QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2024
or
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission File Number 001-36613
Middlefield Banc Corp.
(Exact Name of Registrant as Specified in its Charter)
Ohio
34-1585111
State or Other Jurisdiction of
I.R.S. Employer Identification No.
Incorporation or Organization
15985 East High Street, Middlefield, Ohio
44062-0035
Address of Principal Executive Offices
Zip Code
440-632-1666
Registrant’s Telephone Number, Including Area Code
Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report
Securities Registered Pursuant to Section 12(b) of the Act:
Title of Each Class
Trading Symbol(s)
Name of Each Exchange on Which Registered
Common Stock, Without Par Value
MBCN
The NASDAQ Stock Market, LLC
(NASDAQ Capital Market)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐
Accelerated filer ☐
Non-accelerated filer ☒
Smaller reporting company ☒
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Basis of Presentation
The consolidated financial statements of Middlefield Banc Corp. ("Company") include its bank subsidiary, The Middlefield Banking Company (“MBC” or “Bank”), and a nonbank asset resolution subsidiary EMORECO, Inc. The consolidated financial statements also include the accounts of MBC’s subsidiaries, Middlefield Investments, Inc. (“MI”) and MB Insurance Services (“MIS”). All significant inter-company items have been eliminated.
On March 13, 2019, MBC established MI as an operating subsidiary to hold and manage an investment portfolio. On September 30, 2024, MI’s assets consist of a cash account, available-for-sale investment securities, and related accrued interest accounts. MI may only hold and manage investments and may not engage in any other activity without prior approval of the Ohio Division of Financial Institutions. In the first quarter of 2022, MBC established MIS as an operating subsidiary to offer retail and business customers various insurance services, including home, renters, automobile, pet, identity theft, travel, and professional liability insurance. On September 30, 2024, MIS assets consist of a cash account, a prepaid asset, and an accounts receivable. As a result of the bank merger of Liberty National Bank and MBC on December 1, 2022, Middlefield Banc Corp. acquired a 100% ownership interest in LBSI Insurance, LLC (“LBSI”), a wholly owned financial subsidiary of Liberty National Bank. LBSI did not operate after the merger, and its existence ended January 19, 2024. All significant intercompany items have been eliminated between MBC and these subsidiaries.
The unaudited consolidated financial statements have been prepared in conformity with the instructions to Form 10-Q and Article 10 of Regulation SX. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements. The financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K for the year ended December 31, 2023. The interim consolidated financial statements include all adjustments (consisting of only normal recurring items) that, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the periods presented. The results of operations for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year.
The Company’s significant accounting policies involve the more significant judgments and assumptions used in the preparation of the consolidated financial statements as of September 30, 2024. However, the Company has identified critical accounting policies, and an understanding of these policies is necessary to understand the Company’s financial statements. These policies relate to determining the adequacy of the allowance for credit losses for the investment securities held for sale, loan portfolios, and unfunded commitments.
Investments
Management determines the appropriate classification of investment securities at the time of purchase and re-evaluates such designation as of each balance sheet date.
Investment securities classified as available for sale are those securities that the Bank intends to hold for an indefinite period of time but not necessarily to maturity. Securities available for sale are carried at fair value. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Bank’s assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Unrealized gains or losses are reported as increases or decreases in other comprehensive income (loss), net of the deferred tax effect. Realized gains or losses, determined on the basis of the cost of the specific securities sold, are included in earnings. Premiums and discounts are recognized in interest income using the interest method over the terms of the securities.
Investment securities classified as held to maturity are those securities the Bank has both the intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs, or changes in general economic conditions. These securities are carried at cost, adjusted for the amortization of premium and accretion of discount, and computed by a method that approximates the interest method over the terms of the securities. As of September 30, 2024, the Company did not hold any held-to-maturity securities.
Equity securities, which are included in other investments on the Consolidated Balance Sheet, are measured at fair value with changes in fair value recognized in net income.
The Bank adopted ASU No.2016-13, Financial Instruments - Credit Loses - Topic (326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"), effective January 1, 2023. The Bank measures expected credit losses on available-for-sale investment securities when the Bank intends to sell, or when it is more likely than not that it will be required to sell, the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security's amortized cost basis is written down to fair value through income. For available for sale investment securities that do not meet the aforementioned criteria, the Bank evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, the Bank considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this evaluation indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists, and an allowance for credit losses is recorded for the credit loss, equal to the amount that the fair value is less than the amortized cost basis. Economic forecast data is used to calculate the present value of expected cash flows. The Bank obtains its forecast data through a subscription to a widely recognized and relied-upon company that publishes various forecast scenarios. Management evaluates the various scenarios to determine a reasonable and supportable scenario and uses a single scenario in the model. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income.
The allowance for credit losses is included within investment securities available for sale on the Consolidated Balance Sheet. Changes in the allowance for credit losses are recorded within the provision for credit losses on the Consolidated Statement of Income. Losses are charged against the allowance when the Bank believes the collectability of an available-for-sale security is in jeopardy or when either of the criteria regarding intent or requirement to sell is met.
Accrued interest receivable on available-for-sale investment securities totaled $1.5 million on September 30, 2024, and is included within accrued interest receivable and other assets on the Consolidated Balance Sheet. This amount is excluded from the estimate of expected credit losses. Available for sale investment securities are typically classified as nonaccrual when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about the further collectability of principal or interest. When available for sale investment securities are placed on nonaccrual status, unpaid interest credited to income is reversed.
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at their outstanding unpaid principal balances, net of unearned income, which includes net deferred loan fees and costs and unamortized premiums and discounts. Accrued interest receivable is included within accrued interest receivable and other assets on the Consolidated Balance Sheet. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loans’ yield (interest income). The Bank amortizes these amounts over the contractual life of the loan. Premiums and discounts on purchased loans are amortized as adjustments to interest income using the effective yield method. Interest income is primarily recognized on an accrual basis according to formulas in written contracts, such as loan agreements.
The loan portfolio is segmented into commercial and consumer loans. Commercial loans consist of the following classes: commercial construction, commercial and industrial loans, and commercial real estate loans. Consumer loans consist of the following classes: residential real estate loans, home equity loans, and consumer loans.
For all classes of loans, the accrual of interest is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against the allowance for credit losses. Interest received on nonaccrual loans generally is either applied against the principal or reported as interest income on a cash basis, according to management’s judgment as to the collectability of principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectability of the total contractual principal and interest is no longer in doubt. The past-due status of all classes of loans is determined based on contractual due dates for loan payments.
The Bank adopted ASU 2016-13, effective January 1, 2023. Upon adoption, the reserve for credit losses on loans increased by $5.4 million. The guidance applies an expected-loss methodology, recognizing current expected credit losses for the remaining life of the asset at the time of origination or acquisition. The allowance for credit losses ("ACL") is a valuation reserve established and maintained by charges against income and is deducted from the amortized cost basis of loans to present the net amount expected to be collected on the loans. Loans, or portions thereof, are charged off against the ACL when they are deemed uncollectible. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off.
The ACL is an estimate of expected credit losses, measured over the contractual life of a loan, that considers our historical loss experience, current conditions, and forecasts of future economic conditions. Determination of an appropriate ACL is inherently subjective and may have significant changes from period to period.
Management uses a discounted cash flow ("DCF") model to calculate the present value of the expected cash flows for pools of loans that share similar risk characteristics and compares the results of this calculation to the amortized cost basis to determine its ACL balance.
The contractual term used in projecting the cash flows of a loan is based on the maturity date of a loan and is adjusted for prepayment or curtailment assumptions, which may shorten that contractual time period. Options to extend are considered by management in determining the contractual term.
The key inputs to the DCF model are (1) probability of default, (2) loss given default, (3) prepayment and curtailment rates, (4) reasonable and supportable economic forecasts, (5) forecast reversion period, (6) expected recoveries on charged off loans, and (7) discount rate.
Probability of Default ("PD")
In order to incorporate economic factors into forecasting within the DCF model, management elected to use the Loss Driver method to generate the PD rate inputs. The Loss Driver method analyzes how one or more economic factors change the default rate using statistical regression analysis. Management selected economic factors that have strong correlations to historical default rates.
Loss Given Default ("LGD")
Management elected to use the Frye Jacobs parameter for determining the LGD input, which is an estimation technique that derives an LGD input from segment-specific risk curves that correlate LGD with PD.
Prepayment and Curtailment Rates
Prepayment Rates: Loan-level transaction data is used to calculate semi-annual prepayment rates. These semi-annual rates are annualized, and the average of the annualized rates is used in the DCF calculation for fixed payments or term loans. Rates are calculated for each pool.
Curtailment Rates: Loan-level transaction data is used to calculate annual curtailment rates using available historical loan-level data. The average of the historical rates is used in the DCF model for interest-only payment or line-of-credit type loans. Rates are calculated for each pool.
Reasonable and Supportable Forecasts
The forecast data used in the DCF model is obtained via a subscription to a widely recognized and relied-upon company that publishes various forecast scenarios. Management evaluates the various scenarios to determine a reasonable and supportable forecast.
Forecast Reversion Period
Management uses forecasts to predict how economic factors will perform and has determined to use a four-quarter forecast period as well as an eight-quarter straight-line reversion period to historical averages (also commonly referred to as the mean reversion period).
Expected Recoveries on Charged-off Loans
Management performs an analysis to estimate recoveries that could be reasonably expected based on historical experience in order to account for expected recoveries on loans that have already been fully charged off and are not included in the ACL calculation.
The effective interest rate of the underlying loans of the Company serves as the discount rate applied to the expected periodic cash flows. Management adjusts the effective interest rate used to discount expected cash flows to incorporate expected prepayments.
Individual Evaluation
Management evaluates individual instruments for expected credit losses when those instruments do not share similar risk characteristics with instruments evaluated using a collective (pooled) basis. These instruments will not be included in the collective analyses. The individual analysis will establish a specific reserve for instruments in scope.
The allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist. The Company’s loan portfolio is segmented to a level that allows management to monitor risk and performance. The portfolio is segmented into Commercial Real Estate (“CRE”), which is further segmented into Owner Occupied (“CRE OO”), Non-owner Occupied (“CRE NOO”), and Multifamily Residential, Residential Real Estate (“RRE”), Commercial and Industrial (“C&I”), Home Equity Lines of Credit (“HELOC”), Construction and Other (“Construction”), and Consumer Installment Loans. The CRE loan segments consist of loans made to finance the activities of CRE owners and operators and certain agricultural loans. The RRE and HELOC loan segments consist of loans made to finance the activities of residential homeowners. The C&I loan segment consists of loans made to finance the activities of commercial customers and certain agricultural loans. The consumer loan segment consists primarily of installment loans and overdraft lines of credit connected with customer deposit accounts.
Historical credit loss experience is the basis for the estimation of expected credit losses. We apply historical loss rates to pools of loans with similar risk characteristics. After consideration of the historic loss calculation, management applies qualitative adjustments to reflect the current conditions and reasonable and supportable forecasts not already reflected in the historical loss information at the balance sheet date. The qualitative adjustments for current conditions are based upon national and local economic trends and conditions, levels of and trends in delinquency rates and nonaccrual loans, trends in volumes and terms of loans, effects of changes in lending policies, experience, ability, and depth of lending staff, the value of underlying collateral, concentrations of credit from a loan type, industry, and/or geographic standpoint. These modified historical loss rates are multiplied by the outstanding principal balance of each loan to calculate a required reserve.
The Bank has elected to exclude accrued interest receivable from the measurement of its ACL. When a loan is placed on nonaccrual status, any outstanding accrued interest is reversed against interest income.
The ACL calculation for individual loans begins with the use of normal credit review procedures to identify whether a loan no longer shares similar risk characteristics with other pooled loans and should, therefore, be individually assessed. Beginning in the third quarter of 2023, the Bank automatically considers all nonaccrual loans greater than $250,000 for individual analysis. Additional identification of loans to be individually evaluated is accomplished through the Bank’s normal loan review, criticized asset review, and portfolio management processes. The Bank previously evaluated all commercial loans greater than $150,000 for individual analysis that met the following criteria: 1) when it is determined that foreclosure is probable, 2) substandard, doubtful, and nonperforming loans when repayment is expected to be provided substantially through the operation or sale of the collateral, and 3) when it is determined by management that a loan does not share similar risk characteristics with other loans. Specific reserves are established based on the following three acceptable methods for measuring the ACL: 1) the present value of expected future cash flows discounted at the loan’s original effective interest rate, 2) the loan’s observable market price, or 3) the fair value of the collateral when the loan is collateral dependent. Management considers a financial asset as collateral dependent when the debtor is experiencing financial difficulty and repayment is expected to be provided substantially through the sale or operation of the collateral, based on management's assessment as of the reporting date. Measurement of the expected credit losses on collateral-dependent loans is based on the fair value of the collateral, less any costs to sell. A specific reserve is established or a charge-off is taken if the fair value of the loan is less than the loan balance. Large groups of smaller-balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual residential real estate loans, home equity loans, and consumer loans for impairment disclosures.
The Bank adopted ASU No.2016-13 effective January 1, 2023. Upon adoption, the reserve for credit losses for unfunded commitments increased by $622,000. The Bank estimates expected credit losses over the contractual period in which the Bank is exposed to credit risk via a contractual obligation to extend credit unless that obligation is unconditionally cancellable by the Bank. The allowance for credit losses on off-balance sheet credit exposures is included in accrued interest payable and other liabilities on the balance sheet and adjusted through provision for credit losses. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life, consistent with the estimation process on the loan portfolio.
Reclassification of Comparative Amounts
Certain comparative amounts for prior years have been reclassified to conform to current-year presentations. Such reclassifications did not affect net income or retained earnings.
Accounting Pronouncements Adopted in2024
In March 2023, the FASB issued ASU 2023-02,Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method. The amendments allow entities to elect to account for qualifying tax equity investments using the proportional amortization method, regardless of the program giving rise to the related tax credits. This method of accounting had been available only for qualifying investments in qualified affordable housing projects. The guidance also requires certain disclosures regarding an entity’s tax equity investments. On January 1, 2024, the Bank adopted ASU 2023-02. This ASU did not have a significant impact on the Bank’s financial statements.
Recent Accounting Pronouncements
In January 2020, the FASB issued ASU 2020-04,Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, March 2020, to provide temporary optional expedients and exceptions to the U.S. GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from LIBOR and other interbank offered rates to alternative reference rates, such as the Secured Overnight Financing Rate (SOFR). Entities can elect not to apply certain modification accounting requirements to contracts affected by what the guidance calls “reference rate reform” if certain criteria are met. An entity that makes this election would not have to remeasure the contracts at the modification date or reassess a previous accounting determination. Also, entities can elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform if certain criteria are met, and can make a one-time election to sell and/or reclassify held-to-maturity debt securities that reference an interest rate affected by reference rate reform. ASU 2022-06, Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848 Issued December 2022, which was issued in December 2022, extended the period of time entities can utilize the reference rate reform relief guidance under ASU 2020-04 from December 31, 2022, to December 31, 2024. The ASUs are not expected to have a significant impact on the Bank’s financial statements.
In June 2022, the FASB issued ASU 2022-03,Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions. The amendment clarifies that a contractual restriction on the sale of an equity security is not considered part of the unit account of the equity security and is not considered in measuring its fair value. The ASU clarifies that an entity cannot, as a separate unit of account, recognize and measure a contractual sale restriction. The ASU also requires certain disclosures for equity securities subject to contractual sale restrictions. The amendments in this ASU are effective for all entities for fiscal years beginning after December 15, 2024. This ASU is not expected to have a significant impact on the Company’s results of operations or financial condition.
In November 2023, the FASB issued ASU 2023-07,Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures. The ASU requires enhanced disclosures about significant segment expenses for public entities reporting segment information under ASC Topic 280. The amendments include required disclosure of significant segment expenses regularly reviewed by the chief operating decision maker, description of the composition of other segment items, and title and position of the chief operating decision maker. Additionally, the ASU requires public entities to provide all annual disclosures under Topic 280 in interim periods. The ASU also requires that public entities with a single reportable segment provide all the disclosures required by this amendment and existing disclosure requirements in Topic 820. The amendments in this ASU are effective for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024. The Company has a single reportable segment. This ASU is not expected to have a significant impact on the Company's financial statements.
In December 2023, the FASB issued ASU 2023-09,Income Taxes (Topic 740): Improvements to Income Tax Disclosures. The amendments require entities to disclose specific categories in the rate reconciliation and provide additional information for material reconciling items. The ASU also requires the disclosure of income taxes paid disaggregated by jurisdiction. The amendments in this ASU are effective for public business entities for annual periods beginning after December 15, 2024. This ASU is not expected to have a significant impact on the Company’s financial statements.
In March 2024, the FASB issued ASU 2024-01, Compensation – Stock Compensation (Topic 718). The ASU amended the guidance in ASC 718 to add an example showing how to apply the scope guidance to determine whether profits interest and similar awards should be accounted for as share-based payment arrangements. The guidance is effective for fiscal years beginning after December 15, 2024, and interim periods within those fiscal years. This ASU is not expected to have a significant impact on the Company’s results of operations or financial condition.
NOTE 2– REVENUE RECOGNITION
Following ASC Topic 606,Revenue from Contracts with Customers (Topic 606), management determined that the primary sources of revenue, which emanate from interest income on loans and investments, along with noninterest revenue resulting from equity security gains (losses), gains on the sale of loans, rental income, and BOLI income, are not within the scope of ASC 606. For the nine months ended September 30, 2024, these revenue sources cumulatively comprise 94.5% of the total revenue of the Company.
The main types of noninterest income within the scope of the standard are as follows:
Service charges on deposit accounts – The Company has contracts with its deposit customers whereby fees are charged if the account balance falls below predetermined levels defined as compensating balances. These agreements can be canceled at any time by either the Company or the deposit customer. Revenue from these transactions is recognized monthly as the Company has an unconditional right to the fee consideration. The Company also has transaction fees related to specific customer requests or activities that include overdraft fees, online banking fees, and other transaction fees. All of these fees are attributable to specific performance obligations of the Company where the revenue is recognized at a defined point in time, which is the completion of the requested service/transaction.
Revenue from investment services – The Company earns investment services revenue through its referral agreement with LPL Financial. The performance obligation to investment management customers is satisfied over time, and therefore, revenue is recognized over time. The Company generally receives trailing investment services revenue in arrears and recognizes the revenue when the monthly statement with referral revenue is received.
Miscellaneous fee income – Fees earned on other services, such as ATM surcharge fees, money order fees, and check fees, are recognized at the time of the event or the applicable billing cycle.
The following table depicts the disaggregation of revenue derived from contracts with customers to depict the nature, amount, timing, and uncertainty of revenue and cash flows:
The Company provides a dual presentation of basic and diluted earnings per share. Basic earnings per share is calculated by dividing net income by the average shares outstanding. Diluted earnings per share adds the dilutive effects of restricted stock to average shares outstanding.
The following table sets forth the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings per share computation.
For the Three
For the Nine
Months Ended
Months Ended
September 30,
September 30,
2024
2023
2024
2023
Weighted-average common shares outstanding
9,950,342
9,927,946
9,946,146
9,924,597
Average treasury stock shares
(1,879,310
)
(1,835,452
)
(1,869,706
)
(1,818,080
)
Weighted-average common shares and common stock equivalents used to calculate basic earnings per share
8,071,032
8,092,494
8,076,440
8,106,517
Additional common stock equivalents (stock options and restricted stock) used to calculate diluted earnings per share
15,840
8,812
15,840
8,812
Weighted-average common shares and common stock equivalents used to calculate diluted earnings per share
8,086,872
8,101,306
8,092,280
8,115,329
On September 30, 2024, there were 43,633 shares of restricted stock, 27,793 shares of which were anti-dilutive.
On September 30, 2023, there were 57,361 shares of restricted stock, 48,549 shares of which were anti-dilutive.
When shares recognized as equity are repurchased, the amount of the consideration paid, which includes directly attributable costs, is recognized as a deduction from equity. Repurchased shares are classified as treasury shares and are presented in the treasury share reserve. The reserve for the Company’s treasury shares comprises the cost of the Company’s shares held by the Company. As of September 30, 2024, the Company held 1,879,310 of the Company’s shares, which is an increase of 43,858 from the 1,835,452 shares held as of September 30, 2023.
NOTE 4 - ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME
The following table presents the changes in accumulated other comprehensive (loss) income (“AOCI”) by component, net of tax, for the three and nine months ended September 30, 2024, and 2023, respectively:
(Dollars in thousands)
Unrealized (losses)/gains on securities available-for-sale
Balance at June 30, 2024
$
(19,468
)
Other comprehensive income⁽ª⁾
2,991
Balance at September 30, 2024
$
(16,477
)
Balance at December 31, 2023
$
(16,090
)
Other comprehensive loss⁽ª⁾
(387
)
Balance at September 30, 2024
$
(16,477
)
(Dollars in thousands)
Unrealized (losses)/gains on securities available-for-sale
Balance at June 30, 2023
$
(20,630
)
Other comprehensive loss⁽ª⁾
(5,796
)
Balance at September 30, 2023
$
(26,426
)
Balance at December 31, 2022
$
(22,144
)
Other comprehensive loss⁽ª⁾
(4,282
)
Balance at September 30, 2023
$
(26,426
)
(a)
All amounts are net of tax.
There were no other reclassifications of amounts from AOCI for the three and nine months ended September 30, 2024, and 2023.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. GAAP establishes a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following levels:
Level I:
Quoted prices are available in active markets for identical assets or liabilities as of the reported date.
Level II:
Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are valued using other financial instruments, the parameters of which can be directly observed.
Level III:
Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.
This hierarchy requires the use of observable market data when available.
The following tables present the assets measured at fair value on a recurring basis on the Consolidated Balance Sheet by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
September 30, 2024
(Dollar amounts in thousands)
Level I
Level II
Level III
Total
Assets measured on a recurring basis:
Subordinated debt
$
-
$
25,883
$
6,650
$
32,533
Obligations of states and political subdivisions
-
129,467
-
129,467
Mortgage-backed securities in government-sponsored entities
-
7,895
-
7,895
Total investment securities available for sale
-
163,245
6,650
169,895
Equity securities
785
-
-
785
Total
$
785
$
163,245
$
6,650
$
170,680
December 31, 2023
(Dollar amounts in thousands)
Level I
Level II
Level III
Total
Assets measured on a recurring basis:
Subordinated debt
$
-
$
23,118
$
8,801
$
31,919
Obligations of states and political subdivisions
-
132,542
-
132,542
Mortgage-backed securities in government-sponsored entities
-
6,318
-
6,318
Total investment securities available for sale
-
161,978
8,801
170,779
Equity securities
814
-
-
814
Total
$
814
$
161,978
$
8,801
$
171,593
Investment Securities Available for Sale
An independent pricing service provides the Company fair values determined by pricing models using a market approach that considers observable market data, such as interest rate volatilities, benchmarked yield curve, credit spreads and prices from market makers and live trading systems (Level II). Level III securities are assets whose fair value cannot be determined by using observable measures. The inputs to the valuation methodology of these securities are unobservable and significant to the fair value measurement. Currently, this category includes certain subordinated debt investments that are valued based on the discounted cash flow approach assuming a yield curve of similarly structured instruments.
While the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of specific financial instruments could result in a different estimate of fair value at the reporting date. Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective period-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments following the respective reporting dates may be different from the amounts reported at each period-end.
Equity Securities - Equity securities that are traded on a national securities exchange are valued at their last reported sales price as of the measurement date. Equity securities traded in the over-the-counter (“OTC”) markets and listed securities for which no sale was reported on that date are generally valued at their last reported “bid” price if held long, and last reported “ask” price if sold short. To the extent equity securities are actively traded and valuation adjustments are not applied, they are categorized in Level I of the fair value hierarchy.
The following table presents the fair value reconciliation of Level III assets measured at fair value on a recurring basis.
Subordinated debt
(Dollar amounts in thousands)
September 30, 2024
December 31, 2023
Beginning of year
$
8,801
$
8,737
Purchases, sales, settlements:
Purchases
-
1,000
Transfers out of Level III (1)
(2,250
)
(1,000
)
Net change in unrealized loss on investment securities available-for-sale
99
64
Balance at end of period
$
6,650
$
8,801
(1)
Transfers between hierarchy levels are based on the availability of sufficient observable inputs to meet Level II versus Level III criteria. The level designation of each financial instrument is reassessed at the end of each period.
The following table presents the assets measured at fair value on a non-recurring basis on the Consolidated Balance Sheet by level within the fair value hierarchy.
September 30, 2024
(Dollar amounts in thousands)
Level I
Level II
Level III
Total
Assets measured on a non-recurring basis:
Collateral-dependent loans
$
-
$
-
$
4,155
$
4,155
December 31, 2023
(Dollar amounts in thousands)
Level I
Level II
Level III
Total
Assets measured on a non-recurring basis:
Collateral-dependent loans
$
-
$
-
$
3,361
$
3,361
Collateral-Dependent Loans – The Company has measured impairment on collateral-dependent individually analyzed loans generally based on the fair value of the loan’s collateral. Fair value is generally determined based on independent third-party appraisals of the properties. In some cases, management may adjust the appraised value due to the age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed. Additionally, management makes estimates about expected costs to sell the property, which are also included in the net realizable value. If the fair value of the collateral-dependent loan is less than the carrying amount of the loan, a specific reserve for the loan is made in the allowance for credit losses, or a charge-off is taken to reduce the loan to the fair value of the collateral (less estimated selling costs), and the loan is included in the above table as a Level III measurement in the period in which the adjustment is recorded. If the fair value of the collateral exceeds the carrying amount of the loan, then the loan is not included in the above table as it is not currently being carried at its fair value. The fair values in the preceding tables include selling costs of $1.1 million and $843,000 on September 30, 2024, and December 31, 2023, respectively.
The following table presents additional quantitative information about assets measured at fair value on a non-recurring basis and for which the Company uses Level III inputs to determine fair value.
Quantitative Information about Level III Fair Value Measurements
(Dollar amounts in thousands)
Fair Value Estimate
Valuation Techniques
Unobservable Input
Range (Weighted Average)
September 30, 2024
Collateral-dependent loans
$
4,155
Appraisal of collateral (1)
Appraisal adjustments (2)
10.4% - 23.9%
Quantitative Information about Level III Fair Value Measurements
(Dollar amounts in thousands)
Fair Value Estimate
Valuation Techniques
Unobservable Input
Range (Weighted Average)
December 31, 2023
Collateral-dependent loans
$
3,361
Appraisal of collateral (1)
Appraisal adjustments (2)
20.1
%
(1)
Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level III inputs that are not identifiable, less any associated allowance.
(2)
Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.
The estimated fair value of the Company’s financial instruments not recorded at fair value on a recurring basis is as follows:
Included within other borrowings is an $8.2 million note payable, which matures in December 2037. These borrowings were used to form a special purpose entity to issue $8.0 million of floating rate, obligated mandatorily redeemable securities. The rate adjusts quarterly, equal to SOFR plus 1.67%. The borrowing is a floating rate instrument, and any difference between the cost and fair value is insignificant.
In addition to the financial instruments included in the above tables, cash and cash equivalents, bank-owned life insurance, Federal Home Loan Bank (the “FHLB”) stock, other investments, accrued interest receivable, FHLB advances, finance lease liabilities, and accrued interest payable, are carried at cost, which approximates the fair value of the instruments.
NOTE 6– INVESTMENT AND EQUITY SECURITIES
The amortized cost and fair values of investment securities available for sale are as follows:
September 30, 2024
Gross
Gross
Amortized
Unrealized
Unrealized
Fair
(Dollar amounts in thousands)
Cost (a)
Gains
Losses
Value
Subordinated debt
$
34,300
$
116
$
(1,883
)
$
32,533
Obligations of states and political subdivisions:
Tax-exempt
148,122
49
(18,704
)
129,467
Mortgage-backed securities in government-sponsored entities
8,330
60
(495
)
7,895
Total
$
190,752
$
225
$
(21,082
)
$
169,895
(a)
Amortized cost excludes accrued interest receivable of $1.5 million for the period ending September 30, 2024.
December 31, 2023
Gross
Gross
Amortized
Unrealized
Unrealized
Fair
(Dollar amounts in thousands)
Cost (a)
Gains
Losses
Value
Subordinated debt
$
34,300
$
70
$
(2,451
)
$
31,919
Obligations of states and political subdivisions:
Tax-exempt
149,881
153
(17,492
)
132,542
Mortgage-backed securities in government-sponsored entities
6,965
-
(647
)
6,318
Total
$
191,146
$
223
$
(20,590
)
$
170,779
(a)
Amortized cost excludes accrued interest receivable of $1.6 million for the period ending December 31, 2023.
The amortized cost and fair value of investment securities at September 30, 2024, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Amortized
Fair
(Dollar amounts in thousands)
Cost
Value
Due in one year or less
$
521
$
522
Due after one year through five years
5,942
5,786
Due after five years through ten years
57,041
54,581
Due after ten years
127,248
109,006
Total
$
190,752
$
169,895
There were no investment securities sold during the nine months ended September 30, 2024, or year ended December 31, 2023.
Investment securities with an approximate carrying value of $116.2 million and $118.8 million on September 30, 2024, and December 31, 2023, respectively, were pledged to secure deposits and for other purposes as required by law.
The following table shows the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.
September 30, 2024
Less than Twelve Months
Twelve Months or Greater
Total
Gross
Gross
Gross
Fair
Unrealized
Fair
Unrealized
Fair
Unrealized
(Dollar amounts in thousands)
Value
Losses
Value
Losses
Value
Losses
Subordinated debt
$
2,812
$
(238
)
$
27,105
$
(1,645
)
$
29,917
$
(1,883
)
Obligations of states and political subdivisions:
Tax-exempt
6,381
(154
)
105,040
(18,550
)
111,421
(18,704
)
Mortgage-backed securities in government-sponsored entities
-
-
5,536
(495
)
5,536
(495
)
Total
$
9,193
$
(392
)
$
137,681
$
(20,690
)
$
146,874
$
(21,082
)
December 31, 2023
Less than Twelve Months
Twelve Months or Greater
Total
Gross
Gross
Gross
Fair
Unrealized
Fair
Unrealized
Fair
Unrealized
(Dollar amounts in thousands)
Value
Losses
Value
Losses
Value
Losses
Subordinated debt
$
994
$
(6
)
$
29,356
$
(2,445
)
$
30,350
$
(2,451
)
Obligations of states and political subdivisions:
Tax-exempt
1,386
(10
)
106,078
(17,482
)
107,464
(17,492
)
Mortgage-backed securities in government-sponsored entities
195
(1
)
6,122
(646
)
6,317
(647
)
Total
$
2,575
$
(17
)
$
141,556
$
(20,573
)
$
144,131
$
(20,590
)
Every quarter, the Company evaluates investment securities with unrealized losses to determine if the decline in fair value has resulted from credit losses or other factors. There were 17 securities in an unrealized loss position for less than twelve months and 165 securities in an unrealized loss position for twelve months or greater on September 30, 2024. Unrealized losses on investment securities available for sale have not been recognized into income because we do not intend to sell and it is more likely than not that we will not be required to sell any of the securities in an unrealized loss position before recovery of their amortized cost. The unrealized losses on investment securities were attributable to changes in interest rates and not related to the credit quality of these issuers. As of September 30, 2024, no ACL was required on investment securities available for sale.
Other investments, which primarily represents equity securities, totaled $895,000 and $955,000 at September 30, 2024 and December 31, 2023, respectively. The Company recognized a net gain on other investments of $14,000 and $48,000 for the three months ended September 30, 2024 and 2023, respectively. The Company recognized a net loss on other investments of $65,000 and $157,000 for the nine months ended September 30, 2024 and 2023, respectively. There were no other investments sold during these periods.
NOTE 7– LOANS AND RELATED ALLOWANCE FOR CREDIT LOSSES
The following table summarizes the loan portfolio by primary segment and class of financial receivable (in thousands) (a)(b):
September 30,
December 31,
2024
2023
Commercial real estate:
Owner occupied
$
187,313
$
183,545
Non-owner occupied
407,159
401,580
Multifamily
94,798
82,506
Residential real estate
345,748
328,854
Commercial and industrial
213,172
221,508
Home equity lines of credit
137,761
127,818
Construction and other
111,550
125,105
Consumer installment
7,030
7,214
Total loans
1,504,531
1,478,130
Less: Allowance for credit losses
(22,526
)
(21,693
)
Net loans
$
1,482,005
$
1,456,437
(a)
Accrued interest of $5.3 million and $5.5 million at September 30, 2024 and December 31, 2023, respectively, is excluded from amortized cost and presented in "Accrued interest receivable and other assets" on the Consolidated Balance Sheets.
(b)
Unearned income, including net deferred loan fees and costs and unamortized premiums and discounts, totaled $8.4 million and $9.2 million at September 30, 2024 and December 31, 2023, respectively.
On January 1, 2023, the Company adopted ASU 2016-13. This methodology for calculating the allowance for credit losses considers the possibility of loss over the life of the loan. It also considers historical loss rates and other qualitative adjustments, as well as a new forward-looking component that considers reasonable and supportable forecasts over the expected life of each loan. To develop the ACL estimate under the current expected loss model, the Company segments the loan portfolio into loan pools based on loan type and similar credit risk elements. An ACL is maintained to absorb losses from the loan portfolio. The ACL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of nonperforming loans.
Management reviews the loan portfolio quarterly using a defined, consistently applied process to make appropriate and timely adjustments to the ACL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ACL.
The following tables summarize the ACL within the primary segments of the loan portfolio and the activity within those segments (in thousands):
The total ACL increased by $833,000, or 3.8%, from December 31, 2023 to September 30, 2024. The increase was driven by portfolio activity and the economic outlook. The Bank utilized economic projections issued by the Federal Open Market Committee (FOMC) to estimate credit losses, and the projections are updated quarterly for the ACL calculation. For 2024, the forecast takes into account the national unemployment rates. For 2023, the forecast took into account the national housing price index and national unemployment rates. To the extent that credit risk is not fully identified within the forecasts, management has made qualitative adjustments to the ACL balance.
The provision increased by $731,000, or 3.4%, for the three months ended September 30, 2024. Fluctuations were attributed to:
• Increase in residential real estate loans, residential real estate construction loans, home equity facilities loans, owner occupied CRE and non-owner occupied CRE
• Decrease in commercial real estate construction and development loans
• Increase in charge-offs due to the partial charge-off of one loan during the 2024third quarter that had no previous ACL given the appraised valuation of the underlying collateral
• Increase in calculated loss rates, driven largely by unemployment forecasts
The provision increased by $395,000, or 1.9%, for the three months ended September 30, 2023. Fluctuations were attributed to:
• Increase in multi-family and non-owner occupied commercial real estate and commercial real estate construction and development loans
Credit Quality Indicators
Management evaluates individual loans in all of the commercial segments for possible impairment based on guidelines established by the Board of Directors. Loans are individually analyzed when, based on current information and events, the Company will probably be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in evaluating credit loss include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall concerning the principal and interest owed. The evaluation of the need and amount of a specific allocation of the allowance and whether a loan can be removed from impairment status is made quarterly.
Management uses a nine-point internal risk-rating system to monitor the credit quality of the overall loan portfolio. The firstfive categories are considered not criticized and are aggregated as Pass rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but have potential weaknesses, resulting in undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are considered Substandard. A loan categorized as Doubtful contains all of the weaknesses as a Substandard loan with the added characteristic that the weaknesses are so pronounced that the collection or liquidation in full of both principal and interest is highly questionable or improbable. Any portion of a loan that has been charged off is placed in the Loss category.
To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Company has a structured loan rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as payment delinquency, bankruptcy, repossession, or death, occurs to raise awareness of a possible credit quality loss. The Company’s Commercial Loan Officers are responsible for the timely and accurate risk rating of the loans in their portfolios at origination and on an ongoing basis. The Credit Department performs an annual review of all commercial relationships with loan balances of $750,000 or greater. Detailed reviews, including plans for resolution, are performed on criticized loans of $150,000 or more on at least a quarterly basis. Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.
Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due.
The following table represents outstanding loan balances by credit quality indicators and vintage year by class of financing receivable and current period gross charge-offs by year of origination as of September 30, 2024:
September 30, 2024
Term Loans Amortized Cost Basis by Origination Year
The following table presents individually analyzed and collateral-dependent loans by class of loans (in thousands):
September 30, 2024
Type of Collateral
(Dollar amounts in thousands)
Real Estate
Blanket Lien
Investment/Cash
Other
Total
Commercial real estate:
Owner occupied
$
2,224
$
-
$
-
$
-
$
2,224
Non-owner occupied
14,381
-
-
11,105
25,486
Residential real estate
617
-
-
-
617
Commercial and industrial
-
-
-
1,213
1,213
Total
$
17,222
$
-
$
-
$
12,318
$
29,540
December 31, 2023
Type of Collateral
(Dollar amounts in thousands)
Real Estate
Blanket Lien
Investment/Cash
Other
Total
Commercial real estate:
Non-owner occupied
$
8,150
$
-
$
-
$
-
$
8,150
Total
$
8,150
$
-
$
-
$
-
$
8,150
Nonperforming and Past Due Loans
The following tables present the aging of the recorded investment in past-due loans by class of loans (in thousands):
30-59 Days
60-89 Days
90 Days+
Total
Total
September 30, 2024
Current
Past Due
Past Due
Past Due
Past Due
Loans
Commercial real estate:
Owner occupied
$
187,205
$
48
$
-
$
60
$
108
$
187,313
Non-owner occupied
393,788
1,367
4,396
7,608
13,371
407,159
Multifamily
94,798
-
-
-
-
94,798
Residential real estate
343,090
1,943
566
149
2,658
345,748
Commercial and industrial
211,957
29
190
996
1,215
213,172
Home equity lines of credit
137,081
155
122
403
680
137,761
Construction and other
111,057
-
493
-
493
111,550
Consumer installment
7,016
14
-
-
14
7,030
Total
$
1,485,992
$
3,556
$
5,767
$
9,216
$
18,539
$
1,504,531
30-59 Days
60-89 Days
90 Days+
Total
Total
December 31, 2023
Current
Past Due
Past Due
Past Due
Past Due
Loans
Commercial real estate:
Owner occupied
$
183,242
$
197
$
-
$
106
$
303
$
183,545
Non-owner occupied
397,964
3,616
-
-
3,616
401,580
Multifamily
82,440
-
-
66
66
82,506
Residential real estate
326,224
1,366
1,010
254
2,630
328,854
Commercial and industrial
221,304
-
146
58
204
221,508
Home equity lines of credit
126,894
447
180
297
924
127,818
Construction and other
125,040
65
-
-
65
125,105
Consumer installment
7,138
69
-
7
76
7,214
Total
$
1,470,246
$
5,760
$
1,336
$
788
$
7,884
$
1,478,130
The following tables present the recorded investment in nonaccrual loans and loans 90 and greater days past due and still on accrual by class of loans (in thousands):
Interest income that would have been recorded had these loans not been placed on nonaccrual status was $852,000 and $1.2 million for the three and nine months ended September 30, 2024, respectively, and $211,000 and $414,000 for the three and nine months ended September 30, 2023, respectively.
Modifications to Borrowers Experiencing Financial Difficulty
Effective January 1, 2023, the Company implemented ASU 2022-02, which eliminated the recognition and measure of troubled debt restructurings and enhanced disclosures for loan modifications to borrowers experiencing financial difficulty. The Bank may modify the contractual terms of a loan to a borrower experiencing financial difficulty to mitigate the risk of loss. Such modifications may include a term extension, interest rate reduction, significant payment deferral, other modifications, or a combination of modification types. In general, any delay in payment of greater than 90 days in the last 12 months is considered to be a significant payment deferral.
The table below details the amortized cost basis of the loans modified to borrowings experiencing financial difficulty, disaggregated by class of loans and type of concessions granted, and the financial effect of the modifications:
September 30, 2024
Modifications
Payment
Interest Rate
Interest Rate
Percentage of
Deferral
Reduction
Reduction
Total Loans
Payment
Term
and Term
and Term
and Principal
Held for
Deferral
Extension
Extension
Past Due
Forgiveness
Total
Investment
Commercial real estate:
Non-owner occupied
$
-
$
13,482
$
2,507
$
-
$
-
$
15,989
1.1
%
Construction and other
-
1,819
-
-
-
1,819
0.1
%
Total
$
-
$
15,301
$
2,507
$
-
$
-
$
17,808
1.2
%
September 30, 2023
Modifications
Payment
Interest Rate
Interest Rate
Percentage of
Deferral
Reduction
Reduction
Total Loans
Payment
Term
and Term
and Term
and Principal
Held for
Deferral
Extension
Extension
Past Due
Forgiveness
Total
Investment
Commercial real estate:
Non-owner occupied
$
-
$
145
$
2,507
$
-
$
-
$
2,652
0.2
%
Residential real estate
-
19,074
-
-
-
19,074
1.4
%
Commercial and industrial
-
83
-
-
-
83
0.0
%
Consumer installment
-
8
-
-
-
8
0.0
%
Total
$
-
$
19,310
$
2,507
$
-
$
-
$
21,817
1.6
%
As of September 30, 2024, the Bank had no commitments to lend additional funds on modified loans. As of September 30, 2024, the Bank did not have any loans that were modified for borrowers experiencing financial difficulty and subsequently defaulted. As of September 30, 2024, there were no modified loans that were delinquent. Payment default is defined as movement to nonperforming status, foreclosure or charge-off, whichever occurs first. At September 30, 2024 and December 31, 2023, the Company reported $381,000 and $228,000, respectively, in residential real estate loans in the process of foreclosure.
Allowance for Credit Losses: Unfunded Commitments
Upon adoption of ASU 2016-13 on January 1, 2023, the Company recorded a separate ACL for unfunded commitments using a methodology that is inherently similar to the methodology used for calculating the ACL for loans. The liability for credit losses on these exposures is included in “Accrued interest payable and other liabilities” on the Consolidated Balance Sheet and amounted to $1.8 million as of September 30, 2024, and December 31, 2023.
NOTE 8– COMMITMENTS AND CONTINGENT LIABILITIES
In the ordinary course of business, various outstanding commitments and certain contingent liabilities are not reflected in the accompanying consolidated financial statements. These commitments and contingent liabilities represent financial instruments with off-balance-sheet risk. The contract or notional amounts of those instruments reflect the extent of involvement in particular types of financial instruments.
Our commitments to extend credit were composed of the following:
(Dollar amounts in thousands)
September 30, 2024
December 31, 2023
Commitments to extend credit
$
480,950
$
418,952
Standby letters of credit
728
5,884
Total
$
481,678
$
424,836
The commitments to extend credit involve, to varying degrees, elements of credit and interest rate risk over the amount recognized in the Consolidated Balance Sheet. The Company’s exposure to credit loss, in the event of nonperformance by the other parties to the financial instruments, is represented by the contractual amounts as disclosed. The Company minimizes its exposure to credit loss under these commitments by subjecting them to credit approval, review procedures, and collateral requirements as deemed necessary. Loan commitments generally have fixed expiration dates within one year of their origination. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These instruments are issued primarily to support bid or performance-related contracts. The coverage period for these instruments is typically one year, with an annual renewal option subject to prior approval by management. Fees earned from the issuance of these letters are recognized over the coverage period. The collateral is typically bank deposit instruments or customer business assets for secured letters of credit.
Commitments to Fund
In August 2023, we invested in a low-income housing tax credit operating partnership. As a limited partner, we are allocated tax credits and deductions associated with the underlying properties. Our maximum exposure to loss in connection with the partnership consists of the unamortized investment balance plus any unfunded equity commitments and tax credits claimed but subject to recapture. The investment at September 30, 2024 and December 31, 2023, was $1.9 million and $2.0 million, respectively, and recorded in the Consolidated Balance Sheet in "Accrued interest receivable and other assets". We do not have any loss reserves recorded since we believe the likelihood of loss is remote. The investment is amortized over the period that we expect to receive the tax benefits using the proportional amortization method. For the three months ended September 30, 2024, we recognized $38,000 of amortization. At September 30, 2024 and December 31, 2023, we had an unfunded tax credit commitment of $1.7 million, which is recorded in the Consolidated Balance Sheet in "Accrued interest payable and other liabilities".
Cannabis Industry
We provide deposit services to customers who are licensed by the State of Ohio to do business as growers, processors, and dispensaries under the Ohio Medical Marijuana Control Program. Marijuana businesses are regulated by the Ohio Department of Commerce and legal in the State of Ohio, although it is not legal at the federal level. The U.S. Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) published guidelines in 2014 for financial institutions servicing state-legal cannabis businesses. A financial institution that provides services to cannabis-related businesses can comply with Bank Secrecy Act (“BSA”) disclosure standards by following the FinCEN guidelines. We maintain stringent written policies and procedures related to the acceptance of such businesses and the monitoring and maintenance of such business accounts. We conduct a significant due diligence review of the cannabis business before the business is accepted as a new client, including confirmation that the business is properly licensed by the State of Ohio. Throughout the relationship, we continue monitoring the business, including site visits, to ensure that the business continues to meet our stringent requirements, including maintenance of required licenses and periodic financial reviews of the business.
While we believe we are operating in compliance with the FinCEN guidelines, there can be no assurance that federal enforcement guidelines will not change. Federal prosecutors have significant discretion, and there can be no assurance that the federal prosecutors will not choose to strictly enforce the federal laws governing cannabis. Any change in the Federal government’s enforcement position could cause us to immediately cease providing banking services to the cannabis industry. We are upfront with our customers regarding the fact that we may have to terminate our deposit services relationship if a change occurs with the Federal government’s position, and that the termination may come with little or no notice.
Litigation
As previously disclosed, a cyber-attack occurred in April 2023 that resulted in a temporary disruption to our computer systems. A cybersecurity firm investigated the nature and scope of the incident, evaluated our systems, and confirmed that nonpublic information relating to current and former employees, customers, and others was obtained from our systems.
On January 8, 2024, a customer filed a lawsuit against The Middlefield Banking Company in the U.S. District Court for the Northern District of Ohio related to the cyber-attack incident. A similar lawsuit was filed on January 10, 2024, against The Middlefield Banking Company in the Court of Common Pleas for Cuyahoga County, Ohio. The plaintiffs and class members in the two cases, who are current and former customers of the Bank, claim to have been harmed by alleged actions or inactions by the Bank in connection with the incident. The plaintiffs assert a variety of common law and statutory claims regarding the compromised nonpublic information and seek monetary damages, equitable and injunctive relief, pre-judgment and post-judgment interest, awards of actual and punitive damages, costs and attorneys’ fees, and other related relief. On March 28, 2024, the plaintiff in the case before the U.S. District Court for the Northern District of Ohio voluntarily dismissed their lawsuit against The Middlefield Banking Company without prejudice. We dispute the allegations in the remaining lawsuit filed in the Court of Common Pleas for Cuyahoga County. The Bank continues to defend itself from the claims and causes of action asserted in the Cuyahoga County lawsuit. The plaintiff in the Cuyahoga County lawsuit filed an amended complaint on August 8, 2024, to add an additional plaintiff. The amendment made no change to the relief sought in the original complaint. There is no guarantee that a court-approved settlement will be finalized.
Losses attributable to the April 2023 incident are within the coverage limits of the cyber risk insurance policy in place at that time. The policy has an aggregate limit of $3 million and a deductible of $50,000. The policy includes coverage for business loss, breach response, and liabilities that could occur as a result of a cyber event. Although we believe that our insurance policy will fully cover the losses associated with the lawsuit, it is possible that the losses could exceed the policy limit. Because the Bank has not reached a settlement with the plaintiff in the Cuyahoga County Common Pleas lawsuit, it is not possible to reasonably estimate the amount of such losses or range of losses that might result from the resolution of the lawsuit. We expect that any costs associated with the lawsuit, including attorney fees, adverse judgment or settlement, will be billed to and paid by the insurance company in accordance with the terms of the policy.
Loans to principal officers, directors, and their affiliates during September 30, 2024 and December 31, 2023 were as follows:
(Dollars in thousands)
September 30, 2024
December 31, 2023
Beginning balance
$
24,185
$
2,057
New loans
2,965
23,922
Repayments
(1,063
)
(1,794
)
Ending balance
$
26,087
$
24,185
Deposits of related parties amount to $29.0 million and $33.1 million as of September 30, 2024 and December 31, 2023, respectively.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Form 10-Q contains certain statements that may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are based on a variety of estimates and assumptions. The estimates and assumptions involve judgments about a number of things, including future economic, competitive, cybersecurity, and financial market conditions, conflicts around the world, and future business decisions. These matters are inherently subject to significant business, economic, and competitive uncertainties, all of which are difficult to predict and many of which are beyond the Company's control. Although the Company believes its estimates and assumptions are reasonable, actual results could vary materially from those shown. The inclusion of forward-looking information does not constitute a representation by the Company or any other person that the indicated results will be achieved. Investors are cautioned not to place undue reliance on forward-looking information.
These forward-looking statements may involve significant risks and uncertainties. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from the results in these forward-looking statements.
CHANGES IN FINANCIAL CONDITION
Overview
The following is management’s discussion and analysis of certain significant factors that have affected the financial condition and results of operations of the Company as reflected on the unaudited Consolidated Balance Sheet as of September 30, 2024, as compared with December 31, 2023, and operating results for the three and nine month periods ended September 30, 2024, and 2023. These comments should be read in conjunction with the Company’s unaudited consolidated financial statements and accompanying notes appearing elsewhere herein.
This discussion contains certain performance measures determined by methods other than under GAAP. Management of the Company uses these non-GAAP measures in its analysis of the Company’s performance. These measures are useful when evaluating the underlying performance and efficiency of the Company’s operations and balance sheet. The Company’s management believes that these non-GAAP measures provide a greater understanding of ongoing operations, enhance comparability of results with prior periods and demonstrate the effects of significant gains and charges in the current period. The Company’s management believes that investors may use these non-GAAP financial measures to evaluate the Company’s financial performance without the impact of unusual items that may obscure trends in the Company’s underlying performance. These disclosures should not be viewed as a substitute for financial measures determined under GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. Non-GAAP measures include tangible book value per common share, return on average tangible common equity, and pre-tax, pre-provision income. The Company calculates the regulatory capital ratios using current regulatory report instructions. The Company’s management uses these measures to assess the quality of capital and believes that investors may find them useful in their evaluation of the Company. These capital measures may or may not be necessarily comparable to similar capital measures that may be presented by other companies.
2024 Nnine-Month Financial Highlights (on a year-over-year basis):
●
Net income was $10.7 million, compared to $13.8 million
●
Pre-tax, pre-provision net income(1) was $14.7 million, compared to $19.0 million
●
Earnings were $1.32 per diluted share, compared to $1.70 per diluted share
●
Net interest income after the provision for credit losses was $42.9 million, compared to $47.4 million
●
Noninterest income increased 4.1% to $5.3 million, compared to $5.1 million
●
Total loans increased 3.9% to a record $1.50 billion, compared to $1.45 billion
●
Total deposits increased 3.8% to a record $1.51 billion, compared to $1.46 billion
●
Return on average assets annualized was 0.77%, compared to 1.06%
●
Return on average equity annualized was 6.90%, compared to 9.43%
●
Return on average tangible common equity(1) was 8.68%, compared to 11.92%
●
Nonperforming assets to total assets increased to 1.62% from 0.75%
●
Allowance for credit losses was 1.50% of total loans, compared to 1.45%
●
Equity to assets strengthened to 11.34%, compared to 10.80%
●
Book value increased 9.1% to $26.11 per share from $23.94 per share
●
Tangible book value(1) increased 12.1% to $20.87 per share from $18.62 per share
(1)
See non-GAAP reconciliation under the section “GAAP to Non-GAAP Reconciliations”
Tangible book value per share (period end) (1) (2)
$
20.87
$
20.37
$
20.18
$
20.10
$
18.62
$
20.87
$
18.62
Dividends declared
$
1,615
$
1,613
$
1,613
$
2,023
$
1,619
$
4,841
$
4,841
Dividend yield
2.76
%
3.34
%
3.37
%
3.06
%
3.12
%
2.78
%
3.16
%
Dividend payout ratio
69.02
%
38.74
%
38.71
%
57.10
%
42.21
%
45.37
%
35.02
%
Average shares outstanding - basic
8,071,032
8,067,144
8,091,203
8,093,478
8,092,494
8,076,440
8,106,517
Average shares outstanding - diluted
8,086,872
8,072,499
8,096,317
8,116,261
8,101,306
8,092,280
8,115,329
Period ending shares outstanding
8,071,032
8,067,144
8,067,144
8,095,252
8,092,576
8,071,032
8,092,576
Selected ratios
Return on average assets (Annualized)
0.50
%
0.91
%
0.92
%
0.78
%
0.86
%
0.77
%
1.06
%
Return on average equity (Annualized)
4.45
%
8.15
%
8.16
%
7.13
%
7.73
%
6.90
%
9.43
%
Return on average tangible common equity (1) (3)
5.58
%
10.29
%
10.30
%
9.11
%
9.91
%
8.68
%
11.92
%
Efficiency (4)
67.93
%
67.97
%
68.68
%
68.99
%
65.65
%
68.19
%
63.10
%
Equity to assets at period end
11.34
%
11.31
%
11.32
%
11.28
%
10.80
%
11.34
%
10.80
%
Noninterest expense to average assets
0.66
%
0.64
%
0.66
%
0.68
%
0.68
%
1.94
%
2.06
%
(1) See section “GAAP to Non-GAAP Reconciliations” for the reconciliation of GAAP performance measures to non-GAAP measures.
(2) Calculated by dividing tangible common equity by shares outstanding.
(3) Calculated by dividing annualized net income for each period by average tangible common equity.
(4) The efficiency ratio is calculated by dividing noninterest expense less amortization of intangibles by the sum of net interest income on a fully taxable-equivalent basis plus noninterest income.
For the Three Months Ended
For the Nine Months Ended
September 30,
June 30,
March 31,
December 31,
September 30,
September 30,
September 30,
Yields
2024
2024
2024
2023
2023
2024
2023
Interest-earning assets:
Loans receivable (1)
6.19
%
6.27
%
6.11
%
6.01
%
5.82
%
6.19
%
5.75
%
Investment securities (1) (2)
3.59
%
3.59
%
3.52
%
3.52
%
3.51
%
3.57
%
3.54
%
Interest-earning deposits with other banks
4.27
%
4.59
%
4.88
%
3.71
%
4.13
%
4.58
%
3.85
%
Total interest-earning assets
5.84
%
5.92
%
5.77
%
5.64
%
5.49
%
5.84
%
5.41
%
Deposits:
Interest-bearing demand deposits
2.16
%
1.93
%
1.86
%
1.67
%
1.51
%
1.99
%
1.20
%
Money market deposits
3.93
%
3.95
%
3.81
%
3.58
%
2.94
%
3.90
%
2.29
%
Savings deposits
0.71
%
0.64
%
0.58
%
0.59
%
0.58
%
0.64
%
0.80
%
Certificates of deposit
4.49
%
4.57
%
4.06
%
3.68
%
3.27
%
4.37
%
2.50
%
Total interest-bearing deposits
3.17
%
3.15
%
2.88
%
2.56
%
2.16
%
3.07
%
1.70
%
Non-Deposit Funding:
Borrowings
5.54
%
5.60
%
5.61
%
5.57
%
5.66
%
5.58
%
5.30
%
Total interest-bearing liabilities
3.41
%
3.45
%
3.23
%
2.96
%
2.48
%
3.37
%
2.03
%
Cost of deposits
2.33
%
2.30
%
2.08
%
1.81
%
1.53
%
2.24
%
1.16
%
Cost of funds
2.58
%
2.61
%
2.42
%
2.18
%
1.80
%
2.54
%
1.42
%
Net interest margin (3)
3.46
%
3.51
%
3.54
%
3.63
%
3.82
%
3.50
%
4.09
%
(1) Tax-equivalent adjustments to calculate the yield on tax-exempt securities and loans were determined using an effective tax rate of 21%.
(2) Yield is calculated on the basis of amortized cost.
(3) Net interest margin represents net interest income as a percentage of average interest-earning assets.
GAAP to Non-GAAP Reconciliations
Reconciliation of Common Stockholders' Equity to Tangible Common Equity
Reconciliation of Average Equity to Return on Average Tangible Common Equity
For the Three Months Ended
For the Nine Months Ended
September 30,
June 30,
March 31,
December 31,
September 30,
September 30,
September 30,
2024
2024
2024
2023
2023
2024
2023
Average stockholders' equity
$
209,096
$
205,379
$
205,342
$
197,208
$
196,795
$
206,691
$
196,074
Less average goodwill and other intangibles
42,350
42,607
42,654
42,972
43,232
42,512
41,018
Average tangible common equity
$
166,746
$
162,772
$
162,688
$
154,236
$
153,563
$
164,179
$
155,056
Net income
$
2,340
$
4,164
$
4,167
$
3,543
$
3,836
$
10,671
$
13,825
Return on average tangible common equity (annualized)
5.58
%
10.29
%
10.30
%
9.11
%
9.91
%
8.68
%
11.92
%
Reconciliation of Pre-Tax Pre-Provision Income (PTPP)
For the Three Months Ended
For the Nine Months Ended
September 30,
June 30,
March 31,
December 31,
September 30,
September 30,
September 30,
2024
2024
2024
2023
2023
2024
2023
Net income
$
2,340
$
4,164
$
4,167
$
3,543
$
3,836
$
10,671
$
13,825
Add income taxes
371
690
769
709
703
1,830
2,678
Add provision for (recovery of) credit losses
2,234
87
(136
)
554
1,127
2,185
2,449
PTPP
$
4,945
$
4,941
$
4,800
$
4,806
$
5,666
$
14,686
$
18,952
Financial Condition
General. The Company’s total assets on September 30, 2024 were $1.86 billion, an increase of $34.8 million from December 31, 2023. For the same period, total loans increased by $26.4 million, cash and cash equivalents increased by $13.0 million, and investment securities available for sale decreased by $884,000 million. Stockholders’ equity increased by $5.0 million, or 2.4%, as a result of higher retained earnings, partially offset by an increase in treasury stock. Excluding the increase in treasury stock, total stockholders’ equity increased by $6.1 million.
Cash and cash equivalents. Cash and cash equivalents increased $13.0 million to $73.9 million on September 30, 2024, from $60.8 million on December 31, 2023. The increase in cash and cash equivalents is primarily due to an increase in deposits, and partially offset by an increase in loans and decrease in short-term borrowings. Deposits from customers into savings and checking accounts, loan and securities repayments, and proceeds from borrowed funds typically increase these accounts. Decreases result from customer withdrawals, new loan originations, security purchases, and repayments of borrowed and brokered funds.
Investment securities. Management's objective in structuring the portfolio is to maintain liquidity while providing an acceptable rate of return without sacrificing asset quality. Securities available for sale on September 30, 2024, totaled $169.9 million, a decrease of $884,000, or 0.5%, from $170.8 million on December 31, 2023. The Company purchased securities totaling $1.9 million during the second quarter of 2024. There were no sales of securities for the nine months ended September 30, 2024. During this period, the Company recorded repayments, calls, and maturities of $1.9 million and an decrease in the net unrealized losses of $490,000.
On September 30, 2024, the Company held $32.5 million at fair value of subordinated debt in other banks, as compared to $31.9 million on December 31, 2023. The average yield on this portfolio was 5.16% for the nine-month period ended September 30, 2024, as compared to 4.79% for the 12-month period ended December 31, 2023.
Periodically, management reviews the entire municipal bond portfolio to assess credit quality. Each security held in this portfolio is assessed on attributes that have historically influenced default incidences in the municipal market, such as sector, security, impairment filing, timeliness of disclosure, external credit assessment(s), credit spread, state, vintage, and underwriter. Municipal bonds compose 76.2% of the overall portfolio. These investments have historically proven to have extremely low credit risk.
Loans. The loan portfolio consists primarily of single-family mortgage loans used to purchase or refinance personal residences located within the Company’s market area, commercial and industrial loans, home equity lines of credit, and commercial real estate loans used to finance properties that are used in the borrowers’ businesses, or to finance investor-owned rental properties, and, to a lesser extent, construction and consumer loans. The portfolio is well dispersed geographically. Loans increased $26.4 million, or 1.8%, to $1.50 billion as of September 30, 2024. The increase in residential real estate loans is due to an enhanced focus on the segment along with new product offerings. The segments non-owner occupied loans and multifamily loans increased primarily due to construction loans that moved to permanent financing. The decrease in the commercial and industrial segment's loan balance is mainly due to loan payoffs. The decrease in construction and other loans is the result of construction loans moving to permanent financing. The following table summarizes fluctuation within the primary segments of the loan portfolio (in thousands):
The Company’s Mortgage Banking operation generates loans for sale to the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and the FHLB. There were $249,000 of loans held for sale at September 30, 2024, and no loans held for sale at December 31, 2023. The Company recorded gains on the sale of these loans totaling $135,000 based on proceeds of $5.5 million for the nine months ended September 30, 2024.
Commercial real estate loans represent the Company’s largest loan segment and consist of term loans secured by a mortgage lien on real property and include both owner occupied and non-owner occupied loans as well as multifamily loans. The Company originates fixed and adjustable rate commercial real estate loans to new and existing customers located within its primary markets; however, the property may be located outside of our primary lending areas. As of September 30, 2024, approximately 91% of the properties related to the commercial real estate loans were located in the state of Ohio. Commercial real estate loans are typically originated with maturity dates of less than 20 years with repricing every 5 years. Management believes that the segment is well diversified.
The following table breaks down the Company’s commercial real estate portfolio by category and provides the weighted average loan-to-value for each category as of September 30, 2024:
Balance
Percent of
Percent of
Weighted Average
(in thousands)
CRE Portfolio
Loan Portfolio
Loan-to-Value
Multi-Family
$
94,798
13.8
%
6.3
%
59.0
%
Owner Occupied
Real Estate and Rental and Leasing
60,178
8.7
%
4.0
%
55.0
%
Other Services (except Public Administration)
34,630
5.0
%
2.3
%
53.3
%
Manufacturing
18,631
2.7
%
1.2
%
46.9
%
Agriculture, Forestry, Fishing and Hunting
14,546
2.1
%
1.0
%
35.7
%
Health Care and Social Assistance
11,413
1.7
%
0.8
%
47.0
%
Other
47,915
6.9
%
3.2
%
58.0
%
Total Owner Occupied
$
187,313
27.1
%
12.5
%
Non-Owner Occupied
Real Estate and Rental and Leasing
331,062
48.1
%
22.0
%
69.3
%
Accommodation and Food Services
40,999
5.9
%
2.7
%
55.8
%
Health Care and Social Assistance
21,723
3.2
%
1.4
%
56.7
%
Manufacturing
7,226
1.0
%
0.5
%
51.6
%
Other
6,149
0.9
%
0.4
%
71.2
%
Total Non-Owner Occupied
$
407,159
59.1
%
27.0
%
Total CRE
$
689,270
100.0
%
45.8
%
The federal banking regulators have issued guidance for those institutions that are deemed to have concentrations in commercial real estate lending. According to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions that have (1) total reported loans for construction, land development, and other land acquisitions that represent 100% or more of an institution’s total risk-based capital; or (2) total commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the institution’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions that are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management concerning their commercial real estate portfolios and may be required to hold higher levels of capital. The Company, like many community banks, has a material percentage of its loan portfolio in commercial real estate loans. On September 30, 2024, commercial real estate loans (including construction, land, and land development loans) represented 295.3% of total risk-based capital, and growth in that segment over the past 36 months was 13.3%, which is less than the 50% threshold laid out in the regulatory guidance. Construction, land, and land development loans represent 53.7% of total risk-based capital. Based on the regulatory guidance, the Company does not have a concentration in commercial real estate lending as of September 30, 2024.
Management has extensive experience in commercial real estate lending and has implemented and continues to maintain heightened risk management procedures and strong underwriting criteria for its commercial real estate portfolio. The Board of Directors has adopted limits on both aggregate and industry specific concentration levels, including limits specific to commercial real loans. The underwriting and risk rating of all loans is completed by a team that is independent of the individuals originating the loans. Loan monitoring practices include but are not limited to periodic stress testing analysis to evaluate changes in cash flows due to interest rate increases and declines in net operating income. The primary risk elements with respect to our commercial real estate loans are the financial condition of the borrower, sufficiency of the valued collateral, and timeliness of scheduled loan payments, and these loans may be negatively impacted by changes in the real estate markets or in the general economy. We have a policy that requires a periodic review of financial statements from commercial loan customers and have a disciplined and formalized review of the existence of collateral and its value. Nevertheless, we may be required to maintain higher levels of capital as a result of our commercial real estate concentrations, which could require us to obtain additional capital, and may adversely affect shareholder returns. The Company has an extensive capital planning policy, which includes pro forma projections, including stress testing, in which the Board of Directors has established internal minimum targets for regulatory capital ratios that are more than well-capitalized ratios as defined by regulatory requirements.
Nonperforming loans in the commercial real estate segment were $25.8 million at September 30, 2024. The allowance for credit losses for this segment totaled $11.9 million at September 30, 2024, representing an allowance for credit losses to loans ratio of 1.73% specific to the commercial real estate segment.
Our residential real estate loans totaled $345.7 million, or 23.0% of total loans, at September 30, 2024. The Bank grants real estate loans primarily within its designated lending areas, consisting of the communities surrounding branch offices in Ashtabula, Geauga, Portage, Summit, Cuyahoga, Lake, Trumbull, Madison, Delaware, Franklin, Union, Logan, and Hardin counties in Ohio. At September 30, 2024, approximately 99% of our residential real estate loans were concentrated in Ohio. Management believes our knowledge of these markets and our relative connectedness to the consumer borrowers we serve outweighs the geographic concentration risks. Our credit policy requires minimum credit scores, evidence of stable income, and maximum loan-to-values when underwriting residential real estate loans. The evaluation of our retail credit portfolio is defined in our credit policy and incorporates the Uniform Real Credit Classification and Account Management Policy as prescribed by federal regulatory authorities. Nonperforming loans in the residential real estate segment were $1.9 million at September 30, 2024. The allowance for credit losses for this segment totaled $5.1 million at September 30, 2024, representing an allowance for credit losses to loans ratio of 1.48% specific to the residential real estate segment.
The Company opted not to phase in, over three years, the effects of the initial CECL entry to equity for the implementation of ASC 326, recorded on January 1, 2023. As of September 30, 2024, management believes that the Company and the Bank meet all capital adequacy requirements to which they are subject.
The Company monitors fluctuations in unused commitments as a means of identifying potential material drawdowns on existing lines of credit. On September 30, 2024, unused line of credit commitments totaled $476.0 million, which is an increase of $57.0 million, or 13.6%, from December 31, 2023. The commercial unused line of credit commitments were $324.8 million as of September 30, 2024, compared to $279.4 million on December 31, 2023.
Allowance for Credit Losses and Asset Quality. The ACL increased by $833,000, or 3.8%, to $22.5 million on September 30, 2024, from $21.7 million on December 31, 2023. For the nine months ended September 30, 2024, net loan charge-offs totaled $1.3, or 0.11% of average loans, annualized, compared to $87,000 or 0.01% of average loans, annualized, for the same period in 2023. The provision for credit losses associated with loans was $2.1 million for the nine months ended September 30, 2024. The ratio of the ACL to nonperforming loans was 74.9% as of September 30, 2024, compared to 271.9% for the same period in the prior year. The ACL to total loans ratio increased to 1.50% as of September 30, 2024, compared to 1.45% as of September 30, 2023. The increase in the ACL was mainly from changes in projected loss drivers, prepayment assumptions, curtailment expectations over the reasonable and supportable forecast period, and geographic footprint of unemployment data, as well as an overall increase in total loans.
Management analyzes the adequacy of the ACL regularly through reviews of the performance of the loan portfolio considering economic conditions, changes in interest rates and the effect of such changes on real estate values, and changes in the amount and composition of the loan portfolio. The ACL is a significant estimate that is particularly susceptible to changes in the near term. Risks that may impact our loan portfolio include the weakened economic outlook exacerbated by the current hostilities in Ukraine and the Middle East and the resulting uncertainty characterized by inflation. The direct impacts of the pandemic and related economic disruptions, the market liquidity events in 2023, and persistently high inflation, which previously dominated our risk analysis, have lessened. Geopolitical events with weakening growth prospects raise the potential for adverse impacts on the U.S. economy. Changes in interest rates could potentially impact the valuations of assets that collateralize our loans. The Company is concerned about the impact of tighter credit conditions on the economy and the effect that may have on future economic growth. Management’s analysis includes a review of all loans designated as individually analyzed, historical loan loss experience, the estimated fair value of the underlying collateral, economic conditions, current interest rates, trends in the borrower’s industry, and other factors that management believes warrant recognition in providing for an appropriate allowance for credit losses. Future additions or reductions to the allowance for credit losses will be dependent on these factors. Additionally, the Company uses an outside party to conduct an independent review of commercial and commercial real estate loans that is designed to validate management conclusions of risk ratings and the appropriateness of the allowance allocated to these loans. The Company uses the results of this review to help determine the effectiveness of policies and procedures and to assess the adequacy of the allowance for credit losses allocated to these types of loans. Management believes the ACL is appropriately stated as of September 30, 2024. Based on the variables involved and management’s judgments about uncertain outcomes, the determination of the allowance for credit losses is considered a critical accounting policy.
The following table illustrates the net charge-offs to average loans ratio for each loan category for each reported period:
Nonperforming assets. Nonperforming assets include nonaccrual loans, loans 90 days or more past due, other real estate owned, and repossessed assets. Real estate owned is written down to fair value at its initial recording and continually monitored for changes in fair value. A loan is classified as nonaccrual when, in the opinion of management, there are serious doubts about the collectability of interest and principal. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower’s financial condition is such that collection of principal and interest is doubtful. Payments received on nonaccrual loans are applied against the principal until doubt about collectability ceases.
Asset Quality History
(Dollar amounts in thousands)
September 30, 2024
December 31, 2023
Nonperforming loans
$
30,078
$
10,877
Other real estate owned
0
0
Nonperforming assets
$
30,078
$
10,877
Allowance for credit losses
$
22,526
21,693
Ratios:
Nonperforming loans to total loans
2.00
%
0.74
%
Nonperforming assets to total assets
1.62
%
0.60
%
Allowance for credit losses to total loans
1.50
%
1.47
%
Allowance for credit losses to nonperforming loans
74.89
%
199.44
%
Total loans
$
1,504,531
$
1,478,130
Total assets
$
1,857,635
$
1,822,883
Nonperforming loans at September 30, 2024, were $30.1 million, compared to $10.9 million at December 31, 2023. The increase in nonperforming loans is primarily the result of three commercial real estate loans totaling $20.2 million moved to nonaccrual during the nine-month period ended September 30, 2024. These loans are adequately secured and individually analyzed within the ACL calculation as of September 30, 2024. Management believes these relationships do not indicate a trend in the markets served, the portfolio, or underwriting standards. A major factor in determining the appropriateness of the ACL is the type of collateral that secures the loans. Nonperforming loans secured by real estate totaled $28.7 million and $10.4 million as of September 30, 2024 and December 31, 2023, respectively. Of the total nonperforming loans on September 30, 2024, 95.3% were secured by real estate. Although this does not insure against all losses, real estate typically provides for at least partial recovery, even in a distressed sale and declining-value environment. The objective of the Company is to minimize future loss exposure.
Deposits. The Company considers various sources when evaluating funding needs, including but not limited to deposits, which are a significant source of funds, totaling $1.51 billion or 93.1% of the Company’s total average funding sources at September 30, 2024. Total deposits increased $86.2 million on September 30, 2024, from $1.43 billion on December 31, 2023. The following table summarizes fluctuation within the primary segments of the deposit portfolio (in thousands):
The Company uses specific non-core funding instruments to grow the balance sheet and maintain liquidity. These deposits, either from a broker or a listing service, were $86.5 million on September 30, 2024 and $90.3 million on December 31, 2023 and are included in time deposits on the Consolidated Balance Sheet.
Deposit balances in excess of the $250,000 FDIC-insured limit totaled approximately $452.4 million, or 29.9% of total deposits, at September 30, 2024 and approximately $390.0 million, or 27.3% of total deposits, at December 31, 2023.
State and political subdivisions in the U.S. deposits (“Public funds”) compared to total deposits were $184.8 million, or 12.2% at September 30, 2024 and $141.3 million, or 9.9% at December 31, 2023.
Borrowed funds. The Company uses short-term and long-term borrowings as another source of funding for asset growth and liquidity needs. These borrowings primarily include advances from the FHLB, subordinated debt, short-term borrowings from other banks, and federal funds purchased. Short-term borrowings decreased by $57.0 million to $106.0 million as of September 30, 2024, compared to $163.0 million at December 31, 2023. Other borrowings were relatively unchanged at $11.7 million as of September 30, 2024 and $11.9 million on December 31, 2023.
Stockholders’ equity. Stockholders’ equity increased $5.0, or 2.4%, to $210.7 million at September 30, 2024 from $205.7 million at December 31, 2023. This increase was primarily the result of $10.7 million in net income. These changes were partially offset by a $1.1 million increase in treasury stock due to repurchasing 43,858 common shares during the first quarter of 2024, and $4.8 million of cash dividends paid.
The Company's tangible book value per share, which is a non-GAAP financial measure, was $20.87 at September 30, 2024 compared to $18.62 at September 30, 2023 and $20.18 at December 31, 2023. Tangible equity has been impacted by the changes in stockholders' equity described in the previous paragraph, including the unrealized losses of the Company's available-for-sale investment securities portfolio. Net unrealized losses from available-for-sale investment securities were $20.9 million as of September 30, 2024, compared to net unrealized losses of $24.4 million at September 30, 2023, and net unrealized losses of $20.4 million at December 31, 2023.
RESULTS OF OPERATIONS
General. Net income for the three months ended September 30, 2024, was $2.3 million, a $1.5, or 39.0%, decrease from the amount earned during the same period in 2023. Diluted earnings per share for the quarter was $0.29 for the three months ended September 30, 2024 and $0.47 for the same period in 2023. Net income for the nine months ended September 30, 2024, was $10.7 million, a $3.2 million, or 22.8%, decrease from the amount earned during the same period in 2023. Diluted earnings per share was $1.32 for the nine months ended September 30, 2024 and $1.70 for the same period in 2023.
Net interest income. Net interest income, the primary source of revenue for the Company, is determined by the interest rate spread, which is defined as the difference between income on earning assets and the cost of funds supporting those assets, and the relative amounts of interest-earning assets and interest-bearing liabilities. Management reviews and periodically adjusts the mix of interest-earning assets and interest-bearing liabilities, to manage and improve net interest income. The level of interest rates and changes in the amount and composition of interest-earning assets and liabilities affect the Company’s net interest income. Management’s goal is to maintain a balance between steady net interest income growth and the risks associated with interest rate fluctuations.
Net interest income for the three months ended September 30, 2024, totaled $15.1 million, a decrease of 5.6% from that reported in the comparable period of 2023. The net interest margin was 3.46% for the three months ended September 30, 2024, a decrease of 36 basis points for the same period of 2023. The decrease in the net interest margin is attributable to an increase in the average balance of interest-bearing deposits of $71.1 million, coupled with a 75-basis point increase in the yield earned on those deposits. This was partially offset by a $82.1 million increase in the average balance of loans receivable, coupled with a 37 basis point increase in the rate paid on those loans.
Net interest income for the nine months ended September 30, 2024, totaled $45.1 million, a decrease of 9.4% from that reported in the comparable period of 2023. The net interest margin was 3.50% for the nine months ended September 30, 2024, a decrease of 59 basis points for the same period of 2023. The decrease in the net interest margin is attributable to an increase in the average balance of interest-bearing deposits of $92.4 million, coupled with a 103-basis point increase in the yield earned on those deposits. This was partially offset by a $100.4 million increase in the average balance of loans receivable, coupled with a 44-basis point increase in the rate paid on those loans.
The Company is currently in a slightly liability-sensitive position and expects to remain so for the next 18-month outlook period. A decrease in rates should lead to a minimal expansion of net interest margin as the Company’s interest-bearing liabilities reprice faster than its interest-bearing assets. As part of the Company’s strategy, floor rates are used to protect the Company’s net interest margin in a declining interest rate environment. As of September 30, 2024, nearly all loan contracts with floor rates exceed their contractual floor rates. Please refer to Item 3, Quantitative and Qualitative Disclosures about Market Risk, for further discussion on asset and liability management and interest rate sensitivity.
Interest and dividend income. Interest and dividend income increased $2.5 million or 11.0%, for the three months ended September 30, 2024, compared to the same period in the prior year. This is mainly attributable to a $2.5 million increase in interest and fees on loans. The average balance of investment securities decreased by $307,000, or 0.2%, and the 3.59% yield on the investment portfolio increased by 8 basis points, from 3.51%, for the same period in the prior year. The yield for the investment portfolio is based on amortized cost.
Interest and dividend income increased $9.6 million or 14.5% for the nine months ended September 30, 2024, compared to the same period in the prior year. This is mainly attributable to a $9.3 million increase in interest and fees on loans. The average balance of investment securities decreased by $390,000, or 0.2%, and the 3.57% yield on the investment portfolio increased by 3 basis points, from 3.54%, for the same period in the prior year. The yield for the investment portfolio is based on amortized cost.
Interest expense. Interest expense increased by $3.4 million, or 48.4%, for the three months ended September 30, 2024, compared to the same period in the prior year. This increase in interest expense is primarily attributable to an increase in deposit expense of $3.1 million. The increase in deposit expense is attributable to an increase in the average balance of interest-bearing deposits of $71.1 million, or 6.9% as well as an increase of 122 basis points in the rates paid on certificates of deposits and an increase of 99 basis points in the rates paid on money market deposits. The increase in short-term borrowing expenses is a result of the Bank taking on additional FHLB advances.
Interest expense increased by $14.3 million, or 87.4%, for the nine months ended September 30, 2024, compared to the same period in the prior year. This increase in interest expense is attributable to an increase in deposit expense of $12.2 million and a $2.1 million increase in short-term and other borrowings expenses. The increase in deposit expense is attributable to an increase in the average balance of interest-bearing deposits of $92.3 million, or 2.2% as well as an increase of 187 basis points in the rates paid on certificates of deposits and an increase of 161 basis points in the rates paid on money market deposits. The increase in short-term borrowing expenses is a result of the Bank taking on additional FHLB advances.
Provision for (recovery of) credit losses. The provision for (recovery of) credit losses represents the charge to income necessary to adjust the ACL to an amount that represents management’s assessment of the estimated probable incurred credit losses inherent in the loan portfolio. Each quarter, management reviews the loan portfolio for estimated probable expected credit losses. Based on this review, a provision for credit losses of $2.2 million was recorded for the three months ended September 30, 2024, including a provision for credit losses on loans of $2.1 million and a provision for credit losses for unfunded commitments of $121,000. A provision for credit losses of $1.1 million was recorded for the nine months ended September 30, 2023. The increase in the provision for credit losses for the three months ended September 30, 2024 was mainly due to the partial charge-off of one loan during the 2024 third quarter.
A provision of credit losses of $2.2 million was recorded for the nine months ended September 30, 2024, including a provision for credit losses on loans of $2.1 million and a provision for credit losses for unfunded commitments of $67,000. A provision of $2.4 million was recorded for the nine months ended September 30, 2023. The decrease in the provision for credit losses was mainly due to a decrease in the provision related to unfunded commitments offset by an increase in the provision for credit losses on loans due to the partial charge-off of a loan described in the previous paragraph.
Noninterest income. Noninterest income decreased by $74,000, or 4.1%, for the three months ended September 30, 2024, over the comparable 2023 period. This decrease was the result of a $110,000 decrease in gross rental income as the OREO property was sold and a $34,000 decrease in gain on equity securities. These decreases were partially offset by a $39,000 increase in earnings on bank owned life insurance.
Noninterest income increased by $211,000, or 4.1%, for the nine months ended September 30, 2024, over the comparable 2023 period. This increase was the result of a $129,000 increase in revenue from investment services, a $121,000 increase in other income, a $92,000 improvement in loss on equity securities, a $73,000 increase in earnings on bank owned life insurance, and a $61,000 increase in gain on sale of loans. These increases were partially offset by a $222,000 decrease in gross rental income as the OREO property was sold and a $41,000 decrease in service charges on deposit accounts.
Noninterest expense. Noninterest expense of $11.9 million for the third quarter of 2024 was 2.0%, or $247,000 lower than the third quarter of 2023, primarily due to a $195,000 decrease in gross OREO expenses, a $131,000 decrease in advertising expense, a $94,000 decrease in equipment expense, and a $64,000 decrease in other expenses. This decrease was partially offset by a $207,000 increase in salaries and employee benefits, and a $50,000 increase in software amortization expense.
Noninterest expense of $35.7 million for the nine months ended September 30, 2024 was 0.6%, or $226,000 lower than the nine months ended September 30, 2023, primarily due to a $472,000 decrease in merger related costs, a $291,000 decrease in gross OREO expense, a $274,000 decrease in occupancy expense, a $265,000 decrease in equipment expense, a $105,000 decrease in advertising expense and a $92,000 decrease in other expense. These decreases were partially offset by a $780,000 increase in salaries and employee benefits, a $250,000 increase in data processing and information technology costs, and a $186,000 increase in federal deposit insurance expense.
Provision for income taxes. The Company recognized $371,000 in income tax expense for the three months ended September 30, 2024, which reflected an effective tax rate of 13.7%, as compared to $703,000 in income tax expense with an effective tax rate of 15.5% for the comparable 2023 period. The Company recognized $1.8 million in income tax expense for the nine months ended September 30, 2024, which reflected an effective tax rate of 14.6%, as compared to $2.7 million in income tax expense with an effective tax rate of 16.2% for the comparable 2023 period.
Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resultant average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resultant average costs, net interest income, interest rate spreads and the net interest margin earned on average interest-earning assets. For purposes of this table, average balances are calculated using monthly averages, the average loan balances include nonaccrual loans and exclude the allowance for credit losses, and interest income includes accretion of net deferred loan fees. Yields on tax-exempt securities and loans (tax-exempt for federal income tax purposes) are shown on a fully tax-equivalent basis utilizing a federal tax rate of 21%. Yields and rates have been calculated on an annualized basis utilizing monthly interest amounts.
For the Three Months Ended September 30,
2024
2023
Average
Average
Average
Average
(Dollars in thousands)
Balance
Interest
Yield/Cost
Balance
Interest
Yield/Cost
Interest-earning assets:
Loans receivable ⁽¹⁾
$
1,507,518
$
23,441
6.19
%
$
1,425,375
$
20,899
5.82
%
Investment securities ⁽²⁾
193,659
1,490
3.59
%
193,966
1,457
3.51
%
Interest-earning deposits with other banks ⁽³⁾
63,580
682
4.27
%
68,587
714
4.13
%
Total interest-earning assets
$
1,764,757
$
25,613
5.84
%
$
1,687,928
$
23,070
5.49
%
Noninterest-earning assets
86,733
88,058
Total assets
$
1,851,490
$
1,775,986
Interest-bearing liabilities:
Interest-bearing demand deposits
$
217,124
1,181
2.16
%
$
256,153
975
1.51
%
Money market deposits
362,545
3,583
3.93
%
259,802
1,928
2.94
%
Savings deposits
198,775
357
0.71
%
225,216
327
0.58
%
Certificates of deposit
325,240
3,671
4.49
%
291,409
2,402
3.27
%
Short-term borrowings
113,812
1,575
5.51
%
91,201
1,258
5.47
%
Other borrowings
11,739
173
5.86
%
11,940
213
7.08
%
Total interest-bearing liabilities
$
1,229,235
$
10,540
3.41
%
$
1,135,721
$
7,103
2.48
%
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits
$
396,456
$
431,775
Other liabilities
16,703
11,695
Stockholders' equity
209,096
196,795
Total liabilities and stockholders' equity
$
1,851,490
$
1,775,986
Net interest income
$
15,073
$
15,967
Interest rate spread ⁽⁴⁾
2.43
%
3.01
%
Net interest margin ⁽⁵⁾
3.46
%
3.82
%
Ratio of average interest-earning assets to average interest-bearing liabilities
143.57
%
148.62
%
(1) Tax-equivalent adjustments to calculate the yield on tax-exempt securities and loans were $281 and $270 for the three months ended September 30, 2024 and 2023, respectively.
(2) Yield is calculated on the basis of amortized cost.
(3) Includes dividends received on restricted stock.
(4) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(5) Net interest margin represents net interest income as a percentage of average interest-earning assets.
Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense, between the three-month periods ended September 30, 2024, and 2023, in terms of (1) changes in the volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Company’s interest income and interest expense are attributable to changes in rate (change in rate multiplied by prior period volume), changes in volume (changes in volume multiplied by prior period rate), and changes attributable to the combined impact of volume/rate (change in rate multiplied by the change in volume). The changes attributable to the combined impact of volume/rate are allocated consistently between the volume and rate variances.
Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resultant average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resultant average costs, net interest income, interest rate spreads and the net interest margin earned on average interest-earning assets. For purposes of this table, average balances are calculated using monthly averages, the average loan balances include nonaccrual loans and exclude the allowance for credit losses, and interest income includes accretion of net deferred loan fees. Yields on tax-exempt securities and loans (tax-exempt for federal income tax purposes) are shown on a fully tax-equivalent basis utilizing a federal tax rate of 21%. Yields and rates have been calculated on an annualized basis utilizing monthly interest amounts.
For the Nine Months Ended September 30,
2024
2023
Average
Average
Average
Average
(Dollars in thousands)
Balance
Interest
Yield/Cost
Balance
Interest
Yield/Cost
Interest-earning assets:
Loans receivable ⁽¹⁾
$
1,495,834
$
69,258
6.19
%
$
1,395,438
$
59,935
5.75
%
Investment securities ⁽²⁾
193,719
4,400
3.57
%
194,109
4,353
3.54
%
Interest-earning deposits with other banks ⁽³⁾
63,203
2,166
4.58
%
66,730
1,924
3.85
%
Total interest-earning assets
$
1,752,756
$
75,824
5.84
%
$
1,656,277
$
66,212
5.41
%
Noninterest-earning assets
86,473
89,567
Total assets
$
1,839,229
$
1,745,844
Interest-bearing liabilities:
Interest-bearing demand deposits
$
212,699
3,167
1.99
%
$
216,044
$
1,934
1.20
%
Money market deposits
332,987
9,730
3.90
%
234,236
4,005
2.29
%
Savings deposits
197,477
951
0.64
%
267,951
1,608
0.80
%
Certificates of deposit
330,884
10,833
4.37
%
263,448
4,925
2.50
%
Short-term borrowings
132,275
5,488
5.54
%
86,670
3,373
5.20
%
Other borrowings
11,790
530
6.00
%
11,990
539
6.01
%
Total interest-bearing liabilities
$
1,218,112
$
30,699
3.37
%
$
1,080,339
$
16,384
2.03
%
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits
$
397,764
$
458,086
Other liabilities
16,662
11,345
Stockholders' equity
206,691
196,074
Total liabilities and stockholders' equity
$
1,839,229
$
1,745,844
Net interest income
$
45,125
$
49,828
Interest rate spread ⁽⁴⁾
2.47
%
3.38
%
Net interest margin ⁽⁵⁾
3.50
%
4.09
%
Ratio of average interest-earning assets to average interest-bearing liabilities
143.89
%
153.31
%
(1) Tax-equivalent adjustments to calculate the yield on tax-exempt securities and loans were $851 and $824 for the nine months ended September 30, 2024 and 2023, respectively.
(2) Yield is calculated on the basis of amortized cost.
(3) Includes dividends received on restricted stock.
(4) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(5) Net interest margin represents net interest income as a percentage of average interest-earning assets.
Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense, between the nine-month periods ended September 30, 2024, and 2023, in terms of (1) changes in the volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Company’s interest income and interest expense are attributable to changes in rate (change in rate multiplied by prior period volume), changes in volume (changes in volume multiplied by prior period rate), and changes attributable to the combined impact of volume/rate (change in rate multiplied by the change in volume). The changes attributable to the combined impact of volume/rate are allocated consistently between the volume and rate variances.
2024 versus 2023
Increase (decrease) due to
(Dollars in thousands)
Volume
Rate
Total
Interest-earning assets:
Loans receivable
$
4,322
$
5,001
$
9,323
Investment securities
(10
)
57
47
Interest-earning deposits with other banks
(102
)
344
242
Total interest-earning assets
$
4,210
$
5,402
$
9,612
Interest-bearing liabilities:
Interest-bearing demand deposits
$
(30
)
$
1,263
$
1,233
Money market deposits
1,693
4,032
5,725
Savings deposits
(422
)
(235
)
(657
)
Certificates of deposit
1,262
4,646
5,908
Short-term borrowings
1,775
340
2,115
Other borrowings
(9
)
-
(9
)
Total interest-bearing liabilities
$
4,269
$
10,046
$
14,315
Net interest income
$
(59
)
$
(4,644
)
$
(4,703
)
LIQUIDITY
Management's objective in managing liquidity is to continue meeting the cash flow needs of banking customers, such as new or increased borrowings or deposit withdrawals, as well as the Company’s financial commitments, while doing so at a reasonable cost and in a timely manner. The principal sources of liquidity are customer deposits, loan repayments, maturing and sales of securities available for sale, and federal funds sold, which generate cash that the Company deposits with banks. While investment securities available for sale are generally considered as a source of cash, in the current interest rate environment, it is unlikely that any of these securities would be sold for funding needs. The Company offers a line of retail deposit products created to align with customer expectations while expanding the Company’s core funding base. The Company’s goal is to obtain the majority of its funding from customer deposits, which are generated principally through development of long-term customer relationships. Along with its liquid assets, the Company has additional sources of liquidity available to ensure that adequate funds are available as needed. These include, but are not limited to, the purchase of federal funds, the ability to borrow funds under line of credit agreements with correspondent banks and a borrowing agreement with the FHLB, the purchase of brokered deposits, and the adjustment of interest rates to obtain deposits.
At September 30, 2024, the additional borrowing capacity at the FHLB was $428.4 million, as compared to $430.1 million on December 31, 2023. The Company’s maximum borrowing capacity at the FHLB was $559.4 million at September 30, 2024. During the third quarter of 2024, the Company was approved for its Borrower in Custody ("BIC") Arrangement to pledge certain loan portfolios, and therefore, the Company also has the option of borrowing from the Federal Reserve discount window. The borrowing capacity with the Federal Reserve discount window was $132.4 million at September 30, 2024. Given the flexibility of borrowing structure options with the FHLB, if the Company needed additional liquidity, the FHLB capacity would likely be used before other funding mechanisms.
At September 30, 2024, total net available liquidity was $859.0 million, compared to $702.2 million at December 31, 2024. This accounted for 56.8% of total deposits at September 30, 2024, compared to 49.2% at December 31, 2024. At September 30, 2024, these liquidity sources exceeded the amount of the Company’s uninsured deposit balances. Management believes that the combination of high levels of potentially liquid assets, cash flows from operations, and additional borrowing capacity provided the Bank with strong liquidity as of September 30, 2024. Although the Company currently exhibits strong liquidity, management will continue to monitor liquidity in future periods.
For the nine months ended September 30, 2024, the adjustments to reconcile net income to net cash provided by operating activities consisted mainly of provision for credit losses, core deposit intangibles amortization, origination and proceeds from the sale of loans held for sale, earnings on bank-owned life insurance, and net changes in other assets and liabilities. For a more detailed illustration of sources and uses of cash, refer to the Consolidated Statement of Cash Flows.
INFLATION
Substantially all of the Company's assets and liabilities relate to banking activities and are monetary. The consolidated financial statements and related financial data are presented following US GAAP. US GAAP currently requires the Company to measure the financial position and results of operations in terms of historical dollars, except for investment securities available for sale, individually analyzed loans, and other real estate owned that are measured at fair value. Changes in the value of money due to rising inflation can cause purchasing power loss.
Management believes that movements in interest rates affect the financial condition and results of operations to a greater degree than changes in the inflation rate. It should be noted that interest rates and inflation do affect each other but do not always move in correlation with each other. Please refer to item 3, Quantitative and Qualitative Disclosures about Market Risk, for further discussion on interest rate risk.
REGULATORY MATTERS
The Company is subject to the regulatory requirements of the Federal Reserve System as a bank holding company. The bank subsidiary is subject to regulations of the Federal Deposit Insurance Corporation (“FDIC”) and the Ohio Division of Financial Institutions.
The Federal Reserve Board and the FDIC have extensive authority to prevent and remedy unsafe and unsound practices and violations of applicable laws and regulations by institutions and holding companies. The agencies may assess civil money penalties, issue cease-and-desist or removal orders, seek injunctions, and publicly disclose those actions. In addition, the Ohio Division of Financial Institutions possesses enforcement powers to address violations of Ohio banking law by Ohio-chartered banks.
REGULATORY CAPITAL REQUIREMENTS
Financial institution regulators have established guidelines for minimum capital ratios for banks, thrifts, and bank and thrift holding companies. The net unrealized gain or loss on available-for-sale securities is generally not included in computing regulatory capital. To avoid limitations on capital distributions, including dividend payments, the Bank and the Company must each hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. Within the tabular presentation that follows is the adequately capitalized ratio plus a 2.50% capital conservation buffer.
The Bank and the Company met each of the well-capitalized ratio guidelines as of September 30, 2024. The following table indicates the capital ratios for the Bank and the Company as of September 30, 2024, and December 31, 2023, as well as the capital category threshold ratios for a well-capitalized, adequately capitalized plus the capital conservation buffer institution.
As of September 30, 2024
Leverage
Tier 1 Risk Based
Common Equity Tier 1
Total Risk Based
The Middlefield Banking Company
10.37
%
11.78
%
11.78
%
13.03
%
Middlefield Banc Corp.
10.69
%
12.10
%
11.59
%
13.35
%
Adequately capitalized ratio
4.00
%
6.00
%
4.50
%
8.00
%
Adequately capitalized ratio plus fully phased-in capital conservation buffer
4.00
%
8.50
%
7.00
%
10.50
%
Well-capitalized ratio (Bank only)
5.00
%
8.00
%
6.50
%
10.00
%
As of December 31, 2023
Leverage
Tier 1 Risk Based
Common Equity Tier 1
Total Risk Based
The Middlefield Banking Company
10.48
%
11.82
%
11.82
%
13.08
%
Middlefield Banc Corp.
10.68
%
12.18
%
11.66
%
13.43
%
Adequately capitalized ratio
4.00
%
6.00
%
4.50
%
8.00
%
Adequately capitalized ratio plus fully phased-in capital conservation buffer
4.00
%
8.50
%
7.00
%
10.50
%
Well-capitalized ratio (Bank only)
5.00
%
8.00
%
6.50
%
10.00
%
Item 3. Quantitative and Qualitative Disclosures about Market Risk
ASSET AND LIABILITY MANAGEMENT
The primary objective of the Company’s asset and liability management function is to maximize the Company’s net interest income while simultaneously maintaining an acceptable level of interest rate risk given the Company’s operating environment, capital and liquidity requirements, performance objectives, and overall business focus. The principal determinant of the exposure of the Company’s earnings to interest rate risk is the timing difference between the repricing or maturity of interest-earning assets and the repricing or maturity of interest-bearing liabilities. The Company’s asset and liability management policies are designed to decrease interest rate sensitivity primarily by shortening the maturities of interest-earning assets while at the same time extending the maturities of interest-bearing liabilities. The Board of Directors of the Company continues to believe in a strong asset/liability management process to insulate the Company from material and prolonged increases in interest rates.
The Company’s Board of Directors has established an Asset and Liability Management Committee consisting of outside directors and senior management. This committee meets quarterly and generally monitors various asset and liability management policies and strategies.
Interest Rate Sensitivity Simulation Analysis
The Company engages an external consultant to facilitate net interest income simulation modeling on a quarterly basis. This modeling measures interest rate risk and sensitivity. The Asset and Liability Management Committee of the Company believes the various rate scenarios of the simulation modeling enable the Company to more accurately evaluate and manage the exposure of interest rate fluctuations on net interest income, the yield curve, various loan and mortgage-backed security prepayments, and deposit decay assumptions.
Earnings simulation modeling and assumptions about the timing and volatility of cash flows are critical in net portfolio equity valuation analysis. Particularly important are the assumptions driving mortgage prepayments and the expected attrition of the core deposit portfolios. These assumptions are based on the Company’s historical experience and industry standards and are applied consistently across all rate risk measures.
The Company has established the following guidelines for assessing interest rate risk:
Net interest income simulation (“NII”) - Projected net interest income over the next twelve months will not be reduced by more than 10% given a gradual shift (i.e., over 12 months) in interest rates of up to 200 basis points (+ or -) and assuming no balance sheet growth.
Portfolio equity simulation - Portfolio equity is the net present value of the Company’s existing assets and liabilities. The Company uses an Economic Value of Equity (“EVE”) analysis which shows the estimated changes in portfolio equity considering certain long-term shock rates.Given a 200 basis point immediate and permanent increase in market interest rates, portfolio equity may not correspondingly decrease or increase by more than 20% of stockholders’ equity. Given a 100 basis point immediate and permanent decrease in market interest rates, portfolio equity may not correspondingly decrease or increase by more than 10% of stockholders’ equity.
The following table presents the simulated impact of a 200-basis point upward or 100-basis point downward shift of market interest rates on net interest income and the change in portfolio equity. This analysis assumed the interest-earning asset and interest-bearing liability levels at September 30, 2024, and December 31, 2023, remained constant. The impact of the market rate movements was developed by simulating the effects of rates changing gradually over one year from the September 30, 2024, and December 31, 2023 levels for net interest income and portfolio equity. The impact of market-rate movements was developed by simulating the effects of an immediate and permanent change in rates at September 30, 2024, and December 31, 2023, for portfolio equity.
September 30, 2024
December 31, 2023
Change in Rates
% Change in NII
% Change in EVE
% Change in NII
% Change in EVE
+200bp
(2.70
%)
(7.00
%)
(3.20
%)
(9.20
%)
-100bp
1.60
%
1.60
%
1.73
%
2.90
%
CRITICAL ACCOUNTING ESTIMATES
The Company’s critical accounting estimates involving the more significant judgments and assumptions used in the preparation of the consolidated financial statements as of September 30, 2024, have remained unchanged from December 31, 2023. However, the Company has identified accounting policies that are critical accounting policies and an understanding of these policies is necessary to understand the Company’s financial statements. These policies relate to determining the adequacy of the allowance for credit losses for the investment securities available for sale, loan portfolios, and unfunded commitments. Please refer to Note 1 - Summary of Significant Accounting Policies for further discussion on significant accounting policies.
Item 4. Controls and Procedures
Controls and Procedures Disclosure
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
As of the end of the period covered by this quarterly report, an evaluation was carried out under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are, to the best of their knowledge, effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the periods specified in Securities and Exchange Commission rules and forms. After the date of their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that there were no significant changes in internal control or in other factors that could significantly affect the Company’s internal controls, including any corrective actions concerning significant deficiencies and material weaknesses.
A material weakness is a significant deficiency (as defined in Public Company Accounting Oversight Board Auditing Standard No. 2), or a combination of significant deficiencies, that results in there being more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis by management or employees in the normal course of performing their assigned functions.
Changes in Internal Control over Financial Reporting
There have not been any changes in the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
See the information in Note 8, which we incorporate here by reference.
From time to time, the Company and the subsidiary bank may be involved in litigation relating to claims arising out of their normal course of business. In the opinion of management, no other current legal proceedings are material to the Company's financial condition or the subsidiary bank, either individually or in the aggregate.
Item 1a.
Risk Factors
The Company is attentive to various risks and continuously evaluates the potential impact of such risks. There have been no material updates or changes in risks faced by the Company since December 31, 2023. For more information regarding our risk factors, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2023.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
The following table summarized the Company's repurchases of common shares for the three months ended September 30, 2024:
2024 period
In thousands, except per share data
Total shares purchased
Average price paid per share
Total shares purchased as part of a publicly announced program (a)
Maximum number of shares that may yet be purchased under the program
July 1-31
-
$
-
-
250,052
August 1-31
-
-
-
250,052
September 1-30
-
-
-
250,052
Total
-
$
-
(a) In February 2022, the Board of Directors authorized the repurchase of up to 300,000 shares of common stock under the Company's repurchase program (the "Program") to enhance the value of Company stock and manage its capital. In February 2023, the Board of Directors authorized the Company to repurchase an additional 300,000 shares under the Program. The Company has completed the repurchase of 349,948 shares under the Program through September 30, 2024. The Program may be modified, suspended or terminated by the Company at any time.
Item 3.
Defaults Upon Senior Securities
None
Item 4.
Mine Safety Disclosures
N/A
Item 5.
Other information
During the three months ended September 30, 2024, there were no “Rule 10b5-1 trading plans” or “non-Rule 10b5-1 trading arrangements” adopted, modified or terminated by any director or officer of the Company (as such terms are defined in Item 408 of Regulation S-K of the Exchange Act).
Incorporated by reference to Exhibit 3.1 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Fiscal Year Ended December 31, 2005, filed on March 29, 2006
Incorporated by reference to Middlefield Banc Corp.’s definitive proxy statement for the 2017 Annual Meeting of Shareholders, Appendix A, filed on April 4, 2017
Incorporated by reference to Exhibit 10.5 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2022, filed on March 15, 2023
Incorporated by reference to Exhibit 10.6 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2022, filed on March 15, 2023
Incorporated by reference to Exhibit 10.11 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2001, filed on March 28, 2002
Incorporated by reference to Exhibit 10.12 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2022, filed on March 15, 2023
Incorporated by reference to Exhibit 10.14 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004
Incorporated by reference to Exhibit 10.15 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004
Incorporated by reference to Exhibit 10.18 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004
Incorporated by reference to Exhibit 10.18 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2011, filed on March 20, 2012
Incorporated by reference to Exhibit 10.20 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004
Incorporated by reference to Exhibit 10.21 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004
Incorporated by reference to Exhibit 10.23 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2019, filed on March 4, 2020
Incorporated by reference to Exhibit 10.24 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2019, filed on March 4, 2020
Incorporated by reference to Exhibit 10.25 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2019, filed on March 4, 2020
Incorporated by reference to Exhibit 10.26 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2019, filed on March 4, 2020
Incorporated by reference to Exhibit 10.27 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2019, filed on March 4, 2020
Incorporated by reference to Exhibit 10.28 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2019, filed on March 4, 2020
Incorporated by reference to Exhibit 10.29 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2022, filed on March 15, 2023
Incorporated by reference to Exhibit 99.1 of Middlefield Banc Corp.’s registration statement on Form 10, Amendment No. 1, filed on June 14, 2001
100
[reserved]
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104
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)
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Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned and hereunto duly authorized.
