PEOPLES FINANCIAL SERVICES CORP. Management's Discussion and Analysis 2022 versus 2021
Management's Discussion and Analysis appearing on the following pages should be read in conjunction with the Consolidated Financial Statements and Management's Discussion and Analysis 2021 versus 2020 contained in this Annual Report on Form 10-K.
Critical Accounting Estimates:
Our consolidated financial statements are prepared in accordance with GAAP. The preparation of consolidated financial statements in conformity with GAAP requires us to establish critical accounting policies and make accounting estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements, as well as the reported amounts of revenues and expenses during those reporting periods. An accounting estimate requires assumptions about uncertain matters that could have a material effect on the consolidated financial statements if a different amount within a range of estimates were used or if estimates changed from period to period. Readers of this report should understand that estimates are made considering facts and circumstances at a point in time, and changes in those facts and circumstances could produce results that differ from when those estimates were made. Significant estimates that are particularly susceptible to material change within the near term relate to the determination of allowance for loan losses, and the impairment of goodwill. Actual amounts could differ from those estimates. We maintain the allowance for loan losses at a level we believe adequate to absorb probable credit losses related to individually evaluated loans, as well as probable incurred losses inherent in the remainder of the loan portfolio as of the balance sheet date. The balance in the allowance for loan losses account is based on past events and current economic conditions among other things. We monitor the adequacy of the allowance quarterly and adjust the allowance as necessary through normal operations. This ongoing evaluation reduces potential differences between estimates and actual observed losses. The determination of the level of the allowance for loan losses is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Accordingly, management cannot ensure that charge-offs in future periods will not exceed the allowance for loan losses or that additional increases in the allowance for loan losses will not be required, resulting in an adverse impact on operating results.Goodwill is evaluated at least annually for impairment or more frequently if conditions indicate potential impairment exist. Any impairment losses arising from such testing are reported in the income statement in the current period as a separate line item within operations. For a further discussion of our critical accounting estimates, refer to Note 1 entitled, "Summary of significant accounting policies," in the Notes to Consolidated Financial Statements to this Annual Report. Note 1 lists the significant accounting policies used by us in the development and presentation of the consolidated financial statements. This discussion and analysis, the Notes to Consolidated Financial Statements and other financial statement disclosures identify and address key variables and other qualitative and quantitative factors that are necessary for the understanding and evaluation of our financial position, results of operations and cash flows.
Operating Environment:
2022 has been centered in uncertainty around the lingering effects of COVID-19, high inflation, a tight labor market, fear of recession and the global impact ofRussia's invasion of theUkraine . As COVID-19 restrictions began to ease and -34- Table of Contents
commercial and consumer activity returned to pre-pandemic levels, strong demand driven by low interest rates and government stimulus clashed with weakened supply chains and pandemic-related shortages.
Inflation increased during 2022 to levels well above theFederal Open Market Committee's ("FOMC") long-term desired 2 percent level for items other than food and energy and remained elevated at year-end 2022. Core inflation, as measured by the Consumer Price Index ("CPI"), excluding items known for their volatility such as food and energy, was 5.7 percent for the 12 months endingDecember 31, 2022 . When including food and energy, CPI was 6.5 percent due primarily to higher energy costs. The Personal Consumption Expenditures Index ("PCE"), a measure of the prices that people living in theU.S. pay for goods and services, increased 5.0 percent in December compared to a year ago. Excluding food and energy, PCE increased 4.4 percent. Concerns over the high inflation rate have resulted in central bankers in theU.S. adjusting interest rates to slow economic activity by curbing spending, hiring and investment. TheFOMC has increased rates seven times throughDecember 31, 2022 for a total of 425 basis points, 25 basis points inFebruary 2023 and additional increases are expected through the first quarter 2023. Higher rates or maintaining rates at this elevated level may be justified beyond that by still tight labor markets, elevated wage pressures and high inflation. We saw strong loan growth in 2022 despite these higher rates. However, we have seen lower mortgage origination and sales volume as interest rates on mortgage loans have reached 20 year highs and the housing market cools off. From a funding perspective, the competition for and subsequent costs of deposits and alternative funding sources has increased and likely will continue to increase in 2023 as theFOMC adjusts rates. The labor market remained strong in 2022 with an unemployment rate of 3.5 percent for December. This along with reduced labor force participation has made it difficult and costly for companies to fill open positions and thus could increase our salaries and benefits expenses. The labor market remains strong going into 2023. Job growth accelerated in the beginning of 2023 asU.S. employers added 517 thousand jobs and pushed the unemployment rate to a 53-year low 3.4 percent in January despite announced corporate lay-offs. Wage growth continued to slow as average hourly earnings grew 4.4 percent in January from a year earlier, down from a revised 4.8 percent in December. Continued strength in the labor market may fuel additional interest rate increases. Gross domestic product ("GDP") rose at a 2.9 percent annualized pace in the fourth quarter after increasing 3.2 percent in the third quarter. This reflected increases in inventory investment and consumer spending partially offset by a decrease in housing investment.
Review of Financial Position:
Peoples Financial Services Corp. , a bank holding company incorporated under the laws ofPennsylvania , provides a full range of financial services through its wholly-owned subsidiary,Peoples Security Bank and Trust Company ("Peoples Bank "), collectively, the "Company" or "Peoples." The Company services its retail and commercial customers through twenty-eight full-service community banking offices located within theAllegheny ,Bucks ,Lackawanna ,Lebanon ,Lehigh ,Luzerne ,Monroe ,Montgomery ,Northampton ,Susquehanna andWyoming Counties ofPennsylvania ,Middlesex County ofNew Jersey and Broome County ofNew York .Peoples Bank is a state-chartered bank and trust company under the jurisdiction of thePennsylvania Department of Banking and Securities and theFDIC .Peoples Bank's primary product is loans to small and medium sized businesses. Other lending products include one-to-four family residential mortgages and consumer loans.Peoples Bank primarily funds its loans by offering checking accounts and money market accounts to commercial enterprises and individuals. Other deposit product offerings include certificates of deposits and various non-maturity deposit accounts. The Company faces competition primarily from commercial banks, thrift institutions and credit unions within itsPennsylvania ,New Jersey andNew York market, many of which are substantially larger in terms of assets and capital. In addition, mutual funds and security brokers compete for various types of deposits, and consumer, mortgage, leasing and -35-
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insurance companies compete for various types of loans and leases. Principal methods of competing for banking and permitted nonbanking services include price, nature of product, quality of service and convenience of location.
The Company andPeoples Bank are subject to regulations of certain federal and state regulatory agencies, including theFederal Reserve Board , theFDIC , andPennsylvania Department of Banking and Securities , and undergo periodic examinations by such agencies. Total assets, loans and deposits were$3.6 billion ,$2.7 billion and$3.0 billion , respectively, atDecember 31, 2022 . Total assets, loans and deposits grew 5.5 percent, 17.2 percent and 2.8 percent, respectively, compared to 2021 year-end balances. The loan portfolio consisted of$2.3 billion of business loans, including commercial and commercial real estate loans, and$421.0 million in retail loans, including residential mortgage and consumer loans atDecember 31, 2022 . Total investment securities were$569.0 million atDecember 31, 2022 , including$477.7 million of investment securities classified as available-for sale and$91.2 million classified as held-to-maturity. Total deposits consisted of$772.8 million in noninterest-bearing deposits and$2.3 billion in interest-bearing deposits atDecember 31, 2022 .
Stockholders' equity equaled
Nonperforming assets equaled$4.1 million or 0.12 percent of total assets atDecember 31, 2022 compared to$5.0 million or 0.15 percent atDecember 31, 2021 . The allowance for loan losses equaled$27.5 million or 1.01 percent of loans, net, atDecember 31, 2022 , compared to$28.4 million or 1.22 percent at year-end 2021. Loans charged-off, net of recoveries equaled$0.5 million or 0.02 percent of average loans in 2022, compared to$0.7 million or 0.03 percent of average loans in 2021. Investment Portfolio: Primarily, our investment portfolio provides a source of liquidity needed to meet expected loan demand and generates a reasonable return in order to increase our profitability. Additionally, we utilize the investment portfolio to meet pledging requirements and reduce income taxes. AtDecember 31, 2022 , our portfolio included short-termU.S. Treasury and government agency securities, which provide a source of liquidity, mortgage-backed securities issued byU.S. government-sponsored agencies to provide income and intermediate-term, tax-exempt state and municipal obligations, which mitigate our tax burden. Our investment portfolio is subject to various risk elements that may negatively impact our liquidity and profitability. The greatest risk element affecting our portfolio is market risk or interest rate risk ("IRR"). Understanding IRR, along with other inherent risks and their potential effects, is essential in effectively managing the investment portfolio. Market risk or IRR relates to the inverse relationship between bond prices and market yields. It is defined as the risk that increases in general market interest rates will result in market value depreciation. A marked reduction in the value of the investment portfolio could subject us to liquidity strains and reduced earnings if we are unable or unwilling to sell these investments at a loss. Moreover, the inability to liquidate these assets could require us to seek alternative funding, which may further reduce profitability and expose us to greater risk in the future. In addition, since the majority of our investment portfolio is designated as available-for-sale and carried at estimated fair value, with net unrealized gains and losses reported as a separate component of stockholders' equity, market value depreciation could negatively impact our capital position. TheFOMC , in an attempt to curb inflation, increased the federal funds rate 425 basis points during 2022 to a targeted range of 4.25 percent to 4.50 percent. Our investment portfolio consists primarily of fixed-rate bonds. As a result, changes in the velocity and magnitude of futureFOMC actions can significantly influence the fair value of our portfolio. Specifically, the parts of the yield curve most closely related to our investments include the 2-year and 10-yearU.S. -36- Table of ContentsTreasury security. The yield on the 2-yearU.S. Treasury note affects the values of ourU.S. Treasury and government agency securities, whereas the 10-yearU.S. Treasury note influences the value of tax-exempt and taxable state and municipal obligations. The yield on the 2-yearU.S. Treasury increased 368 basis points in 2022, ending at 441 basis points. The yield on the 10-yearU.S. Treasury increased 237 basis points in 2022, ending at 388 basis points. Since bond prices move inversely to yields, we experienced a decrease in the aggregate fair value of our investment portfolio when comparingDecember 31, 2022 toDecember 31, 2021 due to higher market rates at year end 2022. The net unrealized holding losses included in our available-for-sale investment portfolio were$66.3 million atDecember 31, 2022 compared to a loss of$1.8 million atDecember 31, 2021 . We reported net unrealized holding loss, included as a separate component of stockholders' equity of$52.0 million , net of income taxes of$14.3 million , atDecember 31, 2022 , and an unrealized holding loss of$1.4 million , net of income taxes of$0.4 million , atDecember 31, 2021 . Further increases in interest rates could negatively impact the market value of our investments and our capital position. In order to monitor the potential effects a rise in interest rates could have on the value of our investments, we perform stress test modeling on the portfolio. Stress tests conducted on our portfolio atDecember 31, 2022 , indicated that should general market rates increase immediately by 100, 200 or 300 basis points, we would anticipate declines of 4.5 percent, 8.9 percent and 13.2 percent in the market value of our available-for-sale portfolio. Investment securities decreased$19.7 million , to$569.0 million atDecember 31, 2022 , from$588.7 million atDecember 31, 2021 . AtDecember 31, 2022 , the investment portfolio consisted of$477.7 million of investment securities classified as available-for-sale and$91.2 million classified as held-to-maturity. Security purchases totaled$138.7 million in 2022. Investment purchases in 2021 amounted to$358.6 million . Repayments of investment securities totaled$46.9 million in 2022 and$60.4 million in 2021. During December of 2022, the Company sold$45.5 million of low-yielding, shorter durationU.S. Treasury securities and immediately re-deployed the proceeds by purchasing higher-yielding, longer duration mortgage-backed securities. The transaction resulted in a realized loss of$2.0 million with the expectation the loss would be earned back over the succeeding fifteen months from higher interest income. There were no sales of investments during 2021. During February of 2023, the Company sold a pool of low-yielding tax-exempt municipal bonds and mortgage-backed securities that resulted in a realized gain of$0.1 million and utilized the proceeds to pay-down higher-costing overnight borrowings. We continually analyze the investment portfolio with respect to its exposure to various risk elements. Residential and commercial mortgage backed securities totaled 37.5 percent of the portfolio at year-end 2022 compared to 30.8 percent at year-end 2021. Short-term bulletU.S. Treasury andU.S. government-sponsored enterprise securities comprised 34.6 percent of our total portfolio at year-end 2022 compared to 38.3 percent at the end of 2021. Tax-exempt municipal obligations decreased as a percentage of the total portfolio to 17.5 percent at year-end 2022 from 18.6 percent at the end of 2021. Taxable municipals decreased as a percentage of the total portfolio to 9.7 percent at year-end 2022 from 11.7 percent at the end of 2021. The average life of the investment portfolio lengthened to 7.0 years atDecember 31, 2022 from 5.3 years at year end 2021, while the effective duration of the investment portfolio increased to 4.8 years atDecember 31, 2022 from 4.6 years atDecember 31, 2021 . There were no other-than-temporary impairments ("OTTI") recognized for the years endedDecember 31, 2022 , 2021 and 2020. For additional information related to OTTI refer to Note 3 entitled "Investment securities" in the Notes to Consolidated Financial Statements to this Annual Report. Investment securities averaged$648.6 million and equaled 20.1 percent of average earning assets in 2022, compared to$398.5 million and 13.9 percent of average earning assets in 2021. The tax-equivalent yield on the investment portfolio decreased 27 basis points to 1.67 percent in 2022 from 1.94 percent in 2021. The decrease in the tax-equivalent yield is due to cash flow from maturing and called bonds being reinvested at lower market rates coupled with lower yields on new purchases executed during the first three months of 2022. -37-
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At
The maturity distribution based on the carrying value and weighted-average, tax-equivalent yield of the investment debt security portfolio atDecember 31, 2022 , is summarized as follows. The weighted-average yield, based on amortized cost, has been computed for tax-exempt state and municipals on a tax-equivalent basis using the prevailing federal statutory tax rate of 21.0 percent. The distributions are based on contractual maturity. Expected maturities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties. After one but After five but Within one year within five years within ten years After ten years Total (Dollars in thousands, except percents) Amount Yield Amount Yield
Amount Yield Amount Yield Amount Yield
% $ 155,956 0.99 % $ 24,341 1.17 % $ % $ 180,297 1.01 %
U.S. government-sponsored
enterprises 14,086 1.69 18 4.59 2,266 2.25 16,370 1.78
State and municipals:
Taxable 975 5.55 7,302 2.69 29,282 2.04 17,799 2.04 55,358 2.16
Tax-exempt 540 4.26 5,066 2.90 24,551 2.05 69,487 2.39 99,644 2.34
Corporate debt securities 3,626 4.19 3,626 4.19
Residential
mortgage-backed
securities:
U.S. government agencies 8 2.10 117 1.95 18,121 1.55 18,246 1.55
U.S. government-sponsored
enterprises 95 2.21 501 2.39 4,486 3.02 178,675 2.45 183,757 2.47
Commercial mortgage-backed
securities:
U.S. government-sponsored
enterprises 11,584 2.49 11,584 2.49
Total $ 15,704 2.02 % $ 180,544 1.21 % $ 88,552 1.78 % $ 284,082 2.35 % $ 568,882 1.92 %
Loan Portfolio:
Economic factors and how they affect loan demand are of extreme importance to us and the overall banking industry, as lending is a primary business activity. Loans are the most significant component of earning assets and they generate the greatest amount of revenue for us. Similar to the investment portfolio, there are risks inherent in the loan portfolio that must be understood and considered in managing the lending function. These risks include IRR, credit concentrations and fluctuations in demand. Changes in economic conditions and interest rates affect these risks which influence loan demand, the composition of the loan portfolio and profitability of the lending function. From a lending perspective, organic loan growth, excluding PPP loans, improved during 2022 resulting from our entrance into theGreater Pittsburgh market andCentral New Jersey market with experienced market lenders, coupled with increased loan demand across all our legacy markets. We participated in the CARES Act, Paycheck Protection Program ("PPP"), a$350 billion specialized low-interest loan program funded by theU.S. Treasury Department and administered by theU.S. Small Business Administration ("SBA"). The PPP provides borrower guarantees for lenders, as well as loan forgiveness incentives for borrowers that utilize the loan proceeds to cover employee compensation related business operating costs. During 2020, we had approved 1,450 PPP loans totaling$217.5 million . Substantially all of the loans were made to existing customers, funded under the two year PPP loan program. PPP loan forgiveness commenced during the fourth quarter of 2020 and atDecember 31, 2022 , 13 loans totaling$11.4 million remain outstanding and are expected to be forgiven during 2023. In addition, the Company participated in the 2021 second round of PPP lending and received approval by the SBA on 1,062 applications totaling$121.6 million . AtDecember 31, 2022 , 10 loans totaling -38-
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Overall, total loans increased$400.9 million or 17.2 percent in 2022 to$2.7 billion atDecember 31, 2022 . Excluding PPP loans, loan growth totaled$447.5 million or 19.8 percent. Business loans, including commercial loans and commercial real estate loans, were$2.3 billion or 84.6 percent of total loans atDecember 31, 2022 , and$2.0 billion or 84.0 percent at year-end 2021. Residential mortgages and consumer loans totaled$421.0 million or 15.4 percent of total loans at year-end 2022 and$372.5 million or 16.0 percent at year-end 2021. Total loan growth, excluding PPP loans, of$447.5 million was primarily attributable to increases in our commercial real estate portfolio which grew$366.3 million in 2022 due to continued success of our strategy to expand in larger markets with strong growth potential, and strong organic growth in our legacy markets. Our expansion strategy commenced during 2014 in theLehigh Valley with a community banking office and team of dedicated lenders and has expanded with two additional branch offices and additional teams of experienced lenders and credit professionals. Growth is also due to our presence in theGreater Delaware Valley , first by opening a branch office inKing of Prussia in 2016, and during 2020 with the opening of a branch inDoylestown and recruitment of two experienced lenders. Further growth was attained by our entrance intoCentral Pennsylvania with a branch office inLebanon , staffed with a team of lending professionals during the middle of 2018. Our most recent expansion during the final six months of 2021 into theGreater Pittsburgh market with a new office and team of experienced lenders and entrance intoCentral New Jersey with an office inPiscataway ,Middlesex County , and team of experienced lenders known in the market has exceeded projections and contributed to the strong loan growth in 2022. Based on the customer service oriented philosophy of our organization along with the commitment of these employees, we continue to be well received in these new markets as we are in our existing markets. Residential mortgage loans increased$33.1 million during 2022 as low market rates in the beginning of the year resulted in an increase of refinance and purchase activity, prior to slowing down in the second half of the year as rates rose. Consumer loans increased$15.4 million during 2022 primarily due to our indirect automobile portfolio. Loans averaged$2.5 billion in 2022, compared to$2.2 billion in 2021. Taxable loans averaged$2.3 billion , while tax-exempt loans averaged$0.2 billion in 2022. The loan portfolio continues to play the prominent role in our earning asset mix. As a percentage of earning assets, average loans equaled 78.0 percent in 2022, an increase from 77.2 percent in 2021. The tax-equivalent yield on our loan portfolio increased 10 basis points to 4.04 percent in 2022 from 3.94 percent in 2021 due to higher yields on new loan originations, the repricing of floating and adjustable rate loans due to the increase in market rates beginning during the second quarter of 2022. PPP loans averaged$34.6 million in 2022 and resulted in a 1 basis point increase to the overall loan yield compared to average PPP loans of$147.0 million in 2021 and a 6 basis point increase. The yield on the loan portfolio may increase as repayments on loans are replaced with new originations at current market rates and floating and adjustable rate loans continue to reprice upward. -39-
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The maturity distribution and sensitivity information of the loan portfolio by
major classification at
Within one After one but After five but After
(Dollars in thousands) year within five years within fifteen years fifteen years Total
Maturity schedule:
Commercial $ 171,468 $ 253,345 $ 27,232 $ 147,213 $ 599,258
Real estate:
Commercial 280,993 878,232 488,243 62,359 1,709,827
Residential 65,893 164,504 85,595 14,736 330,728
Consumer 34,401 47,595 8,059 248 90,303
Total $ 552,755 $ 1,343,676 $ 609,129 $ 224,556 $ 2,730,116
Predetermined interest rates $ 277,544 $ 774,825 $ 243,096 $ 110,816 $ 1,406,281
Floating or adjustable interest rates 275,211 568,851 366,033 113,740 1,323,835
Total $ 552,755 $ 1,343,676 $ 609,129 $ 224,556 $ 2,730,116 As previously mentioned, there are numerous risks inherent in the loan
portfolio. We manage the portfolio by employing sound credit policies and
utilizing various modeling techniques in order to limit the effects of such
risks. In addition, we utilize private mortgage insurance ("PMI") and guaranteed
In an attempt to limit IRR and liquidity strains, we continually examine the maturity distribution and interest rate sensitivity of the loan portfolio. Fixed-rate loans represented 51.5 percent of the loan portfolio atDecember 31, 2022 , compared to floating or adjustable-rate loans at 48.5 percent. Additionally, our secondary market mortgage banking program provides us with an additional source of liquidity and a means to limit our exposure to IRR. Through this program, we are able to competitively price conforming one-to-four family residential mortgage loans without taking on IRR which would result from retaining these long-term, low fixed-rate loans on our books. The loans originated are subsequently sold in the secondary market, with the sales price locked in at the time of commitment, thereby greatly reducing our exposure to IRR. Loan concentrations are considered to exist when the total amount of loans to any one borrower, or a multiple number of borrowers engaged in similar business activities or having similar characteristics, exceeds 25.0 percent of capital outstanding in any one category. We provide deposit and loan products and other financial services to individual and corporate customers in our current market area. There are no significant concentrations of credit risk from any individual counterparty or groups of counterparties, except for geographic concentrations in our market area. Credit risk is the principal risk associated with these instruments. Our involvement and exposure to credit loss in the event that the instruments are fully drawn upon and the customer defaults is represented by the contractual amounts of these instruments. In order to control credit risk associated with entering into commitments and issuing letters of credit, we employ the same credit quality and collateral policies in making commitments that we use in other lending activities. We evaluate each customer's creditworthiness on a case-by-case basis, and if deemed necessary, obtain collateral. The amount and nature of the collateral obtained is based on our credit evaluation.
Asset Quality:
We are committed to developing and maintaining sound, quality assets through our
credit risk management policies and procedures. Credit risk is the risk to
earnings or capital which arises from a borrower's failure to meet the terms of
their loan obligations. We manage credit risk by diversifying the loan portfolio
and applying policies and procedures designed to foster sound lending practices.
These policies include certain standards that assist lenders in making judgments
regarding the character, capacity, cash flow, capital structure and collateral
of the borrower.
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With regard to managing our exposure to credit risk in light of general
devaluations in real estate values, we have established maximum loan-to-value
ratios for commercial mortgage loans not to exceed 80.0 percent of the appraised
value. With regard to residential mortgages, customers with loan-to-value ratios
in excess of 80.0 percent are generally required to obtain Private Mortgage
Insurance ("PMI"). PMI is used to protect us from loss in the event
loan-to-value ratios exceed 80.0 percent and the customer defaults on the loan.
Appraisals are performed by an independent appraiser engaged by us, not the
customer, who is either state certified or state licensed depending upon
collateral type and loan amount.
With respect to lending procedures, lenders and our credit underwriters must
determine the borrower's ability to repay their loans based on prevailing and
expected market conditions prior to requesting approval for the loan. The Bank's
board of directors establishes and reviews, at least annually, the lending
authority for certain senior officers, loan underwriters and branch personnel.
Credit approvals beyond the scope of these individual authority levels are
forwarded to a loan committee. This committee, comprised of certain members of
senior management, review credits to monitor the quality of the loan portfolio
through careful analysis of credit applications, adherence to credit policies
and the examination of outstanding loans and delinquencies. These procedures
assist in the early detection and timely follow-up of problem loans.
Credit risk is also managed by monthly internal reviews of individual credit
relationships in our loan portfolio by credit administration and the asset
quality committee. These reviews aid us in identifying deteriorating financial
conditions of borrowers and allows us the opportunity to assist customers in
remedying these situations.
Nonperforming assets consist of nonperforming loans and foreclosed assets.
Nonperforming loans include nonaccrual loans, troubled debt restructured loans
and accruing loans past due 90 days or more. For a discussion of our policy
regarding nonperforming assets and the recognition of interest income on
impaired loans, refer to the notes entitled, "Summary of significant accounting
policies - Nonperforming assets," and "Loans, net and allowance for loan losses"
in the Notes to Consolidated Financial Statements to this Annual Report which
are incorporated in this item by reference.
Information concerning nonperforming assets for the past two years is summarized
as follows. The table includes credits classified for regulatory purposes and
all material credits that cause us to have serious doubts as to the borrower's
ability to comply with present loan repayment terms.
(Dollars in thousands, except percents) December 31, 2022 December 31, 2021
Nonaccrual loans $ 2,035 $ 2,811
Troubled debt restructured loans (including
nonaccrual TDR) 1,351 1,649
Accruing loans past due 90 days or more: 748
13
Total nonperforming loans 4,134 4,473
Foreclosed assets 488
Total nonperforming assets $ 4,134 $ 4,961
Loans modified in a troubled debt restructuring
(TDR):
Performing TDR loans $ 1,351 $ 1,649
Total TDR loans $ 1,351 $ 1,649Total loans held for investment $ 2,730,116 $ 2,329,173 Allowance for loan losses 27,472 28,383 Allowance for loan losses as a percentage of loans held for investment 1.01 % 1.22 % Allowance for loan losses as a percentage of nonaccrual loans 1349.98 1009.71 Nonaccrual loans as a percentage of loans held for investment 0.07 0.12 Nonperforming loans as a percentage of loans, net 0.15 0.19 We experienced improved asset quality during 2022 as evidenced by a decrease in nonperforming assets of$0.8 million or 16.7 percent when compared to year-end 2021. Additionally, our nonperforming assets as a percentage of total assets improved to 0.12 percent atDecember 31, 2022 from 0.15 percent atDecember 31, 2021 , and our nonperforming loans as a percentage of loans, net improved to 0.15 percent from 0.19 percent atDecember 31, 2021 . A reduction of$0.8 million to nonaccrual loans was the primary reason for the improvement. Loans on nonaccrual status, excluding troubled -41- Table of Contents
debt restructured nonaccrual loans, decreased$0.8 million and resulted in part from the sale of commercial and residential nonaccrual loans with a book value of$0.9 million . Restructured loans decreased$0.3 million when comparingDecember 31, 2022 and 2021, respectively, due to loan payoffs and pay downs. AtDecember 31, 2022 , there were no foreclosed properties as compared to three foreclosed properties atDecember 31, 2021 totaling$0.5 million . Loans past due ninety days and accruing increased$0.7 million and include five residential mortgages. For a further discussion of assets classified as nonperforming assets and potential problem loans, refer to the note entitled, "Loans, net and the allowance for loan losses," in the Notes to Consolidated Financial Statements to this Annual Report. We maintain the allowance for loan losses at a level we believe adequate to absorb probable credit losses related to individually evaluated loans, as well as probable incurred losses inherent in the remainder of the loan portfolio as of the balance sheet date. The balance in the allowance for loan losses account is based on past events and current economic conditions. We employ theFederal Financial Institutions Examination Council ("FFIEC") Interagency Policy Statement, as amended, and GAAP in assessing the adequacy of the allowance account. Under GAAP, the adequacy of the allowance account is determined based on the provisions of FASB Accounting Standards Codification ("ASC") 310 for loans specifically identified to be individually evaluated for impairment and the requirements of FASB ASC 450, for large groups of smaller-balance homogeneous loans to be collectively evaluated for impairment. We follow our systematic methodology in accordance with procedural discipline by applying it in the same manner regardless of whether the allowance is being determined at a high point or a low point in the economic cycle. Each quarter, our credit administration department identifies those loans to be individually evaluated for impairment and those to be collectively evaluated for impairment utilizing a standard criteria. We consistently use loss experience from the latest twelve quarters in determining the historical loss factor for each pool collectively evaluated for impairment. Qualitative factors are evaluated in the same manner each quarter and are adjusted within a relevant range of values based on current conditions to assure directional consistency of the allowance for loan loss account. Regulators, in reviewing the loan portfolio as part of the scope of a regulatory examination, may require us to increase our allowance for loan losses or take other actions that would require increases to our allowance for loan losses. For a further discussion of our accounting policies for determining the amount of the allowance and a description of the systematic analysis and procedural discipline applied, refer to the note entitled, "Summary of significant accounting policies- Allowance for loan losses," in the Notes to Consolidated Financial Statements to this Annual Report. -42-
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The following table presents average loans and loan loss experience for the years indicated.
(Dollars in thousands, except
percents) 2022
Net
Charge-offs
Net (Recoveries)
Charge-offs to Average
Average loans (Recoveries) Loans
Commercial $ 595,566 $ 121 0.02 %
Real estate:
Commercial 1,531,383 174 0.01
Residential 315,975 27 0.01
Consumer 79,726 140 0.18
Total $ 2,522,650 $ 462 0.02 %
(Dollars in thousands, except
percents) 2021
Net
Charge-offs
Net (Recoveries)
Charge-offs to Average
Average loans (Recoveries) Loans
Commercial $ 648,192 $ 403 0.06 %
Real estate:
Commercial 1,209,639 184 0.02
Residential 284,060 17 0.01
Consumer 78,686 107 0.14
Total $ 2,220,577 $ 711 0.03 %
(Dollars in thousands, except
percents) 2020
Net
Charge-offs
Net (Recoveries)
Charge-offs to Average
Average loans (Recoveries) Loans
Commercial $ 651,635 $ 2,246 0.34 %
Real estate:
Commercial 1,085,237 128 0.01
Residential 294,952 190 0.06
Consumer 91,252 169 0.02
Total $ 2,123,076 $ 2,733 0.13 %
The allowance for loan losses decreased $0.9 million to $27.5 million at
December 31, 2022 , from $28.4 million at the end of 2021. The decrease resulted
from a credit to the provision for loan losses of $0.4 million and net loans
charged-off of $0.5 million . The release from the allowance for loan losses
during the year ended December 31, 2022 was due to application of our allowance
for loan losses methodology that included a decline in historical loss factors
and overall improvement to the quality of our loan portfolio based on current
conditions. The 2021 period includes the total charge-off of a fully allocated
small-business line of credit originated in our Greater Delaware Valley market
totaling $0.4 million . During 2020, $0.9 million was charged-off related to
small-business lines of credit originated in our Greater Delaware Valley market
offset by $0.2 million of recoveries.
The allowance for loan losses, as a percentage of loans, net of unearned income,
was 1.01 percent at the end of 2022, 1.22 percent at the end of 2021,
respectively. Excluding PPP loans that do not carry an allowance for losses due
to a 100 percent government guarantee, the ratio equaled 1.01 percent at
December 31, 2022 .
Past due loans not satisfied through repossession, foreclosure or related
actions are evaluated individually to determine if all or part of the
outstanding balance should be charged against the allowance for loan losses
account. Any subsequent recoveries are credited to the allowance account. Net
loans charged-off decreased
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from
The allocation of the allowance for loan losses for the past two years is summarized as follows:
2022 2021
(Dollars in thousands, except percents) Amount % Amount % Specific: Commercial$ 19 0.07 %$ 40 0.01 % Real Estate: Commercial 109 0.12 Residential 21 0.08 26 0.06 Consumer Total specific 40 0.15 175 0.19 Formula: Commercial 5,593 20.36 8,413 26.31 Real Estate: Commercial 17,915 65.20 15,819 57.56 Residential 3,051 11.11 3,183 12.72 Consumer 873 3.18 793 3.22 Total formula 27,432 99.85 28,208 99.81 Total allowance$ 27,472 100.00 %$ 28,383 100.00 % The allowance for loan losses account decreased$0.9 million to$27.5 million atDecember 31, 2022 , compared to$28.4 million atDecember 31, 2021 . The specific portion of the allowance for impairment of loans individually evaluated under FASB ASC 310 decreased$135 thousand to$40 thousand atDecember 31, 2022 , from$175 thousand atDecember 31, 2021 and the portion of the allowance for loans collectively evaluated for impairment under FASB ASC 450, decreased$776 thousand to$27.4 million atDecember 31, 2022 , from$28.2 million atDecember 31, 2021 . The decrease in the specific portion of the allowance was a result of a decrease in measured impairment for collateral dependent loans, improved credit quality and a decrease to non-performing loans of$0.3 million . The decrease in the collectively evaluated portion was primarily the result of the roll-off of historical losses within our commercial loan portfolio, improved credit quality and a decrease of non-performing loans. The coverage ratio, the allowance for loan losses, as a percentage of nonperforming loans, is an industry ratio used to test the ability of the allowance account to absorb potential losses arising from nonperforming loans. The coverage ratio was 664.5 percent atDecember 31, 2022 and 634.5 percent atDecember 31, 2021 . We believe that our allowance was adequate to absorb probable credit losses atDecember 31, 2022 .
Deposits:
Our deposit base is the primary source of funds to support our operations. We offer a variety of deposit products to meet the needs of our individual and commercial customers. Total deposits grew$83.2 million or 2.8 percent to$3.0 billion at the end of 2022. The increase in deposits is due to organic growth of customer relationships throughout all our markets and inflows of municipal deposits. Total deposits include$23.1 million of brokered certificates of deposit. Noninterest-bearing deposits grew$35.0 million or 4.8 percent while interest-bearing deposits increased$48.2 million or 2.2 percent in 2022. Noninterest-bearing deposits represented 25.4 percent of total deposits while interest-bearing deposits accounted for 74.6 percent of total deposits atDecember 31, 2022 . Comparatively, noninterest-bearing deposits and interest-bearing deposits represented 24.9 percent and 75.1 percent of total deposits at year end 2021. With regard to noninterest-bearing deposits, personal checking accounts increased$16.9 million or 5.1 percent, while commercial checking accounts increased$18.0 million or 4.4 percent. The increase in noninterest-bearing deposits is essential in attempting to keep our overall cost of funds low given the pressure on our net interest margin from the increase in short-term market rates. -44- Table of Contents With regard to interest-bearing deposits, interest-bearing transaction accounts, which include money market accounts and NOW accounts, and savings accounts, increased$50.8 million in 2022. Commercial interest-bearing transaction accounts increased$29.4 million , while personal interest-bearing transaction accounts increased$21.4 million . Savings accounts increased$32.1 million during 2022 as customers keep a portion of their balances in safe liquid accounts. The strong growth in our non-maturity deposits was due to continuing our strategic initiative to grow our public fund deposits and continued organic growth in all our markets. Total time deposits decreased$2.6 million to$291.9 million atDecember 31, 2022 from$294.5 million atDecember 31, 2021 . The decrease was due to depositors shifting funds to more liquid accounts and the redemption of a few large municipal accounts.
The average amount of, and the rate paid on, the major classifications of deposits for the past three years are summarized as follows:
2022 2021 2020
Average Average Average Average Average Average
(Dollars in thousands, except
percents) Balance Rate Balance Rate Balance Rate
Interest-bearing:
Money market accounts $ 624,528 0.80 % $ 549,169 0.36 % $ 432,621 0.81 %
NOW accounts 791,653 0.57 666,885 0.33 470,701 0.58
Savings accounts 520,770 0.10 468,851 0.08 404,628 0.12
Time deposits 290,799 0.92 301,024 0.92 355,030 1.40
Total interest-bearing 2,227,750 0.57 % 1,985,929 0.37 % 1,662,980 0.71 %
Noninterest-bearing 753,399 684,527 555,459
Total deposits $ 2,981,149 $ 2,670,456 $ 2,218,439 Total deposits averaged
Our cost of interest-bearing deposits increased to 0.57 percent in 2022. Specifically, the cost of money market accounts increased 44 basis points to 0.80 percent from 0.36 percent and NOW accounts increased 24 basis points to 0.57 percent. The increases in the cost of our interest-bearing deposits is due to theFOMC rate increases as rate-sensitive customers require higher rates on their deposits along with competitive pressure for deposits. We expect our cost of funds to continue to rise in 2023 as theFOMC raises rates. Volatile deposits, time deposits$100 or more, averaged$163.0 million in 2022, a decrease of$9.7 million or 5.6 percent from$172.7 million in 2021. Our average cost of these funds increased 6 basis points to 0.84 percent in 2022, from 0.78 percent in 2021. This type of funding is susceptible to withdrawal by the depositor as they are particularly price sensitive and are therefore not considered to be a strong source of liquidity.
At
AtDecember 31, 2022 and 2021, the Company had$92.7 million and$88.3 million , respectively, in time deposits in excess of$250,000 maturing as disclosed in the table below. Brokered deposits in the amount of$23.6 million atDecember 31, 2022 and$12.5 million atDecember 31, 2021 are not included in time deposits more than$250,000 . -45- Table of Contents (Dollars in thousands) 2022 2021 Within three months$ 13,695 $ 29,579
After three months but within six months 21,395 25,453 After six months but within twelve months 27,346 19,462 After twelve months
30,295 13,801
Total $ 92,731 $ 88,295
In addition to deposit gathering, we have a secondary source of liquidity
through existing credit arrangements with the FHLB-Pgh. At December 31, 2022 , we
had outstanding overnight borrowings at the FHLB of $100.4 million and expect
utilization of the credit facility during 2023, the extent determined by deposit
activity and loan growth. For a further discussion of our borrowings and their
terms, refer to the notes entitled, "Short-term borrowings" and "Long-term
debt," in the Notes to Consolidated Financial Statements included in Part II,
Item 8 of this Annual Report.
Subordinated Debt:
OnJune 1, 2020 , the Company sold$33.0 million aggregate principal amount of Subordinated Notes due 2030 (the "2020 Notes") to accredited investors. The 2020 Notes are treated as Tier 2 capital for regulatory capital purposes. The 2020 Notes bear interest at a rate of 5.375 percent per year for the first five years and then float based on a benchmark rate (as defined), provided that the interest rate applicable to the outstanding principal balance during the period the 2020 Notes are floating will at no time be less the 4.75 percent. Interest is payable semi-annually in arrears onJune 1 andDecember 1 of each year for the first five years after issuance and will be payable quarterly in arrears thereafter onMarch 1 ,June 1 ,September 1 , andDecember 1 . The 2020 Notes mature onJune 1, 2030 and are redeemable in whole or in part, without premium or penalty, at any time on or afterJune 1, 2025 and prior toJune 1, 2030 . Additionally, if all or any portion of the 2020 Notes cease to be deemed Tier 2 Capital, the Company may redeem, in whole and not in part, at any time upon giving not less than ten days' notice, an amount equal to one hundred percent (100 percent) of the principal amount outstanding plus accrued but unpaid interest to but excluding the date fixed for redemption. Holders of the 2020 Notes may not accelerate the maturity of the 2020 Notes, except upon the bankruptcy, insolvency, liquidation, receivership or similar proceeding by or against the Company.
Market Risk Sensitivity:
Market risk is the risk to our earnings and/or financial position resulting from adverse changes in market rates or prices, such as interest rates, foreign exchange rates or equity prices. Our exposure to market risk is primarily IRR associated with our lending, investing and deposit gathering activities. During the normal course of business, we are not exposed to foreign exchange risk or commodity price risk. Our exposure to IRR can be explained as the potential for change in our reported earnings and/or the market value of our net worth. Variations in interest rates affect the underlying economic value of our assets, liabilities and off-balance sheet items. These changes arise because the present value of future cash flows, and often the cash flows themselves, change with interest rates. The effects of the changes in these present values reflect the change in our underlying economic value, and provide a basis for the expected change in future earnings related to interest rates. Interest rate changes affect earnings by changing net interest income and the level of other interest-sensitive income and operating expenses. IRR is inherent in the role of banks as financial intermediaries. However, a bank with a high degree of IRR may experience lower earnings, impaired liquidity and capital positions, and most likely, a greater risk of insolvency. Therefore, banks must carefully evaluate IRR to promote safety and soundness in their activities. Market interest rates have risen rapidly during 2022 from historic lows as theFOMC has raised the federal funds rates seven times for 425 basis points throughDecember 31, 2022 . Market expectations are that theFOMC will continue to raise rates with an additional 25 basis point increase announcedFebruary 1, 2023 . It has become challenging to manage IRR. Due to these factors, IRR and effectively managing it are very important to both bank management and regulators. -46-
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Bank regulations require us to develop and maintain an IRR management program, overseen by our board of directors and senior management that involves a comprehensive risk management process in order to effectively identify, measure, monitor and control risk. TheFFIEC through its advisory guidance reiterates the importance of effective corporate governance, policies and procedures, risk measuring and monitoring systems, stress testing and internal controls related to the IRR exposure of depository institutions. According to the advisory, the bank regulators believe that the current financial market and economic conditions present significant risk management challenges to all financial institutions. Although the bank regulators recognize that some degree of IRR is inherent in banking, they expect institutions to have sound risk management practices in place to measure, monitor and control IRR exposure. The advisory states that the adequacy and effectiveness of an institution's IRR management process and the level of IRR exposure are critical factors in the bank regulators' evaluation of an institution's sensitivity to changes in interest rates and capital adequacy. Material weaknesses in risk management processes or high levels of IRR exposure relative to capital will require corrective action. We believe our risk management practices with regard to IRR were suitable and adequate given the level of IRR exposure atDecember 31, 2022 . The Asset/Liability Committee ("ALCO"), comprised of members of our bank's board of directors, senior management and other appropriate officers, oversees our IRR management program. Specifically, ALCO analyzes economic data and market interest rate trends, as well as competitive pressures, and utilizes several computerized modeling techniques to reveal potential exposure to IRR. This allows us to monitor and attempt to control the influence these factors may have on our rate sensitive assets ("RSA"), rate sensitive liabilities ("RSL") and overall operating results and financial position. With respect to evaluating our exposure to IRR on earnings, we utilize a gap analysis model that considers repricing frequencies of RSA and RSL. Gap analysis attempts to measure our interest rate exposure by calculating the net amount of RSA and RSL that reprice within specific time intervals. A positive gap occurs when the amount of RSA repricing in a specific period is greater than the amount of RSL repricing within that same time frame and is indicated by a RSA/RSL ratio greater than 1.0. A negative gap occurs when the amount of RSL repricing is greater than the amount of RSA and is indicated by a RSA/RSL ratio less than 1.0. A positive gap implies that earnings will be impacted favorably if interest rates rise and adversely if interest rates fall during the period. A negative gap tends to indicate that earnings will be affected inversely to interest
rate
changes.
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Our interest rate sensitivity gap position, illustrating RSA and RSL at their
related carrying values, is summarized as follows. The distributions in the
table are based on a combination of maturities, call provisions, repricing
frequencies and prepayment patterns. Adjustable-rate assets and liabilities are
distributed based on the repricing frequency of the instrument. Mortgage
instruments are distributed in accordance with estimated cash flows, assuming
there is no change in the current interest rate environment.
Due after Due after
three months one year
Due within but within but within Due after
(Dollars in thousands, except
ratios) three months twelve months five years five years Total
Rate-sensitive assets:
Interest-bearing deposits in other
banks $ 193 $ $ $ $ 193
Federal funds sold
Investment securities 6,992 29,263 276,821 255,916 568,992
Total loans 630,112 343,745 1,282,365 446,422 2,702,644
Loans held for sale
Total rate-sensitive assets $ 637,297 $ 373,008 $ 1,559,186 $ 702,338 $ 3,271,829
Rate-sensitive liabilities:
Money market accounts $ 685,323 $ $ $$ 685,323 NOW accounts 476,406 296,306 772,712 Savings accounts 523,931 523,931 Time deposits less than$100 thousand 26,420 53,444 37,330 5,374 122,568 Time deposits$100 thousand or more 27,324 89,827 50,151 1,997 169,299 Short-term borrowings 114,930 114,930 Long-term debt 555 555 Subordinated debt 33,000 33,000
Total rate-sensitive liabilities$ 1,330,958 $ 143,271
$ 120,481 $ 827,608 $ 2,422,318 Rate-sensitivity gap: Period$ (693,661) $ 229,737 $ 1,438,705 $ (125,270) 849,511 Cumulative$ (693,661) $ (463,924) $ 974,781 $ 849,511 RSA/RSL ratio: Period 0.48 2.60 12.94 0.85 Cumulative 0.48 0.69 1.61 1.35 1.35 AtDecember 31, 2022 , we had cumulative one-year RSA/RSL ratio of 0.69, a positive gap. AtDecember 31, 2021 , we had cumulative one-year RSA/RSL of 1.16, a positive gap. As previously mentioned, a positive gap indicates that if interest rates increase, our earnings would likely be favorably impacted. The overall focus of ALCO is to maintain a well-balanced IRR position in order to safeguard future earnings during historical low-rate environment and from potential risk to falling interest rates. During the first six months of 2022, ALCO took steps to reduce our positive gap position and guard against rates unchanged or down through the origination of fixed rate loans and the investment in longer term, fixed rate investment securities. However, as interest rates moved higher due to theFOMC's attempt to curb inflation, ALCO focused on funding costs and asset yields.
ALCO will continue to focus efforts on strategies in 2023 to improve asset yields and control funding costs to mitigate expected net interest income compression in an attempt to maintain a positive gap position between RSA and RSL. However, these forward-looking statements are qualified in the aforementioned section entitled "Forward-Looking Discussion" in this Management's Discussion and Analysis.
The change in our cumulative one-year ratio from the previous year-end resulted from a$319.6 million or 24.0 percent decrease in RSA offset by a$324.2 million or 28.2 percent increase in RSL maturing or repricing within one year. The decrease in RSA resulted primarily from a$242.4 million decrease in federal funds sold, resulting from an increase in commercial lending. -48-
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With respect to the$324.2 million increase in RSL maturing or repricing within a twelve month time horizon, non-maturity deposits increased$210.1 million due to customers seeking liquid accounts and saving at a higher percentage due to the economic uncertainty of the pandemic. In addition short-term borrowings increased$114.9 million in part to fund loan growth. Static gap analysis, although a credible measuring tool, does not fully illustrate the impact of interest rate changes on future earnings. First, market rate changes normally do not equally or simultaneously affect all categories of assets and liabilities. Second, assets and liabilities that can contractually reprice within the same period may not do so at the same time or to the same magnitude. Third, the interest rate sensitivity table presents a one-day position and variations occur daily as we adjust our rate sensitivity throughout the year. Finally, assumptions must be made in constructing such a table. For example, the conservative nature of our Asset/Liability Management Policy assigns personal NOW accounts to the "Due after three months but within twelve months" repricing interval. In reality, these accounts may reprice less frequently and in different magnitudes than changes in general market interest rate levels. We utilize a simulation model to address the failure of the static gap model to address the dynamic changes in the balance sheet composition or prevailing interest rates and to enhance our asset/liability management. This model creates pro forma net interest income scenarios under various interest rate shocks. Given instantaneous and parallel shifts in general market rates of plus 100 basis points, our projected net interest income for the 12 months endingDecember 31, 2023 , would decrease 2.8 percent from model results using current interest rates. We will continue to monitor our IRR position in 2023 and anticipate employing deposit and loan pricing strategies and directing the reinvestment of loan and investment payments and prepayments in order to maintain our target IRR position. Financial institutions are affected differently by inflation than commercial and industrial companies that have significant investments in fixed assets and inventories. Most of our assets are monetary in nature and change correspondingly with variations in the inflation rate. It is difficult to precisely measure the impact inflation has on us, however, we believe that our exposure to inflation can be mitigated through our asset/liability management program. Liquidity:
Liquidity management is essential to our continuing operations as it gives us the ability to meet our financial obligations as they come due, as well as to take advantage of new business opportunities as they arise. Our financial obligations include, but are not limited to, the following:
? Funding new and existing loan commitments;
? Payment of deposits on demand or at their contractual maturity;
? Repayment of borrowings as they mature;
? Payment of lease obligations; and
? Payment of operating expenses.
Our liquidity position is impacted by several factors which include, among
others, loan origination volumes, loan and investment maturity structure and
cash flows, demand for core deposits and certificate of deposit maturity
structure and retention. We manage these liquidity risks daily, thus enabling us
to monitor fluctuations in our position and to adapt our position according to
market influence and balance sheet trends. We also forecast future liquidity
needs and develop strategies to ensure adequate liquidity at all times.
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Historically, core deposits have been our primary source of liquidity because of their stability and lower cost, in general, than other types of funding. Providing additional sources of funds are loan and investment payments and prepayments and the ability to sell both available-for-sale securities and mortgage loans held for sale. As a final source of liquidity, we have available borrowing arrangements with various financial intermediaries, including the FHLB-Pgh. AtDecember 31, 2022 , our maximum borrowing capacity with the FHLB-Pgh was$1.2 billion of which$101.0 million was outstanding in borrowings and$388.8 million outstanding in the form of irrevocable standby letters of credit. We believe our liquidity is adequate to meet both present and future financial obligations and commitments on a timely basis. We maintain a contingency funding plan to address liquidity in the event of a funding crisis. Examples of some of the causes of a liquidity crisis include, among others, natural disasters, pandemics, war, events causing reputational harm and severe and prolonged asset quality problems. The plan recognizes the need to provide alternative funding sources in times of crisis that go beyond our core deposit base. As a result, we have created a funding program that ensures the availability of various alternative wholesale funding sources that can be used whenever appropriate. Identified alternative funding sources include:
? FHLB-Pgh liquidity contingency line of credit;
?
? Internet certificates of deposit;
? Brokered deposits;
?
? Repurchase agreements; and ? Federal funds purchased. To further supplement our borrowing capacity, we also maintain a borrower-in-custody of collateral arrangement at theFederal Reserve that enables us to pledge certain loans, not being used as collateral at the FHLB-Pgh, as collateral for borrowings at theFederal Reserve . AtDecember 31, 2022 our borrowing capacity at theFederal Reserve related to this program was$232.2 million and there were no amounts outstanding. We employ a number of analytical techniques in assessing the adequacy of our liquidity position. One such technique is the use of ratio analysis to illustrate our reliance on noncore funds to fund our investments and loans maturing after 2022. AtDecember 31, 2022 , our noncore funds consisted of time deposits in denominations of$100 thousand or more, short-term borrowings, and long-term and subordinated debt. Large denomination time deposits are particularly not considered to be a strong source of liquidity since they are very interest rate sensitive and are considered to be highly volatile. AtDecember 31, 2022 , our net noncore funding dependence ratio, the difference between noncore funds and short-term investments to long-term assets, was 9.6 percent. Our net short-term noncore funding dependence ratio, noncore funds maturing within one year, less short-term investments to long-term assets equaled 8.5 percent. Comparatively, our ratios equaled negative 3.0 percent and negative 5.6 percent at the end of 2021, which indicates a significant increase in our reliance on noncore funds in 2022. Our basic liquidity surplus ratio, defined as liquid assets less short-term potentially volatile liabilities as a percentage of total assets, decreased to 6.5 percent atDecember 31, 2022 , from 14.6 percent atDecember 31, 2021 as our funding of loan demand outpaced our core deposit growth. We anticipate similar circumstances in the coming year and are implementing competitive pricing strategies on deposits and are exploring alternative funding to ensure adequate liquidity to support future growth. The Consolidated Statements of Cash Flows present the change in cash and cash equivalents from operating, investing and financing activities. Cash and cash equivalents consist of cash on hand, cash items in the process of collection, noninterest-bearing and interest-bearing deposits with other banks and federal funds sold. Cash and cash equivalents -50-
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decreased$242.1 million for the year endedDecember 31, 2022 , primarily due to loan growth outpacing deposit growth. For the year endedDecember 31, 2021 , cash and cash equivalents increased$51.7 million .
Operating activities provided net cash of
Net cash provided by financing activities equaled$183.4 million in 2022. Net cash provided by financing activities was$451.1 million in 2021. Deposit gathering, which is our predominant financing activity, increased in both 2022 and 2021 and provided a net cash inflow in 2022 of$83.2 million and$526.3 million in 2021. Short-term borrowings increased net cash by$114.9 million in 2022 and decreased cash by$50.0 million in 2021. Inflows in 2022 were also partially offset by a$2.1 million net decrease due to payments made to our long-term debt as well as cash dividends paid of$11.3 million and the retirement of common stock of$1.3 million . In 2021, deposit gathering was partially offset by a decrease in short term borrowings of$50.0 million , a$12.1 million net decrease in long-term debt, and cash dividends paid of$10.8 million . Our primary investing activities involve transactions related to our investment and loan portfolios. Net cash used in investing activities totaled$467.8 million and$440.1 million in 2022 and 2021, respectively. Net cash used in lending activities was$402.7 million in 2022, an increase from$152.0 million in 2021. Activities related to our investment portfolio used net cash of$48.3 million in 2022 and used net cash of$298.2 million in 2021. We anticipate a more challenging environment faced by financial institutions in maintaining strong liquidity positions in 2023. Our continued growth in our expansion markets coupled with our mature markets is expected to continue to produce loan demand throughout 2023. We expect to fund such demand through deposit gathering initiatives, payments and prepayments on loans and investments and advances from the FHLB. However, we cannot predict the economic climate or the savings habits of consumers. Should economic conditions decline, deposit gathering may be negatively impacted. Regardless of economic conditions and stock market fluctuations, we believe that through constant monitoring and adherence to our liquidity plan, we will have the means to provide adequate cash to fund our normal operations in 2023.
Cash Requirements:
The Company has cash requirements for various financial obligations, including contractual obligations and commitments that require cash payments. The most significant contractual obligation, in both the under and over one-year time period, is for the Bank to repay time deposits. The Company anticipates meeting these obligations by utilizing on-balance sheet liquidity and continuing to provide convenient depository and cash management services through its branch network, thereby replacing these contractual obligations with similar fund sources at rates that are competitive in our market. The Company may also use borrowings and brokered deposits to meet its obligations. Commitments to extend credit are the Company's most significant commitment in both the under and over one-year time periods. These commitments do not necessarily represent future cash requirements in that these commitments often expire without being drawn upon.
Capital Adequacy:
We believe a strong capital position is essential to our continued growth and
profitability. We strive to maintain a relatively high level of capital to
provide our depositors and stockholders with a margin of safety. In addition, a
strong capital base allows us to take advantage of profitable opportunities,
support future growth and provide protection against any unforeseen losses.
Our ALCO reviews our capital position, generally, quarterly. As part of its
review, the ALCO considers: (i) the current and expected capital requirements,
including the maintenance of capital ratios in excess of minimum regulatory
guidelines; (ii) potential changes in the market value of our securities due to
interest rates changes and effect on capital;
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(iii) projected organic and inorganic asset growth; (iv) the anticipated level of net earnings and capital position, taking into account the projected asset/liability position and exposure to changes in interest rates; (v) significant deteriorations in asset quality; and (vi) the source and timing of additional funds to fulfill future capital requirements. Based on the recent regulatory emphasis placed on banks to assure capital adequacy, our board of directors annually reviews and approves a capital plan. Among other specific objectives, this comprehensive plan: (i) attempts to ensure that we andPeoples Bank remain well capitalized under the regulatory framework for prompt corrective action; (ii) evaluates our capital adequacy exposure through a comprehensive risk assessment; (iii) incorporates periodic stress testing in accordance with theFederal Reserve Board's Supervisory Capital Assessment Program ("SCAP"); (iv) establishes event triggers and action plans to ensure capital adequacy; and (v) identifies realistic and readily available alternative sources for augmenting capital if higher capital levels are required. Bank regulatory agencies consider capital to be a significant factor in ensuring the safety of a depositor's accounts. These agencies have adopted minimum capital adequacy requirements that include mandatory and discretionary supervisory actions for noncompliance. Our andPeoples Bank's risk-based capital ratios are strong and have consistently exceeded the minimum regulatory capital ratios required for adequately capitalized institutions. Our ratio of Tier 1 capital to risk-weighted assets and off-balance sheet items was 11.1 percent and 12.3 percent atDecember 31, 2022 and 2021, respectively. Our Total capital ratio was 12.1 percent and 13.6 percent atDecember 31, 2022 and 2021, respectively. Our andPeoples Bank's common equity Tier I capital to risk-weighted assets ratios were 11.1 percent and 12.3 percent atDecember 31, 2022 and 12.3 percent and 13.8 percent atDecember 31, 2021 . Our Leverage ratio, which equaled 9.0 percent atDecember 31, 2022 and 9.2 percent atDecember 31, 2021 , exceeded the minimum of 4.0 percent for capital adequacy purposes.Peoples Bank reported Tier 1 capital, Total capital and Leverage ratios of 12.2 percent, 13.3 percent and 9.7 percent atDecember 31, 2022 , and 13.8 percent, 15.0 percent and 9.6 percent atDecember 31, 2021 . Based on the most recent notification from theFDIC ,Peoples Bank was categorized as well capitalized atDecember 31, 2022 . There are no conditions or events since this notification that we believe have changedPeoples Bank's category. For a further discussion of these risk-based capital standards and supervisory actions for noncompliance, refer to the note entitled, "Regulatory matters," in the Notes to Consolidated Financial Statements to this Annual Report.
Stockholders' equity was
We declared dividends of$1.58 per share in 2022,$1.50 per share in 2021, and$1.44 per share in 2020. The dividend payout ratio, dividends declared as a percent of net income, equaled 29.9 percent in 2022, 24.9 percent in 2021 and 35.8 percent in 2020. Our board of directors intends to continue paying cash dividends in the future and has declared a cash dividend in the first quarter of 2023 of$0.41 per share. Our ability to declare and pay dividends in the future is based on our operating results, financial and economic conditions, capital and growth objectives, dividend restrictions and other relevant factors. We rely on dividends received from our subsidiary,Peoples Bank , for payment of dividends to stockholders.Peoples Bank's ability to pay dividends is subject to federal and state regulations. For a further discussion on our ability to declare and pay dividends in the future and dividend restrictions, refer to the note entitled, "Regulatory matters," in the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report. Since 2014, our Board of Directors has adopted various common stock repurchase plans whereby we were authorized to repurchase shares of our outstanding common stock through open market purchases. During 2022 we repurchased and retired 27,733 shares for$1.3 million under the then current plan. We purchased and retired 54,285 shares for$2.4 million during 2021 and purchased and retired 181,417 shares for$6.9 million during 2020.
Review of Financial Performance:
Net income for the twelve months ended
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decrease in earnings for 2022 is a result of lower non-interest income due to a$2.0 million pre-tax loss on the sale of available for sale securities in the current period and a pre-tax gain of$12.2 million from the sale of Visa Class B shares in 2021, combined with higher non-interest expenses. Higher net interest income and a lower provision for loan losses partially offset the declines. ROAA was 1.12 percent and ROE was 11.86 percent for the year endedDecember 31, 2022 . Tax-equivalent net interest income, a non-GAAP measure, was$97.7 million in 2022 and$86.1 million in 2021. Our net interest margin equaled 3.02 percent in 2022 and 2.99 percent in 2021. Noninterest income, totaled$11.9 million 2022 and$25.6 million in 2021, which included the pre-tax gain of$12.2 million from the sale of Visa Class B shares. Noninterest expense was$62.7 million for the year endedDecember 31, 2022 compared to$55.0 million for the year endedDecember 31, 2021 . Our productivity is measured by the operating efficiency ratio, a non-GAAP measure, defined as noninterest expense less amortization of intangible assets divided by the total of tax-equivalent net interest income and noninterest income. Our operating efficiency ratio was 55.9 percent in 2022 and 54.7 percent in 2021.
Visa Class B Common Stock Sale:
OnOctober 8, 2021 ,Peoples Bank agreed to sell 44,982 shares of the Class B common stock of Visa Inc. for a purchase price of$12.2 million . The shares had no carrying value on the Bank's balance sheet and, as the Bank had no historical cost basis in the shares, the entire purchase was realized as a pretax gain. The transaction had a positive impact on the Bank's regulatory capital, which is being used for capital management and to support the Company's organic growth. The Bank received 73,333 Class B shares of Visa Inc. as part of its membership interest inMarch 2008 , and 28,351 shares were redeemed in connection withVisa's initial public offering in 2008. The sale of the remaining 44,982 Class B shares settled in October, 2021 and was included in our 2021 fourth-quarter and year-end results as an after-tax gain of$9.6 million .
Non-GAAP Financial Measures:
The following are non-GAAP financial measures, which provide useful insight to
the reader of the consolidated financial statements, but should be supplemental
to GAAP used to prepare Peoples' financial statements and should not be read in
isolation or relied upon as a substitute for GAAP measures. In addition,
Peoples' non-GAAP measures may not be comparable to non-GAAP measures of other
companies. The tax rate used to calculate the fully-taxable equivalent ("FTE")
adjustment was 21 percent for 2022, 2021, and 2020.
The following table reconciles the non-GAAP financial measures of FTE net interest income for the years ended 2022, 2021 and 2020:
(Dollars in thousands) 2022 2021 2020 Interest income (GAAP)$ 111,334 $ 94,057 $ 94,125 Adjustment to FTE 1,901 1,512 1,306
Interest income adjusted to FTE (non-GAAP) 113,235 95,569
95,431
Interest expense 15,585 9,422
14,324
Net interest income adjusted to FTE (non-GAAP)
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The efficiency ratio is noninterest expenses, less amortization of intangible
assets, as a percentage of FTE net interest income plus noninterest income less
gains and/or losses on debt security sales and gains on sale of assets. The
following table reconciles the non-GAAP financial measures of the efficiency
ratio to GAAP for the years ended 2022, 2021, and 2020:
(Dollars in thousands, except percents) 2022 2021 2020
Efficiency ratio (non-GAAP):
Noninterest expense (GAAP) $ 62,677 $ 55,004 $ 54,868
Less: amortization of intangible assets expense 363 491 606
Noninterest expense adjusted for amortization of
assets expense (non-GAAP) 62,314 54,513 54,262
Net interest income (GAAP) 95,749 84,635 79,801
Plus: taxable equivalent adjustment 1,901 1,512 1,306
Noninterest income (GAAP) 11,845 25,636 16,642
Less: net (losses) gains on equity securities (31) 2
Less: net (losses) gains on sale of available for sale securities (1,976) 918 Less: gain on sale of Visa Class B shares
12,153
Net interest income (FTE) plus noninterest income (non-GAAP)$ 111,502 $ 99,628 $ 96,831 Efficiency ratio (non-GAAP) 55.9 % 54.7 % 59.6 % Net Interest Income: Net interest income is the fundamental source of earnings for commercial banks. Moreover, fluctuations in the level of net interest income can have the greatest impact on net profits. Net interest income is defined as the difference between interest revenue, interest and fees earned on interest-earning assets, and interest expense, the cost of interest-bearing liabilities supporting those assets. The primary sources of earning assets are loans and investment securities, while interest-bearing deposits and borrowings comprise interest-bearing liabilities. Net interest income is impacted by:
? Variations in the volume, rate and composition of earning assets and
interest-bearing liabilities;
? Changes in general market interest rates; and
? The level of nonperforming assets.
Changes in net interest income are measured by the net interest spread and net
interest margin. Net interest spread, the difference between the average yield
earned on earning assets and the average rate incurred on interest-bearing
liabilities, illustrates the effects changing interest rates have on
profitability. Net interest margin, net interest income as a percentage of
average earning assets, is a more comprehensive ratio, as it reflects not only
the spread, but also the change in the composition of interest-earning assets
and interest-bearing liabilities. Tax-exempt loans and investments carry pretax
yields lower than their taxable counterparts. Therefore, in order to make the
net interest margin analysis more comparable, tax-exempt income and yields are
reported in this analysis on a tax-equivalent basis using the prevailing federal
statutory tax rate.
Similar to all banks, we consider the maintenance of an adequate net interest
margin to be of primary concern. The current economic environment has been
changing rapidly for most of the current year with steadily rising interest
rates. This is in contrast to prior years where impact of the pandemic and
interest rates at historical lows were the predominant driving forces. In
addition to market rates and competition, nonperforming asset levels are of
particular concern for the banking industry and may place additional pressure on
net interest margins. Nonperforming assets may change, given the uncertainty of
the national and global economies, particularly the labor markets. No assurance
can be given as to how general market conditions will change or how such changes
will affect net interest income. We anticipate continued
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margin pressure into the coming year as a result of anticipated future
We analyze interest income and interest expense by segregating rate and volume components of earning assets and interest-bearing liabilities. The impact changes in the interest rates earned and paid on assets and liabilities, along with changes in the volumes of earning assets and interest-bearing liabilities, have on net interest income are summarized as follows. The net change or mix component, attributable to the combined impact of rate and volume changes within earning assets and interest-bearing liabilities' categories, has been allocated proportionately to the change due to rate and the change due to volume.
Net interest income changes due to rate and volume
2022 vs 2021 2021 vs 2020
Increase (decrease) Increase (decrease)
attributable to attributable to
(Dollars in thousands) Total Rate Volume Total Rate Volume
Interest income:
Loans:
Taxable $ 13,012 $ 3,018 $ 9,994 $ (1,189) $ (3,860) $ 2,671
Tax-exempt 1,427 (341) 1,768 280 (830) 1,110
Investments:
Taxable 2,698 (820) 3,518 115 (1,153) 1,268
Tax-exempt 424 (197) 621 700 (407) 1,107Interest-bearing deposits 93 95 (2)
(31) (20) (11)
Federal funds sold 12 440 (428) 264 21 243
Total interest income 17,666 2,195 15,471 139 (6,249) 6,388
Interest expense:
Money market accounts 3,007 2,705 302 (1,550) (2,324) 774
NOW accounts 2,291 1,818 473 (539) (1,439) 900
Savings accounts 114 69 45 (122) (193) 71
Time deposits less than $100 (117) (111) (6) (650) (327) (323)
Time deposits $100 or more 27 105 (78) (1,568) (1,210) (358)
Short-term borrowings 1,025 655 370 (770) (270) (500)
Long-term debt (184) 80 (264) (442) 337 (779)
Subordinated debt 739 433 306
Total interest expense 6,163 5,321 842
(4,902) (4,993) 91
Net interest income - non-GAAP
Tax-equivalent net interest income, a non-GAAP measure, was$97.7 million in 2022 and$86.1 million in 2021. Interest and net fees earned on the PPP loans totaled$1.8 million in 2022, down from$7.1 million in 2021. There was a positive volume variance that was partially offset by a negative rate variance. The growth in average earning assets exceeded that of interest-bearing liabilities, and resulted in additional tax-equivalent net interest income, a non-GAAP measure, of$14.6 million . A rate variance resulted in a decrease in net interest income of$3.1 million as liabilities repriced quicker than assets. Average earning assets increased$355.8 million to$3.2 billion in 2022 from$2.9 billion in 2021 and accounted for a$15.5 million increase in interest income. Average loans, net increased$302.1 million , which caused interest income to increase$11.8 million . Average taxable investments increased$224.2 million comparing 2022 and 2021, which resulted in increased interest income of$3.5 million while average tax-exempt investments increased$25.9 million , which resulted in an increase to interest income of$0.6 million . Average interest-bearing liabilities grew$264.2 million to$2.3 billion in 2022 from$2.0 billion in 2021 resulting in a net increase in interest expense of$0.8 million . In addition, interest-bearing transaction accounts, including
money
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market, NOW and savings accounts grew $252.0 million , which in aggregate caused
an $0.8 million increase in interest expense. Large denomination time deposits
averaged $9.7 million less in 2022 and caused interest expense to decrease $78
thousand . A decrease of $0.5 million in average time deposits less than $100
thousand decreased interest expense by $6 thousand . Short-term borrowings
averaged $28.7 million more and increased interest expense $370 thousand while
long-term debt averaged $6.3 million less and decreased interest expense by $264
thousand comparing 2022 and 2021.
An unfavorable rate variance occurred, as the tax-equivalent yield on earning
assets increased 18 basis points while there was a 22 basis points increase in
the cost of funds. As a result, tax-equivalent net interest income decreased
$3.1 million comparing 2022 and 2021. The tax-equivalent yield on earning assets
was 3.50 percent in 2022 compared to 3.32 percent in 2021 resulting in a
decrease in interest income of $2.2 million . With the tax-equivalent yield on
the investment portfolio decreasing 27 basis points to 1.67 percent in 2022 from
1.94 percent in 2021, interest income decreased $1.0 million . The tax-equivalent
yield on the loan portfolio increased 10 basis points to 4.04 percent in 2022
from 3.94 percent in 2021 and resulted in an increase to interest income of $2.7
million .
An unfavorable rate variance was experienced in the cost of funds. We
experienced increases in the rates paid on most major categories of
interest-bearing liabilities. Specifically, the cost of non-maturity deposit
accounts increased 25 basis points comparing 2022 and 2021. These increases
resulted in an increase in interest expense of $4.6 million . With regard to time
deposits, the average rate paid for time deposits less than $100 thousand
decreased 8 basis points while time deposits $100 thousand or more increased 6
basis points, which together resulted in a $6 thousand decrease in interest
expense. The average rate paid on short-term borrowings increased 202 basis
points in 2022 when compared to 2021, causing a $655 thousand increase in
interest expense. Interest expense increased $80 thousand from a 138 basis point
increase in the average rate paid on long-term debt.
The average balances of assets and liabilities, corresponding interest income and expense and resulting average yields or rates paid are summarized as follows. Averages for earning assets include nonaccrual loans. Investment averages include available-for-sale securities at amortized cost. Income on investment securities and loans is adjusted to a tax-equivalent basis, a non-GAAP measure, using the prevailing federal statutory tax rate of 21.0 percent in 2022, 2021 and 2020.
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Summary of net interest income
2022 2021
Average Average
Average Interest Income/ Interest Average Interest Income/ Interest
(Dollars in thousands, except
percents) Balance Expense Rate Balance Expense Rate
Assets:
Earning assets:
Loans:
Taxable $ 2,306,455 $ 95,505 4.14 % $ 2,063,168 $ 82,493 4.00 %
Tax-exempt 216,195 6,436 2.98 157,409 5,009 3.18
Total Loans 2,522,650 101,941 4.04 2,220,577 87,502 3.94
Investments:
Taxable 537,566 8,236 1.53 313,319 5,538 1.77
Tax-exempt 111,083 2,615 2.35 85,200 2,191 2.57
Total Investments 648,649 10,851 1.67 398,519 7,729 1.94
Interest-bearing deposits 8,536 101 1.17 11,123 8 0.07
Federal funds sold 53,056 342 0.65 246,891 330 0.13
Total interest earning assets 3,232,891 $ 113,235 3.50 % 2,877,110 $ 95,569 3.32 % Less: allowance for loan losses
29,298 27,209
Other assets 210,392 227,293
Total assets $ 3,413,985 $ 3,077,194
Liabilities and Stockholders'
Equity:
Interest-bearing liabilities:
Money market accounts $ 624,528 $ 4,967 0.80 % $ 549,169 $ 1,960 0.36 %
NOW accounts 791,653 4,493 0.57 666,885 2,202 0.33
Savings accounts 520,770 496 0.10 468,851 382 0.08
Time deposits less than $100 127,801 1,299 1.02 128,313 1,416 1.10
Time deposits $100 or more 162,998 1,377 0.84 172,711 1,350 0.78Total interest-bearing deposits 2,227,750 12,632
0.57 1,985,929 7,310 0.37 Short-term borrowings 42,680 1,103 2.58 13,973 78 0.56 Long-term debt 1,634 76 4.65 7,948 260 3.27 Subordinated debt 33,000 1,774 5.38 33,000 1,774 5.38 Total borrowings 77,314 2,953 3.82 54,921 2,112 3.85 Total interest-bearing liabilities 2,305,064 $ 15,585 0.68 % 2,040,850 $ 9,422 0.46 % Noninterest-bearing deposits 753,399 684,527 Other liabilities 34,517 25,704 Stockholders' equity 321,005 326,113 Total liabilities and stockholders' equity$ 3,413,985 $ 3,077,194 Net interest income/spread (non-GAAP) $ 97,650 2.82 % $ 86,147 2.86 % Net interest margin 3.02 % 2.99 % Tax-equivalent adjustments: Loans $ 1,352 $ 1,052 Investments 549 460 Total adjustments $ 1,901 $ 1,512 Note: Average balances were calculated using average daily balances. Interest income on loans includes fees of$1.9 million in 2022,$6.0 million in 2021 and$3.8 million in 2020. The decrease in 2022 is primarily due to net fees from PPP loans. -57- Table of Contents 2020 Average Average Interest Income/ Interest (Dollars in thousands, except percents) Balance Expense Rate Assets: Earning assets: Loans: Taxable$ 1,998,178 $ 83,683 4.19 % Tax-exempt 124,898 4,729 3.79 Total Loans 2,123,076 88,412 4.16 Investments: Taxable 248,059 5,423 2.19 Tax-exempt 44,607 1,491 3.34 Total Investments 292,666 6,914 2.36 Interest-bearing deposits 17,288 39 0.23 Federal funds sold 62,072 66 0.11
Total interest earning assets 2,495,102 $ 95,431 3.82 % Less: allowance for loan losses 25,848 Other assets 227,695 Total assets$ 2,696,949 Liabilities and Stockholders' Equity: Interest-bearing liabilities: Money market accounts$ 432,621 $ 3,510 0.81 % NOW accounts 470,701 2,741 0.58 Savings accounts 404,628 504 0.12
Time deposits less than$100 154,772 2,066 1.33 Time deposits$100 or more 200,258 2,918 1.46 Total Interest-bearing deposits 1,662,980
11,739 0.71 Short-term borrowings 83,716 848 1.01 Long-term debt 38,560 702 1.82 Subordinated debt 19,295 1,035 5.36 Total Borrowings 141,571 2,585 0.79
Total interest-bearing liabilities 1,804,551 $ 14,324 0.79 % Noninterest-bearing deposits 555,459 Other liabilities 27,389 Stockholders' equity 309,550
Total liabilities and stockholders' equity
$ 81,107 3.03 %
Net interest margin (non-GAAP)
3.25 %
Tax-equivalent adjustments:
Loans $ 993
Investments 313
Total adjustments $ 1,306
Provision for Loan Losses:
We evaluate the adequacy of the allowance for loan losses account on a quarterly
basis utilizing our systematic analysis in accordance with procedural
discipline. We take into consideration certain factors such as composition of
the loan portfolio, the volume of nonperforming loans, volumes of net
charge-offs, prevailing economic conditions and other relevant factors when
determining the adequacy of the allowance for loan losses account. We make
monthly
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provisions to the allowance for loan losses account in order to maintain the
allowance at an appropriate level. For the twelve month period ending December
31, 2022 , $449 thousand was released from the allowance for loan losses compared
to a provision of $1.8 million in 2021. The release in 2022 was due to the
overall improvement of credit quality of the loan portfolio based on current
conditions, combined with a decline in historical loss factors utilized for our
loan loss methodology as of December 31, 2022 . The provision in the twelve month
period ended December 31, 2021 was reflective of our allowance for loan losses
methodology and evaluation of qualitative factors that existed during that time.
Based on our most recent evaluation at December 31, 2022 , we believe that the
allowance was adequate to absorb any known or potential losses in our portfolio
as of such date.
Noninterest Income:
Our noninterest income for 2022 was $11.8 million compared with $25.6 million
for the year ago period, a decrease of $13.8 million . The decrease was primarily
due to a loss of $2.0 million on the sale of investment securities in the
current year and a $12.2 million gain the sale of the Visa Class B shares in
2021. Excluding these events, noninterest income increased $338 thousand or 2.5
percent. Service charges, fees and commissions increased $907 thousand , due in
part to the reversal of an accrual of a $335 thousand bank owned life insurance
benefit in the year ago period, higher consumer and commercial deposit service
charges and higher revenue related to debit card activity. The increases were
partially offset by a decrease of $464 thousand in mortgage banking income on
lower sales volume due to higher market rates.
Noninterest Expense:
In general, our noninterest expense is categorized into three main groups, including employee-related expense, occupancy and equipment expense and other expenses. Employee-related expenses are costs associated with providing salaries, including payroll taxes and benefits to our employees. Occupancy and equipment expenses, the costs related to the maintenance of facilities and equipment, include depreciation, general maintenance and repairs, real estate taxes, rental expense offset by any rental income and utility costs. Other expenses include general operating expenses such as marketing, other taxes, stationery and supplies, contractual services, insurance, includingFDIC assessment and loan collection costs. Several of these costs and expenses are variable while the remainder is fixed. We utilize budgets and other related strategies in an effort to control the variable expenses. The major components of noninterest expense for the past three years are summarized as follows:
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(Dollars in thousands) 2022 2021 2020
Salaries and employee benefits expense:
Salaries and payroll taxes $ 29,308 $ 25,176 $24,912
Employee benefits 4,245 4,560
5,223
Salaries and employee benefits expense 33,553 29,736
30,135
Occupancy and equipment expenses: Occupancy expense 10,839 8,212
6,775
Equipment expense 5,739 4,636
6,065
Occupancy and equipment expenses 16,578 12,848
12,840
Other expenses: Professional fees and outside services 2,715 2,137
2,091 Other taxes 1,559 1,336 990 Donations 1,381 1,435 1,357
FDIC insurance and assessments 1,300 1,117
873 Advertising 943 575 463 Stationery and supplies 431 910 697
Amortization of intangible assets 363 491
606
Net (gain) on sale of other real estate owned (478) (210) Other 4,332 4,629 4,816 Other expenses 12,546 12,420 11,893 Total noninterest expense$ 62,677 $ 55,004 $ 54,868 Salaries and employee benefits expense constitute the majority of our noninterest expenses accounting for 53.5 percent of the total noninterest expense. Salaries and employee benefits expense increased$3.8 million or 12.8 percent to$33.6 million in 2022 from$29.7 million in 2021. Salaries and payroll taxes increased$4.1 million or 16.4 percent and employee benefits expense decreased$315 thousand or 6.9 percent. The higher salary expense in 2022 was due to annual merit increases, our investment into our newest expansion markets which operated for an entire twelve month period, additional hires to support our growth and lower deferred loan origination costs, which are initially not expensed but rather deferred and amortized over the life of the loan. Employee benefits expense was lower due to lower health insurance costs and lower pension expense. Occupancy and equipment expense increased$3.7 million or 29.0 percent to$16.6 million in 2022 from$12.8 million in 2021. Occupancy expenses increased$2.6 million or 32.0 percent to$10.8 million in 2022 from$8.2 million in 2021 as a result of entrance into thePiscataway, New Jersey andPittsburgh, Pennsylvania markets. Equipment related expense increased$1.1 million or 23.8 percent to$5.7 million in 2022 from$4.6 million in 2021, due to information technology investments related to mobile/digital banking solutions implemented during the second half of 2021. Other expenses, which consist ofFDIC insurance and assessments, professional fees and outside services, other taxes, stationary and supplies, advertising, amortization of intangible assets and all other expenses were relatively flat at$12.5 million in 2022 and$12.4 million in 2021. A gain of$478 thousand on the sale of properties held as other real estate was offset by an increase in professional services costs of$578 thousand . Stationary and supply costs decreased$479 thousand partially due to our digital banking initiatives.
Peoples anticipates that its
Income Taxes: Our income tax expense was$7.3 million and our effective tax rate was 16.0 percent for the year endedDecember 31, 2022 , a decrease from income tax expense of$10.0 million and an effective tax rate of 18.7 percent for the year endedDecember 31, 2021 . The decrease in 2022 was primarily due to lower pretax income due in part to a$12.2 million pre-tax Visa Class B shares gain in 2021, combined with a$621 deferred tax adjustment. We also utilize loans and investments of tax-exempt organizations to mitigate our tax burden, as interest revenue from these sources is not taxable -60-
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by the federal government. The tax benefit of tax-exempt income was 3.3 percent of pre-tax income in 2022 as compared to a 2.3 percent benefit in 2021.
The effective tax rate in 2022 and 2021 was also influenced by the recognition of investment tax credits related to our limited partnership investments in elderly and low- to- moderate-income residential housing programs which allow us to mitigate our tax burden. By utilizing these credits, we reduced our income tax expense by$911 thousand in 2022 and$1.1 million in 2021. We anticipate investment tax credits from these investments to be$755 thousand in 2023. Over the next two years, we will recognize aggregate tax credits from our investments in these projects of approximately$1.4 million . -61-
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Management's Discussion and Analysis 2021 versus 2020
Operating Environment:
Market yields rose rapidly to start 2022, despite signs that the economy stuttered amid the COVID-19 Omicron outbreak, as inflation pressures remained firm and amid a number ofFederal Open Market Committee ("FOMC") members' commentary. Minutes from theFederal Reserve Board's late-December meeting indicated officials believed Omicron would temporarily impact the economy but would not change the overall trajectory of the recovery. Those minutes also showed officials believed that the labor market would continue its rapid progress towards full employment, with inflation already at its highest levels in decades. The hiring in December's nonfarm payroll report disappointed expectations but the data provided support for theFederal Reserve Board's analysis that the labor market is becoming increasingly tight. Participation was flat at 61.9%, 1.5% points below its pre-pandemic level, while unemployment dropped much further than expected from 4.2% to 3.9%, 0.1% below theFederal Reserve Board's estimate of full employment. Adding to evidence of a tight labor market, average hourly earnings rose firmly again and were 4.7% higher than a year ago. December's Consumer Price Index ("CPI") report was a bit hotter than expected on a monthly basis, pushing the annual headline rate up to 7.0%, the fastest since 1982, and the core rate to 5.5%, its strongest gain since 1991. TheFederal Reserve Board's preferred measure, the core PCE price index (defined as personal consumption expenditures excluding food and energy), accelerated from 4.7% to 4.9%, its highest level since 1983. The combination of historically high inflation and the rapidly tightening labor market spurred a growing number ofFederal Reserve Board officials to indicate policy may need to be tightened more quickly than anticipated at theDecember 2022 meeting.FOMC members began to talk up the probability that a rate hike could be warranted in March. Today's economy is much stronger, the labor market is much tighter, and inflation is much higher than when theFederal Reserve Board last shrank its balance sheet, officials noted. As expected, theFederal Reserve Board's January Statement strongly signaled that aMarch 2022 rate increase was a near certainty. ChairPowell acknowledged that no final decisions on the pace of tightening had been made. However, he read a scripted response several times to emphasize that those differences between today's economy and the economy during the last cycle, when theFederal Reserve Board raised rates at every other meeting, "are likely to have important implications for the appropriate pace of policy adjustments." Yields soared and the curve flattened. Fed funds futures priced in four hikes in 2022 with a chance of a fifth. The employment situation improved nationally as well as inNew York ,Pennsylvania and in all of the thirteen counties representing our market areas inPennsylvania andNew York from one year ago when comparingDecember 31, 2021 toDecember 31, 2020 . Nonfarm payrolls increased 467,000 inJanuary 2022 , well above expectations of 125,000 jobs. Projections for our local market unemployment are not readily available; however the most current economic statistics as ofDecember 31, 2021 show continuing jobless claims of over 1.6 million. This remains elevated as does the unemployment rate at 5.4% per the latest report from theBureau of Labor Statistics atDecember 31, 2021 . -62-
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National,
2021 2020
United States 5.4 % 8.1 %
New York 7.2 10.1
Pennsylvania 6.1 9.1
Broome County 5.5 8.7
Allegheny County 5.9 9.0
Bucks County 5.1 8.3
Lackawanna County 6.6 9.6
Lebanon County 5.3 8.0
Lehigh County 6.6 9.6
Luzerne County 7.9 10.9
Monroe County 7.5 11.6
Montgomery County 4.8 7.7
Northampton County 5.8 9.0
Schuylkill County 6.5 9.2
Susquehanna County 5.2 7.4
Wayne County 6.3 9.2
Wyoming County 6.1 8.4
Review of Financial Position:
Total assets, loans and deposits were$3.4 billion ,$2.3 billion and$3.0 billion , respectively, atDecember 31, 2021 . Total assets, loans and deposits grew 16.9 percent, 6.9 percent and 21.6 percent, respectively, compared to 2020 year-end balances. The loan portfolio consisted of$1.9 billion of business loans, including commercial and commercial real estate loans, and$372.5 million in retail loans, including residential mortgage and consumer loans atDecember 31, 2021 . Total investment securities were$588.7 million atDecember 31, 2021 , including$517.3 million of investment securities classified as available-for sale and$71.2 million classified as held-to-maturity. Total deposits consisted of$737.8 million in noninterest-bearing deposits and$2.2 billion in interest-bearing deposits atDecember 31, 2021 .
Stockholders' equity equaled
Nonperforming assets equaled$5.0 million or 0.15 percent of total assets atDecember 31, 2021 compared to$10.5 million or 0.36 percent atDecember 31, 2020 . The allowance for loan losses equaled$28.4 million or 1.22 percent of loans, net, atDecember 31, 2021 , compared to$27.3 million or 1.26 percent at year-end 2020. Loans charged-off, net of recoveries equaled$0.7 million or 0.03 percent of average loans in 2021, compared to$2.7 million or 0.13 percent
of average loans in 2020. Investment Portfolio: Primarily, our investment portfolio provides a source of liquidity needed to meet expected loan demand and generates a reasonable return in order to increase our profitability. Additionally, we utilize the investment portfolio to meet pledging requirements and reduce income taxes. AtDecember 31, 2021 , our portfolio consisted of short-termU.S. Treasury and government agency securities, which provide a source of liquidity, mortgage-backed securities
issued byU.S. -63- Table of Contents
government-sponsored agencies to provide income and intermediate-term, tax-exempt state and municipal obligations, which mitigate our tax burden.
Investment securities increased$285.4 million , to$588.7 million atDecember 31, 2021 , from$303.3 million atDecember 31, 2020 . AtDecember 31, 2021 , the investment portfolio consisted of$517.3 million of investment securities classified as available-for-sale and$71.2 million classified as held-to-maturity. Deposit increases from strong organic growth from new and existing relationships, inflows of municipal deposits and proceeds from government stimulus payments lead to higher levels of low-yielding overnight federal funds balances. As the level of low-yielding overnight funds increased, our Asset Liability Committee recommended a strategy to deploy a portion of those funds into higher-yielding investments through purchases ofU.S. Treasury securities, taxable and tax-free municipal bonds and mortgage-backed securities to mitigate risk in a flat and down rate environment. Security purchases totaled$358.6 million in 2021. Investment purchases in 2020 amounted to$107.2 million . Repayments of investment securities totaled$60.4 million in 2021 and$85.0 million in 2020. No securities were sold in 2021. During the first quarter of 2020, the Company sold$26.5 million of low-yielding short-term municipal bonds resulting in a gain of$267 thousand . The proceeds were used to fund higher yielding loans. Additionally, two mortgage-backed securities were sold during the second half of 2020 with proceeds totaling$38.3 million and gains recognized of$651 thousand due to favorable market rates. We continually analyze the investment portfolio with respect to its exposure to various risk elements. Investment securities averaged$398.5 million and equaled 13.9 percent of average earning assets in 2021, compared to$292.7 million and 11.7 percent of average earning assets in 2020. The tax-equivalent yield on the investment portfolio decreased 42 basis points to 1.94 percent in 2021 from 2.36 percent in 2020. The decrease in the tax-equivalent yield is due to cash flow from maturing and called bonds being reinvested into lower market rates coupled with lower yields on new purchases. Loan Portfolio: Overall, total loans increased$151.2 million or 6.9 percent in 2021 to$2.3 billion atDecember 31, 2021 . Excluding PPP loans, loan growth totaled$272.0 million or 13.7 percent. Business loans, including commercial loans and commercial real estate loans, were$2.0 billion or 84.0 percent of total loans atDecember 31, 2021 , and$1.8 billion or 83.4 percent at year-end 2020. Residential mortgages and consumer loans totaled$372.5 million or 16.0 percent of total loans at year-end 2021 and$360.7 million or 16.6 percent at year-end 2020. Total loan growth, excluding PPP loans, of$272.0 million was primarily attributable to increases in our commercial real estate portfolio which grew$205.5 million in 2021 due to continued success of our strategy to expand in larger markets with strong growth potential, and strong organic growth in our legacy markets. Our expansion strategy commenced during 2014 in theLehigh Valley with a community banking office and team of dedicated lenders and has expanded with two additional branch offices and additional teams of experienced lenders and credit professionals. Growth is also due to our presence in theGreater Delaware Valley , first by opening a branch office inKing of Prussia in 2016, and during 2020 with the opening of a branch inDoylestown and recruitment of two experienced lenders. Further growth was attained by our entrance intoCentral Pennsylvania with a branch office inLebanon , staffed with a team of lending professionals during the middle of 2018. Additionally, our continued expansion during the final six months of 2021 into theGreater Pittsburgh market with a new office and team of experienced lenders and entrance intoCentral New Jersey with an office inPiscataway ,Middlesex County , and team of experienced lenders known in the market, contributed to the strong loan growth, especially during the latter half of 2021. Based on the customer service oriented philosophy of our organization along with the commitment of these employees, we continue to be well received in these new markets as we are in our existing markets. Loans averaged$2.2 billion in 2021, compared to$2.1 billion in 2020. Taxable loans averaged$2.0 billion , while tax-exempt loans averaged$0.2 billion in 2021. The loan portfolio continues to play the prominent role in our earning asset mix. As a percentage of earning assets, average loans equaled 77.2 percent in 2021, a decrease from 85.1 percent in 2020. -64- Table of Contents Asset Quality:
Nonperforming assets consist of nonperforming loans and foreclosed assets. Nonperforming loans include nonaccrual loans, troubled debt restructured loans and accruing loans past due 90 days or more. For a discussion of our policy regarding nonperforming assets and the recognition of interest income on impaired loans, refer to the notes entitled, "Summary of significant accounting policies - Nonperforming assets," and "Loans, net and allowance for loan losses" in the Notes to Consolidated Financial Statements to this Annual Report which are incorporated in this item by reference. We maintain the allowance for loan losses at a level we believe adequate to absorb probable credit losses related to individually evaluated loans, as well as probable incurred losses inherent in the remainder of the loan portfolio as of the balance sheet date. The balance in the allowance for loan losses account is based on past events and current economic conditions. We employ theFederal Financial Institutions Examination Council ("FFIEC") Interagency Policy Statement, as amended, and GAAP in assessing the adequacy of the allowance account. Under GAAP, the adequacy of the allowance account is determined based on the provisions of FASB Accounting Standards Codification ("ASC") 310 for loans specifically identified to be individually evaluated for impairment and the requirements of FASB ASC 450, for large groups of smaller-balance homogeneous loans to be collectively evaluated for impairment. The allowance for loan losses increased$1.1 million to$28.4 million atDecember 31, 2021 , from$27.3 million at the end of 2020. The increase resulted from a provision for loan losses of$1.8 million less net loans charged-off of$0.7 million . The allowance for loan losses atDecember 31, 2021 continued to reflect the provisions added during 2020 from our adjustment of qualitative factors in our allowance for loan losses methodology, due to economic decline and expectation of increased credit losses from COVID-19's adverse impact on economic and business operating conditions. Past due loans not satisfied through repossession, foreclosure or related actions are evaluated individually to determine if all or part of the outstanding balance should be charged against the allowance for loan losses account. Any subsequent recoveries are credited to the allowance account. Net loans charged-off decreased$2.0 million to$0.7 million in 2021 from$2.7 million in 2020. Net charge-offs, as a percentage of average loans outstanding, equaled 0.03 percent in 2021 and 0.13 percent in 2020. The allowance for loan losses account increased$1.1 million to$28.4 million atDecember 31, 2021 , compared to$27.3 million atDecember 31, 2020 . The specific portion of the allowance for impairment of loans individually evaluated under FASB ASC 310 decreased$1.0 million to$0.2 million atDecember 31, 2021 , from$1.2 million atDecember 31, 2020 and the portion of the allowance for loans collectively evaluated for impairment under FASB ASC 450, increased$2.1 million to$28.2 million atDecember 31, 2021 , from$26.1 million atDecember 31, 2020 . The decrease in the specific portion of the allowance was a result of a decrease in measured impairment for collateral dependent loans, improved credit quality and a decrease to non-performing loans of$5.4 million . The increase in the collectively evaluated portion was primarily the result of a significant increase in volume, improved credit quality and a decrease of$5.4 million of non-performing loans. The coverage ratio, the allowance for loan losses, as a percentage of nonperforming loans, is an industry ratio used to test the ability of the allowance account to absorb potential losses arising from nonperforming loans. The coverage ratio was 634.5 percent atDecember 31, 2021 and 277.0 percent atDecember 31, 2020 . We believe that our allowance was adequate to absorb probable credit losses atDecember 31, 2021 .
Deposits:
Our deposit base is the primary source of funds to support our operations. We offer a variety of deposit products to meet the needs of our individual and commercial customers. Total deposits grew$526.3 million or 21.6 percent to$3.0 billion at the end of 2021. The increase in deposits is due to organic growth of customer relationships throughout all our markets, inflows of municipal deposits and additional deposits by our commercial and retail customers in excess of historic levels, in part to government stimulus. Total deposits include$12.5 million of brokered certificates of deposit. Noninterest-bearing deposits grew$115.3 million or 18.5 percent while interest-bearing deposits increased$411.0 million or 22.6 percent in 2021. Noninterest-bearing deposits represented 24.9 percent of total deposits while interest- -65-
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bearing deposits accounted for 75.1 percent of total deposits atDecember 31, 2021 . Comparatively, noninterest-bearing deposits and interest-bearing deposits represented 34.4 percent and 74.5 percent of total deposits at year end 2020. With regard to noninterest-bearing deposits, personal checking accounts increased$54.5 million or 19.9 percent, while commercial checking accounts increased$60.7 million or 17.4 percent. The increase in noninterest-bearing deposits is essential in attempting to keep our overall cost of funds low given the pressure on our net interest margin from the decrease in short-term market rates. With regard to interest-bearing deposits, interest-bearing transaction accounts, which include money market accounts and NOW accounts, and savings accounts, increased$436.2 million in 2021. Commercial interest-bearing transaction accounts increased$302.8 million , while personal interest-bearing transaction accounts increased$72.8 million . Savings accounts increased$60.6 million during 2021 as customers saved a higher percentage of the government stimulus in safe liquid accounts. The strong growth in our non-maturity deposits was due to continuing our strategic initiative to grow our public fund deposits and continued organic growth in all our markets. Total time deposits decreased$25.2 million to$294.5 million atDecember 31, 2021 from$319.7 million atDecember 31, 2020 . The decrease was due to depositors shifting funds to more liquid accounts and the redemption of a few large municipal accounts.
Total deposits averaged
Our cost of interest-bearing deposits decreased 34 basis points to 0.37 percent in 2021 from 0.71 percent in 2020. Specifically, the cost of money market accounts decreased 45 basis points to 0.36 percent from 0.81 percent, NOW accounts decreased 25 basis points and the cost of time deposits decreased 48 basis points to 0.92 percent comparing 2021 and 2020. The decreases to the cost of our interest-bearing deposits was the result of our initiative to reduce premium rates being paid on core deposit relationships and the reduction of stated rates across all deposit products. The reductions are directly related to theFOMC's decision to decrease the target federal funds rate 225 basis points commencing in 2019 and ending in the first three months of 2020, first in response to economic slowdown and then due to the COVID-19 crisis. We expect our cost of funds to continue to decline as time deposits mature and reinvest into lower rates, however, expected actions by theFOMC to increase the federal funds rate may result in us increasing deposit rates. Volatile deposits, time deposits$100 or more, averaged$172.7 million in 2021, a decrease of$27.6 million or 13.8 percent from$200.3 million in 2020. Our average cost of these funds decreased 68 basis points to 0.78 percent in 2021, from 1.46 percent in 2020. This type of funding is susceptible to withdrawal by the depositor as they are particularly price sensitive and are therefore not considered to be a strong source of liquidity.
Market Risk Sensitivity:
With respect to evaluating our exposure to IRR on earnings, we utilize a gap analysis model that considers repricing frequencies of RSA and RSL. Gap analysis attempts to measure our interest rate exposure by calculating the net amount of RSA and RSL that reprice within specific time intervals. A positive gap occurs when the amount of RSA repricing in a specific period is greater than the amount of RSL repricing within that same time frame and is indicated by a RSA/RSL ratio greater than 1.0. A negative gap occurs when the amount of RSL repricing is greater than the amount of RSA and is indicated by a RSA/RSL ratio less than 1.0. A positive gap implies that earnings will be impacted favorably if interest rates rise and adversely if interest rates fall during the period. A negative gap tends to indicate that earnings will be affected inversely to interest rate changes. AtDecember 31, 2021 , we had cumulative one-year RSA/RSL ratio of 1.16, a positive gap. AtDecember 31, 2020 , we had cumulative one-year RSA/RSL of 1.39, a positive gap. As previously mentioned, a positive gap indicates that if interest rates increase, our earnings would likely be favorably impacted. Given the current economic conditions and the expected action of theFOMC to begin to increase the federal funds rate during the first quarter of 2022, we should -66-
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experience increased net interest income. The overall focus of ALCO is to maintain a well-balanced IRR position in order to safeguard future earnings during historical low-rate environment and from potential risk to falling interest rates. During 2021 ALCO took steps to reduce our positive gap position and guard against rates unchanged or down through the origination of fixed rate loans and the investment in longer term, fixed rate investment securities. Additionally, an initiative to reduce funding costs was executed to mitigate the adverse impact to net interest income from the low rates. ALCO will continue to focus efforts on strategies in 2022 in an attempt to maintain a positive gap position between RSA and RSL. However, these forward-looking statements are qualified in the aforementioned section entitled "Forward-Looking Discussion" in this Management's Discussion and Analysis. The change in our cumulative one-year ratio from the previous year-end resulted from a$25.7 million or 1.9 percent decrease in RSA offset by a$170.5 million or 17.5 percent increase in RSL maturing or repricing within one year. The decrease in RSA resulted primarily from a$64.0 million decrease in total loans, net of unearned income, resulting from an increase in commercial lending, which involves loans with longer-term adjustable rates. With respect to the$170.5 million increase in RSL maturing or repricing within a twelve month time horizon, non-maturity deposits increased$250.8 million due to customers seeking liquid accounts and saving at a higher percentage due to the economic uncertainty of the pandemic. The growth in deposits resulted in lower short-term borrowings of$50.0 million . Time deposits also declined when comparing year end 2021 to 2020 as a number of large accounts matured and customers sought more liquid alternatives.
Liquidity:
We employ a number of analytical techniques in assessing the adequacy of our liquidity position. One such technique is the use of ratio analysis to illustrate our reliance on noncore funds to fund our investments and loans maturing after 2021. AtDecember 31, 2021 , our noncore funds consisted of time deposits in denominations of$100 thousand or more, short-term borrowings, and long-term and subordinated debt. Large denomination time deposits are particularly not considered to be a strong source of liquidity since they are very interest rate sensitive and are considered to be highly volatile. AtDecember 31, 2021 , our net noncore funding dependence ratio, the difference between noncore funds and short-term investments to long-term assets, was negative 3.0 percent. Our net short-term noncore funding dependence ratio, noncore funds maturing within one year, less short-term investments to long-term assets equaled negative 5.6 percent due to our short-term investments being greater than the non-core funding. Comparatively, our ratios equaled 2.8 percent and negative 1.3 percent at the end of 2020, which indicates a significant decrease in our reliance on noncore funds in 2021. Moreover, our basic liquidity surplus ratio, defined as liquid assets less short-term potentially volatile liabilities as a percentage of total assets, increased to 14.6 percent atDecember 31, 2021 , from 8.7 percent atDecember 31, 2020 . We believe that by supplying adequate volumes of short-term investments and implementing competitive pricing strategies on deposits, we can ensure adequate liquidity to support future growth. The Consolidated Statements of Cash Flows present the change in cash and cash equivalents from operating, investing and financing activities. Cash and cash equivalents consist of cash on hand, cash items in the process of collection, noninterest-bearing and interest-bearing deposits with other banks and federal funds sold. Cash and cash equivalents increased$51.7 million for the year endedDecember 31, 2021 . For the year endedDecember 31, 2020 , cash and cash equivalents increased$197.0 million . During 2021, cash provided by operating and financing activities more than offset cash used in investing activities.
Operating activities provided net cash of
Net cash provided by financing activities equaled$451.1 million in 2021. Net cash provided by financing activities was$361.1 million in 2020. Deposit gathering, which is our predominant financing activity, increased in both 2021 and 2020. Deposit gathering provided a net cash inflow in 2021 of$526.3 million and$465.6 million in 2020. Short-term borrowings decreased net cash by$50.0 million in 2021 and by$102.2 million in 2020. Deposit gathering in 2021 was also partially offset by a$12.1 million net decrease in long-term debt as well as cash dividends paid of$10.8 million . In -67-
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2020, deposit gathering and the issuance of$33.0 million of subordinated debt was partially offset by a net$18.0 million repayment of long-term debt and cash dividends paid of$10.5 million . Our primary investing activities involve transactions related to our investment and loan portfolios. Net cash used in investing activities totaled$440.1 million and$201.2 million in 2021 and 2020, respectively. Net cash used in lending activities was$152.0 million in 2021, a decrease from$241.3 million in 2020. Activities related to our investment portfolio used net cash of$298.2 million in 2020 and provided net cash of$43.0 million in 2020.
Capital Adequacy:
Bank regulatory agencies consider capital to be a significant factor in ensuring the safety of a depositor's accounts. These agencies have adopted minimum capital adequacy requirements that include mandatory and discretionary supervisory actions for noncompliance. Our andPeoples Bank's risk-based capital ratios are strong and have consistently exceeded the minimum regulatory capital ratios required for adequately capitalized institutions. Our ratio of Tier 1 capital to risk-weighted assets and off-balance sheet items was 12.3 percent and 12.2 percent atDecember 31, 2021 and 2020, respectively. Our Total capital ratio was 13.6 percent and 15.1 percent atDecember 31, 2021 and 2020, respectively. Our andPeoples Bank's common equity Tier I capital to risk-weighted assets ratios were 12.3 percent and 13.8 percent atDecember 31, 2021 and 12.2 percent and 13.7 percent atDecember 31, 2020 . Our Leverage ratio, which equaled 9.2 percent atDecember 31, 2021 and 9.3 percent atDecember 31, 2020 , exceeded the minimum of 4.0 percent for capital adequacy purposes.Peoples Bank reported Tier 1 capital, Total capital and Leverage ratios of 13.8 percent, 15.0 percent and 9.6 percent atDecember 31, 2021 , and 13.7 percent, 15.0 percent and 10.1 percent atDecember 31, 2020 . Based on the most recent notification from theFDIC ,Peoples Bank was categorized as well capitalized atDecember 31, 2021 . There are no conditions or events since this notification that we believe have changedPeoples Bank's category. For a further discussion of these risk-based capital standards and supervisory actions for noncompliance, refer to the note entitled, "Regulatory matters," in the Notes to Consolidated Financial Statements to this Annual Report. Stockholders' equity was$340.1 million or$47.44 per share atDecember 31, 2021 , and$316.9 million or$43.92 per share atDecember 31, 2020 . Stockholders' equity grew$23.2 million in 2021 as net income offset an increase in accumulated other comprehensive loss, the payment of dividends and the Company's repurchase of its shares.
Review of Financial Performance:
Net income for the twelve months endedDecember 31, 2021 , totaled$43.5 million or$6.02 per diluted share, a 50.5 percent increase when compared to$29.4 million or$4.00 per diluted share for the comparable period of 2020. The increase in earnings for 2021 is the product of the previously disclosed$9.6 after-tax gain on the sale of our Visa Class B shares, a decrease to our provision for loan losses of$5.6 million , primarily due to an adjustment in the year ago period to the economic qualitative factors included in our allowance for loan losses methodology relating to the impact of COVID-19, and an increase to pre-provision net interest income of$4.8 million due primarily from lower deposit costs. Partially offsetting the increase were a higher income tax provision of$5.2 million . Return on average assets ("ROAA") and return on average equity ("ROAE") were 1.41 percent and 13.34 percent for the year endedDecember 31, 2021 . ROAA was 1.09 percent and ROAE was 9.48 percent for the year endedDecember 31, 2020 . Tax-equivalent net interest income, a non-GAAP measure, was$86.1 million in 2021 and$81.1 million in 2020. Our net interest margin equaled 2.99 percent in 2021 and 3.25 percent in 2020. Noninterest income, including the pre-tax gain of$12.2 million from the sale of Visa Class B shares, totaled$25.6 million 2021 and$16.6 million in 2020. Noninterest expense was$55.6 million for the year endedDecember 31, 2021 compared to$54.9 million for the year endedDecember 31, 2020 . Our productivity is measured by the operating efficiency ratio, a non-GAAP measure, defined as noninterest expense less amortization of intangible assets divided by the total of tax-equivalent net interest income and noninterest income. Our operating efficiency ratio was 55.3 percent in 2021
and
56.0 percent in 2020.
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Net Interest Income:
Tax-equivalent net interest income, a non-GAAP measure, was $86.1 million in
2021 and $81.1 million in 2020. Interest and net fees earned on the PPP loans
totaled $7.1 million in 2021. There was a positive volume variance that was
partially offset by a negative rate variance. The growth in average earning
assets exceeded that of interest-bearing liabilities, and resulted in additional
tax-equivalent net interest income, a non-GAAP measure, of $6.3 million . A rate
variance resulted in a decrease in net interest income of $1.3 million as assets
repriced quicker than liabilities.
Average earning assets increased $382.0 million to $2.9 billion in 2021 from
$2.5 billion in 2020 and accounted for a $6.4 million increase in interest
income. Average loans, net increased $97.5 million , which caused interest income
to increase $3.8 million . Average taxable investments increased $65.0 million
comparing 2021 and 2020, which resulted in increased interest income of $1.3
million while average tax-exempt investments increased $32.5 million , which
resulted in an increase to interest income of $1.1 million .
Average interest-bearing liabilities grew $322.9 million to $2.0 billion in 2021
from $1.8 billion in 2020 resulting in a net increase in interest expense of
$1.1 million . Large denomination time deposits averaged $27.5 million less in
2021 and caused interest expense to decrease $0.4 million . A decrease of
$26.5 million in average time deposits less than $100 thousand decreased
interest expense by $0.3 million . In addition, interest-bearing transaction
accounts, including money market, NOW and savings accounts grew $377.0 million ,
which in aggregate caused a $1.7 million increase in interest expense.
Short-term borrowings averaged $69.7 million less and decreased interest expense
$0.5 million while long-term debt averaged $30.6 million less and decreased
interest expense by $0.8 million comparing 2021 and 2020. The issuance of $33.0
million of subordinated debt during June 2020 caused interest expense to
increase $0.3 million for the full year 2021.
An unfavorable rate variance occurred, as the tax-equivalent yield on earning
assets decreased 50 basis points while there was a 33 basis point decrease in
the cost of funds. As a result, tax-equivalent net interest income decreased
$1.3 million comparing 2021 and 2020. The tax-equivalent yield on earning assets
was 3.32 percent in 2021 compared to 3.82 percent in 2020 resulting in a
decrease in interest income of $6.2 million . With the tax-equivalent yield on
the investment portfolio decreasing 42 basis points to 1.94 percent in 2021 from
2.36 percent in 2020, interest income decreased $1.6 million . The tax-equivalent
yield on the loan portfolio decreased 22 basis points to 3.94 percent in 2021
from 4.16 percent in 2020 and resulted in a decrease to interest income of $4.7
million .
A favorable rate variance was experienced in the cost of funds. We experienced
decreases in the rates paid on all major categories of interest-bearing
liabilities. Specifically, the cost of non-maturity deposit accounts decreased
25 basis points comparing 2021 and 2020. These decreases resulted in a decrease
in interest expense of $4.0 million . With regard to time deposits, the average
rate paid for time deposits less than $100 thousand decreased 23 basis points
while time deposits $100 thousand or more decreased 68 basis points, which
together resulted in a $1.5 million decrease in interest expense. The average
rate paid on short-term borrowings decreased 45 basis points in 2021 when
compared to 2020, causing a $0.3 million decrease in interest expense. Interest
expense increased $0.3 million from a 145 basis point increase in the average
rate paid on long-term debt.
Provision for Loan Losses:
We evaluate the adequacy of the allowance for loan losses account on a quarterly
basis utilizing our systematic analysis in accordance with procedural
discipline. We take into consideration certain factors such as composition of
the loan portfolio, volume of nonperforming loans, volumes of net charge-offs,
prevailing economic conditions and other relevant factors when determining the
adequacy of the allowance for loan losses account. We make monthly provisions to
the allowance for loan losses account in order to maintain the allowance at an
appropriate level. The provision for loan losses equaled $1.8 million in 2021
and $7.4 million in 2020. The lower provision in the twelve month period ended
December 31, 2021 is due to improved credit quality and the resulting reversal
of the COVID-19 related asset quality qualitative factor adjustment made in the
year ago period in our allowance for loan losses methodology. The higher
provision in the year ago period reflected changes made to the qualitative
factors related to economic and credit quality declines resulting from the onset
of the coronavirus pandemic and its uncertain economic
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impact. Based on our most recent evaluation atDecember 31, 2021 , we believe that the allowance was adequate to absorb any known or potential losses in
our portfolio as of such date. Noninterest Income: Our noninterest income for 2021 was$25.6 million compared with$16.6 million for the year ago period, an increase of$9.0 million . Excluding the sale of the Visa Class B shares, noninterest income decreased$3.2 million or 19.0 percent due in part to lower revenue generated from commercial loan interest rate swap transactions of$1.6 million as the number of transactions decreased due to unfavorable market rates. Mortgage banking revenue decreased$0.6 million in 2022 from lower volumes of mortgages sold into the secondary market. The year ago period included a net gain of$0.9 million from the sale of available-for-sale securities. Service charges, fees, commissions and other are lower in 2021 by$0.6 million due to a bank owned life insurance benefit of$0.6 million accrued in the year ago period and a lowerFederal Home Loan Bank dividend, partially offset by an increase to our debit card interchange revenue. Wealth management revenue increased$0.3 million in 2021 due to a higher number of transactions and commissions while fees on fiduciary activities increased$0.1 million due primarily to market appreciation.
Noninterest Expense:
Noninterest expense was
Salaries and employee benefits expense constitute the majority of our noninterest expenses accounting for 54.1 percent of the total noninterest expense. Salaries and employee benefits expense decreased$0.4 million or 1.3 percent to$29.7 million in 2021 from$30.1 million in 2020. Salaries and payroll taxes increased$0.3 million or 1.1 percent and employee benefits expense decreased$0.7 million or 12.7 percent. The higher salary expense in 2021 was due to increases resulting from annual performance-based salary adjustments and additional lending professionals in our expansion markets, partially offset by higher deferred loan origination cost benefit of$1.4 million due to our origination of PPP loans in 2021. Employee benefits expense was lower due to lower health insurance costs and lower pension expense. Occupancy and equipment expense was relatively flat when comparing 2021 to 2020. Occupancy expenses were slightly higher due to costs in operating our two newest branches which opened in the fourth quarter. Equipment related expense included a decrease to depreciation expense which offset higher information technology expenses related to our mobile/digital banking solution. We do expect occupancy and equipment expense to increase in 2022 due to a full years' operation of our two newest branch offices and our mobile/digital banking solution. Other expenses, which consist of merchant transaction expense,FDIC insurance and assessments, professional fees and outside services, other taxes, stationary and supplies, advertising, amortization of intangible assets and all other expenses were$12.4 million in 2021 and$11.9 million in 2020.FDIC insurance and assessments was higher by$0.2 million or 27.9 percent due to the remainingFDIC small bank assessment credit recognized in the first quarter of 2020. Other taxes increased$0.3 million due to higherPennsylvania shares tax due to an increase inPeoples Bank stockholder equity. Advertising expenses increased$0.1 million . The increase in stationery and supplies expenses of$0.2 million is offset by lower other expenses as postage related costs were re-classified.
Income Taxes:
Our income tax expense was$10.0 million and our effective tax rate was 18.7 percent for the year endedDecember 31, 2021 , an increase from income tax expense of$4.8 million and an effective tax rate of 14.1 percent for the year endedDecember 31, 2020 . The increases in 2021 were due to higher pre-tax income of$19.3 million , in part due to the sale of our Visa Class B shares, the inclusion of a$0.6 million deferred tax adjustment related to prior periods and the Company's frozen pension plan and$0.5 million forNew Jersey income tax related to our opening a branch office inNew Jersey . We utilize loans and investments of tax-exempt organizations to mitigate our tax burden, as interest revenue -70- Table of Contents from these sources is not taxable by the federal government. The tax benefit of tax-exempt income was 2.3 percent of pre-tax income in 2021 as compared to a 3.0 percent benefit in 2020. The effective tax rate in 2021 and 2020 was also influenced by the recognition of investment tax credits related to our limited partnership investments in elderly and low- to- moderate-income residential housing programs which allow us to mitigate our tax burden. By utilizing these credits, we reduced our income tax expense by$1.1 million in both 2021 and 2020. -71-
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Market risk is the risk to our earnings and/or financial position resulting from
adverse changes in market rates or prices, such as interest rates, foreign
exchange rates or equity prices. Our exposure to market risk is primarily
interest rate risk ("IRR"), which arises from our lending, investing and deposit
gathering activities. Our market risk sensitive instruments consist of
derivative and non-derivative financial instruments, none of which are entered
into for trading purposes. During the normal course of business, we are not
exposed to foreign exchange risk or commodity price risk. Our exposure to IRR
can be explained as the potential for change in reported earnings and/or the
market value of net worth. Variations in interest rates affect the underlying
economic value of assets, liabilities and off-balance sheet items. These changes
arise because the present value of future cash flows, and often the cash flows
themselves, change with interest rates. The effects of the changes in these
present values reflect the change in our underlying economic value, and provide
a basis for the expected change in future earnings related to interest rates.
Interest rate changes affect earnings by changing net interest income and the
level of other interest-sensitive income and operating expenses. IRR is inherent
in the role of banks as financial intermediaries.
A bank with a high degree of IRR may experience lower earnings, impaired
liquidity and capital positions, and most likely, a greater risk of insolvency.
Therefore, banks must carefully evaluate IRR to promote safety and soundness in
their activities. Interest rate risk is the risk of loss to future earnings due
to changes in interest rates. The Asset Liability Committee ("ALCO") is
responsible for establishing policy guidelines on liquidity and acceptable
exposure to interest rate risk. Generally quarterly, ALCO reports on the status
of liquidity and interest rate risk matters to the Company's board of directors.
The objective of the ALCO is to manage assets and funding sources to produce
results that are consistent with the Company's liquidity, capital adequacy,
growth, risk and profitability goals and are within policy limits.
The Company utilizes the pricing and structure of loans and deposits, the size
and duration of the investment securities portfolio, the size and duration of
the wholesale funding portfolio, and off-balance sheet interest rate contracts
to manage interest rate risk. The off-balance sheet interest rate contracts may
include interest rate swaps, caps and floors. These interest rate contracts
involve, to varying degrees, credit risk and interest rate risk. Credit risk is
the possibility that a loss may occur if a counterparty to a transaction fails
to perform according to terms of the contract. The notional amount of the
interest rate contracts is the amount upon which interest and other payments are
based. The notional amount is not exchanged, and therefore, should not be taken
as a measure of credit risk. See Note 15 to the Audited Consolidated Financial
Statements for additional information.
The ALCO uses income simulation to measure interest rate risk inherent in the
Company's on-balance sheet and off-balance sheet financial instruments at a
given point in time by showing the effect of interest rate shifts on net
interest income over a 24-month horizon and a 60-month horizon. The simulations
assume that the size and general composition of the Company's balance sheet
remain static over the simulation horizons, with the exception of certain
deposit mix shifts from low-cost time deposits to higher-cost time deposits in
selected interest rate scenarios. Additionally, the simulations take into
account the specific repricing, maturity, call options, and prepayment
characteristics of differing financial instruments that may vary under different
interest rate scenarios. The characteristics of financial instrument classes are
reviewed typically quarterly by the ALCO to ensure their accuracy and
consistency.
The ALCO reviews simulation results to determine whether the Company's exposure
to a decline in net interest income remains within established tolerance levels
over the simulation horizons and to develop appropriate strategies to manage
this exposure. As of December 31, 2022 and December 31, 2021 , net interest
income simulations indicated that exposure to changing interest rates over the
simulation horizons remained within tolerance levels established by the Company.
All changes are measured in comparison to the projected net interest income that
would result from an "unchanged" rate scenario where both interest rates and the
composition of the Company's balance sheet remain stable for a 24-month and
60-month period. In addition to measuring the change in net interest income as
compared to an unchanged interest rate scenario, the ALCO also measures the
trend of both net interest income and net interest margin over a 24-month and
60-month horizon to ensure the stability and adequacy of this source of earnings
in different interest rate scenarios.
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Model results atDecember 31, 2022 indicated a higher starting level of net interest income ("NII") compared to theDecember 31, 2021 model as balance sheet growth, a shift in balance sheet mix and higher assumed market rates led to an increase to the balance sheet spread of 22 basis points. Our current model indicates the net interest margin may compress as funding sources recycle into higher assumed replacement rates due to theFOMC's actions to increase the federal funds rate 425 basis points in 2022. Our interest rate risk position exhibits a relatively well-matched position to both rising and falling interest rate environments over the next eighteen to twenty-four month period with a benefit emerging to rising rate environments thereafter as asset yields re-price higher. This position atDecember 31, 2022 is less asset-sensitive than the simulation atDecember 31, 2021 indicated due to the addition of fixed rate assets which will not reprice higher as quickly as deposit and borrowing costs. The ALCO regularly reviews a wide variety of interest rate shift scenario results to evaluate interest rate risk exposure, including scenarios showing the effect of steepening or flattening changes in the yield curve as well as parallel changes in interest rates of up to 400 basis points. Because income simulations assume that the Company's balance sheet will remain static over the simulation horizon, the results do not reflect adjustments in strategy that the ALCO could implement in response to rate shifts. During 2022, theFOMC has increased the federal funds target rate in part to mitigate high inflation. ThroughDecember 31, 2022 , there have been seven rate increases, totaling 425 basis points. Although we have realized higher rates on our existing adjustable rate loans and new originations, our average funding costs are increasing at a faster pace as rate-sensitive customers are seeking higher returns. We expect our funding costs to continue to increase in the near-term due to expectations theFOMC will continue to increase the targeted federal funds rate which may negatively impact our net interest income.
The projected impact of instantaneous changes in interest rates on our net
interest income and economic value of equity at
December 31, 2022
% Change in
Changes in Interest Rates (basis points) Net Interest Income Economic Value of Equity
Metric Policy Metric Policy
+400 (11.7) (20.0) (3.2) (40.0)
+300 (8.9) (20.0) (1.7) (30.0)
+200 (6.2) (10.0) (0.7) (20.0)
+100 (2.8) (10.0) 0.8 (10.0)
Static
-100 1.2 (10.0) (4.3) (10.0)
-200 1.0 (10.0) (12.6) (20.0)
-300 (0.3) (20.0) (24.9) (30.0)
-400 (3.6) (20.0) (49.3) (40.0)
Our simulation model creates pro forma net interest income scenarios under various interest rate shocks. Given instantaneous and parallel shifts in general market rates of plus 100 basis points, our projected net interest income for the 12 months endingDecember 31, 2022 , would decrease 2.8 percent from model results using current interest rates. Additional disclosures about market risk are included in Part II, Item 7 of this Annual Report, under the heading "Market Risk Sensitivity," and are incorporated into this Item 7A by reference. -73-
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The Company has certain loans and derivative instruments whose interest rate is
indexed to the London Inter Bank Offered Rate ("LIBOR"). The LIBOR index will be
discontinued for U.S. Dollar settings effective June 30, 2023 . The Alternative
Reference Rates Committee ("ARRC") has proposed that the Secured Overnight
Funding Rate ("SOFR") replace USD-LIBOR. ARRC proposed that the transition to
SOFR from USD-LIBOR take place by the end of 2021. On March 15, 2022 , the
Adjustable Interest Rate Act (the LIBOR Act) was signed into law and includes
establishing a uniform national approach for replacing LIBOR in legacy contracts
that do not provide for the use of a clearly defined replacement benchmark rate.
The LIBOR Act also directs the FRB to issue regulations to implement the
legislation addressed by this Act.
The Company has USD-LIBOR exposure in various agreements, including variable
rate loans and derivatives. The Company created an internal transition team that
is managing the transition away from USD-LIBOR. This transition team is a
cross-functional team composed of representatives from the commercial and retail
banking lines of business, as well as representatives from credit, risk, loan
operations, legal, and finance. The transition team determined that the primary
indices to be utilized for loans will be prime rate and Term SOFR-based.
The Company has begun transitioning LIBOR-indexed loans to alternative indexes,
including prime rate and Term SOFR, and adjusting the spread to maintain the
overall yield. The Company transitioned the LIBOR-indexed derivatives to the
replacement benchmark rate included in the contracts' fallback language. For all
existing LIBOR-based loans and derivatives, remediation efforts are scheduled to
be completed by June 30, 2023 .
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