WESTERN NEW ENGLAND BANCORP, INC. The following discussion should be read in conjunction with the Company's Consolidated Financial Statements and notes thereto, each appearing elsewhere in this Annual Report on Form 10-K. Management's discussion focuses on 2022 results compared to 2021. For a discussion of 2021 results compared to 2020, refer to Part II, Item 7 of our Annual Report filed on Form 10-K, which was filed with theSEC onMarch 11, 2022 . Overview.
We strive to remain a leader in meeting the financial service needs of the local community and to provide quality service to the individuals and businesses in the market areas that we have served since 1853. Historically, we have been a community-oriented provider of traditional banking products and services to business organizations and individuals, including products such as residential and commercial real estate loans, consumer loans and a variety of deposit products. We meet the needs of our local community through a community-based and service-oriented approach to banking. We have adopted a growth-oriented strategy that continues to focus on increasing commercial lending and residential lending. Our strategy also calls for increasing deposit relationships, specifically core deposits, and broadening our product lines and services. We believe that this business strategy is best for our long-term success and viability, and complements our existing commitment to high quality customer service.
In connection with our overall growth strategy, we seek to:
? Grow the Company's commercial loan portfolio and related commercial deposits by
targeting businesses in our primary market area of
County in western
? Supplement the commercial portfolio by growing the residential real estate
portfolio to diversify the loan portfolio and deepen customer relationships;
? Focus on expanding our retail banking deposit franchise and increase the number
of households served within our designated market area;
? Invest in people, systems and technology to grow revenue, improve efficiency
and enhance the overall customer experience;
? Grow revenues, increase tangible book value, continue to pay competitive
dividends to shareholders and utilize the Company's stock repurchase plan to
leverage our capital and enhance franchise value; and
? Consider growth through acquisitions. We may pursue expansion opportunities in
existing or adjacent strategic locations with companies that add complementary
products to our existing business and at terms that add value to our existing
shareholders.
You should read the following financial results for the year ended
For the twelve months endedDecember 31, 2022 , net income was$25.9 million , or$1.18 diluted earnings per share, compared to net income of$23.7 million , or$1.02 diluted earnings per share, for the twelve months endedDecember 31, 2021 . The results for the twelve months endedDecember 31, 2022 showed increases in net interest income and non-interest income, which were both partially offset by increases in the provision for loan losses and non-interest expense. 49 During the twelve months endedDecember 31, 2022 , net interest income increased$6.0 million , or 8.3%, to$79.2 million , compared to$73.2 million for the twelve months endedDecember 31, 2021 . The increase in net interest income was due to an increase in interest and dividend income of$6.1 million , or 7.6%, partially offset by an increase in interest expense of$24,000 , or 0.4%. For the twelve months endedDecember 31, 2022 , the Company generated net interest income growth of 8.3%, overcoming a$6.0 million , or 89.2%, decrease in PPP income as the PPP program comes to a close. Excluding PPP income of$728,000 and$6.8 million for the twelve months endedDecember 31, 2022 and the twelve months endedDecember 31, 2021 , respectively, net interest income increased$12.1 million , or 18.2% for the same period. For the twelve months endedDecember 31, 2022 , the provision for loan losses was$700,000 , compared to a credit for loan losses of$925,000 for the twelve months endedDecember 31, 2021 . The Company recorded net charge-offs of$556,000 for the twelve months endedDecember 31, 2022 , as compared to net charge-offs of$445,000 for the twelve months endedDecember 31, 2021 .
General.
Our consolidated results of operations depend primarily on net interest and dividend income. Net interest and dividend income is the difference between the interest income earned on interest-earning assets and the interest paid on interest-bearing liabilities. Interest-earning assets consist primarily of commercial real estate loans, commercial and industrial loans, residential real estate loans and securities. Interest-bearing liabilities consist primarily of certificates of deposit and money market accounts, demand deposit accounts and savings account deposits and borrowings from the FHLB. The consolidated results of operations also depend on the provision for loan losses, non-interest income, and non-interest expense. Non-interest income includes service fees and charges, income on bank-owned life insurance, gains on sales of mortgages, gains on non-marketable equity investments and gains (losses) on securities. Non-interest expense includes salaries and employee benefits, occupancy expenses, data processing, advertising expense,FDIC insurance assessment, professional fees and other general and administrative expenses.
Loan Modifications/Troubled Debt Restructurings.
The Company implemented a modification deferral program under the CARES Act, which allowed residential, commercial and consumer borrowers who were adversely affected by the COVID-19 pandemic, to defer loan payments for a set period of time. As ofDecember 31, 2022 , the Company had no modified loans remaining
under the CARES Act. Allowance for Loan Losses. In determining the allowance for loan losses, the Company considers quantitative loss factors and a number of qualitative factors, such as underwriting policies, current economic conditions, delinquency statistics, the adequacy of the underlying collateral and the financial strength of the borrower. The long-term consequences of the COVID-19 pandemic could cause us to experience higher credit losses in our lending portfolio, reduce demand for our products and services and other negative impacts on our financial position, results of operations and prospects. As ofDecember 31, 2022 , the Company's delinquency and nonperforming assets have not been materially impacted by the COVID-19 pandemic, and therefore, have not resulted in material credit losses within the lending portfolio.
Critical Accounting Policies.
Our accounting policies are disclosed in Note 1 to our consolidated financial
statements. Given our current business strategy and asset/liability structure,
the more critical policy is the allowance for loan losses and provision for loan
losses. In addition to the informational disclosure in the notes to the
consolidated financial statements, our policy on this accounting policy is
described in detail in the applicable sections of "Management's Discussion and
Analysis of Financial Condition and Results of Operations." Senior management
has discussed the development and selection of this accounting policy and the
related disclosures with the Audit Committee of our Board of Directors.
50
The process of evaluating the loan portfolio, classifying loans and determining
the allowance and provision is described in detail in Part I under "Business -
Lending Activities - Allowance for Loan Losses." This evaluation is inherently
subjective as it requires material estimates that may be susceptible to
significant change. Our methodology for assessing the allocation of the
allowance consists of two key components, which are a specific allowance for
impaired loans and a general allowance for the remainder of the portfolio.
Measurement of impairment can be based on present value of expected future cash
flows discounted at the loan's effective interest rate, the loan's observable
market price or the fair value of the collateral, if the loan is collateral
dependent. The allocation of the allowance is also reviewed by management based
upon our evaluation of then-existing economic and business conditions affecting
our key lending areas and other conditions, such as new loan products, credit
quality trends (including trends in nonperforming loans expected to result from
existing conditions), collateral values, loan volumes and concentrations,
specific industry conditions within portfolio segments that existed as of the
balance sheet date and the impact that such conditions were believed to have had
on the collectability of the loan portfolio.
Although management believes it has established and maintained the allowance for
loan losses at adequate levels, if management's assumptions and judgments prove
to be incorrect due to continued deterioration in economic, real estate and
other conditions, and the allowance for loan losses is not adequate to absorb
inherent losses, our earnings and capital could be significantly and adversely
affected. There were no changes to the Company's allowance for loan losses
methodology during the year ended December 31, 2022 .
Analysis of Net Interest Income.
The Company's earnings are largely dependent on its net interest income, which
is the difference between interest earned on loans and investments and the cost
of funding (primarily deposits and borrowings). Net interest income expressed as
a percentage of average interest-earning assets is referred to as net interest
margin. For more information regarding the Company's use of Non-GAAP financial
measures see "Explanation of Use of Non-GAAP Financial Measurements."
51
Average Balance Sheet.
The following table sets forth information relating to the Company for the years endedDecember 31, 2022 , 2021 and 2020. The average yields and costs are derived by dividing interest income or interest expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively, for the periods shown. Average balances are derived from average daily balances. The yields include fees which are considered adjustments to yields. Loan interest and yield data does not include any accrued interest from non-accruing loans.
For the Years Ended
2022 2021 2020
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
(Dollars in thousands)
ASSETS:
Interest-earning assets
Loans(1)(2) $ 1,953,527 $ 77,758 3.98 % $ 1,887,926 $ 74,620 3.95 % $ 1,922,607 $ 78,284 4.07 %
Securities(2) 407,444 8,299 2.04 319,778 5,398 1.69 214,312 4,360 2.03
Other investments - at
cost 10,289 177 1.72 10,242 115 1.12 14,915 587 3.94
Short-term
investments(3) 25,712 191 0.74 111,931 139 0.12 45,858 109 0.24
Total interest-earning
assets 2,396,972 86,425 3.61 2,329,877 80,272 3.45 2,197,692 83,340 3.79
Total
non-interest-earning
assets 152,941 147,980 140,725
Total assets $ 2,549,913 $ 2,477,857 $ 2,338,417
LIABILITIES AND EQUITY:
Interest-bearing
liabilities
Interest-bearing
checking accounts $ 139,993 530 0.38 $ 109,648 399 0.36 $ 86,086 387 0.45
Savings accounts 222,267 161 0.07 205,394 154 0.07 153,073 136 0.09
Money market accounts 890,763 3,187 0.36 776,725 2,412 0.31 521,692 2,838 0.54
Time deposits 363,258 1,474 0.41 477,067 2,543 0.53 634,111 10,139 1.60
Total interest-bearing
deposits 1,616,281 5,352 0.33 1,568,834 5,508 0.35 1,394,962 13,500 0.97
Short-term borrowings
and long-term debt 31,556 1,344 4.26 38,294 1,164 3.04 190,752 4,945 2.59
Interest-bearing
liabilities 1,647,837 6,696 0.41 1,607,128 6,672 0.42 1,585,714 18,445 1.16
Non-interest-bearing
deposits 647,971 608,936 489,602
Other
non-interest-bearing
liabilities 35,615 39,108 32,251
Total
non-interest-bearing
liabilities 683,586 648,044 521,853
Total liabilities 2,331,423 2,255,172 2,107,567
Total equity 218,490 222,685 230,850
Total liabilities and
equity $ 2,549,913 $ 2,477,857 $ 2,338,417
Less: Tax-equivalent
adjustment(2) (497 ) (424 ) (465 )
Net interest and
dividend income $ 79,232 $ 73,177 $ 64,430
Net interest rate
spread(4) 3.18 % 3.01 % 2.61 %
Net interest rate
spread, on a
tax-equivalent basis(5) 3.20 % 3.03 % 2.63 %
Net interest margin(6) 3.31 % 3.14 % 2.93 %
Net interest margin, on
a tax-equivalent
basis(7) 3.33 % 3.16 % 2.95 %
Ratio of average
interest-earning assets
to average
interest-bearing
liabilities 145.46 % 144.97 % 138.59 %
(1) Loans, including nonaccrual loans, are net of deferred loan origination costs
and unadvanced funds.
(2) Loan and securities income are presented on a tax-equivalent basis using a
tax rate of 21% for 2022, 2021 and 2020. The tax-equivalent adjustment is
deducted from tax-equivalent net interest and dividend income to agree to the
amount reported on the consolidated statements of net income. See
"Explanation of Use of Non-GAAP Financial Measurements".
(3) Short-term investments include federal funds sold.
(4) Net interest rate spread represents the difference between the weighted
average yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities.
(5) Net interest rate spread, on a tax-equivalent basis, represents the
difference between the tax-equivalent weighted average yield on
interest-earning assets and the tax-equivalent weighted average cost of
interest-bearing liabilities. See "Explanation of Use of Non-GAAP Financial
Measurements".
(6) Net interest margin represents net interest and dividend income as a
percentage of average interest-earning assets.
(7) Net interest margin, on a tax-equivalent basis, represents tax-equivalent net
interest and dividend income as a percentage of average interest-earning
assets. See "Explanation of Use of Non-GAAP Financial Measurements".
52
Rate/Volume Analysis.
The following table shows how changes in interest rates and changes in the
volume of interest-earning assets and interest-bearing liabilities have affected
our interest and dividend income and interest expense during the periods
indicated. Information is provided in each category with respect to: (1)
interest income changes attributable to changes in volume (changes in volume
multiplied by prior rate); (2) interest income changes attributable to changes
in rate (changes in rate multiplied by prior volume); and (3) the net change.
The changes attributable to the combined impact of volume and rate have been
allocated proportionately to the changes due to volume and the changes due to
rate.
Year Ended December 31, 2022 Compared to Year Ended Year Ended December 31, 2021 Compared to Year Ended
December 31, 2021 December 31, 2020
Increase (Decrease) Due to Increase (Decrease) Due to
Volume Rate Net Volume Rate Net
Interest-earning
assets (In thousands) (In thousands)
Loans (1) $ 2,593 $ 545 $ 3,138 $ (1,428 ) $ (2,236 ) $ (3,664 )
Investment securities
(1) 1,480 1,421 2,901 2,136 (1,098 ) 1,038
Other investments -
at cost 1 60 61 (184 ) (287 ) (471 )
Short-term
investments (107 ) 159 52 160 (130 ) 30
Total
interest-earning
assets 3,967 2,185 6,152 684 (3,751 ) (3,067 )
Interest-bearing
liabilities
Interest-bearing
checking accounts 110 21 131 106 (94 ) 12
Savings accounts 13 (6 ) 7 48 (30 ) 18
Money market accounts 354 421 775 1,367 (1,793 ) (426 )
Time deposits (607 ) (462 ) (1,069 ) (2,510 ) (5,086 ) (7,596 )
Short-term borrowing
and long-term debt (205 ) 385 180 (3,951 ) 170 (3,781 )
Total
interest-bearing
liabilities (335 ) 359 24 (4,940 ) (6,833 ) (11,773 )
Change in net
interest and dividend
income $ 4,302 $ 1,826 $ 6,128 $ 5,624 $ 3,082 $ 8,706 (1) Securities and loan income and net interest income are presented on a
tax-equivalent basis using a tax rate of 21% for 2022, 2021 and 2020. The
tax-equivalent adjustment is deducted from tax-equivalent net interest income
to agree to the amount reported in the consolidated statements of net income.
See "Explanation of Use of Non-GAAP Financial Measurements".
53
Explanation of Use of Non-GAAP Financial Measurements.
We believe that it is common practice in the banking industry to present
interest income and related yield information on tax-exempt loans and securities
on a tax-equivalent basis and that such information is useful to investors
because it facilitates comparisons among financial institutions. However, the
adjustment of interest income and yields on tax-exempt loans and securities to a
tax-equivalent amount is considered a non-GAAP financial measure. A
reconciliation from GAAP to non-GAAP is provided below.
For the twelve months ended
12/31/2022
(In thousands)
Loans (no tax adjustment)$ 77,264 $ 74,200 $ 77,837 Tax-equivalent adjustment (1) 494 420 447 Loans (tax-equivalent basis)$ 77,758 $
74,620
Securities (no tax adjustment)$ 8,296 $ 5,394 $ 4,342 Tax-equivalent adjustment (1) 3 4 18 Securities (tax-equivalent basis)$ 8,299 $
5,398
Net interest income (no tax adjustment)$ 79,232 $ 73,177 $ 64,430 Tax equivalent adjustment (1) 497 424 465
Net interest income (tax-equivalent basis)
Net interest income (no tax adjustment)$ 79,232 $ 73,177 $ 64,430 Less: Purchase accounting adjustments 175 (55 ) 976 Prepayment penalties and fees 281 181 409 PPP fee income 728 6,769 4,842 Adjusted net interest income (non-GAAP)$ 78,048 $
66,282
Average interest-earning assets$ 2,396,972 $ 2,329,877 $ 2,197,692 Average interest-earnings asset, excluding average PPP loans$ 2,391,252 $ 2,219,286 $ 2,052,188 Net interest margin (no tax adjustment) 3.31 % 3.14 % 2.93 % Net interest margin, tax-equivalent 3.33 % 3.16 % 2.95 % Adjusted net interest margin, excluding purchase accounting adjustments, PPP fee income and prepayment penalties (non-GAAP) 3.26 % 2.99 % 2.84 % 54 For the twelve months ended 12/31/2022 12/31/2021 12/31/2020 (In thousands) Income Before Income Taxes (GAAP)$ 34,629 $ 31,724 $ 14,156 Provision (credit) for loan losses 700 (925 ) 7,775 PPP income (728 ) (6,769 ) (4,842 ) Gain on defined benefit plan curtailment (2,807 ) - - Income Before Taxes, Provision, PPP Income and Defined Benefit Curtailment (non-GAAP)$ 31,794 $ 24,030 $ 17,089 Adjusted Efficiency Ratio: Non-interest Expense (GAAP)$ 57,235 $ 54,942 $ 51,750 Non-GAAP adjustments:
Loss on prepayment of borrowings - (45 ) (987 ) Non-interest Expense for Adjusted Efficiency Ratio (non-GAAP)$ 57,235 $ 54,897 $ 50,763 Net Interest Income (GAAP)$ 79,232 $ 73,177 $ 64,430 Non-interest Income (GAAP)$ 13,332 $ 12,564 $ 9,251 Non-GAAP adjustments:
Loss (gain) on securities, net 4 72 (1,965 ) Unrealized losses (gain) on marketable equity securities 717 168 (109 ) Loss on interest rate swap termination - 402 2,353 Gain on non-marketable equity investments (422 ) (898 ) - Gain on defined benefit plan curtailment (2,807 ) - - Non-interest Income for Adjusted Efficiency Ratio (non-GAAP)$ 10,824 $ 12,308 $ 9,530 Total Revenue for Adjusted Efficiency Ratio (non-GAAP)$ 90,056 $ 85,485 $ 73,960 Efficiency Ratio (GAAP) 61.83 % 64.08 % 70.24 % Adjusted Efficiency Ratio (Non-interest Expense for Efficiency Ratio (non-GAAP)/Total Revenue for Efficiency Ratio (non-GAAP)) 63.55 %
64.64 % 69.97 %
(1) The tax equivalent adjustment is based upon a 21% tax rate for 2022, 2021 and
2020.
55
Comparison of Financial Condition at
At
Cash and Cash Equivalents.
Cash and cash equivalents is comprised of cash on hand and amounts due from banks, interest-earning deposits in other financial institutions and federal funds sold. Cash and cash equivalents totaled$30.3 million , or 1.2% of total assets, atDecember 31, 2022 and$103.5 million , or 4.1% of total assets, atDecember 31, 2021 . Balances in cash and cash equivalents will fluctuate due primarily to the timing of net deposit flows, borrowing and loan inflows and outflows, investment purchases and maturities, calls and sales proceeds, and the immediate liquidity needs of the Company. The decrease in cash and cash equivalents atDecember 31, 2022 is primarily due to the Company utilizing cash on hand to fund loan growth during the year endedDecember 31, 2022 . Investments.
AtDecember 31, 2022 , the Company's available-for-sale securities portfolio decreased$47.4 million , or 24.4%, from$194.4 million atDecember 31, 2021 to$147.0 million atDecember 31, 2022 . The held-to-maturity securities portfolio, recorded at amortized cost, increased$7.9 million , or 3.6%, from$222.3 million atDecember 31, 2021 to$230.2 million atDecember 31, 2022 . The marketable equity securities portfolio decreased$5.7 million , or 47.6%, from$11.9 million atDecember 31, 2021 to$6.2 million atDecember 31, 2022 . The decreases were due to principal pay downs and redemptions, as well as an increase in unrealized loss on securities available-for-sale. The primary objective of the investment portfolio is to provide liquidity and maximize income while preserving the safety of principal. The Bank is required to purchase FHLB stock at par value in association with advances from the FHLB. The stock is classified as a restricted investment and carried at cost which management believes approximates fair value. The Company's investment in FHLB capital stock amounted to$2.9 million and$2.2 million atDecember 31, 2022 andDecember 31, 2021 , respectively. AtDecember 31, 2022 and 2021, the Company held$423,000 ofAtlantic Community Bankers Bank stock. The stock is restricted and carried in other assets at cost. The stock is evaluated for impairment based on an estimate of the ultimate
recovery to the par value. Loans.
AtDecember 31, 2022 , total loans were$2.0 billion , an increase of$126.7 million , or 6.8%, fromDecember 31, 2021 . Excluding PPP loans, total loans increased$149.7 million , or 8.1%, driven by an increase in commercial real estate loans of$89.4 million , or 9.1%, an increase in total commercial and industrial loans of$16.2 million , or 8.1%, an increase in residential real estate loans, which include home equity loans, of$43.0 million , or 6.6%, and a decrease in PPP loans of$23.1 million , or 91.0%, fromDecember 31, 2021 . During the twelve months endedDecember 31, 2022 and 2021, the Company sold$277,000 and$59.7 million , respectively, of fixed rate, low coupon residential real estate loans to the secondary market. As ofDecember 31, 2022 , the Company serviced$79.3 million in loans sold to the secondary market, compared to$88.2 million atDecember 31, 2021 . Servicing rights will likely continue to be retained on all loans written and sold to the secondary market.
Bank-Owned Life Insurance ("BOLI").
The Company indirectly utilizes the earnings on BOLI to offset the cost of the Company's benefit plans. The cash surrender value of BOLI was$74.6 million and$72.9 million atDecember 31, 2022 and 2021, respectively. Deposits.
AtDecember 31, 2022 , total deposits were$2.2 billion , a decrease of$27.5 million , or 1.2%, fromDecember 31, 2021 , primarily due to a decrease in core deposits of$37.1 million , or 2.0%. Core deposits, which the Company defines as all deposits except time deposits, decreased from$1.9 billion , or 82.2% of total deposits, atDecember 31, 2021 , to$1.8 billion , or 81.5% of total deposits, atDecember 31, 2022 . Non-interest-bearing deposits increased$4.2 million , or 0.7%, to$645.5 million , interest-bearing checking accounts increased$3.0 million , or 2.1%, to$148.7 million , savings accounts increased$4.8 million , or 2.2%, to$222.4 million , and money market accounts decreased$49.3 million , or 5.8%, to$801.1 million . Time deposits increased$9.7 million , or 2.4%, from$402.0 million atDecember 31, 2021 to$411.7 million atDecember 31, 2022 . 56 Borrowed Funds.
AtDecember 31, 2022 , total borrowings increased$39.9 million , or 178.9%, from$22.3 million atDecember 31, 2021 , to$62.2 million . Short-term borrowings and long-term debt increased$39.9 million to$42.5 million and subordinated debt outstanding totaled$19.7 million atDecember 31, 2022 and$19.6 million at
December 31, 2021 . Shareholders' Equity. AtDecember 31, 2022 , shareholders' equity was$228.1 million , or 8.9% of total assets, compared to$223.7 million , or 8.8% of total assets, atDecember 31, 2021 . The increase in shareholders' equity reflects net income of$25.9 million , partially offset by$6.4 million for the repurchase of the Company's common stock, the payment of regular cash dividends of$5.3 million and an increase in accumulated other comprehensive loss of$12.7 million . Total shares outstanding as ofDecember 31, 2022 were 22,216,789. The Company's book value per share was$10.27 atDecember 31, 2022 compared to$9.87 atDecember 31, 2021 , while tangible book value per share, a non-GAAP financial measure, increased$0.40 , or 4.3%, from$9.21 atDecember 31, 2021 to$9.61 atDecember 31, 2022 . Reflected in the book value and tangible book value changes during the year endedDecember 31, 2022 are theFederal Reserve's 425 basis points interest rate increases, which resulted in significant changes in unrealized gains and losses on investment securities. Such unrealized gains and losses are generally due to changes in interest rates and represent the difference, net of applicable income tax effect, between the estimated fair value and amortized cost of investment securities classified as available-for-sale. The Company had no other-than-temporary impairment charges in its investment portfolio in 2022 or 2021. Tangible book value is a Non-GAAP measure. For more information regarding the Company's use of Non-GAAP financial measures see "Explanation of Use of Non-GAAP Financial Measurements." As ofDecember 31, 2022 , the Company's and the Bank's regulatory capital ratios continued to exceed the levels required to be considered "well-capitalized" under federal banking regulations. Pension Plan. OnOctober 31, 2022 , theBoard of Director's previously approved termination of the Westfield Bank Defined Benefit Pension Plan ("DB Plan") became effective, subject to regulatory approvals. Once the Company has received regulatory approval to terminate the DB Plan, which is expected in the first quarter of 2023, the Company will make an additional cash contribution during the second quarter of 2023, if necessary, in order to fully fund the DB Plan on a plan termination basis, followed by the purchase of annuity contracts to transfer its remaining liabilities under the DB Plan, for those participants who do not opt for a one-time lump sum payment. The actual amount of this cash contribution, if any, will depend upon the nature and timing of participant settlements, as well as prevailing market conditions. AtDecember 31, 2022 , the Company reversed$7.3 million in net unrealized losses recorded in accumulated other comprehensive income attributed to both the DB plan curtailment resulting from the termination of the DB Plan as well as changes in discount rates. In addition, the Company recorded a gain on curtailment of$2.8 million through non-interest income. The improvement in book value and tangible book value for the three months endedDecember 31, 2022 were primarily related to the termination of the DB Plan.
Assets under Management. Total assets under management include loans serviced for others and investment assets under management. Loans serviced for others and investment assets under management are not carried as assets on the Company's consolidated balance sheet, and as such, total assets under management is not a financial measurement recognized under GAAP, however, management believes its disclosure provides information useful in understanding the trends in total assets under management. The Company provides a wide range of investment advisory and wealth management services through Westfield Investment Services through LPL Financial, a third-party broker-dealer. Investment assets under management decreased$35.6 million , or 18.9%, from$188.1 million for the year endedDecember 31, 2021 , to$152.5 million for the year endedDecember 31, 2022 . 57 Comparison of Operating Results for Years EndedDecember 31, 2022 and 2021.
General.
For the twelve months ended
Net Interest Income and Net Interest Margin.
During the twelve months endedDecember 31, 2022 , net interest income increased$6.0 million , or 8.3%, to$79.2 million , compared to$73.2 million for the twelve months endedDecember 31, 2021 . The increase in net interest income was due to an increase in interest and dividend income of$6.1 million , or 7.6%, partially offset by an increase in interest expense of$24,000 , or 0.4%. For the twelve months endedDecember 31, 2022 , the Company generated net interest income growth of 8.3%, overcoming a$6.0 million , or 89.2%, decrease in PPP income as the PPP program comes to a close. Excluding PPP income of$728,000 and$6.8 million for the twelve months endedDecember 31, 2022 and the twelve months endedDecember 31, 2021 , respectively, net interest income increased$12.1 million , or 18.2% for the same period. The net interest margin for the twelve months endedDecember 31, 2022 was 3.31%, compared to 3.14% during the twelve months endedDecember 31, 2021 . The net interest margin, on a tax-equivalent basis, was 3.33% for the twelve months endedDecember 31, 2022 , compared to 3.16% for the twelve months endedDecember 31, 2021 . Excluding the PPP income, the net interest margin increased 29 basis points from 2.99% for the twelve months endedDecember 31, 2021 to 3.28% for the twelve months endedDecember 31, 2022 . The average yield on interest-earning assets increased 15 basis point from 3.43% for the twelve months endedDecember 31, 2021 to 3.58% for the twelve months endedDecember 31, 2022 . During the twelve months endedDecember 31, 2022 , the average cost of funds, including non-interest-bearing demand accounts and borrowings, decreased one basis point from 0.30% for the twelve months endedDecember 31, 2021 to 0.29% for the twelve months endedDecember 31, 2022 . For the twelve months endedDecember 31, 2022 , the average cost of core deposits, including non-interest-bearing demand deposits, increased three basis points from 0.17% for the twelve months endedDecember 31, 2021 to 0.20% for the twelve months endedDecember 31, 2022 . The average cost of time deposits decreased 12 basis points from 0.53% for the twelve months endedDecember 31, 2021 to 0.41% during the same period in 2022. The average cost of borrowings, which include FHLB advances and subordinated debt, increased 122 basis points from 3.04% for the twelve months endedDecember 31, 2021 to 4.26% for the twelve months endedDecember 31, 2022 , due to the issuance of$20.0 million in subordinated debt inApril 2021 .
For the twelve months endedDecember 31, 2022 , average demand deposits, an interest-free source of funds, increased$39.0 million , or 6.4%, from$609.0 million , or 28.0% of total average deposits, for the twelve months endedDecember 31, 2021 , to$648.0 million , or 28.6% of total average deposits, for the twelve months endedDecember 31, 2022 . During the twelve months endedDecember 31, 2022 , average interest-earning assets increased$67.1 million , or 2.9%, to$2.4 billion . The increase in average interest-earning assets was due to an increase in average loans of$65.6 million , or 3.5%, as well as an increase in average securities of$87.7 million , or 27.4%, partially offset by a decrease of$86.2 million , or 77.0%, in short-term investments, which consists of cash and cash equivalents. Excluding average PPP loans, average loans increased$170.5 million , or 9.6%, and average interest-earnings assets increased$172.0 million , or 7.7%. Provision for Loan Losses. The provision for loan losses is reviewed by management based upon our evaluation of then-existing economic and business conditions affecting our key lending areas and other conditions, such as new loan products, credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectability of the loan portfolio. 58 The provision for loan losses increased$1.6 million , to$700,000 for the twelve months endedDecember 31, 2022 , from a credit for loan losses of$925,000 for the twelve months endedDecember 31, 2021 , primarily driven by loan growth during the year endedDecember 31, 2022 . The credit for loan losses for the twelve months endedDecember 31, 2021 was due to the Company reducing its qualitative factors related to the impact of the COVID-19 pandemic and other economic trends used in the Company's allowance. The Company recorded net charge-offs of$556,000 for the twelve months endedDecember 31, 2022 , as compared to net charge-offs of$445,000 for the twelve months endedDecember 31, 2021 . The allowance for loan losses as a percentage of total loans was 1.00% atDecember 31, 2022 , compared to 1.06% atDecember 31, 2021 . AtDecember 31, 2022 , the allowance for loan losses as a percentage of nonperforming loans was 350.0%, compared to 398.6%, atDecember 31, 2021 . Although management believes it has established and maintained the allowance for loan losses at appropriate levels, future adjustments may be necessary if economic, real estate and other conditions differ substantially from the current operating environment. Non-Interest Income. For the twelve months endedDecember 31, 2022 , non-interest income increased$768,000 , or 6.1%, from$12.6 million for the twelve months endedDecember 31, 2021 to$13.3 million for the twelve months endedDecember 31, 2022 . During the twelve months endedDecember 31, 2021 , non-interest income included the recognition of$555,000 in BOLI death benefits. During the twelve months endedDecember 31, 2022 , service charges and fees increased$712,000 , or 8.5%, and mortgage banking income decreased$1.4 million from the twelve months endedDecember 31, 2021 to the twelve months endedDecember 31, 2022 . In 2021, the Company sold$59.7 million in fixed rate residential real estate loans to the secondary market, compared to$277,000 in sales during the twelve months endedDecember 31, 2022 . Other income from loan-level swap fees on commercial loans decreased$33,000 , or 56.9%, and income from BOLI decreased$187,000 , or 9.8%. OnOctober 31, 2022 , the termination of the Westfield Bank Defined Benefit Pension Plan (the "DB Plan") became effective, subject to regulatory approvals expected in the first quarter of 2023, with final settlement expected to occur occurring in the second quarter of 2023. During the twelve months endedDecember 31, 2022 , the Company recorded a curtailment gain related to the DB Plan termination of$2.8 million through non-interest income. Excluding the defined benefit curtailment gain as a result of the termination of the DB Plan and BOLI death benefits, non-interest income decreased$1.5 million , or 12.5%. During the twelve months endedDecember 31, 2022 , the Company reported unrealized losses on marketable equity securities of$717,000 , compared to unrealized losses of$168,000 during the twelve months endedDecember 31, 2021 . During the twelve months endedDecember 31, 2022 , the Company also reported realized losses on the sale of securities of$4,000 , compared to realized losses on the sale of securities of$72,000 during the twelve months endedDecember 31, 2021 . In addition, the Company reported a gain of$422,000 on non-marketable equity investments during the twelve months endedDecember 31, 2022 , compared to$898,000 during the twelve months endedDecember 31, 2021 . Gains and losses from the investment portfolio vary from quarter to quarter based on market conditions, as well as the related yield curve and valuation changes. During the twelve months endedDecember 31, 2021 , the Company also recognized a loss on interest rate swap termination of$402,000 representing the unamortized portion of a$3.4 million loss associated with the previous termination of a$32.5 million interest rate swap onMarch 16, 2016 . Non-Interest Expense. For the twelve months endedDecember 31, 2022 , non-interest expense increased$2.3 million , or 4.2%, to$57.2 million , compared to$54.9 million for the twelve months endedDecember 31, 2021 . The increase in non-interest expense was primarily due to an increase in salaries and employee benefits expense of$511,000 , or 1.6%, due to normal annual salary increases as well as higher incentive compensation costs. Other non-interest expense increased$878,000 , or 10.2%, professional fees increased$531,000 , or 24.3%, which is comprised of legal fees, audit and compliance fees, as well as other professional fees. Occupancy expense increased$328,000 , or 7.0%, advertising expense increased$116,000 , or 9.0%, andFDIC insurance expense increased$50,000 , or 5.0%. These increases were partially offset by a decrease in furniture and equipment expense of$58,000 , or 2.8%, and a decrease in data processing expense of$18,000 , or 0.6%. During the twelve months endedDecember 31, 2021 , the Company prepaid$32.5 million of FHLB borrowings resulting in a loss of$45,000 . For the twelve months endedDecember 31, 2022 , the efficiency ratio was 61.8%, compared to 64.1% for the twelve months endedDecember 31, 2021 . For the twelve months endedDecember 31, 2022 , the adjusted efficiency ratio, a non-GAAP financial measure, was 63.6%, compared to 64.6% for the twelve months endedDecember 31, 2021 . For more information regarding the Company's use of Non-GAAP financial measures see "Explanation of Use of Non-GAAP Financial Measurements." 59 Income Taxes. Income tax expense for the twelve months endedDecember 31, 2022 was$8.7 million , representing an effective tax rate of 25.2%, compared to$8.0 million , representing an effective tax rate of 25.3%, for twelve months endedDecember 31, 2021 .
Liquidity and Capital Resources.
The term "liquidity" refers to our ability to generate adequate amounts of cash to fund loan originations, loan purchases, deposit withdrawals and operating expenses. Our primary sources of liquidity are deposits, scheduled amortization and prepayments of loan principal and mortgage-backed securities, maturities and calls of investment securities and funds provided by our operations. We also can borrow funds from the FHLB based on eligible collateral of loans and securities. Our material cash commitments include funding loan originations, fulfilling contractual obligations with third-party service providers, maintaining operating leases for certain of our Bank properties and satisfying repayment of our long-term debt obligations. Primary Sources of Liquidity
AtDecember 31, 2022 andDecember 31, 2021 , outstanding borrowings from the FHLB were$36.2 million and$2.7 million , respectively. AtDecember 31, 2022 , we had$407.4 million in available borrowing capacity with the FHLB. We have the ability to increase our borrowing capacity with the FHLB by pledging investment securities or additional loans. In addition, we have available lines of credit of$15.0 million and$50.0 million with other correspondent banks. Interest rates on these lines are determined and reset on a daily basis by each respective bank. AtDecember 31, 2022 and 2021, we did not have an outstanding balance under either of these lines of credit. In addition, we may enter into reverse repurchase agreements with approved broker-dealers. Reverse repurchase agreements are agreements that allow us to borrow money using our securities as collateral. We also have outstanding at any time, a significant number of commitments to extend credit and provide financial guarantees to third parties. These arrangements are subject to strict credit control assessments. Guarantees specify limits to our obligations. Because many commitments and almost all guarantees expire without being funded in whole or in part, the contract amounts are not estimates of future cash flows. We are also obligated under agreements with the FHLB to repay borrowed funds and are obligated under leases for certain of our branches and equipment. Maturing investment securities are a relatively predictable source of funds. However, deposit flows, calls of securities and prepayments of loans and mortgage-backed securities are strongly influenced by interest rates, general and local economic conditions and competition in the marketplace. These factors reduce the predictability of the timing of these sources of funds. The Company's primary activities are the origination of commercial real estate loans, commercial and industrial loans and residential real estate loans, as well as and the purchase of mortgage-backed and other investment securities. During the year endedDecember 31, 2022 , we originated$447.4 million in loans, compared to$611.4 million in 2021. During the year endedDecember 31, 2022 , cash and cash equivalents decreased$73.1 million , or 70.7%, to$30.3 million , as cash on hand was used during the year to fund loan growth. We purchased securities totaling$33.0 million for the year endedDecember 31, 2022 , compared to purchases of$296.6 million for the year endedDecember 31, 2021 . AtDecember 31, 2022 , the Company had approximately$176.7 million in loan commitments and letters of credit to borrowers and approximately$328.8 million in available home equity and other unadvanced lines of credit. 60 Deposit inflows and outflows are affected by the level of interest rates, the products and interest rates offered by competitors and by other factors. AtDecember 31, 2022 , time deposit accounts scheduled to mature within one year totaled$288.7 million . Based on the Company's deposit retention experience and current pricing strategy, we anticipate that a significant portion of these time deposits will remain on deposit. We monitor our liquidity position frequently and anticipate that it will have sufficient funds to meet our current funding commitments for the next 12 months and beyond.
At
Material Cash Commitments The Company entered into a long-term contractual obligation with a vendor for use of its core provider and ancillary services beginning in 2016. Total remaining contractual obligations outstanding with this vendor as ofDecember 31, 2022 were estimated to be$10.7 million , with$4.9 million expected to be paid within one year and the remaining$5.8 million to be paid within the next three years. Further, the Company has operating leases for certain of its banking offices and ATMs. Our leases have remaining lease terms of less than one year to sixteen years, some of which include options to extend the leases for additional five-year terms up to ten years. Undiscounted lease liabilities totaled$11.2 million as ofDecember 31, 2022 . Principal payments expected to be made on our lease liabilities during the twelve months endedDecember 31, 2023 were$1.4 million . The remaining lease liability payments totaled$9.8 million and are expected to be made afterDecember 31, 2023 (See Note 12, Leases, to our consolidated financial statements for further information on our lease obligations). In addition, the Company completed an offering of$20 million in aggregate principal amount of its 4.875% fixed-to-floating rate subordinated notes (the "Notes") to certain qualified institutional buyers in a private placement transaction onApril 20, 2021 . Unless earlier redeemed, the Notes mature onMay 1, 2031 . AtDecember 31, 2022 ,$19.7 million aggregate principle amount of the Notes was outstanding. The Notes will bear interest from the initial issue date to, but excluding,May 1, 2026 , or the earlier redemption date, at a fixed rate of 4.875% per annum, payable quarterly in arrears onMay 1 ,August 1 ,November 1 andFebruary 1 of each year, beginningAugust 1, 2021 , and from and includingMay 1, 2026 , but excluding the maturity date or earlier redemption date, equal to the benchmark rate, which is the 90-day average secured overnight financing rate, plus 412 basis points, determined on the determination date of the applicable interest period, payable quarterly in arrears onMay 1 ,August 1 ,November 1 andFebruary 1 of each year. The Company may also redeem the Notes, in whole or in part, on or afterMay 1, 2026 , and at any time upon the occurrence of certain events, subject in each case to the approval of theBoard of Governors of theFederal Reserve (See Note 8, Long-Term Debt, to our consolidated financial statements for further information on our long-term debt). We do not anticipate any material capital expenditures during the calendar year 2023, except in pursuance of the Company's strategic initiatives. The Company does not have any balloon or other payments due on any long-term obligations or any off-balance sheet items other than the commitments and unused lines of credit noted above.
Off-Balance Sheet Arrangements.
The Company does not have any off-balance sheet arrangements, other than noted above and in Note 16, Commitments and Contingencies, to our consolidated financial statements, that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. Management of Market Risk. As a financial institution, our primary market risk is interest rate risk since substantially all transactions are denominated inU.S. dollars with no direct foreign exchange or changes in commodity price exposure. Fluctuations in interest rates will affect both our level of income and expense on a large portion of our assets and liabilities. Fluctuations in interest rates will also affect the market value of all interest-earning assets and interest-bearing
liabilities.
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The Company's interest rate management strategy is to limit fluctuations in net interest income as interest rates vary up or down and control variations in the market value of assets, liabilities and net worth as interest rates vary. We seek to coordinate asset and liability decisions so that, under changing interest rate scenarios, net interest income will remain within an acceptable range. In order to achieve the Company's objectives of managing interest rate risk, theAsset and Liability Management Committee ("ALCO") meets periodically to discuss and monitor the market interest rate environment relative to interest rates that are offered on our products. ALCO presents quarterly reports to the Board of Directors which includes the Company's interest rate risk position and liquidity position.
The Company's primary source of funds are deposits, consisting primarily of time deposits, money market accounts, savings accounts, demand accounts and interest-bearing checking accounts, which have shorter terms to maturity than the loan portfolio. Several strategies have been employed to manage the interest rate risk inherent in the asset/liability mix, including but not limited to:
? maintaining the diversity of our existing loan portfolio through residential
real estate loans, commercial and industrial loans and commercial real estate
loans;
? emphasizing investments with an expected average duration of five years or
less; and
? when appropriate, using interest rate swaps to manage the interest rate
position of the balance sheet.
In 2022, cash flows from deposit inflows were used to fund loan growth and purchase held-to-maturity and available-for-sale securities. The Company continues its emphasis on growing commercial loans, which typically have variable interest rates and shorter maturities than residential loans.
The actual amount of time before loans are repaid can be significantly affected
by changes in market interest rates. Prepayment rates will also vary due to a
number of other factors, including the regional economy in the area where the
loans were originated, seasonal factors, demographic variables and the
assumability of the loans. However, the major factors affecting prepayment rates
are prevailing interest rates, related financing opportunities and competition.
We monitor interest rate sensitivity so that we can adjust our asset and
liability mix in a timely manner and minimize the negative effects of changing
rates.
The Company's liquidity sources are vulnerable to various uncertainties beyond
our control. Loan amortization and investment cash flows are a relatively stable
source of funds, while loan and investment prepayments and calls, as well as
deposit flows vary widely in reaction to market conditions, primarily prevailing
interest rates. Asset sales are influenced by pledging activities, general
market interest rates and unforeseen market conditions. Our financial condition
is affected by our ability to borrow at attractive rates, retain deposits at
market rates and other market conditions. We consider our sources of liquidity
to be adequate to meet expected funding needs and also to be responsive to
changing interest rate markets.
Interest Rate Risk.
Interest rate risk represents the sensitivity of earnings to changes in market
interest rates. As interest rates change, the interest income and expense
streams associated with our financial instruments also change, thereby impacting
net interest income, the primary component of our earnings. ALCO utilizes the
results of a detailed and dynamic simulation model to quantify the estimated
exposure of net interest income to sustained interest rate changes. While ALCO
routinely monitors simulated net interest income sensitivity over a rolling
two-year horizon, they also utilize additional tools to monitor potential
longer-term interest rate risk.
The simulation model captures the impact of changing interest rates on the
interest income received and interest expense paid on all interest-earning
assets and interest-bearing liabilities reflected on our consolidated balance
sheet, as well as for derivative financial instruments. This sensitivity
analysis is compared to ALCO policy limits, which specify a maximum tolerance
level for net interest income exposure over a one and two-year horizon, assuming
no balance sheet growth.
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The repricing and/or new rates of assets and liabilities moved in tandem with
market rates. However, in certain deposit products, the use of data from a
historical analysis indicated that the rates on these products would move only a
fraction of the rate change amount. Pertinent data from each loan account,
deposit account and investment security was used to calculate future cash flows.
The data included such items as maturity date, payment amount, next repricing
date, repricing frequency, repricing index, repricing spread, caps and floors.
Prepayment speed assumptions were based upon the difference between the account
rate and the current market rate. We also evaluate changes in interest rate
sensitivity under various scenarios including but not limited to nonparallel
shifts in the yield curve, variances in prepayment speeds and variances to
correlations of instrument rates to market indexes.
The table below shows our net interest income sensitivity analysis reflecting
the following changes to net interest income for the first and second years of
the simulation model. The analysis assumes no balance sheet growth, a parallel
shift in interest rates, and all rate changes were "ramped" over the first
12-month period and then maintained at those levels over the remainder of the
simulation horizon.
Estimated Changes in Net Interest
Income
At At
December 31, December 31,
Changes in Interest Rates 2022 2021
1 - 12 Months
+200 basis points -3.9 % -3.9 %
-100 basis points 1.4 % -2.8 %
-200 basis points 2.2 % N/A (1)
13 - 24 Months
+200 basis points 0.2 % -4.5 %
-100 basis points 9.2 % -8.6 %
-200 basis points 11.4 % N/A (1)
(1) The down 200 basis points scenario for 2021 is not presented due to certain market rates being below 200 basis points.
The preceding sensitivity analysis does not represent a forecast of net interest income, nor do the calculations represent any actions that management may undertake in response to changes in interest rates. They should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including, among others, the nature and timing of interest rate levels, yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits and reinvestment/replacement of asset and liability cash flows. While assumptions are developed based upon current economic and local market conditions, we cannot make any assurances as to the predictive nature of these assumptions, including how customer preferences or competitor influences might change.
Periodically, if deemed appropriate, we may use interest rate swaps, floors and caps, which are common derivative financial instruments, to hedge our interest rate exposure to interest rate movements. The Board of Directors has approved hedging policy statements governing the use of these instruments. These interest rate swaps are designated as cash flow hedges and involve the receipt of variable rate amounts from a counterparty in exchange for our making fixed payments. We did not have any interest rate swap agreements designated as cash flow hedges atDecember 31, 2022 or 2021.
Recent Accounting Pronouncements.
Refer to Note 1 to our consolidated financial statements for a summary of the recent accounting pronouncements.
Impact of Inflation and Changing Prices.
The Company's consolidated financial statements and accompanying notes have been
prepared in accordance with GAAP. GAAP generally requires the measurement of
financial position and operating results in terms of historical dollars without
consideration for changes in the relative purchasing power of money over time
due to inflation. The impact of inflation is reflected in the increased cost of
our operations. Unlike industrial companies, our assets and liabilities are
primarily monetary in nature. As a result, changes in market interest rates have
a greater impact on performance than do the effects of inflation.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations-Management of Market Risk," for a discussion of quantitative and qualitative disclosures about market risk.
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