ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(dollars in thousands, except share and per share data)
Forward Looking Statements
Certain statements contained in this report and other publicly available documents incorporated herein by reference
constitute "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as amended (the “Exchange Act”), and as defined in the Private Securities Litigation
Reform Act of 1995. Such statements are often, but not always, identified by the use of such words as “believes,” “anticipates,” “expects,” “intends,” “plan,” “goal,” “seek,” “project,” “estimate,” “strategy,” “future,” “likely,” “may,” “should,”
“will,” and other similar expressions. Such statements involve various important assumptions, risks, uncertainties, and other factors, many of which are beyond our control, and which could cause actual results to differ materially from those expressed
in such forward looking statements. These factors include, but are not limited to: the effects of COVID-19 and recovery therefrom on our business, operations, customers and capital position; unexpected changes in interest rates or disruptions in the
mortgage market; changes in political, economic or other factors, such as inflation rates, recessionary or expansive trends, taxes, the effects of implementation of legislation and the continuing economic uncertainty in various parts of the world;
competitive pressures; fluctuations in interest rates; the level of defaults and prepayment on loans made by Ohio Valley Banc Corp. (“Ohio Valley”) and its direct and indirect subsidiaries (collectively, the “Company”); unanticipated litigation,
claims, or assessments; fluctuations in the cost of obtaining funds to make loans; and regulatory changes. Additional detailed information concerning such factors is available in the Company’s filings with the Securities and Exchange Commission, under
the Exchange Act, including the disclosure under the heading “Item 1A. Risk Factors” of Part I of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2022. Readers are cautioned not to place undue reliance on such forward
looking statements, which speak only as of the date hereof. The Company undertakes no obligation and disclaims any intention to republish revised or updated forward looking statements, whether as a result of new information, unanticipated future
events or otherwise.
BUSINESS OVERVIEW: The following discussion on consolidated
financial statements include the accounts of Ohio Valley and its wholly-owned subsidiaries, The Ohio Valley Bank Company (the “Bank”), Loan Central, Inc., a consumer finance company (“Loan Central”), Ohio Valley Financial Services Agency, LLC, an
insurance agency, and OVBC Captive, Inc., a limited purpose property and casualty insurance company (“the Captive”). The Bank has two wholly-owned subsidiaries, Race Day Mortgage, Inc., an Ohio corporation that provides online consumer mortgages
(“Race Day”), and Ohio Valley REO, LLC, an Ohio limited liability company. In February 2023, Ohio Valley announced that it was taking steps toward closing Race Day. The decision to start this process was made due to low loan demand, issues retaining
personnel, and lack of profitability. Ohio Valley plans to see current loan applications in progress to completion. An exact date of closing is anticipated to be set once existing loan applications have been processed. Ohio Valley and its
subsidiaries are collectively referred to as the “Company.”
The Company is primarily engaged in commercial and retail banking, offering a blend of commercial and consumer banking services within southeastern Ohio as
well as western West Virginia. The banking services offered by the Bank include the acceptance of deposits in checking, savings, time and money market accounts; the making and servicing of personal, commercial, floor plan and student loans; the making
of construction and real estate loans; and credit card services. The Bank also offers individual retirement accounts, safe deposit boxes, wire transfers and other standard banking products and services. Furthermore, the Bank offers Tax Refund Advance
Loans (“TALs”) to Loan Central tax customers. A TAL represents a short-term loan offered by the Bank to tax preparation customers of Loan Central.
IMPACT OF ADOPTING NEW ACCOUNTING GUIDANCE: Effective January 1, 2023, the Company adopted ASU No. 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, (“ASU 2016-13”) (“ASC 326”) as amended. The new accounting guidance replaces the “incurred loss” model with an “expected loss” model, which is referred to as the current expected credit loss (“CECL”) model. The measurement of expected credit losses under the CECL model is
applicable to financial assets measured at amortized cost, including loan receivables and held to maturity debt securities. It also applies to off-balance sheet credit exposures not accounted for as insurance (loan commitments, standby letters of
credit, financial guarantees, and other similar instruments). Upon adoption of ASC 326, the Company increased the allowance for credit losses by $2,162. In addition, a reserve for unfunded commitments and held to maturity securities was established
totaling $631 and $3, respectively. The Company recorded a net charge to retained earnings of $2,209 as of January 1, 2023 for the cumulative effect of adopting ASC 326. The adoption of ASC 326 did not have an effect to net earnings on January 1, 2023.
FINANCIAL RESULTS OVERVIEW: Net income totaled $3,908 during the
first quarter of 2023, a decrease of $217 from the same period of 2022. Earnings per share for the first quarter of 2023 finished at $.82 per share, compared to $.87 per share during the first quarter of 2022. Quarterly earnings decreased largely from
increases in provision for credit loss expense and noninterest expense being partially offset by increases in both net interest and noninterest income. The impact of lower net earnings during the first quarter of 2023 also had a direct impact to the
Company’s annualized net income to average asset ratio, or return on assets, which decreased to 1.28% for the three months ended March 31, 2023, compared to 1.34% for the three months ended March 31, 2022. Conversely, the Company’s net income to
average equity ratio, or return on equity, increased to 11.85% for the three months ended March 31, 2023, compared to 11.78% for the three months ended March 31, 2022. While current year net earnings were down, the Company recorded a $2,209 charge to
retained earnings for the cumulative effect of adopting ASC 326 on January 1, 2023. This impact of adopting new accounting guidance reduced capital but had no corresponding impact to net earnings, which contributed to the increase in average return on
equity during 2023 over 2022.
During the three months ended March 31, 2023, net interest income increased $1,732, or 17.3%, over the same period in 2022. Growth in net interest income was
impacted by an increase in the net interest margin, which completely offset the effects of lower average earning assets. The Federal Reserve’s actions of increasing market interest rates during 2022 and 2023 have had a significant impact in growing the
net interest margin, which finished at 4.21% for the quarter ended March 31, 2023 compared to 3.51% at the end of the same period in 2022. The net interest margin has responded positively due to the yield on earning assets increasing more than the cost
of interest-bearing liabilities. Average assets during the first quarter of 2023 decreased $25,531 compared to the first quarter of 2022. While average assets were down 2.2%, the Company benefited from having higher relative balances maintained in
loans, as opposed to the Federal Reserve, which generally yields less than loans. During the first quarter of 2023, average loans increased $78,563, while average balances with the Federal Reserve decreased $92,224, compared to the same period in 2022.
The Company’s provision for credit loss during the first quarter of 2023 increased $1,615, largely due to a $1,126 negative provision for credit loss
recorded during the three months ended March 31, 2022. This negative provision expense from the first quarter of 2022 was related to lower criticized and classified loans and the partial release of the COVID reserve for the pandemic environment.
During the three months ended March 31, 2023, noninterest income increased $47, or 1.3%, over the same period in 2022. This increase was largely from $231 in
commissions earned by Race Day during 2023 for mortgage application referrals. This was partially offset by a decrease of $188 in mortgage banking income from loan sales to the secondary market, which have been negatively impacted by elevated mortgage
rates.
During the three months ended March 31, 2023, noninterest expense increased $484, or 4.9%, over the same period in 2022. The increase was primarily related
to salaries and employee benefit costs impacted by higher annual merit expenses. The Company also experienced increases in software expense, FDIC insurance premiums, and data processing costs, partially offset by a decrease in professional fees.
The Company’s provision for income taxes decreased $103 during the three months ended March 31, 2023, compared to the same period in 2022. This was largely
due to the changes in taxable income affected by the factors mentioned above.
At March 31, 2023, total assets were $1,266,465, an increase of $55,678 from year-end 2022. Higher assets were primarily impacted by increases in cash and
cash equivalents and loans, which were collectively up $65,122, or 7.0%, from year-end 2022. Growth in cash and cash equivalents came primarily from higher balances held at the Federal Reserve as a result of the growth in deposits exceeding the growth
in loans. Growth in total loans came from increases in the consumer loan segment (+10.9%), commercial and industrial loan segment (+4.3%), commercial real estate loan segment (+1.6%), partially offset by a decrease in the residential real estate loan
segment (-2.0%).
At March 31, 2023, total liabilities were $1,128,920, up $53,161 from year-end 2022. Contributing most to this increase were higher deposit balances, which
increased $53,540 from year-end 2022. The increase was impacted mostly from higher time deposits, partially offset by lower savings, money market, and noninterest-bearing demand deposits.
At March 31, 2023, total shareholders' equity was $137,545, up $2,517 from December 31, 2022. This increase came from quarterly net income, a decrease in net
unrealized losses on available for sale securities, partially offset by quarterly cash dividends paid. The increase in shareholders’ equity was further limited by the adoption of new accounting guidance for measuring credit losses, which required a
$2,209 charge to retained earnings. Regulatory capital ratios of the Company remained higher than the "well capitalized" minimums.
Comparison of Financial Condition
at March 31, 2023 and December 31, 2022
The following discussion focuses, in more detail, on the consolidated financial condition of the Company at March 31, 2023 compared to December 31, 2022.
This discussion should be read in conjunction with the interim consolidated financial statements and the footnotes included in this Form 10‑Q.
Cash and Cash Equivalents
At March 31, 2023, cash and cash equivalents were $89,848, an increase of $43,858, or 95.4%, from December 31, 2022. The increase in cash and cash
equivalents came mostly from higher interest-bearing deposits on hand with correspondent banks. Over 81% of cash and cash equivalents consisted of the Company’s interest-bearing Federal Reserve Bank clearing account, which increased $42,753, or
138.8%, from year-end 2022. The Company utilizes its interest-bearing Federal Reserve Bank clearing account to manage excess funds, as well as to assist in funding earning asset growth. During the first quarter of 2023, the Company experienced increases in funds from Bank deposits, primarily time deposits, which were maintained in the Federal Reserve account. A portion of these clearing account funds
were used to reinvest in higher-yielding loans, and to also help cover deposit runoff in noninterest-bearing demand and other interest-bearing deposit balances. The interest rate paid on both the required and excess reserve balances of the
Federal Reserve Bank account is based on the targeted federal funds rate established by the Federal Open Market Committee. During the first three months of 2023, the rate associated with the Company’s Federal Reserve Bank clearing account increased 50
basis points due to continued rising inflationary concerns, resulting in a target federal funds rate range of 4.75% to 5.00%. The interest-bearing deposit balances in the Federal Reserve Bank account are 100% secured by the U.S. Government.
As liquidity levels continuously vary based on consumer activities, amounts of cash and cash equivalents can vary widely at any given point
in time. The Company’s focus during periods of heightened liquidity will be to invest excess funds into longer-term, higher-yielding assets, primarily loans, when opportunities arise.
Certificates of Deposit
At March 31, 2023, the Company had $735 in certificates of deposit owned by the Captive, down from $1,127 at year-end 2022. The deposits on hand at March
31, 2023 consist of three certificates with remaining maturity terms of less than six months.
Securities
The balance of total securities decreased $4,546, or 2.4%, compared to year-end 2022. The decrease came mostly from U.S. Government agency (“Agency”)
mortgage-backed securities, which were down $2,954, or 2.4%, from year-end 2022. The Company’s investment securities portfolio is made up mostly of Agency mortgage-backed securities, which represented 62.7% of total investments at March 31, 2023.
During the first quarter of 2023, the Company received proceeds from principal repayments of $4,416. The monthly repayment of principal has been the primary advantage of Agency mortgage-backed securities as compared to other types of investment
securities, which deliver proceeds upon maturity or call date. The Company also experienced $2,000 in maturities from its Agency security portfolio, which further decreased investments from year-end 2022.
Partially offsetting these decreasing factors were changes in net unrealized losses associated with available for sale securities. During 2023, long-term
reinvestment rates decreased, which led to a $2,145 increase in the fair value of the Company’s available for sale securities. The fair value of an investment security moves inversely to interest rates, so as rates decreased, the unrealized loss in
the portfolio was reduced causing the fair value to increase. These changes in rates are typical and do not impact earnings of the Company as long as the securities are held to full maturity.
Loans
The loan portfolio represents the Company’s largest asset category and is its most significant source of interest income. Gross loan balances increased to
$906,313 at March 31, 2023, representing an increase of $21,264, or 2.4%, as compared to $885,049 at December 31, 2022. The increase in loans came primarily from the consumer and commercial loan portfolios, partially offset by a decrease in the
residential real estate portfolio from year-end 2022.
The Company’s total consumer loan balances from year-end 2022 increased $16,146, or 10.9%. This change was impacted by an $11,534, or 17.6%, increase in
other consumer loans. Growth in other consumer loans came largely from the purchase of a pool of unsecured loans in January 2023 that had a carrying amount of $14,218 at March 31, 2023. Growth in consumer loans also came from a $3,881, or 7.1%,
increase in automobile loans, and a $731, or 2.6%, increase in home equity lines of credit.
Further increases in loans came from the Company’s commercial loan portfolio, which increased $11,106, or 2.5%, from year-end 2022. Contributing most to this
increase were higher loan balances within the commercial and industrial portfolio, up $6,516, or 4.3%, from year-end 2022. The growth was impacted by an increase in larger loan originations during the year. Commercial and industrial loans consist of
loans to corporate borrowers primarily in small to mid-sized industrial and commercial companies that include service, retail, and wholesale merchants. Collateral securing these loans includes equipment, inventory, and stock.
Commercial loans were also positively impacted by an increase in the commercial real estate portfolio, which increased $4,590, or 1.6%, from year-end 2022.
The commercial real estate segment comprised the largest portion of the Company’s total loan portfolio at March 31, 2023 at 32.4%. The increase came from the nonowner-occupied and construction loan segments, which offset the decrease in owner-occupied
loans from year-end 2022.
While management believes lending opportunities exist in the Company’s markets, future commercial lending activities will depend upon economic and other
related conditions, such as general demand for loans in the Company’s primary markets, interest rates offered by the Company, and the effects of competitive pressure and normal underwriting considerations. Management will continue to place emphasis on
its commercial lending, which generally yields a higher return on investment as compared to other types of loans.
The Company’s residential real estate loan portfolio decreased $5,988, or 2.0%, from year-end 2022. Residential real estate loans represent the second
largest segment of the Company’s total loan portfolio at 32.1% and consists primarily of one- to four-family residential mortgages and carries many of the same customer and industry risks as the commercial loan portfolio. The decrease in residential
real estate loans was largely related to the principal repayments and payoffs in both long-term fixed-rate and short-term adjustable-rate mortgages. A
decrease in refinancing volume and an increase in long-term reinvestment rates have led to a slower demand for mortgage loans during 2023.
Allowance for Credit Losses
The Company maintains an allowance for credit losses (“ACL”) that represents management’s best estimate of the appropriate level of losses and risks inherent
in our applicable financial assets under the current expected credit loss (“CECL”) model. The amount of the ACL should not be interpreted as an indication that charge-offs in future periods will necessarily occur in those amounts, or at all. The
determination of the ACL involves a high degree of judgement and subjectivity. Please refer to Note 1 of the notes to the financial statements for discussion regarding our ACL methodologies for securities and loans.
For AFS debt securities, the Company evaluates the securities at each measurement date to determine whether the decline in the fair value below the amortized
costs basis is due to credit-related factors or noncredit-related factors. Upon adoption of ASC 326 on January 1, 2023, and as of March 31, 2023, the Company determined that all AFS securities that experienced a decline in fair value below the
amortized cost basis were due to non-credit related factors. Furthermore, the security types for all AFS debt securities contained explicit government guarantees. Therefore, no ACL was recorded, and no provision expense was recognized during the three
months ended March 31, 2023.
For HTM debt securities, the Company evaluates the securities collectively by major security type at each measurement date to determine expected credit
losses based on issuer’s bond rating, historical loss, financial condition, and timely principal and interest payments. Upon adoption of ASC 326 on January 1, 2023, a $3 ACL was recognized based on a .03% cumulative default rate taken from the S&P
and Moody’s bond rating index. At March 31, 2023, the ACL for HTM debt securities remained unchanged at $3, resulting in no provision expense during the three months ended March 31, 2023.
For loans, the Company’s ACL is management’s estimate of expected lifetime credit losses, measured over the contractual life of a loan, that considers
historical loss experience, current conditions, and forecasts of future economic conditions. The ACL on loans is established through a provision for credit losses recognized in earnings. The ACL on loans is reduced by charge-offs on loans and is
increased by recoveries of amounts previously charged off. Management employs a process and methodology to estimate the ACL on loans that evaluates both quantitative and qualitative factors within two main components. The first component involves
pooling loans into portfolio segments for loans that share similar risk characteristics. The second component involves individually analyzed loans that do no share similar risk characteristics with loans that are pooled into portfolio segments. The ACL
for loans with similar risk characteristics are collectively evaluated for expected credit losses based on certain quantitative information that include historical loss rates, prepayment rates, and curtailment rates. Expected credit losses on loans
with similar characteristics are also determined by certain qualitative factors that include national unemployment rates, national gross domestic product forecasts, changes in lending policy, quality of loan review, and delinquency status. The ACL for
loans that do not share similar risk characteristics are individually evaluated for expected credit losses primarily based on foreclosure status and whether a loan is collateral-dependent. Expected credit losses on individually evaluated loans are then
determined using the present value of expected future cash flows based upon the loan’s original effective interest rate, at the loan’s observable market price, or if the loan was collateral dependent, at the fair value of the collateral.
As of March 31, 2023, the ACL for loans totaled $7,607, or 0.84%, of total loans. As of December 31, 2022, the ACL for loans totaled $5,269, or 0.60%, of
total loans. The increase in the ACL of $2,338, or 44.4%, was primarily due to the $2,162 impact of adopting ASC 326 on January 1, 2023, affected mostly by the residential real estate and consumer loan portfolio segments. Upon transition to the CECL
model, the Company’s ACL increased another $176 to finish with $7,607 in reserves, all from loans collectively evaluated. This increase was mostly impacted by a $22,441 increase in collectively evaluated loan balances during the first quarter of 2023,
primarily from consumer loans.
The Company experienced lower delinquency levels from year-end 2022, which resulted in lower provision expense. Nonperforming loans to total loans decreased
to 0.39% at March 31, 2023, compared to 0.43% at December 31, 2022, and nonperforming assets to total assets decreased to 0.28% at March 31, 2023, compared to 0.31% at December 31, 2022.
During the first quarter of 2023, the Company individually evaluated several loans with a single borrower relationship for expected credit loss. The fair
value of the loans’ collateral was measured to the loans’ recorded investment and no expected losses were identified as part of that review. As a result, there were no specific reserves recorded during the three months ended March 31, 2023.
Management believes that the allowance for loan losses at March 31, 2023 was appropriate to absorb expected losses in the loan portfolio. Changes in the
circumstances of particular borrowers, as well as adverse developments in the economy, are factors that could change, and management will make adjustments to the allowance for credit losses as needed. Asset quality will continue to remain a key focus
of the Company as management continues to stress not just loan growth, but quality in loan underwriting.
Deposits
Deposits continue to be the most significant source of funds used by the Company to meet obligations for depositor withdrawals, fund the
borrowing needs of loan customers, and fund ongoing operations. Total deposits at March 31, 2023 increased $53,540, or 5.2%, from year-end 2022. This change in deposits came primarily from interest-bearing deposit balances, which were up by $68,359, or
10.2%, from year-end 2022, while noninterest-bearing deposits decreased $14,819, or 4.2%, from year-end 2022.
The increase in interest-bearing deposits came primarily from time deposit balances, which increased $99,678, or 65.6%, from year-end
2022. The increase came from brokered CD issuances, which were up collectively by $58,707, primarily to manage the Company’s tightened liquidity position during the first quarter of 2023. Further increases came from retail time deposits, which
increased $40,971 from year-end 2022. As market rates increased during 2022, deposit rates began adjusting upward during the second half of 2022 and into 2023. This contributed to higher rate offerings on CD products, influencing a consumer shift away
from lower-cost savings and money market products and into more higher-cost time deposit products.
Also impacting deposit balance growth were higher interest-bearing NOW account balances from year-end 2022, which increased $4,055, or
1.9%. This increase was largely driven by higher municipal NOW product balances, particularly within the Gallia County, Ohio, and Mason County, West Virginia, market areas.
Partially offsetting the increases in time deposit and NOW accounts were decreases in other interest-bearing balances that include money
market deposits (down $27,626) and savings deposits (down $7,748). Elevated deposit rates on CD products and deposit rate competition were contributing factors to the deposit decreases.
The decrease in noninterest-bearing demand deposits came primarily from the Company’s business and incentive-based checking account
balances.
While facing increased competition for deposits in its market areas, the Company will continue to emphasize growth and retention in its
core deposit relationships during the remainder of 2023, reflecting the Company’s efforts to reduce its reliance on higher cost funding and improve net interest income.
Other Borrowed Funds
Other borrowed funds were $17,330 at March 31, 2023, a decrease of $615, or 3.4%, from year-end 2022. The decrease was related to the
ongoing monthly principal repayments of FHLB advances. While deposits continue to be the primary source of funding for growth in earning assets, management will continue to utilize FHLB advances and promissory notes to help manage interest rate
sensitivity and liquidity.
Shareholders’ Equity
Total shareholders' equity at March 31, 2023 increased $2,517, or 1.9%, to finish at $137,545, as compared to $135,028 at December 31,
2022. This was primarily from quarterly net income and an increase in the fair value of available for sale securities, partially offset by cash dividends paid and a transition adjustment related to the adoption of ASC 326. The after-tax change in fair
value totaled $1,695 from year-end 2022, as long-term market rates decreased during the first three months of 2023, causing an increase in the fair value of the Company’s available for sale investment portfolio. The after-tax impact from the adoption
of ASC totaled $2,209 and was applied against retained earnings effective January 1, 2023.
Comparison of Results of Operations
For the Three Months Ended
March 31, 2023 and 2022
The following discussion focuses, in more detail, on the consolidated results of operations of the Company for the three months ended
March 31, 2023, compared to the same period in 2022. This discussion should be read in conjunction with the interim consolidated financial statements and the footnotes included in this Form 10‑Q.
Net Interest Income
The most significant portion of the Company's revenue, net interest income, results from properly managing the spread between interest income on earning
assets and interest expense incurred on interest-bearing liabilities. During the three months ended March 31, 2023, net interest income increased $1,732, or 17.3%, compared to the same period in 2022. The improvement came from higher earning asset
yields completely offsetting higher average costs paid on deposits, combined with a composition shift into higher-yielding loans.
Total interest and fee income recognized on the Company’s earning assets increased $3,137, or 29.4%, during the first quarter of 2023, compared to the same
period in 2022. The earnings growth was impacted by interest on loans, which increased $2,478, or 25.3%. This improvement was largely related to average loan yield increases impacted by the aggressive actions taken by the Federal Reserve to increase
rates during 2022 and 2023. Since the end of March 2022, the Federal Reserve has increased rates by another 450 basis points, which contributed to the repricing of a portion of the Company’s loan portfolio. As a result, the average interest rate yield
on loans increased 71 basis points to 5.62% during the first quarter of 2023, compared to 4.91% during the first quarter of 2022. Average loans increased $78,563 during the first quarter of 2023, compared to the first quarter of 2022. The
quarter-to-date increase was largely impacted by growth in average commercial and consumer loans.
Total interest income from interest-bearing deposits with banks increased $372 during the first quarter of 2023, compared to the same period in 2022. The
increase was largely from the rate increases associated with the Company’s interest-bearing Federal Reserve Bank clearing account. As previously mentioned, the Federal Reserve took action during 2022 to increase short-term rates due to rising
inflationary concerns. Since the end of March 2022, the target federal funds rate has increased by another 450 basis points. This had a corresponding effect to the interest rate tied to the Federal Reserve clearing account, which also increased by 450
basis points during that time. The impact from higher rates was partially offset by lower average Federal Reserve Bank balances, which decreased $92,224 during the first quarter of 2023, compared to the same period in 2022. The Company utilized Federal
Reserve Bank balances to help fund new loans and manage the net decrease in average deposits during that time.
Total interest on securities increased $258, or 34.8%, during the first quarter of 2023, compared to the same period in 2022. Contributing most to this
increase was the average yield on securities increasing 41 basis points to reach 1.91% during the first quarter of 2023. The average yield increase was positively impacted by the reinvestment of maturities at market rates higher than the average
portfolio yield. The average securities yield was also positively impacted by the Company’s decision to sell $12,500 in lower yielding securities during the fourth quarter of 2022 and use the proceeds to reinvest into higher-yielding securities.
However, with the Company’s focus of reinvesting excess funds into higher-yielding loans and managing excess funds within its higher-yielding Federal Reserve deposit account, average security balances have decreased $9,017 during the first quarter of
2023, compared to the same period in 2022.
Total interest expense incurred on the Company’s interest-bearing liabilities increased $1,405 during the first quarter of 2023, compared to the same period
in 2022. Increases in interest expense were impacted by a rise in average costs combined with increases in higher-costing average deposit balances. The elevated market rates in 2022 and 2023 had a more immediate impact to increasing rates on earning
assets, while the average cost of deposits did not increase until the second half of 2022. Entering 2023, rates on the Company’s retail CD offerings have adjusted to much higher levels than a year ago, leading to more of a consumer demand to reinvest
from lower-cost savings and money market deposit products (average cost at 0.44%) into more time deposit products (average cost at 2.45%). Furthermore, the Company issued $62,707 in brokered CDs during the first quarter of 2023 at average costs ranging
from 4.5% to 4.6%. These wholesale deposits were used to manage liquidity constraints during the first quarter of 2023, but also contributed to the growth in interest expense over 2022. With deposit rates on the rise, the Company experienced a
composition shift from less lower-cost average savings, NOW and money market account balances (down $33,594) into more higher-cost average time deposit balances (up $30,229). As a result of the rate repricings on time deposits and the deposit shift
into higher-cost deposits, the Company’s total weighted average costs on interest-bearing deposits increased by 75 basis points from 0.29% at March 31, 2022, to 1.04% at March 31, 2023.
The Company’s net interest margin is defined as fully tax-equivalent net interest income as a percentage of average earning assets. During 2023, the
Company’s first quarter net interest margin improved to 4.21%, compared to 2022’s first quarter net interest margin of 3.51%. The quarterly margin increase was impacted by the actions taken by the Federal Reserve to increase rates during 2022 and 2023.
This had a direct impact to the rate repricings on the loan and securities portfolios, and the Federal Reserve Bank account, which had a positive impact on the margin. Margin enhancement also came from the redeployment of Federal Reserve Bank balances
into higher yielding loans. Partially offsetting these positive effects to the margin were increases in average deposit costs and the composition shift to higher-cost time deposit balances from a year ago. The Company’s primary focus is to invest its
funds into higher yielding assets, particularly loans, as opportunities arise. However, if loan balances do not continue to expand and remain a larger component of overall earning assets, the Company will face pressure within its net interest income
and margin improvement.
Provision for Credit Losses
The Company’s provision for credit losses expense totaled $489 during the three months ended March 31, 2023, an increase of $1,615 when compared to $1,126 in
negative provision expense during the three months ended March 31, 2022. For 2023, the provision expense came primarily from $289 in net loan charge-offs, primarily in the commercial real estate and consumer loan portfolios. Further provision expense
on loans came from $176 in expected losses associated with the $22,441 increase in general loan balances from year-end 2022. For 2022, the negative provision expense was primarily impacted by the release of general loan reserves within the allowance
based on various credit quality improvements. During the first quarter of 2022, the Company released $645 in COVID-19 general reserves due to positive asset quality trends and lower net charge offs, which resulted in a corresponding decrease of $645 to
provision expense in March 2022. Further contributing to negative provision expense during the first quarter of 2022 was the release of $574 in other general reserves. This reduction in other general reserves was affected by various improvements within
the economic risk factor calculation that included: lower criticized and classified assets, lower delinquency levels, and higher annualized level of loan recoveries. This resulted in a corresponding decrease of $574 to provision expense in March 2022.
Credit loss expense during the first quarter of 2023 also came from unfunded commitments on off-balance sheet liabilities. Upon adoption of ASC 326, the
Company established $631 in reserves for unfunded commitments within total liabilities on the consolidated balance sheet. This transition adjustment was included as a charge to retained earnings on January 1, 2023. The Company re-evaluated its unfunded
commitments to extend credit at March 31, 2023 and determined a reserve of $655 was required, which resulted in a $24 provision expense charge during the first quarter of 2023.
Future provisions to the allowance for credit losses will continue to be based on management’s quarterly in-depth evaluation that is discussed in further
detail under the caption “Critical Accounting Policies - Allowance for Loan Losses” within this Management’s Discussion and Analysis (this “MD&A”).
Noninterest Income
Noninterest income increased $47, or 1.3%, during the three months ended March 31, 2023, compared to the same period in 2022. Higher noninterest revenue was
largely impacted by increases in other noninterest income, which increased $263 over 2022. This was primarily from broker fee income of $231 at Race Day recorded during the first quarter of 2023. Beginning in the fourth quarter of 2022, Race Day
transitioned from originating and selling loans to a broker that identifies and matches home borrowers with potential lenders, while also assisting in the underwriting process. This transition is a result of the Company’s decision to discontinue
operations of Race Day, as discussed above. The broker fees represent commissions earned by Race Day for mortgage application referrals at the time the loan was funded by the lender. The Company does not expect to continue to receive this level of
broker fee commissions during the second quarter of 2023 as it is anticipated that Race Day will continue to wind down operations.
Partially offsetting the increase in other noninterest income was a $188, or 80.0%, decrease in mortgage banking income affected by a lower volume of real
estate loans sold to the secondary market in 2023. During periods of heavy refinancing due to lower market rates, the Company will take opportunities to sell a portion of its real estate volume to the secondary market to satisfy consumer demand and
help minimize the interest rate risk exposure to rising rates. However, market rates have continued to shift upward in 2023, causing long-term mortgage rates to increase and slow down the consumer demand for long-term, fixed-rate real estate mortgages.
As a result, the Bank’s mortgage banking income decreased $92 and Race Day’s mortgage banking income decreased $96 during the first quarter of 2023, compared to the first quarter of 2022. The impact to Race Day was largely due to their transition to
broker activity as previously discussed.
The remaining noninterest income categories decreased $28, or 0.9%, during the first quarter of 2023, compared to the first quarter of 2022. The net decrease
came primarily from bank owned life insurance and annuity asset income (down $67), and tax preparation fees (down $57), partially offset by increases in service charges on deposit accounts (up $53), and debit/credit card interchange income (up $38).
Noninterest Expense
Noninterest expense increased $484, or 4.9%, during the first quarter of 2023, compared to the same period in 2022. Contributing most to the increase in
noninterest expense were salaries and employee benefits, which increased $314 during the first quarter of 2023, compared to the same period in 2022. The expense
increase was largely from annual performance- based merit increases that were recorded in the first quarter of 2023.
Higher noninterest expense also came from software costs, which increased $59 during the first quarter of 2023, compared to the same period in 2022. The
increase was largely impacted by various software purchases and enhancements at the Bank to further improve operational efficiencies in 2023.
Further impacting higher overhead costs were FDIC premium costs, which increased $56 during the first quarter of 2023, compared to the same period in 2022.
During the fourth quarter of 2022, the FDIC announced it was going to increase initial base deposit insurance assessment rate schedules uniformly by 2 basis points beginning in the first quarterly assessment period of 2023. This action by the FDIC is
in response to the Deposit Insurance Fund reserve falling below the 1.35% minimum level in the second quarter of 2020 following outsized growth in insured deposits in the first half of 2020. The Bank adjusted its premium expense accrual in anticipation
of the 2-basis point adjustment increase to all quarterly assessments during 2023.
Also contributing to higher noninterest expense were data processing expenses, which increased $48 during the first quarter of 2023, compared to the same
period in 2022. Higher costs in this category were the direct result of special programming costs associated with enhancing mobile and desktop user platforms, as well as the volume increase in debit card transactions, which increased processing costs.
Partially offsetting the increases in noninterest expense were lower professional fees, which decreased $56 during the first quarter of 2023, compared to the
same period in 2022. Professional fees for the year were impacted by lower accounting expenses in relation to higher-than-normal costs in 2022 that were associated with adhering to new regulatory guidance in 2022. The Company also experienced a lower volume of collection costs during the first quarter of 2023.
The remaining noninterest expense categories increased $63, or 2.6%,
during the first quarter of 2023, compared to the same period in 2022. The net increase came primarily from other noninterest expense (up $37) impacted by higher loan closing costs, net occupancy/furniture/equipment expense (up $16), and marketing
costs (up $12).
Efficiency
The Company’s efficiency ratio is defined as noninterest expense as a percentage of fully tax-equivalent net interest income plus noninterest income. The
effects from provision expense are excluded from the efficiency ratio. Management continues to place emphasis on managing its balance sheet mix and interest rate sensitivity as well as developing more innovative ways to generate noninterest revenue.
Comparing the three months ended March 31, 2023 to the same period in 2022, the Company has benefited from an increase in earning asset yields due to market rate increases by the Federal Reserve, and a higher composition of higher-yielding loans. These
positive factors have completely offset the negative effects of higher average costs on interest-bearing liabilities and a deposit shift to more higher-cost time deposit balances. As a result, net interest income during the three months ended March 31,
2023 has outperformed the net interest income results during the same period in 2022. Increases in overhead costs associated with annual merit increases have contributed to higher noninterest expense, which was up 4.9% during the three months ended
March 31, 2023, compared to the same periods in 2022. However, the increases in overhead expense, net of noninterest revenue, during the first quarter of 2023 are only partially offsetting the benefits of higher net interest earnings. As a result, the
Company’s quarterly efficiency number decreased (improved) to 65.7% during the three months ended March 31, 2023, from 70.8% during the same period in 2022.
Provision for income taxes
The Company’s income tax provision decreased $103 during the three months ended March 31, 2023, compared to the same period in 2022. The change in tax
expense corresponded directly to the change in associated taxable income during 2023 and 2022.
Capital Resources
Federal regulators have classified and defined capital into the following components: (i) Tier 1 capital, which includes tangible
shareholders’ equity for common stock, qualifying preferred stock and certain qualifying hybrid instruments, and (ii) Tier 2 capital, which includes a portion of the allowance for loan losses, certain qualifying long-term debt, preferred stock and
hybrid instruments which do not qualify as Tier 1 capital.
In September 2019, consistent with Section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act, the federal banking
agencies issued a final rule providing simplified capital requirements for certain community banking organizations (banks and holding companies). Under the rule, a qualifying community banking organization (“QCBO”) is eligible to opt into the Community
Bank Leverage Ratio (“CBLR”) framework in lieu of the Basel III capital requirements if it has less than $10 billion in total consolidated assets, limited amounts of certain trading assets and liabilities, limited amounts of off-balance sheet exposure
and a leverage ratio greater than 9.0%. The new rule took effect January 1, 2020, and QCBOs were allowed to opt into the new CBLR framework in their Call Report beginning the first quarter of 2020.
A QCBO opting into the CBLR framework must maintain a CBLR of 9.0%, subject to a two-quarter grace period to come back into compliance,
provided that the QCBO maintains a leverage ratio of more than 8.0% during the grace period. A QCBO failing to satisfy these requirements must comply with the existing Basel III capital requirements as implemented by the banking regulators in July
2013.
The Bank opted into the CBLR, and will, therefore, not be required to comply with the Basel III capital requirements The numerator of the
CBLR is Tier 1 capital, as calculated under present rules. The denominator of the CBLR is the QCBO’s average assets, calculated in accordance with the QCBO’s Call Report instructions and less assets deducted from Tier 1 capital. The current rules and
Call Report instructions were impacted by the Company’s adoption of ASC 326 and its election to apply the 3-year CECL transition provision on January 1, 2023. By making this election, the Bank, in accordance with Section 301 of the regulatory capital
rules, will increase it retained earnings (Tier 1 Capital) and average assets by 75% of its CECL transition amount during the first year of the transition period, 50% of its CECL transition amount during the second year, and 25% of its CECL
transitional amount during the third year of the transition period. The Bank’s transition amount from the adoption of CECL totaled $2,276, which resulted in the add-back of $1,707 to both Tier 1 capital and average assets as part of the CBLR
calculation for March 31, 2023. As of March 31, 2023, the Bank’s CBLR was 11.22%.
Cash dividends paid by the Company were $1,002 during the first three months of 2023. The year-to-date dividends paid totaled $0.21 per share.
Liquidity
Liquidity relates to the Company's ability to meet the cash demands and credit needs of its customers and is provided by the ability to readily convert
assets to cash and raise funds in the marketplace. Total cash and cash equivalents, held to maturity securities maturing within one year, and available for sale securities, which totaled $270,186, represented 21.3% of total assets at March 31, 2023
compared to $230,853 and 19.1% of total assets at December 31, 2022. This higher composition of liquidity was largely impacted by growth in time deposits, which increased 65.6% from year-end 2022. Of the Company's $251,597 in time deposit balances at
March 31, 2023, only 21.9%, or $55,043, were deemed uninsured as per the $250 FDIC threshold. To further enhance the Bank’s ability to meet liquidity demands, the FHLB offers advances to the Bank. At March 31, 2023, the Bank could borrow an additional
$101,748 from the FHLB. Furthermore, the Bank has established a borrowing line with the Federal Reserve, which had availability of $58,204 at March 31, 2023. Lastly, the Bank also has the ability to purchase federal funds from a correspondent bank. As
our liquidity position dictates, the preceding funding sources, or other sources such as brokered CD’s, may be utilized to supplement our liquidity position. For further cash flow information, see the condensed consolidated statement of cash flows
above. Management does not rely on any single source of liquidity and monitors the level of liquidity based on many factors affecting the Company’s financial condition.
Off-Balance Sheet Arrangements
As discussed in Note 5 – Financial Instruments with Off-Balance Sheet Risk, the Company engages in certain off-balance sheet credit-related activities,
including commitments to extend credit and standby letters of credit, which could require the Company to make cash payments in the event that specified future events occur. 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. Standby letters of credit are conditional commitments to guarantee the
performance of a customer to a third party. While these commitments are necessary to meet the financing needs of the Company’s customers, many of these commitments are expected to expire without being drawn upon. Therefore, the total amount of
commitments does not necessarily represent future cash requirements.
Critical Accounting Policies
The most significant accounting policies followed by the Company are presented in Note A to the financial statements in the Company’s 2022 Annual Report to
Shareholders, as updated in Note 1 of the Notes to Unaudited Consolidated Financial Statements in this Quarterly Report on Form 10-Q. These policies, along with the disclosures presented in the other financial statement notes, provide information on
how significant assets and liabilities are valued in the financial statements and how those values are determined. Management views critical accounting policies to be those which are highly dependent on subjective or complex judgments, estimates and
assumptions, and where changes in those estimates and assumptions could have a significant impact on the financial statements. Management currently views the adequacy
of the allowance for credit losses to be a critical accounting policy.
Allowance for credit losses
The Company believes the determination of the allowance for credit losses involves a higher degree of judgment and complexity than its other significant
accounting policies. The allowance for credit losses is calculated with the objective of maintaining a reserve level believed by management to be sufficient to absorb estimated credit losses over the life of an asset or off-balance sheet credit
exposure. Management’s determination of the adequacy of the allowance for credit losses is based on periodic evaluations of past events, including historical credit loss experience on financial assets with similar risk characteristics, current
conditions, and reasonable and supportable forecasts that affect the collectability of the remaining cash flows over the contractual term of the financial assets. However, this evaluation has subjective components requiring material estimates,
including expected default probabilities, the expected loss given default, the amounts and timing of expected future cash flows on impaired loans, and estimated losses based on historical loss experience and forecasted economic conditions. All of these
factors may be susceptible to significant change. To the extent that actual results differ from management estimates, additional provisions for credit losses may be required that would adversely impact earnings in future periods. Refer to “Allowance
for Credit Losses” and “Provision for Credit Losses” sections within this MD&A for additional discussion.
Concentration of Credit Risk
The Company maintains a diversified credit portfolio, with residential real estate loans currently comprising the most significant portion. Credit risk is
primarily subject to loans made to businesses and individuals in southeastern Ohio and western West Virginia. Management believes this risk to be general in nature, as there are no material concentrations of loans to any industry or consumer group. To
the extent possible, the Company diversifies its loan portfolio to limit credit risk by avoiding industry concentrations.