payments. Although we have historically paid cash dividends on our common stock, we are not required to do so and our Board of Directors could reduce or eliminate our common stock dividend in the future. This could adversely affect the market price of our common stock.
Our shares of common stock are thinly traded and our stock price may be more volatile. Because our common stock is thinly traded, its market price may fluctuate significantly more than the stock market in general or the stock prices of similar companies, which are exchanged, listed or quoted on the NASDAQ Stock Market. We believe there are 9,047,304 shares of our common stock held by nonaffiliates as of March 5, 2024. Thus, our common stock will be less liquid than the stock of companies with broader public ownership, and as a result, the trading prices for our shares of common stock may be more volatile, which may make it difficult for investors to resell shares at the volume, prices and times desired. Among other things, trading of a relatively small volume of our common stock may have a greater impact on the trading price of our stock than would be the case if our public float were larger.
REGULATORY AND COMPLIANCE RISKS
A new accounting standard may require us to increase our allowance for loan losses and may have a material adverse effect on our financial condition and results of operations. The Financial Accounting Standards Board (“FASB”) adopted a new accounting standard referred to as Current Expected Credit Loss, or CECL, which requires financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for loan losses. CECL became effective in January 2023 for smaller reporting companies such as the Company. This changed the current method of providing allowances for loan losses that are probable, which may require us to increase our allowance for loan losses, and to greatly increase the types of data we will need to collect and review to determine the appropriate level of the allowance for loan losses. Banking regulators expect the new accounting standard will increase the allowance for loan losses. Any change in the allowance for loan losses will be an adjustment to retained earnings and would change the Bank’s capital levels. Any increase in our allowance for loan losses or expenses incurred to determine the appropriate level of the allowance for loan losses may have a material adverse effect on our financial condition and results of operations.
We operate in a highly regulated environment, and are subject to changes, which could increase our cost structure or have other negative impacts on our operations. The banking industry is extensively regulated at the federal and state levels. Insured depository institutions and their holding companies are subject to comprehensive regulation and supervision by financial regulatory authorities covering all aspects of their organization, management and operations. We are also subject to regulation by the SEC. Our compliance with these regulations, including compliance with regulatory commitments, is costly.
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Regulation includes, among other things, capital and reserve requirements, the level of deposit insurance premiums assessed, permissible investments and lines of business, mergers and acquisitions, restrictions on transactions with insiders and affiliates, anti-money laundering regulations, dividend limitations, community reinvestment requirements, limitations on products and services offered, loan limits, geographical limits, and consumer credit regulations. The system of supervision and regulation applicable to us establishes a comprehensive framework for our operations and is intended primarily for the protection of the Deposit Insurance Fund, our depositors and the public, rather than our stockholders. Any change in such regulation and oversight, whether in the form of regulatory policy, new regulations or legislation, or additional deposit insurance premiums could have a material impact on our operations. Failure to comply with applicable laws, regulations or policies could result in sanction by regulatory agencies, civil monetary penalties, and/or damage to our reputation, which could have a material adverse effect on our business, consolidated financial condition and results of operations. In addition, any change in government regulation could have a material adverse effect on our business or our ability to pay dividends.
Federal law restricts the amount of voting stock of a bank holding company or a bank, that a person or group may acquire, without the prior approval of banking regulators. Under the federal Change in Bank Control Act and the regulations thereunder, a person or group must give advance notice to the Federal Reserve before acquiring control of any bank holding company, such as the Company, and the OCC before acquiring control of any national bank, such as the Bank. Under the BHCA and Federal Reserve guidance thereunder, a person or group will be presumed to control a bank holding company if they acquire a certain percentage of the bank holding company or if one or more other control factors are present. On October 1, 2020, a Federal Reserve Board final rule became effective that clarified and codified the Federal Reserve’s standards for determining whether one company has control over another. The final rule established four categories of tiered presumptions of non-control that are based on the percentage of voting shares held by the investor (less than 5%, 5-9.9%, 10-14.9% and 15-24.9%) and the presence of other indicia of control. As the percentage of ownership increases, fewer indicia of control are permitted without falling outside of the presumption of non-control. These indicia of control include nonvoting equity ownership, director representation, management interlocks, business relationship and restrictive contractual covenants. Under the final rule, investors can hold up to 24.9% of the voting securities and up to 33% of the total equity of a company without necessarily being deemed to have a controlling influence. The overall effect of the BHCA is to make it more difficult to acquire a bank holding company and a bank by tender offer or similar means than it might be to acquire control of another type of corporation. Consequently, stockholders of the Company may be less likely to benefit from the rapid increases in stock prices that may result from tender offers or similar efforts to acquire control of other non-bank companies. Investors should be aware of these requirements when acquiring shares of our stock.
Our reporting obligations as a public company are costly. Reporting requirements of a public company change depending on the reporting classification in which the Company falls as of the end of its second quarter of each fiscal year. The Company is currently a “smaller reporting company” which allows us to provide certain simplified and scaled disclosures in our filings. We will remain a smaller reporting company for so long as the market value of the Company’s common stock held by non-affiliates as of the end of its most recently completed second fiscal quarter is less than $250 million, or as of the same period the Company’s annual revenues are less than $100 million and its public float is less than $700 million. In addition, the Company is currently considered a “non-accelerated filer” and will maintain that status for so long as the Company’s annual revenues are less than $100 million, and its public float is more than $75 million but less than $700 million. If the Company were to be classified as an “accelerated filer” rather than a “non-accelerated filer,” then we would become subject to the provisions of Section 404(b) of the Sarbanes-Oxley Act. Section 404(b) requires that an independent registered public accounting firm provide an attestation report on the Company’s internal control over financial reporting and the operating effectiveness of these controls, making the public reporting process more costly.
Changes in federal or state tax laws could adversely affect our business, financial condition and results of operations. Our business, financial condition and results of operations are impacted by tax policy implemented at the federal and state level. We cannot predict whether any other tax legislation will be enacted in the future or whether any such changes to existing federal or state tax law would have a material adverse effect on our business, financial condition and results of operations.
We are subject to changes in accounting principles, policies or guidelines. Our financial performance is impacted by accounting principles, policies and guidelines. Some of these policies require the use of estimates and assumptions that may affect the value of our assets or liabilities and financial results. Some of our accounting policies are critical because they require management to make subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. If such estimates or assumptions underlying our financial statements are incorrect, we may experience material losses.
From time to time, the FASB and the SEC change the financial accounting and reporting standards or the interpretation of those standards that govern the preparation of our financial statements. These changes are beyond our control, can be difficult to predict and could materially impact how we report our financial condition and results of operations. Changes in these standards are continuously occurring, and given recent economic conditions, more drastic changes may occur. The implementation of such changes could have a material adverse effect on our financial condition and results of operations.
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ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 1C. CYBERSECURITY
We maintain an information security program and governance framework that are designed to protect our information systems against operational risks related to cybersecurity.
Risk Management and Strategy
Cyber risk management is a critical component of our risk management framework. Processes for assessing, identifying, and managing material risks arising from cybersecurity threats are integrated in our policies and procedures, including our enterprise risk appetite, risk assessment, risk treatment, risk acceptance or exceptions, and third party risk management policies.
Our cybersecurity program (“Cybersecurity Program”) provides a framework for compliance with applicable cybersecurity and data protection laws. Our program is designed to ensure the security and confidentiality of customer information, protect against known or evolving threats to the security or integrity of customer records and personal information and protect against unauthorized access to or use of such information. We work with our regulators to ensure that these policies are adequately designed to appropriately safeguard personal information. We use a variety of processes and technologies to monitor for and identify cybersecurity threats, including vulnerabilities scans, endpoint and network monitoring software, and email scanning software. We also have a Cyber Incident Response Policy and detailed plans. We conduct annual cybersecurity risk assessments which drive strategic decisions. Employees are required to abide by our cybersecurity and data protection policies. We maintain a corporate cyber risk insurance policy as part of our cybersecurity risk strategy that is reviewed annually.
To date, the Company has not experienced a material cybersecurity incident.
Governance
Cybersecurity and data protection are important for the Company to maintain the trust of our customers, team members and stakeholders. Overseen by the Board of Directors and its Risk Committee, we regularly review, and as appropriate, adapt our Cybersecurity Program to an evolving landscape of emerging threats, evaluate effectiveness of key security controls, and assess cybersecurity best practices.
The Chief Information Security Officer (“CISO”) and the Chief Technology Officer (“CTO”) are key management roles responsible for assessing and managing material risks from cybersecurity threats. The CISO reports to the Risk Committee and is responsible for implementing and maintaining our enterprise cybersecurity organization. The CISO will maintain an Incident Response Plan. The CISO ensures that the Incident Response Plan is tested annually and will present testing results to the Risk Committee. The CISO and/or its delegate will share applicable threat information to ensure Board members and staff are informed on the evolving threat environment. The CISO is responsible for ensuring the Board of Directors and staff are trained annually on cybersecurity and information security awareness. Additionally, the CISO ensures staff is adequately trained on Incident Response Plan procedures. The CISO will ensure security incidents are logged and maintained. The CTO provides our Cybersecurity Program with the technical and functional resources to achieve its strategic goals and objectives, and partners and collaborates with the CISO.
The Risk Committee is responsible for overseeing the Company’s management of cybersecurity risk, including oversight into appropriate risk mitigation, strategies, processes, systems, and controls. The CISO has regular and direct communication with the Risk Committee, providing a written cybersecurity report to the Risk Committee and a written cybersecurity report and briefing to the full Board on an annual basis (more frequently as necessary), in order to inform the Risk Committee of the state of the Company’s Cybersecurity Program. These reports cover, but are not limited to, the Company’s cybersecurity posture, overall status of the Company’s compliance with the Cybersecurity Program, threat environment, material cybersecurity risks and events, Cybersecurity Program improvements and effectiveness, and other material matters related to the Cybersecurity Program.
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ITEM 2. PROPERTIES
The Company leases its main administrative offices located at 2174 EastRidge Center, Eau Claire, WI 54701. At December 31, 2023, the Bank had a total of 23 full-service branch offices located in the Wisconsin cities of Altoona, Barron, Eau Claire, Ellsworth, Ettrick, La Crosse, Ladysmith, Lake Hallie, Mondovi, Osseo, Rice Lake, Spooner, Strum and
Tomah (2); and the Minnesota cities of Albert Lea, Blue Earth, Fairmont, Faribault, Mankato, Oakdale, St. Peter and Wells. Of these, the Bank owns 19 and leases the remaining 4 branch offices. Management believes that our current facilities are adequate to meet our present and immediately foreseeable needs. For more information on our properties and equipment, see Note 5, Office Properties and Equipment of Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K. For more information on our leases, see Note 7, Leases of Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, the Company and/or the Bank occasionally become involved in various legal proceedings. While the outcome of any such proceeding cannot be predicted with certainty, in our opinion, any liability from such proceedings would not have a material adverse effect on the business or financial condition of the Company.
ITEM 4. MINE SAFETY DISCLOSURES
None
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Historically, trading in shares of our common stock has been limited. Citizens Community Bancorp, Inc. common stock is traded on the NASDAQ Global Market under the symbol “CZWI”.
We had approximately 564 stockholders of record at March 5, 2024. The number of stockholders does not separately reflect persons or entities that hold their stock in nominee or “street” name through various brokerage firms. We believe that the number of beneficial owners of our common stock on that date was substantially greater.
Dividends
The holders of our common stock are entitled to receive such dividends when and as declared by our Board of Directors and approved by our regulators. During the continuance of an event of default under its Subordinated Note Purchase Agreements entered into with certain accredited purchasers in August 2020 and March 2022, the Company would be restricted from declaring or paying any dividends on its capital stock. In determining the payment of cash dividends, our Board of Directors considers our earnings, capital and debt servicing requirements, the financial ratio guidelines of our regulators, our financial condition and other relevant factors.
The Company’s ability to pay dividends on its common stock is dependent on the dividend payments it receives from the Bank, since the Company receives substantially all of its revenue in the form of dividends from the Bank. Future dividends are not guaranteed and will depend on the Company’s ability to pay them. For more information on dividends, see Note 10, Capital Matters of Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.
Securities Authorized for Issuance Under Equity Compensation Plans
For information relating to securities authorized for issuance under equity compensation plans, see Part III, Item 12.
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Purchases of Equity Securities by the Issuer
On July 23, 2021, the Board of Directors adopted a new share repurchase program. Under this new share repurchase program, the Company may repurchase up to approximately 5% of the outstanding shares of its common stock as of July 23, 2021, or 532,962 shares, from time to time. During the quarter ended December 31, 2023, approximately 27 thousand shares were repurchased under this authorization. The table below shows information about our repurchases of our common stock during the three months ended December 31, 2023.
ITEM 6. RESERVED
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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, 2023 and December 31, 2022, and our financial position as of December 31, 2023 and December 31, 2022, 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, 2023 and December 31, 2022.
PERFORMANCE SUMMARY
The following is a summary of some of the significant factors that affected our operating results for the twelve months ended December 31, 2023, and 2022.In 2023, net interest income decreased, primarily due to the impact of higher short-term interest rates on the Bank’s liability-sensitive balance sheet, i.e., higher deposit costs, and customer account shifts to higher-cost certificates, along with increased borrowing costs, partially offset by higher yields on assets. The Company recorded $0.475 million of negative provision for credit losses in 2023, largely due to net recoveries of $0.451 million.In 2023, the allowance for credit losses (“ACL”) impact of loan growth was offset by favorable changes in overall economic factors and a modest reduction in specific ACL. A provision for loan losses of $1.475 million was recorded in 2022. Fiscal 2023’s higher interest rate and tight housing supply environment, led the Company to originate fewer mortgage loans for sale, which decreased gain on sale and income recorded in loan servicing income from the capitalization of mortgage servicing rights. Non-interest expense decreased modestly in 2023, largely due to lower compensation expense due to lower production incentives and lower net income and higher branch closing costs incurred in 2022.
When comparing year-over-year results, changes in net interest income, provision for credit 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 $13.06 million for the twelve months ended December 31, 2023, compared to net income of $17.76 million for the twelve months ended December 31, 2022. Diluted earnings per share were $1.25 for the twelve months ended December 31, 2023, compared to $1.69 for the twelve months ended December 31, 2022.Return on average assets for the twelve months ended December 31, 2023, was 0.71%, compared to 1.00% for the twelve months ended December 31, 2022. The return on average equity was 7.87% for the twelve months ended December 31, 2023, and 10.70% for the comparable period in 2022.
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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 Credit Losses
We adopted ASU 2016-13, Financial Instruments-Credit Losses (Topic 326), “Measurement of Credit Losses on Financial Instruments” through a cumulative-effect adjustment on January 1, 2023. We have selected a loss estimation methodology, utilizing a third-party model. See also Notes 1 and 3 to the audited consolidated financial statements for further discussion of our adoption of ASU 2016-13.
Allowance for Credit Losses – Held-to-Maturity Securities. Currently, all of the Company’s held-to-maturity securities are backed by governments or government agencies, for which the risk of credit loss is minimal. Accordingly, the Company does not record an allowance for credit losses on held-to-maturity securities.
Allowance for Credit Losses - Loans - We maintain an allowance for credit losses to absorb probable and inherent losses in our loan portfolio. The allowance is based on ongoing, quarterly assessments of the estimated lifetime losses in our loan portfolio. In evaluating the level of the allowance for credit 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 Allowances for Credit losses,” issued by the Office of the Comptroller of the Currency, Department of the Treasury, Federal Deposit Insurance Corporation, and National Credit Union Administration. We believe that the Bank’s Allowance for Credit Losses Policy conforms to all applicable regulatory requirements. However, based on periodic examinations by regulators, the amount of the allowance for credit losses recorded during a particular period may be adjusted.
Our determination of the allowance for credit losses - loans is based on (1) an individual allowance for specifically identified and evaluated loans that management has determined have unique risk characteristics. For these loans, the estimated loss is 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 amortized cost of the 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 collective allowance for loans not specifically identified in (1) above. The allowance for these loans is estimated by pooling loans with a similar risk profile and calculating a collective loss rate using the pool’s risk drivers, historical loss experience, and reasonable and supportable future economic forecasts to project lifetime losses. This collectively estimated loss is adjusted for qualitative factors.
Assessing the allowance for credit losses - loans 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.
Allowance for Credit Losses – Unfunded Commitments. The Company estimates expected credit losses over the contractual period for which the Company is exposed to credit risk, via a contractual obligation to extend credit, unless the obligation is unconditionally cancellable by the Company. The allowance for credit losses - unfunded commitments on off-balance sheet exposures is included in other liabilities on the consolidated balance sheet.
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
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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, 2023, 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 monitored events and conditions quarterly since December 31, 2022, and has determined that no triggering event has occurred that would require goodwill to be tested for impairment at an interim date. The Company also performed its required annual goodwill impairment testing and determined that goodwill was not impaired as of December 31, 2023.
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, 2023, a valuation allowance related to the realizability of its deferred tax assets was necessary due to the 2023 Wisconsin budget change, which resulted in the company not realizing a future deduction on its deferred assets. In the third quarter of 2023, a valuation allowance of $1.8 million was established.
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STATEMENT OF OPERATIONS ANALYSIS
Twelve months ended December 31, 2023 vs. Twelve months ended December 31, 2022
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 $48.3 million for 2023 compared to $56.4 million for 2022. The decrease, overall, is largely due to the impact of higher short-term interest rates, which with the Company’s liability sensitive balance sheet (See Market Risk Section of the MDA) resulted in (1) higher deposit costs due to customer retention strategies; (2) a deposit mix change,increasing deposit costs as customers moved from lower cost savings and money market products to higher cost certificates; (3) increased borrowing costs on FHLB advances; and (4) lower merger discount accretion of $1.2 million and lower SBA accretion of $0.3 million. These decreases to net interest income were partially offset by (1) a positive loan volume variance due to loan growth; and (2) increases in loan and investment yields due to contractual repricing; and (3) higher coupons on new loans.
The net interest margin for 2023 was 2.81% compared to 3.39% for 2022. The decrease in the net interest margin was due to the following factors: (1) higher deposit and borrowing costs, including the impact of a full year of interest expense on the subordinated debt issued in March 2022; and (2) eight basis points of lower accretion on merger discount and SBA PPP accretion. These decreases were partially offset by increases in loan and investment yields.
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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, 2023 and December 31, 2022.Non-accruing loans average balances are included in the table with the loans carrying a zero yield.
Twelve months ended December 31, 2023 Twelve months ended December 31, 2022
Average interest earning assets:
Average interest bearing liabilities:
Interest rate spread 2.31 % 3.19 %
Net interest margin (1) 2.81 % 3.39 %
(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, 2023 and 2022. The FTE adjustment to net interest income included in the rate calculations totaled $0 thousand and $1 thousand for the twelve month periods ended December 31, 2023 and 2022, 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, 2023 v. 2022 increase (decrease) due to
Volume (1) Rate (1) TotalIncrease /(Decrease)
Interest income:
Cash and cash equivalents $ (15) $ 822 $ 807
Interest bearing deposits (17) (6) (23)
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 Credit Losses. We determine our provision for credit losses (“provision”) based on our desire to provide an adequate Allowance for Credit Losses (“ACL”) - Loans to reflect estimated lifetime losses in our loan portfolio and ACL - Unfunded Commitments to reflect estimated losses on our unfunded commitments to lend. We use a third-party model to collectively evaluate and estimate the ACL on loans and unfunded commitments on a pooled basis. The model pools loans and commitments with similar characteristics and calculates an estimated loss rate for the pool based on identified risk drivers. These risk drivers vary with loan type. Projections about future economic conditions and the effect they could have on future losses are inherent in the model. Loans with uniquely identified circumstances and risks are individually evaluated. Lifetime losses on these loans are estimated based on the loans’ individual characteristics.
Total benefit, i.e., negative provision, for credit losses for the twelve months ended December 31, 2023, was $0.475 million, compared to provision of $1.475 million for the twelve months ended December 31, 2022. The current year’s negative provision is primarily the result of net recoveries of $0.425 million in the last six months of 2023 and improving forecasted future economic conditions.
Continued improving economic conditions in our markets, as evidenced by unemployment rates below the national average in our two largest population centers, have resulted in good overall economic trends for businesses.
Note that in discussing ACL allocations, the entire ACL balance is available for any loan that, in management’s judgment, should be charged off.
Management believes that the provision recorded for the current year’s twelve-month period is adequate in view of the present condition of our loan portfolio and the sufficiency of collateral supporting our non-performing loans. We continually
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monitor non-performing loan relationships and will adjust our provision, as necessary, if changing facts and circumstances require a change in the ACL. In addition, a decline in the quality of our loan portfolio as a result of general economic conditions, factors affecting particular borrowers or our market areas, or otherwise, could all affect the adequacy of our ACL. If there are significant charge-offs against the ACL, or we otherwise determine that the ACL is inadequate, we will need to record an additional provision in the future.
Non-Interest Income. The following table reflects the various components of non-interest income for 2023 and 2022, respectively.
Twelve months ended December 31, Change from prior year
Non-interest Income:
Service charges on deposit accounts $ 1,949 $ 2,018 (3.42)%
Net gains on investment securities 459 541 (15.16)%
N/M means not meaningful
Loan servicing income decreased for the twelve-month period ended December 31, 2023, compared to the same prior year period, due to lower origination volume of loans sold resulting in lower capitalization of mortgage service rights, along with lower mortgage servicing income due to servicing a smaller portfolio.
The increase in gain on sale of loans in 2023 is due to an increase in SBA loans sold, more than offsetting lower mortgage gains.
Loan fees and services charges are lower for the twelve-month period ended December 31, 2023, compared to the same period in 2022 due to lower customer transaction activity.
The change in net gains on investment securities between the twelve months ended December 31, 2023, and the twelve months ended December 31, 2022, is primarily due to the change in valuations of equity securities and a small gain on the sale of available for sale securities in the second quarter of 2023.
Other non-interest income increased for the twelve months ended December 31, 2023, compared to the same period in 2022 due in part to higher BOLI income and certain positive one-time events.
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Non-Interest Expense. The following table reflects the various components of non-interest expense for 2023 and 2022.
Twelve months ended December 31, % Change From prior year
Non-interest Expense:
Advertising, marketing and public relations 734 1,017 (27.83)%
(Losses) gains on repossessed assets, net 62 (395) (115.70)%
New market tax credit depletion — 650 N/M
Non-interest expense (annualized) / Average assets 2.19 % 2.32 %
Compensation expense decreased in 2023 largely due to lower incentive compensation due to lower production volumes and lower net income.
Amortization of intangible assets decreased for the twelve months ended December 31,2023, from the same prior year period, as intangible assets related to certain acquisitions have been fully amortized.
Mortgage servicing rights expense, net increased for the twelve months ended December 31, 2023, compared to the comparable prior year period due to the impact of a $566 thousand impairment reversal recorded in the comparable prior year period, partially offset by lower amortization due to lower forecasted prepayments and the impact of a lower balance of loans serviced for others.
Advertising, marketing and public relations expense decreased for the twelve months ended December 31, 2023, compared to the prior year period, due to management’s intentional decision to limit expenditures.
The FDIC insurance premium increased for the twelve-month period ended December 31, 2023, from the comparable prior year period due to an increase in the FDIC assessment rate. This was partially offset by the favorable impact of increased bank capital ratios, largely due to both a $15 million capital injection following the Company’s subordinated debt issuance in March of 2022, and the impact of growth in the Bank’s retained earnings.
In the first quarter of 2022, the Bank invested $4.1 million in a New Market Tax Credit. Based on the applicable accounting guidance at the time of investment, the related non-tax-deductible asset depletion would have occurred over a 5-year period in lockstep with the recognition of the tax credit. In March of 2023, FASB issued ASU 2023-02, which allows for proportional amortization of tax credit investments that meet certain criteria. We determined that our New Market Tax Credit investment met the criteria of ASU 2023-02 and chose to early adopt, using the modified retrospective approach as of January 1, 2023. Under ASU 2023-02, the amortization of the investment is now included in income tax expense.
The decrease in other expenses during the twelve months ended December 31, 2023, from the comparable prior year period, is largely related to branch closure costs incurred in 2022 of $1.0 million compared to $0.4 million in 2023.
Income Taxes. Income tax provision was $5.9 million in 2023 compared to $5.8 million for 2022. The 2023 effective tax rate was 31.0% compared to 24.7% in 2022. The Wisconsin state budget, signed by Governor Evers on July 5, 2023, provides financial institutions a tax exemption on income earned on Wisconsin commercial and agricultural loans up to $5 million retroactive to January 1, 2023. This change reduced the Company’s 2023 Wisconsin state income tax rate and thus, its overall effective tax rate. However, this benefit was offset by a one-time tax expense of $1.8 million reflecting the impact of the lower
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2023 Wisconsin state tax rate on the future realization of existing net deferred tax assets, with the charge creating a Wisconsin state tax valuation allowance. In addition, the impact of the New Market Tax Credit investment depletion, now being included in income tax expense, increased the income tax rate, while lower pre-tax income reduced current period income tax expense.
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. As noted above, a Wisconsin income tax valuation allowance was created due to the Wisconsin budget law change, resulting in reduction of the realization of Wisconsin deferred tax assets.
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BALANCE SHEET ANALYSIS
Total assets increased by $35.0 million to $1.85 billion at December 31, 2023, from $1.82 billion at December 31, 2022.
Cash and Cash Equivalents. Cash and cash equivalents increased from $35.4 million at December 31, 2022, to $37.1 million at December 31, 2023, largely due to an increase in interest-bearing balances.
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 $155.7 million at December 31, 2023, compared with $166.0 million at December 31, 2022. This decrease is due to principal repayments, maturities and $5 million of SBA floating-rate securities sales. These reductions were partially offset by purchases of $8 million of SBA floating-rate securities.
Securities held to maturity decreased to $91.2 million at December 31, 2023, compared to $96.4 million at December 31, 2022. The decrease was largely due to principal repayments. The unrealized loss on the held to maturity portfolio decreased by $1.6 million during the year to $18.0 million at December 31, 2023.
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 $ 16,655 $ 16,576
U.S. government agency obligations $ 18,373 $ 18,313
Held to maturity securities AmortizedCost FairValue
Obligations of states and political subdivisions $ 600 $ 565
Total held to maturity securities $ 91,229 $ 73,262
Obligations of states and political subdivisions $ 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, 2023 were as follows:
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Available for sale securities AmortizedCost EstimatedFair Value
Due in one year or less $ — $ —
Due after one year through five years 13,986 13,703
Due after five years through ten years 45,549 39,701
Total securities with contractual maturities 88,653 82,263
Held to maturity securities AmortizedCost EstimatedFair Value
Due in one year or less $ 100 $ 100
Due after one year through five years 500 465
Due after five years through ten years — —
Total securities with contractual maturities 600 565
Total held to maturity securities $ 91,229 $ 73,262
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
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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
Less than 12 Months 12 Months or More Total
Obligations of states and political subdivisions $ — $ — $ 565 $ 35 $ 565 $ 35
Obligations of states and political subdivisions $ — $ — $ 546 $ 54 $ 546 $ 54
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
Non-rated — — — —
December 31, December 31,
Held to maturity securities AmortizedCost FairValue AmortizedCost FairValue
AAA — — — —
AA — — — —
At December 31, 2023, the Bank pledged certain of its mortgage-backed securities with a carrying value of $29.2 million as collateral to secure a line of credit with the Federal Reserve Bank. As of December 31, 2023, there were no borrowings outstanding on this Federal Reserve Bank line of credit. As of December 31, 2023, the Bank has pledged certain of its U.S. Government Agency securities with a carrying value of $0.5 million and mortgage-backed securities with a carrying value of $1.9 million as collateral against specific municipal deposits. As of December 31, 2023, the Bank also has mortgage-backed securities with a carrying value of $0.2 million and U.S. Government Agencies with a carrying value of $0.4 million pledged as collateral to the Federal Home Loan Bank of Des Moines.
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.
Loans. Total loans outstanding, net of deferred loan fees and costs, increased to $1.46 billion at December 31, 2023, from $1.42 billion at December 31, 2022.
Gross loan growth consisted largely of $24.6 million in commercial real estate loans, $19.2 million of multi-family real estate loans, $8.4 million in construction and land development loans and residential mortgage loan growth of $23.6 million. The growth in these portfolios exceeded the reduction in the remaining loan portfolios of $27.1 million.
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The following table reflects the composition, or mix, of our loan portfolio at December 31, 2023 and December 31, 2022:
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:
Unamortized discount on acquired loans (1,205) (0.1) % (1,766) (0.1) %
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, 2023, the largest loan concentration we identified was commercial real estate loans which comprised 51% of our total loan portfolio. Approximately 89% of our total gross loans are secured by real estate.
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The following table sets forth, as of December 31, 2023 and December 31, 2022 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 1 — % 16 — %
Unamortized discount on acquired loans (1,205) (0.1) % (1,766) (0.1) %
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Loan amounts, their contractual maturities and weighted average interest rates at December 31, 2023 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, 2022 are shown below.
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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Risk Management and the Allowance for Credit Losses - Loans. The Allowance for Credit Losses - Loans (“ACL”) is a valuation allowance for expected future credit losses in the Company’s loan portfolio as of the balance sheet date. In determining the allowance, the Company estimates credit losses over the loan’s entire contractual term, adjusted for expected prepayments when appropriate. The allowance estimate considers qualitative and quantitative relevant information from internal and external sources relating to historical loss experience; known and inherent risks in our portfolio; information about specific borrowers’ ability to repay; estimated collateral values; current economic conditions; reasonable and supportable forecasts for future conditions; and other relevant factors determined by management. To ensure that the ACL is maintained at an adequate level, a detailed analysis is performed on a quarterly basis and an appropriate provision is made to adjust the allowance. The entire ACL balance is available for any loan that, in management’s judgment, should be charged off.
The determination of the ACL requires significant judgement to estimate credit losses. The ACL is measured collectively on a pooled basis when similar risk characteristics exist, and on an individual basis when management determines that the loan does not share similar risk characteristics with other loans. The ACL on loans collectively evaluated is measured using the loss rate model. The Company categorizes its loan portfolio into four segments based on similar risk characteristics. Loans within each segment are pooled based on individual loan characteristics. Aggregated risk drivers are then calculated at a pool level. Risk drivers are identified attributes that have proven to be predictive of loan loss rates and vary based on loan segment and type. A loss rate is calculated and applied to the pool utilizing a model that combines the pool’s risk drivers, historical loss experience, and reasonable and supportable future economic forecasts to projected lifetime losses. The loss rate is then combined with the loan’s balance and contractual maturity, adjusted for expected prepayments, to determine expected future losses. Future and supportable economic forecasts are based on national economic conditions and their reversion to the mean is implicit in the model and generally occurs over a period of two years.
Qualitative adjustments are made to the allowance calculated on collectively evaluated loans to incorporate factors not included in the model. Qualitative factors include but are not limited to: lending policies and procedures, the experience and ability of lending and other staff, the volume and severity of problem credits, quality of the loan review system, and other external factors.
Loans that exhibit different risk characteristics from the pool are individually evaluated for impairment. Loans can be identified for individual evaluation for a variety of reasons including delinquency, nonaccrual status, risk rating and loan modification. Accruing loans that exhibit different risk characteristics from their pool may also be within scope. On these loans, an allowance may be established so that the loan is reported, net, at the lower of (a) its amortized cost; (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 the loan is collateral dependent. Collateral dependency is determined using the practical expedient when: (1) the borrower is experiencing financial difficulty; and (2) repayment is expected to be provided substantially through the sale or operation of the collateral.
In addition, various regulatory agencies periodically review the ACL. These agencies may require the Company to make additions to the ACL or may require that certain loan balances be charged off or downgraded into classified loan categories when the agencies’ evaluation differs from management’s evaluation based on their judgments of collectability from the information available to them at the time of examination.
The Allowance for Credit Losses - Unfunded Commitments is a liability for expected future credit losses on the Company’s commitments to lend. The Company estimates expected credit losses over the contractual period for which the Company is exposed to credit risk, via a contractual obligation to extend credit, unless the obligation is unconditionally cancellable by the Company. The Allowance for Credit Losses - Unfunded Commitments on off-balance sheet exposures is included in other liabilities on the consolidated balance sheet.
On January 1, 2023, the Company adopted Accounting Standards Update (“ASU”) 2016-13, Financial Instruments using the modified retrospective method. This adoption resulted in a $4.7 million increase in the ACL on loans (“ACL - Loans”) and established a $1.5 million ACL on unfunded commitments (“ACL - Unfunded Commitments”). The increase in transition ACL is primarily due to the interaction of change from an incurred loss model to a lifetime loss model and the duration of our portfolio. Since transition, the ACL- Loans modestly increased $0.3 million to $23.0 million at December 31, 2023, representing 1.57% of loans receivable. The allowance for loan losses, prior to the ASU 2016-13 transition, was $17.9 million at December 31, 2022, representing 1.27% of loans receivable. The increase in the ACL - Loans from ACL adoption in 2023, was primarily due to net loan recoveries. The ACL - Unfunded Commitments, established under ASU 2016-13, was $1.3 million at December 31, 2023.
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Allowance for Credit Losses - Loans Roll Forward
(in thousands, except ratios)
Twelve Months Ended
Allowance for Credit Losses (“ACL”)
ACL - Loans, at beginning of period $ 17,939 $ 16,913
Loans charged off:
Commercial/Agricultural real estate (46) (205)
C&I/Agricultural operating — (346)
Residential mortgage (78) (68)
Consumer installment (36) (48)
Total loans charged off (160) (667)
Recoveries of loans previously charged off:
Commercial/Agricultural real estate 489 102
C&I/Agricultural operating 47 36
Residential mortgage 42 29
Consumer installment 33 51
Total recoveries of loans previously charged off: 611 218
Net loan recoveries/(charge-offs) (“NCOs”) 451 (449)
Ratios:
NCOs (annualized) to average loans (0.03) % 0.03 %
Allowance for Credit Losses - Loans Activity by Segment
(in thousands, except ratios)
Twelve months ended December 31, 2023
Allowance for Credit Losses - Loans:
Allowance for Credit Losses - Loans to Percentage
(in thousands, except ratios)
ACL - Loans to loans, end of period 1.57 % 1.27 %
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Allowance for Credit Losses - Unfunded Commitments:
(in thousands)
In addition to the ACL - Loans, the Company has established an ACL - Unfunded Commitments of $1.250 million at December 31, 2023 and $0 at December 31, 2022, classified in other liabilities on the consolidated balance sheets.
ACL - Unfunded Commitments - beginning of period $ — $ —
ACL - Unfunded Commitments - end of period $ 1,250 $ —
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 being recorded as interest income. The Company adopted ASU 2022-02 on January 1, 2023, which eliminated special accounting rules for TDRs. Prior to the elimination of the special accounting rules, TDR loans were accounted for under ASC 310-40. A TDR is typically involved granting some concession to the borrower involving a loan modification, such as modifying the payment schedule or making interest rate changes. TDR loans may have involved loans that 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.
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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 ACL for the periods then ended:
Nonperforming assets:
Nonaccrual loans
Construction and land development 54 —
Commercial and industrial (“C&I”) — 552
Consumer installment 33 31
Accruing loans past due 90 days or more 389 246
Other collateral owned — 6
Total nonperforming assets (“NPAs”) $ 15,368 $ 12,721
ACL - Loans, at beginning of period $ 17,939 $ 16,913
Loans charged off:
Commercial/Agricultural real estate (46) (205)
C&I/Agricultural operating — (346)
Residential mortgage (78) (68)
Consumer installment (36) (48)
Total loans charged off (160) (667)
Recoveries of loans previously charged off:
Commercial/Agricultural real estate 489 102
C&I/Agricultural operating 47 36
Residential mortgage 42 29
Consumer installment 33 51
Total recoveries of loans previously charged off: 611 218
Net loan recoveries/(charge-offs) (“NCOs”) 451 (449)
Ratios:
NCOs (annualized) to average loans 0.03 % (0.03) %
ACL to total loans 1.57 % 1.27 %
NPLs to total loans 0.93 % 0.81 %
NPAs to total assets 0.83 % 0.70 %
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Nonaccrual Loans Roll Forward
Quarter Ended
Transfers to OREO (23) — (110) (25) —
Return to accrual status — (190) — (252) —
Nonaccrual loans increased by $2.0 million at December 31, 2023, from $11.2 million at December 31, 2022, largely due to adding a $5.4 million hotel loan from special mention to substandard and nonaccrual in the second quarter of 2023, partially offset by payments received, which include loan payoffs. Nonperforming assets increased to $15.4 million or 0.83% of total assets at December 31, 2023, compared to $12.7 million, or 0.70% of total assets at December 31, 2022. During 2023, the transfer of a closed branch to REO was offset by the reduction in 90+ delinquent and accruing residential loans.
Refer to the “Allowance for Credit Losses - Loans” and “Nonperforming Loans, Potential Problem Loans and Foreclosed Properties” sections above for more information related to nonperforming loans.
Below is a summary of loan modifications made to borrowers experiencing financial difficulty during the twelve months ended December 31, 2023.
Term Extension
Commercial real estate $ 4,694 0.63 %
Commercial and industrial $ 2,200 1.82 %
Residential mortgage $ 35 0.03 %
Other consumer $ 1 0.02 %
Other-Than-Insignificant Payment Delay
Residential mortgage $ 69 0.05 %
Other consumer $ 19 0.31 %
Included in the nonaccrual loans roll forward table above, for periods prior to the January 1, 2023 adoption of ASU 2022-02 are nonaccrual TDR loans. Nonaccrual TDR loans were $2.6 million at December 31, 2022.
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Number ofModifications RecordedInvestment
Troubled debt restructurings: Accrual Status
Commercial/Agricultural real estate 10 $ 1,336
C&I/Agricultural operating 5 960
Consumer installment — —
The table below shows a summary of criticized loans, split by special mention and substandard balances, for the past five quarters. Criticized loans increased by $8.5 million in the twelve months ended December 31, 2023. Two new relationships, each $9 million, moved to special mention in the second quarter and a $5 million relationship moved from special mention to substandard in the second quarter. Special mention loans decreased $1.7 million in the fourth quarter, largely due to loans being upgraded and principal reductions of $2.2 million. Substandard changes from December 31, 2022, are impacted by the addition of a $5 million loan relationship in the second quarter moving from special mention and a $3.7 million loan relationship secured by single family rental homes in the Twin Cities added in the fourth quarter, partially offset by loan repayments.
In addition to our discussion of criticized, special mention, and substandard loans above, the following information provides further insights about our loans to certain industries. As of December 31, 2023, hotel loans totaled $97 million with a weighted average LTV of 55% and average balance of $3.9 million. Restaurant loans totaled $52 million, at December 31, 2023. The weighted-average LTV percentage on these restaurant loans was 48% and the average loan balance was $709 thousand. Approximately $39 million of restaurant loans are to franchise quick-service restaurants. At December 31, 2023, we have $40 million of office loans with a weighted average LTV of 64% and average loan balance of $574 thousand. A large percentage of the related office properties are located outside of large cities.
(in thousands)
Mortgage Servicing Rights. Mortgage servicing rights (“MSR”) assets are initially measured at fair value; assessed at least quarterly for impairment; carried at the lower of the initial capitalized amount, net of accumulated amortization, or estimated fair value. MSR assets are amortized in proportion to and over the period of estimated net servicing income, with the amortization recorded in non-interest expense in the consolidated statement of operations. The valuation of MSRs and related amortization thereon are based on numerous factors, assumptions, and judgments, such as those for: changes in the mix of loans, interest rates, prepayment speeds, and default rates. Changes in these factors, assumptions and judgments may have a material effect on the valuation and amortization of MSRs. Although management believes that the assumptions used to evaluate the MSRs for impairment are reasonable, future adjustment may be necessary if future economic conditions differ substantially from the economic assumptions used to determine the value of MSRs.
The amortized cost of MSR assets decreased as amortization exceeded additions due to loan sales, resulting in the unpaid balances of one-to-four family residential real estate loans serviced for others to decrease as of December 31, 2023, to $495.5 million from $523.7 million at December 31, 2022.
The fair market value of the Company’s MSR asset was $5.6 million at December 31, 2023, and $5.7 million at December 31, 2022. At December 31, 2023, and December 31, 2022, the Company did not have an MSR impairment, or related valuation allowance. The fair market value of the Company’s MSR asset as a percentage of its servicing portfolio at December 31, 2023, and December 31, 2022, was 1.13% and 1.08%, respectively.
Intangible Assets. We have intangible assets of $1.7 million at December 31, 2023, compared to $2.4 million at December 31, 2022. The intangible assets were comprised of core deposit intangible assets arising from various acquisitions
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from 2016 through 2019. In the fourth quarter of 2022, one of the acquisition core deposits became fully amortized, leading to a reduction in amortization in 2023. Amortization of these intangibles was $0.8 million in 2023.
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 $0.9 million and $0.7 million, respectively, which represent their estimated fair market values less the anticipated costs to sell. In 2023, a loss of $0.4 million was recognized on the reclassification of the $0.7 million from property and equipment to foreclosed assets, which was recorded in other expense.
Deposits. Deposits have grown each quarter since December 31, 2022, with growth in brokered deposits accounting for the growth in the first and second quarters of 2023. From March 7, 2023, to March 31, 2023, a period closely monitored for unusual withdrawal activity, balances remained stable. Total deposits increased $94.4 million during the twelve months ended December 31, 2023, to $1.52 billion.
Deposit Composition
(in thousands)
Consumer, commercial and government deposits have been stable since January 31, 2023, and following the two large coastal bank failures in early March 2023. There are no material customer or industry deposit concentrations. Deposits decreased during January 2023 as commercial customers decreased their cash balances to support the needs of their businesses with the commercial customers balances increasing from March 31, 2023.
Deposit Portfolio Composition
(in thousands)
At December 31, 2023, our deposit portfolio composition was 54% consumer, 28% commercial, 12% public and 6% brokered deposits. At December 31, 2022, our deposit portfolio composition was 57% consumer, 28% commercial, 12% public and 3% brokered deposits.
Uninsured and uncollateralized deposits were $275.8 million, or 18% of total deposits at December 31, 2023, and $298.8 million, or 21% of total deposits at December 31, 2022. Uninsured deposits alone at December 31, 2023, were $427.5 million, or 28% of total deposits, and $441.2 million, or 31% of total deposits at December 31, 2022, with the difference being an increase in fully secured government deposits.
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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, 2023 and December 31, 2022 is as follows:
Other borrowings:
Unamortized debt issuance costs (618) (841)
(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 $1,106,267 and $984,878 at December 31, 2023 and 2022, respectively. At December 31, 2023, the Bank’s available and unused portion under the FHLB borrowing arrangement was approximately $370,569 compared to $256,773 as of December 31, 2022.
(2) Maximum month-end borrowed amounts outstanding under this borrowing agreement were $217,530 and $157,530, during the twelve months ended December 31, 2023 and December 31, 2022, respectively.
(3) The weighted-average interest rates on FHLB borrowings, with maturities less than twelve months, outstanding as of December 31, 2023 and December 31, 2022 were 4.16% and 4.09%, respectively.
(4) At December 31, 2023, one FHLB term note totaling $10,000 could be called once by the FHLB on June 15, 2024, and if not called, would mature in 2028. At December 31, 2022, no FHLB term notes could be called by the FHLB.
(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 and modified in February of 2023, requiring quarterly interest-only payments through March 2027, 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 2024, that remains undrawn upon.
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(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 would have converted to a three-month LIBOR plus 4.90% rate, and the interest rate would have reset quarterly thereafter if not called. 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. The note was callable by the Bank when, and anytime after, the floating rate was initially set. Interest-only payments were due quarterly.
(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 decreased $63.0 million to $79.5 million as of December 31, 2023, compared to $142.5 million as of December 31, 2022. The Bank had January 2024 advance maturities of $44 million and an additional $5 million of advances maturing in the first quarter of 2024. The bank entered into $15 million of five-year advances, callable once after six months, in the second quarter of 2023, which were called in the fourth quarter 2023. The Bank entered into a $10 million five-year maturity advance callable one time in June 2024. The Bank terminated $15.0 million of advances in the quarter ended March 31, 2022, incurring a $2 thousand prepayment penalty, as we 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 $107 million of FHLB advances maturing in January 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, 2023, is approximately $370.6 million.
The Bank maintains two unsecured federal funds purchased lines of credit with its banking partners which total $70.0 million. These lines bear interest at the lender banks announced daily federal funds rate, mature daily and are revocable at the discretion of the lending institution. There were no borrowings outstanding on these lines of credit as of December 31, 2023, or December 31, 2022.
At December 31, 2023, and 2022, the Bank had the ability to borrow $22.4 million and $4.1 million from the Federal Reserve Bank of Minneapolis. The ability to borrow is based on mortgage-backed securities pledged with a carrying value of $29.2 million and $5.4 million as of December 31, 2023, and 2022, respectively. There were no Federal Reserve borrowings outstanding as of December 31, 2023, and 2022.
Stockholders’ Equity. Total stockholders’ equity was $173.3 million at December 31, 2023, compared to $167.1 million at December 31, 2022. The increase in stockholders’ equity included the Company’s net income of $13.0 million, restricted stock amortization of $0.7 million and a decrease in the unrealized loss on available for sale securities of $0.3 million, net of tax, due to lower interest rates. These increases were offset by: (1) the $4.4 million cumulative effect adjustment from the adoption of ASU 2016-13; (2) the payment of the annual cash dividend paid in February to common stockholders of $0.29 per share, or $3.0 million; and (3) the repurchase of approximately 42 thousand shares of its common stock, which reduced equity by $0.4 million.
On July 23, 2021, the Board of Directors adopted a share repurchase program. There were 14 thousand shares repurchased in the second quarter of 2023, no shares repurchased during the first and third quarters of 2023, and 27 thousand
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shares repurchased during the fourth quarter. As of December 31, 2023, an additional 202 thousand shares remain available for repurchase.
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 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 unpledged securities portfolio divided by total assets. At December 31, 2023, our on-balance sheet liquidity ratio decreased to 11.4% percent from 13.0% at December 31, 2022, remaining above our internal requirement of 10%. This was largely due to reductions in the AFS and HTM investment portfolios.
There are no material customers or industry deposit concentrations. At December 31, 2023, our deposit portfolio composition was 54% consumer, 28% commercial, 12% public and 6% brokered deposits. At December 31, 2022, our deposit portfolio composition was 57% consumer, 28% commercial, 12% public and 3% brokered deposits.
Uninsured and uncollateralized deposits were $275.8 million, or 18% of total deposits, at December 31, 2023, and $298.8 million, or 21% of total deposits, at December 31, 2022. Uninsured deposits alone at December 31, 2023, were $427.5 million, or 28% of total deposits, and $441.2 million, or 31% of total deposits at December 31, 2022, with the difference being an increase in fully secured government deposits.
On-balance sheet liquidity, collateralized borrowing and uncommitted federal funds availability was $673.6 million, or 244% of uninsured and uncollateralized deposits at December 31, 2023. At December 31, 2022, on-balance sheet liquidity, collateralized borrowing and uncommitted federal funds availability was $614.9 million, or 221% of uninsured and uncollateralized deposits.
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 $329.9 million of our $359.5 million (92%) 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 2021 and early 2022. Since June of 2022, we strategically increased CD pricing, which resulted in growth in certificates, as customers looked to increase duration. Retail non-maturity interest-bearing accounts have decreased at approximately the same rate as the certificate accounts, as our customers have moved to higher-yielding certificates and spent money. 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. However, this is challenging in the current competitive environment.
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 $370.6 million available to borrow under this arrangement, supported by loan collateral as of December 31, 2023. We also had borrowing capacity of $22.4 million at the Federal Reserve Bank and have been approved to access the Bank Term Funding Program (“BTFP”) if the need should arise. The Bank maintains $70 million of uncommitted federal funds purchased lines with correspondent banks as part of our contingency funding plan. In addition, the Company has 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, 2023, we believe that the Bank could access this market, which provides an additional potential source of liquidity, as evidenced by access to this market during the past four quarters. 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.
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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, 2023, the Company had approximately $210.4 million in unused loan commitments, compared to approximately $243.0 million in unused commitments as of December 31, 2022. In addition, there are $3.4 million of commitments for contributions of capital to an SBIC and an investment company at December 31, 2023. These commitments totaled $4.7 million at December 31, 2022. 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, 2023, 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, 2023:
Cash dividends paid $ 0.29 $ — $ — $ —
Year ended December 31, 2022:
Cash dividends paid $ 0.26 $ — $ — $ —
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 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 managing our assets and liabilities to achieve desired levels of interest rate risk, 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 growing core deposits;
•utilize 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, 2023 and December 31, 2022 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 (up 300 basis points and down 200 basis points).
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 hypothetical changes in interest rates. 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 (up 300 basis points and down 200 basis points). The table below presents our projected change in net interest income for the various rate shock levels at December 31, 2023, and December 31, 2022.
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 projected changes in net interest income in the rate shock scenarios is largely due to the impact of growth in short-term certificates of deposits, which reprice faster and at a higher rate than other deposit products. 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 (Loss)
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, 2023 and 2022, and the related consolidated statements of operations, comprehensive income (loss), 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, 2023 and 2022, 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.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these 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.
Change in Accounting Principle
As discussed in Note 1 to the financial statements, the Company adopted the provisions of FASB Accounting Standards Update 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as of January 1, 2023, using the modified retrospective approach with an adjustment at the beginning of the adoption period. Our opinion is not modified with respect to this matter.
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 Credit Losses
The Company has a gross loan portfolio of $1.5 billion and related allowance for credit losses (ACL) of $22.9 million as of December 31, 2023. As discussed in Notes 1 and 3 to the Company’s consolidated financial statements, the ACL represents management’s estimate of expected credit losses over the contractual life of the loan portfolio. The ACL is estimated using relevant available information relating to past events, current economic conditions, and reasonable and supportable forecasts, as well as qualitative adjustments applied on a portfolio segment basis. the qualitative adjustments are used to bring the ACL to the level management believes is appropriate based on factors that are otherwise unaccounted for in the quantitative process.
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 establishing the ACL, including the models selected by management to estimate quantitative components of the ACL and qualitative adjustments made to the ACL. This includes the process utilized by management to challenge the model results and determine the best estimate of the ACL as of the balance sheet date.
•Evaluating the design and testing the operating effectiveness of controls relating to the development and approval of the ACL methodology, management’s identification and determination of the significant assumptions used in the Probability of Default (PD) and Loss Given Default (LGD) models, controls related to the reliability and accuracy of the data used in the models, analysis of the ACL results and the management’s review and approval of the ACL.
•Evaluating the appropriateness of the model methodology used to incorporate a reasonable and supportable forecast period and reversion to historical loss rates by inspecting the model documentation and by comparing it to relevant industry practices.
•Determining whether the loan portfolio is segmented by similar risk characteristics by comparing to the Company’s business environment and relevant industry practices.
•Testing the completeness and accuracy of internal loan level data used as the basis for the calculation.
•Evaluating the reasonableness of forecasted economic scenarios.
•Evaluating the identification and measurement of the qualitative adjustments, including the basis for concluding an adjustment was warranted and compared the adjustments utilized by management to both internal portfolio metrics and external macroeconomic data to support the adjustments and evaluated the trends in such adjustments. We evaluated information that corroborates or contradicts management’s reasonable and supportable forecast as well as identification and measurement of qualitative factors.
/s/ Eide Bailly, LLP
We have served as the Company’s auditor since 2020.
Phoenix, Arizona
March 5, 2024
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CITIZENS COMMUNITY BANCORP, INC.
Consolidated Balance Sheets
(in thousands, except share data)
Assets
Other interest bearing deposits — 249
Loans held for sale 5,773 —
Mortgage servicing rights, net 3,865 4,262
Foreclosed and repossessed assets, net 1,795 1,271
Liabilities and Stockholders’ Equity
Liabilities:
Stockholders’ Equity:
Accumulated other comprehensive loss (17,328) (17,656)
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, 2023 For the year ended December 31, 2022
Interest and dividend income:
Interest expense:
Interest on FHLB borrowed funds 5,966 2,303
Interest on other borrowed funds 4,184 4,296
Net interest income before provision for credit losses 48,349 56,369
Provision for credit losses (475) 1,475
Net interest income after provision for credit losses 48,824 54,894
Non-interest income:
Service charges on deposit accounts 1,949 2,018
Loan fees and service charges 432 679
Net gains on investment securities 459 541
Non-interest expense:
Amortization of intangible assets 755 1,449
Mortgage servicing rights expense, net 615 222
Advertising, marketing and public relations 734 1,017
FDIC premium assessment 812 470
Losses (gains) on repossessed assets, net 62 (395)
New market tax credit depletion — 650
Income before provision for income taxes 18,932 23,581
Net income attributable to common stockholders $ 13,059 $ 17,761
Per share information:
Cash dividends paid $ 0.29 $ 0.26
See accompanying notes to audited consolidated financial statements.
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CITIZENS COMMUNITY BANCORP, INC.
Consolidated Statements of Comprehensive Income (Loss)
(in thousands)
For the year ended December 31, 2023 For the year ended December 31, 2022
Net income attributable to common stockholders $ 13,059 $ 17,761
Other comprehensive income (loss), net of tax:
Securities available for sale
Net unrealized gains (losses) arising during period, net of tax 337 (17,817)
Other comprehensive income (loss), net of tax 328 (17,817)
Comprehensive income (loss) $ 13,387 $ (56)
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 loss, 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)
Other comprehensive income, net of tax — — — — 328 328
Forfeiture of unvested shares (4,752) — — — — —
Surrender of restricted shares of common stock (10,287) — (129) — — (129)
Restricted common stock awarded under the equity incentive plan 50,606 1 — — — 1
Common stock options exercised 3,000 — 28 — — 28
Amortization of restricted stock — — 722 — — 722
Cash dividends ($0.29 per share) — — — (3,040) — (3,040)
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, 2023 For the year ended December 31, 2022
Cash flows from operating activities:
Net income attributable to common stockholders $ 13,059 $ 17,761
Investment securities net (discount accretion) premium amortization (64) 41
Provision for credit losses (475) 1,475