PEOPLES FINANCIAL CORPORATION Peoples Financial Corporation (the "Company") is a one-bank holding company headquartered inBiloxi, Mississippi . The following presents Management's discussion and analysis of the consolidated financial condition and results of operations of the Company and its consolidated subsidiaries for the years endedDecember 31, 2022 , 2021 and 2020. These comments highlight the significant events for these years and should be considered in combination with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in this annual report.
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FORWARD-LOOKING INFORMATIONCongress passed the Private Securities Litigation Act of 1995 in an effort to encourage corporations to provide information about a company's anticipated future financial performance. This act provides a safe harbor for such disclosure which protects the companies from unwarranted litigation if actual results are different from management expectations. This report contains forward-looking statements and reflects industry conditions, company performance and financial results. These forward-looking statements are subject to a number of factors and uncertainties which could cause the Company's actual results and experience to differ from the anticipated results and expectations expressed in such forward-looking statements. Such factors and uncertainties include, but are not limited to: the effects of changes in interest rates and market prices, changes in local economic and business conditions, increased competition for deposits and loans, a deviation in actual experience from the underlying assumptions used to determine and establish the allowance for loan losses, changes in the availability of funds resulting from reduced liquidity, changes in statutes, government regulations or regulatory policies and practices in general and specifically acts of terrorism, weather or other events beyond the Company's control.
NEW ACCOUNTING PRONOUNCEMENTS
TheFinancial Accounting Standards Board ("FASB") issued new accounting standards updates in 2022, which are disclosed in Note A to the Consolidated Financial Statements. The Company does not expect that the update discussed in the Notes will have a material impact on its financial position, results of operations or cash flows. Further disclosure relating to this and other updates is included in Note A. CRITICAL ACCOUNTING POLICIES The preparation of financial statements in conformity with accounting principles generally accepted inthe United States of America ("GAAP") requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company evaluates these estimates and assumptions on an on-going basis using historical experience and other factors, including the current economic environment. We adjust such estimates and assumptions when facts and circumstances dictate. Certain critical accounting policies affect the more significant estimates and assumptions used in the preparation of the consolidated financial statements.
Investments
Investments which are classified as available for sale are stated at fair value. A decline in the market value of an investment below cost that is deemed to be other-than-temporary is charged to earnings for the decline in value deemed to be credit related and a new cost basis in the security is established. The decline in value attributed to non-credit related factors is recognized in other comprehensive income. The determination of the fair value of securities may require Management to develop estimates and assumptions regarding the amount and timing of cash flows. 30
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Allowance for Loan Losses
The Company's allowance for loan losses ("ALL") reflects the estimated losses
resulting from the inability of its borrowers to make loan payments. The ALL is
established and maintained at an amount sufficient to cover the estimated loss
associated with the loan portfolio of the Company as of the date of the
financial statements. Credit losses arise not only from credit risk, but also
from other risks inherent in the lending process including, but not limited to,
collateral risk, operation risk, concentration risk and economic risk. As such,
all related risks of lending are considered when assessing the adequacy of the
ALL. On a quarterly basis, Management estimates the probable level of losses to
determine whether the allowance is adequate to absorb reasonably foreseeable,
anticipated losses in the existing portfolio based on our past loan loss
experience, known and inherent risk in the portfolio, adverse situations that
may affect the borrowers' ability to repay and the estimated value of any
underlying collateral and current economic conditions. Management believes that
the ALL is adequate and appropriate for all periods presented in these financial
statements. If there was a deterioration of any of the factors considered by
Management in evaluating the ALL, the estimate of loss would be updated, and
additional provisions for loan losses may be required. The analysis divides the
portfolio into two segments: a pool analysis of loans based upon a five-year
average loss history which is updated on a quarterly basis and which may be
adjusted by qualitative factors by loan type and a specific reserve analysis for
those loans considered impaired under GAAP. All credit relationships with an
outstanding balance of $100,000 or greater that are included in Management's
loan watch list are individually reviewed for impairment. All losses are charged
to the ALL when the loss actually occurs or when a determination is made that a
loss is likely to occur; recoveries are credited to the ALL at the time of
receipt.
Other Real Estate
Other real estate ("ORE") includes real estate acquired through foreclosure.
Each other real estate property is carried at fair value, less estimated costs
to sell. Fair value is principally based on appraisals performed by third-party
valuation specialists. If Management determines that the fair value of a
property has decreased subsequent to foreclosure, the Company records a
write-down which is included in non-interest expense.
Employee Benefit Plans
Employee benefit plan liabilities and pension costs are determined utilizing actuarially determined present value calculations. The valuation of the benefit obligation and net periodic expense is considered critical, as it requires Management and its actuaries to make estimates regarding the amount and timing of expected cash outflows including assumptions about mortality, expected service periods and the rate of compensation increases.
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Income Taxes GAAP requires the asset and liability approach for financial accounting and reporting for deferred income taxes. We use the asset and liability method of accounting for deferred income taxes and provide deferred income taxes for all significant income tax temporary differences. See Note I to the Consolidated Financial Statements for additional details. As part of the process of preparing our consolidated financial statements, the Company is required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as the provision for the allowance for loan losses, for tax and financial reporting purposes. These differences result in deferred tax assets and liabilities that are included in our consolidated statement of condition. We must also assess the likelihood that our deferred tax assets will be recovered from future taxable income, and to the extent we believe that recovery is not likely, we must establish a valuation allowance. Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. To the extent the Company establishes a valuation allowance or adjusts this allowance in a period, we must include an expense within the tax provision in the consolidated statement of income.
GAAP Reconciliation and Explanation
This report contains non-GAAP financial measures determined by methods other than in accordance with GAAP. Such non-GAAP financial measures include taxable equivalent interest income and taxable equivalent net interest income. Management uses these non-GAAP financial measures because it believes they are useful for evaluating our operations and performance over periods of time, as well as in managing and evaluating our business and in discussions about our operations and performance. Management believes these non-GAAP financial measures provide users of our financial information with a meaningful measure for assessing our financial results, as well as comparison to financial results for prior periods. These non-GAAP financial measures should not be considered as a substitute for operating results determined in accordance with GAAP and may not be comparable to other similarly titled financial measures used by other companies. A reconciliation of these operating performance measures to GAAP performance measures for the years endedDecember 31, 2022 , 2021 and 2020 is included below. RECONCILIATION OF NON-GAAP PERFORMANCE MEASURES (in thousands) Years Ended December 31, 2022 2021 2020 Interest income reconciliation: Interest income - taxable equivalent$ 23,960 $ 20,531 $ 19,470 Taxable equivalent adjustment (252 ) (239 ) (162 ) Interest income (GAAP)$ 23,708 $ 20,292 $ 19,308 Net interest income reconciliation: Net interest income - taxable equivalent$ 21,802 $ 19,701 $ 17,889 Taxable equivalent adjustment (252 ) (239 ) (162 ) Net interest income (GAAP)$ 21,550 $ 19,462 $ 17,727 32
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OVERVIEW The Company is a community bank serving the financial and trust needs of its customers in our trade area, which is defined as those portions ofMississippi ,Louisiana andAlabama which are within a fifty mile radius of theWaveland ,Wiggins and Gautier branches, the bank subsidiary's three most outlying locations. Maintaining a strong core deposit base and providing commercial and real estate lending in our trade area are the traditional focuses of the Company. Growth has largely been achieved through de novo branching activity, and it is expected that these strategies will continue to be emphasized in the future. TheWorld Health Organization declared the coronavirus COVID-19 ("COVID-19") a pandemic inMarch 2020 . Although many businesses have been able to remain in operation, they continue to have staffing challenges and supply chain disruptions. The Company has had no significant impact on income or loan repayments due to the pandemic. Concerns about inflation and its potential impact on the economy and individual households are among the issues being considered by theFederal Reserve . Raising the Federal funds rate has been a strategy pursued in 2022 to address this issue. TheFederal Reserve has raised interest rates a total of 425 basis points during 2022 in an effort to promote maximum employment, keep prices stable and have moderate long-term interest rates. Assisting our customers during the pandemic was a priority. The Company granted modifications by extending payments 90 days or allowing interest only payments to certain customers as a result of the economic challenges of business closures and unemployment resulting from COVID-19. We also actively participated in the Paycheck Protection Program ("PPP"), a specific stimulus resource designed to provide assistance to small businesses. The Company recorded loan fees associated with the PPP loan program in the amount of approximately$125,000 in 2022 and$958,000 in 2021. The Company reported net income of$8,941,000 for 2022 compared with net income of$8,911,000 for 2021 compared with a net loss of$2,558,000 for 2020, respectively. Results in 2022 included an increase in net interest income an increase in the allowance for loans losses which were partially offset by an increase in non-interest income, a decrease in non-interest expense, and the recording of a large tax benefit as compared with 2021. Results in 2021 included a large reduction in the allowance for loan losses which was partially offset by a decrease in non-interest income and an increase in non-interest expense as compared with 2020. Managing the net interest margin is a key component of the Company's earnings strategy. TheFederal Reserve increased rates by 75 basis points in September and November of 2022 and increased rates by another 50 basis point inDecember 2022 in an attempt to slow inflation. The Company adopted new investment strategies in 2022 and 2021 to improve yields on its securities while not compromising duration or credit risk. As a result, total interest income increased$3,416,000 in 2022 as compared with 2021. The increase in rates increased total interest expense$1,328,000 in 2022 as compared with 2021. InMarch 2020 , theFederal Reserve reduced rates by 150 basis points in two emergency moves to respond to the unprecedented economic disruptions of the COVID-19 pandemic. As a result, total interest income increased$984,000 in 2021 as compared with 2020. The reduction in rates decreased total interest expense$751,000 in 2021 as compared with 2020.
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Monitoring asset quality, estimating potential losses in our loan portfolio and addressing non-performing loans continue to be a major focus of the Company. An increase in the allowance for loan losses of$80,000 was recorded in 2022 as compared to a reduction in the allowance for loan losses of$5,663,000 in 2021. The reduction during 2021 was the result of a large recovery of previously charged-off principal. The Company is working diligently to address and reduce its non-performing assets. The Company's nonaccrual loans totaled$1,441,000 and$701,000 atDecember 31, 2022 and 2021, respectively. Most of these loans are collateral-dependent, and the Company has rigorously evaluated the value of its collateral to determine potential losses. Non-interest income increased$425,000 in 2022 as compared with 2021 results and decreased$781,000 in 2021 as compared with 2020 results. The increase in 2022 was primarily the result of an increase in other income and an increase in trust income related to the recent acquisition. The decrease in 2021 was primarily the result of the prior year including several non-recurring gains. Results for 2020 included non-recurring gains on sales and calls of securities of$539,000 , a gain from the redemption of death benefits on bank owned life insurance of$224,000 and a gain from the sale of banking house of$318,000 . Non-interest expense decreased$767,000 in 2022 as compared with 2021 and increased$1,088,000 for 2021 as compared with 2020. The decrease in 2022 was primarily due to a partial recovery in other expense related to a settlement of a lawsuit in 2021. The increase in other expense in 2021 was primarily due to the settlement of a lawsuit for$1,125,000 and other legal and consulting costs associated with the contested 2021 annual shareholders' meeting. Total assets atDecember 31, 2022 increased$42,689,000 as compared withDecember 31, 2021 . Total deposits increased$80,942,000 primarily as governmental entities' balances increased due to tax collections. This increase in deposits, as well as the decrease in cash and due from banks of$17,155,000 , loans of$1,284,000 and available for sale securities of$26,635,000 funded an increase held to maturity investments of$85,009,000 . RESULTS OF OPERATIONS Net Interest Income Net interest income, the amount by which interest income on loans, investments and other interest-earning assets exceeds interest expense on deposits and other borrowed funds, is the single largest component of the Company's income. Management's objective is to provide the largest possible amount of income while balancing interest rate, credit, liquidity and capital risk. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities combined with changes in market rates of interest directly affect net interest income. 34
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2022 as compared with 2021 The Company's average interest-earning assets increased approximately$106,912,000 , or 15%, from approximately$720,224,000 for 2021 to approximately$827,136,000 for 2022. Average taxable held to maturity securities increased approximately$33,831,000 , average nontaxable held to maturity securities increased approximately$4,941,000 and average taxable available for sale securities increased approximately$107,166,000 as investment purchases exceeded maturities, sales and calls of these securities. Average loans decreased approximately$27,744,000 as principal payments, paydowns, maturities, and charge-offs on existing loans exceeded new loans. Funds available from the decrease in average loans and the increase in average deposits were used to increase the investment in securities. The average yield on interest-earning assets was 2.90% for 2022 compared with 2.85% for 2021. The yield on average investment securities increased as a result of the increase in prime rate during 2022 as discussed in the Overview. Average interest-bearing liabilities increased approximately$127,566,000 , or 26%, from approximately$481,768,000 for 2021 to approximately$609,334,000 for 2022. Average savings and interest-bearing DDA balances increased approximately$120,123,000 primarily as several large public fund customers maintained higher balances with the bank subsidiary and some of the PPP loan proceeds were deposited and maintained in customers' accounts. The average rate paid on interest-bearing liabilities increased from 0.17% for 2021 to 0.35% for 2022. This increase was the result of increased rates in 2022.
The Company's net interest margin on a tax-equivalent basis, which is net interest income as a percentage of average earning assets, was 2.74% for 2021 as compared with 2.64% for 2022.
2021 as compared with 2020 The Company's average interest-earning assets increased approximately$122,058,000 , or 20%, from approximately$598,166,000 for 2020 to approximately$720,224,000 for 2021. Average taxable held to maturity securities increased approximately$23,567,000 , average nontaxable held to maturity securities increased approximately$16,631,000 and average taxable available for sale securities increased approximately$91,853,000 as investment purchases exceeded maturities, sales and calls of these securities. Average loans decreased approximately$17,680,000 as principal payments, particularly on PPP loans, maturities, charge-offs and foreclosures on existing loans exceeded new loans. Funds available from the decrease in average loans and the increase in average deposits were used to increase the investment in securities. The average yield on interest-earning assets was 3.25% for 2020 compared with 2.85% for 2021. The yield on average investment securities decreased as a result of the decrease in prime rate during 2020 as discussed in the Overview.
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Average interest-bearing liabilities increased approximately$83,037,000 , or 21%, from approximately$398,731,000 for 2020 to approximately$481,768,000 for 2021. Average savings and interest-bearing DDA balances increased approximately$82,861,000 primarily as several large public fund customers maintained higher balances with the bank subsidiary and some of the PPP loan proceeds were deposited and maintained in customers' accounts. The average rate paid on interest-bearing liabilities decreased from .40% for 2020 to .17% for 2021. This decrease was the result of decreased rates in 2020.
The Company's net interest margin on a tax-equivalent basis, which is net interest income as a percentage of average earning assets, was 2.99% for 2020 as compared with 2.74% for 2021.
The tables below analyze the changes in tax-equivalent net interest income for
the years ended
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ANALYSIS OF AVERAGE BALANCES, INTEREST EARNED/PAID AND YIELD
(in thousands)
2022 2021 2020
Average Interest Average Interest Average Interest
Balance Earned/Paid Rate Balance Earned/Paid Rate Balance Earned/Paid Rate
Loans (1)(2) $ 235,801 $ 11,135 4.72 % $ 263,545 $ 12,592 4.78 % $ 281,225 $ 13,076 4.65 %
Balances due from
depository
institutions 49,191 408 0.83 % 64,415 95 0.15 % 56,103 227 0.40 %
Held to maturity:
Taxable 105,047 2,713 2.58 % 66,216 1,702 2.57 % 42,649 1,235 2.90 %
Non taxable (3) 37,557 1,050 2.79 % 32,616 952 2.92 % 15,985 525 3.28 %
Available for sale:
Taxable 392,645 8,482 2.16 % 285,479 5,004 1.75 % 193,626 4,140 2.14 %
Non taxable (3) 4,740 145 3.07 % 5,802 178 3.07 % 6,425 240 3.74 %
Other 2,155 27 1.25 % 2,151 8 0.37 % 2,153 27 1.25 %
Total $ 827,136 $ 23,960 2.90 % $ 720,224 $ 20,531 2.85 % $ 598,166 $ 19,470 3.25 %
Savings and
interest- bearing
DDA $ 527,273 $ 1,636 0.31 % $ 407,150 $ 525 0.13 % $ 324,289 $ 833 0.26 %
Time deposits 78,392 349 0.45 % 73,399 281 0.37 % 72,782 716 0.98 %
Borrowings from FHLB 3,669 173 4.72 % 1,219 24 1.97 % 1,660 32 1.93 %
Total $ 609,334 $ 2,158 0.35 % $ 481,768 $ 830 0.17 % $ 398,731 $ 1,581 0.40 %
Net tax-equivalent
spread 2.55 % 2.68 % 2.85 %
Net tax-equivalent
margin on earning
assets 2.64 % 2.74 % 2.99 %
(1) Loan fees of $659 , $1,444 and $814 for 2022, 2021 and 2020, respectively,
are included in these figures. Of the loan fees recognized in 2022, 2021 and
2020, $125 , $958 and $448 , respectively, were related to PPP loans.
(2) Includes nonaccrual loans.
(3) All interest earned is reported on a taxable equivalent basis using a tax rate of 21% in 2022, 2021 and 2020. See disclosure of Non-GAAP financial measures on pages 32 and 33.
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ANALYSIS OF CHANGES IN INTEREST INCOME AND EXPENSE
(in thousands)
For the Year Ended
December 31, 2022
Compared With
Volume Rate Rate/Volume Total
Interest earned on:
Loans $ (1,326 ) $ (147 ) $ 15 $ (1,458 )
Balances due from depository institutions (22 ) 439 (104 ) 313
Held to maturity securities:
Taxable 998 8 5 1,011
Non taxable 144 (41 ) (6 ) 97
Available for sale securities:
Taxable 1,878 1,163 437 3,478
Non taxable (33 ) (33 )
Other 19 19
Total $ 1,639 $ 1,441 $ 347 $ 3,427
Interest paid on:
Savings and interest-bearing DDA $ 155 $ 738 $ 218 $ 1,111
Time deposits 19 46 3 68
Borrowings from FHLB 48 33 67 148
Total $ 222 $ 817 $ 288 $ 1,327
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ANALYSIS OF CHANGES IN INTEREST INCOME AND EXPENSE
(in thousands)
For the Year Ended
December 31, 2021
Compared With
Volume Rate Rate/Volume Total
Interest earned on:
Loans $ (822 ) $ 361 $ (23 ) $ (484 )
Balances due from depository institutions 34 (144 ) (22 ) (132 )
Held to maturity securities:
Taxable 682 (139 ) (76 ) 467
Non taxable 546 (58 ) (61 ) 427
Available for sale securities:
Taxable 1,964 (746 ) (354 ) 864
Non taxable (23 ) (43 ) 4 (62 )
Other (19 ) (19 )
Total $ 2,381 $ (788 ) $ (532 ) $ 1,061
Interest paid on:
Savings and interest-bearing DDA $ 213 $ (415 ) $ (106 ) $ (308 )
Time deposits 6 (437 ) (4 ) (435 )
Borrowings from FHLB (9 ) 1 (8 )
Total $ 210 $ (851 ) $ (110 ) $ (751 )
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Provision for Allowance for Loan Losses
In the normal course of business, the Company assumes risk in extending credit to its customers. This credit risk is managed through compliance with the loan policy, which is approved by the Board of Directors. The policy establishes guidelines relating to underwriting standards, including but not limited to financial analysis, collateral valuation, lending limits, pricing considerations and loan grading. The Company's Loan Review and Special Assets Departments play key roles in monitoring the loan portfolio and managing problem loans. New loans and, on a periodic basis, existing loans are reviewed to evaluate compliance with the loan policy. Loan customers in concentrated industries such as gaming and hotel/motel, as well as the exposure for out of area; residential and land development; construction and commercial real estate loans, and their direct and indirect impact on the Company's operations are evaluated on a monthly basis. Loan delinquencies and deposit overdrafts are closely monitored in order to identify developing problems as early as possible. Lenders experienced in workout scenarios consult with loan officers and customers to address non-performing loans. A monthly watch list of credits which pose a potential loss to the Company is prepared based on the loan grading system. This list forms the foundation of the Company's allowance for loan loss computation. Management relies on its guidelines and existing methodology to monitor the performance of its loan portfolio and to identify and estimate potential losses based on the best available information. The potential effect of declines in real estate values and actual losses incurred by the Company were key factors in our analysis. Much of the Company's loan portfolio is collateral-dependent, requiring careful consideration of changes in the value of the collateral. Note A to the Consolidated Financial Statements discloses a summary of the accounting principles applicable to impaired and nonaccrual loans as well as the allowance for loan losses. Note C to the Consolidated Financial Statements presents additional analyses of the composition, aging, credit quality and performance of the loan portfolio as well as the transactions in the allowance for loan losses. The Company's analysis includes evaluating the current value of collateral securing all nonaccrual loans. Nonaccrual loans totaled$1,441,000 and$701,000 with specific reserves on these loans of$124,000 and$20,000 as ofDecember 31, 2022 and 2021, respectively. The specific reserves allocated to nonaccrual loans are relatively low as collateral values appear sufficient to cover loan losses or the loan balances have been charged down to their realizable value. Additional consideration was given to the impact of COVID-19 on the loan portfolio. The Company granted modifications by extending payments 90 days or granting interest only payments for 3 - 6 months for certain customers as a result of the economic challenges of business closures and unemployment resulting from COVID-19. These credits were generally current at the time they were modified. In compliance with guidance from the regulatory and accounting authorities, these modifications were not classified as troubled debt restructurings. As ofSeptember 30, 2021 , all of these modifications had expired and the customers had resumed making regular payments. The Company continues its policy of closely monitoring past due loans and deposit overdrafts which may serve as indicators of performance issues. Proactive outreach to our loan customers has also been emphasized.
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In addition to the factors considered when assessing risk in the loan portfolio which are identified in the Note A, the Company included the potential negative impact of COVID-19 on its loan portfolio, particularly the gaming and hotel/motel concentrations, in performing the risk assessment as ofDecember 31, 2021 . As ofDecember 31, 2021 , a general reserve of approximately$287,000 was allocated to non-classified loans as a result of COVID-19. As ofDecember 31, 2021 , no specific reserves were allocated to classified loans as a result of COVID-19, as customers in potentially vulnerable industries have resources through business interruption insurance, proceeds from PPP or other loan programs and/or have been able to begin to return to normal operations. As ofDecember 31, 2022 the Company has not experienced difficulty in repayment of loans due to COVID-19, therefore the factor for the potential negative impact of COVID-19 was removed. The Company's on-going, systematic evaluation resulted in the Company recording a provision of$80,000 for the allowance for loan losses in 2022 and recording a total provision for (reduction of) the allowance for loan losses of$(5,663,000) and$6,002,000 in 2021 and 2020, respectively. As a result of recoveries of$4,838,000 during 2021, the Company recorded a reduction in the allowance for loan losses. The provision for the allowance for loan losses in 2020 was the direct result of a charge-off of$5,429,000 of one credit that was on nonaccrual and in bankruptcy. This loss is the result of specific events impacting this specific customer and was not related to COVID-19. The allowance for loan losses as a percentage of loans was 1.40%, 1.38% and 1.59% atDecember 31, 2022 , 2021 and 2020, respectively. The Company believes that its allowance for loan losses is appropriate as ofDecember 31, 2022 . The allowance for loan losses is an estimate, and as such, events may occur in the future which may affect its accuracy. The Company anticipates that it is possible that additional information will be gathered in the future which may require an adjustment to the allowance for loan losses. Management will continue to closely monitor its portfolio and take such action as it deems appropriate to accurately report its financial condition and results of operations. Non-interest Income 2022 as compared with 2021 Total non-interest income increased$425,000 in 2022 as compared with 2021. Trust department income and fees increased$152,000 in 2022 as compared with 2021 as a result of the recent trust acquisition. Other income increased$185,000 in 2022 as compared with 2021. Service charges on deposit accounts increased$33,000 as customer transactions have begun to return to pre-COVID-19 activity. 41
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2021 as compared with 2020 Total non-interest income decreased$781,000 in 2021 as compared with 2020. Results in 2020 included several non-recurring items. These included a gain of$224,000 from the redemption of death benefits on bank owned life insurance and a gain of$318,000 from the sale of banking premises. In addition, gains on liquidation, sales and calls of securities were$539,000 as the Company had opportunities to sell securities which generated gains in 2020 as compared with a loss of$45,000 in 2021. Trust department income and fees increased$154,000 in 2021 as compared with 2020 as a result of new account relationships. Service charges on deposit accounts increased$197,000 as customer transactions have begun to return to pre-COVID-19 activity. Non-interest Expense 2022 as compared with 2021 Total non-interest expense decreased$767,000 in 2022 as compared with 2021. Salaries and employee benefits increased$727,000 primarily due to merit bonuses and increases in benefits. Net occupancy decreased$163,000 primarily due to decreases in insurance expense in 2022. Other expense decreased$1,322,000 primarily as legal and consulting and other real estate decreased while data processing and ATM expense increased. Legal and consulting costs decreased due to the settlement of a lawsuit for$1,125,000 in 2021 in which a partial recovery was received at the end of 2022 in the amount of$486,000 along with non-recurring expenses in 2021 relating to the contested 2021 annual shareholders' meeting. Other real estate expenses decreased$7,000 as a result of decreased expense of holding and selling ORE in 2022 as compared to 2021. Data processing costs increased$37,000 due to the implementation of new applications in the current year. ATM expense increased$131,000 as a result of costs associated with debit card processing charges since conversion to a new provider. 2021 as compared with 2020 Total non-interest expense increased$1,088,000 in 2021 as compared with 2020. Salaries and employee benefits increased$247,000 primarily due to merit bonuses. Equipment rentals, depreciation and maintenance decreased$130,000 primarily as IT-related equipment became fully depreciated. Other expense increased$918,000 primarily as data processing, legal and accounting and ATM expense increased while other real estate expense decreased. Data processing costs increased$182,000 due to the implementation of new applications in the current year. Legal and accounting costs increased$1,398,000 due to the settlement of a lawsuit for$1,125,000 and non-recurring legal and consulting costs relating to the contested 2021 annual shareholders' meeting. ATM expense increased$167,000 as a result of costs associated with debit card processing charges since conversion to a new provider. Other real estate costs decreased$958,000 as a result of decreased write-downs and other expense of holding and selling ORE in 2021 as compared with 2020.
Income Taxes
During 2014, Management established a valuation allowance against its net deferred tax asset of approximately$8,140,000 . As ofDecember 31, 2021 , and 2020, the valuation allowance was still in place. The 2018 Tax Cuts and Jobs Act began limiting NOL usage to 80% of taxable income, which resulted in the Company recording income tax expense for 2021.
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During the fourth quarter of 2022, the Company determined that it was more likely than not that it would realize a certain amount of its deferred tax assets. As ofDecember 31, 2022 , the Company no longer has a net operating loss carryforward and its projections of future income indicate that reversal of a portion of the valuation allowance was appropriate. Accordingly, an income tax benefit of$2,446,000 was recorded in the fourth quarter of 2022.
Note I to the Consolidated Financial Statements presents a reconciliation of income taxes for these three years and further analysis of the valuation allowance.
FINANCIAL CONDITION Cash and due from banks decreased$17,155,000 atDecember 31, 2022 compared withDecember 31, 2021 as the Company utilized some of its excess liquidity to fund investment purchases. Available for sale securities decreased$26,635,000 and held to maturity securities increased$85,009,000 , respectively atDecember 31, 2022 compared withDecember 31, 2021 as the Company increased its held to maturity investment purchases, which were funded by using funds available from cash and due from banks, decreased loans and the increase in deposits. Gross loans decreased$1,284,000 atDecember 31, 2022 compared withDecember 31, 2021 , as principal payments, particularly from PPP loan forgiveness, maturities, and charge-offs on existing loans outpaced new loans.
Total deposits increased
SHAREHOLDERS' EQUITY AND CAPITAL ADEQUACY
Strength, security and stability have been the hallmark of the Company since its founding in 1985 and of its bank subsidiary since its founding in 1896. A strong capital foundation is fundamental to the continuing prosperity of the Company and the security of its customers and shareholders. The primary and risk-based capital ratios are important indicators of the strength of a Company's capital. These figures are presented in the Five-Year Comparative Summary of Selected Financial Information. The Company has established the goal of being classified as "well-capitalized" by the banking regulatory authorities.
Significant transactions affecting shareholders' equity during 2022 are described in Note J to the Consolidated Financial Statements. The Statement of Changes in Shareholders' Equity also presents all activity in the Company's equity accounts.
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LIQUIDITY Liquidity represents the Company's ability to adequately provide funds to satisfy demands from depositors, borrowers and other commitments by either converting assets to cash or accessing new or existing sources of funds. Note L to the Consolidated Financial Statements discloses information relating to financial instruments with off-balance-sheet risk, including letters of credit and outstanding unused loan commitments. The Company closely monitors the potential effects of funding these commitments on its liquidity position. Management monitors these funding requirements in such a manner as to satisfy these demands and to provide the maximum return on its earning assets. The Company monitors and manages its liquidity position diligently through a number of methods, including through the computation of liquidity risk targets and the preparation of various analyses of its funding sources and utilization of those sources on a monthly basis. The Company also uses proforma liquidity projections which are updated on a continuous basis in the management of its liquidity needs and also conducts contingency testing on its liquidity plan. The Company has also been approved to participate in theFederal Reserve's Discount Window Primary Credit Program, which it intends to use only as a contingency. Management carefully monitors its liquidity needs, particularly relating to potentially volatile deposits, and the Company has encountered no problems with meeting its liquidity needs. Deposits, payments of principal and interest on loans, proceeds from maturities of investment securities and earnings on investment securities are the principal sources of funds for the Company.
The Company also uses other sources of funds, including borrowings from the FHLB. The Company generally anticipates relying on deposits, purchases of federal funds and borrowings from the FHLB for its liquidity needs in 2023.
The Company actively participated in the PPP, facilitating approximately$23 million and$6 million , respectively, in funding during 2020 and 2021. As an additional liquidity resource, the Company was approved to participate in theFederal Reserve Bank's PPP Liquidity Facility.
OFF-BALANCE SHEET ARRANGEMENTS
The Company is a party to off-balance-sheet arrangements in the normal course of business to meet the financing needs of its customers. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet arrangements. Since some of the commitments and irrevocable letters of credit may expire without being drawn upon, the total amount does not necessarily represent future cash requirements. As discussed previously, the Company carefully monitors its liquidity needs and considers its cash requirements, especially for loan commitments, in making decisions on investments and obtaining funds from its other sources. Further information relating to off-balance-sheet instruments can be found in Note L to the Consolidated Financial Statements.
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