Consumers Bancorp Inc: Form 10-Q for the period ended Sep 30, 2024

(Dollars in thousands, except per share data)

General

The following is management’s analysis of the Company’s results of operations for the three-month period ended September 30, 2024, compared to the same period in fiscal year 2023, and the consolidated balance sheet at September 30, 2024, compared to June 30, 2024. 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-Month Periods Ended September 30, 2024 and 2023

Net income for the first quarter of fiscal year 2025 was $2,236, or $0.72 per common share, compared to $2,410, or $0.78 per common share for the three months ended September 30, 2023. The following are key highlights of our results of operations for the three months ended September 30, 2024, compared with the prior fiscal year comparable period:

• net interest income decreased by $111 or 1.4%, to $8,043 in the first quarter of fiscal year 2025 from the same prior year period mainly because of the rapid increase in short-term market rates in 2023 and 2024 causing interest bearing liabilities to reprice faster than interest earning assets;
• a $77 provision for credit losses on loans and a $45 reduction to the provision for credit losses on unfunded commitments was recorded for the three-month period ended September 30, 2024 compared with a $40 provision for credit losses on loans and a $79 provision for credit losses on unfunded commitments for the same prior year period. The reduction to the reserve for unfunded commitments recorded in the first quarter of fiscal year 2025 was the result of lower loss rates and a reduction in the balance of unfunded commitments.;
• noninterest income increased by $236, or 20.4%, in the first quarter of fiscal year 2025 from the same prior year period. A $79 loss on the sale of lower yielding securities was included in noninterest income during the three-month period ended September 30, 2023. Excluding this securities loss, noninterest income increased by $157, or 12.7%, compared with the same prior year period primarily because of an increase in debit card interchange income of $65, or 11.8%, gains from mortgage banking activity of $35, or 35.7%, and an increase in service charges on deposit accounts of $24, or 5.6%.
• noninterest expenses increased by $423, or 6.8%, in the first quarter of fiscal year 2025 from the same prior year period primarily due to increases in salaries and benefits, software expenses, and debit card processing expenses.

The annualized return on average equity and return on average assets were 13.08% and 0.80%, respectively, for the three months ended September 30, 2024 compared to 17.31% and 0.90%, 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 2025 and 2024 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 2.92% for the three months ended September 30, 2024, compared with 3.09% for the same prior year period. FTE net interest income for the three months ended September 30, 2024, decreased by $171, or 2.1%, to $7,940 from $8,111 for the same prior year period.

The yield on average interest-earning assets increased to 4.81% for the three months ended September 30, 2024, compared with 4.45% for the same period last year. Tax-equivalent interest income increased by $1,359, or 11.6%, for the three months ended September 30, 2024, from the same prior year period because of a $42,325, or 4.2%, increase in average interest-earning assets as well as the affect of higher market interest rates on new and repricing earning assets. However, the yield on nontaxable securities is being negatively impacted since the interest expense attributable to carrying tax exempt securities is not deductible. Interest expense for the three months ended September 30, 2024 increased by $1,530 from the same prior year period primarily due to an increase in savings and time deposit costs as a result of higher market interest rates, an increase in competition for deposits impacting the time deposit and money market offering rates, and from a shift of funds from lower yielding deposit products to higher yielding time and money market accounts. The Company’s cost of funds increased to 2.56% for the three months ended September 30, 2024 compared with 1.91% for the same prior year period. Competitive pressures on deposit pricing have begun to ease and pricing on money market accounts and time deposits were able to be reduced following the 50-basis point cut in the discount rate in September 2024. As a result, management expects the cost of funds to trend downward in future quarters.

Average Balance Sheets and Analysis of Net Interest Income for the Three Months Ended September 30,

(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

The allowance for credit losses on loans 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. For each portfolio segment, a loss driver analysis (LDA) is performed to identify appropriate loss indicators and create a regression model for use in forecasting cash flows. The LDA analysis utilizes peer data from the Federal Financial Institutions Examination Council’s (FFIEC) Call Report data for all segments. Since the Company has had very limited loss experience, management elected to utilize benchmark peer loss history data to estimate historical loss rates. The Company has established a one-year reasonable and supportable forecast period with a one-year straight-line reversion to the long-term historical average. The Company uses the central tendency seasonally adjusted civilian unemployment rate forecast from the Federal Open Market Committee for all portfolio segments. Other key assumptions include a maturity assumption for loans without maturity dates and prepayment / curtailment rates specific to each loan segment. Prepayment and curtailment rates are calculated based on the Company’s own data.

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 September 30, 2024, individually evaluated loans totaled $29,776 and included the $28,865 third-party residential mortgage warehouse line-of-credit and $911 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 lead financial institution that provides the lines-of-credit, as well as being secured by individual residential properties. There was a $66 specific allocation of the allowance for credit losses to the individually evaluated loans as of September 30, 2024.

For the three-month period ended September 30, 2024, the provision for credit losses on loans was $77 compared with $40 for the same period last year. The allowance for credit losses as a percentage of loans was 1.04% at September 30, 2024 and June 30, 2024. Net charge-offs of $59, or an annualized 0.03% of total loans, were recorded during the three-month period ended September 30, 2024 compared with net charge offs of $34, or an annualized 0.02% of total loans, for the same period last year.

Non-performing loans were $919 as of September 30, 2024, compared with $858 as of June 30, 2024. As of September 30, 2024, non-performing loans included $359 that is guaranteed by the Small Business Administration. Non-performing loans to total loans were 0.12%, or 0.07% excluding the guaranteed portion, at September 30, 2024 and 0.11%, or 0.07% excluding the guaranteed portion, at June 30, 2024. 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.

The allowance for credit losses on off-balance sheet credit exposures is a liability account representing expected credit losses over the contractual period for which the Company is exposed to credit risk resulting from a contractual obligation to extend credit. The reserve for unfunded commitments is primarily related to 1 - 4 family home equity lines of credit and construction loans, land development loans, and commercial construction loans. For the three-month period ended September 30, 2024, a reduction of $45 was recorded to the reserve for unfunded commitments compared with a $79 reserve for the same period last year. The reduction to the reserve recorded in the first quarter of fiscal year 2025 was the result of lower loss rates and a reduction in the balance of unfunded commitments.

Noninterest Income

Noninterest income increased by $236, or 20.4%, for the first quarter of fiscal year 2025 from the same period last year. During the three-month period ended September 30, 2023, a $79 loss on the sale of lower yielding securities was included in noninterest income. Excluding this securities loss, noninterest income increased by $157, or 12.7%, compared with the same prior year period primarily because of an increase in debit card interchange income of $65, or 11.8%, gains from mortgage banking activity of $35, or 35.7%, and an increase in service charges on deposit accounts of $24, or 5.6%.

Noninterest Expenses

Total noninterest expenses increased by $423, or 6.8%, for the first quarter of fiscal year 2025 compared with the same period last year. Salaries and employee benefits expenses increased by $266, or 7.6%, for the three-month period ended September 30, 2024 compared to the same prior year period primarily due to merit and cost of living increases and increases to incentive expense accruals. Occupancy and equipment expenses increased by $100, or 12.8%, for the first quarter of fiscal year 2025 compared with the same period last year primarily because of investments in new software, increases in software licensing fees, and increases in building maintenance and repair. Debit card processing expenses increased by $50, or 16.0%, for the three-month period ended September 30, 2024 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. These increases were partially offset by a decline of $56, or 58.3% in Ohio franchise tax expense for the three-month period ended September 30, 2024 compared to the same prior year period due to the full year impact of the reduction in total shareholders’ equity because of the accumulated other comprehensive loss.

Income Taxes

Income tax expense was $480 for the three-month period ended September 30, 2024 compared to $517 for the three-month period ended September 30, 2023. The effective tax rate was 17.7% for both of the three-month periods ended September 30, 2024 and 2023. 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 September 30, 2024 were $1,123,853 compared to $1,097,089 at June 30, 2024, an increase of $26,764, or an annualized 9.8%. From June 30, 2024 to September 30, 2024, total loans increased by $7,359, or an annualized 3.9%, and total deposits increased by $25,912, or an annualized 10.7%.

Available-for-sale securities increased from $264,802 as of June 30, 2024, to $272,757 as of September 30, 2024. As of September 30, 2024, the portfolio had an unrealized loss of $26,051 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 September 30, 2024, 97.4 % of the municipal bonds held in the available-for-sale portfolio had an S&P or Moody’s investment grade rating, and 2.6% were non-rated issues. The other debt securities consist of subordinated notes issued by other bank holding companies. As of September 30, 2024, the projected cash flow from the portfolio over the next 12 months was approximately $39,679 which may be available to reinvest into loans or securities at the then current market rates.

Total loans increased by $7,359, or an annualized 3.9%, from June 30, 2024. 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 the indirect dealer network.

Asset Quality

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

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As of September 30, 2024, non-accrual loans include loans that are guaranteed by the Small Business Administration. Excluding the guaranteed portion, non-performing loans were $560, or 0.07% of total loans as of September 30, 2024.

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 three months ended September 30, 2024, net cash inflows from operating activities was $1,142, net cash outflows from investing activities was $8,802 and net cash inflows from financing activities was $16,862. A major source of cash was $25,912 from the increase in deposits and $8,423 from maturity, calls, and principal pay downs of available-for-sale securities. A major use of cash was $7,418 for loan originations. Total cash and cash equivalents were $26,925 as of September 30, 2024, compared to $17,723 at June 30, 2024 and $19,643 at September 30, 2023.

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 $998,892 at September 30, 2024, an increase of $25,912, or an annualized 10.7%, compared with $972,980 at June 30, 2024. As of September 30, 2024, the estimated percentage of uninsured deposits, excluding collateralized public fund deposits, was 18.3%.

Jumbo time deposits (those with balances of $250 and over) totaled $66,735 as of September 30, 2024 and $59,233 as of June 30, 2024 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 $2,049 and $6,004 of deposits classified as brokered deposits as of September 30, 2024 and June 30, 2024, respectively. 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 September 30, 2024, advances from the FHLB of Cincinnati totaled $8,087 compared with $13,709 at June 30, 2024. As of September 30, 2024, the Bank had the ability to borrow an additional $102,155 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 September 30, 2024, the Company had approximately $96,877 in securities unencumbered by a pledge that could be used to support additional borrowings, as needed, through the Federal Reserve discount window.

Borrowings with original maturities of one year or less are classified as short-term and were comprised of the following:

Repurchase agreements are financing arrangements with local customers that mature daily. The Bank pledges securities as collateral for the repurchase agreements. The Federal Reserve’s Bank Term Funding Program (BTFP) was a facility established in 2023 in response to liquidity concerns within the banking industry and the program ceased making new loans on March 11, 2024. The BTFP was designed to provide additional funding to eligible depository institutions in order to help assure that banks had the ability to meet the needs of all their depositors. Under the program, eligible depository institutions could 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 were valued at par. A line of credit from another financial institution was established since the holding company does not conduct operations and its primary sources of liquidity are dividends upstreamed from the Bank and borrowings from outside sources. As of September 30, 2024, the available credit on the holding company’s line of credit was $5,000.

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 $142,769 as of September 30, 2024, and $145,796 as of June 30, 202.

Capital Resources

Total shareholders’ equity increased by $9,616 to $73,301 as of September 30, 2024, from $63,685 as of June 30, 2024 because of a reduction of $7,751 in the accumulated other comprehensive loss from the mark-to-market of available-for-sale securities and from net income of $2,236 for the first three months of fiscal year 2025 which was partially offset by cash dividends paid of $594. 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 September 30, 2024, the Bank’s common equity tier 1 capital and tier 1 capital ratios were 11.13% and the leverage and total risk-based capital ratios were 8.05% and 12.13%, respectively. This compares with common equity tier 1 capital and tier 1 capital ratios of 11.07% and leverage and total risk-based capital ratios of 7.98% and 12.07%, respectively, as of June 30, 2024. 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 September 30, 2024 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 1 (Summary of Significant Accounting Policies – Adoption of ASC 326 and Allowance for Credit Losses) and Note 3 (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 5 (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 2024 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 September 30, 2024.

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.