Cass Information Systems Inc: Form 10-Q for the period ended Jun 30, 2024

Overview

Cass Information Systems, Inc. ("Cass" or the "Company") provides payment and information processing services to large manufacturing, distribution, and retail enterprises across the United States. The Company’s services include freight invoice rating, payment processing, auditing, and the generation of accounting and transportation information. Cass also processes and pays facility-related invoices, which include electricity and gas as well as waste and telecommunications expenses, and is a provider of telecom expense management solutions. Cass solutions include integrated payments, a B2B payment platform for clients that require an agile fintech partner. Additionally, the Company offers a church management software solution and an on-line platform to provide generosity services for faith-based and non-profit organizations. The Company’s bank subsidiary, Cass Commercial Bank (the “Bank”), supports the Company’s payment operations. The Bank also provides banking services to its target markets, which include privately held businesses in the St. Louis metropolitan area and restaurant franchises and faith-based ministries within the United States.

In general, Cass is compensated for its information processing services through service fees, transactional level payment services, and investment of account balances generated during the payment process. Both the number of transactions processed and the dollar volume processed are therefore key metrics followed by management. The Bank earns most of its revenue from net interest income.

Various factors will influence the Company’s revenue and profitability, such as changes in the general level of interest rates, which has a significant effect on net interest income; industry-wide factors, such as the willingness of large corporations to outsource key business functions, the general level of transportation costs, deregulation of energy costs, and consolidation of telecommunication providers; and economic factors that include the general level of economic activity, the ability to hire and retain qualified staff, and the growth and quality of the Bank’s loan portfolio. For a more detailed discussion of the Company’s revenue drivers and factors that impact the Company’s results of operation and financial condition generally, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s 2023 Form 10-K.

Recent Industry Developments

The transportation industry continues to experience a decline in overall freight rates caused by an ongoing freight recession. The freight recession adversely affects the number of freight transactions and dollar amount of invoices processed. Partially as a result, the Company's transportation invoice and dollar volumes declined 3.5% and 9.8%, respectively during the first six months of 2024 as compared to the same period in 2023. Transportation dollar volumes are key to the Company’s revenue as higher volumes generally lead to an increase in payment float, which generates interest income, as well as an increase in payments in advance of funding, which generates financial fees.

As a result of rising inflation, the Federal Reserve has increased the Federal Funds rate. The increase in the Federal Funds rate has contributed to a slight increase in the Company's net interest margin. Inflation has also had the impact of increasing operating expenses, such as compensation expense.

2024 Items of Note

Net interest income for the second quarter of 2024 decreased $84,000, or 0.5%, as compared to the same period in 2023. The decrease in net interest income was attributable to a decline in average interest-earning assets of $52.3 million, or 2.6%. The Company had fewer funds to invest due to the loss of approximately $100.0 million of balances in February 2024 as a result of a cyber attack experienced by large client in the Company's CassPay division. CassPay offers solutions such as integrated payments, a B2B payment platform for clients. The Company does not expect these payment volumes and related balances from this client to return.

Despite the decline in average accounts and drafts payable during the quarter, the Company’s liquidity position and balance sheet remains strong. The Company maintained average short-term investments of $265.3 million during the second quarter of 2024. In addition, all of the Company's investment securities are classified as available-for-sale and there were no outstanding borrowings at June 30, 2024.

Included in other operating expenses for the second quarter of 2024 are $2.1 million of reserves and other losses on outstanding receivables in addition to $1.3 million related to estimated late fees to be incurred on facility transactions. See Note 7, "Commitments and Contingencies" for further information on the reserves and other losses. The late fees were mostly driven by a check processing delay with our third-party vendor, the same client that incurred a cyber attack, as described above.

Also, on July 16, 2024, the Company approved an Amendment providing for the termination of its noncontributory defined-benefit pension plan. The Company expects to record one-time termination expenses of approximately $5.0 million through operating expense related to the plan termination. The expense related to the termination is expected to be incurred during the fourth quarter of 2024 and first quarter of 2025 as the plan liabilities are settled. The successful termination of the plan is expected to reduce run rate operating expense by approximately $1.0 million on an annual basis.

Results of Operations

The following paragraphs more fully discuss the results of operations and changes in financial condition for the three-month period ended June 30, 2024 (“second quarter of 2024”) compared to the three-month period ended June 30, 2023 (“second quarter of 2023”) and the six-month period ended June 30, 2024 ("first half of 2024") compared to the six-month period ended June 30, 2023 ("first half of 2023"). The following discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and related notes and with the statistical information and financial data appearing in this report, as well as in the Company’s 2023 Form 10-K. Results of operations for the three months ended June 30, 2024 are not necessarily indicative of the results to be attained for any other period.

Summary of Results

The following table summarizes the Company’s operating results:

(In thousands except per share data)

Second quarter of 2024 compared to second quarter of 2023:

The Company recorded net revenue of $48.6 million during the three-month period ended June 30, 2024, up 0.8% from the three-month period ended June 30, 2023, primarily driven by higher processing fees. Operating expense increased 8.8% primarily driven by $2.1 million of reserves and other losses on outstanding receivables in addition to $1.3 million related to estimated late fees to be incurred on facility transactions. Net income was $4.5 million and diluted EPS was $0.32 per share, decreases of 37.2% and 38.5% from the three-month period ended June 30, 2023, respectively.

The Company posted a 0.78% return on average assets and 8.01% return on average equity.

First half of 2024 compared to first half of 2023:

The Company recorded net revenue of $98.3 million during the first half of 2024, up 0.7% from the first half of June 30, 2023, primarily driven by higher processing fees. Operating expense increased 4.7% primarily driven by the same factors as described above comparing the second quarter of 2024 to the same period in 2023. Net income was $11.6 million and diluted EPS was $0.84 per share, decreases of 18.4% and 18.4% from the first half of June 30, 2023, respectively.

The Company posted a 1.00% return on average assets and 10.36% return on average equity.

Fee Revenue and Other Income

The Company’s fee revenue is derived mainly from transportation and facility processing and financial fees. As the Company provides its processing and payment services, it is compensated by service fees which are typically calculated on a per-item basis, discounts received for services provided to carriers and by the accounts and drafts payable balances generated in the payment process which can be used to generate interest income. Processing volumes, average payments in advance of funding, and fee revenue were as follows:

(In thousands)

1. Includes energy, telecom and environmental.

Second quarter of 2024 compared to second quarter of 2023:

Processing fee revenue increased $1.7 million, or 8.9%, primarily attributable to an increase in facility-related invoice volumes of 25.1%. The Company has experienced recent success in adding facility clients with high transaction volumes. Transportation invoice volumes decreased 3.4% over the same period. The decline in transportation volumes is largely due to the ongoing freight recession.

Financial fee revenue decreased $1.0 million, or 8.9%, primarily attributable to a decline in transportation dollar volumes of 6.5% in addition to changes in the manner certain vendors receive payments.

First half of 2024 compared to first half of 2023:

Processing fee revenue increased $3.5 million, or 8.9%, primarily attributable to an increase in facility-related invoice volumes of 24.0%. Transportation invoice volumes decreased 3.5% over the same period.

Financial fee revenue decreased $1.5 million, or 6.6%, primarily attributable to a decline in transportation dollar volumes of 9.8% in addition to changes in the manner certain vendors receive payments.

Net Interest Income

Net interest income is the difference between interest earned on loans, investments, and other earning assets and interest expense on deposits and other interest-bearing liabilities. Net interest income is a significant source of the Company’s revenues. The following table summarizes the changes in tax-equivalent net interest income and related factors:

(In thousands)

*Presented on a tax-equivalent basis assuming a tax rate of 21% for both 2024 and 2023.

Second quarter of 2024 compared to second quarter of 2023:

The decrease in net interest income is primarily due to the decrease in average earning assets of $52.3 million, or 2.6%, partially offset by an increase in the net interest margin to 3.32%, as compared to 3.25% in the same quarter last year. The yield on interest-earning assets increased 43 basis points from 3.98% to 4.41% while the cost of interest-bearing liabilities increased 46 basis points from 2.89% to 3.35%.

Average loans decreased $36.4 million, or 3.4%, to $1.04 billion. The decrease in average loans was primarily due to the Company opting to be more selective in booking new loans as a result of a decline in average deposits. The average yield on loans increased 44 basis points to 5.26%.

Average investment securities decreased $96.0 million, or 12.8%, to $653.7 million. The Company has not offset maturities and sales of investment securities with new purchase volume primarily due to the decline in average funding sources. The average yield on taxable investment securities increased 25 basis points to 2.88% and the average yield on tax-exempt investment securities increased 7 basis points to 2.75% driven by purchases of investment securities at current market interest rates and maturities and sales of securities at below market interest rates.

Average short-term investments, consisting of interest-bearing deposits in other financial institutions and federal funds sold, increased $80.1 million, or 43.2%, to $265.3 million. The increase is primarily a result of the sale and maturities of investment securities and the decline in average loans, partially offset by a decrease in average funding sources. The average yield on short-term investments increased 40 basis points to 4.95%, primarily due to higher average short-term interest rates when comparing the periods. The majority of these short-term investments are held at the Federal Reserve Bank.

The average balance of interest-bearing deposits increased $129.0 million, or 25.3%, to $638.3 million. Average non-interest-bearing demand deposits decreased $145.6 million, or 26.3%, to $407.1 million. The Company has experienced a migration of client funds from non-interest bearing to interest-bearing driven by the higher interest rate environment. The average rate paid on interest-bearing deposits increased 47 basis points to 3.35% due to higher average short-term interest rates when comparing the periods.

Average accounts and drafts payable decreased $52.3 million, or 5.0%, to $996.9 million. The decrease in average accounts and drafts payable was primarily reflective of a cyber event at a client, as described above, which decreased average balances approximately $100.0 million as well as the decrease in transportation dollar volumes of 6.5%, partially offset by an increase in facility dollar volume of 10.1%.

First half of 2024 compared to first half of 2023:

The decrease in net interest income is primarily due to the decrease in average earning assets of $75.5 million, or 3.6%, partially offset by the increase in the net interest margin to 3.29%, as compared to 3.24% in the prior year. The yield on interest-earning assets increased 43 basis points from 3.91% to 4.34% while the cost of interest-bearing liabilities increased 80 basis points from 2.52% to 3.32%.

Average loans decreased $48.2 million, or 4.5%, to $1.03 billion. The decrease in average loans was primarily due to the Company opting to be more selective in booking new loans as a result of a decline in average deposits. The average yield on loans increased 44 basis points to 5.16%.

Average investment securities decreased $96.1 million, or 12.5%, to $674.3 million. The average yield on taxable investment securities increased 20 basis points to 2.79% and the average yield on tax-exempt investment securities declined 3 basis points to 2.72%. The Company has not offset maturities and sales of investment securities with new purchase volume primarily due to the decline in average funding sources. The increase in the average yield on taxable investment securities was driven by purchases of investment securities at current market interest rates and maturities and sales of securities at below market interest rates.

Average short-term investments, consisting of interest-bearing deposits in other financial institutions and federal funds sold, increased $68.8 million, or 28.7%, to $308.7 million. The increase is primarily a result of the decline in average investment securities and loans, partially offset by a decrease in average funding sources. The average yield on short-term investments increased 64 basis points to 5.02%, primarily due to higher average short-term interest rates when comparing the periods. The majority of these short-term investments are held at the Federal Reserve Bank.

The average balance of interest-bearing deposits increased $85.0 million, or 15.5%, to $635.0 million. Average non-interest-bearing demand deposits decreased $125.7 million, or 22.7%, to $427.5 million. The Company has experienced a migration of client funds from non-interest bearing to interest-bearing driven by the higher interest rate environment. The average rate paid on interest-bearing deposits increased 82 basis points to 3.32% due to higher average short-term interest rates when comparing the periods.

Average accounts and drafts payable decreased $55.7 million, or 5.2%, to $1.02 billion. The decrease in average accounts and drafts payable was primarily reflective of a cyber event experienced by a client, as described above, which decreased average balances approximately $100.0 million as well as the decrease in transportation dollar volumes of 9.8%, partially offset by an increase in facility dollar volumes of 4.8%.

Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rate and Interest Differential

The following tables show the condensed average balance sheets for each of the periods reported, the tax-equivalent interest income and expense for each category of interest-earning assets and interest-bearing liabilities, and the average yield on such categories of interest-earning assets and the average rates paid on such categories of interest-bearing liabilities for each of the periods reported.

(In thousands)

1. Balances shown are daily averages.

2. Interest income on loans includes net loan fees of $146,000 and $291,000 for the second quarter of 2024 and 2023, respectively.

3. For purposes of these computations, yields on investment securities are computed as interest income divided by the average amortized cost of the investments.

4. Interest income is presented on a tax-equivalent basis assuming a tax rate of 21% for both 2024 and 2023. The tax-equivalent adjustment was approximately $239,000 and $263,000 for the second quarter of 2024 and 2023, respectively.

(In thousands)

1. Balances shown are daily averages.

2. Interest income on loans includes net loan fees of $229,000 and $511,000 for the six-month periods ended June 30, 2024 and 2023, respectively.

3. For purposes of these computations, yields on investment securities are computed as interest income divided by the average amortized cost of the investments.

4. Interest income is presented on a tax-equivalent basis assuming a tax rate of 21% for both the six-month periods ended June 30, 2024 and 2023. The tax-equivalent adjustment was approximately $483,000 and $584,000 for the six-month periods ended June 30, 2024 and 2023, respectively.

Analysis of Net Interest Income Changes

The following tables present the changes in interest income and expense between periods due to changes in volume and interest rates. That portion of the change in interest attributable to the combined rate/volume variance has been allocated to rate and volume changes in proportion to the absolute dollar amounts of the change in each.

(In thousands)

1. Interest income includes net loan fees.

2. Interest income is presented on a tax-equivalent basis assuming a tax rate of 21% for the three-month periods ended June 30, 2024 and 2023.

(In thousands)

1. Interest income includes net loan fees.

2. Interest income is presented on a tax-equivalent basis assuming a tax rate of 21% for the six-month periods ended June 30, 2024 and 2023.

Provision and Allowance for Credit Losses and Allowance for Unfunded Commitments

The Company recorded a provision for credit losses and off-balance sheet credit exposures of $400,000 for the second quarter of 2024 and release of credit losses of $120,000 in second quarter of 2023. The Company recorded a provision for credit losses and off-balance sheet credit exposures of $495,000 for the first half of 2024 and release of credit losses of $460,000 in first half of 2023.The amount of the provision for (release of) credit losses is derived from the Company’s quarterly Current Expected Credit Loss (“CECL”) model. The amount of the provision for (release of) credit losses will fluctuate as determined by these quarterly analyses. The provision for credit losses in the second quarter and first half of 2024 was driven by an increase in total loans of $47.7 million, or 4.7%, as compared to December 31, 2023.

The Company experienced no loan charge-offs in the second quarter of 2024 and 2023. The ACL was $13.6 million at June 30, 2024 and $13.1 million at December 31, 2023. The ACL represented 1.28% of outstanding loans at June 30, 2024 and 1.29% of outstanding loans at December 31, 2023. The allowance for unfunded commitments was $82,000 at June 30, 2024 and $132,000 at December 31, 2023. There were no nonperforming loans outstanding at June 30, 2024 and December 31, 2023.

The ACL has been established and is maintained to estimate the lifetime expected credit losses in the loan portfolio. An ongoing assessment is performed to determine if the balance is adequate. Charges or credits are made to expense based on changes in the economic forecast, qualitative risk factors, loan volume, and individual loans. For loans that are individually evaluated, the Company uses two impairment measurement methods: 1) the present value of expected future cash flows and 2) collateral value.

The Company also utilizes ratio analyses to evaluate the overall reasonableness of the ACL compared to its peers and required levels of regulatory capital. Federal and state regulatory agencies review the Company’s methodology for maintaining the ACL. These agencies may require the Company to adjust the ACL based on their judgments and interpretations about information available to them at the time of their examinations.

Summary of Credit Loss Experience

The following table presents information on the Company's provision for (release of) credit losses and analysis of the ACL:

(In thousands)

Operating Expenses

Total operating expenses for the second quarter of 2024 increased $3.5 million, or 8.8%, compared to the second quarter of 2023. Total operating expenses for the first half of 2024 increased $3.8 million, or 4.7%, compared to the first half of 2023.The following table details the components of operating expenses:

(In thousands)

Second quarter of 2024 compared to second quarter of 2023:

Personnel expenses increased $425,000, or 1.4%. Salaries and commissions increased $642,000, or 2.7%, primarily as a result of merit increases. Share-based compensation decreased $435,000, reflecting the Company's financial performance and the impact on performance-based restricted stock between the periods.

Equipment expense increased $239,000, or 13.7%, partially due to an increase in depreciation expense related to technology initiatives throughout our lines of business.

Other operating expenses increased $2.9 million, or 40.9%. Included in other operating expenses for the second quarter of 2024 are $2.1 million of reserves and other losses on outstanding receivables in addition to $1.3 million related to estimated late fees to be incurred on facility transactions. The late fees were mostly driven by a check processing delay with our third-party vendor, the same client that experienced a cyber attack, as described above.

First half of 2024 compared to first half of 2023:

Personnel expenses increased $1.0 million, or 1.7%. Salaries and commissions increased $2.0 million, or 4.4%, primarily as a result of merit increases. Share-based compensation decreased $1.2 million, reflecting the Company's financial performance and the impact on performance-based restricted stock between the periods.

Equipment expense increased $470,000, or 13.8%, partially due to an increase in depreciation expense related to technology initiatives throughout our lines of business.

Other operating expenses increased $2.4 million, or 16.1% for the same reasons as described for the quarterly variance above, partially offset by lower levels of outside service expense as technology initiatives are completed.

Financial Condition

Total assets at June 30, 2024 were $2.28 billion, a decrease of $196.0 million, or 7.9%, from December 31, 2023.

The Company experienced a decrease in cash and cash equivalents of $148.7 million, or 39.9%, during the first half of 2024. The change in cash and cash equivalents reflects the Company’s daily liquidity position and is primarily affected by changes in funding sources, mainly accounts and drafts payable and deposits, cash flows in and out of loans, investments securities and payments in advance of funding.

The investment securities portfolio decreased $86.3 million, or 13.8%, during the first half of 2024. The decrease is due to sales of $25.0 million and maturities of $103.6 million, partially offset by purchases of $47.0 million.

Loans increased $47.7 million, or 4.7%, from December 31, 2023. The Company experienced growth in its franchise restaurant and equipment finance loan portfolios during the first half of 2024.

Payments in advance of funding increased $15.7 million, or 7.9%. from December 31, 2023 due to timing of funding.

Accounts and drafts receivable from customers decreased $32.2 million, or 29.1%, from December 31, 2023. The decrease is solely due to timing of customer funding.

Total deposits at June 30, 2024 were $1.01 billion, a decrease of $128.5 million, or 11.3%, from December 31, 2023. The decrease is primarily due to timing as well as seasonal tax and compensation payments of Bank clients.

Accounts and drafts payable at June 30, 2024 were $996.8 million, a decrease of $74.5 million, or 7.0%, from December 31, 2023. The decrease in accounts and drafts payable was primarily reflective of a cyber event at a client which decreased average balances approximately $100.0 million. Accounts and drafts payable will fluctuate from period-end to period-end due to the payment processing cycle, which results in lower balances on days when payments clear and higher balances on days when payments are issued. For this reason, average balances are generally a more meaningful measure of accounts and drafts payable.

Total liabilities at June 30, 2024 were $2.05 billion, a decrease of $196.1 million, or 8.7%, from December 31, 2023, reflective of the decrease in deposits and accounts and drafts payable.

Total shareholders’ equity at June 30, 2024 was $229.9 million, a $116,000 increase from December 31, 2023. The increase in shareholders’ equity is a result of the first half of 2024 net income of $11.6 million, partially offset by dividends paid of $8.2 million, the repurchase of Company stock of $1.1 million, and an increase in accumulated other comprehensive loss of $2.2 million primarily related to the fair value of available-for-sale investment securities.

Liquidity and Capital Resources

The discipline of liquidity management as practiced by the Company seeks to ensure that funds are available to fulfill all payment obligations relating to invoices processed as they become due and meet depositor withdrawal requests and borrower credit demands while at the same time maximizing profitability. This is accomplished by balancing changes in demand for funds with changes in supply of funds. Primary liquidity to meet demand is provided by short-term liquid assets that can be converted to cash, maturing securities and the ability to obtain funds from external sources. The Company's Asset/Liability Committee has direct oversight responsibility for the Company's liquidity position and profile. Management considers both on-balance sheet and off-balance sheet items in its evaluation of liquidity.

The balance of liquid assets consists of cash and cash equivalents, which include cash and due from banks, interest-bearing deposits in other financial institutions, federal funds sold and money market funds. Cash and cash equivalents totaled $223.7 million at June 30, 2024, a decrease of $148.7 million, or 39.9%, from December 31, 2023. At June 30, 2024, these assets represented 9.8% of total assets and are the Company’s and its subsidiaries’ primary source of liquidity to meet future expected and unexpected loan demand, depositor withdrawals or reductions in accounts and drafts payable.

Secondary sources of liquidity include the investment portfolio and borrowing lines. Total investment securities were $540.8 million at June 30, 2024, a decrease of $86.3 million from December 31, 2023. These assets represented 23.7% of total assets at June 30, 2024. Of the total portfolio, 8.2% mature in one year, 24.1% mature in one to five years, and 67.7% mature in five or more years.

The Bank has unsecured lines of credit at six correspondent banks to purchase federal funds up to a maximum of $83.0 million in aggregate. As of June 30, 2024, the Bank also has secured lines of credit with the Federal Home Loan Bank of $193.1 million collateralized by mortgage loans. The Company also has secured lines of credit from three banks up to a maximum of $250.0 million in aggregate collateralized by investment securities. There were no amounts outstanding under any line of credit as of June 30, 2024 or December 31, 2023.

The deposits of the Company's banking subsidiary have historically been stable, consisting of a sizable volume of core deposits related to customers that utilize other commercial products of the Bank, including CassPay and faith-based customers. The accounts and drafts payable generated by the Company has also historically been a stable source of funds. The Company is part of the Certificate of Deposit Account Registry Service (“CDARS”) and Insured Cash Sweep (“ICS”) deposit placement programs. Time deposits include $49.0 million of CDARS deposits and interest-bearing demand deposits include $154.9 million of ICS deposits. These programs offer the Bank’s customers the ability to maximize Federal Deposit Insurance Corporation (“FDIC”) insurance coverage. The Company uses these programs to retain or attract deposits from existing customers.

Net cash flows provided by operating activities were $20.5 million for the six-month period ended June 30, 2024, compared to $17.0 million for the six-month period ended June 30, 2023, an increase of $3.5 million. Net cash flows from investing and financing activities fluctuate greatly as the Company actively manages its investment and loan portfolios and customer activity influences changes in deposit and accounts and drafts payable balances. Other causes for the changes in these account balances are discussed earlier in this report. Due to the daily fluctuations in these account balances, the analysis of changes in average balances, also discussed earlier in this report, can be more indicative of underlying activity than the period-end balances used in the statements of cash flows. Management anticipates that cash and cash equivalents, maturing investments and cash from operations will continue to be sufficient to fund the Company’s operations and capital expenditures in 2024, which are estimated to range from $10 million to $12 million.

Net income plus amortization of intangible assets, net amortization of premium/discount on investment securities and depreciation of premises and equipment was $16.3 million and $19.0 million for the six-month periods ended June 30, 2024 and 2023, respectively, a decrease of $2.6 million. The first half of 2024 reflected lower net income of $2.6 million and higher depreciation of $296,000, which was partially offset by a decrease in net amortization of premium/discount on investment securities of $305,000. The net amortization of premium/discount on investment securities is dependent on the type of securities purchased and changes in the prevailing market interest rate environment.

Other factors impacting the $3.5 million increase in net cash provided by operating activities include:

• An increase in other operating activities, net of $2.5 million, primarily due to changes in various other assets and liabilities;
• A smaller increase in accounts receivable of $2.2 million; and
• A change in the increase (decrease) of the current income tax liability of $1.6 million and
• A change in the provision for (release of) credit losses of $1.0 million primarily due to changes in loans outstanding during the respective periods.

These factors were partially offset by a decrease in stock compensation expense of $1.2 million.

The Company faces market risk to the extent that its net interest income and fair market value of equity are affected by changes in market interest rates. For information regarding the market risk of the Company’s financial instruments, see Item 3, “Quantitative and Qualitative Disclosures about Market Risk.”

There are several trends and uncertainties that may impact the Company’s ability to generate revenues and income at the levels that it has in the past. Those that could significantly impact the Company include the general levels of interest rates, business activity, inflation, and energy costs as well as new business opportunities available to the Company. For more detailed information on these trends and uncertainties and how they can generally affect the Company’s available liquidity, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity” in the Company’s 2023 Form 10-K.

As a bank holding company, the Company and the Bank are subject to capital requirements administered by state and federal banking agencies. Capital adequacy guidelines, and, for banks, prompt correct action regulations, involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are subject to qualitative judgments by regulators about components, risk weighting, and other factors. In addition, the calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations. For example, as allowed under the Basel III Capital Rules, the Company has elected to opt-out of the requirement to include most components of accumulated other comprehensive income in common equity Tier 1 capital. For more information on these regulatory requirements, including the Basel III Capital Rules and capital classifications, see Item 1, "Business-Supervision and Regulation" and Item 8, Note 2, "Financial Statements and Supplementary Data" of the Company's 2023 Form 10-K.

The Company and the Bank continue to exceed all regulatory capital requirements, as evidenced by the following capital amounts and ratios:

(In thousands)

Impact of New and Not Yet Adopted Accounting Pronouncements

In October 2023, the FASB issued 2023-06, Disclosure Improvements - Codification Amendments in Response to the SEC's Disclosure Update and Simplification Initiative ("ASU 2023-06"). This ASU amends the ASC to incorporate certain disclosure requirements from SEC Release No. 33-10532 - Disclosure Update and Simplification that was issued in 2018.

The effective date for each amendment will be the date on which the SEC's removal of that related disclosure from Regulation S-X or Regulation S-K becomes effective, with early adoption prohibited. ASU 2023-06 is not expected to have a significant impact on the Company's financial statements.

In November 2023, the FASB issued 2023-07, Segment Reporting (Topic 820): Improvements to Reportable Segment Disclosures ("ASU 2023-07"). This ASU expands segment disclosure requirements for public entities to require disclosure of significant segment expenses and other segment items on an annual and interim basis and to provide in interim periods all disclosures about a reportable segment's profit or loss and assets that are currently required annually. ASU 2023-07 is effective for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after

December 15, 2024. Early adoption is permitted. ASU 2023-07 is not expected to have a significant impact on the Company's financial statements.

In December 2023, the FASB issued 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures ("ASU 2023-09"). This ASU requires public business entities to disclose in their rate reconciliation table additional categories of information about federal, state, and foreign income taxes and to provide more details about the reconciling items in some categories if items meet a quantitative threshold. It also requires all entities to disclose income taxes paid, net of refunds, disaggregated by federal, state, and foreign taxes for annual periods and to disaggregate the information by jurisdiction based on a quantitative threshold, among other things. ASU 2023-09 is effective for annual periods beginning after December 15, 2024, though early adoption is permitted. ASU 2023-09 is not expected to have a significant impact on the Company's financial statements.

Critical Accounting Policies

The Company has prepared the consolidated financial statements in this report in accordance with the Financial Accounting Standards Board Accounting Standards Codification. In preparing the consolidated financial statements, management makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. These estimates have been generally accurate in the past, have been consistent and have not required any material changes. There can be no assurances that actual results will not differ from those estimates. The accounting policy that requires significant management estimates and is deemed critical to the Company’s results of operations or financial position has been discussed with the Audit and Risk Committee of the Board of Directors and is described below.

Allowance for Credit Losses. The Company performs periodic and systematic detailed reviews of its loan portfolio to determine management’s estimate of the lifetime expected credit losses. Although these estimates are based on established methodologies for determining allowance requirements, actual results can differ significantly from estimated results. These policies affect both segments of the Company. The impact and associated risks related to these policies on the Company’s business operations are discussed in the “Provision and Allowance for Credit Losses and Allowance for Unfunded Commitments” section of this report.

As described in the Company’s 2023 Form 10-K for the year ended December 31, 2023, the Company manages its interest rate risk through measurement techniques that include gap analysis and a simulation model. As part of the risk management process, asset/liability management policies are established and monitored by management.

The following table summarizes simulated changes in net interest income versus unchanged rates over the next 12 months as of June 30, 2024 and December 31, 2023.

The Company is generally asset sensitive as average interest-earning assets of $1.96 billion for the second quarter of 2024 greatly exceeded average interest-bearing liabilities of $638.3 million. The table above on the projected impact of interest rate shocks results from a static balance sheet at June 30, 2024.

The Company’s management, under the supervision and with the participation of the principal executive officer and the principal financial officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report and concluded that, as of such date, these controls and procedures were effective.

There were no changes in the second quarter of 2024 in the Company's internal control over financial reporting identified by the Company’s principal executive officer and principal financial officer in connection with their evaluation that materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended).

The Company has included in Part I, Item 1A of its 2023 Form 10-K, a description of certain risks and uncertainties that could affect the Company’s business, future performance or financial condition (the “Risk Factors”). There are no material changes to the Risk Factors as disclosed in the Company’s 2023 Form 10-K.