Middlefield Banc (MBCN) 10-Q 2022 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

☒       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended Septmeber 30, 2022

or

☐       TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ___________ to ___________

Commission File Number  001-36613

Middlefield Banc Corp.

(Exact Name of Registrant as Specified in its Charter)

Ohio	34-1585111
State or Other Jurisdiction of	I.R.S. Employer Identification No.
Incorporation or Organization
15985 East High Street, Middlefield, Ohio	44062-0035
Address of Principal Executive Offices	Zip Code

440-632-1666

Registrant’s Telephone Number, Including Area Code

Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report

Securities Registered Pursuant to Section 12(b) of the Act:
	Title of Each Class	Trading Symbol(s)	Name of Each Exchange on Which Registered
	Common Stock, Without Par Value	MBCN	The NASDAQ Stock Market, LLC
			(NASDAQ Capital Market)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒     No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required
to submit such files).  Yes ☒    No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
	Large accelerated filer ☐			Accelerated filer ☐
	Non-accelerated filer ☒			Smaller reporting company ☒
	Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐   No ☒
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Outstanding at November 11, 2022:  5,767,803

MIDDLEFIELD BANC CORP.

INDEX

Part I – Financial Information
Item 1.	Financial Statements (unaudited)
	Consolidated Balance Sheet as of September 30, 2022 and December 31, 2021	3
	Consolidated Statement of Income for the Three and Nine Months ended September 30, 2022 and 2021	4
	Consolidated Statement of Comprehensive Income for the Three and Nine Months ended September 30, 2022 and 2021	5
	Consolidated Statement of Changes in Stockholders' Equity for the Three and Nine Months ended September 30, 2022 and 2021	6
	Consolidated Statement of Cash Flows for the Nine Months ended September 30, 2022 and 2021	8
	Notes to Unaudited Consolidated Financial Statements	10
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	33
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	48
Item 4.	Controls and Procedures	49
Part II – Other Information
Item 1.	Legal Proceedings	50
Item 1a.	Risk Factors	50
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	50
Item 3.	Defaults Upon Senior Securities	50
Item 4.	Mine Safety Disclosures	50
Item 5.	Other Information	50
Item 6.	Exhibits	51
Signatures		56
Exhibit 31.1
Exhibit 31.2
Exhibit 32

2

MIDDLEFIELD BANC CORP.

CONSOLIDATED BALANCE SHEET

(Dollar amounts in thousands, except share data)

(Unaudited)

	September 30,			December 31,
	2022			2021
ASSETS
Cash and due from banks	$	119,777		$	97,172
Federal funds sold		8,800			22,322
Cash and cash equivalents		128,577			119,494
Equity securities, at fair value		972			818
Investment securities available for sale, at fair value		162,064			170,199
Loans held for sale		-			1,051
Loans:
Commercial real estate:
Owner occupied		120,912			111,470
Non-owner occupied		285,419			283,618
Multifamily		38,063			31,189
Residential real estate		247,612			240,089
Commercial and industrial		146,987			148,812
Home equity lines of credit		114,344			104,355
Construction and other		33,748			54,148
Consumer installment		8,110			8,010
Total loans		995,195			981,691
Less: allowance for loan and lease losses		14,532			14,342
Net loans		980,663			967,349
Premises and equipment, net		16,215			17,272
Goodwill		15,071			15,071
Core deposit intangibles		1,171			1,403
Bank-owned life insurance		17,382			17,060
Other real estate owned		6,792			6,992
Accrued interest receivable and other assets		22,104			14,297
TOTAL ASSETS	$	1,351,011		$	1,331,006
LIABILITIES
Deposits:
Noninterest-bearing demand	$	383,675		$	334,171
Interest-bearing demand		160,112			196,308
Money market		162,052			177,281
Savings		247,466			260,125
Time		177,182			198,725
Total deposits		1,130,487			1,166,610
Short-term borrowings:
Federal Home Loan Bank advances		80,000			-
Total short-term borrowings		80,000			-
Other borrowings		12,107			12,901
Accrued interest payable and other liabilities		5,562			6,160
TOTAL LIABILITIES		1,228,156			1,185,671
STOCKHOLDERS' EQUITY
Common stock, no par value; 10,000,000 shares authorized, 7,350,616 and 7,330,548 shares issued; 5,767,803 and 5,888,737 shares outstanding		87,640			87,131
Retained earnings		93,166			83,971
Accumulated other comprehensive (loss) income		(25,080	)		3,462
Treasury stock, at cost; 1,582,813 and 1,441,811 shares		(32,871	)		(29,229	)
TOTAL STOCKHOLDERS' EQUITY		122,855			145,335
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	1,351,011		$	1,331,006

See accompanying notes to unaudited consolidated financial statements.

3

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF INCOME

(Dollar amounts in thousands, except per share data)

(Unaudited)

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2022			2021		2022			2021
INTEREST AND DIVIDEND INCOME
Interest and fees on loans	$	11,892		$	12,258	$	34,145		$	36,310
Interest-earning deposits in other institutions		134			30		232			60
Federal funds sold		51			1		100			2
Investment securities:
Taxable interest		449			461		1,334			1,241
Tax-exempt interest		982			673		2,721			1,833
Dividends on stock		59			24		116			79
Total interest and dividend income		13,567			13,447		38,648			39,525
INTEREST EXPENSE
Deposits		812			915		2,247			3,130
Short-term borrowings		44			-		44			-
Other borrowings		112			68		262			214
Total interest expense		968			983		2,553			3,344
NET INTEREST INCOME		12,599			12,464		36,095			36,181
Provision for loan losses		-			-		-			900
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		12,599			12,464		36,095			35,281
NONINTEREST INCOME
Service charges on deposit accounts		1,004			876		2,874			2,519
(Loss) gain on equity securities		(57	)		102		(96	)		223
Earnings on bank-owned life insurance		108			108		322			440
Gain on sale of loans		7			309		28			1,122
Revenue from investment services		233			190		527			529
Other income		251			236		677			838
Total noninterest income		1,546			1,821		4,332			5,671
NONINTEREST EXPENSE
Salaries and employee benefits		4,491			4,488		12,662			13,063
Occupancy expense		458			426		1,546			1,506
Equipment expense		233			333		822			1,003
Data processing and information technology costs		985			845		2,650			2,447
Ohio state franchise tax		293			287		878			859
Federal deposit insurance expense		84			150		224			444
Professional fees		280			136		1,118			878
Net gain on other real estate owned		1			9		215			77
Advertising expense		268			222		725			664
Software amortization expense		27			88		115			242
Core deposit intangible amortization		78			81		232			241
Merger-related costs		390			-		969			-
Other expense		1,298			842		3,531			2,694
Total noninterest expense		8,886			7,907		25,687			24,118
Income before income taxes		5,259			6,378		14,740			16,834
Income taxes		1,010			1,174		2,569			3,038
NET INCOME	$	4,249		$	5,204	$	12,171		$	13,796
EARNINGS PER SHARE
Basic	$	0.73		$	0.85	$	2.08		$	2.20
Diluted	$	0.73		$	0.85	$	2.08		$	2.19

See accompanying notes to unaudited consolidated financial statements.

4

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF COMPREHENSIVE (LOSS) INCOME

(Dollar amounts in thousands)

(Unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2022			2021			2022			2021
Net income	$	4,249		$	5,204		$	12,171		$	13,796
Other comprehensive loss:
Net unrealized holding loss on available-for-sale investment securities		(9,479	)		(358	)		(36,129	)		(853	)
Tax effect		1,990			75			7,587			179
Total other comprehensive loss		(7,489	)		(283	)		(28,542	)		(674	)
Comprehensive (loss) income	$	(3,240	)	$	4,921		$	(16,371	)	$	13,122

See accompanying notes to unaudited consolidated financial statements.

5

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(Dollar amounts in thousands, except share and per share data)

(Unaudited)

								Accumulated
								Other						Total
	Common Stock				Retained			Comprehensive			Treasury			Stockholders'
	Shares		Amount		Earnings			(Loss) Income			Stock			Equity
Balance, June 30, 2022		7,347,526	$	87,562	$	89,900		$	(17,591	)	$	(31,651	)	$	128,220
Net income						4,249									4,249
Other comprehensive loss									(7,489	)					(7,489	)
Stock-based compensation, net		3,090		78											78
Treasury shares acquired (45,638)												(1,220	)		(1,220	)
Cash dividends ($0.17 per share)						(983	)								(983	)
Balance, September 30, 2022		7,350,616	$	87,640	$	93,166		$	(25,080	)	$	(32,871	)	$	122,855

								Accumulated
								Other						Total
	Common Stock				Retained			Comprehensive			Treasury			Stockholders'
	Shares		Amount		Earnings			(Loss) Income			Stock			Equity
Balance, June 30, 2021		7,325,918	$	87,131	$	76,150		$	3,893		$	(21,130	)	$	146,044
Net income						5,204									5,204
Other comprehensive loss									(283	)					(283	)
Stock-based compensation, net		3,630													-
Treasury shares acquired (165,058)												(3,932	)		(3,932	)
Cash dividends ($0.16 per share)						(978	)								(978	)
Balance, September 30, 2021		7,329,548	$	87,131	$	80,376		$	3,610		$	(25,062	)	$	146,055

(continued on following page)

See accompanying notes to unaudited consolidated financial statements.

6

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(Dollar amounts in thousands, except share and per share data)

(Unaudited, continued from previous page)

								Accumulated
								Other						Total
	Common Stock				Retained			Comprehensive			Treasury			Stockholders'
	Shares		Amount		Earnings			(Loss) Income			Stock			Equity
Balance, December 31, 2021		7,330,548	$	87,131	$	83,971		$	3,462		$	(29,229	)	$	145,335
Net income						12,171									12,171
Other comprehensive loss									(28,542	)					(28,542	)
Stock-based compensation, net		20,068		509											509
Treasury shares acquired (141,002)												(3,642	)		(3,642	)
Cash dividends ($0.51 per share)						(2,976	)								(2,976	)
Balance, September 30, 2022		7,350,616	$	87,640	$	93,166		$	(25,080	)	$	(32,871	)	$	122,855

								Accumulated
								Other						Total
	Common Stock				Retained			Comprehensive			Treasury			Stockholders'
	Shares		Amount		Earnings			(Loss) Income			Stock			Equity
Balance, December 31, 2020		7,308,685	$	86,886	$	69,578		$	4,284		$	(16,938	)	$	143,810
Net income						13,796									13,796
Other comprehensive loss									(674	)					(674	)
Stock options exercised		10,650		94											94
Stock-based compensation, net		10,213		151											151
Treasury shares acquired (346,103)												(8,124	)		(8,124	)
Cash dividends ($0.48 per share)						(2,998	)								(2,998	)
Balance, September 30, 2021		7,329,548	$	87,131	$	80,376		$	3,610		$	(25,062	)	$	146,055

See accompanying notes to unaudited consolidated financial statements.

7

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF CASH FLOWS

(Dollar amounts in thousands)

(Unaudited)

	Nine Months Ended
	September 30,
	2022			2021
OPERATING ACTIVITIES
Net income	$	12,171		$	13,796
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		-			900
Loss (gain) on equity securities		96			(223	)
Depreciation and amortization of premises and equipment, net		968			1,075
Software amortization expense		115			242
Financing lease amortization expense		114			235
Amortization of premium and  discount on investment securities, net		470			351
Accretion of deferred loan fees, net		(1,678	)		(3,750	)
Amortization of core deposit intangibles		232			241
Stock-based compensation income, net		113			(21	)
Origination of loans held for sale		(1,341	)		(30,309	)
Proceeds from sale of loans		1,636			31,633
Gain on sale of loans		(28	)		(1,122	)
Earnings on bank-owned life insurance		(322	)		(440	)
Deferred income tax		48			281
Loss on other real estate owned		-			28
Other real estate owned writedowns		200			-
(Increase) decrease in accrued interest receivable		(143	)		818
Increase (decrease) in accrued interest payable		94			(275	)
Other, net		(271	)		(2,177	)
Net cash provided by operating activities		12,474			11,283
INVESTING ACTIVITIES
Investment securities available for sale:
Proceeds from repayments and maturities		3,576			9,528
Purchases		(32,290	)		(59,429	)
(Increase) decrease in loans, net		(10,852	)		97,365
Proceeds from the sale of other real estate owned		-			332
Proceeds from bank-owned life insurance		-			424
Net purchase of premises and equipment		(636	)		(417	)
Purchase of restricted stock		(1,448	)		-
Redemption of restricted stock		1,183			658
Net cash (used in) provided by investing activities		(40,467	)		48,461
FINANCING ACTIVITIES
Net decrease in deposits		(36,123	)		(24,643	)
Increase in short-term borrowings, net		80,000			-
Repayment of other borrowings		(183	)		(4,139	)
Stock options exercised		-			94
Repurchase of treasury shares		(3,642	)		(8,124	)
Cash dividends		(2,976	)		(2,998	)
Net cash provided (used in) by financing activities		37,076			(39,810	)
Increase in cash and cash equivalents		9,083			19,934
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		119,494			112,417
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	128,577		$	132,351

See accompanying notes to unaudited consolidated financial statements.

8

	Nine Months Ended
	September 30,
	2022			2021
SUPPLEMENTAL INFORMATION
Cash paid during the year for:
Interest on deposits and borrowings	$	2,459		$	3,520
Income taxes		2,727			4,328
Noncash investing transactions:
Transfers from loans held for sale to loans held for investment	$	784		$	63
Transfers from loans to other real estate owned		-			-
Decrease (increase) in finance lease assets included in premises and equipment		611			(67	)
Noncash financing transactions:
(Decrease) increase in finance lease liabilities included in other borrowings	$	(611	)	$	67

See accompanying notes to unaudited consolidated financial statements.

9

MIDDLEFIELD BANC CORP.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - BASIS OF PRESENTATION

The consolidated financial statements of Middlefield Banc Corp. ("Company") include its bank subsidiary, The Middlefield Banking Company (“MBC” or “Middlefield Bank”), and a nonbank asset resolution subsidiary EMORECO, Inc. The consolidated financial statements also include the accounts of MBC’s subsidiaries, Middlefield Investments, Inc. (MI) and Middlefield Insurance Services. All significant inter-company items have been eliminated.

In the first quarter of 2022, MBC established a wholly-owned subsidiary named Middlefield Insurance Services (MIS), headquartered in Middlefield, Ohio. This operating subsidiary exists to offer retail and business customers a variety of insurance services, including home, renters, automobile, pet, identity theft, travel, and professional liability insurance. At September 30, 2022, MIS’s assets consist of a cash account, a prepaid asset, and an accounts receivable. All significant inter-company items have been eliminated between MBC and this subsidiary.

The unaudited condensed consolidated financial statements have been prepared in conformity with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements. The financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K for the year ended December 31, 2021. The interim consolidated financial statements include all adjustments (consisting of only normal recurring items) that, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the periods presented.  The results of operations for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year.  

In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts and liabilities as of the balance sheet date and revenues and expenses for the period. Actual results could differ from those estimates.

Recently Issued Accounting Pronouncements

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments, which changes the impairment model for most financial assets. This Update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The underlying premise of the Update is that financial assets measured at amortized cost should be presented at the net amount expected to be collected through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that is expected to occur over the remaining life of a financial asset. The income statement will be affected by the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. With certain exceptions, the transition to the new requirements will be through a cumulative-effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is adopted. This Update is effective for SEC filers that are eligible to be smaller reporting companies, non-SEC filers, and all other companies, to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. We expect to recognize a one-time cumulative-effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements. Management will continue to monitor model output throughout the deferral period.

Current Expected Credit Loss (CECL) Adoption The Company continues to monitor the opportunity to early adopt ASC Topic 326, which replaces the current incurred loss approach for measuring credit losses with an expected loss model. CECL applies to financial assets subject to credit losses and measured at amortized cost and certain off-balance-sheet credit exposures, which include, but are not limited to, loans, leases, held-to-maturity securities, loan commitments, and financial guarantees. Expected results of adoption are challenging to forecast due to the evolving macroeconomic landscape. Early adoption of CECL is unlikely.

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. To simplify the subsequent measurement of goodwill, the FASB eliminated Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, under the amendments in this Update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The Update is effective for smaller reporting companies and all other entities for fiscal years beginning after December 15, 2022, and interim periods within those fiscal years. This Update is not expected to have a significant impact on the Company’s financial statements.

10

 

In November 2019, the FASB issued ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, to clarify its new credit impairment guidance in ASC 326, based on implementation issues raised by stakeholders. This Update clarified, among other things, that expected recoveries are to be included in the allowance for credit losses for these financial assets; an accounting policy election can be made to adjust the effective interest rate for existing troubled debt restructurings based on the prepayment assumptions instead of the prepayment assumptions applicable immediately prior to the restructuring event; and extends the practical expedient to exclude accrued interest receivable from all additional relevant disclosures involving amortized cost basis. For entities that have not yet adopted ASU 2016-13 as of November 26, 2019, the effective dates for ASU 2019-11 are the same as the effective dates and transition requirements in ASU 2016-13. For entities that have adopted ASU 2016-13, ASU 2019-11 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company qualifies as a smaller reporting company and does not expect to early adopt these ASUs.

In January 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, March 2020, to provide temporary optional expedients and exceptions to the U.S. GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from LIBOR and other interbank offered rates to alternative reference rates, such as the Secured Overnight Financing Rate. Entities can elect not to apply certain modification accounting requirements to contracts affected by what the guidance calls “reference rate reform” if certain criteria are met. An entity that makes this election would not have to remeasure the contracts at the modification date or reassess a previous accounting determination. Also, entities can elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform if certain criteria are met, and can make a one-time election to sell and/or reclassify held-to-maturity debt securities that reference an interest rate affected by reference rate reform. The amendments in this ASU are effective for all entities upon issuance through December 31, 2022. It is too early to predict whether a new rate index replacement and the adoption of the ASU will have a material impact on the Company’s financial statements.

In March 2022, the FASB issued ASU 2022-02, Financial Instruments—Credit Losses (Topic 326) - Troubled Debt Restructurings (TDR) and Vintage Disclosures to update the TDR guidance and required vintage disclosures in ASC 326, based on implementation issues raised by stakeholders. The amendments in this Update eliminate the accounting guidance for TDRs by creditors in Subtopic 310-40, Receivables—Troubled Debt Restructurings by Creditors, while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. Specifically, rather than applying the recognition and measurement guidance for TDRs, an entity must apply the loan refinancing and restructuring guidance in paragraphs 310-20-35-9 through 35-11 to determine whether a modification results in a new loan or a continuation of an existing loan. For public business entities, the amendments in this Update require that an entity disclose current-period gross write-offs by year of origination for financing receivables and net investments in leases within the scope of Subtopic 326-20, Financial Instruments—Credit Losses—Measured at Amortized Cost. The amendments in this ASU are effective for all entities upon adoption of ASU 2016-13.

In June 2022, the FASB issued ASU 2022-03, Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions. These amendments clarify that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value. This guidance is effective for public business entities for fiscal years including interim periods within those fiscal years beginning after December 15, 2023. Early adoption is permitted. The Company has assessed ASU 2022-03 and does not expect it to have a material impact on its accounting and disclosures.

Reclassification of Comparative Amounts

Certain comparative amounts for prior years have been reclassified to conform to current-year presentations. Such reclassifications did not affect net income or retained earnings.

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NOTE 2 – REVENUE RECOGNITION

Following ASC Topic 606, Revenue from Contracts with Customers (Topic 606), management determined that the primary sources of revenue, which emanate from interest income on loans and investments, along with noninterest revenue resulting from investment security gains (losses), gains on the sale of loans, and BOLI income, are not within the scope of ASC 606. These revenue sources cumulatively comprise 89.5% of the total revenue of the Company.

The main types of noninterest income within the scope of the standard are as follows:

Service charges on deposit accounts – The Company has contracts with its deposit customers where fees are charged if the account balance falls below predetermined levels defined as compensating balances. These agreements can be canceled at any time by either the Company or the deposit customer. Revenue from these transactions is recognized monthly as the Company has an unconditional right to the fee consideration. The Company also has transaction fees related to specific customer requests or activities that include overdraft fees, online banking fees, and other transaction fees. All of these fees are attributable to specific performance obligations of the Company where the revenue is recognized at a defined point in time, which is the completion of the requested service/transaction.

Net gains (losses) on sale of other real estate owned (“OREO”) – Gains and losses are recognized after the property sale when the buyer obtains control of the real estate, and all of the performance obligations of the Company have been satisfied. Evidence of the buyer obtaining control of the asset includes the transfer of the property title, physical possession of the asset, and the buyer securing control of the risks and rewards related to the asset. In situations where the Company agrees to provide financing to facilitate the sale, additional analysis is performed to ensure that the contract for sale identifies the buyer and seller, the asset to be transferred, the payment terms, that the contract has an actual commercial substance, and that amounts due from the buyer are reasonable. In situations where financing terms are not reflective of current market terms, the transaction price is discounted, impacting the gain/loss and the carrying value of the asset. Gains and losses on the sale of OREO are reported in the Consolidated Statement of Income.

Revenue from investment services – The Company earns investment services revenue through its servicing partnership with LPL Financial. The performance obligation to investment management customers is satisfied over time, and therefore, revenue is recognized over time.  The Company generally receives trailing investment services revenue in arrears and recognizes the revenue when the monthly statement is received.

Miscellaneous Fee income – Fees earned on other services, such as ATM surcharge fees, money order fees, and check fees, are recognized at the time of the event or the applicable billing cycle.

The following table depicts the disaggregation of revenue derived from contracts with customers to depict the nature, amount, timing, and uncertainty of revenue and cash flows:

	For the Three Months Ended September 30,					For the Nine Months Ended September 30,
Noninterest Income	2022			2021		2022			2021
(Dollar amounts in thousands)
Service charges on deposit accounts:
Overdraft fees	$	237		$	192	$	661		$	523
ATM banking fees		397			354		1,065			1,026
Service charges and other fees		370			330		1,148			970
(Loss) gain on equity securities (a)		(57	)		102		(96	)		223
Earnings on bank-owned life insurance (a)		108			108		322			440
Gain on sale of loans (a)		7			309		28			1,122
Revenue from investment services		233			190		527			529
Miscellaneous Fee income		83			75		222			192
Other income		168			161		455			646
Total noninterest income	$	1,546		$	1,821	$	4,332		$	5,671
Net loss (gain) on other real estate owned	$	1		$	9	$	215		$	77

(a) Not within scope of ASC 606

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NOTE 3 - STOCK-BASED COMPENSATION

The Company had no non-vested stock options outstanding as of September 30, 2022 and 2021.

There was no stock option activity during the three or nine months ended September 30, 2022.

The following table presents the activity during the nine months ended September 30, 2022, related to awards of restricted stock:

				Weighted-
				average
				Grant Date Fair
	Units			Value Per Unit
Nonvested at January 1, 2022		76,933		$	23.01
Granted		25,414			24.80
Vested		(25,263	)		20.95
Forfeited		(13,438	)		-
Nonvested at September 30, 2022		63,646		$	24.34
Expected to vest as of September 30, 2022		57,271		$	24.27

The Company recognizes restricted stock forfeitures in the period they occur.

Share-based compensation expense of $158,000 and $292,000 was recognized for the three-month periods ended September 30, 2022, and 2021, respectively. Share-based compensation expense of $113,000 and $389,000 was recognized for the nine-month periods ended September 30, 2022, and 2021, respectively. Expense recovery is the result of a decrease in the market valuation of the plans. Vesting of shares under the plan is contingent on a combination of service period and a market condition tied to the total shareholder return on the Company’s stock. A change in market conditions leads to adjustments to the probability of the market condition achievement, which results in changes in the liability and the compensation expense. Since the shares of restricted stock are historically paid out at the vesting date in a combination of shares and cash, the Company has recorded a liability related to this plan which totals $498,000 and $887,000 on September 30, 2022, and 2021, respectively. When the shares vest, the amount distributed in shares is transferred to common stock and the remainder is distributed in cash.

Total unrecognized stock compensation cost related to non-vested share-based compensation on restricted stock as of September 30, 2022 totals $546,000, of which $88,000 is estimated for the rest of 2022, $291,000 for 2023, $149,000 for 2024, and $18,000 for 2025.

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NOTE 4 - EARNINGS PER SHARE

The Company provides a dual presentation of basic and diluted earnings per share. Basic earnings per share is calculated by dividing net income by the average shares outstanding. Diluted earnings per share adds the dilutive effects of stock options and restricted stock to average shares outstanding.

The following table sets forth the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings-per-share computation.

	For the Three						For the Nine
	Months Ended						Months Ended
	September 30,						September 30,
	2022			2021			2022			2021
Weighted-average common shares issued		7,350,616			7,329,548			7,345,520			7,323,936
Average treasury stock shares		(1,557,843	)		(1,192,900	)		(1,504,763	)		(1,058,133	)
Weighted-average common shares and common stock equivalents used to calculate basic earnings per share		5,792,773			6,136,648			5,840,757			6,265,803
Additional common stock equivalents (stock options and restricted stock) used to calculate diluted earnings per share		13,026			20,533			13,026			21,753
Weighted-average common shares and common stock equivalents used  to calculate diluted earnings per share		5,805,799			6,157,181			5,853,783			6,287,556

Outstanding on September 30, 2022, were 63,646 shares of restricted stock, 50,620 shares of which were anti-dilutive.

Outstanding on September 30, 2021 were 77,933 shares of restricted stock, 57,400 shares of which were anti-dilutive.

When shares recognized as equity are repurchased, the amount of the consideration paid, which includes directly attributable costs, is recognized as a deduction from equity. Repurchased shares are classified as treasury shares and are presented in the treasury share reserve. The reserve for the Company’s treasury shares comprises the cost of the Company’s shares held by the Company. As of September 30, 2022, the Company held 1,582,813 of the Company’s shares, which is an increase of 141,002 from the 1,441,811 shares held as of December 31, 2021.

NOTE 5 - FAIR VALUE MEASUREMENTS

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. GAAP establishes a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following levels:

Level I: Quoted prices are available in active markets for identical assets or liabilities as of the reported date.

Level II: Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are fair-valued using other financial instruments, the parameters of which can be directly observed.

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Level III: Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

This hierarchy requires the use of observable market data when available.

The following tables present the assets measured on a recurring basis on the Consolidated Balance Sheet at their fair value by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

			September 30, 2022
(Dollar amounts in thousands)	Level I		Level II		Level III		Total
Assets measured on a recurring basis:
Subordinated debt	$	-	$	20,366	$	10,147	$	30,513
Obligations of states and political subdivisions		-		123,714		-		123,714
Mortgage-backed securities in government-sponsored entities		-		7,837		-		7,837
Total debt securities		-		151,917		10,147		162,064
Equity securities in financial institutions		972		-		-		972
Total	$	972	$	151,917	$	10,147	$	163,036

			December 31, 2021
(Dollar amounts in thousands)	Level I		Level II		Level III		Total
Assets measured on a recurring basis:
Subordinated debt	$	-	$	20,337	$	12,200	$	32,537
Obligations of states and political subdivisions		-		127,345		-		127,345
Mortgage-backed securities in government-sponsored entities		-		10,317		-		10,317
Total debt securities		-		157,999		12,200		170,199
Equity securities in financial institutions		818		-		-		818
Total	$	818	$	157,999	$	12,200	$	171,017

Investment Securities Available for Sale - An independent pricing service provides the Company fair values, which represent quoted prices for similar assets, fair values determined by pricing models using a market approach that considers observable market data, such as interest rate volatilities, LIBOR yield curve, credit spreads and prices from market makers and live trading systems (Level II). Level III securities are assets whose fair value cannot be determined by using observable measures. The inputs to the valuation methodology of these securities are unobservable and significant to the fair value measurement. Currently, this category includes certain subordinated debt investments that are valued based on the discounted cash flow approach assuming a yield curve of similarly structured instruments.

While the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of specific financial instruments could result in a different estimate of fair value at the reporting date. Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique.  Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction on the dates indicated.  The estimated fair value amounts have been measured as of their respective period-ends and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments following the respective reporting dates may be different from the amounts reported at each period-end.

Equity Securities - Equity securities that are traded on a national securities exchange are valued at their last reported sales price as of the measurement date. Equity securities traded in the over-the-counter (“OTC”) markets and listed securities for which no sale was reported on that date are generally valued at their last reported “bid” price if held long, and last reported “ask” price if sold short. To the extent equity securities are actively traded and valuation adjustments are not applied, they are categorized in Level I of the fair value hierarchy.

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The following table presents the fair value reconciliation of Level 3 assets measured at fair value on a recurring basis.

(Dollar amounts in thousands)
	Subordinated debt
Balance as of January 1, 2022	$	12,200
Transfers into Level III (1)		500
Transfers out of Level III (1)		(2,250	)
Net unrealized holding gain on available-for-sale investment securities		(303	)
Balance as of September 30, 2022	$	10,147

(1) Transfers between hierarchy levels are based on the availability of sufficient observable inputs to meet Level II versus Level III criteria. The level designation of each financial instrument is reassessed at the end of each period.

The following tables present the assets measured on a non-recurring basis on the Consolidated Balance Sheet at their fair value by level within the fair value hierarchy. Collateral-dependent impaired loans are carried at fair value if they have been charged down to fair value or if a specific valuation allowance has been established. A new cost basis is established at the time a property is initially recorded in OREO. OREO properties are carried at fair value if a devaluation has been taken to the property’s value after the initial measurement.

			September 30, 2022
(Dollar amounts in thousands)	Level I		Level II		Level III		Total
Assets measured on a non-recurring basis:
Other real estate owned		-		-	$	6,792	$	6,792

			December 31, 2021
(Dollar amounts in thousands)	Level I		Level II		Level III		Total
Assets measured on a non-recurring basis:
Impaired loans	$	-	$	-	$	4,162	$	4,162

Impaired Loans – The Company has measured impairment on collateral-dependent impaired loans generally based on the fair value of the loan’s collateral. Fair value is generally determined based on independent third-party appraisals of the properties. In some cases, management may adjust the appraised value due to the age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed. Additionally, management makes estimates about expected costs to sell the property, which are also included in the net realizable value. If the fair value of the collateral-dependent loan is less than the carrying amount of the loan, a specific reserve for the loan is made in the allowance for loan losses, or a charge-off is taken to reduce the loan to the fair value of the collateral (less estimated selling costs) and the loan is included in the above table as a Level III measurement. If the fair value of the collateral exceeds the carrying amount of the loan, then the loan is not included in the above table as it is not currently being carried at its fair value. The fair values in the above table exclude estimated selling costs of $901,000 as of December 31, 2021.

Other Real Estate Owned (OREO) – OREO is carried at the lower of cost or fair value, which is measured at the date of foreclosure. If the fair value of the collateral exceeds the carrying amount of the loan, no charge-off or adjustment is necessary, the loan is not considered to be carried at fair value and is therefore not included in the above table. If the fair value of the collateral is less than the carrying amount of the loan, management will charge the loan down to its estimated realizable value. The fair value of OREO is based on the appraised value of the property, which is generally unadjusted by management and is based on comparable sales for similar properties in the same geographic region as the subject property and is included in the above table as a Level II measurement. In some cases, management may adjust the appraised value due to the age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed. In these cases, the loans are categorized in the above table as a Level III measurement since these adjustments are considered to be unobservable inputs. Income and expenses from operations and further declines in the fair value of the collateral after foreclosure are included in net expenses from OREO.

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The following tables present additional quantitative information about assets measured at fair value on a non-recurring basis and for which the Company uses Level III inputs to determine fair value:

	Quantitative Information about Level III Fair Value Measurements
(Dollar amounts in thousands)	Fair Value Estimate		Valuation Techniques	Unobservable Input	Range (Weighted Average)
September 30, 2022
Other real estate owned	$	6,792	Appraisal of collateral (1)	Appraisal adjustments (2)	14.2%

	Quantitative Information about Level III Fair Value Measurements
(Dollar amounts in thousands)	Fair Value Estimate		Valuation Techniques	Unobservable Input	Range (Weighted Average)
December 31, 2021
Impaired loans	$	4,162	Appraisal of collateral (1)	Appraisal adjustments (2)	25.0%	to	72.2%	(36.6%)

(1) Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level III inputs that are not identifiable, less any associated allowance.

(2) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

The estimated fair value of the Company’s financial instruments not recorded at fair value on a recurring basis is as follows:

	September 30, 2022
	Carrying								Total
	Value		Level I		Level II		Level III		Fair Value
	(Dollar amounts in thousands)
Financial assets:
Net loans	$	980,663		-		-	$	958,067	$	958,067
Financial liabilities:
Deposits	$	1,130,487	$	953,305	$	-	$	171,874	$	1,125,179
Other borrowings		12,107		-		-		12,107		12,107

	December 31, 2021
	Carrying								Total
	Value		Level I		Level II		Level III		Fair Value
	(Dollar amounts in thousands)
Financial assets:
Loans held for sale	$	1,051		-	$	1,051	$	-	$	1,051
Net loans		967,349		-		-		961,645		961,645
Financial liabilities:
Deposits	$	1,166,610	$	967,885	$	-	$	199,503	$	1,167,388
Other borrowings		12,901		-		-		12,901		12,901

Included within other borrowings is an $8.2 million note payable, which matures in December 2037. These borrowings were used to form a special purpose entity (“Entity”) to issue $8.0 million of floating rate, obligated mandatorily redeemable securities.   The rate adjusts quarterly, equal to LIBOR plus 1.67%.  The borrowing is a floating rate instrument, and any difference between the cost and fair value is insignificant. 

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In addition to the financial instruments included in the above tables, cash and cash equivalents, bank-owned life insurance, Federal Home Loan Bank stock, accrued interest receivable, short-term borrowings, and accrued interest payable, are carried at cost, which approximates the fair value of the instruments.

NOTE 6 – ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following table presents the changes in accumulated other comprehensive income (loss) (“AOCI”) by component, net of tax, for the three and nine months ended September 30, 2022, and 2021, respectively:

(Dollars in thousands)	Unrealized (losses)/gains on available-for-sale securities (a)
Balance as of June 30, 2022	$	(17,591	)
Other comprehensive loss		(7,489	)
Balance at September 30, 2022	$	(25,080	)
Balance as of December 31, 2021	$	3,462
Other comprehensive loss		(28,542	)
Balance at September 30, 2022	$	(25,080	)

(Dollars in thousands)	Unrealized (losses)/gains on available-for-sale securities (a)
Balance as of June 30, 2021	$	3,893
Other comprehensive loss		(283	)
Balance at September 30, 2021	$	3,610
Balance as of December 31, 2020	$	4,284
Other comprehensive loss		(674	)
Balance at September 30, 2021	$	3,610

(a) All amounts are net of tax. Amounts in parentheses indicate debits to AOCI.

There were no other reclassifications of amounts from accumulated other comprehensive income for the three and nine months ended September 30, 2022, and 2021.

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NOTE 7 – INVESTMENT AND EQUITY SECURITIES

The amortized cost and fair values of investment securities available for sale are as follows:

	September 30, 2022
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
(Dollar amounts in thousands)	Cost		Gains		Losses			Value
Subordinated debt	$	32,300	$	6	$	(1,793	)	$	30,513
Obligations of states and political subdivisions:
Taxable		500		-		-			500
Tax-exempt		152,297		24		(29,107	)		123,214
Mortgage-backed securities in  government-sponsored entities		8,714		4		(881	)		7,837
Total	$	193,811	$	34	$	(31,781	)	$	162,064

	December 31, 2021
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
(Dollar amounts in thousands)	Cost		Gains		Losses			Value
Subordinated debt	$	32,300	$	356	$	(119	)	$	32,537
Obligations of states and political subdivisions:
Taxable		500		2		-			502
Tax-exempt		122,877		4,307		(341	)		126,843
Mortgage-backed securities in government-sponsored entities		10,140		257		(80	)		10,317
Total	$	165,817	$	4,922	$	(540	)	$	170,199

Equity securities totaled $972,000 and $818,000 at September 30, 2022 and December 31, 2021, respectively.

The Company recognized a net loss on equity investments of $57,000 and $96,000, respectively, for the three and nine months ended September 30, 2022. The Company recognized a net gain on equity investments of $102,000 and $223,000, respectively, for the three and nine months ended September 30, 2021. No net gains on sold equity securities were realized from sales during these periods.

The amortized cost and fair value of debt securities at September 30, 2022, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Amortized		Fair
(Dollar amounts in thousands)	Cost		Value
Due in one year or less	$	601	$	603
Due after one year through five years		2,709		2,671
Due after five years through ten years		45,209		42,783
Due after ten years		145,292		116,007
Total	$	193,811	$	162,064

There were no securities sold during the three and nine months ended September 30, 2022, and 2021, respectively.

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Investment securities with an approximate carrying value of $87.7 million and $77.1 million on September 30, 2022, and December 31, 2021, respectively, were pledged to secure deposits and for other purposes as required by law.

The following table shows the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.

	September 30, 2022
	Less than Twelve Months					Twelve Months or Greater					Total
			Gross					Gross					Gross
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
(Dollar amounts in thousands)	Value		Losses			Value		Losses			Value		Losses
Subordinated debt	$	21,957	$	(993	)	$	8,050	$	(800	)	$	30,007	$	(1,793	)
Obligations of states and political subdivisions:
Tax-exempt		104,880		(24,096	)		11,242		(5,011	)		116,122		(29,107	)
Mortgage-backed securities in government-sponsored entities		5,954		(533	)		1,332		(348	)		7,286		(881	)
Total	$	132,791	$	(25,622	)	$	20,624	$	(6,159	)	$	153,415	$	(31,781	)

	December 31, 2021
	Less than Twelve Months					Twelve Months or Greater					Total
			Gross					Gross					Gross
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
(Dollar amounts in thousands)	Value		Losses			Value		Losses			Value		Losses
Subordinated debt	$	9,150	$	(100	)	$	731	$	(19	)	$	9,881	$	(119	)
Obligations of states and political subdivisions:
Tax-exempt		24,273		(341	)		-		-			24,273		(341	)
Mortgage-backed securities in government-sponsored entities		-		-			1,980		(80	)		1,980		(80	)
Total	$	33,423	$	(441	)	$	2,711	$	(99	)	$	36,134	$	(540	)

There were 174 securities in an unrealized loss position for less than twelve months and 28 securities in an unrealized loss position for twelve months or greater on September 30, 2022.

Every quarter, the Company assesses whether there have been any events or economic circumstances indicating that a security with an unrealized loss has suffered other-than-temporary impairment (“OTTI”). A debt security is considered impaired if the fair value is less than its amortized cost basis at the reporting date. The Company assesses whether the unrealized loss is other than temporary.

OTTI losses are recognized in earnings when the Company has the intent to sell the debt security or it is more likely than not that it will be required to sell the debt security before recovery of its amortized cost basis. However, even if the Company does not expect to sell a debt security, it must evaluate expected cash flows to be received and determine if a credit loss has occurred.

An unrealized loss is generally deemed to be other than temporary and a credit loss is deemed to exist if the present value of the expected future cash flows is less than the amortized cost basis of the debt security. As a result, the credit loss of an OTTI is recorded as a component of investment securities gains (losses) in the accompanying Consolidated Statement of Income, while the remaining portion of the impairment loss is recognized in other comprehensive income, provided the Company does not intend to sell the underlying debt security and it is “more likely than not” that the Company will not have to sell the debt security before recovery.

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Debt securities issued by U.S. government agencies, U.S. government-sponsored enterprises, and state and political subdivisions accounted for 81% of the total available-for-sale portfolio as of September 30, 2022, and no credit losses are expected, given the explicit and implicit guarantees provided by the U.S. federal government and the lack of prolonged unrealized loss positions within the obligations of the state and political subdivisions security portfolio. The Company considers the following factors in determining whether a credit loss exists and the period over which the debt security is expected to recover:

• The length of time and the extent to which the fair value has been less than the amortized cost basis;

• Changes in the near-term prospects of the underlying collateral of a security, such as changes in default rates, loss severity given default, and significant changes in prepayment assumptions;

• The level of cash flows generated from the underlying collateral supporting the principal and interest payments of the debt securities; and

• Any adverse change to the credit conditions and liquidity of the issuer, taking into consideration the latest information available about the overall financial condition of the issuer, credit ratings, recent legislation and government actions affecting the issuer’s industry, and actions taken by the issuer to deal with the present economic climate.

For the three and nine months ended September 30, 2022, and 2021, there were no available-for-sale debt securities with an unrealized loss that suffered OTTI. Management does not believe any individual unrealized loss as of September 30, 2022, or December 31, 2021, represented an other-than-temporary impairment. The unrealized losses on debt securities are primarily the result of interest rate changes. These conditions will not prohibit the Company from receiving its contractual principal and interest payments on these debt securities. The fair value of these debt securities is expected to recover as payments are received on these securities, and they approach maturity. Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.

NOTE 8 - LOANS AND RELATED ALLOWANCE FOR LOAN AND LEASE LOSSES

The Company’s primary business activity is with customers located within its local Northeastern Ohio trade area, eastern Geauga County, and contiguous counties. The Company also serves the central Ohio market with offices in Dublin, Plain City, Powell, Sunbury, and Westerville, Ohio. Commercial, residential, consumer, and agricultural loans are granted. Although the Company has a diversified loan portfolio, loans outstanding to individuals and businesses are dependent upon the local economic conditions in the Company’s immediate trade area.

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff generally are reported at their outstanding unpaid principal balances net of the allowance for loan and lease losses. Interest income is recognized on the accrual method. The accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower’s financial condition is such that the collection of interest is doubtful. Interest payments received on nonaccrual loans are applied against the unpaid principal balance until accrual status is restored.

Loan origination fees and certain direct loan origination costs are deferred with the net amount amortized over the contractual life of the loan as an adjustment of the related loan’s yield.

The following tables summarize the primary segments of the loan portfolio and allowance for loan and lease losses (in thousands):

September 30, 2022
Impairment Evaluation
	Individually		Collectively		Total Loans
Loans:
Commercial real estate:
Owner occupied	$	5,387	$	115,525	$	120,912
Non-owner occupied		14,140		271,279		285,419
Multifamily		-		38,063		38,063
Residential real estate		892		246,720		247,612
Commercial and industrial		1,763		145,224		146,987
Home equity lines of credit		246		114,098		114,344
Construction and other		-		33,748		33,748
Consumer installment		-		8,110		8,110
Total	$	22,428	$	972,767	$	995,195

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December 31, 2021
Impairment Evaluation
	Individually		Collectively		Total Loans
Loans:
Commercial real estate:
Owner occupied	$	731	$	110,739	$	111,470
Non-owner occupied		5,297		278,321		283,618
Multifamily		-		31,189		31,189
Residential real estate		1,104		238,985		240,089
Commercial and industrial		587		148,225		148,812
Home equity lines of credit		250		104,105		104,355
Construction and other		-		54,148		54,148
Consumer installment		-		8,010		8,010
Total	$	7,969	$	973,722	$	981,691

The amounts above include net deferred loan origination fees of $1.9 million and $3.6 million on September 30, 2022, and December 31, 2021, respectively. The net deferred loan origination fees at September 30, 2022, and December 31, 2021, include $14,000 and $1.3 million, respectively, of unearned deferred fees from Paycheck Protection Program (“PPP”) loans.

September 30, 2022
Ending Allowance Balance by Impairment Evaluation:
	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total Allocation
Loans:
Commercial real estate:
Owner occupied	$	36	$	1,848	$	1,884
Non-owner occupied		310		5,388		5,698
Multifamily		-		623		623
Residential real estate		13		2,236		2,249
Commercial and industrial		306		1,426		1,732
Home equity lines of credit		1		1,892		1,893
Construction and other		-		429		429
Consumer installment		-		24		24
Total	$	666	$	13,866	$	14,532

December 31, 2021
Ending Allowance Balance by Impairment Evaluation:
	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total Allocation
Loans:
Commercial real estate:
Owner occupied	$	10	$	1,826	$	1,836
Non-owner occupied		655		6,776		7,431
Multifamily		-		454		454
Residential real estate		17		1,723		1,740
Commercial and industrial		42		840		882
Home equity lines of credit		16		1,436		1,452
Construction and other		-		533		533
Consumer installment		-		14		14
Total	$	740	$	13,602	$	14,342

22

 

The Company’s loan portfolio is segmented to a level that allows management to monitor risk and performance. The portfolio is segmented into Commercial Real Estate (“CRE”), which is further segmented into Owner Occupied (“CRE OO”), Non-owner Occupied (“CRE NOO”), and Multifamily Residential, Residential Real Estate (“RRE”), Commercial and Industrial (“C&I”), Home Equity Lines of Credit (“HELOC”), Construction and Other (“Construction”), and Consumer Installment Loans. The commercial real estate loan segments consist of loans made to finance the activities of commercial real estate owners and operators. The residential real estate and HELOC loan segments consist of loans made to finance the activities of residential homeowners. The C&I loan segment consists of loans made to finance the activities of commercial customers. The consumer loan segment consists primarily of installment loans and overdraft lines of credit connected with customer deposit accounts. The increases in the allowance for loan loss for the C&I, RRE, and HELOC portfolios were partially offset by a decrease in the allowance for the CRE, Construction, and Consumer Installment portfolios.

Management evaluates individual loans in all of the commercial segments for possible impairment based on guidelines established by the Board of Directors. Loans are considered to be impaired when, based on current information and events, the Company will probably be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in evaluating impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall concerning the principal and interest owed. The Company does not separately evaluate individual consumer and residential mortgage loans for impairment unless such loans are part of a larger relationship that is impaired or the loan was modified in a troubled debt restructuring.

Once the determination has been made that a loan is impaired, the determination of whether a specific allocation of the allowance is necessary is measured by comparing the recorded investment in the loan to the fair value of the loan using one of the following methods: (a) the present value of expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s observable market price; or (c) the fair value of the collateral less selling costs. The method is selected on a loan-by-loan basis. The evaluation of the need and amount of a specific allocation of the allowance and whether a loan can be removed from impairment status is made quarterly. The Company’s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition.

23

 

The following tables present impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary (in thousands):

September 30, 2022
Impaired Loans
			Unpaid
	Recorded			Principal	Related
	Investment			Balance	Allowance
With no related allowance recorded:
Commercial real estate:
Non-owner occupied	$	1,085	$	1,821	$	-
Residential real estate		573		635		-
Commercial and industrial		242		354		-
Home equity lines of credit		113		113		-
Total	$	2,013	$	2,923	$	-
With an allowance recorded:
Commercial real estate:
Owner occupied	$	5,387	$	5,387	$	36
Non-owner occupied		13,055		13,124		310
Residential real estate		319		319		13
Commercial and industrial		1,521		1,521		306
Home equity lines of credit		133		133		1
Total	$	20,415	$	20,484	$	666
Total:
Commercial real estate:
Owner occupied	$	5,387	$	5,387	$	36
Non-owner occupied		14,140		14,945		310
Residential real estate		892		954		13
Commercial and industrial		1,763		1,875		306
Home equity lines of credit		246		246		1
Total	$	22,428	$	23,407	$	666

24

 

December 31, 2021
Impaired Loans
			Unpaid
	Recorded			Principal	Related
	Investment			Balance	Allowance
With no related allowance recorded:
Commercial real estate:
Non-owner occupied	$	1,547	$	1,802	$	-
Residential real estate		820		874		-
Commercial and industrial		370		538		-
Home equity lines of credit		7		7		-
Total	$	2,744	$	3,221	$	-
With an allowance recorded:
Commercial real estate:
Owner occupied	$	731	$	731	$	10
Non-owner occupied		3,750		4,277		655
Residential real estate		284		284		17
Commercial and industrial		217		230		42
Home equity lines of credit		243		243		16
Total	$	5,225	$	5,765	$	740
Total:
Commercial real estate:
Owner occupied	$	731	$	731	$	10
Non-owner occupied		5,297		6,079		655
Residential real estate		1,104		1,158		17
Commercial and industrial		587		768		42
Home equity lines of credit		250		250		16
Total	$	7,969	$	8,986	$	740

The tables above include troubled debt restructuring totaling $2.8 million and $2.6 million as of September 30, 2022, and December 31, 2021, respectively. The amounts allocated within the allowance for losses for these troubled debt restructurings were $308,000 and $150,000 on September 30, 2022, and December 31, 2021, respectively.

25

 

The following tables present the average balance and interest income by class, recognized on impaired loans (in thousands):

	For the Three Months Ended September 30, 2022				For the Nine Months Ended September 30, 2022
	Average		Interest		Average		Interest
	Recorded Investment		Income Recognized		Recorded Investment		Income Recognized
Commercial real estate:
Owner occupied	$	3,044	$	119	$	1,884	$	142
Non-owner occupied		9,637		340		7,446		455
Residential real estate		934		10		992		35
Commercial and industrial		1,806		37		1,207		102
Home equity lines of credit		247		4		248		9
Total	$	15,668	$	510	$	11,777	$	743

	For the Three Months Ended September 30, 2021				For the Nine Months Ended September 30, 2021
	Average		Interest		Average		Interest
	Recorded Investment		Income Recognized		Recorded Investment		Income Recognized
Commercial real estate:
Owner occupied	$	1,428	$	14	$	1,485	$	45
Non-owner occupied		5,419		34		4,955		101
Residential real estate		1,190		18		1,234		42
Commercial and industrial		694		9		807		22
Home equity lines of credit		245		6		244		9
Total	$	8,976	$	81	$	8,725	$	219

Management uses a nine-point internal risk-rating system to monitor the credit quality of the overall loan portfolio. The first five categories are considered not criticized and are aggregated as Pass rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but have potential weaknesses, resulting in undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are considered Substandard. Any portion of a loan that has been charged off is placed in the Loss category.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Company has a structured loan rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as payment delinquency, bankruptcy, repossession, or death, occurs to raise awareness of a possible credit quality loss. The Company’s Commercial Loan Officers are responsible for the timely and accurate risk rating of the loans in their portfolios at origination and on an ongoing basis. The Credit Department performs an annual review of all commercial relationships with loan balances of $750,000 or greater.  Confirmation of the appropriate risk grade is included in the review on an ongoing basis. The Company engages an external consultant to conduct loan reviews on a semiannual basis. Generally, the external consultant reviews a sample of commercial relationships greater than $250,000 and criticized relationships greater than $150,000. Detailed reviews, including plans for resolution, are performed on criticized loans on at least a quarterly basis. Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.

The primary risk of commercial and industrial loans is related to deterioration in the cash flow of the business, which may result in the liquidation of the business assets securing the loan. C&I loans are, by nature, secured by less substantial collateral than secured real-estate loans. The primary risk of real estate construction loans is potential delays and disputes during the completion process. The primary risk of residential real estate loans is current economic uncertainties. The primary risk of commercial real estate loans is the loss of income of the owner or occupier of the property and the inability of the market to sustain rent levels. Consumer installment loans historically have experienced higher delinquency rates. Consumer installments are typically secured by less substantial collateral than other types of credits.

26

 

The following tables present the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard and Doubtful within the internal risk-rating system (in thousands):

			Special						Total
September 30, 2022	Pass		Mention		Substandard		Doubtful		Loans
Commercial real estate:
Owner occupied	$	111,173	$	1,164	$	8,575	$	-	$	120,912
Non-owner occupied		242,133		215		43,071		-		285,419
Multifamily		38,063		-		-		-		38,063
Residential real estate		245,278		-		2,334		-		247,612
Commercial and industrial		140,328		3,641		3,018		-		146,987
Home equity lines of credit		113,337		-		1,007		-		114,344
Construction and other		33,359		319		70		-		33,748
Consumer installment		8,071		-		39		-		8,110
Total	$	931,742	$	5,339	$	58,114	$	-	$	995,195

			Special						Total
December 31, 2021	Pass		Mention		Substandard		Doubtful		Loans
Commercial real estate:
Owner occupied	$	104,217	$	2,400	$	4,853	$	-	$	111,470
Non-owner occupied		230,672		3,038		49,908		-		283,618
Multifamily		31,189		-		-		-		31,189
Residential real estate		237,132		-		2,957		-		240,089
Commercial and industrial		143,911		2,748		2,153		-		148,812
Home equity lines of credit		103,296		-		1,059		-		104,355
Construction and other		53,807		341		-		-		54,148
Consumer installment		8,005		-		5		-		8,010
Total	$	912,229	$	8,527	$	60,935	$	-	$	981,691

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due.

Nonperforming assets are nonaccrual loans, including nonaccrual troubled debt restructurings (“TDR”), loans 90 days or more past due, other real estate owned, and repossessed assets. A loan is classified as nonaccrual when, in the opinion of management, there are serious doubts about the collectability of interest and principal. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower’s financial condition is such that collection of principal and interest is doubtful.  Payments received on nonaccrual loans are applied against the principal balance.

27

 

The following tables present the aging of the recorded investment in past-due loans by class of loans (in thousands):

			30-59 Days		60-89 Days		90 Days+		Total		Total
September 30, 2022	Current		Past Due		Past Due		Past Due		Past Due		Loans
Commercial real estate:
Owner occupied	$	120,885	$	27	$	-	$	-	$	27	$	120,912
Non-owner occupied		285,258		-		-		161		161		285,419
Multifamily		38,063		-		-		-		-		38,063
Residential real estate		246,058		1,179		-		375		1,554		247,612
Commercial and industrial		146,805		41		127		14		182		146,987
Home equity lines of credit		114,156		159		-		29		188		114,344
Construction and other		33,748		-		-		-		-		33,748
Consumer installment		7,925		149		36		-		185		8,110
Total	$	992,898	$	1,555	$	163	$	579	$	2,297	$	995,195

			30-59 Days		60-89 Days		90 Days+		Total		Total
December 31, 2021	Current		Past Due		Past Due		Past Due		Past Due		Loans
Commercial real estate:
Owner occupied	$	111,257	$	81	$	132	$	-	$	213	$	111,470
Non-owner occupied		282,365		880		-		373		1,253		283,618
Multifamily		31,189		-		-		-		-		31,189
Residential real estate		238,483		1,187		-		419		1,606		240,089
Commercial and industrial		148,437		112		-		263		375		148,812
Home equity lines of credit		104,316		-		39		-		39		104,355
Construction and other		54,148		-		-		-		-		54,148
Consumer installment		7,799		16		19		176		211		8,010
Total	$	977,994	$	2,276	$	190	$	1,231	$	3,697	$	981,691

The following tables present the recorded investment in nonaccrual loans and loans past due over 89 days and still on accrual by class of loans (in thousands):

			90+ Days Past Due
September 30, 2022	Nonaccrual		and Accruing
Commercial real estate:
Owner occupied	$	71	$	-
Non-owner occupied		1,450		-
Residential real estate		1,568		-
Commercial and industrial		197		-
Home equity lines of credit		131		-
Construction and other		70		-
Consumer installment		205		-
Total	$	3,692	$	-

28

 

			90+ Days Past Due
December 31, 2021	Nonaccrual		and Accruing
Commercial real estate:
Owner occupied	$	81	$	-
Non-owner occupied		2,442		-
Residential real estate		1,577		-
Commercial and industrial		456		-
Home equity lines of credit		121		-
Consumer installment		182		-
Total	$	4,859	$	-

Interest income that would have been recorded had these loans not been placed on nonaccrual status was $39,000 and $120,000 for the three and nine months ended September 30, 2022, respectively. Interest income that would have been recorded had these loans not been placed on nonaccrual status was $107,000 and $290,000 for the three and nine months ended September 30, 2021, respectively.

An allowance for loan and lease losses (“ALLL”) is maintained to absorb losses from the loan portfolio.  The ALLL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification, and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of nonperforming loans.

The Company’s methodology for determining the ALLL is based on the requirements of ASC Section 310-10-35 for loans individually evaluated for impairment (discussed above) and ASC Subtopic 450-20 for loans collectively evaluated for impairment, as well as the Interagency Policy Statement on the Allowance for Loan and Lease Losses and other bank regulatory guidance. The total of the two components represents the Company’s ALLL. Management also performs impairment analyses on TDRs, which may result in specific reserves.

Loans that are collectively evaluated for impairment are analyzed with general allowances being made as appropriate.  For general allowances, historical loss trends are used in the estimation of losses in the current portfolio.  These historical loss amounts are modified by other qualitative factors.

The classes described above, which are based on the purpose code assigned to each loan, provide the starting point for the ALLL analysis.  Management tracks the historical net charge-off activity at the call code level. The historical charge-off factor was calculated using the last twelve consecutive historical quarters.

Management has identified several additional qualitative factors which it uses to supplement the historical charge-off factor because these factors are likely to cause estimated credit losses associated with the existing loan pools to differ from historical loss experience. The additional factors that are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources are national and local economic trends and conditions; levels of and trends in delinquency rates and nonaccrual loans; trends in volumes and terms of loans; effects of changes in lending policies; experience, ability, and depth of lending staff; the value of underlying collateral; and concentrations of credit from a loan type, industry, and geographic standpoint.

Management reviews the loan portfolio quarterly using a defined, consistently applied process to make appropriate and timely adjustments to the ALLL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALLL.

29

 

The following tables summarize the ALLL within the primary segments of the loan portfolio and the activity within those segments (in thousands):

	For the nine months ended September 30, 2022
	Allowance for Loan and Lease Losses
	Balance										Balance
	December 31, 2021		Charge-offs			Recoveries		Provision			September 30, 2022
Loans:
Commercial real estate:
Owner occupied	$	1,836	$	-		$	4	$	44		$	1,884
Non-owner occupied		7,431		(150	)	$	-	$	(1,583	)	$	5,698
Multifamily		454		-		$	-	$	169		$	623
Residential real estate		1,740		-		$	61	$	448		$	2,249
Commercial and industrial		882		(30	)	$	269	$	611		$	1,732
Home equity lines of credit		1,452		(25	)	$	-	$	466		$	1,893
Construction and other		533		-		$	-	$	(104	)	$	429
Consumer installment		14		(46	)	$	107	$	(51	)	$	24
Total	$	14,342	$	(251	)	$	441	$	0		$	14,532

	For the nine months ended September 30, 2021
	Allowance for Loan and Lease Losses
	Balance										Balance
	December 31, 2020		Charge-offs			Recoveries		Provision			September 30, 2021
Loans:
Commercial real estate:
Owner occupied	$	1,342	$	-		$	44	$	166		$	1,552
Non-owner occupied		6,817		(313	)		-		1,196			7,700
Multifamily		461		-			-		(63	)		398
Residential real estate		1,683		(27	)		4		15			1,675
Commercial and industrial		1,353		-			70		(264	)		1,159
Home equity lines of credit		1,405		-			55		(132	)		1,328
Construction and other		378		-			46		(33	)		391
Consumer installment		20		(102	)		98		15			31
Total	$	13,459	$	(442	)	$	317	$	900		$	14,234

	For the three months ended September 30, 2022
	Allowance for Loan and Lease Losses
	Balance										Balance
	June 30, 2022		Charge-offs			Recoveries		Provision			September 30, 2022
Loans:
Commercial real estate:
Owner occupied	$	1,803	$	-		$	1	$	80		$	1,884
Non-owner occupied		7,347		(150	)		-		(1,499	)		5,698
Multifamily		416		-			-		207			623
Residential real estate		1,853		-			34		362			2,249
Commercial and industrial		1,213		-			61		458			1,732
Home equity lines of credit		1,495		-			-		398			1,893
Construction and other		399		-			-		30			429
Consumer installment		24		-			36		(36	)		24
Total	$	14,550	$	(150	)	$	132	$	-		$	14,532

30

 

	For the three months ended September 30, 2021
	Allowance for Loan and Lease Losses
	Balance										Balance
	June 30, 2021		Charge-offs			Recoveries		Provision			September 30, 2021
Loans:
Commercial real estate:
Owner occupied	$	1,525	$	-		$	1	$	26		$	1,552
Non-owner occupied		7,624		(50	)		0		126			7,700
Multifamily		449		-			0		(51	)		398
Residential real estate		1,792		-			1		(118	)		1,675
Commercial and industrial		1,123		-			19		17			1,159
Home equity lines of credit		1,261		-			3		64			1,328
Construction and other		408		-			18		(35	)		391
Consumer installment		18		-			42		(29	)		31
Total	$	14,200	$	(50	)	$	84	$	0		$	14,234

The provision fluctuations during the three and nine months ended September 30, 2022, allocated to:

● non-owner occupied commercial loans due to a decrease in special mention and substandard credits.

● commercial and industrial loans are due to an increase in loans, excluding the impact of PPP forgiveness, coupled with an increase in the specific reserve on impaired loans.

● residential loans and home equity lines of credit are due to an increase in outstanding balances.

The provision fluctuations during the nine months ended September 30, 2021, allocated to:

● non-owner occupied commercial real estate loans are due to exposure to the substandard rate credits related to the hospitality industry.

● commercial and industrial loans are due to a decrease in outstanding balances as PPP loans receive forgiveness.

● home equity lines of credit are due to a decrease in outstanding balances.

The provision fluctuations during the three months ended September 30, 2021, allocated to:

● non-owner occupied commercial real estate loans are due to exposure to the substandard rate credits related to the hospitality industry.

● residential loans are due to a decrease in special mention and substandard credits.

● home equity lines of credit are due to a decrease in outstanding balances.

TDR describes loans on which the bank has granted concessions for reasons related to the customer’s financial difficulties. Such concessions may include one or more of the following:

● reduction in the interest rate to below-market rates

● extension of repayment requirements beyond normal terms

● reduction of the principal amount owed

● reduction of accrued interest due

● acceptance of other assets in full or partial payment of a debt

In each case, the concession is made due to deterioration in the borrower’s financial condition, and the new terms are less stringent than those required on a new loan with similar risk.

31

 

The following tables present the number of loan modifications by class, the corresponding recorded investment, and the subsequently defaulted modifications (in thousands) for the periods ended:

	For the Three Months Ended
	September 30, 2022
	Number of Contracts						Pre-Modification		Post-Modification
	Term						Outstanding Recorded		Outstanding Recorded
Troubled Debt Restructurings	Modification		Other		Total		Investment		Investment
Commercial and industrial		1		-		1	$	27	$	27

	For the Nine Months Ended
	September 30. 2022
	Number of Contracts						Pre-Modification		Post-Modification
	Term						Outstanding Recorded		Outstanding Recorded
	Modification		Other		Total		Investment		Investment
Commercial and industrial		3		-		3	$	1,252	$	1,252

There were no troubled debt restructurings for the three and nine-month periods ended September 30, 2021.

There were no subsequent defaults of troubled debt restructurings for the three and nine-month periods ended September 30, 2022.

NOTE 9 – COMMITMENTS AND CONTINGENCIES

Cannabis Industry

We provide deposit services to customers that are licensed by the State of Ohio to do business in (or are related to) the Medical Marijuana Control Program as growers, processors, and dispensaries. Medical Marijuana businesses are regulated by the Ohio Department of Commerce and legal in the State of Ohio, although it is not legal at the federal level. The U.S. Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) published guidelines in 2014 for financial institutions servicing state-legal cannabis businesses. A financial institution that provides services to cannabis-related businesses can comply with Bank Secrecy Act (“BSA”) disclosure standards by following the FinCEN guidelines. We maintain stringent written policies and procedures related to the acceptance of such businesses and the monitoring and maintenance of such business accounts. We conduct a significant due diligence review of the cannabis business before the business is accepted, including confirmation that the business is properly licensed by the State of Ohio. Throughout the relationship, we continue monitoring the business, including site visits, to ensure that the business continues to meet our stringent requirements, including maintenance of required licenses and periodic financial reviews of the business.

While we believe we are operating in compliance with the FinCEN guidelines, there can be no assurance that federal enforcement guidelines will not change. Federal prosecutors have significant discretion, and there can be no assurance that the federal prosecutors will not choose to strictly enforce the federal laws governing cannabis. Any change in the Federal government’s enforcement position could cause us to immediately cease providing banking services to the cannabis industry. We are upfront with our customers regarding the fact that we may have to terminate our relationship if a change occurs with the Federal government’s position and that the termination may come with little or no notice.

NOTE 10 – PROPOSED ACQUISITION OF LIBERTY BANCSHARES

On May 26, 2022, Middlefield Banc Corp. (the “Company”), Liberty Bancshares, Inc. (“Liberty”), and MBCN Merger Subsidiary, LLC, a wholly-owned subsidiary of the Company (“Merger Sub”), entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which Liberty will merge with and into Merger Sub (the “Merger”), with Merger Sub as the surviving entity in the Merger. Promptly following the consummation of the Merger, it is expected that Merger Sub will be dissolved and liquidated and Liberty National Bank (“Liberty Bank”), the banking subsidiary of Liberty, will merge with and into The Middlefield Banking Company (“Middlefield Bank”), the banking subsidiary of the Company (the “Bank Merger”). Middlefield Bank will be the surviving bank in the Bank Merger (the “Surviving Bank”).

32

 

Under the terms and subject to the conditions of the Merger Agreement, at the effective time of the Merger (the “Effective Time”), each share of the voting common stock, $1.25 par value per share, and each share of non-voting common stock, no par value, of Liberty (the “Liberty Common Stock”) issued and outstanding immediately prior to the Effective Time, will be converted, in accordance with the procedures set forth in the Merger Agreement, into the right to receive, without interest, 2.752 shares (the “Exchange Ratio” and such shares, the “Merger Consideration”) of the common stock, no par value per share, of the Company (the “Company Common Stock”). The Merger Agreement provides that an outstanding and unexercised warrant issued to Castle Creek Partners VI, LP (“Castle Creek”) to purchase shares of Liberty convertible perpetual preferred stock, Series A, shall be canceled and converted into the right to receive the Merger Consideration.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The information contained or incorporated by reference in this report on Form 10-Q contains forward-looking statements, including certain plans, expectations, goals, and projections, which are subject to numerous assumptions, risks, and uncertainties. Actual results could differ materially from those contained or implied by such statements for a variety of factors, including changes in economic conditions, movements in interest rates, competitive pressures on product pricing and services, success and timing of business strategies, the nature, extent, and timing of government actions and reforms, and extended disruption of vital infrastructure and the impact of the COVID-19 pandemic. The Company could experience further adverse effects on its business, financial condition, results of operations, and cash flows.

All forward-looking statements included in this report on Form 10-Q are based on information available at the time of the report. Middlefield Banc Corp. assumes no obligation to update any forward-looking statement.

CHANGES IN FINANCIAL CONDITION

Overview

The following is management’s discussion and analysis of certain significant factors which have affected the financial condition and results of operations of the Company as reflected in the unaudited consolidated balance sheet as of September 30, 2022, as compared with December 31, 2021, and operating results for the three and nine-month periods ended September 30, 2022, and 2021.  These comments should be read in conjunction with the Company’s unaudited consolidated financial statements and accompanying notes appearing elsewhere herein.

This discussion contains certain performance measures determined by methods other than under GAAP. Management of the Company uses these non-GAAP measures in its analysis of the Company’s performance. These measures are useful when evaluating the underlying performance and efficiency of the Company’s operations and balance sheet. The Company’s management believes that these non-GAAP measures provide a greater understanding of ongoing operations, enhance comparability of results with prior periods and demonstrate the effects of significant gains and charges in the current period. The Company’s management believes that investors may use these non-GAAP financial measures to evaluate the Company’s financial performance without the impact of unusual items that may obscure trends in the Company’s underlying performance. These disclosures should not be viewed as a substitute for financial measures determined under GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. Non-GAAP measures include tangible book value per common share, return on average tangible common equity, and pre-tax, pre-provision income. The Company calculates the regulatory capital ratios using current regulatory report instructions. The Company’s management uses these measures to assess the quality of capital and believes that investors may find them useful in their evaluation of the Company. These capital measures may or may not be necessarily comparable to similar capital measures that may be presented by other companies.

2022 Nine-Month Financial Highlights (on a year-over-year basis unless noted):

● Returned $6.6 million of capital to shareholders through dividends and the repurchase of 141,002 shares at an average price of $25.83 per share

● Net income was $12.2 million, or $2.08 per diluted share, compared to $13.8 million, or $2.19 per diluted share

● Nine-month pre-tax income benefited from $1.2 million of accelerated net fees associated with PPP loans compared to $3.1 million in the 2021 nine-month period

● Year-to-date net income was negatively impacted by $969,000 of one-time expenses associated with the proposed Liberty Bancshares, Inc. merger

● Net interest margin improved by 24 basis points to 4.02%, compared to 3.78%

● Total loans were $995.2 million, compared to $981.7 million at December 31, 2021

● Total loans increased by $46.6 million, or 6.6% annualized from December 31, 2021, without the impact of PPP loan forgiveness

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● Return on average assets was 1.24%, compared to 1.34%

● Return on average equity was 11.96%, compared to 12.58%

● Return on average tangible common equity was 13.59%, compared to 14.20%

● Strong asset quality with nonperforming loans to total loans of 0.37%, compared to 0.67%

● Allowance for loan losses was 1.46% of total loans, compared to 1.41%

(1) See reconciliation of non-GAAP measure in the following tables

(Dollar amounts in thousands, except per share and share amounts, unaudited)
	For the Three Months Ended															For the Nine Months Ended
	September 30,			June 30,			March 31,			December 31,			September 30,			September 30,			September 30,
	2022			2022			2022			2021			2021			2022			2021
Per common share data
Net income per common share - basic	$	0.73		$	0.70		$	0.65		$	0.81		$	0.85		$	2.08		$	2.20
Net income per common share - diluted	$	0.73		$	0.70		$	0.65		$	0.81		$	0.85		$	2.08		$	2.19
Dividends declared per share	$	0.17		$	0.17		$	0.17		$	0.21		$	0.16		$	0.51		$	0.48
Book value per share (period end)	$	21.30		$	22.07		$	23.43		$	24.68		$	24.13		$	21.30		$	24.13
Tangible book value per share (period end) (2) (3)	$	18.48		$	19.26		$	20.64		$	21.88		$	21.39		$	18.48		$	21.39
Dividends declared	$	983		$	993		$	1,000		$	1,242		$	978		$	2,976		$	2,998
Dividend yield		2.49	%		2.71	%		2.78	%		3.37	%		2.66	%		2.52	%		2.69	%
Dividend payout ratio		23.13	%		24.28	%		26.09	%		25.68	%		18.79	%		24.45	%		21.73	%
Average shares outstanding - basic		5,792,773			5,851,422			5,879,025			5,951,838			6,136,648			5,840,757			6,265,803
Average shares outstanding - diluted		5,805,799			5,860,098			5,889,836			5,975,333			6,157,181			5,853,783			6,287,556
Period ending shares outstanding		5,767,803			5,810,351			5,873,565			5,888,737			6,054,083			5,767,803			6,054,083
Selected ratios
Return on average assets		1.32	%		1.25	%		1.17	%		1.41	%		1.51	%		1.24	%		1.34	%
Return on average equity		12.94	%		12.30	%		10.75	%		13.17	%		13.95	%		11.96	%		12.58	%
Return on average tangible common equity (2) (4)		14.79	%		14.02	%		12.13	%		14.85	%		15.71	%		13.59	%		14.20	%
Efficiency (1)		61.07	%		61.83	%		62.54	%		56.56	%		54.05	%		61.79	%		56.42	%
Equity to assets at period end		9.09	%		9.91	%		10.40	%		10.92	%		10.69	%		9.09	%		10.69	%
Noninterest expense to average assets		0.69	%		0.65	%		0.62	%		0.58	%		0.58	%		1.96	%		1.75	%

(1) The efficiency ratio is calculated by dividing noninterest expense less amortization of intangibles by the sum of net interest income on a fully taxable equivalent basis plus noninterest income

(2) See reconciliation of non-GAAP measures on the following page

(3) Calculated by dividing tangible common equity by shares outstanding

(4) Calculated by dividing annualized net income for each period by average tangible common equity

	For the Three Months Ended															For the Nine Months Ended
	September 30,			June 30,			March 31,			December 31,			September 30,			September 30,			September 30,
Yields	2022			2022			2022			2021			2021			2022			2021
Interest-earning assets:
Loans receivable (2)		4.78	%		4.66	%		4.53	%		4.61	%		4.74	%		4.66	%		4.54	%
Investment securities (2)		3.90	%		3.76	%		3.41	%		3.30	%		3.37	%		3.69	%		3.51	%
Interest-earning deposits with other banks		2.06	%		0.77	%		0.23	%		0.20	%		0.21	%		0.82	%		0.20	%
Total interest-earning assets		4.55	%		4.28	%		4.06	%		4.07	%		4.20	%		4.30	%		4.12	%
Deposits:
Interest-bearing demand deposits		0.22	%		0.15	%		0.14	%		0.12	%		0.12	%		0.17	%		0.13	%
Money market deposits		0.46	%		0.49	%		0.47	%		0.47	%		0.46	%		0.47	%		0.47	%
Savings deposits		0.19	%		0.06	%		0.06	%		0.06	%		0.06	%		0.10	%		0.06	%
Certificates of deposit		0.96	%		0.83	%		0.87	%		0.90	%		1.08	%		0.89	%		1.19	%
Total interest-bearing deposits		0.43	%		0.36	%		0.37	%		0.36	%		0.41	%		0.39	%		0.47	%
Non-Deposit Funding:
Borrowings		2.94	%		2.51	%		2.16	%		2.09	%		2.08	%		2.61	%		1.14	%
Total interest-bearing liabilities		0.50	%		0.39	%		0.39	%		0.37	%		0.44	%		0.43	%		0.48	%
Cost of deposits		0.29	%		0.24	%		0.25	%		0.26	%		0.30	%		0.26	%		0.35	%
Cost of funds		0.34	%		0.27	%		0.27	%		0.27	%		0.31	%		0.29	%		0.35	%
Net interest margin (1)		4.23	%		4.02	%		3.80	%		3.82	%		3.90	%		4.02	%		3.78	%

(1) Net interest margin represents net interest income as a percentage of average interest-earning assets.

(2) Tax-equivalent adjustments to calculate the yield on tax-exempt securities and loans were determined using an effective tax rate of 21%.

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Reconciliation of Common Stockholders' Equity to Tangible Common Equity	For the Period Ended
(Dollar amounts in thousands, unaudited)	September 30,		June 30,		March 31,		December 31,		September 30,
	2022		2022		2022		2021		2021
Stockholders' Equity (GAAP)	$	122,855	$	128,220	$	137,644	$	145,335	$	146,055
Less Goodwill and other intangibles		16,242		16,320		16,397		16,474		16,555
Tangible Common Equity (Non-GAAP)	$	106,613	$	111,900	$	121,247	$	128,861	$	129,500
Shares outstanding		5,767,803		5,810,351		5,873,565		5,888,737		6,054,083
Tangible book value per share (Non-GAAP)	$	18.48	$	19.26	$	20.64	$	21.88	$	21.39

Reconciliation of Average Equity to Return on Average Tangible Common Equity	For the Three Months Ended															For the Nine Months Ended
	September 30,			June 30,			March 31,			December 31,			September 30,			September 30,			September 30,
	2022			2022			2022			2021			2021			2022			2021
Average Stockholders' Equity (GAAP)	$	130,263		$	133,377		$	144,630		$	145,716		$	148,048		$	136,090		$	146,611
Less Average Goodwill and other intangibles		16,280			16,357			16,435			16,513			16,594			16,357			16,674
Average Tangible Common Equity (Non-GAAP)	$	113,983		$	117,020		$	128,195		$	129,203		$	131,454		$	119,733		$	129,937
Net income	$	4,249		$	4,089		$	3,833		$	4,837		$	5,204		$	12,171		$	13,796
Return on average tangible common equity (annualized) (Non-GAAP)		14.79	%		14.02	%		12.13	%		14.85	%		15.71	%		13.59	%		14.20	%

Reconciliation of Pre-Tax Pre-Provision Income (PTPP)	For the Three Months Ended											For the Nine Months Ended
	September 30,		June 30,		March 31,		December 31,			September 30,		September 30,		September 30,
	2022		2022		2022		2021			2021		2022		2021
Net income	$	4,249	$	4,089	$	3,833	$	4,837		$	5,204	$	12,171	$	13,796
Add Income Taxes		1,010		787		772		1,027			1,174		2,569		3,038
Add Provision for loan losses		-		-		-		(200	)		-		-		900
PTPP	$	5,259	$	4,876	$	4,605	$	5,664		$	6,378	$	14,740	$	17,734

General. The Company’s total assets on September 30, 2022 were $1.35 billion, an increase of $20.0 million from December 31, 2021. For the same period, net loans increased by $13.3 million, cash and cash equivalents increased by $9.1 million, and other assets increased by $7.8 million due to an increase in deferred tax assets. These increases were partially offset by a decrease of $8.1 million in investment securities. Stockholders’ equity decreased by $22.5 million, or 15.5%, primarily as a result of a decrease in accumulated other comprehensive income. This was the result of an increase in the unrealized loss on the available-for-sale investment portfolio during the nine-month period.  Excluding the decrease in accumulated other comprehensive income, total stockholders’ equity increased by $6.1 million.

Cash and cash equivalents. Cash and cash equivalents increased $9.1 million to $128.6 million on September 30, 2022, from $119.5 million on December 31, 2021. The increase in cash and cash equivalents is primarily a result of an increase in borrowings, partially offset by security purchases, a decrease in deposits, and an increase in loans. Deposits from customers into savings and checking accounts, loan and securities repayments, and proceeds from borrowed funds typically increase these accounts. Decreases result from customer withdrawals, new loan originations, security purchases, and repayments of borrowed and brokered funds.

Investment securities. Management's objective in structuring the portfolio is to maintain liquidity while providing an acceptable rate of return without sacrificing asset quality. Available-for-sale and equity investment securities on September 30, 2022, totaled $163.0 million, a decrease of $8.0 million, or 4.7%, from $171.0 million on December 31, 2021. Securities purchased were $32.3 million, and there were no sales of securities for the nine months ended September 30, 2022. During this period, the Company recorded repayments, calls, and maturities of $3.6 million and an increase in the net unrealized holding loss through AOCI of $28.5 million. The Company recorded $96,000 in losses on equity securities during the nine months ended September 30, 2022, on the Company’s Consolidated Statement of Income and Consolidated Statement of Cash Flows. The loss on equity securities is the result of fair value marks of the equity securities held during these nine months.

On September 30, 2022, the Company held $30.5 million at fair value of subordinated debt in other banks, as compared to $32.5 million on December 31, 2021. The average yield on this portfolio was 4.80% on September 30, 2022, as compared to 4.86% on December 31, 2021.

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Periodically, management reviews the entire municipal bond portfolio to assess credit quality. Each security held in this portfolio is assessed on attributes that have historically influenced default incidences in the municipal market, such as sector, security, impairment filing, timeliness of disclosure, external credit assessment(s), credit spread, state, vintage, and underwriter. Municipal bonds compose 76% of the overall portfolio. These investments have historically proven to have extremely low credit risk.

Loans receivable. The loans receivable category consists primarily of single-family mortgage loans used to purchase or refinance personal residences located within the Company’s market area, commercial and industrial loans, home equity lines of credit, and commercial real estate loans used to finance properties that are used in the borrowers’ businesses, or to finance investor-owned rental properties, and, to a lesser extent, construction and consumer loans. The portfolio is well dispersed geographically. Net loans receivable increased $13.3 million, or 1.4%, to $980.7 million as of September 30, 2022. The following table summarizes fluctuation within the primary segments of the loan portfolio (in thousands):

	September 30,			December 31,
	2022			2021			$ change			% change			% of loans
Commercial real estate:
Owner occupied	$	120,912		$	111,470			9,442			8.5	%		12.1	%
Non-owner occupied		285,419			283,618			1,801			0.6	%		28.7	%
Multifamily		38,063			31,189			6,874			22.0	%		3.8	%
Residential real estate		247,612			240,089			7,523			3.1	%		24.9	%
Commercial and industrial		146,987			148,812			(1,825	)		-1.2	%		14.8	%
Home equity lines of credit		114,344			104,355			9,989			9.6	%		11.5	%
Construction and Other		33,748			54,148			(20,400	)		-37.7	%		3.4	%
Consumer installment		8,110			8,010			100			1.2	%		0.8	%
Total loans		995,195			981,691			13,504			1.4	%		100.0	%
Less: Allowance for loan and lease losses		(14,532	)		(14,342	)		190			1.3	%
Net loans	$	980,663		$	967,349			13,314			1.4	%

The decrease in the commercial and industrial portfolio includes the forgiveness of PPP loans of $33.1 million during the nine months ended September 30, 2022. Excluding the impact of PPP forgiveness, total loans increased by $46.6 million or 6.6% annualized from December 31, 2021.

The Company’s Mortgage Banking operation generates loans for sale to the Federal Home Loan Mortgage Corporation (“Freddie Mac”). There were no loans held for sale on September 30, 2022, a decrease of $1.1 million from December 31, 2021. This decrease is the result of decreased demand due to fewer refinance opportunities and increased holdings of residential real estate loans for investment. The Company recorded proceeds from the sale of $1.6 million of these loans for $28,000 in gains on the sale of loans as of September 30, 2022, on the Company’s Consolidated Statement of Cash Flows.

The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending. According to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions that have (1) total reported loans for construction, land development, and other land acquisitions which represent 100% or more of an institution’s total risk-based capital; or (2) total commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the institution’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions that are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management concerning their commercial real estate portfolios and may be required to hold higher levels of capital. The Company, like many community banks, has a concentration in commercial real estate loans. On September 30, 2022, non-owner-occupied commercial real estate loans (including construction, land, and land development loans) represent 240.5% of total risk-based capital. Construction, land, and land development loans represent 24.8% of total risk-based capital. Management has extensive experience in commercial real estate lending and has implemented and continues to maintain heightened risk management procedures and strong underwriting criteria for its commercial real estate portfolio. Loan monitoring practices include but are not limited to periodic stress testing analysis to evaluate changes to cash flows due to interest rate increases and declines in net operating income. Nevertheless, we may be required to maintain higher levels of capital as a result of our commercial real estate concentrations, which could require us to obtain additional capital, and may adversely affect shareholder returns. The Company has an extensive capital planning policy, which includes pro forma projections, including stress testing, in which the Board of Directors has established internal minimum targets for regulatory capital ratios that are more than well-capitalized ratios.

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The Company monitors daily fluctuations in unused commitments as a means of identifying potentially material drawdowns on existing lines of credit. On September 30, 2022, unused line of credit commitments increased by $14.9 million, or 5.3%, from December 31, 2021.

Allowance for Loan and Lease Losses and Asset Quality. The ALLL increased by $190,000, or 1.3%, to $14.5 million on September 30, 2022, from $14.3 million on December 31, 2021. For the three months ended September 30, 2022, net loan charge-offs totaled $18,000, or 0.01% of average loans, annualized, compared to net recoveries of $34,000 or 0.01% of average loans, annualized, for the same period in 2021. No provision was needed during the three or nine months ended September 30, 2022, to maintain the allowance for loan and lease losses. For the nine months ended September 30, 2022, net recoveries totaled $190,000, or (0.02)% loans, annualized, compared to net charge-offs of $125,000, or 0.02% of average loans, annualized, for the same period in 2021. The ratio of the allowance for loan and lease losses to nonperforming loans was 393.6% as of September 30, 2022, compared to 209.1% for the same period in the prior year. The allowance for loan and lease losses to total loans ratio increased from 1.41% as of September 30, 2021, to 1.46% as of September 30, 2022. The increase in the ALLL-to-loans ratio resulted from a decrease in loan balances period over period. While the prior period provision was primarily attributable to the pandemic, the lack of provision for this year was impacted by credit quality.

Management analyzes the adequacy of the allowance for loan and lease losses regularly through reviews of the performance of the loan portfolio considering economic conditions, changes in interest rates and the effect of such changes on real estate values, and changes in the amount and composition of the loan portfolio. The allowance for loan and lease losses is a significant estimate that is particularly susceptible to changes in the near term. Risk which may impact our loan portfolio include the weakened economic outlook exacerbated by the current hostilities in Ukraine and resulting increased uncertainty characterized by persistent inflation. The direct impacts of the pandemic and related economic disruptions which previously dominated our risk analysis have lessened. Geopolitical events and persistently high inflation with weakening growth prospects raise the potential for adverse impacts to the U.S. economy. Increasing interest rates could potentially impact valuations of assets which collateralize our loans. Management’s analysis includes a review of all loans designated as impaired, historical loan loss experience, the estimated fair value of the underlying collateral, economic conditions, current interest rates, trends in the borrower’s industry, and other factors that management believes warrant recognition in providing for an appropriate allowance for loan and lease losses. Future additions or reductions to the allowance for loan and lease losses will be dependent on these factors. Additionally, the Company uses an outside party to conduct an independent review of commercial and commercial real estate loans that is designed to validate management conclusions of risk ratings and the appropriateness of the allowance allocated to these loans. The Company uses the results of this review to help determine the effectiveness of policies and procedures and to assess the adequacy of the allowance for loan and lease losses allocated to these types of loans. Management believes the allowance for loan and lease losses is appropriately stated on September 30, 2022. Based on the variables involved and management’s judgments about uncertain outcomes, the determination of the allowance for loan and lease losses is considered a critical accounting policy.

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The following tables illustrate the net charge-offs to average loans ratio for each loan category for each reported period:

	For the three months ended September 30,
	2022								2021
	Average Loan Balance		Net charge- offs (recoveries)			Net charge- offs (recoveries) to average loans			Average Loan Balance		Net charge- offs (recoveries)			Net charge- offs (recoveries) to average loans
(Dollars in Thousands)
Type of Loans:
Commercial real estate:											��
Owner occupied	$	120,975	$	(1	)		(0.00	)%	$	109,758	$	(1	)		(0.00	)%
Non-owner occupied		287,194		150			0.21			305,681		50			0.07
Multifamily		33,645		-			0.00			32,674		-			0.00
Residential real estate		247,306		(34	)		(0.05	)		228,869		(1	)		(0.00	)
Commercial and industrial		142,350		(61	)		(0.17	)		180,863		(19	)		(0.04	)
Home equity lines of credit		113,162		-			0.00			106,015		(3	)		(0.01	)
Construction and other		34,907		-			0.00			55,514		(18	)		(0.13	)
Consumer installment		8,150		(36	)		(1.77	)		8,560		(42	)		(1.96	)
Total	$	987,689	$	18			0.01	%	$	1,027,935	$	(34	)		(0.01	)%

	For the nine months ended September 30,
	2022								2021
	Average Loan Balance		Net charge- offs (recoveries)			Net charge- offs (recoveries) to average loans			Average Loan Balance		Net charge-offs			Net charge- offs (recoveries) to average loans
(Dollars in Thousands)
Type of Loans:
Commercial real estate:
Owner occupied	$	115,291	$	(4	)		(0.00	)%	$	108,305	$	(44	)		(0.05	)%
Non-owner occupied		282,315		150			0.07			313,596		313			0.13
Multifamily		34,358		-			0.00			35,590		-			0.00
Residential real estate		241,962		(61	)		(0.03	)		235,845		23			0.01
Commercial and industrial		146,754		(239	)		(0.22	)		199,954		(70	)		(0.05	)
Home equity lines of credit		108,503		25			0.03			110,324		(55	)		(0.07	)
Construction and other		43,608		-			0.00			57,163		(46	)		(0.11	)
Consumer installment		7,998		(61	)		(1.02	)		9,281		4			0.06
Total	$	980,787	$	(190	)		(0.02	)%	$	1,070,058	$	125			0.02	%

Goodwill. The carrying value of goodwill was $15.1 million at September 30, 2022, and December 31, 2021. The Company performs a periodic quantitative analysis of goodwill using multiple approaches. The primary methodology is the discounted cash flow approach, while also considering a market approach of comparing multiples of similar public companies as well as market price with control premiums.

Each of the valuation methods used by the Company requires significant assumptions. Depending on the specific method, assumptions are made regarding growth rates, discount rates for cash flows, control premiums, and selected multiples. Changes to any of the assumptions could result in significantly different results. Based on the most recent analysis performed as of March 31, 2020, the Company determined that goodwill was not impaired. The company also completed a qualitative assessment of goodwill as of September 30, 2022, with no resulting goodwill impairment.

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Nonperforming assets. Nonperforming assets include nonaccrual loans, loans 90 days or more past due, other real estate owned, and repossessed assets. Real estate owned is written down to fair value at its initial recording and continually monitored for changes in fair value. A loan is classified as nonaccrual when, in the opinion of management, there are serious doubts about the collectability of interest and principal. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower’s financial condition is such that collection of principal and interest is doubtful. Payments received on nonaccrual loans are applied against the principal until doubt about collectability ceases.

	Asset Quality History
(Dollar amounts in thousands)	September 30, 2022			December 31, 2021
Nonperforming loans	$	3,692		$	4,859
Other real estate owned		6,792			6,992
Nonperforming assets	$	10,484		$	11,851
Allowance for loan and lease losses		14,532			14,342
Ratios:
Nonperforming loans to total loans		0.37	%		0.49	%
Nonperforming assets to total assets		0.78	%		0.89	%
Allowance for loan and lease losses to total loans		1.46	%		1.46	%
Allowance for loan and lease losses to nonperforming loans		393.61	%		295.16	%

Nonperforming loans exclude TDRs that are performing under their terms over a prescribed period. TDRs are those loans for which the Company, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower that the Company would not otherwise consider. The Company has 23 TDRs accruing interest with a balance of $2.6 million as of September 30, 2022. A TDR that yields a market interest rate at the time of restructuring and is in compliance with its modified terms is no longer reported as a TDR in calendar years after the year in which the restructuring took place. To comply with its modified terms, a loan that is a TDR must not be in nonaccrual status and must be current or less than 30 days past due on its contractual principal and interest payments under the modified repayment terms. Nonperforming loans secured by real estate totaled $3.2 million and $4.2 million as of September 30, 2022 and December 31, 2021.

A major factor in determining the appropriateness of the allowance for loan and lease losses is the type of collateral that secures the loans. Of the total nonperforming loans on September 30, 2022, 87.2% were secured by real estate. Although this does not insure against all losses, real estate typically provides for at least partial recovery, even in a distressed sale and declining-value environment. The objective of the Company is to minimize future loss exposure.

Deposits. The Company considers various sources when evaluating funding needs, including but not limited to deposits, which are a significant source of funds, totaling $1.13 billion or 92.5% of the Company’s total average funding sources at September 30, 2022. Total deposits decreased $36.1 million on September 30, 2022, from $1.17 billion on December 31, 2021. The following table summarizes fluctuation within the primary segments of the deposit portfolio (in thousands):

	September 30,		December 31,
	2022		2021		$ change			% change
Noninterest-bearing demand	$	383,675	$	334,171	$	49,504			14.8	%
Interest-bearing demand		160,112		196,308		(36,196	)		-18.4	%
Money market		162,052		177,281		(15,229	)		-8.6	%
Savings		247,466		260,125		(12,659	)		-4.9	%
Time		177,182		198,725		(21,543	)		-10.8	%
Total deposits	$	1,130,487	$	1,166,610	$	(36,123	)		-3.1	%

The Company uses specific non-core funding instruments to grow the balance sheet and maintain liquidity. These deposits, either from a broker or a listing service, were $5.0 million on September 30, 2022 and $15.1 million on December 31, 2021.

39

Borrowed funds. The Company uses short-term and long-term borrowings as another source of funding for asset growth and liquidity needs. These borrowings primarily include advances from the Federal Home Loan Bank of Cincinnati (the “FHLB”), subordinated debt, short-term borrowings from other banks, and federal funds purchased. Short-term borrowings increased to $80.0 million as of September 30, 2022. Other borrowings were relatively unchanged at $12.1 million as of September 30, 2022 compared to $12.9 million at December 31, 2021.

Stockholders’ equity. Stockholders’ equity decreased $22.5 million, or 15.5%, to $122.9 million at September 30, 2022 from $145.3 million at December 31, 2021. This decrease was mostly the result of the $28.5 million decrease in accumulated other comprehensive income due to fair value adjustments of available-for-sale securities, and the $3.6 million increase in treasury stock due to the Company repurchasing 141,002 of its outstanding shares during the nine months ended September 30, 2022. These changes were partially offset by an increase in retained earnings of $9.2 million due to year-to-date net income, less dividends paid.

The Company's tangible book value per share, which is a non-GAAP financial measure, was $18.48 at September 30, 2022 compared to $21.39 at September 30, 2021 and $21.88 at December 31, 2021. Tangible equity has declined due to unrealized losses of the Company’s available-for-sale investment securities portfolio. The market value decline was a result of the yield curve steepening caused by inflation and the tightening of monetary policy by the Federal Reserve Board beginning in March of 2022 and throughout the past six months. Gross unrealized losses from available-for-sale investment securities were $31.7 million as of September 30, 2022, compared to unrealized gains of $4.6 million at September 30, 2021, and unrealized gains of $4.4 million at December 31, 2021.

RESULTS OF OPERATIONS

General. Net income for the three months ended September 30, 2022, was $4.2 million, a $955,000, or 18.4%, decrease from the amount earned during the same period in 2021. Diluted earnings per share for the quarter was $0.73 for the three months ended September 30, 2022 and $0.85 for the same period in 2021. Net income for the nine months ended September 30, 2022, was $12.2 million, a $1.6 million, or 11.8%, decrease from the amount earned during the same period in 2021. Diluted earnings per share was unchanged at $2.08 for these nine months ended September 30, 2022 and $2.19 for the same period in 2021.

The Company’s annualized return on average assets (“ROA”) and return on average equity (“ROE”) for the quarter were 1.32% and 12.94%, respectively, compared with 1.51% and 13.95% for the same period in 2021. The Company’s ROA and ROE for the nine months were 1.24% and 11.96%, respectively, compared with 1.34% and 12.58% for the same period in 2021.

Net interest income. Net interest income, the primary source of revenue for the Company, is determined by the interest rate spread, which is defined as the difference between income on earning assets and the cost of funds supporting those assets, and the relative amounts of interest-earning assets and interest-bearing liabilities. Management periodically adjusts the mix of assets and liabilities, as well as the rates earned or paid on those assets and liabilities, to manage and improve net interest income. The level of interest rates and changes in the amount and composition of interest-earning assets and liabilities affect the Company’s net interest income. Management’s goal is to maintain a balance between steady net interest income growth and the risks associated with interest rate fluctuations.

Net interest income for the three months ended September 30, 2022, totaled $12.6 million, an increase of 1.1% from that reported in the comparable period of 2021. The net interest margin was 4.23% for the third quarter of 2022, an increase from the 3.90% reported for the same quarter of 2021. The increase in the net interest margin is attributable to a decrease in the average balance of certificates of deposit of $44.2 million, coupled with a 12 basis point decrease in the rate paid on those deposits. Further contributing to the improvement in net interest margin was an increase in the average balance of investments of $17.6 million, coupled with a 53 basis point increase in the yield earned on those investments. These fluctuations were partially offset by a $40.2 million decrease in the average balance of loans.

Net interest income for the nine months ended September 30, 2022, totaled $36.1 million, a decrease of 0.2% from that reported in the comparable period of 2021. The net interest margin was 4.02% for the nine months ended September 30, 2022, an increase from the 3.78% reported for the same period of 2021. The increase in the net interest margin is attributable to a decrease in the average balance of certificates of deposit of $56.4 million, coupled with a 30 basis point decrease in the rate paid on those deposits. Further contributing to the improvement in net interest margin was an increase in the average balance of investments of $37.6 million. These fluctuations were partially offset by an $89.3 million decrease in the average balance of loans.

The Company is in an asset-sensitive position. A rising interest rate environment should lead to an expansion of net interest margin as the Company’s interest-earning assets reprice faster than its interest-bearing liabilities.  Much of the Company’s asset sensitivity is due to commercial loans that have variable interest rates.  As part of the Company’s strategy, floor rates are used to protect the Company’s net interest margin in a declining interest rate environment. As of September 30th, nearly all loan contracts with floor rates exceed their contractual floor rates and are repricing accordingly with rising interest rates.  Although the Company expects to benefit from a rising interest rate environment, deposit pricing is expected to increase in order to maintain liquidity. Please refer to Item 3, Quantitative and Qualitative Disclosures about Market Risk, for further discussion on asset and liability management and interest rate sensitivity.

40

Interest and dividend income. Interest and dividend income increased $120,000, or 0.9%, for the three months ended September 30, 2022, compared to the same period in the prior year. This is attributable to a $297,000 increase in interest on investment securities and a $154,000 increase in interest-earning deposits and federal funds sold interest, partially offset by a decrease in interest and fees on loans of $366,000. The average balance of investment securities increased by $17.6 million, or 11.4%, and the 3.90% yield on the investment portfolio increased by 53 basis points, from 3.37%, for the same period in the prior year. The decrease in the average loan balance for the three months ended September 30, 2022, is due in part to the forgiveness of PPP loans.

Interest and dividend income decreased by $877,000, or 2.2%, for the nine months ended September 30, 2022, compared to the same period in the prior year. This is attributable to a decrease in interest and fees on loans of $2.2 million, partially offset by an increase in interest on investment securities of $981,000. The average balance of investment securities increased by $37.6 million, or 27.2%, while the yield on the investment portfolio increased by 18 basis points, from 3.69% for the nine months ended September 30, 2022 compared to 3.51% for the same period 2021. The change in the average loan balance for the nine months ended September 30, 2022, is due in part to the forgiveness of PPP loans, from which the related gross deferred fee income was $1.2 million.

Interest expense. Interest expense decreased by $15,000, or 1.5%, for the three months ended September 30, 2022, compared to the same period in the prior year. This is attributable to a decrease in deposit expense of $103,000, partially offset by an $88,000 increase in short-term and other borrowings expense. The decrease in deposit expense is attributable to a decrease in the average balance of certificates of deposits of $44.2 million, or 20.3%. This decrease is further attributable to decreases of 12 basis points in the rates paid on certificates of deposits. The increase in short-term borrowings expense is a result of the Bank taking on FHLB advances during the third quarter of 2022, while there were no short-term borrowings during 2021.

Interest expense decreased by $791,000 or 23.7%, for the nine months ended September 30, 2022, compared to the same period in the prior year. This is attributable to a decrease in deposit expense of $883,000, partially offset by a $92,000 increase in short-term and other borrowings expense. The decrease in deposit expense is attributable to a decrease in the average balance of certificates of deposits and interest-bearing demand deposits of $56.4 million and $47.5 million, respectively. This decrease is further attributable to decreases of 30 basis points in certificates of deposits. The increase in short-term borrowings expense is a result of the Bank taking on FHLB advances during the third quarter of 2022, while there were no short-term borrowings during 2021.

Provision for loan losses. The provision for loan losses represents the charge to income necessary to adjust the allowance for loan and lease losses to an amount that represents management’s assessment of the estimated probable incurred credit losses inherent in the loan portfolio. Each quarter, management reviews estimated probable incurred credit losses in the loan portfolio. Based on this review, no provision was recorded for the three or nine months ended September 30, 2022, a decrease of $900,000 from the nine months ended September 30, 2021. While the prior period provision was mostly attributable to the pandemic, the lack of provision for this quarter was impacted by credit quality and low loan growth.

The ALLL to total loans for the quarter ended September 30, 2022, was 1.46%, compared to 1.41% during the same period in the prior year. The increase in the ALLL to loans ratio resulted from a decrease in loan balances period over period. The Company remains confident in its conservative and disciplined approach to credit and risk management.

With the passage of the PPP, administered by the Small Business Administration (“SBA”), the Company has actively assisted its customers with applications for resources through the program. On September 30, 2022, the Company carried $1.0 million of PPP loans classified as C&I loans for reporting purposes. Loans funded through the PPP program are fully guaranteed by the U.S. government. This guarantee exists at the inception of the loans and throughout the lives of the loans and was not entered into separately and apart from the loans.

Noninterest income. Noninterest income decreased by $275,000, or 15.1%, for the three months ended September 30, 2022, over the comparable 2021 period. This decrease was the result of a $302,000 decrease in gains on sale of loans, and a $159,000 decrease in gains on equity securities, partially offset by a $128,000 increase in service charges on deposit accounts. The decrease in gains on sale of loans resulted from the decline in demand for residential refinances. The decrease in gains on equity securities was the result of fair value marks of the equity securities held during these three months. The increase in service charges on deposit accounts was primarily due to an increase in checking account fees as a result of a new checking account program offered to customers.

41

Noninterest income decreased $1.3 million, or 23.6%, during the nine months ended September 30, 2022, over the comparable 2021 period. This decrease was the result of a $1.0 million decrease in gains on sale of loans, a $319,000 decrease in gain on equity securities, and a $118,000 decrease in earnings on bank-owned life insurance, partially offset by a $355,000 increase in service charges on deposit accounts. The decrease in gains on sale of loans resulted from the decline in demand for residential refinances. The decrease in gains on equity securities was the result of fair value marks of the equity securities held during these nine months. The decrease in earnings on bank-owned life insurance is due to the prior year payout on a claim. The increase in service charges on deposit accounts was primarily due to an increase in checking account fees as a result of a new checking account program offered to customers.

Noninterest expense. Noninterest expense of $8.9 million for the third quarter of 2022 was 12.4%, or $979,000, higher than the third quarter of 2021. Merger-related costs increased $390,000, professional fees increased $144,000, and data processing and information technology costs increased by $140,000. Noninterest expense of $25.7 million for the nine months ended September 30, 2021, was 6.5%, or $1.6 million, higher than the same period in 2021. The increase was primarily the result of a $969,000 increase in merger-related costs, a $240,000 increase in professional fees, a $203,000 increase in data processing and information technology costs, and a $200,000 write-down of a foreclosed property. These increases were offset by a decrease in salaries and employee benefits expense partially due to a decrease in share-based compensation expense. Please refer to Note 3 for more information on share-based compensation plans.

Provision for income taxes. The Company recognized $1.0 million in income tax expense, which reflected an effective tax rate of 19.2% for the three months ended September 30, 2022, as compared to $1.2 million with an effective tax rate of 18.4% for the comparable 2021 period. The Company recognized $2.6 million in income tax expense, which reflected an effective tax rate of 17.4% for the nine months ended September 30, 2022, as compared to $3.0 million with an effective tax rate of 18.0% for the comparable 2021 period. The decrease in the effective tax rate is due to an increase in tax-exempt income generated from the investment portfolio.

42

Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resultant average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resultant average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average balances are calculated using monthly averages and the average loan balances include nonaccrual loans and exclude the allowance for loan and lease losses, and interest income includes accretion of net deferred loan fees. Yields on tax-exempt securities and loans (tax-exempt for federal income tax purposes) are shown on a fully tax-equivalent basis utilizing a federal tax rate of 21%. Yields and rates have been calculated on an annualized basis utilizing monthly interest amounts.

	For the Three Months Ended September 30,
	2022							2021
	Average				Average			Average				Average
(Dollars in thousands)	Balance		Interest		Yield/Cost			Balance		Interest		Yield/Cost
Interest-earning assets:
Loans receivable (3)	$	987,689	$	11,892		4.78	%	$	1,027,935	$	12,258		4.74	%
Investment securities (3)		172,316		1,431		3.90	%		154,718		1,134		3.37	%
Interest-earning deposits with other banks (4)		46,938		244		2.06	%		105,910		55		0.21	%
Total interest-earning assets		1,206,943		13,567		4.55	%		1,288,563		13,447		4.20	%
Noninterest-earning assets		73,753							82,952
Total assets	$	1,280,696						$	1,371,515
Interest-bearing liabilities:
Interest-bearing demand deposits	$	162,878	$	91		0.22	%	$	225,264	$	67		0.12	%
Money market deposits		155,095		180		0.46	%		182,831		214		0.46	%
Savings deposits		249,898		119		0.19	%		253,960		38		0.06	%
Certificates of deposit		174,091		422		0.96	%		218,323		596		1.08	%
Short-term borrowings		8,554		44		2.04	%		-		-		0.00	%
Other borrowings		12,530		112		3.55	%		12,999		68		2.08	%
Total interest-bearing liabilities		763,046		968		0.50	%		893,377		983		0.44	%
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits		382,351							323,726
Other liabilities		5,036							6,364
Stockholders' equity		130,263							148,048
Total liabilities and stockholders' equity	$	1,280,696						$	1,371,515
Net interest income			$	12,599						$	12,464
Interest rate spread (1)						4.05	%						3.76	%
Net interest margin (2)						4.23	%						3.90	%
Ratio of average interest-earning assets to average interest-bearing liabilities						158.17	%						144.24	%

(1) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(2) Net interest margin represents net interest income as a percentage of average interest-earning assets.

(3) Tax-equivalent adjustments to calculate the yield on tax-exempt securities and loans were $277 and  $195 for the three months ended September 30, 2022 and 2021, respectively.

(4) Includes dividends received on restricted stock.  

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Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense, between the three-month periods ended September 30, 2022, and 2021, in terms of (1) changes in the volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Company’s interest income and interest expense are attributable to changes in rate (change in rate multiplied by prior period volume), changes in volume (changes in volume multiplied by prior period rate), and changes attributable to the combined impact of volume/rate (change in rate multiplied by the change in volume). The changes attributable to the combined impact of volume/rate are allocated consistently between the volume and rate variances.

	2022 versus 2021
	Increase (decrease) due to
(Dollars in thousands)	Volume			Rate			Total
Interest-earning assets:
Loans receivable	$	(481	)	$	115		$	(366	)
Investment securities		149			148			297
Interest-earning deposits with other banks		(31	)		220			189
Total interest-earning assets		(363	)		483			120
Interest-bearing liabilities:
Interest-bearing demand deposits		(19	)		43			24
Money market deposits		(32	)		(2	)		(34	)
Savings deposits		(1	)		82			81
Certificates of deposit		(120	)		(54	)		(174	)
Short-term borrowings		-			44			44
Other borrowings		(2	)		46			44
Total interest-bearing liabilities		(174	)		159			(15	)
Net interest income	$	(189	)	$	324		$	135

44

Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resultant average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resultant average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average balances are calculated using monthly averages and the average loan balances include nonaccrual loans and exclude the allowance for loan and lease losses, and interest income includes accretion of net deferred loan fees. Yields on tax-exempt securities and loans (tax-exempt for federal income tax purposes) are shown on a fully tax-equivalent basis utilizing a federal tax rate of 21%. Yields and rates have been calculated on an annualized basis utilizing monthly interest amounts.

	For the Nine Months Ended September 30,
	2022							2021
	Average				Average			Average				Average
(Dollars in thousands)	Balance		Interest		Yield/Cost			Balance		Interest		Yield/Cost
Interest-earning assets:
Loans receivable (3)	$	980,787	$	34,145		4.66	%	$	1,070,058	$	36,310		4.54	%
Investment securities (3)		173,094		4,055		3.69	%		135,522		3,074		3.51	%
Interest-earning deposits with other banks (4)		72,851		448		0.82	%		94,955		141		0.20	%
Total interest-earning assets		1,226,732		38,648		4.30	%		1,300,535		39,525		4.12	%
Noninterest-earning assets		82,733							74,883
Total assets	$	1,309,465						$	1,375,418
Interest-bearing liabilities:
Interest-bearing demand deposits	$	164,337		210		0.17	%	$	211,797	$	209		0.13	%
Money market deposits		175,024		620		0.47	%		187,945		655		0.47	%
Savings deposits		256,762		197		0.10	%		254,574		123		0.06	%
Certificates of deposit		184,165		1,220		0.89	%		240,582		2,143		1.19	%
Short-term borrowings		2,851		44		2.06	%		113		-		0.00	%
Other borrowings		12,806		262		2.74	%		13,440		214		2.13	%
Total interest-bearing liabilities		795,945		2,553		0.43	%		908,451		3,344		0.49	%
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits		372,343							314,172
Other liabilities		5,087							6,184
Stockholders' equity		136,090							146,611
Total liabilities and stockholders' equity	$	1,309,465						$	1,375,418
Net interest income			$	36,095						$	36,181
Interest rate spread (1)						3.87	%						3.63	%
Net interest margin (2)						4.02	%						3.78	%
Ratio of average interest-earning assets to average interest-bearing liabilities						154.12	%						143.16	%

(1) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(2) Net interest margin represents net interest income as a percentage of average interest-earning assets.

(3) Tax-equivalent adjustments to calculate the yield on tax-exempt securities and loans were $768 and $542 for the nine months ended September 30, 2022 and 2021, respectively.

(4) Includes dividends received on restricted stock.

45

Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense, between the nine-month periods ended September 30, 2022, and 2021, in terms of (1) changes in the volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Company’s interest income and interest expense are attributable to changes in rate (change in rate multiplied by prior period volume), changes in volume (changes in volume multiplied by prior period rate), and changes attributable to the combined impact of volume/rate (change in rate multiplied by the change in volume). The changes attributable to the combined impact of volume/rate are allocated consistently between the volume and rate variances.

	2022 versus 2021
	Increase (decrease) due to
(Dollars in thousands)	Volume			Rate			Total
Interest-earning assets:
Loans receivable	$	(3,031	)	$	866		$	(2,165	)
Investment securities		828			153			981
Interest-earning deposits with other banks		(33	)		340			307
Total interest-earning assets		(2,236	)		1,359			(877	)
Interest-bearing liabilities:
Interest-bearing demand deposits		(46	)		47			1
Money market deposits		(45	)		10			(35	)
Savings deposits		1			73			74
Certificates of deposit		(502	)		(421	)		(923	)
Short-term borrowings		-			44			44
Other borrowings		(10	)		58			48
Total interest-bearing liabilities		(602	)		(189	)		(791	)
Net interest income	$	(1,634	)	$	1,548		$	(86	)

46

LIQUIDITY

Management's objective in managing liquidity is to maintain the ability to continue meeting the cash flow needs of banking customers, such as borrowings or deposit withdrawals, as well as the Company’s financial commitments. The principal sources of liquidity are net income, loan payments, maturing and principal reductions on securities and sales of securities available for sale, federal funds sold, and cash and deposits with banks. While securities are generally considered as a source of cash, in the current environment, it is unlikely that securities would be sold for such funding needs. The Company offers a line of retail deposit products created to align with customer expectations while expanding the Company’s core funding base. Along with its liquid assets, the Company has additional sources of liquidity available to ensure that adequate funds are available as needed. These include, but are not limited to, the purchase of federal funds, the ability to borrow funds under line of credit agreements with correspondent banks and a borrowing agreement with the FHLB, and the adjustment of interest rates to obtain depositors. Management believes the Company has the capital adequacy, profitability, and reputation for meeting the current and projected needs of its customers.

On September 30, 2022, the additional borrowing capacity at the FHLB was $389.3 million, as compared to $417.4 million on December 31, 2021. For the nine months ended September 30, 2022, wholesale funding decreased by $10.1 million. The Company also has the option of borrowing from the Federal Reserve discount window with any assets not currently pledged elsewhere. Management believes that the combination of high levels of potentially liquid assets, cash flows from operations, and additional borrowing capacity provided Middlefield Bank with strong liquidity as of September 30, 2022. Although the Company currently exhibits strong liquidity, management will continue to monitor liquidity in future periods.

For the nine months ended September 30, 2022, the adjustments to reconcile net income to net cash from operating activities consisted mainly of depreciation and amortization of premises and equipment and software, the provision for loan losses, net amortization of securities, earnings on bank-owned life insurance, accretion of net deferred loan fees, and net changes in other assets and liabilities. For a more detailed illustration of sources and uses of cash, refer to the Condensed Consolidated Statements of Cash Flows.

INFLATION

Substantially all of the Company's assets and liabilities relate to banking activities and are monetary. The consolidated financial statements and related financial data are presented following GAAP. GAAP currently requires the Company to measure the financial position and results of operations in terms of historical dollars, except for securities available for sale, impaired loans, and other real estate loans that are measured at fair value. Changes in the value of money due to rising inflation can cause purchasing power loss.

Management's opinion is that movements in interest rates affect the financial condition and results of operations to a greater degree than changes in the rate of inflation. It should be noted that interest rates and inflation do affect each other but do not always move in correlation with each other. The Company's ability to match the interest sensitivity of its financial assets to the interest sensitivity of its liabilities in its asset/liability management may tend to minimize the effect of changes in interest rates on the Company's performance.

REGULATORY MATTERS

The Company is subject to the regulatory requirements of the Federal Reserve System as a bank holding company. The bank subsidiary is subject to regulations of the Federal Deposit Insurance Corporation (“FDIC”) and the Ohio Division of Financial Institutions.

The Federal Reserve Board and the FDIC have extensive authority to prevent and remedy unsafe and unsound practices and violations of applicable laws and regulations by institutions and holding companies. The agencies may assess civil money penalties, issue cease-and-desist or removal orders, seek injunctions, and publicly disclose those actions. In addition, the Ohio Division of Financial Institutions possesses enforcement powers to address violations of Ohio banking law by Ohio-chartered banks.

REGULATORY CAPITAL REQUIREMENTS

Financial institution regulators have established guidelines for minimum capital ratios for banks, thrifts, and bank and thrift holding companies. The net unrealized gain or loss on available-for-sale securities is generally not included in computing regulatory capital. To avoid limitations on capital distributions, including dividend payments, Middlefield Bank and the Company must each hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. Within the tabular presentation that follows is the adequately capitalized ratio plus a 2.50% capital conservation buffer.

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Middlefield Bank and the Company met each of the well-capitalized ratio guidelines on September 30, 2022. The following table indicates the capital ratios for Middlefield Bank and the Company on September 30, 2022, and December 31, 2021.

	As of September 30, 2022
				Tier 1 Risk			Common			Total Risk
	Leverage			Based			Equity Tier 1			Based
The Middlefield Banking Company		10.81	%		12.85	%		12.85	%		14.10	%
Middlefield Banc Corp.		11.05	%		13.23	%		12.48	%		14.48	%
Adequately capitalized ratio		4.00	%		6.00	%		4.50	%		8.00	%
Adequately capitalized ratio plus fully phased-in capital conservation buffer		4.00	%		8.50	%		7.00	%		10.50	%
Well-capitalized ratio (Bank only)		5.00	%		8.00	%		6.50	%		10.00	%

	As of December 31, 2021
				Tier 1 Risk			Common			Total Risk
	Leverage			Based			Equity Tier 1			Based
The Middlefield Banking Company		9.80	%		12.72	%		12.72	%		13.97	%
Middlefield Banc Corp.		10.02	%		12.96	%		12.18	%		14.21	%
Adequately capitalized ratio		4.00	%		6.00	%		4.50	%		8.00	%
Adequately capitalized ratio plus fully phased-in capital conservation buffer		4.00	%		8.50	%		7.00	%		10.50	%
Well-capitalized ratio (Bank only)		5.00	%		8.00	%		6.50	%		10.00	%

Item 3. Quantitative and Qualitative Disclosures about Market Risk

ASSET AND LIABILITY MANAGEMENT

The primary objective of the Company’s asset and liability management function is to maximize the Company’s net interest income while simultaneously maintaining an acceptable level of interest rate risk given the Company’s operating environment, capital and liquidity requirements, performance objectives, and overall business focus. The principal determinant of the exposure of the Company’s earnings to interest rate risk is the timing difference between the repricing or maturity of interest-earning assets and the re-pricing or maturity of interest-bearing liabilities. The Company’s asset and liability management policies are designed to decrease interest rate sensitivity primarily by shortening the maturities of interest-earning assets while at the same time extending the maturities of interest-bearing liabilities. The Board of Directors of the Company continues to believe in a strong asset/liability management process to insulate the Company from material and prolonged increases in interest rates.

The Company’s Board of Directors has established an Asset and Liability Management Committee consisting of outside directors and senior management. This committee, which meets quarterly, generally monitors various asset and liability management policies and strategies.

Interest Rate Sensitivity Simulation Analysis

The Company engages an external consultant to facilitate income simulation modeling quarterly. This modeling measures interest rate risk and sensitivity. The Asset and Liability Management Committee of the Company believes the various rate scenarios of the simulation modeling enable the Company to more accurately evaluate and manage the exposure of interest rate fluctuations on net interest income, the yield curve, various loan and mortgage-backed security prepayments, and deposit decay assumptions.

Earnings simulation modeling and assumptions about the timing and volatility of cash flows are critical in net portfolio equity valuation analysis. Particularly important are the assumptions driving mortgage prepayments and the expected attrition of the core deposit portfolios. These assumptions are based on the Company’s historical experience and industry standards and are applied consistently across all rate risk measures.

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The Company has established the following guidelines for assessing interest rate risk:

Net interest income simulation (“NII”) - Projected net interest income over the next twelve months will not be reduced by more than 10% given a gradual shift (i.e., over 12 months) in interest rates of up to 200 basis points (+ or -) and assuming no balance sheet growth.

Portfolio equity simulation - Portfolio equity is the net present value of the Company’s existing assets and liabilities. The Company uses an Economic Value of Equity (“EVE”) analysis which shows the estimated changes in portfolio equity considering certain long-term shock rates. Given a 200 basis point immediate and permanent increase in market interest rates, portfolio equity may not correspondingly decrease or increase by more than 20% of stockholders’ equity. Given a 100 basis point immediate and permanent decrease in market interest rates, portfolio equity may not correspondingly decrease or increase by more than 10% of stockholders’ equity.

The following table presents the simulated impact of a 200 basis point upward or 100 basis point downward shift of market interest rates on net interest income and the change in portfolio equity. This analysis was done assuming the interest-earning asset and interest-bearing liability levels at September 30, 2022, and December 31, 2021, remained constant. The impact of the market rate movements was developed by simulating the effects of rates changing gradually over one year from the September 30, 2022, and December 31, 2021 levels for net interest income and portfolio equity. The impact of market-rate movements was developed by simulating the effects of an immediate and permanent change in rates at September 30, 2022, and December 31, 2021, for portfolio equity:  

	September 30, 2022						December 31, 2020
Change in Rates	% Change in NII			% Change in EVE			% Change in NII			% Change in EVE
+200bp		0.50	%		(2.30	)%		2.40	%		2.50	%
-100bp		(1.36	)%		(2.60	)%		(1.40	)%		(12.70	)%

CRITICAL ACCOUNTING ESTIMATES

The Company’s critical accounting estimates involving the more significant judgments and assumptions used in the preparation of the consolidated financial statements as of September 30, 2022, have remained unchanged from December 31, 2021.

Item 4. Controls and Procedures

Controls and Procedures Disclosure

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

As of the end of the period covered by this quarterly report, an evaluation was carried out under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are, to the best of their knowledge, effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the periods specified in Securities and Exchange Commission rules and forms. After the date of their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that there were no significant changes in internal control or in other factors that could significantly affect the Company’s internal controls, including any corrective actions concerning significant deficiencies and material weaknesses.

A material weakness is a significant deficiency (as defined in Public Company Accounting Oversight Board Auditing Standard No. 2), or a combination of significant deficiencies, that results in there being more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis by management or employees in the normal course of performing their assigned functions.

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Changes in Internal Control over Financial Reporting

There have not been any changes in the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, the Company and MBC may be involved in litigation relating to claims arising out of their normal course of business. Currently, the Company and MBC are not involved in any legal proceedings, the outcome of which, in management’s opinion, would be material to their financial condition or results of operations.

Item 1a. Risk Factors

There have been no material changes in the Company’s risk factors from those disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Details of repurchases of Company common stock during the third quarter of 2022 are included in the following table:

					Total shares purchased as		Maximum number of shares
2022 period	Total shares				part of a publicly announced		that may yet be purchased
In thousands, except per share data	purchased		Average price paid per share		program (a)		under the program
July 1-31		7,753	$	25.22		7,753		284,434
August 1-31		20,688	$	26.99		28,441		263,746
September 1-30		17,197	$	27.12		45,638		246,549
Total		45,638	$	26.74

(a)    In February of 2022, the Board of Directors authorized an increase to the Program resulting in 300,000 additional shares being available for repurchase. The Program may be modified, suspended or terminated by the Company at any time.

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

N/A

Item 5. Other information

None

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Item 6. Exhibits

Exhibit list for Middlefield Banc Corp.’s Form 10-Q Quarterly Report for the Period Ended September 30, 2022

Exhibit Number	Description	Location
2.1	Agreement and Plan of Merger dated as of May  26, 2022 by and among Middlefield Banc Corp., MBCN Merger Subsidiary, LLC, and Liberty Bancshares, Inc.	Incorporated by reference to Exhibit 2.1 of Middlefield Banc Corp.’s Form 8-K Current Report and Form 425 filed on May 27, 2022
3.1	Second Amended and Restated Articles of Incorporation of Middlefield Banc Corp., as amended	Incorporated by reference to Exhibit 3.1 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Fiscal Year Ended December 31, 2005, filed on March 29, 2006
3.2	Regulations of Middlefield Banc Corp.	Incorporated by reference to Exhibit 3.2 of Middlefield Banc Corp.’s registration statement on Form 10 filed on April 17, 2001
4	Specimen stock certificate	Incorporated by reference to Exhibit 4 of Middlefield Banc Corp.’s registration statement on Form 10 filed on April 17, 2001
4.1	Amended and Restated Trust Agreement, dated as of December 21, 2006, between Middlefield Banc Corp., as Depositor, Wilmington Trust Company, as Property trustee, Wilmington Trust Company, as Delaware Trustee, and Administrative Trustees	Incorporated by reference to Exhibit 4.1 of Middlefield Banc Corp.’s Form 8-K Current Report filed on December 27, 2006
4.2	Junior Subordinated Indenture, dated as of December 21, 2006, between Middlefield Banc Corp. and Wilmington Trust Company	Incorporated by reference to Exhibit 4.2 of Middlefield Banc Corp.’s Form 8-K Current Report filed on December 27, 2006
4.3	Guarantee Agreement, dated as of December 21, 2006, between Middlefield Banc Corp. and Wilmington Trust Company	Incorporated by reference to Exhibit 4.3 of Middlefield Banc Corp.’s Form 8-K Current Report filed on December 27, 2006
10.1.0*	2017 Omnibus Equity Plan	Incorporated by reference to Middlefield Banc Corp.’s definitive proxy statement for the 2017 Annual Meeting of Shareholders, Appendix A, filed on April 4, 2017
10.1.1	[reserved]
10.2	[reserved]

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10.3*	Change in Control Agreement between Middlefield Banc Corp. and James R. Heslop, II	Incorporated by reference to Exhibit 10.3 of Middlefield Banc Corp.’s Form 8-K Current Report filed on March 12, 2019
10.4	Federal Home Loan Bank of Cincinnati Agreement for Advances and Security Agreement dated September 14, 2000	Incorporated by reference to Exhibit 10.4 of Middlefield Banc Corp.’s registration statement on Form 10 filed on April 17, 2001
10.4.1*	Severance Agreement between Middlefield Banc Corp. and Teresa M. Hetrick, dated January 7, 2008	Incorporated by reference to Exhibit 10.4.1 of Middlefield Banc Corp.’s Form 8-K Current Report filed on January 9, 2008
10.4.2*	Change in Control Agreement between Middlefield Banc Corp. and Charles O. Moore	Incorporated by reference to Exhibit 10.4.2 of Middlefield Banc Corp.’s Form 8-K Current Report filed on March 12, 2019
10.4.3*	Change in Control Agreement between Middlefield Banc Corp. and Donald L. Stacy	Incorporated by reference to Exhibit 10.4.3 of Middlefield Banc Corp.’s Form 8-K Current Report filed on March 12, 2019
10.4.4*	Severance Agreement between Middlefield Banc Corp. and Alfred F. Thompson, Jr., dated January 7, 2008	Incorporated by reference to Exhibit 10.4.4 of Middlefield Banc Corp.’s Form 8-K Current Report filed on January 9, 2008
10.4.5*	Change in Control Agreement between Middlefield Banc Corp. and Michael L. Allen	Incorporated by reference to Exhibit 10.4.5 of Middlefield Banc Corp.’s Form 10-Q Quarterly Report filed on November 5, 2019
10.4.6*	Compensation Agreement between Middlefield Banc Corp. and Michael C. Ranttila	Incorporated by reference to Exhibit 10.4.6 of Middlefield Banc Corp.’s Form 10-K Annual Report filed on March 15, 2022
10.4.7*	Change in Control Agreement between Middlefield Banc Corp. and Michael C. Ranttila	Incorporated by reference to Exhibit 10.4.7 of Middlefield Banc Corp.’s Form 10-K Annual Report filed on March 12, 2021
10.5	[reserved]
10.6	[reserved]
10.7*	Amended Director Retirement Agreement with Frances H. Frank	Incorporated by reference to Exhibit 10.7 of Middlefield Banc Corp.’s Form 8-K Current Report filed on January 9, 2008
10.8	Executive Retention Agreement between The Middlefield Banking Company and Michael C. Ranttila	Incorporated by reference to Exhibit 10.8 of Middlefield Banc Corp.’s Form 10-Q Quarterly Report filed on May 10, 2022

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10.9	Executive Retention Agreement between The Middlefield Banking Company and Michael L. Allen	Incorporated by reference to Exhibit 10.8 of Middlefield Banc Corp.’s Form 10-Q Quarterly Report filed on May 10, 2022
10.10	Executive Retention Agreement between The Middlefield Banking Company and Charles O. Moore	Incorporated by reference to Exhibit 10.8 of Middlefield Banc Corp.’s Form 10-Q Quarterly Report filed on May 10, 2022
10.11*	Director Retirement Agreement with Martin S. Paul	Incorporated by reference to Exhibit 10.11 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2001, filed on March 28, 2002
10.12	[reserved]
10.13	[reserved]
10.14*	Executive Survivor Income Agreement (aka DBO agreement [death benefit only]) with Donald L. Stacy	Incorporated by reference to Exhibit 10.14 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004
10.15*	DBO Agreement with Jay P. Giles	Incorporated by reference to Exhibit 10.15 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004
10.16*	DBO Agreement with Alfred F. Thompson, Jr.	Incorporated by reference to Exhibit 10.16 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004
10.17*	DBO Agreement with Teresa M. Hetrick	Incorporated by reference to Exhibit 10.18 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004
10.18 *	Executive Deferred Compensation Agreement with Jay P. Giles	Incorporated by reference to Exhibit 10.18 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2011, filed on March 20, 2012
10.19	[reserved]
10.20*	DBO Agreement with James R. Heslop, II	Incorporated by reference to Exhibit 10.20 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004

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10.21*	DBO Agreement with Thomas G. Caldwell	Incorporated by reference to Exhibit 10.21 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004
10.22*	Annual Incentive Plan	Incorporated by reference to Exhibit 10.22 of Middlefield Banc Corp.’s Form 8-K Current Report filed on March 12, 2019
10.22.1	[reserved]
10.23**	Amended Executive Deferred Compensation Agreement with Thomas G. Caldwell	Incorporated by reference to Exhibit 10.23 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2019, filed on March 4, 2020
10.24**	Amended Executive Deferred Compensation Agreement with James R. Heslop, II	Incorporated by reference to Exhibit 10.24 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2019, filed on March 4, 2020
10.25**	Amended Executive Deferred Compensation Agreement with Donald L. Stacy	Incorporated by reference to Exhibit 10.25 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2019, filed on March 4, 2020
10.26**	Executive Variable Benefit Deferred Compensation Agreement with James R. Heslop, II	Incorporated by reference to Exhibit 10.26 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2019, filed on March 4, 2020
10.27**	Executive Variable Benefit Deferred Compensation Agreement with Donald L. Stacy	Incorporated by reference to Exhibit 10.27 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2019, filed on March 4, 2020
10.28**	Executive Deferred Compensation Agreement with Charles O. Moore	Incorporated by reference to Exhibit 10.28 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2019, filed on March 4, 2020
10.29	[reserved]
10.29.1	Form of conditional stock award under the 2017 Omnibus Equity Plan	Incorporated by reference to Exhibit 10.29 of Middlefield Banc Corp.’s Form 8-K Current Report filed on July 24, 2017

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10.30**	Executive Deferred Compensation Agreement with Michael L. Allen	Incorporated by reference to Exhibit 10.30 of Middlefield Banc Corp.’s Form 10-Q Quarterly Report filed on May 7, 2019
10.31**	Executive Deferred Compensation Agreement with John D. Lane	Incorporated by reference to Exhibit 10.31 of Middlefield Banc Corp.’s Form 10-Q Quarterly Report filed on May 7, 2019
10.32**	Executive Deferred Compensation Agreement with Michael C. Ranttila	Incorporated by reference to Exhibit 10.32 of Middlefield Banc Corp.’s Form 10-K Annual Report filed on March 12, 2021
10.33**	Executive Deferred Compensation Agreement with Courtney M. Erminio	Incorporated by reference to Exhibit 10.33 of Middlefield Banc Corp.’s Form 10-Q Quarterly Report filed on August 8, 2022
10.34**	Executive Deferred Compensation Agreement with Alfred F. Thompson	Incorporated by reference to Exhibit 10.34 of Middlefield Banc Corp.’s Form 10-Q Quarterly Report filed on August 8, 2022
31.1	Rule 13a-14(a) certification of Chief Executive Officer	filed herewith
31.2	Rule 13a-14(a) certification of Chief Financial Officer	filed herewith
32	Rule 13a-14(b) certification	filed herewith
99.1	Form of Indemnification Agreement with directors of Middlefield Banc Corp. and with executive officers of Middlefield Banc Corp. and The Middlefield Banking Company	Incorporated by reference to Exhibit 99.1 of Middlefield Banc Corp.’s registration statement on Form 10, Amendment No. 1, filed on June 14, 2001
101.INS***	Inline XBRL Instance	furnished herewith
101.SCH***	Inline XBRL Taxonomy Extension Schema	furnished herewith
101.CAL***	Inline XBRL Taxonomy Extension Calculation	furnished herewith
101.DEF***	Inline XBRL Taxonomy Extension Definition	furnished herewith
101.LAB***	Inline XBRL Taxonomy Extension Labels	furnished herewith
101.PRE***	Inline XBRL Taxonomy Extension Presentation	furnished herewith
104	Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

* management contract or compensatory plan or arrangement

** management contract or compensatory plan or arrangement, a schedule has been omitted pursuant to Item 601(a)(5) of Regulation S-K and will be provided on a supplemental basis to the Securities and Exchange Commission upon request

*** XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections

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SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned and hereunto duly authorized.

	MIDDLEFIELD BANC CORP.
Date: November 14, 2022	By:	/s/ James R. Heslop, II
		James R. Heslop, II
		President and Chief Executive Officer
Date: November 14, 2022	By:	/s/ Donald L. Stacy
		Donald L. Stacy
		Principal Financial and Accounting Officer

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