Farmers & Merchants Bancorp Inc: Form 10-Q for the period ended Mar 31, 2025

OVERVIEW

The largest improvement in profitability of the first quarter 2025 as compared to both last quarter and the same quarter last year is in the Company’s net interest income generated from the highest net interest margin since 4th quarter 2022. Net interest income for first quarter 2025 is up $3.8 million over the same quarter last year and $1.1 million over last quarter. This represents a solid base from which to continue improvement for the remainder of 2025 as we expect loan repricing and continued growth in low-cost core deposits to increase the margin going forward. The improvement compared to last quarter was driven by a 25-basis point reduction in the cost of funding. The reduction was larger by another 5 basis points, or a 30-basis point reduction in the cost of funding comparing to the first quarter 2024. The difference in the net interest margin of 3.03% for first quarter 2025 as compared to first quarter 2024’s 2.60% is also attributed to a 19-basis point improvement in the asset yield.

There were two primary reasons behind the decrease in the cost of funds for the quarter, the first being the lower repricing of higher cost certificate of deposits (CDs), combined with a balance sheet shift or reduction in CD balances. The second primary reason was a reduction in interest expense due to rate changes in the savings bucket which includes interest bearing checking, money market accounts and savings accounts. The Company experienced a full quarter of the advantage of interest rate cuts implemented due to the Federal Reserve dropping rates over the last four months of 2024.

Higher credit cost in the first quarter 2025 had the opposite impact on profitability and was due to higher net charge-offs from consumer loans coupled with provision related expense from loan growth during the quarter. Provision for credit losses was $811 thousand for the quarter compared to $944 thousand for all of 2024. First quarter 2024 was in a recovery position for the quarter of $289 thousand while fourth quarter 2024 had a provision of $346 thousand.

F&M Commercial Banking Division saw loan demand grow in late 2024 and continue into first quarter 2025. Lending rates and terms remained consistent from fourth quarter 2024 into first quarter 2025. Commercial clients’ primary concerns so far in 2025 remain inflation and any impact on potential tariffs to their business. Credit quality of the commercial portfolio remains strong and first quarter collateral values and auction values are still holding consistent with previous quarters. Past dues and delinquencies remained low for the F&M portfolio, but the team continues to monitor the portfolio closely for the impact from inflationary pressures, input costs and margin compression on the portfolio. Borrowers have plenty availability on lines of credit overall.

As we review the results of our farm and agribusiness clients from 2024, the performance of our customer base was steady. Yields were average with declined commodity prices making net income less than prior years. Marketing and crop insurance coverage was and will continue to be important. Most of our customer base's financial position was sound as we enter a period where they anticipate they may have declining net income. Our anticipation is 2025 will be similar to 2024. We have communicated regularly with our clients potentially affected by the bird flu outbreak and have developed options for individual clients. To date, this portion of our portfolio continues to perform as agreed. Our agribusiness clientele continue to perform well, but declined farm income will potentially affect certain sectors. Global political pressures continue to be monitored. The performance of our agricultural portfolio continues to be monitored but continues to perform well.

Home loan activity has improved slightly in all areas, including with respect to both purchases and refinances, and with respect to loans both held in-house by the Bank and also those sold into the secondary market. The biggest product remains home equity lines as existing borrowers do not want to refinance the lower fixed mortgage rates from previous years. A 300+ basis point difference remains in current fixed rates compared to the lows of the early 2020s. The Bank participated in the “Welcome Home” program offered through the Federal Home Loan Bank of Cincinnati ("FHLB"). This program assists with grants for down payments. The funds are open to all members of FHLB and capped by overall funds available. The funds were depleted in a matter of hours so the Bank is pleased to have received approval for some of our customers. Inventory in our market areas has improved in the midrange values.

Consumer loans increased towards the end of the first quarter, primarily with respect to direct and indirect automobile loans. Consumer interest in used cars increased along with prices recently over concerns related to the potential impact of tariffs. Our activity is and has been more in the used car market than in brand new.

Overall, asset quality metrics are still favorable. However, while it remains too early to tell the overall impact of pending tariffs, we’re expecting past dues and non-accruals to increase throughout the year. Our credit department continues to monitor all areas and complete stress testing to better prepare our responsiveness to market events.

Noninterest income went over the $4 million mark for the quarter without any single line item increasing significantly, all under $150 thousand. Treasury services and interchange revenue from increased debit card usage are primarily credited for the improvement.

Noninterest expense was higher in first quarter 2025 by $919 thousand as compared to same quarter 2024 and almost $2.7 million higher than fourth quarter 2024. Looking at the difference between the first quarter comparisons, increased employee benefits, specifically group medical insurance was up $192 thousand in 2025 along with payroll taxes increasing by $64 thousand. The largest increase was in consulting services, which increased by $559 thousand. Much of the expense was related to the use of a consultant to negotiate our core processor services. While the base contract negotiation is complete, the consultant will continue to be used as we explore additional ancillary products to the core banking system. The benefits of using the consultant have far outweighed the cost and will continue to be realized after our consultant services have ended. In comparing first quarter 2025 to fourth quarter 2024, almost $1.5 million of the increase is attributable to salary, benefits and occupancy expenses. Another $900 thousand in the difference is due to data processing and consulting expenses. Fourth quarter 2024 included a much higher usage of flex credits that were provided in the renegotiation of which some may be used on a wider range of services than others that are product specific. Smaller levels of flex credit will be realized going forward along with lower consulting fee levels throughout 2025.

The Company is encouraged by the higher-than-expected improvement in the net interest margin in the first quarter of 2025. Overall net income, which was $1.6 million higher than first quarter 2024, sets the stage for a more profitable 2025. As with every year, challenges will present opportunities and the Bank has additional projects in the works to improve revenue while keeping an eye on costs. The Company remains well-capitalized with sound liquidity levels and strong asset quality; the future appears bright.

NATURE OF ACTIVITIES

Farmers & Merchants Bancorp, Inc. (the “Company”) is a financial holding company incorporated under the laws of Ohio in 1985. Our subsidiary is The Farmers & Merchants State Bank (the “Bank”), a local independent community bank that has been primarily serving Northwest Ohio, Northeast Indiana and Southeast Michigan since 1897. The Bank includes F&M Insurance Agency, LLC, a subsidiary offering insurance products, which was formed in November of 2023. We report our financial condition and net income on a consolidated basis and we have only one segment.

Our executive offices are located at 307 North Defiance Street, Archbold, Ohio 43502, and our telephone number is (419) 446-2501. The Bank operates thirty-seven full-service banking offices throughout Northwest Ohio, Northeast Indiana and Southeast Michigan along with a drive-up facility in Archbold. The Bank also operates four Loan Production Offices (LPOs), two in Ohio with one in Indiana and one in Michigan.

The Farmers & Merchants State Bank engages in general commercial banking and savings business including commercial, agricultural and residential mortgage as well as consumer lending activities. The largest segment of the lending business relates to commercial, both real estate and non-real estate. The type of commercial business ranges from small business to multi-million dollar companies. The loans are a reflection of business located within the Banks’ market area of Ohio, Indiana and Michigan. Because the Bank's offices are primarily located in Northwest Ohio, Northeast Indiana and Southeast Michigan, a substantial amount of the loan portfolio is comprised of loans made to customers in the farming industry for such items as farmland, farm equipment and operating loans for seed, fertilizer, and feed. Other types of lending activities include loans for home improvements, and loans for the purchase of autos, trucks, recreational vehicles, motorcycles, and other consumer goods.

The Bank also provides checking account services, as well as savings and time deposit services such as certificates of deposits. In addition, Automated Teller Machines (ATMs) or Interactive Teller Machines (ITMs) are provided at most branch locations along with other independent locations in the market area. ITMs operate as an ATM with the addition of remote teller access to assist the user. The Bank has custodial services for Individual Retirement Accounts (IRAs) and Health Savings Accounts (HSAs). The Bank provides on-line banking access for consumer and business customers. For consumers, this includes bill-pay, on-line statement opportunities and mobile banking. For business customers, it provides the option of electronic transaction origination such as wire and Automated Clearing House (ACH) file transmittal. In addition, the Bank offers remote deposit capture or electronic deposit processing. Mobile banking has been widely accepted and used by consumers. Upgrades to our digital products and services continue to occur in both retail and business lines. The Bank continues to offer new suites of products as customer preferences change and the Bank adapts and adopts new technologies. The Bank continues to offer products that also meet the needs of our more traditional customers.

The Bank has established underwriting policies and procedures which facilitate operating in a safe and sound manner in accordance with supervisory and regulatory guidance. Within this sphere of safety and soundness, the Bank's practice has been to not promote innovative, unproven credit products which may not be in the best interest of the Bank or its customers. The Bank does offer a hybrid mortgage loan. Hybrid loans are loans that start out as a fixed rate mortgage but after a set number of years automatically adjust to an adjustable rate mortgage. The Bank offers a three year, a five year and a seven year fixed rate mortgage after which the interest rate will adjust annually. In order to offer longer term fixed rate mortgages, the Bank does participate in the Freddie Mac, Farmer Mac and Small Business Lending programs. The Bank also normally retains the servicing rights on these partially or 100% sold loans. In order for the customer to participate in these programs they must meet the requirements established by those agencies. In addition, the Bank does sell some of its longer term fixed rate agricultural mortgages into the secondary market with the aid of brokers. With the acquisition of Perpetual Federal Savings Bank in the fourth quarter of 2021 and the addition of Peoples Federal Savings in the fourth quarter of 2022, the Bank saw an increase in fixed rate, long-term mortgage loans to our portfolio from that banking service area. The Bank began offering a low income home buyer mortgage program, currently Hometown Advantage Mortgage Program, in November of 2023.

The Bank does not have a program to fund sub-prime loans. Sub-prime loans are characterized as a lending program or strategy that targets borrowers who pose a significantly higher risk of default than traditional retail banking customers.

All loan requests are reviewed as to credit worthiness and are subject to the Bank's underwriting guidelines as to secured versus unsecured credit. Secured loans are in turn subject to loan to value (LTV) requirements based on collateral types as set forth in the Bank's Loan Policy. In addition, credit scores of those seeking consumer credit are reviewed and if they do not meet the Bank's Loan Policy guidelines, an additional officer approval is required.

Consumer Loans:

• Maximum loan to value (LTV) for cars, SUVs, and trucks is 110% depending on whether direct or indirect.
• Loans above 100% are generally the result of sales tax.
• Boats, campers, motorcycles, RV's and Motor Coaches range from 80%-90% based on age of vehicle.
• 1st or 2nd mortgages on 1-4 family homes maximum range from 80-85%.
• Raw land LTV maximum ranges from 65%-75% depending on whether or not the property has been improved.

Commercial/Agriculture:

Accounts Receivable:

• Up to 80% LTV less retainages and greater than 90 days.

Inventory:

• Agriculture:
• Livestock and grain up to 80% LTV, crops (insured) up to 75% and Warehouse Receipts up to 87%.
• Commercial:
• Maximum LTV of 50% on raw and finished goods.
• Floor plan:
• New/used vehicles to 100% of wholesale.
• New/Used recreational vehicles and manufactured homes to 80% of wholesale.

Equipment:

• New, not to exceed (NTE) 80% of invoice, used NTE 50% of listed book or 75% of appraised value.
• Restaurant equipment up to 35% of market value.
• Heavy trucks, titled trailers NTE 75% LTV and aircraft up to 75% of appraised value.

Real Estate:

• Maximum LTVs range from 70%-80% depending on type.
• Maximum LTV on non-traditional loan up to 85%.

FM Investment Services, the brokerage department of the Bank, opened for business in April 1999. Securities are offered through Raymond James Financial Services, Inc. In November of 2020, FM Investment Services purchased the assets and clients of Adams County Financial Resources (ACFR) which is discussed in further detail in Note 2 to the Company’s financial statements.

In December of 2014, the Company became a financial holding company within the meaning of the Bank Holding Company Act of 1956 as amended (the “Act”), in order to provide the flexibility to take advantage of the expanded powers available to a financial holding company under the Act. Our holding company is regulated and examined by the Federal Reserve. Our subsidiary bank is in turn regulated and examined by the Ohio Division of Financial Institutions and the Federal Deposit Insurance Corporation. The activities of our bank subsidiary are also subject to other federal and state laws and regulations.

The Bank formed an insurance agency, F&M Insurance Agency, LLC, in November 2023 to offer insurance products to our customers. The insurance agency is organized in Ohio and regulated by the State of Ohio, Division of Insurance.

The Bank’s primary market includes communities located in the Ohio counties of Butler, Champaign, Defiance, Fulton, Hancock, Henry, Lucas, Shelby, Williams, Wood and in the Indiana counties of Adams, Allen, DeKalb, Jay, Steuben and Wells. The Michigan footprint includes Oakland County. In our banking activities, we compete directly with other commercial banks, credit unions, farm credit services, and savings and loan institutions in each of our operating localities. In a number of our locations, we compete against entities which are much larger than us. The primary factors in competing for loans and deposits are the rates charged as well as location and quality of the services provided.

At March 31, 2025, we had 482 full time equivalent employees. The employees are not represented by a collective bargaining unit. We provide our employees with a comprehensive benefit program, some of which is contributory. We consider our employee relations to be good.

RECENT REGULATORY DEVELOPMENTS

The Company and the Bank remain attentive to the current regulatory environment in light of the regulatory agencies’ risk-based approach to examinations and the change in presidential administration. Regulatory changes and the complexity of new and amended rules have resulted in challenges and uncertainties which could pose an increased risk of noncompliance. Various significant mortgage rules require monitoring by means of testing, validation of results, additional training, and further research or consultation to ensure ongoing compliance.

Under the Truth in Lending Act (TILA) Ability to Repay requirements, the Bank focuses on Qualified Mortgage (QM) status for mortgage loans originated as they provide certain presumptions of compliance under the Ability to Repay rules adopted under the Dodd-Frank Act. In satisfying QM requirements, any mortgage lender regardless of their size can make loans which are entitled to the QM presumption of compliance. New final rules, effective October 2022, amended the Ability to Repay/Qualified Mortgage Rules. The General QM Final Rule amended the definition of the QM category to offset the impact of the sunsetting of the temporary Government Sponsored Enterprise (GSE) QMs. The General QM loan definition amended and removed the 43% debt-to-income limit, eliminated Appendix Q underwriting standards and any requirement to use them as a qualification for General QM status, and instead implemented price-based thresholds. For General QM status, applicable to first-lien mortgage loans offered by the Bank, a loan must still observe existing product features, underwriting requirements, and limits on points and fees. Since the Bank, on occasion, does make Non-Qualified Mortgages, approvals and originations of both Non-QM loans and Higher Priced Mortgage Loans are periodically reported to the Bank’s Loan Committee.

On March 30, 2023, the Consumer Financial Protection Bureau (CFPB) issued final rules which amended Regulation B to implement changes to the Equal Credit Opportunity Act (ECOA) as made by Section 1071 of the Dodd-Frank Act. Covered financial institutions were required to collect and report data on covered credit applications involving small businesses, including those businesses owned by women or minorities. Small businesses were defined as those businesses (including agricultural businesses) which had gross annual revenue of $5 million of less during its most recent fiscal year. Data collection involved demographic information collected from a loan applicant regarding that applicant’s status as a minority-owned business, a women-owned business, and an LGBTQI+-owned business, as well as the applicant’s principal owners’ ethnicity, race, and sex. Applicants could refuse to provide demographic information. Implementation of these final rules would involve significant changes to processes and procedures along with new software configurations to accommodate and capture required data points regarding applications and final action taken. Data would be reported to the CFPB which would then make aggregated information publicly available. These new final rules had a phased implementation period with the largest lenders being required to collect and report data first. A Lender, such as the Bank, that originated at least 500 covered small business loans annually, data collection would have originally commenced on April 1, 2025.

A lawsuit filed in April 2023 by the Texas Bankers Association and Rio Bank based in McAllen, Texas in the U.S. District Court for the Southern District of Texas challenged the CFPB's final rule implementing Section 1071 of the Dodd-Frank Act. Shortly thereafter, the American Bankers Association joined the lawsuit as a plaintiff. The argument was the final rule far exceeded the statutory scope of Section 1071, failed to take into consideration relevant industry comments, and did not conduct appropriate cost-benefit analysis. Additionally, the constitutionality of the CFPB was challenged based on its funding structure, and was also based upon another pending lawsuit which awaited a hearing by the U.S. Supreme Court regarding CFPB's funding. On July 31, 2023, an injunction was granted by a federal judge in the Southern District of Texas banning the CFPB from requiring Rio Bank, and members of both the Texas Bankers Association and the American Bankers Association from complying with the final rules implementing Section 1071 of the Dodd-Frank Act until the Supreme Court of the United States rules on the CFPB's funding. On August 4, 2023, a motion was filed by the Independent Community Bankers of America, the Independent Bankers Association of Texas, and Texas First Bank in the U.S. District Court for the Southern District of Texas requesting expansion of the injunction previously granted. In late October 2023, the federal judge granted the expansion of the injunctive relief to provide a nationwide injunction to all community banks and covered financial institutions thus ensuring relief was not limited by trade association membership. The U.S. Supreme Court issued its long-awaited decision on the challenge to the CFPB’s funding mechanism on May 16, 2024. The Supreme Court ruled that the CFPB’s funding does not violate the U.S. Constitution’s Appropriations Clause. Subsequently, the CFPB issued an interim final rule on June 25, 2024, to make date related adjustments on a day for day basis based on recent court orders involving ongoing litigation. This extended compliance dates for beginning data collection by 290 days. As of February 7, 2025, an order issued by the New Orleans First

Circuit Court of Appeals granted a stay pending appeal and deadlines for compliance were extended further. Recently, the Bank remains attentive to the ongoing arguments, appeals, and related cases in the litigation involving the Section 1071 final rule, as well as the CFPB’s actions on further rulemaking to replace or change the current rule.

A final rule to amend the Community Reinvestment Act (CRA) was jointly released by the Federal Reserve, the FDIC, and Office of the Comptroller of the Currency on October 24, 2023. These amendments were intended to update how CRA activities qualify for consideration, where CRA activities are considered, and how CRA activities are evaluated. The final rule was effective on April 1, 2024, with certain amendments effective April 1, 2024, through January 1, 2031, and other amendments in the final rule were delayed indefinitely. The final CRA rules were published in the Federal Register on February 1, 2024. On February 5, 2024, the American Bankers Association, the U.S. Chamber of Commerce, the Independent Community Bankers of America, along with four state associations jointly sued the Federal Reserve, FDIC, and Office of Comptroller of the Currency for exceeding their statutory authority. The lawsuit filed in the U.S. District Court for the Northern District of Texas requested the regulatory agencies vacate the rule and sought a preliminary injunction pausing the new rules while the court decided the merits of the case. On March 21, 2024, the joint regulatory agencies issued an interim final rule and a technical corrections final rule related to the CRA final rule both effective on April 1, 2024. The Agencies also requested comments on the interim final rule for a period of 45 days after publication in the Federal Register. The interim final rule extended two provisions of the CRA final rule from April 1, 2024, to January 1, 2026. Then on March 29, 2024, the district court judge granted a temporary injunction to pause the implementation of CRA final rule while the case moves forward. The injunction extended implementation dates on a day for day basis for each day the injunction remains in place. A joint press release on March 28, 2025, announced the joint agencies intent to rescind the 2023 Community Reinvestment Act Final Rule and reinstate the CRA framework that existed prior to the October 2023 final rule. As a large bank examined for its CRA performance, the Bank remains attentive to the CRA framework in place prior to the October 2023 final rule.

With regard to all regulatory matters, the Company and the Bank remain committed in making good faith efforts to comply with technical requirements of the laws, rules, regulations, and guidance from both federal and state agencies which govern its activities.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, and the Company follows general practices within the financial services industry in which it operates. At times the application of these principles requires management to make assumptions, estimates and judgments that affect the amounts reported in the financial statements and accompanying notes.

These assumptions, estimates and judgments are based on information available as of the date of the financial statements. As this information changes, the financial statements could reflect different assumptions, estimates and judgments. Certain policies inherently have a greater reliance on assumptions, estimates and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Examples of critical assumptions, estimates and judgments are when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not required to be recorded at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability must be recorded contingent upon a future event. These policies, along with the disclosures presented in the notes to the condensed consolidated financial statements and in the management's discussion and analysis of the financial condition and results of operations, provide information on how significant assets and liabilities are valued and how those values are determined for the financial statements. Based on the valuation techniques used and the sensitivity of financial statement amounts to assumptions, estimates, and judgments underlying those amounts, management has identified the Allowance for Credit Losses (ACL) as the accounting area that requires the most subjective or complex judgments, and as such could be the most subject to revision as new information becomes available.

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at amortized cost. Amortized cost is the principal balance outstanding, net of purchase premiums and discounts, deferred loan fees and costs. Accrued interest receivable totaled $10.9 million and $10.7 million at March 31, 2025 and December 31, 2024, respectively, and was reported in Other Assets on the condensed consolidated balance sheets and is excluded from the estimate of credit losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipation of repayments.

Interest income on mortgage and commercial loans is discontinued and placed on nonaccrual status at the time the loan is 90 days delinquent unless the loan is well secured and in process of collection. Mortgage loans are charged off at 180 days past due and commercial loans are charged off to the extent principal or interest is deemed uncollectible. Consumer loans continue to accrue interest until they are charged off no later than 120 days past due unless the loan is in the process of collection. Past-due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Under the cost-recovery method, interest income is not recognized until the loan balance is reduced to zero. Under the cash-basis method, interest income is recorded when the payment is received in cash. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The ACL represents management’s estimate of expected credit losses inherent in the Bank’s loan portfolio and unfunded loan commitments at the report date. The ACL methodology is regularly reviewed for its appropriateness and is approved annually by the Board of Directors. This written methodology is consistent with Generally Accepted Accounting Principles which provides for a consistently applied analysis.

The ACL is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when management believes the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. The ACL reflects the Company’s estimated credit losses over the life of the loan. Management assesses changes in prepayment assumptions, interest rates, collateral values, portfolio composition, trends in non-performing loans, and other economic factors. In addition to an extensive internal loan monitoring process, the Company also aims to have an annual external, independent loan review of approximately 35% of its commercial and agricultural loan portfolio. Management in turn assesses the results from the reviews to make changes in internal risk ratings of loans and the related ACL.

The Bank’s methodology provides an estimate of the expected credit losses either by calculating a reserve per credit or by applying our methodology to groupings based on similar risk characteristics. The loan portfolio was grouped based on loans of similar type, including acquired loans. The loan groupings for the CECL calculation consist of Commercial Real Estate, Commercial & Industrial, Agricultural Real Estate, Agricultural, Consumer Real Estate and Consumer. All groups use the average charge-off method for calculating the ACL. This incorporates a historical loss period from March 2000, since Call Report data became more granular regarding loan groupings, and includes several economic cycles. As a percentage, the reserves are the highest against construction and development loans, while farmland loans have the lowest overall reserve due to having such low loss rates.

The Company is utilizing peer data from a peer group of 316 banks in the region of Ohio, Michigan and Indiana with asset sizes less than $5 billion as of March 31, 2025. The reserves are calculated at the loan level and based on the note characteristics, essentially balances times loss rate + qualitative factors + forward look, with the forward looking forecast eliminated after 12 months. In order to provide a reasonable and supportable forward looking forecast, a regression analysis of the Bank’s historical loss rates against the Federal Open Market Committee (FOMC) quarterly economic projections for National Unemployment is completed. Annual projections are broken down using a straight-line approach for quarterly changes.

In addition to this quantitative analysis, management also utilizes qualitative analysis each quarter as a component of the ACL. The qualitative factors include nine categories: ability of staff, changes in collateral values, changes in loan concentration levels, economic conditions, external factors such as regulatory, level and trends in non-accrual or adversely classified loans, loan review results, nature and volume of the portfolio and loan terms, and changes in lending policies and procedures. The methodology allows for additional qualitative factors as other risks emerge. Items within these categories are ranked as baseline, low, medium, or high levels of risk, and the related risk level per categories dictates the level of qualitative factor that is used depending on the standard deviation level from historical loss.

Loans that do not share risk characteristics are evaluated on an individual basis. Loans evaluated individually are not included in the collective evaluation; reserves for expected credit losses for collateral-dependent loans are based on the expected shortfall of the loan based on the discounted collateral value. This specific reserve portion of the ACL was $159 thousand at March 31, 2025 and $52 thousand at December 31, 2024. When management determines that foreclosure is probable, expected credit losses are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate. At 90 days delinquent, secured consumer loans are charged down to the value of the collateral, if repossession of the collateral is assured and/or in the process of repossession. Consumer mortgage loan deficiencies are charged down upon the sale of the collateral or sooner upon the recognition of collateral deficiency.

Expected credit losses are estimated over the contractual term of the loans, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals, and modifications unless either of the following applies: management has a reasonable expectation at the reporting date that a modification to a borrower experiencing financial difficulty will be executed with an individual borrower or the extension or renewal options are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the Company.

The Company estimates expected credit losses over the contractual period in which the Company is exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the Company. The allowance for credit losses on off-balance sheet credit exposures is adjusted as a provision for credit loss expense. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life. The loan categories of off-balance sheet exposures are the same as the loan categories for the ACL. The funding assumptions are updated each quarter based on expected utilization percentages.

For more information regarding the actual composition and classification of loans involved in the establishment of the allowance for credit loss, please see Note 4 provided with the notes to consolidated financial statements.

MATERIAL CHANGES IN FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

For 2025, the Company plans to have modest loan growth and continue to focus on earnings improvement. Paydowns and payoffs will be used to fund originations to existing customers and to build relationships in our newer markets. Loan balances as of March 31, 2025, were $19.4 million or 0.08% higher than December 31, 2024 balances and there remains $97.8 million of funds committed to complete construction projects of business customers as of March 31, 2025.

The Company continues to focus on growth in the areas of core deposits and the expansion of contingency funding. Growing deposits has been a focus especially in our newer markets throughout 2024 and continues into 2025. Core deposits provide additional opportunities for noninterest income. The Bank offers the Insured Cash Sweep (ICS) product and CDARS, a certificate of deposit registry, accessed through the IntraFi network of financial institutions which helps to reduce the amount of pledged securities needed. The Bank’s uninsured deposit ratio remains low at 12.1%. As of March 31, 2025, total uninsured deposits of the Bank were $327.0 million of $2.7 billion total deposits. If the amount of coverage is adjusted for what is insured by FDIC alone, the percentage is 21.5% or $579.3 million of uninsured deposits as of March 31, 2025. The underlying difference between these two percentages is the protection required for public funds for which the Bank pledges securities. A State insurance fund exists for public funds in Indiana. The state of Michigan also does not require the pledging of collateral for public funds though some entities do request it.

Deposits have increased $13.5 million as of March 31, 2025 since December 31, 2024, while cash and cash equivalents have decreased $3.3 million over the same time period. The nearly $173.0 million of cash holdings represents 5.1% of total assets and 6.4% of total deposits as of March 31, 2025. The Bank is comfortable with operating at this level as 5% is the guideline the Bank has established. Since March 31, 2024, deposits have increased $78.9 million, or 3.0%, while cash and cash equivalents have decreased $14.7 million or 7.9%. Management has continued to hold biweekly meetings to discuss liquidity in order to be more responsive to opportunities and threats as they arise.

During the first quarter 2025, borrowings from the FHLB decreased $585 thousand through normal paydowns. The Bank has utilized four sources for brokered CDs in 2024 for a total of $26.9 million. This was done to establish relationships to test the access of such funds and decrease the cost of funds going forward. To assure a proper net interest margin over the 3 and 4-year time period of these CDs, the Bank internally looked at loan originations in the first quarter with similar or slightly longer fixed interest rate periods. The Bank also tested all correspondent borrowing lines during the first quarter of 2025 to assure availability should the need arise. The availability for overnight borrowing on unsecured Federal Funds lines is $163.0 million. Combining the available line of credit at the holding company level, the Company has $178 million overnight borrowing availability.

In comparing to the same prior year period, the March 31, 2025 (at amortized cost) loan balances of $2.6 billion accounted for $39.8 million or 1.6% increase when compared to 2024. The year over year improvement was made up of an increase in commercial and industrial related loans of 4.1%. Individual growth was comprised of 8.7% in non-real estate commercial loans, 1.6% in commercial real estate loans and 20.3% in agricultural loans as we saw a slightly heightened use in lines of credit. Consumer real estate loans decreased by 0.3% while consumer loans decreased by 19.6%. Agricultural related loans increased 4.1% year over year. Individual growth was comprised of 20.3% in non-real estate agricultural loans partially offset by a decline of 5.1% in agricultural real estate loans. Other loans decreased by 6.7%. The Company's strong team of lenders remain focused on providing customers valuable localized services and thereby increasing our market share. The acquisition of Peoples Federal Savings and Loan Association in the fourth quarter of 2022 brought $101.8 million of loans to the portfolio. See Note 2 to the consolidated financial statements.

The chart below shows the breakdown by portfolio segment as of March 31, for the last three years, at amortized cost.

(In Thousands)

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The Bank maintains a well-balanced, diverse and high performing commercial real estate loan portfolio. Gross commercial real estate loans, excluding deferred loan fees and costs, represented 51.34% of the Company's total gross loan portfolio as of March 31, 2025. The below charts break out the commercial real estate (CRE) portfolio segment by category, location and loan grade.

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The following is a contractual maturity schedule by portfolio segment at amortized cost excluding fair value adjustments related to acquisitions as of March 31, 2025.

(In Thousands)

Management feels confident that liquidity needs can be met through additional maturities from the security portfolio, increased deposit generating efforts and additional borrowings. For short term needs, the Bank has the unsecured borrowing capacity through its correspondent banks mentioned above along with access to $163.7 million through a Cash Management Advance with the FHLB as of March 31, 2025. The Bank's secured borrowing capacity limits at the FHLB would have allowed draws based on current collateral pledging of $197.7 million on March 31, 2025.

While the security portfolio has been utilized to fund loan growth in previous periods, additional sources have been cultivated during 2024 and 2025. The security portfolio increased in the first three months of 2025 from year end 2024 due to purchases of $13.8 million offset by maturities and paydowns of $8.2 million, net amortization of $0.1 million and a $6.5 million decrease in unrealized losses. The amount of pledged investment securities increased by $20.2 million as compared to year end and increased $13.9 million as compared to March 31, 2024. As of March 31, 2025 pledged investment securities totaled $271.9 million. The Company does plan to do additional purchases of securities the remainder of the year for the purposes of increasing our investment holdings in Community Reinvestment Act (CRA) qualifying securities, liquidity and contingency planning and as a means of balance sheet gap management.

As mentioned previously, an additional $197.7 million is also available to the Bank from the FHLB based on current amounts of pledged collateral. The Bank has pledged eligible 1-4 family, home equity, commercial real estate, multifamily real estate portfolios and specific securities. Multifamily real estate was added to our assets pledged to the FHLB in second quarter 2024 and additional commercial real estate holdings were designated as pledges to increase the availability in first quarter 2024. The CRE holdings may be adjusted quarterly to replace paydowns or increase availability of funds. Based on total asset capacity, the Bank would have nearly $1.1 billion available to borrow.

With the exception of FHLB stocks, carried at cost, which is shown as other securities, all of the Company’s security portfolio is categorized as “available-for-sale” and as such is recorded at fair value.

Overall total assets increased only 0.7% or $24.1 million since year end 2024. The largest areas of growth occurred in the loan portfolio of $19.4 million and in the security portfolio of $12.0 million which was discussed above.

Total deposits accounted for the largest growth within liabilities of $13.5 million or 0.5%. The mix of deposits saw increases in interest bearing checking, savings and money market deposits offset by decreases in time deposit accounts and noninterest bearing accounts since December 31, 2024. The Bank is adjusting its checking product offerings to decrease the number of overall types and provide better service to our customers.

Shareholders’ equity increased by $9.4 million as of the first quarter of 2025 compared to year end 2024. Earnings exceeded dividend declarations during the three months ended March 31, 2025. Accumulated other comprehensive loss decreased in unrealized loss position by $5.1 million from December 2024 to an unrealized loss of $20.1 million on March 31, 2025. Dividends declared remained unchanged from the prior quarter at $0.22125 per share and were 0.6% over first quarter 2024’s $0.22 per share. Compared to March 31, 2024, shareholders’ equity increased 8.5% or $26.9 million with $10.5 million attributed to an improvement in accumulated other comprehensive loss. Net income was higher for the quarter ended March

2025 compared to March 2024 by $1.6 million; however, $1.4 million lower than fourth quarter 2024. We are encouraged that net interest income has continued to improve quarter over quarter since third quarter 2023.

Basel III regulatory capital requirements include a capital conservation buffer of 2.5%. As of March 31, 2025, the Company and the Bank are both positioned well above the current requirement.

While the Holding Company generally has sufficient liquidity to maintain its dividend policy without relying on the upstreaming of dividends from the Bank, the Bank declared a $3.5 million dividend during the first quarter of 2025.

The Bank continues to be well-capitalized at March 31, 2025 in accordance with Federal regulatory capital requirements as the capital ratios below show:

The implementation of ASU 2016-13 (CECL) resulted in an entry which reduced retained earnings $3.4 million on January 1, 2023. This adjustment is permitted to be spread over three years when calculating regulatory capital, which for 2023 was over $2.5 million. This adjustment decreased to $1.7 million for 2024 and $843 thousand for 2025.

MATERIAL CHANGES IN RESULTS OF OPERATIONS

Comparison of Results of Interest Earnings and Expenses for three month periods ended March 31, 2025 and 2024

Interest Income

When comparing first quarter 2025 to first quarter 2024, average loan balances only grew $1.4 million which represented a 0.1% increase in a one-year time period. Interest income on loans increased $1.9 million or 5.3% as compared to the quarter ended March 31, 2024. The Company's loan portfolio is 40.2% variable rate with 23.2% of total loans subject to repricing within the next three months and 33.8% of total loans subject to repricing within the next twelve months.

The available-for-sale securities portfolio increased in average balances by $70.8 million when comparing to the same quarter in 2024 while the income associated with the security portfolio increased $1.0 million over first quarter 2024. The increased balances were the result of increasing our holdings for liquidity and contingency planning purposes and to improve our investments in CRA qualifying securities. Federal funds sold and interest bearing deposits decreased in average balances by $4.6 million as compared to the same quarter in 2024 with decreased income of $569 thousand for the current quarter. The decreased balances are the result of funding loan growth, purchases of available-for-sale securities and repayment of other borrowed money.

The overall total average balance of the Bank’s earning assets increased by $67.6 million and interest income for the quarter comparisons was higher for first quarter 2025 by 6.1% or $2.3 million as compared to first quarter 2024. Rate changes between periods have contributed to approximately 89.1% of the growth.

Annualized yield, for the quarter ended March 31, 2025, was 5.19% as compared to 5.00% for the quarter ended March 31, 2024. The following charts demonstrate rate increases accounted for 99.0% of the increased loan interest income while increased loan balances accounted for the remaining 1.0%. The yields on tax-exempt securities and the portion of the tax-exempt IDB loans included in loans have been tax adjusted based on a 21% tax rate in the charts to follow. The tax-exempt interest income was $115 and $157 thousand for the first quarter 2025 and 2024 which resulted in a federal tax savings of $24 and $33 thousand, respectively.

(In Thousands)

Change in Interest Income Quarter to Date March 31, 2025 Compared to March 31, 2024

(In Thousands)

Interest Expense

Contributing to the increased net interest income for the quarter was a decrease in interest expense of just under $1.5 million or 7.8% compared to first quarter 2024. Since 2024, average interest bearing deposit balances have increased $77.1 million or 3.7% while the Company recognized $1.3 million less in interest expense for the most recent quarter. During 2024, the Federal Reserve decreased the federal funds rate by 50 basis points in September and 25 basis points in November and December. Deposit rates have been adjusted numerous times with all the rate changes. The following charts demonstrate increased average interest bearing deposit balances accounted for 34.4% of additional interest bearing deposit expense while rate decreases accounted for decreased interest bearing deposit expense of 134.4%.

Interest expense on FHLB borrowings and other borrowings decreased $139 thousand in the first quarter 2025 over the same time frame in 2024 due to the repayment of FHLB advances. During the current quarter, FHLB borrowings of $585 thousand were paid down. Interest expense on fed funds purchased and securities sold under agreement to repurchase decreased $13 thousand compared to first quarter 2024 due to the decrease of $978 thousand in average balances. Cost of funds decreased even with growth in interest bearing deposit balances offset by decreased borrowings and decreased noninterest bearing deposits balances of $13.9 million compared to first quarter 2024. The Bank continues to focus on capturing the full customer relationship; however, it has sometimes resulted in more expensive deposits being brought in. The average cost of funds decreased to 2.76% in first quarter 2025 compared to 3.06% in first quarter 2024. Refer to Note 11 for additional information on subordinated notes.

(In Thousands)

59

Change in Interest Expense Quarter to Date March 31, 2025 Compared to March 31, 2024

(In Thousands)

As the following chart indicates, the improvement in yields on interest earning assets of 19 basis points combined with the decreased cost of funds of 30 basis points equated to a 49 basis point improvement in net interest spread when comparing to the same period a year ago. Competition for deposits remains intense with most competitors offering special rates for specific terms.

Net Interest Income

Net interest income increased approximately $3.8 million for the first quarter 2025 over the same time frame in 2024 due to the increase in interest income of $2.3 million combined with the interest expense decrease of approximately $1.5 million as previously mentioned. As the new loans added in 2024 and 2025 generate more income, management expects the benefits of the Company’s strategy of repositioning the balance sheet to increase interest income in the long run. Loans as a percentage of earning assets decreased to 81.6% in first quarter 2025 compared to 83.3% in first quarter 2024. Loans to total assets decreased to 77.5% in first quarter 2025 compared to 79.2% for the same period 2024. The percentage of earning assets to total assets decreased slightly to 95.0% in 2025 compared to 95.1% in 2024. In terms of net interest margin, the Bank recognizes competition for deposits will continue; however, there is a greater opportunity for gradual improvement with loans repricing upwards in the next year and a likely continuing decrease in cost of funds.

Comparison of Noninterest Results of Operations for three month periods ended March 31, 2025 and 2024

Provision Expense

The Allowance for Credit Losses (ACL) has a direct impact on the provision expense. The increase in the ACL is funded through recoveries and provision expense.

Total provision for credit losses increased $1.1 million for the three months ended March 31, 2025 as compared to the same period in 2024. Management continues to monitor asset quality, making adjustments to the provision as necessary. The impact of higher interest rates and inflation are taken into consideration when reviewing qualitative factors. Loan charge-offs were $143 thousand higher during the three months ended March 31, 2025 than the same period in 2024. Recoveries were $87 thousand lower during the three months ended March 31, 2025 as compared to same period in 2024. Combined net charge-offs were $230 thousand higher in the three months ended March 31, 2025 than the same time period 2024.

Loans past due 30 or more days decreased $12.5 million at March 31, 2025 as compared to March 31, 2024. The largest changes were attributed to the combined decrease of past due balances of $14.6 million in the agricultural and agricultural real estate portfolio segments. The consumer real estate portfolio segment past due balances increased $2.5 million for the same time period.

The following table breaks down the activity within the ACL for each portfolio segment and shows the contribution provided by both recoveries and the provision, along with the reduction of the allowance caused by charge-offs. The time period covered is for the three months ended March 31, 2025, 2024, and 2023.

(In Thousands)

*Nonperforming loans are defined as all loans on nonaccrual, plus any loans past due 90 days not on nonaccrual.

The balance of loans, amortized cost at March 31, 2025 and March 31, 2024 within this chart does not include a fair value basis adjustment for derivatives of $1.7 million and $969 thousand, respectively, or a daily average outstanding balance of $1.2 million and $2.0 million, respectively.

Loans classified as nonaccrual were lower as of March 31, 2025 at $4.5 million as compared to $19.4 million as of March 31, 2024. The agricultural real estate portfolio segment accounted for 79.2% or $11.8 million of the decrease as compared to March 31, 2024. The agricultural portfolio segment decreased $4.3 million compared to March 31, 2024. The commercial and industrial portfolio segment decreased $473 thousand while the consumer real estate portfolio segment increased $1.7 million compared to March 31, 2024.

The agricultural portfolio segment along with the consumer portfolio segment accounted for the largest component of recoveries while the consumer portfolio segment accounted for the largest component of charge-offs for the three months ended March 31, 2025 versus the commercial and industrial portfolio segment and consumer portfolio segment which accounted for the largest components of recoveries and the largest component of charge-offs for the three months ended March 31, 2024.

The following table presents the balances for allowance for credit losses per portfolio segment in terms of dollars, as a percentage of ACL and as a percentage of loans at March 31, 2025 and March 31, 2024.

Noninterest Income

Noninterest income was up $216 thousand, or 5.5%, for the three months ended March 31, 2025 over the same time frame in 2024. Other service fees increased by $67 thousand as compared to the three months ended March 31, 2024. Customer service fees decreased by $217 thousand compared to the same period in 2024. Mortgage release fees, which are included in customer service fees, decreased $148 thousand over the same time period in 2024. Servicing rights income for 1-4 family real estate and agricultural real estate loans increased $223 thousand as compared to the same period in 2024 due to an increase in real estate loans sold as discussed below. Bank owned life insurance cash surrender value increased $28 thousand.

The Company has seen improvement in mortgage production volume partially due to the improvement of midrange value housing inventory in many of our markets. The gain on the sale of these loans was $177 thousand higher for the three months ended March 31, 2025 over the same period in 2024. Total originations of loans held for sale for the three months ended March 31, 2025 were $13.0 million with proceeds from sale at $13.9 million for 2025 compared to 2024’s activity of $8.5 million in originations and $6.8 million in sales. The mortgages sold were both 1-4 family real estate and agricultural real estate loans originated for sale.

The impact of loan servicing rights, both to income and expense, is shown in the following table which reconciles the value of loan servicing rights. The capitalization runs through noninterest income while the amortization thereof is included in noninterest expense. For the three months ended March 31, 2025 and 2024, loan servicing rights caused a net $100 thousand in income and $93 thousand in expense, respectively. Capitalized additions of agricultural real estate loan servicing rights were $170 thousand for the three months ended March 31, 2025. There were no capitalized additions during the comparable period in 2024. Amortization of agricultural real estate loan servicing rights were $65 thousand and $60 thousand for the same time periods, respectively. For 1-4 family real estate loans of 15 years and less, the market value of the loan servicing rights was 1.277% in the first quarter 2025 versus 1.177% in first quarter 2024. For 1-4 family real estate loans over 15 years, the value was 1.520% versus 1.354% for the same periods respectively. At March 31, 2025, the carrying value of certain strata were slightly below the market value thus requiring the establishment of a $2 thousand valuation allowance for 1-4 family real estate and a $46 thousand valuation allowance for agricultural real estate servicing rights.

(In Thousands)

Noninterest Expense

For the three months ended March 31, 2025, noninterest expenses were $919 thousand or 5.2% higher than for the same period in 2024. Salaries and wages, including normal merit increases, restricted stock expense and incentive payouts, increased $32 thousand in total. Salaries and deferred costs decreased $128 thousand from last year. Restricted stock expense decreased $81 thousand. An increase to our incentive accrual to match potential payout accounted for $242 thousand. The increase was due to the investment in people for our strategic growth initiative and staffing of new offices. Benefits increased over 2024 with the increased medical expense of $192 thousand and taxes of $114 thousand offset with reductions in pension of $88 thousand. The additional cost of the offices is also evident in the increased expenses in net occupancy with additional lease expense of $172 thousand and building depreciation of $59 thousand. Furniture and equipment decreased $75 thousand.

Consulting fees increased $560 thousand over the same period in 2024. Data processing expenses and ATM expense increased a combined $75 thousand. General and administrative expense increased $151 thousand. The other items on this line of significance include an increase in charitable giving and postage and printing expenses of $93 thousand combined and debit card losses of $19 thousand.

Income Taxes

Income tax expense was $389 thousand higher for the three months ended March 31, 2025 compared to the same period in 2024 based mainly on higher earnings. Amortization of qualified affordable housing projects caused income tax expense to increase $112 thousand and $110 thousand for the three months ended March 31, 2025 and 2024, respectively, as presented in Note 8. Effective tax rates were 20.64% and 20.94% for 2025 and 2024, respectively. Excluding the additional $112 and $110 thousand of income tax expense, the effective tax rates would have been 19.36% and 19.31% for the three months ended March 31, 2025 and 2024, respectively.

Net Income

Overall, net income in the three months ended March 31, 2025 was up $1.6 million or 29.7% to $7.0 million as compared to last year's $5.4 million. The biggest contributor to the improvement was net interest income. Net interest income was up $3.8 million or 18.8% as the increased interest income exceeded the increased interest expense. Provision for credit losses for loans and unfunded commitments increased $1.1 million compared to 2024. Noninterest income increased $216 thousand and noninterest expense increased $919 thousand as described above. The Company remains strong, stable, and well capitalized and has the capacity to continue to cover the increased costs of expansion. The Company is optimistic for continued improvement in profitability due to the opportunity for continued expansion in the net interest margin.

FORWARD LOOKING STATEMENTS

Statements contained in this portion of the Company's report may be forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by the use of words such as "intend," "believe," "expect," "anticipate," "should," "planned," "estimated," and "potential." Such forward-looking statements are based on current expectations, but actual results may differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, factors discussed in documents filed by the Company with the Securities and Exchange Commission from time to time. Other factors which could have a material adverse effect on the operations of the Company and its subsidiaries include, but are not limited to, changes in interest rates, general economic conditions, legislative and regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality and composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Bank's market area, changes in relevant accounting principles and guidelines and other factors over which management has no control. The forward-looking statements are made as of the date of this report, and the Company assumes no obligation to update the forward-looking statements or to update the reasons why actual results differ from those projected in the forward-looking statements.

Market risk is the exposure to loss resulting from changes in interest rates and equity prices. The primary market risk to which we are subject is interest rate risk. Much of our interest rate risk arises from the instruments, positions and transactions entered for purposes other than trading such as loans, available for sale securities, interest bearing deposits, short-term borrowings and long-term borrowings. Interest rate risk occurs when interest bearing assets and liabilities reprice at different times as market interest rates change. For example, if fixed rate assets are funded with variable rate debt, the spread between asset and liability rates will decline or turn negative if rates increase.

Interest rate risk is managed within an overall asset/liability framework. The principal objectives of asset/liability management are to manage sensitivity of net interest spreads and net income to potential changes in interest rates. Funding positions are kept within predetermined limits designed to ensure that risk-taking is not excessive and that liquidity is effectively managed. If our asset/liability management strategies are unsuccessful, our profitability may be adversely affected. The Company employs a sensitivity analysis utilizing interest rate shocks to help in this analysis.

At March 31, 2025, the shocks presented assume an immediate change of rate in the percentages and directions shown:

The Bank’s balance sheet is slightly asset-sensitive after coming through 100 bps of Fed rate cuts from September through December 2024. The net interest margin represents the forecasted twelve-month margin. The Company also reviews shocks with a 4.00% fluctuation and over a 24-month time frame. The goal of the Company is to gather more core deposits, such as checking and savings accounts. Checking accounts are preferable for the lower cost of funds whereas savings and money market accounts are beneficial due to the variability of the interest in both rate and immediate option to reprice. CD pricing is more favorable for the Bank in shorter terms now that the yield curve has normalized somewhat for longer term rates.

The Bank was aggressive in dropping its non-maturity deposit rates in the last 4 months of 2024 while the Fed was cutting their rate. We will have some continued opportunity to be aggressive with future Fed rate cuts, particularly with our higher deposit rates. While net interest income drops in a falling interest rate environment, there are potential revenues and other factors that can insulate the Bank’s overall income, such as prepayment penalty fees, mortgage fees, and rate floors. The Bank’s monthly cost of funds dropped from 2.89% in December 2024 to 2.81% in March 2025. Older loans and investments will continue to reprice higher, in aggregate, in the next twelve months based on current rates. The Bank continues to review and adjust its assumptions concerning decay rates, deposit betas, key rate ties, and loan prepayment speeds. Rates are modified as index rates change. Directional changes shown above are within the Bank's risk tolerance. The effect of the rate shocks may be mitigated to the extent that not all lines of business are directly tied to an external index and actual balance sheet composition may differ from prediction.

Overall, the Company must continue its trajectory of improved pricing discipline for its new loans and deposits.

As of the end of the period covered by this quarterly report on Form 10-Q, an evaluation was performed under the supervision and with the participation of the Company's management including the CEO and CFO, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, the Company's management, including the CEO and CFO, concluded that the Company's disclosure controls and procedures were effective as of the end of the period covered by this report. There have been no changes in the Company's internal control over financial reporting that occurred during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.

Except as indicated below, there have been no material changes in the Company’s risk factors from those disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2024.

Inflation Risk

Periods of inflation may impact our profitability by negatively impacting our fixed costs and expenses, including increasing funding costs and expense related to talent acquisition and retention. Additionally, inflation may lead to a decrease in our customers’ purchasing power and negatively affect the need or demand for our products and services. If significant inflation continues, our business could also be negatively affected by, among other things, increased default rates leading to credit losses which could decrease our appetite for new credit extensions.

Quantitative Modeling Risk

We rely on quantitative modeling to measure risks and to estimate certain financial values. Quantitative models may be used to help manage certain aspects of our business and to assist with certain business decisions, including estimating expected lifetime credit losses, measuring the fair value of financial instruments when reliable market prices are unavailable, estimating the effects of changing interest rates and other market measures on our financial condition and results of operations, managing risk, and for capital planning purposes. All models have certain limitations. For instance, these methodologies inherently rely on assumptions, historical analyses, and correlations which may not capture or fully incorporate all relevant conditions and circumstances. As a consequence, such limitations may result in losses, particularly in times of market distress. Additionally, as businesses and markets continue to rapidly evolve, our measurements may not accurately reflect this evolution. Even if the underlying assumptions and historical correlations used in our models are adequate, our models may be deficient due to errors in computer code, inaccurate data, misuse of data, or the use of a model for a purpose outside the scope of the model’s design.

Reliance on such models presents the risk that our resulting business decisions will be adversely affected due to incorrect, missing, or misleading information. If our models fail to produce reliable results on an ongoing basis, we may not make appropriate risk management, capital planning, or other business or financial decisions. Strategies that we employ to manage and govern the risks associated with our use of models may not be effective or fully reliable. Also, information that we provide to the public or regulators based on poorly designed models could be inaccurate or misleading.

Trade Policy Risk

The ongoing trade policies and tariff initiatives being pursued by the U.S. government under the administration of President Trump could present potential risks unique to the markets within which we operate. Many of our commercial borrowers operate in agriculture, food processing, and manufacturing; industries that are particularly sensitive to changes in trade policy. The imposition of tariffs on imported goods, the added potential for retaliatory tariffs by foreign governments, or other similar restrictions on international trade could increase costs for domestic manufacturers and consumers alike, as well as reduce demand abroad for U.S. exports, and disrupt supply chains. Any prolonged trade tensions could negatively impact the broader economic environment in the Midwest where the Bank operates, potentially leading to reduced consumer spending, lower economic growth, and decreased demand for other banking products and services. If these factors lead to financial strain on our borrowers, we may experience increased credit risk, higher loan delinquencies, and a potential decline in loan demand.

As a result, our financial performance, including credit quality and loan growth, could be adversely affected by these policy changes. While we actively monitor these developments and work closely with our agricultural customers, there is no assurance that we can fully mitigate the risks posed by tariff initiatives or other trade-related disruptions. These factors could materially affect our business, financial condition, and results of operations.