FIRST NATIONAL CORP /VA/ (FXNC) FY 2023 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation

The following discussion and analysis of the financial condition and results of operations of the Company for the years ended December 31, 2023 and 2022 should be read in conjunction with the consolidated financial statements and related notes to the consolidated financial statements included in Item 8 of this Form 10-K.

Executive Overview

The Company

First National Corporation (the Company) is the bank holding company of:

First Bank Financial Services, Inc. owns an interest in an entity that provides title insurance services. Bank of Fincastle Services, Inc. is no longer an active operating entity.  Shen-Valley Land Holdings, LLC and ESF, LLC were formed to hold other real estate owned and future office sites. The Trusts were formed for the purpose of issuing redeemable capital securities, commonly known as trust preferred securities and are not included in the Company’s consolidated financial statements in accordance with authoritative accounting guidance because management has determined that the Trusts qualify as variable interest entities.

Products, Services, Customers and Locations

The Bank offers loan, deposit, and wealth management products and services. Loan products and services include consumer loans, residential mortgages, home equity loans, and commercial loans. Deposit products and services include checking accounts, treasury management solutions, savings accounts, money market accounts, certificates of deposit, and individual retirement accounts. Wealth management services include estate planning, investment management of assets, trustee under an agreement, trustee under a will, individual retirement accounts, and estate settlement. Customers include small and medium-sized businesses, individuals, estates, local governmental entities, and non-profit organizations. The Bank’s office locations are well-positioned in attractive markets along the Interstate 81, Interstate 66, and Interstate 64 corridors in the Shenandoah Valley, Roanoke Valley, central regions of Virginia, and the Richmond market areas. Within these market areas, there are diverse types of industry including regional medical, professional services, manufacturing, retail, warehousing, Federal government, hospitality, and higher education.  The Bank’s products and services are delivered through 20 bank branch offices, mobile banking platform, website, www.fbvirginia.com, a loan production office, and two customer service centers in retirement communities.  The Bank’s services are also delivered through a network of ATMs located throughout its market area.  For the location and general character of each of these offices, see Item 2 of this Form 10-K.

Revenue Sources and Expense Factors

The primary source of revenue is from net interest income earned by the Bank. Net interest income is the difference between interest income and interest expense and typically represents between 70% and 80% of the Company’s total revenue. Interest income is determined by the amount of interest-earning assets outstanding during the period and the interest rates earned on those assets. The Bank’s interest expense is a function of the amount of interest-bearing liabilities outstanding during the period and the interest rates paid. In addition to net interest income, noninterest income is the other source of revenue for the Company. Noninterest income is derived primarily from service charges on deposits, fee income from wealth management services, and ATM and check card fees.

Primary expense categories are salaries and employee benefits, which comprised 57% of noninterest expenses during 2023, followed by occupancy and equipment expense, which comprised 12% of noninterest expenses. The provision for credit losses is also a primary expense of the Bank. The provision is determined by factors that include net charge-offs, asset quality, loan growth, evaluation of the size and current risk characteristics of the loan portfolio, past events, current conditions, reasonable and supportable forecasts of future economic conditions, and prepayment experience.  Changing economic conditions caused by inflation, recession, unemployment, or other factors beyond the Company’s control have a direct correlation with asset quality, net charge-offs, and ultimately the required provision for credit losses.

Overview of Financial Performance and Condition

Net income decreased by $7.2 million to $9.6 million, or $1.53 per diluted share, for the year ended December 31, 2023, compared to $16.8 million, or $2.68 per diluted share, for the same period in 2022. Return on average assets was 0.71% and return on average equity was 8.59% for the year ended December 31, 2023, compared to 1.19% and 15.87%, respectively, for the year ended December 31, 2022.

The $7.2 million decrease in net income resulted from a $4.3 million, increase in provision for credit losses, a $2.2 million, or 5%, decrease in net interest income, a $866 thousand, or 7%, decrease in noninterest income, and a $1.6 million, or 5%, increase in noninterest expense.  These unfavorable variances were partially offset by a $1.8 million, decrease in income tax expense.

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Net interest income decreased $2.2 million, or 5%, from a $10.5 million increase in total interest expense, which was partially offset by an $8.3 million increase in total interest income.  Net interest income was negatively impacted by a 3-basis point contraction of the net interest margin to 3.41% and a $51.6 million, or 4%, decrease in average earning assets.

The provision for credit losses increased $4.3 million, to $6.2 million in 2023 compared to $1.9 million in 2022. The allowance for credit losses on loans totaled $12.0 million, or 1.24% of total loans, at December 31, 2023, compared to $7.4 million, or 0.81% of total loans, at December 31, 2022. The allowance for credit losses on loans individually evaluated increased $1.8 million compared to the prior year.  The allowance for credit losses on loans collectively evaluated increased $2.9 million compared to the prior year.  Net charge-offs totaled $3.6 million in 2023 and $114 thousand in 2022.

Noninterest income totaled $11.8 million for the year, which was a decrease of $866 thousand, or 7%, compared to $12.7 million for the prior year. The decrease was primarily a result of a gain on sale of other investment of $2.9 million in the prior year, which was partially offset by $2.0 million of net losses on sale of securities available for sale in the prior year. The gain on sale of other investment in the prior year resulted from a gain on sale of an interest in a broker-dealer of investment securities by First Bank Financial Services, Inc.

Noninterest expense increased $1.6 million, or 5%, in 2023, compared to the prior year. The increase was attributable to increases in several categories, including salaries and employee benefits, marketing, legal and professional fees, ATM and check card expense, FDIC assessment, bank franchise tax, and other operating expenses.

The following is selected financial data for the Company for the years ended December 31, 2023 and 2022. This information has been derived from audited financial information included in Item 8 of this Form 10-K (in thousands, except ratios and per share amounts).

For a more detailed discussion of the Company's annual performance, see "Net Interest Income,” “Provision for Credit Losses,” "Noninterest Income," "Noninterest Expense" and "Income Taxes" below.

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Non-GAAP Financial Measures

This report refers to the efficiency ratio, which is computed by dividing noninterest expense, excluding OREO expense, amortization of intangibles, and merger expenses, by the sum of net interest income on a tax-equivalent basis and noninterest income, excluding (gains)/losses on disposal of premises and equipment, and securities gains. This is a non-GAAP financial measure that the Company believes provides investors with important information regarding operational efficiency. Such information is not prepared in accordance with GAAP and should not be construed as such. Management believes, however, such financial information is meaningful to the reader in understanding operating performance, but cautions that such information not be viewed as a substitute for GAAP. The Company, in referring to its net income, is referring to income under GAAP. The components of the efficiency ratio calculation are summarized in the following table (dollars in thousands).

This report also refers to net interest margin, which is calculated by dividing tax equivalent net interest income by total average earning assets. Because a portion of interest income earned by the Company is nontaxable, the tax equivalent net interest income is considered in the calculation of this ratio. Tax equivalent net interest income is calculated by adding the tax benefit realized from interest income that is nontaxable to total interest income then subtracting total interest expense. The tax rate utilized in calculating the tax benefit for both 2023 and 2022 is 21%.  The reconciliation of tax equivalent net interest income, which is not a measurement under GAAP, to net interest income, is reflected in the table below (in thousands).

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Critical Accounting Policies

General

The Company’s consolidated financial statements and related notes are prepared in accordance with GAAP. The financial information contained within the statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset, or relieving a liability. The Bank uses historical losses as one factor in determining the inherent loss that may be present in the loan portfolio. Actual losses could differ significantly from the historical factors used. In addition, GAAP itself may change from one previously acceptable method to another. Although the economics of transactions would be the same, the timing of events that would impact transactions could change.

Presented below is a discussion of those accounting policies that management believes are the most important (Critical Accounting Policies) to the portrayal and understanding of the Company’s financial condition and results of operations. The Critical Accounting Policies require management’s most difficult, subjective, and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood.

Allowance for Credit Losses on Loans

The allowance for credit losses on loans (ACLL) is established as losses are estimated to have occurred through a provision for credit losses charged to earnings. Loan losses are charged against the allowance when management determines that the loan balance is uncollectible. Subsequent recoveries, if any, are credited to the allowance. For further information about the Company’s loans and the ACLL, see Notes 1, 3, and 4 to the Consolidated Financial Statements included in this Form 10-K.

The ACLL is evaluated on a quarterly basis by management and is based on a discounted cash flow model to estimate its current expected credit losses. For the purposes of calculating its quantitative reserves, the Company has segmented its loan portfolio based on loans which share similar risk characteristics. Within the quantitative portion of the calculation, the Company utilizes at least one or a combination of loss drivers, which may include unemployment rates, home price indices, and/or gross domestic product (“GDP”), to adjust its loss rates over a reasonable and supportable forecast period of one year. A straight-line reversion technique is used for the following eight quarters, at which time the Company reverts to historical averages. To further adjust the allowance for credit losses for expected losses not already included within the quantitative component of the calculation, the Company may consider qualitative factors, including but not limited to: variability in the economic forecast, changes in volume and severity of adversity classified loans, changes in concentrations of credit, changes in the nature and volume of the loan segments, factors related to credit administration, and other idiosyncratic risks not embedded in the data used in the model.

This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The Company performs regular credit reviews of the loan portfolio to review credit quality and adherence to underwriting standards. The credit reviews consist of reviews by its internal credit administration department and reviews performed by an independent third party. Upon origination, each loan is assigned a risk rating ranging from one to nine, with loans closer to one having less risk. This risk rating scale is the Company's primary credit quality indicator. The Company has various committees that review and ensure that the allowance for credit losses methodology is in accordance with GAAP and loss factors used appropriately reflect the risk characteristics of the loan portfolio.

The allowance for loan credit losses represents an amount which, in management’s judgement, is adequate to absorb the lifetime expected losses that may be sustained on outstanding loans at the balance sheet date based on the evaluation of the size and current risk characteristics of the loan portfolio, past events, current conditions, reasonable and supportable forecasts of future economic conditions, and prepayment experience. The allowance for loan credit losses is measured and recorded upon the initial recognition of a financial asset. The allowance for loan credit losses is reduced by charge-offs, net of recoveries of previous losses, and is increased or decreased by a provision for (or recovery of) credit losses, which is recorded in the Consolidated Statement of Income. The evaluation also considers the following risk characteristics of each loan portfolio class:

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The ACLL consists of loans individually evaluated and loans collectively evaluated. Loans that do not share risk characteristics are evaluated on an individual basis. The Company designates individually evaluated loans on nonaccrual status as collateral dependent loans, as well as other loans that management of the Company designates as having higher risk and loans for which the repayment is expected to be provided substantially through the operation or sale of the collateral. These loans do not share common risk characteristics and are not included within the collectively evaluated loans for determining the allowance for credit losses. Under CECL, for collateral dependent loans, the Company has adopted the practical expedient to measure the allowance for credit losses based on the fair value of collateral. The allowance for credit losses is calculated on an individual loan basis based on the shortfall between the fair value of the loan’s collateral, which is adjusted for liquidation costs/discounts, and amortized cost. If the fair value of the collateral exceeds the amortized cost, no allowance is required. For further information regarding the ACLL, see Notes 1 and 4 to the Consolidated Financial Statements included in this Form 10-K.

Allowance for Credit Losses – Held-to-Maturity Securities

The Company estimates expected credit losses on held-to-maturity securities on an individual basis based on a Probability of Default/Loss Given Default (“PD/LGD”) methodology primarily using security-level credit ratings. The primary indicators of credit quality for the Company’s held-to-maturity portfolio are security type and credit ratings, which are influenced by a number of factors including obligor cash flow, geography, seniority, among other factors. The Company’s held-to-maturity securities with credit risk are municipal bonds and corporate debt securities. All other held-to-maturity securities are covered by the explicit or implied guarantee of the United States government or one if its agencies.

Changes in the allowance for credit loss are recorded as provision for (or recovery of) credit losses in the Consolidated Statements of Income. The Company recorded an allowance for credit losses on held-to-maturity securities of $132 thousand upon adoption of ASC 326.

Allowance for Credit Losses – Available-for-Sale Securities

Management evaluates all available-for-sale securities in an unrealized loss position on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. If the Company has the intent to sell the security or it is more likely than not that the Company will be required to sell the security, the security is written down to fair value and the entire loss is recorded in earnings.

If either of the above criteria is not met, the Company evaluates whether the decline in fair value is the result of credit losses or other factors. In making the assessment, the Company may consider various factors including the extent to which fair value is less than amortized cost, downgrades in the ratings of the security by a rating agency, the failure of the issuer to make scheduled interest or principal payments and adverse conditions specific to the security. If the assessment indicates that a credit loss exists, the present value of cash flows expected to be collected are compared to the amortized cost basis of the security and any deficiency is recorded as an allowance for credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any amount of unrealized loss that has not been recorded through an allowance for credit loss is recognized in other comprehensive income.

Changes in the allowance for credit loss are recorded as a provision for (or recovery of) credit losses in the Consolidated Statements of Income. Losses are charged against the allowance for credit loss when management believes an available-for-sale security is confirmed to be uncollectible or when either of the criteria regarding intent or requirement to sell is met.

Allowance for Credit Losses – Unfunded Commitments

Financial Instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit issued to meet customer financing needs. The Company’s exposure to credit losses in the event of nonperformance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the contractual amount of those instruments. Such financial instruments are recorded when they are funded.

The Company records all allowance for credit losses on off-balance sheet credit exposures, unless the commitments to extend credit are unconditionally cancelable, through a charge to provision for (or recovery of) credit losses in the Consolidated Statement of Income. The allowances for credit losses on off-balance sheet credit exposures is estimated by loan segment at each balance sheet date under the current expected credit losses model using the same methodology as the loan portfolio, taking into consideration the likelihood that funding will occur as well as any third-party guarantees. The allowance for unfunded commitments is included in other liabilities on the Company’s consolidated balance sheet.

Loans Acquired through Third Party Lending Programs

The loan portfolio includes commercial and industrial loans that were originated by a third-party and were acquired at premiums.  Premiums on performing loans are amortized into interest income and fees on loans over the life of the loans using the effective interest method. Premiums on non-performing loans are not amortized into interest income and fees on loans after loans are placed on non-accrual status and are included in the calculation of specific reserve component of the allowance for credit losses on loans for individually analyzed loans.

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Loans Acquired in a Business Combination

Acquired loans are recorded at their fair value at acquisition date without carryover of the acquiree’s previously established ACLL, as credit discounts are included in the determination of fair value. The fair value of the loans is determined using market participant assumptions in estimating the amount and timing of both principal and interest cash flows expected to be collected on the loans and then applying a market-based discount rate to those cash flows. During evaluation upon acquisition, acquired loans are also classified as either PCD or Non-PCD. Acquired loans are subject to the Company’s ACLL policy upon acquisition.

For Non-PCD loans, the difference between the fair value and unpaid principal balance of the loan at acquisition date (premium or discount) is amortized or accreted into interest income over the life of the loans in accordance with ASC 310-20, Receivables – Nonrefundable Fees and Other Costs. If the acquired performing loan has revolving privileges, it is accounted for using the straight-line method; otherwise, the effective interest method is used.

PCD loans are loans that have experienced more-than-insignificant credit deterioration since origination. PCD loans are recorded at the amount paid. An ACLL is determined using the same methodology as other loans held for investment (LHFI). The sum of the loan’s purchase price and ACLL becomes its initial amortized cost basis. The difference between the initial amortized cost basis and the par value of the loan is a noncredit discount or premium, which is amortized into interest income over the life of the loan under ASC 310-20, Receivables – Nonrefundable Fees and Other Costs. If the loan has revolving privileges, the discount/premium is amortized/accreted using the straight-line method; otherwise, the effective interest method is used. Subsequent changes to the ACLL are recorded through provision expense.

Goodwill

The Company reviews the carrying value of goodwill at least annually or more frequently if certain impairment indicators exist. In testing goodwill for impairment, the Company first considers qualitative factors to determine whether the existence of events or circumstances lead to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events and circumstances, the Company concludes that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then no further testing would be required and the goodwill of the reporting unit would not be impaired. If the Company elects to bypass the qualitative assessment or if we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the fair value of the reporting unit will be compared with its carrying value to determine whether an impairment exists.  The Company evaluated goodwill as of June 30, 2023 and determined there was no impairment.

Lending Policies

General

In an effort to manage risk, the Bank’s loan policy gives loan amount approval limits to individual loan officers based on their position within the Bank and level of experience. The Management Loan Committee can approve new loans up to the Bank's legal lending limit. The Board Loan Committee reviews all loans greater than $1.0 million. The Board Loan Committee currently consists of five directors, four of which are non-management directors. The Board Loan Committee approves the Bank’s Loan Policy and reviews risk management reports, including watch list reports, concentrations of credit, policy exceptions, and risk grade migration. The Board Loan Committee meets at least two times per quarter and the Chairman of the Committee then reports to the Board of Directors.

Residential loan originations are primarily generated by mortgage loan officer solicitations and referrals by employees, real estate professionals, and customers. Commercial real estate loan originations and commercial and industrial loan originations are primarily obtained through direct solicitation and additional business from existing customers. All completed loan applications are reviewed by the Bank’s loan officers. As part of the application process, information is obtained concerning the income, financial condition, employment, and credit history of the applicant. The Bank also participates in commercial real estate loans and commercial and industrial loans originated by other financial institutions that are typically outside its market area. In addition, the Bank has purchased consumer loans originated by other financial institutions that are typically outside its market area. Loan quality is analyzed based on the Bank’s experience and credit underwriting guidelines depending on the type of loan involved. Except for loan participations with other financial institutions, real estate collateral is valued by independent appraisers who have been pre-approved by the Board Loan Committee.

As part of the ongoing monitoring of the credit quality of the Company’s loan portfolio, certain appraisals are analyzed by management or by an outsourced appraisal review specialist throughout the year in order to ensure standards of quality are met. The Company also obtains an independent review of loans within the portfolio on an annual basis to analyze loan risk ratings and validate specific reserves on loans individually evaluated.

In the normal course of business, the Bank makes various commitments and incurs certain contingent liabilities which are disclosed but not reflected in its financial statements, including commitments to extend credit. At December 31, 2023, commitments to extend credit, stand-by letters of credit, and rate lock commitments totaled $207.0 million.

Construction and Land Development Lending

The Bank makes local construction loans, including residential and land acquisition and development loans. These loans are secured by the property under construction and the underlying land for which the loan was obtained. The majority of these loans mature in one year. Construction lending entails significant additional risks, compared with residential mortgage lending. Construction and land development loans sometimes involve larger loan balances concentrated with single borrowers or groups of related borrowers. Another risk involved in construction and land development lending is the fact that loan funds are advanced upon the security of the land or property under construction, which value is estimated based on the completion of construction. Thus, there is risk associated with failure to complete construction and potential cost overruns. To mitigate the risks associated with this type of lending, the Bank generally limits loan amounts relative to the appraised value and/or cost of the collateral, analyzes the cost of the project and the creditworthiness of its borrowers, and monitors construction progress. The Bank typically obtains a first lien on the property as security for its construction loans, typically requires personal guarantees from the borrower’s principal owners, and typically monitors the progress of the construction project during the draw period.

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1-4 Family Residential Real Estate Lending

1-4 family residential lending activity may be generated by Bank loan officer solicitations and referrals by real estate professionals and existing or new bank customers. Loan applications are taken by a Bank loan officer. As part of the application process, information is gathered concerning income, employment, and credit history of the applicant. Residential mortgage loans generally are made on the basis of the borrower’s ability to make payments from employment and other income and are secured by real estate whose value tends to be readily ascertainable. In addition to the Bank’s underwriting standards, loan quality may be analyzed based on guidelines issued by a secondary market investor. The valuation of residential collateral is generally provided by independent fee appraisers who have been approved by the Board Loan Committee. In addition to originating mortgage loans with the intent to sell to correspondent lenders or broker to wholesale lenders, the Bank also originates and retains certain mortgage loans in its loan portfolio.

Commercial Real Estate Lending

Commercial real estate loans are secured by various types of commercial real estate typically in the Bank’s market area, including multi-family residential buildings, office and retail buildings, hotels, industrial buildings, and religious facilities. Commercial real estate loan originations are primarily obtained through direct solicitation of customers and potential customers. The valuation of commercial real estate collateral is provided by independent appraisers who have been approved by the Board Loan Committee. Commercial real estate lending entails significant additional risk, compared with residential mortgage lending. Commercial real estate loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the payment experience on loans secured by income producing properties is typically dependent on the successful operation of a business or a real estate project and thus may be subject, to a greater extent, to adverse conditions in the real estate market or in the economy in general. The Bank’s commercial real estate loan underwriting criteria require an examination of debt service coverage ratios, the borrower’s creditworthiness, prior credit history, and reputation. The Bank typically requires personal guarantees of the borrowers’ principal owners and considers the valuation of the real estate collateral.

Commercial and Industrial Lending

Commercial and industrial loans generally have a higher degree of risk than loans secured by real estate, but typically have higher yields. Commercial and industrial loans typically are made on the basis of the borrower’s ability to make repayment from cash flow from its business. The loans may be unsecured or secured by business assets, such as accounts receivable, equipment, and inventory. As a result, the availability of funds for the repayment of commercial business loans is substantially dependent on the success of the business itself. Furthermore, any collateral for commercial business loans may depreciate over time and generally cannot be appraised with as much reliability as real estate.

Also included in this category are loans originated under the SBA's PPP and loans purchased through a third-party lending programs. PPP loans are fully guaranteed by the SBA, and in some cases, borrowers may be eligible to obtain forgiveness of the loans, in which case loans would be repaid by the SBA. Loans purchased through third-party lending programs included in this category carry risks associated with the borrower, changes in the economic environment, the potential for accelerated amortization of purchase premiums, and the vendor itself. The Company manages these risks through policies that require minimum credit scores and other underwriting requirements, robust analysis of actual performance versus expected performance, as well as ensuring compliance with the Company's vendor management program.

Consumer Lending

Loans to individual borrowers may be secured or unsecured, and include unsecured consumer loans and lines of credit, automobile loans, deposit account loans, and installment and demand loans. These consumer loans may entail greater risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or secured by rapidly depreciating assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss, or depreciation. Consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness, or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.

The underwriting standards employed by the Bank for consumer loans include a determination of the applicant’s payment history on other debts and an assessment of ability to meet existing obligations and payments on a proposed loan. The stability of the applicant’s monthly income may be determined by verification of gross monthly income from primary employment, and additionally from any verifiable secondary income.

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Results of Operations

General

Net interest income represents the primary source of earnings for the Company. Net interest income equals the amount by which interest income on interest-earning assets, predominantly loans and securities, exceeds interest expense on interest-bearing liabilities, including deposits, other borrowings, subordinated debt, and junior subordinated debt. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as their respective yields and rates, are the components that impact the level of net interest income. The net interest margin is calculated by dividing tax-equivalent net interest income by average earning assets. The provision for credit losses, noninterest income, noninterest expense and income tax expense are the other components that determine net income. Noninterest income and expense primarily consists of income from service charges on deposit accounts, ATM and check card income, wealth management income, income from other customer services, income from bank owned life insurance, and general and administrative expenses.

Net Interest Income

Net interest income decreased $2.2 million, or 5%, to $43.4 million for 2023 compared to the prior year. Total interest expense increased by $10.5 million and was partially offset by total interest income, which increased by $8.3 million.  The net interest margin decreased by 3-basis points to 3.41% and average earnings assets decreased by $51.6 million, or 4%.

The increase in total interest income was primarily attributable to a $7.6 million, or 18%, increase in interest income and fees on loans. The increase in interest income on loans was attributable to a 48-basis point increase in the yield on loans and a 7% increase in average loan balances compared to the prior year.

The increase in total interest expense was attributable to a $10.4 million increase in interest expense on deposits. The higher interest expense on deposits resulted from a 126-basis point increase in the cost of interest-bearing deposits, which was partially offset by the impact of a 3% decrease in average interest-bearing deposits. The increase in the cost of deposits was impacted by a change in the composition of the deposit portfolio as lower cost deposit balances decreased, while higher cost deposit balances increased.

The net interest margin was 3.41% for the year ended December 31, 2023 compared to the 3.44% for the prior year as the increase in the cost of funds exceeded the increase in yield on earning assets during 2023. Although the interest rate environment continued to be challenging during the year, the net interest margin was stable over the last three quarters of 2023 as the rising cost of funds was offset by an increase in earning asset yields.

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The following table provides information on average interest-earning assets and interest-bearing liabilities for the years ended December 31, 2023 and 2022 as well as amounts and rates of tax equivalent interest earned and interest paid (dollars in thousands). The volume and rate analysis table analyzes the changes in net interest income for the periods broken down by their rate and volume components (in thousands).

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Provision for Credit Losses

Provision for credit losses totaled $6.2 million in 2023, compared to a provision for credit losses of $1.9 million for the prior year. The provision was comprised of a $6.0 million provision for credit losses on loans, a $260 thousand provision for credit losses on unfunded commitments, and a $26 thousand recovery of credit losses on held-to-maturity securities.

For the year ended December 31, 2023, the provision for credit losses on loans of $6.0 million, the adjustment for the adoption of ASU 2016-13 of $2.1 million, and net charge offs of $3.6 million resulted in a $4.5 million increase in the allowance for credit losses on loans. The $3.6 million of net charge-offs included $1.7 million of loans purchased through a third-party lending program and $830 thousand of related unamortized purchase premiums on the loans.

The general reserve component of the ACLL increased $2.7 million and the specific reserve component of the ACLL increased $1.8 million. The increase in the general reserve was attributable to loan growth, higher calculated loss rates, and from the recognition of higher inherent risk in the loan portfolio through adjustments to qualitative risk factors. The specific reserve increased by $1.8 million from fourteen new individually evaluated loan relationships and from two loans to one customer, which were individually analyzed for specific reserves in prior periods.  All new individually evaluated loan relationships were loans purchased through a third-party lending program.

For the year ended December 31, 2022, provision for loan losses of $1.9 million and net charge offs of $114 thousand resulted in a $1.7 million increase in the allowance for loan losses. The general reserve component of the allowance for loan losses increased $903 thousand and the specific reserve component of the allowance for loan losses increased $833 thousand. The increase in the general reserve was attributable to loan growth and reserves on purchased loans, which were partially offset by improvements to the asset quality and economic conditions qualitative factors. The increase in the specific reserve was attributable to two new impaired loans.

Noninterest Income

Noninterest income totaled $11.8 million for the year, which was a decrease of $866 thousand, or 7%, compared to $12.6 million for the prior year. The decrease was primarily a result of a gain on sale of other investment of $2.9 million in the prior year, which was partially offset by $2.0 million of net losses on sale of securities available for sale in the prior year.  The gain on sale of other investment resulted from a gain on sale of an interest in a broker-dealer of investment securities by First Bank Financial Services, Inc.  Noninterest income categories with moderate increases over the prior year included service charges on deposits, which increased $103 thousand, or 4%, ATM and check card fees, which increased $149 thousand, or 5%, and wealth management fees, which increased $112 thousand, or 4%.  Categories that decreased over the prior year included brokered mortgage fees, which decreased $126 thousand, or 51%, and other operating income, which decreased $417 thousand. Brokered mortgage fees decreased from less demand for mortgage loans from customers as home purchases and refinance opportunities were likely impacted by the higher interest rate environment.  Other operating income decreased primarily from a recovery on a purchased loan in the prior year, which was partially offset by an increase in referral fee income.

Noninterest Expense

Noninterest expense increased $1.6 million, or 5%, for the year ended December 31, 2023, compared to the prior year. Categories with the largest increases over the prior year included salaries and employee benefits which increased $330 thousand, or 2%, legal and professional fees increased by $233 thousand, or 17%, ATM and check card expense increased by $208 thousand, or 15%, FDIC assessment increased by $170 thousand, or 37%, and other operating expenses increased by $444 thousand, or 11%.  Other operating expense increased from higher recruiting expense, directors fees, cardcash expense, education and training, loan collection expense, and courier and armored services.

Income Taxes

Income tax expense decreased $1.8 million during the year ended December 31, 2023 compared to the prior year. The Company’s income tax expense differed from the amount of income tax determined by applying the U.S. federal income tax rate to pretax income for the year ended December 31, 2023 and 2022. The difference was a result of net permanent tax deductions, primarily comprised of tax-exempt interest income and income from bank owned life insurance. A more detailed discussion of the Company’s tax calculation is contained in Note 11 to the Consolidated Financial Statements included in this Form 10-K.

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Financial Condition

General

Total assets increased $49.9 million during the year and totaled $1.4 billion at December 31, 2023. The increase was primarily attributable to a $44.4 million increase in loans, net of allowance and a $23.8 million increase in interest-bearing deposits in banks, which was partially offset by a $10.1 million decrease in securities available for sale, and a $4.9 million decrease in securities held to maturity.

Total liabilities increased $42.0 million during the year and totaled $1.3 billion at December 31, 2023. Total deposits decreased $7.6 million and was offset by other borrowings, which increased $50.0 million. Total deposits decreased as noninterest-bearing demand deposits decreased by $48.1 million and savings and interest-bearing deposits decreased by $15.0 million, while time deposits increased $55.5 million.

Total shareholders' equity increased $7.9 million to $116.3 million at December 31, 2023, compared to $108.4 million at December 31, 2022. The increase was primarily attributable to a $3.8 million decrease in accumulated other comprehensive loss and a $3.9 million increase in retained earnings.

Loans

The Bank is an active lender with a loan portfolio that includes commercial and residential real estate loans, commercial loans, consumer loans, construction and land development loans, and home equity loans. The Bank’s lending activity is concentrated on individuals, and small and medium-sized businesses primarily in its market areas. As a provider of community-oriented financial services, the Bank does not attempt to further geographically diversify its loan portfolio by undertaking significant lending activity outside its market areas.

The Bank actively participated as a lender in the U.S. Small Business Administration’s (SBA) Paycheck Protection Program (PPP) to support local small businesses and non-profit organizations by providing forgivable loans. Loan fees received from the SBA are accreted by the Bank into income evenly over the life of the loans, net of loan origination costs, through interest and fees on loans. PPP loans totaled $128 thousand and $350 thousand at December 31, 2023 and 2022, respectively; with $128 thousand scheduled to mature in the first and second quarters of 2026. The Company believes these loans will ultimately be forgiven and repaid by the SBA in accordance with the terms of the program. It is the Company’s understanding that loans funded through the PPP program are fully guaranteed by the U.S. government. Should those circumstances change, the Company could be required to establish additional ACLL through additional provision for credit losses charged to earnings.

The loan portfolio includes loans that were acquired through business combinations. Loans acquired through business combinations included unamortized discounts, net of unamortized premiums totaling $1.9 million and $2.5 million, as of December 31, 2023 and 2022, respectively, which are amortized over the life of the loans.

The loan portfolio also includes loans that were acquired through business combinations and loans that were purchased through a third-party loan originator. Loans acquired through business combinations included unamortized discounts, net of unamortized premiums totaling $1.9 million and $2.5 million, as of December 31, 2023 and 2022, respectively.

Loans purchased from a third-party that originated and serviced loans to health care professionals totaled $24.6 million as of December 31, 2023, which included unamortized premiums totaling $7.9 million, compared to loans totaling $22.3 million as of December 31, 2022, which included unamortized premiums totaling $7.4 million.

Loans increased $48.9 million to $969.4 million at December 31, 2023, compared to $920.5 million at December 31, 2022. Other real estate loans increased by $28.8 million, residential real estate loans increased by $12.9 million, consumer and other loans increased by $4.5 million, commercial, and industrial loans increased by $1.8 million, and construction and land development loans increased by $840 thousand.

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The following table sets forth the maturities of the loan portfolio at December 31, 2023 (in thousands):

Asset Quality

Management classifies non-performing assets as non-accrual loans and OREO. OREO represents real property taken by the Bank when its customers do not meet the contractual obligation of their loans, either through foreclosure or through a deed in lieu thereof from the borrower and properties originally acquired for branch operations or expansion but no longer intended to be used for that purpose. OREO is recorded at the lower of cost or fair value, less estimated selling costs, and is marketed by the Bank through brokerage channels. The Bank had $0 and $184 thousand in assets classified as OREO at December 31, 2023 and 2022, respectively.

Non-performing assets totaled $6.8 million and $2.9 million at December 31, 2023 and 2022, representing approximately 0.48% and 0.21% of total assets, respectively.  Non-performing assets consisted of $6.8 million of non-accrual loans at December 31, 2023.  Non-performing assets consisted of $184 thousand of OREO and $2.7 million of non-accrual loans and at December 31, 2022.

At December 31, 2023, 92.1% of non-performing assets were commercial and industrial loans, 7.3% were residential real estate loans, 0.6% construction loans. Non-performing assets could increase due to the deterioration of other loans identified by management as potential problem loans. Other potential problem loans are defined as performing loans that possess certain risks, including the borrower’s ability to pay and the collateral value securing the loan, that management has identified that may result in the loans not being repaid in accordance with their terms. Other potential problem loans totaled $287 thousand and $2.3 million at December 31, 2023 and December 31, 2022, respectively. The amount of other potential problem loans in future periods may be dependent on economic conditions and other factors influencing a customers’ ability to meet their debt requirements.

There were $524 thousand loans greater than 90 days past due and still accruing at December 31, 2023. There were no loans greater than 90 days past due and still accruing at December 31, 2022.

During the fourth quarter of 2020 and the first half of 2021, the Bank modified terms of certain loans for customers that continued to be negatively impacted by the pandemic by lowering borrower’s loan payments with interest only payments for periods ranging between 6 and 24 months. Modified loans totaled $9.1 million at December 31, 2022, which were all in the Bank’s commercial real estate loan portfolio.  All of these loans resumed regular payments during 2023.

The ACLL represents management’s analysis of the existing loan portfolio and related credit risks. The provision for credit losses is based upon management’s current estimate of the amount required to maintain an adequate ACLL reflective of the risks in the loan portfolio. The allowance for credit losses on loans totaled $12.0 million at December 31, 2023 and $7.4 million at December 31, 2022, representing 1.24% and 0.81% of total loans, respectively. The Company determined that the historical loss analysis and the qualitative adjustment factors that established the general reserve component of the ACLL were appropriate at December 31, 2023. The allowance for credit losses on loans as a percentage of total loans increased to 1.24% at December 31, 2023 compared to 0.81% at December 31, 2022 as a result of a $2.9 million increase in the general reserve and a $1.8 million increase in the specific reserve component of the ACLL.

For further discussion regarding the ACLL, see “Provision for Credit Losses” above.

A recovery of credit losses of $593 thousand was recorded in the other real estate class during the year ended December 31, 2023. The recovery of credit losses resulted primarily from a decrease in the general reserve. This recovery was offset by provision for credit losses totaling $6.5 million in the construction and land development, 1-4 family residential, commercial and industrial, and consumer loan classes.  For more detailed information regarding the provision for credit losses on loans, see Note 4 to the Consolidated Financial Statements included in this Form 10-K.

Loans individually evaluated for impairment totaled $6.8 million and $2.7 million at December 31, 2023 and 2022, respectively. The related allowance for credit losses required for these loans totaled $2.7 million and $888 thousand at December 31, 2023 and December 31, 2022, respectively.

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Management believes, based upon its review and analysis, that the Bank has sufficient reserves to cover losses inherent within the loan portfolio. For each period presented, the provision for credit losses on loans charged to expense was based on factors that include net charge-offs, asset quality, economic conditions, and loan growth. Changing economic conditions caused by inflation, recession, unemployment, or other factors beyond the Company’s control have a direct correlation with asset quality, net charge-offs, and ultimately the required provision for credit losses. There can be no assurance, however, that an additional provision for credit losses will not be required in the future, including as a result of changes in the qualitative factors underlying management’s estimates and judgments, changes in accounting standards, adverse developments in the economy, on a national basis or in the Company’s market area, loan growth, or changes in the circumstances of particular borrowers. For further discussion regarding the ACLL, see “Critical Accounting Policies” above. The following table shows a detail of loans charged-off, recovered, and the changes in the ACLL (dollars in thousands).

The following table shows the balance of the Bank’s ACLL allocated to each major category of loans and the ratio of related outstanding loan balances to total loans (dollars in thousands).

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The following table provides information on the Bank’s non-performing assets at the dates indicated (dollars in thousands).

The following table summarizes the Company's credit ratios on a consolidated basis as of December 31, 2023 and 2022.

The Company purchased commercial and industrial loans between October 2021 and October 2023 from a third-party finance company that originated and serviced loans to health care professionals. The finance company operated a program that historically provided credit support to the Company through, among other things, the repurchase of their loans and unamortized loan premiums when loans did not pay according to the loan agreements. The Company performed an evaluation of the purchased loans, which resulted in a loss classification for $1.7 million of the loans and $830 thousand of their unamortized premiums. The classifications resulted in charge offs of the loans and unamortized premiums totaling $2.5 million to the allowance for credit losses on loans during the fourth quarter of 2023.  On December 31, 2023, loans purchased from the finance company totaled $24.5 million, which was comprised of $16.6 million of loan balances and unamortized premiums totaling $7.9 million. The Company determined that $2.4 million of the loans were non-accrual and thus were individually evaluated. Specific reserves on the individually evaluated loans were included in the Company’s allowance for credit losses on loans. The remaining $22.1 million of loans were considered performing and were included in the calculation of the general reserve component of the allowance for credit losses. Premiums are amortized over the life of the loans using the effective interest method. On December 31, 2023, there was a total of 172 loans purchased from the finance company included in the Company’s loan portfolio with a weighted average maturity of 7.5 years.

Securities

Securities totaled $303.2 million at December 31, 2023, a decrease of $14.8 million, or 4.7%, from $318.0 million at the end of 2022. Investment securities are comprised of U.S. agency and mortgage-backed securities, obligations of state and political subdivisions, corporate debt securities, and restricted securities. As of December 31, 2023, neither the Company nor the Bank held any derivative financial instruments in their respective investment security portfolios. Gross unrealized gains in the available for sale portfolio totaled $61 thousand and $99 thousand at December 31, 2023 and 2022, respectively. Gross unrealized losses in the available for sale portfolio totaled $20.7 million and $24.0 million at December 31, 2023 and 2022, respectively.  Gross unrealized gains in the held to maturity portfolio totaled $107 thousand and $0 at December 31, 2023 and 2022, respectively.  Gross unrealized losses in the held to maturity portfolio totaled $10.8 million and $11.4 thousand at December 31, 2023 and 2022, respectively.  The change in the unrealized gains and losses of investment securities from December 31, 2022 to December 31, 2023 was related to changes in market interest rates and was not related to credit concerns of the issuers.

The Company evaluated securities available for sale in an unrealized loss position for credit related impairment and determined that no allowance for credit losses was necessary at December 31, 2023 and 2022.  At December 31, 2023, the allowance for credit losses on held to maturity securities was $107 thousand.  There was no allowance for credit losses on held to maturity securities at December 31, 2022.

On September 1, 2022, the Bank transferred 24 securities designated as available for sale with a combined book value of $82.2 million, market value of $74.4 million, and unrealized loss of $7.8 million, to securities designated held to maturity. The unrealized loss is being amortized monthly over the life of the securities with an increase to the carrying value of securities and a decrease to the related accumulated other comprehensive loss, which is included in the shareholders’ equity section of the Company’s balance sheet. The amortization of the unrealized loss on the transferred securities totaled $593 thousand, or $468 thousand net of tax, for the year ended December 31, 2022. The securities selected for transfer had larger potential decreases in their fair market values in higher interest rate environments than most of the other securities in the available for sale portfolio and included U.S. Treasury, agency, municipal and commercial mortgage-backed securities. The securities were transferred to mitigate the potential unfavorable impact that higher market interest rates may have on the carrying value of the securities and on the related accumulated other comprehensive loss. Securities designated as held to maturity are carried on the balance sheet at amortized cost, while securities designated as available for sale are carried at fair market value.

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The following table shows the maturities of debt and restricted securities at amortized cost and market value at December 31, 2023 and approximate weighted average yields of such securities (dollars in thousands). Yields on state and political subdivision securities are shown on a tax equivalent basis, assuming a 21% federal income tax rate. The Company attempts to maintain diversity in its portfolio and maintain credit quality and re-pricing terms that are consistent with its asset/liability management and investment practices and policies. For further information on securities, see Note 2 to the Consolidated Financial Statements included in this Form 10-K.

The above table was prepared using the contractual maturities for all securities with the exception of mortgage-backed securities (MBS) and collateralized mortgage obligations (CMO). Both MBS and CMO securities were recorded using the yield book prepayment model that incorporates four causes of prepayments including home sales, refinancing, defaults, and curtailments/full payoffs.

As of December 31, 2023, the Company did not own securities of any issuer for which the aggregate book value of the securities of such issuer exceeded ten percent of shareholders’ equity.

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Deposits

At December 31, 2023, deposits totaled $1.2 billion, decreasing slightly by $7.6 million, from $1.2 billion at December 31, 2022.  There was a change in the deposit mix when comparing the periods. At December 31, 2023, noninterest-bearing demand deposits, savings and interest-bearing demand deposits, and time deposits composed 31%, 54%, and 15% of total deposits, respectively, compared to 34%, 55%, and 11% at December 31, 2022.

The following tables include a summary of average deposits and average rates paid (dollars in thousands).

The table above includes brokered deposits greater than $100 thousand.

As of December 31, 2023 the estimated amount of total uninsured deposits was $368.2 million.  Maturities of the estimated amount of uninsured time deposits at December 31, 2023 are presented in the table below.  The estimate of uninsured deposits generally represents the portion of deposit accounts that exceed the FDIC insurance limit of $250,000 and is calculated based on the same methodologies and assumptions used for purposes of the Bank’s regulatory reporting requirements.

Liquidity

Liquidity sources available to the Bank, including interest-bearing deposits in banks, unpledged securities available for sale, at fair value, unpledged securities held-to-maturity, at par, eligible to be pledged to the Federal Reserve Bank through its Bank Term Funding Program, and available lines of credit totaled $512.7 million on December 31, 2023, and $417.2 million on December 31, 2022.  Available lines of credit from other institutions included in the total amount above was $351.4 million on December 31, 2023, and $287.3 million on December 31, 2022. The available lines of credit were comprised of secured and unsecured lines of credit and the Bank had no borrowings on the lines as of December 31, 2023 and December 31, 2022.

The Bank maintains liquidity to fund loan growth and meet the potential demand from its deposit customers, including potential volatile deposits. The estimated amount of uninsured customer deposits totaled $368.2 million on December 31, 2023, and $261.7 million on December 31, 2022. Excluding municipal deposits, the estimated amount of uninsured customer deposits totaled $286.2 million on December 31, 2023, and $185.3 million on December 31, 2022.

Subordinated Debt

See Note 9 to the Consolidated Financial Statements included in this Form 10-K, for discussion of subordinated debt.

Junior Subordinated Debt

See Note 10 to the Consolidated Financial Statements included in this Form 10-K, for discussion of junior subordinated debt.

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Off-Balance Sheet Arrangements

The Company, through the Bank, is a party to credit related financial instruments with risk not reflected in the consolidated financial statements in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit, and commercial letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Bank’s exposure to credit loss is represented by the contractual amount of these commitments. The Bank follows the same credit policies in making commitments as it does for on-balance sheet instruments.

At December 31, 2023 and 2022, the following financial instruments were outstanding whose contract amounts represent credit risk (in thousands):

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Bank, is based on management’s credit evaluation of the customer.

Unfunded commitments under commercial lines of credit, revolving credit lines, and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit are collateralized as deemed necessary and may or may not be drawn upon to the total extent to which the Bank is committed.

Commercial and standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank generally holds collateral supporting those commitments if deemed necessary.

At December 31, 2023, the Bank had $1.2 million in locked-rate commitments to originate mortgage loans. Risks arise from the possible inability of counterparties to meet the terms of their contracts. The Bank does not expect any counterparty to fail to meet its obligations.

On April 21, 2020, the Company entered into interest rate swap agreements related to its outstanding junior subordinated debt. The Company uses derivatives to manage exposure to interest rate risk through the use of interest rate swaps. Interest rate swaps involve the exchange of fixed and variable rate interest payments between two parties, based on a common notional principal amount and maturity date with no exchange of underlying principal amounts.

The interest rate swaps qualified and are designated as cash flow hedges. The Company’s cash flow hedges effectively modify the Company’s exposure to interest rate risk by converting variable rates of interest on $9.0 million of the Company’s junior subordinated debt to fixed rates of interest for periods that end between June 2034 and October 2036. The cash flow hedges’ total notional amount is $9.0 million. At December 31, 2023, the cash flow hedges had a fair value of $2.5 million, which is recorded in other assets. The net gain/loss on the cash flow hedges is recognized as a component of other comprehensive income and reclassified into earnings in the same period(s) during which the hedged transactions affect earnings. The Company’s derivative financial instruments are described more fully in Note 24 to the Consolidated Financial Statements included in this Form 10-K.

Capital Resources

The adequacy of the Company’s capital is reviewed by management on an ongoing basis with reference to the size, composition, and quality of the Company’s asset and liability levels and consistent with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and absorb potential losses. The Company meets eligibility criteria of a small bank holding company in accordance with the Federal Reserve Board’s Small Bank Holding Company Policy Statement issued in February 2015 and is not obligated to report consolidated regulatory capital.

Effective January 1, 2015, the Bank became subject to capital rules adopted by federal bank regulators implementing the Basel III regulatory capital reforms adopted by the Basel Committee on Banking Supervision (the Basel Committee), and certain changes required by the Dodd-Frank Act.

The minimum capital level requirements applicable to the Bank under the final rules are as follows: a new common equity Tier 1 capital ratio of 4.5%; a Tier 1 capital ratio of 6%; a total capital ratio of 8%; and a Tier 1 leverage ratio of 4% for all institutions. The final rules also established a “capital conservation buffer” above the new regulatory minimum capital requirements. The capital conservation buffer was phased-in over four years and, as fully implemented effective January 1, 2019, requires a buffer of 2.5% of risk-weighted assets. This results in the following minimum capital ratios beginning in 2019: a common equity Tier 1 capital ratio of 7.0%, a Tier 1 capital ratio of 8.5%, and a total capital ratio of 10.5%. Under the final rules, institutions are subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions. Management believes, as of December 31, 2023 and December 31, 2022, that the Bank met all capital adequacy requirements to which it is subject, including the capital conservation buffer.

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The following table summarizes the Bank’s regulatory capital and related ratios at December 31, 2023, and 2022 (dollars in thousands).

The prompt corrective action framework is designed to place restrictions on insured depository institutions if their capital levels begin to show signs of weakness. Under the prompt corrective action requirements, which are designed to complement the capital conservation buffer, insured depository institutions are required to meet the following capital level requirements in order to qualify as “well capitalized:” a common equity Tier 1 capital ratio of 6.5%; a Tier 1 capital ratio of 8%; a total capital ratio of 10%; and a Tier 1 leverage ratio of 5%. The Bank met the requirements to qualify as "well capitalized" as of December 31, 2023 and 2022.

On September 17, 2019 the FDIC finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio (CBLR) framework), as required by the Economic Growth Act. The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework.

In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio greater than 9%, less than $10 billion in total consolidated assets, and limited amounts of off-balance sheet exposures and trading assets and liabilities.  A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the "well-capitalized" ratio requirements under the prompt corrective action regulations and would not be required to report or calculate risk-based capital. Although the Bank did not opt into the CBLR framework at December 31, 2023, it may opt into the CBLR framework in a future quarterly period.

During the fourth quarter of 2022, the Board of Directors of the Company authorized a stock repurchase plan pursuant to which the Company could repurchase up to $5.0 million of its outstanding common stock through December 31, 2023.  During the year ended December 31, 2023 the Company repurchased 37,532 shares of its common stock at an average price of $15.14 per share.  The Company did not repurchase any shares during the year ended December 31, 2022.

The Company issued $5.0 million of subordinated debt in June 2020. The purpose of the issuance was primarily to further strengthen holding company liquidity and to remain a source of strength for the Bank in the event of a severe economic downturn. The Company used the proceeds of the issuance for general corporate purposes.  The subordinated debt issued consisted of a 5.50% fixed-to-floating rate subordinated note due 2030 issued to an institutional investor and was structured to qualify as Tier 2 capital under bank regulatory guidelines.

First Bank remained well-capitalized at December 31, 2023.

Recent Accounting Pronouncements

See Note 1 to the Consolidated Financial Statements included in this Form 10-K, for discussion of recent accounting pronouncements.

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