COMMUNITY FINANCIAL SYSTEM, INC. (CBU) FY 2023 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) primarily reviews the financial condition and results of operations of the Company for the past two years, although in some circumstances a period longer than two years is covered in order to comply with SEC disclosure requirements or to more fully explain long-term trends. The following discussion and analysis should be read in conjunction with the Company’s Consolidated Financial Statements and related notes that appear on pages 78 through 144. All references in the discussion to the financial condition and results of operations refer to the consolidated position and results of the Company and its subsidiaries taken as a whole.

Unless otherwise noted, all earnings per share (“EPS”) figures disclosed in the MD&A refer to diluted EPS. The term “this year” and equivalent terms refer to results in calendar year 2023, “last year” and equivalent terms refer to calendar year 2022, and all references to income statement results correspond to full-year activity unless otherwise noted.

This MD&A contains certain forward-looking statements with respect to the financial condition, results of operations, and business of the Company. These forward-looking statements involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements are provided under the caption “Forward-Looking Statements” on page 72.

Critical Accounting Policies and Estimates

As a result of the complex and dynamic nature of the Company’s business, management must exercise judgment in selecting and applying the most appropriate accounting policies for its various areas of operations. The policy decision process not only ensures compliance with the current accounting principles generally accepted in the United States of America (“GAAP”), but also reflects management’s discretion with regard to choosing the most suitable methodology for reporting the Company’s financial performance. It is management’s opinion that the accounting estimates covering certain aspects of the business have more significance than others due to the relative importance of those areas to overall performance, or the level of subjectivity in the selection process. These estimates affect the reported amounts of assets and liabilities as well as disclosures of revenues and expenses during the reporting period. Actual results could meaningfully differ from these estimates. Management considers its critical accounting estimates those that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the Company’s financial condition or results of operations. Management believes that the critical accounting estimates include the allowance for credit losses; actuarial assumptions associated with the pension, post-retirement and other employee benefit plans; and the carrying value of goodwill and other intangible assets. A summary of the accounting policies used by management is disclosed in Note A, “Summary of Significant Accounting Policies”, starting on page 84.

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Allowance for Credit Losses

The allowance for credit losses (“ACL”) represents management’s judgment of an estimated amount of lifetime losses expected to be incurred on outstanding loans at the balance sheet date. This is estimated using relevant available information from internal and external sources relating to past events, current conditions and reasonable and supportable forecasts. The determination of the appropriateness of the ACL is complex and applies significant and highly subjective estimates. The ACL is measured on a collective (pooled) basis for loan segments that share similar risk characteristics, including collateral type, credit ratings/scores, size, duration, interest rate structure, origination vintage and payment structure. The Company utilizes three methods for calculating the ACL: cumulative loss, vintage loss and line loss. Historical credit loss experience provides the basis for the estimation of expected future credit losses in all three methodologies. Qualitative adjustments are made for differences in loan-specific risk characteristics such as differences in underwriting standards, portfolio mix, acquisition status, current levels of delinquencies, net charge-offs and risk ratings, as well as actual and forecasted macroeconomic variables. Macroeconomic data includes unemployment rates, changes in collateral values such as home prices, commercial real estate prices and automobile prices, gross domestic product, median household income net of inflation and other relevant factors. Management utilizes judgment in determining and applying the qualitative factors and weighting the economic scenarios used, which include baseline, upside and downside forecasts.

One of the most significant estimates and judgments influencing the results of the ACL calculation is the macroeconomic forecasts. Changes in these economic forecasts could significantly affect the estimated expected credit losses and lead to materially different amounts from one period to the next. To illustrate the sensitivity of the ACL calculation to these economic forecasts, management performed a hypothetical sensitivity analysis using a weighting of 100% to the downside forecast, rather than the existing weighting of baseline, upside and downside of 40%, 30% and 30%, respectively. The scenario-weighted average unemployment rate and GDP growth forecasts used in the ACL model at December 31, 2023 were 4.5% and 1.7%, respectively, compared to 4.5% and 1.2% at December 31, 2022, respectively. The hypothetical downside forecast includes assumptions of a weakening economy represented by a cumulative decline in real GDP of 2.6%, enhanced geopolitical tensions, elevated inflation, a peak unemployment rate of 7.7% and an average unemployment rate of 6.4%. The Company calculated that this hypothetical scenario would increase the ACL and provision for credit losses as of and for the year ended December 31, 2023 by approximately $3.7 million, and decrease net income by $2.9 million (net of tax). This change is reflective of the sensitivity of the various economic factors used in the ACL model. The resulting difference is not intended to represent an expected increase in allowance levels, as future conditions are uncertain and there are several other quantitative and qualitative factors that will also fluctuate at the same time that economic conditions are changing, which would affect the results of the ACL calculation. The impact that the economic factors have on the model is affected by the severity of the scenarios used, the product type mix, and the interaction of the economic factors with other quantitative and qualitative factors in the model, as changes in any particular factor or input may not occur at the same rate or be directionally consistent across all loan segments. Improvements in one factor may offset deterioration in other factors, both qualitative and quantitative. The third party downside economic forecast used in the hypothetical scenario described does not predict a severe economic downturn, but rather a moderate recessionary environment. The Company’s geographic distribution of loans outside of major metropolitan areas, combined with low statistical correlation between historical losses and national economic indicators, results in changes to the allowance that are less significant as compared to national economic activity. Further details regarding the methodologies applied to estimate the various components of the ACL are provided in Note A, “Summary of Significant Accounting Policies”, starting on page 84.

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Pension, Post-Retirement and Other Employee Benefit Plans

The Company provides a qualified defined benefit pension to eligible employees and retirees, other post-retirement health and life insurance benefits to certain retirees, an unfunded supplemental pension plan for certain key executives and an unfunded stock balance plan for certain of its nonemployee directors. The benefit obligations for the pension and post-retirement benefits plans require significant management judgment. The assumptions used in calculating the benefit obligation include the discount rate, expected return on plan assets, rate of compensation increase and interest crediting rates. The discount rate was determined based upon the yield on high-quality fixed income investments expected to be available during the period to maturity of the pension benefits. The expected long-term rate of return was estimated by taking into consideration asset allocation, long-term capital market assumptions, reviewing historical returns on the type of assets held and current economic factors. Mortality tables are also utilized in calculating the benefit obligation, the selection of which is based on management judgment. The Company analyzed the sensitivity of the discount rate and the expected long-term rate of return on plan assets on the pension benefit obligation and net periodic pension cost. At December 31, 2023, a decrease in the discount rate of 100 basis points would increase the pension benefit obligation by $13.2 million, while an increase in the discount rate of 100 basis points would decrease the pension benefit obligation by $11.1 million. For the year ended December 31, 2023, a decrease in the discount rate of 100 basis points would reduce the net periodic pension income by $1.1 million, while an increase in the discount rate of 100 basis points would increase the net periodic pension income by $0.9 million. A decrease in the expected long-term rate of return on plan assets of 100 basis points would reduce the net periodic pension income by $2.4 million, while an increase of 100 basis points would increase net periodic pension income by $2.4 million. Further detail on the assumptions used and a comparison between 2023 and 2022 assumptions is included in Note J, “Pension and Other Benefit Plans”, starting on page 120.

Goodwill and Other Intangible Assets

The initial carrying value of goodwill is impacted by the initial carrying value of intangible assets including core deposit intangibles, customer relationship intangibles and acquired loans that are recorded at their fair value as of the date of acquisition. Management judgment and estimates are involved in determining the initial and ongoing carrying value of goodwill and other intangible assets. Initial and ongoing carrying values require the assessment of fair value based on discounted cash flow modeling techniques and inputs such as discount rates, required equity market premiums, peer volatility indicators and company-specific risk indicators. Core deposit intangibles and customer relationship intangibles are amortized on either an accelerated or straight-line basis over periods ranging from seven to 20 years, based on management judgment.

The Company evaluates goodwill for impairment on an annual basis and performs a quarterly analysis to determine if any triggering events have occurred that would require an interim evaluation. In accordance with FASB ASC 350, the Company evaluates whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, and performs either a qualitative or quantitative assessment, depending on circumstances and management judgment. The qualitative assessment requires significant management judgment, and if the qualitative assessment indicates that it is more likely than not that the fair value of a reporting unit is not less than its carrying value, no quantitative analysis is necessary. The inputs for the qualitative analysis that require management judgment include macroeconomic conditions, industry and market conditions, financial performance of the reporting unit and other relevant events that affect the fair value of a reporting unit.

During 2023, the Company performed quantitative goodwill analyses for all of the Company’s operating segments. The inputs for the quantitative analyses that require management judgment include determination of the discount rate, forecasted financial performance of the business entity, macroeconomic and industry conditions, and other relevant events that affect the fair value of the reporting unit. Based on the Company’s annual impairment analysis of goodwill as of October 1, 2023, it was determined that the fair value of each reporting unit was in excess of its respective carrying value, therefore goodwill was not impaired. The Company also performs sensitivity analyses around assumptions for the discount rates in order to assess the reasonableness of the assumptions utilized. The fair value-weighted average discount rate used for the October 1, 2023 quantitative assessment was 11.1%, compared to 8.2% for the December 31, 2021 assessment. As of October 1, 2023, a 100 basis point increase in the discount rates used in each operating segment model would reduce estimated entity level fair value by approximately $275.1 million and would not result in impairment of goodwill, as each reporting unit’s fair value would still exceed its carrying value.

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Supplemental Reporting of Non-GAAP Results of Operations

The Company also provides supplemental reporting of its results on an “operating,” “adjusted” or “tangible” basis, from which it excludes the after-tax effect of amortization of core deposit and other intangible assets (and the related goodwill, core deposit intangible and other intangible asset balances, net of applicable deferred tax amounts), accretion on acquired non-PCD loans, acquisition expenses, acquisition-related contingent consideration adjustment, acquisition-related provision for credit losses, restructuring expenses, unrealized gain (loss) on equity securities, loss on sales of investment securities, litigation accrual and gain on debt extinguishment. Although these items are non-GAAP measures, the Company’s management believes this information helps investors and analysts measure underlying core performance and improves comparability to other organizations that have not engaged in acquisitions or restructuring activities. In addition, the Company provides supplemental reporting for “adjusted pre-tax, pre-provision net revenues,” which excludes the provision for credit losses, acquisition expenses, acquisition-related contingent consideration adjustment, restructuring expenses, unrealized gain (loss) on equity securities, loss on sales of investment securities, litigation accrual and gain on debt extinguishment from income before income taxes. Although adjusted pre-tax, pre-provision net revenue is a non-GAAP measure, the Company’s management believes this information helps investors and analysts measure and compare the Company’s performance through a credit cycle by excluding the volatility in the provision for credit losses associated with the impact of CECL, helps investors and analysts measure underlying core performance and improves comparability to other organizations that have not engaged in acquisitions or restructuring activities. The Company also provides supplemental reporting of its interest income, net interest income and net interest margin on a “fully tax-equivalent” (“FTE”) basis, which includes an adjustment to interest income and net interest income that represents taxes that would have been paid had nontaxable investment securities and loans been taxable. Although fully tax-equivalent interest income, net interest income and net interest margin are non-GAAP measures, the Company’s management believes this information helps enhance comparability of the performance of assets that have different tax liabilities. Reconciliations of GAAP amounts with corresponding non-GAAP amounts are presented in Table 20.

Executive Summary

The Company’s business philosophy is to operate as a diversified financial services enterprise providing a broad array of banking and other financial services, including benefits administration, insurance services and wealth management services, to retail, commercial, institutional and municipal customers. The Company’s banking subsidiary is Community Bank, N.A. (the “Bank” or “CBNA”). The Company’s Benefit Plans Administrative Services, Inc. (“BPAS”) subsidiary is a leading provider of employee benefits administration, trust services, collective investment fund administration and actuarial consulting services to customers on a national scale. In addition, the Company offers comprehensive financial planning, trust administration and wealth management services through its Community Bank Wealth Management Group operating unit and insurance services through its OneGroup NY, Inc. (“OneGroup”) operating unit.

The Company’s core operating objectives are: (i) optimize the branch network and digital banking delivery systems, primarily through disciplined acquisition strategies, certain selective de novo expansions and divestitures/consolidations, (ii) build profitable loan and deposit volume using both organic and acquisition strategies, (iii) increase the noninterest component of total revenues through growth in existing banking, employee benefit, insurance and wealth management services business units, and the acquisition of additional financial services and banking businesses, (iv) manage an investment securities portfolio to complement the Company’s loan and deposit strategies and mitigate interest rate and liquidity risk and optimize net interest income generation, and (v) utilize technology including robotic process automation to deliver customer-responsive products and services and improve efficiencies.

Significant factors reviewed by management to evaluate achievement of the Company’s operating objectives and results and financial condition include, but are not limited to: net income and earnings per share; return on assets and equity; components of net interest margin; noninterest revenues; noninterest expenses; credit metrics; loan and deposit growth; capital management; performance of individual banking and financial services units; performance of specific product lines and customers; liquidity and interest rate sensitivity; enhancements to customer products and services and their underlying performance characteristics; technology advancements; market share; peer comparisons; and the performance of recently acquired businesses.

The Company reported net income of $131.9 million for the year ended December 31, 2023 that was $56.2 million, or 29.9%, below the prior year, while earnings per share of $2.45 for the year was $1.01, or 29.2%, below the prior year. The decreases in net income and earnings per share were mainly driven by the impact of a $52.3 million pre-tax realized loss on sales of investment securities in the first quarter of 2023 as part of a balance sheet repositioning.

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Net income and earnings per share were also negatively impacted by an increase in noninterest expenses driven primarily by higher salaries and employee benefits reflective of merit and market-related increases in employee wages, higher employee medical expenses and certain executive retirement expenses. In addition, other notable noninterest expense items increased including a litigation accrual associated with the expected settlement of a threatened collective and class action matter, higher FDIC insurance costs due to a higher base assessment rate effective beginning 2023 and the impact of a special assessment, elevated fraud expenses and restructuring costs linked to a retail workforce optimization strategy. Additionally, acquisition-related contingent consideration adjustments increased as result of an increase in probability of achievement of the earn-out objectives associated with previous acquisitions.

Partially offsetting these items were higher levels of net interest income, due primarily to an increase in average loan balances and an increase in the yield on average interest-earning assets, partially offset by higher funding costs, an increase in noninterest revenues excluding the realized loss on sales of investment securities, as growth in total financial services noninterest revenues outweighed a decrease in total banking noninterest revenues, a lower provision for credit losses during 2023 primarily the result of the $3.9 million of acquisition-related provision for credit losses due to the Elmira acquisition during 2022, lower income taxes and lower weighted average diluted shares outstanding attributable to share repurchases during 2023.

Net income adjusted to exclude acquisition expenses, acquisition-related provision for credit losses, acquisition-related contingent consideration adjustment, restructuring expenses, loss on sales of investment securities, unrealized gain (loss) on equity securities, litigation accrual, gain on debt extinguishment, amortization of intangibles, and acquired non-PCD loan accretion (“Adjusted Net Income”), a non-GAAP measure, of $189.8 million, decreased $13.7 million, or 6.7%, compared to the prior year. Earnings per share adjusted to exclude acquisition expenses, acquisition-related provision for credit losses, acquisition-related contingent consideration adjustment, restructuring expenses, loss on sales of investment securities, unrealized gain (loss) on equity securities, litigation accrual, gain on debt extinguishment, amortization of intangibles, and acquired non-PCD loan accretion (“Adjusted Earnings Per Share”), a non-GAAP measure, of $3.51 decreased $0.23, or 6.2%, compared to the prior year. See Table 20 for Reconciliation of GAAP to Non-GAAP Measures.

Net interest margin for full year 2023 of 3.11% increased 22 basis points from 2022 to 2023 and fully tax-equivalent net interest margin, a non-GAAP measure, of 3.14% also increased 22 basis points from the prior year period. The yield on average interest earning assets increased 80 basis points compared to the prior year, as the yields on average loans, investments and interest-earning cash equivalents all improved. The Company’s total cost of funds increased 60 basis points from last year as the rate paid on interest-bearing deposits and borrowings both increased.

The Company experienced year-over-year declines in average and ending interest-earning assets, reflective of the sales and maturities of certain lower-yielding available-for-sale investment securities between the periods partially offset by strong organic loan growth. Average and ending deposits also declined due in part to outflows driven by higher customer expenditure levels in the inflationary environment, as well as increased rate competition from other banks and non-depository financial institutions. Average external borrowings in 2023 increased from 2022 as the Company secured certain fixed rate Federal Home Loan Bank (“FHLB”) term borrowings during the year to support the funding of continued loan growth while external borrowings decreased on an ending basis primarily due to a decrease in overnight borrowings as the Company utilized proceeds from its first quarter securities sales and subsequent investment security maturities to pay down these borrowings.

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Asset quality remained strong throughout 2023, although the nonperforming and delinquency ratios increased from historically low 2022 levels, primarily driven by the downgrade of certain business loans from accruing to nonaccrual status and the full year net charge-off ratio increased slightly from the level one year earlier. These metrics remained below long-term historical averages.

The Company’s deposit base and liquidity position continues to be strong, as the Company had total immediately available liquidity sources of $4.83 billion at the end of 2023, more than double its estimated uninsured deposits, net of collateralized and intercompany deposits. Estimated insured deposits, net of collateralized and intercompany deposits, represent greater than 80% of 2023 ending total deposits. The Company’s deposit base is well diversified across customer segments, which as of December 31, 2023 is comprised of approximately 62% personal, 26% business and 12% municipal, and broadly dispersed, illustrated by an average deposit balance per account that is under $20,000. Since the Federal Reserve began raising the federal funds rate in March 2022 in an effort to combat inflation, the cycle-to-date deposit beta (change in the Company’s cost of funds as a proportion of the change in the federal funds rate) for the Company is 17% and the cycle-to-date total funding beta is 19% of the cumulative 525 basis point increase in the federal funds rate, reflective of a high proportion of non-interest bearing deposits, representing approximately 28% of total ending deposits, and the composition and stability of the customer base. In addition, more than 68% of the Company’s total deposits were in noninterest checking, interest checking and savings accounts at the end of 2023, and the Company did not utilize brokered or wholesale deposits during 2023 or 2022.

Net Income and Profitability

Net income for 2023 was $131.9 million, a decrease of $56.2 million, or 29.9%, from 2022. Earnings per share for 2023 was $2.45, down $1.01, or 29.2%, from 2022’s results. Net income and earnings per share for 2023 were impacted by certain notable non-operating items including a $52.3 million pre-tax realized loss on the sales of investment securities, a $5.8 million litigation accrual associated with the expected settlement of a threatened collective and class action matter, $3.3 million of acquisition-related contingent consideration adjustments associated with potential future contingent consideration payments for the FBD and TGA acquisitions completed in 2021, and $1.2 million of restructuring expenses linked to a retail workforce optimization strategy. This is compared to 2022 in which the Company incurred $5.0 million of acquisition expenses and a $3.9 million acquisition-related provision for credit losses related to the Elmira acquisition and $0.3 million of acquisition-related contingent consideration adjustments. Adjusted net income, a non-GAAP measure, of $189.8 million decreased $13.7 million, or 6.7%, compared to the prior year, while adjusted pre-tax, pre-provision net revenue, a non-GAAP measure, of $241.9 million decreased $18.0 million, or 6.9%, compared to 2022. Diluted adjusted net earnings per share, a non-GAAP measure, of $3.51 decreased $0.23, or 6.1%, compared to the prior year, while adjusted pre-tax, pre-provision net revenue per share, a non-GAAP measure, of $4.49 decreased $0.29, or 6.1%, compared to 2022. See Table 20 for Reconciliation of GAAP to Non-GAAP Measures.

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Net income for 2022 was $188.1 million, a decrease of $1.6 million, or 0.9%, from 2021’s net income. Earnings per share for 2022 was $3.46, down $0.02, or 0.6%, from 2021’s results. Net income and earnings per share for 2022 were impacted by $5.0 million of acquisition expenses and a $3.9 million acquisition-related provision for credit losses related to the Elmira acquisition and $0.3 million of acquisition-related contingent consideration adjustments related to the FBD and TGA acquisitions. This is compared to 2021 in which the Company incurred $0.7 million of acquisition expenses related to the Elmira acquisition and the three financial services acquisitions completed in 2021, $0.2 million of acquisition-related contingent consideration adjustment related to the FBD acquisition and a $0.1 million adjustment to litigation accrual expenses. Adjusted net income, a non-GAAP measure, increased $5.2 million, or 2.6%, compared to the prior year, while adjusted pre-tax, pre-provision net revenue, a non-GAAP measure, increased $26.6 million, or 11.4%, compared to 2021. Diluted adjusted net earnings per share, a non-GAAP measure, of $3.74 increased $0.10, or 2.7%, compared to the prior year, while adjusted pre-tax, pre-provision net revenue per share, a non-GAAP measure, of $4.78 increased $0.50, or 11.7%, compared to 2021. See Table 20 for Reconciliation of GAAP to Non-GAAP Measures.

Table 1: Condensed Income Statements

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The Company operates four businesses: Banking, Employee Benefit Services, Insurance Services and Wealth Management Services. These businesses are aggregated into the following three reportable segments: Banking, Employee Benefit Services and All Other. The Banking segment provides a wide array of lending and depository-related products and services to individuals, businesses and governmental units. In addition to these general intermediation services, the Banking segment provides treasury management solutions and payment processing services. The Banking segment also includes certain corporate overhead-related expenses. Employee Benefit Services, consisting of BPAS and its subsidiaries, provides the following on a national basis: employee benefit trust, collective investment fund, retirement plan and health savings account administration, fund administration, transfer agency, actuarial, and health and welfare consulting services. BPAS services more than 5,800 benefit plans with approximately 810,000 plan participants and holds more than $110 billion in employee benefit trust assets. In addition, BPAS employs 418 professionals serving clients in every U.S. state plus the Commonwealth of Puerto Rico, and occupies 14 offices located in New York, Pennsylvania, Massachusetts, New Jersey, Texas, Minnesota, South Dakota, Washington and Puerto Rico. The All Other segment is comprised of wealth management and insurance services. Wealth management services include trust services provided by the Nottingham Trust division of CBNA, investment products and services provided by Community Investment Services, Inc. (“CISI”), The Carta Group, Inc. (“Carta Group”) and OneGroup Wealth Partners, Inc. (“Wealth Partners”), as well as asset management provided by Nottingham Advisors, Inc. (“Nottingham”). Insurance services include the offerings of personal and commercial lines of insurance and other risk management products and services provided by OneGroup. The wealth management and insurance businesses include 373 employees and 21 customer service facilities in New York, Pennsylvania, Massachusetts, South Carolina and Florida. The wealth management business includes assets under management of $8.7 billion at the end of 2023. For additional financial information on the Company’s segments, refer to Note S – Segment Information in the Notes to Consolidated Financial Statements.

The primary factors explaining 2023 financial performance are discussed in the remaining sections of this document and are summarized by segment as follows:

BANKING

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EMPLOYEE BENEFIT SERVICES

ALL OTHER (INSURANCE AND WEALTH MANAGEMENT SERVICES)

Selected Profitability and Other Measures

Return on average assets, return on average equity, dividend payout and average equity to average asset ratios for the years indicated are as follows:

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Table 2: Selected Ratios

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As displayed in Table 2, the 2023 return on average assets ratio decreased 34 basis points, while the return on average equity ratio decreased 258 basis points as compared to 2022. The decrease in the return on average assets was the result of a decrease in net income that was impacted by a $52.3 million pre-tax realized loss on sales of investment securities, partially offset by a decrease in average assets, primarily related to the sales and maturities of certain lower-yielding available-for-sale investment securities, partially offset by strong organic loan growth during the year. The return on average equity ratio decreased in 2023 as net income decreased, which was impacted by the aforementioned loss on sales of investment securities, while average equity decreased due primarily to an increase in the average accumulated other comprehensive loss related to the Company’s investment securities portfolio. The return on average assets ratio in 2022 decreased seven basis points from 2021, while the return on average equity ratio increased 166 basis points as compared to 2021. The decrease in the return on average assets during 2022 was the result of an increase in average assets, primarily related to strong organic loan growth and the Elmira acquisition coupled with a slight decrease in net income that was impacted by a $23.6 million increase in provision for credit losses. The return on average equity ratio increased in 2022 as average equity decreased due primarily to a decline in the after-tax market value of the Company’s available-for-sale investments due to higher market interest rates, while net income, which was impacted by the aforementioned provision for credit losses, decreased slightly.

The return on average assets adjusted to exclude acquisition expenses, acquisition-related provision for credit losses, acquisition-related contingent consideration adjustments, restructuring expenses, loss on sales of investment securities, unrealized gain (loss) on equity securities, litigation accrual, gain on debt extinguishment, amortization of intangibles and acquired non-PCD loan accretion (“adjusted return on average assets”), a non-GAAP measure, decreased seven basis points to 1.24% in 2023, as compared to 1.31% in 2022. The return on average equity adjusted to exclude acquisition expenses, acquisition-related provision for credit losses, acquisition-related contingent consideration adjustments, restructuring expenses, loss on sales of investment securities, unrealized gain (loss) on equity securities, litigation accrual, gain on debt extinguishment, amortization of intangibles and acquired non-PCD loan accretion (“adjusted return on average equity”), a non-GAAP measure, increased 15 basis points to 11.89% in 2023, from 11.74% in 2022. See Table 20 beginning on page 73 for Reconciliation of GAAP to Non-GAAP Measures.

The dividend payout ratio for 2023 of 72.4% increased from 49.9% in 2022 driven by a 29.9% decrease in net income, which was impacted by the aforementioned loss on sales of investment securities, and a 1.7% increase in dividends declared. The increase in dividends declared in 2023 was a result of a 2.3% increase in the dividends declared per share, partially offset by a 0.8% decrease in common shares outstanding as a result of share repurchases during the year. The dividend payout ratio for 2022 of 49.9% increased from 48.3% in 2021 driven by a 2.5% increase in dividends declared and a 0.9% decrease in net income. The increase in dividends declared in 2022 was a result of a 2.4% increase in the dividends declared per share and the issuance of shares in connection with the administration of the Company’s employee stock plans.

The average equity to average assets ratio decreased in 2023 due to a decrease in average equity driven by the aforementioned increase in the average accumulated other comprehensive loss related to the Company’s investment securities portfolio, partially offset by a decrease in average assets primarily driven by the sales and maturities of certain lower-yielding available-for-sale investment securities, partially offset by strong organic loan growth during the year. During 2023, average equity decreased 7.9% while average assets decreased 2.1%. In 2022, the average equity to average assets ratio decreased in comparison to 2021 as average equity decreased 16.0% driven by a decline in the after-tax market value of the Company’s available-for-sale investments, while average assets increased 4.9% due to strong organic loan growth and the Elmira acquisition.

Net Interest Income

Net interest income is the amount by which interest, dividends and fees on interest-earning assets (loans, investments and cash equivalents) exceeds the cost of funds, which consists primarily of interest paid to the Company’s depositors and interest paid on borrowings. Net interest margin is the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities as a percentage of interest-earning assets.

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Net interest income totaled $437.3 million in 2023, an increase of $16.7 million, or 4.0%, from the prior year. As disclosed in Table 3, fully tax-equivalent net interest income (with nontaxable income converted to a fully tax-equivalent basis), a non-GAAP measure, totaled $441.5 million in 2023, an increase of $16.8 million, or 4.0%, from the prior year. The increase is a result of an 80 basis point increase in the yield on average interest-earning assets, partially offset by a $470.6 million, or 3.2%, decrease in average interest-earning assets, an 84 basis point increase in the rate on average interest-bearing liabilities and a $61.5 million, or 0.6%, increase in average interest-bearing liabilities. As reflected in Table 4, the favorable impact of the increase in the yield on average interest-earning assets ($112.7 million) was partially offset by the unfavorable impacts of the decrease in average interest-earning assets ($14.9 million), the increase in the rate on average interest-bearing liabilities ($80.9 million) and the increase in average interest-bearing liabilities ($0.1 million).

The 2023 net interest margin increased 22 basis points to 3.11% from 2.89% reported in 2022, while the fully tax-equivalent net interest margin, a non-GAAP measure, also increased 22 basis points to 3.14% from the 2.92% reported in 2022. These increases were the result of an 80 basis point increase in the yield on interest-earning assets and a higher proportion of those assets being comprised of loan balances due to strong organic loan growth and the sales and maturities of certain lower-yielding available-for-sale investment securities between the periods, partially offset by an 84 basis point increase in the rate paid on average interest-bearing liabilities. The increases in the yield on interest-earnings assets and rate on interest-bearing liabilities was primarily due to the impact of higher market rates during 2023, including a 100 basis point increase in the Federal Funds rate during the year as a result of the Federal Reserve Bank’s efforts to lower elevated inflation, with that movement and other market factors also contributing to average three, five and 10-year treasury rates all rising by more than 100 basis points. The 4.84% yield on loans in 2023 increased 67 basis points as compared to 4.17% in 2022 due to market-related increases in interest rates on new loans, a significant increase in variable and adjustable-rate loan yields driven by rising market interest rates, including the prime rate, and a high level of new loan originations. The yield on investments, including cash equivalents, of 2.05% in 2023 was 33 basis points higher than 2022 primarily due to the impact of the sales and maturities of certain lower-yielding available-for-sale investment securities during the year along with an increase in market rates, including the impact that had on the yield earned on cash equivalents. The cost of interest-bearing liabilities was 1.08% during 2023 as compared to 0.24% for 2022. The increased cost reflects the 55 basis point increase in the rate paid on average deposits and the 136 basis point higher average rate paid on borrowings in 2023.

The 2022 net interest margin increased nine basis points to 2.89% from 2.80% reported in 2021, while the fully tax-equivalent net interest margin, a non-GAAP measure, increased 10 basis points to 2.92% from 2.82% reported in 2021. The increases were attributable to a 16 basis point increase in the interest-earning asset yield partially offset by a nine basis point increase in the cost of interest-bearing liabilities primarily due to the impact of higher market rates during 2022, including a 425 basis point increase in the Federal Funds rate during the year as a result of the Federal Reserve Bank’s efforts to lower elevated inflation. The 4.17% yield on loans in 2022 decreased five basis points as compared to 4.22% in 2021 due in part to lower PPP-related interest income, partially offset by the impact of higher market rates, including the prime rate, on new loans and variable and adjustable rate loans driven by the impact that the aforementioned Federal Funds rate hikes had on market interest rates during 2022. PPP-related interest income in 2022 decreased $15.4 million as compared to the prior year as the 2022 loan yield included the impact of $3.3 million in PPP-related interest income, including the recognition of $3.0 million of deferred loan fees, as compared to $18.7 million in PPP-related interest income, including the recognition of $15.8 million of deferred loan fees in 2021. The yield on investments, including cash equivalents, of 1.72% in 2022 was 37 basis points higher than 2021 due to a change in market rates and the proportion of investments and interest-earning cash equivalents. The cost of interest-bearing liabilities was 0.24% during 2022 as compared to 0.15% for 2021. The increased cost reflects the two basis point increase in the rate paid on average deposits and the 113 basis point higher average rate paid on borrowings in 2022.

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Total interest income increased by $97.7 million, or 22.0%, while as shown in Table 3, total FTE-basis interest income, a non-GAAP measure, increased by $97.8 million, or 21.8%, in 2023 compared to the prior year. Table 4 indicates that a higher yield on interest-earning assets created $112.7 million of incremental interest income, while a lower average interest-earning asset balance had an unfavorable impact of $14.9 million on interest income. Average loans increased $1.17 billion, or 14.6%, in 2023. This increase was driven by increases in the average balance of the business lending, consumer indirect, consumer mortgage and home equity portfolios due to strong organic growth and the impact of the Elmira acquisition, partially offset by a decrease in the average balance of the consumer direct portfolio. Loan interest income and fees increased $110.1 million, or 32.9%, while FTE-basis loan interest income and fees, a non-GAAP measure, increased $110.2 million, or 32.8%, in 2023 as compared to 2022. These increases were attributable to the aforementioned higher average loan balances and the impact of a 67 basis point higher loan yield due to market-related increases in interest rates on new loans, a significant increase in variable and adjustable-rate loan yields driven by rising market interest rates, including the treasury and prime rates during 2023. Investment and interest-earning cash interest income in 2023 was $12.4 million, or 11.4%, lower than the prior year as a result of a $1.34 billion decrease in the average book basis balance of investments and a $304.7 million decrease in average cash equivalents, partially offset by a 33 basis point increase in the average investment yield including cash equivalents. The higher average investment yield and the lower average book balance of investments was reflective of the sales and maturities of certain lower-yielding available-for-sale investment securities during 2023.

Total interest income in 2022 increased by $56.3 million, or 14.5%, while total FTE-basis interest income, a non-GAAP measure, increased by $57.0 million, or 14.6%, in comparison to 2021. A higher average interest-earning asset balance created $34.8 million of incremental interest income while a higher yield on earning assets had a favorable impact of $22.2 million on interest income in 2022. Average loans increased $726.0 million, or 9.9%, in 2022. This increase was driven by increases in the average balance of all portfolios (consumer mortgage, consumer indirect, business lending, home equity and consumer direct) due to both strong organic growth and the Elmira acquisition. Loan interest income and fees increased $26.7 million, or 8.7%, in 2022 as compared to 2021, attributable to the aforementioned higher average loan balances and the impact of higher market rates, including the treasury and prime rates, on new loans and variable and adjustable rate loans driven by the aforementioned Federal Funds rate hikes during 2022. Partially offsetting the increase was a five basis point decrease in the loan yield primarily due to the impact of a $15.4 million decrease in PPP-related interest income. Investment and interest-earning cash interest income increased $29.6 million, or 37.4%, during 2022 while investment and interest-earning cash interest income (FTE basis), a non-GAAP measure, in 2022 was $30.3 million, or 37.1%, higher than the prior year as a result of a 37 basis point increase in the average investment yield and a $1.98 billion increase in the average book basis balance of investments, partially offset by a $1.55 billion decrease in average cash equivalents. The higher average investment yield was reflective of the Company’s investment of over $1.3 billion of cash equivalents that were earning a low yield into higher yielding investment securities during the second half of 2021 and first half of 2022 and an increase in market rates between the periods.

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Total interest expense increased by $81.0 million to $104.1 million in 2023 from $23.1 million in 2022. As shown in Table 4, higher interest rates on interest-bearing liabilities resulted in an increase in interest expense of $80.9 million, while higher average interest-bearing liability balances resulted in a $0.1 million increase in interest expense. Interest expense as a percentage of average earning assets for 2023 increased 58 basis points to 0.74% from 0.16% in the prior year. The rate on interest-bearing deposits of 0.94% was 78 basis points higher than 2022, primarily due to an increase in certain product rates in response to changes in market interest rates during the year and a higher proportion of average time deposit balances that carry a higher average rate than interest checking, savings and money market deposits. The rate on borrowings increased 136 basis points to 2.97% in 2023, primarily due to the aforementioned increase in market interest rates. Total average funding balances (deposits and borrowings) in 2023 decreased $196.3 million, or 1.4%. Average deposits decreased $328.7 million, driven by a decrease in average non-time deposit balances partially offset by an increase in average time deposit balances. Average non-time deposit balances decreased $680.5 million, or 5.5%, and accounted for 90.1% of total average deposits in 2023 compared to 93.0% in 2022, due in part to outflows driven by higher customer expenditure levels in the inflationary environment, increased rate competition from other banks and non-depository financial institutions and shifts to higher-rate time deposit accounts in the rising interest rate environment. Average time deposit balances increased $351.8 million year-over-year and represented 9.9% of total average deposits for 2023 compared to 7.0% in 2022. Average external borrowings increased $132.5 million, or 26.5%, in 2023 as compared to 2022, due to increases in average FHLB term borrowings of $127.8 million and average overnight borrowings of $9.5 million, partially offset by decreases in average securities sold under an agreement to repurchase (“customer repurchase agreements”) of $2.3 million and average subordinated debt held by unconsolidated subsidiary trusts of $2.5 million. The increase in average FHLB term borrowings was due to the Company securing $400.0 million of fixed rate borrowings in the third and fourth quarters of 2023 to meet the Company’s funding needs, including to support strong loan growth.

Total interest expense increased by $10.1 million, or 77.6%, to $23.1 million in 2022 from $13.0 million in 2021. As shown in Table 4, higher interest rates on interest-bearing liabilities resulted in an increase in interest expense of $8.9 million, while higher deposit and borrowing balances resulted in a $1.2 million increase in interest expense. Interest expense as a percentage of average earning assets for 2022 increased six basis points to 0.16% from 0.10% in the prior year. The rate on interest-bearing deposits of 0.16% was two basis points higher than 2021, primarily due to an increase in certain product rates in response to changes in market interest rates during the year. The rate on borrowings increased 113 basis points to 1.61% in 2022, primarily due to the increase in the proportion of variable rate overnight borrowings that carry a higher average rate than the Company’s repurchase agreements and existing FHLB term borrowings. Total average funding balances (deposits and borrowings) in 2022 increased $1.14 billion, or 9.0%. Average deposits increased $927.9 million, driven by a full-year impact of large net inflows of funds from government stimulus and PPP programs throughout 2021, as well as the addition of deposits in conjunction with the Elmira acquisition in the second quarter of 2022. Average non-time deposit balances increased $956.3 million and accounted for 93.0% of total average deposits in 2022 compared to 92.2% in 2021, due largely to the aforementioned net inflows of funds from government stimulus programs in 2021 that were primarily being held in non-time deposit accounts in the low interest rate environment in 2021 and early 2022, and the impact of the deposits assumed from the Elmira acquisition. Average time deposits decreased $28.4 million year-over-year and represented 7.0% of total average deposits for 2022 compared to 7.8% in 2021. Average external borrowings increased $210.8 million, or 73.1%, in 2022 as compared to 2021, due to increases in average overnight borrowings of $175.1 million, average customer repurchase agreements of $42.2 million and average FHLB borrowings of $9.0 million, partially offset by a decrease in average subordinated debt held by unconsolidated subsidiary trusts of $15.5 million. The increase in average overnight borrowings was due to the Company entering an overnight borrowing position during the year to support the funding of strong loan growth, while the increase in average FHLB borrowings was driven by borrowings assumed from the Elmira acquisition. The decrease in average subordinated debt held by unconsolidated subsidiary trusts was due to the redemption of $77.3 million of trust preferred subordinated debt in the first quarter of 2021.

The following table sets forth information related to average interest-earning assets and average interest-bearing liabilities and their associated yields and rates for the years ended December 31, 2023 and 2022. Interest income and yields are on a fully tax-equivalent (“FTE”) basis using a marginal income tax rate of 24.4% in 2023 and 24.3% in 2022. Average balances are computed by totaling the daily ending balances in a period and dividing by the number of days in that period. Loan interest income and yields include amortization of deferred loan income and costs, loan prepayment, late and other fees and the accretion of acquired loan marks. Average loan balances include acquired loan purchase discounts and premiums, nonaccrual loans and loans held for sale.

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Table 3: Average Balance Sheet

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As discussed above and disclosed in Table 4 below, the change in net interest income (FTE basis) may be analyzed by segregating the volume and rate components of the changes in interest income and interest expense for each underlying category.

Table 4: Rate/Volume

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Noninterest Revenues

The Company’s sources of noninterest revenues are of four primary types: 1) general banking services related to loans, including mortgage banking, deposits and other core customer activities typically provided through the branch network and digital banking channels (performed by CBNA); 2) employee benefit trust, collective investment fund, transfer agency, actuarial, benefit plan administration and recordkeeping services (performed by BPAS and its subsidiaries); 3) wealth management services, comprised of trust services (performed by the Nottingham Trust division within CBNA), broker-dealer and investment advisory products and services (performed by CISI, OneGroup Wealth Partners, Inc. and The Carta Group, Inc.) and asset management services (performed by Nottingham Advisors, Inc.); and 4) insurance and risk management products and services (performed by OneGroup). Additionally, the Company has other transactions that impact noninterest revenues, including realized and unrealized gains or losses on investment securities and gains or losses on debt extinguishment.

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Table 5: Noninterest Revenues

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As displayed in Table 5, total noninterest revenues decreased $43.9 million, or 17.0%, to $214.8 million in 2023 as compared to 2022 primarily due to a $52.3 million pre-tax realized loss on the sale of certain available-for-sale securities in connection with a strategic balance sheet repositioning executed during the first quarter of 2023 to provide the Company with greater flexibility in managing interest-earning asset growth and funding mix. Total noninterest revenues, excluding loss on sales of investment securities, unrealized gain (loss) on equity securities and gain on debt extinguishment, increased $8.2 million, or 3.2%, to $267.0 million in 2023 as compared to 2022. The increase was comprised of increases in insurance services revenues, employee benefit services revenues and wealth management services revenues, partially offset by a decrease in banking noninterest revenues. Noninterest revenues, excluding unrealized gain (loss) on equity securities, increased $12.6 million, or 5.1%, to $258.8 million in 2022 as compared to 2021. The increase was comprised of increases in banking noninterest revenues, insurance services revenues and employee benefit services revenues, partially offset by a decrease in wealth management services revenues.

Noninterest revenues as a percent of total revenues (defined as net interest income plus noninterest revenues) was 32.9% in 2023, down from 38.1% in 2022. Noninterest revenues as a percent of operating revenues (FTE basis), a non-GAAP measure, were 37.9% in 2023, down from 38.1% in the prior year. The current year decrease was due to a 4.0% increase in adjusted net interest income (FTE basis) driven by a higher net interest margin and strong organic loan growth, while operating noninterest revenues increased by the 3.2% mentioned above. The decrease in this ratio from 39.7% in 2021 to 38.1% in 2022 was due to a 12.4% increase in adjusted net interest income (FTE basis) driven by significant interest-earning asset growth and a higher net interest margin, while operating noninterest revenues increased by the 5.1% mentioned above.

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A portion of the Company’s noninterest revenues is comprised of the wide variety of fees earned from general banking services provided through the branch network, digital banking channels, mortgage banking and other banking services, which totaled $70.0 million in 2023, a decrease of $1.9 million, or 2.7%, from the prior year. The decrease was driven by decreases in deposit service charges and fees ($5.0 million) and debit interchange and ATM fees ($0.8 million), partially offset by increases in other banking revenues ($3.7 million) and mortgage banking revenues ($0.2 million). The decrease in deposit service charges and fees was reflective of the Company’s implementation of certain deposit fee changes, including the elimination of nonsufficient and unavailable funds fees on personal accounts late in the fourth quarter of 2022. Debit interchange and ATM fees were unfavorably impacted by fluctuations in annual card-related promotional income, while other banking revenues benefitted from incremental revenues from the first quarter 2023 acquisition of Axiom.

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Fees from general banking services were $71.9 million in 2022, an increase of $7.2 million, or 11.2%, from 2021. The increase was driven by increases in deposit service charges and fees ($5.3 million), other banking revenues ($2.4 million) and debit interchange and ATM fees ($0.9 million), partially offset by a decrease in mortgage banking revenues ($1.4 million). The aforementioned increases were reflective of higher levels of transaction activity driven by continued post-pandemic economic recovery along with incremental revenues resulting from the addition of new deposit relationships from the Elmira acquisition in 2022, while the decrease in mortgage banking revenues was primarily driven by a decline in the fair value of mortgage servicing rights.

As disclosed in Table 5, noninterest revenue from financial services (revenues from employee benefit services, wealth management services and insurance services) increased $10.1 million, or 5.4%, in 2023 to $197.0 million. In 2023, financial services revenues accounted for 74% of total noninterest revenues, excluding loss on sales of investment securities, unrealized loss on equity securities and gain on debt extinguishment, as compared to 72% in 2022.

Employee benefit services generated revenue of $118.0 million in 2023 that reflected growth of $2.6 million, or 2.2%, primarily related to new business and a year-over-year increase in the total participants under administration, along with a modest increase from market appreciation. These factors drove a $17.3 billion increase in ending employee benefit trust assets to $124.8 billion for the employee benefit services segment in 2023 as compared to 2022. Employee benefit services generated revenue of $115.4 million in 2022 that reflected growth of $1.1 million, or 0.9%, over 2021 revenues reflective of a full year of incremental revenues from the third quarter of 2021 acquisition of FBD as well as increases in employee benefit trust and custodial fees despite the negative impact of market-related headwinds. Employee benefit trust assets within the Company’s employee benefit services segment decreased $12.8 billion to $107.5 billion at the end of 2022 as compared to 2021 due primarily to the impact of lower financial market valuations at the end of 2022.

Insurance services revenues increased $7.3 million, or 18.3%, in 2023 driven primarily by a strong premium market and organic expansion, along with growth resulting from acquisitions between the periods. Insurance services revenues increased $5.8 million, or 17.1%, in 2022 attributable to a full year of incremental revenues from the first quarter of 2022 acquisitions of three insurance agencies, the third quarter of 2021 acquisition of TGA and the second quarter 2021 acquisition of NuVantage, as well as organic expansion.

Wealth management services revenues increased $0.3 million, or 0.9%, in 2023 as more favorable investment market conditions drove increases in assets under management between the periods. Assets under management within the wealth management businesses increased $1.4 billion to $8.7 billion at December 31, 2023 as compared to one year earlier, a new quarter-end record. Wealth management services revenues decreased $1.5 million, or 4.7%, in 2022 primarily driven by more challenging investment market conditions during that year. Reflective of these conditions, assets under management within the Company’s wealth management services segment were $7.3 billion at the end of 2022, down $1.2 billion from year-end 2021.

Noninterest Expenses

As shown in Table 6, noninterest expenses of $472.7 million in 2023 were $48.4 million, or 11.4%, higher than 2022, reflective of an accrual associated with the expected settlement of a threatened collective and class action matter, an increase in salaries and employee benefits, primarily driven by merit and market-related increases in employee wages, higher employee medical expenses and certain executive retirement expenses, as well as increases in other expenses, acquisition-related contingent consideration adjustment, data processing and communications expenses, business development and marketing expenses, legal and professional fees, restructuring expenses and occupancy and equipment expenses. These increases were partially offset by decreases in acquisition expenses and amortization of intangible assets. The increase in other expenses included the impact of a higher FDIC insurance base assessment rate, a FDIC special assessment and elevated fraud losses.

Noninterest expenses in 2022 increased $36.1 million, or 9.3%, from 2021 to $424.3 million, primarily reflective of an increase in salaries and employee benefits driven by increases in merit-related employee compensation and staffing increases due to organic growth and acquisitions, as well as an increase in data processing and communications expenses associated with the continued investment in new customer interface and operational support technologies and acquisition expenses related to the integration of the Elmira acquisition. Other expenses also increased, driven primarily by additional travel, legal and professional fees and business development and marketing expenses, in part due to business activity expanding post pandemic.

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Noninterest expenses as a percent of average assets for 2023 was 3.10%, an increase of 37 basis points from 2.73% in 2022 and 48 basis points higher than 2.62% in 2021. Operating expenses (excluding acquisition expenses, acquisition-related contingent consideration adjustment, restructuring expenses, litigation accrual and amortization of intangible assets) as a percent of average assets (a non-GAAP measure) for 2023 was 2.95%, an increase of 35 basis points from 2.60% in 2022 and 43 basis points higher than 2.52% in 2021. The increase in these ratios for 2023 was due to a 11.4% increase in noninterest expenses and a 10.8% increase in operating expenses (excluding acquisition expenses, acquisition-related contingent consideration adjustment, restructuring expenses, litigation accrual and amortization of intangible assets), while average assets declined by 2.1%, primarily due to the sales and maturities of certain lower-yielding available-for-sale investment securities. The increases in these ratios for 2022 was due to a 9.3% increase in noninterest expenses and an 8.3% increase in operating expenses (excluding acquisition expenses, acquisition-related contingent consideration adjustment, litigation accrual and amortization of intangible assets), while average assets grew by 4.9%, primarily due to strong organic loan growth and the Elmira acquisition, which was muted by significant declines in the market value of available-for-sale investment securities due to a major upward movement in market interest rates.

The GAAP efficiency ratio expresses the level of noninterest expenses as a percentage of total revenues (net interest income plus total noninterest revenues). The Company also utilizes the operating efficiency ratio, a non-GAAP measure, which is a performance measurement tool widely used by banks, and is defined by the Company as operating expenses (excluding acquisition expenses, acquisition-related contingent consideration adjustment, restructuring expenses, litigation accrual and amortization of intangible assets) divided by operating revenues (fully tax-equivalent net interest income plus noninterest revenue, excluding acquired non-PCD loan accretion, loss on sales of investment securities, unrealized gain (loss) on equity securities and gain on debt extinguishment). Lower ratios correlate to better operating efficiency.

The 2023 GAAP efficiency ratio of 72.5% increased 10.0 percentage points from the 2022 GAAP efficiency ratio as noninterest expenses increased 11.4% while total revenues decreased 4.0% primarily as a result of the loss on sales of investment securities in connection with the Company’s first quarter balance sheet repositioning. The 2022 GAAP efficiency ratio of 62.5% was consistent with the GAAP efficiency ratio for 2021 as noninterest expenses increased in proportion to total revenues. The 2023 non-GAAP efficiency ratio of 63.5% was 4.0 percentage points higher than the 2022 non-GAAP efficiency ratio of 59.5% as the 10.8% increase in operating expenses, as defined above, grew at a faster pace than the 3.8% increase in operating revenues, as defined above, comprised of a 4.0% increase in adjusted net interest income and a 3.2% increase in adjusted noninterest revenues. The 2022 non-GAAP efficiency ratio of 59.5% was 0.7 percentage points lower than the 2021 non-GAAP efficiency ratio of 60.2% as the 9.5% increase in operating revenues, comprised of a 12.4% increase in adjusted net interest income and a 5.1% increase in adjusted noninterest revenues, grew at a faster pace than the 8.3% increase in operating expenses, as defined above. See Table 20 for Reconciliation of GAAP to Non-GAAP Measures.

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Table 6: Noninterest Expenses

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Salaries and employee benefits increased $24.5 million, or 9.5%, in 2023, driven by merit and market-related increases in employee wages, higher employee medical expenses and certain executive retirement expenses. There was a net decrease in full-time equivalent employees during 2023, primarily due to the impact of the fourth quarter 2023 retail workforce optimization, which resulted in $1.2 million of related severance payments recognized as restructuring expenses. Salaries and employee benefits increased $15.8 million, or 6.6%, in 2022, driven by increases in merit-related employee compensation and a net increase in full-time equivalent employees between the periods, including the impact of staff added in conjunction with the Elmira acquisition. Total full-time equivalent staff at the end of 2023 was 2,669 compared to 2,803 at December 31, 2022 and 2,743 at the end of 2021.

Total non-personnel, noninterest expenses, excluding acquisition-related expenses, restructuring expenses and litigation accrual, increased $18.4 million, or 11.3%, in 2023, reflective of increases in other expenses, data processing and communications expenses, business development and marketing expenses, legal and professional fees and occupancy and equipment expenses, partially offset by a decrease in amortization of intangible assets. Other expenses were up $10.5 million, or 66.8%, in 2023 primarily driven by higher FDIC insurance expenses due to a higher base assessment rate and a $1.5 million accrual for a special assessment, the impact of elevated fraud losses and a reduced pension-related benefit. The Company is investing in additional technology to enhance its detection and prevention of customer payment-related fraud. The increase in data processing and communications expenses is reflective of the Company’s continued investment in customer-facing and back-office digital technologies. Business development and marketing expenses increased due to the Company’s investment in digital marketing initiatives and higher levels of targeted advertisements intended to generate deposit inflows. Legal and professional fees were up primarily as a result of legal fees associated with various matters. Occupancy and equipment expenses increased due to inflationary pressures, partially offset by the effects of branch consolidations undertaken in 2022 and 2023.

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Total non-personnel, noninterest expenses, excluding acquisition-related expenses, increased $16.4 million, or 11.2%, in 2022, reflective of increases across all categories of expenses. The increase in data processing and communications expenses was primarily due to the aforementioned investment in technology. Occupancy and equipment increased due to the Elmira acquisition and inflationary pressures, partially offset by the effects of branch consolidations undertaken in 2021 and 2022. Legal and professional fees, business development and marketing and other expenses, including travel and entertainment, were up during 2022 as compared to 2021 as the general level of business activities continued to increase following the lifting of pandemic-related restrictions.

Acquisition-related expenses for 2023 totaled $3.3 million, primarily comprised of acquisition-related contingent consideration adjustments associated with potential future contingent consideration payments for the FBD and TGA acquisitions completed in 2021.

Acquisition-related expenses for 2022 totaled $4.7 million, comprised of $5.0 million associated with the Elmira acquisition that was completed during the second quarter and a $0.3 million benefit from acquisition-related contingent consideration associated with potential future payments for the FBD and TGA acquisitions completed in 2021.

Income Taxes

The Company estimates its income tax expense based on the amount it expects to owe the respective taxing authorities, plus the impact of deferred tax items. Taxes are discussed in more detail in Note I of the Consolidated Financial Statements beginning on page 118. Accrued taxes represent the net estimated amount due or to be received from taxing authorities. In estimating accrued taxes, management assesses the relative merits and risks of the appropriate tax treatment of transactions, taking into account statutory, judicial and regulatory guidance in the context of the Company’s tax position. If the final resolution of taxes payable differs from its estimates due to regulatory determination or legislative or judicial actions, adjustments to tax expense may be required.

The effective income tax rate for 2023 was 21.6%, compared to 21.7% in 2022 and 21.4% in 2021. The decrease in the effective income tax rate for 2023 compared to the effective tax rate for 2022 is primarily attributable to a decrease in pre-tax income driven by the loss on investment security sales recognized in the first quarter of 2023. The increase in the effective income tax rate for 2022, compared to the effective tax rate for 2021, is primarily attributable to lower levels of tax benefits related to stock-based compensation activity.

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Shareholders’ Equity and Regulatory Capital

Shareholders’ equity ended 2023 at $1.70 billion, up $146.2 million, or 9.4%, from the end of 2022. This increase reflects net income of $131.9 million, stock-based compensation of $9.3 million, the issuance of shares through employee stock plans of $1.0 million and a decrease in accumulated other comprehensive loss of $129.5 million, partially offset by common stock dividends declared of $95.5 million and common stock repurchased of $30.0 million. The change in accumulated other comprehensive loss was primarily driven by $125.4 million of other comprehensive income related to the Company’s available-for-sale investment portfolio, including a net decrease in the after-tax market value adjustment on the available-for-sale investment portfolio due to movements in medium to long-term interest rates, as well as the volume and rates associated with the security purchases, sales and maturities that occurred in 2023 and the recognition of the loss on sales of available-for-sale investment securities related to the Company’s first quarter balance sheet repositioning. The change in accumulated other comprehensive loss also reflected a positive $4.1 million adjustment in the overfunded status of the Company’s employee retirement plans. Shares outstanding decreased by 0.4 million during the year due to the repurchase of 580,938 shares during 2023, partially offset by share issuances under employee stock plans and deferred compensation arrangements.

Shareholders’ equity ended 2022 at $1.55 billion, down $549.1 million, or 26.1%, from the end of 2021. This decrease reflects a $635.8 million increase in accumulated other comprehensive loss, common stock dividends declared of $93.9 million and common stock repurchased of $16.4 million. These decreases were partially offset by net income of $188.1 million, stock-based compensation of $7.7 million and issuance of shares through employee stock plans of $1.2 million. The change in accumulated other comprehensive income was comprised of a $620.0 million increase in net unrealized losses in the Company’s available-for-sale investment portfolio (including unrealized losses prior to the transfer of a portion of securities from available-for-sale to held-to-maturity) and a negative $15.8 million adjustment in the overfunded status of the Company’s employee retirement plans. Excluding accumulated other comprehensive income in both 2022 and 2021, shareholders’ equity increased by $86.7 million, or 4.0%. Shares outstanding decreased by 0.1 million during the year due to the repurchase of 0.3 million shares during 2022, partially offset by share issuances under employee stock plans and deferred compensation arrangements.

The Company and the Bank are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s dividend paying ability and financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and the Bank’s assets and certain liabilities and off-balance sheet items as calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

The Company and the Bank are required to maintain a “capital conservation buffer,” composed entirely of common equity Tier 1 capital, in addition to minimum risk-based capital ratios. The required capital conservation buffer is 2.5% as of December 31, 2023 and 2022. Therefore, to satisfy both the minimum risk-based capital ratios and the capital conservation buffer as of December 31, 2023 and 2022, the Company and the Bank must maintain:

(i) Common equity Tier 1 capital to total risk-weighted assets (“Common equity tier 1 capital ratio”) of at least 7.0%,

(ii) Tier 1 capital to total risk-weighted assets (“Tier 1 risk-based capital ratio”) of at least 8.5%, and

(iii) Total capital (Tier 1 capital plus Tier 2 capital) to total risk-weighted assets (“Total risk-based capital ratio”) of at least 10.5%.

In addition, the Company and Bank must maintain a ratio of ending Tier 1 capital to adjusted quarterly average assets (“Tier 1 leverage ratio”) of at least 5.0% to be considered “well capitalized” under the regulatory framework for prompt corrective action.

As of December 31, 2023, and 2022, the Company and Bank meet all applicable capital adequacy requirements to be considered “well capitalized”. As of December 31, 2023, 2022 and 2021, the regulatory capital ratios for the Company and Bank are presented in Table 7 below.

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Table 7: Regulatory Ratios

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The Company’s tier 1 leverage ratio, a primary measure for which regulators have established a 5% minimum for an institution to be considered “well-capitalized,” increased 55 basis points from the prior year to end the year at 9.34%. This was the result of tier 1 capital increasing by 1.5% from the prior year, as the impact of net earnings retention outweighed share repurchases during the year while adjusted quarterly average assets (excludes investment market value adjustment and goodwill and intangible assets net of related deferred tax liabilities) decreased 4.5%, primarily due to a decrease in investment securities balances resulting from sales and maturities throughout the year. For additional financial information on the Company’s regulatory capital, refer to Note O – Regulatory Matters in the Notes to Consolidated Financial Statements. The shareholders’ equity-to-assets ratio was 10.92% at the end of 2023 compared to 9.80% at the end of 2022. The increase was due to shareholders’ equity increasing by 9.4% driven primarily by the $129.4 million decrease in accumulated other comprehensive loss related to the Company’s investment securities portfolio, while assets decreased 1.8%, driven primarily by sales and maturities of certain investment securities in 2023. The tangible equity-to-assets ratio, a non-GAAP and regulatory reporting measure, was 5.75% at the end of 2023 versus 4.64% one year earlier. See Table 20 for Reconciliation of GAAP to Non-GAAP Measures. The increase was due to tangible common shareholders’ equity increasing by 21.6% in 2023 primarily due to the aforementioned $129.4 million decrease in accumulated other comprehensive loss related to the Company’s investment portfolio, while tangible assets decreased 1.8% from the prior year reflective of the sales and maturities of certain investment securities in 2023. The Company manages organic and acquired growth in a manner that enables it to continue to maintain and grow its capital base over time and maintain its ability to take advantage of future strategic growth opportunities.

Cash dividends declared on common stock in 2023 of $95.5 million represented an increase of 1.7% over the prior year. This growth was a result of a $0.04 increase in dividends per share for the year, partially offset by a slight decrease in outstanding shares. Dividends per share for 2023 of $1.78 represents a 2.3% increase from $1.74 in 2022, a result of quarterly dividends per share increasing from $0.43 to $0.44 in the third quarter of 2022 and from $0.44 to $0.45 in the third quarter of 2023. The 2023 increase in quarterly dividends marked the 31st consecutive year of dividend increases for the Company. The dividend payout ratio for 2023 was 72.4% compared to 49.9% in 2022, and 48.3% in 2021. The dividend payout ratio increased during 2023 as dividends declared increased 1.7% while net income decreased 29.9% from 2022, primarily driven by the loss on sales of investment securities recognized in the first quarter of 2023.

The Company’s ability to pay dividends to its shareholders is subject to laws and regulations imposing restrictions on the amount of dividends that may be declared and paid. Dividend payments by the Company are dependent on a number of factors, including earnings and financial conditions, and are subject to the limitations referred to in Note O: Regulatory Matters.

Liquidity

Liquidity risk is a measure of the Company’s ability to raise cash when needed at a reasonable cost and minimize any loss. The Company maintains appropriate liquidity levels in both normal operating conditions as well as stressed environments. The Company must be capable of meeting all obligations to its customers at any time and, therefore, the active management of its liquidity position remains an important management objective. The Bank has appointed the Asset Liability Committee (“ALCO”) to manage liquidity risk using policy guidelines and limits on indicators of potential liquidity risk. The indicators are monitored using a scorecard with three risk level limits. These risk indicators measure core liquidity and funding needs, capital at risk and change in available funding sources. The risk indicators are monitored using such metrics as the core basic surplus ratio, unencumbered securities to average assets, free loan collateral to average assets, loans to deposits, deposits to total funding and borrowings to total funding ratios.

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Given the uncertain nature of the Company’s customers’ demands, as well as the Company’s desire to take advantage of earnings enhancement opportunities, the Company must have adequate sources of on and off-balance sheet funds available that can be utilized when needed. Accordingly, in addition to the liquidity provided by balance sheet cash flows, liquidity must be supplemented with additional sources such as credit lines from correspondent banks and borrowings from the FHLB and the FRB. Other funding alternatives may also be appropriate from time to time, including wholesale and retail repurchase agreements, large certificates of deposit and the brokered CD market. The primary sources of funds are deposits, which were $12.93 billion at December 31, 2023. The primary sources of non-deposit funds are customer repurchase agreements, FHLB or FRB overnight advances and other FHLB term borrowings. At December 31, 2023, there were $304.6 million of customer repurchase agreements, $53.0 million of overnight borrowings and $407.6 million of FHLB term borrowings outstanding.

The Company’s primary sources of available liquidity include cash and cash equivalents, borrowing capacity at the FHLB and FRB, as well as net unpledged investment securities that could be liquidated, subject to market conditions, or used to collateralize additional funding. Table 8 below details the available sources of liquidity at December 31, 2023. In addition, there was $25.0 million available in an unsecured line of credit with a correspondent bank at year end. The Company’s sources of immediately available liquidity of $4.83 billion at the end of 2023 represent over 200% of the Company’s estimated uninsured deposits (deposits in excess of FDIC limits), net of collateralized and intercompany deposits (“net estimated uninsured deposits”), estimated to be approximately $2.18 billion.

Table 8: Sources of Liquidity

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The Company’s primary approach to measuring short-term liquidity is known as the Basic Surplus/Deficit model. It is used to calculate liquidity over two time periods: first, the amount of cash that could be made available within 30 days (calculated as liquid assets less short-term liabilities as a percentage of average assets); and second, a projection of subsequent cash availability over an additional 60 days. As of December 31, 2023, this ratio was 11.5% for 30-days and 10.2% for 90-days, excluding the Company’s capacity to borrow additional funds from the FHLB and other sources. This is considered to be a sufficient amount of liquidity based on the Company’s internal policy requirement of 7.5%.

To measure intermediate risk over the next twelve months, the Company reviews a sources and uses projection. As of December 31, 2023, there is sufficient liquidity available during the next year to cover projected cash outflows. In addition, stress tests on the cash flows are performed for various scenarios ranging from high probability events with a low impact on the liquidity position to low probability events with a high impact on the liquidity position. The results of the stress tests as of December 31, 2023 indicate the Company has sufficient sources of liquidity for the next year in all simulated stressed scenarios.

To measure longer-term liquidity, a baseline projection of growth in interest-earning assets and interest-bearing liabilities for five years is made to reflect how liquidity levels could change over time. This five-year measure reflects ample liquidity for loan and other asset growth over the next five years.

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The possibility of a funding crisis exists at all financial institutions. A funding crisis would most likely result from a shock to the financial system which disrupts orderly short-term funding operations or from a significant tightening of monetary policy that limits the national money supply. Accordingly, management has addressed this issue by formulating a Liquidity Contingency Plan, which has been reviewed and approved by both the Company’s Board of Directors (the “Board”) and the Company’s ALCO. The plan addresses the actions that the Company would take in response to both a short-term and long-term funding crisis. Triggers within the plan and liquidity risk monitor are not by themselves definitive indicators of insufficient liquidity, but rather a mechanism for management to monitor conditions and possibly provide advance warning which could avert or reduce the impact of a crisis. Liquidity triggers are set based on a variety of factors, including Company history, trends, and current operating performance, industry observations, and, as warranted, changes in internal and external economic factors. Indicators include: core liquidity and funding needs such as the core basic surplus, unencumbered securities to average assets, and free FHLB and FRB loan collateral to average assets; heightened funding needs indicators such as average loans to average deposits, average public and nonpublic deposits to total funding, and average borrowings to total funding; capital at risk indicators including regulatory ratios; asset quality indicators; and decrease in funds availability indicators which are a combination of internal and external factors such as increased restrictions on borrowing or downturns in the credit market. The Company has established three risk levels for these liquidity triggers that inform the response based on the severity of the circumstances. Responses vary from an assessment of possible funding deficiencies with no impact on normal business operations to immediate action required due to impending funding problems. For more information regarding the risk factor associated with the possibility of a funding crisis, refer to the discussion under the heading “Item 1A. Risk Factors” beginning on page 15.

Intangible Assets

The changes in intangible assets by reporting segment for the year ended December 31, 2023 are summarized as follows:

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Table 9: Intangible Assets

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Intangible assets at the end of 2023 totaled $898.0 million, a decrease of $4.8 million from the prior year due to $14.5 million of amortization during the year, partially offset by the addition of $3.6 million of goodwill and $6.1 million of other intangibles arising from acquisition activity. The additional goodwill and other intangibles recorded in 2023 resulted from the OneGroup, Wealth Partners and Bank acquisitions during 2023. Goodwill represents the excess cost of an acquisition over the fair value of the net assets acquired. Goodwill at December 31, 2023 totaled $845.4 million, comprised of $732.6 million related to banking acquisitions and $112.8 million arising from the acquisition of financial services businesses. Goodwill is subject to periodic impairment analysis to determine whether the carrying value of the identified businesses exceeds their fair value, which would necessitate a write-down of goodwill. The Company completed its quantitative goodwill impairment analyses as of October 1, 2023 and determined that no adjustments were necessary for the banking or financial services businesses. The impairment analyses were based upon discounted cash flow modeling techniques that require management to make estimates regarding the amount and timing of expected future cash flows. It also requires the selection of discount rates that reflect the current return characteristics of the market in relation to present risk-free interest rates, estimated equity market premiums and company-specific performance and risk indicators. The Company determined that the inputs, assumptions and conclusions reached were appropriate for the purpose of the current year quantitative analysis. The Company performed a qualitative assessment for evaluating impairment of goodwill and other intangibles for 2022, including assessments of macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, other relevant entity-specific events and changes in share price, as well as analyzing previous quantitative goodwill impairment analyses performed as of December 31, 2021. The Company determined that the inputs, assumptions and conclusions reached remained appropriate for the purpose of the 2022 qualitative analysis, and as no impairment was noted during the qualitative analyses, a quantitative analysis for 2022 was not necessary. Furthermore, during 2023, 2022 and 2021, the Company also performed a quarterly analysis to determine if triggering events occurred that would necessitate an interim qualitative or quantitative assessment of goodwill or other intangible impairment. No triggering event or impairment was noted during these interim analyses.

Core deposit intangibles represent the value of acquired non-time deposits in excess of funding that could have been obtained in the capital markets. Core deposit intangibles are amortized on an accelerated basis over periods ranging from seven to twenty years. The recognition of customer relationship intangibles was determined based on a methodology that calculates the present value of the projected future net income derived from the acquired customer base. These customer relationship intangibles are being amortized on an accelerated basis over periods ranging from eight to twelve years.

Loans

Gross loans outstanding of $9.70 billion as of December 31, 2023 increased $895.2 million, or 10.2%, compared to December 31, 2022, driven by increases in all loan categories due to net organic growth. The loan-to-deposit ratio was 75.1% as of December 31, 2023 compared to 67.7% at December 31, 2022. The increase in the loan-to-deposit ratio was driven by the aforementioned organic loan growth while ending deposits decreased $84.2 million, or 0.6%. Gross loans outstanding of $8.81 billion as of December 31, 2022 increased $1.44 billion, or 19.5%, compared to December 31, 2021, driven by increases in all loan categories due to net organic growth and the Elmira acquisition, despite an $83.8 million decrease in PPP loans. Excluding loans acquired in connection with the Elmira acquisition and PPP loans, ending loans increased $1.08 billion, or 14.9%, between 2021 and 2022.

The compounded annual growth rate (“CAGR”) for the Company’s total loan portfolio between 2018 and 2023 was 9.1%. The greatest overall expansion occurred in business lending, which grew at an 11.2% CAGR, followed by consumer indirect at a 9.5% CAGR, consumer mortgage at an 8.0% CAGR, home equity at a 2.9% CAGR and consumer direct at a 0.7% CAGR. The vast majority of the overall growth over the five-year period was organic.

The weighting of the components of the Company’s loan portfolio enables it to be highly diversified. Approximately 58% of loans outstanding at the end of 2023 were made to consumers borrowing on an installment, line of credit or residential mortgage loan basis while 42% of loans outstanding at the end of 2023 were associated with business lending.

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The combined total of general-purpose business lending to commercial, industrial, non-profit and municipal customers, mortgages on commercial property and vehicle dealer floor plan financing is characterized as the Company’s business lending activity. The total business lending portfolio increased $438.7 million, or 12.0%, in 2023 due to net organic growth. Non-owner occupied commercial real estate increased $279.5 million, or 19.5%, multifamily increased $135.0 million, or 27.9%, and owner-occupied commercial real estate increased $30.4 million, or 4.2%, while business non-real estate loans, including commercial and industrial lending, decreased $6.1 million, or 0.6%, during 2023 as compared to the prior year period. While certain macroeconomic concerns are emerging related to non-owner occupied and multifamily commercial real estate, the Company’s exposure to this portfolio is diverse both geographically and by industry type, and remains relatively low at 15% of total assets, 24% of total loans and 193% of total bank-level regulatory capital. Commercial real estate lending represents 75.5% of the total business lending portfolio at December 31, 2023 while other commercial and industrial lending represents the remaining 24.5% of total business lending. The Company’s largest non-owner occupied commercial real estate lending concentration by property type is multifamily at 15.2% of total business lending, followed by office and commercial construction each at 8.4%. The Company’s largest owner-occupied and commercial and industrial lending concentration by industry is retail trade at 7.3% of total business lending, followed by real estate rental and leasing at 7.0%, and health care and social assistance at 4.1%. These demonstrate the Company’s diversity in the lending portfolio, as there are no significant industry or geographic concentrations, as reflected by no metropolitan area accounting for more than 14% of the CRE portfolio and a very low level of commercial real estate lending being conducted in major metropolitan areas. See Table 10 below for concentrations of CRE lending by borrower type and Table 11 below for concentrations of CRE by property location.

The balance increases are reflective of continued high demand for multi-family housing, expansion of internal resources and proactive business development and pricing in the Company’s market areas. Competitive conditions for business lending continue to prevail in both the digital marketplace and geographic regions in which the Company operates. The Company strives to generate growth in its business portfolio in a manner that adheres to its goals of maintaining strong asset quality and producing profitable margins. The Company continues to invest in additional personnel, technology and business development resources to further strengthen its capabilities in this important product category.

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The following table presents the concentration by borrower type of the Company’s commercial real estate (“CRE”) loan balances as of December 31, 2023:

Table 10: Concentrations of CRE Lending by Borrower Type

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The following table presents the geographic concentrations of the Company’s CRE loan balances by property location as of December 31, 2023:

Table 11: Concentrations of CRE by Property Location

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The consumer mortgage portfolio is comprised of fixed (96%) and adjustable rate (4%) residential lending. Consumer mortgages increased $272.5 million, or 9.0%, between the end of 2022 and the end of 2023, driven by organic growth, and includes the impact of selling $6.1 million of consumer mortgage production in the secondary market. Over the past year, the Company produced net organic growth in the consumer mortgage segment due to the Company’s competitive product offerings, recruitment of additional mortgage loan originators and proactive business development efforts. Home equity loans increased $12.5 million, or 2.9%, between the end of 2022 and the end of 2023, in part a result of lower levels of consumer mortgage refinancing-related payoffs and paydowns in the higher interest rate environment.

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Consumer mortgages increased $456.4 million, or 17.9%, between the end of 2021 and the end of 2022, driven by organic growth and $271.4 million of loans acquired from Elmira, and includes the impact of selling $5.3 million of consumer mortgage production in the secondary market. In addition to the Elmira acquisition, the Company experienced net organic growth in the consumer mortgage segment due to refinancing activities in late 2021 and early 2022, combined with the Company’s competitive product offerings and business development efforts and comparatively stable housing market conditions in the Company’s primary markets. Home equity loans increased $35.9 million, or 9.0%, between the end of 2021 and 2022, driven by the same factors as consumer mortgage loans noted above.

Consumer installment loans, both those originated directly in the branches (referred to as “consumer direct”) and indirectly in automobile, marine, and recreational vehicle dealerships (referred to as “consumer indirect”), increased $171.4 million, or 10.0%, from one year ago, including a $163.8 million, or 10.6%, increase in consumer indirect loans and $7.6 million, or 4.3%, increase in consumer direct loans. The increase was primarily due to the Company offering competitive pricing, benefitting from reduced participation by certain competitors and capturing an increased share of the solid sales volumes that existed in its market area and dealer network, which, combined with higher vehicle sales prices, resulted in significant growth in the Company’s consumer installment portfolio. During 2022, consumer installment loans increased $373.7 million, or 27.8%, from one year ago, including a $349.9 million, or 29.4%, increase in consumer indirect loans and $23.8 million, or 15.5%, increase in consumer direct loans, reflective of the same factors noted above along with the impact of $12.5 million of consumer direct loans and $9.4 million of consumer indirect loans acquired from Elmira. Although the consumer indirect loan market is highly competitive, the Company is focused on maintaining a profitable in-market and contiguous market indirect portfolio, while continuing to pursue the expansion of its dealer network. Consumer direct loans have historically provided attractive returns, and the Company is committed to providing competitive market offerings to its customers in this important loan category. Despite the strong competition the Company faces from the financing subsidiaries of vehicle manufacturers and other financial intermediaries, the Company will continue to strive to grow these key portfolios through varying market conditions over the long term.

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As shown in Table 12, 76.3% of the Company’s loan portfolio is tied to fixed interest rates while 23.7% is tied to floating or adjustable interest rates. In addition, 17.1% of the Company’s loan portfolio matures in one year or less, 41.3% matures between one to five years, 33.3% matures between five and 15 years, and 8.3% matures after 15 years. The following table shows the maturities and type of interest rates for loans as of December 31, 2023:

Table 12: Maturity Distribution of Loans (1)

(1)Scheduled repayments are reported in the maturity category in which the payment is due.

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Asset Quality

The Company places a loan on nonaccrual status when the loan becomes 90 days past due, or sooner if management concludes collection of principal and interest is doubtful, except when, in the opinion of management, it is well-collateralized and in the process of collection. Nonperforming loans, defined as nonaccruing loans and accruing loans 90 days or more past due, ended 2023 at $54.6 million. This represents an increase of $21.2 million from $33.4 million in nonperforming loans at the end of 2022. The ratio of nonperforming loans to total loans at December 31, 2023 of 0.56% increased 18 basis points from the prior year’s level. The ratio of nonperforming assets (which includes other real estate owned, or “OREO”, in addition to nonperforming loans) to total loans plus OREO increased to 0.57% at year-end 2023, up 19 basis points from one year earlier. At December 31, 2023, OREO consisted of 21 residential properties with a total value of $1.1 million and one commercial property with a value of $0.1 million. This compares to seven residential properties with a total value of $0.5 million at December 31, 2022. The increase in OREO for 2023 as compared to 2022 was primarily driven by the Company working through a backlog of foreclosures that arose due to pandemic-related moratoriums that were lifted. The increases in nonperforming loans, the ratio of nonperforming loans to total loans and the ratio of nonperforming assets to total loans plus OREO were primarily attributable to an increase in nonaccrual business lending loan balances driven largely by the performance of loans associated with four customers. The Company has reviewed these individually assessed loans and recorded a reserve for one loan as it was determined that the discounted collateral value exceeded the loan balance on all other individually assessed loans.

Approximately 56% of the nonperforming loan balances at December 31, 2023 are related to the consumer mortgage portfolio. Collateral values of residential properties within most of the Company’s market areas have generally remained stable or increased over the past several years. Although high levels of inflation has had some adverse impact on consumers, the unemployment rate remains low and this has contributed to the credit performance in the consumer mortgage loan portfolio remaining favorable. Approximately 37% of nonperforming loan balances at December 31, 2023 are related to the business lending portfolio, which is comprised of business loans broadly diversified by collateral and industry type. Of the nonperforming loans in the business lending portfolio, non-owner occupied commercial real estate represents 88% of the balances, owner-occupied commercial real estate represents 10% of the balances, and other commercial and industrial loans represents 2% of the balances. There are no nonperforming multifamily loans. The level of nonperforming business loans increased from the prior year primarily due to changes in the financial conditions and loan repayment performance of four business lending relationships. The remaining 7% of nonperforming loan balances relate to consumer installment and home equity loans, with home equity nonperforming loan levels being driven by the same factors identified for consumer mortgages. Nonperforming loan levels in the consumer installment category are typically very low in comparison to the other portfolios because they are generally charged off before they reach non-performing status, and consequently the increase in the amount of non-performing consumer installment loans at the end of 2023 as compared to one year earlier was nominal. The allowance for credit losses to nonperforming loans ratio, a general measure of coverage adequacy, was 122% at the end of 2023 compared to 183% at year-end 2022 and 110% at December 31, 2021. The decrease in this ratio from one year ago was primarily driven by the increase in nonperforming business loans previously mentioned.

Total delinquencies, defined as loans 30 days or more past due or in nonaccrual status, ended 2023 at 1.06% of total loans outstanding, compared to 0.89% at the end of 2022. There was an increase in delinquencies for all loan portfolios for 2023 as compared to 2022. As of year-end 2023, delinquency ratios for business lending, consumer installment loans, consumer mortgages and home equity loans were 0.61%, 1.20%, 1.49%, and 1.42%, respectively. Within the business lending loan portfolio, the delinquency ratios at December 31, 2023 for non-owner occupied commercial real estate was 1.18%, owner-occupied commercial real estate was 0.46%, other commercial and industrial loans was 0.12% and there were no delinquent multifamily loans. These ratios compare to the year-end 2022 delinquency rates for business lending, consumer installment loans, consumer mortgages and home equity loans of 0.40%, 1.07%, 1.32%, and 1.35%, respectively. Within the business lending loan portfolio, the delinquency ratios at December 31, 2022 for non-owner occupied commercial real estate was 0.49%, owner-occupied commercial real estate was 0.73%, other commercial and industrial loans was 0.21% and there were no delinquent multifamily loans. Delinquency levels, particularly in the 30 to 89 days category, tend to be somewhat volatile due to their seasonal characteristics and measurement at a point in time, and therefore management believes that it is useful to evaluate this ratio over a longer time period. The average quarter-end delinquency ratio for total loans in 2023 was 0.88%, as compared to an average of 0.80% in 2022, and 1.20% in 2021.

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The Company’s senior management, special asset officers and business lending management review all delinquent and nonaccrual loans and OREO regularly in order to identify deteriorating situations, monitor known problem credits and discuss any needed changes to collection efforts, if warranted. Based on this analysis, a relationship may be assigned a special assets officer or other senior lending officer to review the loan, meet with the borrowers, assess the collateral and recommend an action plan.

This plan could include foreclosure, restructuring loans, issuing demand letters or other actions. The Company’s larger criticized credits are also reviewed on a quarterly basis by senior management, senior credit administration management, special assets officers and business lending management to monitor their status and discuss relationship management plans. Business lending management reviews the criticized business loan portfolio on a monthly basis.

The Company will occasionally modify loans to borrowers experiencing financial difficulty by providing principal forgiveness, term extension, payment delay, interest rate reduction or a combination thereof. As of December 31, 2023, the Company had five loans totaling $2.4 million that were considered to be modified loans to borrowers experiencing financial difficulty.

Prior to the adoption of ASU 2022-02 on January 1, 2023, loans were considered modified in a troubled debt restructuring (“TDR”) when, due to a borrower’s financial difficulties, the Company makes one or more concessions to the borrower that it would not otherwise consider. These modifications primarily include, among others, an extension of the term of the loan or granting a period with reduced or no principal and/or interest payments, which can be recaptured through payments made over the remaining term of the loan or at maturity. As of December 31, 2022, the Company had 62 loans totaling $2.5 million considered to be nonaccruing TDRs and 132 loans totaling $3.2 million considered to be accruing TDRs.

Allowance for credit losses and loan net charge-off ratios for the past two years are as follows:

Table 13: Loan Ratios

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Total net charge-offs in 2023 were $5.8 million, $2.5 million more than the prior year due to an increase in net charge-offs in the business lending, consumer mortgage, consumer installment and home equity portfolios. Net charge-offs in 2022 of $3.3 million were $0.5 million more than the prior year due to an increase in net charge-offs in the consumer installment portfolio, partially offset by decreases in net charge-offs in business lending, consumer mortgage, and home equity.

Due to the significant increases in average loan balances over time as a result of acquisitions and organic growth, management believes that net charge-offs as a percent of average loans (“net charge-off ratio”) offers the most meaningful representation of charge-off trends. The total net charge-off ratio of 0.06% for 2023 was two basis points higher than the ratios from 2022 and 2021. Gross charge-offs as a percentage of average loans were 0.14% in 2023, as compared to 0.13% in 2022, and 0.12% in 2021, evidence of management’s continued focus on maintaining conservative underwriting standards. Recoveries were $7.1 million in 2023, representing 61% of average gross charge-offs for the latest two years, compared to 73% in 2022 and 62% in 2021, reflective of the continued effectiveness of the Company’s repossession and disposition capabilities.

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Business loan net charge-offs increased in 2023, totaling $0.3 million, for a net charge-off ratio of 0.01% of average business loans outstanding, compared to a net recovery of $0.5 million, or 0.02% of average business loans outstanding, for 2022. Consumer installment loan net charge-offs increased to $4.8 million this year from $3.7 million in 2022, with a net charge-off ratio of 0.26% in 2023 and 0.25% in 2022. Consumer mortgage net charge-offs increased to $0.6 million in 2023 compared to $0.3 million in 2022 with a net charge-off ratio of 0.02% and 0.01% in 2023 and 2022, respectively. Home equity had net charge-offs of $0.1 million, or 0.02%, in 2023 compared to net recoveries of $0.1 million, or 0.02%, in 2022.

Management continually evaluates the credit quality of the Company’s loan portfolio and conducts a formal review of the adequacy of the allowance for credit losses on a quarterly basis. The primary components of the review process that are used to determine proper allowance levels are collectively evaluated and individually assessed loan loss allocations. Measurement of individually assessed loan loss allocations is typically based on expected future cash flows, collateral values and other factors that may impact the borrower’s ability to repay. Business loans with outstanding balances that are greater than $0.5 million are individually assessed for specific loan loss allocations. Consumer mortgages, consumer installment and home equity loans are considered smaller balance homogeneous loans and are evaluated collectively. The Company considers qualifying loans to require an individually assessment when, based on current information and events, it is probable that the Company will be unable to collect all principal and interest according to the contractual terms of the loan agreement or the loan is delinquent 90 days or more.

Management estimates the allowance for credit losses balance using relevant available information from internal and external sources relating to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the estimation of expected future credit losses. Adjustments are made for differences in current loan-specific risk characteristics such as differences in underwriting standards, portfolio mix, acquired loans, delinquency level, risk ratings or term of loans as well as actual and forecasted macroeconomic trends, including unemployment rates and changes in property values such as home prices, commercial real estate prices and automobile prices, gross domestic product, median household income net of inflation and other relevant factors in comparison to longer-term performance. Multiple economic scenarios are utilized to encompass a range of economic outcomes and include baseline, upside and downside forecasts, which are weighted in the calculation. The segments of the Company’s loan portfolio are disaggregated into classes that allow management to monitor risk and performance. The allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist, including collateral type, credit ratings/scores, size, duration, interest rate structure, origination vintage and payment structure. In addition to these risk characteristics, the Company considers the portion of acquired loans to the overall segment balance, the change in the volume and terms of originations, differences between the losses incurred in the period used for quantitative modeling and a longer timeframe that includes the Great Recession of 2008 (the “Great Recession”), as well as recent delinquency, charge-off and risk rating trends compared to historical time periods. The Company measures the allowance for credit losses using either the cumulative loss rate method, the line loss method, or the vintage loss rate method, dependent on the loan portfolios’ characteristics. The allowance for credit losses level computed from the collectively evaluated and individually assessed loan loss allocation methods are combined with unallocated allowances, if any, to derive the required allowance for credit losses to be reflected on the consolidated statements of condition. The provision for credit losses is calculated by subtracting the previous period allowance for credit losses, net of the interim period net charge-offs, from the current required allowance level. This provision is then recorded in the income statement for that period. Members of senior management and the Board’s Audit Committee review the adequacy of the allowance for credit losses quarterly.

Acquired loans are reviewed at their acquisition date to determine whether they have experienced a more-than-insignificant credit deterioration since origination. Loans that meet that definition according to the Company’s policy are referred to as purchased credit deteriorated (“PCD”) loans. PCD loans are initially recorded at the amount paid. An allowance for credit losses is determined using the same methodology as other loans. The initial allowance for credit losses determined on a collective basis is allocated to individual loans. The sum of the loan’s purchase price and allowance for credit losses becomes its initial amortized cost basis. The difference between the initial amortized cost basis and the par value of the loan is a noncredit discount or premium, which is amortized into interest income over the life of the loan. Subsequent changes to the allowance for credit losses are recorded as provision for, or reversal of, credit losses.

For acquired loans that are not deemed PCD at acquisition (“non-PCD”), a fair value adjustment is recorded that includes both credit and interest rate considerations. A provision for credit losses is also recorded at acquisition for the credit considerations on non-PCD loans. Subsequent to the purchase date, the methods utilized to estimate the required allowance for credit losses for these loans are the same as originated loans and subsequent changes to the allowance for credit losses are recorded as provision for, or reversal of, credit losses.

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As of December 31, 2023, the net purchase discount related to the $1.05 billion of remaining non-PCD acquired loan balances was approximately $20.7 million, or 1.98% of that portfolio.

The allowance for credit losses increased to $66.7 million at the end of 2023 from $61.1 million as of year-end 2022. During 2023, economic forecasts remained stable and the Company experienced organic loan growth, which drove the increase in the allowance for credit losses. The Company recorded a provision for credit losses of $11.2 million during 2023. Excluding $3.9 million of acquisition-related provision for credit losses in 2022 from the Elmira acquisition, the current year provision for credit losses increased $0.3 million from the prior year, due to the same factors that drove the increase in the allowance for credit losses noted above. While certain national trends are emerging related to commercial real estate, in particular the office sector, the Company determined that its exposure is primarily located in geographical areas that show stable or increasing demand and have vacancy rates below the national average. The Company has also performed internal reviews of its commercial real estate portfolio, which includes a review of the type of collateral, the status of the loan, office commercial real estate-specific balances, percent of total capital, levels of delinquencies, charge-offs, nonperforming loans and classified and criticized loans, and weighted average risk ratings. Based on these reviews, management determined that the commercial real estate loan portfolio was performing in line with expectations. Refer to Note D: Loans and Allowance for Credit Losses in the notes to the consolidated financial statements for a discussion of management’s methodology used to estimate the allowance for credit losses.

The allowance for credit losses increased to $61.1 million at the end of 2022 from $49.9 million as of year-end 2021. During 2022, economic forecasts weakened as high inflation and interest rate increases dampened economic activity. While unemployment remained low, the national market experienced a slowdown in home price appreciation and a decline in automobile prices and new pressures on commercial real estate as well. Inflation put pressure on wages and reduced disposable income for consumers nationally. The Company recorded a provision for credit losses of $14.8 million during 2022 with $3.9 million attributable to the Elmira acquisition. The increase was a result of organic loan growth and the Elmira acquisition, combined with the weaker economic forecast.

The ratio of the allowance for credit losses to total loans of 0.69% for year-end 2023 was consistent with the ratio for year-end 2022, due primarily to the stable economic forecasts as noted previously and levels of charge-offs and delinquencies that have generally remained stable. The ratio at year-end 2022 was up one basis point from the ratio for year-end 2021 of 0.68%, due to the strong loan growth in higher allowance ratio portfolios such as indirect lending, as well as the weakening of the economic forecast during 2022. Management believes the year-end 2023 and 2022 allowance for credit losses to be adequate. The provision for credit losses as a percentage of average loans was 0.12% in 2023 as compared to 0.18% in 2022 and (0.12%) in 2021. The provision for credit losses was 193% of net charge-offs in 2023 versus 443% in 2022 and (310%) in 2021. The results in 2021 were driven by a net benefit in the provision for credit losses due to significant improvement of economic forecasts in the post-pandemic recovery and elevated collateral values.

The following table sets forth the allocation of the allowance for credit losses by loan category as of the end of the years indicated, as well as the proportional share of each category’s loan balance to total loans. This allocation is based on management’s assessment, as of a given point in time, of the risk characteristics of each of the component parts of the total loan portfolio and is subject to change when the risk factors of each component part change. The allocation is not indicative of the specific amount of future net charge-offs that will be incurred in each of the loan categories, nor should it be taken as an indicator of future loss trends. The allocation of the allowance to each category does not restrict the use of the allowance to absorb losses in any category.

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Table 14: Allowance for Credit Losses by Loan Type

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As demonstrated in Table 14, the consumer direct and indirect installment loan portfolios carry higher credit risk than the business lending, consumer mortgage and home equity portfolios and therefore the Company allocates a higher proportional allowance to these portfolios. The unallocated allowance is maintained for potential inherent losses in the specific portfolios that are not captured due to model imprecision. The unallocated allowance of $1.0 million at year-end 2023 was consistent with December 31, 2022. The changes in year-over-year allowance allocations reflect management’s continued refinement of its loss estimation techniques. However, given the inherent imprecision in the many estimates used in the determination of the allocated portion of the allowance, management remained conservative in the approaches used to establish the overall allowance for credit losses. Management considers the allocated and unallocated portions of the allowance for credit losses to be prudent and reasonable.

Funding Sources

The Company utilizes a variety of funding sources to support the interest-earning asset base as well as to achieve targeted growth objectives. Overall funding is comprised of three primary sources that possess a variety of maturity, stability and price characteristics: deposits of individuals, partnerships and corporations (nonpublic deposits), municipal deposits that are collateralized for amounts not covered by FDIC insurance (public funds), and external borrowings. The average daily amount of deposits and the average rate paid on each of the following deposit categories are summarized below for the years indicated:

Table 15: Average Deposits

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As displayed in Table 15, average total deposits in 2023 decreased $328.7 million, or 2.5%, from the prior year, comprised of a $680.5 million, or 5.5%, decrease in non-time deposits, partially offset by a $351.8 million, or 37.9%, increase in time deposits. The decrease in average deposits and the change in deposit mix towards a higher time deposit balance was primarily due to higher customer expenditure levels in the inflationary environment and customers responding to changes in market interest rates by moving funds into higher yielding account types, as well as increased rate competition from other banks and non-depository financial institutions.

Average total deposits in 2022 increased $927.9 million, or 7.5%, from 2021 comprised of a $956.3 million, or 8.4%, increase in non-time deposits, partially offset by a $28.4 million, or 3.0%, decrease in time deposits. The increase in average deposits was primarily due to a full-year impact of large net inflows of funds from government stimulus and PPP programs in 2021 along with the addition of deposits from the Elmira acquisition during the second quarter of 2022. The Company acquired $522.3 million of deposits in the Elmira acquisition, including $356.5 million of non-time deposits and $165.8 million of time deposits. The cost of deposits, including non-interest checking deposit balances, increased two basis points from 0.09% in 2021 to 0.11% in 2022.

Nonpublic, non-time deposits are frequently considered to be an attractive source of funding because they are generally stable, do not need to be collateralized, carry a relatively low rate, generate fee income and provide a strong customer base for which a variety of loan, deposit and other financial service-related products can be cross-sold. The Company’s funding composition continues to benefit from a high level of nonpublic deposits, with an average balance of $11.42 billion, which, decreased $304.6 million, or 2.6%, from 2022, but remained at 89% of total average deposits, consistent with 2022. The Company continues to focus on expanding its core deposit relationship base through its competitive product offerings and high quality customer service.

Full-year average public fund deposits decreased $24.1 million, or 1.6%, during 2023 to $1.48 billion. Public fund deposit balances tend to be more volatile than nonpublic deposits because they are heavily impacted by the seasonality of tax collection and fiscal spending patterns, as well as the longer-term financial position of the local government entities, which can change from year to year. The Company is required to collateralize certain local municipal deposits in excess of FDIC coverage with marketable securities from its investment portfolio. Due to this stipulation, as well as the competitive bidding nature of municipal time deposits, management considers this funding source to share some of the same attributes as borrowings. However, the Company has many long-standing relationships with municipal entities throughout its markets and the deposits held by these customers have provided a relatively attractive and stable funding source over an extended period of time.

The mix of average deposits shifted as compared with the prior year as customers moved to higher yielding deposit accounts. Non-time deposits (noninterest checking, interest checking, savings and money markets) represented approximately 90% of the Company’s average deposit funding base in 2023 versus 93% last year, while time deposits this year represent approximately 10% of total average deposits compared to 7% in 2022. The cost of interest-bearing deposits of 0.94% in 2023 was 78 basis points higher than the 0.16% cost of interest-bearing deposits in 2022 as a result of the aforementioned deposit mix shift and increases in the average rates paid on interest checking, savings, money market and time deposits due to market conditions. The total cost of deposit funding, which includes noninterest-bearing deposit balances, was 0.66% in 2023, a 55 basis point increase from the prior year.

The remaining maturities of deposits in amounts of $250,000 or more (the FDIC insurance limit) outstanding as of December 31 are as follows:

Table 16: Maturity of Time Deposits $250,000 or More

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The Company’s deposit base is well diversified across customer segments, comprised of approximately 62% personal, 26% business and 12% municipal at December 31, 2023, and broadly dispersed among its customer base as illustrated by an average deposit account balance of under $20,000. At the end of 2023, more than 68% of the Company’s total deposits were in noninterest checking, interest checking and savings accounts. The total estimated amount of deposits that exceeded the $250,000 insured limit provided by the FDIC, net of collateralized and intercompany deposits, was approximately $2.18 billion at December 31, 2023. This amount is determined by adjusting the amounts reported in the Bank Call Report by intercompany deposits, which are not external customers and are therefore eliminated in consolidation, and municipal deposits which are collateralized by certain pledged investment securities. The Bank Call Report estimated uninsured deposit balances at December 31, 2023 are reported gross at $3.89 billion, which includes intercompany account balances of $345.3 million and collateralized deposits of $1.36 billion. Estimated insured deposits, net of collateralized and intercompany deposits, represent greater than 80% of ending total deposits at December 31, 2023. These estimates are based on the determination of known deposit account balances of each depositor and the insurance guidelines provided by the FDIC.

Borrowing sources for the Company include the FHLB, Federal Reserve, other correspondent banks, as well as access to the brokered CD and repurchase markets through established relationships with business and municipal customers and primary market security dealers.

As shown in Table 16, year-end 2023 borrowings totaled $765.2 million, a decrease of $372.6 million from the $1.14 billion outstanding at the end of 2022 primarily due to a decrease in overnight borrowings of $715.4 million, a $42.1 million decrease in customer repurchase agreements and a $3.2 million decrease in subordinated notes payable, partially offset by an increase in other FHLB borrowings of $388.1 million from fixed rate FHLB term borrowings secured in the third and fourth quarters of 2023 in part to support the funding of continued loan growth. The decrease in total borrowings was a result of the Company utilizing the proceeds from its first quarter investment securities sales and subsequent investment security maturities to pay down these borrowings. Borrowings averaged $631.4 million, or 4.7% of total funding liabilities for 2023, as compared to $498.9 million, or 3.6% of total funding liabilities for 2022. At the end of 2023, the Company had $359.6 million, or 47%, of contractual obligations that had remaining terms of one year or less which was lower than the $1.12 billion, or 98%, at the end of 2022, due to the decrease in overnight borrowings and a corresponding increase in term borrowings.

As displayed in Table 3 on page 45, the percentage of funding from deposits in 2023 was lower than the level in 2022, primarily due to the increase in average overnight borrowings and average term borrowings in 2023 that were needed to support the funding of strong loan growth. The percentage of average funding derived from deposits was 95.3% in 2023 as compared to 96.4% in 2022 and 97.7% in 2021. During 2023, average deposits decreased 2.5%, while average borrowings increased 26.5%.

The following table summarizes the outstanding balance of borrowings of the Company as of December 31:

Table 17: Borrowings

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Financial Instruments with Off-Balance Sheet Risk

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist primarily of commitments to extend credit and standby letters of credit. Commitments to extend credit are agreements to lend to customers, generally having fixed expiration dates or other termination clauses that may require payment of a fee. These commitments consist principally of unused commercial and consumer credit lines. Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of an underlying contract with a third party. The credit risks associated with commitments to extend credit and standby letters of credit are essentially the same as that involved with extending loans to customers and are subject to the Company’s standard credit policies. Collateral may be required based on management’s assessment of the customer’s creditworthiness. The fair value of the standby letters of credit is considered immaterial for disclosure purposes.

Investments

The objective of the Company’s investment portfolio is to hold low-risk, high-quality earning assets that provide favorable returns and provide another effective tool to actively manage its earning asset/funding liability position in order to maximize future net interest income opportunities. This must be accomplished within the following constraints: (a) implementing certain interest rate risk management strategies which achieve a relatively stable level of net interest income; (b) providing both the regulatory and operational liquidity necessary to conduct day-to-day business activities; (c) considering investment risk-weights as determined by the regulatory risk-based capital guidelines; and (d) generating a favorable return without undue compromise of the other requirements.

During the first quarter of 2023, the Company sold $786.1 million in book value of available-for-sale U.S. Treasury and agency securities, recognizing $52.3 million of gross realized losses. The sales were completed in January and February 2023 as part of a strategic balance sheet repositioning and were unrelated to the negative developments in the banking industry that occurred in March 2023. The proceeds from these sales of $733.8 million were redeployed entirely toward paying off existing overnight borrowings.

The carrying value of the Company’s investment portfolio ended 2023 at $4.17 billion, a decrease of $1.15 billion, or 21.6%, from the end of 2022. The book value (excluding unrealized gains and losses) of the portfolio decreased $1.29 billion, or 22.1%, from December 31, 2022. The net unrealized loss on the available-for-sale investment portfolio was $381.6 million as of December 31, 2023, a decrease of $142.0 million from the $523.6 million unrealized loss at the end of 2022. This decrease is indicative of broader market shifts regarding the state of the economy and future interest rate levels. During 2023, the Company purchased $63.3 million of government agency mortgage-backed securities with an average yield of 5.84%, which the Company classified as held-to-maturity. Additionally, there was $39.5 million of net accretion on investment securities in 2023. The purchases and net accretion were more than offset by proceeds of $733.8 million from the sale of certain available-for-sale U.S. Treasury securities associated with the first quarter 2023 balance sheet repositioning and $598.0 million of investment maturities, calls and principal payments. The effective duration of the securities portfolio was 7.0 years at the end of 2023, as compared to 6.3 years at year end 2022.

The carrying value of the Company’s investment portfolio ended 2022 at $5.31 billion, an increase of $335.8 million, or 6.7%, from the end of 2021. The book value (excluding unrealized gains and losses) of the portfolio increased $813.6 million, or 16.2%, from December 31, 2021. The net unrealized loss on the available-for-sale investment portfolio was $523.6 million as of December 31, 2022, an increase of $477.7 million from the $45.9 million unrealized loss at the end of 2021. During 2022, the Company purchased $1.14 billion of U.S. Treasury and agency securities with an average yield of 1.62%, $41.6 million of government agency mortgage-backed securities with an average yield of 3.22% and $182.0 million of obligations of state and political subdivisions with an average yield of 3.94%. Included in the 2022 purchases was $11.3 million of available-for-sale securities acquired as part of the Elmira transaction. These additions were offset by $266.9 million of investment maturities, calls and principal payments and net accretion on investment securities of $20.6 million in 2022. The effective duration of the securities portfolio was 6.3 years at the end of 2022, as compared to 7.5 years at year end 2021.

During the fourth quarter of 2022, the Company reclassified certain U.S. Treasury securities with a book value of $1.42 billion and market value of $1.08 billion from its available-for-sale investment securities portfolio to its held-to-maturity investment securities portfolio. While the reclassification had no economic, earnings, or regulatory capital impact, it enables the Company to more effectively manage overall capital levels if interest rates rise above year-end levels in future periods. The Company evaluated the securities for credit loss and determined that no allowance for credit losses was necessary.

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The investment portfolio has limited credit risk due to the composition continuing to be heavily weighted towards U.S. Treasury debentures, U.S. Agency mortgage-backed pass-throughs (MBS), U.S. Agency collateralized mortgage obligations (CMOs) and municipal bonds. The U.S. Treasury debentures, U.S. Agency mortgage-backed pass-throughs and U.S. Agency CMOs are all rated AAA (highest possible rating) by Moody’s and AA+ by Standard and Poor’s. The majority of the municipal bonds are rated A or higher. The portfolio does not include any private label MBS or CMOs.

The following table sets forth the carrying value for the Company’s investment securities portfolio:

Table 18: Investment Securities

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The following table sets forth as of December 31, 2023 the weighted-average yield of investment debt securities by maturity date and investment type:

Table 19: Weighted-Average Yield of Investment Debt Securities (1)

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Impact of Inflation and Changing Prices

The Company’s financial statements have been prepared in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effect of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. Notwithstanding this, inflation can directly affect the value of loan collateral, real estate and automobiles in particular. Inflation can also impact the Company’s noninterest expense levels to some extent, and by extension the net income it generates and the earnings it retains as capital.

New Accounting Pronouncements

See “New Accounting Pronouncements” Section of Note A of the notes to the consolidated financial statements on page 97 for recently issued accounting pronouncements applicable to the Company that have not yet been adopted.

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Forward-Looking Statements

This report contains comments or information that constitute forward-looking statements (within the meaning of the Private Securities Litigation Reform Act of 1995), which involve significant risks and uncertainties. Forward-looking statements often use words such as “anticipate,” “could,” “target,” “expect,” “estimate,” “intend,” “plan,” “goal,” “forecast,” “believe,” or other words of similar meaning. These statements are based on the current beliefs and expectations of the Company’s management and are subject to significant risks and uncertainties. Actual results may differ materially from the results discussed in the forward-looking statements. Moreover, the Company’s plans, objectives and intentions are subject to change based on various factors (some of which are beyond the Company’s control). Factors that could cause actual results to differ from those discussed in the forward-looking statements include: (1) adverse developments in the banking industry related to recent bank failures and the potential impact of such developments on customer confidence and regulatory responses to these developments; (2) current and future economic and market conditions, including the effects of changes in housing or vehicle prices, higher unemployment rates, disruptions in the commercial real estate market, labor shortages, supply chain disruption, inability to obtain raw materials and supplies, U.S. fiscal debt, budget and tax matters, geopolitical matters and conflicts, and any changes in global economic growth; (3) the effect of, and changes in, monetary and fiscal policies and laws, including future changes in Federal and state statutory income tax rates and interest rate and other policy actions of the Board of Governors of the Federal Reserve System; (4) the effect of changes in the level of checking or savings account deposits on the Company’s funding costs and net interest margin including the possibility of a sudden withdrawal of the Company’s deposits due to rapid spread of information or disinformation regarding the Company’s well-being; (5) future provisions for credit losses on loans and debt securities; (6) changes in nonperforming assets; (7) the effect of a fall in stock market or bond prices on the Company’s fee income businesses, including its employee benefit services, wealth management, and insurance businesses; (8) risks related to credit quality; (9) inflation, interest rate, liquidity, market and monetary fluctuations; (10) the strength of the U.S. economy in general and the strength of the local economies where the Company conducts its business; (11) the timely development of new products and services and customer perception of the overall value thereof (including features, pricing and quality) compared to competing products and services; (12) changes in consumer spending, borrowing and savings habits; (13) technological changes and implementation and financial risks associated with transitioning to new technology-based systems involving large multi-year contracts; (14) the ability of the Company to maintain the security, including cybersecurity, of its financial, accounting, technology, data processing and other operating systems, facilities and data, including customer data; (15) effectiveness of the Company’s risk management processes and procedures, reliance on models which may be inaccurate or misinterpreted, the Company’s ability to manage its credit or interest rate risk, the sufficiency of its allowance for credit losses and the accuracy of the assumptions or estimates used in preparing the Company’s financial statements and disclosures; (16) failure of third parties to provide various services that are important to the Company’s operations; (17) any acquisitions or mergers that might be considered or consummated by the Company and the costs and factors associated therewith, including differences in the actual financial results of the acquisition or merger compared to expectations and the realization of anticipated cost savings and revenue enhancements; (18) the ability to maintain and increase market share and control expenses; (19) the nature, timing and effect of changes in banking regulations or other regulatory or legislative requirements affecting the respective businesses of the Company and its subsidiaries, including changes in laws and regulations concerning taxes, accounting, banking, service fees, risk management, securities, capital requirements and other aspects of the financial services industry; (20) changes in the Company’s organization, compensation and benefit plans and in the availability of, and compensation levels for, employees in its geographic markets; (21) the outcome of pending or future litigation and government proceedings; (22) the effect of opening new branches to expand the Company’s geographic footprint, including the cost associated with opening and operating the branches and the uncertainty surrounding their success including the ability to meet expectations for future deposit and loan levels and commensurate revenues; (23) the effects of natural disasters could create economic and financial disruption; (24) other risk factors outlined in the Company’s filings with the SEC from time to time; and (25) the success of the Company at managing the risks of the foregoing.

The foregoing list of important factors is not all-inclusive. For more information about factors that could cause actual results to differ materially from the Company’s expectations, refer to “Item 1A Risk Factors” above. Any forward-looking statements speak only as of the date on which they are made and the Company does not undertake any obligation to update any forward-looking statement, whether written or oral, to reflect events or circumstances after the date on which such statement is made. If the Company does update or correct one or more forward-looking statements, investors and others should not conclude that the Company will make additional updates or corrections with respect thereto or with respect to other forward-looking statements.

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Reconciliation of GAAP to Non-GAAP Measures

Table 20: GAAP to Non-GAAP Reconciliations

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