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, 2023
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: 7,150,757 at May l, 2023.
FORM 10-Q
For the Quarter Ended March 31, 2023
Contents
Page No.
PART I.
FINANCIAL INFORMATION:
Item 1.
Financial Statements
Consolidated Balance Sheets at March 31, 2023 (Unaudited) and December 31, 2022 (Unaudited)
3
Consolidated Statements of Income and Comprehensive Income (Loss) for the Three Months ended March 31, 2023 and 2022 (Unaudited)
4
Consolidated Statements of Changes in Stockholders’ Equity for the Three Months ended March 31, 2023 and 2022 (Unaudited)
5
Consolidated Statements of Cash Flows for the Three Months ended March 31, 2023 and 2022 (Unaudited)
6
Notes to Consolidated Financial Statements (Unaudited)
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
37
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
53
Item 4.
Controls and Procedures
55
PART II
OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
56
Defaults upon Senior Securities
57
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
Signatures
58
2
Peoples Financial Services Corp.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)
March 31, 2023
December 31, 2022
Assets:
Cash and cash equivalents
Cash and due from banks
$
31,354
37,675
Interest-bearing deposits in other banks
7,129
193
Federal funds sold
102,100
Total cash and cash equivalents
140,583
37,868
Investment securities:
Available-for-sale
418,125
477,703
Equity investments carried at fair value
81
110
Held-to-maturity: Fair value March 31, 2023, $77,073; December 31, 2022, $76,563
89,705
91,179
Total investment securities
507,911
568,992
Loans
2,818,043
2,730,116
Less: allowance for credit losses
25,444
27,472
Net loans
2,792,599
2,702,644
Goodwill
63,370
Premises and equipment, net
56,561
55,667
Bank owned life insurance
48,598
48,344
Deferred tax assets
16,015
18,739
Accrued interest receivable
11,678
11,715
Intangible assets, net
77
105
Other assets
41,079
46,071
Total assets
3,678,471
3,553,515
Liabilities:
Deposits:
Noninterest-bearing
746,089
772,765
Interest-bearing
2,489,878
2,273,833
Total deposits
3,235,967
3,046,598
Short-term borrowings
17,280
114,930
Long-term debt
25,000
555
Subordinated debentures
33,000
Accrued interest payable
2,304
903
Other liabilities
36,286
42,179
Total liabilities
3,349,837
3,238,165
Stockholders’ equity:
Common stock, par value $2.00, authorized 25,000,000 shares, issued and outstanding 7,150,757 shares at March 31, 2023 and 7,158,017 shares at December 31, 2022
14,323
14,321
Capital surplus
126,231
126,850
Retained earnings
237,522
230,515
Accumulated other comprehensive loss
(49,442)
(56,336)
Total stockholders’ equity
328,634
315,350
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,
2023
2022
Interest income:
Interest and fees on loans:
Taxable
30,049
20,853
Tax-exempt
1,389
1,161
Interest and dividends on investment securities:
2,124
1,972
457
510
Dividends
Interest on interest-bearing deposits in other banks
14
Interest on federal funds sold
243
73
Total interest income
34,278
24,571
Interest expense:
Interest on deposits
9,678
1,468
Interest on short-term borrowings
1,086
Interest on long-term debt
27
28
Interest on subordinated debt
443
444
Total interest expense
11,234
1,940
Net interest income
23,044
22,631
Provision for credit losses
1,264
300
Net interest income after provision for credit losses
21,780
22,331
Noninterest income:
Service charges, fees, commissions and other
1,965
1,692
Merchant services income
118
114
Commission and fees on fiduciary activities
557
Wealth management income
398
351
Mortgage banking income
103
144
Increase in cash surrender value of life insurance
258
218
Interest rate swap revenue
223
343
Net (losses) gains on equity investment securities
(29)
Net gains on sale of investment securities available for sale
Total noninterest income
3,674
3,421
Salaries and employee benefits expense
9,080
8,040
Net occupancy and equipment expense
4,103
3,825
Amortization of intangible assets
29
96
Net gain on sale of other real estate owned
(458)
Professional fees and outside services
619
470
FDIC insurance and assessments
501
326
Donations
397
334
Other expenses
1,757
1,656
Total noninterest expense
16,486
14,289
Income before income taxes
8,968
11,463
Provision for income tax expense
1,833
Net income
7,579
9,630
Other comprehensive income (loss):
Unrealized gain (loss) on investment securities available-for-sale
10,836
(32,612)
Reclassification adjustment for net gain on sales included in net income
(81)
Change in derivative fair value
(1,970)
(493)
Other comprehensive income (loss)
8,785
(33,105)
Income tax expense (benefit) related to other comprehensive income (loss)
1,891
(6,952)
Other comprehensive income (loss), net of income tax expense (benefit)
6,894
(26,153)
Comprehensive income (loss)
14,473
(16,523)
Per share data:
Net income:
Basic
1.06
1.34
Diluted
1.05
1.33
Average common shares outstanding:
7,157,553
7,172,455
7,198,970
7,216,421
Dividends declared
0.41
0.39
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)
Accumulated
Other
Common
Capital
Retained
Comprehensive
Stock
Surplus
Earnings
Loss
Total
Balance, January 1, 2023
Cumulative impact of adoption of ASU 2016-13(1), net of tax
2,364
Other comprehensive income, net of tax
Dividends declared: $0.41 per share
(2,936)
Stock based compensation
209
Restricted stock issued: 17,640 shares
35
(35)
Share retirement: 16,573 shares
(33)
(793)
(826)
Balance, March 31, 2023
(1) See Note 1 for additional details related to adoption of ASU 2016-13.
Balance, January 1, 2022
14,341
127,549
203,750
(5,514)
340,126
Other comprehensive loss, net of tax
Dividends declared: $0.39 per share
(2,796)
(28)
Restricted stock issued: 12,332 shares, (unearned income $210k)
24
(24)
Share retirement: 6,714 shares
(13)
(305)
(318)
Balance, March 31, 2022
14,352
127,192
210,584
(31,667)
320,461
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
703
663
Amortization of right-of-use lease asset
124
146
Amortization of deferred loan fees, net
150
949
Amortization of intangibles
Amortization of low income housing partnerships
121
Net unrealized loss (gain) on equity investment securities
(4)
Loans originated for sale
(1,244)
(3,798)
Proceeds from sale of loans originated for sale
1,245
4,069
Net gain on sale of loans originated for sale
(1)
Net amortization of investment securities
290
431
Net gain on sale of investment securities available-for-sale
Gain on sale of premises and equipment
(14)
(5)
(258)
(218)
Deferred income tax expense
183
Net change in:
(693)
(3,019)
(3,869)
1,401
436
(4,198)
1,388
Net cash provided by operating activities
4,549
9,136
Cash flows from investing activities:
Proceeds from sales of investment securities available-for-sale
67,362
Proceeds from repayments of investment securities:
2,791
12,897
Held-to-maturity
1,446
1,207
Purchases of investment securities:
(64,051)
(25,873)
Net redemption of restricted equity securities
4,743
1,352
Net increase in loans
(88,086)
(69,733)
Investment in bank owned life insurance
(1,081)
Purchases of premises and equipment
(2,506)
(1,284)
Proceeds from the sale of premises and equipment
Proceeds from bank owned life insurance
225
Proceeds from sale of other real estate owned
946
Net cash used in investing activities
(14,236)
(145,390)
Cash flows from financing activities:
Net increase in deposits
189,369
1,467
Proceeds from long-term debt
Repayment of long-term debt
(555)
(529)
Net decrease in short-term borrowings
(97,650)
Retirement of common stock
Cash dividends paid
Net cash provided (used) by financing activities
112,402
(2,176)
Net increase (decrease) in cash and cash equivalents
102,715
(138,430)
Cash and cash equivalents at beginning of period
279,933
Cash and cash equivalents at end of period
141,503
Supplemental disclosures:
Cash paid during the period for:
Interest
9,833
1,504
Income taxes
47
Noncash items:
Initial recognition of right-of-use assets
(785)
Initial recognition of lease liability
(820)
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, 2023, 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 credit 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, 2022.
Second Quarter Dividend Declaration
On April 28, 2023, the Board of Directors declared a second quarter dividend of $0.41 per share. The dividend is payable on June 15, 2023 to shareholders of record as of May 31, 2023.
Adoption of New Accounting Standard
On January 1, 2023, the Company adopted ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (CECL) model. The Company adopted ASU 2016-13 using a modified retrospective approach. Results for reporting periods beginning after January 1, 2023 are presented under Topic 326, while prior period amounts continue to be reported in accordance with previously applicable GAAP. At adoption, the Company decreased its allowance for credit losses by $3.0 million. Upon adoption the Company recorded a cumulative effect adjustment that increased stockholders’ equity by $2.4 million, net of tax.
The Company adopted ASU 2022-02, “Financial Instruments - Credit Losses (Topic 326) Troubled Debt Restructurings and Vintage Disclosures” effective January 1, 2023. The ASU addresses and amends areas identified by the FASB as part of its post-implementation review of the accounting standard that introduced the current expected credit losses model. The amendments eliminate the accounting guidance for troubled debt restructurings by creditors that have adopted the current expected credit losses model and enhance the disclosure requirements for loan refinancings and restructurings made with borrowers experiencing financial difficulty. In addition, the amendments require disclosure of current-period gross write-offs for financing receivables and net investment in leases by year of origination in the vintage disclosures.
Allowance for Credit Losses
The allowance for credit losses represents the estimated amount considered necessary to cover lifetime expected credit losses inherent in financial assets at the balance sheet date. The measurement of expected credit losses is applicable to loans receivable and securities measured at amortized cost. It also applies to off-balance sheet credit exposures such as loan commitments and unused lines of credit. The allowance is established through a provision for credit losses that is charged against income. The methodology for determining the allowance for credit losses is considered a critical accounting policy by management because of the high degree of judgment involved, the subjectivity of the assumptions used, and the potential for changes in the forecasted economic environment that could result in changes to the amount of the recorded allowance for credit losses. The allowance for credit losses is reported separately as a contra-asset on the consolidated balance sheets. The expected credit loss for unfunded lending commitments and unfunded loan commitments is reported on the consolidated balance sheets in other liabilities while the provision for credit losses related to unfunded commitments is reported in other non-interest expense in the consolidated statements of income and comprehensive income (loss).
Allowance for Credit Losses on Loans Receivable
The allowance for credit losses on loans is deducted from the amortized cost basis of the loan to present the net amount expected to be collected. Expected losses are evaluated and calculated on a collective, or pooled, basis for those loans which share similar risk characteristics. The Company has chosen to segment its portfolio consistent with the manner in which it manages credit risk. Such segments include residential real estate, consumer, commercial and industrial, commercial real estate and municipal. At each reporting period, the Company evaluates whether loans within a pool continue to exhibit similar risk characteristics. If the risk characteristics of a loan change, such that they are no longer similar to other loans in the pool, the Company will evaluate the loan with a different pool of loans that share similar risk characteristics. If the loan does not share risk characteristics with other loans, the Company will evaluate the loan on an individual basis. The Company evaluates the pooling methodology at least annually. Loans are charged off against the allowance for credit losses when the Company believes the balances to be uncollectible. Expected recoveries do not exceed the aggregate of amounts previously charged off or expected to be charged off.
The Company estimates the allowance for credit losses on loans using an advanced probability of default model which incorporates probability of default, loss given default, exposure at default and probability of attrition attributes. The model considers relevant available information at both the portfolio and loan level from internal data that is supplemented by shared data pool information. The model also incorporates reasonable and supportable economic forecasts. After the reasonable and supportable forecast period, the model reverts to average historical losses. Expected credit losses are estimated over the contractual term of the loans, adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals, and modifications.
Also included in the allowance for credit losses on loans are qualitative reserves to cover losses that are expected but, in the Company’s assessment, may not be adequately represented in the quantitative analysis described above. Factors that the Company considers include changes in lending policies and procedures, changes in management, changes in the quality of the loan review process, the existence of any concentrations of credit and other external factors.
9
Individually Evaluated Loans
On a case-by-case basis, the Company may conclude that a loan should be evaluated on an individual basis based on its disparate risk characteristics. The Bank has determined that any loans currently on non-accrual status or are 90 or more days past due and still accruing are considered impaired and should be individually evaluated for losses. When the Company determines that a loan no longer shares similar risk characteristics with other loans in the portfolio, the allowance will be determined on an individual basis using the present value of expected cash flows or, for collateral-dependent loans, the fair value of the collateral as of the reporting date, less estimated selling costs, as applicable. If the fair value of the collateral is less than the amortized cost basis of the loan, the Company will establish a reserve for the difference between the fair value of the collateral, less costs to sell and carrying costs at the reporting date and the amortized cost basis of the loan. If this amount is deemed uncollectible, the Company will charge-off that amount.
Acquired Loans
Acquired loans are included in the Company's calculation of the allowance for credit losses. How the allowance on an acquired loan is recorded depends on whether or not it has been classified as a Purchased Credit Deteriorated (“PCD”) loan. PCD loans are loans acquired at a discount that is due, in part, to credit quality. PCD loans are accounted for in accordance with ASC Subtopic 326-20 and are initially recorded at fair value as determined by the sum of the present value of expected future cash flows and an allowance for credit losses at acquisition. The allowance for PCD loans is recorded through a gross-up effect, while the allowance for acquired non-PCD loans is recorded through provision expense, consistent with originated loans. Thus, the determination of which loans are PCD and non-PCD can have a significant impact on the accounting for these loans. Subsequent to acquisition, the allowance for PCD loans will generally follow the same estimation, provision and charge-off process as non-PCD acquired and originated loans.
Under FASB ASC Topic 326, a PCD asset is defined as an individual financial asset that as of the date of acquisition has experienced a more than insignificant deterioration in credit quality since origination as determined during the acquisition process. Upon identification of these assets, the amortized cost basis will be adjusted at the time of acquisition to reflect any impairment amount. After acquisition, PCD loans will be either collectively evaluated for reserve requirements or individually evaluated if on nonaccrual status or are 90 or more days past due and still accruing.
Allowance for Credit Losses on Off-Balance Sheet Commitments
The Company is required to include unfunded commitments that are expected to be funded in the future within the allowance calculation, other than those that are unconditionally cancelable. To arrive at that reserve, the reserve percentage for each applicable segment is applied to the unused portion of the expected commitment balance and is multiplied by the expected funding rate. To determine the expected funding rate, the Company uses a historical utilization rate for each segment. As noted above, the allowance for credit losses on unfunded loan commitments is included in other liabilities on the consolidated balance sheets and the related credit expense is recorded in other non-interest expense in the consolidated statements of income and comprehensive income (loss).
Allowance for Credit Losses on Held to Maturity Securities
The Company’s portfolio of held to maturity securities consists of municipal bonds and U.S. agency residential mortgage-backed securities which are highly rated by major rating agencies and have a long history of no credit losses. In estimating the net amount expected to be collected for held to maturity securities in an unrealized loss position, a historical loss based method is utilized.
10
Allowance for Credit Losses on Available for Sale Securities
For available for sale securities in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For securities available for sale that do not meet the above criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, the Company considers the extent to which fair value is less than amortized cost, any changes to the rating by a rating agency, and adverse conditions related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of the cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income, net of tax. The Company elected the practical expedient of zero loss estimates for securities issued by U.S. government entities and agencies. These securities are either explicitly or implicitly guaranteed by the U.S. government, are highly rated by major agencies and have a long history of no credit losses.
Accrued Interest Receivable
The Company made an accounting policy election to exclude accrued interest receivable from the amortized cost basis of loans, available for sale securities, and held to maturity securities. Accrued interest receivable on loans is reported as a component of accrued interest receivable on the Consolidated Balance Sheets, totaled $9.8 million at March 31, 2023 and is excluded from the estimate of credit losses. Accrued interest receivable on available of sale securities and held to maturity securities, also a component of accrued interest receivable on the Consolidated Balance Sheets, totaled $1.6 million and $191 thousand, respectively, at March 31, 2023 and is excluded from the estimate of credit losses.
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, 2022.
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.
ASU 2023-01, “Leases (Topic 842) - Common Control Arrangements” (ASU 2023-01) requires entities to determine whether a related party arrangement between entities under common control is a lease. If the arrangement is determined to be a lease, an entity must classify and account for the lease on the same basis as an arrangement with an unrelated party (on the basis of legally enforceable terms and conditions). ASU 2023-01 is effective January 1, 2024 and is not expected to have an impact on our financial statements.
ASU 2023-02 “Investments - Equity Method and Join Ventures (Topic 323) - Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method” (ASU 2023-02) permits reporting entities to elect to account for their tax equity investments, regardless of the tax credit program from which the income tax credits are received, using the proportional amortization method if certain conditions are met. ASU 2023-02 is effective January 1, 2024 and is not expected to have an impact on our financial statements.
11
2. Other comprehensive income (loss):
The components of other comprehensive income (loss) and their related tax effects are reported in the consolidated statements of income and comprehensive income (loss). 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.
The components of accumulated other comprehensive loss included in stockholders’ equity at March 31, 2023 and December 31, 2022 are as follows:
(Dollars in thousands)
Net unrealized loss on investment securities available-for-sale
(55,495)
(66,250)
Income tax benefit
(11,950)
(14,266)
Net of income taxes
(43,545)
(51,984)
Benefit plan adjustments
(5,499)
(1,184)
(4,315)
Derivative adjustments
(2,017)
(47)
(434)
(10)
(1,583)
(37)
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, 2023 and 2022:
(Dollars in thousands, except percents)
Average common shares outstanding
Earnings per share
12
4. Investment securities:
The amortized cost and fair value of investment securities aggregated by investment category at March 31, 2023 and December 31, 2022 are summarized as follows:
Gross
Amortized
Unrealized
Fair
Cost
Gains
Losses
Value
Available-for-sale:
U.S. Treasury securities
197,660
16,096
181,564
U.S. government-sponsored enterprises
16,872
441
16,431
State and municipals:
68,426
11,227
57,204
77,668
1
9,095
68,574
Residential mortgage-backed securities:
U.S. government agencies
942
34
908
95,947
17,735
78,212
Commercial mortgage-backed securities:
12,105
484
11,621
Corporate debt securities
4,000
389
3,611
473,620
55,501
Held-to-maturity:
Tax-exempt state and municipals
11,228
674
10,562
16,806
2,541
14,265
61,671
9,425
52,246
12,640
77,073
199,937
19,640
180,297
16,955
585
16,370
68,946
13,588
55,358
99,774
93
11,460
88,407
982
40
141,231
20,112
121,119
12,128
544
11,584
374
3,626
543,953
66,343
11,237
841
10,397
17,304
3,016
14,288
62,638
10,760
51,878
14,617
76,563
13
The Company had net unrealized losses on available-for-sale securities of $43.5 million net of deferred income taxes of $12.0 million at March 31, 2023 and net unrealized losses on available-for-sale securities of $52.0 million net of deferred income taxes of $14.3 million at December 31, 2022. During the three month period ended March 31, 2023, investment securities, including U.S. Treasury bonds and mortgage-backed securities, with a par value of $65.6 million were sold at a net gain of $81 thousand. The proceeds were used to pay-down higher cost short-term borrowings.
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, 2023, is summarized as follows:
Within one year
15,202
After one but within five years
176,975
After five but within ten years
66,629
After ten years
66,319
325,125
Mortgage-backed and other amortizing securities
93,000
The maturity distribution of the amortized cost and fair value, of debt securities classified as held-to-maturity at March 31, 2023, is summarized as follows:
8,877
8,355
2,351
2,207
Mortgage-backed securities
78,477
66,511
Securities with a carrying value of $151.2 million and $168.0 million at March 31, 2023 and December 31, 2022, 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, 2023 and December 31, 2022, there were no significant concentrations of credit risk from any one issuer, with the exception of U.S. government agencies and sponsored enterprises, which exceeded 10.0 percent of stockholders’ equity.
The fair value and gross unrealized losses of investment securities with unrealized losses at March 31, 2023 and December 31, 2022, 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 Greater
Number of
Securities in a
Loss Position
43
999
19
63
54,709
11,208
65
55,708
3,095
98
70,366
9,740
73,461
9,769
818
31
14,355
2,544
15,173
2,575
527
129,931
27,148
41
130,458
27,160
1,926
86
9,695
7,365
177
265
480,662
67,964
278
488,027
68,141
23,700
1,887
156,597
17,753
45
14,104
197
2,266
388
21
19,919
2,908
34,464
10,680
66
54,383
39
30,973
1,690
84
59,664
10,611
123
90,637
12,301
904
14,326
3,017
15,230
3,056
57,166
2,029
25
115,831
28,843
44
172,997
30,872
953
2,673
327
159,303
9,341
204
385,821
71,619
302
545,124
80,960
As described in Note 1, on January 1, 2023 the Company adopted amended accounting guidance that requires an allowance for credit losses be deducted from the amortized cost basis of financial assets, including investment securities held to maturity, to present the net carrying value at the amount that is expected to be collected over the contractual term of the asset. The Company estimated no allowance for credit losses for its investment securities classified as held-to-maturity at January 1, 2023 or March 31, 2023, as the portfolio of held-to-maturity securities consists entirely of U.S. government sponsored enterprises, agencies and states and political subdivisions investments.
The unrealized losses on securities are primarily due to the changes in market interest rates subsequent to purchase. In addition, the Company does not intend to sell and does not believe that it is more likely than not that it will be required to sell these investments until there is a full recovery of the unrealized loss, which may be at maturity. As a result, there was no allowance for credit loss required on available-for-sale debt securities in an unrealized loss position at March 31, 2023 and December 31, 2022.
15
5. Loans, net and allowance for credit losses:
The major classifications of loans outstanding, net of deferred loan origination fees and costs at March 31, 2023 and December 31, 2022 are summarized as follows. The Company had net deferred loan origination fees of $0.1 million and $0.3 million at March 31, 2023 and December 31, 2022, respectively.
Commercial and Industrial
430,098
433,048
Municipal
169,278
166,210
599,376
599,258
Real estate
Commercial
1,782,911
1,709,827
Residential
342,459
330,728
2,125,370
2,040,555
Consumer
Indirect Auto
86,587
76,461
Consumer Other
6,710
13,842
93,297
90,303
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 $4.4 million in related deferred PPP net fees.
Included in the commercial and industrial balances at March 31, 2023 are Paycheck Protection Program (PPP) loans that
had an outstanding balance of $22.2 million comprised of $10.9 million remaining from those originated during 2021 as part of round two and $11.3 million remaining from loans originated during 2020 under round one of the program. At December 31, 2022, PPP loans had outstanding balances totaling $22.3 million. Net deferred loan origination fees remaining related to PPP loans was $0.2 million at March 31, 2023 and December 31, 2022. The PPP loans are risk rated ‘Pass’ and do not carry an allowance for credit losses due to a 100% SBA guarantee. At March 31, 2023 and December 31, 2022, the outstanding PPP balances were considered current.
16
The following tables present the balance of the allowance for credit losses at March 31, 2023 and 2022. For the three months ended March 31, 2023, the balance of the allowance for credit losses is based on the CECL methodology, as presented in Note 1. For the three months ended March 31, 2022, the allowance for loan losses is based upon the calculation methodology as described in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2022. The tables identify the valuation allowances attributable to specifically identified impairments on individually evaluated loans, including those acquired with deteriorated credit quality, as well as valuation allowances for impairments on loans evaluated collectively. The tables include the underlying balance of loans receivable applicable to each category as of those dates.
Allowance for credit losses:
4,365
1,247
17,915
3,072
873
Impact of adopting ASU 2016-13
(1,683)
747
(3,344)
987
30
(3,263)
Adjusted Beginning Balance January 1, 2023
2,682
1,994
14,571
4,059
24,209
Charge-offs
(71)
(75)
Recoveries
49
Provisions (credits)
(197)
324
1,120
(207)
1,244
Ending balance
2,481
2,318
15,692
3,868
1,085
March 31, 2022
Allowance for loan losses:
Beginning Balance January 1, 2022
7,466
15,928
3,209
793
28,383
(161)
(132)
(62)
(355)
51
79
(887)
179
977
(12)
6,427
1,166
16,789
3,255
770
28,407
The following table represents the allowance for credit losses by major classification of loan and whether the loans were individually or collectively evaluated and collateral dependent by class of loans at March 31, 2023 under ASU 2016-13.
Ending balance: individually evaluated
Ending balance: collectively evaluated
2,467
25,430
Loans receivable:
Individually evaluated - collateral dependent - real estate
867
789
1,666
Individually evaluated - collateral dependent - non-real estate
Collectively evaluated
430,074
1,782,044
341,670
2,816,363
17
The following table represents the allowance for loan losses by major classification of loan and whether the loans were individually or collectively evaluated for impairment at December 31, 2022 prior to the adoption of ASU 2016-13.
Ending balance: individually evaluated for impairment
Ending balance: collectively evaluated for impairment
4,346
3,051
27,432
2,063
1,760
3,921
432,950
1,707,764
328,968
2,726,195
Nonaccrual Loans
The following table presents the Company’s nonaccrual loans at March 31, 2023 and December 31, 2022 and interest income for the quarter that would have been recorded under the original terms of such nonaccrual loans.
Interest Income
Recorded for
Nonaccrual with
Nonaccrual
an Allowance for
no Allowance for
in the three months
Credit Losses
ended March 31, 2023
Real estate:
723
194
1,798
1,784
379
ended December 31, 2022
67
1,155
562
232
2,035
2,016
18
The following table summarizes information concerning impaired loans, which include nonaccrual loans, troubled debt restructurings and loans past due 90 days or more and still accruing, as of and for the three months ended March 31, 2022 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
207
217
173
3,967
5,244
3,757
With an allowance recorded:
440
452
477
273
274
338
734
115
846
Total impaired loans
159
496
3,188
3,957
3,039
1,147
1,321
1,212
4,701
5,991
4,603
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:
The following table presents the amortized cost of loans and gross chargeoffs by year of origination and by 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, 2023:
2021
2020
2019
Prior
Revolving Loans Amortized Cost Basis
Pass
11,531
50,495
46,353
32,496
50,260
89,938
140,615
421,688
Special Mention
Substandard
46
276
7,953
8,343
Total Commercial
11,546
46,399
50,313
90,214
148,635
1,400
45,146
91,776
11,850
36
18,983
87
Total Municipal
Commercial real estate
55,319
531,819
488,524
151,845
154,002
386,268
1,767,777
1,763
303
3,301
5,367
175
1,637
165
628
7,162
9,767
Total Commercial real estate
57,257
490,161
152,010
154,933
396,731
Residential real estate
5,741
55,051
69,011
28,927
17,764
93,343
72,014
341,851
214
377
608
Total Residential real estate
69,028
29,141
93,720
17,548
39,005
17,087
8,127
5,179
5,457
700
93,103
111
Total Consumer
17,198
8,157
5,198
5,491
Total Loans
93,492
721,516
714,562
233,654
228,244
605,139
221,436
Gross charge-offs
71
Total Gross charge-offs
75
20
The following table presents the amortized cost of loans by 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 December 31, 2022 as disclosed prior to ASU 2016-13:
Special
Mention
Doubtful
424,411
7,822
815
1,699,041
7,509
3,277
329,098
1,630
90,020
283
2,708,780
15,331
6,005
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
Accruing
156
170
429,928
92
616
245
1,781,958
467
2,876
339,583
59
487
632
92,665
2,700
1,152
779
4,631
2,813,412
137
38
261
432,787
102
438
1,709,389
1,162
128
988
2,278
328,450
748
690
199
120
1,009
89,294
2,091
367
1,528
3,986
2,726,130
Allowance for Credit Losses on Off Balance Sheet Commitments
The following table presents the activity in the ACL on off balance sheet commitments for the three months ended March 31, 2023:
Balance at December 31, 2022
Impact of adopting Topic 326
270
Credit recorded in noninterest expense
(185)
Total allowance for credit losses on off balance sheet commitments
264
Modifications to Borrowers Experiencing Financial Difficulty
The Company adopted Accounting Standards Update (“ASU”) 2022-02, Financial Instruments - Credit Losses (Topic 326) Troubled Debt Restructurings and Vintage Disclosures (“ASU 2022-02”) effective January 1, 2023. The amendments in ASU 2022-02 eliminated the recognition and measure of troubled debt restructurings and enhanced disclosures for loan modifications to borrowers experiencing financial difficulty.
There were no loans made to borrowers experiencing financial difficulty that were modified during the three months ended March 31, 2023 and hence there were no loans made to borrowers experiencing financial difficulty that subsequently defaulted.
Information on loan modifications prior to the adoption of ASU 2022-02 on January 1, 2023 is presented in accordance with the applicable accounting standards in effect at that time. During the three months ended March 31, 2022, the Company did not modify any loans that were determined to be a troubled debt restructuring.
6. Other assets:
The components of other assets at March 31, 2023 and December 31, 2022 are summarized as follows:
Restricted equity securities declined $4.7 million from December 31, 2022 due to lower FHLB stock requirement resulting from a decrease in borrowings. Interest rate swaps balance represents the fair value of our commercial loan back-to-back swaps and is lower due to a decline in market rates from December 31, 2022.
Other real estate owned
Investment in low income housing partnership
5,325
5,446
Mortgage servicing rights
906
914
Restricted equity securities (FHLB and other)
4,887
Interest rate floor
Interest rate swaps
18,485
21,794
11,354
8,165
22
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 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, 2023 and December 31, 2022 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.
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.
23
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, 2023 and December 31, 2022 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:
89,833
Common equity securities
418,206
181,645
236,561
Interest rate floor-other assets
Interest rate swap-other assets
Interest rate floor-other liabilities
(1,980)
Interest rate swap-other liabilities
(17,914)
132,703
477,813
180,407
297,406
(21,466)
Assets and liabilities measured at fair value on a nonrecurring basis at March 31, 2023 and December 31, 2022 are summarized as follows:
Loans individually evaluated for credit loss
1,680
Significant Other
Observable
Impaired loans
220
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
22.8% to 77.0% (67.3)%
Liquidation expenses
3.0% to 6.0% (5.2)%
21.6% to 97.0% (77.7)%
3.0% to 6.0% (4.9)%
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, 2023 and December 31, 2022 and their placement within the fair value hierarchy are as follows:
Fair Value Hierarchy
Quoted
Prices in
Active
Markets for
Identical
Carrying
Assets
Financial assets:
Loans held for sale
2,629,921
1,747
3,477,050
3,302,580
Financial liabilities:
Deposits
3,229,495
24,982
31,898
1,980
17,914
3,333,445
3,325,853
26
294,706
2,562,780
1,762
3,353,558
3,199,926
3,035,615
114,743
53,998
21,466
3,217,452
3,227,280
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 $478 thousand in 2023, and $256 thousand in 2022 relating to the employee benefit plans.
Pension Benefits
Net periodic pension income:
Interest cost
164
Expected return on plan assets
(293)
(352)
Amortization of unrecognized net loss
50
(79)
(188)
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, 2023, there were 17,364 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 re-grant 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, 2023, the Company granted no awards of restricted stock and restricted stock units under the 2017 Plan. For the three months ended March 31, 2022, the Company granted 19,787 shares underlying such awards, respectively.
The non-performance restricted stock grants made in 2022, 2021 and 2020 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 criteria. 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 $209 thousand for the three months ended March 31, 2023 for awards granted under the 2017 Plan. The Company recognized compensation expense of $199 thousand for the three months ended March 31, 2022 for awards granted under the 2017 Plan. As of March 31, 2023, the Company had $0.8 million 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 1.5 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 existing credit derivatives result from participations of loan participation arrangements, therefore, are not used to manage interest rate risk in the Company’s assets or liabilities.
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 $32 thousand will be reclassified as a reduction to interest income.
Fair Value Hedges of Interest Rate Risk
The Company is exposed to changes in the fair value of certain of its fixed-rate pools of assets due to changes in benchmark interest rates. The Company uses interest rate swaps to manage its exposure to changes in fair value on these instruments attributable to changes in the designated benchmark interest rate, SOFR. Interest rate swaps designated as fair value hedges involve the payment of fixed-rate amounts to a counterparty in exchange for the Company receiving variable-rate payments over the life of the agreements without the exchange of the underlying notional amount.
For derivatives designated and that qualify as fair value hedges, the gain or loss on the derivative as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in interest income.
As of March 31, 2023, the following amounts were recorded on the balance sheet related to cumulative basis adjustment for fair value hedges:
Line Item in the Statement of Financial Position in Which the Hedged Item is Included
Amortized Amount of the Hedged Assets/(Liabilities)
Cumulative Amount of Fair Value Hedging Adjustment Included in the Carrying Amount of the Hedged Assets/(Liabilities)
(Dollars in Thousands)
AFS Securities (1)
100,000
1,986
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 derivatives 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 derivatives associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting derivatives are recognized directly in earnings. As of March 31, 2023, the Company had 96 interest rate swaps with an aggregate notional amount of $209.7 million related to this program.
The Company’s existing credit derivatives result from participations in or out of interest rate swaps provided by or to external lenders as part of loan participation arrangements, therefore, are not used to manage interest rate risk in the Company’s assets or liabilities. Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain lenders which participate in loans.
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 Sheet as of March 31, 2023 and December 31, 2022.
Fair Values of Derivative Instruments
Derivative Assets
Derivative Liabilities
As of March 31, 2023
As of December 31, 2022
Notional Amount
Balance Sheet Location
Sheet
Location
Derivatives designated as hedging instruments
Interest Rate Products
Other Assets
Other Liabilities
1,970
Total derivatives designated as hedging instruments
Derivatives not designated as hedging instruments
208,147
18,963
22,195
18,392
Other Contracts
1,522
6,307
Total derivatives not designated as hedging instruments
18,969
18,394
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, 2023 and March 31, 2022.
Amount of Gain or (Loss) Recognized in OCI on Derivative
Amount of Gain or (Loss) Recognized in OCI Included Component
Amount of Gain or (Loss) Recognized in OCI Excluded Component
Location of Gain or (Loss) Recognized from Accumulated Other Comprehensive Income into Income
Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income
Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income Included Component
Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income Excluded Component
Derivatives in Cash Flow Hedging Relationships
$ 1
($ 16)
$ 16
($ 361)
(439)
$ 78
$ 131
147
($ 439)
$ 147
Effect of Fair Value and Cash Flow Hedge Accounting on the Statements of Income and Comprehensive Income (Loss)
The table below presents the effect of the Company’s derivative financial instruments on the consolidated statements of income and comprehensive income (loss) as of March 31, 2023 and March 31, 2022.
Location and Amount of Gain or (Loss)
Recognized in Income on Fair Value and
Cash Flow Hedging Relationships
For the three months ended March 31,
Total amounts of income and expense line items presented in the
statement of financial performance in which the effects of fair value or
cash flow hedges are recorded
131
The effects of fair value and cash flow hedging:
Gain or (loss) on fair value hedging relationships
Interest contracts
Hedged items
(1,955)
Gain or (loss) on cash flow hedging relationships
Amount of gain or (loss) reclassified from accumulated other comprehensive income into income
(16)
Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income - Included Component
Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income - Excluded Component
Effect of Derivative Instruments Not Designated as Hedging Instruments on the Statements of Income and Comprehensive Income (Loss)
The tables below present the effect of the Company’s derivative financial instruments on the consolidated statements of income and comprehensive income (loss) for the three months ended March 31, 2023 and 2022.
Amount of Gain or (Loss)
Recognized in
Location of Gain or (Loss)
Income on Derivative
Recognized in Income on
Three Months Ended
Derivative
Derivatives Not Designated as Hedging Instruments:
Other income / (expense)
240
242
Fee Income
Fee income
384
32
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, 2023 and December 31, 2022. 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, 2023
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
Balance Sheet
Instruments
Posted
Derivatives
18,964
1,684
Offsetting of Derivative Liabilities
of Liabilities
Liabilities
Posted*
20,365
*Cash collateral of $1,710 was paid in March 2023, but not presented in the table above.
as of December 31, 2022
22,196
14,530
7,666
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, 2023, 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 $2.0 million. As of December 31,
33
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 $2.0 thousand. The Company has minimum collateral posting thresholds with certain of its derivative counterparties, and had posted collateral of $1.7 million with dealer counterparties at March 31, 2023. 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, 2023 and December 31, 2022 are summarized as follows:
Interest-bearing deposits:
Money market accounts
775,511
685,323
Now accounts
698,888
772,712
Savings accounts
500,709
523,931
Time deposits less than $250
400,327
199,136
Time deposits $250 or more
114,443
92,731
Total interest-bearing deposits
Noninterest-bearing deposits
The deposit base consisted of 48.6% retail accounts, 33.2% commercial accounts, 12.5% municipal relationships and 5.7% brokered deposits at March 31, 2023. At March 31, 2023, 76.6% of deposits were fully insured by the FDIC while $757.4 million or 23.4% of total deposits were uninsured by the FDIC. In addition, at March 31, 2023, $292.0 million in letters of credit issued by the FHLB were pledged as collateral for municipal deposits. As an additional resource to our uninsured depositors, we offer all depositors access to IntraFi's CDARS and ICS programs which allows deposit customers to obtain full FDIC deposit insurance while maintaining the deposit relationship with our Bank.
11. Borrowings
Short-term borrowings consist 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. Total short-term borrowings at March 31, 2023 were $17.3 million as compared to $114.9 million at December 31, 2022. Other borrowings, which include cash collateral pledged by derivative counterparties to offset interest rate exposure, represented the entire balance of $17.3 million at March 31, 2023. The overall decrease to total short-term borrowings from December 31, 2022 is due to paying-off the overnight borrowings at the FHLB with proceeds from the sale of investment securities and deposit growth.
The table below outlines short-term borrowings at and for the three months ended March 31, 2023 and at and for the year ended December 31, 2022:
At and for the three months ended March 31, 2023
Weighted
Maximum
Ending
Month-End
Rate for
Rate at End
the Year
of the Period
Other borrowings
13,841
4.57
%
4.83
FHLB advances
77,689
158,000
4.86
Total short-term borrowings
91,530
175,280
4.81
At and for the year ended December 31, 2022
of the Year
10,033
16,100
2.10
4.30
100,400
32,647
125,975
2.73
4.45
42,680
142,075
2.58
4.43
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, 2023, the maximum borrowing capacity was $1.2 billion of which $25.0 million was outstanding in borrowings and $292.0 million was used to issue standby letters of credit to collateralize public fund deposits. At December 31, 2022, the maximum borrowing capacity was $1.2 billion of which $101.0 million was outstanding in borrowings and $388.8 million 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, 2023 and December 31, 2022 is as follows:
Interest Rate
Fixed
March 2023
4.69
March 2025
4.37
10,000
March 2026
4.20
15,000
Maturities of long-term debt, by contractual maturity, for the remainder of 2023 and subsequent years are as follows:
2025
2026
The advances from the FHLB totaling $25.0 million are not convertible.
12. Subordinated debt
On June 1, 2020, the Company sold $33.0 million 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.
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, 2022.
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 effects of any recession in the United States; 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; adverse developments in the financial industry generally, such as the recent bank failures, responsive measures to mitigate and manage such developments, related supervisory and regulatory actions and costs, and related impacts on customer and client behavior; 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, 2022, 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, 2022, which is incorporated herein by reference. Some of these policies are particularly sensitive requiring significant judgments, estimates and assumptions.
On January 1, 2023, the Company adopted ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (CECL) model. The Company adopted ASU 2016-13 using a modified retrospective approach. Results for reporting periods beginning after January 1, 2023 are
presented under Topic 326, while prior period amounts continue to be reported in accordance with previously applicable GAAP. At adoption, the Company decreased its allowance for credit losses by $3.0 million. Upon adoption the Company recorded a cumulative effect adjustment that increased stockholders’ equity by $2.4 million, net of tax. For additional information on ASU 2016-13, see the new “Allowance for Credit Losses” policy included in Note 1 “Summary of Significant Accounting Policies”. Other than this, there have been no material changes to our accounting policies from those disclosed on Form 10-K for the year ended December 31, 2022.
Operating Environment:
The first quarter of 2023 has been centered in uncertainty around the lingering possibility of a recession together with existing inflationary conditions.
In addition to these concerns, the banking industry experienced significant volatility due to two recent high-profile bank failures in March 2023, which were followed by a third bank failure at the end of April 2023. These recent bank failures have resulted in significant concerns within the banking industry related to liquidity, deposit outflows, and unrealized losses on investment securities. These concerns and volatility in the banking industry may persist if other industry participants experience similar high-profile financial challenges or if other banks are closed by federal or state banking regulators. These recent events in the banking industry have reinforced the importance of maintaining access to diverse sources of funding and the benefits of a robust and stable deposit base, but the continuing impact of the volatility and turmoil in the banking industry on the Company, and its financial condition and results of operations for the remainder of 2023, is uncertain and cannot be predicted.
In light of the recent events in the banking industry, the Company continues to actively monitor balance sheet trends, deposit flows, and liquidity needs to ensure that the Company and the Bank are able to meet the needs of the Bank’s customers and maintain financial flexibility. Despite the negative developments within the broader banking industry during the first quarter of 2023, the Company’s and the Bank’s regulatory capital ratios continued to exceed the standards to be considered well-capitalized under regulatory requirements. See the discussion under the heading “Capital” within this Item 2 for additional information about the Company’s regulatory capital position.
While inflation decreased since its peak in 2022, it still remains above the Federal Open Market Committee’s
(“FOMC”) long-term desired 2% level for items other than food and energy. Core inflation, as measured by the Consumer Price Index (“CPI”), excluding items known for their volatility such as food and energy, was 5.6% for the 12 months ended March 31, 2023. When including food and energy, CPI increased 5.0% during the 12 months ended March 31, 2023 due primarily to food costs.
Concerns over the high inflation rate have resulted in central bankers in the U.S. continuing to adjust interest rates. The FOMC has increased the federal funds rate three times in 2023 in addition to seven times in 2022 for a total of 500 basis points. These higher rates are expected to continue to negatively impact the fair value of our investment portfolio and to slow economic activity by curbing spending, hiring and investment which may reduce loan demand and result in deposit outflows.
We saw strong loan growth in the first quarter despite these higher rates. However, we have seen lower mortgage origination and sales volume as interest rates on mortgage loans have reached 20 year highs and the housing market cools off. From a funding perspective, the competition and subsequent costs of deposits have increased and likely will continue to increase as the FOMC adjusts rates.
The labor market remains strong with national unemployment at 3.5% in March 2023. This along with a relatively unchanged number of persons not in the labor force has made it difficult and costly for companies to fill open positions and thus could continue to increase our salaries and benefits expenses.
Real gross domestic product (“GDP”) increased at a seasonally adjusted annual rate of 1.1% during the three months ended March 31, 2023, according to the Bureau of Economic Analysis’s “Advance” estimate, after increasing 2.6% in the three months ended December 31, 2022. The increase in the most recent period may reflected increases in both
goods and services. Compared to the fourth quarter, the deceleration in real GDP in the first quarter primarily reflected a downturn in private inventory investment and a slowdown in nonresidential fixed investment.
Economic uncertainty and reductions to spending by retail and commercial customers due to rising costs may reduce loan demand and increase loan delinquencies in the near-term.
Goodwill:
The Company has goodwill with a net carrying value of $63,370 at March 31, 2023 and December 31, 2022. 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, 2023, we performed a qualitative evaluation, which involves determining 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 increased $125.0 million or 14.3% annualized, to $3.7 billion at March 31, 2023, from $3.6 billion at December 31, 2022. The increase in assets during the three months was due to increases in loan growth and federal funds sold, funded primarily by an increase in deposits. Total loans increased to $2.8 billion at March 31, 2023, compared to $2.7 billion at December 31, 2022, an increase of $88.0 million. Investments decreased $61.1 million due primarily from the sale of securities, including U.S. Treasury bonds, tax-exempt municipal bonds and mortgage-backed securities, with the proceeds of $67.4 million used to pay down high cost, short term borrowings. Federal funds sold balances increased to $102.1 million at March 31, 2023 from zero at December 31, 2022 due to growth of deposits.
Deposits increased $189.4 million to $3.2 billion at March 31, 2023 from $3.0 billion at December 31, 2022 with a $161.4 million increase in brokered deposits and an increase of $114.0 million in retail and commercial accounts, partially offset by a decrease of $82.3 million in municipal deposits. Interest-bearing deposits increased $216.1 million while noninterest-bearing deposits decreased $26.7 million. Total short-term borrowings at March 31, 2023 were $17.3 million, a decrease of $97.6 million from $114.9 million at December 31, 2022, while long term debt increased to $25.0 million at March 31, 2023 from $0.6 million at December 31, 2022. Total stockholders’ equity increased $13.3 million from $315.4 million at year-end 2022 to $328.6 million at March 31, 2023 due to net income, a decrease to accumulated other comprehensive loss resulting from a lower unrealized loss on available-for-sale investment securities and an increase to retained earnings from the adoption of and transition to CECL, partially offset by dividends paid. The unrealized losses on the held-to-maturity portfolio totaled $12.6 million and $14.6 million at March 31, 2023 and December 31, 2022, respectively. For the three months ended March 31, 2023, total assets averaged $3.6 billion, an increase of $233.3 million from $3.3 billion for the same period of 2022.
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 $418.1 million at March 31, 2023, a decrease of $59.6 million, or 12.5% from $477.7 million at December 31, 2022. The decrease was primarily due to the sale of $65.6 million in securities, which included U.S. Treasury bonds, tax-exempt municipals and mortgage-backed securities, as part of our strategy to add liquidity and reduce short-term borrowings. Over 65% of our available-for-sale investment portfolio consists of U.S. Treasury, U.S. Government agency or U.S. Government-sponsored entities.
Investment securities held-to-maturity, which consisted of 87.5% of U.S. Government agency and U.S. Government-sponsored entities, totaled $89.7 million at March 31, 2023, a decrease of $1.5 million from $91.2 million at December 31, 2022. HTM securities had a market value of $77.1 million at March 31, 2023.
For the three months ended March 31, 2023, the investment portfolio averaged $599.7 million, a decrease of $34.0 million or 5.4% compared to $633.7 million for the same period last year. Average tax-exempt municipal bonds have decreased $10.0 million or 9.1% to $100.4 million for the three months ended March 31, 2023 from $110.4 million during the comparable period of 2022 due in part to the sale of five tax-exempt municipal bonds during the current three month period. The tax-equivalent yield on the investment portfolio increased 15 basis points to 1.83% for the three months ended March 31, 2023, from 1.68% for the comparable period of 2022.
Securities available-for-sale are carried at fair value, with unrealized gains or losses net of deferred income taxes reported in the Accumulated Other Comprehensive Loss (AOCL) component of stockholders’ equity. We reported net unrealized losses, included as a separate component of stockholders’ equity of $43.5 million net of deferred income taxes of $12.0 million at March 31, 2023, and net unrealized losses of $52.0 million, net of deferred income taxes of $14.3 million, at December 31, 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 $2.8 billion at March 31, 2023 from $2.7 billion at December 31, 2022, an increase of $87.9 million. Our loan growth is due primarily to increases in commercial real estate loans with increases also from residential real estate and indirect loans.
Commercial real estate loans increased $73.1 million or 17.3% annualized, to $1.8 billion at March 31, 2023 compared to $1.7 billion at December 31, 2022 due to increased activity in all our markets.
Consumer loans increased $3.0 million, or 13.4% on an annualized basis, to $93.3 million at March 31, 2023 compared to $90.3 million at December 31, 2022. The increase in consumer loans was due to growth of dealer indirect auto loan originations.
Residential real estate loans increased $11.7 million, or 14.4% on an annualized basis, to $342.5 million at March 31, 2023 compared to $330.7 million at December 31, 2022. The increase in residential mortgages is due to increased home equity loan activity, and a higher percentage of loans not eligible to be sold into the secondary market, including jumbo mortgages.
For the three months ended March 31, 2023, total loans averaged $2.8 billion, an increase of $418.1 million or 17.8% compared to $2.4 billion for the same period of 2022. The tax-equivalent yield on the entire loan portfolio was 4.66% for the three months ended March 31, 2023, an 81 basis point increase from the comparable period last year. The increase in yield is primarily due to the FOMC increases and its corresponding effect on our offering rates on new originations and the indices at which our adjustable and floating rate loans reprice.
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, 2023, totaled $684.2 million, consisting of $629.6 million in unfunded commitments of existing loan facilities and $54.6 million 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, 2022 totaled $689.4
million, consisting of $631.8 million in unfunded commitments of existing loans and $57.6 million in standby letters of credit.
Asset Quality:
Distribution of nonperforming assets
Nonaccrual loans
Troubled debt restructured loans (including nonaccrual TDR)
1,351
Accruing loans past due 90 days or more:
Total nonperforming loans
1,857
4,134
Foreclosed assets
Total nonperforming assets
Total loans held for investment
Allowance for credit losses
Allowance for credit losses as a percentage of loans held for investment
0.90
1.01
Allowance for credit losses as a percentage of nonaccrual loans
1415.13
1349.98
Nonaccrual loans as a percentage of loans held for investment
0.06
0.07
Nonperforming loans as a percentage of loans, net
0.15
We experienced improved asset quality during the first three months of 2023 as evidenced by a decrease of $2.3 million in nonperforming assets. Nonperforming assets totaled $1.9 million or 0.05% of total assets at March 31, 2023, a decrease from $4.1 million or 0.12% of total assets at December 31, 2022. The reduction was the result of the removal of troubled debt restructurings due to a change in accounting guidance, a reduced level of loans 90 days or more past due and still accruing, collection activities, and a sizable principal reduction of one commercial real estate loan.
Loans on nonaccrual status, excluding troubled debt restructured nonaccrual loans, decreased $237 thousand to $1.8 million at March 31, 2023 from $2.0 million at December 31, 2022. The decrease to nonaccrual loans since year-end is due primarily to a decrease in commercial real estate loans of $288 thousand partially offset by an increase of $161 thousand to the residential real estate loan portfolio. Restructured loans decreased to none from $1.4 million at December 31, 2022 due to changes in the accounting guidance. There were no foreclosed properties at March 31, 2023 and at December 31, 2022.
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 maintaining strong asset quality. We continued our efforts to maintain sound underwriting standards for both commercial and consumer credit.
Effective January 1, 2023 the Company adopted ASU 2016-23 “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”. The standard replaces the incurred loss methodology we previously used to maintain the allowance for loan losses. Upon adoption, the Company decreased its allowance for credit losses by $3.3 million and increased its reserve for losses of unfunded commitments by $270 thousand. The current standard measures the estimated amount of allowance necessary to cover lifetime losses inherent in financial assets at the balance sheet date. The Company estimates the allowance for credit losses on loans via a quantitative analysis which considers relevant available information from internal and external sources related to past events and current conditions, as well as the incorporation of reasonable and supportable forecasts. Also included in the allowance are qualitative reserves to cover losses that are expected but, in the Company’s assessment, may not be adequately represented in the quantitative analysis or the forecasts utilized. The Company applies the analysis to loans on a collective, or pooled basis for groups of loans which share similar risk characteristics, and will either assign loans to a different pool or evaluate a loan individually if its risk characteristics change and no longer align with its currently assigned pool of loans. For additional information, see Note 1 “Allowance for Credit Losses”.
The allowance for credit losses equaled $25.4 million or 0.90% of loans, net at March 31, 2023 compared to $27.5 million or 1.01% of loans, net, at December 31, 2022. In addition to the transition adjustment of $3.3 million noted above, a $1.3 million provision for credit losses was applied. Loans charged-off, net of recoveries, for the three months ended March 31, 2023, equaled $9 thousand and less than 0.01% of average loans, compared to $276 thousand or 0.05% of average loans for the comparable period last year. The decrease to charge-offs in the current period is due to improved credit quality resulting in fewer charge-offs.
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, 2023, total deposits increased $189.4 million or 25.2% annualized to $3.2 billion from $3.0 billion at December 31, 2022. Noninterest-bearing deposits decreased $26.7 million, or 14.0% annualized and interest-bearing deposits increased $216.1 million, or 38.5% annualized during the three months ended March 31, 2023. The increase in deposits was due to a $161.4 million net increase in brokered deposits and a $114.0 million increase in retail and commercial accounts partially offset by an $82.3 million seasonal decrease in municipal deposits. During the three months ended March 31, 2023, the Company utilized a portion of its contingency funding sources and added $166.9 million of longer-term callable brokered CDs to improve its on-balance sheet liquidity position. The Company has the option to call the CDs after an initial three or six month period.
Interest-bearing transaction accounts, including NOW and money market accounts were relatively flat at $1.5 billion at March 31, 2023, and December 31, 2022. Savings accounts decreased $23.2 million to $500.7 million as of March 31, 2023 from $523.9 million at December 31, 2022 as rate sensitive depositors shifted a portion of their balances to higher rate offerings both internally and externally. Time deposits less than $250 thousand increased $201.2 million to $400.3 million at March 31, 2023, from $199.1 million at December 31, 2022 primarily due to the addition of $161.4 million in brokered callable certificates of deposit. Time deposits $250 thousand or more increased $21.7 million to $114.4 million at March 31, 2023 from $92.7 million at year end 2022.
The deposit base consisted of 48.6% retail accounts, 33.2% commercial accounts, 12.5% municipal relationships and 5.7% brokered deposits at March 31, 2023. At March 31, 2023, an estimated 76.6% of deposits were fully insured by the FDIC while $757.4 million or 23.4% of total deposits were not insured by the FDIC. In addition, at March 31, 2023 $292.0 million in letters of credit issued by the FHLB were pledged as collateral for municipal deposits. As an additional resource to our uninsured depositors, we offer all depositors access to IntraFi's CDARS and ICS programs which allows deposit customers to obtain full FDIC deposit insurance while maintaining their relationship with our Bank.
For the three months ended March 31, interest-bearing deposits averaged $2.3 billion in 2023 compared to $2.2 billion in 2022, an increase of $126.3 million or 23.2% annualized. The cost of interest-bearing deposits was 1.68% in 2023 compared to 0.27% 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 1.85% in 2023 and 0.35% in 2022. The higher costs are due primarily to increases in interest rates paid on deposits in order to attract and retain current balances. We anticipate that funding costs will continue to increase in the future as a result of the FOMC rate adjustments, local competition for deposits and the cost of alternative funding. The volume and velocity of the rate increases will place pressure on our funding 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 were $75.3 million at March 31, 2023, which included a combination of other
42
borrowings, long-term debt, and subordinated debt, compared to $148.5 million at December 31, 2022, a decrease of $73.2 million. There were no overnight borrowings at March 31, 2023 compared to $100.4 million at December 31, 2022 as proceeds from the sale of investment securities and deposit growth in the current period were utilized to pay-down the balance. Other borrowings, which include cash collateral pledged by derivative counterparties to offset interest rate exposure, totaled $17.3 million compared to $14.5 million at December 31, 2022. The increase was primarily due to higher market interest rates. Long-term debt was $25.0 million at March 31, 2023 compared to $0.6 million at year end 2022 as the Bank utilized its borrowing capacity at the FHLB to add on-balance sheet liquidity and supplement the funding of the loan portfolio growth. Subordinated debt outstanding at March 31, 2023 and December 31, 2022 was $33.0 million.
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.
Market interest rates increased rapidly during 2022 and continued to increase into 2023 as the FOMC has raised the federal funds rate. A total of seven increases for a total of 425 basis points occurred in 2022, and three additional increases totaling 75 basis points have been made so far in 2023, resulting in a total of 500 basis points since the beginning of the FOMC’s initiative to curb 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.
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 an 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 an 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 1.15% at March 31, 2023, an increase from 0.69% at December 31, 2022. 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, along with the action by the FOMC to
increase the federal funds rate 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, 2023, 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, 2023, 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 2023 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:
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, 2023, the
Company’s cash and due from banks balances were $140.6 million and we maintained $225.0 million 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, 2023, the Company’s available-for-sale investment securities portfolio totaled $418.1 million, $278.2 million of which were unencumbered. Net unrealized losses on the portfolio were $55.5 million. The Bank’s unused borrowing capacity at the FHLB at March 31, 2023 was $863.8 million.
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, 2023. Our noncore funds at March 31, 2023, 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, 2023, our net noncore funding dependence ratio, the difference between noncore funds and short-term investments to long-term assets, was 10.8%, while our net short-term noncore funding dependence ratio, noncore funds maturing within one-year, less short-term investments to long-term assets equaled 2.1%. Comparatively, our overall noncore dependence ratio at year-end 2022 was 9.6% and our net short-term noncore funding dependence ratio was negative 8.5%, indicating that our reliance on noncore funds has increased overall due to our relatively static deposit balances but improved in the short-term due to our federal funds sold balances.
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, increased $102.7 million during the three months ended March 31, 2023. Cash and cash equivalents decreased $138.4 million for the same period last year. For the three months ended March 31, 2023, net cash inflows of $112.4 million from financial activities and $4.5 million from operating activities were offset by net cash outflows of $14.2 million from investing activities. For the same period of 2022, net cash inflows of $9.1 million from operating activities were offset by net cash outflows of $2.2 million from financing activities and by net cash outflows of $145.4 million from investing activities.
Operating activities provided net cash of $4.5 million for the three months ended March 31, 2023, and $9.1 million for the corresponding three months of 2022. Net income, adjusted for the effects of gains and losses along with noncash transactions such as depreciation and the provision for credit 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 $14.2 million for the three months ended March 31, 2023, compared to using net cash of $145.4 million for the same period of 2022. A net increase in loans less proceeds from investment sales were the primary factors causing the net cash outflow from investing activities.
Financing activities provided net cash of $112.4 million for the three months ended March 31, 2023, and used net cash of $2.2 million for the corresponding three months of 2022. In 2023, deposit gathering was our predominant financing activity. Deposits provided cash of $189.4 million for the three months ended March 31, 2023 while short term borrowings decreased $97.7 million. We continue to seek deposits from new markets and customers as well as existing customers, including municipalities and school districts.
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 $328.6 million or $45.96 per share at March 31, 2023, compared to $315.4 million or $44.06 per share at December 31, 2022. Stockholders’ equity increased during the three month period ended March 31,
2023 primarily due to a lower AOCL of $6.9 million resulting from a reduction in the unrealized loss on investment securities and addition of $2.4 million to retained earnings from our adoption of CECL, partially offset by cash dividends declared of $2.9 million and the repurchase of 16,573 common shares totaling $0.8 million. Net income of $7.6 million for the three months ended March 31, 2023 was added to our capital position during the period.
Dividends declared equaled $0.41 per share through the three months ended March 31, 2023 and $0.39 per share for the same period of 2022. The dividend payout ratio was 39.0% for the three months ended March 31, 2023 and 29.3% for the same period of 2022. 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 28, 2023 a second quarter dividend of $0.41 per share payable on June 15, 2023 to shareholders of record as of May 31, 2023. 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, 2023, the Bank’s Tier 1 capital to total average assets was 9.66% as compared to 9.69% at December 31, 2022. The Bank’s Tier 1 capital to risk weighted asset ratio was 12.00% and the total capital to risk weighted asset ratio was 12.88% at March 31, 2023. These ratios were 12.27% and 13.26% at December 31, 2022. The Bank’s common equity Tier 1 to risk weighted asset ratio was 12.00% at March 31, 2023 compared to 12.27% at December 31, 2022. The Bank met all capital adequacy requirements and was deemed to be well-capitalized under regulatory standards at March 31, 2023.
Review of Financial Performance:
Peoples reported net income of $7.6 million or $1.05 per diluted share for the three months ended March 31, 2023, a 21.3% decrease when compared to $9.6 million or $1.33 per share for the comparable period of 2022. The decrease in earnings for the three months ended March 31, 2023 was due to a higher provision for credit losses and higher operating expenses which offset an increase in net interest income and noninterest income.
Return on average assets (“ROA”) measures our net income in relation to total assets. Our annualized ROA was 0.86% for the first quarter of 2023 compared to 1.17% for the same period of 2022. Return on average equity (“ROE”) indicates how effectively we can generate net income on the capital invested by stockholders. Our annualized ROE was 9.43% for the first quarter of 2023 compared to 11.82% for the comparable period in 2022.
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 2023 and 2022.
The following table reconciles the non-GAAP financial measures of FTE net interest income for the three months ended March 31, 2023 and 2022:
Interest income (GAAP)
Adjustment to FTE
445
Interest income adjusted to FTE (non-GAAP)
34,765
25,016
Interest expense
Net interest income adjusted to FTE (non-GAAP)
23,531
23,076
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, 2023 and 2022:
Efficiency ratio (non-GAAP):
Noninterest expense (GAAP)
Less: amortization of intangible assets expense
Noninterest expense adjusted for amortization of assets expense (non-GAAP)
16,457
14,193
Net interest income (GAAP)
Plus: taxable equivalent adjustment
Noninterest income (GAAP)
Less: net (losses) gains on equity securities
Less: net (losses) gains on sale of available for sale securities
Net interest income (FTE) plus noninterest income (non-GAAP)
27,153
26,493
Efficiency ratio (non-GAAP)
60.6
53.6
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 2023 and 2022.
For the three months ended March 31, tax-equivalent net interest income increased $455 thousand to $23.5 million in 2023 from $23.1 million in 2022. The net interest spread decreased to 2.31% for the three months ended March 31, 2023 from 2.87% for the three months ended March 31, 2022 as the earning asset yield increased 94 basis points while the average rate paid on interest-bearing liabilities increased 150 basis points. The tax-equivalent net interest margin decreased to 2.81% for the first quarter of 2023 from 2.97% for the comparable period of 2022.
For the three months ended March 31, tax-equivalent interest income, a non-GAAP measure, on earning assets increased $9.7 million to $34.7 million in 2023 as compared to $25.0 million in 2022. The overall yield on earning assets, on a fully tax-equivalent basis, increased 94 basis points for the three months ended March 31, 2023 to 4.16% as compared to 3.22% for the three months ended March 31, 2022. The increase to tax-equivalent interest income is due to the increase in rates for newly acquired assets and rising rate indices, coupled with an increase in our earning asset base of $236.6 million. The overall yield earned on investments increased 15 basis points in the first quarter of 2023 to 1.83% from 1.68% for the first quarter of 2022 as a result of our sale of lower yielding bonds. Average investment balances were $34.0 million lower when comparing the current and year ago quarter. Average federal funds sold decreased $142.9 million to $19.4 million for the three months ended March 31, 2023 and yielded 5.09%, as compared to $162.2 million and yield of 0.18% in the year ago period, to fund our loan growth. We expect asset yields to move upward as asset cash flow reprices higher due to the recent increases to the federal funds rate by the FOMC and expectation of a further rate increase by the FOMC to combat inflation.
Total interest expense increased $9.3 million to $11.2 million for the three months ended March 31, 2023 from $1.9 million for the three months ended March 31, 2022. The total cost of funds increased 150 basis points for the three months ended March 31, 2023 to 1.85% as compared to 0.35% in the year ago period. The increase in costs was due to higher rates paid on both interest-bearing deposits and short term borrowings, combined with higher average balances in the current period. Average rates paid on deposits increased as the result of the FOMC’s corresponding rate increases and local competition for deposits. We expect funding costs to continue to increase into 2023 as market rates rise as the result of anticipated additional FOMC increases.
48
Net interest income changes due to rate and volume for the three months ended March 31
2023 vs 2022
Increase (decrease)
attributable to
Rate
Volume
Loans:
9,196
4,950
4,246
287
134
153
Investments:
154
655
(501)
(70)
(58)
Interest-bearing deposits
(11)
282
(112)
9,749
6,032
3,717
4,203
4,105
NOW accounts
2,693
(375)
122
Time deposits less than $100
879
666
213
Time deposits $100 or more
687
Subordinated debt
9,294
8,247
Net interest income - non-GAAP
455
(2,215)
2,670
Tax-equivalent net interest income, a non-GAAP measure, was $23.5 million in the three months ended March 31, 2023 and $23.1 million 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 $2.7 million. A rate variance resulted in a decrease in net interest income of $2.2 million.
Average earning assets increased $236.6 million to $3.4 billion for the three months ended March 31, 2023
from $3.2 billion for the three months ended March 31, 2022 and accounted for a $3.7 million increase in interest income. Average loans increased $418.1 million, which caused interest income to increase $4.4 million. Average taxable investments decreased $24.0 million comparing 2023 and 2022, which resulted in decreased interest income of $501 thousand while average tax-exempt investments decreased $10.0 million, which resulted in a decrease to interest income of $58 thousand. Average federal funds sold decreased $142.9 million for the three months ended March 31, 2023 which resulted in a decrease of $112 thousand to interest income.
Average interest-bearing liabilities rose $126.3 million to $2.5 billion for the three months ended March 31, 2023 from $2.2 billion for the three months ended March 31, 2022 resulting in a net increase in interest expense of $1.0 million. Interest-bearing deposit accounts, including money market, NOW and savings accounts grew $44.1 million, however, interest expense decreased $276 thousand. In addition, large denomination time deposits averaged $17.3 million more in the current period and caused interest expense to increase $24 thousand. An increase of $64.9 million in average time deposits less than $100 thousand resulted in an increase to interest expense of $213 thousand. In addition, short-term borrowings averaged $91.5 million higher and increased interest expense $1.1 million while long-term remained relatively unchanged comparing the first three months of 2023 and 2022.
An unfavorable rate variance occurred, as the tax-equivalent yield on earning assets increased 94 basis points while there was a 150 basis point increase in the cost of funds. As a result, tax-equivalent net interest income decreased $2.2 million
comparing the three months ended March 31, 2023 and 2022. The tax-equivalent yield on earning assets was 4.16% in the 2023 period compared to 3.22% in 2022 resulting in an increase in interest income of $6.0 million. The yield on the taxable investment portfolio increased 20 basis points to 1.73% during the three months ended March 31, 2023 from 1.53% in the year ago period, resulting in an increase of $655 thousand in interest income. The yield on the tax exempt investment portfolio decreased 4 basis points to 2.33% during the three months ended March 31, 2023 from 2.37% in the year ago period, resulting in a decrease of $12 thousand. The tax-equivalent yield on the loan portfolio increased 81 basis points to 4.66% in 2023 from 3.85% in 2022 and resulted in an increase to interest income of $5.1 million.
The yield on interest bearing deposits increased 141 basis points to 1.68 % from 0.27% in the year ago period resulting in an increase in interest expense of $8.2 million. The yield on long term borrowings and subordinated debt was relatively flat when compared to a year ago.
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:
2,546,068
4.79
2,148,251
3.94
223,917
3.18
203,645
1,470
2.93
Total loans
2,769,985
31,806
4.66
2,351,896
22,323
3.85
499,327
2,126
1.73
523,301
1.53
100,368
576
2.33
110,394
646
2.37
Total investments
599,695
2,702
1.83
633,695
2,618
1.68
1,218
5,888
0.14
19,353
5.09
162,218
0.18
Total earning assets
3,390,251
4.16
3,153,697
3.22
24,557
28,717
209,151
216,581
3,574,845
3,341,561
Liabilities and Stockholders’ Equity:
Interest-bearing liabilities:
721,864
4,588
595,991
385
0.26
731,398
2,806
1.56
820,016
488
0.24
512,655
216
0.17
505,816
192,519
1,181
2.49
127,610
0.96
179,515
887
2.00
162,196
200
0.50
2,337,951
2,211,629
0.27
2,482
4.41
2,474
4.59
5.44
5.38
Total borrowings
127,012
1,556
4.97
35,474
472
5.32
Total interest-bearing liabilities
2,464,963
1.85
2,247,103
0.35
744,931
734,348
38,917
29,816
Stockholders’ equity
326,034
330,294
Net interest income/spread
2.31
2.87
Net interest margin
2.81
2.97
Tax-equivalent adjustments:
368
309
Investments
119
136
Total adjustments
Provision for Credit Losses:
Effective January 1, 2023 the Company transitioned to ASU 2016-13 Financial Instruments - Credit Losses (Topic 326), commonly referred to as CECL. 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, 2023. Refer to Note 1 “Summary of Significant Accounting Policies” for additional detail due to CECL adoption impact effective January 1, 2023.
For the three months ended March 31, 2023, the provision for credit losses increased $1.0 million to $1.3 million from $0.3 million in the year ago period primarily due to loan growth and the change to projected portfolio loss rates associated with application and update of the economic forecast in our CECL model.
Noninterest Income:
Noninterest income for the three months ended March 31, 2023 was $3.7 million, an increase of $0.3 million or 7.4% from $3.4 million in the same quarter a year ago. The increase was primarily due to higher retail and commercial account service charges of $273 thousand and a gain of $81 thousand on the sale of available for sale securities, partially offset by a decrease in swap related revenue of $120 thousand.
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 $2.2 million or 15.4% to $16.5 million for the three months ended March 31, 2023, from $14.3 for the same period a year ago. Salaries and employee benefits increased $1.0 million or 12.9% due to annual merit increases, new hires, and higher benefit costs. Occupancy and equipment expenses were higher by $264 thousand in the current period due to an increase in transactional costs relating to our expansion market volume. Other expenses increased $433 thousand primarily due to higher account processing fees, and FDIC assessment accruals increased by $175 thousand. The year ago period included gains on the sale of other real estate owned of $458 thousand, there were no comparable transactions in the current period.
Income Taxes:
We recorded income tax expense of $1.4 million or 15.5% of pre-tax income for the three months ended March 31, 2023. This compares to the three month period ended March 31, 2022 in which we recorded tax expense of $1.8 million or 16.0% of pre-tax income. A slight increase in our tax free loan portfolio average balance resulted in a corresponding slight decrease in tax expense as a percentage of income. Lower income tax expense was due lower pre-tax income for the three months ended March 31, 2023 compared to the prior year’s period.
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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 14 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, 2023 and December 31, 2022, 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, 2023 indicated a lower starting level of net interest income (“NII”) compared to the December 31, 2022 model as balance sheet growth, a shift in balance sheet mix and higher assumed market rates were more than offset by higher interest-bearing liability costs leading to a decrease to the balance sheet spread of 26 basis
points. After the first twelve months of the model simulation, the benefit to NII increases as a result of the higher assumed replacement rates on assets resulting from the FOMC’s increase to the federal funds rate of 500 basis points since March 2022. Our interest rate risk position exhibits a relatively well-matched position to both rising and falling interest rate environments in the first year of simulation while a sustained falling rate environment presents the greatest potential risk to NII over the longer-term horizon. This position at March 31, 2023 is more asset-sensitive than the simulation at December 31, 2022 indicated due to the increase in our floating rate overnight federal funds sold position resulting, in part, to the strategy to add longer term fixed rate callable deposits and fixed rate FHLB advances to mitigate exposure to rising rates.
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.
During 2022, the FOMC increased the federal funds target rate in part to mitigate historically high inflation. Through March 31, 2023, there have been ten rate increases totaling 500 basis points. Although we have realized higher rates on our existing adjustable rate loans and new originations, our average funding costs have been under pressure and during the three months ended March 31, 2023 increased 65 basis points compared to the three months ended December 31, 2022 as rate-sensitive customers seek higher returns. We expect our funding costs to continue to increase in the future due to expectations the FOMC will continue to increase the targeted federal funds rate which may negatively impact our net interest income.
The projected impacts of instantaneous changes in interest rates on our net interest income and economic value of equity at March 31, 2023, 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
(0.7)
(20.0)
13.4
(40.0)
+300
11.0
(30.0)
+200
(0.8)
(10.0)
7.8
+100
(0.1)
5.2
Static
-100
(0.3)
(8.7)
-200
(1.6)
(22.4)
-300
(3.2)
(40.2)
-400
(7.7)
(76.9)
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, 2023, would decrease 0.1% 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, 2022, 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. The Company formed a LIBOR transition team to monitor this activity. The Company has transitioned the majority of its LIBOR-indexed loans to alternative indexes, including prime and Term SOFR, and adjusting the spread to maintain the overall yield. There are
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approximately $7 million in loans which have not yet been transitioned, but the borrowers have been notified that their loans will be converted by June 30, 2023.
Item 4. Controls and Procedures.
(a) Evaluation of disclosure controls and procedures.
At March 31, 2023, 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, 2023, 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.
Effective January 1, 2023, the Company adopted the CECL accounting standard. The Company designed new controls and modified existing controls as part of its adoption. These additional controls over financial reporting included controls over model creation and design, model governance, assumptions, and expanded controls over loan level data.
Except for the change in controls relating to the adoption of the CECL accounting standard, there were no other changes in the Company’s internal control over financial reporting in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 under the Exchange Act that occurred during the fiscal quarter ended March 31, 2023 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II—OTHER INFORMATION
Item 1. Legal Proceedings.
The nature of the Company’s business generates a certain amount of litigation involving matters arising 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, 2023 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, 2022 (2022 Form 10-K) describes market, credit, and business operations risk factors that could affect our business, results of operations or financial condition. Other than the risk factors set forth below, there have been no material changes from the risk factors as previously disclosed in our 2022 Form 10-K.
Recent negative developments affecting the banking industry, and resulting media coverage, have eroded customer confidence in the banking system.
The recent high-profile bank failures involving Silicon Valley Bank and Signature Bank have generated significant market volatility among publicly traded bank holding companies and, in particular, regional banks like the Company. On May 1, 2023 First Republic Bank was also closed by its primary state regulator, which appointed the FDIC as receiver, and the FDIC announced that JP Morgan Chase Bank, National Association agreed to assume all of First Republic Bank’s deposits and substantially all of its assets. These market developments have negatively impacted customer confidence in the safety and soundness of regional banks. As a result, customers may choose to maintain
deposits with larger financial institutions or invest in higher yielding short-term fixed income securities, all of which could materially adversely impact the Company’s liquidity, loan funding capacity, net interest margin, capital and results of operations. While the Department of the Treasury, the Federal Reserve, and the FDIC have made statements ensuring that depositors of these recently failed banks would have access to their deposits, including uninsured deposit accounts, there is no guarantee that such actions will be successful in restoring customer confidence in regional banks and the banking system more broadly.
Rising interest rates have decreased the value of the Company’s held-to-maturity securities portfolio, and the Company would realize losses if it were required to sell such securities to meet liquidity needs.
As a result of inflationary pressures and the resulting rapid increases in interest rates over the last year, the trading value of previously issued government and other fixed income securities has declined significantly. These securities make up a majority of the securities portfolio of most banks in the U.S., including the Company’s, resulting in unrealized losses embedded in the held-to-maturity and available for sale portion of U.S. banks’ securities portfolios. While the Company does not currently intend to sell these securities, if the Company were required to sell such securities to meet liquidity needs, it may incur losses, which could impair the Company’s capital, financial condition, and results of operations and require the Company to raise additional capital on unfavorable terms, thereby negatively impacting its profitability. While the Company has taken actions to maximize its funding sources, there is no guarantee that such actions will be successful or sufficient in the event of sudden liquidity needs. Furthermore, while the Federal Reserve Board has announced a Bank Term Funding Program available to eligible depository institutions secured by U.S. treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral at par, to mitigate the risk of potential losses on the sale of such instruments, there is no guarantee that such programs will be effective in addressing liquidity needs as they arise.
Any regulatory examination scrutiny or new regulatory requirements arising from the recent events in the banking industry could increase the Company’s expenses and affect the Company’s operations.
The Company also anticipates increased regulatory scrutiny – in the course of routine examinations and otherwise – and new regulations directed towards banks of similar size to the Bank, designed to address the recent negative developments in the banking industry, all of which may increase the Company’s costs of doing business and reduce its profitability. Among other things, there may be an increased focus by both regulators and investors on deposit composition and the level of uninsured deposits. As primarily a commercial bank, the Bank has a high degree of uninsured deposits compared to larger national banks or smaller community banks with a stronger focus on retail deposits. As a result, the Bank could face increased scrutiny or be viewed as higher risk by regulators and the investor community. Also, as a result of the recent bank failures, future FDIC deposit assessments are expected to increase and may have a material impact of the Company’s profitability.
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. On April 27, 2023, we announced that we have temporarily suspended our repurchase plan.
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, 2023.
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, 2023
1,342
50.00
277,865
274,085
February 28, 2023
6,558
49.82
284,423
267,527
8,673
49.73
293,096
258,854
Item 3. Defaults upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
Item 6. Exhibits.
Item Number
Description
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.
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The following materials from Peoples Financial Services Corp. Quarterly Report on Form 10-Q for the period ended March 31, 2023, 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.
104
Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)
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 10, 2023
/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)