NBT BANCORP INC. AND SUBSIDIARIES
| ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The purpose of this discussion and analysis is to provide a concise description of the consolidated financial condition and results of operations of NBT Bancorp Inc. (“NBT”) and its wholly-owned subsidiaries, including NBT Bank, National Association (the “Bank”), NBT Financial Services, Inc. (“NBT Financial”) and NBT Holdings, Inc. (“NBT Holdings”) (collectively referred to herein as the “Company”). This discussion will focus on results of operations, financial condition, capital resources and asset/liability management. Reference should be made to the Company’s consolidated financial statements and footnotes thereto included in this Form 10‑Q as well as to the Company’s Annual Report on Form 10‑K for the year ended December 31, 2022 for an understanding of the following discussion and analysis. Operating results for the three month period ending March 31, 2023 are not necessarily indicative of the results of the full year ending December 31, 2023 or any future period.
Forward-Looking Statements
Certain statements in this filing and future filings by the Company with the Securities and Exchange Commission (“SEC”), in the Company’s press releases or other public or stockholder communications or in oral statements made with the approval of an authorized executive officer, contain forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995. These statements may be identified by the use of phrases such as “anticipate,” “believe,” “expect,” “forecasts,” “projects,” “will,” “can,” “would,” “should,” “could,” “may,” or other similar terms. There are a number of factors, many of which are beyond the Company’s control, that could cause actual results to differ materially from those contemplated by the forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following possibilities: (1) local, regional, national and international economic conditions, including actual or potential stress in the banking industry, and the impact they may have on the Company and its customers and the Company’s assessment of that impact; (2) changes in the level of nonperforming assets and charge-offs; (3) changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements; (4) the effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board (“FRB”); (5) inflation, interest rate, securities market and monetary fluctuations; (6) political instability; (7) acts of war, including international military conflicts, or terrorism; (8) the timely development and acceptance of new products and services and the perceived overall value of these products and services by users; (9) changes in consumer spending, borrowing and saving habits; (10) changes in the financial performance and/or condition of the Company’s borrowers; (11) technological changes; (12) acquisition and integration of acquired businesses; (13) the ability to increase market share and control expenses; (14) changes in the competitive environment among financial holding companies; (15) the effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which the Company and its subsidiaries must comply, including those under the Dodd-Frank Act, Economic Growth, Regulatory Relief, Consumer Protection Act of 2018, Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), and other legislative and regulatory responses to the coronavirus (“COVID-19”) pandemic; (16) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters; (17) changes in the Company’s organization, compensation and benefit plans; (18) the costs and effects of legal and regulatory developments, including the resolution of legal proceedings or regulatory or other governmental inquiries, and the results of regulatory examinations or reviews; (19) greater than expected costs or difficulties related to the integration of new products and lines of business; (20) the adverse impact on the U.S. economy, including the markets in which we operate, of the COVID-19 global pandemic or other public health crises; and (21) the Company’s success at managing the risks involved in the foregoing items.
The Company cautions readers not to place undue reliance on any forward-looking statements, which speak only as of the date made, and advises readers that various factors, including, but not limited to, those described above and other factors discussed in the Company’s annual and quarterly reports previously filed with the SEC, could affect the Company’s financial performance and could cause the Company’s actual results or circumstances for future periods to differ materially from those anticipated or projected.
Unless required by law, the Company does not undertake, and specifically disclaims any obligations to, publicly release any revisions that may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.
Non-GAAP Measures
This Quarterly Report on Form 10-Q contains financial information determined by methods other than in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Where non-GAAP disclosures are used in this Form 10-Q, the comparable GAAP measure, as well as a reconciliation to the comparable GAAP measure, is provided in the accompanying tables. Management believes that these non-GAAP measures provide useful information that is important to an understanding of the results of the Company’s core business as well as provide information standard in the financial institution industry. Non-GAAP measures should not be considered a substitute for financial measures determined in accordance with GAAP and investors should consider the Company’s performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the Company. Amounts previously reported in the consolidated financial statements are reclassified whenever necessary to conform to current period presentation.
Critical Accounting Estimates
SEC guidance requires disclosure of “critical accounting estimates.” The SEC defines “critical accounting estimates” as those estimates made in accordance with GAAP that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the financial condition or results of operations of the registrant. The Company follows financial accounting and reporting policies that are in accordance with GAAP. The more significant of these policies are summarized in Note 1 to the consolidated financial statements presented in our 2022 Annual Report on Form 10-K. Refer to Note 3 in this Quarterly Report on Form 10-Q for recently adopted accounting standards. Not all significant accounting policies require management to make difficult, subjective or complex judgments. The allowance for credit losses and the allowance for unfunded commitments policies noted below are deemed to meet the SEC’s definition of a critical accounting estimate.
The allowance for credit losses consists of the allowance for credit losses and the allowance for losses on unfunded commitments. The measurement of Current Expensed Credit Losses (“CECL”) on financial instruments requires an estimate of the credit losses expected over the life of an exposure (or pool of exposures). The estimate of expected credit losses under the CECL approach is based on relevant information about past events, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amounts. Historical loss experience is generally the starting point for estimating expected credit losses. The Company then considers whether the historical loss experience should be adjusted for asset-specific risk characteristics or current conditions at the reporting date that did not exist over the period from which historical experience was used. Finally, the Company considers forecasts about future economic conditions that are reasonable and supportable. The allowance for credit losses for loans, as reported in our consolidated statements of financial condition, is adjusted by an expense for credit losses, which is recognized in earnings, and reduced by the charge-off of loan amounts, net of recoveries. The allowance for losses on unfunded commitments represents the expected credit losses on off-balance sheet commitments such as unfunded commitments to extend credit and standby letters of credit. However, a liability is not recognized for commitments unconditionally cancellable by the Company. The allowance for losses on unfunded commitments is determined by estimating future draws and applying the expected loss rates on those draws.
Management of the Company considers the accounting policy relating to the allowance for credit losses to be a critical accounting estimate given the uncertainty in evaluating the level of the allowance required to cover management’s estimate of all expected credit losses over the expected contractual life of our loan portfolio. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the then-existing loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance for credit losses in those future periods. While management’s current evaluation of the allowance for credit losses indicates that the allowance is appropriate, the allowance may need to be increased under adversely different conditions or assumptions. Going forward, the impact of utilizing the CECL approach to calculate the reserve for credit losses will be significantly influenced by the composition, characteristics and quality of our loan portfolio, as well as the prevailing economic conditions and forecasts utilized. Material changes to these and other relevant factors may result in greater volatility to the reserve for credit losses, and therefore, greater volatility to our reported earnings.
One of the most significant judgments involved in estimating the Company’s allowance for credit losses relates to the macroeconomic forecasts used to estimate expected credit losses over the forecast period. As of March 31, 2023, the model incorporated a baseline economic outlook along with an alternative downside scenario, which were equally weighted. The baseline outlook reflected an unemployment rate environment below pre-COVID-19 levels throughout much of the forecast period. Northeast GDP’s annualized growth (on a quarterly basis) is expected to start the second quarter of 2023 at approximately 3.9% and rise to 4.4% before falling slightly to 4.1% by the end of the forecast period. The alternative downside scenario assumed northeast unemployment rises from 3.7% in the first quarter of 2023 to a peak of 7.1% in the second quarter of 2024. These scenarios and their respective weightings are evaluated at each measurement date and reflect management’s expectations as of March 31, 2023. All else held equal, the changes in the weightings of our forecasted scenarios would impact the amount of estimated allowance for credit losses through changes in the quantitative reserve and scenario-specific qualitative adjustments. To demonstrate the sensitivity of the allowance for credit losses estimate to macroeconomic forecast weightings assumptions as of March 31, 2023, the Company increased the downside scenario weighting by 10% to 60% and decreased the baseline scenario to 40% weighting which resulted in a 3% increase in the overall estimated allowance for credit losses. To further demonstrate the sensitivity of the allowance for credit losses estimate to macroeconomic forecast weightings assumptions as of March 31, 2023, the Company increased the downside scenario to 100% which resulted in a 17% increase in the overall estimated allowance for credit losses.
The Company’s policies on the CECL method for allowance for credit losses are disclosed in Note 1 to the consolidated financial statements presented in our 2022 Annual Report on Form 10-K. All accounting policies are important and as such, the Company encourages the reader to review each of the policies included in Note 1 to the consolidated financial statements presented in our 2022 Annual Report on Form 10-K to obtain a better understanding of how the Company’s financial performance is reported. Refer to Note 3 to the unaudited interim consolidated financial statements in this Quarterly Report on Form 10-Q for recently adopted accounting standards.
Overview
Significant factors management reviews to evaluate the Company’s operating results and financial condition include, but are not limited to: net income and earnings per share, return on average assets and equity, net interest margin, noninterest income, operating expenses, asset quality indicators, loan and deposit growth, capital management, liquidity and interest rate sensitivity, enhancements to customer products and services, technology advancements, market share and peer comparisons. The following information should be considered in connection with the Company’s results for the three months ended March 31, 2023:
| ● | net income of $33.7 million, or $0.78 diluted earnings per share; |
| ● | noninterest income, excluding securities losses, was $36.4 million, up $2.1 million, or 6.1% from the fourth quarter of 2022 and down $6.4 million, or 15.0% from the first quarter of 2022; represents 28% of total revenues; |
| ● | noninterest expense, excluding $0.6 million of acquisition expenses in the first quarter of 2023 and $1.0 million in the fourth quarter of 2022, was comparable to the previous quarter and up 9.1% from the first quarter of 2022; |
| ● | period end loans were $8.26 billion, up 5.7%, annualized, from December 31, 2022; |
| ● | credit quality metrics including net charge-offs to average loans of 0.19%, annualized, and allowance for loan losses to total loans at 1.21%; |
| ● | period end deposits were $9.68 billion, up 2.0% from December 31, 2022; |
| ● | book value per share of $28.24 at March 31, 2023; tangible book value per share(1) was $21.52 at March 31, 2023, $20.65 at December 31, 2022 and $21.25 at March 31, 2022; |
| ● | the Company incurred a $5.0 million securities loss on the write-off of a subordinated debt security of a failed bank. |
| (1) | Non-GAAP measure - Refer to non-GAAP reconciliation below. |
Results of Operations
Net income for the three months ended March 31, 2023 was $33.7 million, or $0.78 per diluted common share, down $2.5 million from $36.1 million, or $0.84 per diluted common share for the three months ended December 31, 2022 and down $5.5 million from $39.1 million, or $0.90 per diluted common share for the first quarter of 2022.
| ● | Net interest income for the three months ended March 31, 2023 was $95.1 million, down $4.7 million, or 4.7% from the fourth quarter of 2022 and up $14.7 million, or 18.3%, from the first quarter of 2022, primarily due to higher yields on earning assets due to increases in the Federal Reserve’s targeted Federal Funds rate as well as the new loan volume pricing, which was partially offset by the higher cost of interest-bearing liabilities. The first quarter of 2022 also included $2.0 million ($0.04 per diluted share) of income from the Paycheck Protection Program (“PPP”). |
| ● | The Company recorded a provision for loan losses of $3.9 million ($0.07 per diluted share) for the three months ended March 31, 2023, compared to $0.6 million ($0.01 per diluted share) in the first quarter of 2022 and $7.7 million ($0.14 per diluted share) in the fourth quarter of 2022. |
| ● | Card services income was comparable to the three months ended December 31, 2022 and approximately $4.0 million ($0.07 per diluted share) lower than the first quarter of 2022 driven by the impact of the statutory price cap provisions of the Durbin Amendment to the Dodd-Frank Act (“Durbin Amendment”). |
| ● | The Company incurred acquisition expenses of $0.6 million ($0.01 per diluted share) and $1.0 million ($0.02 per diluted share) related to the pending merger with Salisbury Bancorp, Inc. (“Salisbury”) in the first quarter of 2023 and the fourth quarter of 2022, respectively. |
The following table sets forth certain financial highlights:
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Diluted earnings per share | | | | | | | | | | | | |
Return on average assets(2) | | | | | | | | | | | | |
Return on average equity(2) | | | | | | | | | | | | |
Return on average tangible common equity(2) | | | | | | | | | | | | |
Net interest margin, fully taxable equivalent (“FTE”)(2) | | | | | | | | | | | | |
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Tangible book value per share | | | | | | | | | | | | |
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Common equity tier 1 capital ratio | | | | | | | | | | | | |
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Total risk-based capital ratio | | | | | | | | | | | | |
The following tables provide non-GAAP reconciliations:
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(In thousands, except per share data) | | | | | | | | | |
Return on average tangible common equity: | | | | | | | | | |
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Amortization of intangible assets (net of tax) | | | | | | | | | | | | |
Net income, excluding intangible amortization | | | | | | | | | | | | |
Average stockholders’ equity | | | | | | | | | | | | |
Less: average goodwill and other intangibles | | | | | | | | | | | | |
Average tangible common equity | | | | | | | | | | | | |
Return on average tangible common equity(2) | | | | | | | | | | | | |
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Tangible book value per share: | | | | | | | | | | | | |
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Diluted common shares outstanding | | | | | | | | | | | | |
Tangible book value per share | | | | | | | | | | | | |
Net Interest Income
Net interest income is the difference between interest income on earning assets, primarily loans and securities and interest expense on interest-bearing liabilities, primarily deposits and borrowings. Net interest income is affected by the interest rate spread, the difference between the yield on interest-earning assets and cost of interest-bearing liabilities, as well as the volumes of such assets and liabilities. Net interest income is one of the key determining factors in a financial institution’s performance as it is the principal source of earnings.
Net interest income was $95.1 million for the first quarter of 2023, down $4.7 million, or 4.7%, from the previous quarter, and included two less days in the first quarter of 2023 compared to the fourth quarter of 2022. The FTE net interest margin was 3.55% for the three months ended March 31, 2023, a decrease of 13 basis points (“bps”) from the previous quarter. Interest income increased $5.0 million, or 4.6%, as the yield on average interest-earning assets increased 24 bps from the prior quarter to 4.26%, while average interest-earning assets of $10.91 billion increased $108.8 million from the prior quarter, primarily due to an increase in average loans partially offset by a decrease in investment securities. Interest expense was up $9.7 million, or 103.6%, as the cost of interest-bearing liabilities increased 57 bps to 1.14% for the quarter ended March 31, 2023, driven by interest-bearing deposit costs increasing 47 bps, as well as higher balances in short-term borrowings and the rates paid on those borrowings.
Net interest income was $95.1 million for the first quarter of 2023, up $14.7 million, or 18.3%, from the first quarter of 2022. The first quarter of 2022 included $2.0 million of PPP loan interest and fees recognized into interest income. The FTE net interest margin was 3.55% for the three months ended March 31, 2023, an increase of 60 bps from the first quarter of 2022. Interest income increased $30.1 million, or 35.6%, as the yield on average interest-earning assets increased 117 bps from the same period in 2022 to 4.26%, while average interest-earning assets decreased $179.2 million, or 1.6%, from the first quarter of 2022, primarily due to a decrease in excess liquidity was partially offset by an increase in loans and investment securities. Interest expense increased $15.3 million, or 396.4%, as the cost of interest-bearing liabilities increased 91 bps to 1.14% for the quarter ended March 31, 2023, driven by interest-bearing deposit costs increasing 63 bps, as well as higher balances in short-term borrowings and the rates paid on those borrowings.
Average Balances and Net Interest Income
The following tables include the condensed consolidated average balance sheet, an analysis of interest income/expense and average yield/rate for each major category of earning assets and interest-bearing liabilities on a taxable equivalent basis.
| Three Months Ended | | March 31, 2023 | | | December 31, 2022 |
| | March 31, 2022 | |
| (Dollars in thousands) | | Average Balance | | | Interest | | | Yield/ Rates | | | Average Balance | | | Interest | | | Yield/ Rates | | | Average Balance | | | Interest | | | Yield/ Rates | |
| Assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Short-term interest-bearing accounts | | $ | 34,215 | | | $ | 191 | | | | 2.26 | % | | $ | 39,573 | | | $ | 330 | | | | 3.31 | % | | $ | 990,319 | | | $ | 403 | | | | 0.17 | % |
Securities taxable(1) | | | 2,442,732 | | | | 11,543 | | | | 1.92 | % | | | 2,480,959 | | | | 11,770 | | | | 1.88 | % | | | 2,284,578 | | | | 9,407 | | | | 1.67 | % |
Securities tax-exempt(1) (3) | | | 202,321 | | | | 1,402 | | | | 2.81 | % | | | 208,238 | | | | 1,406 | | | | 2.68 | % | | | 258,513 | | | | 1,172 | | | | 1.84 | % |
| Federal Reserve Bank and FHLB stock | | | 41,144 | | | | 451 | | | | 4.45 | % | | | 32,903 | | | | 341 | | | | 4.11 | % | | | 25,026 | | | | 122 | | | | 1.98 | % |
Loans(2) (3) | | | 8,189,520 | | | | 101,000 | | | | 5.00 | % | | | 8,039,442 | | | | 95,717 | | | | 4.72 | % | | | 7,530,674 | | | | 73,382 | | | | 3.95 | % |
| Total interest-earning assets | | $ | 10,909,932 | | | $ | 114,587 | | | | 4.26 | % | | $ | 10,801,115 | | | $ | 109,564 | | | | 4.02 | % | | $ | 11,089,110 | | | $ | 84,486 | | | | 3.09 | % |
| Other assets | | | 836,879 | | | | | | | | | | | | 855,410 | | | | | | | | | | | | 947,578 | | | | | | | | | |
| Total assets | | $ | 11,746,811 | | | | | | | | | | | $ | 11,656,525 | | | | | | | | | | | $ | 12,036,688 | | | | | | | | | |
| Liabilities and stockholders’ equity: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Money market deposit accounts | | $ | 2,081,210 | | | $ | 6,264 | | | | 1.22 | % | | $ | 2,169,192 | | | $ | 2,153 | | | | 0.39 | % | | $ | 2,720,338 | | | $ | 1,022 | | | | 0.15 | % |
| NOW deposit accounts | | | 1,598,834 | | | | 1,433 | | | | 0.36 | % | | | 1,604,096 | | | | 1,341 | | | | 0.33 | % | | | 1,583,091 | | | | 192 | | | | 0.05 | % |
| Savings deposits | | | 1,781,465 | | | | 142 | | | | 0.03 | % | | | 1,823,056 | | | | 150 | | | | 0.03 | % | | | 1,794,549 | | | | 143 | | | | 0.03 | % |
| Time deposits | | | 639,645 | | | | 3,305 | | | | 2.10 | % | | | 432,110 | | | | 448 | | | | 0.41 | % | | | 494,632 | | | | 485 | | | | 0.40 | % |
| Total interest-bearing deposits | | $ | 6,101,154 | | | $ | 11,144 | | | | 0.74 | % | | $ | 6,028,454 | | | $ | 4,092 | | | | 0.27 | % | | $ | 6,592,610 | | | $ | 1,842 | | | | 0.11 | % |
| Federal funds purchased | | | 44,334 | | | | 538 | | | | 4.92 | % | | | 56,576 | | | | 575 | | | | 4.03 | % | | | - | | | | - | | | | - | |
| Repurchase agreements | | | 71,340 | | | | 14 | | | | 0.08 | % | | | 76,334 | | | | 21 | | | | 0.11 | % | | | 72,768 | | | | 16 | | | | 0.09 | % |
| Short-term borrowings | | | 357,200 | | | | 4,367 | | | | 4.96 | % | | | 177,533 | | | | 1,914 | | | | 4.28 | % | | | - | | | | - | | | | - | |
| Long-term debt | | | 7,299 | | | | 47 | | | | 2.61 | % | | | 3,817 | | | | 21 | | | | 2.18 | % | | | 13,979 | | | | 87 | | | | 2.52 | % |
| Subordinated debt, net | | | 96,966 | | | | 1,334 | | | | 5.58 | % | | | 97,839 | | | | 1,346 | | | | 5.46 | % | | | 98,531 | | | | 1,359 | | | | 5.59 | % |
| Junior subordinated debt | | | 101,196 | | | | 1,682 | | | | 6.74 | % | | | 101,196 | | | | 1,424 | | | | 5.58 | % | | | 101,196 | | | | 549 | | | | 2.20 | % |
| Total interest-bearing liabilities | | $ | 6,779,489 | | | $ | 19,126 | | | | 1.14 | % | | $ | 6,541,749 | | | $ | 9,393 | | | | 0.57 | % | | $ | 6,879,084 | | | $ | 3,853 | | | | 0.23 | % |
| Demand deposits | | | 3,502,489 | | | | | | | | | | | | 3,658,965 | | | | | | | | | | | | 3,710,124 | | | | | | | | | |
| Other liabilities | | | 274,517 | | | | | | | | | | | | 290,895 | | | | | | | | | | | | 206,292 | | | | | | | | | |
| Stockholders’ equity | | | 1,190,316 | | | | | | | | | | | | 1,164,916 | | | | | | | | | | | | 1,241,188 | | | | | | | | | |
| Total liabilities and stockholders’ equity | | $ | 11,746,811 | | | | | | | | | | | $ | 11,656,525 | | | | | | | | | | | $ | 12,036,688 | | | | | | | | | |
| Net interest income (FTE) | | | | | | $ | 95,461 | | | | | | | | | | | $ | 100,171 | | | | | | | | | | | $ | 80,633 | | | | | |
| Interest rate spread | | | | | | | | | | | 3.12 | % | | | | | | | | | | | 3.45 | % | | | | | | | | | | | 2.86 | % |
| Net interest margin (FTE) | | | | | | | | | | | 3.55 | % | | | | | | | | | | | 3.68 | % | | | | | | | | | | | 2.95 | % |
| Taxable equivalent adjustment | | | | | | $ | 395 | | | | | | | | | | | $ | 392 | | | | | | | | | | | $ | 285 | | | | | |
| Net interest income | | | | | | $ | 95,066 | | | | | | | | | | | $ | 99,779 | | | | | | | | | | | $ | 80,348 | | | | | |
| (1) | Securities are shown at average amortized cost. |
| (2) | For purposes of these computations, nonaccrual loans and loans held for sale are included in the average loan balances outstanding. |
| (3) | Interest income for tax-exempt securities and loans have been adjusted to an FTE basis using the statutory Federal income tax rate of 21%. |
The following table presents changes in interest income and interest expense attributable to changes in volume (change in average balance multiplied by prior year rate), changes in rate (change in rate multiplied by prior year volume) and the net change in net interest income. The net change attributable to the combined impact of volume and rate has been allocated to each in proportion to the absolute dollar amounts of change.
| Three Months Ended March 31, | | Increase (Decrease) 2023 over 2022 | |
| (In thousands) | | Volume | | | Rate | | | Total | |
| Short-term interest-bearing accounts | | $ | (738 | ) | | $ | 526 | | | $ | (212 | )
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| Securities taxable | | | 682 | | | | 1,454 | | | | 2,136 | |
| Securities tax-exempt | | | (294 | ) | | | 524 | | | | 230 | |
| Federal Reserve Bank and FHLB stock | | | 112 | | | | 217 | | | | 329 | |
| Loans | | | 6,843 | | | | 20,775 | | | | 27,618 | |
| Total FTE interest income | | $ | 6,605 | | | $ | 23,496 | | | $ | 30,101 | |
| Money market deposit accounts | | $ | (295 | ) | | $ | 5,537 | | | $ | 5,242 | |
| NOW deposit accounts | | | 2 | | | | 1,239 | | | | 1,241 | |
| Savings deposits | | | (1 | ) | | | - | | | | (1 | )
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| Time deposits | | | 181 | | | | 2,639 | | | | 2,820 | |
| Federal funds purchased | | | 538 | | | | - | | | | 538 | |
| Repurchase agreements | | | - | | | | (2 | ) | | | (2 | )
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| Short-term borrowings | | | 4,367 | | | | - | | | | 4,367 | |
| Long-term debt | | | (43 | ) | | | 3 | | | | (40 | )
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| Subordinated debt, net | | | (22 | ) | | | (3 | ) | | | (25 | )
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| Junior subordinated debt | | | - | | | | 1,133 | | | | 1,133 | |
| Total FTE interest expense | | $ | 4,727 | | | $ | 10,546 | | | $ | 15,273 | |
| Change in FTE net interest income | | $ | 1,878 | | | $ | 12,950 | | | $ | 14,828 | |
Noninterest Income
Noninterest income is a significant source of revenue for the Company and an important factor in the Company’s results of operations. The following table sets forth information by category of noninterest income for the periods indicated:
| | | Three Months Ended March 31, | |
| (In thousands) | | 2023 | | | 2022 | |
| Service charges on deposit accounts | | $ | 3,548 | | | $ | 3,688 | |
| Card services income | | | 4,845 | | | | 8,695 | |
| Retirement plan administration fees | | | 11,462 | | | | 13,279 | |
| Wealth management | | | 8,087 | | | | 8,640 | |
| Insurance services | | | 3,931 | | | | 3,788 | |
| Bank owned life insurance income | | | 1,878 | | | | 1,654 | |
| Net securities (losses) | | | (4,998 | ) | | | (179 | )
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| Other | | | 2,656 | | | | 3,094 | |
| Total noninterest income | | $ | 31,409 | | | $ | 42,659 | |
Noninterest income for the three months ended March 31, 2023 was $31.4 million, down $2.7 million, or 7.9%, from the fourth quarter of 2022 and down $11.3 million, or 26.4%, from the first quarter of 2022. During the three months ended March 31, 2023, the Company incurred a $5.0 million securities loss on the write-off of a subordinated debt security of a failed bank. Excluding net securities losses, noninterest income for the three months ended March 31, 2023 was $36.4 million, up $2.1 million, or 6.1% from the prior quarter and down $6.4 million, or 15.0% from the first quarter of 2022. The increase from the prior quarter was primarily driven by an increase in retirement plan administration fees driven by seasonal revenues. The decrease from the first quarter of 2022 was driven by lower card services income from the impact of the statutory price cap provisions of the Durbin Amendment of approximately $4.0 million. In addition, the decrease from the prior year was impacted by lower retirement plan administration fees driven by unfavorable market performance and a decrease in certain activity-based fees along with a decrease in wealth management fees driven primarily by a decline in market performance.
Noninterest Expense
Noninterest expenses are also an important factor in the Company’s results of operations. The following table sets forth the major components of noninterest expense for the periods indicated:
| | | Three Months Ended March 31, | |
| (In thousands) | | 2023 | | | 2022 | |
| Salaries and employee benefits | | $ | 48,155 | | | $ | 45,508 | |
| Technology and data services | | | 9,007 | | | | 8,547 | |
| Occupancy | | | 7,220 | | | | 6,793 | |
| Professional fees and outside services | | | 4,178 | | | | 4,276 | |
| Office supplies and postage | | | 1,628 | | | | 1,424 | |
| FDIC assessment | | | 1,396 | | | | 802 | |
| Advertising | | | 649 | | | | 654 | |
| Amortization of intangible assets | | | 536 | | | | 636 | |
| Loan collection and other real estate owned, net | | | 855 | | | | 384 | |
| Acquisition expenses | | | 618 | | | | - | |
| Other | | | 5,080 | | | | 3,119 | |
| Total noninterest expense | | $ | 79,322 | | | $ | 72,143 | |
Noninterest expense for the three months ended March 31, 2023 was $79.3 million, down $0.2 million, or 0.2%, from the prior quarter and up $7.2 million, or 10.0%, from the first quarter of 2022. The Company incurred acquisition expenses of $0.6 million and $1.0 million related to the pending merger with Salisbury in the first quarter of 2023 and the fourth quarter of 2022, respectively. Excluding acquisition expenses, noninterest expense for the three months ended March 31, 2023 was $78.7 million, up $0.2 million, or 0.2%, from the prior quarter and up $6.6 million, or 9.1%, from the first quarter of 2022. The increase from the prior quarter was primarily driven by higher salaries and employee benefits due to seasonally higher payroll taxes, seasonally higher stock-based compensation expenses and merit pay increases. In addition, the increase in occupancy costs was due to seasonal costs including utility expenses and the increase in FDIC assessment expense was due to the statutory increase in the FDIC assessment rate. The increase from the prior quarter was partially offset by lower professional fees and outside services driven by seasonal expenses and timing of external services for several tactical and strategic initiatives incurred in the prior quarter and other expenses declined from the seasonally higher linked fourth quarter of 2022. The increase from the first quarter of 2022 was driven by increased salaries and wages, including merit pay increases, higher benefit plan expenses and staff additions. In addition, the increase in technology and data services was due to continued investment in digital platform solutions, the increase in FDIC assessment expense was driven by the statutory increase in the FDIC assessment rate, and other expenses were higher due to the increase in actuarially determined expenses related to the Company’s retirement plans and higher travel and training expenses due to increased activity compared to the pandemic-impacted first quarter of 2022.
Income Taxes
Income tax expense for the three months ended March 31, 2023 was $9.6 million, down $1.0 million from the prior quarter and down $1.6 million from the first quarter of 2022. The effective tax rate was 22.2% for the first quarter of 2023 compared to 22.6% for the fourth quarter of 2022 and 22.2% for the first quarter of 2022.
ANALYSIS OF FINANCIAL CONDITION
Securities
Total securities decreased $25.9 million, or 1.0%, from December 31, 2022 to March 31, 2023. The securities portfolio represents 20.7% of total assets as of March 31, 2023 as compared to 21.1% of total assets as of December 31, 2022.
The following table details the composition of securities available for sale, securities held to maturity and equity securities for the periods indicated:
| | | March 31, 2023 | | | December 31, 2022 | |
| Mortgage-backed securities: | | | | | | |
| With maturities 15 years or less | | | 13 | % | | | 13 | % |
| With maturities greater than 15 years | | | 11 | % | | | 11 | % |
| Collateral mortgage obligations | | | 37 | % | | | 37 | % |
| Municipal securities | | | 15 | % | | | 15 | % |
| U.S. agency notes | | | 21 | % | | | 21 | % |
| Corporate | | | 2 | % | | | 2 | % |
| Equity securities | | | 1 | % | | | 1 | % |
| Total | | | 100 | % | | | 100 | % |
The Company’s mortgage-backed securities, U.S. agency notes and collateralized mortgage obligations are all guaranteed by Fannie Mae, Freddie Mac, the Federal Home Loan Bank, Federal Farm Credit Banks or Ginnie Mae (“GNMA”). GNMA securities are considered similar in credit quality to U.S. Treasury securities, as they are backed by the full faith and credit of the U.S. government. Currently, there are no subprime mortgages in our investment portfolio.
Loans
A summary of the loan portfolio by major categories(1), net of deferred fees and origination costs, for the periods indicated follows:
| (In thousands) | | March 31, 2023 | | | December 31, 2022 | |
Commercial & industrial | | $ | 1,278,291 | | | $ | 1,266,031 | |
Commercial real estate | | | 2,845,631 | | | | 2,807,941 | |
| Residential real estate | | | 1,651,918 | | | | 1,649,870 | |
| Indirect auto | | | 1,031,315 | | | | 989,587 | |
| Residential solar | | | 920,084 | | | | 856,798 | |
| Home equity | | | 308,219 | | | | 314,124 | |
| Other consumer | | | 229,120 | | | | 265,796 | |
| Total loans | | $ | 8,264,578 | | | $ | 8,150,147 | |
| (1) | Loans are summarized by business line which do not align to how the Company assesses credit risk in the estimate for credit losses under CECL. |
Total loans increased by $114.4 million, or 5.7% annualized, from December 31, 2022 to March 31, 2023. Commercial and industrial loans increased $12.3 million to $1.28 billion; commercial real estate loans increased $37.7 million to $2.85 billion; and total consumer loans increased $64.5 million to $4.14 billion. Total loans represent approximately 69.8% of assets as of March 31, 2023, as compared to 69.4% as of December 31, 2022.
Allowance for Credit Losses, Provision for Loan Losses and Nonperforming Assets
Beginning January 1, 2023, the Company adopted Accounting Standards Updates (“ASU”) 2022-02 Financial Instruments - CECL Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures which resulted in an insignificant change to the Company’s methodology for estimating the allowance for credit losses on Troubled Debt Restructurings (“TDRs”) since December 31, 2022. The January 1, 2023 decrease in allowance for credit loss on TDR loans relating to adoption of ASU 2022-02 was $0.6 million, which increased retained earnings by $0.5 million and decreased the deferred tax asset by $0.1 million.
Management considers the accounting policy relating to the allowance for credit losses to be a critical estimate given the degree of judgment exercised in evaluating the level of the allowance required to estimate expected credit losses over the expected contractual life of our loan portfolio and the material effect that such judgments can have on the consolidated results of operations.
The CECL approach requires an estimate of the credit losses expected over the life of a loan (or pool of loans). The allowance for credit losses is a valuation account that is deducted from, or added to, the loans’ amortized cost basis to present the net, lifetime amount expected to be collected on the loans. Loan losses are charged off against the allowance when management believes a loan balance is confirmed to be uncollectible. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off.
Required additions or reductions to the allowance for credit losses are made periodically by charges or credits to the provision for loan losses. These are necessary to maintain the allowance at a level which management believes is reasonably reflective of the overall loss expected over the contractual life of the loan portfolio. While management uses available information to recognize losses on loans, additions or reductions to the allowance may fluctuate from one reporting period to another. These fluctuations are reflective of changes in risk associated with portfolio content and/or changes in management’s assessment of any or all of the determining factors discussed above. Management considers the allowance for credit losses to be appropriate based on evaluation and analysis of the loan portfolio.
Management estimates the allowance balance for credit losses using relevant available information, from internal and external sources, related to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Company historical loss experience was supplemented with peer information when there was insufficient loss data for the Company. Significant management judgment is required at each point in the measurement process.
The allowance for credit losses is measured on a collective (pool) basis, with both a quantitative and qualitative analysis that is applied on a quarterly basis, when similar risk characteristics exist. The respective quantitative allowance for each segment is measured using an econometric, discounted probability of default and loss given default modeling methodology in which distinct, segment-specific multi-variate regression models are applied to multiple, probabilistically weighted external economic forecasts. Under the discounted cash flows methodology, expected credit losses are estimated over the effective life of the loans by measuring the difference between the net present value of modeled cash flows and amortized cost basis. After quantitative considerations, management applies additional qualitative adjustments so that the allowance for credit loss is reflective of the estimate of lifetime losses that exist in the loan portfolio at the balance sheet date.
Portfolio segment is defined as the level at which an entity develops and documents a systematic methodology to determine its allowance for credit losses. Upon adoption of CECL, management revised the manner in which loans were pooled for similar risk characteristics. Management developed segments for estimating loss based on type of borrower and collateral which is generally based upon federal call report segmentation and have been combined or subsegmented as needed to ensure loans of similar risk profiles are appropriately pooled.
Additional information about our Allowance for Loan Losses is included in Note 5 to the consolidated financial statements. The Company’s management considers the allowance for credit losses to be appropriate based on evaluation and analysis of the loan portfolio.
The allowance for credit losses totaled $100.3 million at March 31, 2023, compared to $100.8 million at December 31, 2022 and $90.0 million at March 31, 2022. The allowance for credit losses as a percentage of loans was 1.21% at March 31, 2023, compared to 1.24% at December 31, 2022 and 1.18% at March 31, 2022. The allowance for credit losses was 538.63% of nonperforming loans at March 31, 2023, compared to 478.72% at December 31, 2022 and 324.25% at March 31, 2022. The allowance for credit losses was 615.63% of nonaccrual loans at March 31, 2023, compared to 584.92% of nonaccrual loans at December 31, 2022 and 348.68% at March 31, 2022. The decrease in allowance for credit losses from December 31, 2022 compared to March 31, 2023 was primarily due to a reduction in expected net losses in the residential solar portfolios, an improvement in economic forecasts and a reduction in allowance on TDRs related to the adoption of ASU 2022-02. These decreases were partially offset by an increase in providing for the increase in loan balances and declining prepayment speeds. The increase in allowance for credit losses from March 31, 2022 to March 31, 2023 was primarily due to an increase in providing for the increase in loan balances.
The provision for loan losses was $3.9 million for three months ended March 31, 2023, compared to $7.7 million in the prior quarter and $0.6 million for the same period in the prior year. Provision expense decreased from the prior quarter due to a lower level of loan growth in the first quarter, generally stable economic forecasts and portfolio mix composition and quality. The increase in provision expense from March 31, 2022, was driven by higher net charge-offs and stable economic conditions, in contrast to improved economic conditions in the CECL forecast in the same period in the prior year. Net charge-offs totaled $3.8 million during the three months ended March 31, 2023, compared to net charge-offs of $3.7 million during the fourth quarter of 2022 and $2.6 million in the first quarter of 2022. Net charge-offs to average loans was 19 bps for the three months ended March 31, 2023, compared to 18 bps for the fourth quarter of 2022 and 14 bps for the three months ended March 31, 2022.
As of March 31, 2023, the unfunded commitment reserve totaled $4.5 million, compared to $5.1 million as of December 31, 2022 and $4.8 million as of March 31, 2022.
Nonperforming assets consist of nonaccrual loans, loans over 90 days past due and still accruing, troubled loans modifications, other real estate owned (“OREO”) and nonperforming securities. Loans are generally placed on nonaccrual when principal or interest payments become 90 days past due, unless the loan is well secured and in the process of collection. Loans may also be placed on nonaccrual when circumstances indicate that the borrower may be unable to meet the contractual principal or interest payments. The threshold for evaluating classified and nonperforming loans specifically evaluated for individual credit loss is $1.0 million. OREO represents property acquired through foreclosure and is valued at the lower of the carrying amount or fair value, less any estimated disposal costs.
| | | March 31, 2023 | | | December 31, 2022 | |
| (Dollars in thousands) | | Amount | | | % | | | Amount | | | % | |
Nonaccrual loans: | | | | | | | | | | | | |
| Commercial | | $ | 7,028 | | | | 43 | % | | $ | 7,664 | | | | 44 | % |
| Residential | | | 7,239 | | | | 45 | % | | | 4,835 | | | | 28 | % |
| Consumer | | | 1,974 | | | | 12 | % | | | 1,667 | | | | 10 | % |
| Troubled loan modifications (TDRs prior to 2023) | | | 43 | | | | 0 | % | | | 3,067 | | | | 18 | % |
| Total nonaccrual loans | | $ | 16,284 | | | | 100 | % | | $ | 17,233 | | | | 100 | % |
| | | | | | | | | | | | | | | | | |
| Loans over 90 days past due and still accruing: | | | | | | | | | | | | | | | | |
| Commercial | | $ | - | | | | - | | | $ | 4 | | | | - | |
| Residential | | | 398 | | | | 17 | % | | | 771 | | | | 20 | % |
| Consumer | | | 1,930 | | | | 83 | % | | | 3,048 | | | | 80 | % |
| Total loans over 90 days past due and still accruing | | $ | 2,328 | | | | 100 | % | | $ | 3,823 | | | | 100 | % |
| | | | | | | | | | | | | | | | | |
| Total nonperforming loans | | $ | 18,612 | | | | | | | $ | 21,056 | | | | | |
| OREO | | | 105 | | | | | | | | 105 | | | | | |
| Total nonperforming assets | | $ | 18,717 | | | | | | | $ | 21,161 | | | | | |
| | | | | | | | | | | | | | | | | |
| Total nonaccrual loans to total loans | | | 0.20 | % | | | | | | | 0.21 | % | | | | |
| Total nonperforming loans to total loans | | | 0.23 | % | | | | | | | 0.26 | % | | | | |
| Total nonperforming assets to total assets | | | 0.16 | % | | | | | | | 0.18 | % | | | | |
| Total allowance for loan losses to total nonperforming loans | | | 538.63 | % | | | | | | | 478.72 | % | | | | |
| Total allowance for loan losses to nonaccrual loans | | | 615.63 | % | | | | | | | 584.92 | % | | | | |
Total nonperforming assets were $18.7 million at March 31, 2023, compared to $21.2 million at December 31, 2022 and $27.8 million at March 31, 2022. Nonperforming loans at March 31, 2023 were $18.6 million, or 0.23% of total loans, compared with $21.1 million, or 0.26% of total loans at December 31, 2022 and $27.8 million, or 0.36% of total loans at March 31, 2022. The decrease in nonperforming loans primarily resulted from a reduction in consumer past due loans 90 days past due and still accruing and a reduction in commercial loans in nonaccrual. Total nonaccrual loans were $16.3 million or 0.20% of total loans at March 31, 2023, compared to $17.2 million or 0.21% of total loans at December 31, 2022 and $25.8 million or 0.34% of total loans at March 31, 2022. Past due loans as a percentage of total loans was 0.30% at March 31, 2023, down from 0.33% at December 31, 2022 and up from 0.24% at March 31, 2022.
In addition to nonperforming loans discussed above, the Company has also identified approximately $55.9 million in potential problem loans at March 31, 2023 as compared to $52.0 million at December 31, 2022 and $66.7 million at March 31, 2022. Potential problem loans are loans that are currently performing, with a possibility of loss if weaknesses are not corrected. Such loans may need to be disclosed as nonperforming at some time in the future. Potential problem loans are classified by the Company’s loan rating system as “substandard.” The decrease in potential problem loans from March 31, 2022 is primarily due to the improved economic conditions. Higher risk industries include entertainment, restaurants, retail, healthcare and accommodations. As of March 31, 2023, 8.4% of the Company’s outstanding loans were in higher risk industries due to the COVID-19 pandemic. Management cannot predict the extent to which economic conditions may worsen or other factors, which may impact borrowers and the potential problem loans. Accordingly, there can be no assurance that other loans will not become over 90 days past due, be placed on nonaccrual, become troubled loans modifications or require increased allowance coverage and provision for loan losses. To mitigate this risk the Company maintains a diversified loan portfolio, has no significant concentration in any particular industry and originates loans primarily within its footprint.
Deposits
Total deposits were $9.68 billion at March 31, 2023, up $185.3 million, or 2.0%, from December 31, 2022. The increase in deposits was concentrated in time and money market accounts with seasonal municipal deposit inflows during the first quarter of 2023. Total average deposits decreased $0.70 billion, or 6.8%, from the same period last year. The decrease was driven primarily by a decrease of $207.6 million, or 5.6%, in demand deposits, combined with a decrease in interest-bearing deposits of $491.5 million, or 7.5%, due to decreases in money market accounts, partially offset by an increase in time accounts. The decrease in average balances was due primarily to larger commercial customers taking advantage of higher yielding investment opportunities in both the Company’s wealth management solutions as well as other attractive offerings in the market. As of March 31, 2023 and December 31, 2022 the estimated amounts of uninsured deposits based on the same methodologies and assumptions used for the bank regulatory reporting was $3.7 billion and $3.6 billion, respectively.
Borrowed Funds
The Company’s borrowed funds consist of short-term borrowings and long-term debt. Short-term borrowings totaled $475.2 million at March 31, 2023 compared to $585.0 million at December 31, 2022. Long-term debt was $29.8 million at March 31, 2023 compared to $4.8 million at December 31, 2022.
For more information about the Company’s borrowing capacity and liquidity position, see “Liquidity Risk” below.
Subordinated Debt
On June 23, 2020, the Company issued $100.0 million of 5.00% fixed-to-floating rate subordinated notes due 2030. The subordinated notes, which qualify as Tier 2 capital, bear interest at an annual rate of 5.00%, payable semi-annually in arrears commencing on January 1, 2021, and a floating rate of interest equivalent to the three-month Secured Overnight Financing Rate (“SOFR”) plus a spread of 4.85%, payable quarterly in arrears commencing on October 1, 2025. The subordinated debt issuance cost of $2.2 million are being amortized on a straight-line basis into interest expense over five years. As of March 31, 2023 and December 31, 2022 the subordinated debt net of unamortized issuance costs was $97.0 million and $96.9 million, respectively. The Company repurchased $2.0 million of the subordinated notes during the year ended December 31, 2022 at a discount of $0.1 million.
Capital Resources
Stockholders’ equity of $1.21 billion represented 10.23% of total assets at March 31, 2023 compared with $1.17 billion, or 10.00% of total assets, as of December 31, 2022. Stockholders’ equity increased $38.1 million from December 31, 2022 driven by net income of $33.7 million for the three months ending March 31, 2023 and a $16.1 million increase in accumulated other comprehensive income due primarily to the change in market value of securities available for sale, partially offset by dividends declared of $12.9 million. The deferred tax asset related to the unrealized losses in investment securities decreased $5.1 million from December 31, 2022.
The Company did not purchase shares of its common stock during the three months ended March 31, 2023. As of March 31, 2023, there were 1,600,000 shares available for repurchase under the Company's share repurchase plan, which was authorized on December 20, 2021 and is set to expire on December 31, 2023.
As the capital ratios in the following table indicate, the Company remained “well capitalized” at March 31, 2023 under applicable bank regulatory requirements. Capital measurements are well in excess of regulatory minimum guidelines and meet the requirements to be considered well capitalized for all periods presented. To be considered well capitalized, tier 1 leverage, common equity tier 1 capital, tier 1 capital and total risk-based capital ratios must be 5%, 6.5%, 8% and 10%, respectively.
| Capital Measurements | | March 31, 2023 | | | December 31, 2022 | |
| Tier 1 leverage ratio | | | 10.43 | % | | | 10.32 | % |
| Common equity tier 1 capital ratio | | | 12.28 | % | | | 12.12 | % |
| Tier 1 capital ratio | | | 13.34 | % | | | 13.19 | % |
| Total risk-based capital ratio | | | 15.53 | % | | | 15.38 | % |
| Cash dividends as a percentage of net income | | | 38.24 | % | | | 32.74 | % |
| Per common share: | | | | | | | | |
| Book value | | $ | 28.24 | | | $ | 27.38 | |
Tangible book value(1) | | $ | 21.52 | | | $ | 20.65 | |
Tangible equity ratio(2) | | | 7.99 | % | | | 7.73 | % |
| (1) | Stockholders’ equity less goodwill and intangible assets divided by common shares outstanding. |
| (2) | Non-GAAP measure - Stockholders’ equity less goodwill and intangible assets divided by total assets less goodwill and intangible assets. |
In March 2020, the Office of Comptroller of the Currency (“OCC”), the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation (“FDIC”) announced an interim final rule to delay the estimated impact on regulatory capital stemming from the implementation of CECL. Under the modified CECL transition provision, the regulatory capital impact of the January 1, 2020 CECL adoption date adjustment to the allowance for credit losses (after-tax) was deferred and was phased into regulatory capital at 25% per year commencing January 1, 2022. For the ongoing impact of CECL, the Company was allowed to defer the regulatory capital impact of the allowance for credit losses in an amount equal to 25% of the change in the allowance for credit losses (pre-tax) recognized through earnings for each period between January 1, 2020 and December 31, 2021. The cumulative adjustment to the allowance for credit losses between January 1, 2020 and December 31, 2021, was also phased into regulatory capital at 25% per year commencing January 1, 2022. The Company adopted the capital transition relief over the permissible five-year period.
Liquidity and Interest Rate Sensitivity Management
Market Risk
Interest rate risk is the most significant market risk affecting the Company. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company’s business activities or are immaterial to the results of operations.
Interest rate risk is defined as an exposure to a movement in interest rates that could have an adverse effect on the Company’s net interest income. Net interest income is susceptible to interest rate risk to the degree that interest-bearing liabilities mature or reprice on a different basis than earning assets. When interest-bearing liabilities mature or reprice more quickly than earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income. Similarly, when earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net interest income.
To manage the Company’s exposure to changes in interest rates, management monitors the Company’s interest rate risk. Management’s Asset Liability Committee (“ALCO”) meets monthly to review the Company’s interest rate risk position and profitability and to recommend strategies for consideration by the Board of Directors. Management also reviews loan and deposit pricing and the Company’s securities portfolio, formulates investment and funding strategies and oversees the timing and implementation of transactions to assure attainment of the Board’s objectives in the most effective manner. Notwithstanding the Company’s interest rate risk management activities, the potential for changing interest rates is an uncertainty that can have an adverse effect on net income.
In adjusting the Company’s asset/liability position, the Board and management aim to manage the Company’s interest rate risk while minimizing net interest margin compression. At times, depending on the level of general interest rates, the relationship between long and short-term interest rates, market conditions and competitive factors, the Board and management may determine to increase the Company’s interest rate risk position somewhat in order to increase its net interest margin. The Company’s results of operations and net portfolio values remain vulnerable to changes in interest rates and fluctuations in the difference between long and short-term interest rates.
The primary tool utilized by the ALCO to manage interest rate risk is earnings at risk modeling (interest rate sensitivity analysis). Information, such as principal balance, interest rate, maturity date, cash flows, next repricing date (if needed) and current rates are uploaded into the model to create an ending balance sheet. In addition, the ALCO makes certain assumptions regarding prepayment speeds for loans and mortgage related investment securities along with any optionality within the deposits and borrowings. The model is first run under an assumption of a flat rate scenario (i.e. no change in current interest rates) with a static balance sheet. Three additional models are run in which a gradual increase of 200 bps, a gradual increase of 100 bps and a gradual decrease of 200 bps takes place over a 12-month period with a static balance sheet. Under these scenarios, assets subject to prepayments are adjusted to account for faster or slower prepayment assumptions. Any investment securities or borrowings that have callable options embedded in them are handled accordingly based on the interest rate scenario. The resulting changes in net interest income are then measured against the flat rate scenario. The Company also runs other interest rate scenarios to highlight potential interest rate risk.
In the declining rate scenario, net interest income is projected to decrease when compared to the forecasted net interest income in the flat rate scenario through the simulation period. The decrease in net interest income is a result of earning assets repricing and rolling over at lower yields at a faster pace than interest-bearing liabilities decline and/or reach their floors. In the rising rate scenarios, net interest income is projected to experience an increase from the flat rate scenario; however, the potential impact on earnings may be affected by the ability to lag deposit repricing on NOW, savings, money market deposit accounts and time accounts. Net interest income for the next twelve months in the +200/+100/-200 bp scenarios, as described above, is within the internal policy risk limits of not more than a 7.5% reduction in net interest income. The following table summarizes the percentage change in net interest income in the rising and declining rate scenarios over a 12-month period from the forecasted net interest income in the flat rate scenario using the March 31, 2023 balance sheet position:
| Interest Rate Sensitivity Analysis | |
| |
Change in interest rates (in bps) | | Percent change in net interest income | |
| +200 | | | 2.08 | % |
| +100 | | | 1.31 | % |
| -200 | | | (2.86 | %) |
The Company anticipates that the trajectory of net interest income will continue to depend significantly on the timing and path of short to mid-term interest rates which are heavily driven by inflationary pressures and FOMC monetary policy. In response to the economic impact of the pandemic, the federal funds rate was reduced to near zero in March 2020, term interest rates fell sharply across the yield curve and the Company reduced deposit rates. Post-pandemic, inflationary pressures have resulted in a higher overall yield curve with Fed Funds increases of 425 bps in 2022. Expectations for continued increases to short-term interest rates in 2023 have been tempered by weakness in the financial sector of the economy. With deposit rates coming off their historic lows, the Company continues to focus on managing deposit expense in an environment with elevated interest rates and heightened demand for deposits.
Liquidity Risk
Liquidity risk arises from the possibility that the Company may not be able to satisfy current or future financial commitments or may become unduly reliant on alternate funding sources. The objective of liquidity management is to ensure the Company can fund balance sheet growth, meet the cash flow requirements of depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. ALCO is responsible for liquidity management and has developed guidelines, which cover all assets and liabilities, as well as off-balance sheet items that are potential sources or uses of liquidity. Liquidity policies must also provide the flexibility to implement appropriate strategies, along with regular monitoring of liquidity and testing of the contingent liquidity plan. Requirements change as loans grow, deposits and securities mature and payments on borrowings are made. Liquidity management includes a focus on interest rate sensitivity management with a goal of avoiding widely fluctuating net interest margins through periods of changing economic conditions. Loan repayments and maturing investment securities are a relatively predictable source of funds. However, deposit flows, calls of investment securities and prepayments of loans and mortgage-related securities are strongly influenced by interest rates, the housing market, general and local economic conditions, and competition in the marketplace. Management continually monitors marketplace trends to identify patterns that might improve the predictability of the timing of deposit flows or asset prepayments.
The primary liquidity measurement the Company utilizes is called “Basic Surplus,” which captures the adequacy of its access to reliable sources of cash relative to the stability of its funding mix of average liabilities. This approach recognizes the importance of balancing levels of cash flow liquidity from short and long-term securities with the availability of dependable borrowing sources, which can be accessed when necessary. At March 31, 2023, the Company’s Basic Surplus measurement was 14.6% of total assets, or $1.73 billion, as compared to the December 31, 2022 Basic Surplus of 13.2%, or $1.55 billion, and was above the Company’s minimum of 5% (calculated at $592.0 million and $587.0 million of period end total assets at March 31, 2023 and December 31, 2022, respectively) set forth in its liquidity policies.
At March 31, 2023 and December 31, 2022, Federal Home Loan Bank (“FHLB”) advances outstanding totaled $457.8 million and $443.8 million, respectively. At March 31, 2023 and December 31, 2022, the Bank had $8.0 million of collateral encumbered by municipal letters of credit. The Bank is a member of the FHLB system and had additional borrowing capacity from the FHLB of approximately $1.16 billion at March 31, 2023 and $1.17 billion at December 31, 2022. In addition, unpledged securities could have been used to increase borrowing capacity at the FHLB by an additional $835.7 million and $898.1 million at March 31, 2023 and December 31, 2022, respectively, or used to collateralize other borrowings, such as repurchase agreements. The Company also has the ability to issue brokered time deposits and to borrow against established borrowing facilities with other banks (federal funds), which could provide additional liquidity of $1.87 billion at March 31, 2023 and $1.92 billion at December 31, 2022. In addition, the Bank has a “Borrower-in-Custody” program with the FRB with the addition of the ability to pledge automobile loans as collateral. At March 31, 2023 and December 31, 2022, the Bank had the capacity to borrow $654.2 million and $622.7 million, respectively, from this program. The Company’s internal policies authorize borrowings up to 25% of assets. Under this policy, remaining available borrowing capacity totaled $2.48 billion at March 31, 2023 and $2.41 billion at December 31, 2022.
This Basic Surplus approach enables the Company to appropriately manage liquidity from both operational and contingency perspectives. By tempering the need for cash flow liquidity with reliable borrowing facilities, the Company is able to operate with a more fully invested and, therefore, higher interest income generating securities portfolio. The makeup and term structure of the securities portfolio is, in part, impacted by the overall interest rate sensitivity of the balance sheet. Investment decisions and deposit pricing strategies are impacted by the liquidity position. The Company considers its Basic Surplus position to be strong. However, certain events may adversely impact the Company’s liquidity position in 2023. Higher interest rates could result in deposit declines as depositors have alternative opportunities for yield on their excess funds. In the current economic environment, draws against lines of credit could drive asset growth higher. Disruptions in wholesale funding markets could spark increased competition for deposits. These scenarios could lead to a decrease in the Company’s Basic Surplus measure below the minimum policy level of 5%. Significant monetary and fiscal policy actions taken by the federal government during the COVID-19 pandemic have helped to mitigate these risks. Enhanced liquidity monitoring was put in place to quickly respond to the changing environment during the COVID-19 pandemic including increasing the frequency of monitoring and adding additional sources of liquidity.
At March 31, 2023, a portion of the Company’s loans and securities were pledged as collateral on borrowings. Therefore, once on-balance-sheet liquidity is depleted, future growth of earning assets will depend upon the Company’s ability to obtain additional funding, through growth of core deposits and collateral management and may require further use of brokered time deposits or other higher cost borrowing arrangements.
The Company’s primary source of funds is the Bank. Certain restrictions exist regarding the ability of the subsidiary bank to transfer funds to the Company in the form of cash dividends. The approval of the OCC is required to pay dividends when a bank fails to meet certain minimum regulatory capital standards or when such dividends are in excess of a subsidiary bank’s earnings retained in the current year plus retained net profits for the preceding two years as specified in applicable OCC regulations. At March 31, 2023, approximately $91.4 million of the total stockholders’ equity of the Bank was available for payment of dividends to the Company without approval by the OCC. The Bank’s ability to pay dividends is also subject to the Bank being in compliance with regulatory capital requirements. The Bank is currently in compliance with these requirements. Under the State of Delaware General Corporation Law, the Company may declare and pay dividends either out of accumulated net retained earnings or capital surplus.
| ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Information called for by Item 3 is contained in the Liquidity and Interest Rate Sensitivity Management section of the Management’s Discussion and Analysis of Financial Condition and Results of Operations.
| ITEM 4. | CONTROLS AND PROCEDURES |
The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of March 31, 2023, the Company’s disclosure controls and procedures were effective.
PART II OTHER INFORMATION
There are no material legal proceedings, other than ordinary routine litigation incidental to the business, to which the Company or any of its subsidiaries is a party or of which any of their property is subject.
There are no material changes to the risk factors as previously discussed in Part I, Item 1A. of our 2022 Annual Report on Form 10-K, except as described below.
Risks Related to Our Business and Industry
Recent negative developments affecting the banking industry, and resulting media coverage, have eroded customer confidence in the banking system.
The recent high-profile bank failures have generated significant market volatility among publicly traded bank holding companies and, in particular, regional banks like the Company. These market developments have negatively impacted customer confidence in the safety and soundness of regional banks. As a result, customers may choose to maintain deposits with larger financial institutions or invest in higher yielding short-term fixed income securities, all of which could materially adversely impact the Company's liquidity, loan funding capacity, net interest margin, capital and results of operations. While the Department of the Treasury, the Federal Reserve and the FDIC have made statements ensuring that depositors of the recently failed banks would have access to their deposits, including uninsured deposit accounts, there is no guarantee that such actions will be successful in restoring customer confidence in regional banks and the banking system more broadly.
Rising interest rates have decreased the value of the Company's held-to-maturity securities portfolio, and the Company would realize losses if it were required to sell such securities to meet liquidity needs.
As a result of inflationary pressures and the resulting rapid increases in interest rates over the last year, the trading value of previously issued government and other fixed income securities has declined significantly. These securities make up a majority of the securities portfolio of most banks in the U.S., including the Company's, resulting in unrealized losses embedded in the held-to-maturity portion of U.S. banks' securities portfolios. While the Company does not currently intend to sell these securities, if the Company were required to sell such securities to meet liquidity needs, it may incur losses, which could impair the Company's capital, financial condition, and results of operations and require the Company to raise additional capital on unfavorable terms, thereby negatively impacting its profitability. While the Company has taken actions to maximize its funding sources, there is no guarantee that such actions will be successful or sufficient in the event of sudden liquidity needs. Furthermore, while the Federal Reserve Board has announced a Bank Term Funding Program available to eligible depository institutions secured by U.S. treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral at par, to mitigate the risk of potential losses on the sale of such instruments, there is no guarantee that such programs will be effective in addressing liquidity needs as they arise.
Risks Related to Legal, Governmental and Regulatory Changes
Any regulatory examination scrutiny or new regulatory requirements arising from the recent events in the banking industry could increase the Company's expenses and affect the Company's operations.
The Company also anticipates increased regulatory scrutiny - in the course of routine examinations and otherwise - and new regulations directed towards banks of similar size to the Bank, designed to address the recent negative developments in the banking industry, all of which may increase the Company's costs of doing business and reduce its profitability. Among other things, there may be an increased focus by both regulators and investors on deposit composition and the level of uninsured deposits. The cost of resolving the recent bank failures may prompt the FDIC to increase its premiums above the recently increased levels or to issue additional special assessments.
| ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
| ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
None
| ITEM 4. | MINE SAFETY DISCLOSURES |
None
None
3.1 | |
3.2 | |
3.3 | |
| Certification by the Chief Executive Officer pursuant to Rules 13(a)-14(a)/15(d)-14(e) of the Securities and Exchange Act of 1934. |
| Certification by the Chief Financial Officer pursuant to Rules 13(a)-14(a)/15(d)-14(e) of the Securities and Exchange Act of 1934. |
| Certification by the Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
| Certification of the Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
101.INS | Inline XBRL Instance Document (the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document). |
101.SCH | Inline XBRL Taxonomy Extension Schema Document. |
101.CAL | Inline XBRL Taxonomy Extension Calculation Linkbase Document. |
101.DEF | Inline XBRL Taxonomy Extension Definition Linkbase Document. |
101.LAB | Inline XBRL Taxonomy Extension Label Linkbase Document. |
101.PRE | Inline XBRL Taxonomy Extension Presentation Linkbase Document. |
104 | Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101). |
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, this 10th day of May 2023.
| | NBT BANCORP INC. |
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By: | /s/ Scott A. Kingsley |
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| | Scott A. Kingsley |
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| | Chief Financial Officer |
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