MetroCity Bankshares, Inc.: Form 10-Q for the period ended Sep 30, 2024

The purpose of this discussion and analysis is to focus on significant changes in the financial condition of MetroCity Bancshares, Inc. and our wholly owned subsidiary, Metro City Bank, from December 31, 2023 through September 30, 2024 and on our results of operations for the three and nine months ended September 30, 2024 and 2023. This discussion and analysis should be read in conjunction with our audited consolidated financial statements and notes thereto for the year ended December 31, 2023 included in our Annual Report on Form 10-K, and information presented elsewhere in this Quarterly Report on Form 10-Q, particularly the unaudited consolidated financial statements and related notes appearing in Item 1.

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements reflect our current views with respect to, among other things, future events and our financial performance. These statements are often, but not always, made through the use of words or phrases such as “may,” “might,” “should,” “could,” “predict,” “potential,” “believe,” “expect,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “strive,” “projection,” “goal,” “target,” “outlook,” “aim,” “would,” “annualized” and “outlook,” or the negative version of those words or other comparable words or phrases of a future or forward-looking nature. These forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. Accordingly, we caution you that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions, estimates and uncertainties that are difficult to predict. Although we believe that the expectations reflected in these forward-looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements.

A number of important factors could cause our actual results to differ materially from those indicated in these forward-looking statements, including those factors discussed elsewhere in this quarterly report and the following:

• General economic and business conditions in our local markets, including conditions affecting employment levels, interest rates, inflation, the threat of recession, volatile equity capital markets, property and casualty insurance costs, collateral values, customer income, creditworthiness and confidence, spending and savings that may affect customer bankruptcies, defaults, charge-offs and deposit activity; and the impact of the foregoing on customer and client behavior (including the velocity and levels of deposit withdrawals and loan repayment);
• changes in interest rate environment (including changes to the federal funds rate, the level and composition of deposits (as well as the cost of, and competition for, deposits), loan demand, liquidity and the values of loan collateral, securities and market fluctuations, and interest rate sensitive assets and liabilities), and competition in our markets may result in increased funding costs or reduced earning assets yields, thus reducing our margins and net interest income;
• adverse developments in the banking industry highlighted by high-profile bank failures and the impact of such developments on customer confidence, liquidity and regulatory responses to these developments (including increases in the cost of our deposit insurance assessments and increased regulatory scrutiny), our ability to effectively manage our liquidity risk and any growth plans and the availability of capital and funding;
• our ability to comply with applicable capital and liquidity requirements, including our ability to generate liquidity internally or raise capital on favorable terms, including continued access to the debt and equity capital markets;
• the risk that a future economic downturn and contraction could have a material adverse effect on our capital, financial condition, credit quality, results of operations and future growth, including the risk that the strength of the current economic environment could be weakened by the continued impact of prolonged elevated interest rates and inflation;
• factors that can impact the performance of our loan portfolio, including real estate values and liquidity in our primary market areas, the financial health of our borrowers and the success of various projects that we finance;
• concentration of our loan portfolio in real estate loans;
• changes in the prices, values and sales volumes of commercial and residential real estate, especially as they relate to the value of collateral supporting the Company’s loans;
• weakness in the real estate market, including the secondary residential mortgage market, which can affect, among other things, the value of collateral securing mortgage loans, mortgage loan originations and delinquencies, profits on sales of mortgage loans, and the value of mortgage servicing rights;
• credit and lending risks associated with our construction and development, commercial real estate, commercial and industrial, residential real estate and SBA loan portfolios;
• negative impacts related to our mortgage banking services, including declines in our mortgage originations or profitability due to prolonged elevated interest rates and increased competition and regulation, the Bank’s or third party’s failure to satisfy mortgage servicing obligations, loan modifications, the effects of judicial or regulatory requirements or guidance, and the possibility of the Bank being required to repurchase mortgage loans or indemnify buyers;
• the impact of prolonged elevated interest rates on our financial projections, models and guidance;
• our ability to attract sufficient loans that meet prudent credit standards, including in our construction and development, commercial and industrial and owner-occupied commercial real estate loan categories;
• our ability to attract and maintain business banking relationships with well-qualified businesses, real estate developers and investors with proven track records in our market areas;
• our ability to successfully manage our credit risk and the sufficiency of our allowance for credit losses (“ACL”);
• the adequacy of our reserves (including ACL) and the appropriateness of our methodology for calculating such reserves;
• our ability to successfully execute our business strategy to achieve profitable growth;
• the concentration of our business within our geographic areas of operation and to the general Asian-American population within our primary market areas;
• our focus on small and mid-sized businesses;
• our ability to manage our growth;
• our ability to increase our operating efficiency;
• significant turbulence or a disruption in the capital or financial markets and the effect of a fall in stock market prices on our investment securities;
• risks that our cost of funding could increase, in the event we are unable to continue to attract stable, low-cost deposits and reduce our cost of deposits;
• inability of our risk management framework (including internal controls) to effectively mitigate credit risk, interest rate risk, liquidity risk, price risk, compliance risk, operational risk (including by virtue of our relationships with third-party business partners, as well as our relationships with third-party vendors and other service providers), strategic risk, reputational risk and other risks inherent to the business of banking;
• our ability to maintain expenses in line with current projections;
• the makeup of our asset mix and investments;
• external economic, political and/or market factors, such as changes in monetary and fiscal policies and laws (including as a result of the 2024 United States presidential election), and also including the interest rate policies of the Federal Reserve, inflation or deflation, changes in the demand for loans, and fluctuations in consumer spending, borrowing and savings habits, which may have an adverse impact on our financial condition;
• the institution and outcome of litigation and other legal proceeding against us or to which we may become subject to and the potential effect on our reputation;
• the impact of recent and future legislative and regulatory changes;
• examinations by our regulatory authorities;
• continued or increasing competition from other financial institutions, credit unions, and non-bank financial services companies (including fintech companies), many of which are subject to different regulations than we are;
• challenges arising from unsuccessful attempts to expand into new geographic markets, products, or services;
• restraints on the ability of the Bank to pay dividends to us, which could limit our liquidity;
• increased capital requirements imposed by banking regulators, which may require us to raise capital at a time when capital is not available on favorable terms or at all;
• inaccuracies in our assumptions about future events, which could result in material differences between our financial projections and actual financial performance;
• changes in our management personnel or our inability to retain motivate and hire qualified management personnel;
• the dependence of our operating model on our ability to attract and retain experienced and talented bankers in each of our markets, which may be impacted as a result of labor shortages;
• our ability to identify and address cyber-security risks, fraud and systems errors, including the impact on our reputation and the costs and effects required to address such risks, fraud and systems errors;
• disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems, which may be exacerbated by the development of generative artificial intelligence, and the cost of defending against them and any reputational or other financial risks following such a cybersecurity incident;
• our business relationships with, and reliance upon, third parties that have strategic partnerships with us or that provide key components of our business infrastructure, including the costs of services and products provided to us by third parties, and disruptions in service, security breaches, financial difficulties with or other adverse events affecting a third-party vendor or business relationship;
• an inability to keep pace with the rate of technological advances due to a lack of resources to invest in new technologies;
• fraudulent and negligent acts by our clients, employees or vendors and our ability to identify and address such acts;
• risks related to potential acquisitions;
• compliance with governmental and regulatory requirements, including the Dodd-Frank Act and others relating to banking, consumer protection, securities and tax matters, and our ability to maintain licenses required in connection with commercial mortgage origination, sale and servicing operations;
• changes in the scope and cost of Federal Deposit Insurance Corporation (“FDIC”) insurance and other coverage;
• changes in our accounting standards;
• changes in tariffs and trade barriers;
• changes in federal tax law or policy;
• the effects of war or other conflicts (including Russia’s military action in Ukraine and the ongoing conflict in Israel and the surrounding areas), acts of terrorism, acts of God, natural disasters, health emergencies, epidemics or pandemics, climate changes, or other catastrophic events that may affect general economic conditions or cause other disruptions and/or increase costs, including, but not limited to, property and casualty and other insurance cost;
• risks related to environmental, social and governance ("ESG") strategies and initiatives, the scope and pace of which could alter the Company’s reputation and shareholder, associate, customer and third-party affiliations;
• a deterioration of the credit rating for U.S. long-term sovereign debt, actions that the U.S. government may take to avoid exceeding the debt ceiling, and uncertainties surrounding the debt ceiling and the federal budget; and
• other risks and factors identified in the Company’s 2023 Form 10-K, including those identified under the heading “Risk Factors”, and detailed from time to time in our other filings with the U.S. Securities and Exchange Commission.

The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this Quarterly Report on Form 10-Q. Because of these risks and other uncertainties, our actual future results, performance or achievement, or industry results, may be materially different from the results indicated by the forward looking statements in this Quarterly Report on Form 10-Q. In addition, our past results of operations are not necessarily indicative of our future results. You should not rely on any forward looking statements, which represent our beliefs, assumptions and estimates only as of the dates on which they were made, as predictions of future events. Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to update or review any forward-looking statement, whether as a result of new information, future developments or otherwise.

CECL Adoption

On January 1, 2023, the Company adopted ASC Topic 326 which replaces the incurred loss approach for measuring credit losses with an expected loss model, referred to the current expected credit loss ("CECL") model. CECL applies to financial assets subject to credit losses and measured at amortized cost and certain off-balance-sheet credit exposures, which include, but are not limited to, loans, leases, held-to-maturity securities, loan commitments and financial guarantees. The adoption of this guidance resulted in an increase of the allowance for credit losses of $5.1 million, the creation of an allowance for unfunded commitments of $239,000 and a reduction of retained earnings of $3.8 million, net of the increase in deferred tax assets of $1.5 million.

The impact of utilizing the CECL approach to calculate the allowance for credit losses will be significantly influenced by the composition, characteristics and quality of our loan portfolio, as well as the prevailing economic conditions and forecasts utilized. Material changes to these and other relevant factors may result in greater volatility to the provision for credit losses, and therefore, greater volatility to our reported earnings. See Note 1 and Note 3 of our consolidated financial statements as of September 30, 2024, included elsewhere in this Form 10-Q, for additional information on the allowance for credit losses and the allowance for unfunded commitments.

Critical Accounting Policies and Estimates

Our accounting and reporting estimates conform with U.S. GAAP and general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. We consider accounting estimates that can (1) be replaced by other reasonable estimates and/or (2) changes to an estimate from period to period that have a material impact on the presentation of our financial condition, changes in financial condition or results of operations as well as (3) those estimates that require significant and complex assumptions about matters that are highly uncertain to be critical accounting estimates. We consider our critical accounting policies to include the allowance for credit losses, servicing assets, fair value of financial instruments and income taxes.

Critical accounting estimates include a high degree of uncertainty in the underlying assumptions. Management bases its estimates on historical experience, current information and other factors deemed relevant. The development, selection and disclosure of our critical accounting estimates are reviewed with the Audit Committee of the Company's Board of Directors. Actual results could differ from these estimates. For additional information regarding critical accounting policies, refer to “Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates” and Note 1 of our consolidated financial statements as of December 31, 2023 in the Company’s 2023 Form 10-K. There have been no significant changes in the Company’s application of critical accounting policies since December 31, 2023.

Reserve for Credit Losses

A consequence of lending activities is that we may incur credit losses. The amount of such losses will vary depending upon the risk characteristics of the loan lease portfolio as affected by economic conditions such as rising interest rates and the financial performance of borrowers.

The reserve for credit losses consists of the allowance for credit losses (“ACL”) and the allowance for unfunded commitments. As a result of our January 1, 2023 adoption of ASU No. 2016-13, and its related amendments, our methodology for estimating the reserve for credit losses changed significantly from December 31, 2022. The standard replaced the “incurred loss” approach with an “expected loss” approach known as the Current Expected Credit Losses (“CECL”). The CECL approach requires an estimate of the credit losses expected over the life of an exposure (or pool of exposures). It removes the incurred loss approach’s threshold that delayed the recognition of a credit loss until it was “probable” a loss event was “incurred.”

The estimate of expected credit losses under the CECL approach is based on relevant information about past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amounts. Historical loss experience is generally the starting point for estimating expected credit losses. We then consider whether the historical loss experience should be adjusted for loan-specific risk characteristics or current conditions at the reporting date that did not exist over the period from which historical experience was used. Finally, we consider forecasts about future economic conditions that are reasonable and supportable. The allowance for unfunded commitments represents the expected credit losses on off-balance sheet commitments such as unfunded commitments to extend credit. This allowance is estimated by loan segment at each balance sheet date under the CECL model using the same methodologies as portfolio loans, taking into consideration the likelihood that funding will occur.

Management’s evaluation of the appropriateness of the reserve for credit losses is often the most critical of accounting estimates for a financial institution. Our determination of the amount of the reserve for credit losses is a critical accounting estimate as it requires significant reliance on the credit risk rating we assign to individual borrowers, the use of estimates and significant judgment as to the amount and timing of expected future cash flows, reliance on historical loss rates on homogenous portfolios, consideration of our quantitative and qualitative evaluation of economic factors, and the reliance on our reasonable and supportable forecasts. The reserve for credit losses attributable to each portfolio segment also includes an amount for inherent risks not reflected in the historical analyses. Relevant factors include, but are not limited to, concentrations of credit risk (geographic, large borrower, and industry), changes in underwriting standards, changes in collateral values, experience and depth of lending staff, trends in delinquencies, and the volume and terms of loans.

See Note 1 and Note 3 of our consolidated financial statements as of September 30, 2024, included elsewhere in this Form 10-Q, for additional information on the reserve and allowance for credit losses.

Overview

MetroCity Bankshares, Inc. is a bank holding company headquartered in the Atlanta metropolitan area. We operate through our wholly-owned banking subsidiary, Metro City Bank, a Georgia state-chartered commercial bank that was founded in 2006. We currently operate 20 full-service branch locations in multi-ethnic communities in Alabama, Florida, Georgia, New York, New Jersey, Texas and Virginia. As of September 30, 2024, we had total assets of $3.57 billion, total loans of $3.09 billion, total deposits of $2.72 billion and total shareholders’ equity of $407.2 million.

We are a full-service commercial bank focused on delivering personalized service in an efficient and reliable manner to the small to medium-sized businesses and individuals in our markets, predominantly Asian-American communities in growing metropolitan markets in the Eastern U.S. and Texas. We offer a suite of loan and deposit products tailored to meet the needs of the businesses and individuals already established in our communities, as well as first generation immigrants who desire to establish and grow their own businesses, purchase a home, or educate their children in the United States. Through our diverse and experienced management team and talented employees, we are able to speak the language of our customers and provide them with services and products in a culturally competent manner.

Selected Financial Data

The following table sets forth unaudited selected financial data for the most recent five quarters and for the nine months ended September 30, 2024 and 2023. This data should be read in conjunction with the unaudited consolidated financial statements and accompanying notes included in Item 1 and the information contained in this Item 2.

(Dollars in thousands, except per share data)

43

(1) Excluding average accumulated other comprehensive income, our return on average equity for the three months ended September 30, 2024 and 2023 was 17.25% and 13.04%, respectively. Excluding average accumulated other comprehensive income, our return on average equity for the nine months ended September 30, 2024 and 2023 was 17.27% and 15.81%, respectively.

(2) Represents noninterest expense divided by total revenue (net interest income and total noninterest income).

Results of Operations

We recorded net income of $16.7 million for the three months ended September 30, 2024 compared to $11.4 million for the same period in 2023, an increase of $5.3 million, or 46.1%. This increase was due to an increase in net interest income of $6.1 million and an increase in noninterest income of $4.0 million, offset by an increase in noninterest expense of $2.1 million, an increase in income tax expense of $1.7 million and an increase in provision for credit losses of $963,000.

For the nine months ended September 30, 2024, we recorded net income of $48.3 million compared to $40.3 million for the nine months ended September 30, 2023, an increase of $8.0 million, or 19.9%. This increase was due to an increase in net interest income of $12.7 million and an increase in noninterest income of $4.3 million, offset by an increase in noninterest expense of $5.2 million, an increase income tax expense of $2.6 million and an increase in provision for credit losses of $1.1 million.

Basic and diluted earnings per common share for the three months ended September 30, 2024 was $0.66 and $0.65, respectively, compared to $0.45 for both the basic and diluted earnings per common share for the same period in 2023. For the nine months ended September 30, 2024, basic and diluted earnings per common share was $1.91 and $1.89, respectively, compared to $1.60 and $1.58 for the same period in 2023, respectively.

Interest Income

Interest income totaled $53.8 million for the three months ended September 30, 2024, an increase of $5.1 million, or 10.5%, from the three months ended September 30, 2023, primarily due to a 45 basis points increase in the loan yield coupled with an $86.2 million increase in average loan balances, as well as a 38 basis points increase in the total investment yield coupled with a $19.7 million increase in the average total investment balance. The increase in average loans is due to an increase of $93.5 million in average commercial real estate loans, an increase of $6.1 million in average residential mortgage loans and an increase of $2.8 million in average commercial and industrial loans, offset by a decrease of $16.4 million in construction and development loans. As compared to the three months ended September 30, 2023, the yield on average interest-earning assets increased by 44 basis points to 6.36% from 5.92% with the yield on average loans increasing by 45 basis points and the yield on average total investments increasing by 38 basis points.

Interest income was $160.3 million for the nine months ended September 30, 2024 compared to $142.2 million for the same period in 2023, an increase of $18.1 million, or 12.8%, primarily due to a 48 basis point increase in the loan yield coupled with an increase in average loan balances of $112.5 million, as well as a 58 basis points increase in the interest earning cash accounts yield coupled with a $20.0 million increase in the average interest earning cash balances. The increase in average loans is due to an increase of $73.9 million in average commercial real estate loans, a $44.5 million increase in average residential mortgage loans and an increase of $13.8 million in average commercial and industrial loans, offset by a decrease of $19.8 million in construction and development loans. As compared to the nine months ended September 30, 2023, the yield on average interest-earning assets increased by 48 basis points to 6.36% from 5.88% with the yield on average loans increasing by 48 basis points and the yield on average total investments increasing by 58 basis points.

Interest Expense

Interest expense for the three months ended September 30, 2024 decreased $1.0 million, or 4.1%, to $23.5 million compared to interest expense of $24.6 million for the three months ended September 30, 2023, primarily due to a 44 basis points decrease in deposit costs, offset by a $31.8 million increase in average deposit balances. The 44 basis points decrease in deposit costs was primarily driven by a 199 basis points decrease in the yield on average money market deposits from the benefit received on our interest rate swaps, offset by an 81 basis point increase in time deposit costs. Average time deposits increased by $91.5 million while average money market deposits decreased by $54.4 million. Average borrowings for the three months ended September 30, 2024 increased by $50.7 million with an increase in rate of 73 basis points compared to the three months ended September 30, 2023.

Interest expense totaled $72.2 million for the nine months ended September 30, 2024, an increase of $5.4 million, or 8.1%, compared to the same period in 2023, primarily due to a $128.4 million increase in average interest-bearing deposits and a 108 basis points increase in borrowing costs, partially offset by a seven basis points decrease in deposit costs. Average borrowings for the nine months ended September 30, 2024 decreased by $3.1 million compared to the same period in 2023.

The Company currently has interest rate derivative agreements totaling $850.0 million that are designated as cash flow hedges of our deposit accounts indexed to the Federal Funds Effective rate. The weighted average pay rate for these interest rate derivatives is 2.29%. During the three months ended September 30, 2024, we recorded a credit to interest expense of $6.4 million from the benefit received on these interest rate derivatives compared to a credit to interest expense of $1.3 million recorded during the three months ended September 30, 2023. During the nine months ended September 30, 2024, we recorded a credit to interest expense of $17.0 million from the benefit received on these interest rate derivatives compared to a credit to interest expense of $2.3 million recorded during the nine months ended September 30, 2023. Based on the Federal Funds Effective rate as of September 30, 2024 (4.83%), the Company would estimate to record a credit to interest expense of approximately $5.4 million for the remainder of 2024 from the benefit received on these interest rate derivatives. See Note 8 of our consolidated financial statements as of September 30, 2024, included elsewhere in this Form 10-Q, for additional information on these interest rate derivatives.

Net Interest Margin

The net interest margin for the three months ended September 30, 2024 increased by 64 basis points to 3.58% from 2.94% for the three months ended September 30, 2023, primarily due to a 44 basis points increase in the yield on average interest-earning assets of $3.37 billion and a 28 basis points decrease in the cost of average interest-bearing liabilities of $2.54 billion. Average earning assets for the three months ended September 30, 2024 increased by $105.9 million from the three months ended September 30, 2023, due to a $86.2 million increase in average loans and a $19.7 million increase in average total investments. Average interest-bearing liabilities for the three months ended September 30, 2024 increased by $82.4 million from the three months ended September 30, 2023, driven by increases in average borrowings of $50.7 million and average interest-bearing deposits of $31.8 million.

The net interest margin for the nine months ended September 30, 2024 increased by 39 basis points to 3.50% from 3.11% for the nine months ended September 30, 2023, primarily due to a 48 basis points increase in the yield on average interest-earning assets of $3.37 billion, offset by a 10 basis points increase in the cost of average interest-bearing liabilities of $2.56 billion. Average earning assets increased by $131.4 million due to a $112.5 million increase in average loans and a $20.0 million increase in average interest-earning cash accounts. Average interest-bearing liabilities increased by $125.3 million, primarily driven by an increase in average interest-bearing deposits of $128.4 million, offset by a $3.1 million decrease in average borrowings.

Net interest margin and net interest income are influenced by internal and external factors. Internal factors include balance sheet changes on both volume and mix and pricing decisions, and external factors include changes in market interest rates, competition and the shape of the interest rate yield curve. The increase in our net interest margin is primarily the result of our decreasing deposit costs from the benefit received on our interest rate derivatives, as well as the continued increase to our loan yields.

Average Balances, Interest and Yields

The following tables present, for the three and nine months ended September 30, 2024 and 2023, information about: (i) weighted average balances, the total dollar amount of interest income from interest-earning assets and the resultant average yields; (ii) average balances, the total dollar amount of interest expense on interest-bearing liabilities and the resultant average rates; (iii) net interest income; (iv) the interest rate spread; and (v) the net interest margin.

(Dollars in thousands)

(1) Includes income and average balances for term federal funds, interest-earning cash accounts, and other miscellaneous earning assets.

(2) Average loan balances include nonaccrual loans and loans held for sale.

(Dollars in thousands)

(1) Includes income and average balances for term federal funds, interest-earning cash accounts, and other miscellaneous earning assets.

(2) Average loan balances include nonaccrual loans and loans held for sale.

Rate/Volume Analysis

Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in average interest rates. The following table sets forth the effects of changing rates and volumes on our net interest income during the period shown. Information is provided with respect to (i) effects on interest income attributable to changes in volume (change in volume multiplied by prior rate) and (ii) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume). Change applicable to both volumes and rate have been allocated to volume.

(Dollars in thousands)

(1) Includes income and average balances for term federal funds, interest-earning cash accounts, and other miscellaneous earning assets.

(2) Average loan balances include nonaccrual loans and loans held for sale.

(Dollars in thousands)

(1) Includes income and average balances for term federal funds, interest-earning cash accounts, and other miscellaneous earning assets.

(2) Average loan balances include nonaccrual loans and loans held for sale.

Provision for Credit Losses

The provision for credit losses reflects our internal calculation and judgment of the appropriate amount of the allowance for credit losses. The adoption of ASU No. 2016-13, “Measurement of Credit Losses on Financial Instruments” or “CECL” has significantly changed the methodology of how we measure credit losses (see Note 1 to the Consolidated Financial Statements for more information). We maintain the allowance for credit losses at levels we believe are appropriate to cover our estimate of expected credit losses over the life of loans in the portfolio as of the end of the reporting period. The allowance for credit losses is determined through detailed quarterly analyses of our loan portfolio. The allowance for credit losses is based on our loss experience, changes in the economic environment, reasonable and supportable forecasts, as well as an ongoing assessment of credit quality and environmental factors not reflective in historical loss rates. Additional qualitative factors that are considered in determining the amount of the allowance for credit losses are concentrations of credit risk (geographic, large borrower, and industry), changes in underwriting standards, changes in collateral value, experience and depth of lending staff, trends in delinquencies, and the volume and terms of loans.

We recorded a provision for credit losses of $582,000 and $314,000 during the three and nine months ended September 30, 2024 compared to a credit to the provision for credit losses of $381,000 and $797,000 during the three and nine months ended September 30, 2023. The provision expense recorded during the nine months ended September 30, 2024 was primarily due to the increase in reserves allocated to our individually analyzed loans, as well as the increase in general reserves allocated to our commercial real estate loan portfolio due to higher loan balances, partially offset by the decrease in the general reserves allocated to our residential mortgage loan portfolio as a large amount of residential mortgage loans were sold during the period. Our ACL as a percentage of gross loans for the periods ended September 30, 2024, December 31, 2023 and September 30, 2023 was 0.60%, 0.57% and 0.58%, respectively. Our ACL as a percentage of gross loans is relatively lower than our peers due to our high percentage of residential mortgage loans, which tend to have lower allowance for credit loss ratios compared to other commercial or consumer loans due to their low LTVs.

See the section captioned “Allowance for Credit Losses” elsewhere in this document for further analysis of our provision for credit losses.

Noninterest Income

Noninterest income for the three months ended September 30, 2024 was $6.6 million, an increase of $4.0 million, or 149.0%, compared to $2.7 million for the three months ended September 30, 2023. Noninterest income for the nine months ended September 30, 2024 was $17.7 million, an increase of $4.3 million, or 31.5%, compared to $13.5 million for the nine months ended September 30, 2023.

The following table sets forth the major components of our noninterest income for the three and nine months ended September 30, 2024 and 2023:

(Dollars in thousands)

Service charges on deposit accounts increased $41,000, or 8.4%, to $531,000 for the three months ended September 30, 2024 compared to $490,000 for the same three months during 2023. Service charges on deposit accounts were $1.5 million for the nine months ended September 30, 2024 compared to $1.4 million for the same period in 2023, an increase of $107,000, or 7.6%. These increases were primarily attributable to higher overdraft fees and wire transfer fees, offset by lower analysis charges.

Other service charges, commissions and fees increased $437,000, or 29.6%, to $1.9 million for the three months ended September 30, 2024 compared to $1.5 million for the three months ended September 30, 2023. Other service charges, commissions and fees increased $1.5 million, or 41.0%, to $5.1 million for the nine months ended September 30, 2024 compared to $3.6 million for the nine months ended September 30, 2023. These increases were mainly attributable to higher origination, underwriting and processing fees earned from our origination of residential mortgage loans as mortgage volume increased during the three and nine months ended September 30, 2024 compared to the same periods in 2023. Mortgage loan originations totaled $122.4 million and $310.4 million during the three and nine months ended September 30, 2024 compared to $91.9 million and $208.1 million during the same periods in 2023.

Total gain on sale of loans was $1.6 million for the three months ended September 30, 2024 compared to $244,000 for the same period of 2023, an increase of $1.4 million, or 559.4%. Total gain on sale of loans was $4.1 million for the nine months ended September 30, 2024 compared to $3.3 million for the same period of 2023, an increase of $792,000, or 24.2%.

Gain on sale of residential mortgage loans totaled $526,000 and $1.9 million for the three and nine months ended September 30, 2024 as we sold $54.2 million and $187.5 million in residential mortgage loans during these periods with an average premium of 1.05%. We recorded no gain on sale of residential mortgage loans during the three and nine months ended September 30, 2023 as no mortgage loans were sold during the period.

Gain on sale of SBA loans totaled $1.1 million and $2.1 million for the three and nine months ended September 30, 2024 compared to $244,000 and $3.3 million for the same periods in 2023. We sold $28.9 million and $52.9 million in SBA loans during the three and nine months ended September 30, 2024 with average premiums of 6.67% and 6.69%, respectively. We sold $5.2 million and $71.9 million in SBA loans during the three and nine months ended September 30, 2023 with average premiums of 6.00% and 6.09%, respectively.

Mortgage loan servicing income, net of amortization, increased by $507,000, or 596.5%, to $422,000 during the three months ended September 30, 2024 compared to an expense balance of $85,000 for the same period of 2023. Mortgage loan servicing income increased by $2.0 million, or 857.8%, to $1.8 million during the nine months ended September 30, 2024 compared to an expense balance of $232,000 for the same period of 2023. The changes in mortgage loan servicing income were primarily due to decreases in mortgage servicing amortization and an increase in capitalized mortgage servicing assets, partially offset by the decrease in mortgage servicing fees. Included in mortgage loan servicing income for the three and nine months ended September 30, 2024 was $580,000 and $1.7 million in mortgage servicing fees compared to $606,000 and $1.9 million for the same periods in 2023 and capitalized mortgage servicing assets of $310,000 and $1.2 million for the three and nine months ended September 30, 2024 compared to $0 for the same periods in 2023. These amounts were offset by mortgage loan servicing asset amortization of $216,000 and $957,000 for the three and nine months ended September 30, 2024 compared to $691,000 and $2.2 million during the three and nine months ended September 30, 2023. During the three and nine months ended September 30, 2024, we recorded a fair value impairment of $252,000 on our mortgage servicing assets. During the three and nine months ended September 30, 2023, we did not record a fair value impairment on our mortgage servicing assets. Our total residential mortgage loan servicing portfolio was $556.4 million at September 30, 2024 compared to $464.8 million at September 30, 2023.

SBA servicing income increased by $961,000, or 355.9%, to $1.2 million for the three months ended September 30, 2024 compared to $270,000 for the three months ended September 30, 2023. SBA servicing income was $3.3 million for the nine months ended September 30, 2024 compared to $3.5 million for the same period in 2023, a decrease of $185,000, or 5.3%. Our total SBA and USDA loan servicing portfolio was $487.4 million as of September 30, 2024 compared to $487.8 million as of September 30 2023. Included in SBA servicing income for the three and nine months ended September 30, 2024 was $1.0 million and $3.2 million in SBA servicing fees compared to $1.2 million and $3.4 million for the same periods in 2023. Our SBA servicing rights are carried at fair value and the inputs used to calculate fair value change from period to period. During the three months ended September 30, 2024, we recorded a $201,000 fair value increase to our SBA servicing rights compared to a $911,000 fair value charge to our SBA servicing rights during the three months ended September 30, 2023. During the nine months ended September 30, 2024, we recorded a $69,000 fair value increase to our SBA servicing rights compared to a $58,000 fair value increase during the nine months ended September 30, 2023.

Other noninterest income increased by $647,000, or 248.8%, to $907,000 for the three months ended September 30, 2024 compared to $260,000 for the three months ended September 30, 2023. Other noninterest income was $2.0 million for the nine months ended September 30, 2024 compared to $2.0 million for the same period in 2023, an increase of $64,000, or 3.3%. The increases were mainly due to increases in bank owned life insurance income and unrealized gains on our equity securities. These increases were partially offset by decreases in gain on sale of foreclosed real estate as a $547,000 gain on sale was recorded during the nine months ended September 30, 2023 compared to a $85,000 loss on sale being recorded during the nine months ended September 30, 2024. The largest component of other noninterest income is the income on bank owned life insurance which totaled $609,000 and $1.7 million, respectively, for the three and nine months ended September 30, 2024 compared to $452,000 and $1.3 million, respectively, for the three and nine months ended September 30, 2023. Included in other noninterest income are fair value gains/losses on our equity securities, which totaled $292,000 (gain) and $233,000 (gain) for the three and nine months ended September 30, 2024, respectively, compared to $245,000 (loss) and $187,000 (loss) for the same periods in 2023, respectively.

Noninterest Expense

Noninterest expense for the three months ended September 30, 2024 was $13.7 million compared to $11.5 million for the three months ended September 30, 2023, an increase of $2.1 million, or 18.4%. Noninterest expense for the nine months ended September 30, 2024 was $39.1 million compared to $33.8 million for the nine months ended September 30, 2023, an increase of $5.2 million, or 15.5%.

The following table sets forth the major components of our noninterest expense for the three and nine months ended September 30, 2024 and 2023:

(Dollars in thousands )

Salaries and employee benefits expense for the three months ended September 30, 2024 was $8.5 million compared to $6.9 million for the three months ended September 30, 2023, an increase of $1.6 million, or 24.0%. Salaries and employee benefits expense for the nine months ended September 30, 2024 was $23.9 million compared to $20.3 million for the nine months ended September 30, 2023, an increase of $3.6 million, or 17.7%. These increases were partially attributable to higher employee salaries, restricted stock expense and employee insurance, as well as higher commissions paid to our loan officers as loan volume increased during the three and nine months ended September 30, 2024 compared to the same periods in 2023.

Occupancy and equipment expense for the three months ended September 30, 2024 was $1.4 million compared to $1.3 million for the three months ended September 30, 2023, an increase of $158,000, or 12.4%. Occupancy and equipment expense for the nine months ended September 30, 2024 was $4.1 million compared to $3.5 million for the nine months ended September 30, 2023, an increase of $593,000, or 16.8%. These increases were primarily due to higher maintenance and service expense, rent expense, and depreciation expense.

Data processing expenses for the three and nine months ended September 30, 2024 remained relatively flat compared to the same periods in 2023.

Advertising expenses for the three and nine months ended September 30, 2024 remained relatively flat compared to the same periods in 2023.

Other expenses for the three months ended September 30, 2024 were $3.3 million compared to $3.0 million for the three months ended September 30, 2023, an increase of $301,000, or 10.2%. This increase was partially due to higher security expense and other real estate owned related expenses, offset by lower FDIC insurance premiums and professional fees. Other operating expenses for the nine months ended September 30, 2024 were $9.6 million compared to $8.6 million for the nine months ended September 30, 2023, an increase of $1.0 million, or 11.7%. This increase was partially due to higher FDIC insurance premiums, audit expense, security expense and other real estate owned expenses, partially offset by lower loan related expenses and legal fees. Included in other expenses for the nine months ended September 30, 2024 and 2023 were directors’ fees of approximately $477,000 and $452,000, respectively.

Income Tax Expense

Income tax expense for the three months ended September 30, 2024 and 2023 was $6.0 million and $4.2 million, respectively. The Company’s effective tax rates were 26.3% and 27.0% for the three months ended September 30, 2024 and 2023, respectively.

Income tax expense for the nine months ended September 30, 2024 and 2023 was $18.2 million and $15.6 million, respectively. The Company’s effective tax rates were 27.4% and 27.9% for the nine months ended September 30, 2024 and 2023, respectively.

Financial Condition

Total assets increased $66.4 million, or 1.9%, to $3.57 billion at September 30, 2024 as compared to $3.50 billion at December 31, 2023. The increase in total assets was primarily attributable to increases in cash and due from banks of $136.6 million, federal funds sold of $9.8 million and Federal Home Loan Bank stock of $2.4 million, partially offset by decreases in loans held for investment of $54.3 million, loans held for sale of $17.7 million and interest rate derivatives of $12.9 million.

Our investment securities portfolio made up only 0.81% of our total assets at September 30, 2024 compared to 0.82% at December 31, 2023.

Loans

Gross loans held for investment decreased $55.5 million, or 1.8%, to $3.10 billion as of September 30, 2024 as compared to $3.15 billion as of December 31, 2023. Our loan decrease during the nine months ended September 30, 2024 was comprised of a decrease of $6.7 million, or 28.9%, in construction and development loans, an increase of $27.8 million, or 3.9%, in commercial real estate loans, a decrease of $2.3 million, or 3.5%, in commercial and industrial loans, a decrease of $74.1 million, or 3.2%, in residential real estate loans and a decrease of $104,000, or 32.6%, in consumer and other loans. We had loans held for sale of $4.6 million as of September 30, 2024 compared to $22.3 million as of December 31, 2023.

The following table presents the ending balance of each major category in our loan portfolio held for investment at the dates indicated.

(Dollars in thousands)

SBA and USDA Loan Servicing

As of September 30, 2024 and December 31, 2023, we serviced $487.4 million and $508.0 million, respectively, in SBA and USDA loans for others. We carried a servicing asset of $7.3 million at both September 30, 2024 and December 31, 2023, respectively. See Note 4 of our consolidated financial statements as of September 30, 2024, included elsewhere in this Form 10-Q, for additional information on the activity for SBA and USDA loan servicing rights for the three and nine months ended September 30, 2024 and 2023.

Residential Mortgage Loan Servicing

As of September 30, 2024, we serviced $556.4 million in residential mortgage loans for others compared to $443.1 million as of December 31, 2023. We carried a servicing asset, net of amortization, of $1.3 million at both September 30, 2024 and December 31, 2023, respectively. Amortization relating to the mortgage loan servicing asset was $216,000 and $957,000 for the three and nine months ended September 30, 2024, respectively, compared to $691,000 and $2.2 million for the same periods in 2023. During the three and nine months ended September 30, 2024, we recorded a fair value impairment of $252,000 on our mortgage servicing asset. During the three and nine months ended September 30, 2023, we did not record a fair value impairment on our mortgage servicing asset. See Note 5 of our consolidated financial statements as of September 30, 2024, included elsewhere in this Form 10-Q, for additional information on the activity for mortgage loans servicing rights for the three and nine months ended September 30, 2024 and 2023.

Asset Quality

Nonperforming Loans

Asset quality remained strong during the third quarter of 2024 as our nonperforming loans to total loans remained low at 0.46% as of September 30, 2024. Nonperforming loans were $14.3 million at September 30 2024 compared to $14.7 million at December 31, 2023. The decrease from December 31, 2023 to September 30, 2024 was attributable to a $366,000 decrease in nonaccrual loans. We did not recognize any interest income on nonaccrual loans during the nine months ended September 30, 2024 or the year ended December 31, 2023.

The following table sets forth the allocation of our nonperforming assets among our different asset categories as of the dates indicated. Nonperforming loans include nonaccrual loans and loans past due 90 days or more and still accruing interest. Nonperforming assets consist of nonperforming loans plus OREO. Nonaccrual loans at September 30, 2024 comprised of $537,000 of commercial real estate loans, $189,000 of commercial and industrial loans and $13.6 million of residential real estate loans. Nonaccrual loans at December 31, 2023 comprised of $548,000 of construction and development loans, $991,000 of commercial real estate loans, $1.3 million of commercial and industrial loans, and $11.9 million of residential real estate loans.

(Dollars in thousands)

Allowance for Credit Losses

The allowance for credit losses was $18.6 million at September 30, 2024 compared to $18.1 million at December 31, 2023, an increase of $477,000, or 2.6%. The increase was primarily due to the increase in reserves allocated to our individually analyzed loans, as well as the increase in general reserves allocated to our commercial real estate loan portfolio due to higher loan balances, partially offset by the decrease in the general reserves allocated to our residential mortgage loan portfolio as a large amount of residential mortgage loans were sold during the nine months ended September 30, 2024.

We maintain a reserve for credit losses that consists of two components, the allowance for credit losses and the allowance for unfunded commitments. The allowance for credit losses provides for the risk of credit losses expected in our loan portfolio and is based on loss estimates derived from a comprehensive quarterly evaluation. The evaluation reflects analyses of individual borrowers for impairment coupled with analysis of historical loss experience in various loan pools that have been grouped based on similar risk characteristics, supplemented as necessary by credit judgment that considers observable trends, conditions, reasonable and supportable forecasts, and other relevant environmental and economic factors. The level of the allowance for credit losses is adjusted by recording an expense or credit through the provision for credit losses. The level of the allowance for unfunded commitments is adjusted by recording an expense or credit in other noninterest expense. The allowance for unfunded commitments was created upon adoption of CECL on January 1, 2023 and had a balance of $216,000 as of September 30, 2024 compared to $294,000 as of September 30, 2023.

Loans that do not share risk characteristics are evaluated on an individual basis. For collateral dependent loans where the Company has determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and the Company expects repayment of the loan to be provided substantially through the operation or sale of the collateral, the ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the loan as of the measurement date. When repayment is expected to be from the operation of the collateral, expected credit losses are calculated as the amount by which the amortized cost basis of the loan exceeds the present value of expected cash flows from the operation of the collateral. When repayment is expected to be from the sale of the collateral, expected credit losses are calculated as the amount by which the amortized costs basis of the loan exceeds the fair value of the underlying collateral less estimated cost to sell. The ACL may be zero if the fair value of the collateral at the measurement date exceeds the amortized cost basis of the loan.

The impact of utilizing the CECL approach to calculate the allowance for credit losses will be significantly influenced by the composition, characteristics and quality of our loan portfolio, as well as the prevailing economic conditions and forecasts utilized. Material changes to these and other relevant factors may result in greater volatility to the provision for credit losses, and therefore, greater volatility to our reported earnings. See Note 1 and Note 3 of our consolidated financial statements as of September 30, 2024, included elsewhere in this Form 10-Q, for additional information on the on the allowance for credit losses and the allowance for unfunded commitments.

It is the policy of management to maintain the allowance for credit losses at a level adequate for risks inherent in the loan portfolio. The FDIC and GA DBF also review the allowance for credit losses as an integral part of their examination process. Based on information currently available, management believes that our allowance for credit losses is adequate. However, the loan portfolio can be adversely affected if economic conditions and the real estate market in our market areas were expected to weaken. The effect of such events, although uncertain at this time, could result in an increase in the level of nonperforming loans and increased credit losses, which could adversely affect our future growth and profitability. No assurance of the ultimate level of credit losses can be given with any certainty.

Analysis of the Allowance for Credit Losses. The following table provides an analysis of the allowance for credit losses, provision for credit losses and net charge-offs for the periods presented below:

(Dollars in thousands )

(1) Excludes loans held for sale.

Management believes the allowance for credit losses is adequate to provide for losses expected in the loan portfolio as of September 30, 2024.

Deposits

Total deposits decreased $7.8 million, or 0.3%, to $2.72 billion at September 30, 2024 compared to $2.73 billion at December 31, 2023. The decrease was due to a $63.1 million decrease in money market accounts (includes a $23.1 million decrease in brokered money markets), a $41.4 million decrease in interest-bearing demand deposits and a $2.2 million decrease in savings accounts, offset by a $58.5 million increase in time deposits and a $40.4 million increase in noninterest-bearing deposits. As of September 30, 2024 and December 31, 2023, 20.3% and 18.7% of total deposits, respectively, were comprised of noninterest-bearing demand accounts and 79.7% and 81.3%, respectively, of interest-bearing deposit accounts.

As of September 30, 2024 and December 31, 2023, the Company had estimated uninsured deposits of $648.8 million and $730.5 million, respectively. These estimates were derived using the same methodologies and assumptions used for the Bank's regulatory reporting. Uninsured deposits were 23.6% of total deposits at September 30, 2024, compared to 26.5% and 27.3% at December 31, 2023 and September 30, 2023, respectively. As of September 30, 2024, we had $1.28 billion of available borrowing capacity at the Federal Home Loan Bank ($701.6 million), Federal Reserve Discount Window ($532.2 million) and various other financial institutions (fed fund lines totaling $47.5 million).

We had $751.0 million of brokered deposits, or 27.6% of total deposits, at September 30, 2024 compared to $766.3 million, or 28.1% of total deposits, at December 31, 2023. We use brokered deposits, subject to certain limitations and requirements, as a source of funding to support our asset growth and augment the deposits generated from our branch network, which are our principal source of funding. Our level of brokered deposits varies from time to time depending on competitive interest rate conditions and other factors and tends to increase as a percentage of total deposits when the brokered deposits are less costly than issuing internet certificates of deposit or borrowing from the Federal Home Loan Bank.

We use interest rate swap and cap agreements to hedge our deposit accounts that are indexed to the federal funds effective rate. These swap agreements are designated as cash flow hedges. As of September 30, 2024, the total amount of deposits tied to the Federal Funds Effective Rate was $903.8 million. See Note 8 of our consolidated financial statements as of September 30, 2024, included elsewhere in this Form 10-Q, for additional information.

The following table summarizes our average deposit balances and weighted average rates for the three and nine months ended September 30, 2024 and 2023.

(Dollars in thousands )

(Dollars in thousands )

The weighted average rates shown in the tables above are inclusive of the benefit received from the interest rate derivatives that hedge our deposit accounts tied to the federal funds effective rate. During the three months ended September 30, 2024, we recorded a credit to interest expense of $6.4 million from the benefit received on these interest rate derivatives compared to a credit to interest expense of $1.3 million recorded during the three months ended September 30, 2023. During the nine months ended September 30, 2024, we recorded a credit to interest expense of $17.0 million from the benefit received on these interest rate derivatives compared to a credit to interest expense of $2.3 million recorded during the nine months ended September 30, 2023. These benefits resulted in a 95 basis points and 83 basis points reduction to the total deposits weighted average rate for the three and nine months ended September 30, 2024, respectively, compared to a 19 basis points and 12 basis points reduction for the three and nine months ended September 30, 2023, respectively.

Borrowed Funds

Other than deposits, we also utilized FHLB advances as a supplementary funding source to finance our operations. The advances from the FHLB are collateralized by residential real estate loans. At September 30, 2024 and December 31, 2023, we had available borrowing capacity from the FHLB of $701.6 million and $721.1 million, respectively. At September 30, 2024 and December 31, 2023, we had $375.0 million and $325.0 million, respectively, of outstanding advances from the FHLB.

In addition to our advances with the FHLB, we maintain federal funds agreements with our correspondent banks. Our available borrowings under these agreements were $47.5 million at September 30, 2024 and December 31, 2023. We did not have any advances outstanding under these agreements as of September 30, 2024 and December 31, 2023. We also have access to the Federal Reserve’s discount window in the amount of $532.2 million and $446.3 million at September 30, 2024 and December 31, 2023, respectively. No discount window borrowings were outstanding as of September 30, 2024 and December 31, 2023. We also maintain relationships in the capital markets with brokers to issue certificates of deposit and money market accounts.

Liquidity and Capital Resources

Liquidity

Liquidity refers to the measure of our ability to meet the cash flow requirements of depositors and borrowers, while at the same time meeting our operating, capital and strategic cash flow needs, all at a reasonable cost. We continuously monitor our liquidity position to ensure that assets and liabilities are managed in a manner that will meet all short-term and long-term cash requirements. We manage our liquidity position to meet the daily cash flow needs of customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of our shareholders.

Our liquidity position is supported by management of liquid assets and access to alternative sources of funds. Our liquid assets include cash, interest-bearing deposits in correspondent banks, federal funds sold, and fair value of unpledged investment securities. Other available sources of liquidity include wholesale/brokered deposits, and additional borrowings from correspondent banks, FHLB advances, and the Federal Reserve discount window.

Our short-term and long-term liquidity requirements are primarily met through cash flow from operations, redeployment of prepaying and maturing balances in our loan and investment portfolios, and increases in customer deposits. Other alternative sources of funds will supplement these primary sources to the extent necessary to meet additional liquidity requirements on either a short-term or long-term basis.

As part of our liquidity management strategy, we open federal funds lines with our correspondent banks. As of September 30, 2024 and December 31, 2023, we had $47.5 million of unsecured federal funds lines with no amounts advanced. In addition, the Company had Federal Reserve Discount Window funds available of approximately $532.2 million and $446.3 million at September 30, 2024 and December 31, 2023, respectively. The FRB discount window line is collateralized by a pool of construction and development, commercial real estate and commercial and industrial loans with carrying balances totaling $631.1 million as of September 30, 2024, as well as all of the Company’s municipal and mortgage backed securities. There were no outstanding borrowings on this line as of September 30, 2024 and December 31, 2023.

At September 30, 2024 and December 31, 2023, we had $375.0 million and $325.0 million, respectively, of outstanding advances from the FHLB. Based on the values of loans pledged as collateral, we had $701.6 million and $721.1 million of additional borrowing availability with the FHLB as of September 30, 2024 and December 31, 2023, respectively. We also maintain relationships in the capital markets with brokers to issue certificates of deposit and money market accounts.

Capital Requirements

The Company and the Bank are required under federal law to maintain certain minimum capital levels based on ratios of capital to total assets and capital to risk-weighted assets. The required capital ratios are minimums, and the federal banking agencies may determine that a banking organization, based on its size, complexity or risk profile, must maintain a higher level of capital in order to operate in a safe and sound manner. Risks such as concentration of credit risks and the risk arising from non-traditional activities, as well as the institution’s exposure to a decline in the economic value of its capital due to changes in interest rates, and an institution’s ability to manage those risks are important factors that are to be taken into account by the federal banking agencies in assessing an institution’s overall capital adequacy.

The table below summarizes the capital requirements applicable to the Company and the Bank in order to be considered “well-capitalized” from a regulatory perspective, as well as the Company’s and the Bank’s capital ratios as of September 30, 2024 and December 31, 2023. The Bank exceeded all regulatory capital requirements and was considered to be “well-capitalized” as of September 30, 2024 and December 31, 2023. As of December 31, 2023, the FDIC categorized the Bank as well-capitalized under the prompt corrective action framework. There have been no conditions or events since December 31, 2023 that management believes would change this classification. While the Company believes that it has sufficient capital to withstand an extended economic recession, its reported and regulatory capital ratios could be adversely impacted in future periods.

Dividends

On October 16, 2024, the Company declared a cash dividend of $0.23 per share, payable on November 8, 2024, to common shareholders of record as of October 30, 2024. Any future determination to pay dividends to holders of our common stock will depend on our results of operations, financial condition, capital requirements, banking regulations, contractual restrictions and any other factors that our board of directors may deem relevant.

Off-Balance Sheet Arrangements

We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in our consolidated balance sheet. The contractual or notional amounts of those instruments reflect the extent of involvement we have in particular classes of financial instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if we deem collateral is necessary upon extension of credit, is based on management’s credit evaluation of the counterparty.

Standby letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. They are intended to be disbursed, subject to certain condition, upon request of the borrower.

See Note 9 of our consolidated financial statements as of September 30, 2024, included elsewhere in this Form 10-Q, for more information regarding our off-balance sheet arrangements as of September 30, 2024 and December 31, 2023.

Market Risk

Market risk represents the risk of loss due to changes in market values of assets and liabilities. We incur market risk in the normal course of business through exposures to market interest rates, equity prices, and credit spreads. We have identified interest rate risk as our primary source of market risk.

Interest Rate Risk

Interest rate risk is the risk to earnings and value arising from changes in market interest rates. Interest rate risk arises from timing differences in the repricings and maturities of interest-earning assets and interest-bearing liabilities (repricing risk), changes in the expected maturities of assets and liabilities arising from embedded options, such as borrowers’ ability to prepay home mortgage loans at any time and depositors’ ability to redeem certificates of deposit before maturity (option risk), changes in the shape of the yield curve where interest rates increase or decrease in a nonparallel fashion (yield curve risk), and changes in spread relationships between different yield curves, such as U.S. Treasuries and Federal funds effective (basis risk).

Our board of directors establishes broad policy limits with respect to interest rate risk. As part of this policy, the asset liability committee, or ALCO, establishes specific operating guidelines within the parameters of the board of directors’ policies. In general, the ALCO focuses on ensuring a stable and steadily increasing flow of net interest income through managing the size and mix of the balance sheet. The management of interest rate risk is an active process which encompasses monitoring loan and deposit flows complemented by investment and funding activities. Effective management of interest rate risk begins with understanding the dynamic characteristics of assets and liabilities and determining the appropriate interest rate risk posture given business forecasts, management objectives, market expectations, and policy constraints.

An asset sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate higher net interest income, as rates earned on our interest-earning assets would reprice upward more quickly than rates paid on our interest-bearing liabilities, thus expanding our net interest margin. Conversely, a liability sensitive position refers to a balance sheet position in which an increase in short-term interest rates is expected to generate lower net interest income, as rates paid on our interest-bearing liabilities would reprice upward more quickly than rates earned on our interest-earning assets, thus compressing our net interest margin.

Interest rate risk measurement is calculated and reported to the ALCO at least quarterly. The information reported includes period-end results and identifies any policy limits exceeded, along with an assessment of the policy limit breach and the action plan and timeline for resolution, mitigation, or assumption of the risk.

Evaluation of Interest Rate Risk

We use income simulations, an analysis of core funding utilization, and economic value of equity (EVE) simulations as our primary tools in measuring and managing interest rate risk. These tools are utilized to quantify the potential earnings impact of changing interest rates over a two year simulation horizon (income simulations) as well as identify expected earnings trends given longer term rate cycles (long term simulations, core funding utilizations, and EVE simulation). A standard gap report and funding matrix will also be utilized to provide supporting detailed information on the expected timing of cashflow and repricing opportunities.

There are an infinite number of potential interest rate scenarios, each of which can be accompanied by differing economic/political/regulatory climates; can generate multiple differing behavior patterns by markets, borrowers, depositors, etc.; and can last for varying degrees of time. Therefore, by definition, interest rate risk sensitivity cannot be predicted with certainty. Accordingly, the Bank’s interest rate risk measurement philosophy focuses on maintaining an appropriate balance between theoretical and practical scenarios; especially given the primary objective of the Bank’s overall asset/liability management process is to facilitate meaningful strategy development and implementation.

Therefore, we model a set of interest rate scenarios capturing the financial effects of a range of plausible rate scenarios, the collective impact of which will enable the Bank to clearly understand the nature and extent of its sensitivity to interest rate changes. Doing so necessitates an assessment of rate changes over varying time horizons and of varying/sufficient degrees such that the impact of embedded options within the balance sheet are sufficiently examined.

We use a net interest income simulation model to measure and evaluate potential changes in our net interest income. We run three standard and plausible simulations comparing current or flat rates with a +/- 200 basis point ramp in rates over 12 and 24 months. These rate scenarios are considered appropriate as we believe they represent a more realistic range of rate movements that could occur in the near to medium term. This analysis also provides the foundation for historical tracking of interest rate risk. The impact of interest rate derivatives, such as interest rate swaps and caps, is included in the model.

Potential changes to our net interest income in hypothetical rising and declining rate scenarios calculated as of September 30, 2024 and December 31, 2023 are presented in the following table:

We also model the impact of rate changes on our Economic Value of Equity, or EVE. We base the modeling of EVE based on interest rate shocks as shocks are considered more appropriate for EVE, which accelerates future interest rate risk into current capital via a present value calculation of all future cashflows from the bank’s existing inventory of assets and liabilities. Our simulation model incorporates interest rate shocks of +/- 100, 200, and 300 basis points. The results of the model are presented in the table below:

Our simulation model incorporates various assumptions, which we believe are reasonable but which may have a significant impact on results such as: (i) the timing of changes in interest rates; (ii) shifts or rotations in the yield curve; (iii) re-pricing characteristics for market-rate-sensitive instruments; (iv) varying loan prepayment speeds for different interest rate scenarios; and (v) the overall growth and mix of assets and liabilities. Because of limitations inherent in any approach used to measure interest rate risk, simulation results are not intended as a forecast of the actual effect of a change in market interest rates on our results but rather as a means to better plan and execute appropriate asset-liability management strategies and manage our interest rate risk.

Evaluation of Disclosure Controls and Procedures

The Company’s management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of September 30, 2024. The Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2024.

Changes in Internal Control over Financial Reporting

During the quarter ended September 30, 2024, there was no change in the Company’s internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rules 13a-15 or 15d-15 of the Exchange Act that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company is continually monitoring and assessing changes in processes and activities to determine any potential impact on the design and operating effectiveness of internal controls over financial reporting.

In addition to the other information set forth in this Quarterly Report, you should carefully consider the factors discussed in “Part I – Item 1A – Risk Factors” of the Company’s 2023 Form 10-K, which could materially affect its business, financial position, results of operations, cash flows, or future results. Please be aware that these risks may change over time and other risks may prove to be important in the future. New risks may emerge at any time, and we cannot predict such risks or estimate the extent to which they may affect our business, financial condition or results of operations, or the trading price of our securities.

There are no material changes during the period covered by this Report to the risk factors previously disclosed in the Company’s 2023 Form 10-K.