FINANCIAL REVIEW OF BANQUE ISABELLA
(in thousands of dollars except per share amounts)
The following is management's discussion and analysis of our financial condition and results of operations for the unaudited three and six-month periods endedJune 30, 2022 and 2021. This analysis should be read in conjunction with our Annual Report on Form 10-K for the year endedDecember 31, 2021 and with the unaudited interim condensed consolidated financial statements and notes, beginning on page 4 of this report.
Summary
During the three and six months endedJune 30, 2022 , we reported net income of$5,295 and$10,029 and earnings per common share of$0.70 and$1.33 , respectively. Net income and earnings per common share for the same periods of 2021 were$4,621 and$10,019 and$0.58 and$1.26 , respectively. Net interest income increased$2,492 , or 9.62%, for the six-month period endedJune 30, 2022 in comparison to the same period in 2021. While PPP loan fees declined, rising interest rates and growth in loans and AFS securities, led to a$934 increase in gross interest income during the six-month period endedJune 30, 2022 , compared to the same period in 2021. We continued to benefit from a reduction in higher-cost borrowings as interest expense on deposits and borrowings decreased$1,558 , or 38.79%, for the six-month period endedJune 30, 2022 when compared to the same period in 2021. The provision for loan losses during the six months endedJune 30, 2022 was$522 , compared to a net provision reversal of$492 for the same period in 2021. During 2020, increased economic and environmental risk factors, predominantly driven by COVID-19, drove a significant increase in the ALLL and provision expense. Strong credit quality, coupled with improvement in economic factors, such as unemployment rates, resulted in a reduction in the ALLL and a provision reversal during the first quarter of 2021. Credit quality remained strong atJune 30, 2022 , as evidenced by total past due and nonaccrual loans which were$1,505 , or 0.12% of gross loans. Despite strong credit quality, the ALLL and provision for loan losses increased during 2022 as a result of loan growth during the second quarter. Noninterest income increased$295 during the first six months of 2022 compared to the same period in 2021. Service charges and fees increased$968 , with$577 attributed to OMSR income. Offsetting this income was a$726 reduction in gain on sale of mortgage loans, as residential mortgage originations sold in the secondary market declined. Noninterest expenses for the first six months of 2022 increased$1,669 in comparison to the same period in 2021 and is primarily a result of increased compensation, other losses, consulting, marketing, and donations and community relations related expenses. As ofJune 30, 2022 , total assets and assets under management were$2,048,373 and$2,776,202 , respectively. Assets under management include loans sold and serviced of$273,294 and investment and trust assets managed by Isabella Wealth of$454,535 , in addition to assets on our consolidated balance sheet. Loans outstanding as ofJune 30, 2022 totaled$1,271,910 . SinceDecember 31, 2021 , gross loans declined$29,127 as a result of a$34,710 reduction in advances to mortgage brokers, which is included within the commercial loan portfolio. Total deposits were$1,759,866 as ofJune 30, 2022 , which was an increase of$49,527 sinceDecember 31, 2021 . All regulatory capital ratios for the Bank exceeded the minimum thresholds to be considered a "well capitalized" institution. Our securities portfolio increased$66,989 fromDecember 31, 2021 , predominantly due to$139,500 in purchases, although offset by maturities and an increase in net unrealized losses. The unrealized loss on our AFS securities portfolio resulted from the recent increases in short-term and intermediate-term benchmark interest rates. As a result, this change in unrealized losses has reduced our balance of shareholders' equity and negatively impacted our tangible book value. Our net yield on interest earning assets (FTE) was 3.16% and 3.01% for the three and six months endedJune 30, 2022 , as compared to 2.79% and 2.88% for the three and six months endedJune 30, 2021 . The marked improvement is a result of strategies management implemented in 2019 and 2020, focused on improving our net yield as rates declined, including enhanced pricing related to loans and a reduced reliance on higher-cost borrowed funds and brokered deposits. With rate increases during the first two quarters of 2022, and anticipation of future rate increases in the remainder of the year, we expect to see continued improvement in our net yield on interest earning assets. 35 -------------------------------------------------------------------------------- Table of Contents Recent Events and Legislation Impact of COVID-19: Unexpected and unprecedented changes have occurred since early 2020 as the result of COVID-19. The full impact of the pandemic, including the uncertainties surrounding the pandemic, remain in 2022. However, significant progress has been made towards the development of vaccinations and medical treatments. Additionally, improved safety guidelines and the easing of restrictions have occurred since the onset of the pandemic. We expect the significance of the pandemic, including the extent of its effect on our financial and operational results, to be dictated by continued developments related to the COVID-19 pandemic. We continue to closely monitor external events and are in continual discussion with our customers to assess, prepare and respond to conditions as they evolve.
Reclassifications
Certain amounts presented in the 2021 interim consolidated financial statements have been reclassified to conform to the 2022 presentation.
Subsequent events
We evaluated subsequent events afterJune 30, 2022 through the date our interim condensed consolidated financial statements were issued for potential recognition and disclosure. No subsequent events require financial statement recognition or disclosure betweenJune 30, 2022 and the date our interim condensed consolidated financial statements were issued. 36 -------------------------------------------------------------------------------- Table of Contents Results of Operations (Unaudited) The following table outlines our quarter-to-date results of operations and provides certain performance measures as of, and for the three-month periods ended: June 30 March 31 December 31 September 30 June 30 2022 2022 2021 2021 2021 INCOME STATEMENT DATA Interest income$ 16,102 $ 14,762 $ 15,041 $ 15,142 $ 14,640 Interest expense 1,175 1,283 1,567 1,829 1,927 Net interest income 14,927 13,479 13,474 13,313 12,713 Provision for loan losses 485 37 81 (107) 31 Noninterest income 3,595 3,547 3,608 3,367 3,315 Noninterest expenses 11,661 11,320 11,197 11,185 10,495 Federal income tax expense (benefit) 1,081 935 1,010 916 881 Net income (loss)$ 5,295 $ 4,734 $ 4,794 $ 4,686 $ 4,621 PER SHARE Basic earnings$ 0.70 $ 0.63 $ 0.63 $ 0.59 $ 0.58 Diluted earnings$ 0.69 $ 0.62 $ 0.63 $ 0.58 $ 0.57 Dividends$ 0.27 $ 0.27 $ 0.27 $ 0.27 $ 0.27 Tangible book value$ 18.85 $ 19.56 $ 21.61 $ 21.87 $ 21.73 Quoted market value High$ 26.25 $ 26.00 $ 29.00 $ 26.74 $ 23.90 Low$ 23.00 $ 24.50 $ 24.75 $ 22.55 $ 21.00 Close (1)$ 24.80 $ 25.85 $ 25.50 $ 26.03 $ 23.00 Common shares outstanding (1) 7,553,113 7,542,758 7,532,641 7,926,610 7,946,658 PERFORMANCE RATIOS Return on average total assets 1.04 % 0.92 % 0.96 % 0.91 % 0.91 % Return on average shareholders' equity 10.83 % 9.02 % 8.83 % 8.35 % 8.35 % Return on average tangible shareholders' equity 14.38 % 11.72 % 11.31 % 10.65 % 10.69 % Net interest margin yield (FTE) 3.16 % 2.86 % 2.86 % 2.85 % 2.79 % BALANCE SHEET DATA (1) Gross loans$ 1,271,910 $ 1,218,371 $ 1,301,037 $ 1,248,558 $ 1,206,663 AFS securities$ 557,590 $ 544,919 $ 490,601 $ 494,384 $ 448,454 Total assets$ 2,048,373 $ 2,060,933 $ 2,032,158 $ 2,082,701 $ 2,031,407 Deposits$ 1,759,866 $ 1,764,161 $ 1,710,339 $ 1,692,316 $ 1,636,506 Borrowed funds$ 86,450 $ 90,534 $ 99,320 $ 156,655 $ 161,395 Shareholders' equity$ 190,680 $ 195,842 $ 211,048 $ 221,642 $ 220,990 Gross loans to deposits 72.27 % 69.06 % 76.07 % 73.78 % 73.73 % ASSETS UNDER MANAGEMENT (1) Loans sold with servicing retained$ 273,294 $ 275,556
Assets managed by Isabella Wealth
Total assets under management
$ 2,776,202 $ 2,838,318
ASSET QUALITY (1) Non-performing receivables on gross receivables
0.05 % 0.06 % 0.10 % 0.25 % 0.28 % Nonperforming assets to total assets 0.05 % 0.05 % 0.08 % 0.18 % 0.19 % ALLL to gross loans 0.76 % 0.76 % 0.70 % 0.73 % 0.78 % CAPITAL RATIOS (1) Shareholders' equity to assets 9.31 % 9.50 % 10.39 % 10.64 % 10.88 % Tier 1 leverage 8.38 % 8.12 % 7.97 % 8.37 % 8.46 % Common equity tier 1 capital 12.44 % 12.83 % 12.07 % 13.07 % 13.81 % Tier 1 risk-based capital 12.44 % 12.83 % 12.07 % 13.07 % 13.81 % Total risk-based capital 15.33 % 15.84 % 14.94 % 16.03 % 17.00 % (1) At end of period 37
-------------------------------------------------------------------------------- Table of Contents The following table outlines our year-to-date results of operations and provides certain performance measures as of, and for the six-month periods ended: June 30 June 30 June 30 2022 2021 2020 INCOME STATEMENT DATA Interest income$ 30,864 $ 29,930 $ 32,070 Interest expense 2,458 4,016 7,764 Net interest income 28,406 25,914 24,306 Provision for loan losses 522 (492) 893 Noninterest income 7,142 6,847 6,244 Noninterest expenses 22,981 21,312 21,645 Federal income tax expense 2,016 1,922 761 Net income$ 10,029 $ 10,019 $ 7,251 PER SHARE Basic earnings$ 1.33 $ 1.26 $ 0.91 Diluted earnings$ 1.31 $ 1.24 $ 0.90 Dividends$ 0.54 $ 0.54 $ 0.54 Tangible book value$ 18.85 $ 21.73 $ 21.52 Quoted market value High$ 26.25 $ 23.90 $ 24.50 Low$ 23.00 $ 19.45 $ 15.60 Close (1)$ 24.80 $ 23.00 $ 18.25 Common shares outstanding (1) 7,553,113 7,946,658 7,977,019 PERFORMANCE RATIOS Return on average total assets 0.98 % 1.00 % 0.78 % Return on average shareholders' equity 9.89 % 9.06 % 6.67 % Return on average tangible shareholders' equity 13.00 % 11.61 % 4.30 % Net interest margin yield (FTE) 3.01 % 2.88 % 2.95 % BALANCE SHEET DATA (1) Gross loans$ 1,271,910 $ 1,206,663 $ 1,284,385 AFS securities$ 557,590 $ 448,454 $ 380,414 Total assets$ 2,048,373 $ 2,031,407 $ 1,913,227 Deposits$ 1,759,866 $ 1,636,506 $ 1,440,678 Borrowed funds$ 86,450 $ 161,395 $ 236,268 Shareholders' equity$ 190,680 $ 220,990 $ 219,991 Gross loans to deposits 72.27 % 73.73 % 89.15 % ASSETS UNDER MANAGEMENT (1) Loans sold with servicing retained$ 273,294 $ 290,033 $ 263,332 Assets managed by Isabella Wealth$ 454,535 $ 493,287 $ 395,214 Total assets under management$ 2,776,202 $ 2,814,727 $ 2,571,773 ASSET QUALITY (1) Nonperforming loans to gross loans 0.05 % 0.28 % 0.42 % Nonperforming assets to total assets 0.05 % 0.19 % 0.33 % ALLL to gross loans 0.76 % 0.78 % 0.69 % CAPITAL RATIOS (1) Shareholders' equity to assets 9.31 % 10.88 % 11.50 % Tier 1 leverage 8.38 % 8.46 % 8.86 % Common equity tier 1 capital 12.44 % 13.81 % 12.90 % Tier 1 risk-based capital 12.44 % 13.81 % 12.90 % Total risk-based capital 15.33 % 17.00 % 13.60 % (1) At end of period 38
-------------------------------------------------------------------------------- Table of Contents Average Balances, Interest Rates, and Net Interest Income The following schedules present the daily average amount outstanding for each major category of interest earning assets, non-earning assets, interest bearing liabilities, and noninterest bearing liabilities. These schedules also present an analysis of interest income and interest expense for the periods indicated. All interest income is reported on a FTE basis using a federal income tax rate of 21%. Loans in nonaccrual status, for the purpose of the following computations, are included in the average loan balances. FRB and FHLB restricted equity holdings are included in other interest earning assets. Three Months Ended June 30, 2022 March 31, 2022 June 30, 2021 Tax Average Tax Average Tax Average Average Equivalent Yield / Average Equivalent Yield / Average Equivalent Yield / Balance Interest Rate Balance Interest Rate Balance Interest Rate INTEREST EARNING ASSETS Loans$ 1,259,573 $ 13,179 4.19 %$ 1,235,788 $ 12,378 4.01 %$ 1,200,998 $ 12,504 4.16 % Taxable investment securities 475,010 2,027 1.71 % 421,503 1,615 1.53 % 281,245 1,140 1.62 % Nontaxable investment securities 109,367 975 3.57 % 101,604 920 3.62 % 122,514 1,117 3.65 % Fed funds sold 6 - 1.47 % 3 - 0.06 % 3 - 0.01 % Other 77,176 192 1.00 % 163,353 109 0.27 % 265,227 193 0.29 % Total earning assets 1,921,132 16,373 3.41 % 1,922,251 15,022 3.13 % 1,869,987 14,954 3.20 % NONEARNING ASSETS Allowance for loan losses (9,288) (9,128)
(9,326)
Cash and demand deposits due from banks 22,838 26,839
28,629
Premises and equipment 24,269 24,461
24,826
Accrued income and other assets 84,590 102,805
106,780
Total assets$ 2,043,541 $ 2,067,228 $ 2,020,896 INTEREST BEARING LIABILITIES Interest bearing demand deposits$ 375,123 $ 56 0.06 %$ 383,474 $ 50 0.05 %$ 330,586 $ 45 0.05 % Savings deposits 627,916 171 0.11 % 615,335 159 0.10 % 550,145 149 0.11 % Time deposits 274,284 627 0.91 % 290,146 727 1.00 % 347,155 1,250 1.44 % Federal funds purchased and repurchase agreements 46,029 8 0.07 % 49,058 9 0.07 % 52,239 11 0.08 % FHLB advances 10,000 47 1.88 % 14,889 72 1.93 % 84,725 389 1.84 % Subordinated debt, net of unamortized issuance costs 29,188 266 3.65 % 29,166 266 3.65 % 9,551 83 3.48 % Total interest bearing liabilities 1,362,540 1,175 0.34 % 1,382,068 1,283 0.37 % 1,374,401 1,927 0.56 % NONINTEREST BEARING LIABILITIES Demand deposits 470,139 458,343 412,600 Other 15,237 16,898 12,478 Shareholders' equity 195,625 209,919
221 417
Total liabilities and shareholders' equity$ 2,043,541 $ 2,067,228 $ 2,020,896 Net interest income (FTE)$ 15,198 $ 13,739 $ 13,027 Net yield on interest earning assets (FTE) 3.16 % 2.86 % 2.79 % 39
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Contents
Six Months Ended June 30, 2022 June 30, 2021 Tax Average Tax Average Average Equivalent Yield / Average Equivalent Yield / Balance Interest Rate Balance Interest Rate INTEREST EARNING ASSETS Loans$ 1,247,746 $ 25,557 4.10 %$ 1,201,344 $ 25,601 4.26 % Taxable investment securities 448,405 3,642 1.62 % 236,099 2,305 1.95 % Nontaxable investment securities 105,507 1,895 3.59 % 127,157 2,311 3.63 % Fed funds sold 4 - 1.12 % 3 - 0.01 % Other 120,027 301 0.50 % 280,083 356 0.25 % Total earning assets 1,921,689 31,395 3.27 % 1,844,686 30,573 3.31 % NONEARNING ASSETS Allowance for loan losses (9,209) (9,574) Cash and demand deposits due from banks 24,827 28,787 Premises and equipment 24,364 24,987 Accrued income and other assets 93,648 109,898 Total assets$ 2,055,319 $ 1,998,784 INTEREST BEARING LIABILITIES Interest bearing demand deposits$ 379,275 $ 106 0.06 %$ 322,931 $ 122 0.08 % Savings deposits 621,661 330 0.11 % 540,776 298 0.11 % Time deposits 282,172 1,354 0.96 % 357,466 2,692 1.51 % Federal funds purchased and repurchase agreements 47,535 17 0.07 % 53,187 27 0.10 % FHLB advances 12,431 119 1.91 % 87,348 794 1.82 % Subordinated debt, net of unamortized issuance costs 29,177 532 3.65 % 4,665 83 3.56 % Total interest bearing liabilities 1,372,251 2,458 0.36 % 1,366,373 4,016 0.59 % NONINTEREST BEARING LIABILITIES Demand deposits 464,271 397,959 Other 16,061 13,311 Shareholders' equity 202,736 221,141 Total liabilities and shareholders' equity$ 2,055,319 $ 1,998,784 Net interest income (FTE)$ 28,937 $ 26,557 Net yield on interest earning assets (FTE) 3.01 %
2.88%
Net interest income is the amount by which interest income on earning assets exceeds the interest expense on interest bearing liabilities. Net interest income is influenced by changes in the balance and mix of assets and liabilities, as well as market interest rates. While we exert some control over these factors, FRB monetary policy and competition have a significant impact. For analytical purposes, net interest income is adjusted to an FTE basis by including the income tax savings from interest on tax exempt loans and nontaxable investment securities, thus making year to year comparisons more meaningful. 40 -------------------------------------------------------------------------------- Table of Contents Volume and Rate Variance Analysis The following table sets forth the effect of volume and rate changes on interest income and expense for the periods indicated. Changes in interest due to volume and rate were determined as follows:
Volume – change in volume multiplied by the rate of the previous period.
Rate of change of the ETP rate multiplied by the volume of the previous period.
The variation in interest due to both volume and rate was attributed to volume and rate variations in proportion to the relationship between the absolute dollar amounts of the variation of each.
Three Months Ended Three Months Ended
Semester completed
June 30, 2022 Compared to June 30, 2022 Compared to June
30, 2022 Compared to
March 31, 2022 June 30, 2021 June 30, 2021 Increase (Decrease) Due to Increase (Decrease) Due to
Increase (decrease) due to
Volume Rate Net Volume Rate Net Volume Rate Net Changes in interest income Loans$ 241 $ 560 $ 801 $ 613 $ 62 $ 675 $ 970 $ (1,014) $ (44) Taxable investment securities 217 195 412 824 63 887 1,779 (442) 1,337 Nontaxable investment securities 69 (14) 55 (118) (24) (142) (389) (27) (416) Other (83) 166 83 (212) 211 (1) (277) 222 (55) Total changes in interest income 444 907 1,351 1,107 312 1,419 2,083 (1,261) 822 Changes in interest expense Interest bearing demand deposits (1) 7 6 6 5 11 19 (35) (16) Savings deposits 3 9 12 21 1 22 43 (11) 32 Time deposits (38) (62) (100) (227) (396) (623) (491) (847) (1,338) Federal funds purchased and repurchase agreements (1) - (1) (1) (2) (3) (3) (7) (10) FHLB advances (23) (2) (25) (351) 9 (342) (715) 40 (675) Subordinated debt, net of unamortized issuance costs - - - 179 4 183 447 2 449 Total changes in interest expense (60) (48) (108) (373) (379) (752) (700) (858) (1,558) Net change in interest margin (FTE)$ 504 $ 955 $ 1,459 $ 1,480 $ 691 $ 2,171 $ 2,783 $ (403) $ 2,380 The interest rate increases during 2022 has alleviated some of the pressure placed on our net interest margin. Additionally, SBA PPP fee income has supported our yield on total earning assets over the past two years. The recent rate increases, and future rate increases expected during the remainder of the year, should lead to continued improvement in our net yield on interest earning assets.
Average yield/rate for the three-month periods ended:
June 30 March 31 December 31 September 30 June 30 2022 2022 2021 2021 2021 Total earning assets 3.41 % 3.13 % 3.19 % 3.23 % 3.20 % Total interest bearing liabilities 0.34 % 0.37 % 0.45 % 0.52 % 0.56 % Net yield on interest earning assets (FTE) 3.16 % 2.86 % 2.86 % 2.85 % 2.79 % Quarter to Date Net Interest Income (FTE) June 30 March 31 December 31 September 30 June 30 2022 2022 2021 2021 2021 Total interest income (FTE)$ 16,373 $ 15,022 $ 15,246 $ 15,452 $ 14,954 Total interest expense 1,175 1,283 1,567 1,829 1,927 Net interest income (FTE)$ 15,198 $ 13,739 $ 13,679 $ 13,623 $ 13,027 41
-------------------------------------------------------------------------------- Table of Contents Allowance for Loan and Lease Losses The viability of any financial institution is ultimately determined by its management of credit risk. Loans represent our single largest concentration of risk. The ALLL is our estimation of incurred losses within the existing loan portfolio. We allocate the ALLL throughout the loan portfolio based on our assessment of the underlying risks associated within each loan segment. Our assessments include allocations based on specific impairment valuation allowances, historical charge-offs, internally assigned credit risk ratings, and past due and nonaccrual balances. A portion of the ALLL is not allocated to any one loan segment, but is instead a representation of other qualitative risks that reflect the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
The following table summarizes our charges, recoveries, loan loss provisions and ALLL balances from and for:
Three Months Ended Six Months Ended June 30 June 30 2022 2021 2022 2021 ALLL at beginning of period$ 9,204 $ 9,271 $ 9,103 $ 9,744 Charge-offs Commercial 3 - 3 31 Agricultural - - - - Residential real estate - - - - Consumer 103 53 194 181 Total charge-offs 106 53 197 212 Recoveries Commercial 26 17 40 99 Agricultural 1 3 3 5 Residential real estate 42 48 70 103 Consumer 48 43 159 113 Total recoveries 117 111 272 320 Net loan charge-offs (recoveries) (11) (58) (75) (108) Provision for loan losses 485 31 522 (492) ALLL at end of period$ 9,700 $ 9,360 $ 9,700 $ 9,360 Net loan charge-offs (recoveries) to average loans outstanding 0.00 % 0.00 % (0.01) % (0.01) %
The following table summarizes our write-offs, recoveries, provisions for loan losses and ALLL balances as of and for the three-month periods ended:
June 30 March 31 December 31 September 30 June 30 2022 2022 2021 2021 2021 Total charge-offs$ 106 $ 91 $ 149 $ 246 $ 53 Total recoveries 117 155 78 86 111 Net loan charge-offs (recoveries) (11) (64) 71 160 (58) Net loan charge-offs (recoveries) to average loans outstanding 0.00 % (0.01) % 0.01 % 0.01 % 0.00 % Provision for loan losses$ 485 $ 37
Allowance for loan losses relative to average outstanding loans
0.04 % 0.00 % 0.01 % (0.01) % 0.00 % ALLL$ 9,700 $ 9,204
ALLL as % of loans at end of period
0.76 % 0.76 % 0.70 % 0.73 % 0.78 %
ALLL as % of outstanding loans 1,796.30% 1,232.13%
731.16 % 295.52 % 281.17 % During 2020, we increased the ALLL as a result of increased economic and environmental related risk factors, primarily driven by COVID-19. While these risk factors remain, improvement in credit quality indicators resulted in a reduction to the ALLL during the first quarter of 2021. While we have experienced fluctuations in credit quality indicators in recent periods, credit quality remained strong atJune 30, 2022 . Despite strong credit quality, the ALLL increased during the second quarter of 2022 as a result of loan growth during the quarter and increased economic and environmental related risk factors. 42 -------------------------------------------------------------------------------- Table of Contents The following table illustrates the two main components of the ALLL as of: June 30 March 31 December 31 September 30 June 30 2022 2022 2021 2021 2021 ALLL Individually evaluated for impairment$ 515 $ 573 $ 578 $ 583 $ 1,201 Collectively evaluated for impairment 9,185 8,631 8,525 8,510 8,159 Total$ 9,700 $ 9,204 $ 9,103 $ 9,093 $ 9,360 ALLL to gross loans Individually evaluated for impairment 0.04 % 0.05 % 0.04 % 0.05 % 0.10 % Collectively evaluated for impairment 0.72 % 0.71 % 0.66 % 0.68 % 0.68 % Total 0.76 % 0.76 % 0.70 % 0.73 % 0.78 % While we utilize our best judgment and information available, the ultimate adequacy of the ALLL is dependent upon a variety of factors beyond our control, including the performance of our borrowers, the economy, and changes in interest rates. We closely monitor overall credit quality indicators and our policies and procedures related to the analysis of the ALLL to ensure that the ALLL remains at an appropriate level.
For further details on the breakdown of ALLL, see “Note 4 – Loans and ALLL” to our condensed interim consolidated financial statements.
Delinquent loans and loans in non-recognition status
Fluctuations in delinquent and unaccrued loans can have a significant impact on the ALLL. To determine the potential impact and corresponding estimated losses, we analyze our historical loss trends on loans more than 30 days past due and loans in non-recognition status for indications of further deterioration.
Total Past Due and Nonaccrual Loans June 30 March 31 December 31 September 30 June 30 2022 2022 2021 2021 2021 Commercial$ 432 $ 412 $ 561 $ 345 $ 513 Agricultural 271 283 987 2,860 3,014 Residential real estate 345 1,560 2,287 268 277 Consumer 457 109 196 25 109 Total$ 1,505 $ 2,364
Total past due and unexpired loans to gross loans
0.12 % 0.19 % 0.31 % 0.28 % 0.32 % Loans past due and in nonaccrual status continued to decline during the second quarter of 2022 as a result of increased credit quality. A summary of loans past due and in nonaccrual status, including the composition of the ending balance of nonaccrual status loans by type, is included in "Note 4 - Loans and ALLL" of our interim condensed consolidated financial statements. 43 -------------------------------------------------------------------------------- Table of Contents Troubled Debt Restructurings We have taken a proactive approach modifying loans to assist borrowers who are willing to work with us, thus making them less likely to default, and to avoid foreclosure. This approach has permitted certain borrowers to develop a payment structure that will allow them to continue making payments in lieu of foreclosure. Modifications have been successful for us and our customers as very few of the modified loans have resulted in foreclosures. The majority of modifications result in terms that satisfy our criteria for continued interest accrual. TDRs that have been placed in nonaccrual status may be placed back on accrual status after six months of continued performance and achievement of current payment status. We restructure debt with borrowers who, due to financial difficulties, are unable to service their debt under the original terms. We may extend the amortization period, reduce interest rates, allow temporary interest-only payment structures, forgive principal, forgive interest, or grant a combination of these modifications. Typically, the modifications are for a period of three years or less. Losses associated with TDRs, if any, are included in the estimation of the ALLL during the quarter in which a loan is identified as a TDR, and we review the analysis of the ALLL estimation each reporting period thereafter to ensure its continued appropriateness.
The following tables provide TDR roll-forwards for:
Three months completed
Accruing Interest Nonaccrual Total Number Number Number of of of Loans Balance Loans Balance Loans Balance April 1, 2022 95$ 22,335 6$ 410 101$ 22,745 New modifications - - - - - - Principal advances (payments) - 61 - (19) - 42 Loans paid off (6) (393) - - (6) (393) June 30, 2022 89$ 22,003 6$ 391 95$ 22,394 Six Months Ended June 30, 2022 Accruing Interest Nonaccrual Total Number Number Number of of of Loans Balance Loans Balance Loans Balance January 1, 2022 98$ 25,276 6$ 449 104$ 25,725 New modifications 1 98 - - 1 98 Principal advances (payments) - (1,675) - (58) - (1,733) Loans paid off (10) (1,696) - - (10) (1,696) June 30, 2022 89$ 22,003 6$ 391 95$ 22,394 44
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Table of Contents Three Months Ended June 30, 2021 Accruing Interest Nonaccrual Total Number Number Number of of of Loans Balance Loans Balance Loans Balance April 1, 2021 113$ 28,947 7$ 2,568 120$ 31,515 New modifications 2 109 - - 2 109 Principal advances (payments) - 222 - (45) - 177 Loans paid off (13) (2,454) - - (13) (2,454) Transfers to nonaccrual status (1) (39) 1 39 - - June 30, 2021 101 26,785 8$ 2,562 109$ 29,347 Six Months Ended June 30, 2021 Accruing Interest Nonaccrual Total Number Number Number of of of Loans Balance Loans Balance Loans Balance January 1, 2021 108$ 22,200 7$ 2,730 115$ 24,930 New modifications 11 8,473 - - 11 8,473 Principal advances (payments) - (838) - (207) - (1,045) Loans paid off (17) (3,011) - - (17) (3,011) Transfers to nonaccrual status (1) (39) 1 39 - - June 30, 2021 101$ 26,785 8$ 2,562 109$ 29,347
The following table summarizes our ToRs as of:
June 30, 2022 December 31, 2021 Accruing Accruing Total Interest Nonaccrual Total Interest Nonaccrual Total Change Current$ 21,905 $ 258 $ 22,163 $ 25,236 $ 294 $ 25,530 $ (3,367) Past due 30-59 days - 41 41 40 85 125 (84) Past due 60-89 days - - - - - - - Past due 90 days or more 98 92 190 - 70 70 120 Total$ 22,003 $ 391 $ 22,394 $ 25,276 $ 449 $ 25,725 $ (3,331)
Additional information on TDRs is included in “Note 4 – Loans and ALLL” to our condensed interim consolidated financial statements.
45 -------------------------------------------------------------------------------- Table of Contents Impaired Loans The following is a summary of information pertaining to impaired loans as of: June 30, 2022 December 31, 2021 Unpaid Unpaid Recorded Principal Valuation Recorded Principal Valuation Balance Balance Allowance Balance Balance Allowance TDRs Commercial real estate$ 5,420 $ 5,673 $ 19 $ 5,707 $ 5,961 $ 9 Commercial other 3,042 3,042 8 3,246 3,246 4 Agricultural real estate 8,665 8,665 - 9,182 9,181 - Agricultural other 2,692 2,692 - 4,543 4,543 - Residential real estate senior liens 2,575 2,712 421 3,047 3,203 504 Total TDRs 22,394 22,784 448 25,725 26,134 517 Other impaired loans Commercial real estate 169 231 - 314 377 - Agricultural real estate - - - 356 357 - Agricultural other - - - 108 108 - Residential real estate senior liens 419 554 67 370 485 61 Home equity lines of credit - - - 37 37 - Total other impaired loans 588 785 67 1,185 1,364 61 Total impaired loans$ 22,982 $ 23,569 $ 515 $ 26,910 $ 27,498 $ 578 We continue to devote considerable attention to identifying impaired loans and adjusting the net carrying value of these loans to their current net realizable values through the establishment of a specific reserve or the recognition of a charge-off.
Additional information relating to impaired loans is included in “Note 4 – Loans and ALLL” to our condensed interim consolidated financial statements.
46 -------------------------------------------------------------------------------- Table of Contents Nonperforming Assets
The following table summarizes our non-performing assets as of:
June 30 March 31
2022 2022 2021 2021 2021 Nonaccrual status loans$ 540 $ 747 $ 1,245 $ 3,077 $ 3,329 Accruing loans past due 90 days or more 119 - 97 - - Total nonperforming loans 659 747 1,342 3,077 3,329 Foreclosed assets 241 187 211 348 365 Debt securities 131 131 131 230 230 Total nonperforming assets$ 1,031 $ 1,065 $ 1,684 $ 3,655 $ 3,924 Nonperforming loans as a % of total loans 0.05 % 0.06 % 0.10 % 0.25 % 0.28 % Nonperforming assets as a % of total assets 0.05 % 0.05 % 0.08 % 0.18 % 0.19 % The accrual of interest on commercial and agricultural loans, as well as residential real estate loans, is discontinued at the time a loan is 90 days or more past due unless the credit is well-secured and in the process of short-term collection. Upon transferring a loan to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if a charge-off is necessary. Consumer loans are typically charged-off no later than 180 days past due. Loans may be placed back on accrual status after six months of continued performance and achievement of current payment status. The level of nonperforming loans continued to decline and remains low in comparison to peer banks.
The following table summarizes outstanding loans as at:
June 30 March 31 December 31 September 30 June 30 2022 2022 2021 2021 2021 Commercial$ 184 $ 319 $ 341 $ 161 $ 182 Agricultural 271 283 774 2,811 3,014 Residential real estate 85 145 130 105 133 Total$ 540 $ 747 $ 1,245 $ 3,077 $ 3,329 Nonaccrual loans as a % of loans at end of period 0.04 % 0.06 % 0.10 % 0.25 % 0.28 % Included in the nonaccrual loan balances above were loans currently classified as TDR as of: June 30 March 31 December 31 September 30 June 30 2022 2022 2021 2021 2021 Commercial$ 120 $ 127 $ 139 $ 146$ 159 Agricultural 271 283 310 2,347 2,362 Residential real estate - - - - 41 Total$ 391 $ 410 $ 449 $ 2,493 $ 2,562
Additional information on unrecognized loans is included in “Note 4 – Loans and ALLL” to our condensed interim consolidated financial statements.
47 -------------------------------------------------------------------------------- Table of Contents Noninterest Income and Noninterest Expenses
Significant non-interest revenue balances are highlighted in the following tables for:
Three months completed
Change 2022 2021 $ % Service charges and fees ATM and debit card fees$ 1,202 $ 1,127 $ 75 6.65 % Service charges and fees on deposit accounts 631 481 150 31.19 % Net OMSR income (loss) 213 (68) 281 N/M Freddie Mac servicing fee 167 181 (14) (7.73) % Other fees for customer services 71 109 (38) (34.86) % Total service charges and fees 2,284 1,830 454 24.81 % Wealth management fees 784 806 (22) (2.73) % Earnings on corporate owned life insurance policies 222 190 32 16.84 % Net gain on sale of mortgage loans 170 375 (205) (54.67) % All other 135 114 21 18.42 % Total noninterest income$ 3,595 $ 3,315 $ 280 8.45 % Six Months Ended June 30 Change 2022 2021 $ % Service charges and fees ATM and debit card fees$ 2,295 $ 2,126 $ 169 7.95 % Service charges and fees on deposit accounts 1,240 917 323 35.22 % Net OMSR income (loss) 477 (100) 577 N/M Freddie Mac servicing fee 338 395 (57) (14.43) % Other fees for customer services 143 187 (44) (23.53) % Total service charges and fees 4,493 3,525 968 27.46 % Wealth management fees 1,538 1,502 36 2.40 % Earnings on corporate owned life insurance policies 432 376 56 14.89 % Net gain on sale of mortgage loans 394 1,120 (726) (64.82) % All other 285 324 (39) (12.04) % Total noninterest income$ 7,142 $ 6,847 $ 295 4.31 % Service charges and fees on deposit accounts increased during the first six months of 2022, mainly due to an increase in the number of deposit accounts. Service charges and fees during the remainder of 2022 are expected to exceed 2021 levels. OMSR income results are driven, in part, by changes in offering rates on residential mortgage loans, anticipated prepayments in the servicing-retained portfolio, and the volume of loans within the servicing-retained portfolio. Decreased prepayment speeds, as a result of an increase in interest rates, was the primary driver of the income recognized during the first half of 2022. Income during the remainder of 2022 will be driven by the volume of loans originated within the servicing-retained portfolio, which could reduce gains driven by the rise in interest rates. The amount of loans sold is driven by customer demand and balance sheet management strategies. We experienced a significant increase in loan demand in early 2021 which led to an increase in the number and dollar amount of loans sold; as such, net gain on sale of mortgage loans increased significantly. In mid-2021, we decided to retain more loan originations on the balance sheet, due to our liquidity position, thereby decreasing the number of mortgage loans sold, which had an impact on the net gain on loans sold. As a result of this change in strategy, coupled with a decline in loan demand, net gain on sale of mortgage loans has declined in comparison to the prior year. As demand is expected to slow during the remainder of 2022, net gain on sale of mortgage loans is not expected to exceed 2021 levels.
Fluctuations in all other non-interest income are broken down into various categories, none of which are individually significant.
48
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Contents
Significant noninterest expense balances are highlighted in the following tables for the: Three Months Ended June 30 Change 2022 2021 $ % Compensation and benefits$ 6,037 $ 5,700 $ 337 5.91 % Furniture and equipment 1,442 1,327 115 8.67 % Occupancy 929 915 14 1.53 % Other Audit, consulting, and legal fees 605 452 153 33.85 % ATM and debit card fees 508 462 46 9.96 % Marketing costs 364 238 126 52.94 % Donations and community relations 139 108 31 28.70 % Memberships and subscriptions 207 217 (10) (4.61) % Loan underwriting fees 215 200 15 7.50 % Director fees 187 180 7 3.89 % FDIC insurance premiums 131 129 2 1.55 % All other 897 567 330 58.20 % Total other noninterest expenses 3,253 2,553 700 27.42 % Total noninterest expenses$ 11,661 $ 10,495 $ 1,166 11.11 % Six Months Ended June 30 Change 2022 2021 $ % Compensation and benefits$ 12,111 $ 11,577 $ 534 4.61 % Furniture and equipment 2,892 2,700 192 7.11 % Occupancy 1,895 1,860 35 1.88 % Other Audit, consulting, and legal fees 1,154 888 266 29.95 % ATM and debit card fees 942 879 63 7.17 % Marketing costs 603 447 156 34.90 % Donations and community relations 426 254 172 67.72 % Memberships and subscriptions 424 428 (4) (0.93) % Loan underwriting fees 397 390 7 1.79 % Director fees 388 339 49 14.45 % FDIC insurance premiums 256 360 (104) (28.89) % All other 1,493 1,190 303 25.46 % Total other noninterest expenses 6,083 5,175 908 17.55 % Total noninterest expenses$ 22,981 $ 21,312 $ 1,669 7.83 % Audit, consulting, and legal fees have increased as a result of legal and other professional services related expenses. While these expenses are not expected to continue to increase at this level, fees are anticipated to exceed 2021 levels for the remainder of 2022. Marketing expenses increased during the second quarter of 2022 as a result of the implementation of a new and enhanced online banking platform designed to increase customer experience. As such, marketing expenses are expected to exceed 2021 levels for the remainder of 2022. Donations and community relations increased during 2022 as a result of initiatives designed to deepen and strengthen our relationship with the communities in which we operate and serve, which includes an expanded footprint. While government restrictions and temporary business closures related to COVID-19 impacted our ability to maintain the level of support in early 2021, we have since increased the level of community support. 49 -------------------------------------------------------------------------------- Table of Contents The fluctuations in all other noninterest expenses are spread throughout various categories, none of which are individually significant.
Analysis of changes in the financial situation
June 30 December 31 % Change 2022 2021 $ Change (unannualized) ASSETS Cash and cash equivalents$ 82,017 $ 105,330 $ (23,313) (22.13) % AFS securities Amortized cost of AFS securities 586,297 485,710 100,587 20.71 % Unrealized gains (losses) on AFS securities (28,707) 4,891 (33,598) N/M AFS securities 557,590 490,601 66,989 13.65 % Mortgage loans AFS 906 1,735 (829) (47.78) % Loans Gross loans 1,271,910 1,301,037 (29,127) (2.24) % Less allowance for loan and lease losses 9,700 9,103 597 6.56 % Net loans 1,262,210 1,291,934 (29,724) (2.30) % Premises and equipment 24,169 24,419 (250) (1.02) % Corporate owned life insurance policies 32,552 32,472 80 0.25 % Equity securities without readily determinable fair values 15,095 17,383 (2,288) (13.16) % Goodwill and other intangible assets 48,294 48,302 (8) (0.02) % Accrued interest receivable and other assets 25,540 19,982 5,558 27.82 % TOTAL ASSETS$ 2,048,373 $ 2,032,158 $ 16,215 0.80 % LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities Deposits$ 1,759,866 $ 1,710,339 $ 49,527 2.90 % Borrowed funds 86,450 99,320 (12,870) (12.96) % Accrued interest payable and other liabilities 11,377 11,451 (74) (0.65) % Total liabilities 1,857,693 1,821,110 36,583 2.01 % Shareholders' equity 190,680 211,048 (20,368) (9.65) %
TOTAL LIABILITIES AND EQUITY
0.80 % As shown above, total assets increased$16,215 fromDecember 31, 2021 , driven primarily by an increase in AFS securities. Purchases of AFS securities were partially funded by a$49,527 increase in deposits. We experienced a$29,127 decrease in loans during the first six months of 2022 which was largely driven by a$34,710 decrease in advances to mortgage brokers, which are included within the commercial loan portfolio. 50 -------------------------------------------------------------------------------- Table of Contents The following table outlines the changes in loan balances: June 30 December 31 % Change 2022 2021 $ Change (unannualized) Commercial$ 772,567 $ 807,439 $ (34,872) (4.32) % Agricultural 94,726 93,955 771 0.82 % Residential real estate 329,795 326,361 3,434 1.05 % Consumer 74,822 73,282 1,540 2.10 % Total$ 1,271,910 $ 1,301,037 $ (29,127) (2.24) %
The following table displays loan balances at:
June 30 March 31 December 31 September 30 June 30 2022 2022 2021 2021 2021 Commercial$ 772,567 $ 727,614 $ 807,439 $ 757,993 $ 723,888 Agricultural 94,726 88,169 93,955 93,782 95,197 Residential real estate 329,795 328,559 326,361 321,620 312,567 Consumer 74,822 74,029 73,282 75,163 75,011 Total$ 1,271,910 $ 1,218,371 $ 1,301,037 $ 1,248,558 $ 1,206,663 Loan demand has been negatively impacted by the strong competition for new commercial loan opportunities while some customers hesitated to borrow due to the pandemic. Advances to mortgage brokers, within the commercial loan portfolio, was the driver behind the increase as ofDecember 31, 2021 , and the decline during the first quarter of 2022, as participation in this mortgage purchase program paused during most of 2021 and again in 2022. We've recently experienced an increase in commercial loan demand, despite changes in advances to mortgage brokers and continued forgiveness of the remaining SBA PPP loans. As demand is expected to continue, we anticipate growth in the commercial loan portfolio during the remainder of 2022. While Agricultural loans have increased, we may continue to experience fluctuations due to the competitive lending environment. Residential mortgage lending activities has slowed during the year as a result of rising interest rates. As interest rates are expected to continue to increase during the remainder in 2022, growth in residential and consumer loans is anticipated to continue but at a slower pace.
The following table shows the changes in deposit balances:
June 30 December 31 % Change 2022 2021 $ Change (unannualized)
Sight deposits not bearing interest
$ 39,758 8.87 % Interest bearing demand deposits 370,284 364,563 5,721 1.57 % Savings deposits 635,397 596,662 38,735 6.49 % Certificates of deposit 265,477 297,696 (32,219) (10.82) % Internet certificates of deposit 598 3,066 (2,468) (80.50) % Total$ 1,759,866 $ 1,710,339 $ 49,527 2.90 %
The following table shows the deposit balances as of:
June 30 March 31 December 31 September 30 June 30 2022 2022 2021 2021 2021 Noninterest bearing demand deposits$ 488,110 $ 461,473 $
448 352
Interest-bearing sight deposits
370,284 387,187 364,563 374,137 326,971 Savings deposits 635,397 635,195 596,662 572,136 549,134 Certificates of deposit 265,477 279,708 297,696 312,027 326,214 Internet certificates of deposit 598 598 3,066 3,066 5,777 Total$ 1,759,866 $ 1,764,161 $ 1,710,339 $ 1,692,316 $ 1,636,506 Total deposits have increased over the past 12 months with significant growth in non-contractual deposits, such as demand and savings deposits. We experienced a decline in certificates of deposit over the past year as a result of the low interest rate environment with customers moving their funds into demand and savings accounts. Over the last few years, we used excess funds to reduce higher-cost deposits, such as brokered certificates of deposit. 51 -------------------------------------------------------------------------------- Table of Contents The primary objective of our investing activities is to provide for safety of the principal invested. Secondary considerations include providing earnings and liquidity while managing our overall exposure to changes in interest rates. Over the last two years, the flat yield curve encouraged the use of excess funds to reduce higher-cost borrowings as opposed to investing in AFS securities. However, based on balance sheet strategies, excess funds above what is required to retire future maturities of higher-cost funding sources was prudently deployed to purchase AFS securities in future periods.
The following table shows the fair values of AFS securities at:
June 30 March 31 December 31 September 30 June 30 2022 2022 2021 2021 2021 U.S. Treasury$ 214,474 $ 218,268 $
209 703
States and political subdivisions 119,649
114,015 121,205 128,689 130,960 Auction rate money market preferred 2,497 2,867 3,242 3,246 3,260 Mortgage-backed securities 45,796 49,578 56,148 62,030 68,155 Collateralized mortgage obligations 167,572 152,441 92,301 100,767 109,294 Corporate 7,602 7,750 8,002 7,583 4,192 Total$ 557,590 $ 544,919 $ 490,601 $ 494,384 $ 448,454 Borrowed funds include FHLB advances, securities sold under agreements to repurchase, subordinated debt, and federal funds purchased. The balance of borrowed funds fluctuates from period to period based on our funding needs that arise from changes in loans, investments, and deposits. To provide balance sheet growth, we may utilize borrowings and brokered deposits to fund earning assets. The following table displays borrowed funds balances as of: June 30 March 31 December 31 September 30 June 30 2022 2022 2021 2021 2021 Securities sold under agreements to repurchase without stated maturity dates$ 47,247 $ 51,353
Advances from the FHLB
10,000 10,000 20,000 60,000 70,000 Fixed rate at 3.25% to floating, due 2031 29,203 29,181 29,158 29,136 29,121 Total$ 86,450 $ 90,534 $ 99,320 $ 156,655 $ 161,395 Over the last few years, we used excess funds to reduce FHLB advances. OnJune 2, 2021 , we completed a private placement of$30,000 in aggregate principal amount of 3.25% Fixed-to-Floating Rate Subordinated Notes due 2031 (the "Notes"). The Notes will initially bear a fixed interest rate of 3.25% untilJune 15, 2026 , after which time until maturity onJune 15, 2031 , the interest rate will reset quarterly to an annual floating rate equal to the then-current 3-month SOFR plus 256 basis points. The Notes are redeemable by us at our option, in whole or in part, on or afterJune 15, 2026 . The Notes are not subject to redemption at the option of the holders.
Contractual obligations and loan commitments
We have various financial obligations, including contractual obligations and commitments related to deposits and borrowings, which may require future cash payments. We also have loan related commitments that may impact liquidity. The commitments include unused lines of credit, commercial and standby letters of credit, and commitments to grant loans. These commitments to grant loans include residential mortgage loans with the majority committed to be sold to the secondary market. Many of these commitments historically have expired without being drawn upon and do not necessarily represent our future cash requirements. We are party to credit related financial instruments with off-balance-sheet risk. These financial instruments are entered into in the normal course of business to meet the financing needs of our customers. These financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The contractual or notional amounts of these instruments reflect the extent of involvement we have in a particular class of financial instrument. Our exposure to credit-related loss in the event of nonperformance by the counterparties to the financial instruments for commitments to extend credit and standby letters of credit could be up to the contractual notional amount of those instruments. We use the same credit policies when analyzing the creditworthiness of counterparties as we do for extending loans to customers. No significant losses are anticipated as a result of these commitments. 52 -------------------------------------------------------------------------------- Table of Contents Capital Capital consists solely of common stock, retained earnings, and accumulated other comprehensive income (loss). We are authorized to raise capital through dividend reinvestment, employee and director stock purchases, and shareholder stock purchases. Pursuant to these authorizations, we issued 36,238 shares or$907 of common stock during the first six months of 2022, as compared to 36,891 shares or$806 of common stock during the same period in 2021. We also offer the Directors Plan in which participants purchase stock units through deferred fees, in lieu of cash payments. Pursuant to this plan, we increased shareholders' equity by$249 and$256 during the six-month periods endedJune 30, 2022 and 2021, respectively. We also grant restricted stock awards pursuant to the RSP. Pursuant to this plan, we increased shareholders' equity by$77 during the first six months of 2022, as compared to$25 during the same period in 2021. We have publicly announced a common stock repurchase plan. Pursuant to this plan, we repurchased 15,766 shares or$397 of common stock during the first six months of 2022 and 87,480 shares or$1,860 during the first six months of 2021. As ofJune 30, 2022 , we were authorized to repurchase up to an additional 451,725 shares of common stock. The FRB has established minimum risk based capital guidelines. Pursuant to these guidelines, a framework has been established that assigns risk weights to each category of on and off-balance-sheet items to arrive at risk adjusted total assets. Regulatory capital is divided by the risk adjusted assets with the resulting ratio compared to the minimum standard to determine whether a corporation has adequate capital. The common equity tier 1 capital ratio has a minimum requirement of 4.50%. The minimum standard for primary, or Tier 1 capital is 6.00% and the minimum standard for total capital is 8.00%. The minimum requirements presented below include the minimum required capital levels based on theBasel III Capital Rules. Capital requirements to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. The following table sets forth these requirements and our ratios as of: June 30, 2022 December 31, 2021 Required to be Required to be Minimum Required Considered Well Minimum Required Considered Well Actual - BASEL III Capitalized Actual - BASEL III Capitalized Common equity tier 1 capital 12.44 % 7.00 % 6.50 % 12.07 % 7.00 % 6.50 % Tier 1 capital 12.44 % 8.50 % 8.00 % 12.07 % 8.50 % 8.00 % Total capital 15.33 % 10.50 % 10.00 % 14.94 % 10.50 % 10.00 % Tier 1 leverage 8.38 % 4.00 % 5.00 % 7.97 % 4.00 % 5.00 % Total capital includes Tier 1 capital and Tier 2 capital. Tier 2 capital includes a permissible portion of the allowances for loan and lease losses and subordinated debt, net of unamortized issuance costs. There are no significant regulatory constraints placed on our capital. AtJune 30, 2022 , the Bank also exceeded minimum capital requirements.
Liquidity
Liquidity is monitored regularly by our ALCO, made up of members of senior management. The committee reviews projected cash flows, key ratios and cash available from primary and secondary sources.
Our primary sources of liquidity are cash and cash equivalents and unencumbered AFS securities. These categories totaled$551,875 or 26.94% of assets as ofJune 30, 2022 , compared to$495,169 or 24.37% as ofDecember 31, 2021 . The increase in the amount and percentage of primary liquidity is a direct result of an increase in market deposits, an increase in unencumbered AFS securities from purchases during the first half of 2022, and a deliberate reduction in non-market funding which required collateralization. Liquidity is important for financial institutions because of their need to meet loan funding commitments, depositor withdrawal requests, and various other commitments including expansion of operations, investment opportunities, and payment of cash dividends. Based on these same factors, daily liquidity could vary significantly. Deposit accounts are our primary source of funds. Our secondary sources include the ability to borrow from the FHLB, from the FRB, and through various correspondent banks in the form of federal funds purchased and a line of credit. These funding methods typically carry a higher interest rate than traditional market deposit accounts. In recent periods, we have elected to use excess funds to reduce borrowings and other higher-cost funding sources. Some borrowed funds, including FHLB advances, FRB Discount Window advances, and repurchase agreements, require us to pledge assets, typically in the form of AFS securities or loans, as collateral. As ofJune 30, 2022 , we had available lines of credit of$328,182 . 53 -------------------------------------------------------------------------------- Table of Contents Our stress testing of liquidity increased since early 2020 and continues to evolve due to economic uncertainly as a result of COVID-19. Our liquidity position remained strong atJune 30, 2022 , which is illustrated in the following table:June 30 2022 Total cash and cash equivalents$ 82,017 Available lines of credit Fed funds lines with correspondent banks 93,000 FHLB borrowings 225,244 FRB Discount Window 4,938 Other lines of credit 5,000 Total available lines of credit 328,182
Loanable value unencumbered by FRB collateral, estimated1 340,000 Total cash and liquid assets
$ 750,199
(1) Includes the estimated unencumbered loanable value of the FHLB collateral of
The following table summarizes our sources and uses of cash for the six-month period ended
2022 2021 $ Variance Net cash provided by (used in) operating activities$ 14,780 $ 15,861 $ (1,081) Net cash provided by (used in) investing activities (70,681) (81,218) 10,537 Net cash provided by (used in) financing activities 32,588 66,906 (34,318) Increase (decrease) in cash and cash equivalents (23,313) 1,549 (24,862) Cash and cash equivalents January 1 105,330 246,640 (141,310) Cash and cash equivalents June 30$ 82,017 $ 248,189 $ (166,172) Fair Value We utilize fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. AFS securities, cash flow hedge derivative instruments and certain liabilities are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other assets on a nonrecurring basis, such as mortgage loans AFS, impaired loans, goodwill, foreclosed assets, OMSR, and certain other assets and liabilities. These nonrecurring fair value adjustments typically involve the application of lower of cost or market accounting or write downs of individual assets.
For more information regarding fair value measurements, see “Note 11 – Fair value” to our condensed interim consolidated financial statements.
Market risk
Our primary market risks are interest rate risk and liquidity risk. IRR is the exposure of our net interest income to changes in interest rates. IRR results from the difference in the maturity or repricing frequency of a financial institution's interest earning assets and its interest bearing liabilities. Managing IRR is the fundamental method by which financial institutions earn income and create shareholder value. Excessive exposure to IRR could pose a significant risk to our earnings and capital. The FRB has adopted a policy requiring banks to effectively manage the various risks that can have a material impact on safety and soundness. The risks include credit, interest rate, liquidity, operational, and reputational. We have policies, procedures, and internal controls for measuring and managing these risks. Specifically, our ALCO policy and procedures include defining acceptable types and terms of investments and funding sources, liquidity requirements, limits on investments in long-term assets, limiting the mismatch in repricing opportunities of assets and liabilities, and the frequency of measuring and reporting to our Board of Directors. The primary technique to measure IRR is simulation analysis. Simulation analysis forecasts the effects on the balance sheet structure and net interest income under a variety of scenarios that incorporate changes in interest rates, the shape of yield curves, interest rate relationships, loan prepayments, and funding sources. These forecasts are compared against net interest income projected in a stable interest rate environment. While many assets and liabilities reprice either at maturity or in accordance with their contractual terms, several balance sheet components demonstrate characteristics that require an evaluation to more accurately reflect their repricing behavior. Key assumptions in the simulation analysis include prepayments on loans, 54
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Table of Contents probable calls of investment securities, changes in market conditions, loan volumes and loan pricing, deposit sensitivity, and customer preferences. These assumptions are inherently uncertain as they are subject to fluctuation and revision in a dynamic rate environment. As a result, the simulation analysis cannot precisely forecast the impact of rising and falling interest rates on net interest income. Actual results will differ from simulated results due to many other factors, including changes in balance sheet components, interest rate changes, changes in market conditions, and management strategies. We regularly monitor our projected net interest income sensitivity to ensure that it remains within established limits. Gap analysis, the secondary method to measure IRR, measures the cash flows and/or the earliest repricing of our interest bearing assets and liabilities. This analysis is useful for measuring trends in the repricing characteristics of the balance sheet. Significant assumptions are required in this process because of the embedded repricing options contained in assets and liabilities. Residential real estate and consumer loans allow the borrower to repay the balance prior to maturity without penalty, while commercial and agricultural loans may have prepayment penalties. The amount of prepayments is dependent upon many factors, including the interest rate of a given loan in comparison to the current offering rates, the level of home sales, and the overall availability of credit in the market place. Generally, a decrease in interest rates will result in an increase in cash flows from these assets. A significant portion of our securities are callable or have prepayment options. The call and prepayment options are more likely to be exercised in a period of decreasing interest rates. Savings and demand accounts may generally be withdrawn on request without prior notice. The timing of cash flows from these deposits is estimated based on historical experience. Certificates of deposit have penalties that discourage early withdrawals. We do not believe there has been a material change in the nature or categories of our primary market risk exposure, or the particular markets that present the primary risk of loss. We do not know of or expect there to be any material change in the general nature of our primary market risk exposure in the near term, and we do not expect to make material changes to our market risk methods in the near term. We may change those methods in the future to adapt to changes in circumstances or to implement new techniques. Our primary market risk exposures related to the COVID-19 pandemic remain uncertain. A review of our market risk methods are ongoing and modeling is incorporating additional assumptions to account for this uncertainty related to this crisis. Repricing, cash flows, and prepayment projections for loans and mortgage-backed securities are not expected to behave as they would be expected to in a more stable interest rate environment. Customer deposit levels may experience unusual fluctuations due to government support programs, customer and business needs, and general money supply. We continue to closely monitor customer and economic indicators to develop more precise market risk assumptions as the economic impact of the crisis continues to reveal itself.
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