Consumers Bancorp Inc: Form 10-Q for the period ended Dec 31, 2023

(Dollars in thousands, except per share data)

General

The following is management’s analysis of the Company’s results of operations for the three-and six month periods ended December 31, 2023, compared to the same period in 2022, and the consolidated balance sheet at December 31, 2023, compared to June 30, 2023. This discussion is designed to provide a more comprehensive review of the operating results and financial condition than could be obtained from an examination of the financial statements alone. This analysis should be read in conjunction with the consolidated financial statements and related footnotes and the selected financial data included elsewhere in this report.

Overview

Consumers Bancorp, Inc., a bank holding company incorporated under the laws of the State of Ohio (the Company), owns all the issued and outstanding common shares of Consumers National Bank, a bank chartered under the laws of the United States of America (the Bank). The Company’s activities have been limited primarily to holding the common shares of the Bank. The Bank’s business involves attracting deposits from businesses and individual customers and using such deposits to originate commercial, mortgage and consumer loans in its market area, consisting primarily of Carroll, Columbiana, Jefferson, Mahoning, Stark, Summit, and contiguous counties in Ohio, Pennsylvania, and West Virginia. The Bank also invests in securities consisting primarily of U.S. government sponsored entities, municipal obligations, mortgage-backed and collateralized mortgage obligations issued by Fannie Mae, Freddie Mac and Ginnie Mae.

Results of Operations

Three-and Six Month Periods Ended December 31, 2023 and 2022

Net income for the second quarter of fiscal year 2024 was $2,015, or $0.65 per common share, compared to $2,809, or $0.91 per common share for the three months ended December 31, 2022. The following are key highlights of our results of operations for the three months ended December 31, 2023, compared with the prior fiscal year comparable period:

• net interest income declined by $812, or 9.3%, to $7,964 in the second quarter of fiscal year 2024 from the same prior year period mainly because of the rapid increase in short-term market rates in 2022 and 2023 causing interest bearing liabilities to reprice faster than interest earning assets;
• a $325 provision for credit losses on loans was recorded for the three-month period ended December 31, 2023 compared with a $225 provision for loan loss expense for the same prior year period;
• noninterest income increased by $87, or 7.5%, in the second quarter of fiscal year 2024 from the same prior year period primarily as a result of an increase in service charges on deposit accounts of $41, or 10.5% and an increase in debit card interechange income of $43, or 8.1%; and
• noninterest expenses increased by $111, or 1.8%, in the second quarter of fiscal year 2024 from the same prior year period primarily due to increases in FDIC insurance assessments, salaries and employee benefits, debit card processing, equipment, and software maintenance expenses which were partially offset by a decline in professional expenses.

In the first six months of fiscal year 2024, net income was $4,425, or $1.43 per common share, compared to $5,344, or $1.74 per common share for the six months ended December 31, 2022. The following are key highlights of our results of operations for the six months ended December 31, 2023, compared to the prior fiscal year comparable period:

• net interest income declined by $1,054, or 6.1%, to $16,118 in the first six months of fiscal year 2024 from the same prior year period primarily as a result of the rapid increase in short-term market rates in 2022 and 2023 causing interest bearing liabilities to reprice faster than interest earning assets;
• a $365 provision for credit losses on loans and a $79 provision for credit losses on unfunded commitments was recorded for the six-month period ended December 31, 2023 compared with a $635 provision for loan losses for the same prior year period primarily as a result of the organic growth within the loan portfolio and as a result of adopting ASC 326;
• noninterest income increased by $113, or 4.9%, in the first six months of fiscal year 2024 from the same prior year period primarily as a result of an increase in service charges on deposit accounts of $70, or 8.9%, an increase in debit card interechange income of $54, or 5.0%, which were partially offset by a $79 loss on the sale of available-for-sale securities so the proceeds could be reinvested at higher market rates; and
• noninterest expenses increased by $298, or 2.4%, in the first six months of fiscal year 2024 from the same prior year period primarily due to increases in salaries and employee benefits and FDIC insurance assessments.

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The annualized return on average equity and return on average assets were 16.50% and 0.83%, respectively, for the six months ended December 31, 2023 compared to 21.01% and 1.06%, respectively, for the same prior year period.

Net Interest Income

Net interest income, the difference between interest income earned on interest-earning assets and interest expense incurred on interest-bearing liabilities, is the largest component of the Company’s earnings. Net interest income is affected by changes in the volumes, rates and composition of interest-earning assets and interest-bearing liabilities. In addition, prevailing economic conditions, fiscal and monetary policies and the policies of various regulatory agencies all affect market rates of interest and the availability and cost of credit, which, in turn, can significantly affect net interest income. Net interest margin is calculated by dividing net interest income on a fully tax equivalent basis (FTE) by total average interest-earning assets. FTE income includes tax-exempt income, restated to a pre-tax equivalent, based on the statutory federal income tax rate. The federal income tax rate in effect for the 2024 and 2023 fiscal years was 21.0%. All average balances are daily average balances. Non-accruing loans are included in average loan balances and average securities include unrealized gains and losses on securities available-for-sale, while yields are based on average amortized cost.

The Company’s net interest margin was 2.95% for the three months ended December 31, 2023, compared with 3.53% for the same period in 2022. FTE net interest income for the three months ended December 31, 2023, decreased by $974, or 11.0%, to $7,893 from $8,867 for the same prior year period.

The yield on average interest-earning assets increased to 4.54% for the three months ended December 31, 2023, compared with 4.03% for the same period last year. Tax-equivalent interest income increased by $2,000, or 19.8%, for the three months ended December 31, 2023, from the same prior year period because of a $66,313, or 7.0%, increase in average interest-earning assets as well as the affect of the increase in market interest rates on new and repricing earning assets. Interest expense for the three months ended December 31, 2023 increased by $2,974 from the same prior year period primarily due to an increase in deposit and short-term borrowing costs as a result of higher market interest rates and increased competition for deposits. The Company’s cost of funds increased to 2.17% for the three months ended December 31, 2023 compared with 0.72% for the same prior year period.

The Company’s net interest margin was 3.03% for the six months ended December 31, 2023, compared with 3.51% for the same period in 2022. FTE net interest income for the six months ended December 31, 2023, decreased by $1,380, or 7.9%, to $16,004 from $17,384 for the same prior year period. The net interest margin is expected to continue to be impacted by the rapid increase in the cost of funds because of the competition for deposits and other borrowing costs as well as the inverted yield curve.

The yield on average interest-earning assets increased to 4.51% for the six months ended December 31, 2023, compared with 3.90% for the same period last year. Tax-equivalent interest income increased by $4,497, or 23.3%, for the six months ended December 31, 2023, from the same prior year period because of a $57,277, or 6.0%, increase in average interest-earning assets as well as the affect of the increase in market interest rates on new and repricing earning assets. Interest expense for the six months ended December 31, 2023 increased by $5,877 from the same prior year period primarily due to an increase in deposit and short-term borrowing costs as a result of higher market interest rates and increased competition for deposits. The Company’s cost of funds increased to 2.05% for the six months ended December 31, 2023 compared with 0.57% for the same prior year period.

Average Balance Sheets and Analysis of Net Interest Income for the Three Months Ended December 31, (In thousands, except percentages)

(1) calculated on a fully taxable equivalent basis utilizing a statutory federal income tax rate of 21.0%

Average Balance Sheets and Analysis of Net Interest Income for the Six Months Ended December 31, (In thousands, except percentages)

(1) calculated on a fully taxable equivalent basis utilizing a statutory federal income tax rate of 21.0%

Provision for Credit Losses

On July 1, 2023, the Company adopted ASU 2016-13 CECL which caused an increase in the allowance for credit losses of $52 and the recording of a liability for expected credit losses on unfunded loans and other commitments of $308. The reserve for unfunded commitments is primarily related to 1 - 4 family home equity lines of credit, commercial construction loans, and 1 - 4 family construction loans. The increase in the allowance and the recording of the liability resulted in a decrease in the retained earnings account on our Consolidated Balance Sheet equal to the after-tax impact, with the tax impact portion being recorded in deferred taxes on our Consolidated Balance Sheet in accordance with FASB guidance.

The allowance for credit losses consists of general and specific components. The general component covers loans collectively evaluated for credit loss and is based on peer historical loss experience adjusted for current and forecasted factors. Management's adjustments to the quantitative evaluation may be for trends in delinquencies, trends in the volume of loans, changes in underwriting standards, changes in the value of underlying collateral, the existence and effect of portfolio concentration, regulatory environment, economic conditions, Company management and the status of portfolio administration including the Company’s loan review function.

The specific component includes loans that do not share similar risk characteristics that are evaluated on an individual basis and are excluded from the pooling approach. As of December 31, 2023, individually evaluated loans totaled $11,123 and included the $10,002 third-party residential mortgage warehouse line-of-credit and $1,114 of nonaccrual loans. The warehouse line-of-credit is included in individually evaluated loans because of the unique structure of the loan given the short-term nature of the advances, curtailment features provided by the financial institution that the line-of-credit is issued to, as well as being secured by individual residential properties. As of June 30, 2023, under the incurred loan loss methodology, individually evaluated loans totaled $405 and included $351 of performing loans classified as troubled debt restructurings and $54 of nonaccrual loans. As of December 31, 2023, there was $12 of specific reserves allocated to individually evaluated loans. There was no allowance for credit losses allocated to the individually evaluated loans as of June 30, 2023.

For the six-month period ended December 31, 2023, the provision for credit losses was $444 and included a $365 provision for credit losses on loans and a $79 provision for credit losses on unfunded commitments. This compared with a provision for loan losses of $635 for the same period last year. The allowance for credit losses as a percentage of loans was 1.09% at December 31, 2023 and June 30, 2023. Net charge-offs of $154, or 0.04% of total loans, were recorded during the six-month period ended December 31, 2023 compared with net charge offs of $120, or 0.04% of total loans, for the same period last year.

Non-performing loans were $1,134 as of December 31, 2023, compared with $104 as of June 30, 2023. As of December 31, 2023, non-performing loans includes $602 that is guaranteed by the Small Business Administration. Non-performing loans to total loans were 0.15%, or 0.07% excluding the guaranteed portion, at December 31, 2023 and 0.01% at June 30, 2023. Due to the recent rapid increase in market interest rates uncertainty remains regarding future levels of criticized and classified loans, non-performing loans and charge-offs. Management will continue to closely monitor changes in the loan portfolio and will work with borrowers as needed to mitigate losses to the Company.

Noninterest Income

Noninterest income increased by $87, or 7.5%, for the second quarter of fiscal year 2024 from the same period last year. For the six month period ended December 31, 2023, noninterest income increased by $113, or 4.9%, for the same period last year. The increase in noninterest income for the six month period ended December 31, 2023 was primarily the result of an increase in service charges on deposit accounts of $70, or 8.9% and an increase in debit card interchange income of $54, or 5.0%. These increases were partially offset by a $79 loss on the sale of available-for-sale securities as lower yielding securities were sold in order to reinvest the proceeds into higher yielding loans.

Noninterest Expenses

Total noninterest expenses increased by $111, or 1.8%, for the second quarter of fiscal year 2024 and by $298, or 2.4% for the six month period end December 31, 2023 compared with the same periods last year. Salaries and employee benefits expenses increased by $152, or 2.2%, for the six-month period ended December 31, 2023 compared to the same prior year period primarily due to merit and cost of living increases which were partially offset by a reduction in incentive expense accruals. FDIC assessments increased by $138, or 57.7%, for the six-month period ended December 31, 2023 primarily because of an increase in the initial base deposit insurance assessment rate paid by all insured depository institutions. Debit card processing expenses increased by $71, or 12.9%, for the six-month period ended December 31, 2023 compared to the same prior year period primarily due to an increase in customer card usage and an increase in the number of cards issued.

Income Taxes

Income tax expenses were $435 and $952 for the three- and six- month periods ended December 31, 2023, respectively, compared to $577 and $1,081 for the three- and six- month periods ended December 31, 2022. The effective tax rates were 17.7% and 16.8% for the six-month periods ended December 31, 2023 and 2022, respectively. The effective tax rates differed from the federal statutory rate because of tax-exempt income from obligations of state and political subdivisions, loans, bank owned life insurance income, and the low-income housing tax credits.

Financial Condition

Total assets as of December 31, 2023 were $1,081,344 compared to $1,060,024 at June 30, 2023, an increase of $21,320, or an annualized 4.0%. From June 30, 2023, total loans increased by $24,865 or an annualized 7.0% and total deposits decreased by $3,985, or an annualized 0.8%.

Available-for-sale securities decreased from $279,605 as of June 30, 2023, to $276,133 as of December 31, 2023. As of December 31, 2023, the portfolio had an unrealized loss of $32,056 as a result of the increase in market interest rates compared with the yields within the portfolio that were available at the time the underlying securities were purchased. The fair value is expected to recover as the securities approach their maturity or repricing dates or if market yields for such securities decline. The portfolio is primarily comprised of agency mortgage-backed securities, obligations of state and political subdivisions, other government agencies’ debt, corporate debt, and U.S. Treasury notes. The municipal bond portfolio consists of tax-exempt and taxable general obligations and revenue bonds to a broad range of counties, towns, school districts, and other essential service providers. As of December 31, 2023, 98.5 % of the municipal bonds held in the available-for-sale portfolio had an S&P or Moody’s investment grade rating, and 1.5% were non-rated issues. As of December 31, 2023, the projected cash flow from the portfolio over the next 12 months was approximately $39,638 which may be available to reinvest into loans or securities at the then current market rates.

Total loans increased by $24,865, or an annualized 7.0%, from June 30, 2023. The growth in loans was primarily within the commercial real estate and consumer loan portfolios. Consumer loan growth was primarily from indirect loans due to the expansion of consumer loan sales staff and an expanded dealer network.

Asset Quality

The following table presents the aggregate amounts of non-performing assets and select ratios as of the dates indicated.

As of December 31, 2023, non-accrual loans include $602 that is guaranteed by the Small Business Administration. Excluding the guaranteed portion, non-performing loans were $532, or 0.07% of total loans as of December 31, 2023.

Contractual Obligations, Commitments, Contingent Liabilities and Off-Balance Sheet Arrangements

Liquidity

The objective of liquidity management is to ensure adequate cash flows to accommodate the demands of our customers and provide adequate flexibility for the Company to take advantage of market opportunities under both normal operating conditions and under unpredictable circumstances of industry or market stress. Cash is used to fund loans, purchase investments, fund the maturity of liabilities, and, at times, to fund deposit outflows and operating activities. The Company’s principal sources of funds are deposits; amortization and prepayments of loans; maturities, sales and principal receipts from securities; borrowings; and operations. Management considers the asset position of the Company to be sufficiently liquid to meet normal operating needs and conditions. The Company’s earning assets are mainly comprised of loans and investment securities. Management continually strives to obtain the best mix of loans and investments to both maximize yield and ensure the soundness of the portfolio, as well as to provide funding for loan demand as needed.

For the six months ended December 31, 2023, net cash inflow from operating activities was $5,833, net cash inflows from investing activities was $16,512 and net cash inflows from financing activities was $11,709. A major source of cash was $11,850 from maturity, calls, and principal pay downs of available-for-sale securities and $4,002 proceeds from the sales of available-for-sale securities. A major use of cash was a $25,019 increase in loans. Total cash and cash equivalents were $12,785 as of December 31, 2023, compared to $11,755 at June 30, 2023 and $13,302 at December 31, 2022.

The Bank offers several types of deposit products to a diverse base of business, public fund, and personal customers. We believe the rates offered by the Bank and the fees charged for them are competitive with the rates and fees charged by other banks for similar deposit products currently available in the market area. Deposits totaled $948,548 at December 31, 2023, an decrease of $3,985, or 0.4%, compared with $952,533 at June 30, 2023. As of December 31, 2023, the estimated percentage of uninsured deposits, excluding collateralized public fund deposits, was 17.0%.

Jumbo time deposits (those with balances of $250 and over) totaled $65,575 as of December 31, 2023 and $46,822 as of June 30, 2023 and are from local customers and businesses. These deposits are monitored closely by the Company and are mainly priced on an individual basis. The Company has the option to use a fee-paid broker or CD listing service to obtain deposits from outside its normal service area as an additional source of funding. The Company, however, does not rely upon these types of deposits as a primary source of funding. There were no brokered deposits or CDs that were obtained from a listing service as of December 31, 2023 or June 30, 2023. Although management monitors interest rates on an ongoing basis, a quarterly rate sensitivity report is used to determine the effect of interest rate changes on the financial statements. In the opinion of management, enough assets or liabilities could be repriced over the near term (up to three years) to compensate for such changes. The spread on interest rates, or the difference between the average earning assets and the average interest-bearing liabilities, is monitored monthly.

To provide additional sources of liquidity, the Company has lines of credit with other financial institutions and entered into agreements with the FHLB of Cincinnati and the Federal Reserve discount window. At December 31, 2023, advances from the FHLB of Cincinnati totaled $26,434 compared with $8,776 at June 30, 2023. As of December 31, 2023, the Bank had the ability to borrow an additional $81,645 from the FHLB of Cincinnati based on a blanket pledge of qualifying first mortgage and multi-family loans. The Company considers the FHLB of Cincinnati to be a reliable source of liquidity funding, secondary to its deposit base. In addition, at December 31, 2023, the Company had approximately $119,000 in securities unencumbered by a pledge that could be used to support additional borrowings, as needed, through the Federal Reseve discount window or the Federal Reserve's Bank Term Funding Program (“BTFP”). The BTFP is a facility established in 2023 in response to liquidity concerns within the banking industry and advances can be requested under the program until March 11, 2024. The BTFP was designed to provide additional funding to eligible depository institutions in order to help assure that banks have the ability to meet the needs of all their depositors. Under the program, eligible depository institutions can obtain loans of up to one year in length by pledging certain U.S. Treasuries, agency debt, mortgage-backed securities, and other qualifying assets as collateral. These assets will be valued at par.

Short-term borrowings consisted of repurchase agreements with local customers, which are financing arrangements that mature daily, and a line of credit from another financial institution . The Bank pledges securities as collateral for the repurchase agreements. Short-term borrowings totaled $25,390 at December 31, 2023 and $26,367 at June 30, 2023. Since the Company is a holding company and does not conduct operations, its primary sources of liquidity are dividends upstreamed from the Bank and borrowings from outside sources. As of December 31, 2023, the available credit on the holding company’s line of credit was $4,500.

To meet the financial needs of our customers, we have issued commitments to originate mortgage, commercial, construction, and consumer loans and commitments for commercial, home equity, and consumer lines of credit. Since commitments to extend credit have a fixed expiration date or other termination clause, some commitments will expire without being drawn upon and the total commitment amounts do not necessarily represent future cash requirements. Financial standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. The same credit policies are used in making commitments and financial standby letters of credit as are used for on-balance sheet instruments. Total unused commitments were $161,868 as of December 31, 2023, and $143,945 as of June 30, 2023.

Capital Resources

Total shareholders’ equity increased by $8,026 to $63,510 as of December 31, 2023, from $55,484 as of June 30, 2023 because of a reduction of $4,648 in the accumulated other comprehensive loss from the mark-to-market of available-for-sale securities and from net income of $4,425 for the first six months of fiscal year 2024 which was partially offset by cash dividends paid of $1,121. As market interest rates rise, the fair value of fixed-rate available-for-sale securities decline with a corresponding net of tax decline recorded in the accumulated other comprehensive loss portion of equity. The fair value is expected to recover as the securities approach their maturity date or repricing date or if market yields for such securities decline.

The Bank is subject to various regulatory capital requirements administered by federal regulatory agencies. Capital adequacy guidelines and prompt corrective-action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the Company’s financial statements.

As of December 31, 2023, the Bank’s common equity tier 1 capital and tier 1 capital ratios were 11.04% and the leverage and total risk-based capital ratios were 7.85% and 12.08%, respectively. This compares with common equity tier 1 capital and tier 1 capital ratios of 11.05% and leverage and total risk-based capital ratios of 7.72% and 12.07%, respectively, as of June 30, 2023. The Bank exceeded minimum regulatory capital requirements to be considered well-capitalized for both periods. Management is not aware of any matters occurring subsequent to December 31, 2023 that would cause the Bank’s capital category to change.

Critical Accounting Policies

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices within the industry in which it operates. Application of these principles requires management to make estimates or judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates or judgments. Certain policies inherently have a greater reliance on the use of estimates, and as such have a greater possibility of producing results that could be materially different than originally reported.

Critical accounting policies are those policies that are highly dependent on subjective or complex judgments, estimates and assumptions and where changes in those estimates and assumptions could have a significant impact on the financial statements. The Company has identified the appropriateness of the allowance for credit losses and the evaluation of goodwill for impairment as critical accounting policies and an understanding of these policies is necessary to understand the financial statements. Note one (Summary of Significant Accounting Policies – Adoption of New Accounting Standards) and Note three (Loans and Allowance for Credit Losses) of the Company’s Consolidated Financial Statements provide detail regarding the Company’s accounting for the allowance for credit losses. Note six (Goodwill and Acquired Intangible Assets) and Management’s Discussion and Analysis of Financial Condition and Results of Operation (Critical Accounting Policies and Use of Significant Estimates) of the 2023 Form 10-K provide detail regarding the Company’s accounting for Goodwill.

Forward-Looking Statements

Certain statements contained in this Quarterly Report on Form 10-Q, which are not statements of historical fact, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The words “may,” “continue,” “estimate,” “intend,” “plan,” “seek,” “will,” “believe,” “project,” “expect,” “anticipate” and similar expressions are intended to identify forward-looking statements. These forward-looking statements may involve risks and uncertainties that are difficult to predict, may be beyond our control, and could cause actual results to differ materially from those described in such statements. Any such forward-looking statements are made only as of the date of this report or the respective dates of the relevant incorporated documents, as the case may be, and, except as required by law, we undertake no obligation to update these forward-looking statements to reflect subsequent events or circumstances. Risks and uncertainties that could cause actual results for future periods to differ materially from those anticipated or projected include, but are not limited to:

• changes in local, regional and national economic conditions becoming less favorable than we expect, resulting in a deterioration in asset credit quality or debtors being unable to meet their obligations because of high unemployment rates and inflationary pressures;
• rapid fluctuations in market interest rates could result in changes in fair market valuations and a decline in net interest income;
• changes in the level of non-performing assets and charge-offs;
• unanticipated changes in our liquidity position, including, but not limited to, changes in the cost of liquidity, our ability to find alternative funding sources, and potential market reactions to the default or risk of default by other financial institutions;
• the effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities, and insurance) with which we must comply;
• the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board;
• breaches of security or failures of our or our vendor’s technology systems due to technological or other factors and cybersecurity threats;
• changes in consumer spending, borrowing and savings habits;
• declining asset values impacting the underlying value of collateral;
• changes in accounting policies, rules and interpretations;
• our ability to attract and retain qualified employees;
• competitive pressures on product pricing and services; and
• changes in the reliability of our vendors, internal control systems or information systems.

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Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by the report, an evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15e. Based on the evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2023.

Changes in Internal Controls Over Financial Reporting

There have not been any changes in the Company’s internal control over financial reporting that occurred during the Company’s last quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.