Citizens Financial Services, Inc. Form 10-K INDEX
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| PART II | |
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| 19 – 49 |
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| PART III | |
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| PART IV | |
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PART I
ITEM 1 – BUSINESS.
CITIZENS FINANCIAL SERVICES, INC.
Citizens Financial Services, Inc. (the “Company”), a Pennsylvania corporation, was incorporated on April 30, 1984 to be the holding company for First Citizens Community Bank (the “Bank”), a Pennsylvania-chartered bank and trust company. During 2020, CZFS Acquisition Company, LLC (CZFS) was formed as a wholly owned subsidiary of the Company, and subsequently the Company’s interest in the Bank was transferred to CZFS to facilitate the merger with MidCoast Community Bancorp, Inc. (MidCoast) and its wholly owned subsidiary, MidCoast Community Bank (“MC Bank”), which was completed on April 17, 2020. On June 16, 2023, the Company acquired HV Bancorp, Inc. (“HVBC”) and its wholly owned subsidiary, Huntingdon Valley Bank (“HVB”). The Company is primarily engaged in the ownership and management of CZFS, its subsidiary, the Bank and the Bank’s wholly owned subsidiaries, First Citizens Insurance Agency, Inc. (“First Citizens Insurance”) and 1st Realty of PA LLC (“Realty”).
AVAILABLE INFORMATION
A copy of the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current events reports on Form 8-K, and amendments to these reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are made available free of charge through the Company’s web site at www.firstcitizensbank.com as soon as reasonably practicable after such reports are filed with or furnished to the Securities and Exchange Commission. Copies of the reports the Company files electronically with the Securities and Exchange Commission are also available through the Securities and Exchange Commission’s website at www.sec.gov. Information on our website shall not be considered as incorporated by reference into this Form 10-K.
FIRST CITIZENS COMMUNITY BANK
The Bank is a full-service bank engaged in a broad range of banking activities and services for individual, business, governmental and institutional customers. These activities and services principally include checking, savings, and time deposit accounts; residential, commercial and agricultural real estate, commercial and industrial, state and political subdivision and consumer loans; and a variety of other specialized financial services. The Trust and Investment division of the Bank offers a full range of client investment, estate, mineral management and retirement services.
The Bank’s main office is located at 15 South Main Street, Mansfield (Tioga County), Pennsylvania. In addition to the main office in Mansfield, the Bank operates 39 full service offices, one limited branch office and four mortgage centers in its market areas. The Bank’s north central, Pennsylvania market area consists of the Pennsylvania Counties of Bradford, Clinton, Potter and Tioga in north central Pennsylvania. It also includes Allegany, Steuben, Chemung and Tioga Counties in Southern New York. The south-central Pennsylvania market consists of Lebanon county and portions of Berks, Lancaster and Schuylkill Counties in Pennsylvania. The Central Pennsylvania market consists of our offices in Centre, Clinton and Union counties and the surrounding communities, as well as Lycoming County with the opening of the Williamsport branch in the fourth quarter of 2023. Our Delaware market consists of Wilmington and Dover, Delaware and portions of Chester County, Pennsylvania and was due to the MidCoast acquisition, completed in April 2020, which added two offices in Wilmington, Delaware and one office in Dover, Delaware. In November of 2020, the Bank opened a full-service branch in Chester County, Pennsylvania. The south east Pennsylvania market consists of Montgomery, Bucks and Philadelphia counties in Pennsylvania, as well as Burlington County New Jersey and was the result of the HVBC acquisition. The economy of the Bank’s market areas are diversified and include manufacturing industries, wholesale and retail trade, service industries, agricultural and the production of natural resources of gas and timber. We are dependent geographically upon the economic conditions in north central, central and south-central Pennsylvania, the southern tier of New York and the cities and surrounding areas of Wilmington and Dover, Delaware.
The economy of the Bank’s market areas are diversified and include manufacturing industries, wholesale and retail trade, service industries, agricultural and the production of natural resources of gas and timber. We are dependent geographically upon the economic conditions in north central, central and south-central Pennsylvania, the southern tier of New York and the cities and surrounding areas of Wilmington and Dover, Delaware.
COMPETITION
The banking industry in the Bank’s service areas are intensely competitive, with competitors including local community banks, larger regional banks, and financial service providers such as consumer finance companies, thrifts, investment firms, mutual funds, insurance companies, credit unions, mortgage banking firms, financial companies, financial affiliates of industrial companies, FinTech and internet entities, and government sponsored agencies, such as Freddie Mac, Fannie Mae and Farm Credit. Competitive pressures continue to increase in our service areas as entities seek both loan and deposit growth, as well as geographic expansion. The Bank is generally competitive with all competing financial institutions in its service areas with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans.
Additional information related to our business and competition is included in Part II, Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations.”
HUMAN CAPITAL RESOURCES
At December 31, 2023, we had a total of 422 employees, including 27 part-time and 11 commissioned employees and of which approximately 71% are women. The full-time equivalent of our total employees at December 31, 2023 was 401. As a financial institution, approximately 42% of our employees are employed at our branch and loan production offices. The success of our business is highly dependent on our employees, who provide value to our customers and communities through their dedication to our mission. Our employees are not represented by any collective bargaining group. Management considers its employee relations to be good.
We encourage and support the growth and development of our associates and, wherever possible, seek to fill positions by promotion and transfer from within the organization. Continual learning and career development are advanced through internally developed training programs and specialty education within banking and using universities that offer Banking Management programs. We believe our ability to attract and retain employees is a key to our success. Accordingly, we strive to offer competitive salaries and employee benefits to all employees and monitor salaries in our market areas. At December 31, 2023, 20% of our current staff had been with us for fifteen years or more.
The safety, health and wellness of our employees is a top priority. All employees are asked not to come to work when they experience signs or symptoms of illness. On an ongoing basis, we further promote the health and wellness of our associates by strongly encouraging work-life balance and sponsoring various wellness programs, whereby associates are compensated for incorporating healthy habits into their daily routines
SUPERVISION AND REGULATION
GENERAL
The Bank is subject to extensive regulation, examination and supervision by the Pennsylvania Department of Banking (“PDB”) and, as a member of the Federal Reserve System, by the Board of Governors of the Federal Reserve System (the “FRB”). Federal and state banking laws and regulations govern, among other things, the scope of a bank’s business, the investments a bank may make, the reserves against deposits a bank must maintain, terms of deposit accounts, loans a bank makes, the interest rates a bank charges and collateral a bank takes, the activities of a bank with respect to mergers and consolidations and the establishment of branches. The Company is registered as a bank holding company and is subject to supervision and regulation by the FRB under the Bank Holding Company Act of 1956, as amended (the “BHCA”).
PENNSYLVANIA BANKING LAWS
The Pennsylvania Banking Code (“Banking Code”) contains detailed provisions governing the organization, location of offices, rights and responsibilities of directors, officers, and employees, as well as corporate powers, savings and investment operations and other aspects of the Bank and its affairs. The Banking Code delegates extensive rule-making power and administrative discretion to the PDB so that the supervision and regulation of state-chartered banks may be flexible and readily responsive to changes in economic conditions and in savings and lending practices.
Pennsylvania law also provides Pennsylvania state-chartered institutions elective parity with the power of national banks, federal thrifts, and state-chartered institutions in other states as authorized by the FDIC, subject to a required notice to the PDB. The Federal Deposit Insurance Corporation Act (“FDIA”), however, prohibits state-chartered banks from making new investments, loans, or becoming involved in activities as principal and equity investments which are not permitted for national banks unless (1) the FDIC determines the activity or investment does not pose a significant risk of loss to the Deposit Insurance Fund and (2) the bank meets all applicable capital requirements. Accordingly, the additional operating authority provided to the Bank by the Banking Code is restricted by the FDIA.
In April 2008, banking regulators in the States of New Jersey, New York, and Pennsylvania entered into a Memorandum of Understanding (the “Interstate MOU”) to clarify their respective roles, as home and host state regulators, regarding interstate branching activity on a regional basis pursuant to the Riegle-Neal Amendments Act of 1997. The Interstate MOU establishes the regulatory responsibilities of the respective state banking regulators regarding bank regulatory examinations and is intended to reduce the regulatory burden on state-chartered banks branching within the region by eliminating duplicative host state compliance exams. Under the Interstate MOU, the activities of branches we established in New York would be governed by Pennsylvania state law to the same extent that federal law governs the activities of the branch of an out-of-state national bank in such host states. Issues regarding whether a particular host state law is preempted are to be determined in the first instance by the PDB. In the event that the PDB and the applicable host state regulator disagree regarding whether a particular host state law is pre-empted, the PDB and the applicable host state regulator would use their reasonable best efforts to consider all points of view and to resolve the disagreement.
COMMUNITY REINVESTMENT ACT
The Community Reinvestment Act, (“CRA”), as implemented by FRB regulations, provides that the Bank has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the FRB, in connection with its examination of the Bank, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain corporate applications by such institution, such as mergers and branching. The Bank’s most recent rating was “Satisfactory.” Various consumer laws and regulations also affect the operations of the Bank. In addition to the impact of regulation, commercial banks are affected significantly by the actions of the FRB as it attempts to control the money supply and credit availability in order to influence the economy.
CURRENT CAPITAL REQUIREMENTS
Federal regulations require FDIC-insured depository institutions, including state-chartered, FRB-member banks, to meet several minimum capital standards. These capital standards were effective January 1, 2015, and result from a final rule implementing regulatory amendments based on recommendations of the Basel Committee on Banking Supervision and certain requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).
The capital standards require the maintenance of common equity Tier 1 capital, Tier 1 capital and total capital to risk-weighted assets of at least 4.5%, 6.0% and 8.0%, respectively, and a leverage ratio of at least 4% of Tier 1 capital. Common equity Tier 1 capital is generally defined as common stockholders’ equity and retained earnings. Tier 1 capital is generally defined as common equity Tier 1 and Additional Tier 1 capital. Additional Tier 1 capital generally includes certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries. Total capital includes Tier 1 capital (common equity Tier 1 capital plus Additional Tier 1 capital) and Tier 2 capital. Tier 2 capital is comprised of capital instruments and related surplus meeting specified requirements, and may include cumulative preferred stock and long-term perpetual preferred stock, mandatory convertible securities, intermediate preferred stock and subordinated debt. Also included in Tier 2 capital is the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and, for institutions that have exercised an opt-out election regarding the treatment of Accumulated Other Comprehensive Income (“AOCI”), up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. The Company has exercised the AOCI opt-out option and therefore AOCI is not incorporated into common equity Tier 1 capital. Calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations.
In determining the amount of risk-weighted assets for purposes of calculating risk-based capital ratios, assets, including certain off-balance sheet assets (e.g., recourse obligations, direct credit substitutes, residual interests) are multiplied by a risk weight factor assigned by the regulations based on the risks believed inherent in the type of asset. Higher levels of capital are required for asset categories believed to present greater risk. For example, a risk weight of 0% is assigned to cash and U.S. government securities, a risk weight of 50% is generally assigned to prudently underwritten first lien one- to four-family residential mortgages, a risk weight of 100% is assigned to commercial and consumer loans, a risk weight of 150% is assigned to certain past due loans and a risk weight of between 0% to 600% is assigned to permissible equity interests, depending on certain specified factors.
In addition to establishing the minimum regulatory capital requirements, the regulations limit capital distributions by the institution and certain discretionary bonus payments to management if an institution does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets above the amount necessary to meet its minimum risk-based capital requirements.
The FRB has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institution’s capital level is or may become inadequate in light of the particular risks or circumstances.
As permitted by applicable federal regulation, the Bank has opted to use the community bank leverage ratio (the “CBLR”) framework for determining its capital adequacy, as discussed above. If a qualifying community bank fails to maintain the applicable minimum CBLR during the grace period, or if it is unable to restore compliance with the CBLR within the grace period, then it will revert to the Basel III capital framework and the normal Prompt Corrective Action capital categories will apply. At December 31, 2023, the Bank is in the grace period under the CBLR framework and the Bank’s leverage ratio was 8.54%.
PROMPT CORRECTIVE ACTION RULES
Federal law establishes a system of prompt corrective action to resolve the problems of undercapitalized institutions. The law requires that certain supervisory actions be taken against undercapitalized institutions, the severity of which depends on the degree of undercapitalization. The FRB has adopted regulations to implement the prompt corrective action legislation as to state member banks. The regulations were amended to incorporate the previously mentioned increased regulatory capital standards that were effective January 1, 2015. An institution is deemed to be “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, a leverage ratio of 5.0% or greater and a common equity Tier 1 ratio of 6.5% or greater. An institution is “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, a leverage ratio of 4.0% or greater and a common equity Tier 1 ratio of 4.5% or greater. An institution is “undercapitalized” if it has a total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based capital ratio of less than 6.0%, a leverage ratio of less than 4.0% or a common equity Tier 1 ratio of less than 4.5%. An institution is deemed to be “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 4.0%, a leverage ratio of less than 3.0% or a common equity Tier 1 ratio of less than 3.0%. An institution is considered to be “critically undercapitalized” if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2.0%.
Subject to a narrow exception, a receiver or conservator must be appointed for an institution that is “critically undercapitalized” within specified time frames. The regulations also provide that a capital restoration plan must be filed with the FRB within 45 days of the date an institution is deemed to have received notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Compliance with the capital restoration plan must be guaranteed by any parent holding company up to the lesser of 5% of the depository institution’s total assets when it was deemed to be undercapitalized or the amount necessary to achieve compliance with applicable capital requirements. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The FRB could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. Significantly and critically undercapitalized institutions are subject to additional mandatory and discretionary measures.
STANDARDS FOR SAFETY AND SOUNDNESS
The federal banking agencies have adopted Interagency Guidelines prescribing Standards for Safety and Soundness in various areas such as internal controls and information systems, internal audit, loan documentation and credit underwriting, interest rate exposure, asset growth and quality, earnings and compensation, fees and benefits. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the FRB determines that a state member bank fails to meet any standard prescribed by the guidelines, the FRB may require the institution to submit an acceptable plan to achieve compliance with the standard.
ENFORCEMENT
The PDB maintains enforcement authority over the Bank, including the power to issue cease and desist orders and civil money penalties and remove directors, officers or employees. The PDB also has the power to appoint a conservator or receiver for a bank upon insolvency, imminent insolvency, unsafe or unsound condition or certain other situations. The FRB has primary federal enforcement responsibility over FRB-member state banks and has authority to bring actions against the institution and all institution-affiliated parties, including shareholders, who knowingly or recklessly participate in wrongful actions likely to have an adverse effect on the bank. Formal enforcement action may range from the issuance of a capital directive or a cease and desist order, to removal of officers and/or directors. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. The FDIC, as deposit insurer, has the authority to recommend to the FRB that enforcement action be taken with respect to a member bank. If the FRB does not take action, the FDIC has authority to take such action under certain circumstances. In general, regulatory enforcement actions occur with respect to situations involving unsafe or unsound practices or conditions, violations of law or regulation or breaches of fiduciary duty. Federal and Pennsylvania law also establish criminal penalties for certain violations.
REGULATORY RESTRICTIONS ON BANK DIVIDENDS
The Bank may not declare a dividend without approval of the FRB, unless the dividend to be declared by the Bank's Board of Directors does not exceed the total of: (i) the Bank's net profits for the current year to date, plus (ii) its retained net profits for the preceding two years, less any required transfers to surplus.
Under Pennsylvania law, the Bank may only declare and pay dividends from its accumulated net earnings. In addition, the Bank may not declare and pay dividends from the surplus funds that Pennsylvania law requires that it maintain. Under these policies and subject to the restrictions applicable to the Bank, the Bank could have declared, during 2023, without prior regulatory approval, aggregate dividends of approximately $42.9 million, plus net profits earned to the date of such dividend declaration.
BANK SECRECY ACT
Under the Bank Secrecy Act (BSA), banks and other financial institutions are required to retain records to assure that the details of financial transactions can be traced if investigators need to do so. Banks are also required to report most cash transactions in amounts exceeding $10,000 made by or on behalf of their customers. Failure to meet BSA requirements may expose the Bank to statutory penalties, and a negative compliance record may affect the willingness of regulating authorities to approve certain actions by the Bank requiring regulatory approval, including acquisition and opening new branches.
INSURANCE OF DEPOSIT ACCOUNTS
The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund (DIF) of the FDIC. Under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors, with less risky institutions paying lower assessments. An institution’s assessment rate depends upon the category to which it is assigned, and certain adjustments specified by FDIC regulations.
As required by the Dodd-Frank Act, the FDIC has issued final rules implementing changes to the assessment rules. The rules change the assessment base used for calculating deposit insurance assessments from deposits to total assets, less tangible (Tier 1) capital. Since the new base is larger than the previous base, the FDIC also lowered assessment rates so that the rule would not significantly alter the total amount of revenue collected from the industry. The range of adjusted assessment rates is now 2.5 to 45 basis points of the new assessment base. The rule is expected to benefit smaller financial institutions, which typically rely more on deposits for funding, and shift more of the burden for supporting the insurance fund to larger institutions, which are thought to have greater access to nondeposit funding. No institution may pay a dividend if it is in default of its assessments. As a result of the Dodd-Frank Act, deposit insurance per account owner is $250,000 for all types of accounts.
The Dodd-Frank Act increased the minimum target DIF ratio from 1.15% to 1.35% of estimated insured deposits. The Dodd-Frank Act eliminated the 1.5% maximum fund ratio, instead leaving it to the discretion of the FDIC to establish a maximum fund ratio. The FDIC has exercised that discretion by establishing a long range fund ratio of 2%.
The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.
Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or regulatory condition imposed in writing. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
FEDERAL RESERVE SYSTEM
Under FRB regulations, the Bank is required to maintain reserves against its transaction accounts (primarily NOW and regular checking accounts). These reserve requirements are subject to annual adjustment by the FRB. For 2023, the Bank would have been required to maintain average daily reserves equal to 3% on aggregate transaction accounts of up to and including $691.7 million, plus 10% on the remainder, and the first $36.1 million of otherwise reservable balances would have been exempt. In March 2020, the FRB reduced all reserve requirements to zero in response to the COVID-19 pandemic.
PROHIBITIONS AGAINST TYING ARRANGEMENTS
State-chartered banks are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.
OTHER REGULATIONS
Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank’s operations are also subject to federal and state laws applicable to credit transactions, such as the:
| • | Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers; |
| • | Home Mortgage Disclosure Act, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves; |
| • | Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit; |
| • | Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies; |
| • | Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; |
| • | Truth in Savings Act; and |
| • | Rules and regulations of the various federal and state agencies charged with the responsibility of implementing such laws. |
The Bank’s operations also are subject to the:
| • | Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; |
| • | Electronic Funds Transfer Act and Regulation E promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services; |
| • | Check Clearing for the 21st Century Act (also known as “Check 21”), which gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check; |
| • | The USA PATRIOT Act, which requires banks operating to, among other things, establish broadened anti-money laundering compliance programs, due diligence policies and controls to ensure the detection and reporting of money laundering. Such required compliance programs are intended to supplement existing compliance requirements, also applicable to financial institutions, under the Bank Secrecy Act and the Office of Foreign Assets Control regulations; and |
| • | The Gramm-Leach-Bliley Act, which places limitations on the sharing of consumer financial information by financial institutions with unaffiliated third parties. Specifically, the Gramm-Leach-Bliley Act requires all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution’s privacy policy and provide such customers the opportunity to “opt out” of the sharing of certain personal financial information with unaffiliated third parties. |
HOLDING COMPANY REGULATION
The Company, as a bank holding company, is subject to examination, supervision, regulation, and periodic reporting under the BHCA, as administered by the FRB. The Company is required to obtain the prior approval of the FRB to acquire all, or substantially all, of the assets of any bank or bank holding company. Prior FRB approval is also required for the Company to acquire direct or indirect ownership or control of any voting securities of any bank or bank holding company if it would, directly or indirectly, own or control more than 5% of any class of voting shares of the bank or bank holding company.
A bank holding company is generally prohibited from engaging in, or acquiring, direct or indirect control of more than 5% of the voting securities of any company engaged in nonbanking activities. One of the principal exceptions to this prohibition is for activities found by the FRB to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the principal activities that the FRB has determined by regulation to be closely related to banking are: (i) making or servicing loans; (ii) performing certain data processing services; (iii) providing securities brokerage services; (iv) acting as fiduciary, investment or financial advisor; (v) leasing personal or real property under certain conditions; (vi) making investments in corporations or projects designed primarily to promote community welfare; and (vii) acquiring a savings association.
A bank holding company that meets specified conditions, including that its depository institutions subsidiaries are “well capitalized” and “well managed,” can opt to become a “financial holding company.” A “financial holding company” may engage in a broader array of financial activities than permitted a typical bank holding company. Such activities can include insurance underwriting and investment banking. The Company does not anticipate opting for “financial holding company” status at this time.
The Company is exempt from the FRB’s consolidated capital adequacy guidelines for bank holding companies because the Company’s consolidated assets are less than $3.0 billion. The FRB consolidated capital adequacy guidelines are at least as stringent as those required for the subsidiary depository institutions.
A bank holding company is generally required to give the FRB prior written notice of any purchase or redemption of then outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the Company’s consolidated net worth. The FRB may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, FRB order or directive, or any condition imposed by, or written agreement with, the FRB. The FRB has adopted an exception to that approval requirement for well-capitalized bank holding companies that meet certain other conditions.
The FRB has issued a policy statement regarding the payment of dividends and other capital distributions by bank holding companies. In general, the FRB’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. The FRB’s policies also require that a bank holding company serve as a source of financial strength to its subsidiary banks by using available resources to provide capital funds during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. The Dodd-Frank Act codified the source of strength policy and requires the promulgation of implementing regulations. Under the prompt corrective action laws, the ability of a bank holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions.
The Federal Deposit Insurance Act makes depository institutions liable to the Federal Deposit Insurance Corporation for losses suffered or anticipated by the insurance fund in connection with the default of a commonly controlled depository institution or any assistance provided by the Federal Deposit Insurance Corporation to such an institution in danger of default. That law would have potential applicability if the Company ever held as a separate subsidiary a depository institution in addition to the Bank.
The status of the Company as a registered bank holding company under the Bank Holding Company Act will not exempt it from certain federal and state laws and regulations applicable to corporations generally, including, without limitation, certain provisions of the federal securities laws.
ACQUISITION OF THE HOLDING COMPANY
Under the Change in Bank Control Act (the “CIBCA”), a federal statute, a notice must be submitted to the FRB if any person (including a company), or group acting in concert, seeks to acquire 10% or more of the Company’s shares of outstanding common stock, unless the FRB has found that the acquisition will not result in a change in control of the Company. Under the CIBCA, the FRB generally has 60 days within which to act on such notices, taking into consideration certain factors, including the financial and managerial resources of the acquirer, the convenience and needs of the communities served by the Company and the Bank, and the anti-trust effects of the acquisition. Under the BHCA, any company would be required to obtain prior approval from the FRB before it may obtain “control” of the Company within the meaning of the BHCA. Control generally is defined to mean the ownership or power to vote 25% or more of any class of voting securities of the Company or the ability to control in any manner the election of a majority of the Company’s directors. An existing bank holding company would be required to obtain the FRB’s prior approval under the BHCA before acquiring more than 5% of the Company’s voting stock.
EFFECT OF GOVERNMENT MONETARY POLICIES
The earnings and growth of the banking industry are affected by the credit policies of monetary authorities, including the Federal Reserve System. An important function of the Federal Reserve System is to regulate the national supply of bank credit in order to control recessionary and inflationary pressures. Among the instruments of monetary policy used by the Federal Reserve to implement these objectives are open market activities in U.S. government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These operations are used in varying combinations to influence overall economic growth and indirectly, bank loans, securities, and deposits. These variables may also affect interest rates charged on loans or paid on deposits. The monetary policies of the Federal Reserve authorities have had a significant effect on the operating results of commercial banks in the past and are expected to continue to have such an effect in the future.
In view of the changing conditions in the national economy and in the money markets, as well as the effect of actions by monetary and fiscal authorities including the Federal Reserve System, no prediction can be made as to possible changes in interest rates, deposit levels, loan demand or their effect on the business and earnings of the Company and the Bank. Additional information is included under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing in this Annual Report on Form 10-K.
ITEM 1A – RISK FACTORS.
The following discussion sets forth the material risk factors that could affect the Company’s consolidated financial condition and results of operations. Readers should not consider any descriptions of these factors to be a complete set of all potential risks that could affect the Company. Any risk factor discussed below could by itself, or combined with other factors, materially and adversely affect the Company’s business, results of operations, financial condition, capital position, liquidity, competitive position or reputation, including by materially increasing expenses or decreasing revenues, which could result in material losses or a decrease in earnings.
RISKS RELATED TO CHANGES IN MARKET INTEREST RATES
Changing interest rates may decrease our earnings and asset values.
Our net interest income is the interest we earn on loans and investments less the interest we pay on our deposits and borrowings. Our net interest margin is the difference between the yield we earn on our assets and the interest rate we pay for deposits and our other sources of funding. Changes in interest rates—up or down—could adversely affect our net interest margin and, as a result, our net interest income. Although the yield we earn on our assets and our funding costs tend to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, causing our net interest margin to expand or contract. Our liabilities tend to be shorter in duration than our assets, so they may adjust faster in response to changes in interest rates. As a result, when interest rates rise, our funding costs may rise faster than the yield we earn on our assets, causing our net interest margin to contract until the asset yields catch up. Changes in the slope of the “yield curve”—or the spread between short-term and long-term interest rates—could also reduce our net interest margin. Normally, the yield curve is upward sloping, meaning short-term rates are lower than long-term rates. Because our liabilities tend to be shorter in duration than our assets, when the yield curve flattens or even inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets.
Changes in interest rates also affect the value of the Bank’s interest-earning assets, and in particular the Bank’s securities portfolio. Generally, the value of fixed-rate securities fluctuates inversely with changes in interest rates. Unrealized gains and losses on securities available for sale are reported as a separate component of shareholder equity, net of tax, while unrealized gains and losses on equity securities directly impact earnings. Decreases in the fair value of securities available for sale resulting from increases in interest rates could have an adverse effect on shareholders’ equity or net income.
The effects of price changes and inflation can vary substantially for most financial institutions. While management believes that inflation affects the growth of total assets, it believes that it is difficult to assess the overall impact. Management believes this to be the case due to the fact that generally neither the timing nor the magnitude of the inflationary changes in the CPI coincides with changes in interest rates. The price of one or more of the components of the CPI may fluctuate considerably and thereby influence the overall CPI without having a corresponding effect on interest rates or upon the cost of those goods and services normally purchased by us. In years of high inflation and high interest rates, intermediate and long-term interest rates tend to increase, thereby adversely impacting the market values of investment securities, mortgage loans and other long-term fixed rate loans. In addition, higher short-term interest rates caused by inflation tend to increase the cost of funds. In other years, the opposite may occur. In addition, inflation increases the cost of goods and services we use in our business operations, such as electricity and other utilities, which increases our noninterest expenses. Our customers are also affected by inflation and the rising costs of goods and services used in their households and businesses, which could have a negative impact on their ability to repay their loans with us.
RISKS RELATED TO OUR LENDING ACTIVITIES
Activities related to the drilling for natural gas in the in the Marcellus and Utica Shale formations impacts certain customers of the Bank.
Our north central Pennsylvania market area is predominately centered in the Marcellus and Utica Shale natural gas exploration and drilling area, and as a result, the economy in north central Pennsylvania is influenced by the natural gas industry. Loan demand, deposit levels and the market value of local real estate are impacted by this activity. While the Company does not lend to the various entities directly engaged in exploration, drilling or production activities, many of our customers provide transportation and other services and products that support natural gas exploration and production activities. Therefore, our customers are impacted by changes in the market price for natural gas, as a significant downturn in this industry could impact the ability of our borrowers to repay their loans in accordance with their terms. Additionally, exploration and drilling activities may be affected by federal, state and local laws and regulations such as restrictions on production, permitting, changes in taxes and environmental protection. Regulatory and market pricing of natural gas could also impact and/or reduce demand for loans and deposit levels or loan collateral values. These factors could have a material adverse effect on our business, prospects, financial condition and results of operations.
Higher loan losses could require us to increase our allowance for credit losses through a charge to earnings.
When we loan money, we incur the risk that our borrowers do not repay their loans. We reserve for credit losses by establishing an allowance through a charge to earnings. The amount of this allowance is based on our assessment of credit losses inherent in our loan portfolio. The process for determining the amount of the allowance is critical to our financial results and condition. It requires subjective and complex judgments about the future, including forecasts of economic or market conditions that might impair the ability of our borrowers to repay their loans. We might underestimate the loan losses inherent in our loan portfolio and have credit losses in excess of the amount reserved. We might increase the allowance because of changing economic conditions. For example, in a rising interest rate environment, borrowers with adjustable-rate loans could see their payments increase. There may be a significant increase in the number of borrowers who are unable or unwilling to repay their loans, resulting in our charging off more loans and increasing our allowance. In addition, when real estate values decline, the potential severity of loss on a real estate-secured loan can increase significantly, especially in the case of loans with high combined loan-to-value ratios. A decline in the national economy and the local economies of the areas in which the loans are concentrated could result in an increase in loan delinquencies, foreclosures or repossessions resulting in increased charge-off amounts and the need for additional loan loss allowances in future periods. In addition, bank regulators may require us to make a provision for credit losses or otherwise recognize further loan charge-offs following their periodic review of our loan portfolio, our underwriting procedures, and our loan loss allowance. Any increase in our allowance for credit losses or loan charge-offs as required by such regulatory authorities could have a material adverse effect on our financial condition and results of operations.
Our allowance for credit losses amounted to $21.2 million, or 0.94% of total loans outstanding and 173.6% of nonperforming loans, at December 31, 2023. Our allowance for credit losses at December 31, 2023 may not be sufficient to cover future loan losses. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would decrease our earnings. In addition, at December 31, 2023 the top 40 relationships of the Bank had an outstanding balance of $559.7 million. These loans represent approximately 24.9% of our entire outstanding loan portfolio as of December 31, 2023 and the deterioration of one or more of these loans could result in a significant increase in our nonperforming loans and our provision for credit losses, which would negatively impact our results of operations.
During 2023, the Bank implemented ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments, which changed the impairment model for most financial assets. The underlying premise of the Update was that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset. The income statement will be affected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. The implementation of this standard did result in a decrease of $2.2 million to the Company’s allowance for credit losses effective January 1, 2023 compared to December 31, 2023.
Our emphasis on commercial real estate, agricultural real estate, construction and other commercial loan lending may expose us to increased lending risks.
At December 31, 2023, we had $1.09 billion in loans secured by commercial real estate, $314.8 million in agricultural real estate loans, $195.8 million in construction loans and $136.2 million in other commercial loans. Commercial real estate loans, agricultural real estate, construction and other commercial loans represented 48.6%, 14.0%, 8.7% and 6.1%, respectively, of our loan portfolio. At December 31, 2023, we had $16.6 million of reserves specifically allocated to these loan types. While commercial real estate, agricultural real estate, construction and other commercial loans are generally more interest rate sensitive and carry higher yields than do residential mortgage loans, these types of loans generally expose a lender to greater risk of non-payment and loss than single-family residential mortgage loans because repayment of the loans often depends on the successful operation of the property, the income stream of the borrowers and, for construction loans, the accuracy of the estimate of the property’s value at completion of construction and the estimated cost of construction. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to single-family residential mortgage loans. We monitor loan concentrations on an individual relationship and industry wide basis to monitor the amount of risk we have in our loan portfolio.
Agricultural loans are dependent for repayment on the successful operation and management of the farm property, the health of the agricultural industry broadly, and on the location of the borrower in particular, and other factors outside of the borrower’s control.
At December 31, 2023, our agricultural loans, consisting primarily of agricultural real estate loans and other agricultural loans, totaled $345.5 million, representing 15.4% of our total loan portfolio. The primary activities of our agricultural customers include dairy and beef farms, poultry and swine operations, crops and support businesses. Agricultural markets are highly sensitive to real and perceived changes in the supply and demand of agricultural products. Weaker prices could reduce the value of agricultural land in our local markets and thereby increase the risk of default by our borrowers or reduce the foreclosure value of agricultural land, animals and equipment that serves as collateral for certain of our loans. At December 31, 2023, the Company had a loan concentration to the dairy industry totaling $118,599,000, or 5.3% of total loans and 34.3% of total agricultural loans compared to 7.0% of total loans and 34.5% of total agricultural loans at December 31, 2022.
Our agricultural loans are dependent on the profitable operation and management of the farm property securing the loan and its cash flows. The success of a farm property may be affected by many factors outside the control of the borrower, including:
| • | adverse weather conditions (such as hail, drought and floods), restrictions on water supply or other conditions that prevent the planting or harvesting of a crop or limit crop yields; |
| • | loss of crops or livestock due to disease or other factors; |
| • | declines in the market prices or demand for agricultural products (both domestically and internationally), for any reason; |
| • | increases in production costs (such as the costs of labor, rent, feed, fuel and fertilizer); |
| • | the impact of domestic and international government policies and regulations (including changes in price supports, subsidies, government-sponsored crop insurance, minimum ethanol content requirements for gasoline, tariffs, trade barriers, trade agreements and health and environmental regulations); |
| • | access to technology and the successful implementation of production technologies; |
| • | and changes in the general economy that could affect the availability of off-farm sources of income and prices of real estate for borrowers. |
| • | Disruptions in the supply chain and the processing of product and delivery to the final retail channel |
Lower prices for agricultural products may cause farm revenues to decline and farm operators may be unable to reduce expenses as quickly as their revenues decline. In addition, many farms are dependent on a limited number of key individuals whose injury or death could significantly affect the successful operation of the farm. If the cash flow from a farming operation is diminished, the borrower’s ability to repay the loan may be impaired. Consequently, agricultural loans may involve a greater degree of risk than residential mortgage lending, particularly in the case of loans that are unsecured or secured by rapidly depreciating assets such as farm equipment (some of which is highly specialized with a limited or no market for resale) or perishable assets such as livestock or crops. In such cases, any repossessed collateral for a defaulted agricultural operating loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation or because the assessed value of the collateral exceeds the eventual realization value
Loan participations comprise a portion of our loan portfolio and a decline in loan participation volume could hurt profits and slow loan growth.
We have actively engaged in loan participations whereby we are invited to participate in loans, primarily commercial real estate and municipal loans, originated by another financial institution known as the lead lender. We have participated with other financial institutions in both our primary markets and out of market areas. We underwrite any loan we participate in as if we are originating the loan. The primary difference is that financial information is received from the participating financial institution and not the borrower. The loans we participate in as a purchaser totaled $87.8 million and $65.3 million at December 31, 2023 and 2022, respectively. As a percent of total loans, participation purchased loans were 3.9%, and 3.8% as of December 31, 2023 and 2022, respectively. Our profits and loan growth could be significantly and adversely affected if the volume of loan participations would materially decrease, whether because loan demand declines, loan payoffs, lead lenders may come to perceive us as a potential competitor in their respective market areas, or otherwise.
Environmental liability associated with lending activities could result in losses.
In the course of our business, we may foreclose on and take title to properties securing our loans. If hazardous substances were discovered on any of these properties, we could be liable to governmental entities or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage. Many environmental laws can impose liability regardless of whether we knew of, or were responsible for, the contamination. In addition, if we arrange for the disposal of hazardous or toxic substances at another site, we may be liable for the costs of cleaning up and removing those substances from the site even if we neither own nor operate the disposal site. Environmental laws may require us to incur substantial expenses and may materially limit use of properties we acquire through foreclosure, reduce their value or limit our ability to sell them in the event of a default on the loans they secure. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability.
RISKS RELATED TO OUR INVESTMENT SECURITIES
If we conclude that the decline in value of any of our investment securities is other than temporary, we are required to write down the value of that security through a charge to earnings.
We review our investment securities portfolio monthly and at each quarter-end reporting period to determine whether the fair value is below the current carrying value. Generally, the fair value of our investment securities decrease during periods of rising market interest rates and increase during periods of declining market interest rates. When the fair value of any of our investment securities has declined below its carrying value, we are required to assess whether the decline is other than temporary. If we conclude that the decline is other than temporary, we are required to write down the value of that security through a charge to earnings. As of December 31, 2023, our investment portfolio included available for sale investment securities with an amortized cost of $453.3 million and a fair value of $417.6 million, which included unrealized losses on 328 securities totaling $36.0 million. Changes in the expected cash flows of these securities and/or prolonged price declines may result in our concluding in future periods that the impairment of these securities is other than temporary, which would require a charge to earnings to write down these securities to their fair value. Any charges for other-than-temporary impairment would not impact cash flow, tangible capital or liquidity.
RISKS RELATED TO OUR SECONDARY MORTGAGE OPERATIONS
Income from secondary mortgage market operations is volatile, and we may incur losses or charges with respect to our secondary mortgage market operations which would negatively affect our earnings.
We generally sell in the secondary market the longer term fixed-rate residential mortgage loans that we originate, earning non-interest income in the form of gains on sale. When interest rates rise, the demand for mortgage loans tends to fall and may reduce the number of loans available for sale. In addition to interest rate levels, weak or deteriorating economic conditions also tend to reduce loan demand. Although we sell loans in the secondary market without recourse, we are required to give customary representations and warranties to the buyers. If we breach those representations and warranties, the buyers can require us to repurchase the loans and we may incur a loss on the repurchase. Because we generally retain the servicing rights on the loans we sell in the secondary market, we are required to record a mortgage servicing right asset, which we test annually for impairment. The value of mortgage servicing rights tends to increase with rising interest rates and to decrease with falling interest rates, with refinance activity increasing in falling rate environments. If we are required to take an impairment charge on our mortgage servicing rights our earnings would be adversely affected.
As a result of acquisitions, the Bank acquired a portfolio of loans sold to the FHLB, which were sold under the Mortgage Partnership Finance Program ("MPF"). While the Bank was not an active participant in the MPF program in 2023, we continue to evaluate the program to see if it would be beneficial to our customers and our performance. The MPF portfolio balance was $10,161,000 at December 31, 2023. The FHLB maintains a first-loss position for the MPF portfolio that totals $165,000. Should the FHLB exhaust its first-loss position, recourse to the Bank's credit enhancement would be up to the next $229,000 of losses. The Bank has not experienced any losses for the MPF portfolio.
RISKS RELATED TO OUR MARKET AREA
The Company’s financial condition and results of operations are dependent on the economy in the Bank’s market area.
The Bank’s primary market area consists of the Pennsylvania Counties of Bradford, Clinton, Potter, and Tioga in north central Pennsylvania, Lebanon, Schuylkill, Berks and Lancaster in south central, Pennsylvania, Centre and Clinton in central Pennsylvania, and Allegany, Steuben, Chemung and Tioga Counties in southern New York. With the acquisition of MidCoast, we consider the cities and surrounding areas of Wilmington and Dover, Delaware, as well as Kennett Square, Pennsylvania in Chester County, as primary market areas. With the acquisition of HVBC, we have expanded further into southeast Pennsylvania, including Montgomery, Bucks and Philadelphia Counties as well as Burlington County, New Jersey through the acquisition of five full service branches, four mortgage centers and one business banking facility. The majority of the Bank’s loan and deposits come from households and businesses whose primary address is located in the Bank’s primary market areas. Because of the Bank’s concentration of business activities in its market area, the Company’s financial condition and results of operations depend upon economic conditions in its market areas. Adverse economic conditions in our market areas could reduce our growth rate, affect the ability of our customers to repay their loans and generally affect our financial condition and results of operations. Conditions such as inflation, recession, unemployment, high interest rates and short money supply and other factors beyond our control may adversely affect our profitability. We are less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies. Any sustained period of increased payment delinquencies, foreclosures or losses caused by adverse market or economic conditions in the States of Pennsylvania, New York, New Jersey and Delaware could adversely affect the value of our assets, revenues, results of operations and financial condition. Moreover, we cannot give any assurance we will benefit from any market growth or favorable economic conditions in our primary market areas if they do occur.
RISKS RELATED TO LAWS AND REGULATIONS
Regulation of the financial services industry is significant, and future legislation could increase our cost of doing business or harm our competitive position.
We are subject to extensive regulation, supervision and examination by the FRB and the PDB, our primary regulators, and by the FDIC, as insurer of our deposits. Such regulation and supervision govern the activities in which an institution and its holding company may engage and are intended primarily for the protection of the insurance fund and the depositors and borrowers of the Bank rather than for holders of our common stock. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for credit losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our profitability and operations. Future legislative changes could require changes to business practices or force us to discontinue businesses and potentially expose us to additional costs, liabilities, enforcement action and reputational risk.
Our ability to pay dividends is limited by law.
Our ability to pay dividends to our shareholders largely depends on our receipt of dividends from the Bank. The amount of dividends that the Bank may pay to us is limited by federal and state laws and regulations. We also may decide to limit the payment of dividends even when we have the legal ability to pay them in order to retain earnings for use in our business.
Federal and state banking laws, our articles of incorporation and our by-laws may have an anti-takeover effect.
Federal law imposes restrictions, including regulatory approval requirements, on persons seeking to acquire control over us. Pennsylvania law also has provisions that may have an anti-takeover effect. These provisions may serve to entrench management or discourage a takeover attempt that shareholders consider to be in their best interest or in which they would receive a substantial premium over the current market price.
RISKS RELATED TO COMPETITION
Strong competition within the Bank’s market areas could hurt profits and slow growth.
The Bank faces intense competition both in making loans and attracting deposits. This competition has made it more difficult for the Bank to make new loans and at times has forced the Bank to offer higher deposit rates. Price competition for loans and deposits might result in the Bank earning less on loans and paying more on deposits, which would reduce net interest income. Competition also makes it more difficult to increase the volume of our loan and deposit portfolios. As of June 30, 2023, which is the most recent date for which information is available, we held 33.8% of the FDIC insured deposits in Bradford, Potter and Tioga Counties, Pennsylvania, which was the second largest share of deposits out of eight financial institutions with offices in the area, and 6.8% of the FDIC insured deposits in Allegany County, New York, which was the third largest share of deposits out of three financial institutions with offices in this area. As of June 30, 2023, we held 7.9% of the FDIC insured deposits in Lebanon County, Pennsylvania, which was the fourth largest share out of the 12 financial institutions with offices in the County. As of June 30, 2023, we held 3.7% of the FDIC insured deposits in Clinton County, Pennsylvania, which was the eighth largest share out of the eight financial institutions with offices in the County. Our offices in Berks, Centre, Chester, Lancaster, Schuylkill, Montgomery, Bucks and Philadelphia Counties of Pennsylvania and our offices in Wilmington and Dover, Delaware and Burlington, New Jersey all have less than 3% of the FDIC insured deposits of the corresponding County as of June 30, 2023. This data does not include deposits held by credit unions. Competition also makes it more difficult to hire employees and more expensive to retain experienced employees. Some of the institutions with which the Bank competes have substantially greater resources and lending limits than the Bank has and may offer services that the Bank does not provide. Management expects competition to increase in the future as a result of legislative, regulatory and technological changes (fintech) and the continuing trend of consolidation in the financial services industry. The Bank’s profitability depends upon its continued ability to compete successfully in its market area.
RISKS RELATED TO OUR OPERATIONS
We rely on our management and other key personnel, and the loss of any of them may adversely affect our operations.
We are and will continue to be dependent upon the services of our executive management team. In addition, we will continue to depend on our ability to retain and recruit key commercial and agricultural loan officers. The unexpected loss of services of any key management personnel or commercial and agricultural loan officers could have an adverse effect on our business and financial condition because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.
We are periodically subject to examination and scrutiny by a number of banking agencies and, depending upon the findings and determinations of these agencies, we may be required to make adjustments to our business that could adversely affect us.
Federal and state banking agencies periodically conduct examinations of our business, including compliance with applicable laws and regulations. If, as a result of an examination, a banking agency was to determine that the financial condition, capital resources, asset quality, asset concentration, earnings prospects, management, liquidity, sensitivity to market risk or other aspects of any of our operations has become unsatisfactory, or that we or our management is in violation of any law or regulation, it could take a number of different remedial actions as it deems appropriate. These actions include the power to enjoin “unsafe or unsound” practices, to require affirmative actions to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital, to restrict our growth, to change the composition of our assets or liabilities, to assess civil monetary penalties against us and/or our officers or directors, to remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to depositors, to terminate our deposit insurance. If we become subject to such regulatory actions, our business, results of operations and reputation may be negatively impacted.
We are subject to certain risks in connection with our use of technology.
Communications and information systems are essential to the conduct of our business, as we use such systems to manage our customer relationships, our general ledger, our deposits, our loans, and to deliver on-line and electronic banking services. Our operations rely on the secure processing, storage, and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify them as circumstances warrant, the security of our computer systems, software, and networks may be vulnerable to breaches, unauthorized access, misuse, computer viruses, or other malicious code and cyber attacks that could have a security impact.
In addition, breaches of security may occur through intentional or unintentional acts by those having authorized or unauthorized access to our confidential or other information or the confidential or other information of our customers, clients, or counterparties. If one or more of such events were to occur, the confidential and other information processed and stored in, and transmitted through, our computer systems and networks could potentially be jeopardized, or could otherwise cause interruptions or malfunctions in our operations or the operations of our customers, clients, or counterparties. This could cause us significant reputational damage or result in our experiencing significant losses from fraud or otherwise.
Furthermore, we may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures arising from operational and security risks. Also, we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance we maintain.
We routinely transmit and receive personal, confidential, and proprietary information by e-mail and other electronic means. We have discussed and worked with our customers, clients, and counterparties to develop secure transmission capabilities, but we do not have, and may be unable to put in place, secure capabilities with all of these constituents, and we may not be able to ensure that these third parties have appropriate controls in place to protect the confidentiality of such information. Any interception, misuse, or mishandling of personal, confidential, or proprietary information being sent to or received from a customer, client, or counterparty could result in legal liability, regulatory action, and reputational harm, and could have a significant adverse effect on our competitive position, financial condition, and results of operations.
Our risk management framework may not be effective in mitigating risks and/or losses to us.
We have implemented a risk management framework to manage our risk exposure. This framework is comprised of various processes, systems and strategies, and is designed to manage the types of risk to which we are subject, including, among others, credit, market, liquidity, interest rate and compliance. Our framework also includes financial or other modeling methodologies which involve management assumptions and judgment. There is no assurance that our risk management framework will be effective under all circumstances or that it will adequately mitigate any risk or loss to us. If our framework is not effective, we could suffer unexpected losses and our business, financial condition, results of operations or prospects could be materially and adversely affected. We may also be subject to potentially adverse regulatory consequences.
RISKS RELATED TO OUR MERGER AND ACQUISITION ACTIVITY
Impairment of goodwill could require charges to earnings, which could result in a negative impact on our results of operations.
Our goodwill could become impaired in the future. If goodwill were to become impaired, it could limit the ability of the Bank to pay dividends to the Company, adversely impacting the Company’s liquidity and ability to pay dividends. The most significant assumptions affecting our goodwill impairment evaluation are variables including the market price of our Common Stock, projections of earnings, and the control premium above our current stock price that an acquirer would pay to obtain control of us. We are required to test goodwill for impairment at least annually or when impairment indicators are present. If an impairment determination is made in a future reporting period, our earnings and book value of goodwill will be reduced by the amount of the impairment. If an impairment loss is recorded, it will have little or no impact on the tangible book value of our Common Stock, or our regulatory capital levels, but such an impairment loss could significantly reduce the Bank’s earnings and thereby restrict the Bank's ability to make dividend payments to us without prior regulatory approval, because Federal Reserve policy states the bank holding company dividends should be paid from current earnings. At December 31, 2023, the book value of our goodwill was $85.8 million, all of which was recorded at the Bank.
We may fail to realize all of the anticipated benefits of entering new markets.
As a result of completed and proposed acquisitions and the hiring of additional agricultural and commercial lending teams, the Company enters new banking market areas. The success of entering these new markets depends upon, in part, the Company’s ability to realize the anticipated benefits and cost savings from combining the businesses of the Company and the acquisition, as well as organically growing loans and deposits. To realize these anticipated benefits and cost savings, the businesses and individuals must be successfully combined and operated. If the Company is not able to achieve these objectives, the anticipated benefits, including growth and cost savings related to the combined businesses, may not be realized at all or may take longer to realize than expected. If the Company fails to realize the anticipated benefits of the acquisitions and the new employee hiring’s, the Company’s results of operations could be adversely affected.
ITEM 1B – UNRESOLVED STAFF COMMENTS.
Not applicable.
ITEM 1C – CYBERSECURITY
Risk Management and Strategy
Cybersecurity is a critical component of our risk management program, given the increasing reliance on technology and potential of cyber threats. Our Information Security Officer is primarily responsible for the cybersecurity / information security program. The Information Security Officer reports directly to the Chief Operations Officer, and periodically reports to the Audit and Examination Committee of our board of directors.
Our objective for managing cybersecurity risk is to avoid or minimize the impacts of external threat events or other efforts to penetrate, disrupt or misuse our systems or information. The structure of our information security program is designed around regulatory guidance and related industry standards. In addition, we leverage various cyber-related associations, threat intelligence feeds, and audits to facilitate and promote program effectiveness. The information security program is periodically reviewed by the Information Security Officer in collaboration with information technology management with the goal of addressing changing threats and conditions.
We employ a layered defensive strategy when designing our cybersecurity controls. We leverage people, processes, and technology as part of our efforts to manage and maintain cybersecurity controls. We employ a variety of preventative and detective tools designed to monitor, block, and provide alerts regarding suspicious activity, as well as to report on suspected threats. We have established processes and systems designed to mitigate cyber risk, including regular and on-going education and training for employees, preparedness simulations, and tabletop exercises. We engage in regular monitoring and assessments of our technology infrastructure using internal staff and third-party specialists. We conduct ongoing social engineering testing and training across our entire employee base. We maintain a vendor management program designed to identify, assess, and manage risks, including cybersecurity risks, associated with external service providers and our supply chain. Our independent auditors periodically review our processes, systems, and controls, including with respect to our information security program, to assess their design and operating effectiveness and make recommendations to strengthen our risk management program.
We maintain an Incident Response Plan that provides a documented framework for responding to actual or potential cybersecurity incidents, including engagement of appropriate third parties such as insurance providers and incident response professionals, and timely reporting to our CEO and Board of Directors as appropriate. The Incident Response Plan is coordinated by the Information Security Officer and key members of management are embedded into the Plan by its design. The Incident Response Plan facilitates coordination across multiple areas of our organization and is evaluated at least annually.
Notwithstanding our defensive measures and processes, the threat posed by cyber-attacks is always present. Our internal systems, processes, and controls are designed to mitigate loss from cyber-attacks. While we have experienced cybersecurity incidents in the past, risks from cybersecurity threats have not materially affected our company to date. For further discussion of risks from cybersecurity threats, see the section captioned “We are subject to certain risks in connection with our use of technology” in Item 1A. Risk Factors.
Governance
Our Information Security Officer is responsible for managing our information security program, inclusive of cybersecurity risk assessment, incident response, vulnerability assessment, threat intelligence, identity access governance, third-party risk management, and business continuity. Some of these responsibilities are carried out in collaboration with other internal departments, such as the information technology department. In any case, the Information Security Officer provides guidance, oversight, and monitoring of the information security program, and acts in an independent role, reporting directly to the Chief Operations Officer and subsequently to the Audit and Examination Committee of the board of directors. Our Information Security Officer has extensive bank operations experience, has attained Certified Banking Security Manager certification with the banking industry, and attends relevant cybersecurity training sessions on a regular basis. Our information technology department consists of technology professionals with varying degrees of education and experience. Our information technology management team has significant technology and operational experience, including experience in mitigating and responding to cybersecurity threats.
The Audit and Examination Committee of our board of directors is responsible for overseeing our information and cybersecurity risk management program, including management’s actions to identify, assess, mitigate, and remediate or prevent material cybersecurity issues and risks. Our Information Security Officer provides quarterly reports to the Audit and Examination Committee of our board of directors regarding the information security program, cybersecurity and/or privacy incidents, key cybersecurity initiatives, and other matters relating to cybersecurity processes. These reports may occur more frequently if a significant issue or incident is being addressed.
ITEM 2 – PROPERTIES.
The headquarters of the Company and Bank are located at 15 South Main Street, Mansfield, Pennsylvania. The building contains the central offices of the Company and Bank. The Bank owns twenty-five banking facilities and leases twenty-three other facilities.
The net book value of owned banking facilities and leasehold improvements totaled $18,072,000 as of December 31, 2023. The properties are adequate to meet the needs of the employees and customers. We have equipped all of our facilities with current technological improvements for data processing.
ITEM 3 - LEGAL PROCEEDINGS.
The Company is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business. Such routine legal proceedings in the aggregate are believed by management to be immaterial to the Company's consolidated financial condition or results of operations.
ITEM 4 – MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5 - MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Since June 3, 2022, the Company’s common stock has been listed on the Nasdaq Stock Market under the symbol “CZFS”. Before that date, the Company’s common stock was quoted on the OTC Pink Market under the same symbol. The high and low prices in the table below are for the full quarter during which the Company’s common stock was quoted on the OTC Pink Market and reflect bid prices between broker-dealers published by the OTC Pink Market and the Pink Sheets Electronic Quotation Service. The prices do not include retail markups or markdowns or any commission to the broker-dealer. The bid prices do not necessarily reflect prices in actual transactions. For 2023 and 2022, cash dividends were declared on a quarterly basis and are summarized in the table below:
| | | | Dividends | | | | | | | | | Dividends | |
| | | 2023 | | | declared | | | 2022 | | | declared | |
| | | High | | | Low | | | per share | | | High | | | Low | | | per share | |
First quarter | | | N/A | | | | N/A | | | $ | 0.485 | | | $ | 62.97 | | | $ | 59.46 | | | $ | 0.475 | |
Second quarter | | | N/A | | | | N/A | | | | 0.485 | | | | N/A | | | | N/A | | | | 0.475 | |
Third quarter | | | N/A | | | | N/A | | | | 0.490 | | | | N/A | | | | N/A | | | | 0.480 | |
Fourth quarter | | | N/A | | | | N/A | | | | 0.490 | | | | N/A | | | | N/A | | | | 0.480 | |
The Company has paid dividends since April 30, 1984, the effective date of our formation as a bank holding company. The Company's Board of Directors expects that comparable cash dividends will continue to be paid by the Company in the future; however, future dividends necessarily depend upon earnings, financial condition, appropriate legal restrictions and other factors in existence at the time the Board of Directors considers a dividend distribution. Cash available for dividend distributions to stockholders of the Company comes primarily from dividends paid to the Company by the Bank. Therefore, restrictions on the ability of the Bank to make dividend payments are directly applicable to the Company. Under the Pennsylvania Business Corporation Law of 1988, the Company may pay dividends only if, after payment, the Company would be able to pay debts as they become due in the usual course of our business and total assets will be greater than the sum of total liabilities. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions. Also see “Supervision and Regulation – Regulatory Restrictions on Bank Dividends,” “Supervision and Regulation – Holding Company Regulation,” and “Note 17 – Regulatory Matters” to the consolidated financial statements.
As of February 26, 2024, the Company had 1,898 stockholders of record. The computation of stockholders of record excludes investors whose shares were held for them by a bank or broker at that date. The following table presents information regarding the Company’s stock repurchases during the three months ended December 31, 2023:
| Period | | Total Number of Shares (or units Purchased) | | | Average Price Paid per Share (or Unit) | | | Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans of Programs | | | Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs (1) | |
| | | | | | | | | | | | | |
10/1/23 to 10/31/23 | | | - | | | $ | 0.00 | | | | - | | | | 150,000 | |
11/1/23 to 11/30/23 | | | - | | | $ | 0.00 | | | | - | | | | 150,000 | |
12/1/23 to 12/31/23 | | | 3 | | | $ | 47.00 | | | | 3 | | | | 149,997 | |
| Total | | | 3 | | | $ | 47.00 | | | | 3 | | | | 149,997 | |
| (1) | On April 22, 2023, the Company announced that the Board of Directors authorized the Company to repurchase up to an additional 150,000 shares at an aggregate purchase price not to exceed $15.0 million over a period of 36 months. The repurchases will be conducted through open-market purchases or privately negotiated transactions and will be made from time to time depending on market conditions and other factors. No time limit was placed on the duration of the share repurchase program. Any repurchased shares will be held as treasury stock and will be available for general corporate purposes. |
ITEM 6 – [RESERVED]
ITEM 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
CAUTIONARY STATEMENT
We have made forward-looking statements in this document, and in documents that we incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of operations of the Company, the Bank, First Citizens Insurance, Realty or the Company on a consolidated basis. When we use words such as “believes,” “expects,” “anticipates,” or similar expressions, we are making forward-looking statements. Forward-looking statements may prove inaccurate. For a variety of reasons, actual results could differ materially from those contained in or implied by forward-looking statements:
| • | Interest rates could change more rapidly or more significantly than we expect or remain inverted for a longer period than anticipated. |
| • | The economy could change significantly in an unexpected way, which would cause the demand for new loans and the ability of borrowers to repay outstanding loans to change in ways that our models do not anticipate. |
| • | The financial markets could suffer a significant disruption, which may have a negative effect on our financial condition and that of our borrowers, and on our ability to raise money by issuing new securities. |
| • | It could take us longer than we anticipate implementing strategic initiatives, including expansions, designed to increase revenues or manage expenses, or we may be unable to implement those initiatives at all. |
| • | Acquisitions and dispositions of assets and companies could affect us in ways that management has not anticipated. |
| • | We may become subject to new legal obligations or the resolution of litigation may have a negative effect on our financial condition or operating results. |
| • | We may become subject to new and unanticipated accounting, tax, regulatory or compliance practices or requirements. Failure to comply with any one or more of these requirements could have an adverse effect on our operations. |
| • | We could experience greater loan delinquencies than anticipated, adversely affecting our earnings and financial condition. |
| | • | We could experience greater losses than expected due to the ever-increasing volume of information theft and fraudulent scams impacting our customers and the banking industry. |
| • | We could lose the services of some or all of our key personnel, which would negatively impact our business because of their business development skills, financial expertise, lending experience, technical expertise and market area knowledge. |
| • | The agricultural economy is subject to extreme swings in both the costs of resources and the prices received from the sale of products as a result of weather, government regulations, international trade agreements and consumer tastes, which could negatively impact certain of our customers. |
| • | Loan concentrations in certain industries could negatively impact our results, if financial results or economic conditions deteriorate. |
| • | Companies providing support services related to the exploration and drilling of the natural gas reserves in our market area may be affected by federal, state and local laws and regulations such as restrictions on production, permitting, changes in taxes and environmental protection, which could negatively impact our customers and, as a result, negatively impact our loan and deposit volume and loan quality. Additionally, the activities the companies providing support services related to the exploration and drilling of the natural gas reserves may be dependent on the market price of natural gas. As a result, decreases in the market price of natural gas could also negatively impact these companies, our customers. |
Additional factors are discussed in this Annual Report on Form 10-K under “Item 1A. Risk Factors.” These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Forward-looking statements speak only as of the date they are made and the Company does not undertake to update forward-looking statements to reflect circumstances or events that occur after the date of the forward-looking statements or to reflect the occurrence of unanticipated events. Accordingly, past results and trends should not be used by investors to anticipate future results or trends.
INTRODUCTION
The following is management’s discussion and analysis of the significant changes in financial condition, the results of operations, capital resources and liquidity presented in the accompanying consolidated financial statements for the Company. The Company’s consolidated financial condition and results of operations consist almost entirely of the Bank’s financial condition and results of operations. Management’s discussion and analysis should be read in conjunction with the audited consolidated financial statements and related notes. Except as noted, tabular information is presented in thousands of dollars.
The Company engages in the general business of banking throughout our service area of Potter, Tioga, Clinton, Bradford and Centre counties in north central Pennsylvania, Lebanon, Berks, Schuylkill, Lancaster and Chester counties in south central Pennsylvania and Allegany County in southern New York and with the MidCoast acquisition, the Cities of Wilmington and Dover, Delaware. We also have a limited branch office in Union county, Pennsylvania, which primarily serves agricultural and commercial customers in the central Pennsylvania market. With the recently completed HVBC acquisition, we have expanded further into southeast Pennsylvania, including Montgomery, Bucks and Philadelphia Counties as well as Burlington County, New Jersey through the acquisition of five full service branches, four mortgage centers and one business banking facility. We maintain our central office in Mansfield, Pennsylvania. Presently we operate 48 banking facilities, 39 of which operate as bank branches. In Pennsylvania, the Company has full service offices located in Mansfield, Blossburg, Ulysses, Genesee, Wellsboro, Troy, Sayre, Canton, Gillett, Millerton, LeRaysville, Towanda, Rome, the Mansfield Wal-Mart Super Center, Mill Hall, Schuylkill Haven, Friedensburg, Mt. Aetna, Fredericksburg, Mount Joy, Ephrata, Fivepointville, State College, Kennett Square, Warrington, Plumsteadville, Philadelphia, two branches near the city of Lebanon and two branches in Huntington Valley. The limited branch office is located in Winfield, Pennsylvania. In New York, our office is in Wellsville. In Delaware, we have three branches in Wilmington and one in Dover. The mortgage centers acquired as part of the acquisition are located in Montgomeryville, PA, Huntington Valley, PA, Philadelphia, PA and Mount Laurel, NJ. The business banking facility is located in Philadelphia, PA. In the fourth quarter of 2023, we opened a branch in Williamsport, Pennsylvania.
Risk identification and management are essential elements for the successful management of the Company. In the normal course of business, the Company is subject to various types of risk, including interest rate, credit, liquidity, reputational and regulatory risk.
Interest rate risk is the sensitivity of net interest income and the market value of financial instruments to the direction and frequency of changes in interest rates. Interest rate risk results from various re-pricing frequencies and the maturity structure of the financial instruments owned by the Company. The Company uses its asset/liability and funds management policies to control and manage interest rate risk.
Credit risk represents the possibility that a customer may not perform in accordance with contractual terms. Credit risk results from loans with customers and the purchasing of securities. The Company’s primary credit risk is in the loan portfolio. The Company manages credit risk by adhering to an established credit policy and through a disciplined evaluation of the adequacy of the allowance for credit losses. Also, the investment policy limits the amount of credit risk that may be taken in the investment portfolio.
Liquidity risk represents the inability to generate or otherwise obtain funds at reasonable rates to satisfy commitments to borrowers and obligations to depositors. The Company has established guidelines within its asset/liability and funds management policy to manage liquidity risk. These guidelines include, among other things, contingent funding alternatives.
Reputational risk, or the risk to our business, earnings, liquidity, and capital from negative public opinion, could result from our actual or alleged conduct in a variety of areas, including legal and regulatory compliance, lending practices, corporate governance, litigation, ethical issues, or inadequate protection of customer information, which could include identify theft, or theft of customer information through third parties. We expend significant resources to comply with regulatory requirements. Failure to comply could result in reputational harm or significant legal or remedial costs. Damage to our reputation could adversely affect our ability to retain and attract new customers, and adversely impact our earnings and liquidity.
Regulatory risk represents the possibility that a change in law, regulations or regulatory policy may have a material effect on the business of the Company and its subsidiary. We cannot predict what legislation might be enacted or what regulations might be adopted, or if adopted, the effect thereof on our operations.
Readers should carefully review the risk factors described in other documents the Company files with the SEC, including the annual reports on Form 10-K, the quarterly reports on Form 10-Q and any current reports on Form 8-K filed by us.
SELECTED FINANCIAL DATA
The following table sets forth certain financial data as of and for each of the years in the five-year period ended December 31, 2023:
| (in thousands, except per share data) | | 2023 | | | 2022 | | | 2021 | | | 2020 | | | 2019 | |
Interest and dividend income | | $ | 127,118 | | | $ | 83,357 | | | $ | 73,217 | | | $ | 70,296 | | | $ | 61,980 | |
Interest expense | | | 46,858 | | | | 11,223 | | | | 7,105 | | | | 8,105 | | | | 12,040 | |
Net interest income | | | 80,260 | | | | 72,134 | | | | 66,112 | | | | 62,191 | | | | 49,940 | |
Provision for credit losses | | | 937 | | | | 1,683 | | | | 1,550 | | | | 2,400 | | | | 1,675 | |
Provision for credit losses - acquisition day 1 non-PCD | | | 4,591 | | | | - | | | | - | | | | - | | | | - | |
Net interest income after provision for credit losses | | | 74,732 | | | | 70,451 | | | | 64,562 | | | | 59,791 | | | | 48,265 | |
Non-interest income | | | 11,800 | | | | 9,999 | | | | 11,754 | | | | 11,158 | | | | 8,242 | |
Investment securities gains (losses), net | | | (195 | ) | | | (261 | ) | | | 551 | | | | 264 | | | | 144 | |
Non-interest expenses | | | 64,822 | | | | 44,694 | | | | 41,550 | | | | 40,847 | | | | 33,341 | |
Income before provision for income taxes | | | 21,515 | | | | 35,495 | | | | 35,317 | | | | 30,366 | | | | 23,310 | |
Provision for income taxes | | | 3,704 | | | | 6,435 | | | | 6,199 | | | | 5,263 | | | | 3,820 | |
Net income | | $ | 17,811 | | | $ | 29,060 | | | $ | 29,118 | | | $ | 25,103 | | | $ | 19,490 | |
| | | | | | | | | | | | | | | | | | | | | |
| Per share data: | | | | | | | | | | | | | | | | | | | | |
Net income - Basic (1) | | $ | 4.06 | | | $ | 7.25 | | | $ | 7.24 | | | $ | 6.40 | | | $ | 5.30 | |
Net income - Diluted (1) | | | 4.06 | | | | 7.25 | | | | 7.24 | | | | 6.40 | | | | 5.30 | |
Cash dividends declared (1) | | | 1.94 | | | | 1.88 | | | | 1.83 | | | | 1.86 | | | | 1.71 | |
Stock dividend | | | 1 | % | | | 1 | % | | | 1 | % | | | 1 | % | | | 1 | % |
Book value (1) (2) | | | 64.70 | | | | 58.17 | | | | 52.87 | | | | 47.46 | | | | 42.23 | |
| | | | | | | | | | | | | | | | | | | | | |
| End of Period Balances: | | | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 2,975,321 | | | $ | 2,333,393 | | | $ | 2,143,863 | | | $ | 1,891,674 | | | $ | 1,466,339 | |
Investments in equity and available for sale debt securities | | | 419,539 | | | | 441,714 | | | | 412,402 | | | | 295,189 | | | | 240,706 | |
Loans | | | 2,248,836 | | | | 1,724,999 | | | | 1,441,533 | | | | 1,405,281 | | | | 1,115,569 | |
Allowance for credit losses | | | 21,153 | | | | 18,552 | | | | 17,304 | | | | 15,815 | | | | 13,845 | |
Total deposits | | | 2,321,481 | | | | 1,844,208 | | | | 1,836,511 | | | | 1,588,858 | | | | 1,211,118 | |
Total borrowings | | | 322,036 | | | | 257,278 | | | | 73,977 | | | | 88,838 | | | | 85,117 | |
Stockholders' equity | | | 279,666 | | | | 200,147 | | | | 212,492 | | | | 194,259 | | | | 154,774 | |
| | | | | | | | | | | | | | | | | | | | | |
| Key Ratios | | | | | | | | | | | | | | | | | | | | |
Return on assets (net income to average total assets) | | | 0.66 | % | | | 1.29 | % | | | 1.45 | % | | | 1.46 | % | | | 1.34 | % |
Return on equity (net income to average total equity) | | | 6.52 | % | | | 12.98 | % | | | 14.26 | % | | | 14.21 | % | | | 13.00 | % |
Equity to asset ratio (average equity to average total assets, excluding other comprehensive income) | | | 10.13 | % | | | 9.93 | % | | | 10.20 | % | | | 10.27 | % | | | 10.31 | % |
Net interest margin (tax equivalent) (3) | | | 3.21 | % | | | 3.41 | % | | | 3.52 | % | | | 3.92 | % | | | 3.72 | % |
Efficiency (4) | | | 66.72 | % | | | 52.55 | % | | | 51.57 | % | | | 53.62 | % | | | 54.27 | % |
Dividend payout ratio (dividends declared divided by net income) | | | 47.74 | % | | | 26.11 | % | | | 25.36 | % | | | 29.32 | % | | | 32.40 | % |
Tier 1 leverage (5) | | | 7.65 | % | | | 9.31 | % | | | 9.31 | % | | | 9.16 | % | | | 9.77 | % |
Common equity risk based capital (5) | | | 9.21 | % | | | 12.03 | % | | | 12.03 | % | | | 11.22 | % | | | 12.11 | % |
Tier 1 risk-based capital (5) | | | 9.53 | % | | | 12.53 | % | | | 12.53 | % | | | 11.75 | % | | | 12.79 | % |
Total risk-based capital (5) | | | 11.26 | % | | | 14.35 | % | | | 14.35 | % | | | 12.86 | % | | | 14.04 | % |
Nonperforming assets/total loans | | | 0.59 | % | | | 0.43 | % | | | 0.61 | % | | | 0.93 | % | | | 1.38 | % |
Nonperforming loans/total loans | | | 0.56 | % | | | 0.40 | % | | | 0.53 | % | | | 0.80 | % | | | 1.08 | % |
Allowance for credit losses/total loans | | | 0.94 | % | | | 1.08 | % | | | 1.20 | % | | | 1.13 | % | | | 1.24 | % |
Net (recoveries)charge-offs/average loans | | | 0.06 | % | | | 0.03 | % | | | 0.00 | % | | | 0.03 | % | | | 0.06 | % |
| (1) | Amounts were adjusted to reflect stock dividends. |
| (2) | Calculation excludes accumulated other comprehensive loss. |
| (3) | Tax adjusted net interest income to average interest-earning assets. Tax adjusted net Interest income is a non-gaap measure and is reconciled to the GAAP equivalent measure on page 25 of this Form 10-k. |
| (4) | Bank non-interest expenses to tax adjusted net interest income and non-interest income, excluding security gains. Tax adjusted net Interest income is a non-gaap measure and is reconciled to the GAAP equivalent measure on page 30 of this 10k. The efficiency ratio calculated using non-tax effected net interest income was 67.50% 53.22%, 52.21%, 54.50% and 55.36%, for the years ended 2023, 2022, 2021, 2020 and 2019, respectively. |
| (5) | Ratio calculated on consolidated level |
TRUST AND INVESTMENT SERVICES; OIL AND GAS SERVICES
Our Investment and Trust Division is committed to helping our customers meet their financial goals. The Trust Division offers professional trust administration, investment management services, estate planning and administration, custody of securities and individual retirement accounts. In addition to traditional trust and investment services offered, we assist our customers through various oil and gas specific leasing matters from lease negotiations to establishing a successful approach to personal wealth management. Assets held by the Bank in a fiduciary or agency capacity for its customers are not included in the consolidated financial statements since such items are not assets of the Bank. As of December 31, 2023, and 2022, assets owned and invested by customers of the Bank through the Bank’s investment representatives totaled $329.4 million and $283.5 million, respectively. Additionally, as summarized in the table below, the Trust Department had assets under management as of December 31, 2023 and 2022 of $167.9 million and $150.0 million, respectively. During the year ended December 31, 2023, $1.4 million of new trust accounts were opened, $7.9 million of additional contributions to trust accounts, $10.1 million distributed from trust accounts, and $8.1 million of accounts were closed. As a result of market fluctuations, the fair value of the trust accounts increased approximately $26.0 million during the year ended December 31, 2023. The following table reflects trust accounts by investment type and structure:
| (market values - in thousands) | | 2023 | | | 2022 | |
| INVESTMENTS: | | | | | | |
Bonds | | $ | 16,386 | | | $ | 13,497 | |
Stock | | | 32,270 | | | | 33,659 | |
Savings and Money Market Funds | | | 16,531 | | | | 14,813 | |
Mutual Funds | | | 86,261 | | | | 75,700 | |
Mineral interests | | | 4,715 | | | | 8,465 | |
Mortgages | | | 780 | | | | 783 | |
Real Estate | | | 9,444 | | | | 1,965 | |
Miscellaneous | | | 1,507 | | | | 847 | |
Cash | | | - | | | | 302 | |
TOTAL | | $ | 167,894 | | | $ | 150,031 | |
| ACCOUNTS: | | | | | | | | |
Trusts | | | 46,713 | | | | 47,762 | |
Guardianships | | | 330 | | | | 400 | |
Employee Benefits | | | 60,759 | | | | 50,883 | |
Investment Management | | | 60,091 | | | | 50,985 | |
Custodial | | | 1 | | | | 1 | |
TOTAL | | $ | 167,894 | | | $ | 150,031 | |
Our financial consultants offer full service brokerage and financial planning services throughout the Bank’s market areas. Appointments can be made at any Bank branch. Products such as mutual funds, annuities, health and life insurance are made available through our insurance subsidiary, First Citizens Insurance Agency, Inc.
RESULTS OF OPERATIONS
Net income for the year ended December 31, 2023 was $17,811,000, which represents a decrease of $11,249,000, or 38.7%, when compared to 2022 due primarily to the one-time costs associated with the HVBC acquisition. Net income for the year ended December 31, 2022 was $29,060,000, which represents a decrease of $58,000, or 0.2%, when compared to 2021. Basic and diluted earnings per share were $4.06, $7.25 and $7.24 for 2023, 2022 and 2021, respectively.
Net income is influenced by five key components: net interest income, provision for credit losses, non-interest income, non-interest expenses, and the provision for income taxes.
Net Interest Income
The most significant source of revenue is net interest income; the amount by which interest earned on interest-earning assets exceeds interest paid on interest-bearing liabilities. Factors that influence net interest income are changes in volume of interest-earning assets and interest-bearing liabilities as well as changes in the associated interest rates.
The following table sets forth the Company’s average balances of, and the interest earned or incurred on, each principal category of assets, liabilities and stockholders’ equity, the related rates, net interest income and rate “spread” created.
| Analysis of Average Balances and Interest Rates |
|
| | | 2023 | | | 2022 | | | 2021 |
|
| | | Average | | | | | | Average | | | Average | | | | | | Average | | | Average | | | | | | Average |
|
| | | Balance | | | Interest | | | Rate | | | Balance | | | Interest | | | Rate | | | Balance | | | Interest | | | Rate |
|
(dollars in thousands) | | | (1) $ |
| | $ | | |
| % | | | | (1) $ |
| | $ | | |
| % | | | | (1) $ |
| | $ | | |
| % |
|
| ASSETS | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
Short-term investments: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
Interest-bearing deposits at banks | | | 24,470 | | | | 572 | | | | 2.34 | | | | 52,655 | | | | 171 | | | | 0.32 | | | | 108,872 | | | | 124 | | | | 0.11 |
|
Total short-term investments | | | 24,470 | | | | 572 | | | | 2.34 | | | | 52,655 | | | | 171 | | | | 0.32 | | | | 108,872 | | | | 124 | | | | 0.11 |
|
Interest bearing time deposits at banks | | | 5,255 | | | | 164 | | | | 3.10 | | | | 8,352 | | | | 229 | | | | 2.75 | | | | 12,527 | | | | 323 | | | | 2.57 |
|
Investment securities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
Taxable | | | 383,241 | | | | 8,043 | | | | 2.10 | | | | 372,430 | | | | 6,238 | | | | 1.68 | | | | 252,470 | | | | 4,198 | | | | 1.66 |
|
Tax-exempt (3) | | | 112,806 | | | | 2,866 | | | | 2.54 | | | | 120,592 | | | | 3,106 | | | | 2.58 | | | | 104,379 | | | | 2,786 | | | | 2.67 |
|
Total investment securities | | | 496,047 | | | | 10,909 | | | | 2.20 | | | | 493,022 | | | | 9,344 | | | | 1.90 | | | | 356,849 | | | | 6,984 | | | | 1.96 |
|
Loans: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
Residential mortgage loans | | | 290,971 | | | | 15,918 | | | | 5.47 | | | | 204,063 | | | | 9,712 | | | | 4.76 | | | | 203,062 | | | | 9,867 | | | | 4.86 |
|
Construction loans | | | 135,315 | | | | 9,485 | | | | 7.01 | | | | 73,214 | | | | 3,298 | | | | 4.50 | | | | 56,315 | | | | 2,292 | | | | 4.07 |
|
Commercial Loans | | | 1,081,488 | | | | 64,561 | | | | 5.97 | | | | 854,460 | | | | 41,155 | | | | 4.82 | | | | 739,000 | | | | 36,215 | | | | 4.90 |
|
Agricultural Loans | | | 342,980 | | | | 17,061 | | | | 4.97 | | | | 347,420 | | | | 15,387 | | | | 4.43 | | | | 349,951 | | | | 15,079 | | | | 4.31 |
|
Loans to state & political subdivisions | | | 59,308 | | | | 2,299 | | | | 3.88 | | | | 56,004 | | | | 1,863 | | | | 3.33 | | | | 52,804 | | | | 1,871 | | | | 3.54 |
|
Other loans | | | 94,519 | | | | 7,204 | | | | 7.62 | | | | 58,715 | | | | 3,201 | | | | 5.45 | | | | 24,125 | | | | 1,385 | | | | 5.74 |
|
Loans, net of discount (2)(3)(4) | | | 2,004,581 | | | | 116,528 | | | | 5.81 | | | | 1,593,876 | | | | 74,616 | | | | 4.68 | | | | 1,425,257 | | | | 66,709 | | | | 4.68 |
|
| Total interest-earning assets | | | 2,530,353 | | | | 128,173 | | | | 5.07 | | | | 2,147,905 | | | | 84,360 | | | | 3.93 | | | | 1,903,505 | | | | 74,140 | | | | 3.89 |
|
Cash and due from banks | | | 9,341 | | | | | | | | | | | | 6,708 | | | | | | | | | | | | 6,525 | | | | | | | | |
|
Bank premises and equipment | | | 19,871 | | | | | | | | | | | | 17,287 | | | | | | | | | | | | 17,194 | | | | | | | | |
|
Other assets | | | 139,474 | | | | | | | | | | | | 84,066 | | | | | | | | | | | | 75,410 | | | | | | | | |
|
| Total non-interest earning assets | | | 168,686 | | | | | | | | | | | | 108,061 | | | | | | | | | | | | 99,129 | | | | | | | | |
|
| Total assets | | | 2,699,039 | | | | | | | | | | | | 2,255,966 | | | | | | | | | | | | 2,002,634 | | | | | | | | |
|
| LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
NOW accounts | | | 666,505 | | | | 13,396 | | | | 2.01 | | | | 520,895 | | | | 2,425 | | | | 0.47 | | | | 457,189 | | | | 1,387 | | | | 0.30 |
|
Savings accounts | | | 318,299 | | | | 1,314 | | | | 0.41 | | | | 323,939 | | | | 421 | | | | 0.13 | | | | 290,376 | | | | 322 | | | | 0.11 |
|
Money market accounts | | | 364,385 | | | | 8,713 | | | | 2.39 | | | | 343,288 | | | | 2,004 | | | | 0.58 | | | | 257,937 | | | | 684 | | | | 0.27 |
|
Certificates of deposit | | | 328,553 | | | | 8,276 | | | | 2.52 | | | | 299,110 | | | | 2,466 | | | | 0.82 | | | | 351,265 | | | | 3,444 | | | | 0.98 |
|
Total interest-bearing deposits | | | 1,677,742 | | | | 31,699 | | | | 1.89 | | | | 1,487,232 | | | | 7,316 | | | | 0.49 | | | | 1,356,767 | | | | 5,837 | | | | 0.43 |
|
Other borrowed funds | | | 326,577 | | | | 15,159 | | | | 4.64 | | | | 149,661 | | | | 3,907 | | | | 2.61 | | | | 84,621 | | | | 1,268 | | | | 1.50 |
|
| Total interest-bearing liabilities | | | 2,004,319 | | | | 46,858 | | | | 2.34 | | | | 1,636,893 | | | | 11,223 | | | | 0.69 | | | | 1,441,388 | | | | 7,105 | | | | 0.49 |
|
| Demand deposits | | | 382,979 | | | | | | | | | | | | 374,675 | | | | | | | | | | | | 341,604 | | | | | | | | |
|
| Other liabilities | | | 38,419 | | | | | | | | | | | | 20,443 | | | | | | | | | | | | 15,420 | | | | | | | | |
|
| Total non-interest-bearing liabilities | | | 421,398 | | | | | | | | | | | | 395,118 | | | | | | | | | | | | 357,024 | | | | | | | | |
|
| Stockholders' equity | | | 273,322 | | | | | | | | | | | | 223,955 | | | | | | | | | | | | 204,222 | | | | | | | | |
|
| Total liabilities & stockholders' equity | | | 2,699,039 | | | | | | | | | | | | 2,255,966 | | | | | | | | | | | | 2,002,634 | | | | | | | | |
|
| Net interest income | | | | | | | 81,315 | | | | | | | | | | | | 73,137 | | | | | | | | | | | | 67,035 | | | | |
|
| Net interest spread (5) | | | | | | | | | | | 2.73 | % | | | | | | | | | | | 3.24 | % | | | | | | | | | | | 3.40 | %
|
Net interest income as a percentage of average interest-earning assets | | | | | | | | | | | 3.21 | % | | | | | | | | | | | 3.41 | % | | | | | | | | | | | 3.52 | %
|
Ratio of interest-earning assets to interest-bearing liabilities | | | | | | | | | | | 126.00 | | | | | | | | | | | | 131.00 | | | | | | | | | | | | 132.00 |
|
| (1) | Averages are based on daily averages. |
| (2) | Includes loan origination and commitment fees. |
| (3) | Tax exempt interest revenue is shown on a tax equivalent basis for proper comparison using a statutory federal income tax rate of 21% for 2023, 2022 and 2021. |
| (4) | Income on non-accrual loans is accounted for on a cash basis, and the loan balances are included in interest-earning assets. |
| (5) | Interest rate spread represents the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities. |
For purposes of the comparison, as well as the discussion that follows, this presentation facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Federal statutory rate for the corresponding year. Accordingly, tax equivalent adjustments for investments and loans have been made accordingly to the previous table for the years ended December 31, 2023, 2022 and 2021, respectively (in thousands):
| | | 2023 | | | 2022 | | | 2021 | |
| Interest and dividend income from investment securities, interest bearing time deposits and short-term investments (non-tax adjusted) (GAAP) | | $ | 11,043 | | | $ | 9,092 | | | $ | 6,846 | |
| Tax equivalent adjustment | | | 602 | | | | 652 | | | | 585 | |
| Interest and dividend income from investment securities, interest bearing time deposits and short-term investments (tax equivalent basis) (Non-GAAP) | | $ | 11,645 | | | $ | 9,744 | | | $ | 7,431 | |
| | | | | | | | | | | | | |
|
|
| 2023 |
|
|
| 2022 |
|
|
| 2021 |
|
| Interest and fees on loans (non-tax adjusted) (GAAP) | | $ | 116,075 | | | $ | 74,265 | | | $ | 66,371 | |
| Tax equivalent adjustment | | | 453 | | | | 351 | | | | 338 | |
| Interest and fees on loans (tax equivalent basis) (Non-GAAP) | | $ | 116,528 | | | $ | 74,616 | | | $ | 66,709 | |
| | | | | | | | | | | | | |
| | | | 2023 | | | | 2022 | | | | 2021 | |
| Total interest income | | $ | 127,118 | | | $ | 83,357 | | | $ | 73,217 | |
| Total interest expense | | | 46,858 | | | | 11,223 | | | | 7,105 | |
| Net interest income (GAAP) | | | 80,260 | | | | 72,134 | | | | 66,112 | |
| Total tax equivalent adjustment | | | 1,055 | | | | 1,003 | | | | 923 | |
| Net interest income (tax equivalent basis) (Non-GAAP) | | $ | 81,315 | | | $ | 73,137 | | | $ | 67,035 | |
The following table shows the tax-equivalent effect of changes in volume and rates on interest income and expense (in thousands):
| Analysis of Changes in Net Interest Income on a Tax-Equivalent Basis | |
| | | 2023 vs. 2022 (1) | | | 2022 vs. 2021 (1) | |
| | | Change in | | | Change | | | Total | | | Change in | | | Change | | | Total | |
| | | Volume | | | in Rate | | | Change | | | Volume | | | in Rate | | | Change | |
| Interest Income: | | | | | | | | | | | | | | | | | | |
Short-term investments: | | | | | | | | | | | | | | | | | | |
| Interest-bearing deposits at banks | | $ | (38 | ) | | $ | 439 | | | $ | 401 | | | $ | (18 | ) | | $ | 65 | | | $ | 47 | |
Interest bearing time deposits at banks | | | (102 | ) | | | 37 | | | | (65 | ) | | | (118 | ) | | | 24 | | | | (94 | ) |
Investment securities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Taxable | | | 187 | | | | 1,618 | | | | 1,805 | | | | 2,010 | | | | 30 | | | | 2,040 | |
| Tax-exempt | | | (199 | ) | | | (41 | ) | | | (240 | ) | | | 414 | | | | (94 | ) | | | 320 | |
Total investment securities | | | (12 | ) | | | 1,577 | | | | 1,565 | | | | 2,424 | | | | (64 | ) | | | 2,360 | |
Total investment income | | | (152 | ) | | | 2,053 | | | | 1,901 | | | | 2,288 | | | | 25 | | | | 2,313 | |
Loans: | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential mortgage loans | | | 4,593 | | | | 1,613 | | | | 6,206 | | | | 49 | | | | (204 | ) | | | (155 | ) |
| Construction loans | | | 3,737 | | | | 2,450 | | | | 6,187 | | | | 742 | | | | 264 | | | | 1,006 | |
| Commercial Loans | | | 12,312 | | | | 11,094 | | | | 23,406 | | | | 5,549 | | | | (609 | ) | | | 4,940 | |
| Agricultural Loans | | | (194 | ) | | | 1,868 | | | | 1,674 | | | | (108 | ) | | | 416 | | | | 308 | |
| Loans to state & political subdivisions | | | 115 | | | | 321 | | | | 436 | | | | 110 | | | | (118 | ) | | | (8 | ) |
| Other loans | | | 2,422 | | | | 1,581 | | | | 4,003 | | | | 1,882 | | | | (66 | ) | | | 1,816 | |
Total loans, net of discount | | | 22,985 | | | | 18,927 | | | | 41,912 | | | | 8,224 | | | | (317 | ) | | | 7,907 | |
| Total Interest Income | | | 22,833 | | | | 20,980 | | | | 43,813 | | | | 10,512 | | | | (292 | ) | | | 10,220 | |
| Interest Expense: | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing deposits: | | | | | | | | | | | | | | | | | | | | | | | | |
| NOW accounts | | | 853 | | | | 10,118 | | | | 10,971 | | | | 215 | | | | 823 | | | | 1,038 | |
| Savings accounts | | | (7 | ) | | | 900 | | | | 893 | | | | 40 | | | | 59 | | | | 99 | |
| Money Market accounts | | | 130 | | | | 6,579 | | | | 6,709 | | | | 285 | | | | 1,035 | | | | 1,320 | |
| Certificates of deposit | | | 266 | | | | 5,544 | | | | 5,810 | | | | (473 | ) | | | (505 | ) | | | (978 | ) |
Total interest-bearing deposits | | | 1,242 | | | | 23,141 | | | | 24,383 | | | | 67 | | | | 1,412 | | | | 1,479 | |
Other borrowed funds | | | 6,786 | | | | 4,466 | | | | 11,252 | | | | 1,343 | | | | 1,296 | | | | 2,639 | |
| Total interest expense | | | 8,028 | | | | 27,607 | | | | 35,635 | | | | 1,410 | | | | 2,708 | | | | 4,118 | |
| Net interest income | | $ | 14,805 | | | $ | (6,627 | ) | | $ | 8,178 | | | $ | 9,102 | | | $ | (3,000 | ) | | $ | 6,102 | |
| (1) | The portion of the total change attributable to both volume and rate changes during the year has been allocated to volume and rate components based upon the absolute dollar amount of the change in each component prior to allocation. |
2023 vs. 2022
Tax equivalent net interest income for 2023 was $81,315,000 compared to $73,137,000 for 2022, an increase of $8,178,000 or 11.2%. Total interest income increased $43,813,000, as loan interest income increased $41,912,000, and total investment income increased $1,901,000. Interest expense increased $35,635,000 from 2022.
Total tax equivalent interest income from investment securities increased $1,565,000 in 2023 from 2022. The average balance of investment securities increased $3.0 million, but the average balance of tax-exempt securities decreased $7.8 million, which had an effect of decreasing interest income by $12,000 due to volume. During 2023, the Bank had limited investment activity, excluding the sales of investments obtained as part of the HVBC acquisition. The average tax-effected yield on our investment portfolio increased from 1.90% in 2022 to 2.20% in 2023. The increase in the tax-effected yield is attributable to purchases made during 2022 and 2023, which were made in a higher rate environment. As a result of the yield on investment securities increasing 30 basis points (bps) to 2.20%, interest income on investment securities increased $1,577,000, with the increase related to taxable securities.The investment strategy for 2023 was to utilize cashflows from the investment portfolio to repay overnight borrowings. The decrease in the investment portfolio was due to long-term interest rates increasing in the first nine months of 2023 compared to December 31, 2022 and investment repayments and maturities. We continually monitor interest rate trading ranges and seek to time investment security purchases when rates are in the top third of the trading range. The Company believes its investment strategy has appropriately mitigated its interest rate risk exposure for various rate environments, including a rising rate environment, while providing sufficient cashflows to meet liquidity needs.
In total, loan interest income increased $41,912,000 in 2023 from 2022. The average balance of our loan portfolio increased by $410.7 million in 2023 compared to 2022, which resulted in an increase in interest income of $22,985,000 due to volume, primarily due to the HVBC acquisition completed in June 2023. The average tax-effected yield on our loan portfolio was 5.81% for 2023 compared to 4.68% for 2022 resulting in an increase in loan interest income of $18,927,000. The tax-effected yield increased during 2023 due to a rise in market interest rates.
| • | Interest income on residential mortgage loans increased $6,206,000. The average balance of residential mortgage loans increased $86.9 million as a result of the HVBC acquisition, resulting in an increase of $4,593,000 due to volume. The change due to rate was an increase of $1,613,000 as the average yield on residential mortgages increased from 4.76% in 2022 to 5.47% in 2023 as a result of the higher rate environment in 2023 and the acquired loans having market interest rates at the time of acquisition in June 2023. |
| • | The average balance of construction loans increased $62.1 million from 2022 to 2023 as a result of projects in our south eastern Pennsylvania market acquired as part of the HVBC acquisition, and Delaware market, which resulted in an increase of $3,737,000 in interest income. The average yield on construction loans increased from 4.50% to 7.01%, which correlated to a $2,450,000 increase in interest income. |
| • | Interest income on commercial loans increased $23,406,000 from 2022 to 2023. The increase in the average balance of commercial loans of $227.0 million is primarily attributable to the HVBC acquisition. The increase in the average balance of these loans resulted in an increase in interest income due to volume of $12,312,000. Our lenders have been able to attract and retain loan relationships in their markets by providing excellent customer service and having attractive products. We believe our lenders are adept at customizing and structuring loans to customers that meet their needs and satisfy our commitment to credit quality. In many cases, the Bank works with the Small Business Administration (SBA) guaranteed loan programs to offset credit risk and to further promote economic growth in our market area. The average yield on commercial loans increased 115 bps to 5.97% in 2023, resulting in an increase in interest income due to rate of $11,094,000. The increase in yield on commercial loans was a result of the higher rate environment in 2023 and the acquired loans having market interest rates at the time of acquisition in June 2023. |
| • | Interest income on agricultural loans increased $1,674,000 from 2022 to 2023. The decrease in the average balance of agricultural loans of $4.4 million is primarily attributable to the south-central Pennsylvania market. The decrease in the average balance of these loans resulted in a decrease in interest income due to volume of $194,000. The average yield on agricultural loans increased from 4.43% in 2022 to 4.97% in 2023 due to the increase in market rates, resulting in an increase in interest income due to rate of $1,868,000. We believe our lenders are adept at customizing, understanding and have the expertise to structure loans for customers that meet their needs and satisfy our commitment to credit quality. In many cases, the Bank works with the United States Department of Agriculture’s (USDA) guaranteed loan programs to offset credit risk and to further promote economic growth in our market area. |
| • | The average balance of loans to state and political subdivisions increased $3.3 million from 2022 to 2023 which had a positive impact of $115,000 on total interest income due to volume was due to customers issuing debt for various public service projects that the Bank was able to finance. The average tax equivalent yield on loans to state and political subdivisions increased from 3.33% in 2022 to 3.38% in 2023, increasing interest income by $321,000. |
| • | The average balance of other loans increased $35.8 million as a result of an increase in outstanding student loans. This resulted in an increase of $2,422,000 on total interest income due to volume. The average tax equivalent yield on other loans increased from 5.45% in 2022 to 7.62% in 2023, increasing interest income by $1,581,000 in other loans |
Total interest expense increased $35,635,000 in 2023 compared to 2022. The majority of the increase was due to an increase in the average rate paid on interest bearing liabilities of 165 basis points to 2.34%. This increase resulted in an increase in interest expense of $27,607,000. The increase in rates was driven by the Federal Reserve’s response to inflation during 2022 and 2023 by increasing interest rates. The average rate on money markets increased from 0.58% to 2.39% resulting in an increase in interest expense of $6,579,000. The average rate paid on savings accounts increased 28 bps and resulted in an increase in interest expense of $900,000. The average rate paid on NOW accounts increased from 0.47% to 2.01% resulting in an increase in interest expense of $10,118,000. The average rate paid on certificates of deposits increased from 0.82% to 2.52% resulting in an increase interest expense of $5,544,000. The average rate paid on other borrowed funds increased from 2.61% to 4.64% resulting in an increase in interest expense of $4,466,000.
Average interest-bearing liabilities increased $367.4 million in 2023, with average interest-bearing deposits increasing $190.5 million and average other borrowings increasing $176.9 million. As a result of the increase in average deposits, interest expense increased $1,242,000 as result of the change in volume. Increases in average deposits, which were primarily driven by the HVBC acquisition, included NOW accounts of $145.6 million, money market accounts of $21.1 million and certificates of deposits $29.4 million. The average balance of other borrowed funds increased $176.9million due to the HVBC acquisition and funding growth, which corresponds to an increase in interest expense of $6,786,000.
Our tax equivalent net interest margin for 2023 was 3.21% compared to 3.41% for 2022, with the change attributable to the yield of interest-earning assets increasing less than the cost from interest-bearing liabilities during 2023. Interest rates continued to increase during the first half of 2023 as the Federal Reserve continued to respond to inflation and to aggressively tighten monetary policy. The year began with inflation remaining significantly above the Federal Reserve’s targets and ended with inflation decreasing but remaining above the target of 2%. The yield curve remained inverted throughout 2023 with some of the highest inversion seen in decades. In the second of half of 2023, the market expected the Federal reserve to start decreasing rates in the first half of 2024. As a result, U.S. Treasury yields ended the year well below the peak.
2022 vs. 2021
Tax equivalent net interest income for 2022 was $73,137,000 compared to $67,035,000 for 2021, an increase of $6,102,000 or 9.1%. Total interest income increased $10,220,000, as loan interest income increased $7,907,000, and total investment income increased $2,313,000. Interest expense increased $4,118,000 from 2021.
Total tax equivalent interest income from investment securities increased $2,360,000 in 2022 from 2021. The average balance of investment securities increased $136.2 million, which had an effect of increasing interest income by $2,424,000 due to volume. The majority of the increase in volume was in taxable securities, which experienced an increase in the average balance of $120.0 million. The average tax-effected yield on our investment portfolio decreased from 1.96% in 2021 to 1.90% in 2022. The decrease in the tax-effected yield is attributable to purchases made prior to 2022, which were made in a lower rate environment. As a result of the yield on investment securities decreasing 6 basis points (bps) to 1.90%, interest income on investment securities decreased $64,000, with the decrease related to tax-exempt securities. The investment strategy for 2022 was to utilize excess cash, cashflows from the investment portfolio and deposit inflows to purchase U.S. treasury securities, due to a limited spread between US treasuries and agencies, mortgage backed securities issued by government sponsored entities and obligations of state and political securities. The increase in the investment portfolio was in response to the deposit inflows that occurred in 2021 and the first half of 2022.
In total, loan interest income increased $7,907,000 in 2022 from 2021. The average balance of our loan portfolio increased by $168.6 million in 2022 compared to 2021, which resulted in an increase in interest income of $8,224,000 due to volume. The increase in the average balance of loans was driven by in large part by growth in the Delaware market during 2022. While the Bank’s other markets experienced loan growth, it was not to the extent experienced in Delaware. The average tax-effected yield on our loan portfolio was 4.68% for both 2022 and 2021 and a small decrease in loan interest income of $317,000 was due to rate. The tax-effected yield remained steady due to 2021 benefitting from additional PPP loan amortization of $2,061,000 compared to 2022, otherwise the yield on loans 2022 would have exceeded 2021.
| • | Interest income on residential mortgage loans decreased $155,000. The average balance of residential mortgage loans increased $1.0 million, resulting in an increase of $49,000 due to volume. The change due to rate was a decrease of $204,000 as the average yield on residential mortgages decreased from 4.86% in 2021 to 4.76% in 2022 as a result of the lower rate environment prior to 2022. The increase in market interest rates during 2022 resulted in a significant slowdown in residential lending activity. |
| • | The average balance of construction loans increased $16.9 million from 2021 to 2022 as a result of projects in our south-central Pennsylvania market and Delaware market, which resulted in an increase of $742,000 in interest income. The average yield on construction loans increased from 4.07% to 4.50%, which correlated to a $264,000 increase in interest income. |
| • | Interest income on commercial loans increased $4,940,000 from 2021 to 2022. The increase in the average balance of commercial loans of $115.5 million is attributable to the Delaware market. The increase in the average balance of these loans resulted in an increase in interest income due to volume of $5,549,000. The average yield on commercial loans decreased 8 basis points to 4.82% in 2022, resulting in a decrease in interest income due to rate of $609,000. The decrease in yield on commercial loans was due to PPP loan amortization decreasing $2,061,000 in 2022 compared to 2021. |
| • | Interest income on agricultural loans increased $308,000 from 2021 to 2022. The decrease in the average balance of agricultural loans of $2.5 million is primarily attributable to the south-central Pennsylvania market. The decrease in the average balance of these loans resulted in a decrease in interest income due to volume of $108,000. The average yield on agricultural loans increased from 4.31% in 2021 to 4.43% in 2022 due to a general increase in market rates, resulting in an increase in interest income due to rate of $416,000. |
| • | The average balance of loans to state and political subdivisions increased $3.2 million from 2021 to 2022 which had a positive impact of $110,000 on total interest income due to volume was due to customers issuing debt for various public service projects that the Bank was able to finance. The average tax equivalent yield on loans to state and political subdivisions decreased from 3.54% in 2021 to 3.33% in 2022, decreasing interest income by $118,000. |
| • | The average balance of other loans increased $34.6 million as a result of an increase in outstanding student loans. This resulted in an increase of $1,882,000 on total interest income due to volume. The average tax equivalent yield on other loans decreased from 5.74% in 2021 to 5.45% in 2022, decreasing interest income by $66,000 in other loans. |
Total interest expense increased $4,118,000 in 2022 compared to 2021. The majority of the increase was due to an increase in the average rate paid on interest bearing liabilities of 20 basis points to 0.69%. This increase resulted in an increase in interest expense of $2,708,000. The increase in rates was driven by the Federal Reserve’s response to inflation during 2022 by increasing interest rates. The average rate on money markets increased from 0.27% to 0.58% resulting in an increase in interest expense of $1,035,000. The average rate paid on savings accounts increased 2 bps and resulted in an increase in interest expense of $59,000. The average rate paid on NOW accounts increased from 0.30% to 0.47% resulting in an increase in interest expense of $823,000. The average rate paid on other borrowed funds increased from 1.50% to 2.61% resulting in an increase in interest expense of $1,296,000. The average rate on certificates of deposit decreased from 0.98% to 0.82% resulting in a decrease in interest expense of $505,000.
Average interest-bearing liabilities increased $195.5 million in 2022, with average interest-bearing deposits increasing $130.5 million and average other borrowings increasing $65.0 million. As a result of the increase in average deposits, interest expense increased $67,000 as result of the change in volume. Increases in average deposits, which were primarily driven by organic growth across all markets of the Bank, included NOW accounts of $63.7 million, savings accounts of $33.6 million and money market accounts of $85.4 million. Certificates of deposits decreased $52.2 million as maturing balances were not placed into term products. The average balance of other borrowed funds increased $60.5 million due to funding loan growth, which corresponds to an increase in interest expense of $1,343,000.
Our tax equivalent net interest margin for 2022 was 3.41% compared to 3.52% for 2021, with the change attributable to the yield of interest-earning assets increasing less than the cost from interest-bearing liabilities during 2022. Interest rates increased dramatically in 2022 in response to historically high inflation forcing the Federal Reserve to aggressively tighten monetary policy at a pace and levels not seen in decades.
PROVISION FOR CREDIT LOSSES
For the year ended December 31, 2023, we recorded a provision for credit losses of $5,528,000. The provision for 2023 was $3,845,000, or 228.5%, higher than the provision in 2022. The provision for 2023 includes $4,591,000 associated with the HVBC acquisition and $36,000 as a provision for off-balance sheet items. Excluding these items, the provision for 2023 is $782,000 less than the comparable period in 2022 and is due to limited organic loan activity in 2023. (see also “Financial Condition – Allowance for Credit Losses - Loans and Credit Quality Risk”).
For the year ended December 31, 2022, we recorded a provision for credit losses of $1,683,000. The provision for 2022 was $133,000, or 8.6%, higher than the provision in 2021. The increase in the provision for credit losses was primarily due to organic loan growth in 2022 compared to 2021 offset by the improved economic outlook compared to 2021 that was impacted more by the Covid-19 pandemic. (see also “Financial Condition – Allowance for Credit Losses - Loans and Credit Quality Risk”).
NON-INTEREST INCOME
The following table reflects non-interest income by major category for the years ended December 31 (dollars in thousands):
| | | 2023 | | | 2022 | | | 2021 | |
Service charges | | $ | 5,639 | | | $ | 5,346 | | | $ | 4,755 | |
Trust | | | 764 | | | | 803 | | | | 865 | |
Brokerage and insurance | | | 1,924 | | | | 1,895 | | | | 1,625 | |
Equity security (losses) gains, net | | | (144 | ) | | | (247 | ) | | | 339 | |
Available for sale security (losses) gains, net | | | (51 | ) | | | (14 | ) | | | 212 | |
Gains on loans sold | | | 1,452 | | | | 258 | | | | 1,283 | |
Earnings on bank owned life insurance | | | 1,254 | | | | 852 | | | | 1,828 | |
Other | | | 767 | | | | 845 | | | | 1,398 | |
Total | | $ | 11,605 | | | $ | 9,738 | | | $ | 12,305 | |
| | | 2023/2022 | | | 2022/2021 | |
| | | Change | | | Change | |
| | | Amount | | | % | | | Amount | | | % | |
Service charges | | $ | 293 | | | | 5.5 | | | $ | 591 | | | | 12.4 | |
Trust | | | (39 | ) | | | (4.9 | ) | | | (62 | ) | | | (7.2 | ) |
Brokerage and insurance | | | 29 | | | | 1.5 | | | | 270 | | | | 16.6 | |
Equity security (losses) gains, net | | | 103 | | | | (41.7 | ) | | | (586 | ) | | | (172.9 | ) |
Available for sale security (losses) gains, net | | | (37 | ) | | | 264.3 | | | | (226 | ) | | | (106.6 | ) |
Gains on loans sold | | | 1,194 | | | | 462.8 | | | | (1,025 | ) | | | (79.9 | ) |
Earnings on bank owned life insurance | | | 402 | | | | 47.2 | | | | (976 | ) | | | (53.4 | ) |
Other | | | (78 | ) | | | (9.2 | ) | | | (553 | ) | | | (39.6 | ) |
Total | | $ | 1,867 | | | | 19.2 | | | $ | (2,567 | ) | | | (20.9 | ) |
2023 vs. 2022
Non-interest income increased $1,867,000 in 2023 from 2022, or 19.2%. We experienced a $51,000 net loss on available for sale securities in 2023 compared to net loss totaling $14,000 in 2022. During 2023, we sold $10.0 million of municipal securities for a pre-tax loss of $51,000. Additionally, $76.5 million of securities obtained as part of the HVBC acquisition were sold for no gain or loss during the second quarter of 2023. During 2022, we sold $7.5 million of US Agency securities for a pre-tax loss of $14,000. During 2023, net equity security losses amounted to $144,000 as a result of market conditions experienced in 2023 compared to losses of $247,000 last year.
Gains on loans sold increased $1,194,000 compared to last year. The increase in gains on loans sold is attributable to the HVBC acquisition and activity acquired as part of the acquisition. The increase in service charges of $293,000 for 2023 is attributable to an increase in customer spending in 2022 compared to 2021. The increase in earnings on bank owned life insurance is due to the HVBC acquisition and the passing of a former employee of the Company during 2023.
2022 vs. 2021
Non-interest income decreased $2,567,000 in 2022 from 2021, or 20.9%. We experienced a $14,000 net loss on available for sale securities in 2022 compared to net gains totaling $212,000 in 2021. During 2022, we sold $7.5 million of US Agency securities for a pre-tax loss of $14,000. During 2021, we sold $17.2 million of US treasury securities for a pre-tax gain of $177,000 and $12.0 million of US Agency securities for a pre-tax gain of $35,000 to take advantage of market conditions at the time of the sales. During 2022, net equity security losses amounted to $247,000 as a result of market conditions experienced in 2022 compared to gains of $339,000 last year.
Gains on loans sold decreased $1,025,000 compared to last year. The decrease in gains on loans sold is attributable to a $41.6 million, or 74.8% decrease in the proceeds from the sale of residential mortgages loans as a result of the increase in mortgage interest rates. The increase in service charges of $591,000 for 2022 is attributable to an increase in customer spending in 2022 compared to 2021. The decrease in other income is due to fees on offering derivative contracts for certain customers, that provided the customer with fixed rate loans, which generated fee income of $88,000 in 2022 compared to $494,000 in 2021. The decrease in earnings on bank owned life insurance is due to two former employees of the Company passing during the first quarter of 2021, which generated a death benefit payable to the Company of $1,155,000. The increase in brokerage and insurance commissions was attributable to growth in our south central and north central, Pennsylvania markets.
Non-interest Expenses
The following tables reflect the breakdown of non-interest expense by major category for the years ended December 31 (dollars in thousands):
| | | 2023 | | | 2022 | | | 2021 | |
Salaries and employee benefits | | $ | 34,990 | | | $ | 27,837 | | | $ | 25,902 | |
Occupancy | | | 4,123 | | | | 3,138 | | | | 2,966 | |
Furniture and equipment | | | 822 | | | | 565 | | | | 519 | |
Professional fees | | | 1,962 | | | | 1,641 | | | | 1,526 | |
FDIC insurance | | | 1,475 | | | | 676 | | | | 522 | |
Pennsylvania shares tax | | | 583 | | | | 907 | | | | 880 | |
Amortization of intangibles | | | 373 | | | | 156 | | | | 192 | |
Merger and acquisition | | | 9,269 | | | | 292 | | | | - | |
ORE expenses | | | 166 | | | | 17 | | | | 439 | |
Software expenses | | | 1,784 | | | | 1,446 | | | | 1,321 | |
Other | | | 9,275 | | | | 8,019 | | | | 7,283 | |
Total | | $ | 64,822 | | | $ | 44,694 | | | $ | 41,550 | |
| | | 2023/2022 | | | 2022/2021 | |
| | | Change | | | Change | |
| | | Amount | | | % | | | Amount | | | % | |
Salaries and employee benefits | | $ | 7,153 | | | | 25.7 | | | $ | 1,935 | | | | 7.5 | |
Occupancy | | | 985 | | | | 31.4 | | | | 172 | | | | 5.8 | |
Furniture and equipment | | | 257 | | | | 45.5 | | | | 46 | | | | 8.9 | |
Professional fees | | | 321 | | | | 19.6 | | | | 115 | | | | 7.5 | |
FDIC insurance | | | 799 | | | | 118.2 | | | | 154 | | | | 29.5 | |
Pennsylvania shares tax | | | (324 | ) | | | (35.7 | ) | | | 27 | | | | 3.1 | |
Amortization of intangibles | | | 217 | | | | 139.1 | | | | (36 | ) | | | (18.8 | ) |
Merger and acquisition | | | 8,977 | | | | 3,074.3 | | | | 292 | | | #DIV/0! | |
ORE expenses | | | 149 | | | | 876.5 | | | | (422 | ) | | | (96.1 | ) |
Software expenses | | | 338 | | | | 23.4 | | | | 125 | | | | 9.5 | |
Other | | | 1,256 | | | | 15.7 | | | | 736 | | | | 10.1 | |
Total | | $ | 20,128 | | | | 45.0 | | | $ | 3,144 | | | | 7.6 | |
2023 vs. 2022
Non-interest expenses for 2023 totaled $64,822,000, which represents an increase of $20,128,000, compared to 2022 expenses of $44,694,000. Salaries and employee benefits increased $7,153,000 or 25.7%. The increase was due to merit increases effective at the beginning of 2023, additional full-time equivalent employees (FTE) of 47.8, which is an increase of 15.4%, and an increase in health care expenses due to higher claims on the Company’s partially self-funded plan and the additional headcount. The additional headcount is due to the HVBC acquisition.
The increase in merger and acquisition expenses was due to fees associated with the acquisition of HVBC that closed in June 2023 and includes severance costs, change in control payments, contract termination payments and various professional and consulting fees. The increase in ORE expenses was due to the sales of OREO properties in 2022 for a gain of $481,000. The increase in occupancy, furniture and fixtures, amortization of intangibles and other expenses was due to the HVBC acquisition. The increase in FDIC insurance is due to the acquisition and organic growth.
2022 vs. 2021
Non-interest expenses for 2022 totaled $44,694,000, which represents an increase of $3,144,000, compared to 2021 expenses of $41,550,000. Salaries and employee benefits increased $1,935,000 or 7.5%. The increase was due to merit increases effective at the beginning of 2022, additional headcount 14.7 FTEs added during 2022 and increased health care related expenses due to actual claims of employees. Employee commissions related to brokerage and insurance commissions increased due to the increased sales in 2022 compared to 2021.
The increase in occupancy expenses is due to the additional branches opened during 2022 and higher utility and maintenance expenses. The increase in other expenses is additional marketing expenses, primarily in the Delaware market, charge-offs associated with fraudulent customer account activity, appraisal fees, travel related expenses as the economy reopens from pandemic related issues and the Delaware franchise tax due to growth in that market. The decrease in ORE expenses is due to gains on sales of ORE properties experienced during 2022.
Provision for Income Taxes
The provision for income taxes was $3,704,000, $6,435,000 and $6,199,000 for 2023, 2022 and 2021, respectively. The effective tax rates for 2023, 2022 and 2021 were 17.2%, 18.1% and 17.6%, respectively.
The decrease in income tax expense of $2,731,000 in 2023 was due to the decrease of $13,980,000 in income before the provision for income taxes, which accounts for a decrease in tax expense of $2,936,000 at a 21% tax rate.
The increase in income tax expense of $236,000 in 2022 was due earnings on bank owned life insurance being excluded from taxable income, which was higher in 2021 than 2022, which accounts for an increase in income taxes of $205,000 at a 21% tax rate.
We are involved in seven limited partnership agreements that operate low-income housing projects in our market areas, two of which we entered into during 2022. During 2023 we recognized credits on two of the seven projects. During 2022 and 2021, we recognized tax credits related to one of the seven partnerships. Tax credits associated with four of the partnerships were fully utilized by December 2022. We started recognizing credits on two of the partnerships during 2023 and expect to recognized credits on the remaining project in 2024. We anticipate recognizing an aggregate of $9.0 million of tax credits over the next twelve years.
FINANCIAL CONDITION
The following table presents ending balances (dollars in millions), the dollar amount of change and the percentage change during the past year:
| | | 2023 | | | | | | % | | | 2022 | |
| | | Balance | | | Increase | | | Change | | | Balance | |
Total assets | | $ | 2,975.3 | | | $ | 641.9 | | | | 27.5 | | | $ | 2,333.4 | |
Total investments | | | 417.6 | | | | (21.9 | ) | | | (5.0 | ) | | | 439.5 | |
Total loans, net | | | 2,227.7 | | | | 521.3 | | | | 30.5 | | | | 1,706.4 | |
Total deposits | | | 2,321.5 | | | | 477.3 | | | | 25.9 | | | | 1,844.2 | |
Total borrowings | | | 322.0 | | | | 64.7 | | | | 25.1 | | | | 257.3 | |
Total stockholders' equity | | | 279.7 | | | | 79.6 | | | | 39.8 | | | | 200.1 | |
Cash and Cash Equivalents
Cash and cash equivalents totaled $52.8 million at December 31, 2023 compared to $26.2 million at December 31, 2022. Management actively measures and evaluates the Company’s liquidity through our Asset – Liability committee and believes its liquidity needs are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources, Federal Home Loan Bank financing, federal funds lines with correspondent banks, brokered certificates of deposit and the portion of the investment and loan portfolios that mature within one year. Management expects that these sources of funds will permit us to meet cash obligations and off-balance sheet commitments as they come due.
Investments
The following table shows the year-end composition of the investment portfolio, at fair value, for the two years ended December 31 (dollars in thousands):
| | | 2023 | | | % of | | | 2022 | | | % of | |
| | | Amount | | | Total | | | Amount | | | Total | |
| Available-for-sale: | | | | | | | | | | | | |
| U. S. Agency securities | | $ | 60,771 | | | | 14.5 | | | $ | 70,677 | | | | 16.0 | |
| U.S. Treasuries | | | 143,288 | | | | 34.1 | | | | 148,570 | | | | 33.6 | |
Obligations of state & political Subdivisions | | | 101,787 | | | | 24.3 | | | | 110,300 | | | | 25.0 | |
| Corporate obligations | | | 12,403 | | | | 3.0 | | | | 9,383 | | | | 2.1 | |
| Mortgage-backed securities | | | 99,352 | | | | 23.6 | | | | 100,576 | | | | 22.8 | |
| Equity securities | | | 1,938 | | | | 0.5 | | | | 2,208 | | | | 0.5 | |
| Total | | $ | 419,539 | | | | 100.0 | | | $ | 441,714 | | | | 100.0 | |
The Company’s investment portfolio decreased during 2023 by $22.2 million. This decreased was fueled by maturities and calls being used to repay borrowings from the FHLB during 2023. As part of the HVBC acquisition, $79.2 million of available for sale securities were acquired. Excluding the acquisition, $10.3 million of mortgage backed securities were purchased during 2023. During 2023, we experienced $12.4 million of principal repayments and $22.6 million of calls and maturities. We sold $86.6 million of securities to deleverage the balance sheet during 2023 that included a loss of $51,000. The majority of the securities sold were acquired as part of the HVBC acquisition. The fair value of our investment portfolio increased approximately $11.7 million in 2023 due to decreases in market interest rates in the fourth quarter of 2023 and a shortening of the portfolio duration. Excluding our short-term investments consisting of monies held primarily at the Federal Reserve, the effective yield on our investment portfolio for 2023 was 2.20% compared to 1.90% for 2022 on a tax equivalent basis.
The Federal Reserve continued with a tighten monetary policy in 2023 pushing the federal funds rate to 5.50% by July 2023 matching levels last seen in 2001. The year began with still elevated inflation but down from the peak as supply chains improved and commodities prices stabilized at lower levels. The Federal Reserve’s concern higher inflation could become entrenched in the economy maintained a higher for longer policy stance emphasizing its willingness to bring inflation back to the 2% target. The Treasury market was volatile with the failure of 3 large regional banks raising the specter of recession due to a systemic banking crisis. The Fed’s actions calmed fears of a banking crisis and the economy proved to be resilient in the face of restrictive monetary policy. The Bank closed on HVBC acquisition in June 2023 utilizing the Bank’s strong capital position. The Treasury yield curve remained inverted ending the year with a 2 year to 10 year Treasury negative spread of 37 basis points. In December the Federal Reserve pivoted away from a rate hiking bias to a neutral outlook with the market expecting the next move to be a rate cut. After reaching a peak in yields last reached in 2007, Treasury yields ended the year within 10 basis points of where it started and 120 basis points below the peak. The labor market remains strong and economic growth continues to surprise to the upside keeping the monetary policy unchanged for the foreseeable future. As inflation moves closer to target level it is expected monetary policy will become less restrictive. For 2023 the bank’s strategy was to increase capital and meet liquidity needs in a volatile market. As liquidity and capital level permit the bank’s investment strategy will continue to mitigated its interest rate risk exposure for various rate environments, while providing sufficient cash flows to meet liquidity needs.
At December 31, 2023, the Company did not own any securities, other than government-sponsored and government-guaranteed mortgage-backed securities, that had an aggregate book value in excess of 10% of its consolidated stockholders’ equity at that date.
The expected principal repayments at amortized cost and average weighted yields for the investment portfolio (excluding equity securities) as of December 31, 2023, are shown below (dollars in thousands). Expected principal repayments, which include prepayment speed assumptions for mortgage-backed securities, are significantly different than the contractual maturities detailed in Note 5 of the consolidated financial statements. Yields on tax-exempt securities are presented on a fully taxable equivalent basis, assuming a 21% tax rate, which was the rate in effect at December 31, 2023.
| | | | | | | | | After One Year | | | After Five Years | | | | | | | | | | | | | |
| | | One Year or Less | | | to Five years | | | to Ten Years | | | After Ten Years | | | Total | |
| | | Amortized | | | Yield | | | Amortized | | | Yield | | | Amortized | | | Yield | | | Amortized | | | Yield | | | Amortized | | | Yield | |
| | | Cost | | | % | | | Cost | | | % | | | Cost | | | % | | | Cost | | | % | | | Cost | | | % | |
| Available-for-sale securities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. agency securities | | $ | 12,654 | | | | 3.5 | | | $ | 26,524 | | | | 2.0 | | | $ | 21,351 | | | | 1.8 | | | $ | 6,040 | | | | 1.5 | | | $ | 66,569 | | | | 2.2 | |
| U.S. treasuries | | | 36,040 | | | | 1.3 | | | | 116,445 | | | | 1.1 | | | | - | | | | - | | | | - | | | | - | | | | 152,485 | | | | 1.2 | |
Obligations of state & political subdivisions | | | 9,344 | | | | 3.9 | | | | 14,876 | | | | 2.3 | | | | 21,023 | | | | 2.1 | | | | 62,702 | | | | 2.3 | | | | 107,945 | | | | 2.4 | |
| Corporate obligations | | | 2,714 | | | | 4.0 | | | | 10,680 | | | | 5.2 | | | | - | | | | - | | | | - | | | | - | | | | 13,394 | | | | 5.0 | |
| Mortgage-backed securities | | | 21,143 | | | | 4.3 | | | | 36,375 | | | | 2.1 | | | | 38,652 | | | | 1.9 | | | | 16,780 | | | | 2.1 | | | | 112,950 | | | | 2.4 | |
| Total available-for-sale | | $ | 81,895 | | | | 2.8 | | | $ | 204,900 | | | | 1.7 | | | $ | 81,026 | | | | 1.9 | | | $ | 85,522 | | | | 2.2 | | | $ | 453,343 | | | | 2.0 | |
At December 31, 2023, approximately 63.3% of the amortized cost of debt securities is expected to mature, call or pre-pay within five years or less. The Company expects that earnings from operations, the levels of cash held at the Federal Reserve and other correspondent banks, the high liquidity level of the available-for-sale securities, growth of deposits and the availability of borrowings from the Federal Home Loan Bank and other third-party banks will be sufficient to meet future liquidity needs.
Loans Held for Sale
Loans held for sale increased $8.7 million to $9,379,000 as of December 31, 2023 from December 31, 2022. The increase in loans held for sale is primarily attributable to the HVBC acquisition and the mortgage division acquired as part of the acquisition. The higher rate environment in 2023 continue to place pressure on refinancing activity as well as new home purchases.
Loans
The Bank’s lending efforts have historically focused on north central Pennsylvania and southern New York. With the acquisition of FNB and the opening of offices in Lancaster County, this focus has grown to include Lebanon, Schuylkill, Berks and Lancaster County markets of south central, Pennsylvania. We have a limited branch office in Union County that is staffed by a lending team to primarily support agricultural opportunities and offices in State College and Mill Hall to support commercial opportunities in central Pennsylvania, especially Centre and Clinton Counties. In April 2020, we completed the MidCoast acquisition, which expanded our markets into the State of Delaware with activity centered around the cities of Wilmington and Dover, Delaware. In November of 2020, we opened a branch in Kennett Square, Pennsylvania, to further serve customers obtained as part of the MidCoast acquisition, as well as to expand operations into Chester County, Pennsylvania. During 2022, expansion efforts continued in both Lancaster, Pennsylvania with the opening of an office in Ephrata, Pennsylvania and in Delaware with the opening of an office in Greenville, Delaware, which is near Wilmington, Delaware. In June 2023, we completed the HVBC acquisition, which expanded our markets into south east Pennsylvania, including the counties of Montgomery, Bucks and Philadelphia. It also includes a Mortgage production in Mount Laurel, New Jersey. The Bank has also opened a full-service branch in Williamsport, Pennsylvania in the fourth quarter of 2023.
We originate loans primarily through direct loans to our existing customer base, with new customers generated through the strong relationships that our lending teams have with their customers, as well as by referrals from real estate brokers, building contractors, attorneys, accountants, corporate and advisory board members, existing customers and the Bank’s website. The Bank offers a variety of loans, although historically most of our lending has focused on real estate loans including residential, commercial, agricultural, and construction loans. As of December 31, 2023, approximately 87.3% of our loan portfolio consisted of real estate loans. All lending is governed by a lending policy that is developed and administered by management and approved by the Board of Directors.
The Bank primarily offers fixed rate residential mortgage loans with terms of up to 25 years and adjustable rate mortgage loans (with amortization schedules up to 30 years) with interest rates and payments that adjust based on one, three, five and 15 year fixed periods. Loan to value ratios are usually 80% or less with exceptions for individuals with excellent credit and low debt to income and/or high net worth. Adjustable rate mortgages are tied to a margin above the comparable Federal Home Loan Bank of Pittsburgh borrowing rate. Home equity loans are written with terms of up to 15 years at fixed rates. Home equity lines of credit are variable rate loans tied to the Prime Rate generally with a ten year draw period followed by a ten year repayment period. Home equity loans are typically written with a maximum 80% loan to value.
Commercial real estate loan terms are generally 20 years or less, with one to five year adjustable interest rates. The adjustable rates are typically tied to a margin above the comparable Federal Home Loan Bank of Pittsburgh borrowing rate with a typical loan to value ratio of 80% or less. During 2023 and 2022, the Bank offered certain customers derivative contracts that allowed the customer to obtain a fixed interest rate for a period up to 10 years. Where feasible, the Bank participates in the United States Department of Agriculture’s (USDA) and Small Business Administration (SBA) guaranteed loan programs to offset credit risk and to further promote economic growth in our market area.
Agriculture is an important industry throughout our market areas. Therefore, the Bank has not only developed an agriculture lending team with significant experience that has a thorough understanding of this industry, but also continually looks for additional employees with a thorough understanding of agriculture. We have an agricultural loan policy to assist in underwriting agricultural loans. Agricultural loans are made to a diversified customer base that include dairy, swine and poultry farmers and their support businesses. Agricultural loans focus on character, cash flow and collateral, while also considering the particular risks of the industry. Loan terms are generally 20 years or less, with one to five year adjustable interest rates. The adjustable rates are typically tied to a margin above the comparable Federal Home Loan Bank of Pittsburgh borrowing rate with a typical loan to value of less than 80%. We evaluate the financial strength of the integrators we have exposure to with our poultry and swine agricultural customers. The Bank is a preferred lender under the USDA’s Farm Service Agency (FSA) and participates in the FSA guaranteed loan program.
The Bank, as part of its commitment to the communities it serves, is an active lender for projects by our local municipalities and school districts. These loans range from short term bridge financing to 20 year term loans for specific projects. These loans are typically written at rates that adjust at least every five years. Due to the size of certain municipal loans, we have developed participation lending relationships with other community banks that allow us to meet regulatory compliance issues, while meeting the needs of the customer. At December 31, 2023, the aggregate balance of our participation loans, in which a portion was sold to other lender’s totaled $387.4 million, of which $206.0 million was sold.
Activity associated with exploration for natural gas continued in 2023 in the Company’s north central Pennsylvania market. Certain entities drilled new wells and created new pad sites and pipelines, while other companies only maintained their existing wells. While the Bank has loaned to companies that service the exploration activities, the Bank has not originated any loans to companies performing the actual drilling and exploration activities. Loans made by the Company were to service industry customers which included trucking companies, stone quarries and other support businesses. We also originated loans to businesses and individuals for restaurants, hotels and apartment rentals that were developed and expanded to meet the housing and living needs of the gas workers. Due to our understanding of the industry and its cyclical nature, the loans made for natural gas-related activities were originated in a prudent and cautious manner and were subject to specific policies and procedures for lending to these entities, which included lower loan to value thresholds, shortened amortization periods, and expansion of our monitoring of loan concentrations associated with this activity.
The following table shows the year-end composition of the loan portfolio as of December 31, 2023 and 2022 (dollars in thousands):
| | | 2023 | | | 2022 | |
| | | Amount | | | % | | | Amount | | | % | |
| Real estate: | | | | | | | | | | | | |
| Residential | | $ | 359,990 | | | | 16.0 | | | $ | 210,213 | | | | 12.2 | |
| Commercial | | | 1,092,887 | | | | 48.6 | | | | 876,569 | | | | 50.8 | |
| Agricultural | | | 314,802 | | | | 14.0 | | | | 313,614 | | | | 18.2 | |
| Construction | | | 195,826 | | | | 8.7 | | | | 80,691 | | | | 4.7 | |
| Consumer | | | 61,316 | | | | 2.7 | | | | 86,650 | | | | 5.0 | |
| Other commercial loans | | | 136,168 | | | | 6.1 | | | | 63,222 | | | | 3.7 | |
| Other agricultural loans | | | 30,673 | | | | 1.4 | | | | 34,832 | | | | 2.0 | |
| State & political subdivision loans | | | 57,174 | | | | 2.5 | | | | 59,208 | | | | 3.4 | |
| Total loans | | | 2,248,836 | | | | 100.0 | | | | 1,724,999 | | | | 100.0 | |
| Less allowance for credit losses | | | 21,153 | | | | | | | | 18,552 | | | | | |
| Net loans | | $ | 2,227,683 | | | | | | | $ | 1,706,447 | | | | | |
| | | 2023/2022 | |
| | | Change | |
| | | Amount | | | % | |
Real estate: | | | | | | | |
Residential | | $ | 149,777 | | | | 71.3 | |
Commercial | | | 216,318 | | | | 24.7 | |
Agricultural | | | 1,188 | | | | 0.4 | |
Construction | | | 115,135 | | | | 142.7 | |
Consumer | | | (25,334 | ) | | | (29.2 | ) |
Other commercial loans | | | 72,946 | | | | 115.4 | |
Other agricultural loans | | | (4,159 | ) | | | (11.9 | ) |
State & political subdivision loans | | | (2,034 | ) | | | (3.4 | ) |
Total loans | | $ | 523,837 | | | | 30.4 | |
Total loans grew $523.8 million in 2023 and total $2.25 billion at the end of 2023. The primary driver of growth during 2023 was the HVBC acquisition. Organic growth for 2023 was $44.0 million and was driven by growth in construction real estate. This growth was offset by a decrease in consumer loans due to a decrease in student loans as of the end of the year.
Residential real estate loans increased $149.8 million primarily due to the acquisition of HVBC. During 2023, $91.1 million of residential real estate loans were originated for sale on the secondary market, which compares to $10.0 million for 2022 and is due to the acquisition and the residential division acquired. For loans sold on the secondary market, the Company recognizes fee income for servicing these sold loans, which is included in non-interest income.
The following table presents the maturity distribution of our loan portfolio as of December 31, 2023 (in thousands). The table does not include any estimate of prepayments which significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below. Demand loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.
| | | Due in One year or less | | | After one year but within five years | | | After five years through fifteen years | | | After fifteen years | | | Total | |
| Real estate: | | | | | | | | | | | | | | | |
| Residential | | $ | 2,947 | | | $ | 9,907 | | | $ | 72,210 | | | $ | 274,926 | | | $ | 359,990 | |
| Commercial | | | 83,532 | | | | 451,886 | | | | 419,371 | | | | 138,098 | | | | 1,092,887 | |
| Agricultural | | | 17,230 | | | | 22,122 | | | | 154,352 | | | | 121,098 | | | | 314,802 | |
| Construction | | | 60,242 | | | | 71,147 | | | | 38,943 | | | | 25,494 | | | | 195,826 | |
| Consumer | | | 53,533 | | | | 3,443 | | | | 4,155 | | | | 185 | | | | 61,316 | |
| Other commercial loans | | | 77,773 | | | | 25,212 | | | | 33,183 | | | | - | | | | 136,168 | |
| Other agricultural loans | | | 16,885 | | | | 11,303 | | | | 2,485 | | | | - | | | | 30,673 | |
| State & political subdivision loans | | | 10 | | | | 1,244 | | | | 34,833 | | | | 21,087 | | | | 57,174 | |
| | | $ | 312,152 | | | $ | 596,264 | | | $ | 759,532 | | | $ | 580,888 | | | $ | 2,248,836 | |
The following table presents the portion of loans that have fixed interest rates or variable interest rates that fluctuate over the life of loans in accordance with changes in the interest rate index that mature after December 31, 2024.
Sensitivity of loans to changes in interest rates - loans due after December 31, 2024: | | Predetermined interest rate | | | Floating or adjustable interest rate | | | Total | |
Real estate: | | | | | | | | | |
Residential | | $ | 197,705 | | | $ | 159,338 | | | $ | 357,043 | |
Commercial | | | 532,358 | | | | 476,997 | | | | 1,009,355 | |
Agricultural | | | 15,088 | | | | 282,484 | | | | 297,572 | |
Construction | | | 34,967 | | | | 100,617 | | | | 135,584 | |
Consumer | | | 5,487 | | | | 2,296 | | | | 7,783 | |
Other commercial loans | | | 19,744 | | | | 38,651 | | | | 58,395 | |
Other agricultural loans | | | 9,221 | | | | 4,567 | | | | 13,788 | |
State & political subdivision loans | | | 18,807 | | | | 38,357 | | | | 57,164 | |
| | | $ | 833,377 | | | $ | 1,103,307 | | | $ | 1,936,684 | |
Allowance for Credit Losses – Loans and Credit Quality Risk
The allowance for credit losses – loans is maintained at a level which, in management’s judgment, is adequate to absorb probable future loan losses inherent in the loan portfolio. The provision for credit losses is charged against current income. Loans deemed not collectable are charged-off against the allowance while subsequent recoveries increase the allowance. The allowance for credit losses - loans was $21,153,000 or 0.94% of total loans as of December 31, 2023 as compared to $18,552,000 or 1.08% of loans as of December 31, 2022. During the first quarter of 2023, the Company adopted CECL, which resulted in a decrease in the allowance for credit losses – loans of $3.3 million. As a result of the acquisition, the Bank recorded a provision for credit losses for non-PCD loans of $4,591,000 and an allowance of $1,689,000 for PCD loans. An additional $901,000 of provision for credit losses-loans was recorded in 2023. Net charge-offs for 2023 totaled $1,280,000, which was primarily associated with PCD loans acquired as part of the HVBC acquisition that were fully reserved for at the time of the acquisition.
The adequacy of the allowance for credit losses – loans is subject to a formal, quarterly analysis by management of the Company. In order to better analyze the risks associated with the loan portfolio, the entire portfolio is divided into several categories. As stated above, commercial loans on non-accrual status are specifically reviewed and given a specific reserve, if appropriate. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for differences in current loan-specific risk characteristics such as differences in underwriting standards, changes in environmental conditions, delinquency level, segment growth rates and changes in duration within new markets, or other relevant factors. For further information on the allowance for credit losses on loans, Note 1, "Summary of Significant Accounting Policies," and Note 6, "Loans," in the consolidated financial statements provides additional disclosure on the allowance for credit losses. As a result of the adoption of ASC 326 effective January 1, 2023, there is a lack of comparability in both the allowance and provision for credit losses for the periods presented. Results for reporting periods beginning after January 1, 2023 are presented using the CECL methodology, while comparative period information continues to be reported in accordance with the incurred loss methodology in effect for prior fiscal years. Note 1, "Summary of Significant Accounting Policies," in the consolidated financial statements provides additional disclosure on the adoption of ASC 326.
The following table shows the distribution of the allowance for credit losses - loans and the percentage of loans compared to total loans by loan category (dollars in thousands) as of December 31:
| | | 2023 | | | 2022 | |
| | | Amount | | | % | | | Amount | | | % | |
| Real estate loans: | | | | | | | | | | | | |
| Residential | | $ | 2,354 | | | | 16.0 | | | $ | 1,056 | | | | 12.2 | |
| Commercial | | | 9,178 | | | | 48.6 | | | | 10,120 | | | | 50.8 | |
| Agricultural | | | 3,264 | | | | 14.0 | | | | 4,589 | | | | 18.2 | |
| Construction | | | 1,950 | | | | 8.7 | | | | 801 | | | | 4.7 | |
| Consumer | | | 1,496 | | | | 2.7 | | | | 135 | | | | 5.0 | |
| Other commercial loans | | | 2,229 | | | | 6.1 | | | | 1,040 | | | | 3.7 | |
| Other agricultural loans | | | 270 | | | | 1.4 | | | | 489 | | | | 2.0 | |
| State & political subdivision loans | | | 45 | | | | 2.5 | | | | 322 | | | | 3.4 | |
| Unallocated | | | 367 | | | | N/A | | | | - | | | | N/A | |
| Total allowance for loan losses | | $ | 21,153 | | | | 100.0 | | | $ | 18,552 | | | | 100.0 | |
The following tables presents the activity in the allowance for credit losses – loans, by portfolio segment, for 2023 (in thousands).
| | | Balance at December 31, 2022 | | | Impact of adopting CECL | | | Allowance for credit loss on PCD acquired loans | | | Charge- offs | | | Recoveries | | | Provision | | | Balance at December 31,
2023 | |
| Real estate loans: | | | | | | | | | | | | | | | | | | | | | |
| Residential | | $ | 1,056 | | | $ | 79 | | | $ | 108 | | | $ | (1 | ) | | $ | - | | | $ | 1,112 | | | $ | 2,354 | |
| Commercial | | | 10,120 | | | | (3,070 | ) | | | 39 | | | | - | | | | - | | | | 2,089 | | | | 9,178 | |
| Agricultural | | | 4,589 | | | | (1,145 | ) | | | 37 | | | | - | | | | - | | | | (217 | ) | | | 3,264 | |
| Construction | | | 801 | | | | (103 | ) | | | | | | | - | | | | - | | | | 1,252 | | | | 1,950 | |
| Consumer | | | 135 | | | | 1,040 | | | | 677 | | | | (365 | ) | | | 40 | | | | (31 | ) | | | 1,496 | |
| Other commercial loans | | | 1,040 | | | | (328 | ) | | | 828 | | | | (963 | ) | | | 9 | | | | 1,643 | | | | 2,229 | |
| Other agricultural loans | | | 489 | | | | (219 | ) | | | - | | | | - | | | | - | | | | - | | | | 270 | |
State and political subdivision loans | | | 322 | | | | (280 | ) | | | - | | | | - | | | | - | | | | 3 | | | | 45 | |
| Unallocated | | | - | | | | 726 | | | | - | | | | - | | | | - | | | | (359 | ) | | | 367 | |
| Total | | $ | 18,552 | | | $ | (3,300 | ) | | $ | 1,689 | | | $ | (1,329 | ) | | $ | 49 | | | $ | 5,492 | | | $ | 21,153 | |
Prior to January 1, 2023, the Company calculated the allowance for loan losses using the probable incurred methodology. The activity in our allowance for loan losses was as follows during the years ended December 31, 2022 and 2021:
| | | Balance at December 31, 2021 | | | Charge-offs | | | Recoveries | | | Provision | | | Balance at December 31, 2022 | |
| Real estate loans: | | | | | | | | | | | | | | | |
| Residential | | $ | 1,147 | | | $ | - | | | $ | - | | | $ | (91 | ) | | $ | 1,056 | |
| Commercial | | | 8,099 | | | | - | | | | 3 | | | | 2,018 | | | | 10,120 | |
| Agricultural | | | 4,729 | | | | - | | | | - | | | | (140 | ) | | | 4,589 | |
| Construction | | | 434 | | | | - | | | | - | | | | 367 | | | | 801 | |
| Consumer | | | 262 | | | | (37 | ) | | | 21 | | | | (111 | ) | | | 135 | |
| Other commercial loans | | | 1,023 | | | | (435 | ) | | | 13 | | | | 439 | | | | 1,040 | |
| Other agricultural loans | | | 558 | | | | - | | | | - | | | | (69 | ) | | | 489 | |
State and political subdivision loans | | | 281 | | | | - | | | | - | | | | 41 | | | | 322 | |
| Unallocated | | | 771 | | | | - | | | | - | | | | (771 | ) | | | - | |
| Total | | $ | 17,304 | | | $ | (472 | ) | | $ | 37 | | | $ | 1,683 | | | $ | 18,552 | |
| | | Balance at December 31, 2020 | | | Charge-offs | | | Recoveries | | | Provision | | | Balance at December 31, 2021 | |
Real estate loans: | | | | | | | | | | | | | | | |
| Residential | | $ | 1,174 | | | $ | - | | | $ | - | | | $ | (27 | ) | | $ | 1,147 | |
| Commercial | | | 6,216 | | | | (54 | ) | | | 89 | | | | 1,848 | | | | 8,099 | |
| Agricultural | | | 4,953 | | | | - | | | | - | | | | (224 | ) | | | 4,729 | |
| Construction | | | 122 | | | | - | | | | - | | | | 312 | | | | 434 | |
Consumer | | | 321 | | | | (27 | ) | | | 21 | | | | (53 | ) | | | 262 | |
Other commercial loans | | | 1,226 | | | | (133 | ) | | | 43 | | | | (113 | ) | | | 1,023 | |
Other agricultural loans | | | 864 | | | | - | | | | - | | | | (306 | ) | | | 558 | |
State and political subdivision loans | | | 479 | | | | - | | | | - | | | | (198 | ) | | | 281 | |
Unallocated | | | 460 | | | | - | | | | - | | | | 311 | | | | 771 | |
| Total | | $ | 15,815 | | | $ | (214 | ) | | $ | 153 | | | $ | 1,550 | | | $ | 17,304 | |
The following table provides information related to credit loss experience and net (charge-offs) recoveries for 2023, 2022 and 2021.
2023 | | Credit Loss
Expense (Benefit) | | | Net (charge-
offs) Recoveries | | | Average Loans | | | Ratio of net (charge-offs) recoveries to Average loans | | | Allowance to total loans | | | Non- accrual
loans as a percent of loans | | | Allowance to total non- accrual loans | |
| Real estate: | | | | | | | | | | | | | | | | | | | | | |
| Residential | | $ | 1,112 | | | | (1 | ) | | $ | 290,971 | | | | 0.00 | % | | | 0.65 | % | | | 0.86 | % | | | 76.38 | % |
| Commercial | | | 2,089 | | | | - | | | | 986,188 | | | | 0.00 | % | | | 0.84 | % | | | 0.10 | % | | | 808.63 | % |
| Agricultural | | | (217 | ) | | | - | | | | 312,423 | | | | 0.00 | % | | | 1.04 | % | | | 0.85 | % | | | 122.25 | % |
| Construction | | | 1,252 | | | | - | | | | 135,315 | | | | 0.00 | % | | | 1.00 | % | | | 1.20 | % | | | 82.73 | % |
| Consumer | | | (31 | ) | | | (325 | ) | | | 94,519 | | | | (0.34 | %) | | | 2.44 | % | | | 1.14 | % | | | 2,197 | |
| Other commercial loans | | | 1,643 | | | | (954 | ) | | | 95,300 | | | | (1.00 | %) | | | 1.64 | % | | | 1.29 | % | | | 127.37 | % |
| Other agricultural loans | | | - | | | | - | | | | 30,557 | | | | 0.00 | % | | | 0.88 | % | | | 1.60 | % | | | 54.88 | % |
| State & political subdivision loans | | | 3 | | | | - | | | | 59,308 | | | | 0.00 | % | | | 0.08 | % | | | 0.00 | % | | NA | |
| Unallocated | | | (359 | ) | | | - | | | | - | | | NA | | | NA | | | NA | | | NA | |
| Total | | $ | 5,492 | | | $ | (1,280 | ) | | $ | 2,004,581 | | | | (0.06 | %) | | | 0.94 | % | | | 0.54 | % | | | 173.57 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| 2022 | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential | | $ | (91 | ) | | | - | | | $ | 204,063 | | | | 0.00 | % | | | 0.50 | % | | | 0.28 | % | | | 178.68 | % |
| Commercial | | | 2,018 | | | | 3 | | | | 782,016 | | | | 0.00 | % | | | 1.15 | % | | | 0.32 | % | | | 364.29 | % |
| Agricultural | | | (140 | ) | | | - | | | | 312,999 | | | | 0.00 | % | | | 1.46 | % | | | 1.03 | % | | | 142.43 | % |
| Construction | | | 367 | | | | - | | | | 73,214 | | | | 0.00 | % | | | 0.99 | % | | | 0.00 | % | | NA | |
| Consumer | | | (111 | ) | | | (16 | ) | | | 58,715 | | | | (0.03 | %) | | | 0.16 | % | | | 0.00 | % | | NA | |
| Other commercial loans | | | 439 | | | | (422 | ) | | | 72,444 | | | | (0.58 | %) | | | 1.64 | % | | | 0.10 | % | | | 1677.42 | % |
| Other agricultural loans | | | (69 | ) | | | - | | | | 34,421 | | | | 0.00 | % | | | 1.40 | % | | | 0.82 | % | | | 171.58 | % |
| State & political subdivision loans | | | 41 | | | | - | | | | 56,004 | | | | 0.00 | % | | | 0.54 | % | | | 0.00 | % | | NA | |
| Unallocated | | | (771 | ) | | | - | | | | - | | | NA | | | NA | | | NA | | | NA | |
| Total | | $ | 1,683 | | | $ | (435 | ) | | $ | 1,593,876 | | | | (0.03 | %) | | | 1.08 | % | | | 0.40 | % | | | 267.40 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| 2021 | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Real estate: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential | | $ | (27 | ) | | | - | | | $ | 203,062 | | | | 0.00 | % | | | 0.57 | % | | | 0.30 | % | | | 192.77 | % |
| Commercial | | | 1,848 | | | | 35 | | | | 639,161 | | | | 0.01 | % | | | 1.18 | % | | | 0.43 | % | | | 275.01 | % |
| Agricultural | | | (224 | ) | | | - | | | | 312,770 | | | | 0.00 | % | | | 1.52 | % | | | 1.00 | % | | | 150.94 | % |
| Construction | | | 312 | | | | - | | | | 56,315 | | | | 0.00 | % | | | 0.79 | % | | | 0.00 | % | | NA | |
| Consumer | | | (53 | ) | | | (6 | ) | | | 24,125 | | | | (0.02 | %) | | | 1.01 | % | | | 0.00 | % | | NA | |
| Other commercial loans | | | (113 | ) | | | (90 | ) | | | 99,839 | | | | (0.09 | %) | | | 1.37 | % | | | 0.19 | % | | | 730.71 | % |
| Other agricultural loans | | | (306 | ) | | | - | | | | 37,181 | | | | 0.00 | % | | | 1.40 | % | | | 2.01 | % | | | 69.49 | % |
| State & political subdivision loans | | | (198 | ) | | | - | | | | 52,804 | | | | 0.00 | % | | | 0.61 | % | | | 0.00 | % | | NA | |
| Unallocated | | | 311 | | | | - | | | | - | | | NA | | | NA | | | NA | | | NA | |
| Total | | $ | 1,550 | | | $ | (61 | ) | | $ | 1,425,257 | | | | 0.00 | % | | | 1.20 | % | | | 0.53 | % | | | 227.21 | % |
The Company believes it utilizes a disciplined and thorough loan review process based upon its internal loan policy approved by the Company’s Board of Directors. The purpose of the review is to assess loan quality, analyze delinquencies, identify problem loans, evaluate potential charge-offs and recoveries, and assess general overall economic conditions in the markets served. An external independent loan review is performed on our commercial portfolio at least semi-annually for the Company. The external consultant is engaged to 1) review a minimum of 50% of the dollar volume of the commercial loan portfolio on an annual basis, 2) a large sample of relationships in aggregate over $1,000,000, 3) selected loan relationships over $750,000 which are over 30 days past due, or classified Special Mention, Substandard, Doubtful, or Loss, and 4) such other loans which management or the consultant deems appropriate. As part of this review, our underwriting process and loan grading system is evaluated.
Management believes it uses the best information available to make such determinations and that the allowance for credit losses – loans is adequate as of December 31, 2023. However, future adjustments could be required if circumstances differ substantially from assumptions and estimates used in making the initial determination. A prolonged downturn in the economy, changes in the economies of various segments of our agricultural and commercial portfolios, high unemployment rates, significant changes in the value of collateral and delays in receiving financial information from borrowers could result in increased levels of non-performing assets, charge-offs, credit loss provisions and reduction in income. Additionally, bank regulatory agencies periodically examine the Bank’s allowance for credit losses - loans. The banking agencies could require the recognition of additions to the allowance for credit losses based upon their judgment of information available to them at the time of their examination.
On a monthly basis, problem loans are identified and updated primarily using internally prepared past due reports. Based on data surrounding the collection process of each identified loan, the loan may be added or deleted from the monthly watch list. The watch list includes loans graded special mention, substandard, doubtful, and loss, as well as additional loans that management may choose to include. Watch list loans are continually monitored going forward until satisfactory conditions exist that allow management to upgrade and remove the loan from the watchlist. In certain cases, loans may be placed on non-accrual status or charged-off based upon management’s evaluation of the borrower’s ability to pay. All commercial loans, which include commercial real estate, agricultural real estate, state and political subdivision loans, other commercial loans and other agricultural loans, on non-accrual are evaluated quarterly for impairment.
See also “Note 6 – Loans and Related Allowance for Credit Losses - Loans” to the consolidated financial statements.
As a result of previous loss experiences and other risk factors utilized in determining the allowance, the Bank’s allocation of the allowance does not directly correspond to the actual balances of the loan portfolio. While commercial and agricultural real estate loans total 62.6% of the loan portfolio at December 31 2023, 58.8% of the allowance is assigned to these portions of the loan portfolio. Residential real estate loans comprise 16.0% of the loan portfolio as of December 31, 2023 and 11.1% of the allowance is assigned to this segment.
The following table is a summary of our non-performing assets for the years ended December 31, 2023 and 2022.
| | | 2023 | | | 2022 | |
| Non-performing loans: | | | | | | |
| Non-accruing loans | | $ | 12,187 | | | $ | 6,938 | |
| Accrual loans - 90 days or more past due | | | 516 | | | | 7 | |
| Total non-performing loans | | | 12,703 | | | | 6,945 | |
| Foreclosed assets held for sale | | | 474 | | | | 543 | |
| Total non-performing assets | | $ | 13,177 | | | $ | 7,488 | |
The following table identifies amounts of loans contractually past due 30 to 90 days and non-performing loans by loan category, as well as the change from December 31, 2022 to December 31, 2023 in non-performing loans (in thousands). Non-performing loans include those accruing loans that are contractually past due 90 days or more and non-accrual loans. Interest does not accrue on non-accrual loans. Subsequent cash payments received are applied to the outstanding principal balance or recorded as interest income, depending upon management's assessment of its ultimate ability to collect principal and interest.
| | | December 31, 2023 | | | December 31, 2022 | |
| | | | | | Non-Performing Loans | | | | | | Non-Performing Loans | |
| | | 30 - 89 Days | | | 90 Days Past | | | Non- | | | Total Non- | | | 30 - 89 Days | | | 90 Days Past | | | Non- | | | Total Non- | |
| | | Past Due | | | Due Accruing | | | accrual | | | Performing | | | Past Due | | | Due Accruing | | | accrual | | | Performing | |
| Real estate: | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential | | $ | 3,061 | | | $ | 18 | | | $ | 3,082 | | | $ | 3,100 | | | $ | 469 | | | $ | - | | | $ | 591 | | | $ | 591 | |
| Commercial | | | 1,396 | | | | 404 | | | | 1,135 | | | | 1,539 | | | | 1,134 | | | | - | | | | 2,778 | | | | 2,778 | |
| Agricultural | | | 73 | | | | 75 | | | | 2,670 | | | | 2,745 | | | | - | | | | - | | | | 3,222 | | | | 3,222 | |
| Construction | | | 4,795 | | | | - | | | | 2,357 | | | | 2,357 | | | | - | | | | - | | | | - | | | | - | |
| Consumer | | | 298 | | | | 13 | | | | 701 | | | | 714 | | | | 147 | | | | 7 | | | | - | | | | 7 | |
| Other commercial loans | | | 826 | | | | 6 | | | | 1,750 | | | | 1,756 | | | | 1,695 | | | | - | | | | 62 | | | | 62 | |
| Other agricultural loans | | | 7 | | | | - | | | | 492 | | | | 492 | | | | - | | | | - | | | | 285 | | | | 285 | |
| Total nonperforming loans | | $ | 10,456 | | | $ | 516 | | | $ | 12,187 | | | $ | 12,703 | | | $ | 3,445 | | | $ | 7 | | | $ | 6,938 | | | $ | 6,945 | |
| | | Change in Non-Performing Loans | |
| | | 2023 / 2022 | |
| | | Amount | | | % | |
Real estate: | | | | | | | |
Residential | | $ | 2,509 | | | | 424.5 | |
Commercial | | | (1,239 | ) | | | (44.6 | ) |
Agricultural | | | (477 | ) | | | (14.8 | ) |
Construction | | | 2,357 | | | NA | |
Consumer | | | 707 | | | | 10,100.0 | |
Other commercial loans | | | 1,694 | | | | 2,732.3 | |
Other agricultural loans | | | 207 | | | | 72.6 | |
Total nonperforming loans | | $ | 5,758 | | | | 82.9 | |
Nonperforming loans increased $5.8 million during 2023. As part of the HVBC acquisition, we acquired $1.8 million of non-performing residential real estate loans, $1.1 million of non-performing consumer loans and $763,000 of non-performing other commercial loans. During the first quarter of 2023, the Bank place two large relationships totaling $3.8 million on non-accrual status, one of which was secured by real estate and the other was secured by airplanes and camera equipment. At December 31, 2023, approximately 53.7% of the Bank’s non-performing loans are associated with the following five customer relationships:
| • | A commercial loan relationship with $585,000 outstanding, and additional letters of credit of $1.2 million available, secured by undeveloped land, stone quarries and equipment, was on non-accrual status as of December 31, 2023. The Company services the natural gas industry, as well as local municipalities. As a result, the reduced exploration for natural gas in north central Pennsylvania has significantly impacted the cash flows of the customer, who provides excavation services and stone for pad construction related to these activities. During 2020, the Company had the underlying equipment collateral appraised and in the first quarter of 2022, the Company had the quarry appraised. The appraisals indicated a decrease in collateral values compared to the appraisal ordered for the loan origination, however, the loan was still considered well secured on a loan to value basis at December 31, 2023. In 2022 and 2023, the customer liquidated some excess equipment and the funds have been utilized to pay down a portion of the loans. Management determined that no specific reserve was required as of December 31, 2023. |
| • | An agricultural loan customer with a total loan relationship of $1.6 million, secured by real estate, equipment and cattle, was on non-accrual status as of December 31, 2023. The customer declared bankruptcy during the fourth quarter of 2018 and developed a workout plan that was approved by the bankruptcy court in the fourth quarter of 2019 and resulted in monthly payments resuming in late 2019 that continued 2023. The customer did miss a portion of required payments in 2023, however, in January 2024 the customer modified the bankruptcy plan to account for these missed payments. Included within these loans to this customer are loans which are subject to Farm Service Agency guarantees in excess of $700,000. Depressed milk prices created cash flow difficulties for this customer. Absent a sizable and sustained increase in milk prices, which is not assured, we will need to rely upon the collateral for repayment of interest and principal. During 2023, the Company had the underlying collateral appraised. Management determined that no specific reserve was required as of December 31, 2023. |
| • | An agricultural loan customer with a total loan relationship of $1.2 million, secured by real estate was on non-accrual status as of December 31, 2023. The customer filed bankruptcy in the first quarter of 2023 and is still developing a plan of workout, which may include the sale of oil and gas rights and the installation of a solar field. We expect that we will need to rely upon the collateral for repayment of interest and principal. During 2023, the Company had the underlying collateral appraised. Management reviewed the collateral and determined that no specific reserve was required as of December 31, 2023. |
| • | A commercial loan customer with a total loan relationship of $1.1 million, secured by airplanes and camera equipment was on non-accrual status as of December 31, 2023. The customer is in the process of selling its business, which has taken longer than expected causing cashflow difficulties. A forbearance agreement was agreed to by the Customer that calls for monthly payments of $90,000 through the first quarter of 2024 and a pay-off of the entire relationship during the first quarter of 2024 as well. Management reviewed the collateral and determined that no specific reserve was required as of December 31, 2023. |
| • | A construction loan customer with a total loan relationship of $2.4 million, secured by partially developed real estate, was on non-accrual status as of December 31, 2023. The customer has experienced delays in developing the real estate for resale resulting in financing difficulties. Management reviewed the collateral and determined that a specific reserve of $286,000 was required as of December 31, 2023. |
Management believes that the allowance for credit losses - loans at December 31, 2023 was adequate at that date, which was based on the following factors:
| • | Five loan relationships comprise 53.7% of the non-performing loan balance, which required a specific reserve of $286,000 as of December 31, 2023. |
| • | The Company has a history of low charge-offs, which were 0.06% and 0.03% of average loans for 2023 and 2022, respectively. |
Bank Owned Life Insurance
The Company holds bank owned life insurance policies to offset current and future employee benefit costs. These policies provide the Bank with an asset that generates earnings to partially offset the current costs of benefits, and eventually (at the death of the insureds) provide partial recovery of cash outflows associated with the benefits. As of December 31, 2023, and 2022, the cash surrender value of the life insurance was $49.9 million and $39.4 million, respectively. The primary cause of the increase was related to the HVBC acquisition, which increased the balance by $10.4 million. The change in cash surrender value, net of purchases and amounts acquired through acquisitions, is recognized in the results of operations. The amounts recorded as non-interest income totaled $1,254,000, $852,000 and $1,828,000 in 2023, 2022 and 2021, respectively with the increase in 2023 due to the HVBC acquisition and death benefits received in 2023 upon the passing of a former employee and the decrease in 2022 due to the death benefits received in 2021 upon the passing of two former employees. The Company evaluates annually the risks associated with the life insurance policies, including limits on the amount of coverage and an evaluation of the various carriers’ credit ratings.
Effective January 1, 2015, the Company restructured its agreements so that any death benefits received from a policy while the insured person is an active employee of the Bank will be split with the beneficiary of the policy. Under the restructured agreements, the employee’s beneficiary will be entitled to receive 50% of the net amount at risk from the proceeds. The policies acquired as part of the acquisition of MidCoast are only for the benefit of the Bank. The net amount at risk is the total death benefit payable less the cash surrender value of the policy as of the date of death. The policies acquired as part of the acquisition of FNB, provide a fixed dollar benefit for the beneficiary’s’ estate, which is dependent on several factors including whether the covered individual was a Director of FNB or an employee of FNB and their salary level. As of December 31, 2023, and 2022, included in other liabilities on the Consolidated Balance sheet is a liability of $610,000 and $660,000, respectively, for the obligation under the split-dollar benefit agreements.
Fair Value of Derivative Instruments - asset
The Company holds derivative instruments to hedge interest rate risk, to offer customers longer term fixed rate loans through a program similar to a back to back swap, which results in both a derivative asset and liability on the Consolidated Balance Sheet, and through the residential lending platform through interest rate locks. (See Note 19 for additional information). As of December 31, 2023, and 2022, the fair value for the derivatives instruments was $13.7 million and $16.6 million, respectively. The change in the fair value of financial instruments was due to the changes in market interest rates during 2023 and the time to maturity of the various instruments. The effective portion of changes in the fair value of the cash flow interest hate hedge derivative is initially reported in other comprehensive income (outside of earnings), net of tax, and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings.
Deferred Tax Asset
Deferred tax assets are computed based on the difference between the financial statement basis and income tax basis of assets and liabilities using the enacted marginal tax rates. Deferred income tax expenses or benefits are based on the changes in the net deferred tax asset or liability from period to period. (See Note 13 for additional information) As of December 31, 2023 and 2022, the balance for deferred tax assets was $17.3 million and $12.9 million, respectively. The change was due to the HVBC acquisition and the deferred taxes acquired as part of the acquisition.
Other Assets
Other assets increased $33.3 million in 2023 to $59.1 million from $25.8 million in 2022 with the majority of the increase due to the HVBC acquisition. Due to increased borrowing levels with FHLB of Pittsburgh and our increased size, regulatory stock increased $7.3 million during 2023. As part of the HVBC, facilities were acquired that are subject to leases, and additionally, we entered into and extended several leases during the year, which resulted in the right of use asset for facilities increasing $6.1 million. The balance in investments in low income housing projects increased $7.2 million due to investments made in three partnerships during 2023 as well as recording the commitment for future investments in the three partnerships. An investment security matured, but did not settle as of December 31, 2023 resulting in a $8.0 million increase in other assets. Income tax receivable increased $2.6 million during 2023.
Deposits
The following table shows the breakdown of deposits by deposit type (dollars in thousands) at December 31:
| | | 2023 | | | 2022 | | | 2021 | |
| | | Amount | | | % | | | Amount | | | % | | | Amount | | | % | |
Non-interest-bearing deposits | | $ | 523,784 | | | | 22.6 | | | $ | 396,261 | | | | 21.5 | | | $ | 358,073 | | | | 19.5 | |
NOW accounts | | | 670,712 | | | | 28.9 | | | | 512,501 | | | | 27.8 | | | | 485,292 | | | | 26.4 | |
Savings deposits | | | 307,357 | | | | 13.2 | | | | 321,917 | | | | 17.5 | | | | 313,048 | | | | 17.0 | |
Money market deposit accounts | | | 400,154 | | | | 17.2 | | | | 335,838 | | | | 18.2 | | | | 350,122 | | | | 19.1 | |
Certificates of deposit | | | 419,474 | | | | 18.1 | | | | 277,691 | | | | 15.0 | | | | 329,616 | | | | 18.0 | |
| Total | | $ | 2,321,481 | | | | 100.0 | | | $ | 1,844,208 | | | | 100.0 | | | $ | 1,836,151 | | | | 100.0 | |
| | | 2023/2022 | | | 2022/2021 | |
| | | Change | | | Change | |
| | | Amount | | | % | | | Amount | | | % | |
Non-interest-bearing deposits | | $ | 127,523 | | | | 32.2 | | | $ | 38,188 | | | | 10.7 | |
NOW accounts | | | 158,211 | | | | 30.9 | | | | 27,209 | | | | 5.6 | |
Savings deposits | | | (14,560 | ) | | | (4.5 | ) | | | 8,869 | | | | 2.8 | |
Money market deposit accounts | | | 64,316 | | | | 19.2 | | | | (14,284 | ) | | | (4.1 | ) |
Certificates of deposit | | | 141,783 | | | | 51.1 | | | | (51,925 | ) | | | (15.8 | ) |
Total | | $ | 477,273 | | | | 25.9 | | | $ | 8,057 | | | | 0.4 | |
2023
Total deposits increased $477.3 million in 2023, or 25.9%. As part of the HVBC acquisition, we acquired $533.4 million of deposits. Excluding the acquisition, deposits would have decreased $56.1 million. The reduction in deposits resulted from customer funds transferred to higher-yielding investment alternatives; and municipal deposits withdrawn to fund various projects within municipalities. Brokered deposits totaled $109.3 million and $16.0 million as of December 31, 2023 and 2022, respectively. As part of the acquisition, we acquired $36.2 million of brokered deposits, which matured during the third quarter of 2023. We continue to work on enhancing our cash management services to improve our customer services. As a percentage of total deposits, non-interest-bearing deposits totaled 22.6% as of the end of 2023, which compares to 21.5% at the end of 2022. The rates paid on certificates of deposit by the Company remain competitive with rates paid by our competition.
Total deposits increased $8.1 million in 2022, or 0.4%. Deposit levels remained consistent during 2022 after significant growth in 2021 that was due to government stimulus funds in response to the COVID-19 pandemic. With the increase in market interest rates, customers are moving funds to obtain additional liquidity and higher rates. We continue to enhance our cash management services to improve our customer services. Brokered certificates of deposit increased $16.0 million as new brokered CDs were issued during 2022. As a percentage of total deposits, non-interest-bearing deposits totaled 21.5% as of the end of 2022, which compares to 19.5% at the end of 2021. The rates paid on certificates of deposit by the Company remain competitive with rates paid by our competition.
Remaining maturities of certificates of deposit in excess of FDIC insurance limits are as follows for December 31, 2023 (dollars in thousands):
| | | 2023 | |
| 3 months or less | | $ | 29,790 | |
| Over 3 months through 6 months | | | 17,490 | |
| Over 6 months through 12 months | | | 25,719 | |
| Over 12 months | | | 19,813 | |
| Total | | $ | 92,812 | |
As a percent of total certificates of deposit | | | 22.13 | % |
Uninsured deposits as of December 31, 2023 and 2022, are estimated based on regulatory reporting requirements to be $1,087,308,000 and $732,173,000, respectively. Included in this balance as of December 31, 2023, are balances held through Intrafi, which provides customers with FDIC insurance coverage by placing customer funds with insured banks within the Intrafi network, as well as deposits collateralized by securities (almost exclusively municipal deposits), which together total $512.8 million, or 22.1% of the Bank’s total deposits.
Deposits by type of depositor are as follows (dollars in thousands) at December 31:
| | | 2023 | | | 2022 | | | 2021 | |
| | | Amount | | | % | | | Amount | | | % | | | Amount | | | % | |
Individuals | | $ | 1,129,655 | | | | 48.7 | | | $ | 921,404 | | | | 50.0 | | | $ | 938,331 | | | | 51.1 | |
Businesses and other organizations | | | 748,257 | | | | 32.2 | | | | 586,531 | | | | 31.8 | | | | 534,402 | | | | 29.1 | |
State & political subdivisions | | | 443,569 | | | | 19.1 | | | | 336,273 | | | | 18.2 | | | | 363,418 | | | | 19.8 | |
Total | | $ | 2,321,481 | | | | 100.0 | | | $ | 1,844,208 | | | | 100.0 | | | $ | 1,836,151 | | | | 100.0 | |
Borrowed Funds
Borrowed funds increased $64.7 million during 2023 as a result of the HVBC acquisition and for liquidity. As part of the acquisition, we acquired $58.6 million of borrowed funds. Short term borrowings from the FHLB decreased $33.3 million and totaled $178.8 million as of December 31, 2023 compared to $212.1 million as of December 31, 2022. Long term borrowings from the FHLB increased $45.3 million and total $55.3 million. Term loans from the FHLB totaled $55.3 million and $10.0 million as of December 31, 2023 and 2022, respectively. The change in term loans was due to $25.3 million acquired as part of the HVBC acquisition and borrowing $20.0 million during 2023. The Bank borrowed $20.0 million during 2023 from the Federal Reserve’s Bank Term Funding program. As part of the HVBC, the Company acquired $8.9 million of subordinated notes that HVBC had issued in 2021. The Company has line of credit with a New York Community Bank for $15.0 million, which has an outstanding balance of $12.6 million as of December 31, 2023. Management continually monitors interest rates in order to minimize interest rate risk in future years and as part of this may extend some of the short-term borrowings via term notes. The Bank has five interest rate swap agreements outstanding to convert floating-rate debt to fixed rate debt on notional amounts of $15.0 million, $10.0 million and three agreements of $6.0 million. The $15.0 million and $10.0 million were originated on April 1, 2020 and expire on April 1, 2025 and April 1, 2027. The three $6.0 million agreements originated on May 14, 2020 with a two year forward start date and expire on May 14, 2027, 2029 and 2032 The Company has an interest rate swap agreement outstanding that was entered into on April 13, 2020, to convert floating-rate debt to fixed rate debt on a notional amount of $7.5 million. The interest rate swap agreement expires on June 17, 2027. The interest rate swap instruments involve an agreement to receive a floating rate and pay a fixed rate, at specified intervals, calculated on the agreed-upon notional amounts. The differentials paid or received on interest rate swap agreements are recognized as adjustments to interest expense in the period. The fair value of the interest rate swaps at December 31, 2023 was $ 5,441,000 and is included within fair value of derivative instruments – asset on the consolidated balance sheets.
Fair Value of Derivative Instruments - liability
The Company holds derivative instruments to hedge interest rate risk and to offer customers longer term fixed rate loans through a program similar to a back to back swap, which results in both a derivative asset and liability on the Consolidated Balance Sheet and through the residential lending platform through interest rate locks. (See Note 19 for additional information). As of December 31, 2023, and 2022, the fair value for the derivatives instruments was $7.9 million and $9.7 million, respectively. The change in the fair value of financial instruments was due to changes in market interest rates during 2023 and the time to maturity of the various instruments. The effective portion of changes in the fair value of the cash flow interest hate hedge derivative is initially reported in other comprehensive income (outside of earnings), net of tax, and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings.
Other Liabilities
Other liabilities increased $19.1 million to $39.9 million during 2023. As part of the HVBC acquisition, facilities were acquired that are subject to leases, and additionally, we entered into and extended several leases during the year, which resulted in the right of use liability for facilities increasing $6.1 million. Employee benefit accruals, including profit sharing increased $946,000. As a result of recording the commitment to invest in low income housing projects, other liabilities increased $6.5 million. As a result of timing of loan payments customers whose loans have been sold in whole or in part to other institutions, other liabilities increased $2.3 million. As a result of the acquisition, escrow payable increased $1.2 million.
Stockholders’ Equity
We evaluate stockholders’ equity in relation to total assets and the risk associated with those assets. The greater our capital resources, the greater the likelihood of meeting our cash obligations and absorbing unforeseen losses. For these reasons, capital adequacy has been, and will continue to be, of paramount importance. Due to its importance, we develop a capital plan and stress test capital levels using various techniques and assumptions annually to ensure that in the event of unforeseen circumstances, we would remain in compliance with our capital plan approved by the Board of Directors and regulatory requirement levels.
Our Board of Directors determines our cash dividend rate after considering our capital requirements, current and projected net income, and other factors. In 2023 and 2022, the Company paid out 47.74% and 26.11% of net income in cash dividends, respectively. The increase in the payout percentage was due to the impact the one-time costs of the acquisition had on net income during 2023.
As of December 31, 2023, the total number of common shares outstanding was 4,706,994. For comparative purposes, outstanding shares for prior periods were adjusted for the June 2023 stock dividend in computing earnings and cash dividends per share as detailed in Note 1 of the consolidated financial statements. During 2023, we purchased 2,775 shares of treasury stock at a weighted average cost of $96.60 per share due to processing issue by HVBC. The Company awarded 3,495 shares of restricted stock to employees at a weighted average cost per share of $77.77 under an equity incentive plan. The Board of Directors was awarded 1,800 shares at a cost of $61.88 per share under an incentive plan.
Stockholders’ equity increased 39.7% in 2023 to $279.7 million. As part of the HVBC acquisition, the Company issued 693,858 shares that had a fair value at the time of issuance of $60.1 million. Excluding accumulated other comprehensive income (loss), stockholders’ equity increased $71.3 million, or 30.6%., Net income for 2023 was $17.8 million, offset by net cash dividends of $8,503,000 and net treasury stock activity of $181,000. As a result of implementing CECL, stockholders’ equity increased $1,766,000. All of the Company’s debt investment securities are classified as available-for-sale, making this portion of the Company’s balance sheet more sensitive to the changing market value of investments. Accumulated other comprehensive loss increased $8,230,000 from December 31, 2022, primarily as result of the increase in the fair market value of the investment portfolio. Total stockholders’ equity was approximately 9.4% of total assets as of December 31, 2023, compared to 8.6% of total assets as of December 31, 2022.
LIQUIDITY
Liquidity is a measure of the Company’s ability to efficiently meet normal cash flow requirements of both borrowers and depositors. Liquidity is needed to meet depositors’ withdrawal demands, extend credit to meet borrowers’ needs, provide funds for normal operating expenses and cash dividends, and fund future capital expenditures.
To maintain proper liquidity, we use funds management policies along with our investment and asset liability policies to assure we can meet our financial obligations to depositors, credit customers and stockholders. Management monitors liquidity by reviewing loan demand, investment opportunities, deposit pricing and the cost and availability of borrowing funds. Additionally, the bank has established various limits and ratios to monitor liquidity. On a quarterly basis, we stress test our liquidity position to ensure that the Bank has the capability of meeting its cash flow requirements in the event of unforeseen circumstances. The Company’s historical activity in this area can be seen in the Consolidated Statement of Cash Flows from investing and financing activities.
Cash generated by operating activities, investing activities and financing activities influences liquidity management. The most important source of funds is the deposits that are primarily core deposits (deposits from customers with other relationships). Short-term debt from the Federal Home Loan Bank supplements the Company’s availability of funds as well as a line of credit arrangement with a corresponding bank. Other sources of short-term funds include brokered CDs and the sale of loans, if needed.
The Company’s use of funds is shown in the investing activity section of the Consolidated Statement of Cash Flows, where the net loan activity is detailed. Other significant uses of funds are capital expenditures, purchase of loans and acquisition premiums. Surplus funds are then invested in investment securities.
Capital expenditures, including software purchases in 2023 totaled $2,617,000, which included:
| ◾ | Corporate Headquarters expansion, Mansfield, Pennsylvania totaling $1,663,000 |
| ◾ | Branch facility, Williamsport, Pennsylvania totaling $391,000 |
| ◾ | Signage upgrades and rebranding purchases totaling $187,000 |
| ◾ | ATM upgrades totaling $34,000 |
| ◾ | Building security improvements totaling $110,000 |
| ◾ | Computers, servers and copier purchases $146,000 |
Capital expenditures, including software purchases in 2022 totaled $1,634,000, which included:
| ◾ | Branch facility, Ephrata, Pennsylvania totaling $1,011,000 |
| ◾ | Branch facility, Greenville, Delaware $73,000 |
| ◾ | Signage upgrades and rebranding purchases totaling $71,000 |
| ◾ | ATM upgrades totaling $40,000 |
| ◾ | Building security improvements totaling $78,000 |
| ◾ | Computers, servers and copier purchases $96,000 |
We expect these expenditures will support our initiatives and will create operating efficiencies, while providing quality customer service.
In addition to the Bank’s cash balances, the Bank achieves additional liquidity primarily from its investment in the FHLB of Pittsburgh and the resulting borrowing capacity obtained through this investment, investments that mature in less than one year and expected principal repayments from mortgage backed securities. The Bank has a maximum borrowing capacity at the Federal Home Loan Bank of approximately $1.07 billion, inclusive of any outstanding amounts, as a source of liquidity. The Bank also has two federal funds line with third party providers in the total amount of $34.0 million as of December 31, 2023, which is unsecured and a borrower in custody agreement was established with the FRB in the amount of $1.0 million, which is collateralized by $1.2 million of municipal loans. The Bank also has available through the Bank Term Funding program initiated by the Federal Reserve during the second quarter of 2023, a line of $54.5 million, which has an outstanding balance of $20.0 million as of December 31, 2023. This line is secured by available for sale securities with a par value of $54.5 million The Company has a $15.0 million line of credit with a New York community bank, which has $12.6 million outstanding as of December 31, 2023.
The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company is responsible for paying any dividends declared to its shareholders. The Company also has repurchased shares of its common stock. The Company’s primary source of income is dividends received from the Bank. The Bank may not declare a dividend without approval of the FRB, unless the dividend to be declared by the Bank’s Board of Directors does not exceed the total of: (i) the Bank’s net profits for the current year to date, plus (ii) its retained net profits for the preceding two current years, less any required transfers to surplus. In addition, the Bank can only pay dividends to the extent that its retained net profits (including the portion transferred to surplus) exceed its bad debts. The FRB, the OCC, the PDB and the FDIC have formal and informal policies which provide that insured banks and bank holding companies should generally pay dividends only out of current operating earnings, with some exceptions. The Prompt Corrective Action Rules, described above, further limit the ability of banks to pay dividends, because banks which are not classified as well capitalized or adequately capitalized may not pay dividends and no dividend may be paid which would make the Bank undercapitalized after the dividend. At December 31, 2023, the Company (unconsolidated basis) had liquid assets of $3.5 million.
CONTRACTUAL OBLIGATIONS
The Company has various financial obligations, including contractual obligations which may require cash payments. The following table (in thousands) presents as of December 31, 2023, significant fixed and determinable contractual obligations to third parties by payment date. Further discussion of the obligations can be found in Notes 10, 11 and 20 to the Consolidated Financial Statements.
| | | One year | | | One to | | | Three to | | | Over Five | | | | |
| Contractual Obligations | | or Less | | | Three Years | | | Five Years | | | Years | | | Total | |
Deposits without a stated maturity | | $ | 1,902,007 | | | $ | - | | | $ | - | | | $ | - | | | $ | 1,902,007 | |
Time deposits | | | 263,074 | | | | 122,239 | | | | 30,955 | | | | 3,206 | | | | 419,474 | |
FHLB Advances | | | 135,841 | | | | - | | | | - | | | | - | | | | 135,841 | |
Term borrowings - FHLB | | | 58,000 | | | | 40,287 | | | | - | | | | - | | | | 98,287 | |
Stifel | | | 10,860 | | | | - | | | | - | | | | - | | | | 10,860 | |
BFTP | | | 20,000 | | | | - | | | | - | | | | - | | | | 20,000 | |
Line of Credit | | | 12,572 | | | | - | | | | - | | | | - | | | | 12,572 | |
Note Payable | | | - | | | | - | | | | - | | | | 7,500 | | | | 7,500 | |
Subordinated Debt | | | - | | | | - | | | | - | | | | 18,933 | | | | 18,933 | |
Repurchase agreements | | | 18,043 | | | | - | | | | - | | | | - | | | | 18,043 | |
Low income housing partnerships | | | 4,063 | | | | 2,293 | | | | 38 | | | | 136 | | | | 6,530 | |
Operating leases | | | 1,785 | | | | 3,292 | | | | 3,161 | | | | 5,406 | | | | 13,644 | |
Total | | $ | 2,426,245 | | | $ | 168,111 | | | $ | 34,154 | | | $ | 35,181 | | | $ | 2,663,691 | |
OFF-BALANCE SHEET ARRANGEMENTS
In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, unused lines of credit and letters of credit. For information about our loan commitments, unused lines of credit and letters of credit, see Note 18 of the notes to consolidated financial statements.
For the year ended December 31, 2023, we did not engage in any off-balance sheet transactions reasonably likely to have a material effect on our financial condition, results of operations or cash flows.
INTEREST RATE AND MARKET RISK MANAGEMENT
The objective of interest rate sensitivity management is to maintain an appropriate balance between the stable growth of income and the risks associated with maximizing income through interest sensitivity imbalances and the market value risk of assets and liabilities.
Because of the nature of our operations, we are not subject to foreign currency exchange or commodity price risk and, since the Company has no trading portfolio, it is not subject to trading risk.
At December 31, 2023, the Company had equity securities that represent only 0.07% of our total assets, and therefore market risk related to equity securities is not significant.
The primary factors that make assets interest-sensitive include adjustable-rate features on loans and investments, loan repayments, investment maturities and money market investments. The primary components of interest-sensitive liabilities include maturing certificates of deposit, IRA certificates of deposit, repurchase agreements and short-term borrowings. Savings deposits, NOW accounts and money market investor accounts, with the exception of top interest tier money market and NOW accounts, are considered core deposits and are not short-term interest sensitive and therefore are included in the table below in the over five year column. Top interest tier money market and NOW accounts are included in the table below in the within three month column. Borrowings subject to swap arrangements are included in the table below based on the swap arrangement maturity.
The following table shows the cumulative static gap (at amortized cost) for various time intervals (dollars in thousands):
| Maturity or Re-pricing of Company Assets and Liabilities as of December 31, 2023 | |
| | | Within | | | Four to | | | One to | | | Two to | | | Three to | | | Over | | | | |
| | | Three | | | Twelve | | | Two | | | Three | | | Five | | | Five | | | | |
| | | Months | | | Months | | | Years | | | Years | | | Years | | | Years | | | Total | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing deposits at banks | | $ | 15,335 | | | $ | 100 | | | $ | - | | | $ | 744 | | | $ | 2,976 | | | $ | - | | | $ | 19,155 | |
Investment securities | | | 40,070 | | | | 50,192 | | | | 73,346 | | | | 54,707 | | | | 89,055 | | | | 145,973 | | | | 453,343 | |
Residential mortgage loans | | | 35,721 | | | | 68,995 | | | | 62,739 | | | | 49,166 | | | | 72,616 | | | | 70,753 | | | | 359,990 | |
Construction loans | | | 110,698 | | | | 40,584 | | | | 44,544 | | | | - | | | | - | | | | - | | | | 195,826 | |
Commercial and farm loans | | | 296,519 | | | | 212,238 | | | | 314,071 | | | | 299,450 | | | | 386,647 | | | | 65,605 | | | | 1,574,530 | |
Loans to state & political subdivisions | | | 7,245 | | | | 4,432 | | | | 4,865 | | | | 11,972 | | | | 5,644 | | | | 23,016 | | | | 57,174 | |
Other loans | | | 44,743 | | | | 1,965 | | | | 1,992 | | | | 1,223 | | | | 1,515 | | | | 9,878 | | | | 61,316 | |
| Total interest-earning assets | | $ | 550,331 | | | $ | 378,506 | | | $ | 501,557 | | | $ | 417,262 | | | $ | 558,453 | | | $ | 315,225 | | | $ | 2,721,334 | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
NOW accounts | | $ | 476,477 | | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | 194,235 | | | $ | 670,712 | |
Savings accounts | | | - | | | | - | | | | - | | | | - | | | | - | | | | 307,357 | | | | 307,357 | |
Money Market accounts | | | 356,934 | | | | - | | | | - | | | | - | | | | - | | | | 43,220 | | | | 400,154 | |
Certificates of deposit | | | 104,527 | | | | 158,547 | | | | 87,829 | | | | 34,410 | | | | 30,955 | | | | 3,206 | | | | 419,474 | |
Long-term borrowing | | | 182,316 | | | | 30,000 | | | | 55,287 | | | | 18,933 | | | | 23,500 | | | | 12,000 | | | | 322,036 | |
| Total interest-bearing liabilities | | $ | 1,120,254 | | | $ | 188,547 | | | $ | 143,116 | | | $ | 53,343 | | | $ | 54,455 | | | $ | 560,018 | | | $ | 2,119,733 | |
| Excess interest-earning assets (liabilities) | | $ | (569,923 | ) | | $ | 189,959 | | | $ | 358,441 | | | $ | 363,919 | | | $ | 503,998 | | | $ | (244,793 | ) | | | | |
Cumulative interest-earning assets | | $ | 550,331 | | | $ | 928,837 | | | $ | 1,430,394 | | | $ | 1,847,656 | | | $ | 2,406,109 | | | $ | 2,721,334 | | | | | |
Cumulative interest-bearing liabilities | | | 1,120,254 | | | | 1,308,801 | | | | 1,451,917 | | | | 1,505,260 | | | | 1,559,715 | | | | 2,119,733 | | | | | |
| Cumulative gap | | $ | (569,923 | ) | | $ | (379,964 | ) | | $ | (21,523 | ) | | $ | 342,396 | | | $ | 846,394 | | | $ | 601,601 | | | | | |
Cumulative interest rate sensitivity ratio (1) | | | 0.49 | | | | 0.71 | | | | 0.99 | | | | 1.23 | | | | 1.54 | | | | 1.28 | | | | | |
The previous table and the simulation models discussed below are presented assuming money market investment accounts and NOW accounts in the top interest rate tier are re-priced within the first three months. The loan amounts reflect the principal balances expected to be re-priced as a result of contractual amortization and anticipated early payoffs.
Gap analysis, one of the methods used by us to analyze interest rate risk, does not necessarily show the precise impact of specific interest rate movements on the Bank’s net interest income because the re-pricing of certain assets and liabilities is discretionary and is subject to competition and other pressures. In addition, assets and liabilities within the same period may, in fact, be repaid at different times and at different rate levels. We have not experienced the kind of earnings volatility that might be indicated from gap analysis.
The Bank currently uses a computer simulation model to better measure the impact of interest rate changes on net interest income. We use the model as part of our risk management and asset liability management processes that we believe will effectively identify, measure, and monitor the Bank’s risk exposure. In this analysis, the Bank examines the results of movements in interest rates with additional assumptions made concerning the timing of interest rate changes, prepayment speeds on mortgage loans and mortgage securities and deposit pricing movements. Shock scenarios, which assume a parallel shift in interest rates and is instantaneous, typically have the greatest impact on net interest income. The following is a rate shock analysis and the impact on net interest income as of December 31, 2023 (dollars in thousands):
| | | | | | Change In | | | % Change In | |
| | | Prospective One-Year | | | Prospective | | | Prospective | |
Changes in Rates | | Net Interest Income | | | Net Interest Income | | | Net Interest Income | |
-400 Shock | | $ | 94,164 | | | $ | 7,403 | | | | 8.53 | % |
-300 Shock | | | 91,582 | | | | 4,821 | | | | 5.56 | % |
-200 Shock | | | 90,379 | | | | 3,618 | | | | 4.17 | % |
-100 Shock | | | 88,704 | | | | 1,943 | | | | 2.24 | % |
Base | | | 86,761 | | | | - | | | | - | |
+100 Shock | | | 84,530 | | | | (2,231 | ) | | | -2.57 | % |
+200 Shock | | | 81,691 | | | | (5,070 | ) | | | -5.84 | % |
+300 Shock | | | 79,371 | | | | (7,390 | ) | | | -8.52 | % |
+400 Shock | | | 77,050 | | | | (9,711 | ) | | | -11.19 | % |
The model makes estimates, at each level of interest rate change, regarding cash flows from principal repayments on loans and mortgage backed securities, call activity of other investment securities, and deposit selection, re-pricing and maturity structure. Because of these assumptions, actual results could differ significantly from these estimates which would result in significant differences in the calculated projected change on net interest income. Additionally, the changes above do not necessarily represent the level of change under which management would undertake specific measures to realign its portfolio in order to reduce the projected level of change. The projections above utilize a static balance sheet and do not include any changes that may result from the growth of the Bank. Management has developed policy limits for acceptable changes in net interest income for multiple scenarios, including shock scenarios. As of December 31, 2023, changes in net interest income projected for all scenarios, including the shock scenarios noted above are in line with Bank policy limits for interest rate risk.
CRITICAL ACCOUNTING POLICIES; CRITICAL ACCOUNTING ESTIMATES
The Company’s accounting policies are integral to understanding the results reported. The accounting policies are described in detail in Note 1 of the consolidated financial statements. Our most complex accounting policies require management’s judgment to ascertain the valuation of assets, liabilities, commitments and contingencies. We have established detailed policies and control procedures that are intended to ensure valuation methods are well controlled and applied consistently from period to period. In addition, the policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. The following is a brief description of our current accounting policies involving significant management valuation judgments and critical accounting estimates.
Allowance for Credit Losses
The Company’s allowance for credit losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of its consolidated financial statements. In determining the appropriate estimate for the allowance for credit losses, management considers a number of factors relative to both individually evaluated credits in the loan portfolio and macroeconomic factors relative to the economy of the U.S. as a whole and the economies of the areas in which the Company does business.
Management performs a quarterly evaluation of the adequacy of the allowance for credit losses. Management considers a variety of factors in establishing this estimate. This evaluation is inherently subjective as it requires material estimates by management that may be susceptible to significant change based on changes in economic and real estate market conditions.
The evaluation is comprised of specific and pooled components. The specific component is the Company’s evaluation of credit loss on individually evaluated loans based on the fair value of the collateral less estimated selling costs if collateral dependent or based on the present value of expected future cash flows discounted at the loan's initial effective interest rate if not collateral dependent. The majority of the Company’s loans subject to individual evaluation are considered collateral dependent. All other loans are evaluated collectively for credit loss by pooling loans based on similar risk characteristics.
As a significant percentage of the Company’s loan portfolio is collateralized by real estate, appraisals of the underlying value of property securing loans are critical in determining the charge-offs for specific loans. Assumptions are instrumental in determining the value of properties. Overly optimistic assumptions or negative changes to assumptions could significantly affect the valuation of a property securing a loan and the related allowance determined. Management carefully reviews the assumptions supporting such appraisals to determine that the resulting values reasonably reflect amounts realizable on the related loans.
The pooled component of the evaluation is determined by applying reasonable and supportable economic forecasts and historical averages to the remaining loans segmented by similar risk characteristics. The key assumptions used in projecting future loss rates include the economic forecast, the forecast and reversion to mean time periods, and prepayment and curtailment assumptions. The assumptions are used to calculate and aggregate estimated cash flows for the time period that remains in each loan's contractual life. The cash flows are discounted back to the balance sheet date using each loan's effective yield, to arrive at a present value of future cash flows, which is compared to the amortized cost basis of the loan pool to determine the amount of allowance for credit loss required by the calculation.
One of the most significant judgments used in projecting loss rates when estimating the allowance for credit loss is the macro-economic forecasts provided by a third party. The economic indices sourced from the macro-economic forecast and used in projecting loss rates are national unemployment rate, national gross domestic product and changes in home values. The economic index used in the calculation to which the calculation is most sensitive is the national unemployment rate and gross domestic product. Changes in the macro-economic forecast, especially for the national unemployment rate and gross domestic product, could significantly impact the calculated estimated credit losses between reporting periods.
Other key assumptions in the calculation of the allowance for credit loss include the forecast and reversion to mean time periods and prepayment and curtailment assumptions. The macro-economic forecast is applied for a reasonable and supportable time period before reverting to long-term historical averages for each economic index. The forecast and reversion to mean time period used for each economic index at December 31, 2023 were four quarters and eight quarters, respectively. Prepayment and curtailment assumptions are based on the Company’s historical experience over the trailing 12 months and are adjusted by management as deemed necessary. The prepayment and curtailment assumptions vary based on segment.
The quantitative estimated losses are supplemented by more qualitative factors that impact potential losses. Qualitative factors include changes in underwriting standards, changes in environmental conditions, delinquency level, segment growth rates and changes in duration within new markets, or other relevant factors. The allowance for credit loss may be materially affected by these qualitative factors, especially during periods of economic uncertainty, for items not reflected in the lifetime credit loss calculation, but which are deemed appropriate by management's current assessment of the risks related to the loan portfolio and/or external factors. The qualitative factors applied at December 31, 2023, and the importance and levels of the qualitative factors applied, may change in future periods depending on the level of changes to items such as the uncertainty of economic conditions and management's assessment of the level of credit risk within the loan portfolio as a result of such changes, compared to the amount of allowance for credit loss calculated by the model. The evaluation of qualitative factors is inherently imprecise and requires significant management judgment.
While management utilizes its best judgment and information available, the adequacy of the allowance for credit loss is determined by certain factors outside of the Company’s control, such as the performance of the Company’s portfolios, changes in the economic environment including economic uncertainty, changes in interest rates, and the view of the regulatory authorities toward classification of assets and the level of allowance for credit loss. Additionally, the level of allowance for credit loss may fluctuate based on the balance and mix of the loan portfolio. If actual results differ significantly from management's assumptions, the Company’s allowance for credit loss may not be sufficient to cover inherent losses in the Company’s loan portfolio, resulting in additions to the Company’s allowance for credit loss and an increase in the provision for credit losses.
Goodwill and Other Intangible Assets
As discussed in Note 1 of the consolidated financial statements, the Company performs an evaluation of goodwill for impairment on an annual basis, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The Company performed a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying value. Based on the fair value of the reporting unit, no impairment of goodwill was recognized in 2023, 2022 or 2021.
Business combinations are accounted for by applying the acquisition method. As of acquisition date, the identifiable assets acquired and liabilities assumed are measured at fair value and recognized separately from goodwill. Results of operations of the acquired entities are included in the consolidated statement of income from the date of acquisition. The calculation of intangible assets including core deposits and the fair value of loans are based on significant judgements. Core deposits intangibles are calculated using a discounted cash flow model based on various factors including discount rate, attrition rate, interest rate, cost of alternative funds and net maintenance costs.
Loans acquired in connection with acquisitions are recorded at their acquisition-date fair value. Determining the fair value of the acquired loans involves estimating the principal and interest cash flows expected to be collected on the loans and discounting those cash flows at a market rate of interest. Management considers a number of factors in evaluating the acquisition-date fair value including the remaining life of the acquired loans, delinquency status, estimated prepayments, payment options and other loan features, internal risk grade, estimated value of the underlying collateral and interest rate environment.
ITEM 7A – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
This information is included under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Interest Rate and Market Risk Management”, appearing in this Annual Report on Form 10-K.
