Farmers National Banc Corp: Form 10-Q for the period ended Mar 31, 2023

Cautionary Note Regarding Forward Looking Statements

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are not statements of historical fact, but rather statements based on the Company’s current expectations, beliefs and assumptions regarding the future of Farmers’ business, future plans and strategies, projections, anticipated events and trends, its intended results and future performance, the economy and other future conditions. Forward-looking statements are preceded by terms such as “will,” “would,” “should,” “could,” “may,” “expect,” “estimate,” “believe,” “anticipate,” “intend,” “plan,” “project,” or variations of these words, or similar expressions. Forward-looking statements are not a guarantee of future performance and actual future results could differ materially from those contained in forward-looking information. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Numerous uncertainties, risks, and changes could cause or contribute to Farmers’ actual results, performance, and achievements to be materially different from those expressed or implied by the forward-looking statements.

Factors that could cause or contribute to such differences include, without limitation, risks and uncertainties detailed from time to time in the Company’s filings with the Securities and Exchange Commission (the “Commission”), including without limitation, the risk factors disclosed in Item 1A, “Risk Factors,” in the Company’s 2022 Form 10-K, as updated in Item 1A, “Risk Factors,” in this Quarterly Report on Form 10-Q.

Many of these factors are beyond the Company’s ability to control or predict, and readers are cautioned not to put undue reliance on those forward-looking statements. The following, which is not intended to be an all-encompassing list, summarizes several factors that could cause the Company’s actual results to differ materially from those anticipated or expected in any forward-looking statement:

• general economic conditions in markets where the Company conducts business, which could materially impact credit quality trends;
• the length and extent of the economic impacts of the COVID-19 pandemic;
• actions by the Federal Reserve Board, U.S. Treasury and other government agencies, including those that impact money supply, market interest rates and inflation;
• disruptions in the mortgage and lending markets and significant or unexpected fluctuations in interest rates related to governmental responses to inflation, including financial stimulus packages and interest rate changes;
• general business conditions in the banking industry;
• the regulatory environment;
• general fluctuations in interest rates;
• demand for loans in the market areas where the Company conducts business;
• rapidly changing technology and evolving banking industry standards;
• competitive factors, including increased competition with regional and national financial institutions;
• Farmers' ability to attract, recruit and retain skilled employees; and
• new service and product offerings by competitors and price pressures.

Other factors not currently anticipated may also materially and adversely affect the Company’s results of operations, cash flows and financial position. There can be no assurance that future results will meet expectations. While the Company believes that the forward-looking statements in the presentation are reasonable, you should not place undue reliance on any forward-looking statement. In addition, these statements speak only as of the date made. The Company does not undertake, and expressly disclaims, any obligation to update or alter any statements whether as a result of new information, future events or otherwise, except as may be required by applicable law.

Results of Operations. The results of operation, and comparisons to results from the first quarter of 2022, are materially impacted by the acquisition of Emlenton which closed on January 1, 2023.

The following is a comparison of selected financial ratios and other results at or for the three month periods ended March 31, 2023 and 2022:

(In Thousands, except Per Share Data)

Net Income. The Company's net income for the quarter ended March 31, 2023 totaled $7.1 million, or $0.19 per diluted share, compared to $15.8 million, or $0.47 per diluted share, for the three months ended March 31, 2022. The change in net income during the first quarter of 2023, compared with the first quarter of 2022, was impacted by acquisition-related expenses for the Emclaire transaction that closed on January 1, 2023. The first quarter of 2023 results of operations included merger-related expenses of $4.3 million compared to merger related costs of $1.9 million for the first quarter of 2022. The first quarter of 2023 also included Day 1 provision for credit losses and provision for unfunded loans under the CECL model of $7.7 million.

Net Interest Income. The following schedule details the various components of net interest income for the periods indicated. All asset yields are calculated on a tax-equivalent basis where applicable. Security yields are based on amortized cost.

Average Balance Sheets and Related Yields and Rates

(Dollar Amounts in Thousands)

(1) Rates are calculated on an annualized basis.

(2) Includes unamortized discounts and premiums. Average balance and yield are computed using the average historical amortized cost.

(3) For 2023, adjustments of $86 thousand and $678 thousand, respectively, are made to tax equate income on tax exempt loans and tax exempt securities. For 2022, adjustments of $84 thousand and $774 thousand, respectively, are made to tax equate income on tax exempt loans and tax exempt securities. These adjustments are based on a marginal federal income tax rate of 21%, less disallowances.

Net Interest Income. Net interest income for the three month period ended March 31, 2023, was $36.6 million compared to $31.2 million for the same period in 2022. A larger earning asset base due to the acquisition of Emlenton was the primary driver of this increase offset by a 20 basis point decline in the net interest margin.

The net interest margin for the three months ended March 31, 2023, was 3.07%, a 20 basis point decrease from the quarter ended March 31, 2022. In comparing the first quarter of 2023 to the same period in 2022, interest-earning asset yields increased 80 basis points, while the cost of interest-bearing liabilities increased 134 basis points. This increase in funding costs has been due to the rapid increase in deposit rates due to intense competition for deposits, the continued Federal Reserve rate hiking cycle and runoff of deposit balances which are being replaced by much costlier wholesale funding. This increase in funding costs continues to outstrip the increases in yield on interest-earning assets pushing the net interest margin lower.

Provision for Credit Losses and Provision for Unfunded Loans. The Company recorded a provision for credit losses and unfunded loans of $8.6 million for the first quarter of 2023 compared to a credit for credit losses and unfunded loans of $358 thousand for the first quarter of 2022. Included in the $8.6 million figure is a Day 1 provision for credit losses and provision for unfunded loans under the CECL model of $7.7 million related to the acquisition of Emlenton. There was no Day 1 provision recorded in the first quarter of 2022. The allowance for credit losses to total loans was 1.14% at March 31, 2023, compared to 1.12% at December 31, 2022.

Noninterest Income. For the three months ended March 31, 2023, noninterest income totaled $10.4 million compared to $17.7 million for the first quarter of 2022. The primary reason for the decrease in 2023 was the recognition of $8.4 million in income in 2022 for a legal settlement that was not repeated in 2023. Several categories of noninterest income increased year over year due to growth including trust fees and insurance commissions while other categories grew due to growth and the acquisition of Emlenton. Categories that increased year over year due to both reasons included service charges on deposit accounts, bank owned life insurance income, debit card income and other noninterest income. Net gains on the sale of loans dropped from $1.1 million in the first quarter of 2022 to $310,000 for the first quarter of 2023. This drop was caused by lower mortgage production compared to the prior year due to the dramatic increase in interest rates in the last year. The Company also recognized $121,000 in gains on the sale of securities for the first three months of 2023 compared to a loss on the sale of securities of $11,000 for the first quarter of 2022.

Noninterest Expense. Noninterest expense increased from $30.5 million during the three months ended March 31, 2022, to $30.7 million for the same period in 2023. During the first quarter of 2022, the Company made a charitable contribution of $6.0 million to the Farmers Charitable Foundation and incurred $2.1 million in legal costs associated with the legal settlement discussed above.

Salaries and employee benefits increased $2.8 million to $14.6 million in the first quarter of 2023 compared to the same period in 2022. The acquisition of Emlenton along with normal raise activity was the primary reason for the increase. Occupancy and equipment, FDIC and state and local taxes, intangible amortization and core processing charges all saw increases year over year primarily as a result of the Emlenton acquisition. Merger related costs were $4.3 million in the first quarter of 2023 compared to $1.9 million in the first quarter of 2022. Professional fees were $2.0 million lower in the first quarter of 2023 compared to the first quarter of 2022 due to the legal costs discussed previously while other operating expense was down $5.3 million for the first three months of 2023 due primarily to the charitable contribution.

Income Taxes. Income tax expense totaled $639 thousand for the quarter ended March 31, 2023 compared to $3.0 million for the quarter ended March 31, 2022. The decrease was due to the decline in income before taxes.

Financial Condition

Cash and Cash Equivalents. Cash and cash equivalents increased $52.4 million during the first three months of 2023 from $75.6 million at December 31, 2022 to $128.0 million at March 31, 2023. The increase in the cash balances was primarily due to the Company intentionally holding more cash on its balance sheet due to the turmoil in the banking industry due to the failures of several banks in March.

Securities. Securities available-for-sale increased by $87.4 million to $1.36 billion at March 31, 2023, compared to $1.27 billion at December 31, 2022. The increase was driven by the addition of $127.0 million in available for sale securities from Emlenton and a reduction in the gross amount of unrealized losses of $42.8 million. Offsetting these increases, the Company also had sales and runoff from the portfolio that totaled approximately $82.4 million in the first three months of 2023.

Loans. Gross loans (excluding loans held for sale) increased to $3.15 billion at March 31, 2023 from $2.40 billion at December 31, 2022. The increase of $747.6 million for the quarter was primarily driven by the loans acquired from Emlenton which totaled $741.7 million.

Allowance for Credit Losses. The following table indicates key asset quality ratios that management evaluates on an ongoing basis. The recorded investment balances were used in the calculations.

Asset Quality History

(In Thousands of Dollars)

ASU 2022-02 was adopted on January 1, 2023 and such, non-performing loans balances include prior period TDRs and current period loans that had modifications due to financial difficulty.

The Company's allowance for credit losses increased to $36.0 million for the period ended March 31, 2023 from $27.0 million for the period ended December 31, 2022. This increase was primarily driven by the Day 1 provision for credit losses associated with the acquisition of Emlenton that added $7.5 million to to the allowance for credit losses. In addition, the Company also recorded a $1.0 million increase to the allowance for credit losses for the Day 1 reserve for purchase credit deteriorated loans from Emlenton. The Company estimates the ACL based on the amortized cost basis of the underlying loan and has made an accounting policy election to exclude accrued interest from the loan’s amortized cost basis and the related measurement of the ACL. Estimating the amount of the ACL is a function of a number of factors, including but not limited to changes in the loan portfolio, net charge-offs, trends in past due and nonaccrual loans, and the level of potential problem loans, all of which may be susceptible to significant change.

Based on the evaluation of the adequacy of the allowance for credit losses, management believes that the allowance for credit losses at March 31, 2023, is adequate. The provision for credit losses is based on management’s judgment after taking into consideration all factors connected with the collectability of the existing loan portfolio. Management estimates the allowance balance using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Specific factors considered by management in determining the amounts charged to operating expenses include previous credit loss experience, the status of past due interest and principal payments, the quality of financial information supplied by loan customers and the general condition of the industries in the community to which loans have been made.

Non-performing loans to total loans at March 31, 2023 was 0.57% compared to 0.62% at December 31, 2022 and 0.61% at March 31, 2022. Early stage delinquencies, which are loans 30 - 89 days delinquent, also continue to remain at low levels, at 0.32% of total loans, at March 31, 2023 compared to 0.40% at December 31, 2022 and 0.32% at March 31, 2022. Annualized net charge-offs to average net loans outstanding for the current quarter were 0.03% compared to 0.25% for the same quarter in 2022.

Deposits. Total deposits increased to $4.40 billion at March 31, 2023, compared to $3.56 billion at December 31, 2022. This increase was primarily due to the $875.8 million in deposits assumed in the acquisition of Emlenton. These increases were slightly offset by a decline of $55.9 million in brokered time deposits.

Short-term Borrowings. Total short-term borrowing balances increased from $95.0 million at December 31, 2022 to $204.0 million at March 31, 2023, due to a $109.0 million increase in FHLB advances. This increase was due to the Company paying down brokered time deposits with FHLB advances during the quarter and also due to the Company carrying more cash on its balance sheet during the first quarter.

Total Stockholders' Equity. Total stockholders’ equity increased to $374.6 million at March 31, 2023 from $292.3 million at December 31, 2022. The increase was primarily due to a $59.2 million increase from the share issuance for the acquisition of Emclaire and a reduction of $33.8 million in the accumulated other comprehensive loss. Offsetting these increases, was an increase of $11.1 million in treasury stock balances as the Company repurchased 850,799 of its outstanding shares during the quarter. Shareholders received $0.17 per share in cash dividends in the first three months of 2023, or $6.4 million, which was paid for with the $7.1 million in net income the Company earned in the first quarter of 2023.

The capital management function is a regular process that consists of providing capital for both the current financial position and the anticipated future growth of the Company. At March 31, 2022 the Company is required to maintain 4.5% common equity tier 1 to risk weighted assets excluding the conservation buffer to be adequately capitalized. The Company’s common equity tier 1 to risk weighted assets was 10.04%, total risk-based capital ratio stood at 13.60%, and the Tier 1 risk-based capital ratio and Tier 1 leverage ratio were at 10.54% and 7.43%, respectively, at March 31, 2023. The Company opted not to phase in, over 3 years, the effects of the initial CECL entry to equity for the implementation of ACS 326, recorded on January 1, 2021. Management believes that the Company and the Bank meet all capital adequacy requirements to which they are subject, as of March 31, 2023.

Federal bank regulatory agencies finalized a rule that simplifies capital requirements for community banks by allowing them to adopt a simple leverage ratio to measure capital adequacy. The community bank leverage ratio framework removes requirements for calculating and reporting risk-based capital ratios for a qualifying community bank that opts into the framework. The Company has not elected to adopt this framework.

Critical Accounting Policies

The Company follows financial accounting and reporting policies that are in accordance with U.S. GAAP. These policies are presented in Note 1 of the consolidated audited financial statements in the Company’s Annual Report to Shareholders included in the Company’s 2022 Form 10-K. Critical accounting policies are those policies that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company has identified three accounting policies that are critical accounting policies and an understanding of these policies is necessary to understand the Company’s financial statements. These policies relate to determining the adequacy of the allowance for credit losses, for both the investment and loan portfolios and if there is any impairment of goodwill or other intangible. Additional information regarding these policies is included in the notes to the aforementioned 2022 consolidated financial statements, Note 1 (Summary of Significant Accounting Policies), Note 2 (Business Combinations), Note 4 (Loans), and the sections captioned “Loan Portfolio.”

Securities classified as AFS are those securities that the Company intends to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as AFS would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company’s assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors.

The Company evaluates securities AFS in unrealized loss positions on a quarterly basis to determine whether the decline in fair value below the amortized costs basis (impairment) is due to credit-related factors or noncredit-related factors. In making this evaluation, management considers the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value. Any impairment that is not credit-related is recognized in other comprehensive income, net of related deferred income taxes. Credit-related impairment is recognized as an allowance for credit losses (“ACL”) on the balance sheet based on the amount by which the amortized cost basis exceeds the fair value, with a corresponding charge to net income. Both the ACL and the charge to net income may be reversed if conditions change. However, if the Company intends to sell an impaired AFS security, or more likely than not will be required to sell such a security before recovering its amortized cost basis, the entire impairment amount must be recognized in net income with a corresponding adjustment to the security’s amortized cost basis rather than through the establishment of an ACL. The Company has recorded no ACL related to the investment portfolio as of March 31, 2023.

The Company adopted the current expected credit loss model (“CECL”). This methodology for calculating the allowance for credit losses considers the possibility of loss over the life of the loan. It also considers historical loss rates and other qualitative adjustments, as well as a new forward-looking component that considers reasonable and supportable forecasts over the expected life of each loan. To develop the ACL estimate under the current expected loss model, the Company segments the loan portfolio into loan pools based on loan type and similar credit risk elements. The Company uses the cohort (“cohort”) and the probability of default/loss given default (“PD/LGD”) methodologies as described in the Credit Quality Indicators section of the loan footnote. Under ASC 326, if a loan does not share similar risk characteristics with loans in that pool, expected credit losses for that loan are evaluated individually. The Company has established specific thresholds for the loan portfolio that trigger when loans need to be evaluated individually. In addition, ASC 326 requires the Company to establish a separate liability for anticipated credit losses for unfunded commitments.

Under CECL the credit loss estimation process involves procedures that consider the unique characteristics of the Company’s loan portfolio segments. These segments are disaggregated into the loan pools for monitoring. A model of risk characteristics, such as loss history and delinquency experience, trends in past due and non-performing loans, as well as existing economic conditions and supportable forecasts used to determine credit loss assumptions.

The Company uses two methodologies, the cohort and the PD/LGD, to analyze loan pools. Cohort relies on the creation of cohorts to capture loans that qualify for a particular segment, as of a point in time. Those loans are then tracked over their remaining lives to determine their loss experience. The Company aggregates financial assets on the basis of similar risk characteristics when evaluating loans on a collective basis. Those characteristics include, but aren’t limited to, internal or external credit score, risk ratings, financial asset, loan type, collateral type, size, effective interest rate, term, or geographical location. The Company uses cohort primarily for consumer loan portfolios.

The probability of default (“PD”) portion of PD/LGD is defined by the Company as 90 days past due, placed on non-accrual or is partially, or wholly, charged-off. Typically, a one-year time period is used to asses PD. PD can be measured and applied using various risk criteria. Risk rating is one common way to apply PDs. Loss given default (“LGD”) is to determine the percentage of loss by facility or collateral type. LGD estimates can sometimes be driven, or influenced, by product type, industry or geography. The Company uses PD/LGD primarily for commercial loan portfolios.

To the extent that any purchased loan is not specifically reviewed, such loan is assumed to have characteristics similar to the characteristics of the originated risk pools. The grade for each purchased loan without evidence of credit deterioration is reviewed subsequent to the date of acquisition any time a loan is renewed or extended or at any time information becomes available to the Company that provides material insight regarding the loan’s performance, the status of the borrower or the quality or value of the underlying collateral. To the extent that current information indicates it is probable that the Company will collect all amounts according to the contractual terms thereof, such loan is not individually considered in the determination of the required allowance for credit losses. To the extent that current information indicates it is probable that the Company will not be able to collect all amounts according to the contractual terms thereof, such loan is considered in the determination of the required level of allowance.

In determining the day one fair values of purchased loans without evidence of credit deterioration at the date of acquisition, management includes (i) no carry-over of any previously recorded allowance for loan losses and (ii) an adjustment of the unpaid principal balance to reflect an appropriate market rate of interest and credit risk, given the risk profile and grade assigned to each loan. This adjustment is accreted into earnings as a yield adjustment, using the effective yield method, over the remaining life of each loan.

The ACL represents management’s estimate of expected credit losses in the Company’s loan portfolio at the balance sheet date. The Company estimates the ACL based on the amortized cost basis of the underlying loan and has made an accounting policy election to exclude accrued interest from the loan’s amortized cost basis and the related measurement of the ACL. Estimating the amount of the ACL is a function of a number of factors, including but not limited to changes in the loan portfolio, net charge-offs, trends in past due and nonaccrual loans, and the level of potential problem loans, all of which may be susceptible to significant change. While management uses the best information available to establish the allowance, future adjustments to the allowance may be necessary, which may be material, if economic conditions differ substantially from the assumptions used in estimating the allowance. If additions to the original estimate of the allowance for credit losses are deemed necessary, they will be reported in earnings in the period in which they become reasonably estimable and probable. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off.

Liquidity

The Company maintains, in the opinion of management, liquidity sufficient to satisfy depositors’ requirements and meet the credit needs of customers. The Company depends on its ability to maintain its market share of deposits as well as acquiring new funds. The Company’s ability to attract deposits and borrow funds depends in large measure on its profitability, capitalization and overall financial condition. The Company’s objective in liquidity management is to maintain the ability to meet loan commitments, purchase securities or to repay deposits and other liabilities in accordance with their terms without an adverse impact on current or future earnings. Principal sources of liquidity for the Company include assets considered relatively liquid, such as federal funds sold, cash-due from banks, as well as cash flows from maturities and repayments of loans, and to a lesser extent securities.

Along with its liquid assets, the Bank has additional sources of liquidity available which help to ensure that adequate funds are available as needed. These other sources include, but are not limited to, access to funds in the wholesale arena, the ability to obtain deposits through the adjustment of interest rates and the purchasing of federal funds and borrowings on approved lines of credit at major domestic banks. At March 31, 2023, this line of credit totaled $35.0 million of which the Bank had not borrowed against. In addition, the Company has two revolving lines of credit with correspondent banks totaling $6.5 million. There was no balance on these lines at March 31, 2023 and December 31, 2022. Management feels that its liquidity position is adequate and will continue to monitor the position on a monthly basis. As of March 31, 2023, the Bank had outstanding balances with the FHLB of $204.0 million with additional borrowing capacity of approximately $656.1 million, as well as access to the Federal Reserve Discount Window, which provides an additional source of funds with the posting of collateral. The Bank views its membership in the FHLB as a solid source of liquidity.

Off-Balance Sheet Arrangements

In the normal course of business, to meet the financial needs of our customers, we are a party to financial instruments with off-balance sheet risk. These financial instruments generally include commitments to originate mortgage, commercial and consumer loans, and involve to varying degrees, elements of credit and interest rate risk in excess of amounts recognized in the Consolidated Balance Sheets. The Bank’s maximum exposure to credit loss in the event of nonperformance by the borrower is represented by the contractual amount of those instruments. Because some commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The same credit policies are used in making commitments as are used for on-balance sheet instruments. Collateral is required in instances where deemed necessary. Undisbursed balances of loans closed include funds not disbursed but committed for construction projects. Unused lines of credit include funds not disbursed, but committed for, home equity, commercial and consumer lines of credit. Financial standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Those guarantees are primarily used to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Total unused commitments were $755.2 million at March 31, 2023, and $634.3 million at December 31, 2022. Additionally, the Company committed up to $19.7 million in subscriptions in Small Business Investment Company investment funds. At March 31, 2023, the Company has invested $16.2 million in these funds.

Recent Market and Regulatory Developments

Various and significant legislation affecting financial institutions and the financial industry is from time to time introduced in the U.S. Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system.

Also, such statutes, regulations and policies are continually under review by Congress, state legislatures and federal and state regulatory agencies and are subject to change at any time, particularly in the current economic and regulatory environment. Any such change in statutes, regulations or regulatory policies applicable to the Company could have a material effect on the business of the Company.

The Company’s ability to maximize net income is dependent, in part, on management’s ability to plan and control net interest income through management of the pricing and mix of assets and liabilities. Because a large portion of assets and liabilities of the Company are monetary in nature, changes in interest rates and monetary or fiscal policy affect its financial condition and can have significant impact on the net income of the Company.

The Company considers the primary market exposure to be interest rate risk. Simulation analysis is used to monitor the Company’s exposure to changes in interest rates, and the effect of the change to net interest income. The following table shows the effect on net interest income and the net present value of equity in the event of sudden and sustained interest rate increases and sudden and sustained interest rate decreases.

* Not calculated for December 31, 2022

The yield curve at March 31, 2023 is dramatically different than that of a year ago. The Federal Open Market Committee, in its intense efforts to diffuse inflation, has raised the discount rate 5% throughout the past five quarters, the fastest pace on record. These movements have inverted the yield curve whereby the two-year treasury yield exceeds the ten-year treasury yield by 63 basis points, versus the year agos ten-year exceeding the two-year by over 4 basis points. With the entire curve highly elevated, asset valuation has declined substantially as evidenced by the 14% valuation reserve on the investment portfolio. For interest rate risk modeling purposes, although further rate increases are probable, movement beyond 50 more basis points is doubtful. However, the elevated rates do bring back into play the 400 basis point scenarios, which have not been modeled in recent years. The above table presents results in the up rate scenarios that exceed policy limits for the Economic Value of Equity (“EVE”). This unprecedented outcome was created by the events occurring over the past two years, namely, the massive influx of liquidity in the form of deposits in 2020 and 2021 from government assistance while interest rates were at their lowest; the deployment of those funds at those low rates; and now the usage of those deposits as consumers drain their accounts in this highly inflationary economy and prevent the Company from investing in the higher rates now available. With the EVE model moving rates even higher, it further exacerbates the differential between market rates and book rates, thereby creating the out of policy consequence. To mitigate these results, the Company has prioritized loan growth, while shrinking the investment portfolio, thereby closing the gap between the book rates and market rates. The Company has also utilized wholesale funding in response to deposit shrinkage so as not to incur cost increases on its core deposits.

The remaining results of the simulations indicate that interest rate change results fall within internal limits established by the Company at March 31, 2023 and December 31, 2022. A report on interest rate risk is presented to the Board of Directors and the Asset/Liability Committee on a quarterly basis. The Company has no market risk sensitive instruments held for trading purposes, nor does it hold derivative financial instruments, and does not plan to purchase these instruments in the near future.

Based on their evaluation, as of the end of the period covered by this Quarterly Report on Form 10-Q, the Company’s Chief Executive Officer and Chief Financial Officer have concluded the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) are effective. There were no changes in the Company’s internal controls over financial reporting (as defined in Rule 13a–15(f) under the Exchange Act) that occurred during the fiscal quarter ended March 31, 2023, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

The Company is exposed to risk when other financial institutions experience financial difficulties which could have an adverse impact on the banking industry environment in which the Company operates. The recent and rapid collapses of Silicon Valley Bank, Signature Bank and First Republic Bank have caused uncertainty in the investor community and banking customers. While the Company does not believe that the circumstances of these three bank failures are indicators of broader issues within the banking system, the failures may reduce customer confidence, affect sources of funding and liquidity, increase regulatory requirements and costs, adversely affect financial markets and/or have a negative reputational ramification for the financial services industry, including the Company. The Company will continue to monitor the ongoing events concerning these three banks as well as any future potential bank failures and volatility within the financial services industry generally, together with any responsive measures taken by the banking regulators to mitigate or manage potential turmoil in the financial services industry.

For further discussion of risk factors related to the Company, refer to Part 1, Item 1A, “Risk Factors,” contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.