Table of Contents
United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended June 30, 2023
¨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 001-35021
EVANS BANCORP, INC.
(Exact name of registrant as specified in its charter)
New York 16-1332767
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6460 Main St. Williamsville, NY 14221
(Address of principal executive offices) (Zip Code)
(716) 926-2000
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed
since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.50 par value
EVBN
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 x 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 x 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 definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨
Accelerated filer ¨
Non-accelerated filer x
Smaller reporting company x
Emerging growth company ¨
If an emerging growth company, indicate by checkmark 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 x
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Common Stock, $.50 par value, 5,477,505 shares as of July 27, 2023.
INDEX
EVANS BANCORP, INC. AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION
PAGE
Item 1.
Financial Statements
Unaudited Consolidated Balance Sheets – June 30, 2023 and December 31, 2022
1
Unaudited Consolidated Statements of Income – Three months ended June 30, 2023 and 2022
2
Unaudited Consolidated Statements of Income – Six months ended June 30, 2023 and 2022
3
Unaudited Consolidated Statements of Comprehensive (Loss) Income – Three months ended June 30, 2023 and 2022
4
Unaudited Consolidated Statements of Comprehensive (Loss) Income – Six months ended June 30, 2023 and 2022
Unaudited Consolidated Statements of Changes in Stockholders’ Equity – Three months ended June 30, 2023 and 2022
5
Unaudited Consolidated Statements of Changes in Stockholders’ Equity – Six months ended June 30, 2023 and 2022
6
Unaudited Consolidated Statements of Cash Flows – Six months ended June 30, 2023 and 2022
7
Notes to Unaudited Consolidated Financial Statements
9
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
31
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
39
Item 4.
Controls and Procedures
40
PART II. OTHER INFORMATION
Legal Proceedings
41
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
42
Defaults Upon Senior Securities
Mine Safety Disclosure
Item 5.
Other Information
Item 6.
Exhibits
43
Signatures
44
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
UNAUDITED CONSOLIDATED BALANCE SHEETS
JUNE 30, 2023 AND DECEMBER 31, 2022
(in thousands, except share and per share amounts)
June 30,
December 31,
2023
2022
ASSETS
Cash and due from banks
$
15,197
16,796
Interest-bearing deposits at banks
10,334
6,258
Securities:
Available for sale, at fair value and net of valuation allowance
351,595
364,326
(amortized cost: $416,403 at June 30, 2023; $428,216 at December 31, 2022)
Held to maturity, at amortized cost and net of valuation allowance
2,241
6,949
(fair value: $2,149 at June 30, 2023; $6,809 at December 31, 2022)
Federal Home Loan Bank common stock, at cost
3,939
10,437
Federal Reserve Bank common stock, at cost
3,087
3,074
Loans, net of allowance for credit losses of $21,368 at June 30, 2023
and $19,438 at December 31, 2022
1,649,385
1,652,931
Properties and equipment, net of accumulated depreciation of $11,923 at June 30, 2023
and $11,596 at December 31, 2022
16,194
16,999
Goodwill
12,702
Intangible assets
1,027
1,227
Bank-owned life insurance
42,288
41,826
Operating lease right-of-use asset
4,297
4,392
Other assets
42,677
40,593
TOTAL ASSETS
2,154,963
2,178,510
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Demand
442,195
493,710
NOW
303,159
273,359
Savings
726,687
801,943
Time
314,574
202,667
Total deposits
1,786,615
1,771,679
Securities sold under agreement to repurchase
19,185
7,147
Other borrowings
140,386
193,001
Operating lease liability
4,604
4,723
Other liabilities
13,563
16,892
Subordinated debt
31,126
31,075
Total liabilities
1,995,479
2,024,517
STOCKHOLDERS' EQUITY:
Common stock, $0.50 par value, 10,000,000 shares authorized; 5,581,183 and 5,544,339 shares issued at
June 30, 2023 and December 31, 2022, respectively, and 5,477,505 and 5,437,048 shares outstanding at
June 30, 2023 and December 31, 2022, respectively.
2,795
2,775
Capital surplus
81,777
81,031
Treasury stock, at cost, 103,678 and 107,291 shares at June 30, 2023 and
December 31, 2022, respectively
(3,656)
(3,891)
Retained earnings
128,465
123,356
Accumulated other comprehensive income (loss), net of tax
(49,897)
(49,278)
Total stockholders' equity
159,484
153,993
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
See Notes to Unaudited Consolidated Financial Statements
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED JUNE 30, 2023 AND 2022
Three Months Ended June 30,
INTEREST INCOME
Loans
21,602
16,828
80
226
Taxable
2,252
1,984
Non-taxable
54
59
Total interest income
23,988
19,097
INTEREST EXPENSE
Deposits
6,280
580
1,486
541
423
Total interest expense
8,307
1,045
NET INTEREST INCOME
15,681
18,052
PROVISION FOR CREDIT LOSSES
(116)
267
NET INTEREST INCOME AFTER
15,797
17,785
NON-INTEREST INCOME
Deposit service charges
645
703
Insurance service and fees
2,720
2,567
238
171
Interchange fee income
528
539
Other
570
632
Total non-interest income
4,701
4,612
NON-INTEREST EXPENSE
Salaries and employee benefits
8,649
9,436
Occupancy
1,145
1,131
Advertising and public relations
407
438
Professional services
808
843
Technology and communications
1,542
1,237
Amortization of intangibles
100
FDIC insurance
350
250
1,171
1,349
Total non-interest expense
14,172
14,784
INCOME BEFORE INCOME TAXES
6,326
7,613
INCOME TAX PROVISION
1,394
1,879
NET INCOME
4,932
5,734
Net income per common share-basic
0.90
1.04
Net income per common share-diluted
1.03
Weighted average number of common shares outstanding
5,467,897
5,512,741
Weighted average number of diluted shares outstanding
5,474,462
5,550,436
SIX MONTHS ENDED JUNE 30, 2023 AND 2022
Six Months Ended June 30,
42,488
32,552
176
296
4,546
3,661
143
105
47,353
36,614
10,295
1,148
2,985
89
1,067
824
14,347
2,061
33,006
34,553
(770)
488
33,776
34,065
1,258
1,395
5,149
4,866
462
325
1,021
1,031
924
1,426
8,814
9,043
18,062
18,906
2,318
2,311
563
617
1,691
1,715
2,898
2,411
200
700
520
2,242
2,564
28,674
29,244
13,916
13,864
3,184
3,382
10,732
10,482
1.97
1.90
1.96
1.89
5,456,189
5,503,811
5,476,024
5,548,533
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(in thousands)
OTHER COMPREHENSIVE (LOSS) INCOME , NET OF TAX:
Unrealized loss on available-for-sale securities:
(4,294)
(12,033)
Defined benefit pension plans:
Amortization of prior service cost
-
Amortization of actuarial loss
20
50
Total
55
(4,274)
(11,978)
COMPREHENSIVE INCOME (LOSS)
658
(6,244)
Six Months Ended June
OTHER COMPREHENSIVE (LOSS) INCOME, NET OF TAX:
Unrealized loss on available-for-sale securities
(659)
(28,738)
10
110
OTHER COMPREHENSIVE (LOSS) INCOME, NET OF TAX
(619)
(28,628)
10,113
(18,146)
UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Accumulated
Common
Capital
Retained
Comprehensive
Treasury
Stock
Surplus
Earnings
Loss
Balance, March 31, 2022
2,762
79,396
109,366
(22,321)
169,203
Net Income
Other comprehensive loss
Cash dividends
(3)
Stock compensation expense
291
Issued 3,705 shares under Dividend Reinvestment Plan
141
Issued 6,902 shares in Employee Stock Purchase Plan
195
199
Reissued 6,660 restricted shares in stock option exercises
(115)
249
134
issued 2,020 shares in stock option exercises
49
Repurchased 29,269 shares of common stock
(1,098)
Forfeitures 1,186 shares of restricted stock
Balance, June 30, 2022
2,769
80,072
114,982
(34,299)
(849)
162,675
Balance, March 31, 2023
2,787
81,210
123,533
(45,623)
158,251
228
Issued 4,545 shares in Dividend Reinvestment Plan
152
154
Issued 9,101 shares in Employee Stock Purchase Plan
187
193
Balance, June 30, 2023
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Balance, December 31, 2021
2,744
78,795
108,024
(5,671)
183,892
Cash dividends ($0.62 per common share)
(3,409)
624
Issued 18,244 restricted shares
(9)
Issued 20,851 shares in stock option exercises
326
336
Reissued 3,705 shares through Dividend Reinvestment Program
Balance, December 31, 2022
Cumulative effect of change in accounting principle— credit losses
(2,026)
Beginning balance after cumulative effect adjustment
121,330
151,967
Cash dividends ($0.66 per common share)
(3,597)
534
Reissued 6,228 restricted shares
(235)
235
Issued 12421 shares in stock option exercises
114
120
Issued 11,775 restricted shares, net of forfeitures
(6)
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
OPERATING ACTIVITIES:
Interest received
47,051
35,332
Fees received
8,830
9,236
Interest paid
(13,634)
(2,301)
Cash paid to employees and vendors
(29,972)
(32,005)
Income taxes paid
(6,223)
(1,801)
Proceeds from sale of loans held for sale
4,591
3,529
Originations of loans held for sale
(4,503)
(3,368)
Net cash provided by operating activities
6,140
8,622
INVESTING ACTIVITIES:
Available for sales securities:
Purchases
(144,413)
Proceeds from sales, maturities, calls, and payments
18,412
16,198
Held to maturity securities:
(644)
(5,825)
Proceeds from maturities, calls, and payments
5,352
1,288
Proceeds from bank-owned life insurance claims
378
Additions to properties and equipment
(479)
(388)
Proceeds from sales of assets
370
Proceeds from tax credit investment
12
56
Net decrease (increase) in loans
1,935
(40,854)
Net cash provided by (used in) investing activities
24,958
(173,560)
FINANCING ACTIVITIES:
Repayments from long-term borrowings, net
(13,278)
(9,672)
(Repayments) proceeds from short-term borrowings, net
(27,163)
958
Net increase in deposits
14,950
31,322
Dividends paid
Repurchase of treasury stock
Issuance of common stock
467
678
Reissuance of treasury stock
Net cash (used in) provided by financing activities
(28,621)
18,913
Net increase (decrease) in cash and cash equivalents
2,477
(146,025)
CASH AND CASH EQUIVALENTS:
Beginning of period
23,054
244,785
End of period
25,531
98,760
RECONCILIATION OF NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES:
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization
869
890
Deferred tax expense
279
329
Provision for credit losses
Loss on sales of assets
Gain on loans sold
(86)
(62)
Changes in assets and liabilities affecting cash flow:
(5,408)
(2,267)
(129)
(2,023)
NET CASH PROVIDED BY OPERATING ACTIVITIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND SIX MONTH PERIODS ENDED JUNE 30, 2023 AND 2022
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies followed by Evans Bancorp, Inc. (the “Company”), a financial holding company, and its two direct, wholly-owned subsidiaries: (i) Evans Bank, National Association (the “Bank”), and the Bank’s subsidiaries, Evans National Leasing, Inc. (“ENL”), and Evans National Holding Corp. (“ENHC”); and (ii) Evans National Financial Services, LLC (“ENFS”), and ENFS’s subsidiary, The Evans Agency, LLC (“TEA”), and TEA’s subsidiary ENB Associates Inc. (“ENBA”), in the preparation of the accompanying interim unaudited consolidated financial statements conform with U.S. generally accepted accounting principles (“GAAP”) and with general practice within the industries in which it operates. Except as the context otherwise requires, the Company and its direct and indirect subsidiaries are collectively referred to in this report as the “Company.”
The Financial Accounting Standards Board (“FASB”) establishes changes to GAAP in the form of accounting standards updates (“ASUs”) to the FASB Accounting Standards Codification. The Company considers the applicability and impact of all ASUs when they are issued by FASB.
Effective January 1, 2023 the Company adopted ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments which requires an allowance for credit losses be deducted from the amortized cost basis of financial assets to present the net carrying value at the amount that is expected to be collected over the contractual term of the asset considering relevant information about past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. In estimating expected losses in the loan portfolio, borrower-specific financial data and macro-economic assumptions are utilized to project losses over a reasonable and supportable forecast period. Assumptions and judgment are applied to measure amounts and timing of expected future cash flows, collateral values and other factors used to determine the borrowers’ abilities to repay obligations. Subsequent to the forecast period, the Company utilizes longer-term historical loss experience to estimate losses over the remaining contractual life of the loans. See Note 3 – “Loans and the Allowance for Credit Losses” to this Quarterly Report on Form 10-Q for the accounting policy for determining the Allowance for Credit Losses.
Prior to January 1, 2023, the allowance for credit losses represented the amount that in management’s judgment reflected incurred credit losses inherent in the loan and lease portfolio as of the balance sheet date. Based on portfolio composition, then current economic conditions, and reasonable and supportable forecasts of future conditions, the Company recognized an increase to the allowance for credit losses of $2.7 million upon adoption of the standard as of January 1, 2023 as compared with the allowance for credit losses recognized on its consolidated balance sheet at December 31, 2022. The $2.7 million increase was recognized as a net of tax cumulative effect adjustment to retained earnings of $2.0 million.
All other ASUs adopted by the Company during the current fiscal year are not expected to have a material impact on the Company’s consolidated financial position, results of operations, cash flows or disclosures.
The results of operations for the six month period ended June 30, 2023 are not necessarily indicative of the results to be expected for the full year.
The accompanying unaudited consolidated financial statements should be read in conjunction with the Audited Consolidated Financial Statements and the Notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2022 (the “10-K”).
2. SECURITIES
The amortized cost of securities and their approximate fair value at June 30, 2023 and December 31, 2022 were as follows:
June 30, 2023
Amortized
Unrealized
Fair
Cost
Gains
Losses
Value
Available for Sale:
Debt securities:
U.S. treasuries and government agencies
160,622
(23,686)
136,936
States and political subdivisions
22,716
(1,528)
21,189
Total debt securities
183,338
(25,214)
158,125
Mortgage-backed securities:
FNMA
74,130
(12,496)
61,634
FHLMC
45,897
(6,591)
39,306
GNMA
39,387
(7,675)
31,712
SBA
21,623
(2,600)
19,023
CMO
52,028
(10,233)
41,795
Total mortgage-backed securities
233,065
(39,595)
193,470
Total securities designated as available for sale
416,403
(64,809)
Held to Maturity:
Debt securities
(92)
2,149
Total securities designated as held to maturity
December 31, 2022
165,495
(24,814)
140,682
23,480
(1,662)
21,822
188,975
(26,476)
162,504
75,921
(12,819)
63,102
46,922
(6,695)
40,227
40,039
(6,580)
33,459
22,556
(2,419)
20,137
53,803
(8,906)
44,897
239,241
(37,419)
201,822
428,216
(63,895)
(140)
6,809
Available for sale securities with a total fair value of $209 million and $226 million were pledged as collateral to secure public deposits and for other purposes required or permitted by law at June 30, 2022 and December 31, 2022, respectively.
The scheduled maturities of debt and mortgage-backed securities at June 30, 2023 are summarized below. All maturity amounts are contractual maturities. Actual maturities may differ from contractual maturities because certain issuers have the right to call or prepay obligations with or without call premiums.
Estimated
cost
fair value
Debt securities available for sale:
Due in one year or less
5,703
5,581
Due after one year through five years
86,952
80,186
Due after five years through ten years
61,692
51,962
Due after ten years
28,991
20,396
Mortgage-backed securities
available for sale
Debt securities held to maturity:
1,532
1,527
333
305
376
317
Contractual maturities of the Company’s mortgage-backed securities generally exceed ten years; however, the effective lives may be significantly shorter due to prepayments of the underlying loans and due to the nature of these securities.
There were no gross realized gains or losses from sales of investment securities for the three and six month periods ended June 30, 2023 and 2022.
Management has assessed the securities available for sale in an unrealized loss position at June 30, 2023 and December 31, 2022 and determined the decline in fair value below amortized cost to be temporary. In making this determination, management considered the period of time the securities were in a loss position, the percentage decline in comparison to the securities’ amortized cost, and the financial condition of the issuer (primarily government or government-sponsored enterprises). In addition, management does not intend to sell these securities and it is not more likely than not that the Company will be required to sell these securities before recovery of their amortized cost. Management believes the decline in fair value is primarily related to market interest rate fluctuations and not to the credit deterioration of the individual issuers.
The Company has not recorded any other-than-temporary impairment (“OTTI”) charges during the six month period ended June 30, 2023 and did not record any OTTI charges during 2022. The credit worthiness of the Company’s securities portfolio is largely reliant on the ability of U.S. government sponsored agencies such as Federal Home Loan Bank (“FHLB”), Federal National Mortgage Association (“FNMA”), Government National Mortgage Association (“GNMA”), and Federal Home Loan Mortgage Corporation (“FHLMC”), and municipalities throughout New York State to meet their obligations. In addition, dysfunctional markets could materially alter the liquidity, interest rate, and pricing risk of the portfolio. Past performance is not a guarantee for similar performance of the Company’s securities portfolio in future periods.
Information regarding unrealized losses within the Company’s available for sale securities at June 30, 2023 and December 31, 2022 is summarized below.
Less than 12 months
12 months or longer
7,781
(219)
129,155
(23,467)
2,310
(91)
17,923
(1,437)
20,233
10,091
(310)
147,078
(24,904)
157,169
574
(24)
61,060
(12,472)
7,739
(345)
31,567
(6,246)
93
31,619
(7,672)
6,504
(266)
35,291
(9,967)
14,910
(638)
178,560
(38,957)
1,478
(5)
671
(87)
Total temporarily impaired
securities
26,479
(953)
326,309
(63,948)
352,788
(64,901)
68,292
(5,929)
71,389
(18,885)
139,681
19,540
(1,645)
418
(17)
19,958
87,832
(7,574)
71,807
(18,902)
159,639
23,242
(3,081)
39,860
(9,738)
11,927
(790)
28,300
(5,905)
10,763
(1,298)
22,696
(5,282)
16,996
(1,971)
3,141
(448)
11,288
(673)
33,609
(8,233)
74,216
(7,813)
127,606
(29,606)
6,627
(118)
182
(22)
168,675
(15,505)
199,595
(48,530)
368,270
(64,035)
3. LOANS AND THE ALLOWANCE FOR CREDIT LOSSES
Loan Portfolio Composition
The following table presents selected information on the composition of the Company’s loan portfolio as of the dates indicated:
Mortgage loans on real estate:
Residential mortgages
438,081
440,123
Commercial and multi-family
801,062
778,714
Construction-Residential
3,183
3,626
Construction-Commercial
118,963
117,403
Home equities
80,528
82,414
Total real estate loans
1,441,817
1,422,280
Commercial and industrial loans
228,302
250,069
Consumer and other loans
572
Unaccreted yield adjustments*
(593)
(552)
Total gross loans
1,670,753
1,672,369
Allowance for credit losses
(21,368)
(19,438)
Loans, net
* Includes net premiums and discounts on acquired loans and net deferred fees and costs on loans originated.
The outstanding principal balance and the carrying amount of acquired credit-impaired loans totaled $0.8 million and $0.7 million at June 30, 2023 and December 31, 2022, respectively. There were no valuation allowances for specifically identified impairment attributable to acquired credit-impaired loans at June 30, 2023 or December 31, 2022.
There were $594 million and $495 million in residential and commercial mortgage loans pledged to FHLBNY to serve as collateral for potential borrowings as of June 30, 2023 and December 31, 2022, respectively.
The Company may also sell certain fixed rate residential mortgages to FNMA, FHLMC and FHLB while maintaining the servicing rights for those mortgages. At June 30, 2023 and December 31, 2022, the Company had loan servicing portfolio principal balances of $115 million and $116 million, respectively, upon which it earned servicing fees. In the three month and six month periods ended June 30, 2023, the Company sold $2.9 million and $4.6 million, respectively, of residential mortgages. In the three month and six month periods ended June 30, 2022, the Company sold $0.6 million and $3.5 million, respectively, of residential mortgages.
The fair value of the mortgage servicing rights for that portfolio was $1.1 million at both June 30, 2023 and December 31, 2022. There were no residential mortgages held for sale at June 30, 2023 and December 31, 2022.
Credit Quality Indicators
The Company monitors the credit risk in its loan portfolio by reviewing certain credit quality indicators (“CQI”). The primary CQI for the commercial mortgage and commercial and industrial portfolios is the individual loan’s credit risk rating. The following list provides a description of the credit risk ratings that are used internally by the Bank when assessing the adequacy of its allowance for credit losses:
Acceptable or better
Watch
Special Mention
Substandard
Doubtful
Loss
“Special mention” and “substandard” loans are weaker credits with a higher risk of loss and are categorized as “criticized” assets.
The Company’s consumer loans, including residential mortgages and home equities, are not individually risk rated or reviewed in the Company’s loan review process. Unlike commercial customers, consumer loan customers are not required to provide the Company with updated financial information. Consumer loans also carry smaller balances. Given the lack of updated information after the initial underwriting of the loan and small size of individual loans, the Company uses delinquency status as the primary credit quality indicator for consumer loans. However, once a consumer loan is identified as impaired, it is individually evaluated for impairment.
The following tables summarize amortized cost of loans by year of origination and internally assigned credit grades:
Term Loans Amortized Cost Basis by Origination Year
As of June 30, 2023
2021
2020
2019
Prior
Revolving Loans Amortized Cost Basis
Risk rating
Pass
10,210
40,898
27,245
9,464
6,502
7,562
98,867
200,748
Special Mention
8,859
445
4,891
877
2,104
5,336
22,829
Substandard
22
53
941
3,705
4,728
Doubtful/Loss
10,527
49,760
27,694
14,377
7,432
10,607
107,908
228,305
Current period gross writeoffs
Commercial real estate mortgages
50,416
202,641
173,515
95,499
69,887
283,278
875,236
1,256
405
1,547
10,163
9,946
23,317
12,069
201
7,092
3,373
22,735
203,897
185,989
97,247
87,142
296,597
921,288
Consumer and other
Payment performance
Performing
245
246
34
21
19
33
137
735
Nonperforming
62
17
79
14,912
73,992
103,982
71,910
18,405
154,383
437,584
126
146
168
233
92
2,935
3,700
15,038
74,138
104,150
72,143
18,497
157,318
441,284
6,246
3,140
657
639
2,321
65,194
78,836
302
2,324
65,496
79,141
25
The amortized cost of criticized assets of $74 million included $20 million of loans in the Company’s hotel loan portfolio at June 30, 2023. At December 31, 2022 the amortized cost of criticized assets was $93 million including $29 million of loans in the Company’s hotel loan portfolio.
Past Due Loans
The following tables provide an analysis of the age of the amortized cost of loans that are past due as of the dates indicated:
Current
Non-accruing
Balance
30-59 days
60-89 days
90+ days
Commercial and industrial
226,270
1,982
Residential real estate:
Residential
432,490
1,911
438,101
Construction
Commercial real estate:
Commercial
787,565
1,327
810
6,569
6,055
802,326
105,522
4,205
875
8,360
118,962
78,039
652
145
729
Total Loans
1,633,798
6,240
2,868
7,445
20,402
246,412
684
139
2,625
250,095
434,393
1,105
472
3,738
439,708
3,502
771,871
1,083
75
6,648
779,677
107,369
1,648
8,765
117,782
79,320
759
206
80,948
1,643,519
3,185
891
2,435
22,339
Allowance for Credit losses
Effective January 1, 2023 the Company adopted ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments which requires an allowance for credit losses be deducted from the amortized cost basis of financial assets to present the net carrying value at the amount that is expected to be collected over the contractual term of the asset. In determining the allowance for credit losses, accruing loans with similar risk characteristics are generally evaluated collectively. The Company utilizes discounted cash flow models considering relevant information about past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount to project principal balances over the remaining contractual lives of the loan portfolios and to determine estimated credit losses through a reasonable and supportable forecast period. The models have been statistically developed based on historical correlations of credit losses with prevailing economic metrics, including unemployment and gross domestic product. The Company utilizes a reasonable and supportable forecast period of one year. Subsequent to this forecast period the Company reverts, on a straight-line basis over a one-year period, to historical loss experience to inform its estimate of losses for the remaining contractual life of each portfolio. Model forecasts may be adjusted for inherent limitations of biases that have been identified through independent validation and back-testing of model performance to actual realized results. The Company also considered the impact of qualitative factors, including portfolio concentrations, changes in underwriting practices, imprecision in its economic forecasts, geopolitical conditions and other risk factors that might influence its loss estimation process.
The Company also estimates losses attributable to specific troubled credits identified through both normal and targeted credit review processes and includes all loans on nonaccrual status. The amounts of individually analyzed losses are determined through a loan-by-loan analysis. Such loss estimates are typically based on expected future cash flows, collateral values and other factors that may impact the borrower’s ability to pay. To the extent that those loans are collateral-dependent, they are evaluated based on recent estimations of the fair value of the loan’s collateral. In those cases where current appraisals may not yet be available, prior appraisals are utilized with
adjustments, as deemed necessary, for estimates of subsequent declines in values as determined by line of business and/or loan workout personnel. Those adjustments are reviewed and assessed for reasonableness by the Company’s credit risk personnel. Accordingly, for real estate collateral securing larger nonaccrual commercial loans and commercial real estate loans, estimated collateral values are based on current appraisals and estimates of value. For non-real estate loans, collateral is assigned a discounted estimated liquidation value and, depending on the nature of the collateral, is verified through field exams or other procedures. In assessing collateral, real estate and non-real estate values are reduced by an estimate of selling costs. Charge-offs are based on recent indications of value from external parties that are generally obtained shortly after a loan becomes nonaccrual. Loans to consumers that file for bankruptcy are generally charged-off to estimated net collateral value shortly after the Company is notified of such filings. When evaluating individual home equity loans and lines of credit for charge off and for purposes of estimating losses in determining the allowance for credit losses, the Company considers the required repayment of any first lien positions related to collateral property.
Prior to 2023, the allowance for credit losses represented the amount that in management’s judgement reflected incurred credit losses inherent in the loan and lease portfolio as of the balance sheet date. A description of the methodologies used by the Company to estimate its allowance for credit losses prior to January 1, 2023 is included in note 4 of Notes to Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.
The following tables present the activity in the allowance for credit losses according to portfolio segment for the three month periods ended June 30, 2023 and 2022.
Three months ended June 30, 2023
Commercial and Industrial
Commercial Real Estate Mortgages*
Consumer and Other
Residential Mortgages*
Home Equities
Allowance for credit
losses:
Beginning balance
5,267
12,554
3,378
320
21,523
Charge-offs
(49)
(1)
(25)
(75)
Recoveries
16
36
Provision
(314)
88
Ending balance
4,973
12,633
3,465
290
21,368
*Includes construction loans
Three months ended June 30, 2022
3,688
12,279
2,117
490
18,618
(7)
(27)
(55)
(89)
23
14
26
102
76
3,714
12,305
70
2,164
566
18,819
* Includes construction loans
The following tables present the activity in the allowance for credit losses according to portfolio segment for the six month periods ended June 30, 2023 and 2022.
Six months ended June 30, 2023
Allowance for credit losses:
4,980
11,595
153
2,102
608
19,438
Adoption of new accounting
standard
324
(147)
1,618
(205)
2,735
Beginning balance after
cumulative effect adjustment
5,304
12,740
3,720
403
22,173
(79)
(105)
51
(382)
(107)
61
(254)
(88)
*Includes construction loans
Six months ended June 30, 2022
3,309
12,367
2,127
581
18,438
(31)
(67)
(153)
46
400
73
(15)
The following tables present the allowance for credit losses and recorded investment on loans by segment as of June 30, 2023 and December 31, 2022:
Ending balance:
Individually evaluated for impairment
179
186
Collectively evaluated for impairment
12,454
3,458
21,182
Loans:
2,035
17,161
4,122
633
23,951
226,267
902,864
437,142
79,895
1,647,395
920,025
441,264
1,671,346
Loans acquired with deteriorated credit quality
251
28
77
356
11,344
2,074
531
19,082
687
2,697
18,144
4,020
949
25,810
247,372
877,973
439,042
81,465
1,646,424
896,117
443,749
1,672,921
The Company’s reserve for off-balance sheet credit exposures was not material at June 30, 2023 and upon adoption of ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments.
Nonaccrual Loans
The following tables provide amortized costs, at the class level, for nonaccrual loans as of the dates indicated:
Six Months Ended
January 1, 2023
Amortized Cost with Allowance
Amortized Cost without Allowance
Amortized Cost
Interest Income Recognized
3,607
72
1,268
Total nonaccrual loans
1,361
19,041
96
June 30, 2022
January 1, 2022
448
451
899
4,919
30
13,893
13,923
3,020
4,430
4,629
5,758
177
108
2,942
196
2,437
755
873
21,123
21,996
17,394
203
Modifications to Borrowers Experiencing Financial Difficulty
The Company adopted Accounting Standards Update (“ASU”) 2022-02, Financial Instruments – Credit Losses (Topic 326) Troubled Debt Restructurings and Vintage Disclosures (“ASU 2022-02”) effective January 1, 2023. The amendments in ASU 2022-02 eliminated the recognition and measure of troubled debt restructurings and enhanced disclosures for loan modifications to borrowers experiencing financial difficulty.
There were no modifications made to borrowers experiencing financial difficulty during the three months ended June 30, 2023.
The table below details the amortized cost of gross loans held for investment made to borrowers experiencing financial difficulty that were modified during the six months ended June 30, 2023:
Term Extension
Total Class of Receivable
%
104
0
The financial impacts of residential mortgage loan modifications made to borrowers experiencing financial difficulty during the six months ended June 30, 2023 were maturity extensions ranging from 159 months to 164 months.
The company has not committed to lend any additional amounts to the borrowers included in the previous table.
As of June 30, 2023, the Company did not have any loans made to borrowers experiencing financial difficulty that were modified during the first six months of 2023 that subsequently defaulted. Payment default is defined as movement to nonperforming status, foreclosure or charge-off, whichever occurs first.
The Company closely monitors the performance of loans that are modified to borrowers experiencing financial difficulty to understand the effectiveness of its modification efforts. The payment status of all loans modified to borrowers experiencing financial difficulties during the first six months of 2023 was current as of June 30, 2023.
Troubled debt restructurings
Information on loan modifications prior to the adoption of ASU 2022-02 on January 1, 2023 is presented in accordance with the applicable accounting standards in effect at that time. During the three months ended June 30, 2022 the Company modified one loan that was determined to be a troubled debt restructuring, a commercial and industrial loan with an outstanding balance of $461 thousand that included an extension of maturity. During the first six months of 2022, the Company modified two loans that were determined to be troubled debt restructurings, a home equity loan with an outstanding balance of $38 thousand that included extension of maturity and interest rate reduction concessions and a commercial and industrial loan with an outstanding balance of $461 thousand that included an extension of maturity.
4. COMMON EQUITY AND EARNINGS PER SHARE DATA
The common stock per share information is based upon the weighted average number of shares outstanding during each period. For the three and six month periods ended June 30, 2023 the Company had an average of 6,565 and 19,835 dilutive shares outstanding, respectively. For the three and six month periods ended June 30, 2022 the Company had an average of 37,695 and 44,722 dilutive shares outstanding, respectively.
Potential common shares that would have the effect of increasing diluted earnings per share are considered to be anti-dilutive and not included in calculating diluted earnings per share. There was an average of 85,312 and 86,392 potentially anti-dilutive shares outstanding for the three and six month periods ended June 30, 2023, respectively, that were not included in calculating diluted earnings per share because their effect was anti-dilutive.
5. OTHER COMPREHENSIVE INCOME (LOSS)
The following tables summarize the changes in the components of accumulated other comprehensive income (loss) during the three and six month periods ended June 30, 2023 and 2022:
Balance at March 31, 2023
Net Change
Balance at June 30, 2023
Net unrealized loss on investment securities
(43,713)
(48,007)
Net defined benefit pension plan adjustments
(1,910)
(1,890)
Balance at March 31, 2022
Balance at June 30, 2022
(19,865)
(31,898)
(2,456)
(2,401)
Balance at December 31, 2022
(47,348)
(1,930)
Balance at December 31, 2021
(3,160)
(2,511)
Before-Tax Amount
Income Tax (Provision) Benefit
Net-of-Tax Amount
Unrealized loss on investment
securities:
(5,802)
1,508
(16,243)
4,210
Defined benefit pension plan
adjustments:
8
27
67
Net change
(20)
Other comprehensive (loss) income
(5,775)
1,501
(16,168)
4,190
(918)
259
(38,780)
10,042
(14)
135
(35)
151
(41)
(864)
(38,629)
10,001
6. NET PERIODIC BENEFIT COSTS
On January 31, 2008, the Bank froze its defined benefit pension plan. The plan covered substantially all Bank employees. The plan provides benefits that are based on the employees’ compensation and years of service. Under the freeze, eligible employees will receive, at retirement, the benefits already earned through January 31, 2008, but have not accrued any additional benefits since then. As a result, service cost is no longer incurred.
The Bank uses an actuarial method of amortizing prior service cost and unrecognized net gains or losses which result from actual expense and assumptions being different than those that are projected. The amortization method the Bank used recognized the prior service cost and net gains or losses over the average remaining service period of active employees.
The Bank also maintains a nonqualified supplemental executive retirement plan covering certain members of the Company’s senior management. The Bank uses an actuarial method of amortizing unrecognized net gains or losses which result from actual expense and assumptions being different than those that are projected. The amortization method the Bank uses recognizes the net gains or losses over the average remaining service period of active employees.
The following table presents the net periodic cost for the Bank’s defined benefit pension plan and supplemental executive retirement plan for the three and six month periods ended June 30, 2023 and 2022:
Three months ended June 30,
Supplemental Executive
Pension Benefits
Retirement Plan
Service cost
Interest cost
63
45
Expected return on plan assets
Amortization of the net loss
Net periodic (benefit) cost
99
116
Six months ended June 30,
66
125
(134)
(176)
47
(40)
197
232
The components of net periodic benefit cost other than the service cost component are included in the line item “other expense” in the income statement.
7. REVENUE RECOGNITION OF NON-INTEREST INCOME
A description of the Company’s material revenue streams in non-interest income accounted for under ASC 606 follows:
Insurance Service and Fees: Insurance services revenue relates to various revenue streams from services provided by TEA and the Bank:
TEA earns commission revenue from selling commercial and personal property and casualty (“P&C”) insurance as well as employee benefits solutions to commercial customers.
TEA has agreements with various insurance companies to sell policies to customers on behalf of the carriers. The performance obligation for TEA is to sell annual P&C policies to commercial customers and consumers. This performance obligation is met when a new policy is sold or when an existing policy renews. The policies are generally one year terms. In the agreements with the respective insurance companies, a commission rate is agreed upon. The commission is recognized at the time of the sale of the policy or when a policy renews.
TEA has signed contracts with insurance carriers that enable TEA to sell benefit plans to commercial customers on behalf of the insurance carriers. The performance obligation for TEA is to sell the plans to commercial customers. After the initial sale when the customer signs an agreement to purchase the offered benefit plan, the performance obligation is met each month when a customer continues utilizing benefit plans from the carrier. The customer does not commit to a specific length of time with the carrier. In the agreements with the respective insurance companies, a commission rate is agreed upon. Revenue is recognized each month when the customer continues with the benefit plan sold by TEA.
TEA also earns contingent profit sharing revenue. The insurance companies measure the loss ratio for TEA’s customers and pay TEA according to how profitable TEA customers are.
TEA has signed written agreements with insurance carriers that document payouts to TEA based on the loss ratios of its customers. The performance obligation for TEA is to maintain a customer base with loss ratios below the agreed upon thresholds. In the contracts with the insurance companies, payout rates based on loss ratios are documented. The consideration is variable as loss ratios vary based on customer experience. TEA’s performance obligation is over the course of the year as its customers’ performance with insurance carriers is measured throughout the year as losses occur. Due to the variable nature of contingent profit sharing revenue, TEA will accrue contingent profit sharing revenue throughout the year based on recent historical results. As loss events occur and overall performance becomes known to TEA, accrual adjustments will be made until the cash is ultimately received.
Financial services commission revenue from the Bank related to wealth management such as life insurance, annuities, and mutual funds sales is also included in the “insurance service and fees” line of the income statement.
The Company earns wealth management fees from its contracts with customers for certain financial services. Fees that are transaction-based are recognized at the point in time that the transaction is executed. Other related services provided include financial planning services and the fees the Bank earns are recognized when the services are rendered.
A disaggregation of the total insurance service and other fees for the three and six months ended June 30, 2023 and 2022 is provided in the tables below:
Commercial property and casualty insurance commissions
1,164
Personal property and casualty insurance commissions
999
930
Employee benefits sales commissions
167
209
Profit sharing and contingent revenue
198
191
Wealth management and other financial services
162
Other insurance-related revenue
Total insurance service and other fees
2,053
1,819
1,738
1,653
361
443
626
561
288
83
8. FAIR VALUE MEASUREMENT
Fair value is defined in ASC Topic 820 “Fair Value Measurement” as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
There are three levels of inputs to fair value measurement:
Level 1 inputs are quoted prices for identical instruments in active markets;
Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and
Level 3 inputs are unobservable inputs.
Observable market data should be used when available.
FINANCIAL INSTRUMENTS MEASURED AT FAIR VALUE ON A RECURRING BASIS
The following table presents, for each of the fair-value hierarchy levels as defined in this footnote, those financial instruments which are measured at fair value on a recurring basis as of June 30, 2023 and December 31, 2022, respectively:
Level 1
Level 2
Level 3
Fair Value
Securities available-for-sale:
US treasuries and government agencies
Securities available for sale
Fair values for available for sale securities are determined using independent pricing services and market-participating brokers. The Company utilizes a third-party for these pricing services. The third-party utilizes evaluated pricing models that vary by asset class and incorporate available trade, bid and other market information for structured securities, cash flow and, when available, loan performance data. Because many fixed income securities do not trade on a daily basis, the third-party service provider’s evaluated pricing applications apply information as applicable through processes, such as benchmarking of like securities, sector groupings, and matrix pricing, to prepare evaluations. In addition, our third-party pricing service provider uses model processes, such as the Option Adjusted Spread model, to assess interest rate impact and develop prepayment scenarios. The models and the process take into account market convention. For each asset class, a team of evaluators gathers information from market sources and integrates relevant credit information, perceived market movements and sector news into the evaluated pricing applications and models. The third-party, at times, may determine that it does not have sufficient verifiable information to value a particular security. In these cases the Company will utilize valuations from another pricing service.
On a quarterly basis the Company reviews changes, as submitted by our third-party pricing service provider, in the market value of its securities portfolio. Individual changes in valuations are reviewed for consistency with general interest rate movements and any known credit concerns for specific securities. Additionally, on a quarterly basis the Company has its entire securities portfolio priced by a second pricing service to determine consistency with another market evaluator. If, on the Company’s review or in comparing with another servicer, a material difference between pricing evaluations were to exist, the Company may submit an inquiry to our third-party pricing service provider regarding the data used to value a particular security. If the Company determines it has market information that would support a different valuation than our third-party service provider’s evaluation it can submit a challenge for a change to that security’s valuation.
Securities available for sale are classified as Level 2 in the fair value hierarchy as the valuation provided by the third-party provider uses observable market data.
ASSETS AND LIABILITIES MEASURED AT FAIR VALUE ON A NONRECURRING BASIS
The Company is required, on a nonrecurring basis, to adjust the carrying value of certain assets or provide valuation allowances related to certain assets using fair value measurements. The following table presents for each of the fair-value hierarchy levels as defined in this footnote, those financial instruments which are measured at fair value on a nonrecurring basis June 30, 2023 and December 31, 2022:
Collateral dependent impaired loans
1,168
1,170
Impaired loans
Collateral dependent loans carried at fair value have been partially charged-off or receive individually analyzed allocations of the allowance for credit losses. The Company evaluates and values collateral dependent impaired loans at the time the loan is identified as impaired, and the fair values of such loans are estimated using Level 3 inputs in the fair value hierarchy. Each loan’s collateral value has a unique appraisal and management’s discount of the value is based on factors unique to each impaired loan. The significant unobservable input in determining the fair value is management’s subjective discount on appraisals of the collateral securing the loan, which ranges from 10%-50%. Fair value is estimated based on the value of the collateral securing these loans. Collateral may consist of real estate and/or business assets including equipment, inventory and/or accounts receivable and the value of these assets is determined based on appraisals by qualified licensed appraisers hired by the Company. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, estimated costs to sell, and/or management’s expertise and knowledge of the client and the client’s business.
The Company has an appraisal policy in which appraisals are obtained upon a commercial loan being downgraded on the Company’s internal loan rating scale to a special mention or a substandard depending on the amount of the loan, the type of loan and the type of collateral. All impaired commercial loans are graded substandard or worse on the internal loan rating scale. For consumer loans, the Company obtains appraisals when a loan becomes 90 days past due or is determined to be impaired, whichever occurs first. Subsequent to the downgrade or reaching 90 days past due, if the loan remains outstanding and impaired for at least one year more, management may require another follow-up appraisal. Between receipts of updated appraisals, if necessary, management may perform an internal valuation based on any known changing conditions in the marketplace such as sales of similar properties, a change in the condition of the collateral, or feedback from local appraisers. Collateral dependent impaired loans had a gross value of $1.4 million, with an allowance for credit loss of $0.2 million, at June 30, 2023 compared with $1.5 million and $0.4 million, respectively, at December 31, 2022.
The table below depicts the estimated fair values of the Company’s financial instruments, including those that are not measured and reported at fair value on a recurring basis or nonrecurring basis.
Carrying
Amount
Financial assets:
Level 1:
Cash and cash equivalents
Level 2:
Available for sale securities
FHLB and FRB stock
7,026
N/A
13,511
Level 3:
Held to maturity securities
1,571,996
1,564,641
Financial liabilities:
Demand deposits
NOW deposits
Savings deposits
Securities sold under agreement to
repurchase
Other borrowed funds
139,678
192,443
30,060
30,263
Time deposits
310,117
199,910
9. SEGMENT INFORMATION
The Company comprises two primary business segments, banking and insurance agency activities. The following tables set forth information regarding these segments for the three and six month periods ended June 30, 2023 and 2022.
Banking
Insurance Agency
Activities
Net interest income
Net interest income after
provision for credit losses
Other non-interest income
1,981
Amortization expense
95
Other non-interest expense
12,225
1,847
14,072
Income before income taxes
5,701
625
Income tax provision
1,241
4,460
169
2,398
2,045
12,885
1,799
14,684
7,109
504
1,748
131
5,361
373
276
4,873
3,665
190
24,782
3,692
28,474
12,925
991
2,948
236
9,977
308
4,558
4,177
25,387
3,657
29,044
13,153
711
3,197
185
9,956
526
10. CONTINGENT LIABILITIES AND COMMITMENTS
The unaudited consolidated financial statements do not reflect various commitments and contingent liabilities, which arise in the normal course of business, and which involve elements of credit risk, interest rate risk and liquidity risk. These commitments and contingent liabilities consist of commitments to extend credit and standby letters of credit. A summary of the Bank’s commitments and contingent liabilities is as follows:
Commitments to extend credit
439,445
376,167
Standby letters of credit
2,848
3,673
442,293
379,840
Commitments to extend credit and standby letters of credit include some exposure to credit loss in the event of nonperformance by the customer. The Bank’s credit policies and procedures for credit commitments and financial guarantees are the same as those for extensions of credit that are recorded on the Company’s unaudited consolidated balance sheets. Because these instruments have fixed maturity dates, and because they may expire without being drawn upon, they do not necessarily represent cash requirements of the Bank. The Bank did not incur any losses on its commitments and did not record a reserve for its commitments during the first six months of 2023 or during 2022.
Certain lending commitments for construction residential mortgage loans are considered derivative instruments under the guidelines of GAAP. The changes in the fair value of these commitments, due to interest rate risk, are not recorded on the consolidated balance sheets as the fair value of these derivatives is not considered to be material.
11. RECENT ACCOUNTING PRONOUNCEMENTS
The FASB establishes changes to U.S. GAAP in the form of accounting standards updates (“ASUs”) to the FASB Accounting Standards Codification. The Company considers the applicability and impact of all ASUs when they are issued by FASB. Effective January 1, 2023 the Company adopted both ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses of Financial Instruments and ASU 2022-02, Financial Instruments – Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures. Excluding those ASUs, the Company did not adopt any accounting pronouncements during its current fiscal year that had a material impact on the Company’s consolidated financial position, results of operations, cash flows or disclosures. There have been no accounting standards that have been recently issued but not yet required to be adopted as of June 30, 2023 that management expects will have a material impact on the Company’s financial condition, results of operations, cash flows or disclosures.
ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments – The Company adopted this ASU (commonly known as the Current Expected Credit Loss Impairment Model, or CECL) effective January 1, 2023. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in CECL replace the incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. See Note 3 – “Loans and the Allowance for Credit Losses” to this Quarterly Report on Form 10-Q for further details regarding the Company’s accounting policy for determining the Allowance for Credit Losses under this new accounting standard.
Upon adoption of ASU 2016-13, Measurement of Credit Losses on Financial Instruments, the Company recognized a $2.7 million increase in the allowance for credit losses as of January 1, 2023 with a net of tax cumulative effect adjustment to retained earnings of $2.0 million.
ASU 2022-02, Financial Instruments – Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures – The Company adopted this ASU effective January 1, 2023. This ASU eliminates the accounting guidance for troubled debt restructurings ("TDRs") in ASC 310-40, "Receivables - Troubled Debt Restructurings by Creditors" for entities that have adopted the CECL model introduced by ASU 2016-13. ASU 2022-02 also requires that public business entities disclose current-period gross charge-offs by year of origination for financing receivables and net investments in leases within the scope of Subtopic 326-20, "Financial Instruments—Credit Losses—Measured at Amortized Cost". The adoption of ASU 2022-02 did not have a material impact on the Company’s financial condition, results of operations or cash flows, but did affect the financial statement disclosures.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Quarterly Report on Form 10-Q may contain certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that involve substantial risks and uncertainties. When used in this report, or in the documents incorporated by reference herein, the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “seek,” and similar expressions identify such forward-looking statements. These forward-looking statements include statements regarding the Company’s business plans, prospects, growth and operating strategies, statements regarding the asset quality of the Company’s loan and investment portfolios, and estimates of the Company’s risks and future costs and benefits.
These forward-looking statements are based largely on the expectations of the Company’s management and are subject to a number of risks and uncertainties, including but not limited to: adverse changes in general economic conditions, either nationally or in the Company’s market areas; increased competition among depository or other financial institutions; inflation and changes in the interest rate environment that reduce the Company’s margins or reduce the fair value of financial instruments; the cost and availability of funds; changes in laws or government regulations affecting financial institutions, including changes in regulatory fees, monetary policy, and capital requirements; the Company’s ability to enter new markets successfully and capitalize on growth opportunities; the Company’s ability to successfully integrate acquired entities; credit losses in excess of the Company’s allowance for credit losses; changes in accounting pronouncements and practices, as adopted by financial institution regulatory agencies, the Financial Accounting Standards Board and the Public Company Accounting Oversight Board; the impact of such changes in accounting pronouncements and practices being greater than anticipated; the ability to realize the benefit of deferred tax assets; changes in tax policies, rates and regulations of federal, state and local tax authorities; changes in consumer spending, borrowing and saving habits; changes in the Company’s organization, compensation and benefit plans; and other factors discussed elsewhere in this Quarterly Report on Form 10-Q, as well as in the Company’s periodic reports filed with the Securities and Exchange Commission (the “SEC”), in particular the “Risk Factors” discussed in Item 1A of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2022 and this Quarterly Report on Form 10-Q. Many of these factors are beyond the Company’s control and are difficult to predict.
Because of these and other uncertainties, the Company’s actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements contained herein. Forward-looking statements speak only as of the date they are made. The Company undertakes no obligation to publicly update or revise forward-looking information, whether as a result of new, updated information, future events or otherwise, except to the extent required by law.
The Discussion and Analysis of Financial Condition and Results of Operations that follows includes comparisons of the quarter ended June 30, 2023 to the quarter ended June 30, 2022 as well as the trailing quarter ended March 31, 2023, and of the six months ended June 30, 2023 to the six months ended June 30, 2022. Financial information for the quarter ended March 31, 2023 can be found in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2023, as filed with the SEC on May 2, 2023.
APPLICATION OF CRITICAL ACCOUNTING ESTIMATES
The Company’s Unaudited Consolidated Financial Statements included in this Quarterly Report on Form 10-Q are prepared in accordance with U.S. GAAP and follow general practices within the industries in which it operates. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the Company’s Unaudited Consolidated Financial Statements and Notes. These estimates, assumptions, and judgments are based on information available as of the date of the Unaudited Consolidated Financial Statements. Accordingly, as this information changes, the Unaudited Consolidated Financial Statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments, and as such, have a greater possibility of producing results that could be materially different than originally reported.
Significant accounting policies followed by the Company are presented in Note 1 – “Organization and Summary of Significant Accounting Policies” to the Audited Consolidated Financial Statements included in Item 8 in its Annual Report on Form 10-K for the year ended December 31, 2022. These policies, along with the disclosures presented in the other Notes to the Company's Audited Consolidated Financial Statements contained in its Annual Report on Form 10-K and in this financial review, provide information on how significant assets and liabilities are presented in the Company’s Unaudited Consolidated Financial Statements and how those values are determined.
Effective January 1, 2023 the Company adopted ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments. See Note 3 – “Loans and the Allowance for Credit Losses” to this Quarterly Report on Form 10-Q for the accounting policy for determining the Allowance for Credit Losses (“ACL”).
The more significant areas in which management of the Company applies critical assumptions and estimates includes the allowance for credit losses.
Allowance for Credit Losses
The ACL on loans is management’s estimate of expected lifetime credit losses on loans carried at amortized cost. The ACL on loans is established through a provision for credit losses recognized in the Consolidated Statements of Income. Additionally, the ACL on loans is reduced by charge-offs on loans and increased by recoveries of amounts previously charged-off. At June 30, 2023 the ACL on loans totaled $21.4 million, compared to $22.2 million recorded upon adoption of ASU 2016-13 at January 1, 2023. A significant portion of our ACL is allocated to the commercial portfolio (both commercial real estate and commercial and industrial (“C&I”) loans). As of June 30, 2023, March 31, 2023 and January 1, 2023, the ACL allocated to the total commercial portfolio was $17.6 million, $17.8 million and $18.0 million, respectively.
Management employs a process and methodology to estimate the ACL on loans that evaluates both quantitative and qualitative factors. The methodology for evaluating quantitative factors consists of two basic components: pooling loans into portfolio segments for loans that share similar risk characteristics and identifying individually analyzed loans that do not share similar risk characteristics with loans that are pooled into portfolio segments.
For pooled loan portfolio segments, the Company utilizes a discounted cash flow (“DCF”) methodology to estimate credit losses over the expected life of the loan. The methodology incorporates a probability of default and loss given default framework. Loss given default is estimated based on historical credit loss experience. Probability of default is estimated utilizing a regression model that incorporates econometric factors. The model utilizes forecasted econometric factors with a one-year reasonable and supportable forecast period and one-year straight-line reversion period in order to estimate the probability of default for each loan portfolio segment. The DCF methodology combines the probability of default, the loss given default, prepayment speeds and the remaining life of the loan to estimate a reserve for each loan.
The ACL for individually analyzed loans is measured using a DCF method based upon the loan’s contractual effective interest rate, or at the loan’s observable market price, or, if the loan was collateral dependent, at the fair value of the collateral.
Quantitative loss factors are also supplemented by certain qualitative risk factors reflecting management’s view of how losses may vary from those represented by quantitative loss rates. Qualitative loss factors are applied to each portfolio segment with the amounts determined by historical loan charge-offs of a peer group of similar-sized regional banks.
Because the methodology is based upon historical experience and trends, current economic data, reasonable and supportable forecasts, as well as management’s judgment, factors may arise that result in different estimations. Deteriorating conditions or assumptions could lead to further increases in the ACL on loans; conversely, improving conditions or assumptions could lead to further reductions in the ACL on loans.
In estimating the ACL on loans, management considers the sensitivity of the model and significant judgments and assumptions that could result in an amount that is materially different from management’s estimate. Given the concentration of ACL allocation to the total commercial portfolio and the significant judgments made by management in deriving the qualitative loss factors, management analyzed the impact that changes in judgments could have. The result was an ACL allocated to the total commercial loan portfolio that ranged between $13.5 million and $28.5 million at June 30, 2023. The sensitivity and related range of impact is a hypothetical analysis and is not intended to represent management’s judgments or assumptions of qualitative loss factors that were utilized at June 30, 2023 in estimation of the ACL on loans recognized on the Consolidated Balance Sheet.
If the assumptions underlying the determination of the ACL prove to be incorrect, the ACL may not be sufficient to cover actual loan losses and an increase to the ACL may be necessary to allow for different assumptions or adverse developments. In addition, a problem with one or more loans could require a significant increase to the ACL.
ANALYSIS OF FINANCIAL CONDITION
Loan Activity
Total gross loans were $1.7 billion at June 30, 2023 and December 31, 2022 compared with $1.6 billion at June 30, 2022. Loans secured by real estate were $1.4 billion at June 30, 2023, December 31, 2022 and June 30, 2022. Residential real estate loans, including construction loans, were $441 million at June 30, 2023, $2 million or 1% lower than at December 31, 2022, and $12 million or 3% higher than at June 30, 2022. The increase in residential real estate loans from June 30, 2022 reflects management’s decision to retain the majority of residential mortgages originated within our loan portfolio. Commercial real estate loans, including construction loans, were $920 million at June 30, 2023, $24 million or 3% higher than the balance at December 31, 2022, and $55 million or 6% higher than the balance at June 30, 2022.
In the second quarter of 2023, residential mortgage originations were $10 million compared with the previous quarter’s originations of $8 million and $18 million in the second quarter of 2022. The Company originated $18 million in residential mortgages in the first six months of 2023, compared with $40 million in the first six months of 2022. The decrease in residential mortgage originations as compared to the prior year was primarily due to the impact of the rising rate environment. The Company sold $3 million of residential mortgages during the second quarter of 2023 compared with $1 million during the first quarter of 2023. During the first six months of 2023 the Company sold $4 million of residential mortgages. The Company sold $4 million of residential mortgages during the first six months of 2022. Management decides to keep or sell residential mortgage loans at the time of origination based on interest rate risk management and the risk-adjusted return of alternative investment sources such as mortgage-backed securities.
The Company has also focused on growth opportunities in C&I lending as a way to diversify its overall loan portfolio. The C&I portfolio was $228 million at June 30, 2023, representing a $22 million or a 9% decrease from December 31, 2022. When compared with last year’s second quarter, C&I loans decreased $5 million or 2%, excluding Paycheck Protection Program loan balances.
Credit Quality of Loan Portfolio
Non-performing loans, defined as accruing loans greater than 90 days past due and nonaccrual loans, totaled $28 million, or 1.66% of total loans outstanding at June 30, 2023, compared with $25 million, or 1.48% of total loans outstanding, as of December 31, 2022 and $22 million, or 1.36% of total loans outstanding, as of June 30, 2022.
Commercial credits graded as “special mention” and “substandard,” or the criticized loan portfolio, were $74 million at June 30, 2023, a $19 million decrease from $93 million at December 31, 2022, and a $34 million decrease from $108 million at June 30, 2022. The level of criticized loans can fluctuate as new information is constantly received on the Company’s borrowers and their financial circumstances change over time. Internal risk rating are the credit quality indicators used by management to monitor credit risk in its commercial loan portfolio. “Special mention” and “substandard” loans are weaker credits with a higher risk of loss and are categorized as “criticized” credits rather than “pass” or “watch” credits.
Prior to January 1, 2023, the allowance for credit losses represented the amount that in management’s judgement reflected incurred credit losses inherent in the loan and lease portfolio as of the balance sheet date. Based on portfolio composition, then current economic conditions, and reasonable and supportable forecasts of future conditions, the Company recognized an increase to the allowance for credit losses of $2.7 million upon adoption of the new credit loss accounting standard, ASU 2016-13, Financial instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments, as of January 1, 2023 as compared with the allowance for credit losses recognized on its consolidated balance sheet at December 31, 2022. The $2.7 million increase was recognized as a net of tax cumulative effect adjustment to retained earnings of $2.0 million.
The Company recorded a $0.1 million release of allowance during the three months ended June 30, 2023, primarily due to lower criticized loan balances and lower reserves on individually analyzed loans, partially offset by loan growth.
Prior to the adoption of ASU 2016-13, loans acquired in a business combination were recorded at fair value with no carry-over of an acquired entity’s previously established allowance for credit losses. Acquired loans that previously did not have an allowance valuation totaled $129 million at January 1, 2023. Upon adoption of the new ACL accounting standard these loans contributed $1 million to the allowance for credit losses. The allowance for credit losses totaled $21.4 million or 1.28% of total loans outstanding at June 30, 2023, compared with $19.4 million, or 1.16% of total loans outstanding as of December 31, 2022, and $18.8 million, or 1.17% of total loans outstanding at June 30, 2022. The increase in the percentage of allowance for credit losses to total loans outstanding from both comparative periods was the result of the adoption of the new accounting standard.
Investing Activities
Total investment securities were $354 million at June 30, 2023, compared with $371 million at December 31, 2022 and $403 million at June 30, 2022. The decreases reflect changes in unrealized losses on investment securities and maturities within our available-for-sale investment portfolio. Interest-bearing deposits at other banks, which consist of overnight funds kept at correspondent banks and the Federal Reserve, were $10 million at June 30, 2023 compared to $6 million at December 31, 2022, and $88 million at June 30, 2022. The primary objectives of the Company’s investment portfolio are to provide liquidity, provide collateral to secure municipal deposits, and maximize income while preserving safety of principal. Average investment securities and interest-bearing cash were 19% of average interest-earning assets in both the second quarter of 2023 and sequential first quarter, compared with 24% in the second quarter of 2022.
The Company’s highest concentration in its securities portfolio was in available for sale U.S. government sponsored mortgage-backed securities which comprised 55%, 54% and 55% of total investment securities at June 30, 2023, December 31, 2022 and June 30, 2022, respectively. Tax-advantaged debt securities issued by state and political subdivisions as a percent of the total investment securities portfolio were 2% in each of the second quarters of 2023 and 2022, and the first quarter of 2023.
The total net unrealized loss position of the available-for-sale investment portfolio was $65 million at June 30, 2023, compared with $64 million at December 31, 2022 and $43 million at June 30, 2022. The securities in an unrealized loss position at the end of the second quarter of 2023 generally reflect an increase in market interest rates. Management believes that the credit quality of the securities portfolio as a whole is strong.
The Company monitors extension and prepayment risk in the securities portfolio to limit potential exposures. The Company has no direct exposure to subprime mortgages, nor does the Company hold private mortgage-backed securities, credit default swaps, or FNMA or FHLMC preferred stock investments in its investment portfolio.
Funding Activities
Total deposits at June 30, 2023 were $1.8 billion, a $15 million or 1% increase from December 31, 2022, but a decrease of $182 million or 9% from June 30, 2022. When compared to last year’s second quarter, there were decreases in consumer savings of $196 million, demand deposits of $108 million, commercial savings of $64 million, municipal savings of $29 million, and brokered deposits of $6 million. Those decreases were offset by higher consumer time deposits of $183 million and NOW deposits of $38 million. These changes include $14 million that transferred to our securities under agreement to repurchase account during the second quarter of 2023, which provides commercial clients collateralization for their deposits. In addition, consumer clients continue migrating from saving accounts to higher-yielding accounts such as time deposits.
Total borrowings decreased from $193 million at December 31, 2022 to $140 million at June 30, 2023. The decrease is primarily due to investment securities maturities, growth in deposits and securities under agreement to repurchase. The Company had $6 million in long-term Federal Home Loan Bank of New York (“FHLBNY”) advances at June 30, 2023, compared with $20 million at December 31, 2022 and $23 million at June 30, 2022. This represents long-term advances from FHLBNY that were acquired in the FSB acquisition. As of June 30, 2023 the Bank had $34 million in overnight borrowings at the FHLB. The Company’s use of its overnight line of credit with FHLBNY varies depending on its ability to fund investment and loan growth with deposits along with the line usage’s impact on interest rate risk. Additionally, the Bank has the ability to borrow from the Federal Reserve and participates in the Bank Term Funding Program. At June 30, 2023 the Bank had $100 million in short-term borrowings with the Federal Reserve. There were no overnight borrowings at the FHLB or short-term borrowings at the Federal Reserve at June 30, 2022.
ANALYSIS OF RESULTS OF OPERATIONS
Average Balance Sheets
The following tables present the significant categories of the assets and liabilities of the Company, interest income and interest expense, and the corresponding yields earned and rates paid for the periods indicated. The assets and liabilities are presented as daily averages. The average loan balances include both performing and non-performing loans. Interest income on loans does not include interest on loans for which the Bank has ceased to accrue interest. Investments are included at book value. Yields are presented on a non-tax-equivalent basis.
Average
Interest
Outstanding
Earned/
Yield/
Paid
Rate
(dollars in thousands)
Interest-earning assets:
1,646,502
5.26
1,591,971
4.24
Taxable securities
366,568
2.46
382,512
2.08
Tax-exempt securities
7,354
2.95
9,859
2.40
Interest bearing deposits at banks
7,235
4.44
111,457
0.81
Total interest-earning assets
2,027,659
4.75
2,095,799
3.65
Non interest-earning assets:
13,547
14,219
Premises and equipment, net
16,428
17,511
99,818
84,472
Total Assets
2,157,452
2,212,001
LIABILITIES & STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
281,910
1.24
258,197
0.09
776,020
3,058
1.58
1,020,004
348
0.14
304,575
2,353
3.10
143,677
0.49
116,524
1,429
4.92
25,321
0.63
31,111
6.97
31,010
5.47
Securities sold U/A to repurchase
15,703
57
1.46
6,872
0.12
Total interest-bearing liabilities
1,525,843
2.18
1,485,081
0.28
Noninterest-bearing liabilities:
451,990
542,827
18,532
17,562
1,996,365
2,045,470
Stockholders' equity
161,087
166,531
Total Liabilities and Equity
Net interest margin
3.45
Interest rate spread
2.57
3.37
1,643,847
5.21
1,579,413
4.16
368,671
2.49
364,915
2.02
9,431
3.06
10,331
2.05
8,523
144,907
0.41
2,030,472
4.70
2,099,566
3.52
15,163
13,763
16,662
17,604
100,026
81,909
2,162,323
2,212,842
271,135
1,352
1.01
255,595
112
Regular savings
786,349
4,918
1.26
1,022,214
692
281,283
4,026
2.89
150,070
344
0.46
125,570
2,925
27,289
85
31,099
1,066
6.91
30,997
5.36
11,499
60
1.05
5,887
1,506,935
1.92
1,492,052
477,824
527,558
19,505
19,220
2,004,264
2,038,830
158,059
174,012
3.28
3.32
2.78
3.24
Net income was $4.9 million, or $0.90 per diluted share, in the second quarter of 2023, compared with $5.8 million, or $1.06 per diluted share, in the first quarter of 2023 and $5.7 million, or $1.03 per diluted share, in last year’s second quarter. The change from the first quarter of 2023 was largely due to a decrease in net interest income and lower release of allowance for credit losses, partially offset by higher non-interest income and lower non-interest expense. The change from the prior year’s second quarter largely reflected a reduction in net interest income, partially offset by lower non-interest expense and a release of allowance compared to a provision for credit losses in the prior year period. Return on average equity was 12.25% for the second quarter of 2023, compared with 14.97% in the first quarter of 2023 and 13.77% in the second quarter of 2022.
Net income was $10.7 million, or $1.96 per diluted share, in the first six months of 2023, compared with $10.5 million, or $1.89 per diluted share, in the first six months of 2022. The increase from last year’s comparative period was due to a release of allowance for credit losses of $0.8 million compared with provision for credit losses of $0.5 million during the first half of 2022. In addition, non-interest expense decreased $0.6 million year-over-year. Offsetting those benefits were decreases in net interest income of $1.5 million and non-interest income of $0.2 million.
Other Results of Operations – Quarterly Comparison
Net interest income of $15.7 million decreased $1.6 million, or 9%, from the sequential first quarter, and $2.4 million, or 13% when compared with the prior year’s second quarter. The decrease from the prior quarters reflected higher interest expense given the cost increase of interest-bearing liabilities as a result of competitive pricing on deposits in the rising interest rate environment.
Second quarter net interest margin of 3.10% declined 36 basis points from the first quarter of 2023 and 35 basis points from the second quarter of 2022. The yield on loans increased 10 basis points compared with the first quarter of 2023 and 102 basis points compared with the second quarter of 2022. The cost of interest-bearing liabilities was 2.18% in the second quarter of 2023 compared with 1.65% in the first quarter of 2023 and 0.28% in the second quarter of 2022.
The $0.1 million release of allowance in the current quarter was largely due to lower criticized loan balance, and lower reserves on individually analyzed loans, partially offset by loan growth.
Non-interest income was $4.7 million in the second quarter of 2023 compared with $4.1 million in the first quarter of 2023, and $4.6 million in the prior year’s second quarter. The increase from the sequential first quarter reflects an increase of $0.3 million in insurance service and fee revenue due to seasonally higher policy renewals for institutional clients, movements in mortgage servicing rights, and higher loan fees. The increase from the prior year’s second quarter was largely due to higher insurance service and fee revenue from commissions and new commercial lines insurance sales.
Non-interest expenses of $14.2 million in the second quarter of 2023 decreased $0.3 million, or 2%, when compared with the first quarter of 2023 and $0.6 million, or 4%, from last year’s second quarter. Salaries and employee benefits were down $0.8 million, or 8%, from both comparative periods. Included in salaries and employee benefits during the first quarter of 2023 was the funding of employee’s heath savings accounts and payroll taxes that are typically higher in the first quarter. Compared with the second quarter or 2022, the decrease was primarily due to lower incentive accruals of $1.2 million, partially offset by merit increases and strategic hires.
Included in non-interest expenses are technology and communication expenses. Technology and communications increased $0.2 million from the sequential first quarter and $0.3 million from last year’s second quarter primarily due to higher ATM card fees and software costs.
The Company’s GAAP efficiency ratio, or noninterest expenses divided by the sum of net interest income and noninterest income, was 69.5% in the second quarter of 2023, 67.6% in the first quarter of 2023, and 65.2% in the second quarter of 2022.
Income tax expense was $1.4 million, for an effective tax rate of 22.0%, in the second quarter of 2023 compared with 23.6% in the first quarter of 2023 and 24.7% in last year’s second quarter. The decreases were due to stable non-taxable income and a decreasing overall pre-tax income base.
Other Results of Operations – Year-to-Date Comparison
Net interest income was $33.0 million for the first six months of 2023, a $1.5 million or 4% decrease from the first six months of 2022. The decrease from last year’s comparative period was due to higher cost of interest-bearing liabilities, partially offset by higher interest earned on loans and investment securities. Average loans increased $64 million during the first six months of 2023 when compared to the prior year period.
The Company’s net interest margin of 3.28% in the first six months of 2023 was 4 basis points lower than the 3.32% margin in the first six months of 2022. The yield on loans during the first six months of 2023 increased 105 basis points, from 4.16% to 5.21% when compared with the first six months of 2022. In the first six months of 2023 the cost of interest-bearing liabilities increased 164 basis points to 1.92% when compared with the first six months of 2022. The rate paid on average time deposits increased from 0.46% in the first half of 2022 to 2.89% during the first six months of 2023.
The Company had a $0.8 million release of allowance in the six-month period ended June 30, 2023 largely due to lower criticized loan balances, lower reserves on individually analyzed loans, and a reduction in the rate of increases in home prices in the Company’s market, partially offset by loan growth, compared to a provision for credit losses of $0.5 million for the six-month period ended June 30, 2022.
Non-interest income for the first six months of 2023 and 2022 was $9 million for both respective periods. During the first six months of 2023 changes in the fair value of mortgage servicing rights decreased non-interest income by $0.2 million when compared to last
year’s comparative period. Partially offsetting the decrease was an increase in insurance service and fees revenue, the largest component of non-interest income, which increased $0.3 million to $5.1 million as of June 30, 2023.
Total non-interest expense decreased to $28.7 million in the first six months of 2023, 2% lower than the six-month period ended June 30, 2022. The decrease from last year’s second quarter was mostly attributable to lower salaries and employee benefits costs of $0.8 million and loan fees of $0.3 million. Salaries and employee benefits costs were $18.1 million for the first six months of 2023 compared to $18.9 million in the prior year period. This decrease was due to lower incentive accruals, partially offset by merit increases and strategic hires. Partially offsetting those decreases was higher technology and communications costs of $0.5 million.
The Company’s GAAP efficiency ratio, or noninterest expenses divided by the sum of net interest income and noninterest income, was 68.6% in the first six months of 2023, compared with 67.1% during the prior-year period.
The Company recorded income tax expense of $3.2 million for the six-month period ended June 30, 2023, compared with $3.4 million in the first six months of 2022. The effective tax rate for the first six months of 2023 was 22.9%, compared with 24.4% in the comparable 2022 period. The decrease is due to stable non-taxable income on a decreasing overall pre-tax income base.
CAPITAL
The Company consistently maintains regulatory capital ratios significantly above the federal “well capitalized” standard, including a Tier 1 leverage ratio of 9.43% at June 30, 2023, compared with 9.13% at March 31, 2023 and 8.73% at June 30, 2022.
Book value per share was $29.12 at June 30, 2023 compared with $28.97 at March 31, 2023 and $29.53 at June 30, 2022. Reflected in the book value changes are the Federal Reserve’s aggressive interest rate hikes, that have resulted in significant changes in unrealized gains and losses on investment securities, which reduced book value per share at June 30, 2022 by $2.94 when compared with the last year’s second quarter. Such unrealized gains and losses are generally due to changes in interest rates and represent the difference, net of applicable income tax effect, between the estimated fair value and amortized cost of investment securities classified as available-for-sale.
The Company has also issued subordinated capital notes and junior subordinated debentures associated with trust preferred securities to provide liquidity and enhance regulatory capital ratios. The Company had $11.3 million of junior subordinated debentures associated with trust preferred securities outstanding at June 30, 2023 and December 31, 2022 which are considered Tier 1 capital and are includable in total regulatory capital. On July 9, 2020, the Company executed a private offering of $20 million of its 6.00% Fixed-to-Floating Rate Subordinated Notes due 2030. During 2020, $15 million of the proceeds from the sale of the Notes were contributed to Evans Bank as Tier 1 capital.
While we are currently classified as well capitalized, an extended economic recession could adversely impact our reported and regulatory capital ratios. The Company relies on cash on hand as well as dividends from its subsidiary bank to service its debt. If the Company’s subsidiary bank’s capital deteriorates such that it is unable to pay dividends to the Company for an extended period of time, the Company may not be able to service its debt that was issued.
LIQUIDITY
The Bank utilizes cash flows from the investment portfolio and federal funds sold balances to manage the liquidity requirements related to loan demand and deposit fluctuations. The Bank also has many borrowing options. The Company uses the FHLBNY as its primary source of overnight funds and has long-term advance with FHLBNY. The Company’s use of its overnight line of credit with FHLBNY varies depending on its ability to fund investment and loan growth with core deposits along with the line usage’s impact on interest rate risk. The Company has pledged sufficient collateral in the form of residential and commercial real estate loans at FHLBNY that meets FHLB collateral requirements. As a member of the FHLB, the Bank is able to borrow funds at competitive rates. As of June 30, 2023, advances of up to $337 million could be drawn on the FHLB via an Overnight Line of Credit Agreement between the Bank and the FHLB. The Bank also has the ability to borrow from the Federal Reserve and participates in the Bank Term Funding Program. At June 30, 2023 the Bank had $54.5 million in additional availability to borrow against collateral at the Federal Reserve. By placing sufficient collateral in safekeeping at the Federal Reserve Bank, the Bank could borrow at the discount window. As of June 30, 2023, the Bank had the ability to purchase up to $18 million in federal funds from its correspondent banks. The Bank’s liquidity needs also can be met by more aggressively pursuing time deposits, or accessing the brokered time deposit market, including the Certificate of Deposit Account Registry Service (“CDARS”) network.
Cash flows from the Bank’s investment portfolio are laddered, so that securities mature at regular intervals, to provide funds from principal and interest payments at various times as liquidity needs may arise. Contractual maturities are also laddered, with consideration as to the volatility of market prices. At June 30, 2023, approximately 2% of the Bank’s securities had contractual maturity dates of one year or less and approximately 25% had maturity dates of five years or less. Additionally, mortgage-backed securities, which comprised 55% of the investment portfolio at June 30, 2023, provide consistent cash flows for the Bank.
The Company’s primary source of liquidity is dividends from the Bank. Additionally, the Company has access to capital markets as a funding source.
Management, on an ongoing basis, closely monitors the Company’s liquidity position for compliance with internal policies and believes that available sources of liquidity are adequate to meet funding needs in the normal course of business. As part of that monitoring process, management calculates the 90-day liquidity each month by analyzing the cash needs of the Bank. Included in the calculation are liquid assets and potential liabilities. Management stresses the potential liabilities calculation to ensure a strong liquidity position. Included in the calculation are assumptions of some significant deposit run-off as well as funds needed for loan closings and investment purchases. In the Company’s internal stress test at June 30, 2023, the Company had net short-term liquidity of $352 million as compared with $209 million at December 31, 2022. Available assets of $367 million, divided by public and purchased funds of $536 million, resulted in a long-term liquidity ratio of 68% at June 30, 2023, compared with 75% at December 31, 2022.
Management does not anticipate engaging in any activities, either currently or in the long term, for which adequate funding would not be available and which would therefore result in significant pressure on liquidity.
The Company believes that the Bank maintains a sufficient level of U.S. government and government agency securities and New York State municipal bonds that can be pledged as collateral for municipal deposits.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Additional information responsive to this Item is contained in the Liquidity section of Management’s Discussion and Analysis of Financial Condition and Results of Operations, which information is incorporated herein by reference.
Market risk is the risk of loss from adverse changes in market prices and/or interest rates of the Bank’s financial instruments. The primary market risk that the Company is exposed to is interest rate risk. The core banking activities of lending and deposit-taking expose the Bank to interest rate risk, which occurs when assets and liabilities reprice at different times and by different amounts as interest rates change. As a result, net interest income earned by the Bank is subject to the effects of changing interest rates. The Bank measures interest rate risk by calculating the variability of net interest income in future periods under various interest rate scenarios using projected balances for interest-earning assets and interest-bearing liabilities. Management’s philosophy toward interest rate risk management is to limit the variability of net interest income to changes in net interest rates. The balances of financial instruments used in the projections are based on expected growth from forecasted business opportunities, anticipated prepayments of loans, and expected maturities of investment securities, loans, and deposits. Management supplements the modeling technique described above with analysis of market values of the Bank’s financial instruments and changes to such market values given changes in the interest rates.
The Bank’s Asset-Liability Committee, which includes members of senior management, monitors the Bank’s interest rate sensitivity with the aid of a model that considers the impact of ongoing lending and deposit taking activities, as well as interrelationships in the magnitude and timing of the repricing of financial instruments, including the effect of changing interest rates on expected prepayments and maturities. When deemed prudent, management has taken actions, and intends to do so in the future, to mitigate exposure to interest rate risk through the use of on- or off-balance sheet financial instruments. Possible actions include, but are not limited to, changing the pricing of loan and deposit products, and modifying the composition of interest-earning assets and interest-bearing liabilities, and reliance on other financial instruments used for interest rate risk management purposes.
The following table demonstrates the possible impact of changes in interest rates on the Bank’s net interest income over a 12-month period of time:
SENSITIVITY OF NET INTEREST INCOME TO CHANGES IN INTEREST RATES
Calculated increase (decrease)
in projected annual net interest income
Changes in interest rates
+200 basis points
(2,680)
(2,867)
+100 basis points
695
770
-100 basis points
(715)
(962)
-200 basis points
(1,334)
(2,661)
Many assumptions were utilized by management to calculate the impact that changes in interest rates may have on the Bank’s net interest income. The more significant assumptions related to the rate of prepayments of mortgage-related assets, loan and deposit volumes and pricing, and deposit maturities. The Bank assumed immediate changes in rates including 200 basis point rate changes. In the 200 basis point rate reduction scenario, the applicable rate changes may be limited to lesser amounts such that interest rates are not less than zero. The assumptions in the Company’s projections are inherently uncertain and, as a result, the Bank cannot precisely predict the impact of changes in interest rates on net interest income. Actual results may differ significantly due to the timing, magnitude, and frequency of interest rate changes in market conditions and interest rate differentials (spreads) between maturity/repricing categories, as well as any actions such as those previously described, which management may take to counter such changes. In light of the uncertainties and assumptions associated with the process, the amounts presented in the table and changes in such amounts are not considered significant to the Bank’s projected net interest income.
ITEM 4 - CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
The Company’s management, with the participation of the Company’s principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of June 30, 2023 (the end of the period covered by this Report). Based on that evaluation, the Company’s principal executive and principal financial officers concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2023.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
No other changes in the Company’s internal control over financial reporting were identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 under the Exchange Act that occurred during the fiscal quarter ended June 30, 2023 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1 – LEGAL PROCEEDINGS
The nature of the Company’s business generates a certain amount of litigation involving matters arising in the ordinary course of business.
In the opinion of management, there are no proceedings pending to which the Company is a party or to which its property is subject, which, if determined adversely, would have a material effect on the Company’s results of operations or financial condition.
ITEM 1A – RISK FACTORS
Other than the risk factors set forth below, which were included in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2023, there have been no material changes to the risk factors previously disclosed in Item 1A. Part I of the Company’s Annual Report on Form 10- K for the fiscal year ended December 31, 2022.
Recent Negative Developments Affecting the Banking Industry, and Resulting Media Coverage, May Erode Customer Confidence in the Banking System
The March 2023 high-profile bank failures involving Silicon Valley Bank and Signature Bank have generated significant market volatility among publicly traded bank holding companies and, in particular, community banks like the Company. These market developments have negatively impacted customer confidence in the safety and soundness of community banks. As a result, customers may choose to maintain deposits with larger financial institutions or invest in higher yielding short-term fixed income securities, all of which could materially adversely impact the Company’s liquidity, loan funding capacity, net interest margin, capital and results of operations. While the Department of the Treasury, the Federal Reserve, and the FDIC have made statements ensuring that depositors of these recently failed banks would have access to their deposits, including uninsured deposit accounts, there is no guarantee that such actions will be successful in restoring customer confidence in community banks and the banking system more broadly.
A Lack of Liquidity Could Adversely Affect the Company’s Financial Condition and Results of Operations and Result in Regulatory Restrictions
The Company must maintain sufficient funds to respond to the needs of depositors and borrowers. Deposits have traditionally been the Company’s primary source of funds for use in lending and investment activities and are emphasized due to the relatively lower cost of these funds. The Company also receives funds from loan repayments, investment maturities and income on other interest-earning assets, as well as borrowings. If the Company is required to rely more heavily on more expensive funding sources to support liquidity and future growth, its revenues may not increase proportionately to cover its increased costs, which would adversely affect its operating margins, profitability and growth prospects. Alternatively, the Company may need to sell a portion of its investment securities portfolio to raise funds, which, as discussed below, could result in a loss. Any decline in funding could adversely impact the Company’s ability to originate loans, invest in securities, pay expenses, or fulfill obligations such as repaying its borrowings or meeting deposit withdrawal demands, any of which could have a material adverse impact on its liquidity, business, financial condition and results of operations. A lack of liquidity could also attract increased regulatory scrutiny and potential restraints imposed by regulators. Depending on the capitalization status and regulatory treatment of depository institutions, including whether an institution is subject to a supervisory prompt corrective action directive, regulatory restrictions and prohibitions may include restrictions on growth, restrictions on interest rates paid on deposits, restrictions or prohibitions on payment of dividends and restrictions on the acceptance of brokered deposits.
Rising Interest Rates Have Decreased the Value of the Company’s Securities Portfolio, and the Company Would Realize Losses if it Were Required to Sell Such Securities to Meet Liquidity Needs
As a result of inflationary pressures and the resulting rapid increases in interest rates over the last year, the trading value of previously issued government and other fixed income securities has declined significantly. These securities make up a majority of the securities portfolio of most banks in the U.S., including the Company’s, resulting in unrealized losses embedded in the securities portfolios. While the Company does not currently intend to sell these securities, if the Company were required to sell such securities to meet liquidity needs, it may incur losses, which could impair the Company’s capital, financial condition, and results of operations and require the Company to raise additional capital on unfavorable terms, thereby negatively impacting its profitability. While the Company has taken actions to maximize its funding sources, there is no guarantee that such actions will be successful or sufficient in the event of sudden liquidity needs. Furthermore, while the Federal Reserve Board has announced a Bank Term Funding Program available to eligible depository institutions secured by U.S. treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral at par, to mitigate the risk of potential losses on the sale of such instruments, there is no guarantee that such programs will be effective in addressing liquidity needs as they arise.
ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchases of Equity Securities
Period
Total Number of Shares Purchased
Average Price Paid per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Maximum Number of Shares that may yet be Purchased Under the Plans or Programs
April 1, 2023 - April 30, 2023
Repurchase program(1)
187,932
Employee transactions
May 1, 2023 - May 31, 2023
June 1, 2023 - June 30, 2023
Total:
(1)On February 25, 2021, the Board of Directors authorized the Company to repurchase up to 300,000 shares of the Company’s common stock (the “2021 Repurchase Program”). The 2021 Repurchase program does not expire and may be suspended or discontinued by the Board of Directors at any time. The remaining number of shares that may be purchased under the 2021 Repurchase Program as of June 30, 2022 was 187,932.
ITEM 3 – DEFAULTS UPON SENIOR SECURITIES
(Not Applicable.)
ITEM 4 – MINE SAFETY DISCLOSURE
ITEM 5 – OTHER INFORMATION
ITEM 6 – EXHIBITS
The following exhibits are filed as a part of this report:
EXHIBIT INDEX
Exhibit No.
Name
3.1
Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3a to the Company’s Registration Statement on Form S-4 (Registration No. 33-25321), as filed on November 7, 1988). (Filed on paper – hyperlink is not required pursuant to Rule 105 of Regulation S-T)
3.1.1
Certificate of Amendment to the Company’s Certificate of Incorporation (incorporated by reference to Exhibit 3.3 to the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1997, as filed on May 14, 1997). (Filed on paper – hyperlink is not required pursuant to Rule 105 of Regulation S-T)
3.2
Amended and Restated Bylaws of the Company, effective as of January 24, 2023 (incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K filed on January 30, 2023)
31.1
Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of Principal Executive Officer pursuant to 18 USC Section 1350 Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Principal Financial Officer pursuant to 18 USC Section 1350 Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101
The following materials from Evans Bancorp, Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2023, formatted in XBRL (eXtensible Business Reporting Language): (i) Unaudited Consolidated Balance Sheets – June 30, 2023 and December 31, 2022; (ii) Unaudited Consolidated Statements of Income – Three months ended June 30, 2023 and 2022; (iii) Unaudited Consolidated Statements of Income – Six months ended June 30, 2023 and 2022; (iv) Unaudited Statements of Consolidated Comprehensive Income (Loss) – Three months ended June 30, 2023 and 2022; (v) Unaudited Statements of Consolidated Comprehensive Income (Loss) – Six months ended June 30, 2023 and 2022; (vi) Unaudited Consolidated Statements of Stockholders' Equity – Three months ended June 30, 2023 and 2022; (vii) Unaudited Consolidated Statements of Stockholders' Equity – Six months ended June 30, 2023 and 2022; (viii) Unaudited Consolidated Statements of Cash Flows – Six months ended June 30, 2023 and 2022; and (ix) Notes to Unaudited Consolidated Financial Statements.
The cover page from the Evans Bancorp, Inc’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2023, formatted in Inline XBRL.
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.
Evans Bancorp, Inc.
DATE
August 01, 2023
/s/ David J Nasca
David J. Nasca
President and CEO
(Principal Executive Officer)
/s/ John B. Connerton
John B. Connerton
Treasurer
(Principal Financial Officer and Principal Accounting Officer)