Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
☒
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
for the quarterly period ended March 31, 2022
or
☐
Transition report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934
for the transition period from
001-36388
(Commission File Number)
PEOPLES FINANCIAL SERVICES CORP.
(Exact name of registrant as specified in its charter)
Pennsylvania
23-2391852
(State of
incorporation)
(IRS Employer
ID Number)
150 North Washington Avenue, Scranton, PA
18503
(Address of principal executive offices)
(Zip code)
(570) 346-7741
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class:
Trading Symbol
Name of each exchange on which registered:
Common stock, $2.00 par value
PFIS
The Nasdaq Stock Market
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act. Yes ☐ No ☒
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of the registrant’s common stock, as of the latest practicable date: 7,171,958 at May l, 2022.
FORM 10-Q
For the Quarter Ended March 31, 2022
Contents
Page No.
PART I.
FINANCIAL INFORMATION:
Item 1.
Financial Statements
Consolidated Balance Sheets at March 31, 2022 (Unaudited) and December 31, 2021 (Unaudited)
3
Consolidated Statements of Income and Comprehensive Income (Loss) for the Three Months ended March 31, 2022 and 2021 (Unaudited)
4
Consolidated Statements of Changes in Stockholders’ Equity for the Three Months ended March 31, 2022 and 2021 (Unaudited)
5
Consolidated Statements of Cash Flows for the Three Months ended March 31, 2022 and 2021 (Unaudited)
6
Notes to Consolidated Financial Statements (Unaudited)
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
33
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
49
Item 4.
Controls and Procedures
51
PART II
OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults upon Senior Securities
52
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
Signatures
53
2
Peoples Financial Services Corp.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)
March 31, 2022
December 31, 2021
Assets:
Cash and cash equivalents
Cash and due from banks
$
35,863
30,415
Interest-bearing deposits in other banks
4,440
7,093
Federal funds sold
101,200
242,425
Total cash and cash equivalents
141,503
279,933
Investment securities:
Available-for-sale
535,482
517,321
Equity investments carried at fair value
144
140
Held-to-maturity: Fair value March 31, 2022, $89,280; December 31, 2021, $70,446
95,829
71,213
Total investment securities
631,455
588,674
Loans
2,397,681
2,329,173
Less: allowance for loan losses
28,407
28,383
Net loans
2,369,274
2,300,790
Loans held for sale
161
408
Premises and equipment, net
51,977
51,502
Accrued interest receivable
9,221
8,528
Goodwill
63,370
Intangible assets, net
372
468
Bank owned life insurance
43,828
42,754
Other assets
41,640
33,056
Total assets
3,352,801
3,369,483
Liabilities:
Deposits:
Noninterest-bearing
759,986
737,756
Interest-bearing
2,204,878
2,225,641
Total deposits
2,964,864
2,963,397
Long-term debt
2,182
2,711
Subordinated debentures
33,000
Accrued interest payable
844
Other liabilities
31,450
29,841
Total liabilities
3,032,340
3,029,357
Stockholders’ equity:
Common stock, par value $2.00, authorized 25,000,000 shares, issued and outstanding 7,179,037 shares at March 31, 2022 and 7,169,372 shares at December 31, 2021
14,352
14,341
Capital surplus
127,192
127,549
Retained earnings
210,584
203,750
Accumulated other comprehensive loss
(31,667)
(5,514)
Total stockholders’ equity
320,461
340,126
Total liabilities and stockholders’ equity
See notes to unaudited consolidated financial statements
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
(Dollars in thousands, except per share data)
For the Three Months Ended March 31,
2022
2021
Interest income:
Interest and fees on loans:
Taxable
20,853
20,900
Tax-exempt
1,161
870
Interest and dividends on investment securities:
1,972
1,243
510
390
Dividends
23
Interest on interest-bearing deposits in other banks
Interest on federal funds sold
73
Total interest income
24,571
23,477
Interest expense:
Interest on deposits
1,468
2,092
Interest on short-term borrowings
71
Interest on long-term debt
28
103
Interest on subordinated debt
444
443
Total interest expense
1,940
2,709
Net interest income
22,631
20,768
Provision (credit) for loan losses
300
(500)
Net interest income after provision for loan losses
22,331
21,268
Noninterest income:
Service charges, fees, commissions and other
1,692
1,184
Merchant services income
114
93
Commission and fees on fiduciary activities
555
533
Wealth management income
351
358
Mortgage banking income
312
Increase in cash surrender value of life insurance
218
219
Interest rate swap revenue
343
797
Net gain on equity investment securities
21
Total noninterest income
3,421
3,517
Salaries and employee benefits expense
8,040
6,570
Net occupancy and equipment expense
3,825
3,267
Amortization of intangible assets
96
125
Professional fees and outside services
470
439
FDIC insurance and assessments
326
260
Donations
334
339
Other expenses
1,198
1,629
Total noninterest expense
14,289
12,629
Income before income taxes
11,463
12,156
Income tax expense
1,833
2,678
Net income
9,630
9,478
Other comprehensive loss:
Unrealized loss on investment securities available-for-sale
(32,612)
(7,750)
Change in derivative fair value
(493)
242
Other comprehensive loss
(33,105)
(7,508)
Income tax benefit
(6,952)
(1,577)
Other comprehensive loss, net of income taxes
(26,153)
(5,931)
Comprehensive income (loss)
(16,523)
3,547
Per share data:
Net income:
Basic
1.34
1.31
Diluted
1.33
Average common shares outstanding:
7,172,455
7,210,952
7,216,421
7,246,016
Dividends declared
0.39
0.37
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)
Accumulated
Other
Common
Capital
Retained
Comprehensive
Stock
Surplus
Earnings
Loss
Total
Balance, January 1, 2022
Dividends declared: $0.39 per share
(2,796)
Stock based compensation
(28)
Restricted stock issued: 12,332 shares, (unearned income $210k)
24
(24)
Share retirement: 6,714 shares
(13)
(305)
(318)
Balance, March 31, 2022
Income (Loss)
Balance, January 1, 2021
14,431
129,274
171,023
2,149
316,877
Dividends declared: $0.37 per share
(2,665)
89
Restricted stock issued: 9,192 shares, (unearned income $182k)
18
(18)
Share retirement: 13,101 shares
(26)
(491)
(517)
Balance, March 31, 2021
14,423
128,854
177,836
(3,782)
317,331
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation of premises and equipment
663
680
Amortization of right-of-use lease asset
146
109
Accretion of deferred loan fees, net
949
626
Amortization of intangibles
Amortization of low income housing partnerships
121
120
Net unrealized gain on equity investment securities
(4)
(21)
Net (gain) loss on sale of other real estate owned
(458)
10
Loans originated for sale
(3,798)
(4,869)
Proceeds from sale of loans originated for sale
4,069
5,382
Net gain on sale of loans originated for sale
(134)
Net amortization of investment securities
431
Gain on sale of premises and equipment
(5)
(218)
(219)
Deferred income tax expense
620
Net change in:
(693)
(3,869)
(918)
436
384
1,388
383
Net cash provided by operating activities
9,136
11,654
Cash flows from investing activities:
Proceeds from sales of investment securities available-for-sale
Proceeds from repayments of investment securities:
12,897
12,876
Held-to-maturity
1,207
58
Purchases of investment securities:
(64,051)
(58,726)
(25,873)
Net redemption (purchase) of restricted equity securities
1,352
(64)
Net increase in loans
(69,733)
(2,296)
Purchases of premises and equipment
(1,284)
(521)
Proceeds from the sale of premises and equipment
Investment in bank owned life insurance
(1,081)
Proceeds from bank owned life insurance
225
Proceeds from sale of other real estate owned
946
549
Net cash used in investing activities
(145,390)
(48,124)
Cash flows from financing activities:
Net increase in deposits
1,467
113,303
Repayment of long-term debt
(529)
(505)
Net increase in short-term borrowings
1,980
Retirement of common stock
Cash dividends paid
Net cash (used in) provided by financing activities
(2,176)
111,596
Net (decrease) increase in cash and cash equivalents
(138,430)
75,126
Cash and cash equivalents at beginning of period
228,192
Cash and cash equivalents at end of period
303,318
Supplemental disclosures:
Cash paid during the period for:
Interest
1,504
2,325
Income taxes
35
Noncash items:
Transfers of loans to other real estate
57
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. Summary of significant accounting policies:
Nature of operations:
Peoples Financial Services Corp., a bank holding company incorporated under the laws of Pennsylvania, provides a full range of financial services through its wholly-owned subsidiary, Peoples Security Bank and Trust Company (“the Bank”), collectively, the “Company” or “Peoples”. The Company services its retail and commercial customers through twenty-eight full-service community banking offices located within Allegheny, Bucks, Lackawanna, Lebanon, Lehigh, Luzerne, Monroe, Montgomery, Northampton, Susquehanna and Wyoming Counties of Pennsylvania, Middlesex County of New Jersey and Broome County of New York.
Basis of presentation:
The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10-01 of Regulation S-X. In the opinion of management, all normal recurring adjustments necessary for a fair presentation of the consolidated financial position and results of operations for the periods presented have been included. All significant intercompany balances and transactions have been eliminated in consolidation. Prior-period amounts are reclassified when necessary to conform to the current year’s presentation. These reclassifications did not have any effect on the consolidated operating results or financial position of the Company. The consolidated operating results and financial position of the Company for the three months ended and as of March 31, 2022, are not necessarily indicative of the results of consolidated operations and financial position that may be expected in the future.
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates that are particularly susceptible to material change in the near term relate to the determination of the allowance for loan losses, fair value of financial instruments, the valuation of deferred tax assets, and impairment of goodwill. Actual results could differ from those estimates. For additional information and disclosures required under GAAP, reference is made to the Company’s Annual Report on Form 10-K for the period ended December 31, 2021.
Second Quarter Dividend Declaration
On April 29, 2022, the Board of Directors declared a second quarter dividend of $0.39 per share. The dividend is payable June 15, 2022 to shareholders of record May 31, 2022.
Recent accounting standards:
From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board ("FASB") or other standard setting bodies that are adopted by the Company as of the required effective dates. The following should be read in conjunction with "Note 1 Summary of significant accounting policies" of the Notes to the Consolidated Financial Statements included in the Company’s annual report on Form 10-K for the year ended December 31, 2021.
Unless otherwise discussed, management believes the impact of any recently issued standards, including those issued but not yet effective, will not have a material impact on the Company’s consolidated financial statements.
Recently Issued But Not Yet Effective Accounting Pronouncements
ASU 2016-13, Financial Instruments-Credit Losses (Topic 326), as modified by subsequent ASUs, changes accounting for credit losses on loans receivable and debt securities from an incurred loss methodology to an expected credit loss methodology. Among other things, ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Accordingly, ASU 2016-13 requires the use of forward-looking information to form credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, though the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, ASU 2016-13 amends the accounting for credit losses on debt securities and purchased financial assets with credit deterioration. The effect of implementing this ASU is recorded through a cumulative-effect adjustment to retained earnings. The Company has formed a committee and engaged outside vendors to implement a platform to utilize the alternative loss estimation methodologies in determining the impact that adoption of this standard will have on the Company’s financial condition and results of operations. The Company is required to adopt this guidance effective January 1, 2023.
ASU No. 2022-02 Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. This ASU eliminates the accounting guidance for troubled debt restructurings (TDRs) by creditors in Subtopic 310-40, Receivables - Troubled Debt Restructurings by Creditors, while adding disclosures for certain loan restructurings by creditors when a borrower is experiencing financial difficulty. This guidance requires an entity to determine whether the modification results in a new loan or a continuation of an existing loan. Additionally, the ASU requires disclosure of current period gross writeoffs by year of origination for financing receivables. The Company is required to adopt this guidance effective January 1, 2023. The Company does not believe adoption of this ASU will have a material impact on its financial results and will add the required disclosures for gross chargeoffs in its financial statements upon adoption of the new standard.
ASU 2020-04, Reference Rate Reform (Topic 848) provides temporary optional guidance to ease the potential burden in accounting for reference rate reform. The amendments in Update 2020-04 are elective and apply to all entities that have contracts, hedging relationships, and other transactions that reference the London Inter Bank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued. The guidance includes a general principle that permits an entity to consider contract modifications due to reference rate reform to be an event that does not require contract remeasurement at the modification date or reassessment of a previous accounting determination. Some specific optional expedients are as follows:
●
Simplifies accounting for contract modifications, including modifications to loans receivable and debt, by prospectively adjusting the effective interest rate.
Simplifies the assessment of hedge effectiveness and allows hedging relationships affected by reference rate reform to continue.
The amendments in ASU 2020-04 are effective as of March 12, 2020 through December 31, 2022. The Company expects to apply the amendments prospectively for applicable loan and other contracts within the effective period of ASU 2020-04.
2. Other comprehensive loss:
The components of other comprehensive loss and their related tax effects are reported in the consolidated statements of income and comprehensive income. The accumulated other comprehensive loss included in the consolidated balance sheets relates to net unrealized gains and losses on investment securities available-for-sale, benefit plan adjustments and adjustments to derivative fair values.
9
The components of accumulated other comprehensive loss included in stockholders’ equity at March 31, 2022 and December 31, 2021 are as follows:
Net unrealized loss on investment securities available-for-sale
(34,403)
(1,791)
(7,225)
(376)
Net of income taxes
(27,178)
(1,415)
Benefit plan adjustments
(5,868)
(1,232)
(4,636)
Derivative adjustments
187
Income tax
40
143
147
537
3. Earnings per share:
Basic earnings per share represent income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance.
The following table presents the calculation of both basic and diluted earnings per share of common stock for the three months ended March 31, 2022 and 2021:
Average common shares outstanding
Earnings per share
4. Investment securities:
The amortized cost and fair value of investment securities aggregated by investment category at March 31, 2022 and December 31, 2021 are summarized as follows:
Gross
Amortized
Unrealized
Fair
Cost
Gains
Losses
Value
Available-for-sale:
U.S. Treasury securities
250,268
12,624
237,672
U.S. government-sponsored enterprises
28,174
31
184
28,021
State and municipals:
69,027
106
6,021
63,112
99,805
505
6,843
93,467
Residential mortgage-backed securities:
U.S. government agencies
1,563
1
1,571
105,652
50
9,168
96,534
Commercial mortgage-backed securities:
12,396
14
129
12,281
Corporate debt securities
3,000
176
2,824
569,885
743
35,146
Held-to-maturity:
Tax-exempt state and municipals
11,266
30
653
10,643
18,511
1,315
17,196
66,052
4,612
61,441
6,580
89,280
193,849
107
2,382
191,574
33,435
33,778
69,066
994
1,082
68,978
96,412
2,452
614
98,250
1,790
1,843
109,018
939
2,925
107,032
12,542
406
12,948
82
2,918
519,112
5,294
7,085
11,476
126
56
11,546
18,802
392
18,410
40,935
448
40,490
896
70,446
11
Restricted Investment In Stock
Restricted investment in stock includes Federal Home Loan Bank (“FHLB”) stock with a carrying cost of $3,413 and $4,003 at March 31, 2022 and December 31, 2021, respectively, and Atlantic Community Bankers Bank (“ACBB”) stock with a carrying cost of $42 at March 31, 2022 and December 31, 2021, respectively, which are included in other assets in the consolidated balance sheets. FHLB and ACBB stock was issued as a requirement to facilitate participation in borrowing and other banking services. The investment in FHLB stock may fluctuate, as it is based on the member bank’s use of FHLB’s services.
These restricted investments are carried at cost and evaluated for other-than-temporary impairment (“OTTI”) quarterly. As of March 31, 2022, there was no OTTI associated with these investments.
The maturity distribution of the fair value, which is the net carrying amount, of the debt securities classified as available-for-sale at March 31, 2022, is summarized as follows:
Within one year
19,709
After one but within five years
205,581
After five but within ten years
95,545
After ten years
101,618
422,453
Mortgage-backed and other amortizing securities
113,029
The maturity distribution of the amortized cost and fair value, of debt securities classified as held-to-maturity at March 31, 2022, is summarized as follows:
8,098
7,657
3,168
2,986
Mortgage-backed securities
84,563
78,637
Securities with a carrying value of $186,388 and $203,580 at March 31, 2022 and December 31, 2021, respectively, were pledged to secure public deposits and certain other deposits as required or permitted by law.
Securities and short-term investment activities are conducted with a diverse group of government entities, corporations and state and local municipalities. The counterparty’s creditworthiness and type of collateral is evaluated on a case-by-case basis. At March 31, 2022 and December 31, 2021, there were no significant concentrations of credit risk from any one issuer, with the exception of U.S. government agencies and sponsored enterprises, that exceeded 10.0 percent of stockholders’ equity.
12
The fair value and gross unrealized losses of investment securities with unrealized losses for which an OTTI has not been recognized at March 31, 2022 and December 31, 2021, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, are summarized as follows:
Less Than 12 Months
12 Months or More
230,144
13,918
47,356
4,074
11,711
1,947
59,067
59,847
5,420
13,125
2,076
72,972
7,496
17,193
1,316
91,894
6,551
58,780
7,229
150,674
13,780
10,042
2,356
32
472,750
30,442
84,084
11,284
556,834
41,726
179,974
26,827
718
8,008
364
34,835
38,693
357
10,319
313
49,012
670
18,398
77,875
1,454
48,276
1,919
126,151
3,373
2,449
2,919
344,216
5,354
67,073
2,627
411,289
7,981
The Company had 50 U.S. Treasury securities, 3 U.S. government-sponsored enterprises securities, 45 mortgage-backed securities, 97 tax-exempt municipals, 62 taxable municipals and 5 corporate bonds that were in unrealized loss positions at March 31, 2022. Of these securities, one corporate bond, 23 tax-exempt municipals, 10 mortgage-backed securities and 14 taxable municipals were in a continuous unrealized loss position for twelve months or more. Management does not consider the unrealized losses on the debt securities, as a result of significantly higher market interest rates, to be OTTI based on historical evidence that indicates the cost of these securities is recoverable within a reasonable period of time in relation to normal cyclical changes in the market rates of interest. Moreover, because there has been no known material change in the credit quality of the issuers or other events or circumstances that may cause a significant adverse impact on the fair value of these securities, and management does not intend to sell these securities and it is unlikely that the Company will be required to sell these securities before recovery of their amortized cost basis, which may be maturity, the Company does not consider the unrealized losses to be OTTI at March 31, 2022. There was no OTTI recognized for the three months ended March 31, 2022 and 2021.
5. Loans, net and allowance for loan losses:
The major classifications of loans outstanding, net of deferred loan origination fees and costs at March 31, 2022 and December 31, 2021 are summarized as follows. The Company had net deferred loan origination fees of $618 and $1,567 at March 31, 2022 and December 31, 2021, respectively. The decrease to the fees since yearend is due in part to the forgiveness by the Small Business Administration (“SBA”) of Paycheck Protection Program (“PPP”) loans.
13
Commercial
580,758
613,127
Real estate:
1,436,196
1,343,539
Residential
306,068
297,624
Consumer
74,659
74,883
PPP loans are forgivable, in whole or in part, if the proceeds are used for payroll and other permitted purposes in accordance with the requirements of the PPP. These loans carry a fixed rate of 1.00% and a term of two years or five years, if not forgiven, in whole or in part. Payments are deferred until either the date on which the SBA remits the amount of forgiveness proceeds to the lender or the date that is 10 months after the last day of the covered period if the borrower does not apply for forgiveness within that 10 month period. PPP fees are deferred and accreted into interest income over the contractual period of 24 months or 60 months, as applicable. Upon SBA forgiveness, unamortized fees are then recognized into interest income.
The Bank originated additional loans through the PPP, which expired on May 31, 2021. During 2021, the Bank had generated and received SBA approval on 1,062 PPP loans totaling $121.6 million and generated $4.3 million in related deferred PPP net fees.
Net deferred loan origination fees remaining related to PPP loans is $740 at March 31, 2022, compared to $1,659 at December 31, 2021. The PPP loans are included in the commercial loan classification and had an outstanding balance at March 31, 2022 of $38,680 comprised of $25,444 remaining from those originated during 2021 as part of round two and $13,236 remaining from loans originated during 2020 under round one of the program. At December 31, 2021, PPP loans had outstanding balances totaling $68,893. The PPP loans are risk rated ‘Pass’ and do not carry an allowance for loan losses due to a 100% SBA guarantee. The outstanding balance is considered current at March 31, 2022 and December 31, 2021.
The changes in the allowance for loan losses account by major classification of loan for the three months ended March 31, 2022 and 2021 are summarized as follows:
Real estate
Allowance for loan losses:
Beginning Balance January 1, 2022
8,453
15,928
3,209
793
Charge-offs
(161)
(132)
(62)
(355)
Recoveries
16
79
Provisions (credits)
(708)
977
43
(12)
Ending balance
7,593
16,789
3,255
770
March 31, 2021
Beginning Balance January 1, 2021
8,734
14,559
3,129
922
27,344
(15)
(96)
(22)
(195)
61
134
(565)
182
(114)
(3)
8,215
14,703
2,994
871
26,783
The allocation of the allowance for loan losses and the related loans by major classifications of loans at March 31, 2022 and December 31, 2021 is summarized as follows:
Ending balance: individually evaluated for impairment
45
—
115
Ending balance: collectively evaluated for impairment
7,572
16,744
3,206
28,292
Loans receivable:
159
3,188
1,148
4,495
580,599
1,433,008
304,920
2,393,186
26
175
8,413
15,819
3,183
28,208
199
2,890
1,273
4,362
612,928
1,340,649
296,351
2,324,811
The Company segments loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. Loans are individually analyzed for credit risk by classifying them within the Company’s internal risk rating system. The Company’s risk rating classifications are defined as follows:
15
The following tables present the major classification of loans summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within the Company’s internal risk rating system at March 31, 2022 and December 31, 2021:
Special
Pass
Mention
Substandard
Doubtful
571,829
8,089
840
1,421,727
8,322
6,147
304,324
127
1,617
74,452
207
2,372,332
16,538
8,811
611,151
1,080
1,324,646
13,939
4,954
294,892
333
2,399
74,744
139
2,305,433
15,168
8,572
The increase to special mention commercial loans is primarily the result of the downgrade of one credit with an outstanding balance of $7.8 million due to insufficient cash flows as the borrower’s operations have not stabilized in the anticipated timeframe. The decrease to special mention commercial real estate loans is due in part to an upgrade of a $3.5 million credit resulting from improved financial performance and satisfactory repayment history, and the $0.8 million downgrade to ‘substandard’ of one credit and $0.2 million charge-off to a second credit of a commercial relationship. Substandard residential real estate loans decreased $0.8 million primarily due to the payoff of a $0.5 million credit.
Information concerning nonaccrual loans by major loan classification at March 31, 2022 and December 31, 2021 is summarized as follows:
185
2,143
1,793
575
694
206
3,070
2,811
The increase to non-accrual loans since year end was due primarily to the addition of a $0.8 million commercial real estate loan due to its delinquency status; the loan was subsequently paid-off during April 2022. Partially offsetting the increase was the payoff of a $0.5 million non-accrual real estate loan.
The major classifications of loans by past due status are summarized as follows:
Greater
Loans > 90
30-59 Days
60-89 Days
than 90
Total Past
Days and
Past Due
Days
Due
Current
Total Loans
Accruing
60
200
580,558
1,242
1,568
1,434,628
1,794
249
2,054
304,014
542
188
95
825
73,834
2,722
213
1,712
4,647
2,393,034
Improved credit quality resulted in lower levels of past due loans from year end.
101
155
158
414
612,713
768
423
834
2,025
1,341,514
1,552
265
2,024
295,600
477
163
691
74,192
2,898
948
1,308
5,154
2,324,019
17
The following tables summarize information concerning impaired loans as of and for the three months ended March 31, 2022 and March 31, 2021, and as of and for the year ended December 31, 2021 by major loan classification:
For the Quarter Ended
Unpaid
Average
Recorded
Principal
Related
Income
Investment
Balance
Allowance
Recognized
With no related allowance:
138
475
148
2,748
3,505
2,562
874
1,047
217
173
3,967
5,244
3,757
With an allowance recorded:
440
452
273
274
338
734
747
846
Total impaired loans
496
179
3,957
3,039
1,147
1,321
1,212
4,701
5,991
4,603
25
For the Year Ended
481
964
2,376
3,120
2,719
22
873
1,073
1,016
19
100
3,546
4,822
4,799
54
41
1,091
513
543
802
401
955
985
2,329
522
2,055
2,889
3,663
3,521
44
1,274
1,474
1,452
4,501
5,807
7,128
104
673
1,108
1,462
3,280
4,051
2,826
1,121
1,241
1,104
94
105
5,168
6,505
5,495
1,978
2,041
697
2,012
710
796
108
1,145
422
457
64
441
3,110
3,294
869
3,598
2,651
3,149
3,474
3,990
4,847
3,971
1,543
1,698
1,545
8,278
9,799
9,093
29
Loan Modifications/Troubled Debt Restructurings/COVID-19
Included in the commercial real estate and residential real estate categories are troubled debt restructurings that are classified as impaired. Troubled debt restructurings totaled $1,503 at March 31, 2022, $1,649 at December 31, 2021 and $2,740 at March 31, 2021.
Troubled debt restructured loans are loans with original terms, interest rate, or both, that have been modified as a result of a deterioration in the borrower’s financial condition and a concession has been granted that the Company would not otherwise consider. Unless on nonaccrual, interest income on these loans is recognized when earned, using the interest method. The Company offers a variety of modifications to borrowers that would be considered concessions. The modification categories offered generally fall within the following categories:
There were no loans modified as troubled debt restructurings during the three months ended March 31, 2022 or 2021.
During the three months ended March 31, 2022, or 2021, there were no payment defaults on troubled debt restructurings.
6. Other assets:
The increase in other assets was due to the increase to the net deferred tax asset related to the higher unrealized loss of the available-for-sale securities portfolio. The components of other assets at March 31, 2022, and December 31, 2021 are summarized as follows:
Other real estate owned
609
Investment in low income housing partnership
5,780
5,900
Mortgage servicing rights
909
882
Restricted equity securities (FHLB and other)
3,455
4,045
Net deferred tax asset
12,303
5,355
Interest rate floor
Interest rate swaps
10,720
9,026
8,019
6,395
7. Fair value estimates:
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosure under GAAP. Fair value estimates are calculated without attempting to estimate the value of anticipated future business and the value of certain assets and liabilities that are not considered financial. Accordingly, such assets and liabilities are excluded from disclosure requirements.
In accordance with FASB ASC 820, “Fair Value Measurements and Disclosures,” fair value is the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement
20
date. Fair value is best determined based upon quoted market prices. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets. In many cases, these values cannot be realized in immediate settlement of the instrument.
Current fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction that is not a forced liquidation or distressed sale between participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.
In accordance with GAAP, the Company groups its assets and liabilities generally measured at fair value into three levels based on market information or other fair value estimates in which the assets and liabilities are traded or valued and the reliability of the assumptions used to determine fair value. These levels include:
An asset’s or liability’s placement in the fair value hierarchy is based on the lowest level of input that is significant to the fair value estimate.
During the periods ended March 31, 2022 and December 31, 2021 there were no transfers in or out of Level 3.
The following methods and assumptions were used by the Company to calculate fair values and related carrying amounts of financial instruments:
Investment securities: The fair values of U.S. Treasury securities and marketable equity securities are based on quoted market prices from active exchange markets. The fair values of debt securities are based on pricing from a matrix pricing model.
Loans held for sale: The fair values of loans held for sale are based upon current delivery prices in the secondary mortgage market.
Interest rate swaps and options: The Company’s interest rate swaps and options are reported at fair value utilizing Level 2 inputs. Values of these instruments are obtained through an independent pricing source utilizing information which may include market observed quotations for interest rate, forward rates, rate volatility, and volatility surface. Derivative contracts create exposure to interest rate movements as well as risks from the potential of non-performance of the counterparty.
Assets and liabilities measured at fair value on a recurring basis at March 31, 2022 and December 31, 2021 are summarized as follows:
Fair Value Measurement Using
Quoted Prices in
Significant
Active Markets for
Other Observable
Unobservable
Identical Assets
Inputs
Amount
(Level 1)
(Level 2)
(Level 3)
Mortgage-backed securities:
108,815
Common equity securities
535,626
237,816
297,810
Loan held for sale
Interest rate floor-other assets
Interest rate swap-other assets
Interest rate swap-other liabilities
(10,265)
119,980
517,461
191,714
325,747
(8,811)
Assets and liabilities measured at fair value on a nonrecurring basis at March 31, 2022 and December 31, 2021 are summarized as follows:
Impaired loans
Significant Other
Observable
780
487
Fair values of impaired loans are based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent.
The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which the Company has utilized Level 3 inputs to determine fair value:
Quantitative Information about Level 3 Fair Value Measurements
Fair Value
Range
Estimate
Valuation Techniques
Unobservable Input
(Weighted Average)
Appraisal of collateral
Appraisal adjustments
6.4% to 98.5% (68.3)%
Liquidation expenses
3.0% to 6.0% (5.2)%
6.4% to 97.0% (65.2)%
3.0% to 6.0% (5.1)%
35.9% to 35.9% (35.9)%
3.0% to 6.0% (5.0)%
Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various Level 3 inputs which are not identifiable.
Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.
The carrying and fair values of the Company’s financial instruments at March 31, 2022 and December 31, 2021 and their placement within the fair value hierarchy are as follows:
Fair Value Hierarchy
Quoted
Prices in
Active
Markets for
Identical
Carrying
Assets
(level 1)
(level 2)
Financial assets:
2,333,676
1,398
3,167,031
3,125,373
Financial liabilities:
Deposits
2,960,470
2,214
33,152
10,265
3,011,155
3,006,945
2,261,586
1,357
3,193,130
3,153,634
2,963,547
2,778
32,337
3,008,327
3,007,881
8. Employee benefit plans:
The Company provides an Employee Stock Ownership Plan (“ESOP”) and a Retirement Profit Sharing Plan. The Company also maintains Supplemental Executive Retirement Plans (“SERPs”) and an Employees’ Pension Plan, which is currently frozen.
For the three months ended March 31, salaries and employee benefits expense includes approximately $256 in 2022, and $306 in 2021 relating to the employee benefit plans.
Pension Benefits
Three Months Ended March 31,
Components of net periodic pension benefit:
Interest cost
Expected return on plan assets
(352)
(322)
Amortization of unrecognized net gain
76
Net periodic benefit
(188)
(141)
In May 2017, the Company’s stockholders approved the 2017 equity incentive plan (“2017 Plan”). The 2017 Plan allows for eligible participants to be granted equity awards. Under the 2017 Plan the Compensation Committee of the Board of Directors has the authority to, among other things:
Persons eligible to receive awards under the 2017 Plan include directors, officers, employees, consultants and other service providers of the Company and its subsidiaries.
As of March 31, 2022, there were 17,365 shares of the Company’s common stock available for grant as awards pursuant to the 2017 Plan. If any outstanding awards under the 2017 Plan are forfeited by the holder or canceled by the Company, the underlying shares would be available for regrant to others.
The 2017 Plan authorizes grants of stock options, stock appreciation rights, cash awards, performance awards, restricted stock and restricted stock units.
For the three months ended March 31, 2022 and 2021, the Company granted awards of restricted stock and restricted stock units under the 2017 Plan, with an aggregate of 19,787 shares and 19,818 shares underlying such awards, respectively.
The non-performance restricted stock grants made in 2021, 2020 and 2019 vest equally over three years. The performance-based restricted stock units vest over three fiscal years and include conditions based on the Company’s three year cumulative diluted earnings per share and three-year average return on equity or tangible equity that determines the number of restricted stock units that may vest.
The Company expenses the fair value of all-share based compensation over the requisite service period commencing at grant date. The fair value of restricted stock is expensed on a straight-line basis. Compensation is recognized over the vesting period and adjusted based on the performance criterea. The Company classifies share-based compensation for employees within “salaries and employee benefits expense” on the consolidated statements of income and comprehensive income.
The Company recognized net compensation costs of $199 for the three months ended March 31, 2022 for awards granted under the 2017 Plan. The Company recognized compensation expense of $89 for the three months ended March 31, 2021 for awards granted under the 2017 Plan. As of March 31, 2022, the Company had $1,635 of unrecognized compensation expense associated with restricted stock awards. The remaining cost is expected to be recognized over a weighted average vesting period of under 2.1 years.
9. Derivatives and hedging activities
Risk Management Objective of Using Derivatives
The Company is exposed to certain risk arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts principally related to the Company’s assets and borrowings.
Cash Flow Hedges of Interest Rate Risk
The Company’s objectives in using interest rate derivatives are to add stability to interest income/expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps and floors as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. Interest rate floors designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty if interest rates fall below the strike rate on the contract in exchange for an up-front premium. Such derivatives have been used to hedge the variable cash flows associated with existing variable-rate assets and issuances of debt.
For derivatives designated and that qualify as cash flow hedges of interest rate risk, the gain or loss on the derivative is recorded in accumulated other comprehensive income (loss) and subsequently reclassified into interest expense/income in the same period(s) during which the hedged transaction affects earnings. Amounts reported in accumulated other comprehensive income (loss) related to derivatives will be reclassified to interest expense/income as interest payments are made/received on the Company’s variable-rate debt/assets. During the next twelve months, the Company estimates that an additional $123 will be reclassified as an increase to interest income.
Non-designated Hedges
Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain customers. The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting interest rate swaps that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. As of March 31, 2022, the Company had 86 interest rate swaps with an aggregate notional amount of $399,121 related to this program.
Fair Values of Derivative Instruments on the Balance Sheet
The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Consolidated Balance Sheets as of March 31, 2022 and December 31, 2021.
Asset Derivatives
Liability Derivatives
As of March 31, 2022
As of December 31, 2021 (1)
As of December 31, 2021 (2)
Notional
Balance Sheet
Location
Derivatives designated as hedging instruments
Interest Rate Floor
25,000
Other Assets
Total derivatives designated as hedging instruments
0
Derivatives not designated as hedging instruments
Interest Rate Swaps (2)
399,121
Other Liabilities
Total derivatives not designated as hedging instruments
27
Effect of Fair Value and Cash Flow Hedge Accounting on Accumulated Other Comprehensive Income (Loss)
The table below presents the effect of fair value and cash flow hedge accounting on accumulated other comprehensive income (loss) as of March 31, 2022 and March 31, 2021.
Location of
Amount of
Gain or (Loss)
Gain (Loss)
Recognized from
Reclassified
Recognized in
from Accumulated
Derivatives in
OCI on
OCI Included
OCI Excluded
Other Comprehensive
OCI into Income
Hedging
Derivative
Component
Income into
Included Component
Excluded Component
Relationships
Derivatives in Cash Flow Hedging Relationships
Interest Rate Floor (*)
(361)
(439)
78
Interest Income
131
(16)
Gain
Cash Flow Swap
Interest Expense
(48)
(23)
(25)
(76)
(85)
133
149
325
316
85
(41)
Effect of Fair Value and Cash Flow Hedge Accounting on the Consolidated Statements of Income and Comprehensive Income
The table below presents the effect of the Company’s derivative financial instruments on the Consolidated Statements of Income and Comprehensive Income for the three months ended March 31, 2022 and March 31, 2021.
Location and Amount of Gain or (Loss) Recognized in
Income on Fair Value and Cash Flow Hedging
For the three months ended March 31,
Total amounts of income and expense line items presented in the statements of income and comprehensive income in which the effects of fair value or cash flow hedges are recorded
The effects of fair value and cash flow hedging:
Gain or (loss) on cash flow hedging relationships
Interest contracts
Amount of gain or (loss) reclassified from accumulated other comprehensive income into income
Amount of gain or (loss) reclassified from accumulated other comprehensive income into income as a result that a forecasted transaction is no longer probable of occurring
Amount of gain or (loss) reclassified from accumulated other comprehensive income into income - included component
150
Amount of gain or (loss) reclassified from accumulated other comprehensive income into income - excluded component
Effect of Derivative Instruments on the Consolidated Statements of Income and Comprehensive Income
The tables below present the effect of the Company’s derivative financial instruments on the Consolidated Statements of Income and Comprehensive Income for the three months ended March 31, 2022 and 2021.
Amount of Gain
Location of Gain or (Loss)
Recognized in Income on
Three Months Ended
Derivatives Not Designated as Hedging Instruments
Interest Rate Swaps
240
405
Fee Income
Fee income
Offsetting Derivatives
The table below presents a gross presentation, the effects of offsetting, and a net presentation of the Company’s derivatives as of March 31, 2022 and December 31, 2021. The net amounts of derivative assets or liabilities can be
reconciled to the tabular disclosure of fair value. The tabular disclosure of fair value provides the location that derivative assets and liabilities are presented on the Consolidated Balance Sheets.
Offsetting of Derivative Assets
as of March 31, 2022
Gross Amounts Not Offset in the Balance Sheet
Net Amounts
Amounts of
Gross Amounts
of Assets
Offset in the
presented in the
Financial
Cash Collateral
Net
Instruments
Received
Derivatives
11,053
9,395
1,658
Offsetting of Derivative Liabilities
Paid
10,270
875
as of December 31, 2021
9,870
3,218
6,652
8,818
5,600
Credit-risk-related Contingent Features
The Company has agreements with certain of its derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations.
The Company also has agreements with certain of its derivative counterparties that contain a provision where if the Company fails to maintain its status as a well capitalized institution, then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations under the agreements.
As of March 31, 2022, the termination value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $0. As of December 31, 2021, the termination value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $5,600. The Company has minimum collateral posting thresholds with certain of its derivative counterparties, and had no posted collateral as of March 31, 2022, compared to having posted collateral of $7,380 with counterparties at December 31, 2021. Cash collateral represents the amount that cannot be used to offset our derivative assets and liabilities from a gross basis to a net basis in accordance with the agreement. The cash collateral is exchanged under bilateral collateral and master netting agreements that allow us to
offset the net derivative position with the related collateral. The application of the cash collateral cannot reduce the net derivative position below zero. Therefore, excess other collateral, if any, is not reflected above. If the Company had breached any of these provisions it could have been required to settle its obligations under the agreements at the termination value.
10. Deposits
The major components of interest-bearing and noninterest-bearing deposits at March 31, 2022 and December 31, 2021 are summarized as follows:
At the period end
Interest-bearing deposits:
Money market accounts
605,686
588,245
Now accounts
797,333
851,086
Savings accounts
515,169
491,796
Time deposits less than $250
200,345
203,719
Time deposits $250 or more
86,345
90,795
Total interest-bearing deposits
Noninterest-bearing deposits
Total deposits increased slightly by $1.5 million from December 31, 2021 as seasonal outflows of public fund non-maturity deposits and reductions to time deposits by customers seeking higher yields were replaced with consumer and commercial non-maturity deposits.
11. Borrowings
Short-term borrowings consists of FHLB advances representing overnight borrowings or with stated original terms of less than twelve months and other borrowings related to collateral held from derivative counterparties. During the three months ended March 31, 2022 there were no short-term borrowings outstanding due to the Bank’s liquidity position. The table below outlines short-term borrowings at and for the year ended December 31, 2021:
At and for the year ended December 31, 2021
Weighted
Maximum
Ending
Month-End
Rate for
Rate at End
the Year
of the Year
FHLB advances
13,973
50,000
0.56
%
The Company has an agreement with the FHLB which allows for borrowings up to its maximum borrowing capacity based on a percentage of qualifying collateral assets. At March 31, 2022, the maximum borrowing capacity was $970,621 of which $2,182 was outstanding in borrowings and $297,535 was used to issue standby letters of credit to collateralize public fund deposits. At December 31, 2021, the maximum borrowing capacity was $896,130 of which $2,711 was outstanding in borrowings and $373,035 was used to issue standby letters of credit to collateralize public fund deposits.
Advances with the FHLB are secured under terms of a blanket collateral agreement by a pledge of FHLB stock and certain other qualifying collateral, such as investments and mortgage-backed securities and mortgage loans. Interest accrues daily on the FHLB advances based on rates of the FHLB discount notes. The overnight borrowing rate resets each day.
Long-term debt consisting of advances from the FHLB at March 31, 2022 and December 31, 2021 are as follows:
Interest Rate
Fixed
March 2023
4.69
Maturities of long-term debt, by contractual maturity, for the remainder of 2022 and subsequent years are as follows:
1,627
2023
The advances from the FHLB totaling $2,182 are not convertible.
12. Subordinated debt
On June 1, 2020, the Company sold $33,000 aggregate principal amount of Subordinated Notes due 2030 (the “2020 Notes”) to accredited investors. The 2020 Notes qualify as Tier 2 capital for regulatory capital purposes.
The 2020 Notes bear interest at a rate of 5.375% per year for the first five years and then float based on a benchmark rate (as defined), provided that the interest rate applicable to the outstanding principal balance during the period the 2020 Notes are floating will at no time be less the 4.75%. Interest is payable semi-annually in arrears on June 1 and December 1 of each year, beginning on June 1, 2020, for the first five years after issuance and will be payable quarterly in arrears thereafter on March 1, June 1, September 1, and December 1. The 2020 Notes will mature on June 1, 2030 and are redeemable in whole or in part, without premium or penalty, at any time on or after June 1, 2025 and prior to June 1, 2030. Additionally, if all or any portion of the 2020 Notes cease to be deemed Tier 2 Capital, the Company may redeem, in whole and not in part, at any time upon giving not less than ten days’ notice, an amount equal to one hundred percent (100%) of the principal amount outstanding plus accrued but unpaid interest to but excluding the date fixed for redemption.
Holders of the 2020 Notes may not accelerate the maturity of the 2020 Notes, except upon the bankruptcy, insolvency, liquidation, receivership or similar proceeding by or against the Company or the Bank.
13. Income taxes
The Company’s effective tax rate was 16.0% for the three months ended March 31, 2022 compared to 22.0% for the three months ended March 31, 2021. The lower tax rate was due to a higher level of tax-exempt income in the current quarter and a $621 deferred tax adjustment related to prior periods in the quarter ended March 31, 2021. Excluding this adjustment, the effective tax rate would have been 16.9% for the three month period ended March 31, 2021.
MANAGEMENT’S DISCUSSION AND ANALYSIS
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the unaudited consolidated interim financial statements contained in Part I, Item 1 of this report, and with our audited consolidated financial statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” presented in our Annual Report on Form 10-K for the year ended December 31, 2021.
Cautionary Note Regarding Forward-Looking Statements:
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to risks and uncertainties. These statements are based on assumptions and may describe future plans, strategies and expectations of Peoples Financial Services Corp. and its subsidiaries. These forward-looking statements are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions. All statements in this report, other than statements of historical facts, are forward-looking statements.
Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Important factors that could cause our actual results to differ materially from those in the forward-looking statements include, but are not limited to: the COVID-19 crisis and the governmental responses to the crisis; the impact on financial markets from geopolitical conflicts such as the military conflict between Russia and Ukraine; risks associated with business combinations; changes in interest rates; economic conditions, particularly in our market area; legislative and regulatory changes and the ability to comply with the significant laws and regulations governing the banking and financial services business; monetary and fiscal policies of the U.S. government, including policies of the U.S. Department of Treasury and the Federal Reserve System; credit risk associated with lending activities and changes in the quality and composition of our loan and investment portfolios; demand for loan and other products; deposit flows; competition; changes in the values of real estate and other collateral securing the loan portfolio, particularly in our market area; changes in relevant accounting principles and guidelines; inability of third party service providers to perform; and our ability to prevent, detect and respond to cyberattacks. Additional factors that may affect our results are discussed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2021, in Part II, Item 1A of this report and in reports we file with the Securities and Exchange Commission from time to time.
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, we do not undertake, and specifically disclaim any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.
Notes to the Consolidated Financial Statements referred to in the Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) are incorporated by reference into the MD&A. Certain prior period amounts may have been reclassified to conform with the current year’s presentation. Any reclassifications did not have any effect on our operating results or financial position.
Critical Accounting Policies:
Disclosure of our significant accounting policies is included in Note 1 to the consolidated financial statements of the Annual Report on Form 10-K for the year ended December 31, 2021, which is incorporated herein by reference. Some of these policies are particularly sensitive requiring significant judgments, estimates and assumptions.
Operating Environment:
During the first quarter of 2022, restrictive measures related to the COVID-19 pandemic began to ease, both on a national level and more specifically in the Company's market area. Most businesses have reopened at full capacity, which has improved commercial and consumer activity but still has not returned to pre-pandemic levels. Risk of further
resurgence and possible reimplementation of restrictions remains. If there is a resurgence in the virus, the Company could experience adverse effects on its business, financial condition, results of operations and cash flows.
From a lending perspective, loan growth, excluding our PPP loan transactions, continued to improve during the first quarter as momentum from our entrance in two new markets continues and overall economic activity improves in all our markets. The PPP loans have remaining balances of $38.7 million at March 31, 2022 and we expect the majority of these loans to be forgiven by year-end.
Inflation increased during the first quarter of 2022 to a level well above the Federal Open Market Committee’s (“FOMC”) long-term desired 2% level for items other than food and energy. For the 12 months ended March 31, 2022, the consumer price index (“CPI”) registered 4.0%. CPI registered 4.5% for the 12 months ended December 31, 2021 and 4.0% for the 12 months ended September 30, 2021. The all items index was 5.4% for the 12 months ending March 31, 2022, identical to the reading for the 12 months ending December 31, 2021 and up from the 5.4% which was reported at September 30, 2021. Up until June 30, 2021 this reading was the largest 12 month increase since a 5.4% increase for the period ended August 31, 2008. As the U.S. economy continues to rebound from the initial slowdown in the second quarter of 2020 that was brought on by the nationwide shutdown, the initial estimate of gross domestic product (“GDP”), the value of all goods and services produced in the nation, for the first quarter 2022 indicated growth of a 2.0% annualized rate per the U.S. Bureau of Economic Analysis (“BEA”). This was lower than the consensus forecast of 2.6% for the quarter. Personal consumption slowed from 12.0% in the second quarter of 2021 to 1.6% in the current quarter on a 9.2% decline in goods consumption as spending on motor vehicles and parts dropped significantly. Housing activity was down 7.7%, while business investment also disappointed expectations with a 3.2% decline in investment in equipment.
Goodwill:
The Company has goodwill with a net carrying value of $63.4 million at March 31, 2022 and December 31, 2021. The Company's policy is to test goodwill for impairment annually on December 31 or on an interim basis if an event triggering impairment may have occurred. If a reporting unit’s carrying amount exceeds its fair value, an entity will record an impairment charge based on that difference. At March 31, 2022, we evaluated whether any events occurred or circumstances changed that would more likely than not reduce the Company's fair value below its carrying value. We noted no such matters. There is no assurance that changes in events or circumstances in the future will not result in impairment.
Review of Financial Position:
Total assets decreased $16,682, or 2.0% annualized, to $3,352,801 at March 31, 2022, from $3,369,483 at December 31, 2021. The decrease in assets during the three months was due in part to a $32,612 reduction in the fair value of our available-for-sale investment portfolio. Loan and investment growth was funded primarily with our federal funds sold balances as deposit growth was relatively stable since yearend. Total loans increased to $2,397,681 at March 31 2022, compared to $2,329,173 at December 31, 2021, an increase of $68,508. Excluding PPP loans and a net decrease of $30,212 to PPP loan balances, loan growth during the first three months of 2022 totaled $98,720, or 17.7% annualized. Investments increased $42,781 or 29.5% annualized as the purchase of higher yielding investment securities with a portion of our lower earning excess cash position offset the reduction to the fair value of the available-for-sale investment portfolio. Federal funds sold balances decreased $141,225 to $101,200 at March 31, 2022 from $242,425 at December 31, 2021. Deposits were relatively stable increasing $1,467 or 0.2% annualized, as consumer and commercial growth offset the seasonal outflow of public fund deposits. Interest-bearing deposits decreased $20,763 while noninterest-bearing deposits increased $22,230. Total borrowings at March 31, 2021 total $35,182. Total stockholders’ equity decreased $19,665 or 5.8%, from $340,126 at year-end 2021 to $320,461 at March 31, 2022 as net income was offset by a decrease to accumulated other comprehensive income (“AOCI”), resulting from an increase to the unrealized loss on investment securities, and dividends paid to shareholders. For the three months ended March 31, 2022, total assets averaged $3,341,561, an increase of $427,516 from $2,914,045 for the same period of 2021.
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Investment Portfolio:
The majority of the investment portfolio is classified as available-for-sale, which allows for greater flexibility in using the investment portfolio for liquidity purposes by allowing securities to be sold when market opportunities occur. Investment securities available-for-sale totaled $535,482 at March 31, 2022, an increase of $18,021, or 3.5% from $517,461 at December 31, 2021. The increase was due to the purchase of U.S. Treasury notes, taxable and tax-exempt municipal bonds and mortgage-backed securities as we deployed a portion of excess cash into higher earning assets. A decrease in the market value of the available-for-sale portfolio of $32,612 since December 31, 2021, due to the rapid increase of market rates, and principal received from mortgage-backed securities and maturing bonds partially offset the increases. Investment securities held-to-maturity totaled $95,829 at March 31, 2022, an increase of $24,616 from $71,213 at December 31, 2021 due to classifying new low coupon security purchases to mitigate market value risk.
For the three months ended March 31, 2022, the investment portfolio averaged $633,695, an increase of $301,280 or 90.6% compared to $332,415 for the same period last year. Average tax-exempt municipal bonds have increased $38,217 or 52.9% to $110,394 for the three months ended March 31, 2021 from $72,177 during the comparable period of 2021. The increase in tax-exempt municipal bonds is due to purchases during the last twelve months with a portion of excess liquidity. The tax-equivalent yield on the investment portfolio decreased 47 basis points to 1.68% for the three months ended March 31, 2022, from 2.15% for the comparable period of 2021. The decrease in yield is due to lower reinvestment rates for cash flow from matured and called bonds.
Securities available-for-sale are carried at fair value, with unrealized gains or losses net of deferred income taxes reported in the AOCI component of stockholders’ equity. We reported net unrealized losses, included as a separate component of stockholders’ equity of $27,178 net of deferred income taxes of $7,225 at March 31, 2022, and net unrealized gains of $1,415, net of deferred income taxes of $376, at December 31, 2021.
Management, from a credit risk perspective, has taken action to identify and assess its COVID-19 related credit exposures based on asset class. No specific COVID-19 related credit impairment was identified within our investment securities portfolio, including our municipal securities, during the first three months of 2022.
Our Asset/Liability Committee (“ALCO”) reviews the performance and risk elements of the investment portfolio quarterly. Through active balance sheet management and analysis of the securities portfolio, we endeavor to maintain sufficient liquidity to satisfy depositor requirements and meet the credit needs of our customers.
Loan Portfolio:
Total loans increased to $2,397,681 at March 31, 2022 from $2,329,173 at December 31, 2021, an increase of $68,508. Loan activity improved since year-end as the economic outlook improved and certain government restrictions began to ease. Our recent entrance into the Greater Pittsburgh market and Piscataway, New Jersey via community banking offices has resulted in positive loan opportunities and has contributed to the overall loan growth since yearend.
Our loan growth is due to increases in commercial real estate loans and tax-free commercial loans, offset by a reduction in PPP loan balances. At March 31, 2022, we had 18 loans totaling $13,236 remaining from PPP loans originated during 2020 and 151 loans totaling $25,444 remaining from the second PPP program, and we expect the majority to be forgiven during 2022. Excluding the PPP loans, total loans have increased $98,720 or 17.7% annually. Commercial real estate loans increased $92,657 or 28.0% annualized, to $1,436,196 at March 31, 2022 compared to $1,343,539 at December 31, 2021 due to increased activity in all our markets. Commercial and industrial loans, excluding PPP, decreased $2,153 to $542,077 at March 31, 2022 compared to $544,230 at December 31, 2021 due to growth of tax-exempt loans. We continue to actively pursue commercial and industrial loans as this segment of our loan portfolio provides an attractive yield commensurate with an appropriate level of credit risk and creates opportunities for in-market deposit, treasury management, and wealth management relationships which generate additional fee income.
Consumer loans decreased $224, or 1.2% on an annualized basis, to $74,659 at March 31, 2022 compared to $74,883 at December 31, 2021. The decrease in consumer loans was primarily due to payoffs outpacing dealer indirect auto loan origination volumes. Lower origination volumes have resulted from changes to the structure of the Bank’s loan pricing.
Residential real estate loans increased $8,444, or 11.5% on an annualized basis, to $306,068 at March 31, 2022 compared to $297,624 at December 31, 2021. The increase in residential mortgages is due to increased refinance and purchase activity during the current low rate environment coupled with a higher percentage of loans not eligible to be sold into the secondary market, including jumbo mortgages.
For the three months ended March 31, 2022, total loans excluding PPP loans, averaged $2,302,912, an increase of $318,964 or 16.1% compared to $1,983,947 for the same period of 2021. The PPP loans averaged $48,984 for the three months ended March 31, 2022 and yielded 8.55% due to the acceleration of unamortized net fees and interest earned. The tax-equivalent yield on the entire loan portfolio was 3.85% for the three months ended March 31, 2022, a 24 basis point decrease from the comparable period last year. The decrease in yield is primarily due to decreases in market rates. The FOMC took aggressive steps in March 2020 to combat the COVID-19 pandemic by cutting the federal funds rate 100 basis points to a target range of 0.00% to 0.25% during an emergency meeting which followed an emergency 50 basis point cut on March 3, 2020. The lower market rates negatively impacted our floating and adjustable rate loans and yields on new loan originations.
In addition to the risks inherent in our loan portfolio, in the normal course of business, we are also a party to financial instruments with off-balance sheet risk to meet the financing needs of our customers. These instruments include legally binding commitments to extend credit, unused portions of lines of credit and commercial letters of credit made under the same underwriting standards as on-balance sheet instruments, and may involve, to varying degrees, elements of credit risk and interest rate risk (“IRR”) in excess of the amount recognized in the consolidated financial statements.
Unused commitments at March 31, 2022, totaled $572,484, consisting of $514,920 in unfunded commitments of existing loan facilities and $57,564 in standby letters of credit. Due to fixed maturity dates, specified conditions within these instruments, and the ultimate needs of our customers, many will expire without being drawn upon. We believe that amounts actually drawn upon can be funded in the normal course of operations and therefore, do not represent a significant liquidity risk to us. In comparison, unused commitments at December 31, 2021 totaled $533,373, consisting of $495,119 in unfunded commitments of existing loans and $58,254 in standby letters of credit.
Asset Quality:
Distribution of nonperforming assets
Nonaccrual loans
Troubled debt restructured loans (including nonaccrual TDR)
1,503
1,649
Accruing loans past due 90 days or more:
Total nonperforming loans
4,676
4,473
Foreclosed assets
488
Total nonperforming assets
4,961
Loans modified in a troubled debt restructuring (TDR):
Performing TDR loans
Nonperforming TDR loans
Total TDR loans
Total loans held for investment
Nonaccrual loans as a percentage of loans held for investment
0.13
0.12
Allowance for loan losses
Allowance for loan losses as a percentage of loans held for investment
1.18
1.22
Allowance for loan losses as a percentage of nonaccrual loans
925.31
1009.71
Nonperforming loans as a percentage of loans, net
0.20
0.19
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We experienced improved asset quality during the first three months of 2022 as evidenced by a decrease of $285 in nonperforming assets. Nonperforming assets totaled $4,676 or 0.14% of total assets at March 31, 2022, a decrease from $4,961 or 0.15% of total assets at December 31, 2021. This was the result of the sale of foreclosed assets during the quarter.
Loans on nonaccrual status, excluding trouble debt restructured nonaccrual loans, increased $259 to $3,070 at March 31, 2022 from $2,811 at December 31, 2021. The increase to nonaccrual loans since year-end is due primarily to the addition of a $852 million commercial real estate loan due to its delinquency status; the loan was subsequently paid-off during April 2022. Partially offsetting the increase was the payoff of a $546 million non-accrual real estate loan. Restructured loans decreased $146 to $1,503 at March 31, 2022 from $1,649 at December 31, 2021 due to payments received. Foreclosed assets decreased $488. There were no foreclosed properties at March 31, 2022 compared to three properties at December 31, 2021.
Generally, maintaining a high loan to deposit ratio is our primary goal in order to drive profitability. However, this objective is superseded by our goal of strong asset quality to ensure that asset quality remains strong. We continued our efforts to maintain sound underwriting standards for both commercial and consumer credit.
We maintain the allowance for loan losses at a level we believe adequate to absorb probable credit losses related to specifically identified loans, as well as probable incurred loan losses inherent in the remainder of the loan portfolio as of the balance sheet date. The allowance for loan losses is based on past events and current economic conditions. We employ the Federal Financial Institutions Examination Council Interagency Policy Statement, as amended December 13, 2006, and GAAP in assessing the adequacy of the allowance account. Under GAAP, the adequacy of the allowance account is determined based on the provisions of FASB Accounting Standards Codification (“ASC”) 310, “Receivables,” for loans specifically identified to be individually evaluated for impairment and the requirements of FASB ASC 450, “Contingencies,” for large groups of smaller-balance homogeneous loans to be collectively evaluated for impairment.
We follow our systematic methodology in accordance with procedural discipline by applying it in the same manner regardless of whether the allowance is being determined at a high point or a low point in the economic cycle. Each quarter, credit administration identifies those loans to be individually evaluated for impairment and those loans collectively evaluated for impairment utilizing a standard criteria. We consistently use loss experience from the latest twelve quarters in determining the historical loss factor for each pool collectively evaluated for impairment. Qualitative factors are evaluated in the same manner each quarter and are adjusted within a relevant range of values based on current conditions. For additional disclosure related to the allowance for loan losses refer to the note entitled, “Loans, net and Allowance for Loan Losses,” in the Notes to Consolidated Financial Statements to this Quarterly Report.
The Company’s allowance for loan losses increased $24 or 0.08% during the first three months of 2022. The allowance for loan losses equaled $28,407 or 1.18% of loans, net at March 31, 2022 compared to $28,383 or 1.22% of loans, net, at December 31, 2021. Excluding PPP loans that do not carry an allowance for loan losses due to a 100% government guarantee, the ratio equaled 1.20% at March 31, 2022. Loans charged-off, net of recoveries, for the three months ended March 31, 2022, equaled $276 or 0.05% of average loans, compared to $61 or 0.01% of average loans for the comparable period last year. The increase to charge-offs in the current period is due to the delinquency status of one commercial relationship and subsequent charge-off of $219. A partial recovery of charge-off was received during April upon sale of the property.
We attract the majority of our deposits from within our market area through the offering of various deposit instruments including demand deposit accounts, NOW accounts, money market deposit accounts, savings accounts, and time deposits, including certificates of deposit and IRAs. For the three months ended March 31, 2022, total deposits increased $1,467 or 0.05% to $2,964,864 from $2,963,397 at December 31, 2021. Growth of consumer and commercial deposits replaced the seasonal outflows of public fund deposits. Interest-bearing deposits decreased $20,763 while noninterest-bearing deposits increased $22,230. Interest-bearing transaction accounts, including NOW and money market accounts
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decreased by $36,312, or 2.6%, to $1,403,019 at March 31, 2022, from $1,439,331 at December 31, 2021, savings accounts increased $23,373 to $515,169 as of March 31, 2022 from $491,796 at December 31, 2021. Time deposits less than $250 decreased $3,374, or 1.7%, to $200,345 at March 31, 2022, from $203,719 at December 31, 2021. Time deposits $250 or more decreased $4,450, or 4.9% to $86,345 at March 31, 2022 from $90,795 at year end 2021.
For the three months ended March 31, interest-bearing deposits averaged $2,211,629 in 2022 compared to $1,833,661 in 2021, an increase of $377,968 or 20.6%. The cost of interest-bearing deposits was 0.27% in 2022 compared to 0.46% for the same period last year. For the first three months, the overall cost of interest-bearing liabilities including the cost of borrowed funds, was 0.35% in 2022 and 0.57% in 2021. The lower costs are due primarily to our actions to lower deposit rates to mitigate net interest margin compression. We intend to monitor deposit rates; the FOMC increased the federal funds target rate 25 basis points in March 2022, 50 basis points on May 4, 2022 and the expectation is that the FOMC will continue to move aggressively over the short-term to increase the federal funds rate to combat inflation. The volume and velocity of the rate increases will place pressure on our deposit costs.
Borrowings:
The Bank utilizes borrowings as a secondary source of liquidity for its asset/liability management. Advances are available from the Federal Home Loan Bank of Pittsburgh (“FHLB”) provided certain standards related to credit worthiness have been met. Repurchase and term agreements are also available from the FHLB. In addition, the Bank may borrow from the Federal Reserve utilizing the Discount Window.
Overall, total borrowings at March 31, 2022, totaled $35,182, including long-term and subordinated debt, compared to $35,711 at December 31, 2021, a decrease of $529. There were no short-term borrowings outstanding at March 31, 2022 and December 31, 2021. Long-term debt was $2,182 at March 31, 2022 compared to $2,711 at year end 2021. Subordinated debt outstanding at March 31, 2022 and December 31, 2021 was $33,000.
Market Risk Sensitivity:
Market risk is the risk to our earnings or financial position resulting from adverse changes in market rates or prices, such as interest rates, foreign exchange rates or equity prices. Our exposure to market risk is primarily interest rate risk (“IRR”) associated with our lending, investing and deposit-gathering activities. During the normal course of business, we are not exposed to foreign exchange risk or commodity price risk. Our exposure to IRR can be explained as the potential for change in our reported earnings and/or the market value of our net worth. Variations in interest rates affect earnings by changing net interest income and the level of other interest-sensitive income and operating expenses. Interest rate changes also affect the underlying economic value of our assets, liabilities and off-balance sheet items. These changes arise because the present value of future cash flows, and often the cash flows themselves, change with interest rates. The effects of the changes in these present values reflect the change in our underlying economic value and provide a basis for the expected change in future earnings related to interest rates. IRR is inherent in the role of banks as financial intermediaries. However, a bank with a high degree of IRR may experience lower earnings, impaired liquidity and capital positions, and most likely, a greater risk of insolvency. Therefore, banks must carefully evaluate IRR to promote safety and soundness in their activities.
Due to the decreases to short-term market rates at the onset of the pandemic, economic uncertainty and more recently the increase in market rates and anticipation of the FOMC to aggressively move the federal funds rate higher to mitigate inflation, it has become challenging to manage IRR. Due to these factors, IRR and effectively managing it are very important to both bank management and regulators. Bank regulations require us to develop and maintain an IRR management program, overseen by our board of directors and senior management, that involves a comprehensive risk management process in order to effectively identify, measure, monitor and control risk. Should bank regulatory agencies identify a material weakness in our risk management process or high exposure relative to our capital, bank regulatory agencies may take action to remedy these shortcomings. Moreover, the level of IRR exposure and the quality of our risk management process is a determining factor when evaluating capital adequacy.
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The ALCO, comprised of members of our board of directors, senior management and other appropriate officers, oversees our IRR management program. Specifically, ALCO analyzes economic data and market interest rate trends, as well as competitive pressures, and utilizes computerized modeling techniques to reveal potential exposure to IRR. This allows us to monitor and attempt to control the influence these factors may have on our rate-sensitive assets (“RSA”) and rate-sensitive liabilities (“RSL”), and overall operating results and financial position. One such technique utilizes a static gap model that considers repricing frequencies of RSA and RSL in order to monitor IRR. Gap analysis attempts to measure our interest rate exposure by calculating the net amount of RSA and RSL that reprice within specific time intervals. A positive gap occurs when the amount of RSA repricing in a specific period is greater than the amount of RSL repricing within that same time frame and is indicated by a RSA/RSL ratio greater than 1.0. A negative gap occurs when the amount of RSL repricing is greater than the amount of RSA and is indicated by a RSA/RSL ratio of less than 1.0. A positive gap implies that earnings will be impacted favorably if interest rates rise and adversely if interest rates fall during the period. A negative gap tends to indicate that earnings will be affected inversely to interest rate changes.
Our cumulative one-year RSA/RSL ratio equaled 1.48% at March 31, 2022, an increase from 1.16% at December 31, 2021. As previously mentioned, a positive gap indicates that if interest rates increase, our earnings would likely be favorably impacted. Given the current economic conditions and outlook, and the action by the FOMC to increase the federal funds rate 25 basis points at their March 2022 meeting and an expectation the FOMC will aggressively increase the federal funds rate to mitigate inflation, we should experience increased net interest income. The overall focus of ALCO is to maintain a well-balanced interest rate risk position in order to safeguard future earnings. The current position at March 31, 2022, indicates that the amount of RSA repricing within one year would exceed that of RSL, thereby causing net interest income to increase as market rates increase. However, these forward-looking statements are qualified in the aforementioned section entitled “Cautionary Note Regarding Forward-Looking Statements” in this Management’s Discussion and Analysis.
Static gap analysis, although a standard measuring tool, does not fully illustrate the impact of interest rate changes on future earnings. First, market rate changes normally do not equally or simultaneously affect all categories of assets and liabilities. Second, assets and liabilities that can contractually reprice within the same period may not do so at the same time or to the same magnitude. Third, the interest rate sensitivity analysis presents a one-day position. Variations occur daily as we adjust our rate sensitivity throughout the year. Finally, assumptions must be made in constructing such an analysis.
As the static gap report fails to address the dynamic changes in the balance sheet composition or prevailing interest rates, we utilize a simulation model to enhance our asset/liability management. This model is used to create pro forma net interest income scenarios under various interest rate shocks. Model results at March 31, 2022, produced results similar to those indicated by the one-year static gap position. In addition, parallel and instantaneous shifts in interest rates under various interest rate shocks resulted in changes in net interest income that were well within ALCO policy limits during the first year of simulation. We will continue to monitor our IRR throughout 2022 and endeavor to employ deposit and loan pricing strategies and direct the reinvestment of loan and investment repayments in order to manage our IRR position.
Financial institutions are affected differently by inflation than commercial and industrial companies that have significant investments in fixed assets and inventories. Most of our assets are monetary in nature and change correspondingly with variations in the inflation rate. It is difficult to precisely measure the impact inflation has on us, however we believe that our exposure to inflation can be mitigated through asset/liability management.
Liquidity:
Liquidity management is essential to our continuing operations and enables us to meet financial obligations as they come due, as well as to take advantage of new business opportunities as they arise. Financial obligations include, but are not limited to, the following:
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These obligations are managed daily, thus enabling us to effectively monitor fluctuations in our liquidity position and to adapt that position according to market influences and balance sheet trends. Future liquidity needs are forecasted and strategies are developed to ensure adequate liquidity at all times.
Historically, core deposits have been the primary source of liquidity because of their stability and lower cost, in general, than other types of funding. Providing additional sources of funds are loan and investment payments and prepayments and the ability to sell both available for sale securities and mortgage loans held for sale.
Our ALCO generally meets quarterly, and most recently met in February, to review our interest rate risk profile, capital adequacy and liquidity. Management believes the Company’s liquidity position is strong. At March 31, 2022, the Company’s cash and due from banks balances were $141,503 and we maintained $152,542 of availability at the Federal Reserve Bank’s discount window. The Company also maintains an available-for-sale investment securities portfolio, comprised primarily of highly liquid U.S. Treasury and U.S. agency securities, highly-rated municipal securities and U.S. agency-backed mortgage backed securities. This portfolio serves as a ready source of liquidity and capital. At March 31, 2022, the Company’s available-for-sale investment securities portfolio totaled $535,482, $358,546 of which were unencumbered. Net unrealized losses on the portfolio were $34,403. The Bank’s unused borrowing capacity at the FHLB at March 31, 2022 was $670,708.
We employ a number of analytical techniques in assessing the adequacy of our liquidity position. One such technique is the use of ratio analysis to determine the extent of our reliance on noncore funds to fund our investments and loans maturing after March 31, 2022. Our noncore funds at March 31, 2022, were comprised of time deposits in denominations of $100 or more and other borrowings. These funds are not considered to be a strong source of liquidity because they are very interest rate sensitive and are considered to be highly volatile. At March 31, 2022, our net noncore funding dependence ratio, the difference between noncore funds and short-term investments to long-term assets, was 2.4%, while our net short-term noncore funding dependence ratio, noncore funds maturing within one-year, less short-term investments to long-term assets equaled negative 0.3% due to our short-term investments including $101.2 million of federal funds sold, exceeding our noncore funds. Comparatively, our overall noncore dependence ratio at year-end 2021 was negative 3.0% and our net short-term noncore funding dependence ratio was negative 5.6%, indicating that our reliance on noncore funds has increased both in the short-term and overall due to our relatively static deposit balances and use of our federal funds sold to fund loan and investment growth.
The Consolidated Statements of Cash Flows present the changes in cash and cash equivalents from operating, investing and financing activities. Cash and cash equivalents, consisting of cash on hand, cash items in the process of collection, deposit balances with other banks and federal funds sold, decreased $138,430 during the three months ended March 31, 2022. Cash and cash equivalents increased $75,126 for the same period last year. For the three months ended March 31, 2022, net cash inflows of $9,136 from operating activities were offset by net cash outflows of $145,390 from investing activities and net cash outflows of $2,176 from financing activities. For the same period of 2021, net cash inflows of $11,654 from operating activities and $111,596 from financing activities were partially offset by net cash outflows of $48,124 from investing activities.
Operating activities provided net cash of $9,136 for the three months ended March 31, 2022, and $11,654 for the corresponding three months of 2021. Net income, adjusted for the effects of gains and losses along with noncash transactions such as depreciation and the provision for loan losses, is the primary source of funds from operations.
Investing activities primarily include transactions related to our lending activities and investment portfolio. Investing activities used net cash of $145,390 for the three months ended March 31, 2022, compared to using net cash of $48,124
for the same period of 2021. In 2022, the combination of purchases of investment securities and an increase in lending activities were the primary factors causing the net cash outflow from investing activities, while an increase in investment purchases was the primary factor during the 2021 comparable period.
Financing activities used net cash of $2,176 for the three months ended March 31, 2022, and provided net cash of $111,596 for the corresponding three months of 2021. Deposit gathering is our predominant financing activity. Deposits provided cash of $1,467 for the three months ended March 31, 2022. Comparatively, deposits provided $113,303 for the same period of 2021. We continue to seek low-cost deposits from new markets and customers as well as existing customers, including municipalities and school districts. In the event that loan growth should exceed the growth in deposits, short-term and long-term borrowings provide additional funding. Long term borrowings were paid down and used $529 during the three months ended March 31, 2022.
We believe that our future liquidity needs will be satisfied through maintaining an adequate level of cash and cash equivalents, by maintaining readily available access to traditional funding sources, and through proceeds received from the investment and loan portfolios. The current sources of funds will enable us to meet all cash obligations as they come due.
Capital:
Stockholders’ equity totaled $320,461 or $44.64 per share at March 31, 2022, compared to $340,126 or $47.44 per share at December 31, 2021. Stockholders’ equity was reduced during the three month period ended March 31, 2022 by cash dividends declared of $2,796, a decrease to AOCI of $26,153 primarily due to an increase to the unrealized gain on investment securities from higher market rates, and the repurchase of 6,714 common shares totaling $318. Net income of $9,630 for the three months ended March 31, 2022 was added to our capital position during the period.
Higher market rates since year end resulted in a mark-to-market impact of $27,178, which runs through AOCI and affects our book value, but not our regulatory capital ratios.
Dividends declared equaled $0.39 per share through the three months ended March 31, 2022 and $0.37 per share for the same period of 2021. The dividend payout ratio was 29.3% for the three months ended March 31, 2022 and 28.2% for the same period of 2021. The Company has paid cash dividends since its formation as a bank holding company in 1986. It is the present intention of the Board of Directors to continue this dividend payment policy. The Board declared on April 29, 2022 a second quarter dividend of $0.39 per share payable June 15, 2022. Further dividends, however, must necessarily depend upon earnings, financial condition, appropriate legal restrictions and other factors relevant at the time the Board of Directors considers payment of dividends.
Current rules, which implemented the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act, call for the following capital requirements: (i) a minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5%; (ii) a minimum ratio of tier 1 capital to risk-weighted assets of 6%; (iii) a minimum ratio of total capital to risk-weighted assets of 8%; and (iv) a minimum leverage ratio of 4%. In addition, the final rules establish a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets applicable to all banking organizations. If a banking organization fails to hold capital above the minimum capital ratios and the capital conservation buffer, it will be subject to certain restrictions on capital distributions and discretionary bonus payments.
The adequacy of capital is reviewed on an ongoing basis with reference to the size, composition and quality of resources and regulatory guidelines. We seek to maintain a level of capital sufficient to support existing assets and anticipated asset growth, maintain favorable access to capital markets, and preserve high quality credit ratings. At March 31, 2022, the Bank’s Tier 1 capital to total average assets was 9.64% as compared to 9.58% at December 31, 2021. The Bank’s Tier 1 capital to risk weighted asset ratio was 13.47% and the total capital to risk weighted asset ratio was 14.67% at March 31, 2022. These ratios were 13.76% and 15.01% at December 31, 2021. The Bank’s common equity Tier 1 to risk weighted asset ratio was 13.47% at March 31, 2022 compared to 13.76% at December 31, 2021. The Bank met all capital adequacy requirements and was deemed to be well-capitalized under regulatory standards at March 31, 2022.
Review of Financial Performance:
Peoples reported net income of $9,630, or $1.33 per diluted share for the three months ended March 31, 2022, an increase of 2.0% when compared to $9,478, or $1.31 per diluted share for the comparable period of 2021. The increase in earnings for the three months ended March 31, 2022 is the product of an increase to net interest income of $1,863, due to higher income on our securities portfolio and lower funding costs, as well as a lower income tax provision. Partially offsetting these increases were a higher provision for loan losses, lower noninterest income and higher noninterest expenses.
Return on average assets (“ROA”) measures our net income in relation to total assets. Our ROA was 1.17% for the first quarter of 2022 compared to 1.32% for the same period of 2021. Return on average equity (“ROE”) indicates how effectively we can generate net income on the capital invested by stockholders. Our ROE was 11.82% for the first quarter of 2022 compared to 12.00% for the comparable period in 2021.
Non-GAAP Financial Measures:
The following are non-GAAP financial measures which provide useful insight to the reader of the consolidated financial statements but should be supplemental to GAAP used to prepare Peoples’ consolidated financial statements and should not be read in isolation or relied upon as a substitute for GAAP measures. In addition, Peoples’ non-GAAP measures may not be comparable to non-GAAP measures of other companies. The tax rate used to calculate the fully-taxable equivalent (FTE) adjustment was 21% for 2022 and 2021.
The following table reconciles the non-GAAP financial measures of FTE net interest income for the three months ended March 31, 2022 and 2021:
Three months ended March 31
Interest income (GAAP)
Adjustment to FTE
445
335
Interest income adjusted to FTE (non-GAAP)
25,016
23,812
Interest expense
Net interest income adjusted to FTE (non-GAAP)
23,076
21,103
42
The efficiency ratio is noninterest expenses, less amortization of intangible assets, as a percentage of FTE net interest income plus noninterest income less gains on equity securities and gains on sale of assets. The following table reconciles the non-GAAP financial measures of the efficiency ratio to GAAP for the three months ended March 31, 2022 and 2021:
Efficiency ratio (non-GAAP):
Noninterest expense (GAAP)
Less: amortization of intangible assets expense
Noninterest expense adjusted for amortization of assets expense (non-GAAP)
14,193
12,504
Net interest income (GAAP)
Plus: taxable equivalent adjustment
Noninterest income (GAAP)
Less: net gains (losses) on equity securities
Net interest income (FTE) plus noninterest income (non-GAAP)
26,493
24,599
Efficiency ratio (non-GAAP)
53.6
50.8
Net Interest Income:
Net interest income is the fundamental source of earnings for commercial banks. Fluctuations in the level of net interest income can have the greatest impact on net profits. Net interest income is defined as the difference between interest revenue, interest and fees earned on interest-earning assets, and interest expense, the cost of interest-bearing liabilities supporting those assets. The primary sources of earning assets are loans and investment securities, while interest-bearing deposits, short-term and long-term borrowings, and subordinated debt comprise interest-bearing liabilities. Net interest income is impacted by:
Changes in net interest income are measured by the net interest spread and net interest margin. Net interest spread, the difference between the average yield earned on earning assets and the average rate incurred on interest-bearing liabilities, illustrates the effects changing interest rates have on profitability. Net interest margin, net interest income as a percentage of earning assets, is a more comprehensive ratio, as it reflects not only the spread, but also the change in the composition of interest-earning assets and interest-bearing liabilities. Tax-exempt loans and investments carry pre-tax yields lower than their taxable counterparts. Therefore, in order to make the analysis of net interest income more comparable, tax-exempt income and yields are reported herein on a tax-equivalent basis using the prevailing federal statutory tax rate of 21.0% in 2022 and 2021.
For the three months ended March 31, tax-equivalent net interest income increased $1,973 to $23,076 in 2022 from $21,103 in 2021. The net interest spread decreased to 2.87% for the three months ended March 31, 2022 from 2.98% for the three months ended March 31, 2021 as the earning asset yield decreased 33 basis points while the average rate paid on interest bearing liabilities decreased 22 basis points. The tax-equivalent net interest margin decreased to 2.97% for the first quarter of 2022 from 3.15% for the comparable period of 2021.
For the three months ended March 31, tax-equivalent interest income, a non-GAAP measure, on earning assets increased $1,204, to $25,016 in 2022 as compared to $23,812 in 2021. The overall yield on earning assets, on a fully tax-equivalent basis, decreased 33 basis points for the three months ended March 31, 2022 to 3.22% as compared to 3.55%
for the three months ended March 31, 2021. The increase to tax-equivalent interest income despite the lower overall earning asset yield is due primarily from the higher earning asset base of $436,830. The higher volume is partially offset by the earning assets repricing downward and new loan originations and investment purchases being added at lower portfolio rates. Loan yields decreased due to lower rates on new loan originations during 2022 and adjustable and variable rate loans repricing into a lower rate environment. PPP loan interest income and net fees totaled $1,033 and the yield was 8.6% during the current quarter. Excluding the PPP loans, the loan yield was 3.75%. The overall yield earned on investments decreased 47 basis points in the first quarter of 2022 to 1.68% from 2.15% for the first quarter of 2021 as investment cashflow from high yielding matured and pre-refunded municipal bonds are deployed into lower yielding bonds. Average investment balances were $301,280 higher when comparing the current and year ago quarter. Average federal funds sold decreased $29,502 to $162,218 for the three months ended March 31, 2022 and yielded 0.18%, as compared to $191,720 and yield of 0.10% in the year ago period. We recognize the negative impact to the overall net interest margin due to the high federal funds sold balances and invested a portion into the investment portfolio during the current three month period to improve interest income and asset yield. We expect asset yields to move upward as asset cash flow reprice higher due to the recent increase to the federal funds rate by the FOMC and expectation of further rate increases at higher volumes and velocity by the FOMC to combat inflation.
Total interest expense decreased $769 to $1,940 for the three months ended March 31, 2022 from $2,709 for the three months ended March 31, 2021. The total cost of funds decreased 22 basis points for the three months ended March 31, 2022 to 0.35% as compared to 0.57% in the year ago period. The decrease in costs was due to lower rates on interest bearing deposits partially offset by higher average balances. The average rate paid on deposits declined as we decreased deposit rates throughout 2021 and early in 2022 to mitigate margin compression during a historically low rate environment. We expect our cost of funds to come under pressure over the remaining months of 2022 as market rates have risen rapidly since yearend in anticipation of the FOMC’s action to aggressively increase the targeted federal funds rate to subdue inflation.
Net interest income changes due to rate and volume for the three months ended March 31
2022 vs 2021
Increase (decrease)
attributable to
Rate
Volume
Loans:
(47)
(3,913)
3,866
369
(1,157)
1,526
Investments:
706
(1,765)
2,471
152
(424)
576
Interest-bearing deposits
(7)
1,204
(7,181)
8,385
(181)
(711)
530
NOW accounts
(111)
(1,109)
998
(59)
55
Time deposits less than $100
(87)
(89)
Time deposits $100 or more
(241)
(192)
(49)
Short-term borrowings
(71)
(35)
(36)
(75)
258
(333)
Subordinated debt
(769)
(1,936)
1,167
Net interest income - non-GAAP
1,973
(5,245)
7,218
Tax-equivalent net interest income, a non-GAAP measure, was $23,076 in the three months ended March 31, 2022 and $21,103 in the comparable period last year. There was a positive volume variance that was partially offset by a negative rate variance. The growth in average earning assets exceeded that of interest-bearing liabilities, and resulted in additional tax-equivalent net interest income, a non-GAAP measure, of $7,218. A rate variance resulted in a decrease in net interest income of $5,245.
Average earning assets increased $436,830 to $3,153,697 for the three months ended March 31, 2022 from $2,716,867 for the three months ended March 31, 2021 and accounted for a $8,385 increase in interest income. Average loans increased $172,424, which caused interest income to increase $5,392. Specifically, average PPP loans totaled $48,984 and generated $1,033 of interest and net fees in the current period compared to average PPP loans of $195,525 and $2,469 of interest and fees in the prior period. Average taxable investments increased $263,063 comparing 2022 and 2021, which resulted in increased interest income of $2,471 while average tax-exempt investments increased $38,217, which resulted in an increase to interest income of $576. Average federal funds sold decreased $29,502 for the three months ended March 31, 2022 which resulted in a decrease of $47 to interest income.
Average interest-bearing liabilities rose $315,463 to $2,247,103 for the three months ended March 31, 2022 from $1,931,640 for the three months ended March 31, 2021 resulting in a net increase in interest expense of $1,167. Interest-bearing transaction accounts, including money market, NOW and savings accounts grew $400,810, which in aggregate caused a $1,583 increase in interest expense. In addition, large denomination time deposits averaged $22,892 less in the current period and caused interest expense to decrease $49. An increase of $50 in average time deposits less than $100 thousand increased interest expense by $2. In addition, short-term borrowings averaged $50,470 lower and decreased interest expense $36 while long-term debt averaged $12,035 lower and decreased interest expense by $333 comparing the first three months of 2022 and 2021.
An unfavorable rate variance occurred, as the tax-equivalent yield on earning assets decreased 33 basis points while there was a 22 basis point decrease in the cost of funds. As a result, tax-equivalent net interest income decreased $5,245 comparing the three months ended March 31, 2022 and 2021. The tax-equivalent yield on earning assets was 3.22% in the 2022 period compared to 3.55% in 2021 resulting in a decrease in interest income of $7,181. The yield on the taxable investment portfolio decreased 44 basis points to 1.53% during the three months ended March 31, 2022 from 1.97% in the year ago period, resulting in a decrease of $1,765. The yield on the tax exempt investment portfolio decreased 41 basis points to 2.37% during the three months ended March 31, 2022 from 2.78% in the year ago period, resulting in a decrease of $424. The tax-equivalent yield on the loan portfolio decreased 24 basis points to 3.85% in 2022 from 4.09% in 2021 and resulted in a decrease to interest income of $5,070.
PPP loans yielded 8.55% during the three months ended March 31, 2022 compared to 5.12% in the year ago period. The increase resulted from the high volume of PPP loan forgiveness and the accretion of deferred fees.
A favorable rate variance was experienced in the cost of funds as incremental deposit rate reductions have been completed to mitigate the effect of low market rates to our net interest income. We experienced decreases in the rates paid on most of the major categories of interest-bearing liabilities. The cost of money market accounts decreased 20 basis points comparing the three months ended March 31, 2022 and 2021. The decrease resulted in a decrease in interest expense of $711. The cost of NOW accounts decreased 19 basis points and resulted in a $1,109 reduction of interest expense. The cost of savings accounts decreased 2 basis points and resulted in a $59 reduction of interest expense. With regard to time deposits, the average rate paid for time deposits less than $100 thousand decreased 28 basis points while time deposits $100 thousand or more decreased 47 basis points, which together resulted in a $281 decrease in interest expense. Interest expense increased $258 from a 171 basis point increase in the average rate paid on long-term debt.
The average balances of assets and liabilities, corresponding interest income and expense and resulting average yields or rates paid are summarized as follows. Averages for earning assets include nonaccrual loans. Investment averages include available-for-sale securities at amortized cost. Income on investment securities and loans is adjusted to a tax equivalent basis using the prevailing federal statutory tax rate of 21%.
Three months ended
Interest Income/
Yield/
Expense
Earning assets:
2,148,251
3.94
2,054,120
4.13
203,645
1,470
2.93
125,352
1,101
3.56
Total loans
2,351,896
22,323
3.85
2,179,472
22,001
4.09
523,301
1.53
260,238
1,266
1.97
110,394
646
2.37
72,177
494
2.78
Total investments
633,695
2,618
1.68
332,415
1,760
2.15
5,888
0.14
13,260
0.06
162,218
0.18
191,720
0.10
Total earning assets
3,153,697
3.22
2,716,867
3.55
28,717
27,692
216,581
224,870
3,341,561
2,914,045
Liabilities and Stockholders’ Equity:
Interest-bearing liabilities:
595,991
385
0.26
504,302
566
0.46
820,016
0.24
571,344
599
0.43
505,816
0.07
445,367
97
0.09
127,610
302
0.96
127,560
389
1.24
162,196
0.50
185,088
0.97
2,211,629
0.27
1,833,661
50,470
0.57
2,474
4.59
14,509
2.88
5.38
Total borrowings
35,474
472
5.32
97,979
617
2.55
Total interest-bearing liabilities
2,247,103
0.35
1,931,640
734,348
634,806
29,816
27,371
Stockholders’ equity
330,294
320,228
Net interest income/spread
2.87
2.98
Net interest margin
2.97
3.15
Tax-equivalent adjustments:
309
231
Investments
136
Total adjustments
46
Provision for Loan Losses:
We evaluate the adequacy of the allowance for loan losses account on a quarterly basis utilizing our systematic analysis in accordance with procedural discipline. We take into consideration certain factors such as composition of the loan portfolio, volumes of nonperforming loans, volumes of net charge-offs, prevailing economic conditions and other relevant factors when determining the adequacy of the allowance for loan losses account. We generally make monthly provisions to the allowance for loan losses account in order to maintain the allowance at the appropriate level indicated by our evaluations. Based on our most current evaluation, we believe that the allowance is adequate to absorb any known and inherent losses in the portfolio as of March 31, 2022.
For the three months ended March 31, 2022, the provision for loan losses increased $800 to $300 from a credit of $500 in the year ago period due to improving credit trends. The provision for loan losses in the three month period ended March 31, 2022 is the result of growth of non-PPP loans and improved credit quality.
Noninterest Income:
Noninterest income for the three months ended March 31, 2022 was $3,421, a decrease of $96 or 2.7% from $3,517 in 2021. The decrease was primarily due to a decrease in revenue generated from our commercial loan interest rate swaps of $454 due to higher transaction volumes and credit value adjustments in the year ago period. Mortgage banking revenue declined $168 in the three month period ended March 31, 2022 due to lower volumes of mortgage loans being sold into the secondary market. Services charges, fees, commissions and other were higher in the current period by $508 due to the reversal of an accrual of a $0.3 million bank owned life insurance benefit in the year ago period, and a $0.1 million incentive received related to our debit card activity in the current period.
Noninterest Expenses:
In general, noninterest expense is categorized into three main groups: employee-related expenses, occupancy and equipment expenses and other expenses. Employee-related expenses are costs associated with providing salaries, including payroll taxes and benefits, to our employees. Occupancy and equipment expenses, the costs related to the maintenance of facilities and equipment, include depreciation, general maintenance and repairs, real estate taxes, rental expense offset by any rental income, and utility costs. Other expenses include general operating expenses such as advertising, contractual services, insurance, including FDIC assessment, other taxes and supplies. Several of these costs and expenses are variable while the remainder are fixed. We utilize budgets and other related strategies in an effort to control the variable expenses.
Noninterest expense increased $1,660 or 13.1% to $14,289 for the three months ended March 31, 2022, from $12,629 for the three months ended March 31, 2021. Salaries and employee benefits increased $1,470 or 22.4% due to the addition of lending teams and credit support staff in our newest expansion markets of Piscataway, New Jersey and Pittsburgh, Pennsylvania that opened during the fourth quarter of 2021. Additionally, deferred loan origination costs, which are recorded as a contra-salary expense, were $0.7 million higher in the year ago period due to the origination of PPP loans related to round two of the program. Occupancy and equipment expenses were higher by $558 in the current period due to information technology investments related to mobile/digital banking solutions implemented during the second half of 2021. Other expenses were lower by $368 due primarily to higher gains realized on the sale of other real estate owned of $412.
Income Taxes:
We recorded income tax expense of $1,833 or 16.0% of pre-tax income for the three months ended March 30, 2022. This compares to the three month period ended March 31, 2021 in which we recorded tax expense of $2,678 or 22.0% of pre-tax income. The current quarter benefited from a higher level of tax-exempt income while the prior year’s quarter
47
included a $621 deferred tax adjustment related to prior periods. Excluding this adjustment, the effective tax rate would have been 16.9% for the three month period ended March 31, 2021.
48
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
Market risk is the risk to our earnings and/or financial position resulting from adverse changes in market rates or prices, such as interest rates, foreign exchange rates or equity prices. Our exposure to market risk is primarily interest rate risk (“IRR”), which arises from our lending, investing and deposit gathering activities. Our market risk sensitive instruments consist of derivative and non-derivative financial instruments, none of which are entered into for trading purposes. During the normal course of business, we are not exposed to foreign exchange risk or commodity price risk. Our exposure to IRR can be explained as the potential for change in reported earnings and/or the market value of net worth. Variations in interest rates affect the underlying economic value of assets, liabilities and off-balance sheet items. These changes arise because the present value of future cash flows, and often the cash flows themselves, change with interest rates. The effects of the changes in these present values reflect the change in our underlying economic value, and provide a basis for the expected change in future earnings related to interest rates. Interest rate changes affect earnings by changing net interest income and the level of other interest-sensitive income and operating expenses. IRR is inherent in the role of banks as financial intermediaries.
A bank with a high degree of IRR may experience lower earnings, impaired liquidity and capital positions, and most likely, a greater risk of insolvency. Therefore, banks must carefully evaluate IRR to promote safety and soundness in their activities. Interest rate risk is the risk of loss to future earnings due to changes in interest rates. The Asset Liability Committee (“ALCO”) is responsible for establishing policy guidelines on liquidity and acceptable exposure to interest rate risk. Generally quarterly, ALCO reports on the status of liquidity and interest rate risk matters to the Company’s board of directors. The objective of the ALCO is to manage assets and funding sources to produce results that are consistent with the Company’s liquidity, capital adequacy, growth, risk and profitability goals and are within policy limits.
The Company utilizes the pricing and structure of loans and deposits, the size and duration of the investment securities portfolio, the size and duration of the wholesale funding portfolio, and off-balance sheet interest rate contracts to manage interest rate risk. The off-balance sheet interest rate contracts may include interest rate swaps, caps and floors. These interest rate contracts involve, to varying degrees, credit risk and interest rate risk. Credit risk is the possibility that a loss may occur if a counterparty to a transaction fails to perform according to terms of the contract. The notional amount of the interest rate contracts is the amount upon which interest and other payments are based. The notional amount is not exchanged, and therefore, should not be taken as a measure of credit risk. See Note 15 to the Audited Consolidated Financial Statements for additional information.
The ALCO uses income simulation to measure interest rate risk inherent in the Company’s on-balance sheet and off-balance sheet financial instruments at a given point in time by showing the effect of interest rate shifts on net interest income over a 24-month horizon and a 60-month horizon. The simulations assume that the size and general composition of the Company’s balance sheet remain static over the simulation horizons, with the exception of certain deposit mix shifts from low-cost time deposits to higher cost time deposits in selected interest rate scenarios. Additionally, the simulations take into account the specific repricing, maturity, call options, and prepayment characteristics of differing financial instruments that may vary under different interest rate scenarios. The characteristics of financial instrument classes are reviewed typically quarterly by the ALCO to ensure their accuracy and consistency.
The ALCO reviews simulation results to determine whether the Company’s exposure to a decline in net interest income remains within established tolerance levels over the simulation horizons and to develop appropriate strategies to manage this exposure. As of March 31, 2022 and December 31, 2021, net interest income simulations indicated that exposure to changing interest rates over the simulation horizons remained within tolerance levels established by the Company. All changes are measured in comparison to the projected net interest income that would result from an “unchanged” rate scenario where both interest rates and the composition of the Company’s balance sheet remain stable for a 24-month and 60-month period. In addition to measuring the change in net interest income as compared to an unchanged interest rate scenario, the ALCO also measures the trend of both net interest income and net interest margin over a 24-month and 60-month horizon to ensure the stability and adequacy of this source of earnings in different interest rate scenarios
Model results at March 31, 2022 indicated a significantly higher starting level of net interest income (“NII”) compared to the December 31, 2021 model as balance sheet growth, a shift in balance sheet mix and higher assumed market rates led to an increase to the balance sheet spread of 16 basis points. As the model simulation progresses the benefit to NII
increases as a result of the higher assumed replacement rates on assets resulting from the FOMC’s recent increase to the federal funds rate and the recent bond market sell-off. Our interest rate risk position continues to exhibit a benefit to rising interest rates throughout the simulations while a sustained falling rate environment presents the greatest potential exposure to earnings. This position at March 31, 2022 is slightly less asset-sensitive than the simulation at December 31, 2021 indicated.
The ALCO regularly reviews a wide variety of interest rate shift scenario results to evaluate interest rate risk exposure, including scenarios showing the effect of steepening or flattening changes in the yield curve as well as parallel changes in interest rates of up to 400 basis points. Because income simulations assume that the Company’s balance sheet will remain static over the simulation horizon, the results do not reflect adjustments in strategy that the ALCO could implement in response to rate shifts.
The FOMC increased the federal funds target by 25 basis points in March 2022 to a range of 25 to 50 basis points in part to mitigate historically high inflation. Recent statements by members of the FOMC strongly signal that rate increases will continue in 2022 to combat inflation, and no final decision on the pace of the tightening had been made. Given the Company’s current asset/liability position, higher market interest rates may have a positive impact on our earning asset yields and variable-rate loans indexed to prime, LIBOR or other market rates.
The projected impacts of instantaneous changes in interest rates on our net interest income and economic value of equity at March 31, 2022, based on our simulation model, as compared to our ALCO policy limits are summarized as follows:
% Change in
Changes in Interest Rates (basis points)
Net Interest Income
Economic Value of Equity
Metric
Policy
+400
0.8
(20.0)
(16.5)
(40.0)
+300
0.6
(12.3)
(30.0)
+200
0.2
(10.0)
(8.1)
+100
(3.0)
Static
-100
(4.8)
(7.2)
Our simulation model creates pro forma net interest income scenarios under various interest rate shocks. Given instantaneous and parallel shifts in general market rates of plus 100 basis points, our projected net interest income for the 12 months ending March 31, 2022, would increase 0.2% from model results using current interest rates. Additional disclosures about market risk are included in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2021, and in Part I, Item 2 of this quarterly report, in each case under the heading “Market Risk Sensitivity,” and are incorporated into this Item 3 by reference.
The Company has certain loans and derivative instruments whose interest rate is indexed to the London Inter Bank Offered Rate (“LIBOR”). The LIBOR index will be discontinued for U.S. Dollar settings effective June 30, 2023. The Alternative Reference Rates Committee ("ARRC") has proposed that the Secured Overnight Funding Rate ("SOFR") replace USD-LIBOR. The Company has contracts that are indexed to USD-LIBOR. Industry organizations are currently working on the transition plan. The Company has formed a LIBOR transition team which is currently monitoring this activity. The Company has begun transitioning LIBOR-indexed loans to alternative indexes, including prime and Term SOFR, and adjusting the spread to maintain the overall yield.
Item 4. Controls and Procedures.
(a) Evaluation of disclosure controls and procedures.
At March 31, 2022, the end of the period covered by this Quarterly Report on Form 10-Q, the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) evaluated the effectiveness of the Company’s disclosure controls and procedures as defined in Rule 13a-15(e) under the Exchange Act. Based upon that evaluation, the CEO and CFO concluded that the disclosure controls and procedures, at March 31, 2022, were effective to provide reasonable assurance that information required to be disclosed in the Company’s reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and to provide reasonable assurance that information required to be disclosed in such reports is accumulated and communicated to the CEO and CFO to allow timely decisions regarding required disclosure.
(b) Changes in internal control.
There were no changes made in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II—OTHER INFORMATION
Item 1. Legal Proceedings.
The nature of the Company’s business generates a certain amount of litigation involving matters arising out of the ordinary course of business. In the opinion of management, there were no legal proceedings that had or might have a material effect on the consolidated results of operations, liquidity, or the financial position of the Company during the three-months ended March 31, 2022 and through the date of this quarterly report on Form 10-Q.
Item 1A. Risk Factors
Our Annual Report on Form 10-K for the year ended December 31, 2021 (2021 Form 10-K) describes market, credit, and business operations risk factors that could affect our business, results of operations or financial condition including, among other things, outbreaks of highly infectious or contagious diseases. There have been no material changes from the risk factors as previously disclosed in our 2021 Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
On January 29, 2021, our board of directors authorized a common stock repurchase plan whereby we are authorized to repurchase up to 343,400 shares of our outstanding common stock through open market purchases.
The following purchases were made by or on behalf of the Company or any “affiliated purchaser,” as defined in the Exchange Act Rule 10b-18(a)(3), of the Company’s common stock during each of the months for the quarter ended March 31, 2022.
Total Number of
Maximum Number
Shares Purchased
of Shares that may
as Part of Publicly
yet be Purchased
Average Price
Announced
Under the
Month Ending
Paid Per Share
Programs
January 31, 2022
250,313
301,637
February 28, 2022
3,865
47.65
254,178
297,772
2,849
46.96
257,027
294,923
Item 3. Defaults upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
Item 6. Exhibits.
Item Number
Description
10.1
Supplemental Executive Retirement Plan by and between Peoples Security Bank and Trust Company and John Anderson, dated March 30, 2022 (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the Commission on April 1, 2022)*
10.2
Supplemental Executive Retirement Plan by and between Peoples Security Bank and Trust Company and Timothy Kirtley, dated March 30, 2022 (incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed with the Commission on April 1, 2022)*
31.1
CEO Certification Pursuant to Rule 13a-14 (a) /15d-14 (a).
31.2
CFO Certification Pursuant to Rule 13a-14 (a) /15d-14 (a). (a).
CEO and CFO Certifications Pursuant to Section 1350.
The following materials from Peoples Financial Services Corp. Quarterly Report on Form 10-Q for the period ended March 31, 2022, formatted in inline XBRL: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income and Comprehensive Income, (iii) the Consolidated Statements of Changes in Stockholders’ Equity, (iv) the Consolidated Statements of Cash Flows and (v) the Notes to the Consolidated Financial Statements.
Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)
*Management contract or compensatory plan or arrangement.
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.
(Registrant)
Date: May 9, 2022
/s/ Craig W. Best
Craig W. Best
Chief Executive Officer
(Principal Executive Officer)
/s/ John R. Anderson, III
John R. Anderson, III
Executive Vice President and Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)