Virginia National Bankshares Corp: Form 10-Q for the period ended Mar 31, 2024

The following discussion should be read in conjunction with the unaudited consolidated financial statements, and notes thereto, of Virginia National Bankshares Corporation included in this report and the audited consolidated financial statements, and notes thereto, of the Company included in the Company’s Form 10-K for the year ended December 31, 2023. Operating results for the three months ended March 31, 2024 are not necessarily indicative of the results for the year ending December 31, 2024 or any future period.

FORWARD-LOOKING STATEMENTS AND FACTORS THAT COULD AFFECT FUTURE RESULTS

Certain statements in this release may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include, without limitation, statements with respect to the Company’s operations, performance, future strategy and goals, and are often characterized by use of qualified words such as “expect,” “believe,” “estimate,” “project,” “anticipate,” “intend,” “will,” “should,” or words of similar meaning or other statements concerning the opinions or judgment of the Company and its management about future events. While Company management believes such statements to be reasonable, future events and predictions are subject to circumstances that are not within the control of the Company and its management. Actual results may differ materially from those included in the forward-looking statements due to a number of factors, including, without limitation, the effects of and changes in: inflation, interest rates, market and monetary fluctuations; liquidity and capital requirements; market disruptions including pandemics or significant health hazards, severe weather conditions, natural disasters, terrorist activities, financial crises, political crises, war and other military conflicts or other major events, the governmental and societal responses thereto, or the prospect of these events; changes, particularly declines, in general economic and market conditions in the local economies in which the Company operates, including the effects of declines in real estate values; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; the impact of changes in laws, regulations and guidance related to financial services including, but not limited to, taxes, banking, securities and insurance; changes in accounting principles, policies and guidelines; the financial condition of the Company’s borrowers; the Company's ability to attract, hire, train and retain qualified employees; an increase in unemployment levels; competitive pressures on loan and deposit pricing and demand; fluctuation in asset quality; assumptions underlying the Company’s ACL; the value of securities held in the Company's investment portfolio; performance of assets under management; cybersecurity threats or attacks and the development and maintenance of reliable electronic systems; changes in technology and their impact on the marketing of new products and services and the acceptance of these products and services by new and existing customers; the willingness of customers to substitute competitors’ products and services for the Company’s products and services; the risks and uncertainties described from time to time in the Company’s press releases and filings with the SEC; and the Company’s performance in managing the risks involved in any of the foregoing. Many of these factors and additional risks and uncertainties are described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2023 and other reports filed from time to time by the Company with the Securities and Exchange Commission. These statements speak only as of the date made, and the Company does not undertake to update any forward-looking statements to reflect changes or events that may occur after this release.

OVERVIEW

Our primary financial goal is to maximize the Company’s earnings to increase long-term shareholder value. We monitor three key financial performance measures to determine our success in realizing this goal: 1) return on average assets, 2) return on average equity, and 3) net income per share.

• ROAA for the three months ended March 31, 2024 was 0.91% compared to 1.48% realized in the same period in the prior year, as net income was lower in the current period as compared to the same period in the prior year.
• ROAE for the three months ended March 31, 2024 was 9.57% compared to 17.57% realized in same period in the prior year.
• Net income per diluted share was $0.68 for the three months ended March 31, 2024, compared to $1.08 for the same period in the prior year. The period over period declines were due to the decrease in net income.

We also manage our capital levels through growth, quarterly cash dividends, share repurchases, when prudent, while maintaining a strong capital position. During the second quarter of 2023, the Board of Directors approved a share repurchase plan of up to 5% of outstanding common stock. Repurchases may be made through open market purchases or in privately negotiated transactions. The actual timing, number, and value of shares repurchased under the program will be determined by a committee of the Board. During the first quarter of 2024, the Company repurchased 874 shares under this program. Through May 13, 2024, a total of 20,350 shares have been repurchased.

Refer to the Results of Operations, Non-GAAP Presentation section, later in this Management’s Discussion and Analysis for more discussion on these financial performance measures.

APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The accounting and reporting policies followed by the Company conform, in all material respects, to GAAP and to general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While the Company bases estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.

The Company considers accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain, and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the Company’s consolidated financial statements. The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of financial condition and results of operations.

For additional information regarding critical accounting policies, refer to the Application of Critical Accounting Policies and Critical Accounting Estimates section under Item 7 in the Company’s 2023 Form 10-K.

FINANCIAL CONDITION

Total assets

The total assets of the Company as of March 31, 2024 were $1.6 billion. This is a $26.5 million, or 1.6%, decrease from total assets reported at December 31, 2023 and a $48.0 million, or 3.1%, increase from total assets reported at March 31, 2023. The deposit declines experienced during the first half of 2023 as a result of the strategic decision to hold rates steady in the last quarter of 2022 reversed themselves in the last half of 2023, and the Company has continued to recognize measured deposit growth through the first quarter of 2024. As a result, decreases within overnight investments and the securities portfolio which were funding outflow in the first half of 2023 are now funding loan growth. Deposit balances increased $22.9 million, or 1.6%, from December 31, 2023 to March 31, 2024.

Interest-bearing deposits in other banks

The Company had $10.6 million of interest-bearing deposits in other banks as of March 31, 2024, compared to $10.3 million as of December 31, 2023 and $15.6 million as of March 31, 2023. During the first six months of 2023, declines in customer deposit balances were largely funded by liquidation of interest-bearing deposits in other banks. During the quarter ended March 31, 2024, interest-bearing deposits in other banks have remained steady, with deposit growth and investment maturities funding other customer demands.

Federal funds sold

The Company had $27.7 million in overnight Federal funds sold as of March 31, 2024, compared to no overnight Federal funds sold as of December 31, 2023 and $12 thousand as of March 31, 2023. Any excess funds are sold on a daily basis in the federal funds market. The Company monitors liquidity on a daily basis to ensure that it maintains sufficient liquidity to meet its funding commitments at all times.

The Company participates in the Excess Balance Account of the Federal Reserve Bank of Richmond. The EBA is a limited-purpose account at the FRB for the maintenance of excess cash balances held by financial institutions. The EBA eliminates the potential of concentration risk that comes with depositing excess balances with one or multiple correspondent banks.

Securities

The Company’s investment securities portfolio as of March 31, 2024 totaled $348.0 million, a decrease of $80.9 million compared with the $429.0 million reported at December 31, 2023 and a $150.5 million decrease from the $498.5 million reported at March 31, 2023. A security in the amount of $1.5 million which matured on March 31, 2024 was reclassified as a receivable resulting in an increase in other assets, as the proceeds were received after quarter-end. The decrease from year-end and the prior year was part of a strategic decision to reinvest proceeds into higher yielding assets. At March 31, 2024 and December 31, 2023, the investment securities holdings represented 21.5% and 26.1% of the Company’s total assets, respectively.

The Company’s investment securities portfolio included restricted securities totaling $6.2 million as of March 31, 2024, compared to $8.4 million as of December 31, 2023 and $5.8 million as of March 31, 2023. These securities represent stock in the FRB, the FHLB, CBB Financial Corporation (the holding company for Community Bankers' Bank), and an investment in an SBA loan fund. The level of FRB and FHLB stock that the Company is required to hold is determined in accordance with membership guidelines provided by the Federal Reserve and the FHLB, respectively. Stock ownership in the bank holding company for Community Bankers’ Bank provides the Company with several benefits that are not available to non-shareholder correspondent banks. None of these restricted securities are traded on the open market and can only be redeemed by the respective issuer.

At March 31, 2024, the unrestricted securities portfolio totaled $341.9 million. The following table summarizes the Company's AFS securities by type as of March 31, 2024, December 31, 2023, and March 31, 2023 (dollars in thousands):

The unrestricted securities are held primarily for earnings, liquidity, and asset/liability management purposes and are reviewed quarterly for possible other-than-temporary impairments. During this review, management analyzes the length of time the fair value has been below cost, the expectation for that security’s performance, the creditworthiness of the issuer, and the Company’s intent and ability to hold the security to recovery or maturity. These factors are analyzed for each individual security.

Loan portfolio

A management objective is to grow loan balances while maintaining the asset quality of the loan portfolio. The Company seeks to achieve this objective by maintaining rigorous underwriting standards coupled with regular evaluation of the creditworthiness of, and the designation of lending limits for, each borrowing relationship. The portfolio strategies include seeking industry, loan size, and loan type diversification to minimize credit exposure and originating loans in markets with which the Company is familiar. The Company's geographical trade area includes localities in Virginia, Maryland and the District of Columbia that are within a 100-mile radius of any office of the Company as well as the counties of Jefferson and Berkeley in West Virginia.

Total loans were $1.1 billion as of March 31, 2024 and December 31, 2023, compared to $940.0 million at March 31, 2023. Loans as a percentage of total assets at March 31, 2024 were 69.7%, compared to 59.8% as of March 31, 2023. Loans as a percentage of deposits at March 31, 2024 were 78.8%, compared to 67.3% as of March 31, 2023.

The following table summarizes the Company's loan portfolio by type of loan as of March 31, 2024, December 31, 2023, and March 31, 2023 (dollars in thousands):

Loan balances increased by $35.5 million or 3.2% from December 31, 2023 to March 31, 2024. During the first quarter of 2024, the Company funded $27.0 million in organic loan production and purchased $34.2 million in government guaranteed loans. Paydowns and normal amortization of $25.7 million partially offset the loans funded during the first quarter of the current year.

The following table details the Company's levels of non-owner occupied commercial real estate as of March 31, 2024, along with the average loan size and % of risk ratings for each category (dollars in thousands):

Loan quality

The Company continues to experience extremely low levels of NPAs, as a result of strict underwriting standards and practices. However, the economic environment in the Company's lending footprint could be impacted as persistent inflation, higher interest rates, and other signs of recession materialize, which could increase NPAs in future periods.

Nonaccruals - Nonaccrual loans, comprised of nine loans to seven borrowers, totaled $2.2 million at March 31, 2024, compared to balances of $1.9 million and $1.2 million reported at December 31, 2023 and March 31, 2023, respectively.

Past Due Loans - The Company had loans in its portfolio totaling $876 thousand, $879 thousand and $69 thousand, as of March 31, 2024, December 31, 2023 and March 31, 2023, respectively, that were 90 or more days past due and still accruing interest as the Company deemed them to be collectible. The past due balance as of March 31, 2024 is comprised of two loans totaling $783 thousand which are 100% government-guaranteed, and five student loans totaling $93 thousand.

Troubled Loan Modifications - The Company adopted ASU 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures, effective January 1, 2023 on a prospective basis. During the three months ended March 31, 2024, one loan was modified for a borrower experiencing financial difficulties, totaling $703 thousand; as of March 31, 2024, the Company had TLMs totaling $1.0 million.

Management identifies potential problem loans through its periodic loan review process and considers potential problem loans as those loans classified as special mention, substandard, or doubtful.

Allowance for Credit Losses

The relationship of the ACL to total loans and nonaccrual loans appears below (dollars in thousands):

The ACL on loans as a percentage of loans was 0.73% as of March 31, 2024, 0.77% as of December 31, 2023, and 0.83% as of March 31, 2023. The fair value mark that was allocated to the acquired loans was $21.3 million as of the Effective Date, with a remaining balance of $8.8 million as of March 31, 2024.

Provision for (recoveries of) credit losses totaling $11 thousand and ($235) thousand were recorded in the three months ended March 31, 2024 and 2023, respectively. The following is a summary of the changes in the ACL for the three months ended March 31, 2024 and 2023 (dollars in thousands):

For additional insight into management’s approach and methodology in estimating the ACL, please refer to the earlier discussion of “Allowance for Credit Losses” in Note 5 of the Notes to Consolidated Financial Statements. In addition, Note 5 includes details regarding the rollforward of the allowance by loan portfolio segments. The rollforward tables indicate the activity for loans that are charged-off, amounts received from borrowers as recoveries of previously charged-off loan balances, and the allocation by loan portfolio segment of the provision made during the period. The events that can positively impact the amount of allowance in a given loan segment include any one or all of the following: the recovery of a previously charged-off loan balance; the decline in the amount of classified or delinquent loans in a loan segment from the previous period, which most commonly occurs when these loans are repaid or are foreclosed; or when there are improvements in the ratios used to estimate the probability of loan losses. Improvements to the ratios could include lower historical loss rates, improvements to any of the qualitative factors mentioned above, or reduced loss expectations for individually-classified loans.

Management reviews the ACL on a quarterly basis to ensure it is adequate based upon the calculated probable losses inherent in the portfolio. Management believes the ACL was adequately provided for as of March 31, 2024 and acknowledges that the ACL may increase throughout the year as economic conditions may continue to deteriorate for the foreseeable future.

Premises and equipment

The Company’s premises and equipment, net of depreciation, as of March 31, 2024 totaled $15.9 million compared to $16.2 million as of December 31, 2023 and $17.7 million as of March 31, 2023, decreasing from prior year first quarter due to the sale of a branch facility in 2023. Premises and equipment are stated at cost less accumulated depreciation. Depreciation expense is computed by the straight-line method based on the estimated useful lives of assets. Expenditures for repairs and maintenance are charged to expense as incurred. The costs of major renewals and betterments are capitalized and depreciated over their estimated useful lives. Upon disposition, assets and related accumulated depreciation are removed from the books, and any resulting gain or loss is charged to income.

As of March 31, 2024, the Company occupied fourteen full-service banking facilities throughout Albemarle, Fauquier and Prince William counties and the cities of Charlottesville, Richmond, Manassas and Winchester, Virginia. The Company also operates a drive-through location at 301 East Water Street, Charlottesville, Virginia.

The five-story office building at 404 People Place, Charlottesville, Virginia, located in Albemarle County, also serves as the Company’s corporate headquarters and operations center. VNB Trust & Estate Services is located at 103 Third Street, SE, Charlottesville, Virginia.

Both the Arlington Boulevard facility in Charlottesville and the People Place facility in Albemarle County also contain office space that is currently under lease to tenants.

Leases

As of March 31, 2024, the Company has recorded $6.7 million of right-of-use assets and $6.5 million of lease liabilities, in accordance with ASU 2016-02 “Leases” (Topic 842). As of December 31, 2023, $6.7 million of right-of-use assets and $6.5 million of lease liabilities were included on the balance sheet. Right-of-use assets are assets that represent the Company’s right to use, or control the use of, a specified asset for the lease term, offset by the lease liability, which is the Company’s obligation to make lease payments arising from a lease, measured on a discounted basis.

Deposits

Deposit accounts represent the Company’s primary source of funds and are comprised of demand deposits, interest-bearing checking, money market, and savings accounts as well as time deposits. These deposits have been provided predominantly by individuals, businesses and charitable organizations in the Commonwealth of Virginia.

Total deposits as of March 31, 2024 were $1.4 billion, a decrease of $22.9 million compared to December 31, 2023, and a decrease of $34.7 million compared to March 31, 2023 (dollars in thousands). As stated above, during 2022, the Company made a strategic decision to delay increasing rates paid on deposit accounts. As a result, the Company experienced expected declines in deposit balances during 2022 and the first half of 2023. Since then, deposit balances have continued to increase modestly as a result of renewed emphasis on relationship banking.

Noninterest-bearing demand deposits on March 31, 2024 were $382.3 million, representing 26.7% of total deposits. Interest-bearing transaction, money market, and savings accounts totaled $700.1 million, and represented 48.9% of total deposits at March 31, 2024. Collectively, noninterest-bearing and interest-bearing transaction, money market and savings accounts represented 75.6% of total deposit accounts at March 31, 2024. These account types are an excellent source of low-cost funding for the Company.

The Company also offers insured cash sweep deposit products. ICS® deposit balances of $31.2 million and $112.8 million are included in the interest checking accounts and in the money market and savings deposit accounts balances, respectively, in the table above, as of March 31, 2024. As of December 31, 2023, ICS® deposit balances of $44.2 million and $107.4 million are included in the interest checking accounts and in the money market and savings deposit account balances, respectively. All ICS® accounts consist of reciprocal balances for the Company’s customers. The Company currently holds no brokered or specialty CDs.

The remaining 24.4% of total deposits consisted of certificates of deposit and other time deposit accounts totaling $349.6 million at March 31, 2024, increasing over the balances as of December 31, 2023 as a result of several interest rate promotions that the Bank continued in the first quarter of 2024. Included in these deposit totals are CDARSTM, whereby depositors can obtain FDIC deposit insurance on account balances of up to $50 million. CDARSTM deposits totaled $8.0 million as of March 31, 2024 and $7.2 million as of December 31, 2023, all of which were reciprocal balances for the Company’s customers.

As of March 31, 2024 and December 31, 2023, the estimated amounts of uninsured deposits were $366.8 million, or 25.6% and $360.0 million, or 25.5% of total deposits, respectively.

Federal funds purchased

The Company purchased no federal funds as of March 31, 2024, $3.5 million at December 31, 2023 and no federal funds at March 31, 2023. As noted in the Federal funds sold section previously, any excess funds are sold on a daily basis in the federal funds market and Federal funds are purchased as needed to meet liquidity needs.

Borrowings

Borrowings, consisting primarily of FHLB advances and Federal funds purchased, are additional sources of funds for the Company. The level of these borrowings is determined by various factors, including customer demand and the Company's ability to earn a favorable spread on the funds obtained.

As of March 31, 2024, based on the FHLB’s evaluation, the Company has an available credit position of $411 million, for which access can be negotiated based on multiple factors. The Company currently has a collateral dependent line of credit with the FHLB for $90.2 million, secured by commercial mortgages, with borrowings of $20.0 million as of March 31, 2024. As of December 31, 2023, there were $66.5 million in outstanding borrowings with the FHLB. At March 31, 2023, the Company had a $30.0 million letter of credit issued in favor of the Commonwealth of Virginia Department of the Treasury to secure public fund depository accounts. The letter of credit was secured under the collateral dependent line of credit described above and was retired in the second quarter of 2023.

Additional borrowing arrangements maintained by the Company include formal unsecured federal funds lines with six major regional correspondent banks for a total of $119.0 million and a secured line with the Federal Reserve discount window in the amount of $4.0 million, based on the market value of the collateral. See above for outstanding balances in Federal funds purchased as of the dates presented.

Junior Subordinated Debt

In 2006, a subsidiary of Fauquier, Fauquier Statutory Trust II, privately issued $4.0 million face amount of the trust’s Floating Rate Capital Securities in a pooled capital securities offering. Simultaneously, the trust used the proceeds of that sale to purchase $4.0 million principal amount of the Fauquier’s Floating Rate Junior Subordinated Deferrable Interest Debentures due 2036. As of March 31, 2024 and December 31, 2023, total capital securities were $3.5 million, as adjusted to fair value as of the date of the Merger. Historically, the interest rate on the capital security reset every three months at 1.70% above the then current three-month LIBOR and was paid quarterly. With the cessation of LIBOR, on September 13, 2023, the rate converted to a spread adjustment of 0.03% plus a margin of 1.70% above the three-month CME Term SOFR.

The Trust II issuance of capital securities and the respective subordinated debentures are callable at any time. The subordinated debentures are an unsecured obligation of the Company and are junior in right of payment to all present and future senior indebtedness of the Company. The capital securities are guaranteed by the Company on a subordinated basis.

Shareholders' equity and regulatory capital ratios

The following table displays the changes in shareholders' equity for the Company from December 31, 2023 to March 31, 2024 (dollars in thousands):

The Basel III capital rules require banks and bank holding companies to comply with the following minimum capital ratios: (i) a ratio of common equity Tier 1 capital to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7%); (ii) a ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum Tier 1 capital ratio of 8.5%); (iii) a ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum total capital ratio of 10.5%); and (iv) a leverage ratio of 4%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (computed as the average for each quarter of the month-end ratios for the quarter).

The Company’s Tier 1, common equity Tier 1, total capital to risk-weighted assets, and leverage ratios were 17.67%, 17.67%, 18.49% and 11.24%, respectively, as of March 31, 2024, thus exceeding the minimum requirements. The Bank’s Tier 1, common equity Tier 1, total capital to risk-weighted assets, and leverage ratios were 17.48%, 17.48%, 18.29% and 11.17%, respectively, as of March 31, 2024, also exceeding the minimum requirements.

As of March 31, 2024, the Bank exceeded all of the following minimum capital ratios in order to be considered “well capitalized” under the PCA regulations, as revised: (i) a common equity Tier 1 capital ratio of at least 6.5%; (ii) a Tier 1 capital to risk-weighted assets ratio of at least 8.0%; (iii) a total capital to risk-weighted assets ratio of at least 10.0%; and (iv) a leverage ratio of at least 5.0%.

RESULTS OF OPERATIONS

Non-GAAP presentations

The accounting and reporting policies of the Company conform to GAAP and prevailing practices in the banking industry. However, certain non-GAAP measures are used by management to supplement the evaluation of the Company’s performance. These include tangible book value per share, tangible equity and the following fully-taxable equivalent measures: net interest income-FTE, efficiency ratio-FTE and net interest margin-FTE. Interest on tax-exempt loans and securities is presented on a taxable-equivalent basis (which converts the income on loans and investments for which no income taxes are paid to the equivalent yield as if income taxes were paid) using the federal corporate income tax rate of 21 percent that was applicable for all periods presented.

Management believes that the use of these non-GAAP measures provides meaningful information about operating performance by enhancing comparability with other financial periods, other financial institutions, and between different sources of interest income. The non-GAAP measures used by management enhance comparability by excluding the effects of (1) items that do not reflect ongoing operating performance, (2) balances of intangible assets, including goodwill, that vary significantly between institutions, and (3) tax benefits that are not consistent across different opportunities for investment. These non-GAAP financial measures should not be considered an alternative to GAAP-basis financial statements, and other banks and bank holding companies may define or calculate these or similar measures differently. Net income is discussed in Management’s Discussion and Analysis on a GAAP basis unless noted as “non-GAAP.”

A reconcilement of the non-GAAP financial measures used by the Company to evaluate and measure the Company's performance to the most directly comparable GAAP financial measures is presented below (dollars in thousands, except for the per share data):

Net income

Net income for the three months ended March 31, 2024 was $3.6 million, a $2.1 million decrease compared to $5.8 million reported for the three months ended March 31, 2023. Net income per diluted share was $0.68 for the three months ended March 31, 2024 compared to $1.08 per diluted share for the same period in the prior year.

Net interest income

Net interest margin (FTE) is the ratio of net interest income (FTE) to average earning assets for the period. The level of interest rates, together with the volume and mix of earning assets and interest-bearing liabilities, impact net interest income (FTE) and net interest margin (FTE).

Net interest income (FTE) for the three months ended March 31, 2024 was $11.0 million, a $2.5 million decrease compared to net interest income (FTE) of $13.5 million for the three months ended March 31, 2023. The increase in average loan balances, from $932.8 million for the three months ended March 31, 2023 to $1.1 billion for the three months ended March 31, 2024, positively impacted interest income by $2.5 million. This metric was however negatively impacted by the decrease in the average balances of securities, decreasing from $514.5 million in the three months ended March 31, 2023 to $370.3 in the three months ended March 31, 2024, negatively impacting interest income (FTE) by $1.1 million period over period. Interest expense increased $4.7 million, also negatively impacting net interest margin (FTE), compared to the same period in the prior year. The net interest margin (FTE) of 2.93% for the three months ended March 31, 2024 was 78 bps lower than the 3.71% for the three months ended March 31, 2023. Overall, the cost of interest-bearing deposits increased period over period, from a cost of 109 bps to 273 bps. A $3.4 million increase in average balances of time deposit product with premium rates drove interest expense higher for the first 3 months of 2024. The cost of Federal funds purchased positively impacted net interest margin (FTE) by $158 thousand compared to the same period in the prior year due to reduced average balances while the cost of borrowings negatively impacted net interest margin (FTE) by $52 thousand as compared to the same period in the prior year due to increased average balances.

Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP presentations section for a reconcilement of GAAP to non-GAAP net interest margin.

The following tables detail the average balance sheet, including an analysis of net interest income (FTE) for earning assets and interest-bearing liabilities, for the three months ended March 31, 2024 and 2023. These tables also include rate/volume analyses for these same periods (dollars in thousands).

Consolidated Average Balance Sheet and Analysis of Net Interest Income

(1) Tax-exempt income for investment securities has been adjusted to a fully tax-equivalent basis (FTE), using a Federal income tax rate of 21%. Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP Presentations earlier in this section.

(2) Interest spread is the average yield earned on earning assets less the average rate paid on interest-bearing liabilities.

(3) Net interest margin (FTE) is net interest income expressed as a percentage of average earning assets.

(4) The impact on the net interest income (FTE) resulting from changes in average balances and average rates is shown for the period indicated. The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

The Company believes that higher interest rates will continue to have a positive effect on yields of variable rate loans, new loan originations and purchases/reinvestment of AFS securities. The Company also understands that the cost of deposits may increase as competition for deposits increases and as time deposits reprice at maturity. A portion of the Company’s funding may continue to be drawn from borrowings in the near term, also resulting in a higher cost of funds. The effect of these factors on the Corporation’s net interest margin (FTE) will depend on a number of factors, including the Company’s ability to continue to increase the loan portfolio, compete for deposits and manage its borrowings. The Company can give no assurance as to the timing or extent of further increases in market interest rates or the impact of rising interest rates or any other factor on the Company's net interest margin (FTE). Alternatively, if market interest rates begin to decline, the Company’s net interest margin (FTE) may be adversely affected as the Company generally expects its assets to reprice more quickly than its deposits and borrowings.

Provision for credit losses

A recovery of provision for credit losses of $22 thousand was recognized during the three months ended March 31, 2024 compared to a recovery of provision for loan losses of $248 thousand recognized during the three months ended March 31, 2023. The first quarter 2024 recovery of provision for credit losses was comprised of $11 thousand of provision for loan losses and $33 thousand of recovery for provision for losses on unfunded commitments.

A significant portion of the increase in loan balances in the first quarter of 2024 was attributable to the purchase of government-guaranteed loans which do not require an ACL. No changes have been made to the qualitative factor methodology since January 1, 2023.

Further discussion of management’s assessment of the ACL is provided earlier in the report and in Note 5 – Allowance for Credit Losses, found in the Notes to the Consolidated Financial Statements. In management’s opinion, the ACL was adequately provided for at March 31, 2024. The ACL calculation, provision for credit losses, asset quality and collateral values may be significantly impacted by deterioration in economic conditions. Should economic conditions worsen, we could experience further increases in our required ACL and record additional provision for credit loss exposure.

Noninterest income

The components of noninterest income for the three months ended March 31, 2024 and 2023 are shown below (dollars in thousands):

Noninterest income for the three months ended March 31, 2024 of $2.2 million was $98 thousand or 4.3% less than the amount recorded for the three months ended March 31, 2023, due primarily to the fact that the gain on the termination of the interest rate swap that occurred in the first quarter of 2023 was $81 thousand more than the gain on the early redemption of debt in the first quarter of 2024.

Noninterest expense

The components of noninterest expense for the three months ended March 31, 2024 and 2023 are shown below (dollars in thousands):

Noninterest expense for the quarter ended March 31, 2024 of $8.8 million was $42 thousand or 0.5% lower than the quarter ended March 31, 2023. This decrease is primarily due to reduced occupancy expense of $207 thousand after closing a branch and a reduction of marketing expenses of $127 thousand.

The efficiency ratio (FTE) was 66.8% for the three months ended March 31, 2024 compared to 56.1% for the same quarter of 2023, due predominantly to the decrease in net interest income (FTE), as described above. Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP presentations section for a reconcilement of GAAP to non-GAAP efficiency ratio.

Provision for Income Taxes

For the three months ended March 31, 2024 and 2023, the Company provided $671 thousand and $1.3 million for Federal income taxes, respectively, resulting in effective income tax rates of 15.5% and 18.2%, respectively, declining due to the application of prior period tax adjustments. For each period, the effective income tax rate differed from the U.S. statutory rate of 21% due to the recognition of low-income housing tax credits and the effect of tax-exempt income from municipal bonds and bank owned life insurance policies.

OTHER SIGNIFICANT EVENTS

None

The Company maintains “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Exchange Act, that are designed to ensure that information required to be disclosed in reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

In designing and evaluating its disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

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 that the disclosure controls and procedures were effective at the reasonable assurance level. There were no changes in the Company’s internal control over financial reporting that occurred during the three months ended March 31, 2024 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

During the quarter ended March 31, 2024, there have been no material changes from the risk factors described in the Company’s Form 10-K for the year ended December 31, 2023. The risks described may not be the only risks facing us. Additional risks and uncertainties not currently known to us or that are currently considered not to be material also may materially adversely affect our business, financial condition and/or operating results.