The Company does not undertake any obligation to publicly correct or update any forward-looking statements if it later becomes aware that actual results are likely to differ materially from those expressed in such forward-looking statements, except as required by law.

Overview

Farmers & Merchants Bancorp (the “Company” or “FMCB”) is a Delaware registered bank holding company organized in 1999. As a registered bank holding company, FMCB is subject to regulation, supervision, and examination by the Board of Governors of the Federal Reserve System (“FRB”) and by the California Department of Financial Protection and Innovation (“DFPI”). The Company’s principal business is to serve as a holding company for Farmers & Merchants Bank of Central California (the “Bank” or “F&M Bank”) the Bank and for other banking or banking related subsidiaries, which the Company may establish or acquire. As a legal entity separate and distinct from its subsidiary, the Company’s principal source of funds is, and will continue to be, dividends paid by and other funds received from the Bank. Legal limitations are imposed on the amount of dividends that may be paid and loans that may be made by the Bank to the Company.

F & M Bancorp, Inc. was created in March 2002 to protect the name “F & M Bank.” During 2002, the Company completed a fictitious name filing in California to begin using the streamlined name, “F & M Bank,” as part of a larger effort to enhance the Company’s image and build brand name recognition. Since 2002, the Company has converted all of its daily operating and image advertising to the “F & M Bank” name and the Company’s logo, slogan and signage were redesigned to incorporate the trade name, “F & M Bank”.

The Company’s outstanding common stock as of ~~June~~September 30, 2023, consisted of ~~754,523~~752,013 shares of common stock, $0.01 par value and no shares of preferred stock were issued or outstanding. The common stock of the Company is not widely held or listed on any exchange. However, trades are reported on the OTCQX under the symbol “FMCB.”

The primary source of funding for the Company’s growth has been the generation of core deposits, which the Company raises through its existing branch locations, newly opened branch locations, or through acquisitions. Loan growth over the years is the result of organic growth generated by the Company’s seasoned relationship managers and supporting associates who provide outstanding service and responsiveness to the Company’s clients.

The Company’s results of operations are largely dependent on net interest income. Net interest income is the difference between interest income earned on interest earning assets, which are comprised of loans and leases, investment securities and short-term investments, and the interest the Company pays on interest bearing liabilities, which are primarily deposits, and, to a lesser extent, other borrowings. Management strives to match the re-pricing characteristics of the interest earning assets and interest bearing liabilities to protect net interest income from changes in market interest rates and changes in the shape of the yield curve.

The Company measures its performance by calculating the net interest margin, return on average assets, and return on average equity. Net interest margin is calculated by dividing net interest income, which is the difference between interest income on interest earning assets and interest expense on interest bearing liabilities, by average interest earning assets. Net interest income is the Company’s largest source of revenue. Interest rate fluctuations, as well as changes in the amount and type of earning assets and liabilities, combine to affect net interest income. The Company also measures its performance by the efficiency ratio, which is calculated by dividing non-interest expense by the sum of net interest income and non-interest income.

2829

Critical Accounting Policies and Estimates

Our accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition. We identify critical policies and estimates as those that require management to make particularly difficult, subjective, and/or complex judgments about matters that are inherently uncertain and because of the likelihood that materially different amounts would be reported under different conditions or using different assumptions. These policies and estimates relate to the allowance for credit losses on loans and leases ~~held for investment,~~held-for-investment, investment securities, the carrying value of goodwill and other intangible assets, fair value measurements and the realization of deferred income tax assets and liabilities.

Our critical accounting policies and estimates are described in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Form 10-K.

Impact of Recently Issued Accounting Standards

See Note 1. “Basis of Presentation and Significant Accounting Policies” to the Unaudited Consolidated Financial Statements in “Item 1. Financial Information” in this Quarterly Report on Form 10-Q.

Non-GAAP Measurements

We use certain non-GAAP financial measures to provide meaningful supplemental information regarding the Company’s operational performance and to enhance investors’ overall understanding of such financial performance. The methodology for determining these non-GAAP measures may differ among companies. We used the following non-GAAP measures in this Form 10-Q:

•

Tangible common equity ratio and tangible book value per common share: Given that the use of these measures is prevalent among banking regulators, investors, and analysts, we disclose them in addition the related GAAP measures of return on average equity and book value per common share. The reconciliations of these non-GAAP measurements to the GAAP measurements are presented in the following tables for and as of the periods presented.

Tangible Common Equity Ratio and	June 30,			June 30,
Tangible Book Value Per Common Share	2023			2022
Tangible Common Equity Ratio and Tangible Book Value Per Common Share							September 30, 2023			September 30, 2022
(Dollars in thousands, except per share data)
Shareholders' equity	$	514,709		$	461,353
Shareholders’ equity							$	530,623		$	468,178
Less: Intangible assets		13,705			14,289			13,563			14,140
Tangible common equity	$	501,004		$	447,064		$	517,060		$	454,038

Total Assets	$	5,250,378		$	5,326,681		$	5,375,375		$	5,466,781
Less: Intangible assets		13,705			14,289			13,563			14,140
Tangible assets	$	5,236,673		$	5,312,392		$	5,361,812		$	5,452,641

Tangible comon equity ratio⁽¹⁾		9.57	%		8.42	%
Book Value per common share⁽²⁾	$	682.16		$	593.62
Tangible common equity ratio⁽¹⁾								9.64	%		8.33	%
Book value per common share⁽²⁾							$	705.60		$	607.37
Tangible book value per common share⁽³⁾	$	664.00		$	575.23		$	687.57		$	589.03
Common shares oustanding		754,523			777,190
Common shares outstanding								752,013			770,822

⁽¹⁾	Tangible common equity divided by tangible ~~asssets~~assets

⁽²⁾	Total common ~~equtiy~~equity divided by common shares outstanding.

⁽³⁾	Tangible common equity divided by common shares outstanding.

2930

Results of Operations

The following discussion and analysis is intended to provide a better understanding of Farmers & Merchants Bancorp and its subsidiaries’ financial condition at ~~June~~September 30, 2023 and December 31, 2022 and results of operations during the three and ~~six~~nine months ended ~~June~~September 30, 2023 and 2022, respectively. Information related to the comparison of the results of operations for the years ended December 31, 2022, and 2021 can be found in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the 2022 Annual Report on Form 10-K filed with the SEC on March 15, 2023.

Factors that determine the level of net income include the volume of earning assets and interest bearing liabilities, yields earned and rates paid, fee income, non-interest expense, the level of non-performing loans and other non-earning assets, and the amount of non-interest bearing liabilities supporting earning assets. Non-interest income includes card processing fees, service charges on deposit accounts, bank-owned life insurance income, gains/losses on the sale of investment securities, and gains/losses on deferred compensation plan investments. Non-interest expense consists primarily of salaries and employee benefits, cost of deferred compensation benefits, occupancy, data processing, FDIC insurance, marketing, legal and other expenses.

Earnings Performance

The following table presents performance metrics for the periods indicated:

	Three Months ended June 30,						Six Months Ended June 30,						Three Months Ended September 30,						Nine Months Ended September 30,
(dollars in thousands, except per share amounts)	2023			2022			2023			2022			2023			2022			2023			2022
Earnings Summary:
Interest income	$	61,017		$	45,695		$	120,649		$	88,789		$	65,713		$	51,713		$	186,362		$	140,502
Interest expense		8,595			976			12,505			1,861			12,272			1,256			24,777			3,117
Net interest income		52,422			44,719			108,144			86,928			53,441			50,457			161,585			137,385
Provision for credit losses		2,557			1,500			4,057			1,500			3,000			1,500			7,057			3,000
Noninterest income		5,447			3,512			8,907			7,824
Noninterest expense		26,822			23,031			55,005			46,819
Non-interest income														3,606			1,559			12,513			9,383
Non-interest expense														24,468			24,375			79,473			71,194
Income before taxes		28,490			23,700			57,989			46,433			29,579			26,141			87,568			72,574
Income tax expense		7,182			5,257			13,134			10,932			7,545			6,605			20,679			17,537
Net Income	$	21,308		$	18,443		$	44,855		$	35,501		$	22,034		$	19,536		$	66,889		$	55,037

Per Common Share Data:
Diluted earnings per common share	$	28.03		$	23.58		$	58.83		$	45.28		$	29.23		$	25.20		$	88.06		$	70.47
Book value per common share	$	682.16		$	593.62		$	682.16		$	593.62		$	705.60		$	607.37		$	705.60		$	607.37
Tangible book value per common share⁽¹⁾	$	664.00		$	575.23		$	664.00		$	575.23		$	687.57		$	589.03		$	687.57		$	589.03

Performance Ratios:
Return on average assets		1.65	%		1.38	%		1.73	%		1.33	%		1.65	%		1.45	%		1.70	%		1.37	%
Return on average equity		16.60	%		15.94	%		17.75	%		15.30	%		16.80	%		16.64	%		17.43	%		15.75	%
Net interest margin (tax equivalent)		4.27	%		3.52	%		4.38	%		3.44	%		4.17	%		3.91	%		4.33	%		3.62	%
Yield on average loans and leases (tax equivalent)		5.75	%		4.76	%		5.72	%		4.76	%		5.87	%		5.06	%		5.77	%		4.86	%
Cost of average total deposits		0.74	%		0.07	%		0.53	%		0.07	%		1.01	%		0.09	%		0.70	%		0.08	%
Efficiency Ratio		46.35	%		47.75	%		46.99	%		49.41	%
Efficiency ratio														42.89	%		46.86	%		45.65	%		48.51	%
Loan-to-deposit ratio		75.50	%		68.32	%		75.50	%		68.32	%		75.13	%		67.71	%		75.13	%		67.71	%
Percentage of checking deposits to total deposits		52.09	%		58.98	%		52.09	%		58.98	%		51.72	%		60.32	%		51.72	%		60.32	%

Capital Ratios Bancorp:
Common equity tier 1 capital to risk-weighted assets		12.22	%		11.55	%		12.22	%		11.55	%		12.48	%		11.82	%		12.48	%		11.82	%
Tier 1 capital to risk-weighted assets		12.46	%		11.80	%		12.46	%		11.80	%		12.72	%		12.06	%		12.72	%		12.06	%
Risk-based capital to risk-weighted assets		13.71	%		13.05	%		13.71	%		13.05	%		13.97	%		13.32	%		13.97	%		13.32	%
Tier 1 leverage capital ratio		10.21	%		8.94	%		10.21	%		8.94	%		10.22	%		9.12	%		10.22	%		9.12	%
Tangible Common Equity Ratio⁽¹⁾		9.57	%		8.42	%		9.57	%		8.42	%
Tangible common equity ratio⁽¹⁾														9.64	%		8.33	%		9.64	%		8.33	%

(1)

See “Non-GAAP Measurements”

⁽¹⁾	~~See "Non-GAAP Measurements"~~

3031

Average Balance and Yields

The following table sets forth a summary of average balances with corresponding interest income and interest expense as well as average yield, cost and net interest margin information for the periods presented. Average balances are derived from daily balances.

	Three Months Ended June 30,																Three Months Ended September 30,
	2023								2022								2023								2022
(Dollars in thousands)	Average Balance			Interest Income / Expense		Average Yield / Rate			Average Balance			Interest Income / Expense		Average Yield / Rate			Average Balance			Interest Income / Expense		Average Yield / Rate			Average Balance			Interest Income / Expense		Average Yield / Rate
ASSETS
Interest earnings deposits in other banks and federal funds sold	$	458,927		$	5,882		5.14	%	$	683,655		$	1,409		0.83	%	$	592,012		$	8,075		5.41	%	$	718,794		$	4,159		2.30	%
Investment Securities:⁽¹⁾
Investment securities:⁽¹⁾
Taxable securities		923,063			4,626		2.00	%		1,090,507			5,107		1.87	%		908,591			4,588		2.02	%		1,063,166			5,091		1.92	%
Non-taxable securities⁽²⁾		61,576			564		3.66	%		48,339			391		3.24	%		61,580			575		3.73	%		47,005			386		3.28	%
Total investment securities		984,639			5,190		2.11	%		1,138,846			5,498		1.94	%		970,171			5,163		2.13	%		1,110,171			5,477		2.00	%
Loans:⁽³⁾
Real estate:
Commercial		1,307,376			16,744		5.14	%		1,158,892			13,531		4.68	%		1,290,892			16,990		5.22	%		1,224,689			15,179		4.92	%
Agricultural		718,094			9,762		5.45	%		701,905			8,509		4.86	%		749,899			10,497		5.55	%		715,286			9,243		5.13	%
Residential and home equity		390,416			4,267		4.38	%		365,872			3,591		3.94	%		394,500			4,527		4.55	%		375,699			3,836		4.05	%
Construction		161,992			2,928		7.25	%		205,491			2,535		4.95	%		180,658			3,168		6.96	%		164,664			2,468		5.95	%
Total real estate		2,577,878			33,701		5.24	%		2,432,160			28,166		4.64	%		2,615,949			35,182		5.34	%		2,480,338			30,726		4.91	%
Commercial & industrial		475,472			8,346		7.04	%		439,137			4,891		4.47	%		479,113			8,729		7.23	%		438,761			5,770		5.22	%
Agricultural		281,321			5,613		8.00	%		264,791			2,988		4.53	%		296,973			6,138		8.20	%		259,345			3,607		5.52	%
Commercial leases		126,158			1,947		6.19	%		90,855			1,377		6.08	%		127,383			2,018		6.29	%		93,051			1,365		5.82	%
Consumer and other		5,531			83		6.02	%		21,457			1,148		21.46	%		5,432			86		6.28	%		8,929			400		17.77	%
Total loans and leases		3,466,360			49,690		5.75	%		3,248,400			38,570		4.76	%		3,524,850			52,153		5.87	%		3,280,424			41,868		5.06	%
Non-marketable securities		15,549			255		6.58	%		15,549			218		5.62	%		15,549			322		8.22	%		15,549			209		5.33	%
Total interest earning assets		4,925,475			61,017		4.97	%		5,086,450			45,695		3.60	%		5,102,582			65,713		5.11	%		5,124,938			51,713		4.00	%
Allowance for credit losses		(69,800	)							(61,439	)							(72,639	)							(63,107	)
Non-interest earning assets		313,671								317,066								324,105								318,078
Total average assets	$	5,169,346							$	5,342,077							$	5,354,048							$	5,379,909

LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest bearing deposits:
Demand	$	941,500			444		0.19	%	$	1,117,283			319		0.11	%	$	973,380			741		0.30	%	$	1,101,830			445		0.16	%
Savings and money market accounts		1,624,285			5,153		1.27	%		1,544,753			361		0.09	%		1,691,933			6,919		1.62	%		1,588,234			476		0.12	%
Certificates of deposit greater than $250,000		227,958			1,655		2.91	%		165,944			106		0.26	%		285,741			2,495		3.46	%		156,110			96		0.24	%
Certificates of deposit less than $250,000		261,372			1,139		1.75	%		219,157			87		0.16	%		302,826			1,896		2.48	%		212,036			105		0.20	%
Total interest bearing deposits		3,055,115			8,391		1.10	%		3,047,137			873		0.11	%		3,253,880			12,051		1.47	%		3,058,210			1,122		0.15	%
Short-term borrowings		-			-		0.00	%		-			-		0.00	%		-			-		0.00	%		-			-		0.00	%
Subordinated debentures		10,310			204		7.94	%		10,310			103		4.01	%		10,310			221		8.50	%		10,310			134		5.16	%
Total interest bearing liabilities		3,065,425			8,595		1.12	%		3,057,447			976		0.13	%		3,264,190			12,272		1.49	%		3,068,520			1,256		0.16	%
Non-interest bearing deposits		1,506,145								1,735,258								1,474,752								1,764,266
Total funding		4,571,570			8,595		0.75	%		4,792,705			976		0.08	%		4,738,942			12,272		1.03	%		4,832,786			1,256		0.10	%
Other non-interest bearing liabilities		84,454								86,550								90,510								77,389
Shareholders' equity		513,322								462,822
Total average liabilities and shareholders' equity	$	5,169,346							$	5,342,077
Shareholders’ equity																		524,596								469,734
Total average liabilities and shareholders’ equity																	$	5,354,048							$	5,379,909

Net interest income				$	52,422							$	44,719							$	53,441							$	50,457
Interest rate spread							3.84	%							3.48	%							3.62	%							3.84	%
Net interest margin⁽⁴⁾							4.27	%							3.53	%							4.16	%							3.91	%

⁽¹⁾Excludes average unrealized losses of ($24.4) million and ($28.5) million for the three months ended September 30, 2023, and 2022, respectively, which are included in non-interest earning assets.

⁽¹⁾	~~Excludes average unrealized (losses)~~ ~~of ($22.5)~~ ~~million and ($24.7) million for the three months ended June 30, 2023, and 2022, respectively, which are included in non-interest earning assets.~~

⁽²⁾The average yield does not include the federal tax benefits at an assumed effective yield of 26% related to income earned on tax-exempt municipal securities totaling $152,000 and $102,000 for the three months ended September 30, 2023, and 2022, respectively.

⁽²⁾

~~The average yield does not include the federal tax benefits at an assumed effective yield of 26% related to income earned on tax-exempt municipal securities totaling~~ ~~$149,000~~ ~~and $103,000 for the three months ended June~~⁽³⁾Loan interest income includes loan fees of $1.3 million and $2.6 million for the three months ended September 30, 2023 and 2022, respectively.

⁽³⁾	~~Loan interest income includes loan fees of $1.3~~ ~~million and $3.3 million for the three months ended June 30, 2023 and 2022, respectively.~~

⁽⁴⁾	Net interest margin is computed by dividing net interest income by average interest earning assets.

For the Six Months Ended June 30,
2023 2022
(Dollars in thousands)
Average
Balance

Interest
Income /
Expense

Average
Yield /
Rate

Average
Balance

Interest
Income /
Expense

Average
Yield / Rate

ASSETS
Interest earnings deposits in other banks and federal funds sold
$
489,865

$
11,843

4.88
%

$
721,656

$
1,775

0.50
%
Investment Securities:⁽¹⁾

Taxable securities
945,258

9,431

2.00
%

1,056,670

9,695

1.84
%
Non-taxable securities⁽²⁾

59,556

1,121

3.76
%

49,164

793

3.23
%
Total investment securities
1,004,814

10,552

2.10
%

1,105,834

10,488

1.90
%
Loans:⁽³⁾

Real estate:
Commercial
1,293,712

33,393

5.21
%

1,155,271

26,807

4.68
%
Agricultural
716,921

19,376

5.45
%

691,128

16,302

4.76
%
Residential and home equity
388,901

8,362

4.34
%

359,656

6,892

3.86
%
Construction
166,428

5,865

7.11
%

198,626

4,607

4.68
%
Total real estate
2,565,962

66,996

5.27
%

2,404,681

54,608

4.58
%
Commercial & industrial
470,498

15,970

6.84
%

431,907

9,690

4.52
%
Agricultural
280,896

10,817

7.77
%

256,648

5,743

4.51
%
Commercial leases
121,579

3,752

6.22
%

92,844

2,793

6.07
%
Consumer and other
5,555

163

5.92
%

36,683

3,169

17.42
%
Total loans and leases
3,444,490

97,698

5.72
%

3,222,763

76,003

4.76
%
Non-marketable securities
15,549

556

7.21
%

15,549

523

6.78
%
Total interest earning assets
4,954,718

120,649

4.91
%

5,065,802

88,789

3.53
%
Allowance for credit losses
(68,752
)

(61,232
)

Non-interest earning assets
311,891

315,037

Total average assets
$
5,197,857

$
5,319,607

LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing deposits:
Demand
$
1,004,651

888

0.18
%

$
1,116,436

578

0.10
%
Savings and money market accounts
1,593,158

7,656

0.97
%

1,531,069

703

0.09
%
Certificates of deposit greater than $250,000
188,053

2,142

2.30
%

166,725

203

0.25
%
Certificates of deposit less than $250,000
233,945

1,419

1.22
%

221,487

192

0.17
%
Total interest bearing deposits
3,019,807

12,105

0.81
%

3,035,717

1,676

0.11
%
Short-term borrowings
1

-

0.00
%

1

-

0.00
%
Subordinated debentures
10,310

400

7.82
%

10,310

185

3.62
%
Total interest bearing liabilities
3,030,118

12,505

0.83
%

3,046,028

1,861

0.12
%
Non-interest bearing deposits
1,584,215

1,728,962

Total funding
4,614,333

12,505

0.55
%

4,774,990

1,861

0.08
%
Other non-interest bearing liabilities
78,150

80,413

Shareholders' equity
505,374

464,204

Total average liabilities and shareholders' equity
$
5,197,857

$
5,319,607

Net interest income
$
108,144

$
86,928

Interest rate spread
4.08
%

3.41
%
Net interest margin⁽⁴⁾

4.40
%

3.46
%

⁽¹⁾	~~Excludes average unrealized (losses) of ($25.3) million and ($15.9) million for the six months ended June 30, 2023, and 2022, respectively, which are included in non-interest earning assets.~~

⁽²⁾	The average yield does not include the federal tax benefits at an assumed effective yield of 26% related to income earned on tax-exempt municipal securities totaling $296,000 and $210,000 for the six months ended June 30, 2023, and 2022, respectively.

⁽³⁾	~~Loan interest income includes loan fees of $3.3 million and $7.2 million for the six months ended June 30, 2023 and 2022, respectively.~~

⁽⁴⁾	~~Net interest margin is computed by dividing net interest income by average interest earning assets.~~

	For the Nine Months Ended September 30,
	2023								2022
(Dollars in thousands)	Average Balance			Interest Income / Expense		Average Yield / Rate			Average Balance			Interest Income / Expense		Average Yield / Rate
ASSETS
Interest earnings deposits in other banks and federal funds sold	$	524,288		$	19,918		5.08	%	$	720,692		$	5,934		1.10	%
Investment securities:⁽¹⁾
Taxable securities		932,901			14,019		2.00	%		1,058,859			14,786		1.86	%
Non-taxable securities⁽²⁾		60,238			1,696		3.75	%		48,436			1,179		3.25	%
Total investment securities		993,139			15,715		2.11	%		1,107,295			15,965		1.92	%
Loans:⁽³⁾
Real estate:
Commercial		1,292,817			50,383		5.21	%		1,178,731			41,986		4.76	%
Agricultural		728,035			29,873		5.49	%		699,205			25,545		4.88	%
Residential and home equity		390,788			12,889		4.41	%		365,062			10,728		3.93	%
Construction		171,223			9,033		7.05	%		187,181			7,075		5.05	%
Total real estate		2,582,863			102,178		5.29	%		2,430,179			85,334		4.69	%
Commercial & industrial		473,346			24,699		6.98	%		434,217			15,460		4.76	%
Agricultural		286,314			16,955		7.92	%		257,555			9,350		4.85	%
Commercial leases		123,534			5,770		6.24	%		92,914			4,158		5.98	%
Consumer and other		5,514			249		6.04	%		27,330			3,569		17.46	%
Total loans and leases		3,471,571			149,851		5.77	%		3,242,195			117,871		4.86	%
Non-marketable securities		15,549			878		7.55	%		15,549			732		6.29	%
Total interest earning assets		5,004,547			186,362		4.98	%		5,085,731			140,502		3.69	%
Allowance for credit losses		(70,062	)							(61,864	)
Non-interest earning assets		314,924								314,520
Total average assets	$	5,249,409							$	5,338,387

LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest bearing deposits:
Demand	$	994,113			1,629		0.22	%	$	1,111,513			1,023		0.12	%
Savings and money market accounts		1,626,444			14,575		1.20	%		1,550,334			1,179		0.10	%
Certificates of deposit greater than $250,000		220,973			4,637		2.81	%		163,148			299		0.25	%
Certificates of deposit less than $250,000		257,158			3,315		1.72	%		218,302			297		0.18	%
Total interest bearing deposits		3,098,688			24,156		1.04	%		3,043,297			2,798		0.12	%
Short-term borrowings		1			-		0.00	%		1			-		0.00	%
Subordinated debentures		10,310			621		8.05	%		10,310			319		4.14	%
Total interest bearing liabilities		3,108,999			24,777		1.07	%		3,053,608			3,117		0.14	%
Non-interest bearing deposits		1,547,327								1,740,859
Total funding		4,656,326			24,777		0.71	%		4,794,467			3,117		0.09	%
Other non-interest bearing liabilities		81,348								77,953
Shareholders’ equity		511,735								465,967
Total average liabilities and shareholders’ equity	$	5,249,409							$	5,338,387

Net interest income				$	161,585							$	137,385
Interest rate spread							3.91	%							3.56	%
Net interest margin⁽⁴⁾							4.32	%							3.61	%

⁽¹⁾Excludes average unrealized losses of ($25.0) million and ($20.1) million for the nine months ended September 30, 2023, and 2022, respectively, which are included in non-interest earning assets.

⁽²⁾The average yield does not include the federal tax benefits at an assumed effective yield of 26% related to income earned on tax-exempt municipal securities totaling $448,000 and $312,000 for the nine months ended September 30, 2023, and 2022, respectively.

⁽³⁾Loan interest income includes loan fees of $4.6 million and $9.8 million for the nine months ended September 30, 2023 and 2022, respectively.

⁽⁴⁾Net interest margin is computed by dividing net interest income by average interest earning assets.

~~Second~~Third Quarter 2023 vs. ~~Second~~Third Quarter 2022

Interest-bearing deposits with banks and Federal Reserve balances are earning assets available to the Company. Average interest-bearing deposits with banks consisted primarily of FRB deposits. Balances with the FRB earned an average interest rate of ~~5.14%~~5.41% and ~~0.83%~~2.30% for the ~~second~~third quarter of 2023 and 2022, respectively. The increase was primarily the result of the FRB increasing rates by ~~350~~225 basis points from the ~~second~~third quarter of 2022 and the first ~~six~~nine months of 2023. Average interest-bearing deposits were ~~$458.9~~$592.0 million and ~~$683.7~~$718.8 million for the quarter ended ~~June~~September 30, 2023 and 2022, respectively. Interest income on interest-bearing deposits with banks was ~~$5.9~~$8.1 million and ~~$1.4~~$4.2 million for the quarter ended ~~June~~September 30, 2023 and 2022, respectively.

The investment portfolio is also a component of the Company’s earning assets. Historically, the ~~company~~Company invested primarily in: (1) mortgage-backed securities issued by government-sponsored entities; (2) debt securities issued by the U.S. Treasury, government agencies and government-sponsored entities; and (3) investment grade bank-qualified municipal bonds. However, at certain times the Company has selectively added investment grade corporate securities (floating rate and fixed rate with maturities less than 7 years) to the portfolio in order to obtain yields that exceed government agency securities of equivalent maturity. Since the risk factor for these types of investments is generally lower than that of loans and leases, the yield earned on investments is generally less than that of loans and leases.

Average total investment securities were ~~$984.6~~$970.2 million and $1.1 billion for the quarter ended ~~June~~September 30, 2023 and 2022, respectively. The average yield on total investment securities was ~~2.11%~~2.13% and ~~1.94%~~2.00% for the quarter ended ~~June~~September 30, 2023 and 2022, respectively.

Average loans and leases ~~held for investment~~held-for-investment were $3.5 billion and ~~$3.2~~$3.3 billion for the quarter ended ~~June~~September 30, 2023 and 2022, respectively. The average yield on the loan and lease portfolio was ~~5.75%~~5.87% and ~~4.76%~~5.06% for the quarter ended ~~June~~September 30, 2023 and 2022, respectively. The increase in the loan yield reflects the increase in market interest rates over the last year.

Average interest-bearing deposits were ~~$3.1~~$3.3 billion and $3.1 billion for the quarter ended ~~June~~September 30, 2023 and 2022, respectively. The average rate paid on interest-bearing deposits was ~~1.10%~~1.47% and ~~0.11%~~0.15% for the quarter ended ~~June~~September 30, 2023 and 2022, respectively. Total interest expense on interest-bearing deposits was ~~$8.4~~$12.1 million and ~~$0.9~~$1.1 million for the quarter ended ~~June~~September 30, 2023 and 2022, respectively, as a result of increases in short-term market interest rates during 2022 and the first ~~half~~nine months of 2023. The average rate paid on total funding costs was ~~0.75%~~1.03% and ~~0.08%~~0.10% for the quarter ended ~~June~~September 30, 2023 and 2022, respectively. Industry competition for deposits ~~remains challenging~~continues, which has the potential to increase future deposit costs in order to retain key customers, which could place negative pressure on the net interest margin looking forward.

~~Six~~Nine Months Ended ~~June~~September 30, 2023 vs. ~~Six~~Nine Months Ended ~~June~~September 30, 2022

Average interest-bearing deposits with banks consisted primarily of FRB deposits. Balances with the FRB earned an average interest rate of ~~4.88%~~5.08% and ~~0.50%~~1.10% for the first ~~six~~nine months ended of 2023 and 2022, respectively. The increase was primarily the result of the FRB increasing rates by ~~500~~525 basis points during 2022 and the first ~~six~~nine months of 2023. Average interest-bearing deposits were ~~$489.9~~$524.3 million and ~~$721.7~~$720.7 million for the ~~six~~nine months ended ~~June~~September 30, 2023 and 2022, respectively. Interest income on interest-bearing deposits with banks was ~~$11.8~~$19.9 million and ~~$1.8~~$5.9 million for the ~~six~~nine months ended ~~June~~September 30, 2023 and 2022, respectively.

Average total investment securities were $1.0 billion and $1.1 billion for the ~~six~~nine months ended ~~June~~September 30, 2023 and 2022, respectively. The average yield on total investment securities was ~~2.10%~~2.11% and ~~1.90%~~1.92% for the ~~six~~nine months ended ~~June~~September 30, 2023 and 2022, respectively.

Average loans and leases ~~held for investment~~held-for-investment were ~~$3.4~~$3.5 billion and $3.2 billion for the ~~six~~nine months ended ~~June~~September 30, 2023 and 2022, respectively. The average yield on the loan and lease portfolio was ~~5.72%~~5.77% and ~~4.76%~~4.86% for the ~~six~~nine months ended ~~June~~September 30, 2023 and 2022, respectively. The increase in the loan yield reflects the increase in market interest rates over the last year.

3334

Average interest-bearing deposits were ~~$3.0~~$3.1 billion and $3.0 billion for the ~~six~~nine months ended ~~June~~September 30, 2023 and 2022, respectively. The average rate paid on interest-bearing deposits was ~~0.81%~~1.04% and ~~0.11%~~0.12% for the ~~six~~nine months ended ~~June~~September 30, 2023 and 2022, respectively. Total interest expense on interest-bearing deposits was ~~$12.1~~$24.2 million and ~~$1.7~~$2.8 million for the ~~six~~nine months ended ~~June~~September 30, 2023 and 2022, respectively, as a result of increases in short-term market interest rates during 2022 and the first ~~six~~nine months of 2023. The average rate paid on total funding costs was ~~0.55%~~0.71% and ~~0.08%~~0.09% for the ~~six~~nine months ended ~~June~~September 30, 2023 and 2022, respectively.

Rate/Volume Analysis

The following table shows the change in interest income and interest expense and the amount of change attributable to variances in volume, rates and the combination of volume and rates based on the relative changes of volume and rates. For purposes of this table, the change in interest due to both volume and rate has been allocated to change due to volume and rate in proportion to the relationship of absolute dollar amounts of change in each.

	Three Months Ended June 30, 2023 compared with 2022									Six Months Ended June 30, 2023 compared with 2022									Three Months Ended September 30, 2023 compared with 2022									Nine Months Ended September 30, 2023 compared with 2022
	Increase (Decrease) Due to:									Increase (Decrease) Due to:									Increase (Decrease) Due to:									Increase (Decrease) Due to:
(Dollars in thousands)	Volume			Rate			Net			Volume			Rate			Net			Volume			Rate			Net			Volume			Rate			Net
Interest income:
Interest earnings deposits in other banks and federal funds sold		(609	)		5,082		$	4,473			(756	)		10,824		$	10,068			(837	)		4,753		$	3,916			(2,035	)		16,019		$	13,984
Investment securities:
Taxable securities		(822	)		341			(481	)		(1,071	)		807			(264	)		(770	)		267			(503	)		(1,841	)		1,074			(767	)
Non-taxable securities		117			56			173			183			145			328			131			58			189			315			202			517
Total investment securities		(705	)		397			(308	)		(888	)		952			64			(638	)		324			(314	)		(1,526	)		1,276			(250	)
Loans:
Real estate:
Commercial		1,829			1,384			3,213			3,399			3,187			6,586			844			967			1,811			4,258			4,139			8,397
Agricultural		200			1,053			1,253			626			2,448			3,074			461			793			1,254			1,086			3,242			4,328
Residential and home equity		251			425			676			588			882			1,470			199			492			691			790			1,371			2,161
Construction		(617	)		1,010			393			(849	)		2,107			1,258			255			445			700			(648	)		2,606			1,958
Total real estate		1,664			3,871			5,535			3,764			8,624			12,388			1,759			2,697			4,456			5,485			11,359			16,844
Commercial & industrial		434			3,021			3,455			932			5,348			6,280			570			2,389			2,959			1,498			7,741			9,239
Agricultural		197			2,428			2,625			588			4,486			5,074			582			1,949			2,531			1,143			6,462			7,605
Commercial leases		544			26			570			885			74			959			537			116			653			1,423			189			1,612
Consumer and other⁽¹⁾		(541	)		(524	)		(1,065	)		(1,690	)		(1,316	)		(3,006	)		(118	)		(196	)		(314	)		(1,825	)		(1,495	)		(3,320	)
Total loans and leases		2,299			8,821			11,120			4,479			17,216			21,695			3,329			6,956			10,285			7,725			24,255			31,980
Non-marketable securities		-			37			37			-			33			33			-			113			113			-			146			146
Total interest income		985			14,337			15,322			2,835			29,025			31,860			1,853			12,147			14,000			4,164			41,696			45,860

Interest expense:
Interest bearing deposits:
Demand		(57	)		182			125			(64	)		374			310			(56	)		352			296			(119	)		725			606
Savings and money market accounts		20			4,772			4,792			30			6,923			6,953			33			6,410			6,443			61			13,335			13,396
Certificates of deposit greater than $250,000		54			1,495			1,549			29			1,910			1,939			142			2,257			2,399			142			4,196			4,338
Certificates of deposit less than $250,000		20			1,032			1,052			11			1,216			1,227			64			1,727			1,791			62			2,956			3,018
Total interest bearing deposits		37			7,481			7,518			7			10,422			10,429			182			10,747			10,929			146			21,212			21,358
Short-term borrowings		-			-			-			-			-			-			-			-			-			-			-			-
Subordinated debentures		-			101			101			-			215			215			-			87			87			-			302			302
Total interest expense		37			7,582			7,619			7			10,637			10,644			182			10,834			11,016			146			21,514			21,660
Net interest income	$	948		$	6,755		$	7,703		$	2,828		$	18,388		$	21,216		$	1,671		$	1,313		$	2,984		$	4,017		$	20,183		$	24,200

⁽¹⁾	~~Consumer and other - These decreases represent the end of the PPP loans which were $0 and $6.8 million as of June~~⁽¹⁾ Consumer and other - These decreases represent the end of the PPP loans which were $0 and $1.8 million as of September 30, 2023 and 2022 respectively.

3435

Comparison of Results of Operations for the Three and ~~Six~~Nine Months Ended ~~June~~September 30, 2023 and 2022

	Three Months Ended June 30,										Six Months Ended June 30,										Three Months Ended September 30,										Nine Months Ended September 30,
(Dollars in thousands)	2023		2022		$ Better / (Worse)			% Better / (Worse)			2023		2022		$ Better / (Worse)			% Better / (Worse)			2023		2022		$ Better / (Worse)			% Better / (Worse)			2023		2022		$ Better / (Worse)			% Better / (Worse)
Selected Income Statement Information:
Interest income	$	61,017	$	45,695	$	15,322			33.53	%	$	120,649	$	88,789	$	31,860			35.88	%	$	65,713	$	51,713	$	14,000			27.07	%	$	186,362	$	140,502	$	45,860			32.64	%
Interest expense		8,595		976		(7,619	)		(780.64	%)		12,505		1,861		(10,644	)		(571.95	%)		12,272		1,256		(11,016	)		(877.07	%)		24,777		3,117		(21,660	)		(694.90	%)
Net interest income		52,422		44,719		7,703			17.23	%		108,144		86,928		21,216			24.41	%		53,441		50,457		2,984			5.91	%		161,585		137,385		24,200			17.61	%
Provision for credit losses		2,557		1,500		(1,057	)		(70.47	%)		4,057		1,500		(2,557	)		(170.47	%)		3,000		1,500		(1,500	)		(100.00	%)		7,057		3,000		(4,057	)		(135.23	%)
Net interest income after provision for credit losses		49,865		43,219		6,646			15.38	%		104,087		85,428		18,659			21.84	%		50,441		48,957		1,484			3.03	%		154,528		134,385		20,143			14.99	%
Non-interest income		5,447		3,512		1,935			55.10	%		8,907		7,824		1,083			13.84	%		3,606		1,559		2,047			131.30	%		12,513		9,383		3,130			33.36	%
Non-interest expense		26,822		23,031		(3,791	)		(16.46	%)		55,005		46,819		(8,186	)		(17.48	%)		24,468		24,375		(93	)		(0.38	%)		79,473		71,194		(8,279	)		(11.63	%)
Income before income tax expense		28,490		23,700		4,790			20.21	%		57,989		46,433		11,556			24.89	%		29,579		26,141		3,438			13.15	%		87,568		72,574		14,994			20.66	%
Income tax expense		7,182		5,257		(1,925	)		(36.62	%)		13,134		10,932		(2,202	)		(20.14	%)		7,545		6,605		(940	)		(14.23	%)		20,679		17,537		(3,142	)		(17.92	%)
Net income	$	21,308	$	18,443	$	2,865			15.53	%	$	44,855	$	35,501	$	9,354			26.35	%	$	22,034	$	19,536	$	2,498			12.79	%	$	66,889	$	55,037	$	11,852			21.53	%

For the three and ~~six~~nine months ended ~~June~~September 30, 2023, net income was ~~$21.3~~$22.0 million and ~~$44.9~~$66.9 million, respectively compared to ~~$18.4~~$19.5 million and ~~$35.5~~$55.0 million for the same periods a year ago. For the three months ended ~~June~~September 30, 2023 the increase in net income was primarily the result of higher net interest income of ~~$7.7~~$3.0 million and an increase in non-interest income of ~~$1.9~~$2.0 million. These increases were offset by ~~an increase in non-interest expense of $3.8 million,~~a higher provision for credit losses of ~~$1.1~~$1.5 million and higher income tax expense of ~~$1.9~~$0.9 million.

For the ~~six~~nine months ended ~~June~~September 30, 2023, the increase in net income was primarily the result of higher net interest income of ~~$21.2~~$24.2 million. The Company also recognized in non-interest income, a $4.3 million death benefit on bank-owned life insurance (“BOLI”) during the ~~six~~nine months ended ~~June~~September 30, 2023 that was not present during the ~~six~~nine months ended ~~June~~September 30, 2022. This increase was offset by an increase in non-interest expense of ~~$8.2~~$8.3 million, higher provision for credit losses of ~~$2.5~~$4.1 million and higher income tax expense of ~~$2.2~~$3.1 million.

Net Interest Income and Net Interest Margin.

For the quarter ended ~~June~~September 30, 2023, net interest income increased ~~$7.7~~$3.0 million, or ~~17.23%~~5.91%, to ~~$52.4~~$53.4 million compared with ~~$44.7~~$50.5 million for the same period a year earlier. The increase is primarily the result of the net interest margin increasing 7425 basis points to ~~4.27%~~4.16% compared with ~~3.53%~~3.91% for the same period a year earlier. The increase in the net interest margin was primarily the result of the FRB increasing the federal funds rate by ~~350~~225 basis points from the ~~second~~third quarter of 2022 and the first ~~half~~nine months of 2023. The yield on interest earning assets increased ~~137~~111 basis points to ~~4.97%~~5.11% compared to ~~3.60%~~4.00% for the ~~second~~third quarter of 2022 aswhile the yield on interest bearing liabilities increased 99133 basis points to ~~1.12%~~1.49% compared to ~~.13%~~0.16% for the ~~second~~third quarter of 2022.

For the ~~six~~nine months ended ~~June~~September 30, 2023, net interest income increased ~~$21.2~~$24.2 million, or ~~24.41%~~17.61%, to ~~$108.1~~$161.6 million compared with ~~$86.9~~$137.4 million for the same period a year earlier. The increase is primarily the result of the net interest margin increasing 9471 basis points to ~~4.40%~~4.32% compared with ~~3.46%~~3.61% for the same period a year earlier. The increase in the net interest margin was primarily the result of the FRB increasing the federal funds rate by ~~350~~225 basis points from the ~~second~~third quarter of 2022 and the first ~~six~~nine months of 2023. The loan yield increased 9691 basis points compared to the first ~~six~~nine months of 2022 and ~~outpaced~~ the ~~increase in~~ deposit yield ~~of 71~~increased 93 basis points compared to the same period a year earlier.

Provision for Credit Losses

The Company made a ~~$2.6~~$3.0 million provision for credit losses during the three months ended ~~June~~September 30, 2023 compared to $1.5 million for the same period a year ago. Net recoveries during the three months ended ~~June~~September 30, 2023 were ~~$39,000~~$47,000 compared to net ~~charge-offs~~recoveries of ~~$59,000~~$38,000 for the same period a year ago.

The Company made a ~~$4.1~~$7.1 million provision for credit losses during the first ~~half~~nine months of 2023 compared to ~~$1.5~~$3.0 million during the first ~~half~~nine months of 2022. Net recoveries during the first ~~half~~nine months of 2023 were ~~$227,000~~$274,000 compared to net ~~charge-offs~~recoveries of ~~$34,000~~$4,000 in the first ~~half~~nine months of 2022. The increase in ACL during the first ~~six~~nine months of 2023 was primarily related to higher expected probable losses inherent in the loan and lease portfolio that was directly related to quantitative and qualitative factors associated with the current economic environment.

Non-interest Income

Non-interest income increased ~~$1.9~~$2.0 million, or ~~55.1%~~131.30%, to ~~$5.4~~$3.6 million for the quarter ended ~~June~~September 30, 2023 compared with ~~$3.5~~$1.6 million for the same period a year earlier. The increase in non-interest income was primarily due to a ~~$2.3~~$3.0 million net loss on sales of securities during 2022 and a $0.7 million increase in net ~~gains~~losses on deferred compensation plan ~~investments.~~investments compared to a net gain during the same period in 2022.

The Company recorded net ~~gains~~losses on deferred compensation plan investments of ~~$1.3~~$0.3 million for the quarter ended ~~June~~September 30, 2023 compared with net ~~losses~~gains of ~~$1.0~~$0.4 million for the same respective period a year ago. See Note 11, located in “Item 8. Financial Statements and Supplementary Data” in the Company’s December 31, 2022 Form 10-K filed on March 15, 2023 for a description of these plans. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although GAAP requires these investment gains/losses to be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no net-effect on the Company’s net income.

Non-interest income increased ~~$1.1~~$3.1 million, or ~~13.8%~~33.36%, to ~~$8.9~~$12.5 million for the ~~six~~nine months ended ~~June~~September 30, 2023 compared with ~~$7.8~~$9.4 million for the same period of 2022. The year-over-year increase in non-interest income was primarily due to a $4.3 million BOLI death benefit gain and a ~~$2.8~~$2.1 million increase in net gains on deferred compensation plan investments. These increases were partially off-set by a ~~$5.7~~$2.7 million increase in net ~~loss~~losses on the sale of investment securities in the first quarter of 2023 to reposition the investment portfolio.

The Company recorded net gains on deferred compensation plan investments of ~~$2.2~~$1.9 million for the ~~six~~nine months ended ~~June~~September 30, 2023 compared with net losses of ~~$0.6~~$0.2 million for the same respective period. See Note 11, located in “Item 8. Financial Statements and Supplementary Data” in the Company’s December 31, 2022 Form 10-K filed on March 15, 2023 for a description of these plans. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although GAAP requires these investment gains/losses to be recorded in non-interest income, an offsetting entry is also required to be made to non-interest expense resulting in no net-effect on the Company’s net income.

Non-interest Expense

Non-interest expense increased ~~$3.8~~$0.1 million, or ~~16.46%~~0.38%, to ~~$26.8~~$24.5 million for the quarter ended ~~June~~September 30, 2023 compared with ~~$23.0~~$24.4 million for the same period a year ago. This increase was primarily comprised of a ~~$2.3 million increase in net gains on deferred compensation plan investments, a $1.1~~$1.2 million increase in salaries and employee benefits partially off-set by a ~~$0.4~~$1.0 million ~~increase~~decrease in ~~employee benefits.~~other expenses.

Net ~~gains~~losses on deferred compensation plan obligations were ~~$1.3~~$0.3 million for the quarter ended ~~June~~September 30, 2023 compared with net ~~losses~~gains of ~~$1.0~~$0.4 million for the same respective period. See Note 11, located in “Item 8. Financial Statements and Supplementary Data” in the Company’s December 31, 2022 Form 10-K filed on March 15, 2023 for a description of these plans. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although GAAP requires these gains on obligations to be recorded in non-interest expense, an offsetting entry is also required to be made to non-interest income resulting in no net-effect on the Company’s net income.

Non-interest expense increased ~~$8.2~~$8.3 million, or ~~17.48%~~11.63%, to ~~$55.0~~$79.5 million for the ~~six~~nine months ended ~~June~~September 30, 2023 compared with ~~$46.8~~$71.2 million for the same period a year ago. This increase was primarily comprised of a ~~$2.8~~$5.5 million increase in salaries and employee benefits, a $2.1 million increase in net gains on deferred compensation plan investments, a ~~$2.2 million increase in salaries, a $2.1 million increase in employee benefits, a $0.6 million increase in other expenses and a $0.5~~$0.7 million increase in FDIC insurance.

3637

The Company recorded net gains on deferred compensation plan investments of ~~$2.2~~$1.9 million for the ~~six~~nine months ended ~~June~~September 30, 2023 compared with net losses of ~~$0.6~~$0.2 million for the same respective period. See Note 11, located in “Item 8. Financial Statements and Supplementary Data” in the Company’s December 31, 2022 Form 10-K filed on March 15, 2023 for a description of these plans. Balances in non-qualified deferred compensation plans may be invested in financial instruments whose market value fluctuates based upon trends in interest rates and stock prices. Although GAAP requires these gains on obligations to be recorded in non-interest expense, an offsetting entry is also required to be made to non-interest income resulting in no net-effect on the Company’s net income.

Income Tax Expense

For the three and ~~six~~nine months ended ~~June~~September 30, 2023, income tax expense was ~~$7.2~~$7.5 million and ~~$13.1~~$20.7 million, respectively compared to ~~$5.3~~$6.6 million and ~~$10.9~~$17.5 million for the same periods a year ago. The Company’s effective tax rate for the three and ~~six~~nine months ended ~~June~~September 30, 2023 was ~~25.21%~~25.51% and ~~22.65%~~23.61%, respectively compared to ~~22.18%~~25.27% and ~~23.54%~~24.16% for the same period in 2022. The Company’s effective tax rate for the ~~six~~nine months ended ~~June~~September 30, 2023 was lower than its historical effective tax rate primarily due to a non-taxable BOLI death benefit gain of $4.3 million recognized during the ~~six~~nine months ended ~~June~~September 30, 2023. The Company’s effective tax rate can fluctuate from quarter to quarter due primarily to changes in the mix of taxable and tax-exempt earning sources. The effective rates were lower than the combined Federal and State statutory rate of 30% due primarily to BOLI death benefits, the cash surrender value of life ~~insurance;~~insurance, credits associated with low income housing tax credit investments (LIHTC);, and tax-exempt interest income on municipal securities and loans.

Balance Sheet Analysis

Total assets ~~were~~grew by $48.0 million, or 0.90%, to $5.4 billion at September 30, 2023 compared with $5.3 billion at ~~June 30, 2023, a decrease of $77.0 million or 1.45% compared to~~ December 31, 2022. Loans ~~held for investment~~held-for-investment were ~~$3.5~~$3.6 billion at ~~June~~September 30, 2023, ~~a decrease~~an increase of ~~$20.6~~$44.8 million, or ~~0.59%~~1.28% compared to December 31, 2022. Total deposits were ~~$4.6~~$4.75 billion at ~~June~~September 30, 2023 compared with ~~$4.8~~$4.76 billion at December 31, 2022, a decrease of ~~$121.0~~$10.5 million or ~~2.54%~~0.22%.

Cash and Cash Equivalents

The Company’s cash and cash equivalents consists of interest bearing deposits with banks and overnight investments in Federal Reserve balances. Interest bearing deposits with banks consisted primarily of FRB deposits. Since balances at the FRB are effectively risk free, the Company elected to maintain its excess cash at the FRB. Interest bearing deposits with banks totaled ~~$506.7~~$597.7 million at ~~June~~September 30, 2023 and $514.9 million at December 31, 2022. The Company’s total cash and cash equivalents as of ~~June~~September 30, 2023 represents ~~11.2%~~12.4% of the Company’s total assets as compared to 11.0% as of December 31, 2022.

Investment Securities

The Company’s net investment portfolio decreased by ~~$45.2~~$65.8 million or ~~4.53%~~6.59% to ~~$952.6~~$932.1 million at ~~June~~September 30, 2023 compared to December 31, 2022. ~~This decrease is net~~During the first quarter of ~~the impact of~~2023, $36.2 million in available for sale securities were sold for interest rate risk management purposes. The Company uses its investment portfolio to manage interest rate and liquidity risks. The ~~Company's~~Company’s total investment portfolio as of ~~June~~September 30, 2023 represents ~~18.14%~~17.35% of the Company’s total assets as compared to ~~18.72%~~18.74% at December 31, 2022.

The Company classifies its investment securities as either held-to-maturity (“HTM”) or available-for-sale (“AFS”). Securities are classified as HTM and are carried at amortized cost, net of an allowance for credit losses, when the Company has the intent and ability to hold the securities to maturity. See Note 2 “Investment Securities” to the Unaudited Consolidated Financial Statements in “Item 1. Financial Statements” in this Quarterly Report on Form 10-Q. Securities classified as AFS include securities, which may be sold to effectively manage interest rate risk exposure, prepayment risk, satisfy liquidity demands and other factors. These securities are reported at fair value with aggregate, unrealized gains or losses excluded from income and included as a separate component of shareholders’ equity, as accumulated other comprehensive income(loss), net of related income taxes. As of ~~June~~September 30, 2023, the Company held no investment securities from any issuer (other than the U.S. Treasury or an agency of the U.S. government or a government sponsored entity) that totaled over 10% of our shareholders’ equity.

The carrying value of our portfolio of investment securities was as follows:

(Dollars in thousands)	June 30, 2023		December 31, 2022		September 30, 2023		December 31, 2022
Available-for-Sale Securities
U.S. Treasury notes	$	-	$	4,964	$	-	$	4,964
U.S. Government-sponsored securities		3,841		4,427		3,609		4,427
Mortgage-backed securities⁽¹⁾		100,068		132,528		92,118		132,528
Collateralized mortgage obligations⁽¹⁾		586		1,054		563		1,054
Corporate securities		9,838		9,581		9,893		9,581
Other		310		310		310		310
Total available-for-sale securities	$	114,643	$	152,864	$	106,493	$	152,864

⁽¹⁾	⁽¹⁾All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.

(Dollars in thousands)	June 30, 2023		December 31, 2022		September 30, 2023		December 31, 2022
Held-to-Maturity Securities
Mortgage-backed securities⁽¹⁾	$	685,028	$	702,858	$	673,924	$	702,858
Collateralized mortgage obligations⁽¹⁾		77,290		80,186		75,507		80,186
Municipal securities⁽²⁾		76,128		61,909		76,134		61,909
Total held-to-maturity securities	$	838,446	$	844,953	$	825,565	$	844,953

⁽¹⁾	⁽¹⁾All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.

⁽²⁾	⁽²⁾Municipal securities are net of allowance for credit losses of $450 and $393, respectively.

The following tables show the carrying value for contractual final maturities of investment securities and the weighted average yields of such securities, including the benefit of tax-exempt securities:

	As of June 30, 2023																									As of September 30, 2023
	Within One Year					After One but Within Five Years					After Five but Within Ten Years					After Ten Years					Total					Within One Year					After One but Within Five Years					After Five but Within Ten Years					After Ten Years					Total
(Dollars in thousands)	Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield
Securities available-for-sale
U.S. Government-sponsored securities	$	-		0.00	%	$	80		6.35	%	$	271		6.19	%	$	3,490		5.91	%	$	3,841		5.94	%	$	-		0.00	%	$	107		6.28	%	$	228		6.55	%	$	3,274		6.17	%	$	3,609		6.19	%
Mortgage-backed securities⁽¹⁾		10		2.56	%		8,100		2.52	%		6,600		3.58	%		85,358		1.95	%		100,068		2.11	%		76		1.85	%		7,321		2.54	%		5,893		3.59	%		78,828		1.98	%		92,118		2.12	%
Collateralized mortgage obligations⁽¹⁾		-		0.00	%		-		0.00	%		-		0.00	%		586		2.28	%		586		2.28	%		-		0.00	%		-		0.00	%		-		0.00	%		563		2.28	%		563		2.28	%
Corporate securities		-		0.00	%		9,838		5.31	%		-		0.00	%		-		0.00	%		9,838		5.31	%		-		0.00	%		9,893		5.74	%		-		0.00	%		-		0.00	%		9,893		5.74	%
Other		310		3.90	%		-		0.00	%		-		0.00	%		-		0.00	%		310		3.90	%		310		5.99	%		-		0.00	%		-		0.00	%		-		0.00	%		310		5.99	%
Total securities available-for-sale	$	320		3.86	%	$	18,018		4.06	%	$	6,871		3.68	%	$	89,434		2.11	%	$	114,643		2.52	%	$	386		5.18	%	$	17,321		4.39	%	$	6,121		3.70	%	$	82,665		2.14	%	$	106,493		2.61	%

⁽¹⁾	~~All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.~~

⁽¹⁾ All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.

As of June 30, 2023
Within One Year
After One but Within
Five Years

After Five but
Within Ten Years
After Ten Years Total
(Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
Securities held-to-maturity
Mortgage-backed securities⁽¹⁾

$
-

0.00
%

$
-

0.00
%

$
16,315

1.27
%

$
668,713

1.91
%

$
685,028

1.89
%
Collateralized mortgage obligations⁽¹⁾

-

0.00
%

-

0.00
%

-

0.00
%

77,290

1.77
%

77,290

1.77
%
Municipal securities
283

1.93
%

12,292

2.49
%

12,040

3.65
%

51,513

3.34
%

76,128

3.24
%
Total securities held-to-maturity
$
283

1.93
%

$
12,292

2.49
%

$
28,355

2.28
%

$
797,516

1.99
%

$
838,446

2.00
%

⁽¹⁾	~~All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.~~

3839

As of December 31, 2022
Within One Year
After One but Within
Five Years

After Five but
Within Ten Years
After Ten Years Total
(Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
Securities available-for-sale
U.S. Treasury notes
$
4,964

2.37
%

$
-

0.00
%

$
-

0.00
%

$
-

0.00
%

$
4,964

2.37
%
U.S. Government-sponsored securities
3

2.17
%

53

2.29
%

380

4.52
%

3,991

4.52
%

4,427

4.29
%
Mortgage-backed securities⁽¹⁾

13

2.82
%

16,460

2.31
%

15,156

2.41
%

100,899

1.82
%

132,528

1.95
%
Collateralized mortgage obligations⁽¹⁾

-

0.00
%

-

0.00
%

-

0.00
%

1,054

2.35
%

1,054

2.35
%
Corporate securities
-

0.00
%

9,581

3.13
%

-

0.00
%

-

0.00
%

9,581

3.13
%
Other
310

4.60
%

-

0.00
%

-

0.00
%

-

0.00
%

310

4.60
%
Total securities available-for-sale
$
5,290

2.50
%

$
26,094

2.61
%

$
15,536

2.46
%

$
105,944

1.93
%

$
152,864

2.11
%

	As of September 30, 2023
	Within One Year					After One but Within Five Years					After Five but Within Ten Years					After Ten Years					Total
(Dollars in thousands)	Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield
Securities held-to-maturity
Mortgage-backed securities⁽¹⁾	$	-		0.00	%	$	2,260		0.74	%	$	13,107		1.38	%	$	658,557		1.91	%	$	673,924		1.89	%
Collateralized mortgage obligations⁽¹⁾		-		0.00	%		-		0.00	%		-		0.00	%		75,507		1.78	%		75,507		1.78	%
Municipal securities		450		4.01	%		14,650		4.14	%		10,924		3.68	%		50,560		3.86	%		76,584		3.89	%
Total securities held-to-maturity	$	450		4.01	%	$	16,910		3.69	%	$	24,031		2.43	%	$	784,624		2.02	%	$	826,015		2.07	%

⁽¹⁾ All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.

	As of December 31, 2022
	Within One Year					After One but Within Five Years					After Five but Within Ten Years					After Ten Years					Total
(Dollars in thousands)	Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield
Securities available-for-sale
U.S. Treasury notes	$	4,964		2.37	%	$	-		0.00	%	$	-		0.00	%	$	-		0.00	%	$	4,964		2.37	%
U.S. Government-sponsored securities		3		2.17	%		53		2.29	%		380		4.52	%		3,991		4.52	%		4,427		4.29	%
Mortgage-backed securities⁽¹⁾		13		2.82	%		16,460		2.31	%		15,156		2.41	%		100,899		1.82	%		132,528		1.95	%
Collateralized mortgage obligations⁽¹⁾		-		0.00	%		-		0.00	%		-		0.00	%		1,054		2.35	%		1,054		2.35	%
Corporate securities		-		0.00	%		9,581		3.13	%		-		0.00	%		-		0.00	%		9,581		3.13	%
Other		310		4.60	%		-		0.00	%		-		0.00	%		-		0.00	%		310		4.60	%
Total securities available-for-sale	$	5,290		2.50	%	$	26,094		2.61	%	$	15,536		2.46	%	$	105,944		1.93	%	$	152,864		2.11	%

⁽¹⁾All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.

	As of December 31, 2022
	Within One Year					After One but Within Five Years					After Five but Within Ten Years					After Ten Years					Total
(Dollars in thousands)	Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield
Securities held-to-maturity
Mortgage-backed securities⁽¹⁾	$	-		0.00	%	$	-		0.00	%	$	18,197		1.22	%	$	684,661		1.90	%	$	702,858		1.88	%
Collateralized mortgage obligations⁽¹⁾		-		0.00	%		-		0.00	%		-		0.00	%		80,186		1.80	%		80,186		1.80	%
Municipal securities		883		5.92	%		8,058		3.98	%		15,670		3.70	%		37,691		4.83	%		62,302		4.45	%
Total securities held-to-maturity	$	883		5.92	%	$	8,058		3.98	%	$	33,867		2.37	%	$	802,538		2.03	%	$	845,346		2.07	%

⁽¹⁾	~~All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.~~

⁽¹⁾ All mortgage-backed securities and collateralized mortgage obligations were issued by an agency or government sponsored entity of the U.S. Government.

Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur. Expected maturities of mortgage-backed and CMO securities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without penalties. The Company evaluates securities for expected credit losses at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation.

Loans and Leases

Loans and leases can be categorized by borrowing purpose and use of funds. Common examples of loans and leases made by the Company include:

Commercial and Agricultural Real Estate – These are loans secured by owner-occupied real estate, non-owner-occupied real estate, owner-occupied farmland, and multifamily residential properties. Commercial mortgage term loans can be made if the property is either income producing or scheduled to become income producing based upon acceptable pre-leasing, or the income will be the ~~Bank's~~Bank’s primary source of repayment for the loan. Loans are made both on owner occupied and investor properties; maturities generally do not exceed 15 years (and may have pricing adjustments on a shorter timeframe) amortizations of up to 25 years (30 years for multifamily residential properties); have debt service coverage ratios of 1.00 or better with a target of 1.25 or greater; and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk in the loan.

Real Estate Construction – These are loans for acquisition, development and construction and are secured by commercial or residential real estate. These loans are generally made only to experienced local developers with a successful track record; for projects in our service area; with Loan to Value (LTV) below 75%; and where the property can be developed and sold within 2 years. Commercial construction loans are generally made only when there is an approved take-out commitment from the Bank or an acceptable financial institution or government agency. Most acquisition, development and construction loans are tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan.

Single Family Residential Real Estate – These are loans primarily made on owner occupied residences; generally underwritten to income and LTV guidelines similar to those used by FNMA and FHLMC. However, the Company will make loans on rural residential properties up to 41 acres. Most residential loans have terms from ten to thirty years and carry fixed or variable rates priced to treasury rates. The Company has always underwritten mortgage loans based upon traditional underwriting criteria and does not make loans that are known in the industry as “subprime,” “no or low doc,” or “stated income” loans.

Home Equity Lines and Loans – These are loans made to individuals for home improvements and other personal needs. Generally, amounts do not exceed $500,000; but can be made for up to $1,000,000 in high cost counties. Combined Loan to Value (CLTV) does not exceed 75%; FICO scores are at or above 670; Total Debt Ratios do not exceed 43%; and in some situations the Company is in a 1^st lien position.

Agricultural – These are non-real estate loans and lines of credit made to farmers to finance agricultural production. Lines of credit are extended to finance the seasonal needs of farmers during peak growing periods; are usually established for periods no longer than 12 to 36 months; are often secured by general filing liens on livestock, crops, crop proceeds and equipment; and are most often tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Term loans are primarily made for the financing of equipment, expansion or modernization of a processing plant, or orchard/vineyard development; have maturities from five to seven years; and fixed rates that are most often tied to treasury indices or variable rates tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan.

Commercial – These are non-real estate loans and lines of credit to businesses that are sole proprietorships, partnerships, LLC’s and corporations. Lines of credit are extended to finance the seasonal working capital needs of customers during peak business periods; are usually established for periods no longer than 12 to 36 months; are often secured by general filing liens on accounts receivable, inventory and equipment; and are most often tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan. Term loans are primarily made for the financing of equipment, expansion or modernization of a plant or purchase of a business; have maturities from three to seven years; and fixed rates that are most often tied to treasury indices or variable rates tied to the prime rate with an appropriate spread based on the amount of perceived risk in the loan.

Consumer – These are loans to individuals for personal use, and primarily include loans to purchase automobiles or recreational vehicles, and unsecured lines of credit. The Company has a minimal consumer loan portfolio.

Commercial Leases – These are leases primarily to businesses and farmers for financing the acquisition of equipment. They can be either “finance leases” where the lessee retains the tax benefits of ownership but obtains 100% financing on their equipment purchases; or “true tax leases” where the Company, as lessor, places reliance on equipment residual value and in doing so obtains the tax benefits of ownership. Leases typically have a maturity of three to ten years, and fixed rates that are most often tied to treasury indices with an appropriate spread based on the amount of perceived risk. Credit risks are underwritten using the same credit criteria the Company would use when making an equipment term loan. Residual value risk is managed with qualified, independent appraisers that establish the residual values the Company uses in structuring a lease.

The Company accounts for leases with Investment Tax Credits (“ITC”) under the deferred method as established in ASC 740-10. ITCs are viewed and accounted for as a reduction of the cost of the related assets and presented as deferred income on the Company’s financial statement.

Each loan or lease type involves risks specific to the: (1) borrower; (2) collateral; and (3) loan or lease structure. See “Results of Operations - Provision and Allowance for Credit Losses” for a more detailed discussion of risks by loan and lease type. The Company’s current underwriting policies and standards are designed to mitigate the risks involved in each loan and lease type. The Company’s policies require that loans and leases be approved only to those borrowers exhibiting a clear source of repayment and the ability to service existing and proposed debt. The Company’s underwriting procedures for all loan and lease types require careful consideration of the borrower, the borrower’s financial condition, the borrower’s management capability, the borrower’s industry, and the economic environment affecting the loan or lease.

Most loans and leases made by the Company are secured, but collateral is the secondary or tertiary source of repayment; cash flow is our primary source of repayment. The quality and liquidity of collateral are important and must be confirmed before the loan or lease is made.

In order to be responsive to borrower needs, the Company prices loans and leases: (1) on both a fixed rate and adjustable rate basis; (2) over different terms; and (3) based upon different rate indices as long as these structures are consistent with the Company’s interest rate risk management policies and procedures. See “Item 3. Quantitative and Qualitative Disclosures about Market Risk” in this Report on Form 10-Q for further details.

Overall, the ~~Company's~~Company’s loan and lease portfolio at ~~June~~September 30, 2023 totaled ~~$3.5~~$3.6 billion, ~~a decrease~~an increase of ~~$20.6~~$44.8 million or ~~0.59%~~1.28% compared to December 31, 2022.

The following table sets forth the distribution of the loan and lease portfolio by type and percent at the end of each period presented:

	June 30, 2023					December 31, 2022					September 30, 2023					December 31, 2022
(Dollars in thousands)	Dollars		Percent of Total			Dollars		Percent of Total			Dollars		Percent of Total			Dollars		Percent of Total
Gross Loans and Leases
Gross loans and leases
Real estate:
Commercial	$	1,302,460		37.19	%	$	1,328,691		37.73	%	$	1,297,380		36.36	%	$	1,328,691		37.73	%
Agricultural		739,207		21.11	%		726,938		20.64	%		753,353		21.12	%		726,938		20.64	%
Residential and home equity		392,754		11.21	%		387,753		11.01	%		398,990		11.18	%		387,753		11.01	%
Construction		172,903		4.94	%		166,538		4.73	%		192,745		5.40	%		166,538		4.73	%
Total real estate		2,607,324		74.45	%		2,609,920		74.11	%		2,642,468		74.06	%		2,609,920		74.11	%
Commercial & industrial		479,908		13.71	%		478,758		13.59	%		489,772		13.73	%		478,758		13.59	%
Agricultural		282,725		8.07	%		314,525		8.93	%		301,951		8.46	%		314,525		8.93	%
Commercial leases		126,554		3.61	%		112,629		3.20	%		128,063		3.59	%		112,629		3.20	%
Consumer and other		5,553		0.16	%		5,886		0.17	%		5,553		0.16	%		5,886		0.17	%
Total gross loans and leases	$	3,502,064		100.00	%	$	3,521,718		100.00	%	$	3,567,807		100.00	%	$	3,521,718		100.00	%

The following table shows the maturity distribution and interest rate sensitivity of the loan and lease portfolio of the Company as of ~~June~~September 30, 2023.

	Loan Contractual Maturity										Loan Contractual Maturity
(Dollars in thousands)	One Year or Less		After One But Within Five Years		After Five Years But Within Fifteen Years		After Fifteen Years		Total		One Year or Less		After One But Within Five Years		After Five Years But Within Fifteen Years		After Fifteen Years		Total
Gross loan and leases:
Real estate:
Commercial	$	36,189	$	396,249	$	835,140	$	34,882	$	1,302,460	$	25,332	$	400,168	$	837,301	$	34,579	$	1,297,380
Agricultural		21,047		188,361		452,673		77,126		739,207		19,394		193,583		465,169		75,207		753,353
Residential and home equity		33		4,310		118,004		270,407		392,754		124		4,316		114,246		280,304		398,990
Construction		100,220		72,683		-		-		172,903		114,543		78,202		-		-		192,745
Total real estate		157,489		661,603		1,405,817		382,415		2,607,324		159,393		676,269		1,416,716		390,090		2,642,468
Commercial & industrial		164,160		217,555		92,166		6,027		479,908		177,231		215,299		91,261		5,981		489,772
Agricultural		139,259		117,908		23,858		1,700		282,725		154,486		126,216		19,561		1,688		301,951
Commercial leases		5,083		43,476		77,995		-		126,554		2,574		48,447		77,042		-		128,063
Consumer and other		858		3,589		1,106		-		5,553		730		3,573		1,250		-		5,553
Total gross loans and leases	$	466,849	$	1,044,131	$	1,600,942	$	390,142	$	3,502,064	$	494,414	$	1,069,804	$	1,605,830	$	397,759	$	3,567,807
Rate Structure for Loans
Rate structure for loans and leases
Fixed Rate	$	97,118	$	586,584	$	1,166,360	$	231,022	$	2,081,084	$	85,475	$	617,148	$	1,152,734	$	228,707	$	2,084,064
Adjustable Rate		369,731		457,547		434,582		159,120		1,420,980		408,939		452,656		453,096		169,052		1,483,743
Total gross loans and leases	$	466,849	$	1,044,131	$	1,600,942	$	390,142	$	3,502,064	$	494,414	$	1,069,804	$	1,605,830	$	397,759	$	3,567,807

The following table summarizes the loans for which the accrual of interest has been discontinued and loans more than 90 days past due and still accruing interest, and OREO (as hereinafter defined):

(Dollars in thousands)	June 30, 2023			December 31, 2022			September 30, 2023			December 31, 2022
Non-performing assets:
Non-accrual loans and leases
Real estate:
Commercial	$	375		$	403		$	363		$	403
Agricultural		-			-			4,094			-
Residential and home equity		-			-			-			-
Construction		-			168			-			168
Total real estate		375			571			4,457			571
Commercial & industrial		-			-			39			-
Agricultural		-			-			-			-
Commercial leases		-			-			-			-
Consumer and other		-			-			-			-
Total non-performing loans and leases	$	375		$	571		$	4,496		$	571
Other real estate owned ("OREO")	$	873		$	873
Other real estate owned (“OREO”)							$	873		$	873
Total non-performing assets	$	1,248		$	1,444		$	5,369		$	1,444

Selected ratios:
Non-performing loans to total loans and leases		0.01	%		0.02	%		0.13	%		0.02	%
Non-performing assets to total assets		0.02	%		0.03	%		0.10	%		0.03	%

Non-Accrual Loans and Leases - Accrual of interest on loans and leases is generally discontinued when a loan or lease becomes contractually past due by 90 days or more with respect to interest or principal. When loans and leases are 90 days past due, but in ~~management's~~management’s judgment are well secured and in the process of collection, they may not be classified as non-accrual. When a loan or lease is placed on non-accrual status, all interest previously accrued but not collected is reversed. Income on such loans and leases is then recognized only to the extent that cash is received and where the future collection of principal is probable. Non-accrual loans and leases totaled ~~$375,000~~$4.5 million and $571,000 at ~~June~~September 30, 2023 and December 31, 2022, respectively. The increase was primarily due to one borrower.

Other Real Estate Owned ~~–OREO~~– OREO represents real property taken either through foreclosure or through a deed in lieu thereof from the borrower. The Company records all OREO properties at amounts equal to or less than the fair market value of the properties based on current independent appraisals reduced by estimated selling costs. The Company reported $873,000 of foreclosed OREO at ~~June~~September 30, 2023, and at December 31, 2022.

Although management believes that non-performing loans and leases are generally well-secured and that potential losses are provided for in the Company’s allowance for credit losses, there can be no assurance that future deterioration in economic conditions and/or collateral values will not result in future credit losses. See Note 3. “Loans and Leases”, located in “Item 1. Financial Statements” in this Quarterly Report on Form 10-Q for an allocation of the allowance classified to collateral dependent loans and leases.

Except for non-performing loans and leases discussed above, the Company’s management is not aware of any loans and leases as of June 30, 2023, for which known financial problems of the borrower would cause serious doubts asLoan Modifications to the ability of these borrowers to materially comply with their present loan or lease repayment terms, or any known events that would result in the loan or lease being designated as non-performing at some future date. However, the State of California has routinely experienced drought conditions such as from 2013 through 2016 and 2020-2022. Although the availability of water in our primary service area was not an issue for the 2022 growing season, the weather patterns over the past nine years further reinforce the fact that the long-term risks associated with the availability of water are significant.

~~Loan Modifications/Restructurings~~Borrowers Experiencing Financial Difficulties – ~~A modification/restructuring~~In the normal course of ~~a loan or lease happens when~~business, the Company ~~makes certain concessions~~may execute loan modifications to ~~a borrower~~borrowers experiencing financial ~~difficulty. These concessions either stem from an agreement between the Company and the borrower or is imposed by law or a court; some~~difficulties. Some of these ~~concessions~~modifications include: term extension, principle forgiveness, rate reduction, other-than-insignificant payment delay, or aany combination of ~~any of~~ those. ~~The Company has granted a concession when, as a result of the modification/restructuring, it does not expect to collect all amounts due, including interest accrued at the original contract rate.~~ ASU 2022-02 requires certain disclosure of loans and leases that have been modified ~~or restructured~~ within the past 12 months and the effects that ~~said~~those modifications had on the modified loans orand leases. Because the effect of most modifications made to borrowers experiencing financial difficulty is already included in the allowance for credit losses and because of the measurement methodologies used to estimate the allowance, a change to the allowance for credit losses is generally not recorded upon modification. Occasionally, the Company modifies loans by providing principal forgiveness that is deemed to be uncollectable; therefore, that portion of the loan is written off, resulting in a reduction of the amortized cost basis and a corresponding adjustment to the allowance for credit losses.

The Company modified one residential real estate loan in the amount of $127,000, during the ~~three~~nine months ended ~~June~~September 30, 2023.

Allowance for Credit Losses—Loans and Leases

The Company maintains an allowance for credit losses (“ACL”) under ASC Topic 326, Financial Instruments – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments (“CECL”). The allowance is established through a provision for credit losses, which is charged to expense. Additions to the allowance are expected to maintain the adequacy of the total allowance after credit losses and loan and lease growth. Credit exposures determined to be uncollectible are charged against the allowance. Cash received on previously charged off amounts is recorded as a recovery to the allowance. The overall allowance consists of three primary components: specific reserves related to collateral dependent loans and leases; general reserves for current expected credit losses related to loans and leases that are not collateral dependent; and an unallocated component that takes into account the imprecision in estimating and allocating allowance balances associated with macro factors. The Company uses the Weighted Average Remaining Maturity (“WARM”) method to calculate the ACL as this method is the most appropriate given the Company’s current size and complexity. See “Summary of Critical Accounting Policies and Estimates - Allowance for Credit Losses – Loans and Leases.”

4344

The following table sets forth the activity in our ACL for loans and leases for the periods indicated:

	Six Months Ended June 30,						Nine Months Ended September 30,
(Dollars in thousands)	2023			2022			2023			2022
Allowance for credit losses:
Balance at beginning of year	$	66,885		$	61,007		$	66,885		$	61,007
Provision for credit losses		4,000			1,107			7,000			2,606
Charge-offs:
Real estate:
Commercial		-			-			-			-
Agricultural		-			-			-			-
Residential and home equity		(14	)		-			(14	)		-
Construction		-			-			-			-
Total real estate		(14	)		(276	)		(14	)		-
Commercial & industrial		-			-			-			(324	)
Agricultural		-			-			-			-
Commercial leases		-			-			-			-
Consumer and other		(18	)		(18	)		(33	)		(38	)
Total charge-offs		(32	)		(294	)		(47	)		(362	)
Recoveries:
Real estate:
Commercial		170			-			170			-
Agricultural		-			-			-			-
Residential and home equity		31			119			42			125
Construction		-			-			-			-
Total real estate		201			119			212			125
Commercial & industrial		38			131			57			176
Agricultural		3			4			27			51
Commercial leases		-			-			-			-
Consumer and other		17			6			25			14
Total recoveries		259			260			321			366
Net recoveries / (charge-offs)		227			(34	)		274			4

Balance at end of year	$	71,112		$	62,080		$	74,159		$	63,617

Selected financial information:
Net loans and leases held-for-investment	$	3,491,723		$	3,249,886		$	3,557,203		$	3,323,862
Average loans and leases		3,444,490			3,222,763			3,471,571			3,242,195
Non-performing loans and leases		375			3,028			4,496			411
Allowance for credit losses to non-performing loans and leases		18963.20	%		2050.20	%		1649.44	%		15478.59	%
Net (recoveries)/charge-offs to average loans and leases		(0.01	%)		0.00	%		(0.01	%)		0.00	%
Provision for credit losses to average loans and leases		0.12	%		0.03	%		0.20	%		0.08	%
Allowance for credit losses to gross loans and leases held-for-investment		2.03	%		1.91	%		2.08	%		1.91	%

The increase in ACL during the first ~~six~~nine months of 2023 was primarily related to higher expected probable losses inherent in the loan and lease portfolio that was directly related to quantitative and qualitative factors associated with the current economic environment.

The allowance for credit losses in total is ~~$73.2~~$76.2 million which includes the allowance for loan and lease losses of ~~$71.1~~$74.1 million and the reserve for unfunded loan commitments of $2.1 million.

4445

The following table indicates management’s allocation of the ACL for loans and leases by loan type as of each of the following dates:

	June 30, 2023					December 31, 2022					September 30, 2023					December 31, 2022
(Dollars in thousands)	Dollars		Percent of Each Loan Type to Total Loans			Dollars		Percent of Each Loan Type to Total Loans			Dollars		Percent of Each Loan Type to Total Loans			Dollars		Percent of Each Loan Type to Total Loans
Allowance for credit losses:
Real estate:
Commercial	$	24,787		37.19	%	$	18,055		37.73	%	$	26,724		36.36	%	$	18,055		37.73	%
Agricultural		9,908		21.11	%		14,496		20.64	%		7,241		21.12	%		14,496		20.64	%
Residential and home equity		7,179		11.21	%		7,508		11.01	%		7,458		11.18	%		7,508		11.01	%
Construction		3,195		4.94	%		3,026		4.73	%		3,612		5.40	%		3,026		4.73	%
Total real estate		45,069		74.45	%		43,085		74.11	%		45,035		74.06	%		43,085		74.11	%
Commercial & industrial		11,291		13.71	%		11,503		13.59	%		17,903		13.73	%		11,503		13.59	%
Agricultural		12,903		8.07	%		10,202		8.93	%		9,082		8.46	%		10,202		8.93	%
Commercial leases		1,657		3.61	%		1,924		3.20	%		1,967		3.59	%		1,924		3.20	%
Consumer and other		192		0.16	%		171		0.17	%		172		0.16	%		171		0.17	%
Total allowance for credit losses	$	71,112		100.00	%	$	66,885		100.00	%	$	74,159		100.00	%	$	66,885		100.00	%

Deposits

Total deposits were ~~$4.6~~$4.75 billion and ~~$4.8~~$4.76 billion as of ~~June~~September 30, 2023 and December 31, 2022, respectively a decrease of ~~$121.0~~$10.5 million or ~~2.5% due in part to seasonality within our agriculture client base.~~0.22%. The Company experienced a decrease in deposits in the first quarter of 2023 of $220.1 million ~~or 4.6% while~~followed by an increase of $99.1 million and an increase of $110.5 million in the second and third quarters, respectively. The fluctuations during the ~~second quarter of 2023, deposits increased $99.1 million or 2.2%. The increase~~year were due in ~~deposits during the second of 2023 reflects~~part to seasonality within our ~~agricultural~~agriculture client base and ~~the Company~~customer behavior in a changing interest rate environment. The Company’s continuous focus on business development activities for ~~deposits.~~deposits, contributed to the increases in the second and third quarters of 2023.

Non-interest bearing demand deposits were ~~$1.50~~$1.47 billion as of ~~June~~September 30, 2023 and $1.76 billion at December 31, 2022. Non-interest bearing deposits were ~~32.24%~~30.97% of total deposits, as of ~~June~~September 30, 2023 and 36.96% as of December 31, 2022. Interest bearing deposits were ~~$3.1~~$3.28 billion as of ~~June~~September 30, 2023 and ~~$3.0~~$3.00 billion as of December 31, 2022. Interest bearing deposits are comprised of interest-bearing transaction accounts, money market accounts, regular savings accounts, and certificates of deposit. The decrease in non-interest bearing deposits and the increase in interest-bearing deposits reflects customer behavior in shifting from non-interest bearing accounts to higher interest earning accounts given the current interest rate environment.

The following table shows the average ~~amount~~balances and average rate paid on the categories of deposits for each of the periods presented:

	Six Months Ended June 30,														Nine Months Ended September 30,
	2023							2022							2023							2022
(Dollars in thousands)	Average Balance		Interest Expense		Average Rate			Average Balance		Interest Expense		Average Rate			Average Balance		Interest Expense		Average Rate			Average Balance		Interest Expense		Average Rate
Total deposits:
Interest bearing deposits:
Demand	$	1,004,651	$	888		0.18	%	$	1,116,436	$	578		0.10	%	$	994,113	$	1,629		0.22	%	$	1,111,513	$	1,023		0.12	%
Savings and money market		1,593,158		7,656		0.97	%		1,531,069		703		0.09	%		1,626,444		14,575		1.20	%		1,550,334		1,179		0.10	%
Certificates of deposit greater than $250,000		188,053		2,142		2.30	%		166,725		203		0.25	%		220,973		4,637		2.81	%		163,148		299		0.25	%
Certificates of deposit less than $250,000		233,945		1,419		1.22	%		221,487		192		0.17	%		257,158		3,315		1.72	%		218,302		297		0.18	%
Total interest bearing deposits		3,019,807		12,105		0.81	%		3,035,717		1,676		0.11	%		3,098,688		24,156		1.04	%		3,043,297		2,798		0.12	%
Non-interest bearing deposits		1,584,215							1,728,962							1,547,327							1,740,859
Total deposits	$	4,604,022	$	12,105		0.53	%	$	4,764,679	$	1,676		0.07	%	$	4,646,015	$	24,156		0.70	%	$	4,784,156	$	2,798		0.08	%

4546

Deposits are gathered from individuals and businesses in our market areas. The interest rates paid are competitively priced for each particular deposit product and structured to meet our funding requirements.

The significant increase in short-term interest rates during 2022 and into 2023 has placed pressure on deposit pricing, and we will continue to manage this ongoing impact through careful deposit pricing. The average cost of deposits, including non-interest bearing deposits, increased to 1.01% for the three months ended September 30, 2023, compared to 0.74% for the three months ended June 30, 2023 ~~compared to 0.32%~~and 0.70% for the ~~three~~nine months ended ~~March 31, 2023 and 0.53% for the six months ended June~~September 30, 2023 compared with ~~0.07%~~0.08% for the same period a year ago.

The Bank participates in a program wherein the State of California places time deposits with the Bank at the Bank’s option. ~~At June~~As of September 30, 2023 and December 31, 2022, the Bank had $3.0 million, of these deposits.

Federal Home Loan Bank Advances and Federal Reserve Bank Borrowings

Lines of Credit with the Federal Reserve Bank and Federal Home Loan Bank are other key sources of funds to support earning assets and liquidity. These sources of funds are also used to manage the Company’s interest rate risk exposure; and, as opportunities arise, to borrow and invest the proceeds at a positive spread through the investment portfolio. There were no FHLB advances at ~~June~~September 30, 2023 or December 31, 2022. There were no Federal Funds purchased or advances from the FRB at ~~June~~September 30, 2023 or December 31, 2022.

Long-Term Subordinated Debentures

On December 17, 2003, the Company raised $10.0 million through the sale of subordinated debentures to an off-balance-sheet trust and its sale of trust-preferred securities. See Note 9. “Long-Term Subordinated Debentures” located in “Item 8. Financial Statements and Supplementary Data” in our Annual Report on Form 10-K filed with the SEC on March 15, 2023. Although this amount is reflected as subordinated debt on the Company’s balance sheet, under current regulatory guidelines, our Trust Preferred Securities will continue to qualify as regulatory capital.

These securities accrue interest at a variable rate based upon 3-month ~~LIBOR~~SOFR plus 2.85%. Interest rates reset quarterly (the next reset is ~~September~~December 18, 2023) and the rate was ~~8.36%~~8.52% as of ~~June~~September 30, 2023 and 7.59% at December 31, 2022. The average rate paid for these securities was ~~7.82%~~8.05% for the first ~~half~~nine months of 2023 and ~~3.62%~~4.14% for the first ~~half~~nine months of 2022. Additionally, if the Company decided to defer interest on the subordinated debentures, the Company would be prohibited from paying cash dividends on the Company’s common stock.

Capital Resources

The Company relies primarily on capital generated through the retention of earnings to satisfy its capital requirements. The Company engages in an ongoing assessment of its capital needs in order to support business growth and to insure depositor protection. Shareholders’ Equity totaled ~~$514.7~~$530.6 million at ~~June~~September 30, 2023, and $485.3 million at December 31, 2022.

The Company and the Bank are subject to various regulatory capital adequacy guidelines as outlined under Part 324 of the FDIC Rules and Regulations. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the ~~Bank's~~Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Company and the ~~Bank's~~Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company and the ~~Bank's~~Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. The Company believes that it is currently in compliance with all of these capital requirements and that they will not result in any restrictions on the Company’s business activity. Management believes that the Bank meets the requirements to be categorized as “well capitalized” under the FDIC regulatory framework for prompt corrective action. To be categorized as “well capitalized,” the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following tables.

4647

The Company’s and Bank’s actual and required capital amounts and ratios are as follows:

	June 30, 2023															September 30, 2023
	Actual					Required for Capital Adequacy Purposes					Minimum to be Categorized as "Well Capitalized" Under Prompt Corrective Action Regulation					Actual					Required for Capital Adequacy Purposes					Minimum to be Categorized as “Well Capitalized” Under Prompt Corrective Action Regulation
(Dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
Farmers & Merchants Bancorp
CET1 capital to risk-weighted assets	$	518,285		12.22	%	$	190,829		4.50	%		N/A		N/A		$	537,981		12.48	%	$	193,910		4.50	%		N/A		N/A
Tier 1 capital to risk-weighted assets		528,285		12.46	%		254,439		6.00	%		N/A		N/A			547,981		12.72	%		258,546		6.00	%		N/A		N/A
Risk-based capital to risk-weighted assets		581,548		13.71	%		339,252		8.00	%		N/A		N/A			602,126		13.97	%		344,728		8.00	%		N/A		N/A
Tier 1 leverage capital ratio		528,285		10.21	%		206,998		4.00	%		N/A		N/A			547,981		10.22	%		214,463		4.00	%		N/A		N/A

Farmers & Merchants Bank
CET1 capital to risk-weighted assets	$	528,826		12.47	%	$	190,821		4.50	%	$	275,630		6.50	%	$	548,020		12.72	%	$	193,906		4.50	%	$	280,087		6.50	%
Tier 1 capital to risk-weighted assets		528,826		12.47	%		254,428		6.00	%		339,238		8.00	%		548,020		12.72	%		258,542		6.00	%		344,723		8.00	%
Risk-based capital to risk-weighted assets		582,087		13.73	%		339,238		8.00	%		424,047		10.00	%		602,165		13.97	%		344,723		8.00	%		430,903		10.00	%
Tier 1 leverage capital ratio		528,826		10.23	%		206,821		4.00	%		258,527		5.00	%		548,020		10.22	%		214,390		4.00	%		267,987		5.00	%

	December 31, 2022															December 31, 2022
	Actual					Required for Capital Adequacy Purposes					Minimum to be Categorized as "Well Capitalized" Under Prompt Corrective Action Regulation					Actual					Required for Capital Adequacy Purposes					Minimum to be Categorized as “Well Capitalized” Under Prompt Corrective Action Regulation
(Dollars in thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
Farmers & Merchants Bancorp
CET1 capital to risk-weighted assets	$	493,438		11.57	%	$	191,984		4.50	%		N/A		N/A		$	493,438		11.57	%	$	191,984		4.50	%		N/A		N/A
Tier 1 capital to risk-weighted assets		503,438		11.80	%		255,978		6.00	%		N/A		N/A			503,438		11.80	%		255,978		6.00	%		N/A		N/A
Risk-based capital to risk-weighted assets		556,964		13.06	%		341,305		8.00	%		N/A		N/A			556,964		13.06	%		341,305		8.00	%		N/A		N/A
Tier 1 leverage capital ratio		503,438		9.36	%		215,201		4.00	%		N/A		N/A			503,438		9.36	%		215,201		4.00	%		N/A		N/A

Farmers & Merchants Bank
CET1 capital to risk-weighted assets	$	502,838		11.79	%	$	191,970		4.50	%	$	277,290		6.50	%	$	502,838		11.79	%	$	191,970		4.50	%	$	277,290		6.50	%
Tier 1 capital to risk-weighted assets		502,838		11.79	%		255,960		6.00	%		341,280		8.00	%		502,838		11.79	%		255,960		6.00	%		341,280		8.00	%
Risk-based capital to risk-weighted assets		556,361		13.04	%		341,280		8.00	%		426,600		10.00	%		556,361		13.04	%		341,280		8.00	%		426,600		10.00	%
Tier 1 leverage capital ratio		502,838		9.35	%		215,018		4.00	%		268,772		5.00	%		502,838		9.35	%		215,018		4.00	%		268,772		5.00	%

On November 8, 2022, the Board of Directors authorized an extension to its share repurchase program through December 31, 2024 for an additional $20.0 million of the Company’s common stock (“Repurchase Plan”), which ~~represents~~represented approximately 4% of outstanding shareholders’ ~~equity.~~equity at the time of approval. Repurchases by the Company under the Repurchase Plan may be made from time to time through open market purchases, trading plans established in accordance with SEC rules, privately negotiated transactions, or by other means. The Inflation Reduction Act of 2022 signed into law in August 2022 includes a provision for an excise tax equal to 1% of the fair market value of any stock repurchased by covered corporations during a taxable year, subject to certain limits and provisions. The excise tax became effective on January 1, 2023.

During the ~~six~~nine months of 2023 the Company repurchased ~~13,814~~16,324 shares under the Repurchase Plan, for a total of ~~$13.9~~$16.4 million. The Company has repurchased a total of ~~14,616~~17,126 shares or ~~$14.6~~$17.0 million under the current Repurchase Plan.

4748

Off-Balance-Sheet Arrangements

Off-balance-sheet arrangements are any contractual arrangement to which an unconsolidated entity is a party, under which the Company has: (1) any obligation under a guarantee contract; (2) a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity, or market risk support to that entity for such assets; (3) any obligation under certain derivative instruments; or (4) any obligation under a material variable interest held by us in an unconsolidated entity that provides financing, liquidity, market risk, or credit risk support to the Company, or engages in leasing, hedging, or research and development services with the Company. The Company had the following off balance sheet commitments as of the dates indicated.

The following table sets forth our off-balance-sheet lending commitments as of ~~June~~September 30, 2023:

			Amount of Commitment Expiration per Period										Amount of Commitment Expiration per Period
(Dollars in thousands)	Total Committed Amount		Less than One Year		One to Three Years		Three to Five Years		After Five Years		Total Committed Amount		Less than One Year		One to Three Years		Three to Five Years		After Five Years
Off-balance sheet commitments
Commitments to extend credit	$	1,123,756	$	422,126	$	465,434	$	41,354	$	194,842	$	1,156,479	$	541,321	$	376,208	$	45,504	$	193,446
Standby letters of credit		16,863		10,800		4,593		1,470		-		16,802		13,782		1,950		1,070		-
Total off-balance sheet commitments	$	1,140,619	$	432,926	$	470,027	$	42,824	$	194,842	$	1,173,281	$	555,103	$	378,158	$	46,574	$	193,446

The ~~Company's~~Company’s exposure to credit loss in the event of nonperformance by the other party with regard to standby letters of credit, undisbursed loan commitments, and financial guarantees is represented by the contractual notional amount of those 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. The Company uses the same credit policies in making commitments and conditional obligations as it does for recorded balance sheet items. The Company may or may not require collateral or other security to support financial instruments with credit risk. Evaluations of each ~~customer's~~customer’s creditworthiness are performed on a case-by-case basis. Additionally, the Company maintains an allowance for credit losses – unfunded loan commitments, for off-balance-sheet commitments, which totaled $2.1 million at ~~June~~September 30, 2023 and December 31, 2022.

Standby letters of credit are conditional commitments issued by the Company to guarantee performance of or payment for a customer to a third-party. Most standby letters of credit have maturity dates ranging from 1 to 7860 months with final expiration in January 2027. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.

Liquidity

The ability to have readily available funds sufficient to repay maturing liabilities is of primary importance to depositors, creditors and regulators. In an effort to satisfy our liquidity needs, we actively manage our assets and liabilities. We have access to immediate liquid resources in the form of cash which totaled $668.4 million or 12.4% of total assets as of September 30, 2023. The majority of cash is ~~primarily~~ on deposit with the FRB and amounted to ~~$506.7 million as of June 30, 2023.~~$597.7 million. Potential sources of liquidity also include investment securities in our available-for-sale securities portfolio, our ability to sell loans in the secondary market, and to ~~secure~~secured borrowings from the FRB and FHLB. Our diversified deposit portfolio has historically provided us with a long-term source of stable low cost funding. Maturities and payments on outstanding loans and investment securities also provide a steady flow of funds. Our liquidity, represented by cash borrowing lines, federal funds and available for sale securities, is a result of our operating, investing and financing activities and related cash flows. In order to ensure funds are available at all times, we devote resources to projecting the amount of funds that will be required and we maintain relationships with a diversified client base so funds are accessible. Liquidity requirements can also be met through short-term borrowings or the disposition of short-term assets.

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We had the following borrowing lines available at ~~June~~September 30, 2023:

	June 30, 2023										September 30, 2023
(Dollars in thousands)	Total Credit Line Limit		Current Credit Line Available		Outstanding Amount		Remaining Credit Line Available		Value of Collateral Pledged		Total Credit Line Limit		Current Credit Line Available		Outstanding Amount		Remaining Credit Line Available		Value of Collateral Pledged
Additional liquidity sources:
Federal Reserve BIC											$	1,165,853	$	1,165,853	$	-	$	1,165,853	$	1,526,304
Federal Home Loan Bank	$	784,138	$	784,138	$	-	$	784,138	$	1,267,719		796,666		796,666		-		796,666		1,272,566
Federal Reserve BIC		655,017		655,017		-		655,017		894,400
FHLB Fed Funds		18,000		18,000		-		18,000		-
FRB Bank Term Funding Program												147,655		147,655		-		147,655		147,655
US Bank Fed Funds		50,000		50,000		-		50,000		-		50,000		50,000		-		50,000		-
PCBB Fed Funds		50,000		50,000		-		50,000		-		50,000		50,000		-		50,000		-
FHLB Fed Funds												18,000		18,000		-		18,000		-
Total additional liquidity sources	$	1,557,155	$	1,557,155	$	-	$	1,557,155	$	2,162,119	$	2,228,174	$	2,228,174	$	-	$	2,228,174	$	2,946,525

We continued our focus on maintaining a strong liquidity position throughout the first ~~six~~nine months of 2023 and we believe our liquid assets and short-term borrowing credit lines are adequate to meet our cash flow needs for loan and lease funding and deposit cash withdrawal for the foreseeable future. As of ~~June~~September 30, 2023, we had ~~$835.6~~internal sources of liquidity comprised of $668.4 million in cash and $256.7 million unencumbered investment securities, which is ~~15.91%~~17.21% of total assets. We also had $2.23 billion in external sources of liquidity as outlined in the table above bringing our total available liquidity to $3.15 billion. Our pledged collateral on short-term borrowing lines is comprised of $2.8 billion in loans, $148 million in investment securities pledged at par value and $2.0 million in investment securities ~~and $2.2 billion in loans pledged as collateral on short-term borrowing credit lines.~~held at market value. We have the option of either borrowing on our credit lines or selling these investment securities for cash flow needs. ~~We also have additional loans which are available to pledge which would further increase our borrowing capacity.~~

On a long-term basis, our liquidity will be met by changing the relative distribution of our asset portfolios by reducing our investment or loan and lease volumes, or selling or encumbering assets. Further, we will increase liquidity by soliciting higher levels of deposit accounts through promotional activities and/or borrowing from our correspondent banks as well as the FHLB. At the current time, our long-term liquidity needs primarily relate to funds required to support loan and lease originations and commitments and deposit withdrawals.

We believe we can meet all of these needs from existing liquidity sources. Our liquidity is comprised of three primary classifications: cash flows from or used in operating activities; cash flows from or used in investing activities; and cash flows from or used in financing activities. Net cash provided by or used in operating activities has consisted primarily of net income adjusted for certain non-cash income and expense items such as the credit loss provision, investment and other amortization and depreciation.

Our primary investing activities are the origination of loans and lease and purchases and sales of investment securities. As of ~~June~~September 30, 2023, we had unfunded loan commitments of ~~$1.1~~$1.2 billion and unfunded letters of credit of ~~$16.9~~$16.8 million. We anticipate that we will have sufficient funds available to meet current loan commitments.

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

The Company’s assessment of market risk at ~~June~~September 30, 2023 indicates there have been no material changes in the quantitative and qualitative disclosures from those made in the Company’s Annual Report on Form 10-K filed with the SEC on March 15, 2023.

Market risk is the risk of loss in a financial instrument arising from adverse changes in market prices and rates, foreign currency exchange rates, commodity prices and equity prices. Our market risk arises primarily from interest rate risk inherent in our lending and deposit taking activities. Management actively monitors and manages our interest rate risk exposure. In monitoring interest rate risk we continually analyze and manage our earning assets and funding liabilities based on their payment streams and interest rates, the timing of their maturities and/or prepayments, and their sensitivity to actual or potential changes in market interest rates.

4950

Since our earnings are primarily dependent on our ability to generate net interest income, we focus on actively monitoring and managing the effects of adverse changes in interest rates on our net interest income. Our Asset Liability Management Committee (“ALCO”), which is comprised of members of the Board of Directors and executive officers, manages market risk. ALCO monitors interest rate risk by analyzing the potential impact on net interest income from potential changes in interest rates, and considers the impact of alternative strategies or changes in balance sheet structure. ALCO manages our balance sheet in part to maintain the potential impact of changes in interest rates on net interest income within acceptable ranges despite changes in interest rates.

Our exposure to interest rate risk is reviewed on at least a quarterly basis by ALCO. Interest rate risk exposure is measured using interest rate sensitivity analysis to determine our change in net interest income in the event of hypothetical changes in interest rates. If potential changes to net interest income resulting from hypothetical interest rate changes are not within risk tolerances determined by ALCO, and approved by the full Board of Directors, Management may make adjustments to the Company’s asset and liability mix to bring interest rate risk levels within the Board approved limits.

Net Interest Income Simulation. In order to measure interest rate risk, we use a simulation model to project changes in net interest income that result from forecasted changes in interest rates. This analysis calculates the difference between net interest income forecasted using a rising and a falling interest rate scenario and a net interest income forecast using a base market interest rate derived from the current treasury yield curve. The income simulation model includes various assumptions regarding the re-pricing relationships for each of our products. Many of our assets are floating rate loans, which are assumed to re-price immediately, and to the same extent as the change in market rates according to their contracted index.

Some loans and investment vehicles include the opportunity of prepayment (embedded options), and accordingly the simulation model uses national indexes to estimate these prepayments and assumes the reinvestment of the proceeds at current yields. Our non-term deposit products re-price more slowly, usually changing less than the change in market rates and at our discretion.

This analysis indicates the impact of changes in net interest income for the given set of rate changes and assumptions. It assumes the balance sheet size remains static throughout the simulation horizon by replacing existing cashflows/amortization into similar products at current rates to try and capture the ongoing activity of the balance sheet without forecasting any level of growth. It does not account for all factors that affect this analysis, including changes by management to mitigate the effect of interest rate changes or secondary impacts such as changes to our credit risk profile as interest rates change.

Furthermore, loan prepayment-rate estimates and spread relationships change regularly. Interest rate changes create changes in actual loan prepayment rates that will differ from the market estimates incorporated in this analysis. Changes that vary significantly from the assumptions may have significant effects on our net interest income.

For the rising and falling interest rate scenarios, the base market interest rate forecast was increased or decreased, on an instantaneous and sustained basis, by 100, 200 and 300 basis points. We then evaluate the simulation results using two approaches: Net Interest Income at Risk (“NII at Risk”) and Economic Value of Equity (“EVE”). Under NII at Risk, the impact on net interest income from the changes in interest rates on interest-earning assets and interest-bearing liabilities is modeled using various assumptions of assets and liabilities. EVE measures the period end present value of assets minus the present value of liabilities. Management uses this value to measure the changes in the economic value of the Company under various interest rate scenarios. In some ways, the economic value approach provides a broader scope than net income volatility approach since it captures all anticipated cash flows.

Based on our quarterly simulations, our net interest margin exposure related to these hypothetical changes in market interest rates was within the current guidelines established by us. Our simulation model highlights the fact that our balance sheet is asset sensitive, which means that our net interest income rises in a rising interest rate environment as rates earned on our interest-bearing assets reprice higher at a faster pace than rates paid on our interest-bearing liabilities.

The ratio of variable to fixed-rate loans in our loan portfolio, the ratio of short-term (maturing at a given time within 12 months) to long-term loans, and the ratio of our demand, money market and savings deposits to CDs (and their time periods), are the primary factors affecting the sensitivity of our net interest income to changes in market interest rates. Our short-term loans are typically priced at prime plus a margin, and our long-term loans are typically priced based on a specific term of the Treasury Curve for comparable maturities, plus a margin. The composition of our rate-sensitive assets or liabilities is subject to change and could result in a more unbalanced position that would cause market rate changes to have a greater impact on our net interest margin.

The following table present the projected change in the Company’s net interest income over the next twelve months and the economic value of equity at ~~June~~September 30, 2023, that would occur upon an immediate change in interest rates, but without giving effect to any steps that management might take to counteract that change:

	Estimated Change in Net Interest Income (NII) (as a % of NII)	Estimated Change in Market Value of Equity (MVE) (as a % of MVE)	Estimated Change in Net Interest Income (NII) (as a % of NII)			Estimated Change in Economic Value of Equity (EVE) (as a % of EVE)
June 30, 2023
September 30, 2023
+300 bps	3.44%	(10.50%)		3.6	%		(10.7	%)
+200 bps	2.09%	(7.31%)		2.1	%		(7.5	%)
+100 bps	1.19%	(2.99%)		1.2	%		(3.0	%)
0 bps	-	-		-			-
-100 bps	(3.43%)	(0.65%)		(3.1	%)		0.5	%
-200 bps	(7.18%)	(3.90%)		(6.5	%)		(1.5	%)
-300 bps	(11.21%)	(9.50%)		(10.1	%)		(5.8	%)

Item 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

An evaluation was carried out under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the disclosure controls and procedures (as required by Exchange Act Rules 240.13a-15(b) and 15d-14(a)). Based on that evaluation, the CEO and CFO have concluded that as of the end of the period covered by this Report, the disclosure controls and procedures are effective to provide reasonable assurance that the information required to be disclosed by the Company in reports that are filed or submitted under the Exchange Act are recorded, processed, summarized and timely reported as provided in the SEC’s rules and forms.

Changes in Internal Controls

There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the ~~six~~nine months ended ~~June~~September 30, 2023, to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II – OTHER INFORMATION

Item 1.

Legal Proceedings

Certain lawsuits and claims arising in the ordinary course of business have been filed or are pending against the Company or its subsidiaries. Based upon information available to the Company, its review of such lawsuits and claims and consultation with its counsel, the Company believes the liability relating to these actions, if any, would not have a material adverse effect on its consolidated financial statements.

There are no material proceedings adverse to the Company to which any director, officer or affiliate of the Company is a party.

Item 1A.

Risk Factors

There have been no material changes in the risk factors previously disclosed in Part 1, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2022.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

The following table reports information regarding repurchases of our common stock during the ~~six~~nine months ended ~~June~~September 30, 2023:

Period	Total number of shares purchased		Average price paid per share⁽²⁾		Total number of shares purchased as part of publicly announced plans or programs		Maximum number (or approximate dollar value) of shares that may yet purchased under the plans or programs (In thousands) ⁽¹⁾		Total number of shares purchased		Average price paid per share⁽²⁾		Total number of shares purchased as part of publicly announced plans or programs		Maximum number (or approximate dollar value) of shares that may yet purchased under the plans or programs (In thousands) ⁽¹⁾
Total 1st Quarter 2023		5,406	$	1,024.02		5,406	$	13,682		5,406	$	1,024.02		5,406	$	13,682

April 1, 2023 to April 30, 2023		538	$	997.40		538	$	13,145
May 1, 2023 to May 31, 2023		20		982.49		20		12,830
June 1, 2023 to June 30, 2023		7,850		982.54		7,850		5,413
Total 2nd Quarter 2023		8,408	$	983.49		8,408	$	5,413		8,408		983.49		8,408		5,413

July 1, 2023 to July 31, 2023										87	$	975.86		87	$	5,328
August 1, 2023 to August 31, 2023										903		963.94		903		4,457
September 1, 2023 to September 30, 2023										1,520		967.60		1,520		2,987
Total 3rd Quarter 2023										2,510	$	966.57		2,510	$	2,987

Total 2023		13,814	$	999.35		13,814	$	5,413		16,324	$	994.31		16,324	$	2,987

⁽¹⁾

~~As of November 8, 2022 the Board approved an extension to the repurchase program through December 31, 2024 and for an additional $20 million of the Company's~~⁽¹⁾As of November 8, 2022 the Board approved an extension to the repurchase program through December 31, 2024 and for an additional $20 million of the Company’s common stock.

⁽²⁾	The aggregate purchase price and weighted average price per share does not include the effect of excise tax expense incurred on net stock repurchases. For the six months ended June 30, 2023, excise tax expense totaled $138,000.

⁽²⁾The aggregate purchase price and weighted average price per share does not include the effect of excise tax expense incurred on net stock repurchases. For the nine months ended September 30, 2023, the excise tax expense accrual totaled $162,000.

On November 8, 2022, the Board of Directors authorized an extension to its share repurchase program through December 31, 2024 for an additional $20.0 million of the Company’s common stock (“Repurchase Plan”), which represents approximately 4% of outstanding shareholders’ equity. Repurchases by the Company under the Repurchase Plan may be made from time to time through open market purchases, trading plans established in accordance with SEC rules, privately negotiated transactions, or by other means. The Inflation Reduction Act of 2022 signed into law in August 2022 includes a provision for an excise tax equal to 1% of the fair market value of any stock repurchased by covered corporations during a taxable year, subject to certain limits and provisions. The excise tax became effective on January 1, 2023.

During the first ~~half~~nine months of 2023 the Company repurchased ~~13,814~~16,324 shares under the Repurchase Plan, for a total of ~~$13.9~~$16.4 million. All of these shares were purchased at prices ranging from ~~$967.00~~$949.00 to $1,082.00 per share, based upon the then current price on the OTCQX. The Company has repurchased a total of ~~14,616~~17,126 shares or ~~$14.6~~$17.0 million under the current Repurchase Plan.

5253