HAWTHORN BANCSHARES, INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)
Forward-looking statements
This report contains certain forward-looking statements regarding the financial condition, results of operations, plans, objectives, future performance and activities of
• statements that are not of a historical nature, and • statements preceded, followed by or containing the words believes, expects, may, will, should, might, anticipates, estimates, intends, plans, hopes or similar expressions.
Forward-looking statements are not guarantees of future performance or results. They involve risks, uncertainties and assumptions. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors: •competitive pressures among financial services companies may increase significantly, •changes in the interest rate environment may reduce interest margins, •general economic conditions, either nationally or inMissouri , may be less favorable than expected and may adversely affect the quality of our loans and other assets, •increases in non-performing assets in the Company's loan portfolios and adverse economic conditions may necessitate increases to our provisions for loan losses, •costs or difficulties related to any integration of any business of the Company and its acquisition targets may be greater than expected, •legislative, regulatory or tax law changes may adversely affect the business in which the Company and its subsidiaries are engaged, •credit and market risks relating to increasing inflation, •changes may occur in the securities markets, and •the COVID-19 pandemic, or any resurgence thereof, or other external events may adversely affect the Company. We have described additional factors that could cause actual results to be materially different from those described in the forward-looking statements under the caption Risk Factors in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2021 , and in other reports filed with theSEC from time to time. Other factors that have not been identified in this report could also have this effect. You are cautioned not to put undue reliance on any forward-looking statement, which speak only as of the date they were made. Except as required by law, the Company undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events, or changes in its business, results of operations or financial condition over time. 35 --------------------------------------------------------------------------------
Insight
Crucial to the Company's community banking strategy is growth in its commercial banking services, retail mortgage lending and retail banking services. Through the branch network of its subsidiary bank,Hawthorn Bank (the Bank), the Company, with$1.8 billion in assets atSeptember 30, 2022 , provides a broad range of commercial and personal banking services. The Bank's specialties include commercial banking for small and mid-sized businesses, including equipment, operating, commercial real estate,Small Business Administration (SBA) loans, and personal banking services including real estate mortgage lending, installment and consumer loans, certificates of deposit, individual retirement and other time deposit accounts, checking accounts, savings accounts, and money market accounts. Other financial services that the Company provides include trust services that include estate planning, investment and asset management services and a comprehensive suite of cash management services. The geographic areas in which the Company provides products and services include theMissouri communities in and surroundingJefferson City ,Columbia ,Clinton ,Warsaw ,Springfield ,St. Louis , and the greaterKansas City metropolitan area. The Company's primary source of revenue is net interest income derived primarily from lending and deposit taking activities. Much of the Company's business is commercial, commercial real estate development, and residential mortgage lending. The Company's income from mortgage brokerage activities is directly dependent on mortgage rates and the level of home purchases and refinancing activity. The success of the Company's growth strategy depends primarily on the ability of the Bank to generate an increasing level of loans and deposits at acceptable risk levels and on acceptable terms without significant increases in non-interest expenses relative to revenues generated. The Company's financial performance also depends, in part, on its ability to manage various portfolios and to successfully introduce additional financial products and services by expanding new and existing customer relationships, utilizing improved technology, and enhancing customer satisfaction. Furthermore, the success of the Company's growth strategy depends on its ability to maintain sufficient regulatory capital levels during periods in which general economic conditions are unfavorable and despite economic conditions being beyond its control. The Bank is a full-service bank that conducts a general banking business, offering its customers checking and savings accounts, debit cards, certificates of deposit, safety deposit boxes and a wide range of lending services, including commercial and industrial loans, residential real estate loans, single payment personal loans, installment loans and credit card accounts. In addition, the Bank provides trust services. The deposit accounts of the Bank are insured by theFederal Deposit Insurance Corporation (FDIC) to the extent provided by law. The operations of the Bank are supervised and regulated by theFDIC and theMissouri Division of Finance . Periodic examinations of the Bank are conducted by representatives of theFDIC and theMissouri Division of Finance . Such regulations, supervision and examinations are principally for the benefit of depositors, rather than for the benefit of shareholders. The Company is subject to supervision and examination by theBoard of Governors of theFederal Reserve System . 36
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The following accounting policies are considered most critical to the understanding of the Company's financial condition and results of operations. These critical accounting policies require management's most difficult, subjective and complex judgments about matters that are inherently uncertain. Because these estimates and judgments are based on current circumstances, they may change over time or prove to be inaccurate based on actual experiences. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of a materially different financial condition and/or results of operations could reasonably be expected. The impact and any associated risks related to the critical accounting policies on the business operations are discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations, where such policies affect the reported and expected financial results.
Allowance for loan losses
Management has identified the accounting policy related to the allowance for
loan losses as critical to the understanding of the Company's results of
operations, since the application of this policy requires significant management
assumptions and estimates that could result in materially different amounts to
be reported if conditions or underlying circumstances were to change. Further
discussion of the methodology used in establishing the allowance and the impact
of any associated risks related to these policies on the Company's business
operations is provided in Note 1 - Summary of Significant Accounting Policies
and is also discussed in the Lending and Credit Management section below. Many
of the loans are deemed collateral dependent for purposes of the measurement of
the impairment loss, thus the fair value of the underlying collateral and
sensitivity of such fair values due to changing market conditions, supply and
demand, condition of the collateral and other factors can be volatile over
periods of time. Such volatility can have an impact on the financial performance
of the Company.
37
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Summary
The Company has prepared all of the consolidated financial information in this report in accordance withU.S. GAAP. In preparing the consolidated financial statements in accordance withU.S. GAAP, the Company makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurances that actual results will not differ from those estimates. The Three Months Ended September 30, September 30, (Dollars in thousands, except per share data) 2022 June 30, 2022 2021 Net interest income$ 15,067 $ 14,561 $ 15,380 Provision for loan losses 300 1,200 300 Non-interest income 3,485 3,648 3,776 Investment securities gains (losses), net 1 (9) 126 Non-interest expense 12,195 11,540 11,769 Income before income taxes 6,058 5,460 7,213 Income tax expense 1,131 971 1,417 Net income$ 4,927 $ 4,489 $ 5,796 Basic earnings per share $ 0.73 $ 0.66 $ 0.84 Diluted earnings per share $ 0.73 $ 0.66 $ 0.84 Efficiency ratio (1) 65.73% 63.38% 61.44% Net interest spread 3.28% 3.47% 3.62% Net interest margin 3.56% 3.64% 3.78% Nine Months Ended September 30, (Dollars in thousands, except per share data) 2022 2021 Net interest income$ 43,773 $ 43,442 (Release of) provision for loan losses (1,000) 700 Non-interest income 10,859 13,010 Investment securities (losses) gains, net (12) 140 Non-interest expense 35,962 35,391 Income before income taxes 19,658 20,501 Income tax expense 3,633 3,974 Net income$ 16,025 $ 16,527 Basic earnings per share $ 2.36 $ 2.40 Diluted earnings per share $ 2.36 $ 2.40 Efficiency ratio (1) 65.83% 62.69% Net interest spread 3.36% 3.43% Net interest margin 3.57% 3.60% (1)Efficiency ratio is calculated as non-interest expense as a percentage of revenue. Total revenue is calculated as net interest income plus non-interest income. 38 --------------------------------------------------------------------------------
The Three Months Ended As of and for the Nine months ended
September 30, September 30, September 30,
2022 June 30, 2022 2021 September 30, 2022 2021
Key financial ratios
Book value per share $ 16.97 $ 18.20 $ 20.22
Market price per share $ 21.86 $ 25.49 $ 22.27
Cash dividends paid on common
stock $ 1,105 $ 990 $ 954 $ 3,088 $ 2,624
Return on total assets 1.08% 1.04% 1.33% 1.21% 1.28%
Return on stockholders' equity 15.30% 14.00% 16.49% 16.00%
16.37%
Average stockholders' equity to total assets 7.06% 7.40% 8.05% 7.55% 7.82% Capital Ratios Stockholders' equity to assets 6.25% 6.93% 8.00% Total risk-based capital ratio 13.84% 13.97% 15.01% Tier 1 risk-based capital ratio 12.25% 12.53% 13.64% Common equity Tier 1 capital 9.82% 9.85% 10.26% Tier 1 leverage ratio (1) 10.60% 10.98% 10.82% Asset Quality Net-charge-offs (recoveries)$ 148 $ 126$ 106 $ 398$ (116) Non-performing loans$ 17,348 $ 17,817 $ 32,835 Classified assets$ 96,705 $ 99,200 $ 111,697 Non-performing loans to total loans 1.16% 1.25% 2.56% Non-performing assets to total assets 1.44% 1.51% 2.56% Allowance for loan losses to total loans 1.04% 1.08% 1.48%
(1)The Tier 1 leverage ratio is calculated by dividing the Tier 1 capital by the average total consolidated assets
Highlights of operating results
Consolidated net income of$4.9 million for the third quarter 2022 increased$0.4 million , or 9.8%, compared to the second quarter 2022 ("linked quarter") and decreased$0.9 million , or 15.0%, from the third quarter 2021 (the "prior year quarter"). Earnings per diluted share were$0.73 for the third quarter 2022 compared to$0.66 and$0.84 for the linked quarter and prior year quarter, respectively. For the third quarter 2022, the return on average assets was 1.08%, the return on average stockholders' equity was 15.30%, and the efficiency ratio was 65.7%. Consolidated net income of$16.0 million , or$2.36 per diluted share, for the nine months endedSeptember 30, 2022 decreased$0.5 million , or 3.0%, compared to$16.5 million , or$2.40 per diluted share, for the nine months endedSeptember 30, 2021 . For the nine months endedSeptember 30, 2022 , the return on average assets was 1.21%, the return on average stockholders' equity was 16.00%, and the efficiency ratio was 65.8%. Net interest income of$15.1 million for the third quarter 2022 increased$0.5 million from the linked quarter, and decreased$0.3 million from the prior year quarter. Net interest margin, on a fully taxable equivalent basis ("FTE") basis, was 3.56% for the third quarter, a decrease from 3.64% and 3.78% for the linked quarter and the prior year quarter, respectively. Net interest income of$43.8 million for the nine months endedSeptember 30, 2022 increased$0.3 million compared to$43.4 million for the nine months endedSeptember 30, 2021 . Net interest margin, on a fully taxable equivalent basis ("FTE") basis, was 3.57% for the nine months endedSeptember 30, 2022 , a decrease from 3.60% for the nine months endedSeptember 30, 2021 . These changes are discussed in greater detail under the Average Balance Sheet Data and Rate and Volume Analysis section below. Non-interest income for the third quarter 2022 was$3.5 million , a decrease of$0.2 million , or 4.5%, from the linked quarter, and a decrease of$0.3 million , or 7.7%, from the prior year quarter. The change in the current quarter compared to 39 --------------------------------------------------------------------------------
the prior year quarter was primarily due to lower gain on sale of real estate mortgages of
Non-interest income of$10.9 million for the nine months endedSeptember 30, 2022 decreased$2.2 million , or 16.5%, compared to$13.0 million for the nine months endedSeptember 30, 2021 . The change was primarily due to the decrease in the gain on sale of real estate mortgages of$3.6 million , or 60.5%. These changes are discussed in greater detail under the Non-interest Income and Expense section below. Non-interest expense for the third quarter 2022 was$12.2 million , an increase of$0.7 million , or 5.7%, from the linked quarter, and an increase of$0.4 million , or 3.6%, from the prior year quarter. The change in the current quarter compared to the linked quarter was primarily due to the increase in salary and benefits expenses, processing, network, and bankcard expense, and advertising and promotion expenses. Non-interest expense for the nine months endedSeptember 30, 2022 was$36.0 million , an increase of$0.6 million , or 1.6%, from the nine months endedSeptember 30, 2021 . The change was primarily due to the new software maintenance agreements and the change in the fair value adjustment for mortgage banking derivatives, partially offset by a decrease in salary and benefits and loan expense. These changes are discussed in greater detail under the Non-interest Income and Expense section below.
Balance Sheet Highlights
Loans – Loans held for investment increased by
Asset quality - Non-performing loans totaled$17.3 million atSeptember 30, 2022 , a decrease of$0.5 million from$17.8 million at the end of the linked quarter, and a decrease of$15.5 million from$32.8 million at the end of the prior year quarter. The reduction in non-performing loans in the current quarter as compared to the prior year quarter was primarily due to three large non-accrual loan relationships returning to accrual status. The allowance for loan losses to total loans was 1.04% atSeptember 30, 2022 , compared to 1.30% atDecember 31, 2021 and 1.48% atSeptember 30, 2021 . These changes are discussed in greater detail under the Lending and Credit Management section below. Deposits - Total deposits increased by$62.0 million , or 4.0%, equal to$1.6 billion as ofSeptember 30, 2022 as compared to the end of the linked quarter. Year-over-year deposits grew$181.7 million , or 12.9%, from$1.4 billion as ofSeptember 30, 2021 . Capital - Total shareholder's equity was$115.4 million and the common equity to assets ratio was 6.25% atSeptember 30, 2022 as compared to 6.93% and 8.00% at the end of the linked quarter and the prior year quarter, respectively. Regulatory capital ratios remain "well-capitalized," with a tier 1 leverage ratio of 10.60% and a total risk-based capital ratio of 13.84% atSeptember 30, 2022 . Average Balance Sheet Data Net interest income is the largest source of revenue resulting from the Company's lending, investing, borrowing, and deposit gathering activities. It is affected both by changes in the level of interest rates and changes in the amounts and mix of interest earning assets and interest-bearing liabilities. The following table presents average balance sheet data, net interest income, average yields of earning assets, average costs of interest-bearing liabilities, net interest spread and net interest margin on a fully taxable equivalent basis for each of the three and nine month periods endedSeptember 30, 2022 and 2021, respectively. The average balances used in this table and other statistical data were calculated using average daily balances. 40 --------------------------------------------------------------------------------
Three Months Ended September 30, 2022
2022 2021
Interest Income/ Interest Income/
(Dollars in thousands) Average Balance Expense (1) Rate Earned/ Paid (1) Average Balance Expense (1) Rate Earned/ Paid (1)
ASSETS
Loans: (2) (3)
Commercial $ 245,877 $ 3,211 5.18% $ 247,564 $ 4,575 7.33%
Real estate construction - residential 24,249 333 5.45 35,358 453 5.08
Real estate construction - commercial 127,594 1,522 4.73 75,081 885 4.68
Real estate mortgage - residential 323,158 3,581 4.40 270,464 2,863 4.20
Real estate mortgage - commercial 702,139 7,597 4.29 633,238 6,590 4.13
Installment and other consumer 23,738 206 3.44 24,363 242 3.94
Total loans $ 1,446,755 $ 16,450 4.51% $ 1,286,068 $ 15,608 4.81%
Loans held for sale 1,560 23 5.85 3,092 24 3.08
Investment securities:
U.S. Treasury 3,586 12 1.33 3,033 4 0.52
U.S. government and federal agency
obligations 25,440 87 1.36 20,819 75 1.43
Obligations of states and political
subdivisions 113,003 1,040 3.65 114,804 868 3.00
Mortgage-backed securities 111,616 493 1.75 130,659 443 1.35
Other debt securities 12,781 163 5.06 10,608 128 4.79
Total investment securities 266,426 1,795 2.67 279,923 1,518 2.15
Other investment securities 5,431 64 4.68 6,010 81 5.35
Federal funds sold 46 - - 6,829 1 0.06
Interest bearing deposits in other
financial institutions 15,462 76 1.95 84,825 78 0.36
Total interest earning assets $ 1,735,680 $ 18,408 4.21% $ 1,666,747 $ 17,310 4.12%
All other assets 88,159 84,269
Allowance for loan losses (15,431) (18,801)
Total assets $ 1,808,408 $ 1,732,215
LIABILITIES AND STOCKHOLDERS' EQUITY
Savings $ 182,364 $ 16 0.03% $ 161,308 $ 14 0.03%
NOW accounts 268,780 646 0.95 225,351 130 0.23
Interest checking 47,788 264 2.19 37,391 45 0.48
Money market 302,773 456 0.60 281,425 91 0.13
Time deposits 273,550 584 0.85 252,731 437 0.69
Total interest bearing deposits $ 1,075,255 $ 1,966 0.73% $ 958,206 $ 717 0.30%
Federal funds purchased and securities
sold under agreements to repurchase 6,181 13 0.84 29,753 19 0.25
Federal Home Loan Bank advances and other
borrowings 75,262 277 1.46 93,533 383 1.62
Subordinated notes 49,486 570 4.57 49,486 305 2.45
Total borrowings 130,929 860 2.61 172,772 707 1.62
Total interest-bearing liabilities
2,826 0.93% $ 1,130,978 $ 1,424 0.50% Demand deposits 464,377 445,062 Other liabilities 10,100 16,723 Total liabilities$ 1,680,661 $ 1,592,763 Stockholders' equity 127,747 139,452 Total liabilities and stockholders' equity$ 1,808,408 $ 1,732,215 Net interest income (FTE) $ 15,582 $ 15,886 Net interest spread 3.28% 3.62% Net interest margin 3.56% 3.78% (1)Interest income and yields are presented on a fully taxable equivalent basis using the federal statutory income tax rate of 21%, net of nondeductible interest expense, for the three months endedSeptember 30, 2022 and 2021. Such adjustments totaled$0.5 million and$0.5 million for the three months endedSeptember 30, 2022 and 2021, respectively. (2)Non-accruing loans are included in the average amounts outstanding. (3)Fees and costs on loans are included in interest income ($20,000 and$2.0 million of PPP fees were included in commercial loan income for the three months endedSeptember 30, 2022 and 2021, respectively) 41 --------------------------------------------------------------------------------
Nine Months Ended September 30, 2022
2022 2021
Interest Income/ Interest Income/
(Dollars in thousands) Average Balance Expense (1) Rate Earned/ Paid (1) Average Balance Expense (1) Rate Earned/ Paid (1)
ASSETS
Loans: (2) (3)
Commercial $ 233,076 $ 8,860 5.08% $ 253,878 $ 11,732 6.18%
Real estate construction - residential 23,627 865 4.89 34,625 1,274 4.92
Real estate construction - commercial 110,540 3,683 4.45 77,115 2,676 4.64
Real estate mortgage - residential 300,518 9,461 4.21 264,699 8,546 4.32
Real estate mortgage - commercial 685,041 21,743 4.24 624,455 19,809 4.24
Installment and other consumer 22,987 614 3.57 25,044 750 4.00
Total loans $ 1,375,789 $ 45,226 4.40% $ 1,279,816 $ 44,787 4.68%
Loans held for sale 1,841 69 5.01 4,262 79 2.48
Investment securities:
U.S. Treasury 3,909 29 0.99 3,026 13 0.57
U.S. government and federal agency
obligations 26,235 271 1.38 22,579 275 1.63
Obligations of states and political
subdivisions 118,845 3,152 3.55 88,333 1,989 3.01
Mortgage-backed securities 120,806 1,503 1.66 125,813 1,249 1.33
Other debt securities 13,080 476 4.87 11,675 430 4.92
Total investment securities 282,875 5,431 2.57 251,426 3,956 2.10
Other investment securities 5,430 204 5.02 6,021 246 5.46
Federal funds sold 2,285 5 0.29 10,979 6 0.07
Interest bearing deposits in other
financial institutions 34,210 179 0.70 108,021 263 0.33
Total interest earning assets $ 1,702,430 $ 51,114 4.01% $ 1,660,525 $ 49,337 3.97%
All other assets 85,993 84,682
Allowance for loan losses (15,575) (18,579)
Total assets $ 1,772,848 $ 1,726,628
LIABILITIES AND STOCKHOLDERS' EQUITY
Savings $ 179,952 $ 45 0.03% $ 153,730 $ 40 0.03%
NOW accounts 267,266 1,196 0.60 227,925 402 0.24
Interest checking 34,404 346 1.34 46,661 168 0.48
Money market 295,105 688 0.31 280,839 255 0.12
Time deposits 260,610 1,297 0.67 255,494 1,612 0.84
Total interest bearing deposits $ 1,037,337 $ 3,572 0.46% $ 964,649 $ 2,477 0.34%
Federal funds purchased and securities
sold under agreements to repurchase 8,812 32 0.49 38,797 72 0.25
Federal Home Loan Bank advances and other
borrowings 76,278 778 1.36 95,486 1,164 1.63
Subordinated notes 49,486 1,316 3.56 49,486 921 2.49
Total borrowings 134,576 2,126 2.11 183,769 2,157 1.57
Total interest-bearing liabilities
5,698 0.65% $ 1,148,418 $ 4,634 0.54% Demand deposits 455,689 426,290 Other liabilities 11,339 16,953 Total liabilities$ 1,638,941 $ 1,591,661 Stockholders' equity 133,907 134,967 Total liabilities and stockholders' equity$ 1,772,848 $ 1,726,628 Net interest income (FTE) $ 45,416 $ 44,703 Net interest spread 3.36% 3.43% Net interest margin 3.57% 3.60% (1)Interest income and yields are presented on a fully taxable equivalent basis using the federal statutory income tax rate of 21%, net of nondeductible interest expense, for the nine months endedSeptember 30, 2022 and 2021. Such adjustments totaled$1.6 million and$1.3 million for the nine months endedSeptember 30, 2022 and 2021, respectively. (2)Non-accruing loans are included in the average amounts outstanding. (3)Fees and costs on loans are included in interest income ($0.4 million and$4.0 million of PPP fees were included in commercial loan income for the nine months endedSeptember 30, 2022 and 2021, respectively). 42 --------------------------------------------------------------------------------
Rate and volume analysis
The following table summarizes the changes in net interest income on a fully taxable equivalent basis, by major category of interest-earning assets and interest-bearing liabilities, identifying changes related to volumes and rates for the three and nine months endedSeptember 30, 2022 compared to the three and nine months endedSeptember 30, 2021 . The change in interest due to the combined rate/volume variance has been allocated to rate and volume changes in proportion to the absolute dollar amounts of change in each. Three Months Ended September 30, Nine Months Ended September 30, 2022 vs. 2021 2022 vs. 2021 Change due to Change due to Average Average (in thousands) Total Change Volume Average Rate Total Change Volume Average Rate Interest income on a fully taxable equivalent basis: (1) Loans: (2) (3) Commercial$ (1,364) $ (31)
Building construction – residential
(120) (151) 31 (409) (402)
(seven)
Real estate construction - commercial 637 626 11 1007 1117
(110)
Real estate mortgage - residential 718 579 139 915 1133
(218)
Real estate mortgage - commercial 1,007 738 269 1,934 1921
13
Installment and other consumer (36) (6) (30) (136) (59) (77) Loans held for sale (1) (16) 15 (10) (61) 51 Investment securities: U.S. Treasury 8 1 7 16 5 11U.S. government and federal agency obligations 12 16 (4) (4) 41
(45)
Obligations of states and political subdivisions 172 (14) 186 1,163 768 395 Mortgage-backed securities 50 (71) 121 254 (52) 306 Other debt securities 35 27 8 46 51 (5) Other investment securities (17) (7) (10) (42) (23) (19) Federal funds sold (1) (1) - (1) (7) 6 Interest bearing deposits in other financial institutions (2) (106) 104 (84) (260)
176
Total interest income$ 1,098 $ 1,584 $ (486) $ 1,777 $ 3,264 $ (1,487) Interest expense: Savings $ 2$ 2 $ - $ 5$ 6 $ (1) NOW accounts 516 30 486 794 82 712 Interest checking 219 16 203 178 (54) 232 Money market 365 8 357 433 13 420 Time deposits 147 38 109 (315) 32 (347) Federal funds purchased and securities sold under agreements to repurchase (6) (24) 18 (40) (80)
40
Federal Home Loan Bank advances and other borrowings (106) (70) (36) (386) (213) (173) Subordinated notes 265 - 265 395 - 395 Total interest expense$ 1,402 $ -$ 1,402 $ 1,064 $ (214) $ 1,278 Net interest income on a fully taxable equivalent basis$ (304) $ 1,584 $ (1,888) $ 713 $ 3,478 $ (2,765) (1)Interest income and yields are presented on a fully taxable equivalent basis using the federal statutory income tax rate of 21%, net of nondeductible interest expense, for the three and nine months endedSeptember 30, 2022 and 2021, respectively. Such adjustments totaled$0.5 million and$1.6 million for the three and nine months endedSeptember 30, 2022 compared to$0.5 million and$1.3 million for the three and nine months endedSeptember 30, 2021 , respectively. (2)Non-accruing loans are included in the average amounts outstanding. (3)Fees and costs on loans are included in interest income ($20,000 and$0.4 million of PPP fees were included in commercial loan income for the three and nine months endedSeptember 30, 2022 compared to$2.0 million and$4.0 million for the nine months endedSeptember 30, 2021 , respectively). 43 -------------------------------------------------------------------------------- Financial results for the quarter endedSeptember 30, 2022 compared to the quarter endedSeptember 30, 2021 reflected a decrease in net interest income, on a tax equivalent basis, of$0.3 million , or 1.9%, and the financial results for the nine months endedSeptember 30, 2022 compared to the nine months endedSeptember 30, 2021 reflected an increase of$0.7 million , or 1.6%. Measured as a percentage of average earning assets, the net interest margin (expressed on a fully taxable equivalent basis) decreased to 3.56% for the quarter endedSeptember 30, 2022 compared to 3.78% for the quarter endedSeptember 30, 2021 , and decreased to 3.57% for the nine months endedSeptember 30, 2022 compared to 3.60% for the nine months endedSeptember 30, 2021 . Driving the decrease in net interest income in the quarter compared to the prior year quarter was higher interest expense for interest bearing liabilities, partially offset by higher interest income resulting from growth in loans of 12.5%. The significant loan growth more than offset the reduction in PPP fee income of$2.0 million from the prior year quarter. Driving the increase in net interest income for the current year compared to the prior year, on a year-to-date basis, was higher interest income resulting from growth in loans of 7.5%, and investment securities portfolio of 12.5%, partially offset by higher interest expense for interest bearing liabilities and a reduction of PPP fee income of$3.7 million . Average interest-earning assets increased$68.9 million , or 4.1%, to$1.74 billion for the quarter endedSeptember 30, 2022 compared to$1.67 billion for the quarter endedSeptember 30, 2021 , and average interest-bearing liabilities increased$75.2 million , or 6.6%, to$1.21 billion for the quarter endedSeptember 30, 2022 compared to$1.13 billion for the quarter endedSeptember 30, 2021 . Average interest-earning assets increased$41.9 million , or 2.5%, to$1.70 billion for the nine months endedSeptember 30, 2022 compared to$1.66 billion for the nine months endedSeptember 30, 2021 , and average interest-bearing liabilities increased$23.5 million , or 2.0%, to$1.17 billion for the nine months endedSeptember 30, 2022 compared to$1.15 billion for the nine months endedSeptember 30, 2021 . Total interest income (expressed on a fully taxable equivalent basis) was$18.4 million and$51.1 million for the three and nine months endedSeptember 30, 2022 , respectively, compared to$17.3 million and$49.3 million for the three and nine months endedSeptember 30, 2021 , respectively. The Company's rates earned on interest earning assets were 4.21% and 4.01% for the three and nine months endedSeptember 30, 2022 , respectively, compared to 4.12% and 3.97% for the three and nine months endedSeptember 30, 2021 , respectively. Interest income on loans held for investment was$16.5 million and$45.2 million for the three and nine months endedSeptember 30, 2022 , respectively, compared to$15.6 million and$44.8 million for the three and nine months endedSeptember 30, 2021 , respectively. Average loans outstanding increased$160.7 million , or 12.5%, to$1.45 billion for the quarter endedSeptember 30, 2022 compared to$1.29 billion for the quarter endedSeptember 30, 2021 . The average yield on loans decreased to 4.51% for the quarter endedSeptember 30, 2022 compared to 4.81% for the quarter endedSeptember 30, 2021 . Average loans outstanding increased$96.0 million , or 7.5%, to$1.38 billion for the nine months endedSeptember 30, 2022 compared to$1.28 billion for the nine months endedSeptember 30, 2021 . The average yield on loans decreased to 4.40% for the nine months endedSeptember 30, 2022 compared to 4.68% for the nine months endedSeptember 30, 2021 . See the Lending and Credit Management section for further discussion of changes in the composition of the lending portfolio. Interest income on available-for-sale securities was$1.8 million and$5.4 million for the three and nine months endedSeptember 30, 2022 , respectively, compared to$1.5 million and$4.0 million for the three and nine months endedSeptember 30, 2021 , respectively. Average securities decreased$13.5 million , or 4.8%, to$266.4 million for the quarter endedSeptember 30, 2022 compared to$279.9 million for the quarter endedSeptember 30, 2021 . The average yield on securities increased to 2.67% for the quarter endedSeptember 30, 2022 compared to 2.15% for the quarter endedSeptember 30, 2021 . See the Liquidity Management section for further discussion. Average securities increased$31.4 million , or 12.5%, to$282.9 million for the nine months endedSeptember 30, 2022 compared to$251.4 million for the nine months endedSeptember 30, 2021 . The average yield on securities increased to 44 -------------------------------------------------------------------------------- 2.57% for the nine months endedSeptember 30, 2022 compared to 2.10% for the nine months endedSeptember 30, 2021 . See the Liquidity Management section for further discussion. Total interest expense increased to$2.8 million for the quarter endedSeptember 30, 2022 compared to$1.4 million for the quarter endedSeptember 30, 2021 , and increased to$5.7 million for the nine months endedSeptember 30, 2022 compared to$4.6 million for the nine months endedSeptember 30, 2021 . The Company's rates paid on interest bearing-liabilities were 0.93% and 0.65% for the three and nine months endedSeptember 30, 2022 , respectively, compared to 0.50% and 0.54% for the three and nine months endedSeptember 30, 2021 , respectively. See the Liquidity Management section for further discussion. Interest expense on deposits increased to$2.0 million for the quarter endedSeptember 30, 2022 compared to$0.7 million for the quarter endedSeptember 30, 2021 , and increased to$3.6 million for the nine months endedSeptember 30, 2022 compared to$2.5 million for the nine months endedSeptember 30, 2021 . Average interest-bearing deposits increased$117.0 million , or 12.2%, to$1.08 billion for the quarter endedSeptember 30, 2022 compared to$0.96 billion for the quarter endedSeptember 30, 2021 . The average cost of deposits increased to 0.73% for the quarter endedSeptember 30, 2022 compared to 0.30% for the quarter endedSeptember 30, 2021 . Average interest-bearing deposits increased$72.7 million , or 7.5%, to$1.04 billion for the nine months endedSeptember 30, 2022 compared to$0.96 billion for the nine months endedSeptember 30, 2021 . The average cost of deposits increased to 0.46% for the nine months endedSeptember 30, 2022 compared to 0.34% for the nine months endedSeptember 30, 2021 . Interest expense on borrowings increased to$0.9 million for the quarter endedSeptember 30, 2022 compared to$0.7 million for the quarter endedSeptember 30, 2021 , and decreased to$2.1 million for the nine months endedSeptember 30, 2022 compared to$2.2 million for the nine months endedSeptember 30, 2021 . Average borrowings decreased to$130.9 million for the quarter endedSeptember 30, 2022 compared to$172.8 million for the quarter endedSeptember 30, 2021 . The average cost of borrowings increased to 2.61% for the quarter endedSeptember 30, 2022 compared to 1.62% for the quarter endedSeptember 30, 2021 . The increase in cost of funds primarily resulted from higher market interest rates. Average borrowings decreased to$134.6 million for the nine months endedSeptember 30, 2022 compared to$183.8 million for the nine months endedSeptember 30, 2021 . The average cost of borrowings increased to 2.11% for the nine months endedSeptember 30, 2022 compared to 1.57% for the nine months endedSeptember 30, 2021 . The increase in cost of funds primarily resulted from higher market interest rates.
Non-interest income and expenses
Non-interest income for the periods indicated was as follows:
Three Months Ended September 30, Nine Months Ended September 30,
(Dollars in thousands) 2022 2021 $ Change % Change 2022 2021 $ Change %
To change
Non-interest income Service charges and other fees$ 693 $ 782 $ (89) (11.4) %$ 2,322 $ 2,285 $ 37 1.6 % Bank card income and fees 1,030 1,043 (13) (1.2) % 3,054 2,925 129 4.4 % Trust department income 287 308 (21) (6.8) % 924 910 14 1.5 % Real estate servicing fees, net 383 71 312 439.4 % 861 495 366 73.9 % Gain on sales of mortgage loans, net 628 1,369 (741) (54.1) % 2,322 5,881 (3,559) (60.5) % Other 464 203 261 128.6 % 1,376 514 862 167.7 % Total non-interest income$ 3,485 $ 3,776 $ (291) (7.7) %$ 10,859 $ 13,010 $ (2,151) (16.5) % Non-interest income as a % of total revenue * 18.8 % 19.7 % 19.9 % 23.0 %
*Total income is net interest income plus non-interest income.
45 -------------------------------------------------------------------------------- Total non-interest income decreased$0.3 million , or 7.7%, to$3.5 million for the third quarter endedSeptember 30, 2022 compared to$3.8 million for the third quarter endedSeptember 30, 2021 , and decreased$2.2 million , or 16.5%, to$10.9 million for the nine months endedSeptember 30, 2022 compared to$13.0 million for the nine months endedSeptember 30, 2021 . The decrease was primarily due to the decrease in gain on sale of real estate mortgages due to lower volumes of real estate mortgage loans sold as further discussed below. Real estate servicing fees, net of the change in valuation of mortgage servicing rights (MSRs) increased to$0.4 million for the quarter endedSeptember 30, 2022 compared to$0.1 million for the quarter endedSeptember 30, 2021 , and increased to$0.9 million for the nine months endedSeptember 30, 2022 compared to$0.5 million for the nine months endedSeptember 30, 2021 . Mortgage loan servicing fees earned on loans sold were$0.2 million and$0.7 million for the three and nine months endedSeptember 30, 2022 , respectively, compared to$0.2 million and$0.6 million for the three and nine months endedSeptember 30, 2021 , respectively. The current quarter's MSR valuation increased$155,000 and$186,000 from the end of the linked quarter andDecember 31, 2021 , respectively, primarily due to an increase in market rates. Mortgage rates have increased significantly to over 6.0% for a new thirty-year conforming mortgage. The Company was servicing$247.6 million of mortgage loans atSeptember 30, 2022 compared to$270.0 million and$277.1 million atDecember 31, 2021 andSeptember 30, 2021 , respectively. Gain on sales of mortgage loans decreased$0.7 million to$0.6 million for the third quarter endedSeptember 30, 2022 compared to$1.4 million for the third quarter endedSeptember 30, 2021 , and decreased$3.6 million to$2.3 million for the nine months endedSeptember 30, 2022 compared to$5.9 million for the nine months endedSeptember 30, 2021 . The Company sold$21.4 million and$76.1 million of loans for the three and nine months endedSeptember 30, 2022 , respectively, compared to$39.1 million and$167.3 million for the three and nine months endedSeptember 30, 2021 , respectively. Loans sold to the secondary market slowed after strong sales during the first nine months of 2021. Other Income increased$0.3 million to$0.5 million for the quarter endedSeptember 30, 2022 compared to$0.2 million for the quarter endedSeptember 30, 2021 , and increased$0.9 million to$1.4 million for the nine months endedSeptember 30, 2022 compared to$0.5 million for the nine months endedSeptember 30, 2021 . The increase primarily resulted from mortgage banking derivative income, interest component of net pension cost, net gain on sale of property in other real estate owned, and income received from theMissouri Department of Transportation related to a land easement. The following table presents the gross realized gains and losses from sales and calls of available-for-sale securities, as well as gains and losses on equity securities from fair value adjustments which have been recognized in earnings: Three Months Ended September 30, Nine Months Ended September 30, (in thousands) 2022 2021 2022 2021 Investment securities gains (losses), net Available-for-sale securities: Gross realized gains $ - $ 119 $ - $ 121 Gross realized losses - - - - Other-than-temporary impairment recognized - - - - Other investment securities: Fair value adjustments, net 1 7 (12) 19 Investment securities gains (losses), net $ 1 $ 126 $ (12) $ 140 46 --------------------------------------------------------------------------------
Non-interest expenses for the periods indicated were as follows:
Three Months Ended September 30, Nine Months Ended September 30, (Dollars in thousands) 2022 2021 $ Change % Change 2022 2021 $ Change % Change Non-interest expense Salaries$ 5,153 $ 4,954 $ 199 4.0%$ 15,315 $ 15,446 $ (131) (0.9)% Employee benefits 1,597 1,711 (114) (6.7) 4,936 5,320 (384) (7.2) Occupancy expense, net 789 808 (19) (2.4) 2,339 2,298 41 1.8 Furniture and equipment expense 774 787 (13) (1.7) 2,301 2,284 17 0.7 Processing, network and bank card expense 1,261 1,288 (27) (2.1) 3,545 3,520 25 0.7 Legal, examination, and professional fees 395 357 38 10.6 1,210 1,146 64 5.6 Advertising and promotion 430 310 120 38.7 1,027 862 165 19.1 Postage, printing, and supplies 237 218 19 8.7 653 608 45 7.4 Loan expense 123 209 (86) (41.1) 426 612 (186) (30.4) Other 1,436 1,127 309 27.4 4,210 3,295 915 27.8 Total non-interest expense$ 12,195 $ 11,769 $ 426 3.6%$ 35,962 $ 35,391 $ 571 1.6% Efficiency ratio* 65.7 % 61.4 % 65.8 % 62.7 % Number of full-time equivalent employees 299 302 299 302
*The efficiency ratio is calculated as non-interest expense as a percentage of revenue. Total income is net interest income plus non-interest income.
Total non-interest expense increased$0.4 million to$12.2 million for the quarter endedSeptember 30, 2022 compared to$11.8 million for the quarter endedSeptember 30, 2021 , and increased$0.6 million to$36.0 million for the nine months endedSeptember 30, 2022 compared to$35.4 million for the nine months endedSeptember 30, 2021 . Salaries increased$0.2 million , or 4.0%, to$5.2 million for the quarter endedSeptember 30, 2022 compared to$5.0 million for the quarter endedSeptember 30, 2021 , and decreased$0.1 million , or 0.9%, to$15.3 million for the nine months endedSeptember 30, 2022 compared to$15.4 million for the nine months endedSeptember 30, 2021 . The decrease for the nine months endedSeptember 30, 2022 was primarily due to reduced commissions based on lower loan volume. See Gains on sales of mortgage loans discussion above. Employee benefits decreased$0.1 million , or 6.7%, to$1.6 million for the quarter endedSeptember 30, 2022 compared to$1.7 million for the quarter endedSeptember 30, 2021 , and decreased$0.4 million , or 7.2%, to$4.9 million for the nine months endedSeptember 30, 2022 compared to$5.3 million for the nine months endedSeptember 30, 2021 . The decreases were primarily due to a decrease in 401(k) plan contributions, medical premiums, and pension cost due to lower annual discount rate assumptions compared to the prior year's annual assumptions. Other non-interest expense increased$0.3 million , or 27.4%, to$1.4 million for the quarter endedSeptember 30, 2022 compared to$1.1 million for the quarter endedSeptember 30, 2021 , and increased$0.9 million , or 27.8%, to$4.2 million for the nine months endedSeptember 30, 2022 compared to$3.3 million for the nine months endedSeptember 30, 2021 . The increases were primarily related to the change in the fair value adjustment for mortgage banking derivatives, insurance expense, telephone, and software expense related to network upgrades and maintenance agreements.
Income taxes
Income taxes as a percentage of earnings before income taxes as reported in the consolidated financial statements were 18.7% and 18.5% for the three and nine months endedSeptember 30, 2022 , respectively, compared to 19.6% and 19.4% for the three and nine months endedSeptember 30, 2021 , respectively. The decrease in the effective tax rate for the three months endedSeptember 30, 2022 compared to the three months endedSeptember 30, 2021 was primarily attributable to the decrease in earnings and the benefit recorded pertaining to the historical tax credit. The decrease in the effective tax rate for the nine months endedSeptember 30, 2022 compared to the nine months endedSeptember 30, 2021 was primarily attributable to the decrease in earnings and the benefit recorded pertaining to the historical tax credit. The effective tax rate for each of the three and nine months endedSeptember 30, 2022 and 2021, respectively, is lower than theU.S. federal statutory rate of 21% primarily due to tax-free revenues. 47 -------------------------------------------------------------------------------- Included in the effective tax rate is a$13,000 and$40,000 benefit associated with a historic tax credit investment for the three and nine months endedSeptember 30, 2022 , respectively. The investment is expected to generate a$331,000 tax benefit over the life of the project and is being recognized under the deferral method of accounting.
Loan and credit management
Interest earned on the loan portfolio is a primary source of interest income for the Company. Net loans represented 79.9% of total assets as ofSeptember 30, 2022 compared to 70.2% as ofDecember 31, 2021 . Lending activities are conducted pursuant to an established loan policy approved by the Bank's Board of Directors. The Bank's credit review process is overseen by regional loan committees with established loan approval limits. In addition, a senior loan committee reviews all credit relationships in aggregate over an established dollar amount. The senior loan committee meets weekly and is comprised of senior managers of the Bank.
The main classifications within the Company’s portfolio of loans held for investment purposes at the dates indicated are as follows:
September 30, 2022 December 31, 2021
(Dollars in thousands) Amount % of Loans Amount % of Loans
Commercial, financial, and agricultural
(a) $ 248,913 16.7 % $ 217,214 16.7 %
Real estate construction - residential 25,243 1.7 27,920 2.1
Real estate construction - commercial 133,186 8.9 91,369 7.0
Real estate mortgage - residential 343,661 23.0 279,346 21.5
Real estate mortgage - commercial 717,192 48.1 663,256 50.9
Installment and other consumer 23,802 1.6 23,028 1.8
Total loans held for investment $ 1,491,997 100.0 % $ 1,302,133 100.0 %
(a) Includes
The Company extends credit to its local community markets through traditional real estate mortgage products. The Company does not participate in credit extension to sub-prime residential real estate markets. The Company does not lend funds for transactions defined as "highly leveraged" by bank regulatory authorities or for foreign loans. Additionally, the Company does not have any concentrations of loans exceeding 10% of total loans that are not otherwise disclosed in the loan portfolio composition table. The Company does not have any interest-earning assets that would have been included in non-accrual, past due, or restructured loans if such assets were loans. The Company generally does not retain long-term fixed rate residential mortgage loans in its portfolio. Fixed rate loans conforming to standards required by the secondary market are offered to qualified borrowers but are not funded until the Company has a non-recourse purchase commitment from the secondary market at a predetermined price. During the nine months endedSeptember 30, 2022 , the Company sold approximately$76.1 million of loans to investors compared to$167.3 million for the nine months endedSeptember 30, 2021 . AtSeptember 30, 2022 , the Company was servicing approximately$247.6 million of loans sold to the secondary market compared to$270.0 million atDecember 31, 2021 , and$277.1 million atSeptember 30, 2021 .
Loan Portfolio Risk Elements
Management, the senior loan committee, and internal loan review, formally review all loans in excess of certain dollar amounts (periodically established) at least annually. Loans in excess of$2.0 million in aggregate and all adversely classified credits identified by management are reviewed by the senior loan committee. In addition, all other loans are reviewed on a risk weighted selection process. The senior loan committee reviews and reports to the Board of Directors, at scheduled meetings: past due, classified, and watch list loans in order to classify or reclassify loans as loans requiring attention, substandard, doubtful, or loss. During this review, management also determines which loans should be considered impaired. Management follows the guidance provided in theFinancial Accounting Standards Board's (FASB) ASC Topic 310-10-35 in identifying and measuring loan impairment. If management determines that it is probable that all amounts due on a loan will not be collected under the original terms of the loan agreement, the loan is considered impaired. These loans are evaluated individually for impairment, and in conjunction with current economic conditions and loss experience, specific reserves are estimated as further discussed below. Loans not individually evaluated are aggregated and reserves are recorded using a consistent methodology that considers historical loan loss experience by loan type, 48 -------------------------------------------------------------------------------- delinquencies, current economic conditions, loan risk ratings and industry concentration. Management believes, but there can be no assurance, that these procedures keep management informed of potential problem loans. Based upon these procedures, both the allowance and provision for loan losses are adjusted to maintain the allowance at a level considered necessary by management to provide for probable losses inherent in the loan portfolio.
Non-performing assets
The following table summarizes non-performing assets at the dates indicated:
September 30, December 31,
(Dollars in thousands) 2022 2021
Non-accrual loans:
Commercial, financial, and agricultural $ 173 $ 153
Real estate construction - commercial 91 105
Real estate mortgage - residential 1,083 1,129
Real estate mortgage - commercial 15,995 24,029
Installment and other consumer 6 43
Total $ 17,348 $ 25,459
Contractually past due loans – 90 days or more past due and still outstanding:
Real estate mortgage - residential $ - $ 14 Total $ - $ 14 Total non-performing loans (a) 17,348 25,473 Other real estate owned and repossessed assets 9,210 10,525 Total non-performing assets $ 26,558 $ 35,998 Loans held for investment $ 1,491,997 $ 1,302,133 Allowance for loan losses to loans 1.04 % 1.30 % Non-accrual loans to total loans 1.16 % 1.96 % Non-performing loans to loans (a) 1.16 % 1.96 % Non-performing assets to loans (b) 1.78 % 2.76 % Non-performing assets to assets (b) 1.44 % 1.97 % Allowance for loan losses to non-accrual loans 89.38 % 66.39 % Allowance for loan losses to non-performing loans 89.38 % 66.36 % (a)Non-performing loans include loans 90 days past due and accruing, non-accrual loans, and non-performing TDRs included in non-accrual loans and 90 days past due. (b)Non-performing assets include non-performing loans and other real estate owned and repossessed assets.
Total non-performing assets were
Total non-accrual loans atSeptember 30, 2022 decreased$8.1 million , or 31.9%, to$17.3 million compared to$25.5 million atDecember 31, 2021 . There were no loans past due 90 days and still accruing interest atSeptember 30, 2022 compared to$14,000 atDecember 31, 2021 . Other real estate and repossessed assets were$9.2 million and$10.5 million atSeptember 30, 2022 andDecember 31, 2021 , respectively. During the nine months endedSeptember 30, 2022 , there were$3,000 of non-accrual loans, net of charge-offs taken, added to other real estate owned and repossessed assets compared to$142,000 during the nine months endedSeptember 30, 2021 . As ofSeptember 30, 2022 , approximately$14.7 million of loans classified as substandard, which include performing TDRs, and were not included in the non-performing asset table, were identified as potential problem loans having more than normal risk which raised doubts as to the ability of the borrower to comply with present loan repayment terms, compared to$13.8 million atDecember 31, 2021 . Management believes the allowance for loan losses was sufficient to cover the risks and probable losses related to such loans atSeptember 30, 2022 andDecember 31, 2021 , respectively. 49 --------------------------------------------------------------------------------
The following table summarizes the Company’s ToRs on the dates indicated:
September 30, 2022 December 31, 2021
Number of Specific Number of Specific
(Dollars in thousands) contracts Recorded Investment Reserves contracts Recorded Investment Reserves
Performing TDRs
Commercial, financial and
agricultural 3 $ 177 $ 23 2 $ 188 $ 24
Real estate mortgage - residential 5 1,098 53 6 1,262 56
Real estate mortgage - commercial 2 313 53 2 328 38
Installment and other consumer 0 - - 2 17 2
Total performing TDRs 10 $ 1,588 $ 129 12 $ 1,795 $ 120
Non-performing TDRs
Real estate mortgage - residential 5 $ 330 $ 42 5 $ 561 $ 39
Total non-performing TDRs 5 $ 330 $ 42 5 $ 561 $ 39
Total TDRs 15 $ 1,918 $ 171 17 $ 2,356 $ 159
At September 30, 2022 , loans classified as TDRs totaled $1.9 million , with $0.2
million of specific reserves, compared to $2.4 million of loans classified as
TDRs, with $0.2 million of specific reserves, at December 31, 2021 .
Non-performing loans, included $0.3 million of loans classified as TDRs at
September 30, 2022 compared to $0.6 million at December 31, 2021 . Both
performing and non-performing TDRs are considered impaired loans. When an
individual loan is determined to be a TDR, the amount of impairment is based
upon the present value of expected future cash flows discounted at the loan's
effective interest rate or the fair value of the underlying collateral less
applicable selling costs if the loan is collateral dependent. The net decrease
in total TDRs from December 31, 2021 to September 30, 2022 was primarily due to
$439,000 of payments received on TDRs.
Allowance for loan losses and provision
Allowance for loan losses
The following table is a summary of the allocation of the allowance for loan
losses:
September 30, 2022 December 31, 2021
% of loans in % of loans in
each category to each category to
(in thousands) Amount total loans Amount total loans
Allocation of allowance for loan losses at end of
period:
Commercial, financial, and agricultural $ 2,848 16.7 % $ 2,717 16.7 %
Real estate construction - residential 71 1.7 137 2.1
Real estate construction - commercial 849 8.9 588 7.0
Real estate mortgage - residential 3,232 23.0 2,482 21.5
Real estate mortgage - commercial 8,002 48.1 10,662 50.9
Installment and other consumer 316 1.6 256 1.8
Unallocated 187 - 61 -
Total $ 15,505 100.0 % $ 16,903 100.0 %
The allowance for loan losses was $15.5 million , or 1.04%, of loans outstanding
at September 30, 2022 compared to $16.9 million , or 1.30%, of loans outstanding
at December 31, 2021 . The ratio of the allowance for loan losses to
non-performing loans was 89.38% at September 30, 2022 , compared to 66.36% at
December 31, 2021 .
50
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The following table is a summary of the general and specific allocations of the
allowance for loan losses:
September 30,
(in thousands) 2022 December 31, 2021
Breakdown of allowance for loan losses: assessed individually for impairment – specific reserves $ 302 $
3,044 Collectively evaluated for impairment - general reserves 15,203 13,859 Total$ 15,505 $ 16,903 The specific reserve component applies to loans evaluated individually for impairment. The net carrying value of impaired loans is generally based on the fair values of collateral obtained through independent appraisals and/or internal evaluations, or by discounting the total expected future cash flows. Once the impairment amount is calculated, a specific reserve allocation is recorded. AtSeptember 30, 2022 ,$0.3 million of the Company's ALL was allocated to impaired loans totaling approximately$18.9 million compared to$3.0 million of the Company's ALL allocated to impaired loans totaling approximately$27.3 million atDecember 31, 2021 . Management determined that$15.9 million , or 84%, of total impaired loans required no reserve allocation atSeptember 30, 2022 compared to$16.6 million , or 61%, atDecember 31, 2021 , primarily due to adequate collateral values, acceptable payment history and adequate cash flow ability. The incurred loss component of the general reserve, or loans collectively evaluated for impairment, is determined by applying loss rates to pools of loans by asset type. Loans not individually evaluated are aggregated by risk characteristics and reserves are recorded using a consistent methodology that considers historical loan loss experience by loan type. The look-back period begins with loss history in the first quarter 2012 as the starting point through the current quarter and it will continue to include this starting point going forward. Management determined that the look-back period should be expanded until a loss-producing downturn is recognized. This would be accomplished by allowing the look-back period to shift forward by eliminating the earliest loss period and replenishing it with losses from the most recent period. The look-back period is consistently evaluated for relevance given the current facts and circumstances. These historical loss rates for each risk group are used as the starting point to determine loss rates for measurement purposes. The historical loan loss rates are multiplied by loss emergence periods (LEP) which represent the estimated time period between a borrower first experiencing financial difficulty and the recognition of a loss. The Company's methodology includes qualitative risk factors that allow management to adjust its estimates of losses based on the most recent information available and to address other limitations in the quantitative component based on historical loss rates. Such risk factors are generally reviewed and updated quarterly, as appropriate, and are adjusted to reflect changes in national and local economic conditions and developments, the nature, volume and terms of loans in the portfolio, including changes in volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified or graded loans, loan concentrations, assessment of trends in collateral values, assessment of changes in the quality of the Company's internal loan review department, and changes in lending policies and procedures, including underwriting standards and collections, charge-off and recovery practices. The specific and general reserve allocations represent management's best estimate of probable losses inherent in the loan portfolio at the evaluation date. Although the ALL is comprised of specific and general allocations, the entire ALL is available to absorb any credit losses. The decrease in the allowance for loan losses fromDecember 31, 2021 as compared toSeptember 30, 2022 primarily resulted from one large non-accrual loan relationship impacted by COVID-19 that returned to performing status. This transition was made according to the Company's established internal loan policies regarding loan performance as well as consultation with industry experts. This transition back to performing status also reduced specific reserves based on the attributes of the individual loan collateral, to the general allocations method described above. The Company continues to monitor the risks associated with its non-performing loans. Partially offsetting this decrease in the allowance for loan losses was an increase in the reserve due to the significant loan growth that occurred during the first nine months of 2022.
Arrangement
The Company recognized a provision expense and a negative provision expense for loan losses of$0.3 million and$1.0 million for the three and nine months endedSeptember 30, 2022 , respectively, compared to$0.3 million and$0.7 million provision expense for the three and nine months endedSeptember 30, 2021 , respectively. The negative provision 51 -------------------------------------------------------------------------------- expense primarily resulted from the release of specific reserves totaling$2.8 million in the first quarter of 2022 due to returning the balances related to one loan relationship to accrual from non-accrual status. The following table summarizes loan loss experience for the periods indicated: Three Months Ended September 30, 2022 2022 2021 Net (Recoveries) Net (Recoveries) Net Charge-offs Charge-offs / Net Charge-offs Charge-offs / (Dollars in thousands) (Recoveries) Average Loans Average Loans (Recoveries) Average Loans Average Loans Commercial, financial, and agricultural $ 33$ 245,877 0.01 % $ 26$ 247,564 0.01 % Real estate construction - residential - 24,249 - - 35,358 - Real estate construction - commercial - 127,594 - - 75,081 - Real estate mortgage - residential (4) 323,158 - 10 270,464 - Real estate mortgage - commercial (6) 702,139 - 14 633,238 - Installment and other consumer 125 23,738 0.53 56 24,363 0.23 Total $ 148$ 1,446,755 0.01 % $ 106$ 1,286,068 0.01 % Nine Months Ended September 30, 2022 2021 Net (Recoveries) Net (Recoveries) Net Charge-offs Charge-offs / Net Charge-offs Charge-offs / (Dollars in thousands) (Recoveries) Average Loans Average Loans (Recoveries) Average Loans Average Loans Commercial, financial, and agricultural $ 57$ 233,076 0.02 % $ (102)$ 253,878 (0.04) % Real estate construction - residential - 23,627 - (13) 34,625 (0.04) Real estate construction - commercial - 110,540 - - 77,115 - Real estate mortgage - residential (27) 300,518 (0.01) (161) 264,699 (0.06) Real estate mortgage - commercial 169 685,041 0.02 41 624,455 0.01 Installment and other consumer 199 22,987 0.87 119 25,044 0.48 Total $ 398$ 1,375,789 0.03 % $ (116)$ 1,279,816 (0.01) %
Net loan write-offs (recoveries)
The Company's net charge-offs were$0.1 million , or 0.01% of average loans, for the quarter endedSeptember 30, 2022 compared to$0.1 million , or 0.01% of average loans, for the quarter endedSeptember 30, 2021 , and net charge-offs were$0.4 million , or 0.03% of average loans, for the nine months endedSeptember 30, 2022 compared to net recoveries of$0.1 million , or (0.01)% of average loans, for the nine months endedSeptember 30, 2021 .
Loans held for sale
The Company designates certain long-term fixed rate personal real estate loans as held for sale. In the fourth quarter of 2021, the Company elected the fair value option for all newly originated long-term personal real estate loans held for sale. As ofDecember 31, 2021 , all loans held for sale were carried at fair value. The loans are primarily sold to Freddie Mac, Fannie Mae, andPennyMac and other various secondary market investors. AtSeptember 30, 2022 , the carrying amount of these loans was$0.9 million compared to$2.2 million atDecember 31, 2021 . 52 --------------------------------------------------------------------------------
Cash and capital resources
Cash management
The role of liquidity management is to ensure funds are available to meet depositors' withdrawal and borrowers' credit demands while at the same time maximizing profitability. This is accomplished by balancing changes in demand for funds with changes in the supply of those funds. Liquidity to meet these demands is provided by maturing assets, short-term liquid assets that can be converted to cash and the ability to attract funds from external sources, principally depositors. Due to the nature of services offered by the Company, management prefers to focus on transaction accounts and full service relationships with customers as the primary sources of funding. The Company's Asset/Liability Committee (ALCO), primarily made up of senior management, has direct oversight responsibility for the Company's liquidity position and profile. A combination of daily, weekly, and monthly reports provided to management detail the following: internal liquidity metrics, composition and level of the liquid asset portfolio, timing differences in short-term cash flow obligations, available pricing and market access to the financial markets for capital, and exposure to contingent draws on the Company's liquidity. The Company has a number of sources of funds to meet liquidity needs on a daily basis. The Company's most liquid assets are comprised of available-for-sale investment securities, not including other debt securities, federal funds sold, and excess reserves held at theFederal Reserve . (in thousands) September 30, 2022 December 31, 2021 Federal funds sold $ 46 $
7,122
Other interest-bearing deposits 26,259
135,500
Certificates of deposit in other banks 4,195
5,193
Available-for-sale investment securities 245,155 310,870 Total $ 275,655 $ 458,685 Federal funds sold and resale agreements normally have overnight maturities and are used for general daily liquidity purposes. The fair value of the available-for-sale investment portfolio was$245.2 million atSeptember 30, 2022 and included an unrealized net loss of$54.5 million . The portfolio includes projected maturities and mortgage-backed securities pay-downs of approximately$5.7 million over the next twelve months, which offer resources to meet either new loan demand or reductions in the Company's borrowings. The Company pledges portions of its investment securities portfolio to secure public fund deposits, federal funds purchase lines, securities sold under agreements to repurchase, borrowing capacity at theFederal Reserve Bank , and for other purposes as required or permitted by law. AtSeptember 30, 2022 andDecember 31, 2021 , the Company's unpledged securities in the available-for-sale portfolio totaled approximately$76.1 million and$35.5 million , respectively.
The total investment securities pledged for these purposes were as follows:
September 30, December 31,
(in thousands) 2022 2021
Marketable securities pledged to guarantee:
$ 8,040 $ 10,778 Federal funds purchased and securities sold under agreements to repurchase 8,513 28,769 Other deposits 152,454 235,829 Total pledged, at fair value$ 169,007 $ 275,376 Liquidity is available from the Company's base of core customer deposits, defined as demand, interest checking, savings, money market deposit accounts, and time deposits less than$250,000 , less all brokered deposits under$250,000 . AtSeptember 30, 2022 , such deposits totaled$1.4 billion and represented 90.8% of the Company's total deposits. These core deposits are normally less volatile and are often tied to other products of the Company through long lasting relationships. 53 --------------------------------------------------------------------------------
Basic deposits at
(in thousands) September 30, 2022 December 31, 2021 Core deposit base: Non-interest bearing demand $ 498,653 $ 453,066 Interest checking 341,096 357,825 Savings and money market 448,411 440,331 Other time deposits 157,444 175,827 Total $ 1,445,604$ 1,427,049 Estimated uninsured deposits totaled$538.5 million , including$110.9 million of certificates of deposit, atSeptember 30, 2022 , compared to$513.5 million , including$69.1 million of certificates of deposit, atDecember 31, 2021 . The Company had brokered deposits totaling$36.1 million and$20.2 million atSeptember 30, 2022 andDecember 31, 2021 , respectively. Other components of liquidity are the level of borrowings from third-party sources and the availability of future credit. The Company's outside borrowings are comprised of securities sold under agreements to repurchase,Federal Home Loan Bank advances, and subordinated notes. Federal funds purchased are overnight borrowings obtained mainly from upstream correspondent banks with which the Company maintains approved credit lines. As ofSeptember 30, 2022 , under agreements with these unaffiliated banks, the Bank may borrow up to$60.0 million in federal funds on an unsecured basis and$7.6 million on a secured basis. There were no federal funds purchased outstanding atSeptember 30, 2022 . Securities sold under agreements to repurchase are generally borrowed overnight and are secured by a portion of the Company's investment portfolio. AtSeptember 30, 2022 , there were$5.9 million in repurchase agreements. The Company may periodically borrow additional short-term funds from theFederal Reserve Bank through the discount window, although no such borrowings were outstanding atSeptember 30, 2022 . The Bank is a member of theFederal Home Loan Bank of Des Moines (FHLB) and has access to credit products of the FHLB. As ofSeptember 30, 2022 , the Bank had$73.0 million in outstanding borrowings with the FHLB. In addition, the Company has$49.5 million in outstanding subordinated notes issued to wholly-owned grantor trusts, funded by preferred securities issued by the trusts. Borrowings outstanding atSeptember 30, 2022 andDecember 31, 2021 were as follows: September 30, December 31, (in thousands) 2022 2021 Borrowings:
Fed Funds Purchased and Securities Sold Under Repurchase Agreements
$ 5,890 $ 23,829 Federal Home Loan Bank advances 73,000 77,418 Subordinated notes 49,486 49,486 Total$ 128,376 $ 150,733 The Company pledges certain assets, including loans and investment securities to theFederal Reserve Bank , FHLB, and other correspondent banks as security to establish lines of credit and borrow from these entities. Based on the type and value of collateral pledged, the FHLB establishes a collateral value from which the Company may draw advances against this collateral. This collateral is also used to enable the FHLB to issue letters of credit in favor of public fund depositors of the Company. TheFederal Reserve Bank also establishes a collateral value of assets pledged to support borrowings from the discount window. 54 --------------------------------------------------------------------------------
The following table reflects the collateral value of pledged assets, borrowings and outstanding letters of credit, in addition to the estimated future funding capacity available to the Company, as follows:
September 30, 2022 December 31, 2021
Federal Funds Federal Funds
(in thousands) FHLB Federal Reserve Bank Purchased Lines Total FHLB Federal Reserve Bank Purchased Lines Total
Advance equivalent $ 320,097 $ 7,567 $ 60,000 $ 387,664 $ 273,479 $ 10,384 $ 60,000 $ 343,863
Letters of credit (53,500) - - (53,500) (31,000) - - (31,000)
Advances outstanding (73,000) - - (73,000) (77,418) - - (77,418)
Total available $ 193,597 $ 7,567 $ 60,000 $ 261,164 $ 165,061 $ 10,384 $ 60,000 $ 235,445
At September 30, 2022 , loans of $636.5 million were pledged to the Federal Home
Loan Bank as collateral for borrowings and letters of credit. At September 30,
2022 , investments with a market value of $8.0 million were pledged to secure
federal funds purchase lines and borrowing capacity at the Federal Reserve Bank .
Based upon the above, management believes the Company has more than adequate
liquidity, both on balance sheet and through the additional funding capacity
with the FHLB, the Federal Reserve Bank and Federal funds purchased lines to
meet future anticipated needs in both the short and long-term.
Sources and uses of funds
Cash and cash equivalents were$41.4 million atSeptember 30, 2022 compared to$159.9 million atDecember 31, 2021 . The$118.5 million decrease resulted from changes in the various cash flows produced by operating, investing, and financing activities of the Company, as shown in the accompanying consolidated statement of cash flows for the nine months endedSeptember 30, 2022 . Cash flow provided from operating activities consists mainly of net income adjusted for certain non-cash items. Operating activities provided cash flow of$14.2 million for the nine months endedSeptember 30, 2022 . Investing activities, consisting mainly of purchases, sales and maturities of available-for-sale securities, and changes in the level of the loan portfolio, used total cash of$180.3 million during the nine months endedSeptember 30, 2022 . The cash outflow primarily consisted of a net increase in loans held for investment of$190.2 million and$17.3 million in purchases of investment securities partially offset by$27.0 million from maturities and calls and sales of investment securities. Financing activities provided total cash of$47.6 million during the nine months endedSeptember 30, 2022 , resulting primarily from a$76.0 million increase in demand deposits, interest-bearing transaction accounts and time deposits. These increases were partially offset by a$17.9 million decrease in securities sold under agreements to repurchase. In the normal course of business, the Company enters into certain forms of off-balance sheet transactions, including unfunded loan commitments and letters of credit. These transactions are managed through the Company's various risk management processes. Management considers both on-balance sheet and off-balance sheet transactions in its evaluation of the Company's liquidity. The Company had$426.3 million in unused loan commitments and standby letters of credit as ofSeptember 30, 2022 . Although the Company's current liquidity resources are adequate to fund this commitment level, the nature of these commitments is such that the likelihood of such a funding demand is very low. The Company is a legal entity, separate and distinct from the Bank, which must provide its own liquidity to meet its operating needs. The Company's ongoing liquidity needs primarily include funding its operating expenses, paying cash dividends to its shareholders and, to a lesser extent, repurchasing its shares of common stock. The Company paid cash dividends to its shareholders totaling approximately$3.1 million and$2.6 million for the nine months endedSeptember 30, 2022 and 2021, respectively. A large portion of the Company's liquidity is obtained from the Bank in the form of dividends. The Bank declared and paid$9.0 million and$6.5 million in dividends to the Company during the nine months endedSeptember 30, 2022 and 2021, respectively. AtSeptember 30, 2022 andDecember 31, 2021 , the Company had cash and cash equivalents totaling$3.1 million and$1.8 million , respectively. Subject to declaration by the Company's Board of Directors, the Company expects to continue paying quarterly cash dividends as a part of its current capital allocation strategy. Future dividends will be subject to the determination, declaration and discretion of the Company's Board of Directors and compliance with applicable regulatory capital requirements. 55 -------------------------------------------------------------------------------- The Company's 2019 Repurchase Plan was amended during the second quarter 2021 to authorize the purchase of up to an additional$5.0 million in market value of the Company's common stock. Management was given discretion to determine the number and pricing of the shares to be purchased, as well as the timing of any such purchases. The Company repurchased 108,724 common shares under the plan during the nine months endedSeptember 30, 2022 , at an average cost of$26.60 per share totaling$2.9 million . The repurchases under these authorizations may be effectuated in the open market, by block purchase, in privately negotiated transactions, or through other transactions managed by broker-dealers, or any combination thereof. No time limit was set for the completion of these authorized share repurchases. As ofSeptember 30, 2022 ,$2.1 million remained available for the repurchase of shares pursuant to the share repurchase authorizations. The Company may continue to repurchase shares under its share repurchase authorizations, but the amount and timing of such repurchases will be dependent on a number of factors, including the price of its common stock and other cash flow needs. There is no assurance that the Company will repurchase up to the full amount remaining under its share repurchase authorizations.
capital management
The Company and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company's consolidated financial statements. Under capital adequacy guidelines, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification of the Company and the Bank are subject to qualitative judgments by the regulators about components, risk-weightings, and other factors. The Basel III regulatory capital framework (the "Basel III Capital Rules") adopted byU.S. federal regulatory authorities, among other things, (i) establishes the capital measure called "Common Equity Tier 1" ("CET1"), (ii) specifies that Tier 1 capital consist of CET1 and "Additional Tier 1 Capital" instruments meeting stated requirements, (iii) requires that most deductions/adjustments to regulatory capital measures be made to CET1 and not to other components of capital and (iv) defines the scope of the deductions/adjustments to the capital measures. Additionally, the Basel III Capital Rules require that the Company maintain a 2.5% capital conservation buffer with respect to each of CET1, Tier 1 and total capital to risk-weighted assets, which provides for capital levels that exceed the minimum risk-based capital adequacy requirements. A financial institution with a conservation buffer of less than the required amount is subject to limitations on capital distributions, including dividend payments and stock repurchases, and certain discretionary bonus payments to executive officers. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of CET1, Tier 1 and total capital to risk-weighted assets, and of Tier 1 capital to average assets, each as defined in the regulations. Management believes, as ofSeptember 30, 2022 , that the Company and the Bank meet all capital adequacy requirements to which they are subject. Financial institutions are categorized as well capitalized or adequately capitalized, based on minimum total risk-based, Tier 1 risk-based, CET1 and Tier 1 leverage ratios. As shown in the table below, the Company's capital ratios exceeded the regulatory definition of adequately capitalized as ofSeptember 30, 2022 andDecember 31, 2021 . Based upon the information in its most recently filed call report, the Bank met the capital ratios necessary to be well-capitalized. The regulatory authorities can apply changes in classification of assets and such changes may retroactively subject the Company to changes in capital ratios. Any such change could reduce one or more capital ratios below well-capitalized status. In addition, a change may result in imposition of additional assessments by theFDIC or could result in regulatory actions that could have a material effect on our condition and results of operations. In addition, bank holding companies generally are required to maintain a Tier 1 leverage ratio of at least 4%. Because the Bank had less than$15.0 billion in total consolidated assets as ofDecember 31, 2009 , the Company is allowed to continue to classify its trust preferred securities, all of which were issued prior toMay 19, 2010 , as Tier 1 capital. 56 -------------------------------------------------------------------------------- Under the Basel III requirements, atSeptember 30, 2022 andDecember 31, 2021 , the Company met all capital adequacy requirements and had regulatory capital ratios in excess of the levels established for well-capitalized institutions, as shown in the following table as of periods indicated: Minimum Capital Required - Basel III Required to be
Well considered-
Actual Fully Phased-In Capitalized (Dollars in thousands) Amount Ratio Amount Ratio Amount
Report
September 30, 2022 Total Capital (to risk-weighted assets): Company$ 219,214 13.84 %$ 166,292 10.50 % $ - N.A% Bank 217,040 13.73 % 165,928 10.50 % 158,027 10.00 % Tier 1 Capital (to risk-weighted assets): Company$ 194,017 12.25 %$ 134,617 8.50 % $ - N.A% Bank 201,375 12.74 % 134,323 8.50 % 126,421 8.00 % Common Equity Tier 1 Capital (to risk-weighted assets): Company$ 155,549 9.82 %$ 110,861 7.00 % $ - N.A% Bank 201,375 12.74 % 110,619 7.00 % 102,717 6.50 % Tier 1 leverage ratio (to adjusted average assets): Company$ 194,017 10.60 %$ 73,184 4.00 % $ - N.A% Bank 201,375 10.97 % 73,443 4.00 % 91,803 5.00 % December 31, 2021 Total Capital (to risk-weighted assets): Company$ 210,726 14.79 %$ 149,640 10.50 % $ - N.A% Bank 210,148 14.78 % 149,339 10.50 % 142,228 10.00 % Tier 1 Capital (to risk-weighted assets): Company$ 193,663 13.59 %$ 121,137 8.50 % $ - N.A% Bank 193,085 13.58 % 120,894 8.50 % 113,782 8.00 % Common Equity Tier 1 Capital (to risk-weighted assets): Company$ 145,663 10.22 %$ 99,760 7.00 % $ - N.A% Bank 193,085 13.58 % 99,559 7.00 % 92,448 6.50 % Tier 1 leverage ratio: Company$ 193,663 11.01 %$ 70,342 4.00 % $ - N.A% Bank 193,085 11.04 % 69,959 4.00 % 87,449 5.00 % 57
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