Virginia National Bankshares Corp: Form 10-Q for the period ended Sep 30, 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 and nine months ended September 30, 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 September 30, 2024 was 1.15% compared to 1.18% realized in the same period in the prior year, as net income was lower and average assets were higher in the current period as compared to the same period in the prior year. ROAA for the nine months ended September 30, 2024 was 1.04% compared to 1.37% realized in the same period in the prior year for the same reasons.
• ROAE for the three months ended September 30, 2024 was 11.82% compared to 12.91% realized in same period in the prior year. ROAE for the nine months ended September 30, 2024 was 10.70% compared to 15.42% realized in the same period in the prior year.
• Net income per diluted share was $0.85 for the three months ended September 30, 2024, compared to $0.86 for the same period in the prior year. Net income per diluted share was $2.30 for the nine months ended September 30, 2024, compared to $2.99 for the same period in the prior year. The period over period declines were due to the decrease in net income, primarily as a result of increased cost of funds, as described below.

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 half of 2024, 20,350 shares were repurchased. No additional repurchases were made during the third quarter of 2024.

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 September 30, 2024 were $1.6 billion. This is a $31.2 million, or 1.9%, decrease from total assets reported at December 31, 2023 yet a $52.2 million, or 3.3%, increase from total assets reported at September 30, 2023. For the nine months ended September 30, 2024, maturities within the securities portfolio were utilized to fund loan growth. In addition, outstanding borrowings were reduced by $14.0 million from the balances held as of December 31, 2023.

Securities

The Company’s investment securities portfolio as of September 30, 2024 totaled $287.1 million, a decrease of $141.9 million compared with the $429.0 million reported at December 31, 2023 and a $111.0 million decrease from the $398.1 million reported at September 30, 2023. The decrease from year-end and the prior year was part of a strategic decision to reinvest proceeds into higher yielding assets. At September 30, 2024 and December 31, 2023, the investment securities holdings represented 17.8% and 26.1% of the Company’s total assets, respectively.

The Company’s investment securities portfolio included restricted securities totaling $7.7 million as of September 30, 2024, compared to $8.4 million as of December 31, 2023 and $7.3 million as of September 30, 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 September 30, 2024, the unrestricted securities portfolio totaled $279.3 million. The following table summarizes the Company's AFS securities by type as of September 30, 2024, December 31, 2023, and September 30, 2023 (dollars in thousands):

The unrestricted securities are held primarily for earnings, liquidity, and asset/liability management purposes and are reviewed quarterly for possible impairments indicating credit losses. 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 $1.2 billion as of September 30, 2024, $1.1 billion as of December 31, 2023, and $1.0 billion as of September 30, 2023. Loans as a percentage of total assets at September 30, 2024 were 75.3%, compared to 65.3% as of September 30, 2023. Loans as a percentage of deposits at September 30, 2024 were 88.1%, compared to 74.5% as of September 30, 2023.

The following table summarizes the Company's loan portfolio by type of loan as of September 30, 2024, December 31, 2023, and September 30, 2023 (dollars in thousands):

Loan balances increased by $122.8 million or 11.2% from December 31, 2023 to September 30, 2024. During the nine months ended September 30, 2024, the Company funded $93.1 million in organic loan production and purchased $111.1 million in government guaranteed loans (included in commercial loans above). Paydowns and normal amortization of $81.4 million partially offset the loans funded during the first nine months of the current year.

The following tables details the Company's levels of non-owner occupied commercial real estate as of September 30, 2024 and December 31, 2023, along with the average loan size and % of risk ratings for each category (dollars in thousands):

September 30, 2024

December 31, 2023

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, volatile interest rates, and other signs of recession materialize, which could increase NPAs in future periods.

Nonaccruals - Nonaccrual loans, comprised of ten loans to nine borrowers, totaled $2.1 million at September 30, 2024, compared to balances of $1.9 million and $1.1 million reported at December 31, 2023 and September 30, 2023, respectively.

Past Due Loans - The Company had loans in its portfolio totaling $3.2 million, $879 thousand and $854 thousand, as of September 30, 2024, December 31, 2023 and September 30, 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 September 30, 2024 is comprised of four loans totaling $3.1 million which are 100% government-guaranteed, and four student loans totaling $66 thousand.

Troubled Loan Modifications - No loans were modified during the three months ended September 30, 2024. During the first quarter of 2024, one loan was modified for a borrower experiencing financial difficulties, totaling $703 thousand. As of September 30, 2024, the Company had TLMs totaling $1.2 million.

Foreclosures - There were two loans secured by 1-4 family residential property, with a total balance of $264 thousand, in the process of foreclosure at September 30, 2024, and no loans in the process of foreclosure at December 31, 2023.

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 0.70% as of September 30, 2024, 0.77% as of December 31, 2023, and 0.76% as of September 30, 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 $7.3 million as of September 30, 2024.

Recoveries of credit losses totaling $511 thousand and $17 thousand were recorded in the nine months ended September 30, 2024 and 2023, respectively. The following is a summary of the changes in the ACL for the nine months ended September 30, 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 September 30, 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 September 30, 2024 totaled $15.6 million compared to $16.2 million as of December 31, 2023 and $16.3 million as of September 30, 2023, decreasing from prior year due to normal depreciation. 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 September 30, 2024, the Company occupied thirteen 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 September 30, 2024, the Company has recorded $5.9 million of right-of-use assets and $5.7 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. During the first quarter of 2024, the Company extended one branch lease for an additional five-year period.

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 September 30, 2024 were $1.4 billion, a decrease of $29.2 million, or 2.1%, compared to December 31, 2023, and an increase of $9.6 million, or 0.7%, compared to September 30, 2023 (dollars in thousands).

Noninterest-bearing demand deposits on September 30, 2024 were $359.9 million, representing 26.1% of total deposits. Interest-bearing transaction, money market, and savings accounts totaled $690.1 million, and represented 50.0% of total deposits at September 30, 2024. Collectively, noninterest-bearing and interest-bearing transaction, money market and savings accounts represented 76.1% of total deposit accounts at September 30, 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 $19.4 million and $126.2 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 September 30, 2024. As of December 31, 2023, ICS® deposit balances of $22.8 million and $105.9 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 23.9% of total deposits consisted of certificates of deposit and other time deposit accounts totaling $329.9 million at September 30, 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 nine months 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 $6.3 million as of September 30, 2024 and $7.2 million as of December 31, 2023, all of which were reciprocal balances for the Company’s customers.

As of September 30, 2024 and December 31, 2023, the estimated amounts of uninsured deposits were $331.9 million, or 24.0% and $360.0 million, or 25.5% of total deposits, respectively.

Federal funds purchased

The Company purchased $3.1 million in federal funds at September 30, 2024, $3.5 million at December 31, 2023 and none at September 30, 2023. (Note that the Company was in a Federal funds sold position at September 30, 2023 in the amount of $1.0 million.) 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, 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. The Company curtailed $14.0 million of outstanding FHLB advances during the first nine months of 2024, primarily utilizing proceeds from the maturities of securities, to assist in margin improvement.

As of October 31, 2024, based on the FHLB’s evaluation, the Company has an available credit position of $403 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 $100.1 million, secured by commercial mortgages, with borrowings of $52.5 million as of September 30, 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 five 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 September 30, 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 September 30, 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 18.04%, 18.04%, 18.88% and 11.81%, respectively, as of September 30, 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 17.86%, 17.86%, 18.70% and 11.69%, respectively, as of September 30, 2024, also exceeding the minimum requirements.

As of September 30, 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

Industry events and economic environment

Management of the Company continually monitors the impact of various global and national events on the Company's results of operations and financial condition, including inflation, changes in interest rates, and the political environment in light of the recent U.S. presidential election and other elections. The timing and impact of inflation, fluctuations in and volatility of interest rates, and the competitive landscape of deposits on our business and results of operations will depend on future developments, which are uncertain and unpredictable.

In response to the modest progress on inflation, on September 18, 2024 and November 7, 2024, the FOMC announced that it was lowering the Federal Funds target rate by 50 bps and 25 bps, respectively. The Federal Funds target current range is 4.50% to 4.75%. While inflation has eased in 2024, it remains elevated over the FOMC's target of 2.0%. The FOMC noted that it has gained greater confidence that inflation is moving sustainably toward 2.0%. Further the FOMC has also noted that it will carefully assess incoming data, the evolving outlook, and the balance of risks in considering

additional adjustments to the target range for the Federal Funds rate and that its assessments will take into account a

wide range of information, including readings on labor market conditions, inflation pressures and inflation

expectations, and financial and international developments. The FOMC noted that it would be prepared to adjust the

stance of monetary policy as appropriate if risks emerge that could impede the attainment of the FOMC’s goals. The

FOMC also confirmed the continued reduction to the Federal Reserve’s holdings of U.S. Treasury securities and

agency debt and agency MBS.

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 September 30, 2024 was $4.6 million, a $53 thousand decrease compared to $4.7 million reported for the three months ended September 30, 2023. Net income per diluted share was $0.85 for the three months ended September 30, 2024 compared to $0.86 per diluted share for the same period in the prior year.

Net income for the nine months ended September 30, 2024 was $12.4 million, compared to $16.1 million for the nine months ended September 30, 2023. Net income per diluted share was $2.30 for the nine months ended September 30, 2024, compared to $2.99 for the nine months ended September 30, 2023.

The decline in net income for each of the periods noted above is primarily the result of increased cost of funds, as discussed in more detail below.

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).

Quarterly overview - Net interest income (FTE) for the three months ended September 30, 2024 was $12.1 million, a $924 thousand increase compared to net interest income (FTE) of $11.2 million for the three months ended September 30, 2023. The net interest margin (FTE) of 3.24% for the three months ended September 30, 2024 was 20 bps higher than the 3.04% realized during the three months ended September 30, 2023. The main driver of this increase was increased volume of loans; the increase in average loan balances, from $986.5 million for the three months ended September 30, 2023 to $1.2 billion for the three months ended September 30, 2024, positively impacted interest income by $2.8 million, while the increase in rates associated with such loans positively impacted interest income by $812 thousand. These increases were partially offset by the decrease in the average balances of securities, decreasing from $454.0 million in the three months ended September 30, 2023 to $287.9 in the three months ended September 30, 2024, negatively impacting interest income (FTE) by $1.2 million period over period. Interest expense increased $1.3 million, negatively impacting net interest income (FTE) and net interest margin (FTE), compared to the same period in the prior year. Overall, the cost of interest-bearing deposits increased 45 bps period over period, from 226 bps to 271 bps. A $81.9 million increase in average balances of time deposit products contributed to the higher interest expense during the third quarter of 2024.

Year-to-date overview - Net interest income (FTE) for the nine months ended September 30, 2024 was $34.4 million, a $4.1 million decrease compared to net interest income (FTE) for the nine months ended September 30, 2023. The net interest margin (FTE) of 3.07% for the nine months ended September 30, 2024 was 45 bps lower than the 3.52% realized during the nine months ended September 30, 2023. Interest expense increased $8.8 million, negatively impacting net interest income (FTE) and net interest margin (FTE), compared to the same period in the prior year. Overall, the cost of interest-bearing deposits increased 103 bps period over period, from 170 bps to 273 bps. A $146.0 million increase in average balances of time deposit products contributed to the higher interest expense during the first nine months of 2024. The increase in average loan balances, from $953.4 million for the nine months ended September 30, 2023 to $1.1 billion for the nine months ended September 30, 2024, positively impacted interest income by $8.2 million. This increase was partially offset by the decrease in the average balances of securities, decreasing from $485.3 million in the nine months ended September 30, 2023 to $328.5 in the nine months ended September 30, 2024, negatively impacting interest income (FTE) by $3.4 million period over period.

For the quarterly and year-to-date periods of 2024, the shift in the composition of earnings assets was intentional to shift the mix to higher yielding assets.

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 and nine months ended September 30, 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.

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.

Provision for credit losses

A recovery of provision for credit losses of $114 thousand was recognized during the three months ended September 30, 2024 compared to a recovery of $73 thousand recognized during the three months ended September 30, 2023. The third quarter 2024 recovery of provision for credit losses was comprised of $3 thousand of recovery of provision for loan losses and $111 thousand of recovery of provision for losses on unfunded commitments.

A recovery of provision for credit losses of $474 thousand was recognized during the nine months ended September 30, 2024 compared to a recovery of $60 thousand recognized during the nine months ended September 30, 2023. The first nine months of 2024 recovery of provision for credit losses was comprised of $511 thousand of recovery of provision for loan losses and $37 thousand of provision for losses on unfunded commitments.

An update to the peer data used in the Company's CECL model was performed during the three months ended June 30, 2024. This included a new group of peer banks, an adjustment to the k-factors used in the DCF models, and the election to mirror CRE non-owner occupied data for the multifamily pool based on the more appropriate and reasonable data fit. In addition, during the second quarter of 2024, a reallocation of qualitative factor weightings for each pool was performed based on assessment of applicability and significance in terms of anticipated effect of each factor on loss rates for each pool. An update to the prepayment and curtailment rates used in the Company's CECL model was performed during the three months ended September 30, 2024.

A significant portion of the increase in loan balances in the first nine months of 2024 was attributable to the purchase of government-guaranteed loans which do not require an ACL as they are 100% guaranteed, with balances increasing by $111.1 million from December 31, 2023 to September 30, 2024.

The decrease in unfunded commitment reserve from the prior quarter, and therefore the recovery of provision related thereto, was almost entirely due to the decrease in the balances of unfunded construction loans, declining from $24.8 million as of June 30, 2024 to $17.3 million as of September 30, 2024.

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 September 30, 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 September 30, 2024 and 2023 are shown below (dollars in thousands):

Noninterest income for the three months ended September 30, 2024 of $1.5 million was $1.2 million or 45.1% less than the amount recorded for the three months ended September 30, 2023, due primarily to the receipt of proceeds from bank-owned life insurance due to the death of a former employee in the third quarter of the prior year.

The components of noninterest income for the nine months ended September 30, 2024 and 2023 are shown below (dollars in thousands):

Noninterest income for the nine months ended September 30, 2024 of $5.3 million was $1.6 million or 23.6% less than the amount recorded for the nine months ended September 30, 2023, due primarily, as noted above, to the receipt of proceeds from bank-owned life insurance due to the death of a former employee in the third quarter of the prior year. In addition, wealth management and debit/credit card and ATM fees declined as a result of a reduction in number of accounts.

Noninterest expense

The components of noninterest expense for the three months ended September 30, 2024 and 2023 are shown below (dollars in thousands):

Noninterest expense for the quarter ended September 30, 2024 of $7.9 million was $397 thousand or 4.8% lower than the quarter ended September 30, 2023. This decrease is primarily due to reduced compensation and occupancy costs, as a result of right-sizing the branch network from the Merger, and reduced marketing, advertising and promotion expense.

The components of noninterest expense for the nine months ended September 30, 2024 and 2023 are shown below (dollars in thousands):

Noninterest expense for the nine months ended September 30, 2024 of $24.9 million was $881 thousand or 3.4% lower than the nine months ended September 30, 2023. This decrease is primarily due to reduced compensation, occupancy and data processing costs, as a result of right-sizing the branch network from the Merger, and reduced marketing, advertising and promotion expense.

The efficiency ratio (FTE) was 58.6% for the three months ended September 30, 2024 compared to 60.3% for the same quarter of 2023, due predominantly to the increase in net interest income (FTE), as described above. The efficiency ratio (FTE) of 62.6% for the nine months ended September 30, 2024 increased from the 56.7% realized in the nine months ended September 30, 2023 due predominantly to the decline in net interest income (FTE). 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 September 30, 2024 and 2023, the Company provided $1.0 million and $824 thousand for Federal income taxes, respectively, resulting in effective income tax rates of 18.5% and 15.0%, respectively. The effective income tax rate was lower in the prior period due to the effect of tax-exempt income from bank owned life insurance proceeds received due to the death of a former employee in the third quarter of the prior year. For the nine months ended September 30, 2024 and 2023, the Company provided $2.6 million and $3.4 million for Federal income taxes, respectively, resulting in effective income tax rates of 17.6% and 17.4%, respectively. 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 September 30, 2024 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

During the quarter ended September 30, 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.