UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
(Mark One)
For the quarterly
period ended
OR
For the transition period from _______________________ to _______________________
(Exact name of registrant as specified in its charter)
| (State or Other Jurisdiction of Incorporation) | (Commission File Number) | (IRS Employer Identification No) | ||
| (Address of principal executive offices) | (Zip Code) |
| 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 | ||
| None. | N/A | N/A |
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.
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 and post such files.)
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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 | ☐ | |
| ☒ | 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 ☐
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of
each of the issuer’s classes of common stock, as of the latest practicable date. As of May 1, 2023, the registrant had
ENB FINANCIAL CORP
INDEX TO FORM 10-Q
March 31, 2023
2
ENB FINANCIAL CORP
Part I - Financial Information
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
| March 31, | December 31, | March 31, | ||||||||||
| 2023 | 2022 | 2022 | ||||||||||
| $ | $ | $ | ||||||||||
| ASSETS | ||||||||||||
| Cash and due from banks | ||||||||||||
| Interest-bearing deposits in other banks | ||||||||||||
| Total cash and cash equivalents | ||||||||||||
| Securities available for sale (at fair value, net of allowance for credit losses of $ | ||||||||||||
| Equity securities (at fair value) | ||||||||||||
| Loans held for sale | ||||||||||||
| Loans (net of unearned income) | ||||||||||||
| Less: Allowance for credit losses | ||||||||||||
| Net loans | ||||||||||||
| Premises and equipment | ||||||||||||
| Regulatory stock | ||||||||||||
| Bank owned life insurance | ||||||||||||
| Other assets | ||||||||||||
| Total assets | ||||||||||||
| LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||||||
| Liabilities: | ||||||||||||
| Deposits: | ||||||||||||
| Noninterest-bearing | ||||||||||||
| Interest-bearing | ||||||||||||
| Total deposits | ||||||||||||
| Short-term borrowings | ||||||||||||
| Long-term debt | ||||||||||||
| Subordinated debt | ||||||||||||
| Other liabilities | ||||||||||||
| Total liabilities | ||||||||||||
| Stockholders' equity: | ||||||||||||
| Common stock, par value $ | ||||||||||||
| Shares: Authorized | ||||||||||||
| Issued | ||||||||||||
| Capital surplus | ||||||||||||
| Retained earnings | ||||||||||||
| Accumulated other comprehensive loss, net of tax | ( | ) | ( | ) | ( | ) | ||||||
| Less: Treasury stock cost on | ( | ) | ( | ) | ( | ) | ||||||
| Total stockholders' equity | ||||||||||||
| Total liabilities and stockholders' equity | ||||||||||||
See Notes to the Unaudited Consolidated Interim Financial Statements
3
ENB FINANCIAL CORP
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
| Three Months ended March 31, | ||||||||
| 2023 | 2022 | |||||||
| $ | $ | |||||||
| Interest and dividend income: | ||||||||
| Interest and fees on loans | ||||||||
| Interest on securities available for sale | ||||||||
| Taxable | ||||||||
| Tax-exempt | ||||||||
| Interest on deposits at other banks | ||||||||
| Dividend income | ||||||||
| Total interest and dividend income | ||||||||
| Interest expense: | ||||||||
| Interest on deposits | ||||||||
| Interest on borrowings | ||||||||
| Total interest expense | ||||||||
| Net interest income | ||||||||
| Provision for credit losses | ||||||||
| Net interest income after provision for credit losses | ||||||||
| Other income: | ||||||||
| Trust and investment services income | ||||||||
| Service fees | ||||||||
| Commissions | ||||||||
| (Losses) gains on the sale of debt securities, net | ( | ) | ||||||
| Losses on equity securities, net | ( | ) | ( | ) | ||||
| Gains on sale of mortgages | ||||||||
| Earnings on bank-owned life insurance | ||||||||
| Other income | ||||||||
| Total other income | ||||||||
| Operating expenses: | ||||||||
| Salaries and employee benefits | ||||||||
| Occupancy | ||||||||
| Equipment | ||||||||
| Advertising & marketing | ||||||||
| Computer software & data processing | ||||||||
| Shares tax | ||||||||
| Professional services | ||||||||
| Other expense | ||||||||
| Total operating expenses | ||||||||
| Income before income taxes | ||||||||
| Provision for federal income taxes | ||||||||
| Net income | ||||||||
| Earnings per share of common stock | ||||||||
| Cash dividends paid per share | ||||||||
| Weighted average shares outstanding | ||||||||
See Notes to the Unaudited Consolidated Interim Financial Statements
4
ENB FINANCIAL CORP
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(DOLLARS IN THOUSANDS)
| Three Months ended March 31, | ||||||||
| 2023 | 2022 | |||||||
| $ | $ | |||||||
| Net income | ||||||||
| Other comprehensive income (loss), net of tax: | ||||||||
| Securities available for sale not other-than-temporarily impaired: | ||||||||
| Unrealized gains (losses) arising during the period | ( | ) | ||||||
| Income tax effect | ( | ) | ||||||
| ( | ) | |||||||
| Losses (gains) recognized in earnings | ( | ) | ||||||
| Income tax effect | ( | ) | ||||||
| ( | ) | |||||||
| Other comprehensive income (loss), net of tax | ( | ) | ||||||
| Comprehensive Income/(Loss) | ( | ) | ||||||
See Notes to the Unaudited Consolidated Interim Financial Statements
5
ENB FINANCIAL CORP
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
| Accumulated | ||||||||||||||||||||||||
| Other | Total | |||||||||||||||||||||||
| Common | Capital | Retained | Comprehensive | Treasury | Stockholders' | |||||||||||||||||||
| Stock | Surplus | Earnings | Income (Loss) | Stock | Equity | |||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||
| Balances, December 31, 2021 | ( | ) | ||||||||||||||||||||||
| Net income | ||||||||||||||||||||||||
| Other comprehensive loss net of tax | ( | ) | ( | ) | ||||||||||||||||||||
| Treasury stock issued - | ||||||||||||||||||||||||
| Cash dividends paid, $ | ( | ) | ( | ) | ||||||||||||||||||||
| Balances, March 31, 2022 | ( | ) | ( | ) | ||||||||||||||||||||
| Balances, December 31, 2022 | ( | ) | ( | ) | ||||||||||||||||||||
| Cumulative effect of adoption of ASU 2016-13 | ( | ) | ( | ) | ||||||||||||||||||||
| Net income | ||||||||||||||||||||||||
| Other comprehensive income net of tax | ||||||||||||||||||||||||
| Stock-based compensation expense | ||||||||||||||||||||||||
| Treasury stock purchased - | ( | ) | ( | ) | ||||||||||||||||||||
| Treasury stock issued - | ( | ) | ||||||||||||||||||||||
| Cash dividends paid, $ | ( | ) | ( | ) | ||||||||||||||||||||
| Balances, March 31, 2023 | ( | ) | ( | ) | ||||||||||||||||||||
See Notes to the Unaudited Consolidated Interim Financial Statements
6
ENB FINANCIAL CORP
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(DOLLARS IN THOUSANDS)
| Three Months Ended March 31, | ||||||||
| 2023 | 2022 | |||||||
| $ | $ | |||||||
| Cash flows from operating activities: | ||||||||
| Net income | ||||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
| Net amortization of securities premiums and discounts and loan fees | ||||||||
| Decrease (increase) in interest receivable | ( | ) | ||||||
| Decrease in interest payable | ||||||||
| Provision for credit losses | ||||||||
| Losses (gains) on the sale of debt securities, net | ( | ) | ||||||
| Losses on equity securities, net | ||||||||
| Gains on sale of mortgages | ( | ) | ( | ) | ||||
| Loans originated for sale | ( | ) | ( | ) | ||||
| Proceeds from sales of loans | ||||||||
| Earnings on bank-owned life insurance | ( | ) | ( | ) | ||||
| Depreciation of premises and equipment and amortization of software | ||||||||
| Deferred income tax | ( | ) | ||||||
| Amortization of deferred fees on subordinated debt | ||||||||
| Stock-based compensation expense | ||||||||
| Other assets and other liabilities, net | ||||||||
| Net cash provided by operating activities | ||||||||
| Cash flows from investing activities: | ||||||||
| Securities available for sale: | ||||||||
| Proceeds from maturities, calls, and repayments | ||||||||
| Proceeds from sales | ||||||||
| Purchases | ( | ) | ||||||
| Equity securities | ||||||||
| Proceeds from sales | ||||||||
| Purchases | ( | ) | ( | ) | ||||
| Purchase of regulatory bank stock | ( | ) | ( | ) | ||||
| Redemptions of regulatory bank stock | ||||||||
| Proceeds from bank-owned life insurance | ||||||||
| Net increase in loans | ( | ) | ( | ) | ||||
| Purchases of premises and equipment, net | ( | ) | ( | ) | ||||
| Purchase of computer software | ( | ) | ||||||
| Net cash used for investing activities | ( | ) | ( | ) | ||||
| Cash flows from financing activities: | ||||||||
| Net (decrease) increase in demand, NOW, and savings accounts | ( | ) | ||||||
| Net increase in time deposits | ||||||||
| Net decrease in short-term borrowings | ( | ) | ||||||
| Proceeds from long-term debt | ||||||||
| Dividends paid | ( | ) | ( | ) | ||||
| Proceeds from sale of treasury stock | ||||||||
| Treasury stock purchased | ( | ) | ||||||
| Net cash provided by financing activities | ||||||||
| Increase (decrease) in cash and cash equivalents | ( | ) | ||||||
| Cash and cash equivalents at beginning of period | ||||||||
| Cash and cash equivalents at end of period | ||||||||
| Supplemental disclosures of cash flow information: | ||||||||
| Interest paid | ||||||||
| Income taxes paid | ||||||||
| Supplemental disclosure of non-cash investing and financing activities: | ||||||||
| Fair value adjustments for securities available for sale | ( | ) | ||||||
| Recognition of lease operating right-of-use assets | ||||||||
| Recognition of operating lease liabilities | ||||||||
See Notes to the Unaudited Consolidated Interim Financial Statements
7
1. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited consolidated interim financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and to general practices within the banking industry. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all significant adjustments considered necessary for fair presentation have been included. Certain items previously reported have been reclassified to conform to the current period’s reporting format. Such reclassifications did not affect net income or stockholders’ equity.
ENB Financial Corp (“the Corporation”) is the bank holding company for its wholly-owned subsidiary Ephrata National Bank (the “Bank”). Ephrata National Bank has one wholly-owned subsidiary, ENB Insurance, LLC that is consolidated into its financial statements. This Form 10-Q, for the first quarter of 2023, is reporting on the results of operations and financial condition of ENB Financial Corp on a consolidated basis.
Operating results for the three months ended March 31, 2023, are not necessarily indicative of the results that may be expected for the year ending December 31, 2023. For further information, refer to the consolidated financial statements and footnotes thereto included in ENB Financial Corp’s Annual Report on Form 10-K for the year ended December 31, 2022.
Accounting Pronouncements Adopted in 2023
In June 2016, the FASB issued ASU No. 2016-13, "Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" and subsequent related updates. This ASU replaces the incurred loss methodology for recognizing credit losses and requires businesses and other organizations to measure the current expected credit losses (CECL) on financial assets measured at amortized cost, including loans and held-to-maturity securities, net investments in leases, off-balance sheet credit exposures such as unfunded commitments, and other financial instruments. In addition, ASC 326 requires credit losses on available-for-sale debt securities to be presented as an allowance rather than as a write-down when management does not intend to sell or believes that it is not more likely than not they will be required to sell. This guidance became effective on January 1, 2023 for the Corporation. The results reported for periods beginning after January 1, 2023 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable accounting standards.
The Corporation adopted this guidance, and subsequent
related updates, using the modified retrospective approach for all financial assets measured at amortized cost, including loans, available-for-sale
debt securities and unfunded commitments. On January 1, 2023, the Corporation recorded a cumulative effect decrease to retained earnings
of $
The Corporation has elected to exclude accrued interest receivable from the measurement of its allowance for credit losses (ACL). When a loan is placed on nonaccrual status, any outstanding accrued interest is reversed against interest income.
The Corporation adopted the provisions of ASC 326 related to presenting other-than-temporary impairment on available-for-sale debt securities prior to January 1, 2023, using the prospective transition approach, though no such charges had been recorded on the securities held by the Corporation as of the date of adoption.
In connection with the adoption of ASU 2016-13, the Corporation made changes to the loan portfolio segments to align with the methodology applied in determining the allowance under CECL. Refer to Note 5 Loans and Allowance for Credit Losses for further discussion of these portfolio segments. The new segmentation consists of: Agriculture, Business Loans, Consumer Loans, Home Equity, Non-Owner Occupied Commercial Real Estate, and Residential Real Estate.
The impact of the change from the incurred loss model to the current expected credit loss model and the reclassification of loans for the identification of new portfolio loan segments under CECL is detailed below (in thousands).
8
| January 1, 2023 | ||||||||||||
| Pre-adoption | Adoption Impact | As Reported | ||||||||||
| Assets | $ | $ | $ | |||||||||
| ACL on debt securities available for sale | ||||||||||||
| ACL on loans | ||||||||||||
| Commercial Real Estate | ( | ) | ||||||||||
| Consumer Real Estate | ( | ) | ||||||||||
| Commercial and Industrial | ( | ) | ||||||||||
| Consumer | ||||||||||||
| Agriculture | ||||||||||||
| Business Loans | ||||||||||||
| Home Equity | ||||||||||||
| Non-Owner Occupied CRE | ||||||||||||
| Residential Real Estate | ||||||||||||
| Unallocated | ( | ) | ||||||||||
| Liabilities | ||||||||||||
| ACL for unfunded commitments | ||||||||||||
| $ | $ | $ | ||||||||||
Investment Securities
Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date.
Investment securities classified as available for sale are those securities that the Corporation intends to hold for an indefinite period of time but not necessarily to maturity. Securities available for sale are carried at fair value. Any decision to sell a security classified as available for sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Corporation’s assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Unrealized gains or losses are reported as increases or decreases in other comprehensive income (loss), net of the deferred tax effect. Realized gains or losses, determined on the basis of the cost of the specific securities sold, are included in earnings. Premiums and discounts are recognized in interest income using the interest method over the terms of the securities. The Corporation classifies all of its securities as available for sale. Equity securities are measured at fair value with changes in fair value recognized in net income.
Allowance for Credit Losses – Available for Sale Securities
The Corporation measures expected credit losses on available-for-sale debt securities when the Corporation does not intend to sell, or when it is not more likely than not that it will be required to sell, the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security's amortized cost basis is written down to fair value through income. For available-for-sale debt securities that do not meet the aforementioned criteria, the Corporation evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, the Corporation considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this evaluation indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, equal to the amount that the fair value is less than the amortized cost basis. Economic forecast data is utilized to calculate the present value of expected cash flows. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income (loss).
The allowance for credit losses on available-for-sale debt securities is included within investment securities available-for-sale on the consolidated balance sheet. Changes in the allowance for credit losses are recorded within the provision for credit losses on the consolidated statement of income. Losses are charged against the allowance when the Corporation believes the collectability of an available-for-sale security is in jeopardy or when either of the criteria regarding intent or requirement to sell is met.
9
Accrued interest
receivable on available-for-sale debt securities totaled $
Loans Receivable
Loans receivable that management has the intent and
ability to hold for the foreseeable future or until maturity or payoff are stated at their outstanding unpaid principal balances, net
of an allowance for credit losses and any deferred fees or costs. Accrued interest receivable totaled $
The loans receivable portfolio is segmented into Agriculture, Business Loans, Consumer Loans, Home Equity, Non-Owner Occupied Commercial Real Estate (CRE), and Residential Real Estate.
For all classes of loans receivable, the accrual of interest is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against the allowance for credit losses. Interest received on nonaccrual loans, including impaired loans, generally is either applied against principal or reported as interest income on a cash basis, according to management’s judgment as to the collectability of principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months), and the ultimate collectability of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans receivable is determined based on contractual due dates for loan payments.
Allowance for Credit Losses - Loans
The allowance for credit losses (ACL) is a valuation reserve established and maintained by charges against income and is deducted from the amortized cost basis of loans to present the net amount expected to be collected on the loans. Loans, or portions thereof, are charged off against the ACL when they are deemed uncollectible. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off.
The ACL is an estimate of expected credit losses, measured over the contractual life of a loan, that considers historical loss experience, current conditions, and forecasts of future economic conditions. Determination of an appropriate ACL is inherently subjective and may have significant changes from period to period. The methodology for determining the ACL has two main components: evaluation of expected credit losses for certain groups of homogeneous loans that share similar risk characteristics and evaluation of loans that do not share risk characteristics with other loans.
The ACL is measured on a collective (pool) basis when similar risk characteristics exist. The Corporation measures the ACL using the following methods. Historical credit loss experience is the basis for the estimation of expected credit losses. The Corporation applies historical loss rates to pools of loans with similar risk characteristics. After consideration of the historic loss calculation, management applies qualitative adjustments to reflect the current conditions and reasonable and supportable forecasts not already reflected in the historical loss information at the balance sheet date. Reasonable and supportable forecast adjustment is based on the unemployment forecast, BBB Rated Corporate Bond Spread, GDP Growth, Retail Sales, Asset Prices, and Management Judgement. The reasonable and supportable period is the life of the loan as credit loss models used produce reasonable estimates of losses over the life of the loan. The qualitative adjustments for current conditions are based upon changes in lending policies and procedures, loan portfolio trends, lending management experience, asset quality, loan review, underlying collateral, credit concentrations, and external factors. These modified historical loss rates are multiplied by the outstanding principal balance of each loan to calculate a required reserve.
10
The Corporation has elected to exclude accrued interest receivable from the measurement of its ACL. When a loan is placed on nonaccrual status, any outstanding accrued interest is reversed against interest income.
Allowance for Credit Losses on Off-Balance Sheet Credit Exposures
The Corporation estimates expected credit
losses over the contractual period in which the Corporation is exposed to credit risk via a contractual obligation to extend credit, unless
that obligation is unconditionally cancellable by the Corporation. The allowance for credit losses on off-balance sheet credit exposures
is adjusted through credit loss expense. The estimate includes consideration of the likelihood that funding will occur and an estimate
of expected credit losses on commitments expected to be funded over its estimated life. The allowance is carried as a liability
and is included in other liabilities on the Corporation’s Consolidated Balance Sheets. The liability was $
2. Revenue from Contracts with Customers
The Corporation records revenue from contracts with customers in accordance with Accounting Standards Topic 606, Revenue from Contracts with Customers (Topic 606). Under Topic 606, the Corporation must identify contracts with customers, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when the Corporation satisfies a performance obligation. Significant revenue has not been recognized in the current reporting period that results from performance obligations satisfied in previous periods.
The Corporation’s primary sources of revenue are derived from interest and dividends earned on loans, investment securities, and other financial instruments that are not within the scope of Topic 606. The Corporation has evaluated the nature of its contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary. The Corporation generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed; charged either on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.
11
3. Securities Available for Sale
The amortized cost, gross unrealized gains and losses, approximate fair value, and allowance for credit losses of investment securities held at March 31, 2023, are as follows:
| Gross | Gross | Allowance | ||||||||||||||||||
| (DOLLARS IN THOUSANDS) | Amortized | Unrealized | Unrealized | for Credit | Fair | |||||||||||||||
| Cost | Gains | Losses | Losses | Value | ||||||||||||||||
| $ | $ | $ | $ | $ | ||||||||||||||||
| March 31, 2023 | ||||||||||||||||||||
| U.S. treasuries | ( | ) | ||||||||||||||||||
| U.S. government agencies | ( | ) | ||||||||||||||||||
| U.S. agency mortgage-backed securities | ( | ) | ||||||||||||||||||
| U.S. agency collateralized mortgage obligations | ( | ) | ||||||||||||||||||
| Non-agency MBS/CMO | ( | ) | ||||||||||||||||||
| Asset-backed securities | ( | ) | ||||||||||||||||||
| Corporate bonds | ( | ) | ||||||||||||||||||
| Obligations of states and political subdivisions | ( | ) | ||||||||||||||||||
| Total securities available for sale | ( | ) | ||||||||||||||||||
The amortized cost, gross unrealized gains and losses, and approximate fair value of investment securities held at December 31, 2022, are as follows:
| Gross | Gross | |||||||||||||||
| (DOLLARS IN THOUSANDS) | Amortized | Unrealized | Unrealized | Fair | ||||||||||||
| Cost | Gains | Losses | Value | |||||||||||||
| $ | $ | $ | $ | |||||||||||||
| December 31, 2022 | ||||||||||||||||
| U.S. Treasuries | ( | ) | ||||||||||||||
| U.S. government agencies | ( | ) | ||||||||||||||
| U.S. agency mortgage-backed securities | ( | ) | ||||||||||||||
| U.S. agency collateralized mortgage obligations | ( | ) | ||||||||||||||
| Non-agency MBS/CMO | ( | ) | ||||||||||||||
| Asset-backed securities | ( | ) | ||||||||||||||
| Corporate bonds | ( | ) | ||||||||||||||
| Obligations of states and political subdivisions | ( | ) | ||||||||||||||
| Total securities available for sale | ( | ) | ||||||||||||||
The amortized cost and fair value of securities available for sale at March 31, 2023, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities due to certain call or prepayment provisions.
| CONTRACTUAL MATURITY OF DEBT SECURITIES | ||||||||
| (DOLLARS IN THOUSANDS) | ||||||||
| Amortized | ||||||||
| Cost | Fair Value | |||||||
| $ | $ | |||||||
| Due in one year or less | ||||||||
| Due after one year through five years | ||||||||
| Due after five years through ten years | ||||||||
| Due after ten years | ||||||||
| Total debt securities | ||||||||
Securities available for sale with a par value of $
Proceeds from active sales of securities available for sale, along with the associated gross realized gains and gross realized losses, are shown below. Realized gains and losses are computed on the basis of specific identification.
12
PROCEEDS FROM SALES OF SECURITIES AVAILABLE FOR SALE
(DOLLARS IN THOUSANDS)
| Three Months Ended March 31, | ||||||||
| 2023 | 2022 | |||||||
| $ | $ | |||||||
| Proceeds from sales | ||||||||
| Gross realized gains | ||||||||
| Gross realized losses | ( | ) | ||||||
Information pertaining to securities with gross unrealized losses at March 31, 2023, for which an allowance for credit losses has not been recorded, aggregated by investment category and length of time that individual securities have been in a continuous loss position follows:
TEMPORARY IMPAIRMENTS OF SECURITIES
(DOLLARS IN THOUSANDS)
| Less than 12 months | More than 12 months | Total | ||||||||||||||||||||||
| Gross | Gross | Gross | ||||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
| Value | Losses | Value | Losses | Value | Losses | |||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||
| As of March 31, 2023 | ||||||||||||||||||||||||
| U.S. Treasuries | ( | ) | ( | ) | ||||||||||||||||||||
| U.S. government agencies | ( | ) | ( | ) | ||||||||||||||||||||
| U.S. agency mortgage-backed securities | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| U.S. agency collateralized mortgage obligations | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Non-Agency MBS/CMO | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Asset-backed securities | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Corporate bonds | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Obligations of states & political subdivisions | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Total temporarily impaired securities | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
Information pertaining to securities with gross unrealized losses at December 31, 2022, aggregated by investment category and length of time that individual securities have been in a continuous loss position follows:
TEMPORARY IMPAIRMENTS OF SECURITIES
(DOLLARS IN THOUSANDS)
| Less than 12 months | More than 12 months | Total | ||||||||||||||||||||||
| Gross | Gross | Gross | ||||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
| Value | Losses | Value | Losses | Value | Losses | |||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||
| As of December 31, 2022 | ||||||||||||||||||||||||
| U.S. Treasuries | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| U.S. government agencies | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| U.S. agency mortgage-backed securities | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| U.S. agency collateralized mortgage obligations | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Non-Agency MBS/CMO | ( | ) | ( | ) | ||||||||||||||||||||
| Asset-backed securities | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Corporate bonds | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Obligations of states & political subdivisions | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Total temporarily impaired securities | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
In the debt security portfolio there were 337 positions carrying unrealized losses as of March 31, 2023.
Management evaluates all of the Corporation’s securities for expected credit losses. No securities in the portfolio required an allowance for credit losses to be recorded in the first three months of 2023 and no impairment was recorded in the first three months of 2022.
13
Unrealized losses on the Corporation’s available-for-sale debt securities have not been recognized into income because the bonds are of high credit quality, management does not intend to sell and it is likely that management will not be required to sell the securities prior to their anticipated recovery, and the decline in fair value is solely due to changes in interest rates and other market conditions. The issuers continue to make timely principal and interest payments on the bonds. The fair value is expected to recover as the bonds approach maturity.
4. Equity Securities
The following table summarizes the amortized cost, gross unrealized gains and losses, and fair value of equity securities held at March 31, 2023 and December 31, 2022.
| Gross | Gross | |||||||||||||||
| (DOLLARS IN THOUSANDS) | Amortized | Unrealized | Unrealized | Fair | ||||||||||||
| Cost | Gains | Losses | Value | |||||||||||||
| $ | $ | $ | $ | |||||||||||||
| March 31, 2023 | ||||||||||||||||
| CRA-qualified mutual funds | ||||||||||||||||
| Bank stocks | ( | ) | ||||||||||||||
| Total equity securities | ( | ) | ||||||||||||||
| Gross | Gross | |||||||||||||||
| (DOLLARS IN THOUSANDS) | Amortized | Unrealized | Unrealized | Fair | ||||||||||||
| Cost | Gains | Losses | Value | |||||||||||||
| $ | $ | $ | $ | |||||||||||||
| December 31, 2022 | ||||||||||||||||
| CRA-qualified mutual funds | ||||||||||||||||
| Bank stocks | ( | ) | ||||||||||||||
| Total equity securities | ( | ) | ||||||||||||||
The following table presents the net gains and losses on the Corporation’s equity investments recognized in earnings during the three months ended March 31, 2023 and 2022, and the portion of unrealized gains and losses for the period that relates to equity investments held as of March 31, 2023 and 2022.
NET GAINS AND LOSSES ON EQUITY INVESTMENTS RECOGNIZED IN EARNINGS
(DOLLARS IN THOUSANDS)
| Three Months Ended | ||||||||
| March 31, | ||||||||
| 2023 | 2022 | |||||||
| $ | $ | |||||||
| Net losses recognized in equity securities during the period | ( | ) | ( | ) | ||||
| Less: Net gains realized on the sale of equity securities during the period | ||||||||
| Unrealized losses recognized in equity securities held at reporting date | ( | ) | ( | ) | ||||
14
5. Loans and Allowance for Credit Losses
The following table presents the Corporation’s loan portfolio by category of loans as of March 31, 2023 (in thousands):
| March 31, | ||||
| 2023 | ||||
| $ | ||||
| Agriculture | ||||
| Business Loans | ||||
| Consumer | ||||
| Home Equity | ||||
| Non-Owner Occupied Commercial Real Estate | ||||
| Residential Real Estate (a) | ||||
| Gross loans prior to deferred costs | ||||
| Deferred loan costs, net | ||||
| Allowance for credit losses | ( | ) | ||
| Total net loans (b) | ||||
| (a) |
| (b) | Refer to Note 1, Accounting Pronouncements Adopted in 2023 for details of reclassification of the portfolio segments related to the adoption of ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. |
The following table presents the Corporation’s loan portfolio, prior to the adoption of ASC 326, by category of loans and the impact of the change from the adoption of the standard (in thousands):
| Post Adoption | ||||||||||||
| December 31, | Adoption | January, 1 | ||||||||||
| 2022 | Impact | 2023 | ||||||||||
| $ | $ | $ | ||||||||||
| Agriculture | ||||||||||||
| Business Loans | ||||||||||||
| Home Equity | ||||||||||||
| Non-Owner Occupied CRE | ||||||||||||
| Residential Real Estate (a) | ||||||||||||
| Commercial real estate | ||||||||||||
| Commercial mortgages | ( |
) | ||||||||||
| Agriculture mortgages | ( |
) | ||||||||||
| Construction | ( |
) | ||||||||||
| Total commercial real estate | ( |
) | ||||||||||
| Consumer real estate (a) | ||||||||||||
| 1-4 family residential mortgages | ( |
) | ||||||||||
| Home equity loans | ( |
) | ||||||||||
| Home equity lines of credit | ( |
) | ||||||||||
| Total consumer real estate | ( |
) | ||||||||||
| Commercial and industrial | ||||||||||||
| Commercial and industrial | ( |
) | ||||||||||
| Tax-free loans | ( |
) | ||||||||||
| Agriculture loans | ( |
) | ||||||||||
| Total commercial and industrial | ( |
) | ||||||||||
| Consumer | ||||||||||||
| Gross loans prior to deferred fees | ||||||||||||
| Deferred loan costs, net | ||||||||||||
| Allowance for credit losses | ( |
) | ||||||||||
| Total net loans | ||||||||||||
| (a) |
15
Age Analysis of Past-Due Loans Receivable
The performance and credit quality of the loan portfolio is monitored by analyzing the age of the loans receivable as determined by the length of time a recorded payment is past due. The following table presents the classes of the loan portfolio summarized by the past-due status as of March 31, 2023 (in thousands):
| March 31, 2023 | ||||||||||||||||||||||||
| 31-60 | 61-90 | Greater Than | ||||||||||||||||||||||
| Days | Days | 90 Days | Total | Total | ||||||||||||||||||||
| Current | Past Due | Past Due | Past Due | Past Due | Loans | |||||||||||||||||||
| Agriculture | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| Business Loans | ||||||||||||||||||||||||
| Consumer | ||||||||||||||||||||||||
| Home Equity | ||||||||||||||||||||||||
| Non-Owner Occupied CRE | ||||||||||||||||||||||||
| Residential Real Estate | ||||||||||||||||||||||||
| Total (a) | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| (a) |
The following table presents the classes of the loan portfolio summarized by the past-due status as of December 31, 2022 (in thousands):
| December 31, 2022 | ||||||||||||||||||||||||||||
| Loans | ||||||||||||||||||||||||||||
| Greater | Receivable > | |||||||||||||||||||||||||||
| 30-59 Days | 60-89 Days | than 90 | Total Past | Total Loans | 90 Days and | |||||||||||||||||||||||
| Past Due | Past Due | Days | Due | Current | Receivable | Accruing | ||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||
| Commercial real estate | ||||||||||||||||||||||||||||
| Commercial mortgages | ||||||||||||||||||||||||||||
| Agriculture mortgages | ||||||||||||||||||||||||||||
| Construction | ||||||||||||||||||||||||||||
| Consumer real estate | ||||||||||||||||||||||||||||
| 1-4 family residential mortgages | ||||||||||||||||||||||||||||
| Home equity loans | ||||||||||||||||||||||||||||
| Home equity lines of credit | ||||||||||||||||||||||||||||
| Commercial and industrial | ||||||||||||||||||||||||||||
| Commercial and industrial | ||||||||||||||||||||||||||||
| Tax-free loans | ||||||||||||||||||||||||||||
| Agriculture loans | ||||||||||||||||||||||||||||
| Consumer | ||||||||||||||||||||||||||||
| Total | ||||||||||||||||||||||||||||
Nonperforming Loans
The following table presents the amortized cost basis of loans on nonaccrual status and loans past due
over 90 days still accruing interest as of March 31, 2023, (in thousands):
16
| Nonaccrual | Nonaccrual | Loans Past | ||||||||||||||||||
| with no | with | Total | Due Over 90 Days | Total | ||||||||||||||||
| ACL | ACL | Nonaccrual | Still Accruing | Nonperforming | ||||||||||||||||
| Agriculture | $ | $ | $ | $ | $ | |||||||||||||||
| Business Loans | ||||||||||||||||||||
| Consumer Loans | ||||||||||||||||||||
| Home Equity | ||||||||||||||||||||
| Non-Owner Occupied CRE | ||||||||||||||||||||
| Residential Real Esate | ||||||||||||||||||||
| Total (a) | $ | $ | $ | $ | $ | |||||||||||||||
| (a) |
The following table presents nonaccrual loans by classes of the loan portfolio as of December 31, 2022 (in thousands):
Nonaccrual Loans
| December 31, | ||||
| 2022 | ||||
| $ | ||||
| Commercial real estate | ||||
| Commercial mortgages | ||||
| Agriculture mortgages | ||||
| Construction | ||||
| Consumer real estate | ||||
| 1-4 family residential mortgages | ||||
| Home equity loans | ||||
| Home equity lines of credit | ||||
| Commercial and industrial | ||||
| Commercial and industrial | ||||
| Tax-free loans | ||||
| Agriculture loans | ||||
| Consumer | ||||
| Total | ||||
Credit Quality Indicators
The Corporation grades commercial credits differently than consumer credits. The following tables represent all of the Corporation’s commercial credit exposures by internally assigned grades as of March 31, 2023 and December 31, 2022. The grading analysis estimates the capability of the borrower to repay the contractual obligations under the loan agreements as scheduled. The Corporation's internal commercial credit risk grading system is based on experiences with similarly graded loans.
The Corporation's internally assigned grades for commercial credits are as follows:
| ● | Pass – loans which are protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral. |
| ● | Special Mention – loans where a potential weakness or risk exists, which could cause a more serious problem, if not corrected. |
| ● | Substandard – loans that have a well-defined weakness based on objective evidence and characterized by the distinct possibility that the Corporation will sustain some loss if the deficiencies are not corrected. |
17
| ● | Doubtful – loans classified as doubtful have all the weaknesses inherent in a substandard asset. In addition, these weaknesses make collection or liquidation in full highly questionable and improbable, based on existing circumstances. |
| ● | Loss – loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not warranted. |
Based on the most recent analysis performed, the following table presents the recorded investment by internal risk rating system for Commercial Credit exposure as of March 31, 2023 (in thousands):
| Revolving | Revolving | |||||||||||||||||||||||||||||||||||
| Term Loans Amortized Costs Basis by Origination Year | Loans | Loans | ||||||||||||||||||||||||||||||||||
| Amortized | Converted | |||||||||||||||||||||||||||||||||||
| March 31, 2023 | 2023 | 2022 | 2021 | 2020 | 2019 | Prior | Cost Basis | to Term | Total | |||||||||||||||||||||||||||
| Agriculture | ||||||||||||||||||||||||||||||||||||
| Risk Rating | ||||||||||||||||||||||||||||||||||||
| Pass | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Special Mention | ||||||||||||||||||||||||||||||||||||
| Substandard | ||||||||||||||||||||||||||||||||||||
| Doubtful | ||||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | — | $ | ||||||||||||||||||||||||||
| Agriculture | ||||||||||||||||||||||||||||||||||||
| Current period gross charge-offs | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Business Loans | ||||||||||||||||||||||||||||||||||||
| Risk Rating | ||||||||||||||||||||||||||||||||||||
| Pass | $ | $ | $ | $ | $ | $ | $ | $ | — | $ | ||||||||||||||||||||||||||
| Special Mention | ||||||||||||||||||||||||||||||||||||
| Substandard | — | — | — | |||||||||||||||||||||||||||||||||
| Doubtful | ||||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | — | $ | ||||||||||||||||||||||||||
| Business Loans | ||||||||||||||||||||||||||||||||||||
| Current period gross charge-offs | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Non-Owner Occupied CRE | ||||||||||||||||||||||||||||||||||||
| Risk Rating | ||||||||||||||||||||||||||||||||||||
| Pass | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Special Mention | ||||||||||||||||||||||||||||||||||||
| Substandard | ||||||||||||||||||||||||||||||||||||
| Doubtful | ||||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | — | $ | ||||||||||||||||||||||||||
| Non-Owner Occupied CRE | ||||||||||||||||||||||||||||||||||||
| Current period gross charge-offs | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Total | ||||||||||||||||||||||||||||||||||||
| Risk Rating | ||||||||||||||||||||||||||||||||||||
| Pass | $ | $ | $ | $ | $ | $ | $ | $ | — | $ | ||||||||||||||||||||||||||
| Special Mention | ||||||||||||||||||||||||||||||||||||
| Substandard | — | |||||||||||||||||||||||||||||||||||
| Doubtful | ||||||||||||||||||||||||||||||||||||
| Total (a) | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| (a) |
18
The following table presents the recorded investment in loans by internal risk rating system for Commercial Credit Exposure as of December 31, 2022 in accordance with ASC 310 (in thousands):
| December 31, 2022 | Commercial Mortgages | Agriculture Mortgages | Construction | Commercial and Industrial | Tax-free Loans | Agriculture Loans | Total | |||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||
| Grade: | ||||||||||||||||||||||||||||
| Pass | ||||||||||||||||||||||||||||
| Special Mention | ||||||||||||||||||||||||||||
| Substandard | ||||||||||||||||||||||||||||
| Doubtful | ||||||||||||||||||||||||||||
| Loss | ||||||||||||||||||||||||||||
| Total | ||||||||||||||||||||||||||||
For consumer loans, the Corporation evaluates credit quality based on whether the loan is considered performing or non-performing. Non-performing loans consist of those loans greater than 90 days delinquent and nonaccrual loans. The following table presents the balances of consumer loans by classes of the loan portfolio based on payment performance as of March 31, 2023 (in thousands):
| Revolving | Revolving | |||||||||||||||||||||||||||||||||||
| Term Loans Amortized Costs Basis by Origination Year | Loans | Loans | ||||||||||||||||||||||||||||||||||
| Amortized | Converted | |||||||||||||||||||||||||||||||||||
| March 31, 2023 | 2023 | 2022 | 2021 | 2020 | 2019 | Prior | Cost Basis | to Term | Total | |||||||||||||||||||||||||||
| Consumer | ||||||||||||||||||||||||||||||||||||
| Payment Performance | ||||||||||||||||||||||||||||||||||||
| Performing | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Nonperforming | ||||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | — | $ | ||||||||||||||||||||||||||
| Consumer | ||||||||||||||||||||||||||||||||||||
| Current period gross charge-offs | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Home equity | ||||||||||||||||||||||||||||||||||||
| Payment Performance | ||||||||||||||||||||||||||||||||||||
| Performing | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Nonperforming | ||||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Home equity | ||||||||||||||||||||||||||||||||||||
| Current period gross charge-offs | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Residential Real Estate | ||||||||||||||||||||||||||||||||||||
| Payment Performance | ||||||||||||||||||||||||||||||||||||
| Performing | $ | $ | $ | $ | $ | $ | $ | — | $ | — | $ | |||||||||||||||||||||||||
| Nonperforming | ||||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Residential Real Estate | ||||||||||||||||||||||||||||||||||||
| Current period gross charge-offs | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Total | ||||||||||||||||||||||||||||||||||||
| Payment Performance | ||||||||||||||||||||||||||||||||||||
| Performing | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Nonperforming | ||||||||||||||||||||||||||||||||||||
| Total (a) | $ | $ | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| (a) | Refer to Note 1, Accounting Pronouncements Adopted in 2023 for details of reclassification of the portfolio segments related to adoption of ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. |
19
The following table presents the balances of consumer loans by classes of the loan portfolio based on payment performance as of December 31, 2022 in accordance with ASC 310 (in thousands):
| December 31, 2022 | 1-4 Family Residential Mortgages | Home Equity Loans | Home Equity Lines of Credit | Consumer | Total | |||||||||||||||
| Payment performance: | $ | $ | $ | $ | $ | |||||||||||||||
| Performing | ||||||||||||||||||||
| Non-performing | ||||||||||||||||||||
| Total | ||||||||||||||||||||
As of December 31, 2022, all of the Corporation’s commercial loans on nonaccrual status were also considered impaired. Information with respect to impaired loans for the three months ended March 31, 2022, in accordance with ASC 310 is as follows:
| Three Months Ended March 31 | ||||
| 2022 | ||||
| $ | ||||
| Average recorded balance of impaired loans | ||||
| Interest income recognized on impaired loans | ||||
20
The following tables summarize information regarding impaired loans by loan portfolio class as of December 31, 2022, in accordance with ASC 310:
| IMPAIRED LOAN ANALYSIS | ||||||||||||
| (DOLLARS IN THOUSANDS) | ||||||||||||
| December 31, 2022 | Recorded Investment | Unpaid Principal Balance | Related Allowance | |||||||||
| $ | $ | $ | ||||||||||
| With no related allowance recorded: | ||||||||||||
| Commercial real estate | ||||||||||||
| Commercial mortgages | ||||||||||||
| Agriculture mortgages | ||||||||||||
| Construction | ||||||||||||
| Total commercial real estate | ||||||||||||
| Commercial and industrial | ||||||||||||
| Commercial and industrial | ||||||||||||
| Tax-free loans | ||||||||||||
| Agriculture loans | ||||||||||||
| Total commercial and industrial | ||||||||||||
| Total with no related allowance | ||||||||||||
| With an allowance recorded: | ||||||||||||
| Commercial real estate | ||||||||||||
| Commercial mortgages | ||||||||||||
| Agriculture mortgages | ||||||||||||
| Construction | ||||||||||||
| Total commercial real estate | ||||||||||||
| Commercial and industrial | ||||||||||||
| Commercial and industrial | ||||||||||||
| Tax-free loans | ||||||||||||
| Agriculture loans | ||||||||||||
| Total commercial and industrial | ||||||||||||
| Total with a related allowance | ||||||||||||
| Total by loan class: | ||||||||||||
| Commercial real estate | ||||||||||||
| Commercial mortgages | ||||||||||||
| Agriculture mortgages | ||||||||||||
| Construction | ||||||||||||
| Total commercial real estate | ||||||||||||
| Commercial and industrial | ||||||||||||
| Commercial and industrial | ||||||||||||
| Tax-free loans | ||||||||||||
| Agriculture loans | ||||||||||||
| Total commercial and industrial | ||||||||||||
| Total | ||||||||||||
21
Allowance for Credit Losses
The following table presents the activity in the allowance for credit losses by portfolio segment for the three months ended March 31, 2023 (in thousands):
| Impact of | ||||||||||||||||||||||||
| Beginning | adopting | Provisions | Ending | |||||||||||||||||||||
| Balance | ASC 326 | Charge-offs | Recoveries | (Reductions) | Balance | |||||||||||||||||||
| Allowance for credit losses: | ||||||||||||||||||||||||
| Commercial Real Estate | $ | $ | ( | ) | $ | $ | $ | $ | ||||||||||||||||
| Consumer Real Estate | ( | ) | ||||||||||||||||||||||
| Commerical & Industrial | ( | ) | ||||||||||||||||||||||
| Consumer | ( | ) | ||||||||||||||||||||||
| Agriculture | ( | ) | ||||||||||||||||||||||
| Business Loans | ||||||||||||||||||||||||
| Consumer Loans | ( | ) | ||||||||||||||||||||||
| Home Equity | ||||||||||||||||||||||||
| Non-Owner Occupied CRE | ||||||||||||||||||||||||
| Residential Real Estate | ||||||||||||||||||||||||
| Unallocated | ( | ) | ||||||||||||||||||||||
| Total (a) | $ | $ | $ | ( | ) | $ | $ | $ | ||||||||||||||||
| (a) |
During the three months ended March 31, 2023, management charged off $
The ACL is maintained at a level determined to be adequate to absorb estimated expected credit losses within the loan portfolio over the contractual life of an instrument that considers our historical loss experience, current conditions, and forecasts of future economic conditions as of the balance sheet date. The Corporation develops and documents a systematic ACL methodology based on the following portfolio segments: Agriculture, Business Loans, Consumer Loans, Home Equity, Non-Owner Occupied CRE, and Residential Real Estate. The following are key risks within each portfolio segment:
Agriculture – Loans made to individuals or operating companies within the Agricultural industry. These loans are generally secured by a first lien mortgage on agricultural land. The primary source of repayment is the income and assets of the borrower. The condition of the agriculture industry as well as the condition of the national economy is an important indicator of risk for this segment.
Business Loans —Loans made to operating companies or manufacturers for the purpose of production, operating capacity, accounts receivable, inventory or equipment financing. The primary source of repayment for these loans is cash flow from the operations of the company. The condition of the national economy is an important indicator of risk, but there are also more specific risks depending on the industry of the company. This segment also includes loans made to finance construction of buildings or other structures, as well as to finance the acquisition and development of raw land for various purposes. While the risk of these loans is generally confined to the construction period, if there are problems, the project may not be completed, and as such, may not provide sufficient cash flow on its own to service the debt or have sufficient value in a liquidation to cover the outstanding principal. The condition of the national economy is an important indicator of risk, but there are also more specific risks depending on the type of project and the experience and resources of the developer.
Consumer - Loans made to individuals that may be secured by assets other than 1-4 family residences, as well as unsecured loans. This segment includes personal loans and lines of credit that may be secured or unsecured. The primary source of repayment for these loans is the income and assets of the borrower. The condition of the national economy, in particular the unemployment rate, is an important indicator of risk for this segment. The value of the collateral, if there is any, is less likely to be a source of repayment due to less certain collateral values.
22
Home Equity – This segment generally includes lines of credit and term loans secured by the equity in the borrower’s residence. The primary source of repayment for these facilities is the income and assets of the borrower. The condition of the national economy, in particular the unemployment rate, is an important indicator of risk for this segment. The state of the national housing market can also have a significant impact on this segment because low demand and/or declining home values can limit the ability of borrowers to sell a property and satisfy the debt.
Non-Owner Occupied CRE - Loans secured by commercial purpose real estate for various purposes such as hotels, retail, multifamily and health care. The primary sources of repayment for these loans are the operations of the individual projects and global cash flows of the debtors. The condition of the national economy is an important indicator of risk, but there are also more specific risks depending on the collateral type and the business prospects of the lessee.
Residential Real Estate—Loans secured by first liens on 1-4 family residential mortgages. The primary source of repayment for these loans is the income and assets of the borrower. The condition of the national economy, in particular the unemployment rate, is an important indicator of risk for this segment. The state of the national housing market can also have a significant impact on this segment because low demand and/or declining home values can limit the ability of borrowers to sell a property and satisfy the debt.
The following table details activity in the allowance for credit losses by portfolio segment for the three months ended March 31, 2022:
ALLOWANCE FOR CREDIT LOSSES
(DOLLARS IN THOUSANDS)
| Commercial Real Estate | Consumer Real Estate | Commercial and Industrial | Consumer | Unallocated | Total | |||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||
| Allowance for credit losses: | ||||||||||||||||||||||||
| Beginning balance - December 31, 2021 | ||||||||||||||||||||||||
| Charge-offs | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Recoveries | ||||||||||||||||||||||||
| Provision | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Balance - March 31, 2022 | ||||||||||||||||||||||||
During the three months ended March 31, 2022, management charged off $
During the three months ended March 31, 2022, net provision expense was recorded for the commercial real estate sector as well as the consumer sector with credit provisions recorded for the consumer real estate and commercial and industrial sectors. The higher provision in the commercial real estate sector was due to growth in this portfolio of loans since December 31, 2021, as well as an increase in the qualitative factor related to the trends in the nature and volume of this sector. There were minimal charge-offs and recoveries recorded during the three months ended March 31, 2022, so the provision expense was primarily related to an increase in loan balances as well as slightly higher unallocated portion of the allowance.
23
The following table presents the balance in the allowance for credit losses and the recorded investment in loans receivable by portfolio segment based on impairment method as of March 31, 2023:
ALLOWANCE FOR CREDIT LOSSES AND RECORDED INVESTMENT IN LOANS RECEIVABLE
(DOLLARS IN THOUSANDS)
| As of March 31, 2023: | Agriculture | Business Loans | Consumer Loans | Home Equity | Non- Owner Occupied CRE | Residential Real Estate | Total | |||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||
| Allowance for credit losses: | ||||||||||||||||||||||||||||
| Ending balance: individually evaluated | ||||||||||||||||||||||||||||
| Ending balance: collectively evaluated | ||||||||||||||||||||||||||||
| Loans receivable: | ||||||||||||||||||||||||||||
| Ending balance | ||||||||||||||||||||||||||||
| Ending balance: individually evaluated | — | |||||||||||||||||||||||||||
| Ending balance: collectively evaluated | ||||||||||||||||||||||||||||
The following table presents the balance in the allowance for credit losses and the recorded investment in loans receivable by portfolio segment based on impairment method as of December 31, 2022:
ALLOWANCE FOR CREDIT LOSSES AND RECORDED INVESTMENT IN LOANS RECEIVABLE
(DOLLARS IN THOUSANDS)
| As of December 31, 2022: | Commercial Real Estate | Consumer Real Estate | Commercial and Industrial | Consumer | Unallocated | Total | ||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||
| Allowance for credit losses: | ||||||||||||||||||||||||
| Ending balance: individually evaluated for impairment | ||||||||||||||||||||||||
| Ending balance: collectively evaluated for impairment | ||||||||||||||||||||||||
| Loans receivable: | ||||||||||||||||||||||||
| Ending balance | ||||||||||||||||||||||||
| Ending balance: individually evaluated for impairment | ||||||||||||||||||||||||
| Ending balance: collectively evaluated for impairment | ||||||||||||||||||||||||
6. Fair Value Presentation
U.S. generally accepted accounting principles establish a hierarchal disclosure framework associated with the level of observable pricing utilized in measuring assets and liabilities at fair value. The three broad levels defined by the hierarchy are as follows:
| 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. |
| Level III: | Assets and liabilities that have little to no observable pricing 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. |
24
The following tables provide the fair market value for assets required to be measured and reported at fair value on a recurring basis on the Consolidated Balance Sheets as of March 31, 2023, and December 31, 2022, by level within the fair value hierarchy. As required by U.S. generally accepted accounting principles, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
| ASSETS MEASURED ON A RECURRING BASIS | ||||||||||||||||
| (DOLLARS IN THOUSANDS) | ||||||||||||||||
| March 31, 2023 | ||||||||||||||||
| Level I | Level II | Level III | Total | |||||||||||||
| $ | $ | $ | $ | |||||||||||||
| U.S. treasuries | ||||||||||||||||
| U.S. government agencies | ||||||||||||||||
| U.S. agency mortgage-backed securities | ||||||||||||||||
| U.S. agency collateralized mortgage obligations | ||||||||||||||||
| Non-agency MBS/CMO | ||||||||||||||||
| Asset-backed securities | ||||||||||||||||
| Corporate bonds | ||||||||||||||||
| Obligations of states & political subdivisions | ||||||||||||||||
| Equity securities | ||||||||||||||||
| Total securities | ||||||||||||||||
On March 31, 2023, the Corporation held no securities valued using level III inputs. All of the Corporation’s
debt instruments were valued using level II inputs, where quoted prices are available and observable, but not necessarily quotes on identical
securities traded in active markets on a daily basis. The Corporation’s U.S. Treasury bonds, CRA fund investments, and bank stocks
are fair valued utilizing level I inputs because the funds have their own quoted prices in an active market. As of March 31, 2023, the
CRA fund investments had a $
Financial instruments are considered level III when their values are determined using pricing models, discounted cash flow methodologies, or similar techniques, and at least one significant model assumption or input is unobservable. In addition to these unobservable inputs, the valuation models for level III financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly. Level III financial instruments also include those for which the determination of fair value requires significant management judgment or estimation.
25
| ASSETS MEASURED ON A RECURRING BASIS | ||||||||||||||||
| (DOLLARS IN THOUSANDS) | ||||||||||||||||
| December 31, 2022 | ||||||||||||||||
| Level I | Level II | Level III | Total | |||||||||||||
| $ | $ | $ | $ | |||||||||||||
| U.S. Treasuries | ||||||||||||||||
| U.S. government agencies | ||||||||||||||||
| U.S. agency mortgage-backed securities | ||||||||||||||||
| U.S. agency collateralized mortgage obligations | ||||||||||||||||
| Non-agency MBS/CMO | ||||||||||||||||
| Asset-backed securities | ||||||||||||||||
| Corporate bonds | ||||||||||||||||
| Obligations of states & political subdivisions | ||||||||||||||||
| Equity securities | ||||||||||||||||
| Total securities | ||||||||||||||||
On December 31, 2022, the Corporation held no securities valued using level
III inputs. All of the Corporation’s debt instruments were valued using level II inputs, where quoted prices are available and observable
but not necessarily quotes on identical securities traded in active markets on a daily basis. The Corporation’s U.S. Treasury bonds,
CRA fund investments, and bank stocks are fair valued utilizing level I inputs because the funds have their own quoted prices in an active
market. As of December 31, 2022, the CRA fund investments had a $
The following tables provide the fair value for each class of assets required to be measured and reported at fair value on a nonrecurring basis on the Consolidated Balance Sheets as of March 31, 2023 and December 31, 2022, by level within the fair value hierarchy:
ASSETS MEASURED ON A NONRECURRING BASIS
(Dollars in Thousands)
| March 31, 2023 | ||||||||||||||||
| Level I | Level II | Level III | Total | |||||||||||||
| $ | $ | $ | $ | |||||||||||||
| Assets: | ||||||||||||||||
| Individually analyzed loans | $ | $ | $ | $ | ||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||
| December 31, 2022 | ||||||||||||||||
| Level I | Level II | Level III | Total | |||||||||||||
| $ | $ | $ | $ | |||||||||||||
| Assets: | ||||||||||||||||
| Impaired Loans | $ | $ | $ | $ | ||||||||||||
| Total | $ | $ | $ | $ | ||||||||||||
The Corporation had a total of $
26
The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis for which the Corporation has utilized level III inputs to determine fair value:
QUANTITATIVE INFORMATION ABOUT LEVEL III FAIR VALUE MEASUREMENTS
(DOLLARS IN THOUSANDS)
| March 31, 2023 | ||||
| Fair Value | Valuation | Unobservable | Range | |
| Estimate | Techniques | Input | (Weighted Avg) | |
| Individually analyzed loans | Appraisal of collateral (1) |
Appraisal adjustments (2) |
- |
|
Liquidation expenses (2) |
- |
|||
| December 31, 2022 | ||||
| Fair Value | Valuation | Unobservable | Range | |
| Estimate | Techniques | Input | (Weighted Avg) | |
| Impaired loans | Appraisal of collateral (1) |
Appraisal adjustments (2) |
||
Liquidation expenses (2) |
||||
| (1) |
| (2) |
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The following table provides the carrying amount for each class of assets and liabilities and the fair value for certain financial instruments that are not required to be measured or reported at fair value on the Consolidated Balance Sheets as of March 31, 2023 and December 31, 2022:
FINANCIAL INSTRUMENTS NOT REQUIRED TO BE MEASURED OR REPORTED AT FAIR VALUE
(DOLLARS IN THOUSANDS)
| March 31, 2023 | ||||||||||||||||||||
| Quoted Prices in | ||||||||||||||||||||
| Active Markets | Significant Other | Significant | ||||||||||||||||||
| for Identical | Observable | Unobservable | ||||||||||||||||||
| Carrying | Assets | Inputs | Inputs | |||||||||||||||||
| Amount | Fair Value | (Level 1) | (Level II) | (Level III) | ||||||||||||||||
| $ | $ | $ | $ | $ | ||||||||||||||||
| Financial Assets: | ||||||||||||||||||||
| Cash and cash equivalents | ||||||||||||||||||||
| Regulatory stock | ||||||||||||||||||||
| Loans held for sale | ||||||||||||||||||||
| Loans, net of allowance | ||||||||||||||||||||
| Mortgage servicing assets | ||||||||||||||||||||
| Accrued interest receivable | ||||||||||||||||||||
| Bank owned life insurance | ||||||||||||||||||||
| Financial Liabilities: | ||||||||||||||||||||
| Demand deposits | ||||||||||||||||||||
| Interest-bearing demand deposits | ||||||||||||||||||||
| NOW accounts | ||||||||||||||||||||
| Money market deposit accounts | ||||||||||||||||||||
| Savings accounts | ||||||||||||||||||||
| Time deposits | ||||||||||||||||||||
| Total deposits | ||||||||||||||||||||
| Short-term borrowings | ||||||||||||||||||||
| Long-term debt | ||||||||||||||||||||
| Subordinated debt | ||||||||||||||||||||
| Accrued interest payable | ||||||||||||||||||||
28
FINANCIAL INSTRUMENTS NOT REQUIRED TO BE MEASURED OR REPORTED AT FAIR VALUE
(DOLLARS IN THOUSANDS)
| December 31, 2022 | ||||||||||||||||||||
| Quoted Prices in | ||||||||||||||||||||
| Active Markets | Significant Other | Significant | ||||||||||||||||||
| for Identical | Observable | Unobservable | ||||||||||||||||||
| Carrying | Assets | Inputs | Inputs | |||||||||||||||||
| Amount | Fair Value | (Level 1) | (Level II) | (Level III) | ||||||||||||||||
| $ | $ | $ | $ | $ | ||||||||||||||||
| Financial Assets: | ||||||||||||||||||||
| Cash and cash equivalents | — | — | ||||||||||||||||||
| Regulatory stock | — | — | ||||||||||||||||||
| Loans held for sale | — | — | ||||||||||||||||||
| Loans, net of allowance | — | — | ||||||||||||||||||
| Mortgage servicing assets | — | — | ||||||||||||||||||
| Accrued interest receivable | — | — | ||||||||||||||||||
| Bank owned life insurance | — | — | ||||||||||||||||||
| Financial Liabilities: | ||||||||||||||||||||
| Demand deposits | — | — | ||||||||||||||||||
| Interest-bearing demand deposits | — | — | ||||||||||||||||||
| NOW accounts | — | — | ||||||||||||||||||
| Money market deposit accounts | — | — | ||||||||||||||||||
| Savings accounts | — | — | ||||||||||||||||||
| Time deposits | — | — | ||||||||||||||||||
| Total deposits | — | |||||||||||||||||||
| Short-term debt | — | — | ||||||||||||||||||
| Long-term debt | — | — | ||||||||||||||||||
| Subordinated debt | — | — | ||||||||||||||||||
| Accrued interest payable | — | — | ||||||||||||||||||
7. Commitments and Contingent Liabilities
In order to meet the financing needs of its customers in the normal course
of business, the Corporation makes various commitments that are not reflected in the accompanying consolidated financial statements. These
commitments include firm commitments to extend credit, unused lines of credit, and open letters of credit. As of March 31, 2023, firm
loan commitments were $
29
8. Accumulated Other Comprehensive Income (Loss)
The activity in accumulated other comprehensive income (loss) for the three months ended March 31, 2023 and 2022 is as follows:
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) (1) (2)
(DOLLARS IN THOUSANDS)
| Unrealized | ||||
| Gains (Losses) | ||||
| on Securities | ||||
| Available-for-Sale | ||||
| $ | ||||
| Balance at December 31, 2022 | ( | ) | ||
| Other comprehensive income before reclassifications | ||||
| Amount reclassified from accumulated other comprehensive loss | ||||
| Period change | ||||
| Balance at March 31, 2023 | ( | ) | ||
| Balance at December 31, 2021 | ||||
| Other comprehensive loss before reclassifications | ( | ) | ||
| Amount reclassified from accumulated other comprehensive loss | ( | ) | ||
| Period change | ( | ) | ||
| Balance at March 31, 2022 | ( | ) | ||
| (1) |
| (2) |
DETAILS ABOUT ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) COMPONENTS (1)
(DOLLARS IN THOUSANDS)
| Amount Reclassified from | ||||||||||
| Accumulated Other Comprehensive | ||||||||||
| Income (Loss) | ||||||||||
| For the Three Months | ||||||||||
| Ended March 31, | ||||||||||
| 2023 | 2022 | Affected Line Item in the | ||||||||
| $ | $ | Consolidated Statements of Income | ||||||||
| Securities available-for-sale: | ||||||||||
| Net securities (losses) gains,reclassified into earnings | ( | ) | ||||||||
| Related income tax (benefit) expense | ( | ) | ||||||||
| Net effect on accumulated other comprehensive income (loss) for the period | ( | ) | ||||||||
| (1) |
9. Recently Issued Accounting Standards
In March 2023, the FASB issued ASU No. 2023-02, “Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method (a consensus of the Emerging Issues Task Force)”. The ASU allows entities to elect the proportional amortization method, on a tax-credit-program-by-tax-credit-program basis, for all equity investments in tax credit programs meeting the eligibility criteria in Accounting Standards Codification (ASC) 323-740-25-1. While the ASU does not significantly alter the existing eligibility criteria, it does provide clarifications to address existing interpretive issues. It also prescribes specific information reporting entities must disclose about tax credit investments each period. This ASU is effective for reporting periods beginning after December 15, 2023, for public business entities, or January 1, 2024 for the Corporation. The Corporation does not expect the adoption of this ASU to have a material impact on the Corporation's financial statements.
30
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis represents management’s view of the financial condition and results of operations of the Corporation. This discussion and analysis should be read in conjunction with the consolidated financial statements and other financial schedules included in this quarterly report, and in conjunction with the 2022 Annual Report to Shareholders of the Corporation. The financial condition and results of operations presented are not indicative of future performance.
Forward-Looking Statements
The U.S. Private Securities Litigation Reform Act of 1995 provides safe harbor in regards to the inclusion of forward-looking statements in this document and documents incorporated by reference. Forward-looking statements pertain to possible or assumed future results that are made using current information. These forward-looking statements are generally identified when terms such as: “believe,” “estimate,” “anticipate,” “expect,” “project,” “forecast,” and other similar wordings are used. The readers of this report should take into consideration that these forward-looking statements represent management’s expectations as to future forecasts of financial performance, or the likelihood that certain events will or will not occur. Due to the very nature of estimates or predications, these forward-looking statements should not be construed to be indicative of actual future results. Additionally, management may change estimates of future performance, or the likelihood of future events, as additional information is obtained. This document may also address targets, guidelines, or strategic goals that management is striving to reach but may not be indicative of actual results.
Readers should note that many factors affect this forward-looking information, some of which are discussed elsewhere in this document and in the documents that are incorporated by reference into this document. These factors include, but are not limited to, the following:
| ● | National and local economic conditions |
| ● | The continuing banking crisis caused by the recent failure and continuous financial instability of certain banks which may adversely impact the corporation and its securities values, deposit stability, capital adequacy, financial condition, operations, liquidity, and results of operations |
| ● | Interest rate and monetary policies of the Federal Reserve Board |
| ● | Inflation and monetary fluctuations and volatility |
| ● | Health of the housing market |
| ● | Real estate valuations and its impact on the loan portfolio |
| ● | Volatility of the securities markets including the valuation of securities |
| ● | Future actions or inactions of the United States government, including a failure to increase the government debt limit, a prolonged shutdown of the federal government, increase in taxes or regulations, or increasing debt balances |
| ● | Political changes and their impact on new laws and regulations |
| ● | Competitive forces |
| ● | Impact of mergers and acquisition activity in the local market and the effects thereof |
| ● | Potential impact from continually evolving cybersecurity and other technological risks and attacks, including additional costs, reputational damage, regulatory penalties, and financial losses |
| ● | Changes in customer behavior impacting deposit levels and loan demand |
| ● | Changes in accounting principles, policies, or guidelines as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board, and other accounting standards setters |
| ● | Ineffective business strategy due to current or future market and competitive conditions |
| ● | Management’s ability to manage credit risk, liquidity risk, interest rate risk, and fair value risk |
| ● | Operation, legal, and reputation risk |
| ● | Results of the regulatory examination and supervision process |
| ● | The impact of new laws and regulations |
| ● | Possible changes to the capital and liquidity requirements and other regulatory pronouncements, regulations and rules |
| ● | Effects of economic conditions particularly with regard to any pandemic, epidemic, or health-related crisis, (such as COVID-19) and government and business responses thereto, specifically the effect on loan customers to repay loans |
| ● | Large scale global disruptions such as pandemics, terrorism, trade wars, and armed conflict. |
| ● | Local disruptions due to flooding, severe weather, or other natural disasters |
31
| ● | The risk that our analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful |
| ● | Business and competitive disruptions caused by new market and industry entrants |
Readers should be aware if any of the above factors change significantly, the statements regarding future performance could also change materially. The safe harbor provision provides that the Corporation is not required to publicly update or revise forward-looking statements to reflect events or circumstances that arise after the date of this report. Readers should review any changes in risk factors in documents filed by the Corporation periodically with the Securities and Exchange Commission, including Item 1A of Part II of this Quarterly Report on Form 10-Q, Annual Reports on Form 10-K, and Current Reports on Form 8-K.
Critical Accounting Policies
See Note 1, "Basis of Presentation" for additional information on the adoption of ASC 326, which changes the methodology under which management calculates its reserve for loans and investment securities, now referred to as the allowance for credit losses. Management considers the measurement of the allowance for credit losses to be a critical accounting policy.
Results of Operations
Overview
The Corporation recorded net income of $2,441,000 for the three-month period ended March 31, 2023, a $750,000, or 23.5% decrease from the $3,191,000 earned during the three months ended March 31, 2022. The earnings per share, basic and diluted, were $0.43 for the first quarter of 2023, compared to $0.57 for the same period in 2022, a 24.6% decrease. The decrease in the Corporation’s 2023 earnings was caused primarily by higher interest expense, higher provision for credit losses, lower operating income, and higher operating expenses as discussed below.
The Corporation’s net interest income (NII) increased by $3,083,000, or 28.8%, for the three months ended March 31, 2023, compared to the same period in 2022. The increase in NII primarily resulted from an increase in interest income on loans of $4,882,000, or 55.4%, and an increase in interest income on securities of $1,373,000, or 55.9%, for the three months ended March 31, 2023, compared to the same period in the prior year. Conversely, interest expense on deposits and borrowings increased by $3,330,000, or 487.6%, for the three months ended March 31, 2023, compared to the same period in the prior year due to the rapid market rate increases causing pressure on deposit retention and rates.
The Corporation recorded a $1,257,000 provision for credit losses in the first quarter of 2023, compared to $100,000 for the first quarter of 2022. The Corporation adopted ASU 2016-13 Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments as of January 1, 2023. This standard implements a methodology that reflects credit losses that are expected to occur over the remaining life of the financial asset. This new current expected credit loss model (CECL) is based on possible economic scenarios as well as qualitative factors specific to the Corporation. During the first quarter of 2023, there was a significant change in the forward credit outlook due to a high interest rate environment and due to the Corporation downgrading a $5 million loan relationship to substandard requiring a higher provision related to this relationship. Due to the more subjective methodology of the CECL standard, provision expense in subsequent quarters is expected to be much more volatile than historical experience. The allowance as a percentage of total loans was 1.28% as of March 31, 2023, 1.19% as of December 31, 2022, and 1.37% as of March 31, 2022. While the allowance as a percentage of total loans declined from the first quarter in the prior year, it did increase from December 31, 2022.
The financial services industry uses two primary performance measurements to gauge performance: return on average assets (ROA) and return on average equity (ROE). ROA measures how efficiently a bank generates income based on the amount of assets or size of a company. ROE measures the efficiency of a company in generating income based on the amount of equity or capital utilized. The latter measurement typically receives more attention from shareholders. The ROA and ROE decreased for the three months ended March 31, 2023, compared to the same period in the prior year, due to lower earnings in 2023.
| Key Ratios | Three Months Ended | |||||||
| March 31, | ||||||||
| 2023 | 2022 | |||||||
| Return on Average Assets | 0.53% | 0.76% | ||||||
| Return on Average Equity | 9.76% | 9.82% | ||||||
32
The results of the Corporation’s operations are best explained by addressing, in further detail, the five major sections of the income statement, which are as follows:
| ● | Net interest income |
| ● | Provision for credit losses |
| ● | Other income |
| ● | Operating expenses |
| ● | Provision for income taxes |
The following discussion analyzes each of these five components.
Net Interest Income
NII represents the largest portion of the Corporation’s operating income. In the first three months of 2023, NII generated 83.9% of the Corporation’s revenue stream, which consists of NII and non-interest income, compared to 74.5% in the first three months of 2022. This increase is a result of higher levels of NII in the first three months of 2023 as well as lower non-interest income compared to 2022. The overall performance of the Corporation is highly dependent on the changes in NII since it comprises such a significant portion of operating income.
The following table shows a summary analysis of NII on a fully taxable equivalent (FTE) basis. For analytical purposes and throughout this discussion, yields, rates, and measurements such as NII, net interest spread, and net yield on interest earning assets are presented on an FTE basis. The FTE NII shown in both tables below will exceed the NII reported on the consolidated statements of income, which is not shown on an FTE basis. The amount of FTE adjustment totaled $196,000 for the three months ended March 31, 2023, compared to $304,000 for the same period in 2022.
| NET INTEREST INCOME | ||||||||
| (DOLLARS IN THOUSANDS) | ||||||||
| Three Months Ended | ||||||||
| March 31, | ||||||||
| 2023 | 2022 | |||||||
| $ | $ | |||||||
| Total interest income | 17,817 | 11,404 | ||||||
| Total interest expense | 4,013 | 683 | ||||||
| Net interest income | 13,804 | 10,721 | ||||||
| Tax equivalent adjustment | 196 | 304 | ||||||
| Net interest income (fully taxable equivalent) | 14,000 | 11,025 | ||||||
NII is the difference between interest income earned on assets and interest expense incurred on liabilities. Accordingly, two factors affect NII:
| ● | The rates earned on interest earning assets and paid on interest bearing liabilities |
| ● | The average balance of interest earning assets and interest bearing liabilities |
NII is impacted by yields earned on assets and rates paid on liabilities. During 2022, asset yields increased with the Federal Reserve rate movements, but liability costs were still low due to the ability to slowly raise deposit rates. In the first quarter of 2023, interest rates on deposits increased more dramatically as a result of competitive pressure and the desire to retain existing deposits and attract new ones to add to the Corporation’s liquidity position. While higher market rates have helped the Corporation’s NIM through March 31, 2023, management believes that compression will start to happen with the continued higher cost of liabilities without a similar-sized increase in asset yield.
As a result of a larger balance sheet and improved asset yields in the first quarter of 2023, the Corporation’s NII on a tax equivalent basis increased while the Corporation’s margin increased to 3.08% for the quarter ended March 31, 2023, compared to 2.73% in the first quarter of 2022. The Corporation’s NII on a fully-taxable basis for the three months ended March 31, 2023, increased over the same period in 2022 by $2,975,000, or 27.0%.
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Security yields will generally fluctuate more rapidly than loan yields based on changes to the U.S. Treasury rates and yield curve. With higher Treasury rates in 2022 and 2023, security yields have increased and have helped to increase NII during the first quarter of 2023.
The Corporation’s overall cost of funds has risen significantly through the first three months of 2023. Core deposit interest rates have risen over the past year; however, time deposit rates have risen much higher and faster than core deposit rates. The change in deposit rates has resulted in some movement from low interest bearing core deposits to time deposits or other higher yielding money market deposits. The average balance of borrowings was higher in the first three months of 2023 than 2022, and interest rates were also higer, resulting in the total cost of borrowings increasing by $738,000, or 171.2%.
The following table provides an analysis of year-to-date changes in NII by distinguishing what changes were a result of average balance increases or decreases and what changes were a result of interest rate increases or decreases.
RATE/VOLUME ANALYSIS OF CHANGES IN NET INTEREST INCOME
(TAXABLE EQUIVALENT BASIS, DOLLARS IN THOUSANDS)
| Three Months Ended March 31, | Three Months Ended March 31, | |||||||||||||||||||||||
| 2023 vs. 2022 | 2022 vs. 2021 | |||||||||||||||||||||||
| Increase (Decrease) | Increase (Decrease) | |||||||||||||||||||||||
| Due To Change In | Due To Change In | |||||||||||||||||||||||
| Net | Net | |||||||||||||||||||||||
| Average | Interest | Increase | Average | Interest | Increase | |||||||||||||||||||
| Balances | Rates | (Decrease) | Balances | Rates | (Decrease) | |||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||
| INTEREST INCOME | ||||||||||||||||||||||||
| Interest on deposits at other banks | (58 | ) | 55 | (3 | ) | 14 | 1 | 15 | ||||||||||||||||
| Securities available for sale: | ||||||||||||||||||||||||
| Taxable | 55 | 1,636 | 1,691 | 268 | 92 | 360 | ||||||||||||||||||
| Tax-exempt | (187 | ) | (178 | ) | (365 | ) | 161 | (61 | ) | 100 | ||||||||||||||
| Total securities | (132 | ) | 1,458 | 1,326 | 429 | 31 | 460 | |||||||||||||||||
| Loans | 3,138 | 1,763 | 4,901 | 892 | (450 | ) | 442 | |||||||||||||||||
| Regulatory stock | 25 | 56 | 81 | (7 | ) | — | (7 | ) | ||||||||||||||||
| Total interest income | 2,973 | 3,332 | 6,305 | 1,328 | (418 | ) | 910 | |||||||||||||||||
| INTEREST EXPENSE | ||||||||||||||||||||||||
| Deposits: | ||||||||||||||||||||||||
| Demand deposits | 18 | 2,034 | 2,052 | 6 | 5 | 11 | ||||||||||||||||||
| Savings deposits | — | 59 | 59 | 4 | — | 4 | ||||||||||||||||||
| Time deposits | 63 | 418 | 481 | (11 | ) | (66 | ) | (77 | ) | |||||||||||||||
| Total deposits | 81 | 2,511 | 2,592 | (1 | ) | (61 | ) | (62 | ) | |||||||||||||||
| Borrowings: | ||||||||||||||||||||||||
| Total borrowings | 584 | 154 | 738 | (72 | ) | (34 | ) | (106 | ) | |||||||||||||||
| Total interest expense | 665 | 2,665 | 3,330 | (73 | ) | (95 | ) | (168 | ) | |||||||||||||||
| NET INTEREST INCOME | 2,308 | 667 | 2,975 | 1,401 | (323 | ) | 1,078 | |||||||||||||||||
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The following tables show a more detailed analysis of NII on an FTE basis with all the major elements of the Corporation’s balance sheet, which consists of interest earning and non-interest earning assets and interest bearing and non-interest bearing liabilities.
COMPARATIVE AVERAGE BALANCE SHEETS AND NET INTEREST INCOME
| For the Three Months Ended March 31, | ||||||||||||||||||||||||
| 2023 | 2022 | |||||||||||||||||||||||
| (c) | (c) | |||||||||||||||||||||||
| Average | Annualized | Average | Annualized | |||||||||||||||||||||
| Balance | Interest | Yield/Rate | Balance | Interest | Yield/Rate | |||||||||||||||||||
| $ | $ | % | $ | $ | % | |||||||||||||||||||
| ASSETS | ||||||||||||||||||||||||
| Interest earning assets: | ||||||||||||||||||||||||
| Federal funds sold and interest | ||||||||||||||||||||||||
| on deposits at other banks | 11,818 | 34 | 1.18 | 94,688 | 37 | 0.16 | ||||||||||||||||||
| Securities available for sale: | ||||||||||||||||||||||||
| Taxable | 406,215 | 3,155 | 3.11 | 391,931 | 1,464 | 1.49 | ||||||||||||||||||
| Tax-exempt | 166,080 | 924 | 2.23 | 197,160 | 1,289 | 2.62 | ||||||||||||||||||
| Total securities (d) | 572,295 | 4,079 | 2.85 | 589,091 | 2,753 | 1.87 | ||||||||||||||||||
| Loans (a) | 1,227,153 | 13,758 | 4.51 | 931,158 | 8,858 | 3.82 | ||||||||||||||||||
| Regulatory stock | 7,272 | 141 | 7.76 | 5,410 | 60 | 4.42 | ||||||||||||||||||
| Total interest earning assets | 1,818,538 | 18,012 | 3.97 | 1,620,347 | 11,708 | 2.90 | ||||||||||||||||||
| Non-interest earning assets (d) | 43,042 | 80,048 | ||||||||||||||||||||||
| Total assets | 1,861,580 | 1,700,395 | ||||||||||||||||||||||
| LIABILITIES & | ||||||||||||||||||||||||
| STOCKHOLDERS' EQUITY | ||||||||||||||||||||||||
| Interest bearing liabilities: | ||||||||||||||||||||||||
| Demand deposits | 476,473 | 2,102 | 1.79 | 371,516 | 49 | 0.05 | ||||||||||||||||||
| Savings deposits | 358,368 | 76 | 0.09 | 354,773 | 18 | 0.02 | ||||||||||||||||||
| Time deposits | 145,400 | 666 | 1.86 | 113,904 | 185 | 0.66 | ||||||||||||||||||
| Borrowed funds | 131,377 | 1,169 | 3.61 | 63,877 | 431 | 2.74 | ||||||||||||||||||
| Total interest bearing liabilities | 1,111,618 | 4,013 | 1.46 | 904,070 | 683 | 0.31 | ||||||||||||||||||
| Non-interest bearing liabilities: | ||||||||||||||||||||||||
| Demand deposits | 638,766 | 659,028 | ||||||||||||||||||||||
| Other | 9,772 | 5,478 | ||||||||||||||||||||||
| Total liabilities | 1,760,156 | 1,568,576 | ||||||||||||||||||||||
| Stockholders' equity | 101,424 | 131,819 | ||||||||||||||||||||||
| Total liabilities & stockholders' equity | 1,861,580 | 1,700,395 | ||||||||||||||||||||||
| Net interest income (FTE) | 13,999 | 11,025 | ||||||||||||||||||||||
| Net interest spread (b) | 2.51 | 2.59 | ||||||||||||||||||||||
| Effect of non-interest | ||||||||||||||||||||||||
| bearing deposits | 0.57 | 0.14 | ||||||||||||||||||||||
| Net yield on interest earning assets (c) | 3.08 | 2.73 | ||||||||||||||||||||||
| (a) | Includes balances of nonaccrual loans and the recognition of any related interest income. The quarter-to-date average balances include net deferred loan costs of $2,653,000 as of March 31, 2023, and $1,832,000 as of March 31, 2022. Such fees and costs recognized through income and included in the interest amounts totaled $(112,000) in 2023, and $90,000 in 2022. |
| (b) | Net interest spread is the arithmetic difference between the yield on interest earning assets and the rate paid on interest bearing liabilities. |
| (c) | Net yield, also referred to as net interest margin, is computed by dividing NII (FTE) by total interest earning assets. |
| (d) | Securities recorded at amortized cost. Unrealized holding gains and losses are included in non-interest earning assets. |
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The Corporation’s average balance on securities decreased by $16.8 million, or 2.9%, for the three months ended March 31, 2023, compared to the same period in 2022. The tax equivalent yield on investments was 2.85% for the first three months ended March 31, 2023, compared to 1.87% for the three months ended March 31, 2022. Interest income on securities increased due to the Fed rate increases causing variable rate bonds to reprice to higher rates.
Average balances on loans increased by $296.0 million, or 31.8%, for the three months ended March 31, 2023, compared to the same period in the prior year. Loan yields increased by 69 basis points for the quarter and loan interest income increased $4,900,000, or 55.3%, as a result of the increase in loan balances and higher yields on loans.
The average balance of interest-bearing deposit accounts increased by $140.0 million, or 16.7%, for the three months ended March 31, 2023, compared to the same period in the prior year. All deposit categories showed an increase since the prior year. Demand deposits and time deposits increased significantly while savings deposits increased minimally. The interest rate paid on deposits increased for this time period as well. This resulted in a significant increase in interest expense on deposits of $2,592,000, or 1,028.5%, for the three months ended March 31, 2023, compared to the same period in 2022.
The Corporation’s average balance on borrowed funds increased by $67.5 million, or 105.7%, for the three months ended March 31, 2023, compared to the same period in 2022. The Corporation’s borrowed funds consist of overnight borrowings, FHLB advances, and subordinated debt which is used to support capital growth for the Bank. The increase in borrowed funds for the period is a result of $20 million of subordinated debt issued in July of 2022 as well as higher levels of FHLB advances to support the Corporation’s balance sheet growth. The rate paid on borrowed funds increased by 87 basis points for the three months ended March 31, 2023, compared to the same period in the prior year and interest expense increased by $738,000, or 171.2%.
For the three months ended March 31, 2023, the net interest spread decreased by eight basis points to 2.51%, compared to 2.59% for the three months ended March 31, 2022. The effect of non-interest bearing funds increased to 57 basis points from 14 basis points in the prior year. The effect of non-interest bearing funds refers to the benefit gained from deposits on which the Corporation does not pay interest. As rates go higher, the benefit of non-interest bearing deposits increases because there is more difference between non-interest bearing funds and interest bearing liabilities. The Corporation’s NIM for the first quarter of 2023 was 3.08%, compared to 2.73% for the first quarter of 2022.
The Asset Liability Committee (ALCO) carefully monitors the NIM because it indicates trends in NII, the Corporation’s largest source of revenue. For more information on the plans and strategies in place to protect the NIM and moderate the impact of changes in rates, refer to Item 7A: Quantitative and Qualitative Disclosures about Market Risk.
Provision for Credit Losses
The provision for credit losses includes a provision for losses on loans, available-for-sale debt securities, and unfunded loan commitments. The provision provides for losses inherent in the financial assets as determined by a quarterly analysis and calculation of various factors related to the financial assets. The amount of the provision reflects the adjustment management determines necessary to ensure the allowance for credit losses (ACL) is adequate to cover any losses inherent in the financial assets. The Corporation recorded a provision expense of $1,147,000 for credit losses related to loans, $110,000 for unfunded commitments and $0 related to available-for-sale securities for the first quarter of 2023, compared to $100,000 related to loans for the three months ended March 31, 2022. The provision expense was higher in the first quarter of 2023 due to the Corporation’s adoption of ASU 2016-13 which requires a reliance on forward economic indicators to project expected credit losses as well as a higher balance of classified loans. As of March 31, 2023, the allowance as a percentage of total loans was 1.28%, compared to 1.37% at March 31, 2022. More detail is provided under Allowance for Credit Losses in the Financial Condition section that follows.
Other Income
Other income for the first quarter of 2023 was $2,654,000, a decrease of $1,022,000, or 27.8%, compared to the $3,676,000 earned during the first quarter of 2022. The following table details the categories that comprise other income.
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| OTHER INCOME | ||||||||||||||||
| (DOLLARS IN THOUSANDS) | ||||||||||||||||
| Three Months Ended March 31, | ||||||||||||||||
| 2023 | 2022 | Increase (Decrease) | ||||||||||||||
| $ | $ | $ | % | |||||||||||||
| Trust and investment services | 785 | 671 | 114 | 17.0 | ||||||||||||
| Service charges on deposit accounts | 287 | 293 | (6 | ) | (2.0 | ) | ||||||||||
| Other fees | 613 | 295 | 318 | 107.8 | ||||||||||||
| Commissions | 895 | 869 | 26 | 3.0 | ||||||||||||
| Net (losses) gains on debt and equity securities | (606 | ) | 131 | (737 | ) | (562.6 | ) | |||||||||
| Gains on sale of mortgages | 122 | 735 | (613 | ) | (83.4 | ) | ||||||||||
| Earnings on bank owned life insurance | 226 | 190 | 36 | 18.9 | ||||||||||||
| Other miscellaneous income | 332 | 492 | (160 | ) | (32.5 | ) | ||||||||||
| Total other income | 2,654 | 3,676 | (1,022 | ) | (27.8 | ) | ||||||||||
Trust and investment services income increased by 17.0% as a result of a larger level of assets under management and higher fees. Other fees increased by 107.8%, driven by fees earned on an off-balance-sheet sweep product. The Corporation incurred $606,000 of losses on debt and equity securities in 2023 as a result of strategic sales of debt securities to fund higher yielding loan growth and depreciation of bank stock values causing an unrealized loss on equity securities. Mortgage gains declined by $613,000, or 83.4%, in the first quarter of 2023 compared to the first quarter of 2022. This was primarly a result of the rapid increase in interest rates during the last three quarters of 2022 that resulted in very low margins on mortgages sold and a switch to mortgages held on the Corporation’s balance sheet as opposed to sold on the secondary market. Earnings on bank-owned life insurance increased by 18.9%. The miscellaneous income category was lower in 2023 by 32.5% as a result of non-recurring income items that impacted the first quarter of 2022.
Operating Expenses
Operating expenses for the first quarter of 2023 were $12,364,000, an increase of $1,756,000, or 16.6%, compared to the $10,608,000 for the first quarter of 2022. The following table provides details of the Corporation’s operating expenses for the three-month period ended March 31, 2023, compared to the same period in 2022.
| OPERATING EXPENSES | ||||||||||||||||
| (DOLLARS IN THOUSANDS) | ||||||||||||||||
| Three Months Ended March 31, | ||||||||||||||||
| 2023 | 2022 | Increase (Decrease) | ||||||||||||||
| $ | $ | $ | % | |||||||||||||
| Salaries and employee benefits | 7,455 | 6,512 | 943 | 14.5 | ||||||||||||
| Occupancy expenses | 736 | 718 | 18 | 2.5 | ||||||||||||
| Equipment expenses | 344 | 265 | 79 | 29.8 | ||||||||||||
| Advertising & marketing expenses | 274 | 279 | (5 | ) | (1.8 | ) | ||||||||||
| Computer software & data processing expenses | 1,782 | 1,138 | 644 | 56.6 | ||||||||||||
| Shares tax | 300 | 351 | (51 | ) | (14.5 | ) | ||||||||||
| Professional services | 663 | 630 | 33 | 5.2 | ||||||||||||
| Other operating expenses | 810 | 715 | 95 | 13.3 | ||||||||||||
| Total Operating Expenses | 12,364 | 10,608 | 1,756 | 16.6 | ||||||||||||
Salaries and employee benefits are the largest category of operating expenses. For the first quarter of 2023, salaries and benefits increased $943,000, or 14.5%, compared to 2022. This was primarily due to a competitive labor market that resulted in higher costs to attract and retain employees. Occupancy and equipment expenses in total increased by 9.9% from the prior year as a result of new branch and leased office locations. Computer software and data processing expenses increased by $644,000, or 56.6%, as a result of higher technology costs caused primarily by a debit card conversion scheduled to take place in 2023 that resulted in amortized contract costs. Shares tax expense is based on the Corporation’s level of shareholders’ equity and has decreased by 14.5% due to the decline in the Corporation’s level of shareholders’ equity. Professional services expenses increased by 5.2% in the first quarter of 2023 compared to the prior year driven by higher fees associated with the issuance of subordinated debt. Other operating expenses increased by 13.3% quarter-over-quarter primarily as a result of higher FDIC assessment costs, higher insurance costs, higher travel costs, and miscellaneous other operating costs that are increasing to a lesser degree.
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Income Taxes
Federal income tax expense was $396,000 for the first quarter of 2023 compared to $498,000 for the same period in 2022. The effective tax rate for the Corporation was 14.0% for the three months ended March 31, 2023 and 13.5% for the three months ended March 31, 2022. Certain items of income are not subject to Federal income tax, such as tax-exempt interest income on loans and securities, and Bank Owned Life Insurance (BOLI) income; therefore, the effective income tax rate for the Corporation is lower than the stated tax rate.
Financial Condition
Investment Securities
The Corporation classifies all of its debt securities as available for sale and reports the portfolio at fair value. As of March 31, 2023, the Corporation had $494.7 million of securities available for sale, which accounted for 26.2% of assets, compared to 28.5% as of December 31, 2022, and 34.6% as of March 31, 2022. Based on ending balances, the securities portfolio decreased 16.1% from March 31, 2022, and 6.5% from December 31, 2022.
The debt securities portfolio was showing a net unrealized loss of $51,435,000 as of March 31, 2023, compared to an unrealized loss of $61,129,000 as of December 31, 2022, and an unrealized loss of $25,692,000 at March 31, 2022. The valuation of the Corporation’s securities portfolio, predominately debt securities, is impacted by both the U.S. Treasury rates and the perceived forward direction of interest rates.
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Each quarter, management sets portfolio allocation guidelines and adjusts the security portfolio strategy generally based on the following factors:
| ● | ALCO positions as to liquidity, credit risk, interest rate risk, and fair value risk |
| ● | Growth of the loan portfolio |
| ● | Slope of the U.S. Treasury curve |
| ● | Relative performance of the various instruments, including spread to U.S. Treasuries |
| ● | Duration and average length of the portfolio |
| ● | Volatility of the portfolio |
| ● | Direction of interest rates |
| ● | Economic factors impacting debt securities |
The investment policy of the Corporation establishes guidelines to promote diversification within the portfolio. The diversity specifications provide opportunities to shorten or lengthen duration, maximize yield, and mitigate credit risk.
There were no investment securities purchased in the first quarter of 2023 and $7.2 million was called or matured with an additional $28.1 million of investments being sold to support the Corporation’s liquidity position and fund higher yielding loan growth. All bond sectors, except U.S. Treasuries have declined in market value. U.S. Treasuries have increased slightly in market value since December 31, 2022. U.S. Treasuries represent a safe credit at a market-appropriate yield which adds some diversity to the portfolio. The Corporation’s U.S. government agency sector decreased slightly since December 31, 2022.
The Corporation’s U.S. agency MBS and CMO sectors have decreased since December 31, 2022, with MBS decreasing $920,000, or 2.0%, and CMOs decreasing $3.9 million, or 14.1%. These two security types both consist of mortgage instruments that pay monthly interest and principal, however the behavior of the two types vary according to the structure of the mortgage pool or CMO instrument. Management desires to maintain some MBS and CMOs in order to assist in adding to and maintaining a stable five-year ladder of cash flows, which is important in providing stable liquidity and interest rate risk positions. U.S. agency MBS and CMO securities pay contractual monthly principal and interest, but are also subject to additional prepayment of principal. The combined effect of all of these instruments paying monthly principal and interest provides the Corporation with a reasonably stable base cash flow. Cash flows coming off of MBS and CMOs do slow down and speed up as interest rates increase or decrease, which has an impact on the portfolio’s length and yield.
Non-agency MBS and CMO securities have decreased $1.5 million since December 31, 2022, or 3.0%. This sector provides better structure to the portfolio helping to achieve higher yields and shorten the duration while also adding rates-up protection. This sector also pays contractual monthly principal and interest which is the primary reason for the decline in balance since December 31, 2022.
The Corporation’s asset-backed securities declined by $3.1 million, or 4.3%, from December 31, 2022, to March 31, 2023. Many of the bonds in this sector receive regular monthly principal payments which caused the value to decline. Most of the asset-backed bonds are variable rate instruments which has helped to stabilize the overall portfolio yield in the rising rate environment.
During the first quarter of 2023, three corporate bonds totaling $6 million in par value were either called or matured. This caused a decrease in the ending balances of Corporate bonds compared to December 31, 2022. Like any security, corporate bonds have both positive and negative qualities and management must evaluate these securities on a risk versus reward basis. Corporate bonds add diversity to the portfolio and provide strong yields for short maturities; however, by their very nature, corporate bonds carry a high level of credit risk should the entity experience financial difficulties. As a result of the higher level of credit risk taken by purchasing a corporate bond, management has in place procedures to closely analyze the financial health of the company as well as policy guidelines. The guidelines include both maximum investment by issuer and minimal credit ratings that must be met in order for management to purchase a corporate bond. Financial analysis is conducted prior to every corporate bond purchase with ongoing monitoring performed on all securities held.
Obligations of states and political subdivisions, or municipal bonds, consist of both tax-free and taxable securities. They carry the longest duration on average of any instrument in the securities portfolio. Municipal tax-equivalent yields generally start well above other taxable bonds. These instruments also experience significant fair market value gains and losses when interest rates decrease and increase. The municipal bond sector decreased by $19.2 million, or 9.3%, from December 31, 2022 to March 31, 2023, as a result of sales of a number of bonds to fund loan growth offset by an improvement in the unrealized losses on the sector as a whole. Municipal bonds represented 37.7% of the securities portfolio as of March 31, 2023, compared to 38.9% as of December 31, 2022.
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Loans
Net loans outstanding increased by $303.0 million, or 32.3%, to $1.24 billion at March 31, 2023, from $937.6 million at March 31, 2022. Net loans increased by 5.4%, an annualized rate of 21.6%, from $1.18 billion at December 31, 2022. The following table shows the composition of the loan portfolio as of March 31, 2023 and December 31, 2022.
LOANS BY MAJOR CATEGORY
(DOLLARS IN THOUSANDS)
| March 31, | December 31, | |||||||||||||||
| 2023 | 2022 | |||||||||||||||
| $ | % | $ | % | |||||||||||||
| Agriculture | 240,006 | 19.1 | 238,734 | 20.1 | ||||||||||||
| Business Loans | 353,537 | 28.2 | 336,340 | 28.3 | ||||||||||||
| Consumer | 6,061 | 0.5 | 5,932 | 0.5 | ||||||||||||
| Home Equity | 100,743 | 8.0 | 98,854 | 8.3 | ||||||||||||
| Non-Owner Occupied CRE | 119,412 | 9.6 | 111,333 | 9.4 | ||||||||||||
| Residential Real Estate (a) | 434,215 | 34.6 | 397,260 | 33.4 | ||||||||||||
| Total loans | 1,253,974 | 100 | 1,188,453 | 100 | ||||||||||||
| Less: | ||||||||||||||||
| Deferred loan fees (costs), net | 2,625 | 2,664 | ||||||||||||||
| Allowance for credit losses | (16,054 | ) | (14,151 | ) | ||||||||||||
| Total net loans (b) | 1,240,545 | 1,176,966 | ||||||||||||||
| (a) | Residential real estate loans do not include mortgage loans serviced for others which totaled $295,917,000 as of March 31, 2023 and $298,375,000 as of December 31, 2022. |
| (b) | Refer to Note 1, Accounting Pronouncements Adopted in 2023 for details of reclassification of the portfolio segments related to the adoption of ASU 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. |
There was moderate growth in the loan portfolio since December 31, 2022. All of the loan categories showed an increase in balances since December 31, 2022.
From December 31, 2022, the Agriculture Loan segment increased 1,272,000, or 0.5%, the Business Loan segment increased 17,197,000, of 5.1%, the Consumer Loan segment increased $129,000, or 2.2%, the Home Equity segment increased $1,889,000, or 1.9%, the Non-Owner Occupied segment increased $8,079,000, or 7.3%, and the Residential Real Estate segment increased $36,955,000, or 9.3% from December 31, 2022.
In the first quarter of 2023, mortgage production decreased 2% from the previous quarter and was down 26% from the first quarter of 2022. Purchase money origination constituted 94% of the Corporation’s mortgage originations for the quarter, with construction-only and construction-permanent loans making up 55% of that mix. With the continued elevated fixed interest rate environment, the percentage of mortgage originations placed in the Corporation’s held-for-investment mortgage portfolio remained abnormally high at 92%, 84% of which were adjustable rate mortgages. As of March 31, 2023, ARM balances were $250.0 million, representing 55.2% of the 1-4 family residential loan portfolio of the Corporation. With a decline in dollar volume of loans being delivered into the secondary market, the gains on the sale of mortgages declined quarter-over-quarter.
The consumer loan portfolio represents 0.5% of total loans. The long-term trend over the past decade has seen homeowners turning to the equity in their homes to finance cars and education rather than traditional consumer loans that are generally unsecured. Demand for unsecured credit is being matched by principal payments on existing loans resulting in stable balances.
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Non-Performing Assets
Non-performing assets include:
| ● | Nonaccrual loans |
| ● | Loans past due 90 days or more and still accruing |
| ● | Other real estate owned |
NON-PERFORMING ASSETS
(DOLLARS IN THOUSANDS)
| March 31 | December 31, | March 31 | ||||||||||
| 2023 | 2022 | 2022 | ||||||||||
| $ | $ | $ | ||||||||||
| Nonaccrual loans | 3,514 | 4,178 | 3,553 | |||||||||
| Loans past due 90 days or more and still accruing | 441 | 169 | 86 | |||||||||
| Total non-performing loans | 3,955 | 4,347 | 3,639 | |||||||||
| Other real estate owned | — | — | — | |||||||||
| Total non-performing assets | 3,955 | 4,347 | 3,639 | |||||||||
| Non-performing assets to net loans | 0.32% | 0.31% | 0.39% | |||||||||
The total balance of non-performing assets increased by $317,000, or 8.7% from balances at March 31, 2022, and decreased by $391,000, or 9.0%, from balances at December 31, 2022. There were no non-performing TDR loans in any of the periods presented. A TDR is a loan where management has granted a concession to the borrower from the original terms. A concession is generally granted in order to improve the financial position of the borrower and improve the likelihood of full collection by the lender. Non-accrual loans decreased by $39,000, or 1.1%, since March 31, 2022, and decreased $664,000, or 15.9% since December 31, 2022. Loans past due 90 days or more and still accruing increased $356,000 since March 31, 2022, and $273,000, since December 31, 2022. This increase was primarily caused by the addition of one agriculture mortgage totaling $269,000 and several smaller residential mortgages.
There was no other real estate owned (OREO) as of March 31, 2023, December 31, 2022, or March 31, 2022.
Allowance for Credit Losses
The allowance for credit losses (ACL) is a valuation account that is deducted from the loans' amortized cost basis to present the net amount expected to be collected on total loans. Management reviews the adequacy of the ACL on a quarterly basis. The ACL represents management’s estimate of lifetime credit losses inherent in loans as of the balance sheet date. The ACL is estimated by management using relevant available information, from both internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. The Corporation measures expected credit losses for loans on a pooled basis when similar risk characteristics exist. Additionally, the ACL calculation includes subjective adjustments for qualitative risk factors that are likely to cause estimated credit losses to differ from historical experience. These qualitative adjustments may increase or reduce reserve levels and include adjustments for lending policies and procedures, loan portfolio trends, lending management experience, asset quality, loan review, underlying collateral, credit concentrations, and external factors. Loans that do not share risk characteristics are evaluated on an individual basis. When management determines that foreclosure is probable and the borrower is experiencing financial difficulty, the expected credit losses are based on the fair value of collateral at the reporting date adjusted for selling costs as appropriate. Based on the quarterly calculation, management will adjust the ACL through the provision for credit losses as necessary.
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Strong credit and collateral policies have been instrumental in producing a favorable history of loan losses for the Corporation. The Net Charge-Off table below shows the net charge-offs for each segment of the Corporation’s loan portfolio as of March 31, 2023.
| Net Charge-Offs | ||||
| (DOLLARS IN THOUSANDS) | ||||
| March 31, | ||||
| 2023 | ||||
| $ | ||||
| Loans charged-off: | ||||
| Agriculture | — | |||
| Business Loans | — | |||
| Consumer Loans | 1 | |||
| Home Equity | — | |||
| Non-Owner Occupied CRE | — | |||
| Residential Real Estate | — | |||
| Total loans charged-off | 1 | |||
| Recoveries of loans previously charged-off | ||||
| Agriculture | 63 | |||
| Business Loans | 13 | |||
| Consumer Loans | — | |||
| Home Equity | — | |||
| Non-Owner Occupied CRE | — | |||
| Residential Real Estate | 1 | |||
| Total recoveries | 77 | |||
| Net charge-offs (recoveries) | ||||
| Agriculture | (63 | ) | ||
| Business Loans | (13 | ) | ||
| Consumer Loans | 1 | |||
| Home Equity | — | |||
| Non-Owner Occupied CRE | — | |||
| Residential Real Estate | (1 | ) | ||
| Total net charge-offs (recoveries) | (76 | ) | ||
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The Net Charge-Off table below shows the net charge-offs for each segment of the Corporation’s loan portfolio as of March 31, 2022.
| Net Charge-Offs | ||||
| (DOLLARS IN THOUSANDS) | ||||
| March 31, | ||||
| 2022 | ||||
| $ | ||||
| Loans charged-off: | ||||
| Commercial real estate | 65 | |||
| Consumer real estate | — | |||
| Commercial and industrial | — | |||
| Consumer | 1 | |||
| Total loans charged-off | 66 | |||
| Recoveries of loans previously charged-off | ||||
| Commercial real estate | — | |||
| Consumer real estate | 3 | |||
| Commercial and industrial | 10 | |||
| Consumer | 1 | |||
| Total recoveries | 14 | |||
| Net charge-offs (recoveries) | ||||
| Commercial real estate | 65 | |||
| Consumer real estate | (3 | ) | ||
| Commercial and industrial | (10 | ) | ||
| Consumer | — | |||
| Total net charge-offs (recoveries) | 52 | |||
The net charge-offs as a percentage of average total loans outstanding indicates the percentage of the Corporation’s total loan portfolio that has been charged off during the period. The Corporation has historically experienced very low net charge-off percentages due to conservative credit practices. As of March 31, 2023, there were $1,000 in charge-offs and $77,000 of recoveries, representing a net recovery position of 0.01% of average loans outstanding as reflected above. As of March 31, 2022, net charge-offs were very low at $52,000, resulting in a net charge-off as a percentage of average loans of 0.01% for the quarter.
Management regularly reviews the overall risk profile of the loan portfolio and the impact that current economic trends have on the Corporation’s loans. The financial industry typically evaluates the quality of loans on a scale with “unclassified” representing healthy loans, “special mention” being the first indication of credit concern, and several successive classified ratings indicating further credit declines of “substandard,” “doubtful,” and, ultimately, “loss.”
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The Corporation’s level of classified loans was $13.6 million on March 31, 2023, compared to $17.0 million on March 31, 2022. Total classified loans have decreased from the prior year. Having more loans in a classified status could result in a larger allowance as higher amounts of projected historical losses and qualitative factors are attached to these loans. The allowance as a percentage of total loans was 1.28% as of March 31, 2023, 1.19% as of December 31, 2022, and 1.37% as of March 31, 2022.
Premises and Equipment
Premises and equipment, net of accumulated depreciation, increased by $965,000, or 4.0%, to $25.4 million as of March 31, 2023, from $24.4 million as of March 31, 2022. As of March 31, 2023, $812,000 was classified as construction or improvement in process compared to $498,000 as of March 31, 2022. Fixed assets increased as a result of new purchases outpacing depreciation on existing assets year over year.
Regulatory Stock
The Corporation owns multiple forms of regulatory stock that is required in order to be a member of the Federal Reserve Bank (FRB) and members of banks such as the Federal Home Loan Bank (FHLB) and Atlantic Community Bankers Bank (ACBB). The Corporation’s $7.3 million of regulatory stock holdings as of March 31, 2023, consisted of $6.1 million of FHLB of Pittsburgh stock, $1.1 million of FRB stock, and $37,000 of Atlantic Community Bancshares, Inc. stock, the Bank Holding Company of ACBB. All of these stocks are valued at a stable dollar price, which is the price used to purchase or liquidate shares; therefore, the investment is carried at book value and there is no fair market value adjustment.
The Corporation’s investment in FHLB stock is required for membership in the organization. The amount of stock required is dependent upon the relative size of outstanding FHLB borrowings and mortgage activity. Excess stock is typically repurchased from the Corporation at par if the borrowings decline to a predetermined level. The Corporation’s FHLB stock position was $6.1 million on March 31, 2023, $5.6 million on December 31, 2022, and $4.7 million on March 31, 2022, with no excess capital stock position. Any future stock repurchases would be the result of lower borrowing balances. Stock repurchases by the FHLB occur every quarter.
Deposits
The Corporation’s total ending deposits at March 31, 2023, increased by $10.7 million, or 0.6%, and by $131.7 million, or 8.7%, from December 31, 2022, and March 31, 2022, respectively. Customer deposits are the Corporation’s primary source of funding for loans and securities. The mix of the Corporation’s deposit categories has changed moderately since March 31, 2022, with the changes being a $33.4 million, or 4.9% decrease in non-interest bearing demand deposit accounts, a $140.6 million, or 212.7% increase in interest bearing demand balances, a $12.3 million, or 9.2% decrease in NOW balances, a $4.1 million, or 2.5% increase in money market account balances, a $12.3 million, or 3.4% decrease in savings account balances, and a $45.0 million, or 39.4% increase in time deposit balances.
The growth in interest bearing demand balances was a result of participating in a reciprocal arrangement for the Corporation’s off balance sheet cash management sweep product as a strategic decision to fund loan growth. This product allows customers to sweep balances off the Corporation’s balance sheet, maintain a competitive yield, and receive full FDIC insurance coverage. The Corporation now fully receives reciprocal balances back on balance sheet for this product, resulting in the large increase in balances since March 31, 2022.
The significant increase in time deposit balances was a result of issuing $20 million in brokered time deposits since March 31, 2022, as well as increases in the Corporation’s customer time deposits as a result of the increased rate environment and offering several promotional rates on specific time deposit terms. Time deposits are typically a more rate-sensitive product, making them a source of funding that is prone to balance variations depending on the interest rate environment and how the Corporation’s time deposit rates compare with the local market rates. Time deposits fluctuate as consumers search for the best rates in the market, with less allegiance to any particular financial institution.
As of March 31, 2023 and 2022, the total uninsured deposits of the Corporation were approximately $235,753,000 and $288,011,000, respectively. Total uninsured deposits is calculated based on regulatory reporting requirements and reflects the portion of any deposit of a customer at an insured depository institution that exceeds the applicable FDIC insurance coverage for that depositor at that institution and amounts in any other uninsured investment or deposit accounts that are classified as deposits and not subject to any federal or state deposit insurance regime.
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The Deposits by Major Classification table, shown below, provides the balances of each category for March 31, 2023, December 31, 2022, and March 31, 2022.
| DEPOSITS BY MAJOR CLASSIFICATION | ||||||||||||
| (DOLLARS IN THOUSANDS) | ||||||||||||
| March 31, | December 31, | March 31, | ||||||||||
| 2023 | 2022 | 2022 | ||||||||||
| $ | $ | $ | ||||||||||
| Non-interest bearing demand | 642,136 | 672,342 | 675,519 | |||||||||
| Interest bearing demand | 206,669 | 164,208 | 66,083 | |||||||||
| NOW accounts | 121,684 | 139,846 | 134,018 | |||||||||
| Money market deposit accounts | 168,991 | 163,836 | 164,893 | |||||||||
| Savings accounts | 351,027 | 364,897 | 363,300 | |||||||||
| Time deposits | 159,101 | 133,829 | 114,144 | |||||||||
| Total deposits | 1,649,608 | 1,638,958 | 1,517,957 | |||||||||
The growth and mix of deposits is often driven by several factors including:
| ● | Convenience and service provided |
| ● | Current rates paid on deposits relative to competitor rates |
| ● | Level of and perceived direction of interest rates |
| ● | Financial condition and perceived safety of the institution |
| ● | Possible risks associated with other investment opportunities |
| ● | Level of fees on deposit products |
Borrowings
Total borrowings were $123.1 million, $113.4 million, and $63.9 million as of March 31, 2023, December 31, 2022, and March 31, 2022, respectively. Short-term borrowings consisted of $5.0 million at March 31, 2023 and $16.0 million at December 31, 2022, with no short-term funds outstanding at March 31, 2022. Short-term funds are used for immediate liquidity needs and are not typically part of an ongoing liquidity or interest rate risk strategy; therefore, they fluctuate more rapidly. When short-term funds are used, they are purchased through correspondent and member bank relationships as overnight borrowings or through the FHLB for terms less than one year.
Total long-term borrowings, borrowings initiated for terms longer than one year, were $78.6 million as of March 31, 2023, $58.0 million as of December 31, 2022, and $44.2 million as of March 31, 2022, respectively. The long-term borrowings for the Corporation were made up entirely of FHLB long-term advances. FHLB advances are used as a secondary source of funding and to mitigate interest rate risk. These long-term funding instruments are typically a more effective funding instrument in terms of selecting the exact amount, rate, and term of funding rather than trying to source the same through deposits. In this manner, management can efficiently meet known liquidity and interest rate risk needs. The increase in long-term FHLB borrowings since March 31, 2022, can be attributed to the changing interest rate environment and the desire to ladder out some borrowings into future years to cover anticipated liquidity needs. The Corporation continues to be well under the FHLB maximum borrowing capacity (MBC), which is currently $604.9 million. The Corporation’s internal policy limits are far more restrictive than the FHLB MBC, which is calculated and set quarterly by FHLB.
In addition to the long-term advances funded through the FHLB, on December 30, 2020, the Corporation completed the sale of a subordinated debt note offering. The Corporation sold $20.0 million of subordinated debt notes with a maturity date of December 30, 2030. These notes are non-callable for 5 years and carry a fixed interest rate of 4% per year for 5 years and then convert to a floating rate for the remainder of the term. The notes can be redeemed at par beginning 5 years prior to maturity. The notes are structured to qualify as Tier 2 capital for the Corporation and any funds it invests in the Bank qualify as Tier 1 capital at the Bank. As of March 31, 2023, $16.0 million of funds were invested in the Bank. The Corporation paid an issuance fee of 2% of the total issue that will be amortized to the call date on a pro-rata basis.
45
On July 22, 2022, the Corporation completed the sale of an additional subordinated debt note offering. The Corporation sold $20.0 million of subordinated debt notes with a maturity date of September 30, 2032. These notes are all non-callable for 5 years and carry a fixed interest rate of 5.75% per year for the 5 years and then convert to a floating rate for the remainder of the term. The notes can be redeemed at par beginning 5 years prior to maturity. The notes are structured to qualify as Tier 2 capital for the Corporation and any funds it invests in the Bank qualify as Tier 1 capital at the Bank. As of March 31, 2023, $17.0 million of funds were invested in the Bank. The Corporation paid an issuance fee of 2% of the total issue that will be amortized to the call date on a pro-rata basis.
Stockholders’ Equity
Federal regulatory authorities require banks to meet minimum capital levels. The Corporation, as well as the Bank, as the solely owned subsidiary of the Corporation, maintains capital ratios well above those minimum levels. The risk-weighted capital ratios are calculated by dividing capital by total risk-weighted assets. Regulatory guidelines determine the risk-weighted assets by assigning assets to specific risk-weighted categories. The calculation of tier I capital to risk-weighted average assets does not include an add-back to capital for the amount of the allowance for credit losses, thereby making this ratio lower than the total capital to risk-weighted assets ratio.
The consolidated asset limit on small bank holding companies is $3 billion and a company with assets under that limit is not subject to the consolidated capital rules but may disclose capital amounts and ratios. The Corporation has elected to disclose those amounts and ratios.
The following tables reflect the capital ratios for the Corporation and Bank compared to the regulatory capital requirements.
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| REGULATORY CAPITAL RATIOS: | ||||||||||||
| Regulatory Requirements | ||||||||||||
| Adequately | Well | |||||||||||
| As of March 31, 2023 | Capital Ratios | Capitalized | Capitalized | |||||||||
| Total Capital to Risk-Weighted Assets | ||||||||||||
| Consolidated | 14.9% | N/A | N/A | |||||||||
| Bank | 14.4% | 8.0% | 10.0% | |||||||||
| Tier 1 Capital to Risk-Weighted Assets | ||||||||||||
| Consolidated | 10.8% | N/A | N/A | |||||||||
| Bank | 13.2% | 6.0% | 8.0% | |||||||||
| Common Equity Tier 1 Capital to Risk-Weighted Assets | ||||||||||||
| Consolidated | 10.8% | N/A | N/A | |||||||||
| Bank | 13.2% | 4.5% | 6.5% | |||||||||
| Tier 1 Capital to Average Assets | ||||||||||||
| Consolidated | 7.7% | N/A | N/A | |||||||||
| Bank | 9.4% | 4.0% | 5.0% | |||||||||
| As of December 31, 2022 | ||||||||||||
| Total Capital to Risk-Weighted Assets | ||||||||||||
| Consolidated | 15.0% | N/A | N/A | |||||||||
| Bank | 14.5% | 8.0% | 10.0% | |||||||||
| Tier I Capital to Risk-Weighted Assets | ||||||||||||
| Consolidated | 10.9% | N/A | N/A | |||||||||
| Bank | 13.4% | 6.0% | 8.0% | |||||||||
| Common Equity Tier I Capital to Risk-Weighted Assets | ||||||||||||
| Consolidated | 10.9% | N/A | N/A | |||||||||
| Bank | 13.4% | 4.5% | 6.5% | |||||||||
| Tier I Capital to Average Assets | ||||||||||||
| Consolidated | 7.6% | N/A | N/A | |||||||||
| Bank | 9.3% | 4.0% | 5.0% | |||||||||
| As of March 31, 2022 | ||||||||||||
| Total Capital to Risk-Weighted Assets | ||||||||||||
| Consolidated | 15.2% | N/A | N/A | |||||||||
| Bank | 14.3% | 8.0% | 10.0% | |||||||||
| Tier 1 Capital to Risk-Weighted Assets | ||||||||||||
| Consolidated | 12.2% | N/A | N/A | |||||||||
| Bank | 13.1% | 6.0% | 8.0% | |||||||||
| Common Equity Tier 1 Capital to Risk-Weighted Assets | ||||||||||||
| Consolidated | 12.2% | N/A | N/A | |||||||||
| Bank | 13.1% | 4.5% | 6.5% | |||||||||
| Tier 1 Capital to Average Assets | ||||||||||||
| Consolidated | 8.0% | N/A | N/A | |||||||||
| Bank | 8.9% | 4.0% | 5.0% | |||||||||
As of March 31, 2023, the Bank’s Tier 1 Leverage Ratio stood at 9.4% while the Corporation’s Tier 1 Leverage Ratio was 7.7%. Tier 1 Capital levels at the Corporation level were not impacted by the subordinated debt issue since subordinated debt only qualifies as Tier 2 Capital at the corporate level. As such, in terms of the Corporation’s regulatory capital ratios, only the Total Capital to Risk-Weighted Assets ratio was enhanced as a result of the $40 million subordinated debt issue. Most of the marked improvement in capital ratios occurred at the Bank level. In 2022, the Corporation’s earnings, net of dividends paid, positively impacted the level of stockholders’ equity, but a devaluation of the investment portfolio, resulted in a higher level of unrealized losses, and a negative impact.
47
Off-Balance Sheet Arrangements
In the normal course of business, the Corporation typically has off-balance sheet arrangements related to loan funding commitments. These arrangements may impact the Corporation’s financial condition and liquidity if they were to be exercised within a short period of time. As discussed in the following liquidity section, the Corporation has in place sufficient liquidity alternatives to meet these obligations. The following table presents information on the commitments by the Corporation as of March 31, 2023.
| OFF-BALANCE SHEET ARRANGEMENTS | ||||
| (DOLLARS IN THOUSANDS) | ||||
| March 31, | ||||
| 2023 | ||||
| $ | ||||
| Commitments to extend credit: | ||||
| Revolving home equity | 201,489 | |||
| Construction loans | 54,614 | |||
| Real estate loans | 96,170 | |||
| Business loans | 220,068 | |||
| Consumer loans | 1,445 | |||
| Other | 5,817 | |||
| Standby letters of credit | 11,057 | |||
| Total | 590,660 | |||
Market Risks
During March and April 2023 three significant bank failures occurred (Silicon Valley Bank, Signature Bank, and First Republic Bank). This was and continues to be accompanied by financial instability at certain additional banks. These bank failures and bank instabilities have created and may continue to create market and other risks, for all financial institutions and banks, including the Corporation. These risks include, but are not limited to:
| 1. | Market risk and loss of confidence in the financial services sector, and/or specific banks; |
| 2. | Deterioration of securities and loan portfolios; |
| 3. | Deposit reductions with higher volumes and occurring over shorter periods of time; |
| 4. | Increased liquidity demand and utilization of sources of liquidity; and |
| 5. | Interest rate volatility and abrupt, sudden and greater than usual rate changes. |
These factors individually, or in any combination, could materially and adversely affect:
| 1. | Financial condition; |
| 2. | Operations and results thereof; and |
| 3. | Stock price. |
In addition, the previously mentioned bank failures and instabilities may result in an increase of FDIC deposit insurance premiums and/or result in special FDIC deposit insurance assessments, which also may adversely affect the Corporation’s financial condition, operations, results thereof or stock price.
The Corporation cannot predict the impact, timing or duration of such events.
Significant Legislation
Dodd-Frank Wall Street Reform and Consumer Protection Act
In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) was signed into law. Dodd-Frank is intended to affect a fundamental restructuring of federal banking regulation. Among other things, Dodd-Frank creates a new Financial Stability Oversight Council to identify systemic risks in the financial system and gives federal regulators new authority to take control of and liquidate financial firms. Dodd-Frank additionally creates a new independent federal regulator to administer federal consumer protection laws. Among the provisions that have already or are likely to affect the Corporation are the following:
Holding Company Capital Requirements
Dodd-Frank requires the Federal Reserve to apply consolidated capital requirements to bank holding companies that are no less stringent than those currently applied to depository institutions. Under these standards, trust preferred securities will be excluded from tier I capital unless such securities were issued prior to May 19, 2010, by a bank holding company with less than $15 billion in assets. Dodd-Frank additionally requires that bank regulators issue countercyclical capital requirements so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, are consistent with safety and soundness.
Deposit Insurance
Dodd-Frank permanently increased the maximum deposit insurance amount for banks, savings institutions, and credit unions to $250,000 per depositor. Additionally, on February 7, 2011, the Board of Directors of the FDIC approved a final rule based on the Dodd-Frank Act that revises the assessment base from one based on domestic deposits to one based on assets. This change, which was effective in April 2011, saved the Corporation a significant amount of FDIC insurance premiums from the significantly higher FDIC insurance premiums placed into effect after the financial crisis.
48
Corporate Governance
Dodd-Frank requires publicly traded companies to give stockholders a non-binding vote on executive compensation at least every three years, a non-binding vote regarding the frequency of the vote on executive compensation at least every six years, and a non-binding vote on “golden parachute” payments in connection with approvals of mergers and acquisitions unless previously voted on by shareholders. The SEC has finalized the rules implementing these requirements which took effect on January 21, 2011. The Corporation was exempt from these requirements until January 21, 2013, due to its status as a smaller reporting company.
Consumer Financial Protection Bureau
Dodd-Frank created the Consumer Financial Protection Bureau (CFPB), which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy Provisions of the Gramm-Leach-Bliley Act, and certain other statutes. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions will be subject to rules promulgated by the CFPB but will continue to be examined and supervised by federal banking regulators for consumer compliance purposes. The CFPB will have authority to prevent unfair, deceptive, or abusive practices in connection with the offering of consumer financial products. Dodd-Frank authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower’s ability to repay. In addition, Dodd-Frank will allow borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the CFPB. Dodd-Frank permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.
Interstate Branching
Dodd-Frank authorizes national and state banks to establish branches in other states to the same extent as a bank chartered by that state would be permitted. Previously, banks could only establish branches in other states if the host state expressly permitted out-of-state banks to establish branches in that state. Accordingly, banks will be able to enter new markets more freely.
Limits on Interstate Acquisitions and Mergers
Dodd-Frank precludes a bank holding company from engaging in an interstate acquisition – the acquisition of a bank outside its home state – unless the bank holding company is both well capitalized and well managed. Furthermore, a bank may not engage in an interstate merger with another bank headquartered in another state unless the surviving institution will be well capitalized and well managed. The previous standard in both cases was adequately capitalized and adequately managed.
49
ENB FINANCIAL CORP
Item 3. Quantitative and Qualitative Disclosures about Market Risk
As a financial institution, the Corporation is subject to three primary risks:
| ● | Credit risk |
| ● | Liquidity risk |
| ● | Interest rate risk |
The Board of Directors has established an Asset Liability Management Committee (ALCO) to measure, monitor, and manage these primary market risks. The Asset Liability Policy has instituted guidelines for all of these primary risks, as well as other financial performance measurements with target ranges. The Asset Liability goals and guidelines are consistent with the Strategic Plan goals related to financial performance.
Credit Risk
For discussion on credit risk refer to the sections in Item 2. Management’s Discussion and Analysis, on securities, non-performing assets, and allowance for credit losses.
Liquidity Risk
Liquidity refers to having an adequate supply of cash available to meet business needs. Financial institutions must ensure that there is adequate liquidity to meet a variety of funding needs, at a minimal cost. Funding new loans and covering deposit withdrawals are the primary liquidity needs of the Corporation. The Corporation uses a variety of funding sources to meet liquidity needs, such as deposits, loan repayments, cash flows from securities, borrowings, and current earnings.
As noted in the discussion on deposits, customers have historically provided the Corporation with a reliable and steadily increasing source of funds liquidity. The Corporation also has in place relationships with other banking institutions for the purpose of buying and selling Federal funds. The lines of credit with these institutions provide immediate sources of additional liquidity. The Corporation currently has unsecured lines of credit totaling $32 million. This does not include amounts available from member banks such as the Federal Reserve Discount Window or the FHLB of Pittsburgh.
The Corporation regularly reviews its liquidity position by measuring its projected net cash flows at a 30 and 90-day interval. The Corporation stresses the measurements by assuming a level of deposit out-flows that have not historically been realized. In addition to this forecast, other funding sources are reviewed as a method to provide emergency funding if necessary. The objective of this measurement is to identify the amount of cash that could be raised quickly without the need to liquidate assets. The Corporation also stresses its liquidity position utilizing different longer-term scenarios. The varying degrees of stress create pressure on deposit flows in its local market, reduce access to wholesale funding and limit access of funds available through brokered deposit channels. In addition to stressing cash flow, specific liquidity risk indicators are monitored to help identify risk areas. This analysis helps identify and quantify the potential cash surplus/deficit over a variety of time horizons to ensure the Corporation has adequate funding resources. Assumptions used for liquidity stress testing are subjective. Should an evolving liquidity situation or business cycle present new data, potential assumption changes will be considered. The Corporation believes it can meet all anticipated liquidity demands.
Historically, the Corporation has satisfied its liquidity needs from earnings, repayment of loans and amortizing investment securities, maturing investment securities, loan sales, deposit growth and its ability to access existing lines of credit. All investment securities are classified as available for sale; therefore, securities that are unencumbered can be used as collateral for borrowings and are an additional source of readily available liquidity.
The Corporation analyzes the following additional liquidity measurements in an effort to monitor and mitigate liquidity risk:
| ● | On-hand Liquidity/Total Liabilities – Net liquid assets as a percentage of total liabilities |
| ● | Non-Core Funding Dependence – Non-core liabilities minus short-term investments as a percentage of long-term assets |
| ● | Reliance on Wholesale Funding – Wholesale funding as a percentage of total funding |
| ● | Net Short-term Liabilities/Total Assets – Short-term liabilities minus short-term assets as a percentage of total assets |
| ● | Loan to Deposit Ratio – Total loans as a percentage of total deposits |
50
ENB FINANCIAL CORP
These measurements are designed to prevent undue reliance on outside sources of funding and to ensure a steady stream of liquidity is available should events occur that would cause a sudden decrease in deposits or large increase in loans or both, which would in turn draw significantly from the Corporation’s available liquidity sources. As of March 31, 2023, the Corporation was within guidelines for all of the above measurements.
The Corporation’s liquidity measurements are tracked and reported quarterly by management to both observe trends and ensure the measurements stay within desired ranges. Management is confident that a sufficient amount of internal and external liquidity exists to provide for significant unanticipated liquidity needs.
Interest Rate Risk
Interest rate risk is measured using two analytical tools:
| ● | Changes in net interest income |
| ● | Changes in net portfolio value |
Financial modeling is used to forecast net interest income and earnings, as well as net portfolio value, also referred to as fair value. The modeling is generally conducted under seven different interest rate scenarios that can vary according to the present level of interest rates. The scenarios consist of a projection of net interest income if rates remain flat, increase 100, 200, or 300 basis points, or decrease 100, 200, or 300 basis points.
The results obtained through the use of forecasting models are based on a variety of factors. Both the net interest income and fair value forecasts make use of the maturity and repricing schedules to determine the changes to the balance sheet over the course of time. Additionally, there are many assumptions that factor into the results. These assumptions include, but are not limited to, the following:
| ● | Projected forward interest rates |
| ● | Slope of the U.S. Treasury curve |
| ● | Spreads available on securities over the U.S. Treasury curve |
| ● | Prepayment speeds on loans held and mortgage-backed securities |
| ● | Anticipated calls on securities with call options |
| ● | Deposit and loan balance fluctuations |
| ● | Competitive pressures affecting loan and deposit rates |
| ● | Economic conditions |
| ● | Consumer reaction to interest rate changes |
As a result of the many assumptions, this information should not be relied upon to predict future results. Additionally, both of the analyses discussed below do not consider any action that management could take to minimize or offset the negative effect of changes in interest rates. These tools are used to assist management in identifying possible areas of risk in order to address them before a greater risk is posed. Back testing of the model is completed to compare actual results to projections to ensure the validity of the assumptions in the model. The back testing analyses indicate that the model assumptions are reliable.
Changes in Net Interest Income
The change in net interest income measures the amount of net interest income fluctuation that would be experienced over one year, assuming interest rates change immediately and remain the same for one year. This is considered to be a short-term view of interest rate risk. The analysis of changes in net interest income due to changes in interest rates is commonly referred to as interest rate sensitivity. The Corporation’s interest rate sensitivity analysis indicates that if interest rates were to change immediately, the Corporation would realize less net interest income in all up and down rate scenarios. In past years, the Corporation was generally showing asset sensitivity meaning in a rates-up environment, assets would reprice faster than liabilities resulting in higher net interest income. In the past few quarters, this increase in net interest income shifted to a decline primarily due to the increased impact from a higher cost of funds as rates continue to rise. While the Corporation would recognize higher interest income on its variable-rate assets, it would also now be repricing liabilities at a much faster pace resulting in increased interest expense that would offset the rise in interest income.
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The first quarter of 2023 analysis projects net interest income expected in the seven rate scenarios over a one-year time horizon. As of March 31, 2023, the Corporation was within guidelines for the maximum amount of net interest income change in all rate scenarios.
The assumptions and analysis of interest rate risk are based on historical experience during varied economic cycles. Management believes these assumptions to be appropriate; however, actual results could vary significantly. Management uses this analysis to identify trends in interest rate sensitivity and determine if action is necessary to mitigate asset liability risk.
Changes in Net Portfolio Value
The change in net portfolio value is considered a tool to measure long-term interest rate risk. The analysis measures the exposure of the balance sheet to valuation changes due to changes in interest rates. The calculation of net portfolio value discounts future cash flows to the present value based on current market rates. The change in net portfolio value estimates the gain or loss in value that would occur on market sensitive instruments given an interest rate increase or decrease in the same seven scenarios mentioned above. As of March 31, 2023, the Corporation was within guidelines for all rate scenarios except the down-200 and down-300 basis point scenarios. The Corporation shows a favorable benefit to net portfolio value in the rising rate scenarios, due primarily to the large amount of core deposits on the Corporation’s balance sheet. The non-interest bearing demand deposit accounts and low-interest bearing checking, NOW, and money market accounts provide more benefit to the Corporation when interest rates are higher and the difference between the overnight funding costs compared to the average interest bearing core deposit rates are greater. As interest rates increase, the discount rate used to value the Corporation’s interest bearing accounts increases, causing a lower net present value for these interest-bearing deposits. This improves the modeling of the Corporation’s fair value risk to higher interest rates as the liability amounts decrease causing a higher net portfolio value of the Corporation’s balance sheet. However, as interest rates decrease, the discount rate used to value the Corporation’s interest bearing accounts decreases, causing a higher net present value for these interest-bearing deposits.
The analysis shows a valuation loss in the down rate scenarios. Policy allows for a valuation decline of 25% for the down-200 basis point scenario and actual projected results show a valuation decline of 37%. In the down-300 basis point scenario, policy allows for a valuation decline of 30% and actual projection results show a valuation decline of 68%. While this loss is outside of policy guidelines, the Federal Reserve has signaled that their preferred course of action is to increase rates until inflation retracts. The down-300 basis point scenario is very unlikely. The Corporation will continue to monitor these measurements in the down-rate scenarios and adjust balance sheet structure as necessary to prepare for future potential lower rates.
The weakness with the net portfolio value analysis is that it assumes liquidation of the Corporation rather than as a going concern. For that reason, it is considered a secondary measurement of interest rate risk to “Changes in Net Interest Income” discussed above. However, the net portfolio value analysis is a more important tool to measure the impact of interest rate changes to capital. In the current regulatory climate, the focus is on ensuring adequate asset liability modeling is being done to project the impact of very large interest rate increases on capital. The asset liability modeling currently in place measures the impact of such a rate change on the valuation of the Corporation’s loans, securities, deposits, and borrowings, and the resulting impact to capital. Management continues to analyze additional scenario testing to model “worst case” scenarios to adequately plan for the possible severe impact of such events.
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Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures.
Management carried out an evaluation, under the supervision and with the participation of the Chief Executive Officer (Principal Executive Officer) and Treasurer (Principal Financial Officer), of the effectiveness of the design and the operation of the Corporation’s disclosure controls and procedures (as such term as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of March 31, 2023, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer (Principal Executive Officer) along with the Treasurer (Principal Financial Officer) concluded that the Corporation’s disclosure controls and procedures as of March 31, 2023, are effective to ensure that information required to be disclosed in the reports that the company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.
(b) Changes in Internal Controls.
Effective January 1, 2023, the Corporation adopted CECL. The Corporation designed new controls and modified existing controls as part of this adoption. These additional controls over financial reporting included controls over model governance, assumptions, and expanded controls over loan level data. There were no other changes in the Corporation's internal control over financial reporting (as defined in Rule 13a-15(f)) during the quarter ended March 31, 2023 that materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
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PART II – OTHER INFORMATION
March 31, 2023
Item 1. Legal Proceedings
Management is not aware of any litigation that would have a material adverse effect on the consolidated financial position or results of operations of the Corporation or its subsidiaries taken as a whole. There are no proceedings pending other than ordinary routine litigation incident to the business of the Corporation. In addition, no material proceedings are pending, are known to be threatened, or contemplated against the Corporation by governmental authorities.
Item 1A. Risk Factors
The Corporation continually monitors the risks related to the Corporation’s business, other events, the Corporation’s Common Stock, and the Corporation’s industry. Other than as noted below, there have been no material changes in risk factors applicable to the Corporation from those disclosed in "Risk Factors" in Item 1A of the Corporation's Annual Report on Form 10-K for the year ended December 31, 2022.
Recent negative developments affecting the banking industry, including recent bank failures or concerns regarding liquidity, have eroded customer confidence in the banking system and may have a material adverse effect on the Corporation.
Recent events impacting the banking industry, including the high-profile failure or instability of certain banking institutions, have resulted in general uncertainty and eroded confidence in the safety, soundness, and financial strength of the financial services sector. In particular, the bank failures highlighted the potential serious impact of a financial institution unable to meet withdrawal requests by depositors. This has resulted in a growing concern about liquidity in the banking industry, access to and volatile capital markets and reduced stock valuations for certain financial institutions. Similar future events, including additional bank failures or bank instability, could directly or indirectly adversely impact our own liquidity, access to capital markets, stock price, financial condition and results of operations. Further, these recent events may also result in: greater regulatory scrutiny and enforcement; additional and more stringent laws and regulations for the financial services industry; increased FDIC deposit insurance premiums or special FDIC assessments; and higher capital ratio requirements, which as a result could have a material negative impact and adverse effect on our business, financial condition and results of operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Purchases
The following table details the Corporation’s purchase of its own common stock during the three months ended March 31, 2023.
| Issuer Purchase of Equity Securites | ||||||||||||||||
| Total Number of | Maximum Number | |||||||||||||||
| Total Number | Average | Shares Purchased | of Shares that May | |||||||||||||
| of Shares | Price Paid | as Part of Publicly | Yet be Purchased | |||||||||||||
| Period | Purchased | Per Share | Announced Plans * | Under the Plan * | ||||||||||||
| January 2023 | 3,653 | 16.86 | 3,653 | 156,991 | ||||||||||||
| February 2023 | 5,250 | 16.25 | 5,250 | 151,741 | ||||||||||||
| March 2023 | — | — | — | 151,741 | ||||||||||||
| Total | 8,903 | |||||||||||||||
* On October 21, 2020, the Board of Directors of the Corporation approved a plan to repurchase, in open market and privately negotiated transactions, up to 200,000 shares of its outstanding common stock. The first purchase of common stock under this plan occurred on October 28, 2020. By March 31, 2023, a total of 48,259 shares were repurchased at a total cost of $932,000 for an average cost per share of $19.31.
Item 3. Defaults Upon Senior Securities – Nothing to Report
Item 4. Mine Safety Disclosures – Not Applicable
Item 5. Other Information – Nothing to Report
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Item 6. Exhibits:
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SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| ENB Financial Corp | ||
| (Registrant) | ||
| Dated: May 15, 2023 | By: | /s/ Jeffrey S. Stauffer |
| Jeffrey S. Stauffer | ||
| Chairman of the Board | ||
| Chief Executive Officer and President | ||
| Principal Executive Officer | ||
| Dated: May 15, 2023 | By: | /s/ Rachel G. Bitner |
| Rachel G. Bitner | ||
| Treasurer | ||
| Principal Financial Officer | ||
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