Introduction
This overview highlights selected information in this Annual Report on Form 10-K and may not contain all of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources, and critical accounting estimates, you should carefully read this entire Annual Report on Form 10-K. For a discussion of changes in results of operations comparing the years endedDecember 31, 2021 and 2020, for the Company and its subsidiary, see Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year endedDecember 31, 2021 , filed with theSEC onMarch 11, 2022 . Our subsidiary,First Northern Bank of Dixon , is aCalifornia state-chartered bank that derives most of its revenues from lending and deposit taking in theSacramento Valley region ofNorthern California . Interest rates, business conditions and customer confidence all affect our ability to generate revenues. In addition, the regulatory environment and competition can challenge our ability to generate those revenues.
Financial highlights for 2022 include:
The Company reported net income of$15.9 million for 2022, a 12.0% increase compared to net income of$14.2 million for 2021. Net income per common share for 2022 was$1.11 , an increase of 15.6% compared to net income per common share of$0.96 for 2021. Net income per common share on a fully diluted basis was$1.09 for 2022, an increase of 14.7% compared to net income per common share on a fully diluted basis of$0.95 for 2021. Net interest income totaled$54.7 million for 2022, an increase of 18.2% from$46.3 million in 2021, primarily due to loan growth and an increasing interest rate environment. Net interest margin was 3.06% for the year ended 2022 which was a 16.8% or 44 basis point improvement from the 2.62% reported for the year ended 2021. Provision for loan losses totaled$0.9 million in 2022, an increase of 160.0% from a reversal of provision for loan losses of$1.5 million in 2021. The year-to-date provision for loan loss was primarily due to loan growth. The prior year-to-date reversal of provision for loan losses was primarily due to a decrease in specific reserves on loans to one borrower, coupled with an overall decrease in qualitative factors resulting from an improvement in economic conditions. Non-interest income totaled$6.9 million in 2022, a decrease of 11.8% from$7.9 million in 2021. The decrease was primarily due to a decrease in gains on sales of loans held-for-sale due to a decrease in mortgage loan origination volumes due to an increase in interest rates and slowdown in refinancing activity. This was partially offset by an increase in other income, which was primarily due to non-taxable income from a bank owned life insurance policy. Non-interest expenses totaled$39.1 million for 2022, up 7.9% from$36.2 million in 2021. The increase was primarily due to increases in salaries and employee benefits and other expenses. The increase in salaries and employee benefits was primarily due to increased staffing levels, decrease in capitalization of loan origination costs, and increases in contingent compensation and profit-sharing expenses. The increase in other expenses was primarily due to increases in provision for unfunded commitments, and legal and consulting fees, which was partially offset by a decrease in loan collection expenses.
The Company reported total assets of
Investments decreased to$618.1 million as ofDecember 31, 2022 , a 2.2% decrease from$632.2 million as ofDecember 31, 2021 .U.S. Treasury securities totaled$113.8 million as ofDecember 31, 2022 , up 32.0% from$86.2 million as ofDecember 31, 2021 ; securities ofU.S. government agencies and corporations totaled$118.9 million , up 15.9% from$102.6 million as ofDecember 31, 2021 ; obligations of state and political subdivisions totaled$53.3 million , up 16.0% from$46.0 million as ofDecember 31, 2021 ; collateralized mortgage obligations totaled$95.4 million , down 29.7% from$135.6 million as ofDecember 31, 2021 ; and mortgage-backed securities totaled$236.7 million , down 9.6% from$261.8 million as ofDecember 31, 2021 . Loans (including loans held-for-sale), net of allowance, increased to$970.1 million as ofDecember 31, 2022 , a 13.6% increase from$853.8 million as ofDecember 31, 2021 . Commercial loans totaled$106.8 million as ofDecember 31, 2022 , down 21.4% from$135.9 million as ofDecember 31, 2021 ; commercial real estate loans were$645.2 million , up 22.4% from$526.9 million as ofDecember 31, 2021 ; agriculture loans were$114.0 million , up 6.4% from$107.2 million as ofDecember 31, 2021 ; residential mortgage loans were$92.7 million , up 21.7% from$76.2 million as ofDecember 31, 2021 ; residential construction loans were$10.2 million , up 126.8% from$4.5 million as ofDecember 31, 2021 ; and consumer loans totaled$15.3 million , down 11.4% from$17.2 million as ofDecember 31, 2021 . 30
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Deposits decreased to
There were no FHLB advances outstanding as of
Stockholders' equity decreased to
Critical Accounting Policies and Estimates
The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted inthe United States . The preparation of these consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, income and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to the allowance for loan losses, other real estate owned, investments, and income taxes. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements: Allowance for Loan Losses The Company believes the allowance for loan losses accounting policy is critical because the loan portfolio represents the largest asset on the consolidated balance sheet, and there is significant judgment used in determining the adequacy of the allowance for loan losses. The Company maintains an allowance for loan losses at an amount estimated to equal all credit losses incurred in our loan portfolio that are both probable and reasonable to estimate at a balance sheet date. Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance.
A
provision for loan losses is based on the Company's periodic evaluation of the factors mentioned below, as well as other pertinent factors.
The allowance for loan losses consists of a specifically allocated component and a collective or pooled component. The components of the allowance for loan losses represent estimates. The specifically allocated component of the allowance for loan losses reflects expected losses resulting from specific analyses resulting in credit allocations for individual loans. The specific credit analyses are based on regular analyses of all loans where the internal credit rating (risk rating) is at or below a predetermined classification. The Company manages risk ratings through the analysis of initial credit requests and ongoing examination of outstanding loans and delinquencies, with particular attention to portfolio dynamics and loan mix. Determination of the risk rating involves significant management judgement. These specific analyses involve a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. A significant portion of the allowance for loan losses is measured on a collective (pooled) basis by loan type when similar risk characteristics exist. For loans evaluated collectively, the allowance for loan losses is determined using historical losses adjusted for qualitative and environmental factors to reflect current conditions. The qualitative and environment factors used to adjust our historical loss rates by loan type consist of the risks of the Company's general lending activity, including risk of losses that are attributable to national or local economic or industry trends which have occurred but have yet been recognized in past loan charge-off history, and risk of losses attributable to general attributes of the Company's loan portfolio and credit administration. The most significant component of the factors used to estimate the allowance for loan losses are adjustments related to prevailing economic and business conditions. The prevailing economic and business conditions factor is estimated based on a range of potential economic conditions and is applied at the pooled level based on various factors. This estimate is subject to significant judgment and could potentially add$3.0 million based on existing loan balances, if not more, to the allowance for loan losses in more pessimistic business and economic conditions. Although the Company believes its process for determining the allowance adequately considers all of the potential factors that could potentially result in credit losses, the process includes subjective elements and may be susceptible to significant change. To the extent actual outcomes differ from Company estimates, additional provision for credit losses could be required that could adversely affect earnings or financial position in future periods. For information regarding the changes in methodology relating to the allowance for loan losses effectiveJanuary 1, 2023 , due to the FASB's ASU 2016-13, see "Impact of Recently Issued Accounting Standards" below in this section. 31
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Impaired Loans
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement, including scheduled interest payments. For a loan that has been restructured in a troubled debt restructuring, the contractual terms of the loan agreement refer to the contractual terms specified by the original loan agreement, not the contractual terms specified by the restructuring agreement. An impaired loan is measured based upon the present value of future cash flows discounted at the loan's effective rate, the loan's observable market price, or the fair value of collateral if the loan is collateral dependent. If the measurement of the impaired loan is less than the recorded investment in the loan, an impairment is recognized by a charge to the allowance for loan losses.
Other-than-temporary Impairment in
Debt securities with fair values that are less than amortized cost are considered impaired. Impairment may result from either a decline in the financial condition of the issuing entity or, in the case of fixed interest rate debt securities, from rising interest rates. At each consolidated financial statement date, management assesses each debt security in an unrealized loss position to determine if impaired debt securities are temporarily impaired or if the impairment is other than temporary. This assessment includes consideration regarding the duration and severity of impairment, the credit quality of the issuer and a determination of whether the Company intends to sell the security, or if it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis less any current-period credit losses. Other-than-temporary impairment is recognized in earnings if one of the following conditions exists: 1) the Company's intent is to sell the security; 2) it is more likely than not that the Company will be required to sell the security before the impairment is recovered; or 3) the Company does not expect to recover its amortized cost basis. If, by contrast, the Company does not intend to sell the security and will not be required to sell the security prior to recovery of the amortized cost basis, the Company recognizes only the credit loss component of other-than-temporary impairment in earnings. The credit loss component is calculated as the difference between the security's amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security's fair value and the present value of the future expected cash flows is deemed to be due to factors that are not credit related and is recognized in other comprehensive income.
Fair Value Measurements
The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a non-recurring basis, such as loans held-for-sale, loans held-for-investment and certain other assets. These non-recurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally corresponds with the Company's quarterly valuation process. For additional discussion, see Note 13 to the Consolidated Financial Statements in this Form 10-K.
Share-Based Payment
The Company determines the fair value of stock options at grant date using the Black-Scholes-Merton pricing model that takes into account the stock price at the grant date, the exercise price, the expected dividend yield, stock price volatility, and the risk-free interest rate over the expected life of the option. The Black-Scholes-Merton model requires the input of highly subjective assumptions including the expected life of the stock-based award and stock price volatility. The estimates used in the model involve inherent uncertainties and the application of Management's judgment. As a result, if other assumptions had been used, our recorded stock-based compensation expense could have been materially different from that reflected in these financial statements. The fair value of non-vested restricted common shares generally equals the stock price at grant date. In addition, we estimate the expected forfeiture rate and only recognize expense for those share-based awards expected to vest. If our actual forfeiture rate is materially different from the estimate, the share-based compensation expense could be materially different. For additional discussion, see Note 15 to the Consolidated Financial Statements in this Form 10-K.
Accounting for Income Taxes
Income taxes reported in the consolidated financial statements are computed based on an asset and liability approach. We recognize the amount of taxes payable or refundable for the current year, and deferred tax assets and liabilities for the expected future tax consequences that have been recognized in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the consolidated financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We record net deferred tax assets to the extent it is more-likely-than-not that they will be realized. In evaluating our ability to recover the deferred tax assets, Management considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations. In projecting future taxable income, Management develops assumptions including the amount of future state and federal pretax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates being used to manage the underlying business. The Company files consolidated federal and combined state income tax returns. 32
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A "more-likely-than-not" recognition threshold must be met before a tax benefit can be recognized in the consolidated financial statements. For tax positions that meet the more-likely-than-not threshold, an enterprise may recognize only the largest amount of tax benefit that is greater than fifty percent likely of being realized upon ultimate settlement with the taxing authority. To the extent tax authorities disagree with these tax positions, our effective tax rates could be materially affected in the period of settlement with the taxing authorities. For additional discussion, see Note 18 to the Consolidated Financial Statements in this Form 10-K.
Mortgage Servicing Rights
Transfers and servicing of financial assets and extinguishments of liabilities are accounted for and reported based on consistent application of a financial-components approach that focuses on control. Transfers of financial assets that are sales are distinguished from transfers that are secured borrowings. Retained servicing rights on loans sold are measured by allocating the previous carrying amount of the transferred assets between the loans sold and retained interest, if any, based on their relative fair value at the date of transfer. Fair values are estimated using discounted cash flows based on a current market interest rate. The Company recognizes a gain and a related asset for the fair value of the rights to service loans for others when loans are sold. The recorded value of mortgage servicing rights is included in other assets on the Consolidated Balance Sheets initially at fair value, and is amortized in proportion to, and over the period of, estimated net servicing revenues. The Company assesses capitalized mortgage servicing rights for impairment based upon the fair value of those rights at each reporting date. For purposes of measuring impairment, the rights are stratified based upon the product type, term and interest rates. Fair value is determined by discounting estimated net future cash flows from mortgage servicing activities using discount rates that approximate current market rates and estimated prepayment rates, among other assumptions. The amount of impairment recognized, if any, is the amount by which the capitalized mortgage servicing rights for a stratum exceeds their fair value. Impairment, if any, is recognized through a valuation allowance for each individual stratum.
Impact of Recently Issued Accounting Standards
The FASB issued ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (CECL) methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized costs, including loan receivables and held-to-maturity debt securities. It also applies to off-balance sheet credit exposures not accounted for as insurance (loan commitments, standby letters of credit, financial guarantees, and other similar instruments) and net investments in certain leases. In addition, ASC 326 made changes to the accounting for available-for-sale debt securities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available-for-sale debt securities, based on management's intent to sell the security or likelihood the Company will be required to sell the security, before recovery of the amortized cost basis. The Company will apply the amendment's provisions as a cumulative-effect adjustment to retained earnings at the beginning of the first period the amendment is effective. ASU 2016-13 is effective for the Company as ofJanuary 1, 2023 . Management has taken steps to prepare for the implementation requirements of this standard, such as developing policies, procedures and internal controls over the model and working with a software vendor to measure expected losses required by the amendment. Based on the loan portfolio composition, characteristics and quality of the loan portfolio as ofDecember 31, 2022 , and the current economic environment, management estimates that the total allowance for loan losses and reserve for unfunded commitments will increase from approximately$15.5 million to approximately$16.7 million to$18.3 million or an increase of$1.2 million to$2.8 million . The estimated decline in equity, net of tax, will range from$0.9 million to$2.1 million . The economic conditions, forecasts and assumptions used in the model could be significantly different in future periods. The impact of the change in the allowance on our results of operations in a provision for credit losses will depend on the current period net charge-offs, level of loan originations, and change in mix of the loan portfolio. As time progresses and the results of economic conditions require model assumption inputs to change, further refinements to the estimation process may also be identified. InMarch 2020 , the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848). This ASU provides temporary optional guidance to ease the potential burden in accounting for reference rate reform. This ASU provides optional expedients and exceptions for contracts, hedging relationships, and other transactions that reference LIBOR or other reference rates expected to be discontinued because of reference rate reform. This ASU was effective for all entities as ofMarch 12, 2020 throughDecember 31, 2022 . As ofJanuary 1, 2022 , the Company is no longer originating LIBOR based loans and are originating new loans using the Secured Overnight Financing Rate (SOFR). For existing LIBOR based loans, the Company is monitoring the development and reporting of fallback indices. The Company does not expect this ASU to have a material impact on the Company's consolidated financial statements. 33
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InJanuary 2021 , the FASB issued ASU 2021-01, Reference Rate Reform (Topic 848): Scope. This ASU clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity may elect to apply ASU 2021-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includesMarch 12, 2020 , or prospectively to new modifications from any date within the interim period that includes or is subsequent toJanuary 7, 2021 , up to the date that financial statements are available to be issued. An entity may elect to apply ASU 2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includesMarch 12, 2020 , and to new eligible hedging relationships entered into after the beginning of the interim period that includesMarch 12, 2020 . The Company is in the process of evaluating the provisions of this ASU but does not expect it to have a material impact on the Company's consolidated financial statements. InDecember 2022 , the FASB issued ASU 2022-06, Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848. This ASU extends the period of time preparers can utilize the reference rate reform relief guidance in Topic 848. ASU 2022-06 defers the sunset date of Topic 848 fromDecember 31, 2022 , toDecember 31, 2024 , after which entities will no longer be permitted to apply the relief in Topic 848. The Company does not expect this ASU to have a material impact on the Company's consolidated financial statements. InMarch 2022 , the FASB issued ASU 2022-02, Financial Instruments-Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. These amendments eliminate the TDR recognition and measurement guidance and, instead, require that an entity evaluate (consistent with the accounting for other loan modifications) whether the modification represents a new loan or a continuation of an existing loan. The amendments also enhance existing disclosure requirements and introduce new requirements related to certain modifications of receivables made to borrowers experiencing financial difficulty. For public business entities, these amendments require that an entity disclose current-period gross writeoffs by year of origination for financing receivables and net investment in leases within the scope of Subtopic 326-20. This ASU is effective onJanuary 1, 2023 , the same effective date as ASU 2016-13. The Company is currently evaluating the effects that the adoption of these amendments will have on its consolidated financial statements. InJune 2022 , the FASB issued ASU 2022-03, Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions. These amendments clarify that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value. This ASU is effective for fiscal years, including interim periods within those fiscal years, beginning afterDecember 15, 2023 . The Company does not expect this ASU to have a material impact on the Company's consolidated financial statements. 34
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STATISTICAL INFORMATION AND DISCUSSION
The following statistical information and discussion should be read in conjunction with the audited consolidated financial statements and accompanying notes included in Part II (Item 8) of this Annual Report on Form 10-K.
The following tables present information regarding the consolidated average assets, liabilities and stockholders' equity, the amounts of interest income from average earning assets and the resulting yields, and the amount of interest expense paid on interest-bearing liabilities. Average loan balances include non-performing loans. Interest income includes proceeds from loans on non-accrual status only to the extent cash payments have been received and applied as interest income. Tax-exempt income is not shown on a tax equivalent basis. Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and Interest Differential (Dollars in thousands) 2022 2021 2020 Average Average Average Balance Percent Balance Percent Balance Percent ASSETS Cash and Due From Banks$ 268,041 14.2 %$ 363,172 19.6 %$ 221,140 14.3 % Certificates of Deposit 12,804 0.7 % 14,250 0.8 % 19,210 1.2 % Investment Securities 629,600 33.2 % 542,709 29.4 % 358,005 23.2 % Loans (1) 915,278 48.3 % 876,502 47.4 % 894,626 57.9 % Stock in Federal Home Loan Bank and other equity securities, at cost 8,746 0.5 % 6,919 0.4 % 6,509 0.4 % Other Assets 58,767 3.1 % 45,059 2.4 % 46,388 3.0 % Total Assets$ 1,893,236 100.0 %$ 1,848,611 100.0 %$ 1,545,878 100.0 % LIABILITIES & STOCKHOLDERS' EQUITY Deposits: Demand$ 805,738 42.6 %$ 764,676 41.4 %$ 577,559 37.3 % Interest-Bearing Transaction Deposits 441,543 23.3 % 420,481 22.7 % 356,867 23.1 % Savings and MMDAs 449,169 23.7 % 436,931 23.6 % 387,490 25.0 % Time Certificates 47,022 2.5 % 54,465 2.9 % 54,147 3.5 % Federal Home Loan Bank Advances - 0.0 % 1,809 0.1 % 5,656 0.4 % Other Liabilities 18,887 1.0 % 19,418 1.1 % 19,493 1.3 % Stockholders' Equity 130,877 6.9 % 150,831 8.2 % 144,666 9.4 % Total Liabilities and Stockholders' Equity$ 1,893,236 100.0 %$ 1,848,611 100.0 %$ 1,545,878 100.0 %
(1) Average balances for loans include loans held-for-sale and non-accrual loans
and are net of the allowance for loan losses. 35
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Table of Contents Net Interest Earnings Average Balances, Yields and Rates (Dollars in thousands) 2022 2021 2020 Yields Yields Yields Interest Earned/ Interest Earned/ Interest Earned/ Average Income/ Rates Average Income/ Rates Average Income/ Rates Assets Balance Expense Paid Balance Expense Paid Balance Expense Paid Total Loans, Including Loan Fees(1)$ 915,278 $ 42,316 4.62 %$ 876,502 $ 39,207 4.47 %$ 894,626 $ 40,569 4.53 % Due From Banks 222,335 3,546 1.59 % 322,951 425 0.13 % 188,021 582 0.31 % Certificates of Deposit 12,804 283 2.21 % 14,250 297 2.08 % 19,210 438 2.28 % Investment Securities: Taxable 591,987 8,296 1.40 % 514,350 6,249 1.21 % 336,586 6,406 1.90 % Non-taxable (2) 37,613 909 2.42 % 28,359 603 2.13 % 21,419 498 2.33 % Total Investment Securities 629,600 9,205 1.46 % 542,709 6,852 1.26 % 358,005 6,904 1.93 % Other Earning Assets 8,746 532 6.08 % 6,919 395 5.71 % 6,509 371 5.70 % Total Earning Assets$ 1,788,763 $ 55,882 3.12 %$ 1,763,331 $ 47,176 2.68 %$ 1,466,371 $ 48,864 3.33 % Cash and Due from Banks 45,706 40,221 33,119 Interest Receivable and Other Assets 58,767 45,059 46,388 Total Assets$ 1,893,236 $ 1,848,611 $ 1,545,878
(1) Average balances for loans include loans held-for-sale and non-accrual loans
and are net of the allowance for loan losses, but non-accrued interest
thereon is excluded. Includes amortization of deferred loan fees and costs.
(2) Interest income and yields on tax-exempt securities are not presented on a
taxable equivalent basis. 36
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Table of Contents Continuation of Net Interest Earnings Average Balances, Yields and Rates (Dollars in thousands) 2022 2021 2020 Yields Yields Yields Interest Earned/ Interest Earned/ Interest Earned/ Average Income/ Rates Average Income/ Rates Average Income/ Rates Liabilities and Stockholders' Equity Balance Expense Paid Balance Expense Paid Balance Expense Paid Interest-Bearing Deposits: Interest-Bearing Transaction Deposits$ 441,543 $ 337 0.08 %$ 420,481 $ 248 0.06 %$ 356,867 $ 358 0.10 % Savings and MMDAs 449,169 716 0.16 % 436,931 474 0.11 % 387,490 786 0.20 % Time Certificates 47,022 133 0.28 % 54,465 190 0.35 % 54,147 340 0.63 % Total Interest-Bearing Deposits 937,734 1,186 0.13 % 911,877 912 0.10 % 798,504 1,484 0.19 % Demand Deposits 805,738 764,676 577,559 Total Deposits 1,743,472$ 1,186 0.07 % 1,676,553$ 912 0.05 % 1,376,063$ 1,484 0.11 % Federal Home Loan Bank Advances - 1,809 5,656 Interest payable and Other Liabilities 18,887 19,418 19,493 Stockholders' Equity 130,877 150,831 144,666 Total Liabilities and Stockholders' Equity$ 1,893,236 $ 1,848,611 $ 1,545,878 Net Interest Income and Net Interest Margin (1)$ 54,696 3.06 %$ 46,264 2.62 %$ 47,380 3.23 % Net Interest Spread (2) 2.99 % 2.58 % 3.14 %
(1) Net interest margin is computed by dividing net interest income by total
average interest-earning assets.
(2) Net interest spread represents the average yield earned on interest-earning
assets less the average rate paid on interest-bearing liabilities. 37
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Table of Contents Analysis of Changes in Interest Income and Interest Expense (Dollars in thousands)
Following is an analysis of changes in interest income and expense (dollars in thousands) for 2022 over 2021. Changes not solely due to interest rate or volume have been allocated proportionately to interest rate and volume.
2022 Over 2021 Interest Volume Rate Change
Increase (Decrease) in Interest Income:
Loans$ 1,768 $ 1,341 $ 3,109 Due From Banks (171 ) 3,292 3,121 Certificates of Deposit (32 ) 18 (14 ) Investment Securities - Taxable 1,003 1,044
2,047
Investment Securities - Non-taxable 216 90 306 Other Earning Assets 110 27 137 2,894 5,812 8,706
Increase (Decrease) in Interest Expense:
Deposits:
Interest-Bearing Transaction Deposits 12 77 89 Savings and MMDAs 14 228 242 Time Certificates (23 ) (34 ) (57 ) 3 271 274 Increase in Net Interest Income:$ 2,891 $ 5,541 $ 8,432 38
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Table of Contents INVESTMENT PORTFOLIO Composition ofInvestment Securities
The mix of investment securities held by the Company at
2022
2021
Investment securities available-for-sale (at fair value):
U.S. Treasury Securities$ 113,815 $
86,211
Securities of
53,326
45,985
Collateralized Mortgage Obligations 95,350 135,652 Mortgage-Backed Securities 236,690 261,755 Total Investments$ 618,092 $ 632,213 Maturities of Investment Securities The following table summarizes the contractual maturity (dollars in thousands) and projected yields of the Company's investment securities as ofDecember 31, 2022 . The yields on tax-exempt securities are shown on a tax equivalent basis. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. In addition, factors such as prepayments and interest rates may affect the yield on carrying value of mortgage related securities. Period to Maturities After One But After Five But Within One Year Within Five Years Within Ten Years Amount Yield Amount Yield Amount Yield Investment securities available-for-sale (at fair value): U.S. Treasury Securities$ 34,254 1.59 %$ 77,387 1.59 %$ 2,174 1.28 % Securities of U.S. Government Agencies and Corporations 16,793 1.47 % 85,821 1.48 % 16,297 2.25 % Obligations of State and Political Subdivisions 207 0.44 % 8,410 2.17 % 16,283 3.11 % Collateralized Mortgage Obligations - - 2,894 1.88 % 1,325 2.13 % Mortgage-Backed Securities 136 1.79 % 12,613 2.16 % 73,570 1.91 % TOTAL$ 51,390 1.55 %$ 187,125 1.61 %$ 109,649 2.13 % After Ten Years Total Amount Yield Amount Yield Investment securities available-for-sale (at fair value): U.S. Treasury Securities $ - -$ 113,815 1.58 % Securities ofU.S. Government Agencies and Corporations - - 118,911 1.58 % Obligations of State & Political Subdivisions 28,426 3.13 % 53,326 2.96 % Collateralized Mortgage Obligations 91,131 1.50 % 95,350 1.52 % Mortgage-Backed Securities 150,371 1.39 % 236,690 1.59 % TOTAL$ 269,928 1.61 %$ 618,092 1.70 % 39
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Table of Contents LOAN PORTFOLIO Composition of Loans The mix of loans, net of deferred origination fees and costs and allowance for loan losses and excluding loans held-for-sale, atDecember 31, 2022 andDecember 31, 2021 is as follows (dollars in thousands): 2022 2021 Balance Percent Balance Percent Commercial$ 106,771 10.8 %$ 135,894 15.7 % Commercial Real Estate 645,166 65.6 % 526,924 60.7 % Agriculture 114,040 11.6 % 107,183 12.3 % Residential Mortgage 92,669 9.4 % 76,160 8.8 % Residential Construction 10,167 1.0 % 4,482 0.5 % Consumer 15,287 1.6 % 17,258 2.0 % 984,100 100.0 % 867,901 100.0 % Allowance for loan losses (14,792 ) (13,952 ) Net deferred origination fees and costs 830 (1,232 ) TOTAL$ 970,138 $ 852,717 As shown in the comparative figures for loan mix during 2022 and 2021, total loans increased as a result of increases in commercial real estate, agriculture, residential mortgage and residential construction loans, which was partially offset by decreases in commercial and consumer loans. The decrease in commercial loans was primarily due to PPP loan forgiveness and payoffs totaling approximately$37 million during the year endedDecember 31, 2022 . Included in net deferred origination fees was$0 and$2.7 million in unearned PPP loan fees atDecember 31, 2022 andDecember 31, 2021 , respectively. The Company received PPP processing fees totaling$13.2 million from the SBA during 2021 and 2020. These fees were required to be recognized as an adjustment to the effective yield over the life of the loan. The Company recognized approximately$2.7 million and$4.7 million of PPP loan fees during the years endedDecember 31, 2022 andDecember 31, 2021 , respectively, which are included as a component of interest income on loans. The Company recognized the remaining balance of PPP loan fees during 2022. Commercial loans are primarily for financing the needs of a diverse group of businesses located in the Bank's market areas. Commercial real estate loans generally fall into two categories, owner-occupied and non-owner occupied. Real estate construction loans are generally for financing the construction of single-family residential homes for individuals and builders we believe are well-qualified. These loans are secured by real estate and have short maturities. Residential mortgage loans, which are secured by real estate, include owner-occupied and non-owner occupied properties in the Bank's market areas. Loans are considered agriculture loans when the primary source of repayment is from the sale of an agricultural or agricultural-related product or service. Such loans are secured and/or unsecured to producers and processors of crops and livestock. The Bank also makes loans to individuals for investment purposes. 40
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Maturities and Sensitivities of Loans to Changes in Interest Rates
The following table presents the maturity distribution of our loan portfolio atDecember 31, 2022 (dollars in thousands) (excludes loans held-for-sale). The table also presents the portion of loans that have fixed interest rates or variable interest rates that fluctuate over the life of the loans in accordance with changes in an interest rate index. After One, After Five Due in One but Within but Within After Fifteen Year or Less Five Years Fifteen Years Years Total Commercial$ 18,121 $ 66,916 $ 21,703 $ 31$ 106,771 Commercial Real Estate 13,507 98,935 454,802 77,922 645,166 Agriculture 24,892 11,824 24,494 52,830 114,040 Residential Mortgage - 833 29,239 62,597 92,669 Residential Construction 4,006 85 1,756 4,320 10,167 Consumer 903 5,305 8,460 619 15,287 Total$ 61,429 $ 183,898 $ 540,454 $ 198,319 $ 984,100 Loans with fixed interest rates: Commercial$ 3,605 $ 53,827 $ 10,271 $ -$ 67,703 Commercial Real Estate 7,207 61,728 213,559 36,901 319,395 Agriculture 2,199 10,277 18,235 - 30,711 Residential Mortgage - 191 26,754 8,375 35,320
Residential Construction 117 - - - 117 Consumer 9 689 49 619 1,366 Total$ 13,137 $ 126,712 $ 268,868 $ 45,895 $ 454,612 Loans with variable interest rates: Commercial$ 14,516 $ 13,089 $ 11,432 $ 31$ 39,068 Commercial Real Estate 6,300 37,207 241,243 41,021 325,771 Agriculture 22,693 1,547 6,259 52,830 83,329 Residential Mortgage - 642 2,485 54,222 57,349 Residential Construction 3,889 85 1,756 4,320 10,050 Consumer 894 4,616 8,411 - 13,921 Total$ 48,292 $ 57,186 $ 271,586 $ 152,424 $ 529,488 Non-Accrual, Past Due, OREO and Restructured Loans It is generally the Company's policy to discontinue interest accruals once a loan is past due for a period of 90 days as to interest or principal payments. When a loan is placed on non-accrual, interest accruals cease and uncollected accrued interest is reversed and charged against current income. Payments received on non-accrual loans are applied against principal. A loan may only be restored to an accruing basis when it again becomes well secured and in the process of collection or all past due amounts have been collected and an appropriate period of performance has been demonstrated. The following table summarizes the Company's non-accrual loans by loan category (dollars in thousands), net of guarantees of theState of California andU.S. Government , including its agencies and its government-sponsored agencies, atDecember 31, 2022 and 2021. At December 31, 2022 At December 31, 2021 Gross Guaranteed Net Gross Guaranteed Net Commercial $ - $ - $ -$ 133 $ 33$ 100 Commercial real estate - - - 555 - 555 Agriculture 7,416 - 7,416 8,712 - 8,712 Residential mortgage 123 - 123 138 - 138 Residential construction - - - - - - Consumer 637 - 637 659 - 659 Total non-accrual loans$ 8,176 $ -$ 8,176 $ 10,197 $ 33$ 10,164 41
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Non-accrual loans amounted to$8,176,000 atDecember 31, 2022 , and were comprised of three agriculture loans totaling$7,416,000 , one residential mortgage loan totaling$123,000 and four consumer loans totaling$637,000 . Non-accrual loans amounted to$10,197,000 atDecember 31, 2021 , and were comprised of two commercial loans totaling$133,000 , one commercial real estate loans totaling$555,000 , three agriculture loans totaling$8,712,000 , one residential mortgage loan totaling$138,000 and four consumer loans totaling$659,000 . If interest on non-accrual loans had been accrued, such interest income would have approximated$812,000 and$206,000 during the years endedDecember 31, 2022 and 2021, respectively. Income actually recognized on nonaccrual loans at payoff approximated$51,000 and$516,000 for the years endedDecember 31, 2022 and 2021, respectively. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Non-performing impaired loans are non-accrual loans and loans that are 90 days or more past due and still accruing. Non-performing impaired loans atDecember 31, 2022 and 2021 totaled$8,579,000 and$10,197,000 , respectively. A restructuring of a loan can constitute a troubled debt restructuring ("TDR") if the Company for economic or legal reasons related to the borrower's financial difficulties grants a concession to the borrower that it would not otherwise consider. The Company had$8,399,000 and$10,103,000 in TDR loans as ofDecember 31, 2022 and 2021, respectively. A loan that is restructured in a TDR is considered an impaired loan. Performing impaired loans, which solely consisted of loans modified as TDRs, totaled$563,000 and$822,000 atDecember 31, 2022 and 2021, respectively. The Company expects to collect all principal and interest due from performing impaired loans. These loans are not on non-accrual status. No assurance can be given that the existing or any additional collateral will be sufficient to secure full recovery of the obligations owed under these loans. The Company had one loan totaling$403,000 that was 90 days or more past due and still accruing atDecember 31, 2022 . The Company had no loans 90 days past due and still accruing as of the periods endedDecember 31, 2021 . As the following table illustrates, total non-performing assets, which consists of loans on non-accrual status, loans past due 90-days and still accruing and Other Real Estate Owned ("OREO") net of guarantees of theState of California andU.S. Government , including its agencies and its government-sponsored agencies, decreased$1,585,000 , or 15.6%, to$8,579,000 fromDecember 31, 2021 toDecember 31, 2022 . Non-performing assets net of guarantees represented 0.5% of total assets at each of the periods endedDecember 31, 2022 and 2021. The Bank's management believes that the$8,176,000 in non-accrual loans were appropriately reflected at their fair value atDecember 31, 2022 . However, no assurance can be given that the existing or any additional collateral will be sufficient to secure full recovery of the obligations owed under these loans. AtDecember 31, 2022
At
Gross Guaranteed Net Gross Guaranteed Net (dollars in thousands) Non-accrual loans$ 8,176 $ -$ 8,176 $ 10,197 $ 33$ 10,164 Loans 90 days past due and still accruing 403 - 403 - - - Total non-performing loans 8,579 - 8,579 10,197 33 10,164 Other real estate owned - - - - - - Total non-performing assets 8,579 - 8,579 10,197 33 10,164 Non-performing loans (net of guarantees) to total loans 0.9 % 1.2 % Non-performing assets (net of guarantees) to total assets 0.5 % 0.5 % Allowance for loan and lease losses to non-performing loans (net of guarantees) 172.4 % 137.3 % OREO consists of property that the Company has acquired by deed in lieu of foreclosure or through foreclosure proceedings, and property that the Company does not hold title to but is in actual control of, known as in-substance foreclosure. The estimated fair value of the property is determined prior to transferring the balance to OREO. The balance transferred to OREO is the estimated fair value of the property less estimated cost to sell. Impairment may be deemed necessary to bring the book value of the loan equal to the appraised value. Appraisals or loan officer evaluations are then conducted periodically thereafter charging any additional impairment to the appropriate expense account. The Company had no OREO as of the years endedDecember 31, 2022 and 2021. 42
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Potential Problem Loans The Company manages asset quality and credit risk by maintaining diversification in its loan portfolio and through review processes that include analysis of credit requests and ongoing examination of outstanding loans and delinquencies, with particular attention to portfolio dynamics and loan mix. The Company strives to identify loans experiencing difficulty early enough to correct the problems, to record charge-offs promptly based on realistic assessments of collectability and current collateral values and to maintain an adequate allowance for loan losses at all times. Asset quality reviews of loans and other non-performing assets are administered using credit risk rating standards and criteria similar to those employed by state and federal banking regulatory agencies. The federal banking regulatory agencies utilize the following definitions for assets adversely classified for supervisory purposes: "Substandard Assets: a substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected." "Doubtful Assets: An asset classified doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. OREO and loans rated Substandard and Doubtful are deemed "classified assets." This category, which includes both performing and non-performing assets, receives an elevated level of attention regarding collection. Commercial loans, whether secured or unsecured, generally are made to support the short-term operations and other needs of small businesses. These loans are generally secured by the receivables, equipment, and other real property of the business and are susceptible to the related risks described above. Problem commercial loans are generally identified by periodic review of financial information that may include financial statements, tax returns, and payment history of the borrower. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. When repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Appropriate valuations are obtained at origination of the credit and periodically thereafter (generally every 3-12 months depending on the collateral type and market conditions), once repayment is questionable, and the loan has been deemed classified. Commercial real estate loans generally fall into two categories, owner-occupied and non-owner occupied. Loans secured by owner occupied real estate are primarily susceptible to changes in the market conditions of the related business. This may be driven by, among other things, industry changes, geographic business changes, changes in the individual financial capacity of the business owner, general economic conditions, and changes in business cycles. These same risks apply to commercial loans whether secured by equipment, receivables, or other personal property or unsecured. Problem commercial real estate loans are generally identified by periodic review of financial information that may include financial statements, tax returns, payment history of the borrower, and site inspections. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Losses on loans secured by owner-occupied real estate, equipment, or other personal property generally are dictated by the value of underlying collateral at the time of default and liquidation of the collateral. When default is driven by issues related specifically to the business owner, collateral values tend to provide better repayment support and may result in little or no loss. Alternatively, when default is driven by more general economic conditions, underlying collateral generally has devalued more and results in larger losses due to default. Loans secured by non-owner occupied real estate are primarily susceptible to risks associated with swings in occupancy or vacancy and related shifts in lease rates, rental rates or room rates. Most often, these shifts are a result of changes in general economic or market conditions or overbuilding and resultant over-supply of space. Losses are dependent on the value of underlying collateral at the time of default. Values are generally driven by these same factors and influenced by interest rates and required rates of return as well as changes in occupancy costs. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, sales invoices, or other appropriate means. Appropriate valuations are obtained at origination of the credit and periodically thereafter (generally every 3-12 months depending on the collateral type and market conditions), once repayment is questionable, and the loan has been deemed classified. Agricultural loans, whether secured or unsecured, generally are made to producers and processors of crops and livestock. Repayment is primarily from the sale of an agricultural product or service. Agricultural loans are generally secured by inventory, receivables, equipment, and other real property. Agricultural loans primarily are susceptible to changes in market demand for specific commodities. This may be exacerbated by, among other things, industry changes, changes in the individual financial capacity of the business owner, general economic conditions and changes in business cycles, as well as changing weather conditions. Problem agricultural loans are generally identified by periodic review of financial information that may include financial statements, tax returns, crop budgets, payment history, and crop inspections. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Appropriate valuations are obtained at origination of the credit and periodically thereafter (generally every 3-12 months depending on the collateral type and market conditions), once repayment is questionable, and the loan has been deemed classified. 43
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Residential mortgage loans, which are secured by real estate, are primarily susceptible to four risks: non-payment due to diminished or lost income, over-extension of credit, a lack of borrower's cash flow to sustain payments, and shortfalls in collateral value. In general, non-payment is due to loss of employment and follows general economic trends in the marketplace, particularly the upward movement in the unemployment rate, loss of collateral value, and demand shifts. Problem residential mortgage loans are generally identified via payment default. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. When repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Appropriate valuations are obtained at origination of the credit and periodically thereafter (generally every 3-12 months depending on the collateral type and market conditions), once repayment is questionable, and the loan has been deemed classified. Construction loans, whether owner occupied or non-owner occupied residential development loans, are not only susceptible to the related risks described above but the added risks of construction itself, including cost over-runs, mismanagement of the project, or lack of demand and market changes experienced at time of completion. Again, losses are primarily related to underlying collateral value and changes therein as described above. Problem construction loans are generally identified by periodic review of financial information that may include financial statements, tax returns and payment history of the borrower. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors, or repossession or foreclosure of the underlying collateral. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Appropriate valuations are obtained at origination of the credit and periodically thereafter (generally every 3-12 months depending on the collateral type and market conditions), once repayment is questionable, and the loan has been deemed classified. Consumer loans, whether unsecured or secured, are primarily susceptible to four risks: non-payment due to diminished or lost income, over-extension of credit, a lack of borrower's cash flow to sustain payments, and shortfall in collateral value. In general, non-payment is due to loss of employment and will follow general economic trends in the marketplace, particularly the upward movements in the unemployment rate, loss of collateral value, and demand shifts. Problem consumer loans are generally identified via payment default. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. When repayment becomes unlikely based on the borrower's income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Appropriate valuations are obtained at origination of the credit and periodically thereafter (generally every 3-12 months depending on the collateral type and market conditions), once repayment is questionable, and the loan has been deemed classified. Once a loan becomes delinquent or repayment becomes questionable, a Company collection officer will address collateral shortfalls with the borrower and attempt to obtain additional collateral or a principal payment. If this is not forthcoming and payment of principal and interest in accordance with the contractual terms of the loan agreement becomes unlikely, the Company will consider the loan to be impaired and will estimate its probable loss, using the present value of future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. For collateral dependent loans, the Company will utilize a recent valuation of the underlying collateral less estimated costs of sale, and charge-off the loan down to the estimated net realizable amount. Depending on the length of time until final collection, the Company may periodically revalue the estimated loss and take additional charge-offs or specific reserves as warranted. Revaluations may occur as often as every 3-12 months depending on the underlying collateral and volatility of values. Final charge-offs or recoveries are taken when the collateral is liquidated and the actual loss is confirmed. Unpaid balances on loans after or during collection and liquidation may also be pursued through legal action and attachment of wages or judgment liens on the borrower's other assets. 44
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Excluding the non-performing loans cited previously, loans totaling$6,490,000 and$4,687,000 were classified as substandard or doubtful loans, representing potential problem loans atDecember 31, 2022 and 2021, respectively. In Management's opinion, the potential loss related to these problem loans was sufficiently covered by the Bank's existing loan loss reserve (Allowance for Loan Losses) atDecember 31, 2022 and 2021. The ratio of the Allowance for Loan Losses to total loans atDecember 31, 2022 and 2021 was 1.50% and 1.61%, respectively. SUMMARY OF LOAN LOSS EXPERIENCE The Company's allowance for credit losses is maintained at a level considered adequate to provide for losses that can be estimated based upon specific and general conditions. These include conditions unique to individual borrowers, as well as overall credit loss experience, the amount of past due, non-performing loans and classified loans, recommendations of regulatory authorities, prevailing economic conditions and other factors. A portion of the allowance is specifically allocated to classified loans whose full collectability is uncertain. Such allocations are determined by Management based on loan-by-loan analyses. In addition, loans with similar characteristics not usually criticized using regulatory guidelines are analyzed based on the historical loss rates and delinquency trends, grouped by the number of days the payments on these loans are delinquent. Last, allocations are made to non-criticized and classified commercial loans and residential real estate loans based on historical loss rates, and other statistical data. The remainder of the allowance is considered to be unallocated. The unallocated allowance is established to provide for probable losses that have been incurred as of the reporting date but not reflected in the allocated allowance. It addresses additional qualitative factors consistent with Management's analysis of the level of risks inherent in the loan portfolio, which are related to the risks of the Company's general lending activity. Included in the unallocated allowance is the risk of losses that are attributable to national or local economic or industry trends which have occurred but have yet been recognized in past loan charge-off history (external factors). The external factors evaluated by the Company include: economic and business conditions, external competitive issues, and other factors. Also included in the unallocated allowance is the risk of losses attributable to general attributes of the Company's loan portfolio and credit administration (internal factors). The internal factors evaluated by the Company include: loan review system, adequacy of lending Management and staff, loan policies and procedures, problem loan trends, concentrations of credit, and other factors. By their nature, these risks are not readily allocable to any specific loan category in a statistically meaningful manner and are difficult to quantify. Management assigns a range of estimated risk to the qualitative risk factors described above based on Management's judgment as to the level of risk and assigns a quantitative risk factor from the range of loss estimates to determine the appropriate level of the unallocated portion of the allowance. Management considered the$14,792,000 allowance for credit losses to be adequate as a reserve against losses as ofDecember 31, 2022 . For information regarding the changes in methodology relating to the allowance for loan losses effectiveJanuary 1, 2023 , due to the FASB's ASU 2016-13, see "Impact of Recently Issued Accounting Standards" above in this section. 45
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Analysis of the Allowance for Loan Losses (Dollars in thousands) 2022 2021 2020 Balance at Beginning of Year$ 13,952 $ 15,416 $ 12,356 Provision for Loan Losses 900 (1,500 ) 3,050 Loans Charged-Off: Commercial (297 ) (502 ) (212 ) Commercial Real Estate - - - Agriculture - - - Residential Mortgage - (5 ) - Residential Construction - - - Consumer (48 ) (12 ) (15 ) Total Charged-Off (345 ) (519 ) (227 ) Recoveries: Commercial 275 429 201 Commercial Real Estate - 14 - Agriculture - - - Residential Mortgage - - - Residential Construction - - - Consumer 10 112 36 Total Recoveries 285 555 237 Net (Charge-offs) Recoveries (60 ) 36 10 Balance at End of Year$ 14,792 $ 13,952 $ 15,416 Ratio of Net (Charge-Offs) Recoveries During the Year to Average Loans Outstanding During the Year (0.01 %) 0.00 % 0.00 % Allowance for Loan Losses to Total Loans 1.50 % 1.61 % 1.73 % Nonaccrual loans to Total Loans 0.8 % 1.2 % 1.7 % Allowance for Loan Losses to Nonaccrual loans 180.9 % 136.8 % 101.3 % 46
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Allocation of the Allowance for Loan Losses
The Allowance for Loan Losses has been established as a general component available to absorb probable inherent losses throughout the loan portfolio.
The
following table is an allocation of the Allowance for Loan Losses balance on the dates indicated (dollars in thousands):
December 31, 2022 December 31, 2021 Allocation of Allowance as a Loans as a % Allocation of Allowance as a Loans as a % Allowance for Loan % of Total of Total Allowance for Loan % of Total of Total Losses Balance Allowance Loans, net Losses Balance Allowance Loans, net Loan Type: Commercial $ 1,463 9.9 % 10.8 % $ 1,604 11.5 % 15.7 % Commercial Real Estate 10,073 68.1 % 65.6 % 8,808 63.1 % 60.7 % Agriculture 1,757 11.9 % 11.6 % 1,482 10.7 % 12.3 % Residential Mortgage 880 5.9 % 9.4 % 742 5.3 % 8.8 % Residential Construction 178 1.2 % 1.0 % 74 0.5 % 0.5 % Consumer 173 1.2 % 1.6 % 167 1.2 % 2.0 % Unallocated 268 1.8 % - 1,075 7.7 % - Total $ 14,792 100.0 % 100.0 % $ 13,952 100.0 % 100.0 % The Bank believes that any breakdown or allocation of the allowance into loan categories lends an appearance of exactness, which does not exist, because the allowance is available for all loans. The allowance breakdown shown above is computed taking actual experience into consideration but should not be interpreted as an indication of the specific amount and allocation of actual charge-offs that may ultimately occur. 47
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Deposits The following table sets forth the average amount and the average rate paid on each of the listed deposit categories (dollars in thousands) during the periods specified: 2022 2021 2020 Average Average Average Amount Average Rate Amount Average Rate Amount Average Rate Deposit Type:
Non-interest-Bearing
Demand$ 805,738 -$ 764,676 -$ 577,559 - Interest-Bearing Demand (NOW)$ 441,543 0.08 %$ 420,481 0.06 %$ 356,867 0.10 % Savings and MMDAs$ 449,169 0.16 %$ 436,931 0.11 %$ 387,490 0.20 % Time$ 47,022 0.28 %$ 54,465 0.35 %$ 54,147 0.63 %
The following table sets forth by time remaining to maturity for the Bank's time
deposits over
Three months or less$ 1,211
Over three months through six months 1,012
Over six months through twelve months 3,769
Over twelve months 3,248 Total$ 9,240 Short-Term Borrowings
The Company had no secured borrowings and no Federal Funds purchased at
Additional short-term borrowings available to the Company consist of a line of credit and advances with theFederal Home Loan Bank ("FHLB") secured under terms of a blanket collateral agreement by a pledge of FHLB stock and all loans held by the Company. AtDecember 31, 2022 , the Company had a current collateral borrowing capacity with the FHLB of$365,786,000 and, at such date, also had unsecured formal lines of credit totaling$122,000,000 with correspondent banks.
The Company had no Federal Funds purchased during the years ended
Long-Term Borrowings The Company had no long-term borrowings atDecember 31, 2022 and 2021. There were no average outstanding balances of long-term borrowings during 2022 and 2021. 48
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Supplemental Compensation Plans The Company and the Bank maintain an unfunded non-contributory defined benefit pension plan ("Salary Continuation Plan") and related split dollar plan for a select group of highly compensated employees. Eligibility to participate in the Salary Continuation Plan is limited to a select group of management or highly compensated employees of the Bank that are designated by the Board. Additionally, the Company and the Bank adopted a supplemental executive retirement plan ("SERP") in 2006. The SERP is intended to integrate the various forms of retirement payments offered to executives. There are currently three participants in the SERP. AtDecember 31, 2022 , the accrued benefit liability was$5,339,000 , of which$4,901,000 was recorded in interest payable and other liabilities and$438,000 was recorded in accumulated other comprehensive loss, net, in the Consolidated Balance Sheets. AtDecember 31, 2021 , the accrued benefit liability was$6,581,000 , of which$4,588,000 was recorded in interest payable and other liabilities and$1,993,000 was recorded in accumulated other comprehensive income, net, in the Consolidated Balance Sheets. The Company and the Bank maintain an unfunded non-contributory defined benefit pension plan ("Directors' Retirement Plan") and related split dollar plan for the directors of the Bank. AtDecember 31, 2022 , the accrued benefit liability was$560,000 , of which$636,000 was recorded in interest payable and other liabilities and$(76,000) was recorded in accumulated other comprehensive loss, net, in the Consolidated Balance Sheets. AtDecember 31, 2021 , the accrued benefit liability was$710,000 , of which$692,000 was recorded in interest payable and other liabilities and$18,000 was recorded in accumulated other comprehensive income, net, in the Consolidated Balance Sheets.
For additional information, see Note 17 to the Consolidated Financial Statements in this Form 10-K.
Overview Year EndedDecember 31, 2022 Compared to Year EndedDecember 31, 2021 Net income for the year endedDecember 31, 2022 , was$15.9 million , representing an increase of$1.7 million , or 12.0%, compared to net income of$14.2 million for the year endedDecember 31, 2021 . The increase in net income was attributable to an increase in net interest income of$8.4 million , which was partially offset by an increase in provision for loan losses of$2.4 million , decrease in non-interest income of$0.9 million , increase in non-interest expenses of$2.9 million and$0.5 million increase in provision for income taxes. Total assets decreased by$27.7 million , or 1.5%, to$1.87 billion as ofDecember 31, 2022 , compared to$1.90 billion atDecember 31, 2021 . The decrease in total assets was primarily due to a$158.5 million decrease in cash and cash equivalents and a$14.0 million decrease in investment securities, which was partially offset by a$116.4 million increase in net loans (including loans held-for-sale),$7.7 million increase in certificates of deposit and$19.0 million increase in interest receivable and other assets. Total deposits decreased$1.4 million , or 0.08%, to$1.7 billion as ofDecember 31, 2022 , compared to$1.7 billion atDecember 31, 2021 . 49
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Table of Contents Results of Operations Net Interest Income Net interest income is the excess of interest and fees earned on the Bank's loans, investment securities, federal funds sold and banker's acceptances over the interest expense paid on deposits and other borrowed funds which are used to fund those assets. Net interest income is primarily affected by the yields and mix of the Bank's interest-earning assets and interest-bearing liabilities outstanding during the period. The$8,706,000 increase in the Bank's interest and dividend income in 2022 from 2021 was driven by increased interest rates and loan growth improving the earning asset mix. The$3,109,000 increase in the Bank's interest income on loans was primarily driven by an increase of$1,768,000 driven by an increase in average loans outstanding compounded by an increase of$1,341,000 due to increasing interest rates. The$3,121,000 increase in the Bank's interest income on due from banks was primarily driven by an increase of$3,292,000 due to increase in average interest rates paid on excess reserves at theFederal Reserve , partially offset by a decrease of$171,000 driven by decreased average due from bank balances outstanding. The$2,353,000 increase in the Bank's interest income on investment securities was driven by an increase of$1,219,000 driven by increased investment securities balances outstanding coupled with an increase of$1,134,000 due to increasing interest rates. The$274,000 increase in the Bank's interest expense on deposits was primarily driven by a$271,000 increase due to increasing interest rates. See "Analysis of Changes in Interest Income and Interest Expense" set forth on page 38 of this Annual Report on Form 10-K for a discussion of the effects of interest rates and loan/deposit volume on net interest income. The FRB influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. Our loan portfolio is significantly affected by changes in the prime interest rate. As ofDecember 31, 2021 , the prime rate was 3.25%. The prime rate increased numerous times during 2022, increasing to 7.50% as ofDecember 31, 2022 . As ofDecember 31, 2021 , the target range for the federal funds rate was 0% to 0.25%. In late 2021 and continuing into 2022, the FRB raised interest rates in light of inflationary trends in the economy. As ofDecember 31, 2022 , the target range for the federal funds rate was 4.25% to 4.50%. For additional information, see "During 2021 and continuing through 2022, theU.S. Economy Began to Reflect Relatively Rapid Rates of Increase in the Consumer Price Index and Other Economic Indices; a Prolonged Elevated Rate of Inflation Could Present Risks for theU.S. Banking Industry and Our Business", in "Risk Factors" (Item 1A) of this Annual Report on Form 10-K.
We are primarily funded by core deposits, with non-interest-bearing demand deposits historically being a significant source of funds. This lower-cost funding base is expected to have a positive impact on our net interest income and net interest margin in a rising interest rate environment.
The nature and impact of future changes in interest rates and monetary policy on the business and earnings of the Company cannot be predicted. For additional information, see "The Effects of Changes or Increases in, or Supervisory Enforcement of, Banking or Other Laws and Regulations or Governmental Fiscal or Monetary Policies Could Adversely Affect Us" and "During 2021 and continuing through 2022, theU.S. Economy Began to Reflect Relatively Rapid Rates of Increase in the Consumer Price Index and Other Economic Indices; a Prolonged Elevated Rate of Inflation Could Present Risks for theU.S. Banking Industry and Our Business" in "Risk Factors" (Item 1A) of this Annual Report on Form 10-K. Interest income on loans for 2022 was up 7.9% from 2021, increasing from$39,207,000 to$42,316,000 . The increase in interest income on loans was primarily due to an increase in average balance of loans and higher yields earned on newly originated loans and loans repricing at higher rates, which was partially offset by a decrease in PPP fee recognition. The Company recognized approximately$2.7 million and$4.7 million of PPP loan fees during the years endedDecember 31, 2022 andDecember 31, 2021 , respectively. The Company recognized the remaining balance of PPP loan fees during 2022. Interest income on interest-bearing due from banks for 2022 was up 734.4% from 2021, increasing from$425,000 to$3,546,000 . The increase in interest income on interest-bearing due from banks was the result of an 146 basis point increase in yield on interest-bearing due from banks, which was partially offset by a 31.2% decrease in average balances of interest-bearing due from banks. The increase in yield was due to the increase in the effective federal funds rate as discussed above. Interest income on certificates of deposit for 2022 was down 4.7% from 2021, decreasing from$297,000 to$283,000 . The decrease in interest income on certificates of deposit was the result of a 10.2% decrease in average balances of certificates of deposit, which was partially offset by a 13 basis point increase in yield on certificates of deposit. Interest income on investment securities for 2022 was up 34.3% from 2021, increasing from$6,852,000 to$9,205,000 . The increase in interest income on investment securities was the result of a 20 basis point increase in investment securities yields coupled with a 16.0% increase in average investment securities volume. The Bank deployed excess liquidity into the investment portfolio over the course of 2022 at higher reinvestment rates. Investment securities yields were 1.46% and 1.26% for 2022 and 2021, respectively. 50
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Interest expense on deposits for 2022 was up 30.0% from 2021, increasing from$912,000 to$1,186,000 . The increase in interest expense on deposits was the result of a 2 basis point increase in interest rates paid on interest-bearing deposits coupled with a 2.8% increase in average balances of interest-bearing deposits. The mix of deposits for the previous three years was as follows (dollars in thousands): 2022 2021 2020 Average Balance Percent Average Balance Percent Average Balance Percent
Non-interest-Bearing
Demand $ 805,738 46.2 % $ 764,676 45.6 % $ 577,559 42.0 % Interest-Bearing Demand (NOW) 441,543 25.3 % 420,481 25.1 % 356,867 25.9 % Savings and MMDAs 449,169 25.8 % 436,931 26.1 % 387,490 28.2 % Time 47,022 2.7 % 54,465 3.2 % 54,147 3.9 % Total$ 1,743,472 100.0 %$ 1,676,553 100.0 %$ 1,376,063 100.0 % The Bank's net interest margin (net interest income divided by average earning assets) was 3.06% in 2022 and 2.62% in 2021. The net interest spread (average yield earned on interest-earning assets less the average rate paid on interest-bearing liabilities) was 2.99% in 2022 and 2.58% in 2021. The 41 basis point increase in net spread in 2022 over 2021 was due to an overall increase in interest rates on earning assets, which was partially offset by an overall increase in interest rates on interest-bearing deposits. Provision for Loan Losses The provision for loan losses is established by charges to earnings based on management's overall evaluation of the collectability of the loan portfolio. Based on this evaluation, the Company recorded provision for loan losses of$900,000 in 2022, compared to a reversal of provision for loan losses of$1,500,000 in 2021. The provision for loan losses in 2022 was primarily due to loan growth. The reversal of provision for loan losses in 2021 was primarily due to the decrease in specific reserves on impaired loans to one borrower, coupled with an overall decrease in qualitative factors resulting from an improvement in economic conditions. The ratio of the Allowance for Loan Losses to total loans atDecember 31, 2022 was 1.50% compared to 1.61% atDecember 31, 2021 . The ratio of the Allowance for Loan Losses to total non-accrual loans and loans past due 90 days or more, net of guarantees was 172.4% atDecember 31, 2022 , compared to 137.3% atDecember 31, 2021 . The increase was primarily due to the decrease in nonaccrual loans, net of guarantees totaling$2.0 million . 51
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Non-Interest Income and Expenses Non-interest income consisted primarily of service charges on deposit accounts, net losses on sale of available-for-sale securities, net realized gains on loans held-for-sale, debit card income and other income. Non-interest income decreased to$6,933,000 in 2022 from$7,863,000 in 2021, representing a decrease of$930,000 , or 11.8%. The decrease was primarily due to a decrease in net realized gains on loans held-for-sale, which was partially offset by an increase in other income. Net realized gains on loans held-for-sale decreased$1,383,000 in 2022 over 2021. The decrease in gains on sales of loans held-for-sale was primarily due to a decrease in loan origination volumes due to an increase in interest rates and slowdown in refinancing activity. Other income increased$414,000 in 2022 over 2021. The increase in other income was primarily due to non-taxable income from a bank owned life insurance policy. Non-interest expenses consisted primarily of salaries and employee benefits, occupancy and equipment expense, data processing expense and other expenses. Non-interest expenses increased to$39,063,000 in 2022 from$36,201,000 in 2021, representing an increase of$2,862,000 , or 7.9%.
Following is an analysis of the increase or decrease in the components of non-interest expenses (dollars in thousands) during the periods specified:
2022 over 2021 Amount Percent Salaries and Employee Benefits$ 1,448 6.4 % Occupancy and Equipment 147 4.3 % Data Processing 73 2.2 % Stationery and Supplies 39 15.4 % Advertising 114 29.8 % Directors Fees (3 ) (1.0 %) Other Expense 1,044 18.4 % Total$ 2,862 7.9 % The increase in salaries and employee benefits in 2022 was primarily due to a 3.6% increase in regular salaries, a 36.5% increase in contingent compensation, and a 17.2% increase in profit sharing plan contributions, partially offset by a 26.6% decrease in commissions paid. The increase in regular salaries expense was primarily due to merit increases and an increase in full-time equivalent employees. The increases in contingent compensation and profit sharing plan contributions were primarily the result of improved financial performance. The decrease in commissions paid was primarily due to a decrease in mortgage loan production volumes. The increase in other expenses was primarily due to a 169.3% increase in legal fees and 116.7% increase in reserves for unfunded commitments expense, which was partially offset by a 53.8% decrease in loan collection expenses. The increase in legal fees was primarily due to the legal costs associated with the purchase and acquisition of three branches from another bank that was finalized in the first quarter of 2023. The increase in reserves for unfunded commitments expense was primarily due to the increase in unfunded commitments balances. The decrease in loan collection expense is primarily due to the prior year expenses associated with one borrower. 52
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Income Taxes The provision for income taxes is primarily affected by the tax rate, the level of earnings before taxes and the level of tax-exempt income. In 2022, tax expense increased to$5,782,000 from$5,240,000 in 2021, due to an increase in income before taxes. Non-taxable municipal bond income was$909,000 and$603,000 for the years endedDecember 31, 2022 and 2021, respectively. Liquidity Liquidity is defined as the ability to generate cash at a reasonable cost to fulfill lending commitments and support asset growth, while satisfying the withdrawal demands of deposit customers and any debt repayment requirements. The Bank's principal sources of liquidity are core deposits and loan and investment payments and proceeds of sale and prepayments. Providing a secondary source of liquidity is the available-for-sale investment portfolio. The Company held$618,092,000 in total investment securities atDecember 31, 2022 . Under certain deposit, borrowing, and other arrangements, the Company must hold and pledge investment securities as collateral. AtDecember 31, 2022 , such collateral requirements totaled approximately$44,319,000 . As a smaller source of liquidity, the Bank can utilize existing credit arrangements. The Company's primary source of liquidity on a stand-alone basis is dividends from the Bank. As discussed in Part I (Item 1) of this Annual Report on Form 10-K, dividends from the Bank are subject to regulatory and corporate law restrictions. Liquidity risk can result from the mismatching of asset and liability cash flows, or from disruptions in the financial markets. The Bank experiences seasonal swings in deposits, which impact liquidity. Management has sought to address these seasonal swings by scheduling investment maturities and developing seasonal credit arrangements with the FHLB,Federal Reserve Bank and Federal Funds lines of credit with correspondent banks. In addition, the ability of the Bank's real estate department to originate and sell loans into the secondary market has provided another tool for the management of liquidity. As ofDecember 31, 2022 , the Company has not created any special purpose entities to securitize assets or to obtain off-balance sheet funding. The liquidity position of the Bank is managed daily, thus enabling the Bank to adapt its position according to market fluctuations. Liquidity is measured by various ratios, the most common of which is the ratio of net loans (including loans held-for-sale) to deposits. This ratio was 56.2% onDecember 31, 2022 , and 49.4% onDecember 31, 2021 . AtDecember 31, 2022 and 2021, the Bank's ratio of core deposits to total assets was 91.8% and 90.4%, respectively. Core deposits include demand deposits, interest-bearing transaction deposits, savings and money market deposit accounts, and time deposits of$250,000 or less. Core deposits are important in maintaining a strong liquidity position as they represent a stable and relatively low-cost source of funds. Management believes that the Bank's liquidity position was adequate in 2022. This is best illustrated by the change in the Bank's net non-core ratio, which explains the degree of reliance on non-core liabilities to fund long-term assets. AtDecember 31, 2022 , the Bank's net core funding dependence ratio, the difference between non-core funds, time deposits$250,000 or more and brokered time deposits under$250,000 , and short-term investments to long-term assets, was (13.58)% as ofDecember 31, 2022 , and (21.32%) as ofDecember 31, 2021 . This ratio indicated atDecember 31, 2022 , the Bank did not significantly rely upon non-core deposits and borrowings to fund the Bank's long-term assets, namely loans and investments. The Bank believes that by maintaining adequate volumes of short-term investments and implementing competitive pricing strategies on deposits, it can ensure adequate liquidity to support future growth. The Bank also believes that its liquidity position remains strong to meet both present and future financial obligations and commitments, events or uncertainties that have resulted or are reasonably likely to result in material changes with respect to the Bank's liquidity. 53
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Commitments
The following table details the amounts and expected maturities of commitments
as of
Maturities by period Less than 1 More than 5 Commitments Total year 1-3 years 3-5 years years Commitments to extend credit Commercial$ 77,548 $ 53,543 $ 9,469 $ 7,006 $ 7,530 Commercial Real Estate 37,992 621 - 937 36,434 Agriculture 28,341 21,787 440 795 5,319 Residential Mortgage 250 - 250 - - Residential Construction 13,486 4,831 - - 8,655 Consumer 47,993 13,739 6,880 6,348 21,026 Commitments to sell loans - - - - - Standby Letters of Credit 1,930 1,930 - - - Total$ 207,540 $ 96,451 $ 17,039 $ 15,086 $ 78,964 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 amounts do not necessarily represent future cash requirements. Off-Balance Sheet Arrangements The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit in the form of loans or through standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheet. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. These loans have been sold to third parties without recourse, subject to customary default, representations and warranties, recourse for breaches of the terms of the sales contracts and payment default recourse.
Financial instruments, whose contract amounts represent credit risk at
2022 2021 Undisbursed loan commitments$ 205,610 $ 192,874 Standby letters of credit 1,930 2,305 Commitments to sell loans - 1,500$ 207,540 $ 196,679 Our liquidity position is continuously monitored and adjustments are made to balance between sources and uses of funds as deemed appropriate. The Bank believes that it has the means to provide adequate liquidity for funding normal operations in 2023. 54
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Capital The Company believes a strong capital position is essential to the Company's continued growth and profitability. A solid capital base provides depositors and shareholders with a margin of safety, while allowing the Company to take advantage of profitable opportunities, support future growth and provide protection against any unforeseen losses. AtDecember 31, 2022 , stockholders' equity totaled$125.0 million , a decrease of$25.9 million from$150.9 million atDecember 31, 2021 . The decrease was primarily due to a decrease in accumulated other comprehensive income of$42.3 million , which was partially offset by net income of$15.9 million . Also affecting capital in 2022 were stock repurchases totaling$0.2 million and paid-in capital in the amount of$0.8 million resulting from employee stock purchases and stock plan accruals. See "Business - Capital Standards" in Part I, Item 1 of this Annual Report on Form 10-K, for additional information. OnMay 20, 2021 , the Company approved a stock repurchase program effectiveJune 15, 2021 . The stock repurchase program, which will remain in effect untilJune 14, 2023 , allows repurchases by the Company in an aggregate amount of up to 4% of the Company's 13,680,085 outstanding shares of common stock as ofMarch 31, 2021 . This represents total shares of 547,203 eligible for repurchase. The Company repurchased 21,325 and 505,824 shares of the Company's outstanding common stock during the years endedDecember 31, 2022 and 2021, respectively. The purpose of the stock repurchase program is to give management the ability to manage capital and create liquidity for shareholders who want to sell their stock. Management believes that the stock repurchase program is a prudent use of excess capital. The capital of the Company and the Bank historically have been maintained at a level that is in excess of regulatory guidelines for a "well capitalized" institution. The policy of annual stock dividends rather than cash dividends has, over time, allowed the Company to match capital and asset growth through retained earnings and a managed program of geographic growth.
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