Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operations.
The following
discussion and analysis identifies significant factors that have affected our financial position and operating results during
the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction
with the financial statements and the related notes and the other statistical information also included in this Annual Report
on Form 10-K.
Overview
We are headquartered
in Lexington, South Carolina and serve as the bank holding company for the Bank. We engage in a general commercial and retail
banking business characterized by personalized service and local decision making, emphasizing the banking needs of small to medium-sized
businesses, professionals and individuals. We operate from our main office in Lexington, South Carolina, and our 21 full-service
offices located in the South Carolina counties of Lexington County (6 offices), Richland County (4 offices), Newberry County (2
offices), Kershaw County (1 office), Aiken County (1 office), Greenville County (2 offices), Anderson County (1 office), Pickens
County (1 office), and York County (1 office); and in the Georgia counties of Richmond County (1 office) and Columbia County (1
office).
The following
discussion describes our results of operations for 2025, as compared to 2024 and 2023, and also analyzes our financial condition
as of December 31, 2025, as compared to December 31, 2024. Like most community banks, we derive most of our income from interest
we receive on our loans and investments. A primary source of funds for making these loans and investments is our deposits, on
which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference
between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities,
such as deposits and borrowings.
We have included
a number of tables to assist in our description of these measures. For example, the “Average Balances” table shows
the average balance during 2025, 2024 and 2023 of each category of our assets and liabilities, as well as the yield we earned
or the rate we paid with respect to each category. A review of this table shows that our loans typically provide higher interest
yields than do other types of interest earning assets, which is why we intend to channel a substantial percentage of our earning
assets into our loan portfolio. Similarly, the “Rate/Volume Analysis” table helps demonstrate the impact of changing
interest rates and changing volume of assets and liabilities during the years shown. We also track the sensitivity of our various
categories of assets and liabilities to changes in interest rates, and we have included a “Sensitivity Analysis Table”
to help explain this. Finally, we have included a number of tables that provide detail about our investment securities, our loans,
our deposits and our borrowings.
There are risks inherent
in all loans, so we maintain an allowance for credit losses to absorb expected losses. We establish and maintain this allowance
by charging a provision for credit losses against our operating earnings. In the following section, we have included a detailed discussion
of this process, as well as several tables describing our allowance for credit losses and the allocation of this allowance among our
various categories of loans.
In addition to
earning interest on our loans and investments, we earn income through fees and other expenses we charge to our customers. We describe
the various components of this noninterest income, as well as our noninterest expense, in the following discussion. The discussion
and analysis also identifies significant factors that have affected our financial position and operating results during the periods
included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with the
financial statements and the related notes and the other statistical information also included in this report.
Critical Accounting Estimates
We have
adopted various accounting policies that govern the application of accounting principles generally accepted in the United States
and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting
policies are described in the notes to our consolidated financial statements in this report.
Certain
accounting policies inherently involve a greater reliance on the use of estimates, assumptions, and judgments and, as such, have
a greater possibility of producing results that could be materially different than originally reported, which could have a material
impact on the carrying values of our assets and liabilities and our results of operations. We consider these accounting policies
and estimates to be critical accounting policies. We have identified the determination of the allowance for credit losses,
income taxes and deferred tax assets and liabilities, goodwill and other intangible assets, and derivative instruments to be the
accounting areas that require the most subjective or complex judgments and, as such, could be most subject to revision as new
or additional information becomes available or circumstances change, including overall changes in the economic climate and/or
market interest rates. Therefore, management has reviewed and approved these critical accounting policies and estimates and has
discussed these policies with our Audit and Compliance Committee.
Allowance for Credit Losses
As of
January 1, 2023, we adopted Financial Accounting Standards Board (“FASB”) Accounting Standard Update (“ASU”)
2016-13 Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASC
326”), which changed the methodology, accounting policies and inputs used in determining the allowance for credit losses
(“ACL”). We believe the allowance for credit losses is the critical accounting policy that requires the most significant
judgment and estimates used in preparation of our consolidated financial statements.
The allowance
for credit losses represents our best estimate of credit losses on financial assets. The allowance for credit losses is assessed
at least quarterly and adjustments are recorded in the provision for credit losses. These losses are estimated using historical
loss rates and a projection of reasonable and supportable macroeconomic forecast, combined with additional qualitative factors.
At December 31, 2025 and 2024, we held an allowance for credit losses for our held-to-maturity investment securities, our loans
held-for-investment and our unfunded commitments that are not unconditionally cancelable.
The allowance
for credit losses represents an amount which we believe will be adequate to absorb expected losses on existing financial assets
that may become uncollectible. Our judgment as to the adequacy of the allowance for credit losses is based on assumptions about
future events, which we believe to be reasonable, but which may or may not prove to be accurate. There can be no assurance that
charge-offs of financial assets in future periods will not exceed the allowance for credit losses as estimated at any point in
time or that provisions for credit losses will not be significant to a particular accounting period.
The allowance
for credit losses represents management’s best estimate for our expected losses at December 31, 2025 and 2024, but significant
downturns in circumstances relating to asset quality and economic conditions could result in a requirement for additional allowance
for credit losses. Likewise, an upturn in asset quality and improved economic conditions may allow a reduction in the required
allowance for credit losses. In either instance, unanticipated changes could have a significant impact on results of operations.
In addition, regulatory agencies, as an integral part of their examination process, periodically review our allowance for credit
losses. Such agencies may require us to recognize additions to the allowance for credit losses based on their judgments about
information available to them at the time of their examination.
Income Taxes, Deferred Tax Assets,
and Deferred Tax Liabilities
We are subject
to the income tax laws of the U.S., its states, and the municipalities in which we operate. These tax laws are complex and subject
to different interpretations by the taxpayer and the relevant government taxing authorities.
Income taxes
are provided for the tax effects of the transactions reported in our consolidated financial statements and consist of taxes currently
due plus deferred taxes related to differences between the tax basis and accounting basis of certain assets and liabilities, including
available-for-sale securities, allowance for credit losses, write-downs of OREO properties, write-downs on premises held-for-sale,
accumulated depreciation, net operating loss carry forwards, accretion income, deferred compensation, intangible assets, and pension
plan and post-retirement benefits. The deferred tax assets and liabilities represent the future tax return consequences of those
differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax
assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets or liabilities
are expected to be realized or settled. A valuation allowance is recorded when it is “more likely than not” that a
deferred tax asset will not be realized. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are
adjusted through the provision for income taxes.
In establishing
our provision for income taxes, our deferred tax assets and liabilities, and our valuation allowance, we must make judgments and
interpretations about the application of these inherently complex tax laws. We must also make estimates about when in the future
certain items will affect taxable income in the various tax jurisdictions. Disputes over interpretations of the tax laws may be
subject to review/adjudication by the court systems of the various tax jurisdictions or may be settled with the taxing authority
upon examination or audit. Although we believe that the judgments and estimates used are reasonable, and we believe our estimates
have been reasonably accurate, actual results could differ, and we may be exposed to losses or gains that could be material. To
the extent we prevail in matters for which reserves have been established, or are required to pay amounts in excess of our reserves,
our effective income tax rate in a given financial statement period could be materially affected. An unfavorable tax settlement
would result in an increase in our effective income tax rate in the period of resolution. A favorable tax settlement would result
in a reduction in our effective income tax rate in the period of resolution.
Goodwill and Other Intangible
Assets
Goodwill
represents the cost in excess of fair value of the net assets we acquired (including identifiable intangibles) in purchase transactions.
Other intangible assets represent premiums paid for acquisitions of core deposits (core deposit intangibles).
We
test our goodwill for impairment by evaluating whether the carrying amount exceeds the asset’s fair value. This test is
done annually or more frequently if events and circumstances indicate the asset might be impaired.
Derivative Instruments
We
utilize derivative instruments to manage risks such as interest rate risk or market risk. Our Derivatives Policy prohibits using
derivatives for speculative purposes.
Accounting
for derivatives differs significantly depending on whether a derivative is designated as an accounting hedge, which is a transaction
intended to reduce a risk associated with a specific asset or liability or future expected cash flow at the time it is purchased. In
order to qualify as an accounting hedge, a derivative must be designated as such at inception by management and meet certain criteria.
Management must also continue to evaluate whether the instrument effectively reduces the risk associated with that item. To determine
if a derivative instrument continues to be an effective hedge, we must make assumptions and judgments about the continued effectiveness
of the hedging strategies and the nature and timing of forecasted transactions. If our hedging strategy was to become ineffective, hedge
accounting would no longer apply, and the reported results of operations or financial condition could be materially affected.
Financial Highlights
As of or For the Years Ended December 31,
(Dollars in thousands except per share amounts) 2025 2024 2023
Balance Sheet Data:
Results of Operations:
Per Share Data:
Basic earnings per common share $ 2.51 $ 1.83 $ 1.56
Diluted earnings per common share 2.47 1.81 1.55
Tangible book value at period end (non-GAAP) 19.84 16.93 15.23
Asset Quality Ratios:
Non-performing assets to total assets(3) 0.02 % 0.04 % 0.05 %
Non-performing loans to period end loans 0.02 % 0.02 % 0.02 %
Net charge-offs (recoveries) to average loans 0.00 % 0.01 % 0.00 %
Allowance for credit losses to period-end total loans 1.05 % 1.08 % 1.08 %
Selected Ratios:
Return on average tangible common equity (non-GAAP): 13.68 % 11.44 % 10.95 %
Noninterest income to operating revenue(2) 21.46 % 21.20 % 17.57 %
Net interest margin (tax equivalent) 3.23 % 2.92 % 3.01 %
(2) Operating revenue is defined as net interest income plus noninterest income.
(5) Includes loans held for sale.
Certain financial
information presented above is determined by methods other than in accordance with GAAP. These non-GAAP financial measures include “efficiency
ratio,” “tangible book value at period end,” “return on average tangible common equity” and “tangible
common shareholders’ equity to tangible assets.” The “efficiency ratio” is defined as non-interest expense less
merger expenses divided by net interest income on a tax equivalent basis and non-interest income, excluding loss on sale of securities,
gain on sale of other assets, loss on early extinguishment of debt, and other non-recurring noninterest income. The efficiency ratio
is a measure of the relationship between operating expenses and net revenue. “Tangible book value at period end” is defined
as total equity reduced by recorded intangible assets divided by total common shares outstanding. “Return on average tangible common
equity” is defined as net income on an annualized basis divided by average total equity reduced by average recorded intangible
assets. “Tangible common shareholders’ equity to tangible assets” is defined as total common equity reduced by recorded
intangible assets divided by total assets reduced by recorded intangible assets. Our management believes that these non-GAAP measures
are useful because they enhance the ability of investors and management to evaluate and compare our operating results from period-to-period
in a meaningful manner. Non-GAAP measures have limitations as analytical tools, and investors should not consider them in isolation or
as a substitute for analysis of our results as reported under GAAP.
The table
below provides a reconciliation of non-GAAP measures to GAAP for the three years ended December 31:
Tangible book value, dollars in thousands
Tangible book value per common share, dollars
Tangible common equity per common share (non-GAAP) $ 19.84 $ 16.93 $ 15.23
Effect to adjust for intangible assets 1.94 1.97 2.00
Return on average tangible common equity
Return on average tangible common equity (non-GAAP) 13.68 % 11.44 % 10.95 %
Effect to adjust for intangible assets (1.32 )% (1.27 )% (1.36 )%
Return on average common equity (GAAP) 12.36 % 10.17 % 9.59 %
Tangible common shareholders’ equity to tangible assets
Tangible common equity to tangible assets (non-GAAP) 7.47 % 6.66 % 6.39 %
Effect to adjust for intangible assets 0.67 % 0.72 % 0.78 %
Common equity to assets (GAAP) 8.14 % 7.38 % 7.17 %
Results of Operations
Year Ended December 31, 2025 and
2024
Our net income
for the twelve months ended December 31, 2025 was $19.2 million, or $2.47 diluted earnings per common share, as compared to $14.0
million, or $1.81 diluted earnings per common share, for the twelve months ended December 31, 2024. The $5.3 million increase
in net income between the two periods is primarily due to an increase in net interest income of $10.0 million, a decrease in provision
for credit losses of $39 thousand, and an increase in non-interest income of $2.9 million, partially offset by an increase in
non-interest expense of $5.9 million and an increase in income tax expense of $1.8 million.
Year Ended December 31, 2024 and
2023
Our net income
for the twelve months ended December 31, 2024 was $14.0 million, or $1.81 diluted earnings per common share, as compared to $11.8
million, or $1.55 diluted earnings per common share, for the twelve months ended December 31, 2023. The $2.1 million increase
in net income between the two periods is primarily due to an increase in net interest income of $3.1 million, a decrease in provision
for credit losses of $320 thousand, and an increase in non-interest income of $3.6 million, partially offset by an increase in
non-interest expense of $4.3 million and an increase in income tax expense of $618 thousand.
Net Interest Income
Net interest
income is our primary source of revenue. Net interest income is the difference between income earned on assets and interest paid
on deposits and borrowings used to support such assets. Net interest income is determined by the rates earned on our interest-earning
assets and the rates paid on our interest-bearing liabilities, the relative amounts of interest-earning assets and interest-bearing
liabilities, and the degree of mismatch and the maturity and repricing characteristics of our interest-earning assets and interest-bearing
liabilities.
Year Ended December 31, 2025 and
2024
Net interest
income increased $10.0 million, or 19.2%, to $62.0 million for the twelve months ended December 31, 2025 from $52.0 million for
the twelve months ended December 31, 2024. Our net interest margin increased by 31 basis points to 3.22% during the twelve months
ended December 31, 2025 from 2.91% during the twelve months ended December 31, 2024. Our net interest margin, on a taxable equivalent
basis, was 3.23% for the twelve months ended December 31, 2025 compared to 2.92% for the twelve months ended December 31, 2024.
Average earning assets increased $140.0 million, or 7.8%, to $1.9 billion for the twelve months ended December 31, 2025 compared
to $1.8 billion in the same period of 2024.
Average loans
increased $86.6 million, or 7.3%, to $1.3 billion for the twelve months ended December 31, 2025 from $1.2 billion for the same
period in 2024. Average loans represented 66.0% of average earning assets during the twelve months ended December 31, 2025 compared
to 66.3% of average earning assets during the same period in 2024. Our loan (including loans held-for-sale) to deposit ratio on
average during 2025 was 73.3%, as compared to 74.4% during 2024. This decrease was due to the growth rate on our average loans
(including loans held-for-sale) in 2025 being exceeded by the growth rate on our deposits of during the same time period. The
loan to deposit ratio (including loans held-for-sale) increased to 75.5% at December 31, 2025 as compared to 73.4% at December
31, 2024. Our growth in loans from December 31, 2024 to December 31, 2025 exceeded our growth in deposits during the same period.
The growth in our average
deposits and securities sold under agreements to repurchase of $174.7 million compared to the growth in our average loans of $86.6
million resulted in a reduction in borrowings. The yield on loans increased 0.18% to 5.79% during the twelve months ended December 31,
2025 from 5.61% during the same period in 2024 due to new and renewed loan rates exceeding maturing loan rates. Average securities
for the twelve months ended December 31, 2025 increased $8.7 million, or 1.8%, to $499.7 million from $491.0 million during the same
period in 2024. Other short-term investments increased $44.7 million to $155.6 million during the twelve months ended December 31, 2025
from $110.9 million during the same period in 2024 due to the additional cash on hand as deposit growth outpaced loan growth. The yield
on our securities portfolio declined to 3.39% for the twelve months ended December 31, 2025 from 3.56% for the same period in
2024. The yield on our other short-term investments declined to 4.16% for the twelve months ended December 31, 2025 from 4.95% for the
same period in 2024 due to the Federal Open Market Committee (FOMC) decreasing the target range of federal funds during the twelve months
of 2025.
The yield on
earning assets for the twelve months ended December 31, 2025 and 2024 were 5.04% and 5.00%, respectively.
The cost of interest-bearing
liabilities was 2.52% during the twelve months ended December 31, 2025 compared to 2.88% during the same period in 2024. The cost
of deposits, including demand deposits, was 1.80% during the twelve months ended December 31, 2025 compared to 1.96% during the
same period in 2024. The cost of funds, including demand deposits, was 1.88% during the twelve months ended December 31, 2025
compared to 2.15% during the same period in 2024. We continue to focus on growing our pure deposits plus customer cash management
repurchase agreements (demand deposits, interest-bearing transaction accounts, savings deposits, money market accounts, IRAs,
and customer cash management repurchase agreements) as these accounts tend to be low-cost deposits and assist us in controlling
our overall cost of funds. During the twelve months ended December 31, 2025, these pure deposits plus customer cash management
repurchase agreements averaged 84.9% of total deposits plus customer cash management repurchase agreements as compared to 83.1%
during the same period of 2024.
Year Ended December 31, 2024 and
2023
Net interest
income increased $3.1 million, or 6.4%, to $52.0 million for the twelve months ended December 31, 2024 from $48.9 million for
the twelve months ended December 31, 2023. Our net interest margin declined by nine basis points to 2.91% during the twelve months
ended December 31, 2024 from 3.00% during the twelve months ended December 31, 2023. Our net interest margin, on a taxable equivalent
basis, was 2.92% for the twelve months ended December 31, 2024 compared to 3.01% for the twelve months ended December 31, 2023.
Average earning assets increased $154.9 million, or 9.5%, to $1.8 billion for the twelve months ended December 31, 2024 compared
to $1.6 billion in the same period of 2023.
Average loans
increased $136.9 million, or 13.1%, to $1.2 billion for the twelve months ended December 31, 2024 from $1.0 billion for the same
period in 2023. Average loans represented 66.3% of average earning assets during the twelve months ended December 31, 2024 compared
to 64.2% of average earning assets during the same period in 2023. Our loan (including loans held-for-sale) to deposit ratio on
average during 2024 was 74.4%, as compared to 73.2% during 2023. This increase was due to the growth rate on our average loans
(including loans held-for-sale) of 13.1% in 2024 exceeding the growth rate on our deposits of 11.4% during the same time period.
The loan to deposit ratio (including loans held-for-sale) declined to 73.4% at December 31, 2024 as compared to 75.3% at December
31, 2023. Our growth in loans of $91.8 million or 8.1% from December 31, 2023 to December 31, 2024 was exceeded by our growth
in deposits of $164.9 million or 10.4% during the same period.
The growth in
our average deposits of $162.9 million and securities sold under agreements to repurchase of $2.6 million compared to the growth
in our average loans of $136.9 million resulted in a reduction in borrowings. The yield on loans increased 0.62% to 5.61% during
the twelve months ended December 31, 2024 from 4.99% during the same period in 2023 due to market interest rates and the Pay-Fixed
Swap Agreement. Average securities for the twelve months ended December 31, 2024 declined $50.0 million, or 9.2%, to $491.0 million
from $541.1 million during the same period in 2023. Other short-term investments increased $68.0 million to $110.9 million during
the twelve months ended December 31, 2024 from $42.9 million during the same period in 2023 due to the additional cash on hand
as deposit growth outpaced loan growth. The yield on our securities portfolio increased to 3.90% for the twelve months ended December
31, 2024 from 3.36% for the same period in 2023. The yield on our other short-term investments declined to 4.95% for the twelve
months ended December 31, 2024 from 5.11% for the same period in 2023 due to the Federal Open Market Committee (FOMC) decreasing
the target range of federal funds during the twelve months of 2024 a total of 1.00% to a target federal funds rate range of 4.25%
– 4.50% at December 31, 2024 from a target federal funds rate range of 5.25% – 5.50% at December 31, 2023.
The yield on
earning assets for the twelve months ended December 31, 2024 and 2023 were 5.00% and 4.45%, respectively.
The cost of interest-bearing
liabilities was 2.88% during the twelve months ended December 31, 2024 compared to 2.06% during the same period in 2023. The cost
of deposits, including demand deposits, was 1.96% during the twelve months ended December 31, 2024 compared to 1.16% during the
same period in 2023. The cost of funds, including demand deposits, was 2.15% during the twelve months ended December 31, 2024
compared to 1.48% during the same period in 2023. We continue to focus on growing our pure deposits plus customer cash management
repurchase agreements (demand deposits, interest-bearing transaction accounts, savings deposits, money market accounts, IRAs,
and customer cash management repurchase agreements) as these accounts tend to be low-cost deposits and assist us in controlling
our overall cost of funds. During the twelve months ended December 31, 2024, these pure deposits plus customer cash management
repurchase agreements averaged 83.1% of total deposits plus customer cash management repurchase agreements as compared to 89.9%
during the same period of 2023.
Average Balances,
Income Expenses and Rates. The following table depicts, for the periods indicated, certain information related to our average
balance sheet and our average yields on assets and average costs of liabilities. Such yields are derived by dividing income or
expense by the average balance of the corresponding assets or liabilities. Average balances have been derived from daily averages.
Year ended December 31,
Assets
Earning assets
Allowance for credit losses-investments (21 ) (27 ) (39 )
Liabilities
Interest-bearing liabilities
Allowance for credit losses-unfunded commitments 489 501 464
Cost of deposits, including demand deposits 1.80 % 1.96 % 1.16 %
Cost of funds, including demand deposits 1.88 % 2.15 % 1.48 %
(2) Based on a 21.0% marginal tax rate.
The following
table presents the dollar amount of changes in interest income and interest expense attributable to changes in volume and the
amount attributable to changes in rate. The combined effect related to volume and rate which cannot be separately identified,
has been allocated proportionately, to the change due to volume and the change due to rate.
(In thousands) Volume Rate Net Volume Rate Net
Assets
Earning assets
Investment securities-taxable (79 ) 37 (42 ) (57 ) 6 (51 )
Fed Funds sold 1 (1 ) — — — —
Interest-bearing liabilities
Fed funds purchased — — — (74 ) 23 (51 )
Market Risk and Interest
Rate Sensitivity
Market risk reflects
the risk of economic loss resulting from adverse changes in market prices and interest rates. The risk of loss can be measured by
either diminished current market values or reduced current and potential net income. Our primary market risk is interest rate risk. We
have established an Asset/Liability Committee of the board of directors (the “ALCO”), which has members from our board of
directors and management to monitor and manage interest rate risk. Our ALCO:
Further, our ALCO and board of directors
explicitly review our ALCO policies at least annually and review our ALCO assumptions and policy limits quarterly.
We employ a monitoring
technique to measure our interest sensitivity “gap,” which is the positive or negative dollar difference between assets
and liabilities that are subject to interest rate repricing within a given period of time. Simulation modeling is performed to
assess the impact of varying interest rates and balance sheet mix assumptions will have on net interest income. We model the impact
on net interest income for several different changes in the yield curve. We model the impact on net interest income in an increasing
and decreasing rate environment of 100, 200, 300, and 400 basis points. We also periodically stress certain assumptions such as
loan prepayment rates, average lives, interest rate betas, and deposit migration to evaluate our overall sensitivity to changes
in interest rates. Policies have been established in an effort to maintain the maximum anticipated negative impact of these modeled
changes in net interest income at no more than 10%, 15%, 20%, and 20%, respectively, in a 100, 200, 300, and 400 basis point change
in interest rates over the first 12-month period subsequent to interest rate changes. Interest rate sensitivity can be managed
by repricing assets or liabilities, selling securities available-for-sale, replacing an asset or liability at maturity, by adjusting
the interest rate during the life of an asset or liability, or by the use of derivatives such as interest rate swaps and other
hedging instruments. Managing the amount of assets and liabilities repricing in the same time interval helps to hedge the risk
and minimize the impact on net interest income of rising or falling interest rates. Neither the “gap” analysis nor
asset/liability modeling is precise indicators of our interest sensitivity position due to the many factors that affect net interest
income including the timing, magnitude, and frequency of interest rate changes as well as changes in the volume and mix of earning
assets and interest-bearing liabilities.
The following
table illustrates our interest rate sensitivity at December 31, 2025.
Interest Sensitivity Analysis
Assets
Earning assets
Liabilities
Interest bearing liabilities
Interest bearing deposits
(2) Securities based on amortized cost.
Net Interest
Income Sensitivity
Based on the
many factors and assumptions used in simulating the effect of changes in interest rates, the following table estimates the hypothetical
percentage change in net interest income at December 31, 2025 and at December 31, 2024 over the subsequent 12 months.
Flat — — —
The maximum anticipated
negative impacts of the modeled changes in net interest income were within policy limits at December 31, 2025 and December 31,
2024.
Present Value
of Equity Sensitivity
We perform a valuation analysis projecting
future cash flows from assets and liabilities to determine the Present Value of Equity (“PVE”) over a range of changes
in market interest rates. The sensitivity of PVE to changes in interest rates is a measure of the sensitivity of earnings over
a longer time horizon. We have established policy limits for the maximum negative impact of modeled changes in PVE, shown below.
Change in present value of equity Hypothetical percentage change in PVE
Flat — — —
Except for the down 400 basis point
scenario, the maximum anticipated negative impacts of the modeled changes in PVE were within policy limits at December 31, 2025
and December 31, 2024. We are monitoring the risk posed by the down 400 basis point scenario.
Provision and Allowance for Credit
Losses
Year Ended December 31, 2025 and
2024
During the twelve
months ended December 31, 2025, the allowance for credit losses on loans increased $671 thousand to $13.8 million, the allowance
for credit losses on unfunded commitments increased $51 thousand to $531 thousand, and the allowance for credit loss on held-to-maturity
investments declined $4 thousand to $19 thousand compared to December 31, 2024. At December 31, 2025, the combined allowance for
credit losses for loans, unfunded commitments, and investments was $14.4 million compared to $13.6 million at December 31, 2024.
The allowance
for credit losses on loans as a percentage of total loans held-for-investment was 1.05% at December 31, 2025 and 1.08% at December
31, 2024.
The total ACL
is composed of three parts: the ACL for loans, the ACL for unfunded commitments, and the ACL for HTM investments. The ACL for
loans is further composed of the allowance for individually assessed loans, the allowance for collectively assessed expected losses,
the allowance for collectively assessed qualitative adjustments, and the allowance for collectively assessed additional allowance.
The allowance for collectively assessed qualitative adjustments is calculated using a set of qualitative factors, which at December
31, 2025 and 2024 included changes in lending policies and procedures, changes in staff, markets, and products, changes in total
of 30-89 days past due and other loans especially mentioned, changes in the loan review system, changes in collateral value for
non-collateral dependent loans, changes in concentration of credits, changes in the legal or regulatory requirements and competition,
data limitations, model imprecision, and reasonable and supportable forecast alternative scenarios.
We have a significant
portion of our loan portfolio with real estate as the underlying collateral. As of December 31, 2025 and December 31, 2024,
approximately 91.5% and 91.4%, respectively, of the loan portfolio had real estate collateral. When loans, whether commercial
or personal, are granted, they are based on the borrower’s ability to generate repayment cash flows from income sources
sufficient to service the debt. Real estate is generally taken to reinforce the likelihood of the ultimate repayment and as a
secondary source of repayment. We work closely with all our borrowers that experience cash flow or other economic problems, and
we believe that we have the appropriate processes in place to monitor and identify problem credits. There can be no assurance
that charge-offs of loans in future periods will not exceed the allowance for credit losses as estimated at any point in time
or that provisions for credit losses will not be significant to a particular accounting period. The allowance is also subject
to examination and testing for adequacy by regulatory agencies, which may consider such factors as the methodology used to determine
adequacy and the size of the allowance relative to that of peer institutions. Such regulatory agencies could require us to adjust
our allowance based on information available to them at the time of their examination.
The non-performing asset
ratio was 0.02% of total assets with the nominal level of $372 thousand in non-performing assets at December 31, 2025 compared to 0.04%
and $810 thousand at December 31, 2024. Nonaccrual loans decreased to $202 thousand at December 31, 2025 from $219 thousand at December
31, 2024. We had $2 thousand in accruing loans past due 90 days or more at December 31, 2025 compared to $48 thousand at December 31,
2024. Loans past due 30 days or more represented 0.07% of the loan portfolio at December 31, 2025 compared to 0.05% at December 31, 2024. The
ratio of classified loans plus OREO and repossessed assets declined to 0.76 % of total bank regulatory risk-based capital at December
31, 2025 from 1.06% at December 31, 2024.
There were four loans
totaling $204 thousand (0.02% of total loans) included on non-performing status (nonaccrual loans and loans past due 90 days and still
accruing) at December 31, 2025. Two of these loans were on nonaccrual status. The largest loan of the two is $201 thousand and is secured
by a first lien mortgage. The balance of the remaining loan on nonaccrual status is $1 thousand, and it is secured by a second
lien mortgage. We had five loans totaling $267 thousand that were accruing loans past due 90 days or more at December 31, 2024. At December
31, 2025 and December 31, 2024, we considered loan relationships exceeding $500 thousand and on nonaccrual status as individually assessed
loans for the allowance for credit losses. At December 31, 2025 and December 31, 2024, we had no individually assessed loans. The specific
allowance for individually assessed loans is based on the fair value of collateral method or present value of expected cash flows method.
For collateral dependent loans, the fair value of collateral method is used, and the fair value is determined by an independent
appraisal less estimated selling costs. There were no specific allowances for credit losses on our individually assessed loans at December
31, 2025 and December 31, 2024. At December 31, 2025, we had $934 thousand in loans that were delinquent 30 days to 89 days representing
0.07% of total loans compared to $554 thousand or 0.05% of total loans at December 31, 2024.
Year Ended December 31, 2024 and
2023
On January
1, 2023, we adopted CECL, which resulted in a day one reduction of $14 thousand to the allowance for credit losses on loans
offset by increases of $398 thousand to the allowance for credit losses on unfunded commitments and $43.5 thousand to the
allowance for credit losses on held-to-maturity investments. Furthermore, deferred tax assets increased $90 thousand and retained
earnings declined $337 thousand. During the twelve months ended December 31, 2024, the allowance for credit losses on loans increased
$868 thousand to $13.1 million, the allowance for credit losses on unfunded commitments declined $117 thousand to $480 thousand,
and the allowance for credit loss on held-to-maturity investments declined $7 thousand to $23 thousand compared to the day one
CECL results, the allowance for credit losses on loans increased $945 thousand to $12.3 million at December 31, 2023 from $11.3
million at January 1, 2023; the allowance for credit losses on unfunded commitments increased $199 thousand to $597 thousand as
of December 31, 2023 from $398 thousand as of January 1, 2023; and the allowance for credit losses on held-to-maturity investments
declined $14 thousand to $30 thousand at December 31, 2023 from $43.5 thousand at January 1, 2023. At December 31, 2024, the combined
allowance for credit losses for loans, unfunded commitments, and investments was $13.6 million compared to $12.9 million at December
31, 2023 and $11.8 million at January 1, 2023.
The allowance
for credit losses on loans as a percentage of total loans held-for-investment was 1.08% at December 31, 2024, 1.08% at December
31, 2023 and 1.15% at January 1, 2023.
The total ACL
is composed of three parts: the ACL for loans, the ACL for unfunded commitments, and the ACL for HTM investments. The ACL for
loans is further composed of the allowance for individually assessed loans, the allowance for collectively assessed expected losses,
the allowance for collectively assessed qualitative adjustments, and the allowance for collectively assessed additional allowance.
The allowance for collectively assessed qualitative adjustments is calculated using a set of qualitative factors, which at December
31, 2024 and 2023 included changes in lending policies and procedures, changes in staff, markets, and products, change in total
of 30-89 days past due and other loans especially mentioned, changes in the loan review system, changes in collateral value for
non-collateral dependent loans, changes in concentration of credits, changes in the legal or regulatory requirements and competition,
data limitations, model imprecision, and reasonable and supportable forecast alternative scenarios.
We have a significant
portion of our loan portfolio with real estate as the underlying collateral. As of December 31, 2024 and December 31, 2023,
approximately 91.4% and 91.7%, respectively, of the loan portfolio had real estate collateral. When loans, whether commercial
or personal, are granted, they are based on the borrower’s ability to generate repayment cash flows from income sources
sufficient to service the debt. Real estate is generally taken to reinforce the likelihood of the ultimate repayment and as a
secondary source of repayment. We work closely with all our borrowers that experience cash flow or other economic problems, and
we believe that we have the appropriate processes in place to monitor and identify problem credits. There can be no assurance
that charge-offs of loans in future periods will not exceed the allowance for credit losses as estimated at any point in time
or that provisions for credit losses will not be significant to a particular accounting period. The allowance is also subject
to examination and testing for adequacy by regulatory agencies, which may consider such factors as the methodology used to determine
adequacy and the size of the allowance relative to that of peer institutions. Such regulatory agencies could require us to adjust
our allowance based on information available to them at the time of their examination.
The non-performing
asset ratio was 0.04% of total assets with the nominal level of $810 thousand in non-performing assets at December 31, 2024 compared
to 0.05% and $864 thousand at December 31, 2023. Nonaccrual loans increased to $219 thousand at December 31, 2024 from $27 thousand
at December 31, 2023. We had $48 thousand in accruing loans past due 90 days or more at December 31, 2024 compared to $215 thousand
at December 31, 2023. Loans past due 30 days or more represented 0.05% of the loan portfolio at December 31, 2024 compared to
0.06% at December 31, 2023. The ratio of classified loans plus OREO and repossessed assets declined to 1.06% of total bank
regulatory risk-based capital at December 31, 2024 from 1.25% at December 31, 2023.
There were five loans
totaling $267 thousand (0.02% of total loans) included on non-performing status (nonaccrual loans and loans past due 90 days and still
accruing) at December 31, 2024. Two of these loans were on nonaccrual status. The largest loan of the two is $217 thousand and is secured
by a first lien mortgage. The balance of the remaining loan on nonaccrual status is $2 thousand, and it is secured by a second
lien mortgage. We had two loans totaling $215 thousand that were accruing loans past due 90 days or more at December 31, 2023. At December
31, 2024 and December 31, 2023, we considered loan relationships exceeding $500 thousand and on nonaccrual status as individually assessed
loans for the allowance for credit losses. At December 31, 2024 and December 31, 2023, we had no individually assessed loans. The specific
allowance for individually assessed loans is based on the fair value of collateral method or present value of expected cash flows method.
For collateral dependent loans, the fair value of collateral method is used, and the fair value is determined by an independent
appraisal less estimated selling costs. There were no specific allowances for credit losses on our individually assessed loans at December
31, 2024 and December 31, 2023. At December 31, 2024, we had $554 thousand in loans that were delinquent 30 days to 89 days representing
0.05% of total loans compared to $498 thousand or 0.04% of total loans at December 31, 2023.
The following
table summarizes the activity related to our allowance for credit losses.
Allowance for Credit Losses
Loans past due 90 days and still accruing $ 2 $ 48 $ 215
CECL Day 1 Adjustment — — (14 )
Loans charged-off:
Real Estate Mortgage - Commercial 2 2 —
Recoveries:
Real Estate - Construction 3 2 2
Real Estate Mortgage - Residential — 18 9
Real Estate Mortgage - Commercial 11 11 37
Consumer - Home equity 8 9 22
Net loans (charged off) recovered (51 ) (65 ) 6
Allowance as percent of total loans 1.05 % 1.08 % 1.08 %
Non-performing loans as % of total loans 0.02 % 0.04 % 0.02 %
Nonaccrual loans as % of total loans 0.02 % 0.02 % 0.00 %
The following
table details net charge-offs to average loans outstanding by loan category for the years ended December 31:
Commercial
Net (recoveries) charge-offs $ (11 ) $ 27 $ 15
Net (recoveries) charge-offs /average loans (0.01 )% 0.03 % 0.02 %
Real estate:
Construction
Net recoveries $ (3 ) $ (2 ) $ (2 )
Net recoveries/average loans 0.00 % 0.00 % 0.00 %
Mortgage-residential
Net charge-offs (recoveries) $ — $ (18 ) $ (9 )
Net charge-offs (recoveries)/average loans(1) 0.00 % (0.02 )% (0.01 )%
Mortgage-commercial
Net charge-offs (recoveries) $ (16 ) $ (11 ) $ (37 )
Net charge-offs (recoveries)/average loans 0.00 % 0.00 % 0.00 %
Consumer:
Home Equity
Net recoveries $ (8 ) $ (9 ) $ (22 )
Net recoveries/average loans (0.02 )% (0.02 )% (0.07 )%
Other
Net charge-offs/average loans 0.48 % 0.48 % 0.34 %
Total:
Net charge-offs (recoveries) $ 51 $ 65 $ (6 )
Net charge-offs (recoveries)/average loans(1) 0.00 % 0.01 % 0.00 %
(1) Average loans exclude loans held for sale
Accrual of interest
is discontinued on loans when we believe, after considering economic and business conditions and collection efforts, that a borrower’s
financial condition is such that the collection of interest is doubtful. A delinquent loan is generally placed in nonaccrual status when
it becomes 90 days or more past due. At the time a loan is placed in nonaccrual status, all interest, which has been accrued on the loan
but remains unpaid, is reversed and deducted from earnings as a reduction of reported interest income. No additional interest is accrued
on the loan balance until the collection of both principal and interest becomes reasonably certain.
The following
table shows the allocation of the allowance for credit losses on loans:
Allocation of the Allowance for
Credit Losses on Loans
Real Estate Mortgage:
Unallocated — N/A — N/A — N/A
Non-interest Income and
Expense
Non-interest
Income. A source of noninterest income is service charges on deposit accounts. We also originate and sell residential loans
on a servicing released basis in the secondary market. These loans are originated in our name. The loans have locked in price
commitments to be purchased by investors at the time of closing. Therefore, these loans present very little market risk for us.
We typically deliver to, and receive funding from, the investor within 30 days. Other sources of noninterest income are derived
from investment advisory fees and commissions on non-deposit investment products, ATM/debit card fees, commissions on check sales,
safe deposit box rent, wire transfer, official check fees, rental income, and bank owned life insurance income.
Non-interest
income during the twelve months ended December 31, 2025 increased to $16.9 million from $14.0 million during the same period in
2024. The increase in non-interest income is primarily related to increases in mortgage banking income and investment advisory
fees and non-deposit commissions.
Mortgage banking
income increased $902 thousand to $3.3 million during the twelve months ended December 31, 2025 from $2.4 million during the same
period in 2024. Secondary mortgage production during the twelve months ended December 31, 2025 was $115.4 million compared to
$79.3 million during the same period in 2024 while the gain on sale margin decreased to 2.82% during the twelve months ended December
31, 2025 from 2.96% during the same period in 2024.
Total mortgage
production during the twelve months ended December 31, 2025 was $202.7 million, $115.4 million of the production was originated
to be sold in the secondary market, $16.8 million of the loan production was originated as ARM loans for our loans held-for-investment
portfolio, and $70.5 million of the loan production was commitments for new construction residential real estate loans. As these
ARM and new construction residential real estate loans are being held on our balance sheet as loans held-for-investment, the result
is additive to loan growth and interest income but results in less gain on sale fee income, which is reported in noninterest income
as mortgage banking income.
Investment advisory
fees increased by $1.4 million to $7.6 million during the twelve months ended December 31, 2025 from $6.2 million during the same
period in 2024. Total assets under management were $1.2 billion at December 31, 2025 compared to $926.0 million at December 31, 2024.
Our net new assets were $83.4 million during the twelve months ended December 31, 2025. Furthermore, our investment performance for the
twelve months ended December 31, 2025 was 17.3% compared to 16.4% for the S&P 500.
The $229 thousand
loss on early extinguishment of debt included in other income during the twelve months ended December 31, 2024 resulted from our decision to use available
cash to reduce FHLB advances to zero, including the pre-payment of $35.0 million in FHLB advances during the fourth quarter of
2024. We believe this reduction in these borrowings positioned us for improvements in net interest income and margin in the future.
Non-interest income
during the twelve months ended December 31, 2024 increased to $14.0 million from $10.4 million during the same period in 2023. The $3.6
million increase in non-interest income is primarily related to a reduction in loss on sale of securities of $1.2 million, increases
in mortgage banking income of $962 thousand, investment advisory fees and non-deposit commissions of $1.7 million, and an increase in
gains on insurance proceeds of $73 thousand partially offset by a decrease in gain on sale of other assets of $146 thousand and
a loss on early extinguishment of debt of $229 thousand.
During
the third quarter of 2023, we sold $39.9 million of book value U.S. Treasuries in our available-for-sale investment securities
portfolio. While this sale created a one-time pre-tax loss of $1.2 million, it provided additional liquidity which was used to
pay down borrowings and fund loan growth. The weighted average book yield of the securities sold was 1.75% and the projected earn
back period is 1.6 years. There was no such similar sale during 2024.
Mortgage banking
income increased $962 thousand to $2.4 million during the twelve months ended December 31, 2024 from $1.4 million during the same
period in 2023. Secondary mortgage production during the twelve months ended December 31, 2024 was $79.3 million compared to $49.7
million during the same period in 2023 while the gain on sale margin increased to 2.96% during the twelve months ended December
31, 2024 from 2.83% during the same period in 2023.
During 2022, we began
to market an adjustable rate mortgage (ARM) product to provide borrowers with an alternative to fixed-rate mortgages and to help offset
anticipated mortgage production challenges. Currently, we are offering 5/6, 7/6, and 10/6 ARM loans that are originated for our loans
held-for-investment portfolio. Furthermore, in 2022, we added a new construction residential real estate team and product. Total mortgage
production during the twelve months ended December 31, 2024 was $165.6 million, $79.3 million of the production was originated to be
sold in the secondary market, while $40.9 million of the loan production was originated as ARM loans for our loans held-for-investment
portfolio, and $45.4 million of the loan production was commitments for new construction residential real estate loans. As these ARM
and new construction residential real estate loans are being held on our balance sheet as loans held-for-investment, the result is additive
to loan growth and interest income but results in less gain on sale fee income, which is reported in noninterest income as mortgage banking
income.
Investment advisory
fees increased by $1.7 million to $6.2 million during the twelve months ended December 31, 2024 from $4.5 million during the same
period in 2023. Total assets under management were $926.0 million at December 31, 2024 compared to $755.4 million at December 31, 2023.
Our net new assets were $37.5 million during the twelve months ended December 31, 2024. Furthermore, our investment performance for the
twelve months ended December 31, 2024 was 17.6% compared to 23.3% for the S&P 500.
Gain (loss) on
sale of other assets declined $146 thousand to a gain of $5 thousand during the twelve months ended December 31, 2024 from $151
thousand during the same period in 2023 due to an income tax recovery in 2024 on a previously sold other real estate owned property
and due to a sale of other real estate owned during the twelve months ended December 31, 2023.
The $229 thousand