Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2022
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 001-13349
BAR HARBOR BANKSHARES
(Exact name of registrant as specified in its charter)
Maine
01-0393663
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
PO Box 400
82 Main Street, Bar Harbor, ME
04609-0400
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (207) 288-3314
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol
Name of each exchange on which registered
Common Stock, par value $2.00 per share
BHB
NYSE American
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ⌧ No ◻
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ⌧ No ◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definition of "large accelerated filer," "accelerated filer", "smaller reporting company", and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ◻ Accelerated Filer ⌧ Non-Accelerated Filer Smaller Reporting Company ☐ Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes ☐ No ⌧
The Registrant had 15,065,620 shares of common stock, par value $2.00 per share, outstanding as of November 2, 2022.
BAR HARBOR BANKSHARES AND SUBSIDIARIES
INDEX
Page
PART I.
FINANCIAL INFORMATION
Item 1.
Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets as of September 30, 2022 and December 31, 2021
5
Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2022 and 2021
7
Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2022 and 2021
8
Consolidated Statements of Changes in Shareholders’ Equity for the Three and Nine Months Ended September 30, 2022 and 2021
9
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2022 and 2021
10
Notes to Unaudited Consolidated Interim Financial Statements
Note 1
Basis of Presentation
11
Note 2
Securities Available for Sale
12
Note 3
Loans and Allowance for Credit Losses
15
Note 4
Borrowed Funds
26
Note 5
Deposits
28
Note 6
Capital Ratios and Shareholders' Equity
29
Note 7
Earnings per Share
34
Note 8
Derivative Financial Instruments and Hedging Activities
35
Note 9
Fair Value Measurements
45
Note 10
Revenue from Contracts with Customers
52
Note 11
Leases
54
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
56
Selected Financial Data
58
Consolidated Loan and Deposit Analysis
59
Average Balances and Average Yields/Rates
60
Non-GAAP Financial Measures
62
Reconciliation of Non-GAAP Financial Measures
63
Performance Summary
65
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
70
Item 4.
Controls and Procedures
72
PART II.
OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
73
Item 6.
Exhibits
74
Signatures
75
Bar Harbor Bankshares conducts business operations principally through Bar Harbor Bank & Trust, which may be referred to as the “Bank” and which is a subsidiary of Bar Harbor Bankshares. Unless the context requires otherwise, references in this report to “the Company” "our company, "our," "us," and similar terms refer to Bar Harbor Bankshares and its subsidiaries, including the Bank, collectively.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in this Quarterly Report on Form 10-Q (the “Form 10-Q”) that are not historical facts may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended ("Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended ("Exchange Act"), and are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. When used in this Form 10-Q the words “believe,” “anticipate,” “expect,” “may,” “will,” “assume,” “should,” “predict,” “could,” “would,” “intend,” “targets,” “estimates,” “projects,” “plans,” and “potential,” and other similar words and expressions of the future, are intended to identify such forward-looking statements, but other statements not based on historical information may also be considered forward-looking, including statements about the Company’s future financial and operating results and the Company’s plans, objectives, and intentions. All forward-looking statements are subject to risks, uncertainties, and other factors that may cause the actual results, performance, or achievements of the Company to differ materially from any results, performance, or achievements expressed or implied by such forward-looking statements. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause the actual results to differ materially from the statements, including, but not limited to:
3
Other factors not identified above, including those described under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, our quarterly reports on Form 10-Q, and current reports on Form 8-K filed with the Securities and Exchange Commission (the “SEC”) and available on the SEC’s website at http://www.sec.gov, may also cause actual results to differ materially from those described in our forward-looking statements. Most of these factors are difficult to anticipate and are generally beyond our control. You should consider these factors in connection with considering any forward-looking statements that may be made by us. We undertake no obligation to release publicly any revisions to any forward-looking statements, to report events or to report the occurrence of unanticipated events unless we are required to do so by law.
4
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands, except share data)
September 30, 2022
December 31, 2021
Assets
Cash and cash equivalents:
Cash and due from banks
$
50,760
33,508
Interest-earning deposits with other banks
31,305
216,881
Total cash and cash equivalents
82,065
250,389
Securities:
Securities available for sale
556,752
618,276
Federal Home Loan Bank stock
9,035
7,384
Total securities
565,787
625,660
Loans held for sale
982
5,523
Total loans
2,850,364
2,531,910
Less: Allowance for credit losses
(25,018)
(22,718)
Net loans
2,825,346
2,509,192
Premises and equipment, net
48,010
49,382
Goodwill
119,477
Other intangible assets
6,034
6,733
Cash surrender value of bank-owned life insurance
80,758
79,020
Deferred tax assets, net
25,288
5,547
Other assets
86,499
58,310
Total assets
3,840,246
3,709,233
Liabilities
Deposits:
Demand
700,218
664,420
NOW
918,822
940,631
Savings
669,317
628,670
Money market
513,075
389,291
Time
334,248
425,532
Total deposits
3,135,680
3,048,544
Borrowings:
Senior
188,757
118,400
Subordinated
60,248
60,124
Total borrowings
249,005
178,524
Other liabilities
75,596
58,018
Total liabilities
3,460,281
3,285,086
(continued)
CONSOLIDATED BALANCE SHEETS (UNAUDITED) (continued)
Shareholders’ equity
Capital stock, par value $2.00; authorized 20,000,000 shares; issued 16,428,388 shares at September 30, 2022 and December 31, 2021
32,857
Additional paid-in capital
191,438
190,876
Retained earnings
235,218
215,592
Accumulated other comprehensive (loss) income
(62,589)
2,303
Less: 1,362,768 and 1,427,059 shares of treasury stock at September 30, 2022 and December 31, 2021, respectively
(16,959)
(17,481)
Total shareholders’ equity
379,965
424,147
Total liabilities and shareholders’ equity
The accompanying notes are an integral part of these consolidated financial statements.
6
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended
Nine Months Ended
September 30,
(in thousands, except earnings per share data)
2022
2021
Interest and dividend income
Loans
27,940
25,094
75,192
72,490
Securities and other
5,145
3,821
13,178
11,792
Total interest and dividend income
33,085
28,915
88,370
84,282
Interest expense
1,801
1,555
4,185
7,109
Borrowings
1,374
1,778
3,458
5,415
Total interest expense
3,175
3,333
7,643
12,524
Net interest income
29,910
25,582
80,727
71,758
Provision for credit losses
1,306
(174)
2,217
(1,428)
Net interest income after provision for credit losses
28,604
25,756
78,510
73,186
Non-interest income
Trust and investment management fee income
3,548
3,868
11,131
11,335
Customer service fees
3,836
3,515
11,108
9,742
Gain on sales of securities, net
44
1,930
53
1,980
Mortgage banking income
315
850
1,427
4,973
Bank-owned life insurance income
496
494
1,501
1,510
Customer derivative income
341
213
837
Other income
526
352
1,660
726
Total non-interest income
8,823
11,350
27,093
31,103
Non-interest expense
Salaries and employee benefits
12,242
11,743
35,757
35,275
Occupancy and equipment
4,458
4,029
13,254
12,251
Gain on sales of premises and equipment, net
—
(146)
(65)
(137)
Outside services
393
547
1,143
1,512
Professional services
421
491
1,122
1,200
Communication
204
188
617
707
Marketing
518
339
1,150
1,163
Amortization of intangible assets
233
699
Loss on debt extinguishment
1,768
Acquisition, conversion and other expenses
31
318
356
1,759
Other expenses
4,532
3,862
12,585
11,382
Total non-interest expense
23,032
23,372
66,618
67,587
Income before income taxes
14,395
13,734
38,985
36,702
Income tax expense
2,965
2,706
7,940
7,169
Net income
11,430
11,028
31,045
29,533
Earnings per share:
Basic
0.76
0.74
2.07
1.97
Diluted
0.73
2.06
1.96
Weighted average common shares outstanding:
15,058
14,983
15,029
14,961
15,113
15,051
15,100
15,035
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(in thousands)
Other comprehensive (loss) income, before tax:
Changes in unrealized loss on securities available for sale
(26,933)
(3,700)
(79,186)
(7,328)
Changes in unrealized (loss) gain on hedging derivatives
(1,568)
(203)
(5,446)
2,311
Income taxes related to other comprehensive income:
6,522
861
18,486
1,703
Changes in unrealized loss (gain) on hedging derivatives
361
48
1,254
(538)
Total other comprehensive loss
(21,618)
(2,994)
(64,892)
(3,852)
Total comprehensive (loss) income
(10,188)
8,034
(33,847)
25,681
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)
Accumulated
Common
Additional
other
stock
paid-in
Retained
comprehensive
Treasury
(in thousands, except per share data)
amount
capital
earnings
income (loss)
Total
Balance at December 31, 2020
190,084
195,607
6,740
(18,223)
407,065
Allowance for credit losses cumulative-effect adjustment - ASU 2016-13
(5,242)
18,505
Other comprehensive loss
(858)
Cash dividends declared ($0.46 per share)
(6,876)
Net issuance (56,290 shares) to employee stock plans, including related tax effects
(280)
449
169
Recognition of stock based compensation
997
Balance at June 30, 2021
190,801
201,994
5,882
(17,774)
413,760
Other comprehensive income
Cash dividends declared ($0.24 per share)
(3,596)
Net issuance (14,412 shares) to employee stock plans, including related tax effects
(276)
146
(130)
367
Balance at September 30, 2021
190,892
209,426
2,888
(17,628)
418,435
Balance at December 31, 2021
19,615
(43,274)
Cash dividends declared ($0.50 per share)
(7,509)
Net issuance (24,768 shares) to employee stock plans, including related tax effects
376
148
524
94
Balance at June 30, 2022
191,346
227,698
(40,971)
(17,333)
393,597
Cash dividends declared ($0.26 per share)
(3,910)
Net issuance (39,523 shares) to employee stock plans, including related tax effects
(530)
374
(156)
622
Balance at September 30, 2022
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended September 30,
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Originations of loans held for sale
(33,919)
(149,948)
Proceeds from loan sales
38,184
153,832
Loss on sale of loans
281
3,621
Net amortization of securities
2,287
3,788
Change in unamortized net loan costs and premiums
353
(2,739)
Premises and equipment depreciation
3,186
3,466
Stock-based compensation expense
716
1,364
Accretion of purchase accounting entries, net
Amortization of other intangibles
704
Income from cash surrender value of bank-owned life insurance policies
(1,501)
(1,510)
(53)
(1,980)
Amortization of right-of-use lease assets
893
851
Decrease in lease liabilities
(851)
(786)
Gain on premises and equipment, net
Net change in other assets and liabilities
(2,954)
(7,878)
Net cash provided by operating activities
40,518
30,763
Cash flows from investing activities:
Proceeds from sales of securities available for sale
19,591
54,388
Proceeds from maturities, calls and prepayments of securities available for sale
48,073
99,580
Purchases of securities available for sale
(99,294)
(123,335)
Net change in loans
(319,036)
47,360
Recoveries of previously charged off loans
312
159
Purchase of FHLB stock
(2,924)
(790)
Proceeds from sale of FHLB stock
1,273
4,634
Purchase of premises and equipment, net
(1,842)
(1,216)
Net investment in community limited partnerships
(1,430)
(1,112)
Net cash (used in) provided by investing activities
(355,277)
79,668
Cash flows from financing activities:
Net change in deposits
87,136
101,050
Net change in short-term senior borrowings
92,250
9,324
Repayments of long-term senior borrowings
(21,014)
Net change in short-term other borrowings
(886)
(89,018)
Net issuance to employee stock plans
368
(6,073)
Cash dividends paid on common stock
(11,419)
(10,472)
Net cash provided by financing activities
146,435
4,811
Net change in cash and cash equivalents
(168,324)
115,242
Cash and cash equivalents at beginning of year
226,007
Cash and cash equivalents at end of period
341,249
Supplemental cash flow information:
Interest paid
7,028
13,052
Income taxes paid, net
6,781
7,755
NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The consolidated financial statements (unaudited) (the “financial statements”) of Bar Harbor Bankshares and its subsidiaries (the “Company,” “we,” “our” or “us” or similar terms) have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The Company is a Maine Financial Institution Holding Company for the purposes of the laws of the State of Maine, and as such is subject to the jurisdiction of the Superintendent of the Maine Bureau of Financial Institutions. These financial statements include our accounts, the accounts of our wholly owned subsidiary Bar Harbor Bank & Trust (the “Bank”) and the Bank’s consolidated subsidiaries. The results of operations of companies or assets acquired are included only from the dates of acquisition. All material wholly owned and majority owned subsidiaries are consolidated unless GAAP requires otherwise.
In addition, these interim financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X, and accordingly, certain information and footnote disclosures normally included in financial statements prepared according to GAAP have been omitted.
The results for any interim period are not necessarily indicative of results for the full year. These consolidated financial statements should be read in conjunction with the audited financial statements and note disclosures in the Annual Report on Form 10-K for the fiscal year ended December 31, 2021 previously filed with the Securities and Exchange Commission (the "SEC"). In management's opinion, all adjustments necessary for a fair statement are reflected in the interim periods presented.
Reclassifications: Whenever necessary, amounts in the prior years’ financial statements are reclassified to conform to current presentation. The reclassifications had no impact on net income in the consolidated income statement.
Recent Accounting Pronouncements
The following table provides a brief description of recent accounting standards updates (“ASU”) that could have a material impact to the Company’s consolidated financial statements upon adoption:
Standard
Description
Required Date of Adoption
Effect on financial statements
Standards Not Yet Adopted
ASU 2022-02 Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings (“TDR”) and Vintage Disclosures
The amendments in this update eliminate TDR recognition and measurement guidance and, instead, require that an entity evaluate (consistent with the accounting for other loan modifications) whether the modification represents a new loan or a continuation of an exisiting loan. The amendments enhance existing disclosure requirements and introduce new requirements related to certain modifications of receivables made to borrowers experiencing financial difficulty.
January 1, 2023
We do not expect adoption of this ASU to have a material impact on our consolidated financial statements.
NOTE 2. SECURITIES AVAILABLE FOR SALE
The following is a summary of securities available for sale (“AFS”):
Gross
Unrealized
Amortized Cost
Gains
Losses
Fair Value
Mortgage-backed securities:
US Government-sponsored enterprises
252,369
(36,349)
216,024
US Government agency
93,643
(10,128)
83,526
Private label
72,484
(5,749)
66,769
Obligations of states and political subdivisions thereof
123,350
9,205
(27,903)
104,652
Corporate bonds
91,512
(5,757)
85,781
Total securities available for sale
633,358
9,280
(85,886)
237,283
2,289
(3,455)
236,117
79,143
1,016
(522)
79,637
68,691
142
(138)
68,695
140,585
1,489
(298)
141,776
89,994
2,479
(422)
92,051
615,696
7,415
(4,835)
Credit Quality Information
We monitor the credit quality of available for sale debt securities through credit ratings from various rating agencies and substantial price changes. Credit ratings express opinions about the credit quality of a security and are utilized us to make informed decisions. Securities are triggered for further review in the quarter if the security has significant fluctuations in ratings, drops below investment grade, or significant pricing changes. For securities without credit ratings, we utilize other financial information indicating the financial health of the underlying municipality, agency, or organization associated with the underlying security.
As of September 30, 2022 and December 31, 2021, we carried no allowance on available for sale debt securities in accordance with ASU 2016-13, Measurement of Credit Losses on Financial Instruments.
The amortized cost and estimated fair value of available for sale securities segregated by contractual maturity at September 30, 2022 are presented below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Mortgage-backed securities are shown in total, as their maturities are highly variable.
Available for sale
Within 1 year
195
196
Over 1 year to 5 years
30,292
28,426
Over 5 years to 10 years
49,666
55,025
Over 10 years
134,709
106,786
Total bonds and obligations
214,862
190,433
Mortgage-backed securities
418,496
366,319
The following table presents the gains and losses from the sale of AFS securities for the periods presented:
Gross gains on sales of available for sale securities
151
2,030
Gross losses on sales of available for sale securities
(98)
(50)
Net gains on sale of available for sale securities
Securities with unrealized losses, segregated by the duration of their continuous unrealized loss positions, are summarized as follows:
Less Than Twelve Months
Over Twelve Months
Fair
Value
18,262
139,219
18,087
76,291
36,349
215,510
6,591
64,575
3,537
17,021
10,128
81,596
35,740
2,283
30,994
5,749
66,734
20,425
78,085
7,478
21,373
27,903
99,458
3,770
65,251
1,987
16,763
5,757
82,014
52,514
382,870
33,372
162,442
85,886
545,312
1,589
127,780
1,866
39,717
3,455
167,497
381
32,628
141
4,548
522
37,176
133
44,372
16
138
44,388
187
36,878
111
6,129
298
43,007
21,358
328
11,922
422
33,280
2,384
263,016
2,451
62,332
4,835
325,348
13
We expect to recover the amortized cost basis on all securities in our AFS portfolio. Furthermore, we do not intend to sell nor do we anticipate that we will be required to sell any securities in an unrealized loss position as of September 30, 2022, prior to this recovery. Our ability and intent to hold these securities until recovery is supported by our capital and liquidity positions as well as historically low portfolio turnover.
The following summarizes, by investment security type, the impact of securities in an unrealized loss position for greater than 12 months at September 30, 2022:
489 out of the total 521 securities in our portfolios of AFS US Government-sponsored enterprises were in unrealized loss positions. Aggregate unrealized losses represented 14.55% of the amortized cost of securities in unrealized loss positions. The Federal National Mortgage Association and Federal Home Loan Mortgage Corporation guarantee the contractual cash flows of all of our US Government-sponsored enterprises. The securities are investment grade rated and there were no material underlying credit downgrades during the quarter.
139 out of the total 161 securities in our portfolios of AFS US Government agency securities were in unrealized loss positions. Aggregate unrealized losses represented 11.04% of the amortized cost of securities in unrealized loss positions. The Government National Mortgage Association guarantees the contractual cash flows of all of our US Government agency securities. The securities are investment grade rated and there were no material underlying credit downgrades during the quarter.
33 of the total 35 securities in our portfolio of AFS private label mortgage-backed securities were in unrealized loss positions. Aggregate unrealized losses represented 7.93% of the amortized cost of securities in unrealized loss positions. We expect to receive all of the future contractual cash flows related to the amortized cost on these securities.
68 of the total 83 securities in our portfolio of AFS municipal bonds and obligations were in unrealized loss positions. Aggregate unrealized losses represented 22.06% of the amortized cost of securities in unrealized loss positions. We continually monitor the municipal bond sector of the market carefully and periodically evaluate the appropriate level of exposure to the market. At this time, we feel the bonds in this portfolio carry minimal risk of default, and we are appropriately compensated for the risk. There were no material underlying credit downgrades during the quarter.
26 out of the total 31 securities in our portfolio of AFS corporate bonds were in an unrealized loss position. The aggregate unrealized loss represents 7.07% of the amortized cost of bonds in unrealized loss positions. We review the financial strength of all of these bonds, and we have concluded that the amortized cost remains supported by the expected future cash flows of these securities. The most recent review includes all bond issuers and their current credit ratings, financial performance and capitalization.
14
NOTE 3. LOANS AND ALLOWANCE FOR CREDIT LOSSES
We evaluate risk characteristics of loans based on regulatory call report code with segmentation based on the underlying collateral for certain loan types. The following is a summary of total loans by regulatory call report code segmentation based on underlying collateral for certain loan types:
December 31,
Commercial construction
97,156
56,263
Commercial real estate owner occupied
256,475
257,122
Commercial real estate non-owner occupied
1,081,924
887,092
Tax exempt
41,622
41,280
Commercial and industrial
319,645
307,112
Residential real estate
953,113
888,263
Home equity
92,296
86,657
Consumer other
8,133
8,121
Allowance for credit losses
25,018
22,718
Total unamortized net costs and premiums included in loan totals were as follows:
Net unamortized loan origination costs
3,367
3,014
Net unamortized fair value discount on acquired loans
(3,898)
(4,758)
(531)
(1,744)
We exclude accrued interest receivable from the amortized cost basis of loans disclosed throughout this footnote. As of September 30, 2022 and December 31, 2021, accrued interest receivable for loans totaled $8.8 million and $6.3 million, respectively, and is included in the “other assets” line item on the consolidated balance sheets.
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and subsequent legislation established the Payroll Protection Program (“PPP”) are administered directly by the Small Business Administration (“SBA”). As of September 30, 2022, we had no remaining PPP loans and as of December 31, 2021, we had 61 PPP loans outstanding, with an outstanding principal balance of $6.7 million. PPP loans are included in the commercial and industrial portfolio segment.
Characteristics of each loan portfolio segment are as follows:
Commercial construction - Loans in this segment primarily include raw land, land development and construction of commercial and multifamily residential properties. Collateral values are determined based upon appraisals and evaluations of the completed structure in accordance with established policy guidelines. Maximum loan-to-value ratios at origination are governed by established policy guidelines that are more restrictive than on stabilized commercial real estate transactions. Construction loans are primarily paid by the cash flow generated from the completed structure, such as operating leases, rents, or other operating cash flows from the borrower.
Commercial real estate owner occupied and non-owner occupied - Loans in these segments are primarily owner-occupied or income-producing properties. Loans to Real Estate Investment Trusts (REITs) and unsecured loans to developers that closely correlate to the inherent risk in commercial real estate markets are also included. Commercial real estate loans are typically written with amortizing payment structures. Collateral values are determined based upon appraisals and evaluations in accordance with established policy guidelines. Maximum loan-to-value ratios at origination are governed by established policy and regulatory guidelines. Commercial real estate loans are primarily paid by the cash flow generated from the real property, such as operating leases, rents, or other operating cash flows from the borrower.
Tax Exempt - Loans in this segment primarily include loans to various state and municipal government entities. Loans made in these borrowers may provide us with tax-exempt income. While governed and underwritten similar to commercial loans they do have unique requirements based on established polices. Almost all state and municipal loans are considered a general obligation of the issuing entity. Given the size of many municipal borrowers, borrowings are normally not rated by major rating agencies.
Commercial and industrial loans - Loans consist of revolving and term loan obligations extended to business and corporate enterprises for the purpose of financing working capital and/or capital investment in this segment. Generally loans are secured by assets of the business such as accounts receivable, inventory, marketable securities, other liquid collateral, equipment and other business assets. Some loans in this category may be unsecured or guaranteed by government agencies such as the SBA. Loans are primarily paid by the operating cash flow of the borrower.
Residential real estate - All loans in this segment are collateralized by one-to-four family homes. Residential real estate loans held in the loan portfolio are made to borrowers who demonstrate the ability to make scheduled payments with full consideration to various underwriting factors. Borrower qualifications include favorable credit history combined with supportive income requirements and combined loan-to-value ratios within established policy guidelines.
Home equity - All loans and lines of credit are made to qualified individuals and are secured by senior or junior mortgage liens on owner-occupied one- to four-family homes, condominiums, or vacation homes. The home equity loan has a fixed rate and is billed as equal payments comprised of principal and interest. The home equity line of credit has a variable rate and is billed as interest-only payments during the draw period. At the end of the draw period, the home equity line of credit is billed as a percentage of the principal balance plus all accrued interest. Borrower qualifications include favorable credit history combined with supportive income requirements and combined loan-to-value ratios within established policy guidelines.
Consumer other - Loans in this segment include personal lines of credit and amortizing loans made to qualified individuals for various purposes such as auto loans, recreational equipment, overdraft protection or other consumer loans. Borrower qualifications include favorable credit history combined with supportive income and collateral requirements within established policy guidelines, as applicable.
Allowance for Credit Losses
The Allowance for Credit Losses (“ACL”) is comprised of the allowance for loan losses and the allowance for unfunded commitments which is accounted for as a separate liability in other liabilities on the balance sheet. The level of the ACL represents management’s estimate of expected credit losses over the expected life of the loans at the balance sheet date.
The allowance for credit losses is a valuation account that 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 allowance 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 comprised of reserves measured on a collective (pool) basis based on a lifetime loss-rate model when similar risk characteristics exist. Loans that do not share risk characteristics are evaluated on an individual basis, generally larger non-accruing commercial loans and TDRs.
The activity in the allowance for credit losses for the periods ended are as follows:
At or for the Three Months Ended September 30, 2022
Balance at
Beginning of
Period
Charge Offs
Recoveries
Provision
End of Period
1,010
1,223
2,722
132
2,861
7,361
610
7,971
105
(11)
4,820
(8)
20
290
5,122
6,806
85
6,886
865
2
(76)
791
67
(66)
23,756
(85)
41
At or for the Nine Months Ended September 30, 2022
2,111
(888)
2,751
120
(10)
5,650
2,321
86
5,369
(14)
(289)
5,862
(26)
103
947
814
(6)
22
(39)
(181)
167
(227)
310
17
At or for the Three Months Ended September 30, 2021
2,372
(286)
2,086
2,552
(142)
237
2,719
5,604
(22)
5,582
91
5,225
(24)
5,306
6,069
19
(290)
5,792
822
(49)
1
30
804
80
22,815
93
22,448
At or for the Nine Months Ended September 30, 2021
Impact of ASC
326
824
1,196
18
1,783
708
(403)
559
7,864
(2,008)
(278)
40
(13)
3,137
2,996
(44)
(797)
5,010
1,732
(67)
(1,024)
285
603
(108)
121
(119)
101
19,082
5,228
(741)
307
Unfunded Commitments
The allowance for credit losses on unfunded commitments is recognized as a liability (other liabilities on the consolidated balance sheet), with adjustments to the reserve recognized in other non-interest expense in the consolidated statement of operations. The activity in the allowance for credit losses on unfunded commitments for the periods ended was as follows:
Three Months Ended September 30, 2022
Nine Months Ended September 30, 2022
Beginning Balance
2,523
2,152
345
Ending Balance
2,497
Three Months Ended September 30, 2021
Nine Months Ended September 30, 2021
1,921
359
Impact of ASC 326
1,616
280
226
2,201
Loan Origination/Risk Management: We have certain lending policies and procedures in place designed to maximize loan income within an acceptable level of risk. Our Board of Directors review and approve these policies and procedures on a regular basis. A reporting system supplements the review process by providing management and the Board of Directors with frequent reports related to loan production, loan quality, and concentration of credit, loan delinquencies, non-performing loans and potential problem loans. We seek to diversify the loan portfolio as a means of managing risk associated with fluctuations in economic conditions.
Credit Quality Indicators: In monitoring the credit quality of the portfolio, management applies a credit quality indicator and uses an internal risk rating system to categorize commercial loans. These credit quality indicators range from one through nine, with a higher number correlating to increasing risk of loss. Consistent with regulatory guidelines, the Company provides for the classification of loans which are considered to be of lesser quality as special mention, substandard, doubtful, or loss (i.e. risk-rated 6, 7, 8 and 9, respectively).
The following are the definitions of our credit quality indicators:
Pass: Loans we consider in the commercial portfolio segments that are not adversely rated, are contractually current as to principal and interest, and are otherwise in compliance with the contractual terms of the loan agreement. Management believes there is a low risk of loss related to these loans considered pass-rated.
Special Mention: Loans considered having some potential weaknesses, but are deemed to not carry levels of risk inherent in one of the subsequent categories, are designated as special mention. A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. This might include loans which may require a higher level of supervision or internal reporting because of: (i) declining industry trends; (ii) increasing reliance on secondary sources of repayment; (iii) the poor condition of or lack of control over collateral; or (iv) failure to obtain proper documentation or any other deviations from prudent lending practices. Economic or market conditions which may, in the future, affect the obligor may warrant special mention of the asset. Loans for which an adverse trend in the borrower's operations or an imbalanced position in the balance sheet which has not reached a point where the liquidation is jeopardized may be included in this classification. Special mention loans are not adversely classified and do not expose us to sufficient risks to warrant classification.
Substandard: Loans we consider as substandard are inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged, if any. Substandard loans have a well-defined weakness that jeopardizes
liquidation of the debt. Substandard loans include those loans where there is the distinct possibility of some loss of principal, if the deficiencies are not corrected.
Doubtful: Loans we consider as doubtful have all of the weaknesses inherent in those loans that are classified as substandard. These loans have the added characteristic of a well-defined weakness which is inadequately protected by the current sound worth and paying capacity of borrower or of the collateral pledged, if any, and calls into question the collectability of the full balance of the loan. The possibility of loss is high but because of certain important and reasonably specific pending factors, which may work to the advantage and strengthening of the loan, its classification as loss is deferred until its more exact status is determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans. The entire amount of the loan might not be classified as doubtful when collection of a specific portion appears highly probable. Loans are generally not classified doubtful for an extended period of time (i.e., over a year).
Loss: Loans we consider as losses are those considered uncollectible and of such little value that their continuance as an asset is not warranted and the uncollectible amounts are charged-off. This classification does not mean the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this worthless asset even though partial recovery may be affected in the future. Losses are taken in the period in which they are determined to be uncollectible.
The following table presents our loans by year of origination, loan segmentation and risk indicator as of September 30, 2022:
2020
2019
2018
Prior
Risk rating:
Pass
34,032
32,179
5,928
1,011
973
74,123
Special mention
23,033
Substandard
28,961
20,248
12,973
23,785
31,795
47,090
110,306
246,197
245
672
1,145
1,711
3,773
931
5,276
6,207
Doubtful
147
24,030
32,467
49,317
117,440
283,316
249,574
146,764
89,252
35,671
259,250
1,063,827
139
918
14,665
15,722
173
2,048
2,221
154
89,564
36,589
276,117
6,944
1,044
256
778
13,276
19,324
56,222
70,975
60,338
29,867
11,053
84,792
313,247
1,497
155
1,083
516
2,432
5,683
55
514
651
64
57,719
71,030
60,505
31,020
11,569
87,802
Performing
170,291
178,875
113,573
71,869
51,588
361,823
948,019
Nonperforming
50
643
4,353
5,094
178,923
71,919
52,231
366,176
11,839
12,152
8,965
7,796
7,326
43,173
91,251
1,045
44,218
3,833
1,596
1,029
362
980
8,128
1,034
Total Loans
588,222
559,471
384,088
234,917
171,609
912,057
21
The following table presents our loans by year of origination, loan segmentation and risk indicator as of December 31, 2021:
2017
22,866
4,787
19,211
9,399
12,940
25,240
34,782
49,136
19,292
103,144
244,534
760
2,659
3,419
853
247
7,737
8,838
164
331
35,543
50,156
19,539
113,704
235,646
172,785
119,326
39,663
136,120
165,329
868,869
174
14,789
14,963
3,097
163
119,500
183,378
1,249
299
968
14,408
5,329
19,027
77,608
80,569
33,405
16,457
33,413
61,594
303,046
584
468
172
1,396
2,620
512
578
1,199
92
77,666
80,572
34,501
16,925
33,725
63,723
191,466
120,495
83,044
62,299
59,642
364,482
881,428
286
178
6,371
6,835
62,585
59,820
370,853
12,770
10,461
9,005
7,855
6,474
38,823
85,388
1,269
40,092
2,525
1,659
792
669
2,379
8,116
557,128
416,298
302,564
201,660
261,099
793,161
Past Dues
The following is a summary of past due loans for the periods ended:
30-59
60-89
90+
Total Past Due
Current
84
256,391
471
1,081,453
200
100
319,333
565
928
1,882
3,375
949,738
269
236
709
91,587
8,118
1,268
2,271
4,966
2,845,398
1,190
1,198
255,924
185
534
306,578
1,238
1,416
7,664
880,599
149
949
85,708
8,090
6,959
1,712
1,705
10,376
2,521,534
Non-Accrual Loans
The following is a summary of non-accrual loans for the periods ended:
Nonaccrual With No
90+ Days Past
Nonaccrual
Related Allowance
Due and Accruing
604
371
747
430
279
1,539
242
7,773
2,597
259
23
783
424
459
677
542
2,537
305
10,191
4,267
134
Collateral Dependent Loans
Loans that do not share risk characteristics are evaluated on an individual basis. For loans that are individually evaluated and collateral dependent, financial loans where we have determined that foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and we expect repayment of the financial asset to be provided substantially through the operation or sale of the collateral, the ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the asset as of the measurement date.
The following table presents the amortized cost basis of collateral-dependent loans by loan portfolio segment for the periods ended.
Real Estate
Other
122
157
385
292
7,616
9,899
Troubled Debt Restructuring Loans
The loan portfolio also includes certain loans that have been modified in a TDR, where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. Certain TDRs are classified as non-performing at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months. TDRs are evaluated individually for impairment and may result in a specific allowance amount allocated to an individual loan. There were no modifications qualifying as TDR’s for the three and nine months ended September 30, 2022 and 2021.
Foreclosure
Residential mortgage loans collateralized by real estate that are in the process of foreclosure as of September 30, 2022 and December 31, 2021 totaled $249 thousand and $574 thousand, respectively.
Mortgage Banking
Loans held for sale had at September 30, 2022 and December 31, 2021 had an unpaid principal balance of $987 thousand and $5.4 million, respectively. The interest rate exposure on loans held for sale are mitigated through forward delivery commitments with certain approved secondary market investors. Forward delivery commitments had a notional amount
24
of $200 thousand, and $14.8 million at September 30, 2022 and December 31, 2021, respectively. Refer to Note 8 for further discussion of forward delivery commitments.
For the three months ended September 30, 2022 and 2021, we sold $5.2 million and $28.5 million, respectively, of residential mortgage loans on the secondary market, which resulted in a net loss on sale of loans (net of costs, including direct and indirect origination costs) of $52 thousand and a gain of $682 thousand, respectively. For the nine months ended September 30, 2022 and 2021, we sold $38.2 million and $153.8 million, respectively, of residential mortgage loans on the secondary market, which resulted in a net gain on sale of loans (net of costs, including direct and indirect origination costs) of $281 thousand and $3.6 million, respectively.
We sell residential loans on the secondary market while primarily retaining the servicing of these loans. Servicing sold loans helps to maintain customer relationships and earn fees over the servicing period. Loans serviced for others are not included in the accompanying consolidated balance sheets. The risks inherent in servicing assets relate primarily to level of prepayments that result from shifts in interest rates. We obtain third-party valuations of our servicing assets portfolio quarterly, and the assumptions are reflected in Fair Value disclosures.
25
NOTE 4. BORROWED FUNDS
Borrowed funds at September 30, 2022 and December 31, 2021 are summarized, as follows:
Weighted
(dollars in thousands)
Carrying Value
Average Rate
Short-term borrowings
Advances from the FHLB
167,250
2.95
%
75,000
0.30
Other borrowings
18,916
0.14
19,802
0.17
Total short-term borrowings
186,166
1.27
94,802
0.21
Long-term borrowings
2,591
0.39
23,598
1.08
Subordinated borrowings
5.05
4.34
Total long-term borrowings
62,839
4.86
83,722
3.42
1.74
0.91
Short-term debt includes Federal Home Loan Bank of Boston (“FHLB”) advances with a remaining maturity of less than one year. We also maintain a $1.0 million secured line of credit with the FHLB that bears a daily adjustable rate calculated by the FHLB. There was no outstanding balance on the FHLB line of credit for the periods ended September 30, 2022 and December 31, 2021.
We have the capacity to borrow funds on a secured basis utilizing the Borrower in Custody program and the Discount Window at the Federal Reserve Bank of Boston (the “FRB”). At September 30, 2022, our available secured line of credit at the FRB was $84.1 million. We have pledged certain loans and securities to the FRB to support this arrangement. There were no borrowings with the FRB for the periods ended December 31, 2021.
We maintain, with a correspondent bank, an unused unsecured federal funds line of credit that has an aggregate overnight borrowing capacity of $50.0 million as of September 30, 2022 and December 31, 2021. There was no outstanding balance on the line of credit as of September 30, 2022 and December 31, 2021.
Long-term FHLB advances consist of advances with a remaining maturity of more than one year. The advances outstanding at September 30, 2022 include no callable advances and amortizing advances of $291 thousand. The advances outstanding at December 31, 2021 included $20.0 million of callable advances and $298 thousand of amortizing advances. All FHLB borrowings, including the line of credit, are secured by a blanket security agreement on certain qualified collateral, principally all residential first mortgage loans and certain securities.
A summary of maturities of FHLB advances as of September 30, 2022 is, as follows:
Weighted Average
(in thousands, except rates)
Amount
Rate
166,250
2.97
2023
1,000
2024
2,300
2025
2026
2027 and thereafter
291
3.45
Total FHLB advances
169,841
2.92
On November 26, 2019, we entered into Subordinated Note Purchase Agreements with certain qualified institutional buyers and accredited investors pursuant to which we sold and issued $40.0 million in aggregate principal amount of subordinated notes due 2029 (the “Notes”). The Notes have a maturity date of December 1, 2029 and bear a fixed interest rate of 4.63% through December 1, 2024 payable semi-annually in arrears. From December 1, 2024 and thereafter the interest rate shall be reset quarterly to an interest rate per annum equal to the then current three-month Secured Overnight
Financing Rate (SOFR) plus 3.27%. We have the option beginning with the interest payment date of December 1, 2024, and on any scheduled payment date thereafter, to redeem the Notes, in whole or in part upon prior approval of the Federal Reserve. The transaction included debt issuance costs of $372 thousand as of September 30, 2022 and $496 thousand net of amortization as of December 31, 2021, that are netted against the subordinated debt.
We also have $20.6 million in floating Junior Subordinated Deferrable Interest Debentures (“Debentures”) issued by NHTB Capital Trust II (“Trust II”) and NHTB Capital Trust III (“Trust III”), which are both Connecticut statutory trusts. The Debentures were issued on March 30, 2004, carry a variable interest rate of three-month LIBOR plus 2.79%, and mature in 2034. The debt is callable by us at the time when any interest payment is made. Trust II and Trust III are considered variable interest entities for which we are not the primary beneficiary. Accordingly, Trust II and Trust III are not consolidated into our financial statements.
Repurchase Agreements
We can raise additional liquidity by entering into repurchase agreements at our discretion. In a security repurchase agreement transaction, we will generally sell a security, agreeing to repurchase either the same or substantially identical security on a specified later date, at a greater price than the original sales price. The difference between the sale price and purchase price is the cost of the proceeds, which is recorded as interest expense on the consolidated statements of income. The securities underlying the agreements are delivered to counterparties as security for the repurchase obligations. Since the securities are treated as collateral and the agreement does not qualify for a full transfer of effective control, the transactions do not meet the criteria to be classified as sales, and are therefore considered secured borrowing transactions for accounting purposes. Payments on such borrowings are interest only until the scheduled repurchase date. In a repurchase agreement, we are subject to the risk that the purchaser may default at maturity and not return the securities underlying the agreements. In order to minimize this potential risk, we either deal with established firms when entering into these transactions or with customers whose agreements stipulate that the securities underlying the agreement are not delivered to the customer and instead are held in segregated safekeeping accounts by our safekeeping agents.
Customer Repurchase Agreements
27
NOTE 5. DEPOSITS
A summary of time deposits is, as follows:
Time less than $100,000
167,056
181,586
Time $100,000 through $250,000
113,168
169,645
Time $250,000 or more
54,024
74,301
At September 30, 2022 and December 31, 2021, the scheduled maturities by year for time deposits are, as follows:
262,787
318,692
Over 1 year to 2 years
46,867
71,247
Over 2 years to 3 years
12,626
18,201
Over 3 years to 4 years
5,971
8,498
Over 4 years to 5 years
5,302
6,751
Over 5 years
695
2,143
Included in time deposits are brokered deposits of $15.1 million and $16.1 million at September 30, 2022 and December 31, 2021, respectively. Also included in time deposits are reciprocal deposits of $12.7 million and $17.3 million at September 30, 2022 and December 31, 2021, respectively.
NOTE 6. CAPITAL RATIOS AND SHAREHOLDERS’ EQUITY
The actual and required capital ratios are, as follows:
Minimum Regulatory
Actual
Capital Requirements
(in thousands, except ratios)
Ratio
Company (consolidated)
Total capital to risk-weighted assets
404,804
13.42
241,314
8.00
Common equity tier 1 capital to risk-weighted assets
317,043
10.51
135,740
4.50
Tier 1 capital to risk-weighted assets
337,663
11.19
180,986
6.00
Tier 1 capital to average assets (leverage ratio)
9.13
147,908
4.00
Bank
398,292
13.22
241,079
371,151
12.32
135,606
180,808
10.05
147,791
380,690
14.31
212,798
295,635
11.11
119,699
316,255
11.89
159,598
8.66
146,029
375,435
14.13
220,425
351,000
13.21
123,812
165,082
9.62
151,082
In order to be classified as “well-capitalized” under the relevant regulatory framework, the Company must, on a consolidated basis, maintain a total risk-based capital ratio of 10.00% or greater and a Tier 1 risk-based capital ratio of 6.00% or greater; and the Bank must maintain a total risk-based capital ratio of 10.00% or greater, a Tier 1 risk-based capital ratio of 8.00% or greater, a common equity Tier 1 capital ratio of 6.50% or greater, and a leverage ratio of 5.00% or greater. At each date shown in the tables above, the Company and the Bank met the conditions to be classified as “well-capitalized” under the relevant regulatory framework.
Components of accumulated other comprehensive income is, as follows:
Accumulated other comprehensive income, before tax:
Net unrealized (loss) gain on AFS securities
(76,606)
2,580
Net unrealized (loss) gain on hedging derivatives
(4,316)
1,130
Net unrealized loss on post-retirement plans
(718)
Income taxes related to items of accumulated other comprehensive income:
Net unrealized loss (gain) on AFS securities
17,891
(595)
Net unrealized loss (gain) on hedging derivatives
994
(260)
166
The following table presents the components of other comprehensive income (loss) for the three and nine months ended September 30, 2022 and 2021:
Before Tax
Tax Effect
Net of Tax
Net unrealized loss on AFS securities:
Net unrealized loss arising during the period
(26,889)
6,512
(20,377)
Less: reclassification adjustment for gains (losses) realized in net income
Net unrealized loss on AFS securities
(20,411)
Net unrealized loss on hedging derivatives:
(1,207)
Net unrealized loss on cash flow hedging derivatives
Net unrealized loss on post-retirement plans:
(28,501)
6,883
Net unrealized gain on AFS securities:
Net unrealized gain arising during the period
(1,770)
403
(1,367)
(458)
1,472
Net unrealized gain on AFS securities
(2,839)
Net unrealized gain on derivative hedgess:
(155)
Net unrealized gain on cash flow derivative hedges
Other comprehensive (loss) income
(3,903)
909
(79,133)
18,474
(60,659)
(12)
(60,700)
(4,192)
Net unrealized gain on hedging derivatives
(84,632)
19,740
(5,348)
1,234
(4,114)
Less: reclassification adjustment for gains realized in net income
(469)
1,511
(5,625)
Net unrealized gain on hedging derivatives:
1,773
Net unrealized gain on cash flow hedging derivatives
(5,017)
1,165
The following table presents the changes in each component of accumulated other comprehensive income (loss), net of tax impacts, for the three and nine months ended September 30, 2022 and 2021:
Net unrealized
Net gain (loss) on
gain (loss)
effective cash
loss
on AFS
flow hedging
on pension
Securities
derivatives
plans
Balance at beginning of period
(38,304)
(2,115)
(552)
Other comprehensive loss before reclassifications
(21,584)
Less: amounts reclassified from accumulated other comprehensive income
Total other comprehensive income
Balance at end of period
(58,715)
(3,322)
7,237
(1,418)
Other comprehensive gain before reclassifications
(1,522)
4,398
(92)
1,985
870
(64,851)
10,023
(1,865)
Other comprehensive (loss) gain before reclassifications
(2,341)
Total other comprehensive (loss) gain
32
The following tables presents the amounts reclassified out of each component of accumulated other comprehensive income for three and nine months ended September 30, 2022 and 2021:
Three Months Ended September 30,
Affected Line Item where
Net Income is Presented
Net realized gains on AFS securities:
Before tax (1)
Tax effect
Tax expense
Total reclassifications for the period
33
NOTE 7. EARNINGS PER SHARE
The following table presents the calculation of earnings per share:
(in thousands, except per share and share data)
Average number of basic common shares outstanding
15,057,598
14,982,766
15,028,963
14,960,753
Plus: dilutive effect of stock options and awards outstanding
55,757
67,990
71,317
73,829
Average number of diluted common shares outstanding(1)
15,113,355
15,050,756
15,100,280
15,034,582
NOTE 8. DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
We use derivative instruments to minimize fluctuations in earnings and cash flows caused by interest rate volatility. Our interest rate risk management strategy involves modifying the re-pricing characteristics of certain assets or liabilities so the changes in interest rates do not have a significant effect on net interest income. Thus, all of our derivative contracts are considered to be interest rate contracts.
We recognize our derivative instruments on the consolidated balance sheet at fair value. On the date the derivative instrument is entered into, we designate whether the derivative is part of a hedging relationship (i.e., cash flow or fair value hedge). We formally document relationships between hedging instruments and hedged items, as well as our risk management objective and strategy for undertaking hedge transactions. We also assess, both at the hedge’s inception and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting the changes in cash flows or fair values of hedged items. Changes in fair value of derivative instruments that are highly effective and qualify as cash flow hedges are recorded in other comprehensive income or loss.
We offer derivative products in the form of interest rate swaps, to commercial loan customers to facilitate their risk management strategies. These instruments are executed through Master Netting Arrangements (“MNA”) with financial institution counterparties or Risk Participation Agreements (“RPA”) with commercial bank counterparties, for which we assumes a pro rata share of the credit exposure associated with a borrower's performance related to the derivative contract with the counterparty.
The following tables present information about derivative assets and liabilities at September 30, 2022 and December 31, 2021:
Notional
Average
Location Fair
Maturity
Asset (Liability)
Value Asset
(in years)
(Liability)
Cash flow hedges:
Interest rate swap on wholesale fundings
2.3
5,153
Interest rate swap on variable rate loans
50,000
3.5
(5,289)
Total cash flow hedges
125,000
(136)
Fair value hedges:
Interest rate swap on securities
37,190
6.8
5,017
Total fair value hedges
Economic hedges:
Forward sale commitments
Customer Loan Swaps-MNA Counterparty
193,743
6.0
(21,795)
Customer Loan Swaps-RPA Counterparty
110,317
6.3
Customer Loan Swaps-Customer
304,060
6.1
21,795
Total economic hedges
608,320
Non-hedging derivatives:
Interest rate lock commitments
Total non-hedging derivatives
770,510
4,889
3.0
(121)
4.2
(756)
(877)
7.6
16,600
0.1
260,102
6.2
(9,429)
115,285
6.7
(4,421)
375,387
6.4
13,850
767,374
14,059
283
943,623
(1,109)
As of September 30, 2022 and December 31, 2021, the following amounts were recorded on the balance sheet related to cumulative basis adjustments for fair value hedges:
Cumulative Amount of Fair
Location of Hedged Item on
Carrying Amount of Hedged
Value Hedging Adjustment in
Balance Sheet
Carrying Amount
27,993
(9,197)
39,726
2,536
36
Information about derivative assets and liabilities for the three and nine months eneded September 30, 2022 and 2021, follows:
Amount of
Gain (Loss)
Recognized in
Reclassified
Location of
Location of Gain (Loss)
from Other
Comprehensive
Reclassified from Other
Recognized
Income
Comprehensive Income
in Income
Interest rate swap on wholesale funding
1,262
140
(1,181)
Interest income
(238)
81
(1,287)
Forward commitments
Other expense
(1,206)
37
4,058
(1)
(3,489)
(239)
569
(240)
(4,761)
(48)
(7)
(283)
(578)
38
(205)
(101)
66
(113)
(221)
(144)
(96)
(331)
39
Income(1)
1,148
(589)
(93)
189
1,055
(400)
720
(421)
(45)
1,775
(840)
The effect of cash flow hedging and fair value accounting on the consolidated statements of income for the three and nine months ended September 30, 2022 and 2021:
Interest and Dividend Income
Interest Expense
Non-interest Income
Income and expense line items presented in the consolidated statements of income
The effects of cash flow and fair value hedging:
Gain (loss) on cash flow hedges:
Gain (loss) on fair value hedges:
42
Cash flow hedges
Interest rate swaps on wholesale funding
As of September 30, 2022, we have two interest rate swaps on wholesale borrowings to limit our exposure to rising interest rates over a five-year term on 3-month FHLB borrowings or brokered certificates, or a combination thereof at each maturity date. The first of the two agreements was entered into in November 2019 with a $50.0 million notional amount and pays a fixed interest rate of 1.53%. A second agreement was entered into in April 2020 with a $25.0 million notional amount and pays a fixed rate of 0.59%. The financial institution counterparty pays us interest on the three-month LIBOR rate. We designated the swaps as cash flow hedges.
We have an interest rate swap that effectively fixes our interest rate on $50 million of 1 month USD-LIBOR-BBA (or LIBOR less two days) based loan assets at 0.806% plus the credit spread on the loans that reprices on weighted average basis. The instrument is specifically designed to hedge the risk of changes in its cash flows from interest receipts attributable to changes in a contractually specified interest rate, on an amount of our variable rate loan assets equal to $50 million. We designated the swap as a cash flow hedge.
Fair value hedges
For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative instrument as well as the offsetting loss or gain on the hedged asset or liability attributable to the hedged risk are recognized in current earnings. We utilize interest rate swaps designated as fair value hedges to mitigate the effect of changing interest rates on the fair values of fixed rate callable securities available-for-sale. The hedging strategy on securities converts the fixed interest rates to LIBOR-based variable interest rates. These derivatives are designated as partial term hedges of selected cash flows covering specified periods of time prior to the call dates of the hedged securities. During 2019, we entered into eight swap transactions with a notional amount of $37.2 million designated as fair value hedges. These derivatives are intended to protect against the effects of changing interest rates on the fair values of fixed rate securities. The fixed rates on the transactions have a weighted average of 1.696%.
Economic hedges
We utilize forward sale commitments on residential mortgage loans to hedge interest rate risk and the associated effects on the fair value of interest rate lock commitments and loans originated for sale. The forward sale commitments are accounted for as derivatives. We typically use a combination of best efforts and mandatory delivery contracts. The contracts are loan sale agreements where we commit to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified date. Generally, we enter into contracts just prior to the loan closing with a customer.
Customer loan derivatives
We enter into customer loan derivatives to facilitate the risk management strategies for commercial banking customers. We mitigate this risk by entering into equal and offsetting loan swap agreements with highly rated third-party financial institutions. The loan swap agreements are free standing derivatives and are recorded at fair value in our consolidated balance sheet. We are party to master netting arrangements with our financial institutional counterparties; however, we do not offset assets and liabilities under these arrangements for financial statement presentation purposes.
43
The master netting arrangements provide for a single net settlement of all loan swap agreements, as well as collateral or cash funds, in the event of default on, or termination of, any one contract. Collateral is provided by cash or securities received or posted by the counterparty with net liability positions, respectively, in accordance with contract thresholds.
Gross Amounts Offset in the Consolidated Balance Sheet
Derivative
Cash Collateral
Derivative Assets
Pledged
Net Amount
As of September 30, 2022
Customer Loan Derivatives:
MNA counterparty
RPA counterparty
As of December 31, 2021
9,429
12,000
4,421
(13,850)
Non-hedging derivatives
We enter into interest rate lock commitments (“IRLCs”) for residential mortgage loans, which commit us to lend funds to a potential borrower at a specific interest rate and within a specified period of time. IRLCs relate to the origination of residential mortgage loans that are held for sale and are considered derivative financial instruments under applicable accounting guidance. Outstanding IRLCs expose us to the risk that the price of the mortgage loans underlying the commitments may decline due to increases in mortgage interest rates from inception of the rate lock to the funding of the loan. The IRLCs are free standing derivatives, which are carried at fair value with changes recorded in non-interest income in our Consolidated Statements of Income. Changes in the fair value of IRLCs subsequent to inception are based on (i) changes in the fair value of the underlying loan resulting from the fulfillment of the commitment and (ii) changes in the probability when the loan will fund within the terms of the commitment, which is affected primarily by changes in interest rates and the passage of time.
NOTE 9. FAIR VALUE MEASUREMENTS
Recurring Fair Value Measurements
The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of September 30, 2022 and December 31, 2021, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
Level 1
Level 2
Level 3
Inputs
Available for sale securities:
Derivative assets
31,964
31,972
Derivative liabilities
(27,084)
14,148
(15,257)
Securities Available for Sale: All securities and major categories of securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, we obtain fair value measurements from independent pricing providers. The fair value measurements used by the pricing providers consider observable data that may include dealer quotes, market maker quotes and live trading systems. If quoted prices are not readily available, fair values are determined using matrix pricing models, or other model-based valuation techniques requiring observable inputs other than quoted prices such as market pricing spreads, credit information, callable features, cash flows, the US Treasury yield curve, trade execution data, market consensus prepayment speeds, default rates, and the securities’ terms and conditions, among other things.
Loans Held for Sale: The valuation of the Company’s loans held for sale are determined on an individual basis using quoted secondary market prices and are classified as Level 2 measurements.
Derivative Assets and Liabilities
Cash Flow Hedges. The valuation of our cash flow hedges are obtained from a third party. The pricing analysis is based on observable inputs for the contractual terms of the derivatives, including the period to maturity and interest rate curves. The inputs used to value the cash flow hedges are all classified as Level 2 measurements.
Interest Rate Lock Commitments. We enter into IRLCs for residential mortgage loans, which commit us to lend funds to potential borrowers at a specific interest rate and within a specified period of time. The estimated fair value of commitments to originate residential mortgage loans for sale is based on quoted prices for similar loans in active markets. However, this value is adjusted by a factor which considers the likelihood of a loan in a lock position will ultimately close. The closing ratio is derived from internal data and is adjusted using significant management judgment. As such, IRLCs are classified as Level 3 measurements.
Forward Sale Commitments. We utilize forward sale commitments as economic hedges against potential changes in the values of the IRLCs and loans originated for sale. The fair values of mandatory delivery loan sale commitments are determined similarly to the IRLCs using quoted prices in the market place that are observable. However, closing ratios included in the calculation are internally generated and are based on management’s judgment and prior experience, which are not considered observable factors. As such, mandatory delivery forward commitments are classified as Level 3 measurements.
Customer Loan Derivatives. The valuation of our customer loan derivatives is obtained from a third-party pricing service and is determined using a discounted cash flow analysis on the expected cash flows of each derivative. The pricing analysis is based on observable inputs for the contractual terms of the derivatives, including the period to maturity and interest rate curves. We incorporate credit valuation adjustments to appropriately reflect our nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of the derivative contracts for the effect of nonperformance risk, we have considered the impact of master netting arrangements and any applicable credit enhancements, such as collateral postings.
Although we have determined that the majority of the inputs used to value customer loan derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and counterparties. However, as of September 30, 2022, we assessed the significance of the impact of the credit valuation adjustments on the overall valuation of our derivative positions and determined that the credit valuation adjustments are not significant to the overall valuation of our derivatives. As a result, we determined that the derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
46
The table below presents the changes in Level 3 assets and liabilities that were measured at fair value on a recurring basis for the three and nine months ended September 30, 2022 and 2021:
Assets (Liabilities)
Interest Rate Lock
Forward
Commitments
Realized gain (loss) recognized in non-interest income
Realized (loss) gain recognized in non-interest income
(95)
47
(140)
Realized loss recognized in non-interest income
Realized gain recognized in non-interest income
Quantitative information about the significant unobservable inputs within Level 3 recurring assets and liabilities is, as follows:
Significant
Valuation
Unobservable
Techniques
Input Value
Interest Rate Lock Commitment
Pull-through Rate Analysis
Closing Ratio
Pricing Model
Origination Costs, per loan
Discount Cash Flows
Mortgage Servicing Asset
Forward Commitments
Quoted prices for similar loans in active markets
Freddie Mac pricing system
$97.2 to $101.4
1.7
1.0
$99.8 to $103.2
Non-Recurring Fair Value Measurements
We are required, on a non-recurring basis, to adjust the carrying value or provide valuation allowances for certain assets using fair value measurements in accordance with GAAP. The following is a summary of applicable non-recurring fair value measurements:
Fair Value Measurement Date as of September 30, 2022
Gains (Losses)
Individually evaluated loans
15,388
17,932
(2,544)
September 2022
Capitalized servicing rights
7,127
5,263
1,864
Premises held for sale
327
February 2022
22,842
23,421
1,862
(579)
There are no liabilities measured at fair value on a non-recurring basis in 2022 and 2021.
Quantitative information about the significant unobservable inputs within Level 3 non-recurring assets is, as follows:
Fair Value September 30, 2022
Valuation Techniques
Unobservable Inputs
Range (Weighted Average)(a)
10,903
Fair value of collateral-appraised value
Loss severity
10% to 70%
Appraised value
$80 to $1,175
4,485
Discount cash flow
Discount rate
2.88% to 6.45%
Cash flows
$4 to $925
Discounted cash flow
Constant prepayment rate (CPR)
7.10%
9.54%
Fair value of asset less selling costs
$347
Selling Costs
6%
Fair Value December 31, 2021
12,127
$71 to $1,792
5,805
2.88% to 9.50%
$6 to $931
12.47%
9.53%
$240
There were no Level 1 or Level 2 non-recurring fair value measurements for the periods ended September 30, 2022 and December 31, 2021.
49
Individually evaluated loans. Loans are generally not recorded at fair value on a recurring basis. Periodically, we record non-recurring adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of those loans. Non-recurring adjustments can also include certain impairment amounts for collateral-dependent loans calculated when establishing the allowance for credit losses. Such amounts are generally based on the fair value of the underlying collateral supporting the loan and, as a result, the carrying value of the loan less the calculated valuation amount does not necessarily represent the fair value of the loan. Real estate collateral is typically valued using appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally observable in the marketplace. However, the choice of observable data is subject to significant judgment, and there are often adjustments based on judgment in order to make observable data comparable and to consider the impact of time, the condition of properties, interest rates, and other market factors on current values. Additionally, commercial real estate appraisals frequently involve discounting of projected cash flows, which relies inherently on unobservable data. Therefore, non-recurring fair value measurement adjustments relating to real estate collateral have generally been classified as Level 3. Estimates of fair value for other collateral supporting commercial loans are generally based on assumptions not observable in the marketplace and therefore such valuations have been classified as Level 3.
Capitalized loan servicing rights. A loan servicing right asset represents the amount by which the present value of the estimated future net cash flows to be received from servicing loans exceed adequate compensation for performing the servicing. The fair value of loan servicing rights is estimated using a present value cash flow model. The most important assumptions used in the valuation model are the anticipated rate of the loan prepayments and discount rates. Adjustments are only recorded when the discounted cash flows derived from the valuation model are less than the carrying value of the asset. Although some assumptions in determining fair value are based on standards used by market participants, some are based on unobservable inputs and therefore are classified in Level 3 of the valuation hierarchy.
Other real estate owned or OREO. OREO results from the foreclosure process on residential or commercial loans issued by the Company. Upon assuming the real estate, we record the property at the fair value of the asset less the estimated sales costs. Thereafter, OREO properties are recorded at the lower of cost or fair value less the estimated sales costs. OREO fair values are primarily determined based on Level 3 data including sales comparables and appraisals.
Premises held for sale. Assets held for sale, identified as part of our strategic review and branch optimization exercise, were transferred from premises and equipment at the lower of amortized cost or fair value less the estimated sales costs. Assets held for sale fair values are primarily determined based on Level 3 data including sales comparables and appraisals.
Summary of Estimated Fair Values of Financial Instruments
The estimated fair values, and related carrying amounts, of our financial instruments are included in the table below. Certain financial instruments and all non-financial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented herein may not necessarily represent the underlying fair value of the Company.
Carrying
Financial Assets
Cash and cash equivalents
FHLB stock
987
2,783,612
Accrued interest receivable
4,053
Cash surrender value of bank-owned life insurance policies
31,973
Financial Liabilities
Non-maturity deposits
2,801,432
2,616,000
Time deposits
330,059
Securities sold under agreements to repurchase
FHLB advances
169,459
57,744
27,084
2,442,741
2,712
2,623,012
2,853,000
424,000
98,598
98,439
61,884
15,257
51
NOTE 10. REVENUE FROM CONTRACTS WITH CUSTOMERS
We account for our various non-interest revenue streams and related contracts under ASC 606. Revenue from contracts with customers is based on the consideration specified in the contract with a customer and excludes amounts collected on behalf of third parties. Revenue is recognized when we satisfy our performance obligation, which is generally when services are rendered and can be either satisfied at a point in time or over time. We recognize revenue at a point in time that is transactional in nature. We recognize revenue over time that is earned as services are performed and performance obligations are satisfied over time.
A substantial portion of our revenue is specifically excluded from the scope of ASC 606. This exclusion is associated with financial instruments, including interst income on loans and investment securities, in addition to loan derivative income and gains on loan and investment sales.
Disaggregation of Revenue
The following tables present disaggregation of our non-interest revenue by major business line and timing of revenue recognition for the transfer of products or services:
Major Products/Service Lines
Trust management fees
3,077
3,403
9,941
10,052
Financial services fees
465
1,283
Interchange fees
1,953
5,849
5,509
Customer deposit fees
1,578
1,363
4,418
3,542
Other customer service fees
270
841
691
7,383
22,239
21,077
Timing of Revenue Recognition
Products and services transferred at a point in time
4,020
3,737
11,755
10,593
Products and services transferred over time
3,364
3,646
10,484
Trust Management Fees
The trust management business generates revenue through a range of fiduciary services including trust and estate administration, financial advice, and investment management to individuals, businesses, not-for-profit organizations, and municipalities. These fees are primarily earned over time as we charge our customers on a monthly or quarterly basis in accordance with investment advisory agreements. Fees are generally assessed based on a tiered scale of the market value of assets under management at month end. Certain fees, such as bill paying fees, distribution fees, real estate sale fees, and supplemental tax service fees, are recorded as revenue at a point in time upon the completion of the service.
Financial Services Fees
Bar Harbor Financial Services is a branch office of Infinex, an independent registered broker dealer offering securities and insurance products not affiliated with the Company or its subsidiaries. We have a revenue sharing agreement with Infinex for any financial service fee income generated. Financial services fees are recognized at a point in time upon the completion of service requirements.
Interchange Fees
We earn interchange fees from transaction fees that merchants pay whenever a customer uses a debit card to make a purchase from their store. The fees are paid to the card-issuing bank to cover handling costs, fraud, bad debt costs and the risk involved in approving the payment. Interchange fees are generally recognized as revenue at a point in time upon the completion of a debit card transaction.
Customer Deposit Fees
The Customer Deposit business offers a variety of deposit accounts with a range of interest rates, fee schedules and other terms, which are designed to meet the customer's financial needs. Additional depositor-related services provided to customers include ATM, bank-by-phone, internet banking, internet bill pay, mobile banking, and other cash management services which include remote deposit capture, ACH origination, and wire transfers. These customer deposit fees are generally recognized at a point in time upon the completion of the service.
Other Customer Service Fees
We have certain incentive and referral fee arrangements with independent third parties in which fees are earned for new account activity, product sales, or transaction volume generated for the respective third parties. We also earn a percentage of the fees generated from third-party credit card plans promoted through the Bank. Revenue from these incentive and referral fee arrangements are recognized over time using the right to invoice measure of progress.
Contract Balances from Contracts with Customers
The following table provides information about contract assets or receivables and contract liabilities or deferred revenues from contracts with customers:
Balances from contracts with customers only:
Other Assets
1,325
1,184
Other Liabilities
2,535
2,324
The timing of revenue recognition, billings and cash collections results in contract assets or receivables and contract liabilities or deferred revenue on the consolidated balance sheets. For most customer contracts, fees are deducted directly from customer accounts and, therefore, there is no associated impact on the accounts receivable balance. For certain types of service contracts, we have an unconditional right to consideration under the service contract and an accounts receivable balance is recorded for services completed. When consideration is received, or such consideration is unconditionally due, from a customer prior to transferring goods or services to the customer under the terms of a contract, a contract liability is recorded. Contract liabilities are recognized as revenue after control of the products or services is transferred to the customer and all revenue recognition criteria have been met.
Costs to Obtain and Fulfill a Contract
We currently expense contract costs for processing and administrative fees for debit card transactions. We also expense custody fees and transactional costs associated with securities transactions as well as third party tax preparation fees. We have elected the practical expedient in ASC 340-40-25-4, whereby we recognize the incremental costs of obtaining contracts as an expense when incurred if the amortization period of the assets we otherwise would have recognized is one year or less.
NOTE 11. LEASES
A lease is defined as a contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration. Most of our leases are for branches, ATM locations, and office space and have terms extending through 2040. All leases are classified as operating leases, and are recognized on the consolidated balance sheets as a right- of-use (“ROU”) asset with a corresponding lease liability.
The following table presents the consolidated statements of condition classification of the ROU assets and lease liabilities:
Classification
Lease Right-of-Use Assets
Operating lease right-of-use assets
8,381
9,274
Lease Liabilities
Operating lease liabilities
8,791
9,643
The calculated amount of the ROU assets and lease liabilities in the table above are impacted by the length of the lease term and the discount rate used for the present value of the minimum lease payments. The lease agreements often include one or more options to renew at our discretion. If at lease inception, we consider the exercising of a renewal option to be reasonably certain, we will include the extended term in the calculation of the ROU asset and lease liability.
The following table presents the weighted average lease term and discount rate of the leases:
Weighted-average remaining lease term (in years)
Operating leases
7.42
8.03
Weighted-average discount rate
3.09
3.07
The following table represents lease costs and other lease information. As we have elected, for all classes of underlying assets, not to separate lease and non-lease components and instead to account for them as a single lease component, the variable lease cost primarily represents variable payments such as real estate taxes, common area maintenance and utilities.
September 30, 2021
Lease Costs
Operating lease cost
338
324
966
Variable lease cost
71
179
Total lease cost
409
1,339
Future minimum payments for operating leases with initial or remaining terms of one year or more as of September 30, 2022 are, as follows:
Payments
Twelve Months Ended:
September 30, 2023
1,343
September 30, 2024
1,344
September 30, 2025
1,129
September 30, 2026
1,032
September 30, 2027
889
Thereafter
3,411
Total future minimum lease payments
9,148
Amounts representing interest
(357)
Present value of net future minimum lease payments
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The following is management’s discussion and analysis of the major factors that influenced our results of operations and financial condition as of and for the three and nine months ended September 30, 2022 and should be read in conjunction with our unaudited consolidated financial statements and condensed notes thereto included elsewhere in this Form 10-Q as well as our audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021. The following discussion contains "forward-looking statements" that reflect our future plans, estimates, beliefs and expected performance. We caution that assumptions, expectations, projections, intentions or beliefs about future events may, and often do, vary from actual results and the differences can be material. Please see "Cautionary Statement Regarding Forward-Looking Statements" and "Part II, Item 1A. Risk Factors." All amounts, dollars and percentages presented in this Form 10-Q are rounded and therefore approximate.
Bar Harbor Bankshares (the “Company,” “we,” “our” or “us” or similar terms) is the parent company of Bar Harbor Bank & Trust (the "Bank”), which is the only community bank headquartered in Northern New England with branches in Maine, New Hampshire and Vermont. The Bank is a regional community bank that thinks differently about banking. The Bank provides the technology offerings and capabilities of larger banks, accompanied by access to local decision makers who are acutely focused on their local markets. Having recently celebrated the 135th anniversary of the Bank’s founding, we remain focused on helping our customers achieve their goals as the key to the Bank’s success. With over 500 dedicated professionals and more than 50 locations, we are committed to servicing and building enduring relationships by providing a higher standard of banking. We offer a variety of financial products and services designed around our customers in order to serve their banking and financial needs. Through these efforts, we continue to be a relationship-focused community bank, maintaining our credit quality and serving businesses, entrepreneurs and individuals within our footprint. Our corporate goal is to be one of the top performing banks in New England, and our business model is centered on the following:
Shown below is our profile as of September 30, 2022:
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SELECTED FINANCIAL DATA
The following summary data is based in part on the unaudited consolidated financial statements and accompanying notes and other information appearing elsewhere in this or prior Form 10-Q filings.
PER SHARE DATA
Net earnings, diluted
Adjusted earnings, diluted(1)
2.04
Total book value
25.22
27.92
Tangible book value per share(1)
16.89
19.48
Market price at period end
26.52
28.05
Dividends
0.26
0.24
0.70
PERFORMANCE RATIOS(2)
Return on assets
1.20
1.16
1.11
1.05
Adjusted return on assets(1)
1.12
1.09
Pre-tax, pre-provision return on assets
1.65
1.43
1.48
1.26
Adjusted pre-tax, pre-provision return on assets (1)
1.49
1.31
Return on equity
11.55
10.38
10.32
9.54
Adjusted return on equity(1)
11.54
10.39
9.98
Return on tangible equity
17.25
15.08
15.28
14.01
Adjusted return on tangible equity(1)
17.24
15.09
15.37
14.50
Net interest margin, fully taxable equivalent (FTE)(1) (3)
3.47
3.02
3.21
2.88
Adjusted net interest margin(1)
2.75
2.73
Efficiency ratio(1)
57.67
59.18
59.66
61.48
FINANCIAL DATA (In millions)
3,840
3,738
Total earning assets(4)
3,525
3,394
Total investments
566
556
2,850
2,534
Total goodwill and intangible assets
126
3,136
3,007
Total shareholders' equity
380
418
Adjusted income(1)
ASSET QUALITY AND CONDITION RATIOS
Net charge-offs (recoveries) (annualized)/average loans
0.01
0.03
(0.02)
Allowance for credit losses/total loans
0.88
0.89
Loans/deposits
Shareholders' equity to total assets
9.89
Tangible shareholders' equity to total tangible assets(1)
6.85
8.08
CONSOLIDATED LOAN AND DEPOSIT ANALYSIS
The following tables present the quarterly trend in loan and deposit data and accompanying growth rates as of September 30, 2022 on an annualized basis:
LOAN ANALYSIS
Annualized
Growth %
Quarter
Year
Sep 30, 2022
Jun 30, 2022
Mar 31, 2022
Dec 31, 2021
Sep 30, 2021
to Date
Commercial real estate
1,421,962
1,331,860
1,289,968
1,210,580
1,170,372
376,624
360,304
346,394
340,129
331,091
Paycheck Protection Program (PPP)
170
1,126
6,669
24,227
*
Total commercial loans
1,798,586
1,692,334
1,637,488
1,557,378
1,525,690
Total commercial loans, excluding PPP
1,692,164
1,636,362
1,550,709
1,501,463
896,618
876,644
868,382
821,004
849,692
Consumer
100,822
100,816
96,876
98,949
100,933
Tax exempt and other
54,338
57,480
51,816
54,579
57,839
2,727,274
2,654,562
2,534,154
*Indicates ratios of 100% or greater.
DEPOSIT ANALYSIS
670,268
653,471
664,395
883,239
918,768
888,021
(3)
663,676
658,834
605,977
499,456
424,750
379,651
Total non-maturity deposits
2,716,639
2,655,823
2,538,044
Total time deposits
361,906
391,940
469,221
(31)
(29)
3,078,545
3,047,763
3,007,265
AVERAGE BALANCES AND AVERAGE YIELDS/RATES
The following tables present average balances and average yields and rates on an annualized fully taxable equivalent basis for the periods included:
Balance
Interest(3)
Yield/Rate(3)
59,556
320
2.13
284,429
110
0.15
Securities available for sale and FHLB stock(2)(3)
642,475
5,058
3.12
610,381
3,986
2.59
Loans:
1,351,599
14,510
4.26
1,153,813
10,269
3.53
421,963
4,739
4.46
391,191
3,739
3.79
Paycheck protection program
45,835
2,690
23.28
Residential
882,158
7,676
824,686
7,574
3.64
101,175
1,161
4.55
101,545
3.78
Total loans (1)
2,756,989
28,086
4.04
2,517,070
3.98
Total earning assets
3,459,020
33,464
3.84
3,411,880
29,336
3.41
313,289
352,208
3,772,309
3,764,088
905,668
366
0.16
860,206
272
0.13
668,255
143
0.08
591,440
124
491,683
808
0.65
381,755
115
0.12
349,787
485
0.55
471,934
Total interest bearing deposits
2,415,393
1,802
2,305,335
0.27
202,296
2.69
334,097
2.11
Total interest bearing liabilities
2,617,689
3,176
0.48
2,639,432
0.50
Non-interest bearing demand deposits
690,134
641,769
71,934
61,436
3,379,757
3,342,637
392,552
421,451
Total liabilities and shareholders' equity
Net interest spread
3.36
2.91
Net interest margin
Adjusted net interest margin(4)
Interest
Yield/
(in millions, except ratios)
(3)
Rate(3)
86,390
503
0.78
229,235
203
630,679
13,297
2.82
617,373
12,424
1,306,664
37,765
3.86
1,128,134
30,177
3.58
Commercial and industrial(3)
408,620
11,871
3.88
381,753
10,727
3.76
4,676
223
6.39
62,562
10.81
865,259
22,801
3.52
861,629
24,145
3.75
99,673
2,943
3.95
105,371
2,833
3.59
2,684,892
75,603
2,539,449
72,940
3,401,961
89,403
3.51
3,386,057
85,567
3.38
323,253
357,334
3,725,214
3,743,391
909,793
984
801,292
655,727
0.09
568,726
431
0.10
455,645
1,139
0.33
376,775
354
376,496
1,645
0.58
583,529
5,565
1.28
2,397,661
4,186
0.23
2,330,322
7,110
0.41
187,629
2.46
336,432
2.15
2,585,290
7,644
0.40
2,666,754
12,525
0.63
671,490
598,434
66,298
64,360
3,323,078
3,329,548
402,136
413,843
61
NON-GAAP FINANCIAL MEASURES
This document contains certain non-GAAP financial measures in addition to results presented in accordance with accounting principles generally accepted in the United States of America, or GAAP. These non-GAAP measures are intended to provide the reader with additional supplemental perspectives on operating results, performance trends, and financial condition. Non-GAAP financial measures are not a substitute for GAAP measures; they should be read and used in conjunction with our GAAP financial information. A reconciliation of non-GAAP financial measures to GAAP measures is provided below. In all cases, it should be understood that non-GAAP measures do not depict amounts that accrue directly to the benefit of shareholders. An item that management excludes when computing non-GAAP adjusted earnings can be of substantial importance to our results for any particular quarter or year. Our non-GAAP adjusted earnings information set forth is not necessarily comparable to non-GAAP information that may be presented by other companies. Each non-GAAP measure used by us in this report as supplemental financial data should be considered in conjunction with our GAAP financial information. In addition, our non-GAAP financial measures may not be comparable to similarly titled measures of other companies because such measures may include or exclude other specified items.
We use the non-GAAP measure of adjusted earnings in evaluating operating trends, including components for adjusted revenue and expense. These measures exclude amounts that we view as unrelated to normalized operations, including gains/losses on securities, premises, equipment and other real estate owned, acquisition costs, restructuring costs, legal settlements, and systems conversion costs. Non-GAAP adjustments are presented net of an adjustment for income tax expense.
We also calculate adjusted earnings per share based on our measure of adjusted earnings. We view these amounts as important to understanding operating trends, particularly due to the impact of accounting standards related to acquisition activity. Analysts also rely on these measures in estimating and evaluating our performance. We believe that the computation of non-GAAP adjusted earnings and adjusted earnings per share may facilitate the comparison of us to other companies in the financial services industry. We also adjust certain equity related measures to exclude intangible assets due to the importance of these measures to the investment community.
RECONCILIATION OF NON-GAAP FINANCIAL MEASURES
The following table summarizes the reconciliation of non-GAAP items for the time periods presented:
Calculations
Non-recurring items:
Gain on sale of securities, net
(1,930)
Gain on sale of premises and equipment, net
Gain on other real estate owned
Income tax expense (1)
(2)
(55)
(332)
Total non-recurring items
183
1,067
Total adjusted income(2)
(A)
11,420
11,036
31,228
30,600
(B)
Plus: Non-interest income
Total Revenue
38,733
36,932
107,820
102,861
Total adjusted revenue(2)
(C)
38,689
35,002
107,767
100,881
Non-recurring expenses:
137
(1,768)
(318)
(356)
(1,759)
Total non-recurring expenses
(1,940)
(291)
(3,379)
Adjusted non-interest expense(2)
(D)
23,001
21,432
66,327
64,208
Total revenue
Pre-tax, pre-provision net revenue
15,701
13,560
41,202
35,274
Adjusted revenue(2)
Adjusted pre-tax, pre-provision net revenue(2)
15,688
13,570
41,440
36,673
(in millions)
Average earning assets
(E)
3,459
3,412
3,402
3,386
Average paycheck protection program (PPP) loans
(R)
Average earning assets, excluding PPP loans
(S)
3,366
3,397
3,323
Average assets
(F)
3,772
3,764
3,725
3,743
Average shareholders' equity
(G)
402
414
Average tangible shareholders' equity(2)(3)
(H)
267
295
276
287
Tangible shareholders' equity, period-end(2)(3)
(I)
254
Tangible assets, period-end(2)(3)
(J)
3,715
3,612
Common shares outstanding, period-end
(K)
15,066
14,987
Average diluted shares outstanding
(L)
Adjusted earnings per share, diluted(2)
(A/L)
Tangible book value per share, period-end(2)
(I/K)
Securities adjustment, net of tax(1)(4)
(M)
Tangible book value per share, excluding securities adjustment(2)(4)
(I+M)/K
20.79
19.19
Total tangible shareholders' equity/total tangible assets(2)
(I/J)
Performance ratios(5)
Adjusted return on assets(2)
(A/F)
Adjusted pre-tax, pre-provision return on assets (2)
(U/F)
Adjusted return on equity(2)
(A/G)
Adjusted return on tangible equity(1)(2)
(A+Q)/H
Efficiency ratio(2)(6)
(D-O-Q)/(C+N)
(B+P)/E
Adjusted net interest margin(2)(7)
(B+P-T)/S
Supplementary data (in thousands)
Taxable equivalent adjustment for efficiency ratio
(N)
533
576
1,500
1,757
Franchise taxes included in non-interest expense
(O)
434
396
Tax equivalent adjustment for net interest margin
(P)
379
1,033
1,284
Intangible amortization
(Q)
Interest and fees on PPP loans
(T)
QUARTERLY PERFORMANCE SUMMARY
Earnings (third quarter of 2022 compared to the same quarter of 2021)
Financial Position (As of September 30, 2022, compared to June 30, 2022)
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2022 AND DECEMBER 31, 2021
Total securities decreased to $565.8 million from $625.6 million at year-end 2021. The $59.8 million decrease in total securities included $99.3 million of purchases, $19.5 million in sales, an $11.7 million cost reduction to municipal securities that are hedged, and $50.4 million of maturities, calls and pay-downs and amortization. Fair value adjustments reduced the security portfolio by $76.6 million at the end of the September 30, 2022 quarter, compared to an increase of $2.6 million at year-end 2021. Net unrealized losses in the nine months of 2022 resulted from the Federal Reserve increasing the federal funds target interest rate 300 basis points in that period. All securities remain classified as available for sale to provide flexibility in loan funding and management of our cost of funds. The weighted average yield of our securities portfolio was 3.43% at quarter-end and 2.63% at year-end. Securities held at quarter-end had an average life of 9.5 years and an effective duration of 5.1 years compared to 5.3 years and 4.2 years at year-end 2021, respectively.
Total loans increased by $318.5 million from year-end 2021, or 17% annualized, to $2.9 billion at September 30, 2022. Commercial loans increased by $241.2 million with growth from existing customers and 491 new lending relationships. PPP loan balances were zero at the end of the quarter, compared to $6.7 million at year-end. Total residential loans increased by $75.6 million from 2021, as we placed more originations on the balance sheet instead of selling into the secondary market. Residential loan origination volume in 2022 is significantly down as compared to respective periods 2021 on lower refinancing activity and increasing market rates.
The ACL increased to $25.0 million at quarter-end as compared to $22.7 million at year-end 2021 principally due to loan growth. The ratio of the allowance to loans decreased to 0.88% from 0.90% at year-end reflecting an improvement in economic forecasts used the ACL calculation. Non-accruing loans continue to trend downwards on a quarterly basis to $7.8 million from $10.2 million. The ratio of accruing past due loans to total loans improved to 0.10% of total loans from 0.32%. Total delinquent and non-accruing loans as percentage of total improved to 0.37% from 0.72%. Net recoveries on previously charged-off loans for the first nine months of 2022 totaled $83 thousand compared to net charge-offs of $434 thousand for the same period of 2021.
Other assets were $366.1 million compared to $318.5 million at year-end 2021. The increase includes $18.5 million of deferred tax assets recorded in connection with unrealized losses on securities, $6.5 million of investments made in tax credits and community developments, a $7.9 million increase in the fair value of customer loan swaps, and a $10.2 million increase in the fair value of derivative instruments.
Deposits and Borrowings
Total deposits increased by $87.1 million from year-end 2021 to $3.1 billion. In the first nine months of 2022 over 2,300 net new deposit accounts opened and over 2,900 were opened in the same period of 2021. The loan to deposit ratio increased to 91% from 83% at the end of 2021 due to loan growth offset in part by 4% annualized growth in total deposits. Core deposits grew by $178.4 million, or 9% annualized, while time deposits decreased by $27.7 million, which includes $36.0 million of wholesale deposits that matured. Borrowings increased by $70.5 million from year-end 2021 to supplement excess cash and deposit funding. FHLB borrowings totaled $169.8 million and $98.6 million with weighted average rates of 2.91% and 0.49% at the end of the third quarter of 2022 and year-end 2021, respectively. Wholesale borrowings as a percentage of total debt decreased to 5.8% in the third quarter from 6.0% at year-end 2021.
Other liabilities were $75.6 million compared to $58.0 million at year-end 2021. The $17.6 million increase includes $7.0 million in remaining tax credit investment commitments, a $7.9 million increase related to the fair value of customer loan swaps, and a $4.5 million increase related to the fair value of derivative instruments.
Equity
Total equity at the end of the third quarter of 2022 was $380.0 million compared to $424.1 million at year-end 2021. The $44.1 million decrease in the first nine months of 2022 included net income totaling $31.0 million, $11.4 million of dividends to shareholders and $64.9 million of other comprehensive losses. Other comprehensive losses were primarily due to unrealized losses on securities, net of tax, totaling $60.7 million.
In June 2022, our Board of Directors authorized a stock repurchase plan for up to 5% of outstanding shares of common stock, which represents approximately 751,000 shares. As of September 30, 2022, no repurchases have been made, but we will continue examine buying opportunities considering market conditions, including interest rate volatility and potential loan and risk-weighted asset growth.
COMPARISON OF OPERATING RESULTS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2022 AND 2021
Net Income
Net income in the third quarter of 2022 was $11.4 million, or $0.76 per diluted share, compared to $11.0 million, or $0.73 per diluted share, in the same quarter of 2021.
During the first nine months of 2022, net income was $31.0 million, or $2.06 per diluted share, compared to $29.5 million, or $1.96 per diluted share, in the same period of 2021. Non-recurring items reduced net income by $1.1 million, or $0.07 per diluted share, in 2021.
Net Interest Income
Net interest income was $29.9 million in the third quarter of 2022 compared with $25.6 million in the third quarter of 2021. NIM was 3.47% compared to 3.02% for the same periods, and was 3.50%% and 2.94%, respectively, on a non-GAAP basis when excluding the impact of PPP loan fees and interest-bearing excess cash. The increase in net interest income and net interest margin was due to higher interest on earning assets due to the Federal Reserve increasing their federal funds target rate. The yield on earning assets totaled 3.84% compared to 3.41% in the third quarter of 2021. The yield on loans was 4.04% in the third quarter of 2022, and 3.98% in the third quarter of 2021. The non-GAAP the yield on loans was 4.04% and 3.62% for the same periods when excluding PPP loan fees. Total cost of deposits was 0.30% in the third quarter of 2022 compared to 0.27% in the third quarter of 2021 reflecting a lower correlation to federal fund rate movements. Borrowing costs were 2.69% compared to 2.11% for the same periods due to the repricing of rolling short-term FHLB borrowings to market rates.
For the first nine months of 2022, net interest income was $80.7 million compared with $71.8 million in the same period of 2021. The comparison of NIM and earning asset yields were 3.21% and 2.88%, and 3.51% and 3.38% in 2022 and 2021, respectively. The explanations for improvement in those ratios are consistent with the three month comparison above.
Provision for Credit Losses
The provision for credit losses for the quarter was $1.3 million, compared to a recapture of $174 thousand in the third quarter of 2021.
During the first nine months of 2022, the provision for credit losses was $2.2 million compared to a benefit of $1.4 million in the same period of 2021. The change in the provisions for credit losses and benefit are mostly attributable to loan growth in 2022, and improved economic forecasts in 2021 as compared to 2020, respectively.
Non-Interest Income
Non-interest income in the third quarter of 2022 was $8.8 million, compared to $11.4 million in the same quarter of 2021. Customer service fees were $3.8 million in the third quarter of 2022, compared to $3.5 million in the same period of 2021. The increase reflects the net new accounts that were opened and a higher volume of customer activity and transactions. Wealth management income was $3.5 million in the third quarter of 2022, down from $3.9 million in the same quarter of 2021. Assets under management (“AUM”) declined approximately 16.1% year to date, as compared to the blended decline of the S&P 500 of 24.1%. The smaller decline in AUM is a direct function of effective portfolio management and new business successes. Mortgage banking income was $315 thousand in the third quarter of 2022, compared to $850 thousand in the same period of 2021 reflecting higher on balance sheet activity and lower residential loan originations.
Non-interest income for the first nine months of 2022 was $27.1 million compared to $31.1 million in the same period in 2021. Customer service fees increased $1.4 million while mortgage banking income decreased $3.5 million and in 2021 included a $2.0 million net gain on security sales. The reasons for these changes are the same as the quarterly comparison above.
Non-Interest Expense
Non-interest expense was $23.0 million in the third quarter of 2022, compared to $23.4 million in the same quarter of 2021. The decrease is primarily the net result of a $499 thousand increase in salary and benefit expense, a $429 thousand increase in occupancy and equipment expense, and non-recurring expenses totaling $2.1 million in 2021. Salary and benefit expense increased due to annual cost of living adjustments in the second quarter 2022 along with higher pay-for-performance incentives. Occupancy and equipment expense increased on higher utility costs and software amortization in 2022. Non-recurring expenses (non-GAAP) in 2021, included a $1.8 million loss on debt extinguishment and $318 thousand of fees related to consolidating our Wealth Management businesses.
For the first nine months of 2022, non-interest expense was $66.6 million compared to $67.6 million in the same period of 2021. The reasons for the decrease in the nine month period is similar to the quarterly explanation above with higher salary and benefits expense and occupancy costs, and lower non-recurring expenses. Non-recurring expenses in 2022 totaled $291 thousand consisting of mostly contract renegotiation fees. In 2021, non-recurring expenses were $3.4 million consisting of $1.8 million of reduction in workforce costs and a $1.8 million loss on extinguishment of debt. The efficiency ratio was 59.66% in the first nine months of 2022 compared to 61.48% in same period 2021, which reflects managements disciplined approach to expense management as revenue continues to grow.
Liquidity and Cash Flows
Liquidity is measured by our ability to meet short-term cash needs at a reasonable cost or minimal loss. We seek to obtain favorable sources of liabilities and to maintain prudent levels of liquid assets in order to satisfy varied liquidity demands. Besides serving as a funding source for maturing obligations, liquidity provides flexibility in responding to customer-initiated needs. Many factors affect our ability to meet liquidity needs, including variations in the markets served by our network of offices, mix of assets and liabilities, reputation and credit standing in the marketplace, and general economic conditions.
The Bank actively manages its liquidity position through target ratios established under its Asset-Liability Management Policy. Continual monitoring of these ratios, by using historical data and through forecasts under multiple rate and stress scenarios, allows the Bank to employ strategies necessary to maintain adequate liquidity. The Bank's policy is to maintain a liquidity position of at least 8% of total assets. A portion of the Bank’s deposit base has been historically seasonal in nature, with balances typically declining in the winter months through late spring, during which period the Bank’s liquidity position tightens.
During the third quarter 2022 we initiated pandemic-specific liquidity stress tests to analyze potential impacts from payment deferrals, unanticipated use of committed lines of credit, as well as the possibility of required servicer advances on sold loans. At September 30, 2022, available same-day liquidity totaled approximately $1.0 billion, including cash, borrowing capacity at FHLB and the Federal Reserve Discount Window and various lines of credit. Additional sources of liquidity include cash flows from operations, wholesale deposits, cash flow from our amortizing securities and loan portfolios. We had unused borrowing capacity at the FHLB of $385 million, unused borrowing capacity at the Federal
68
Reserve of $84 million and unused lines of credit totaling $51.0 million, in addition to over $82.1 million in unencumbered, liquid investment portfolio assets.
The Bank maintains a liquidity contingency plan approved by the Bank’s Board of Directors. This plan addresses the steps that would be taken in the event of a liquidity crisis, and identifies other sources of liquidity available to us. Our management believes the level of liquidity is sufficient to meet current and future funding requirements. However, changes in economic conditions, including consumer savings habits and availability or access to the brokered deposit market could potentially have a significant impact on our liquidity position.
Capital Resources
Please see the section titled “Comparison of Financial Condition at September 30, 2022 and December 31, 2021--Equity” for a discussion of shareholders’ equity together with Note 6 “Capital Ratios and Shareholders’ Equity” in the consolidated financial statements. Additional information about regulatory capital is contained in the notes to the consolidated financial statements and in our most recent Annual Report on Form 10-K.
Our principal cash requirement is the payment of dividends on our common stock, as and when declared by our Board of Directors. Dividends to shareholders in the aggregate amount of $11.4 million and $10.5 million for the nine months ended September 30, 2022 and 2021, respectively. All dividends declared and distributed by us will be in compliance with applicable state corporate law and regulatory requirements.
Off-Balance Sheet Arrangements
We are, from time to time, a party to certain off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources, that may be material to investors.
Our off-balance sheet arrangements are limited to standby letters of credit whereby the Bank guarantees the obligations or performance of certain customers. These letters of credit are sometimes issued in support of third-party debt. The risk involved in issuing standby letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same origination, portfolio maintenance and management procedures in effect to monitor other credit products. The amount of collateral obtained, if deemed necessary by the Bank upon issuance of a standby letter of credit, is based upon management's credit evaluation of the customer.
Our off-balance sheet arrangements have not changed materially since previously reported in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021.
CRITICAL ACCOUNTING POLICIES
Our Consolidated Financial Statements were prepared in accordance with GAAP and follow general practices within the industries in which we operate. The most significant accounting policies we follow are presented in Note 1 to our Annual Report on Form 10-K for the fiscal year ended December 31, 2021. Application of these principles requires us to make estimates, assumptions, and judgments that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Most accounting policies are not considered by management to be critical accounting policies. Several factors are considered in determining whether or not a policy is critical in the preparation of the Consolidated Financial Statements. These factors include among other things, whether the policy requires management to make difficult, subjective, and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. The accounting policies which we believe to be most critical in preparing our Consolidated Financial Statements are presented in the section titled “Management's Discussion and Analysis of Financial Condition and Results of Operations--Critical Accouting Policies and Estimates” included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021. There have been no significant changes in our application of critical accounting policies since December 31, 2021.
Refer to “Note 1 Basis of Presentation--Recent Accounting Pronouncements” of the consolidated financial statements for discussion of accounting pronouncements issued but yet to be adopted and implemented.
69
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk
Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates/prices, such as interest rates, foreign currency exchange rates, commodity prices and equity prices. The most significant market risk that affects us is interest rate risk. Other types of market risk do not arise in the normal course of our business activities.
The responsibility for interest rate risk management oversight is the function of the Bank’s Asset and Liability Committee, or ALCO, chaired by the Bank’s Chief Financial Officer and composed of various members of the Bank’s senior management. ALCO meets regularly to review balance sheet structure, formulate strategies in light of current and expected economic conditions, adjust product prices as necessary, implement policy, monitor liquidity, and review performance against guidelines established to control exposure to the various types of inherent risk.
Interest Rate Risk
Interest rate risk can be defined as an exposure to movement in interest rates that could have an adverse impact on the Bank's net interest income. Interest rate risk arises from the imbalance in the re-pricing, maturity and/or cash flow characteristics of assets and liabilities. Management’s objectives are to measure, monitor and develop strategies in response to the interest rate risk profile inherent in the Bank’s balance sheet. The objectives in managing the Bank's balance sheet are to preserve the sensitivity of net interest income to actual or potential changes in interest rates, and to enhance profitability through strategies that promote sufficient reward for understood and controlled risk.
The Bank’s interest rate risk measurement and management techniques incorporate the re-pricing and cash flow attributes of balance sheet and off-balance sheet instruments as each relate to current and potential changes in interest rates. The level of interest rate risk, measured in terms of the potential future effect on net interest income, is determined through the use of modeling and other techniques under multiple interest rate scenarios. Interest rate risk is evaluated in depth on a quarterly basis and reviewed by ALCO and the Bank’s Board of Directors.
The Bank's Asset Liability Management Policy, approved annually by the Bank’s Board of Directors, establishes interest rate risk limits in terms of variability of net interest income under rising, flat, and decreasing rate scenarios. It is the role of the ALCO to evaluate the overall risk profile and to determine actions to maintain and achieve a posture consistent with policy guidelines.
Interest Rate Sensitivity Modeling:
The Bank utilizes an interest rate risk model widely recognized in the financial industry to monitor and measure interest rate risk. The model simulates the behavior of interest income and expense for all balance sheet and off-balance sheet instruments, under different interest rate scenarios together with a dynamic future balance sheet. Interest rate risk is measured in terms of potential changes in net interest income based upon shifts in the yield curve.
The interest rate risk sensitivity model requires that assets and liabilities be broken down into components as to fixed, variable, and adjustable interest rates, as well as other homogeneous groupings, which are segregated as to maturity and type of instrument. The model includes assumptions about how the balance sheet is likely to evolve through time and in different interest rate environments. The model uses contractual re-pricing dates for variable products, contractual maturities for fixed rate products, and product-specific assumptions for deposit accounts, such as money market accounts, that are subject to re-pricing based on current market conditions. Re-pricing margins are also determined for adjustable rate assets and incorporated in the model. Investment securities and borrowings with option provisions are examined on an individual basis in each rate environment to estimate the likelihood of exercise. Prepayment assumptions for mortgage loans are calibrated using specific Bank experience while mortgage-backed securities are developed from industry standard models of prepayment speeds, based upon similar coupon ranges and degree of seasoning. Cash flows and maturities are then determined, and for certain assets, prepayment assumptions are estimated under different interest rate scenarios. Interest income and interest expense are then simulated under several hypothetical interest rate conditions.
The simulation models a parallel and pro rata shift in rates over a 12-month period. Using this approach, we are able to produce simulation results that illustrate the effect that both a gradual “rate ramp” and a “rate shock” have on earnings expectations. Our net interest income sensitivity analysis reflects changes to net interest income assuming no balance sheet
growth and a parallel shift in interest rates. All rate changes were “ramped” over the first 12-month period and then maintained at those levels over the remainder of the simulation horizon. Changes in net interest income based upon these simulations are measured against the flat interest rate scenario.
As of September 30, 2022, interest rate sensitivity modeling results indicate that the Bank’s balance sheet was asset sensitive over the one- and two-year horizons.
The following table presents the changes in sensitivities on net interest income for the periods ended September 30, 2022 and 2021:
Change in Interest Rates-Basis Points (Rate Ramp)
1 - 12 Months
13 - 24 Months
$ Change
% Change
At September 30, 2022
-100
(3,414)
(2.4)
(10,292)
(6.9)
+100
1,956
1.4
6,544
4.4
+200
3,721
2.6
12,622
8.5
At September 30, 2021
(2,226)
(6,019)
(6.7)
4,715
5.1
11,583
13.0
9,548
10.3
21,878
24.5
Assuming short-term and long-term interest rates decline 100 basis points from current levels (i.e., a parallel yield curve shift) and the Bank’s balance sheet structure and size remain at current levels, management believes net interest income will deteriorate over the one year horizon while deteriorating further from that level over the two-year horizon.
Assuming the Bank’s balance sheet structure and size remain at current levels and the Federal Reserve increases short-term interest rates by 200 basis points with the balance of the yield curve shifting in parallel with these increases, management believes net interest income will improve over both the one and two-year horizons.
As compared to September 30, 2021, sensitivity to both a down 100 basis point rate movement and an up 200 basis point rate movement has decreased.
The preceding sensitivity analysis does not represent a forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels and yield curve shape, prepayment speeds on loans and securities, deposit rates, pricing decisions on loans and deposits, reinvestment or replacement of asset and liability cash flows, and renegotiated loan terms with borrowers. While assumptions are developed based upon current economic and local market conditions, we cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.
As market conditions vary from those assumed in the sensitivity analysis, actual results may also differ due to: prepayment and refinancing levels deviating from those assumed; the impact of interest rate changes, caps or floors on adjustable rate assets; the potential effect of changing debt service levels on customers with adjustable rate loans; depositor early withdrawals and product preference changes; and other such variables. The sensitivity analysis also does not reflect additional actions that the Bank’s Senior Executive Team and Board of Directors might take in responding to or anticipating changes in interest rates, and the anticipated impact on the Bank’s net interest income.
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our senior management, consisting of our principal executive officer and our principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this Form 10-Q. Based on this evaluation, our management, including our principal executive officer and principal financial officer, concluded that as of September 30, 2022, our disclosure controls and procedures were effective to ensure that information required to be disclosed by the reports that we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms. Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by using our Exchange Act reports is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
There were no changes in our internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We and our subsidiaries are parties to certain ordinary routine litigation incidental to the normal conduct of their respective businesses. Although the Company is not able to predict the outcome of such actions, after reviewing pending and threatened actions with counsel, our management believes that based on the information currently available the outcome of such actions, individually or in the aggregate, will not have a material adverse effect on the Company’s consolidated financial position as a whole.
ITEM 1A. RISK FACTORS
There were no material changes to the risk factors discussed in Part I, Item 1A. of the our Annual Report on Form 10-K for the fiscal year ended December 31, 2021. In addition to the other information set forth in this Form 10-Q, you should carefully consider those risk factors, which could materially affect our business, financial condition and future operating results. Those risk factors are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may have a material adverse effect on our business, financial condition and operating results.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(c)On June 23, 2022, our Board of Directors approved a twelve-month plan to repurchase up to 5% of our outstanding shares of common stock, representing 751,000 shares.
The following table indicates that no shares were repurchased by us in the third quarter of 2022:
Total number of shares
Maximum number of
purchased as a part of
shares that may yet be
Total number of
Average price
publicly announced
purchased under
shares purchased
paid per share
plans or programs
the plans or programs
July 1-31, 2022
751,000
August 1-31, 2022
September 1-30, 2022
ITEM 6. EXHIBITS
31.1*
Certification of Chief Executive Officer under Rule 13a-14(a)/15d-14(a)
31.2*
Certification of Chief Financial Officer under Rule 13a-14(a)/15d-14(a)
32.1**
Certification of Chief Executive Officer under 18 U.S.C. Sec. 1350
32.2**
Certification of Chief Financial Officer under 18 U.S.C. Sec. 1350
101*
The following financial information from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2022 is formatted in Inline Extensible Business Reporting Language (iXBRL): (i) Consolidated Condensed Statements of Income, (ii) the Condensed Consolidated Balance Sheets, (iii) the Condensed Consolidated Statements of Changes in Shareholders’ Equity, (iv) Consolidated Statements of Cash Flows and (v) Notes to the Consolidated Condensed Financial Statements
104
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)
*Filed herewith
**Furnished herewith
SIGNATURES
Pursuant to the requirements 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.
Dated: November 4, 2022
By:
/s/ Curtis C. Simard
Curtis C. Simard
President & Chief Executive Officer
(Principal Executive Officer)
/s/ Josephine Iannelli
Josephine Iannelli
Executive Vice President & Chief Financial Officer
(Principal Financial and Accounting Officer)