Civista Bancshares, Inc.: Form 10-Q for the period ended Sep 30, 2020

Introduction

The following discussion focuses on the consolidated financial condition of the Company at September 30, 2020 compared to December 31, 2019, and the consolidated results of operations for the three- and nine-month periods ended September 30, 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; potential litigation or other risks related to participating in the U.S. Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”), 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 the Company’s Quarterly Reports 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 September 30, 2020 were $2,817,993 compared to $2,309,557 at December 31, 2019, an increase of $508,436, or 22.0%. The increase in total assets was due to increases in cash and due from financial institutions of $146,238, accompanied by other increases in securities available for sale, loans held for sale, loans, accrued interest receivable and swap assets of $7,375, $10,971, $324,100, $3,134 and $15,809, respectively. Total liabilities at September 30, 2020 were $2,475,938 compared to $1,979,431 at December 31, 2019, an increase of $496,507, or 25.1%. The increase in total liabilities was primarily attributable to increases in noninterest-bearing demand accounts, interest-bearing demand accounts, other borrowings and swap liabilities of $147,567, $242,438, $183,695 and $15,809, respectively, partially offset by a decrease in short-term FHLB advances of $101,500.

Loans outstanding as of September 30, 2020 and December 31, 2019 were as follows:

Included in Commercial & Agriculture as of September 30, 2020 is $259,097 of PPP loans.

Loans held for sale increased $10,971 or 480.1% since December 31, 2019. The increase is due to an increase in volume due to refinances as rates have declined. At September 30, 2020, 68 loans totaling $13,256 were held for sale as compared to 15 loans totaling $2,285 at December 31, 2019.

Net loans have increased $324,100 or 19.1% since December 31, 2019. The Commercial & Agriculture, Commercial Real Estate – Owner Occupied, Commercial Real Estate – Non-Owner Occupied, Real Estate Construction and Farm Real Estate loan portfolios increased $232,175, $15,629, $91,357, $11,735 and $1,118, respectively, since December 31, 2019, while the Residential Real Estate and Consumer and Other loan portfolios decreased $19,072 and $972, respectively, since December 31, 2019. The increase in Commercial & Agriculture loans is the result of PPP loans totaling $259,097 at September 30, 2020. At September 30, 2020, the net loan to deposit ratio was 97.6% 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 nine months of 2020, provisions made to the allowance for loan losses from earnings totaled $7,862, compared to a provision of $150 during the same period in 2019. The increase in provision was due to an increase in the bank’s qualitative factors, primarily changes in international, national, regional and local conditions, related to the economic shutdown driven by the ongoing COVID-19 pandemic and the significant increase in classified loans during the period. Economic impacts related to the COVID-19 pandemic include the loss of revenue being experienced by our business clients, disruption of supply chains, additional employee costs for businesses due to the pandemic, higher unemployment rates throughout our footprint and a large number of customers requesting payment relief. Net recoveries for the first nine months of 2020 totaled $8, compared to net recoveries of $315 in the first nine months of 2019. For the first nine months of 2020, the Company charged off a total of 20 loans. One Commercial and Agriculture loan totaling $15, two Commercial Real Estate – Owner Occupied totaling $148, eight Residential Real Estate loans totaling $108 and nine Consumer and Other loans totaling $54 were charged off in the first nine months of the year. In addition, during the first nine months of 2020, the Company had recoveries on previously charged-off Commercial and Agriculture loans of $5, Commercial Real Estate – Owner Occupied loans of $20, Commercial Real Estate – Non-Owner Occupied loans of $44, Residential Real Estate loans of $196, Real Estate Construction loans of $3, Farm Real Estate loans of $10 and Consumer and Other loans of $55. 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 $233 since December 31, 2019, which was due to a decrease in loans on nonaccrual status of $233. 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 1.11% at September 30, 2020 and 0.86% December 31, 2019.

The available for sale security portfolio increased by $7,375, from $358,499 at December 31, 2019 to $365,874 at September 30, 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 September 30, 2020, the Company was in compliance with all pledging requirements.

Accrued interest receivable increased $3,134, from $7,093 at December 31, 2019 to $10,227 at September 30, 2020. The increase is the result of loan modifications consisting of the deferral of principal and/or interest payments, which are the result of the COVID-19 pandemic.

Premises and equipment, net, increased $87 from December 31, 2019 to September 30, 2020. The increase is the result of new purchases of $1,780, offset by depreciation of $1,683 and proceeds from the sale of premises and equipment of $10.

Bank owned life insurance (BOLI) increased $733 from December 31, 2019 to September 30, 2020. The increase is the result of increases in the cash surrender value of the underlying insurance policies.

Swap assets increased $15,809 from December 31, 2019 to September 30, 2020. The increase of $15,809 is primarily the result of an increase in volume of swap activity related to our Commercial Real Estate loan growth.

Total deposits as of September 30, 2020 and December 31, 2019 were as follows:

Total deposits at September 30, 2020 increased $390,005 from year-end 2019. Noninterest-bearing deposits increased $147,567 from year-end 2019, while interest-bearing deposits, including savings and time deposits, increased $242,438 from December 31, 2019. The increase in noninterest-bearing deposits was partially due to increases in cash balances related to the Company’s participation in a tax refund processing program, which added noninterest-bearing deposits of $24,533. In addition, personal demand and business demand deposit accounts increased $16,207 and $107,479, respectively. Much of the increase in business demand deposit accounts resulted from customer deposits of PPP loan proceeds. The increase in interest-bearing deposits was primarily due to an increase in non-public interest-bearing demand, savings and money markets and brokered money market accounts of $45,565, $98,619 and $29,801, respectively. Public fund interest-bearing demand and public fund time deposit accounts increased $47,045 and $20,072, respectively. The year-to-date average balance of total deposits increased $356,818 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 $116,689 and $73,694, respectively, accompanied by increases in non-public interest-bearing demand, savings and money markets and public funds interest-bearing demand of $33,434, $67,661 and $38,446, respectively. In addition, the average balance of time deposits increased $16,263 as compared to the same period in 2019.

Short-term FHLB advances decreased $101,500 from December 31, 2019 to September 30, 2020. The decrease is due to a decrease in overnight borrowings. Securities sold under agreements to repurchase, which tend to fluctuate, have increased $7,139 from December 31, 2019 to September 30, 2020.

Other borrowings increased $183,695 from December 31, 2019 to September 30, 2020. The increase is the result of borrowings by Civista under the Paycheck Protection Program Lending Facility (“PPPLF”) to provide funding for PPP loans.

Swap liabilities increased $15,809 from December 31, 2019 to September 30, 2020. The increase of $15,809 is primarily the result of an increase in volume of swap activity related to our Commercial Real Estate loan growth, as well as an increase in the fair value resulting from the low interest rate environment.

Shareholders’ equity at September 30, 2020 was $342,055, or 12.1% of total assets, compared to $330,126, or 14.3% of total assets, at December 31, 2019. The increase was the result of net income of $22,019, a decrease in the Company’s pension liability, net of tax, of $171, and an increase in the fair value of securities available for sale, net of tax, of $7,342, offset by dividends on common shares of $5,365 and the purchase of treasury shares of $12,756.

Total outstanding common shares at September 30, 2020 were 15,945,479, which decreased from 16,687,542 common shares outstanding at December 31, 2019. Common shares outstanding decreased as a result of 783,308 common shares being repurchased by the Company at an average repurchase price of $16.29. The Company repurchased 672,000 common shares pursuant to a stock repurchase program announced on December 17, 2019, 107,500 common shares pursuant to a stock repurchase program announced on May 4, 2020 and 3,808 common shares surrendered to pay taxes upon vesting of restricted shares. The repurchase plan publicly-announced on December 17, 2019 authorized the Company to repurchase up to 672,000 shares of the Company’s common shares until December 17, 2020. The repurchase plan publicly-announced on May 4, 2020 authorized the Company to repurchase a maximum aggregate value of $13,500 of the Company’s common shares until April 20, 2021. The repurchase of in common shares was offset by the grant of 26,979 restricted common shares to certain officers under the Company’s 2014 Incentive Plan. In addition, 14,266 common shares were issued to Civista directors as a retainer payment for service on the Civista Board of Directors.

Results of Operations

Three Months Ended September 30, 2020 and 2019

The Company had net income of $7,682 for the three months ended September 30, 2020, a decrease of $26 from net income of $7,708 for the same three months of 2019. Basic earnings per common share were $0.48 for the quarter ended September 30, 2020, compared to $0.48 for the same period in 2019. Diluted earnings per common share were $0.48 for the quarter ended September 30, 2020, compared to $0.46 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 September 30, 2020 was $22,006, an increase of $1,588 from $20,418 for the same three months of 2019. This increase is the result of an increase of $535 in total interest income with a decrease of $1,053 in interest expense. Interest-earning assets averaged $2,617,884 during the three months ended September 30, 2020, an increase of $596,104 from $2,021,780 for the same period of 2019. The Company’s average interest-bearing liabilities increased from $1,385,867 during the three months ended September 30, 2019 to $1,764,283 during the three months ended September 30, 2020. The Company’s fully tax equivalent net interest margin for the three months ended September 30, 2020 and 2019 was 3.44% and 4.12%, respectively.

Total interest income was $24,558 for the three months ended September 30, 2020, an increase of $535 from $24,023 of total interest income for the same period in 2019. The increase in interest income is attributable to an increase of $862 in interest and fees on loans, partially offset by an increase in the average balance of loans, which resulted from a lower yield on the portfolio. The average balance of loans increased by $414,482 or 25.5% to $2,040,492 for the three months ended September 30, 2020 as compared to $1,626,010 for the same period in 2019. The loan yield decreased to 4.22% for 2020, from 5.07% in 2019 mainly due to the impact of lower interest rates in 2020 as compared to the same period of 2019. During the quarter, the average balance of PPP loans was $259,037. These loans had an average yield of 2.90% including the amortization of PPP fees.

Interest on taxable securities decreased $387 to $1,325 for the three months ended September 30, 2020, compared to $1,712 for the same period in 2019. The average balance of taxable securities decreased $15,798 to $183,196 for the three months ended September 30, 2020 as compared to $198,994 for the same period in 2019. The yield on taxable securities decreased 49 basis points to 3.01% for 2020, compared to 3.50% for 2019. Interest on tax-exempt securities increased $87 to $1,536 for the three months ended September 30, 2020, compared to $1,449 for the same period in 2019. The average balance of tax-exempt securities increased $24,867 to $205,398 for the three months ended September 30, 2020 as compared to $180,531 for the same period in 2019. The yield on tax-exempt securities decreased 19 basis points to 4.14% for 2020, compared to 4.33% for 2019 due to the impact of lower interest rates in 2020 as compared to the same period of 2019.

Interest expense decreased $1,053 or 29.2% to $2,552 for the three months ended September 30, 2020, compared with $3,605 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 September 30, 2020, the average balance of interest-bearing liabilities increased $378,416 to $1,764,283, as compared to $1,385,867 for the same period in 2019. Interest incurred on deposits decreased by $468 to $1,631 for the three months ended September 30, 2020, compared to $2,099 for the same period in 2019. Although the average balance of interest-bearing deposits increased to $261,686 for the three months ended September 30, 2020 as compared to the same period in 2019, deposit expense decreased due to a decrease in the rate paid on demand and savings accounts from 0.33% in 2019 to 0.14% in 2020. The rate paid on time deposits decreased from 2.03% to 1.69% in 2020. Interest expense incurred on FHLB advances and subordinated debentures decreased 38.9% from 2019. The average balance on FHLB balances decreased $76,977 for the three months ended September 30, 2020 as compared to the same period in 2019. In addition, the rate paid on subordinated debentures decreased 210 basis points for the three months ended September 30, 2020 as compared to the same period in 2019. The average balance of other borrowings increased $183,695 for the three months ended September 30, 2020 as compared to the same period in 2019 as a result of the Company’s borrowings under the PPPLF to fund PPP loans.

The following table presents the condensed average balance sheets for the three months ended September 30, 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.

* —Average yields are presented on a tax equivalent basis. The tax equivalent effect associated with loans and investments, included in the yields above, was $411 and $389 for the periods ended September 30, 2020 and 2019, respectively.

** —Average balance includes nonaccrual loans.

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 September 30, 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 $2,250 and $150 during the quarters ended September 30, 2020 and 2019. The increase in the provision was due to an increase in the bank’s qualitative factors, primarily changes in international, national, regional and local conditions, related to the economic shutdown driven by the ongoing COVID-19 pandemic and the substantial increase in special mention loans. Economic impacts relating to the COVID-19 pandemic include the loss of revenue being experienced by our business clients, disruption of supply chains, additional employee costs for businesses due to the pandemic, higher unemployment rates throughout our footprint and a large number of customers requesting payment relief. Our Commercial, Commercial Real Estate and Consumer portfolios have been, and are expected to continue to be impacted the most.

Noninterest income for the three-month periods ended September 30, 2020 and 2019 are as follows:

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Noninterest income for the three months ended September 30, 2020 was $6,786, an increase of $1,357 or 25.0% from $5,429 for the same period of 2019. The increase was primarily due to increases in net gain on sale of securities, net gain on sale of loans and ATM/Interchange fees, offset by decreases in service charges, swap fees and other. Net 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 September 30, 2020, 418 loans were sold, totaling $84,315. During the three-months ended September 30, 2019, 214 loans were sold, totaling $36,040. ATM/Interchange fees increased as a result of increased transaction volume. Service charges decreased as a result of lower overdraft charges. Swap fees decreased due to the volume of swaps performed during the quarter ended September 30, 2020 as compared to the same period of 2019. Other income decreased due to a decrease in wire transfer fees, an increase in claims paid and loss reserves related to our captive insurance company and the amortization of mortgage servicing rights as a result of higher loan payoffs.

Noninterest expense for the three-month periods ended September 30, 2020 and 2019 are as follows:

Noninterest expense for the three months ended September 30, 2020 was $17,727, an increase of $996, or 6.0%, from $16,731 reported for the same period of 2019. The primary reasons for the increase were increases in compensation expense, net occupancy expense, FDIC assessment and software maintenance expense, offset by decreases in equipment expense, state franchise tax, professional services and marketing expense. The increase in compensation expense was due to increased commission and incentive based costs, offset by a decrease in employee insurance costs. The increase in net occupancy is the result of increased COVID-19 pandemic related expenses to janitorial services and supplies of $94. The quarter-over-quarter decrease in equipment expense is due to lower equipment repair and maintenance cost. The quarter-over-quarter increase in FDIC assessments was attributable to an increase in the assessment base and small bank credits applied to the 2019 assessments. The state franchise tax decrease is related to a refund of taxes paid in 2020. The quarter-over-quarter decrease in professional services costs is the result of decreases in investment advisory fees, examination fees and legal and audit fees. The increase in software maintenance expense is due to a general increase in software maintenance contracts. The quarter-over-quarter decrease in marketing expense is primarily due to a decrease in business promotion expense.

Income tax expense for the three months ended September 30, 2020 totaled $1,133, down $125 compared to the same period in 2019. The effective tax rates for the three-month periods ended September 30, 2020 and 2019 were 12.9% and 14.0%, 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 and lower taxable income for the three months ended September 30, 2020, as compared to the same period in 2019.

Nine Months Ended September 30, 2020 and 2019

The Company had net income of $22,019 for the nine months ended September 30, 2020, a decrease of $4,019 from net income of $26,038 for the same nine months of 2019. Basic earnings per common share were $1.36 for the period ended September 30, 2020, compared to $1.64 for the same period in 2019. Diluted earnings per common share were $1.36 for the period ended September 30, 2020, compared to $1.54 for the same period in 2019. The primary reasons for the changes in net income are explained below.

Net interest income for the nine months ended September 30, 2020 was $66,196, an increase of $2,318 from $63,878 in the same nine months of 2019. This increase is the result of an increase of $611 in total interest income with a decrease of $1,707 in interest expense. Interest-earning assets averaged $2,459,933 during the nine months ended September 30, 2020, an increase of $451,202 from $2,008,731 for the same period of 2019. The Company’s average interest-bearing liabilities increased from $1,326,084 at September 30, 2019 to $1,590,433 at September 30, 2020. The Company’s fully tax equivalent net interest margin for the nine months ended September 30, 2020 and 2019 was 3.70% and 4.35%, respectively.

Total interest income increased $611 to $74,144 for the period ended September 30, 2020, which is attributable to an increase of $1,529 in interest and fees on loans. This change was the result of an increase in the average balance of loans, accompanied by a lower yield on the portfolio. The average balance of loans increased by $322,037 or 20.2% to $1,913,514 for the period ended September 30, 2020, as compared to $1,591,477 for the period ended September 30, 2019. The loan yield decreased to 4.53% for 2020, from 5.33% in 2019.

Interest on taxable securities decreased $1,055 to $4,100 for the period ended September 30, 2020, compared to $5,155 for the same period in 2019. The average balance of taxable securities decreased $17,588 to $185,577 for the period ended September 30, 2020 as compared to $203,165 for the period ended September 30, 2019. The yield on taxable securities decreased 37 basis points to 3.07% for 2020, compared to 3.44% for 2019. Interest on tax-exempt securities increased $381 to $4,589 for the period ended September 30, 2020, compared to $4,208 for the same period in 2019. The average balance of tax-exempt securities increased $31,501 to $201,303 for the period ended September 30, 2020 as compared to $169,802 for the period ended September 30, 2019. The yield on tax-exempt securities decreased 22 basis points to 4.18% for 2020, compared to 4.40% for 2019.

Interest on interest-bearing deposits in other banks decreased $244 to $531 for the period ended September 30, 2020, compared to $775 for the same period in 2019. The average balance of interest-bearing deposits in other banks increased $115,252 to $159,539 for the period ended September 30, 2020 as compared to $44,287 for the period ended September 30, 2019. The yield on interest-bearing deposits in other banks decreased 190 basis points to 0.44% for 2020, compared to 2.34% for 2019.

Interest expense decreased $1,707 or 17.7% to $7,948 for the period ended September 30, 2020, compared with $9,655 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 rate. For the period ended September 30, 2020, the average balance of interest-bearing liabilities increased $264,349 to $1,590,433, as compared to $1,326,084 for the period ended September 30, 2019. Interest incurred on deposits decreased by $548 to $5,418 for the period ended September 30, 2020, compared to $5,966 for the same period in 2019. Although the average balance of interest-bearing deposits increased by $166,487 for the period ended September 30, 2020 as compared to the same period in 2019, deposit expense decreased due to a decrease in the rate paid on demand and savings accounts from 0.33% in 2019 to 0.19% in 2020. The rate paid on time deposits decreased from 1.89% to 1.85% in 2020. Interest expense incurred on FHLB advances and subordinated debentures decreased 39.1% from 2019. The average balance on Short-term FHLB balances decreased $106,341 for the period ended September 30, 2020 as compared to the same period in 2019, while the average balance on Long-term FHLB advances increased $96,007 for the period ended September 30, 2020 as compared to the same period in 2019. The rate paid on Short-term and Long-term FHLB advances decreased 80 and 61 basis points, respectively for the period ended September 30, 2020 as compared to the same period in 2019. In addition, the rate paid on subordinated debentures decreased 153 basis points for the period ended September 30, 2020 as compared to the same period in 2019. The average balance of other borrowings increased $103,133 for the period ended September 30, 2020 as compared to the same period in 2019 as a result of the Company’s borrowings under the PPPLF to fund PPP loans.

The following table presents the condensed average balance sheets for the nine months ended September 30, 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.

* —Average yields are presented on a tax equivalent basis. The tax equivalent effect associated with loans and investments, included in the yields above, was $1,230 and $1,130 for the periods ended September 30, 2020 and 2019, respectively.

** —Average balance includes nonaccrual loans.

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 nine months ended September 30, 2020 and 2019. The table is presented on a fully tax-equivalent basis.

(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 $7,862 and $150 during the periods ended September 30, 2020 and 2019, respectively. The increase in the provision was due to an increase in the bank’s qualitative factors, primarily changes in international, national, regional and local conditions, related to the economic shutdown driven by the ongoing COVID-19 pandemic. Economic impacts related to the COVID-19 pandemic include the loss of revenue being experience by our business clients, disruption of supply chains, additional employee costs for businesses due to the pandemic, higher unemployment rates throughout our footprint and a large number of customers requesting payment relief. Our Commercial, Commercial Real Estate and Consumer portfolios have been, and are expected to continue to be impacted the most.

Noninterest income for the nine-month periods ended September 30, 2020 and 2019 are as follows:

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Noninterest income for the nine months ended September 30, 2020 was $20,516, an increase of $3,700 or 22.0% from $16,816 for the same period of 2019. The increase was primary due to increases in net gain on sale of loans of $3,800, ATM/Interchange fees of $355 and swap fees of $973, partially offset by a decrease in service charges of $921, tax refund processing fees of $375 and other income of $163. In addition, net gain on sale of securities increased $75 due to security sales, while net gain (loss) on equity securities decreased $207 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 nine-months ended September 30, 2020, 1,076 loans were sold, totaling $211,143. During the nine-months ended September 30, 2019, 465 loans were sold, totaling $80,482. ATM/Interchange fees increased as a result of increased transaction volume. Swap fees increased due to the volume of swaps performed during the nine-months ended September 30, 2020 as compared to the same period of 2019. Service charges decreased due to Civista waiving $93 of service fees on deposits accounts related to the COVID-19 pandemic. In addition, overdraft fees decreased during 2020. Other income decreased due to the amortization of mortgage servicing rights as a result of higher loan payoffs.

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 $2,375 for the period ended September 30, 2019, a decrease of $375 from $2,750 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 nine-month periods ended September 30, 2020 and 2019 are as follows:

Noninterest expense for the nine months ended September 30, 2020 was $53,697, an increase of $3,879, or 7.8%, from $49,818 reported for the same period of 2019. The primary reasons for the increase were increases in compensation expenses of $3,004, FDIC assessments of $234, professional services costs of $138, software maintenance expense of $249 and other operating expenses of $272, offset by decreases in ATM/Interchange expense of $121. The increase in compensation expense was due to increased payroll, overtime pay, 401k expenses, payroll taxes and commission and incentive based costs, offset by a decrease in employee insurance costs. The year-to-date average full time equivalent (FTE) employees were 452.1 at September 30, 2020, an increase of 11.3 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 as the result of increased loan activity. The year-over-year increase in FDIC assessments was attributable to small bank assessment credits applied to the 2019 assessment charges. The increase in professional services costs is the result of increased consulting services to implement cost savings and customer services and increased recruitment costs. The decrease in ATM/Interchange expense is primarily due to a settlement received in the second quarter of 2020. The increase in software maintenance expense is due to a general increase in software maintenance contracts. The increase in other operating expense is primarily due to increases in software depreciation, amortization of low income housing investments, other loan expense, MSR valuation expense, ATM/debit card losses and communication expense, offset by decreases in travel, lodging and meals.

Income tax expense for the nine months ended September 30, 2020 totaled $3,134, down $1,554 compared to the same period in 2019. The effective tax rates for the nine month periods ended September 30, 2020 and 2019 were 12.5% and 15.3%, 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 lower taxable income for the nine-months ended September 30, 2020, as compared to the same period in 2019.

Capital Resources

Shareholders’ equity totaled $342,055 at September 30, 2020 compared to $330,126 at December 31, 2019. The Company repurchased common shares during the period, which totaled $12,756. The increase in shareholders’ equity was also impacted by net income of $22,019, a $171 net decrease in the Company’s pension liability and an increase in the fair value of securities available for sale, net of tax, of $7,342, which was partially offset by dividends on common stock of $5,365.

All of the Company’s capital ratios exceeded the regulatory minimum guidelines as of September 30, 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 $11,311, or 3.1% of the total security portfolio at September 30, 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 $25,301 and $22,522 for the nine months ended September 30, 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 net deferred loan fees of $7,862 and $7,721, respectively added to cash from operating activities. The primary use of cash from operating activities is from loans originated for sale. The increase in originations and sales of loans held for sale is due to an increase in volume due to refinances as rates have declined. Net cash used for investing activities was $340,281 and $81,955 for the nine months ended September 30, 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 $461,218 and $78,873 for the nine months ended September 30, 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 September 30, 2020, Civista had total credit availability with the FHLB of $617,547 with standby letters of credit totaling $20,000 and a remaining borrowing capacity of approximately $472,547. 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 September 30, 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 September 30, 2020 and December 31, 2019.

The Company had derivative financial instruments as of December 31, 2019 and September 30, 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 September 30, 2020, can be attributed to a couple of factors. There was a 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. Both the increase in loans and cash are primarily a result of PPP loans and the proceeds of those loans on deposit, respectively. Similarly, the volume and mix of liabilities has shifted toward deposits and other borrowings. Deposits increased as a result of PPP loan proceeds on deposit and other borrowings increased as a result of PPP funding acquired from the PPPLF. The mix shifts from the end of the year led to a slight increase in the base net portfolio value. Generally, assets have shifted toward less volatile components while liabilities have shifted toward more volatile components. Combined, this led to an 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 assets would increase more quickly than the market value of liabilities, 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 September 30, 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

There were no material changes during the current period to 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, as supplemented by the risk factors in “Item 1A. Risk Factors” of the Company’s Quarterly Reports on Form 10-Q for the quarterly periods ended March 31, 2020 and June 30, 2020.