Civista Bancshares, Inc.: Form 10-Q for the period ended Mar 31, 2020

Introduction

The following discussion focuses on the consolidated financial condition of the Company at March 31, 2020 compared to December 31, 2019, and the consolidated results of operations for the three-month period ended March 31, 2020, compared to the same periods in 2019. This discussion should be read in conjunction with the consolidated financial statements and footnotes included in this Form 10-Q.

Forward-Looking Statements

This Quarterly Report on Form 10-Q may contain “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), relating to such matters as the Company’s financial condition, anticipated operating results, cash flows, business line results, credit quality expectations, prospects for new lines of business, economic trends (including interest rates) and similar matters. Forward-looking statements reflect our expectations, estimates or projections concerning future results or events. These statements are generally identified by the use of forward-looking words or phrases such as “believe,” “belief,” “expect,” “anticipate,” “may,” “could,” “intend,” “intent,” “estimate,” “plan,” “foresee,” “likely,” “will,” “should” or other similar words or phrases. Forward-looking statements are not guarantees of performance and are inherently subject to known and unknown risks, uncertainties and assumptions that are difficult to predict and could cause our actual results, performance or achievements to differ materially from those expressed in or implied by the forward-looking statements. Factors that could cause actual results, performance or achievements to differ from those discussed in the forward-looking statements include, but are not limited to, changes in financial markets or national or local economic conditions, including impacts from the COVID-19 pandemic on local, national and global economic conditions; higher default rates on loans made to our customers related to the impact of COVID-19 on our customers operations and financial conditions; the effects of various governmental responses to the COVID-19 pandemic, including stimulus packages and programs; sustained weakness or deterioration in the real estate market; volatility and direction of market interest rates; credit risks of lending activities; changes in the allowance for loan losses; legislation or regulatory changes or actions; increases in Federal Deposit Insurance Corporation (“FDIC”) insurance premiums and assessments; changes in tax laws; failure of or breach in our information and data processing systems; unforeseen litigation; and other risks identified from time-to-time in the Company’s other public documents on file with the SEC, including those risks identified in “Item 1A. Risk Factors” of Part I of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019, as supplemented by “Item 1A. Risk Factors” of Part II of this Quarterly Report on Form 10-Q. The Company does not undertake, and specifically disclaims, any obligation to publicly release the result of any revisions that may be made to any forward-looking statements to reflect occurrence of anticipated or unanticipated events or circumstances after the date of such statements, except as required by law.

Financial Condition

Total assets of the Company at March 31, 2020 were $2,575,856 compared to $2,309,557 at December 31, 2019, an increase of $266,299, or 11.5%. The increase in total assets was due to increases in cash and due from financial institutions of $207,488, accompanied by other increases in securities available for sale, loans held for sale, loans and other assets of $7,387, $5,347, $31,974 and $14,779, respectively. Total liabilities at March 31, 2020 were $2,247,689 compared to $1,979,431 at December 31, 2019, an increase of $268,258, or 13.6%. The increase in total liabilities was primarily attributable to increases in noninterest-bearing demand accounts, interest-bearing demand accounts and accrued expenses and other liabilities of $299,423, $13,752 and $35,558, respectively, partially offset by a decrease in short-term FHLB advances of $84,500.

Loans outstanding as of March 31, 2020 and December 31, 2019 were as follows:

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Net loans have increased $31,974 or 1.9% since December 31, 2019. The Commercial Real Estate – Owner Occupied, Commercial Real Estate – Non-Owner Occupied and Real Estate Construction loan portfolios increased $10,027, $23,970 and $7,982, respectively, since December 31, 2019, while the Commercial & Agriculture, Residential Real Estate, Farm Real Estate and Consumer and Other loan portfolios decreased $1,250, $4,554, $1,962 and $58, respectively, since December 31, 2019. At March 31, 2020, the net loan to deposit ratio was 86.7% compared to 100.9% at December 31, 2019. The decrease in the net loan to deposit ratio is the result of an increase in deposits.

During the first three months of 2020, provisions made to the allowance for loan losses from earnings totaled $2,126, compared to a provision of $0 during the same period in 2019. The increase in provision was due to an increase in the bank’s qualitative factors related to the economic shutdown that is driven by COVID-19. Economic impacts include the loss of revenue being experience by our business clients, additional employee costs for businesses due to the pandemic, higher unemployment rates throughout our footprint and a large percentage of customers requesting payment relief. Net recoveries for the first three months of 2020 totaled $55, compared to net recoveries of $143 in the first three months of 2019. For the first three months of 2020, the Company charged off a total of 5 loans. Four Residential Real Estate loans totaling $23 and one Consumer and Other loan totaling $1 were charged off in the first three months of the year. In addition, during the first three months of 2020, the Company had recoveries on previously charged-off Commercial and Agriculture loans of $1, Commercial Real Estate – Owner Occupied loans of $7, Commercial Real Estate – Non-Owner Occupied loans of $3, Residential Real Estate loans of $48, Real Estate Construction loans of $1, Farm Real Estate loans of $2 and Consumer and Other loans of $17. For each loan category, as well as in total, the percentage of net charge-offs to loans was less than one percent. Nonperforming loans decreased by $8 since December 31, 2019, which was due to a decrease in loans on nonaccrual status of $25 and an increase in loans past due 90 days and accruing of $17. Each of these factors was considered by management as part of the examination of both the level and mix of the allowance by loan type as well as the overall level of the allowance.

Management specifically evaluates loans that are impaired for estimates of loss. To evaluate the adequacy of the allowance for loan losses to cover probable losses in the portfolio, management considers specific reserve allocations for identified portfolio loans, reserves for delinquencies and historical reserve allocations. Loss migration rates are calculated over a three-year period for all portfolio segments. Management also considers certain economic factors for trends that management uses to account for the qualitative and environmental changes in risk, which affects the level of the reserve.

Management analyzes each impaired Commercial and Commercial Real Estate loan relationship with a balance of $350 or larger, on an individual basis and designates a loan as impaired when it is in nonaccrual status or when an analysis of the borrower’s operating results and financial condition indicates that underlying cash flows are not adequate to meet its debt service requirements. Loans held for sale are excluded from consideration as impaired. Loans are generally moved to nonaccrual status when 90 days or more past due. Impaired loans, or portions thereof, are charged-off when deemed uncollectible. The allowance for loan losses as a percent of total loans was 0.97% at March 31, 2020 and 0.86% December 31, 2019.

The available for sale security portfolio increased by $7,387, from $358,499 at December 31, 2019 to $365,886 at March 31, 2020. Management continually evaluates our securities portfolio in response to established asset/liability management objectives, changing market conditions that could affect profitability and the level of interest rate risk to which the Company is exposed. These evaluations may cause the Company to change the level of funds it deploys into investment securities and change the composition of its investment securities portfolio. As of March 31, 2020, the Company was in compliance with all pledging requirements.

Premises and equipment, net, decreased $428 from December 31, 2019 to March 31, 2020. The decrease is the result of new purchases of $135, offset by depreciation of $553 and proceeds from the sale of premises and equipment of $10.

Bank owned life insurance (BOLI) increased $250 from December 31, 2019 to March 31, 2020. The increase is the result of increases in the cash surrender value of the underlying insurance policies.

Other assets increased $14,779 from December 31, 2019 to March 31, 2020. The increase is the result of increases in the fair value of swap assets of $14,085.

Total deposits as of March 31, 2020 and December 31, 2019 were as follows:

Total deposits at March 31, 2020 increased $313,175 from year-end 2019. Noninterest-bearing deposits increased $299,423 from year-end 2019, while interest-bearing deposits, including savings and time deposits, increased $13,752 from December 31, 2019. The increase in noninterest-bearing deposits was primarily due to increases in cash balances related to the Company’s participation in a tax refund processing program, which added noninterest-bearing deposits of $307,549. This increase is temporary as transactions are processed and is expected to return to levels more consistent with December 31, 2019 over the next two quarters. The increase in interest-bearing deposits was primarily due to an increase in non-public and public fund interest-bearing accounts of $7,610 and $23,286, respectively, offset by a decrease in brokered money market accounts of $29,274. The year-to-date average balance of total deposits increased $168,031 compared to the average balance for the same period in 2019 mainly due to increases in noninterest-bearing business demand and tax refund processing program accounts of $45,665 and $70,862, respectively, accompanied by increases in interest-bearing demand and public funds interest-bearing demand of $7,459 and $23,581, respectively. In addition, the average balance of time deposits increased $10,194 as compared to the same period in 2019.

Short-term FHLB advances decreased $84,500 from December 31, 2019 to March 31, 2020. The decrease is due to a decrease in overnight borrowings. Securities sold under agreements to repurchase, which tend to fluctuate, have increased $4,025 from December 31, 2019 to March 31, 2020.

Accrued expenses and other liabilities increased $35,558 from December 31, 2019 to March 31, 2020. The increase is primarily the result of increases in swap liabilities of $14,085 and a clearing account related to the tax refund processing program of $23,578.

Shareholders’ equity at March 31, 2020 was $328,167, or 12.7% of total assets, compared to $330,126, or 14.3% of total assets, at December 31, 2019. The decrease was the result of net income of $7,833, a decrease in the Company’s pension liability, net of tax, of $57, and an increase in the fair value of securities available for sale, net of tax, of $2,957, offset by dividends on common shares of $1,835 and the purchase of treasury shares of $11,095.

Total outstanding common shares at March 31, 2020 were 16,064,010, which decreased from 16,687,542 common shares outstanding at December 31, 2019. Common shares outstanding decreased as a result of 650,511 common shares being repurchased by the Company at an average repurchase price of $17.06. The Company repurchased 646,703 common shares pursuant to a stock repurchase program announced on December 17, 2019 and 3,808 common shares surrendered to pay taxes upon vesting of restricted shares. The plan authorizes the Company to repurchase up to 672,000 shares of the Company’s common shares until December 17, 2020. The decrease in common shares outstanding was offset by the grant of 26,979 restricted common shares to certain officers under the Company’s 2014 Incentive Plan.

Results of Operations

Three Months Ended March 31, 2020 and 2019

The Company had net income of $7,833 for the three months ended March 31, 2020, a decrease of $1,836 from a net income of $9,669 for the same three months of 2019. Basic earnings per common share were $0.47 for the quarter ended March 31, 2020, compared to $0.61 for the same period in 2019. Diluted earnings per common share were $0.47 for the quarter ended March 31, 2020, compared to $0.57 for the same period in 2019. The primary reasons for the changes in net income are explained below.

Net interest income for the three months ended March 31, 2020 was $22,115, an increase of $396 from $21,719 in the same three months of 2019. This increase is the result of an increase of $418 in total interest income with only an increase of $22 in interest expense. Interest-earning assets averaged $2,232,168 during the three months ended March 31, 2020, an increase of $214,645 from $2,017,523 for the same period of 2019. The Company’s average interest-bearing liabilities increased from $1,275,064 during the three months ended March 31, 2019 to $1,385,502 during the three months ended March 31, 2020. The Company’s fully tax equivalent net interest margin for the three months ended March 31, 2020 and 2019 was 4.10% and 4.45%, respectively.

Total interest income was $25,002 for the three months ended March 31, 2020, an increase of $418 from $24,584 of total interest income for the same period in 2019. The increase in interest income is attributable to an increase of $710 in interest and fees on loans, which resulted from an increase in the average balance of loans, accompanied by a lower yield on the portfolio. The average balance of loans increased by $161,477 or 10.3% to $1,725,685 for the three months ended March 31, 2020 as compared to $1,564,208 for the same period in 2019. The loan yield decreased to 5.05% for 2020, from 5.44% in 2019 mainly due to the impact of lower interest rates during the first three months of 2020 as compared to the same period of 2019.

Interest on taxable securities decreased $332 to $1,416 for the three months ended March 31, 2020, compared to $1,748 for the same period in 2019. The average balance of taxable securities decreased $19,996 to $187,604 for the three months ended March 31, 2020 as compared to $207,600 for the same period in 2019. The yield on taxable securities decreased 30 basis points to 3.13% for 2020, compared to 3.43% for 2019. Interest on tax-exempt securities increased $161 to $1,512 for the three months ended March 31, 2020, compared to $1,351 for the same period in 2019. The average balance of tax-exempt securities increased $39,964 to $197,583 for the three months ended March 31, 2020 as compared to $157,619 for the same period in 2019. The yield on tax-exempt securities decreased 27 basis points to 4.22% for 2020, compared to 4.49% for 2019 due to the impact of lower interest rates during the first three months of 2020 as compared to the same period of 2019.

Interest expense increased $22 or 0.8% to $2,887 for the three months ended March 31, 2020, compared with $2,865 for the same period in 2019. The change in interest expense can be attributed to an increase in the average balance of interest-bearing liabilities, offset by a decrease in rates on demand and savings accounts, FHLB borrowings and subordinated debentures. For the three months ended March 31, 2020, the average balance of interest-bearing liabilities increased $110,438 to $1,385,502, as compared to $1,275,064 for the same period in 2019. Interest incurred on deposits increased by $94 to $1,985 for the three months ended March 31, 2020, compared to $1,891 for the same period in 2019. The change in deposit expense was due to an increase in the average balance of interest-bearing deposits of $49,420 for the three months ended March 31, 2020 as compared to the same period in 2019. In addition, the rate paid on demand and savings accounts decreased from 0.34% in 2019 to 0.27% in 2020 and the rate paid on time deposits increased from 1.77% to 1.98% in 2020. The increase in the rate paid on time deposits is mainly due to special rates offered on time deposits, during 2019 and through 2020. Interest expense incurred on FHLB advances and subordinated debentures decreased 7.7% from 2019. While the average balance on FHLB balances increased $60,482 for the three months ended March 31, 2020 as compared to the same period in 2019, the rate paid decreased 101 basis points. In addition, the rate paid on subordinated debentures decreased 85 basis points for the three months ended March 31, 2020 as compared to the same period in 2019.

The following table presents the condensed average balance sheets for the three months ended March 31, 2020 and 2019. The daily average loan amounts outstanding are net of unearned income and include loans held for sale and nonaccrual loans. The average balance of securities is computed using the carrying value of securities. Rates are annualized and taxable equivalent yields are computed using a 21% tax rate for tax-exempt interest income. The average yield has been computed using the historical amortized cost average balance for available-for-sale securities.

* —All yields and costs are presented on an annualized basis

Net interest income may also be analyzed by comparing the volume and rate components of interest income and interest expense. The following table provides an analysis of the changes in interest income and expense between the three months ended March 31, 2020 and 2019.

(Dollars in thousands)

(1) The change in interest income and interest expense due to changes in both volume and rate, which cannot be segregated, has been allocated proportionately to the change due to volume and the change due to rate.

The Company provides for loan losses through regular provisions to the allowance for loan losses. Provisions for loan losses totaled $2,126 and $0 during the quarters ended March 31, 2020 and 2019. The increase in the provision was due to an increase in the bank’s qualitative factors related to the economic shutdown that is driven by COVID-19 pandemic. Economic impacts include the loss of revenue being experience by our business clients, additional employee costs for businesses due to the pandemic, higher unemployment rates throughout our footprint and a large percentage of customers requesting payment relief. We expect our Commercial, Commercial Real Estate and Consumer portfolios to be impacted the most.

Noninterest income for the three-month periods ended March 31, 2020 and 2019 are as follows:

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Noninterest income for the three months ended March 31, 2020 was $6,876, an increase of $592 or 9.4% from $6,284 for the same period of 2019. The increase was primarily due to increases in net gain on sale of loans, wealth management fees, swap fees and other, offset by decreases in net gain (loss) on equity securities and tax refund processing fees. Net gain (loss) on equity securities decreased as a result of market value decreases. Net gain on sale of loans increased primarily as a result of an increase in volume of loans sold. During the three-months ended March 31, 2020, 214 loans were sold, totaling $35,368. During the three-months ended March 31, 2019, 102 loans were sold, totaling $16,500. Wealth management fees increased primarily as a result of an increase in trust and brokerage fees of $97 and $62, respectively. Trust income increased as a result of new accounts and market conditions. While brokerage income has increased due to volume of business. Swap fees increased due to the volume of swaps performed during the quarter ended March 31, 2020 as compared to the same period of 2019. Other income increased as a result of fewer direct claims paid in the first three months of 2020 as compared to the same period of 2019.

Additionally, the Company processes state and federal income tax refund payments for customers of third-party income tax preparation vendors for which we receive a fee for processing the refund payments. Tax refund processing fees were $1,900 for the three months ended March 31, 2019, a decrease of $300 from $2,200 for the same period of 2019. The decrease is the result of a decrease in volume of transactions processed during the period. This fee income is seasonal in nature, the majority of which is earned in the first quarter of the year.

Noninterest expense for the three-month periods ended March 31, 2020 and 2019 are as follows:

Noninterest expense for the three months ended March 31, 2020 was $17,856, an increase of $1,407, or 8.6%, from $16,449 reported for the same period of 2019. The primary reasons for the increase were increases in compensation expense, state franchise taxes, ATM/Interchange expense, software maintenance expense and other, offset by a decrease in FDIC assessment due to the small bank assessment credit applied to the Company’s first quarter 2020 assessment. The increase in compensation expense was due to increased payroll, payroll taxes and unemployment insurance, commission and incentive based costs and employee insurance costs. The quarter-to-date average full time equivalent (FTE) employees were 452.5 at March 31, 2020, an increase of 22.0 FTEs over 2019, which increased payroll and payroll related expenses. Payroll and payroll related expenses also increased due to annual pay increases and increases in commission based costs and employee insurance costs. The increases in ATM/Interchange expense is primarily due to increases in monthly processing fees and increases in monitoring software costs. The quarter-over-quarter increase in state franchise taxes was attributable to an increase in equity capital, which is the basis of the Ohio Financial Institutions tax. The increase in software maintenance expense is due to the buyout of certain contracts of $54. The increase in other operating expense is primarily due to increases in software depreciation, bad check expense, education and training, amortization on low income housing investment, other loan expense and MSR valuation expense.

Income tax expense for the three months ended March 31, 2020 totaled $1,176, down $709 compared to the same period in 2019. The effective tax rates for the three-month periods ended March 31, 2020 and 2019 were 13.1% and 16.3%, respectively. The difference between the statutory federal income tax rate and the Company’s effective tax rate is the permanent tax differences, primarily consisting of tax-exempt interest income from municipal investments and loans, low income housing tax credits and bank owned life insurance income. The decrease in the effective tax rate is due to higher non-taxable income for the three months ended March 31, 2020, as compared to the same period in 2019.

Capital Resources

Shareholders’ equity totaled $328,167 at March 31, 2020 compared to $330,126 at December 31, 2019. The Company repurchased common shares during the period, which totaled $11,095. The decrease in shareholders’ equity was also impacted by net income of $7,833, a $57 net decrease in the Company’s pension liability and an increase in the fair value of securities available for sale, net of tax, of $2,957, which was partially offset by dividends on common stock of $1,835.

All of the Company’s capital ratios exceeded the regulatory minimum guidelines as of March 31, 2020 and December 31, 2019 as identified in the following table:

Liquidity

The Company maintains a conservative liquidity position. All securities are classified as available for sale. Securities, with maturities of one year or less, totaled $8,255, or 2.3% of the total security portfolio at March 31, 2020. The available for sale portfolio helps to provide the Company with the ability to meet its funding needs. The Condensed Consolidated Statements of Cash Flows (Unaudited) contained in the consolidated financial statements detail the Company’s cash flows from operating activities resulting from net earnings.

As reported in the Condensed Consolidated Statements of Cash Flows (Unaudited), our cash flows are classified for financial reporting purposes as operating, investing or financing cash flows. Net cash provided by operating activities was $25,554 and $12,905 for the three months ended March 31, 2020 and 2019, respectively. The primary additions to cash from operating activities are from proceeds from the sale of loans. In addition, in 2020, additions from the change in the provision of loan losses and accrued expenses and other liabilities of $2,126 and $21,653, respectively added to cash from operating activities. The primary use of cash from operating activities is from loans originated for sale. Net cash used for investing activities was $37,836 and $9,201 for the three months ended March 31, 2020 and 2019, respectively, principally reflecting our loan and investment security activities. Cash provided by and used for deposits, borrowings and purchase of treasury shares comprised most of our financing activities, which resulted in net cash provided by of $219,770 and $117,611 for the three months ended March 31, 2020 and 2019, respectively.

Future loan demand of Civista may be funded by increases in deposit accounts, proceeds from payments on existing loans, the maturity of securities, and the sale of securities classified as available for sale. Additional sources of funds may also come from borrowing in the Federal Funds market and/or borrowing from the FHLB. Through its correspondent banks, Civista maintains federal funds borrowing lines totaling $50,000. As of March 31, 2020, Civista had total credit availability with the FHLB of $581,739 with standby letters of credit totaling $20,000 and a remaining borrowing capacity of approximately $419,739. In addition, CBI maintains a credit line totaling $10,000.

Quantitative and Qualitative Disclosures About Market Risk

The Company’s primary market risk exposure is interest-rate risk and, to a lesser extent, liquidity risk. All of the Company’s transactions are denominated in U.S. dollars with no specific foreign exchange exposure.

Interest-rate risk is the exposure of a banking organization’s financial condition to adverse movements in interest rates. Accepting this risk can be an important source of profitability and shareholder value. However, excessive levels of interest-rate risk can pose a significant threat to the Company’s earnings and capital base. Accordingly, effective risk management that maintains interest-rate risk at prudent levels is essential to the Company’s safety and soundness.

Evaluating a financial institution’s exposure to changes in interest rates includes assessing both the adequacy of the management process used to control interest-rate risk and the organization’s quantitative level of exposure. When assessing the interest-rate risk management process, the Company seeks to ensure that appropriate policies, procedures, management information systems and internal controls are in place to maintain interest-rate risk at prudent levels with consistency and continuity. Evaluating the quantitative level of interest rate risk exposure requires the Company to assess the existing and potential future effects of changes in interest rates on its consolidated financial condition, including capital adequacy, earnings, liquidity and, where appropriate, asset quality.

The Federal Reserve Board, together with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation, adopted a Joint Agency Policy Statement on interest-rate risk, effective June 26, 1996. The policy statement provides guidance to examiners and bankers on sound practices for managing interest-rate risk, which will form the basis for ongoing evaluation of the adequacy of interest-rate risk management at supervised institutions. The policy statement also outlines fundamental elements of sound management that have been identified in prior Federal Reserve guidance and discusses the importance of these elements in the context of managing interest-rate risk. Specifically, the guidance emphasizes the need for active board of director and senior management oversight and a comprehensive risk-management process that effectively identifies, measures, and controls interest-rate risk.

Financial institutions derive their income primarily from the excess of interest collected over interest paid. The rates of interest an institution earns on its assets and owes on its liabilities generally are established contractually for a period of time. Since market interest rates change over time, an institution is exposed to lower profit margins (or losses) if it cannot adapt to interest-rate changes. For example, assume that an institution’s assets carry intermediate- or long-term fixed rates and that those assets were funded with short-term liabilities. If market interest rates rise by the time the short-term liabilities must be refinanced, the increase in the institution’s interest expense on its liabilities may not be sufficiently offset if assets continue to earn at the long-term fixed rates. Accordingly, an institution’s profits could decrease on existing assets because the institution will have either lower net interest income or, possibly, net interest expense. Similar risks exist when assets are subject to contractual interest-rate ceilings, or rate sensitive assets are funded by longer-term, fixed-rate liabilities in a decreasing-rate environment.

Several techniques may be used by an institution to minimize interest-rate risk. One approach used by the Company is to periodically analyze its assets and liabilities and make future financing and investment decisions based on payment streams, interest rates, contractual maturities, and estimated sensitivity to actual or potential changes in market interest rates. Such activities fall under the broad definition of asset/liability management. The Company’s primary asset/liability management technique is the measurement of the Company’s asset/liability gap, that is, the difference between the cash flow amounts of interest sensitive assets and liabilities that will be refinanced (or repriced) during a given period. For example, if the asset amount to be repriced exceeds the corresponding liability amount for a certain day, month, year, or longer period, the institution is in an asset sensitive gap position. In this situation, net interest income would increase if market interest rates rose or decrease if market interest rates fell. If, alternatively, more liabilities than assets will reprice, the institution is in a liability sensitive position. Accordingly, net interest income would decline when rates rose and increase when rates fell. Also, these examples assume that interest rate changes for assets and liabilities are of the same magnitude, whereas actual interest rate changes generally differ in magnitude for assets and liabilities.

Quantitative and Qualitative Disclosures About Market Risk

Several ways an institution can manage interest-rate risk include selling existing assets or repaying certain liabilities; matching repricing periods for new assets and liabilities, for example, by shortening terms of new loans or securities; and hedging existing assets, liabilities, or anticipated transactions. An institution might also invest in more complex financial instruments intended to hedge or otherwise change interest-rate risk. Interest rate swaps, futures contracts, options on futures, and other such derivative financial instruments often are used for this purpose. Because these instruments are sensitive to interest rate changes, they require management expertise to be effective. The Company has not purchased derivative financial instruments to hedge interest rate risk in the past and does not currently intend to purchase such instruments in the near future. Financial institutions are also subject to prepayment risk in falling rate environments. For example, mortgage loans and other financial assets may be prepaid by a debtor so that the debtor may refinance its obligations at new, lower rates. Prepayments of assets carrying higher rates reduce the Company’s interest income and overall asset yields. A large portion of an institution’s liabilities may be short-term or due on demand, while most of its assets may be invested in long-term loans or securities. Accordingly, the Company seeks to have in place sources of cash to meet short-term demands. These funds can be obtained by increasing deposits, borrowing, or selling assets. FHLB advances and wholesale borrowings may also be used as important sources of liquidity for the Company.

The following table provides information about the Company’s financial instruments that were sensitive to changes in interest rates as of December 31, 2019 and March 31, 2020, based on certain prepayment and account decay assumptions that management believes are reasonable. The table shows the changes in the Company’s net portfolio value (in amount and percent) that would result from hypothetical interest rate increases of 200 basis points and 100 basis points and interest rate decreases of 100 basis points and 200 basis points at March 31, 2020 and December 31, 2019.

The Company had derivative financial instruments as of December 31, 2019 and March 31, 2020. The changes in fair value of the assets and liabilities of the underlying contracts offset each other. Expected maturity date values for interest-bearing core deposits were calculated based on estimates of the period over which the deposits would be outstanding. The Company’s borrowings were tabulated by contractual maturity dates and without regard to any conversion or repricing dates.

Net Portfolio Value

The change in net portfolio value from December 31, 2019 to March 31, 2020, can be attributed to a couple of factors. There was a nearly parallel drop in the yield curve from the end of the year, and both the volume and mix of assets and funding sources has changed. The volume of loans has increased, but the mix has shifted toward cash, primarily as a result of cash related to our tax refund processing program. Similarly, the volume and mix of liabilities has shifted away from borrowed money toward deposits, again as a result of deposits related to our tax refund processing program. The mix shifts from the end of the year led to a decrease in the base net portfolio value. Assets have shifted toward less volatile components while liabilities have shifted toward more volatile components. Combined, this led to a small increase in volatility. Beyond the change in the base level of net portfolio value, projected movements in rates, up or down, would also lead to changes in market values. The change in the rates up scenarios for both the 100 and 200 basis point movements would lead to a larger decrease in the market value of liabilities than assets. Accordingly, we see an increase in the net portfolio value. For 100 and 200 basis point downward changes in rates, the market value of liabilities would decrease more quickly than the market value of assets, leading to an increase in the net portfolio value.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive and our principal financial officers, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation, our principal executive and our principal financial officers concluded that our disclosure controls and procedures as of March 31, 2020, were effective.

Changes in Internal Control over Financial Reporting

There have not been any changes in the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Other Information

The following information updates our risk factors and should be read in conjunction with the risk factors disclosed in “Item 1A. Risk Factors” of Part I of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

THE OUTBREAK OF THE RECENT COVID-19, OR AN OUTBREAK OF ANOTHER HIGHLY INFECTIOUS OR CONTAGIOUS DISEASE, COULD ADVERSELY AFFECT OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Our business is dependent upon the willingness and ability of our customers to conduct banking and other financial transactions. The spread of a highly infectious or contagious disease, such as COVID-19. Could cause severe and prolonged disruptions to the economies in the U.S. and our market areas, which could in turn disrupt the business activities, and operations of our customers, as well as our business and operations. Since January 2020, the COVID-19 outbreak has caused significant disruption in the financial markets both globally and in the United States. The spread of COVID-19, or an outbreak of another highly infectious or contagious disease, including the time such outbreak takes to wane and the time it takes our markets to return to normal, may result in a significant decrease in business and/or cause our customers to be unable to meet existing payment or other obligations to us, particularly in the event of a significant spread of COVID-19 or an outbreak of an infectious disease in our market area. Although we maintain contingency plans for pandemic outbreaks, a spread of COVID-19, or an outbreak of another contagious disease could also negatively impact the availability of key personnel necessary to conduct our business activities. Such a spread or outbreak also negatively impacts the business and operations of third-party service providers who perform critical services for us. The spread of COVID-19, or another highly infectious or contagious disease, or the failure to contain such spread could have a material adverse effect to our business, financial condition, and results of operations.

On March 11. 2020, the World Health Organization announced that infections of COVID-19 had become pandemic, and on March 13, the U.S. President announced a national emergency relating to the disease. National, state and local authorities have recommended social distancing and imposed quarantine and isolation measures on large portions of the population, including mandatory stay-at-home orders and business closures. These measures, while intended to protect human life, are expected to have serious adverse impacts on the U.S. and our local economies of uncertain severity and duration. The effectiveness of economic stabilization efforts, including government payments to affected citizens and industries, is uncertain. Some economists are predicting the United States will soon enter a recession. Any of the foregoing factors, or other cascading effects of the pandemic that are not currently foreseeable, could materially affect our business, including our customers’ willingness to conduct banking transactions, their ability to pay on existing obligations and the availability of liquidity, which would negatively affect our financial condition and results of operations. The duration of any such impacts cannot be predicted.

ADVERSE CHANGES IN FINANCIAL MARKETS AND ECONOMIC CONDITIONS MAY ADVERSELY IMPACT OUR RESULTS OF OPERATIONS.

The current outbreak of the coronavirus (COVID-19) internationally and in the U.S. could have an adverse effect on our business operations. A significant outbreak of disease pandemics or other adverse public health developments in the population could result in a widespread health crisis that could adversely affect the economies and financial markets of many countries, resulting in an economic downturn that could adversely affect our customers’ businesses and results of operations. Our business is also significantly affected by monetary and related policies of the U.S. government and its agencies. The Federal Reserve’s recent unprecedented cuts to the federal funds interest rate in response to the coronavirus pandemic, at a time when the existing economic environment was already characterized by interest rates at historically low levels, may further impact our ability to attract deposits, generate attractive earnings through our investment portfolio, and negatively affect the value of our loans and other assets. If and when monetary policy changes lead to an increase in interest rates, it may also have an adverse effect on our business, financial condition and results of operations as increased interest rates could reduce the demand for loans and affect the ability of our borrowers to repay their indebtedness subjecting us to potential loan losses. Changes in any of these policies are influenced by macroeconomic conditions and other factors that are beyond our control. Adverse economic conditions and government policy responses to such conditions could have a material adverse effect on our business, financial condition, results of operations and prospects. All of these factors are detrimental to our business, and the interplay between these factors can be complex and unpredictable.

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OUR ALLOWANCE FOR LOAN LOSSES MAY PROVE TO BE INSUFFICIENT TO ABSORB POTENTIAL LOSSES IN OUR LOAN PORTFOLIO.

We may further experience increased delinquencies, credit losses, and corresponding charges to capital, which could require us to increase our provision for loan losses associated with impacts related to the coronavirus outbreak due to quarantines, market downturns, increased unemployment rates, changes in consumer behavior related to pandemic fears, and related emergency response legislation, including the Families First Coronavirus Response Act (“FFCRA”). We cannot predict the full impact of the coronavirus outbreak or any other future global pandemic on our business, but we may experience increased delinquencies and credit losses as a result of the outbreak. Further, if real estate markets or the economy in general deteriorate (due to the coronavirus outbreak or otherwise), Civista may experience increased delinquencies and credit losses. The allowance for loan losses may not be sufficient to cover actual loan-related losses. Additionally, banking regulators may require Civista to increase its allowance for loan losses in the future, which could have a negative effect on Civista’s financial condition and results of operations. Additions to the allowance for loan losses will result in a decrease in net earnings and capital and could hinder our ability to grow our assets.

THE SMALL TO MEDIUM SIZED BUSINESSES THAT WE LEND TO MAY HAVE FEWER RESOURCES TO WEATHER ADVERSE BUSINESS CONDITIONS, WHICH MAY IMPAIR THEIR ABILITY TO REPAY LOANS, AND SUCH IMPAIRMENT COULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION.

Our business development and marketing strategies primarily result in us serving the banking and financial services needs of small to medium-sized businesses. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities, frequently have smaller market shares than their competition, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete and may experience substantial volatility in operating results, any of which may impair a borrower’s ability to repay a loan. In addition, the success of a small to medium-sized business often depends on the management skills, talents and efforts of one or two people or a small group of people, and the death, disability or resignation of one or more of these people could have a material adverse impact on the business and its ability to repay its loans. If general economic conditions negatively impact Ohio, Indiana or the specific markets in these states in which we operate and small to medium-sized businesses are adversely affected or our borrowers are otherwise affected by adverse business conditions, our business, financial condition and results of operations could be adversely affected.

Further, in response to the coronavirus pandemic, the FFCRA was passed on March 18, 2020. The FFCRA provides wide ranging emergency relief and appropriations for coronavirus testing, expansion of food assistance, Medicaid funding, and unemployment insurance benefits. In addition, the FFCRA requires that employers with 500 or fewer employees provide emergency paid sick leave and expanded emergency leave under the Family and Medical Leave Act. In addition to the regulatory compliance costs, the FFCRA could have a significant financial impact on our customers that are small to medium-sized businesses with 500 or fewer employees as the FFCRA will require these businesses to provide two weeks of paid sick leave and up to 12 weeks of paid (after 10 days) family and medical leave for employees who have worked at the company for at least 30 calendar days and who are unable to work (or even telework) in order to care for their children because of school closures or the unavailability of the child care provider due to the public health emergency. While the U.S. Department of Labor has broad authority to waive the applicability of these requirements for small businesses with fewer than 50 employees from the paid leave requirements if compliance with these requirements would affect the viability of the business, the applicability of this waiver, and the impact of these provisions on our impacted customers is unpredictable and unknown. The FFCRA has the potential to negatively impact our customers’ costs, demand for our customers’ products, and, thus, adversely affect our business, financial condition, and results of operations.

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