FINANCIAL INSTITUTIONS INC (FISI) FY 2024 MD&A

MANAGEMENT’S DISCUSSION AND ANALYSIS

The provision for credit losses was $6.2 million in 2024 compared to a provision of $13.7 million in 2023. Net charge-offs were $8.7 million in 2024, representing 0.20% of average loans, which were relatively flat compared with $8.5 million, or 0.20% of average loans in 2023. Non-performing loans increased $14.7 million to $41.4 million compared to a year ago and represented 0.92% of total loans at December 31, 2024, compared to 0.60% of total loans at December 31, 2023. The increase in non-performing loans in the current year was primarily driven by one $15.5 million commercial loan relationship that was placed on nonaccrual status during the third quarter of 2024. We have remained strategically focused on the importance of credit discipline, allocating resources to credit and risk management functions as the loan portfolio has grown. The ratio of allowance for credit losses on loans to non-performing loans was 116% at December 31, 2024, compared to 192% at December 31, 2023, with the decrease reflective of the higher level of nonperforming loans at December 31, 2024.

We reported a net loss in noninterest income of $46.7 million for 2024, compared to noninterest income of $48.2 million for 2023. The decrease in noninterest income was primarily attributable to an increase in net loss on investment securities, a decrease in income from company owned life insurance, and a decrease in insurance income, partially offset by an increase in net gain (loss) on other assets. The net loss on investments securities of $100.1 million for 2024 was reflective of the strategic investment securities portfolio restructuring in late December 2024 described above. Net loss on investment securities of $3.6 million for 2023 reflected the loss on the sale of approximately $54 million of lower yielding AFS securities agency mortgage-backed securities, reinvesting the proceeds of such sale into higher yielding bonds. Income from company owned life insurance decreased $6.6 million in 2024 compared to 2023, due to a normalized crediting rate associated with the separate account policies purchased in the fourth quarter of 2023. The decrease in insurance income was reflective of the sale of the assets of our insurance agency subsidiary, SDN, in April 2024. The gain from this sale of $13.7 million was included in net gain (loss) on other assets.

Noninterest expense for the full year 2024 totaled $178.9 million, a $41.7 million increase compared to $137.2 million in the prior year. The increase in noninterest expense was primarily attributable to the previously disclosed fraud matter and the provision for the litigation settlement. Computer and data processing expense increased $2.6 million year-over-year, as a result of strategic investments in data efficiency and marketing technology. Professional services expense of $7.7 million increased $2.4 million from 2023 primarily due to legal expenses associated with the previously mentioned fraud event. Other expense of $15.3 million increased $1.0 million from 2023, due in part to New York State capital base tax. Salaries and benefits expense of $66.1 million decreased $5.8 million from 2023, primarily due to the decrease in headcount as a result of the sale of our SDN subsidiary and organizational changes made in the fourth quarter of 2023.

Income tax benefit for full year 2024 was $26.5 million, representing an effective tax rate of (38.9%), which was reflective of the net loss for the year. Income tax expense for 2023 was $12.8 million, representing an effective tax rate of 20.3%. Income tax expense for 2023 included $5.4 million of incremental taxes associated with the COLI surrender and redeployment strategy executed in 2023. Effective tax rates are impacted by items of income and expense not subject to federal or state taxation. The Company’s effective tax rates differ from statutory rates primarily because of interest income from tax-exempt securities, earnings on COLI and tax credit investments placed in service.

Total assets were $6.12 billion at December 31, 2024, down $43.8 million from $6.16 billion at December 31, 2023.

Investment securities were $1.03 billion at December 31, 2024, down $8.8 million from December 31, 2023. The decrease from year-end 2023 was primarily due to repayment, sales, and maturities of investment securities, and the use of cash to fund loan originations and reduce short-term borrowings.

Total loans were $4.48 billion at December 31, 2024, up $17.1 million, or 0.4%, from December 31, 2023. The increase in loans in 2024 was primarily driven by strong commercial mortgage loan growth. The following discusses significant changes within our loan portfolio for the current year:

•
Commercial business loans totaled $665.3 million, a decrease of $70.4 million, or 10%.

•
Commercial mortgage–construction loans totaled $582.6 million, an increase of $89.6 million, or 18%.

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Commercial mortgage– non-owner occupied loans totaled $858.0 million, an increase of $69.5 million, or 9%.

•
Consumer indirect loans totaled $845.8 million, a decrease of $103.1 million, or 19%.

Total deposits were $5.10 billion at December 31, 2024, a decrease of $108.2 million from December 31, 2023, which was attributable to reductions in brokered deposits and lower reciprocal balances. The Bank reduced the outstanding balance of the brokered sweep deposit portfolio by $180.0 million in March 2024 through the utilization of more cost effecting funding sources.

Short-term borrowings were $99.0 million at December 31, 2024, a decrease of $86.0 million from December 31, 2023. Short-term borrowings and brokered deposits have historically been utilized to manage the seasonality of public deposits.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Shareholders’ equity was $569.0 million at December 31, 2024, compared to $454.8 million at December 31, 2023. Common book value per share was $27.48 at December 31, 2024, a decrease of $0.92, or 3.2%, from $28.40 at December 31, 2023. Tangible common book value per share(1) was $24.45 at December 31, 2024, an increase of $0.76, or 3%, from $23.69 at December 31, 2023. The increase in shareholders’ equity as compared to December 31, 2023, was reflective of the $108.6 million net proceeds from the common stock offering and a decrease in our accumulated other comprehensive loss associated with unrealized losses on AFS securities portfolio, due to the investment securities restructuring, partially offset by the net loss for the year. Management believes the unrealized losses on the AFS securities portfolio are temporary in nature. The securities portfolio continues to generate cash flow and given the high quality of our agency mortgaged-backed securities portfolio, management expects the bonds to ultimately mature at a terminal value equivalent to par.

(1)
This is a non-GAAP measure that we believe is useful in understanding our financial performance and condition. Refer to the “GAAP to Non-GAAP Reconciliation” section of this Item 7 for further information.

Our leverage ratio was 9.15% at December 31, 2024 compared to 8.18% at December 31, 2023. The Bank’s leverage ratio and total risk-based capital ratio were 9.79% and 12.60%, respectively, at December 31, 2024, compared to 9.06% and 11.76%, respectively, at December 31, 2023.

Additional financial highlights are as follows:

(1)
This is a non-GAAP measure that we believe is useful in understanding our financial performance and condition. Refer to the “GAAP to Non-GAAP Reconciliation” section of this Item 7 for further information.

(2)
The efficiency ratio provides a ratio of operating expenses to operating income. Efficiency ratio is calculated by dividing noninterest expense by net revenue, which is defined as the sum of tax-equivalent net interest income and noninterest income before net gains on investment securities. The efficiency ratio is not a financial measurement required by GAAP. However, the efficiency ratio is used by management in its assessment of financial performance specifically as it relates to noninterest expense control. Management also believes such information is useful to investors in evaluating Company performance.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

GAAP to Non-GAAP Reconciliation

(1)
Tangible common equity divided by tangible assets.

(2)
Tangible common equity divided by common shares outstanding.

(3)
Net income available to common shareholders divided by average tangible common equity.

(4)
Net income available to common shareholders divided by average tangible assets.

This table contains disclosure that includes calculations for tangible common equity, tangible assets, tangible common equity to tangible assets, tangible common book value per share, average tangible common equity, average tangible assets, return on average tangible common equity and return on average tangible assets, which are determined by methods other than in accordance with GAAP. We believe that these non-GAAP measures are useful to our investors as measures of the strength of our capital and ability to generate earnings on tangible common equity invested by our shareholders. These non-GAAP measures provide supplemental information that may help investors to analyze our capital position without regard to the effects of intangible assets. Non-GAAP financial measures have inherent limitations and are not uniformly utilized by issuers. Therefore, these non-GAAP financial measures should not be considered in isolation, or as a substitute for comparable measures prepared in accordance with GAAP.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

RESULTS OF OPERATIONS FOR THE YEARS ENDED

December 31, 2024 AND December 31, 2023

Net Interest Income and Net Interest Margin

Net interest income was our primary source of revenue for the year ended December 31, 2024. Net interest income is the difference between interest income on interest-earning assets, such as loans and investment securities, and interest expense on interest-bearing deposits and other borrowings used to fund interest-earning and other assets or activities. Net interest income is affected by changes in interest rates and by the amount and composition of interest-earning assets and interest-bearing liabilities, as well as the sensitivity of the balance sheet to changes in interest rates, including characteristics such as the fixed or variable nature of the financial instruments, contractual maturities and repricing frequencies.

We use interest rate spread and net interest margin to measure and explain changes in net interest income. Interest rate spread is the difference between the yield on interest-earning assets and the rate paid for interest-bearing liabilities that fund those assets. The net interest margin is expressed as the percentage of net interest income to average interest-earning assets. The net interest margin exceeds the interest rate spread because noninterest-bearing sources of funds (“net free funds”), principally noninterest-bearing demand deposits and shareholders’ equity, also support interest-earning assets. To compare tax-exempt asset yields to taxable yields, the yield on tax-exempt investment securities is computed on a taxable equivalent basis. Net interest income, interest rate spread, and net interest margin are discussed on a taxable equivalent basis.

The Federal Reserve influences the general market rates of interest, which impacts the deposit and loan rates offered by many financial institutions. Throughout 2022 and 2023, the Federal Reserve increased the intended federal funds rate, which is the cost of immediately available overnight funds in an attempt by the Federal Reserve to curb inflation, resulting in a federal funds rate of 4.25% to 4.50% as of December 31, 2022. The Federal Reserve further increased the federal funds rate by 25-basis points each in February, March, May, and July 2023 resulting in a federal funds rate of 5.25% to 5.50% as of December 31, 2023. The federal funds rate remained at 5.50% until a 50-basis point reduction in September 2024. Amid cooling inflation, the rate decreased 25-basis points in both November and December, resulting in a federal funds rate of 4.25% to 4.50% as of December 31, 2024. Our loan portfolio is significantly affected by changes in the prime interest rate, which generally follow changes in the federal funds rate. The prime interest rate, which is the rate offered on loans to borrowers with strong credit, was 7.50% at December 31, 2024, compared to 8.50% and 7.50% at December 31, 2023 and 2022, respectively.

The following table reconciles interest income per the consolidated statements of operations to interest income adjusted to a fully taxable equivalent basis for the years ended December 31 (in thousands):

(1) The interest on tax-exempt securities is calculated on a tax-equivalent basis assuming a Federal income tax rate of 21%.

Analysis of Net Interest Income and Net Interest Margin

Net interest income on a taxable equivalent basis for 2024 was $163.9 million, a decrease of $2.3 million compared to $166.1 million for 2023. The decrease in net interest income was due primarily to higher funding costs amid the high interest rate environment that persisted for the majority of 2024.

Our net interest margin for 2024 was 2.86%, 8-basis points lower than 2.94% from the prior year. This decrease was a function of a 16-basis points decrease in the interest rate spread, partially offset by an 8-basis points higher contribution from net free funds. The change in interest rate spread was a net result of a 57-basis points increase in the average cost of interest-bearing liabilities, partially offset by a 41-basis points increase in the average yield on average interest-earning assets.

For the year ended December 31, 2024, the average yield on average interest-earning assets of 5.48% was 41-basis points higher than 2023. Average loan yield increased 38-basis points during 2024 to 6.36%. The average yield on investment securities increased 28-basis points during 2024 to 2.20%. Overall, the interest-earning asset rate changes increased interest income by $19.4 million during 2024 and a favorable volume variance increased interest income by $7.5 million, which collectively drove a $27.0 million increase in interest income.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Average interest-earning assets were $5.72 billion for 2024 compared to $5.65 billion for 2023, an increase of $71.3 million, or 1%, with average loans up $114.9 million from $4.32 billion for 2023 to $4.44 billion for 2024, while average investment securities were down $78.8 million from $1.25 billion for 2023 to $1.17 billion for 2024. Average investment securities represented 20.5% of average interest-earning assets during 2024 compared to 22.1% in 2023. The decrease in the average balance of investment securities was primarily due to repayment and maturities of investment securities, and the use of cash to fund loan originations and reduce short-term borrowings. Loans comprised 77.5% of average interest-earning assets during 2024 compared to 76.5% during 2023. The growth in average loans was primarily due to organic growth in commercial mortgage loans, as well as organic growth in residential and other consumer loans, partially offset by a planned reduction in our consumer indirect portfolio. Loans generally have significantly higher yields compared to other interest-earning assets and, as such, have a more positive effect on the net interest margin. An increase in the volume of average loans resulted in a $7.6 million increase in interest income and higher interest rates increased interest income by $16.0 million.

For the year ended December 31, 2024, the average cost of total interest-bearing liabilities of 3.32% was 57-basis points higher than 2023. The average cost of total interest-bearing deposits of 3.29% was 66-basis points higher than 2023 primarily due to the continued repricing of deposits at higher rates due to the higher interest rate environment that began in 2023 and persisted for the majority of 2024. The average cost of total borrowings decreased 39-basis points to 3.84% in 2024, compared to 4.23% in 2023.

Average interest-bearing liabilities of $4.51 billion in 2024 were $122.5 million, or 3%, higher than 2023. On average, interest-bearing deposits grew $180.5 million from $4.08 billion for 2023 to $4.26 billion for 2024, while noninterest-bearing demand deposits (a principal component of net free funds) decreased $77.2 million, or 7%, to $953.4 million. The increase in average deposits was due to growth in non-public deposits, public deposits, and reciprocal deposits, partially offset by a decrease in brokered deposits. Average short-term borrowings decreased $60.7 million from $186.9 million in 2023 to $126.2 million in 2024 as deposit growth enabled us to pay down short-term borrowings. For further discussion of our reciprocal and brokered deposits, refer to the “Funding Activities—Deposits” section of this Management’s Discussion and Analysis. Overall, interest-bearing deposit interest rate changes and volume changes resulted in an increase in interest expense of $26.2 million and $6.4 million, respectively, as compared to 2023, and total borrowings volume and interest rate changes contributed $1.8 million and $1.7 million, respectively, of lower interest expense during 2024.

The following table presents, for the years indicated, information regarding: (i) average balances, which were derived from daily balances; (ii) the amount of interest income from interest-earning assets and the resulting annualized yields (tax-exempt yields have been adjusted to a tax-equivalent basis using the applicable Federal tax rate in each year); (iii) the amount of interest expense on interest-bearing liabilities and the resulting annualized rates; (iv) net interest income; (v) net interest rate spread; (vi) net interest income as a percentage of average interest-earning assets (“net interest margin”); and (vii) the ratio of average interest-earning assets to average interest-bearing liabilities. Investment securities are at amortized cost for both held to maturity and available for sale securities. Loans include net unearned income, net deferred loan fees and costs and non-accruing loans. Dollar amounts are shown in thousands.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

(1) Investment securities are shown at amortized cost.

(2) The interest on tax-exempt securities is calculated on a tax-equivalent basis assuming a Federal income tax rate of 21%.

(3) Loans include net unearned income, net deferred loan fees and costs and non-accruing loans. Net deferred loan fees (costs) included in interest income were as follows (in thousands):

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MANAGEMENT’S DISCUSSION AND ANALYSIS

The net interest spread, as well as the net interest margin, will be impacted by future changes in short-term and long-term interest rate levels, as well as the impact from the competitive environment. A discussion of the effects of changing interest rates on net interest income is set forth in Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk” included elsewhere in this report.

Rate/Volume Analysis

The following table presents, on a tax-equivalent basis, the relative contribution of changes in volumes and changes in rates to changes in net interest income for the periods indicated. The change in interest income or interest expense not solely due to changes in volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each (in thousands). No out-of-period adjustments were included in the rate/volume analysis.

Provision for Credit Losses

The table below presents the composition of the provision for credit losses for the years ended December 31 (in thousands):

The decrease in the provision for credit losses–loans in 2024 compared to 2023 was primarily driven by a shift in mix of loan balances (consumer indirect category decreased and represented a smaller percentage of the portfolio), combined with positive trends in qualitative factors and a slight decrease in loan specific reserves.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

See the “Allowance for Credit Losses” and “Non-Performing Assets and Potential Problem Loans” sections of this Management’s Discussion and Analysis for further discussion.

Noninterest (Loss) Income

The following table summarizes our noninterest (loss) income for the years ended December 31 (in thousands):

The sale of the assets of our insurance subsidiary in April 2024 resulted in a gain on other assets of $13.7 million. The $4.6 million decline in insurance income was also attributed to this transaction.

Company owned life insurance (“COLI”) income decreased $6.6 million to $5.5 million in 2024, compared to $12.1 million in 2023. The decrease was primarily attributable to income from the surrender and redeploy of $53.9 million in cash surrender COLI in 2023. The revenue from the transaction, which was partially offset by $5.4 million of related incremental income taxes, was based upon the credit rating of the premium allocation to separate account investments, as supported by the performance of the underlying investment divisions.

A net loss on investment securities of $100.1 million was recognized in 2024 due to the sale of $653.5 million of AFS securities as part of the strategic investment securities restructuring resulting from the common stock offering. The after-tax impact of the loss was approximately $75 million. The net loss on investment securities in 2023 was reflective of the sale of $54 million in lower yielding AFS agency mortgage-backed securities at an after-tax loss of $2.8 million.

Noninterest Expense

The following table summarizes our noninterest expense for the years ended December 31 (in thousands):

Salaries and employee benefits expense decreased $5.8 million, or 8%, to $66.1 million in 2024, compared to $71.9 million in 2023. The decrease was primarily due to the decrease in headcount as a result of the sale of our SDN subsidiary and the fourth quarter 2023 organizational changes.

Computer and data processing expense increased $2.6 million, or 13%, to $22.7 million in 2024, compared to $20.1 million in 2023. The increase was primarily a result of our strategic investments in data efficiency and marketing technology.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Professional services expense increased $2.4 million, or 46%, to $7.7 million in 2024, compared to $5.6 million in 2023. Professional services expense for 2024 included $1.4 million of legal and other professional expense related to the deposit-related fraud event.

Provision for litigation settlement of $23.0 million in 2024 represented the pre-tax litigation accrual, which reflects the agreed upon settlement of $29.5 million less $6.5 million of available related insurance proceeds.

Deposit related charged-off items of $20.3 million in 2024 included an $18.2 million loss associated with charge-offs related to the deposit-related fraudulent activity we experienced in early March 2024.

Other expense of $15.3 million in 2024 increased $1.0 million, or 7%, compared to $14.2 million in 2023, primarily due to increases in the New York State capital base tax.

The efficiency ratio for the year ended December 31, 2024 was 82.35% compared with 62.96% for 2023. The higher efficiency ratio was primarily the result of the increase in noninterest expense in 2024 as described above. The efficiency ratio is calculated by dividing total noninterest expense by net revenue, defined as the sum of tax-equivalent net interest income and noninterest income before net gains on investment securities. An increase in the efficiency ratio indicates that more resources are being utilized to generate the same volume of income, while a decrease indicates a more efficient allocation of resources. The efficiency ratio, a banking industry financial measure, is not required by GAAP. However, the efficiency ratio is used by management in its assessment of financial performance specifically as it relates to noninterest expense control. Management also believes such information is useful to investors in evaluating Company performance.

Income Taxes

Income tax benefit was $26.5 million for 2024, reflective of the net loss reported for the year, compared to income tax expense of $12.8 million for 2023. In 2023, we incurred additional taxes of approximately $5.4 million associated with the capital gains of the previously mentioned COLI surrenders coupled with a 10% modified endowment contract penalty that is typical of general account surrenders. In 2024 and 2023, we recognized tax credit investments resulting in a $4.6 million and $3.0 million, respectively, reduction in income tax expense, in each year, and a $775 thousand and $252 thousand net loss recorded in noninterest income, respectively.

Our effective tax rate was -38.9% for 2024, compared to 20.3% for 2023. Effective tax rates are typically impacted by items of income and expense that are not subject to federal or state taxation. Our effective tax rates reflect the impact of these items, which include, but are not limited to, interest income from tax-exempt securities, earnings on company owned life insurance and the impact of tax credit investments. In addition, our effective tax rate for 2024 and 2023 reflects the New York State tax benefit generated by our real estate investment trust.

RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2023 AND DECEMBER 31, 2022

A discussion regarding our financial condition and results of operations at and for the year ended December 31, 2023 and year-to-year comparisons between 2023 and 2022, which are not included in this Form 10-K, can be found in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2023 and are incorporated by reference herein.

ANALYSIS OF FINANCIAL CONDITION

OVERVIEW

At December 31, 2024, we had total assets of $6.12 billion, a decrease of 1% from $6.16 billion as of December 31, 2023, reflective of a decrease in cash resulting from the decreased deposits and borrowings and a decrease in other assets, partially offset by a slight increase in loans, and the sale of the assets of our insurance subsidiary. Net loans were $4.43 billion as of December 31, 2024, up $20.1 million, compared to $4.41 billion as of December 31, 2023. The increase in net loans was primarily due to organic growth in our commercial mortgage loan portfolio, partially offset by a decrease in consumer indirect loans and commercial business loans. Non-performing assets totaled $41.5 million as of December 31, 2024, up $14.7 million compared to December 31, 2023. The increase in non-performing assets was primarily driven by one $15.5 million commercial loan relationship that was placed on nonaccrual status during the third quarter of 2024. Total deposits amounted to $5.10 billion as of December 31, 2024, down $108.2 million, or 2%, compared to December 31, 2023. As of December 31, 2024, borrowings totaled $223.8 million, compared to $309.5 million as of December 31, 2023. Common book value per common share was $27.48 and $28.40 as of December 31, 2024 and 2023, respectively. As of December 31, 2024, our total shareholders’ equity was $569.0 million compared to $454.8 million as of December 31, 2023. The increase in shareholders’ equity as compared to December 31, 2023, was reflective of the $108.6 million in net proceeds from the common stock offering, and a decrease in our accumulated other comprehensive loss associated with unrealized losses on AFS securities portfolio, due to the investment securities restructuring, partially offset by the net loss for the year.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

INVESTING ACTIVITIES

The following table summarizes the composition of our available for sale and held to maturity securities portfolios (in thousands).

Our investment policy is contained within our overall Asset-Liability Management and Investment Policy. This policy dictates that investment decisions will be made based on the safety of the investment, liquidity requirements, potential returns, cash flow targets, need for collateral and desired risk parameters. In pursuing these objectives, we consider the ability of an investment to provide earnings consistent with factors of quality, maturity, marketability, pledgeable nature and risk diversification. Our Chief Financial Officer and Treasurer, guided by ALCO, is responsible for investment portfolio decisions within the established policies.

Our AFS investment securities portfolio increased $23.4 million from $887.7 million at December 31, 2023 to $911.1 million at December 31, 2024. Our AFS portfolio had a net unrealized loss totaling $61.6 million at December 31, 2024 compared to a net unrealized loss of $150.3 million at December 31, 2023. The fair value of most of the investment securities in the AFS portfolio fluctuates as market interest rates change. A net loss on investment securities of $100.1 million was recognized in 2024 due to the investment securities restructuring plan, which was executed in December 2024 following our common stock offering. As part of the restructuring, the Bank sold $653.5 million of AFS investment securities, which resulted in a pre-tax loss on the sale of securities of $100.2 million in the fourth quarter of 2024. The after-tax impact of the loss of approximately $75 million was entirely funded by a portion of the capital raised through our common stock offering that was downstreamed to the Bank. The net proceeds from the pre-tax sale of the securities were reinvested into higher yielding, agency wrapped investment securities.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Impairment Assessment

For AFS securities in an unrealized loss position, we first assess whether (i) we intend to sell, or (ii) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. If either case is affirmative, any previously recognized allowances are charged-off and the security’s amortized cost is written down to fair value through income. If neither case is affirmative, the security is evaluated to determine whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency and any adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income. Adjustments to the allowance are reported in our income statement as a component of credit loss expense. AFS securities are charged-off against the allowance or, in the absence of any allowance, written down through income when deemed uncollectible by management or when either of the aforementioned criteria regarding intent or requirement to sell is met. For the year ended December 31, 2024 and 2023 no allowance for credit losses has been recognized on AFS securities in an unrealized loss position as management does not believe any of the securities are impaired due to reasons of credit quality.

The unrealized losses are largely due to increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the bonds approach their maturity date, repricing date or if market yields for such investments decline. We do not believe any of the securities in a loss position are impaired due to reasons of credit quality. Accordingly, as of December 31, 2024, we concluded that unrealized losses on our AFS securities were not impaired due to reasons of credit quality and no allowance for credit losses has been recognized on AFS securities. As the portfolio is managed from a liquidity, earnings, and risk standpoint, sales from the AFS portfolio may be warranted based upon prevailing market factors. The following discussion provides further details of our assessment of the AFS securities portfolio by investment category.

Agency Mortgage-backed Securities

With the exception of the non-Agency mortgage-backed securities (“non-Agency MBS”) discussed below, all of the mortgage-backed securities held by us as of December 31, 2024, were issued by U.S. Government sponsored entities and agencies (“Agency MBS”), primarily FNMA and FHLMC. The contractual cash flows of our Agency MBS are guaranteed by FNMA, FHLMC or GNMA. The GNMA mortgage-backed securities are backed by the full faith and credit of the U.S. Government.

Our AFS portfolio as of December 31, 2024, reflected our strategic investment securities restructuring as a result of the common stock offering. As of December 31, 2024, there were 76 securities in the AFS Agency MBS portfolio with an aggregate fair value of $854.2 million that were in an unrealized loss position with unrealized losses totaling $62.5 million. Of these, 39 were in an unrealized loss position for 12 months or longer and had an aggregate fair value of $176.6 million and unrealized losses of $53.4 million. The unrealized loss of these securities was driven by the timing of the purchases of fixed-rate securities during the extended low interest rate environments experienced in prior years, which has been compounded with subsequent increases in benchmark interest rates. However, these fixed-rate securities were purchased with the expectation that they will continue to prepay principal and the proceeds will be invested at current market rates.

Given the high credit quality inherent in Agency MBS, we do not consider any of the unrealized losses as of December 31, 2024 on such Agency MBS to be credit related. As of December 31, 2024, we did not intend to sell any Agency MBS that were in an unrealized loss position, all of which were performing in accordance with their terms.

Non-Agency Mortgage-backed Securities

Our non-Agency MBS portfolio consists of positions in one privately issued whole loan collateralized mortgage obligations with a fair value and net unrealized gain of $365 thousand as of December 31, 2024. As of that date, the one non-Agency MBS was rated below investment grade. This security was not in an unrealized loss position.

Other Investments

As a member of the FHLB, the Bank is required to hold FHLB stock. The amount of required FHLB stock is based on the Bank’s asset size and the amount of borrowings from the FHLB. We have assessed the ultimate recoverability of our FHLB stock and believe that no impairment currently exists. As a member of the FRB system, we are required to maintain a specified investment in FRB stock based on a ratio relative to our capital. At December 31, 2024, our ownership of FHLB and FRB stock totaled $11.3 million and $7.0 million, respectively, and is included in other assets and recorded at cost, which approximates fair value.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

LENDING ACTIVITIES

Total loans were $4.48 billion at December 31, 2024, an increase of $17.1 million, from December 31, 2023. The composition of our loan portfolio, excluding loans held for sale and including net unearned income and net deferred fees and costs, is summarized as follows (in thousands):

Total commercial loans of $2.86 billion, represented 64% of total loans at December 31, 2024, compared to $2.74 billion, or 61% of total loans as of December 31, 2023. Commercial business loans of $665.3 million, or 15% of total loans, were down $70.4 million, or 10%, from December 31, 2023, and total commercial mortgage loans of $2.20 billion, or 49% of total loans, were up $194.3 million, or 10%, from December 31, 2023. The increase in commercial mortgage loans was attributable to increases in construction, multifamily, owner and non-owner occupied loans. As of December 31, 2024, commercial real estate (“CRE”) loans made up approximately 67% of total commercial loans, and 43% of total loans, commercial and industrial loans approximated 29% of total commercial loans, and 19% of total loans, and business banking unit loans were approximately 4% of total commercial loans and 3% of total loans. Our CRE committed credit exposure at December 31, 2024 related to approximately 44% multi-family, 17% office, 8% retail, 8% hospitality, 7% industrial property, and 5% home builder. Approximately 68% of our office exposure at December 31, 2024, or 12% of our total CRE exposure, related to Class B or medical office space. More than 75% of our office and 90% of our multifamily CRE loans have full or limited personal or corporate recourse.

We typically originate commercial business loans of up to $25.0 million for small- to mid-sized businesses in our market area for working capital, equipment financing, inventory financing, accounts receivable financing, or other general business purposes. Loans of this type are in a diverse range of industries. We also offer commercial mortgage loans to finance the purchase of real property, which generally consists of real estate with completed structures. The majority of our commercial mortgage loans are secured by office buildings, manufacturing facilities, distribution/warehouse facilities, and retail centers, which are generally located in our local market area.

The credit risk related to commercial loans is largely influenced by general economic conditions, inflation, and the resulting impact on a borrower’s operations or on the value of underlying collateral, if any. Factors that are important to managing overall credit quality are sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, early identification of potential problems, an appropriate allowance for credit losses, and sound nonaccrual and charge off policies. An active credit risk management process is used for commercial loans to further ensure that sound and consistent credit decisions are made. Credit risk is controlled by detailed underwriting procedures, comprehensive loan administration, and periodic review of borrowers’ outstanding loans and commitments. Borrower relationships are formally reviewed and graded on an ongoing basis for early identification of potential problems. Further analyses by customer, industry, and geographic location are performed to monitor trends, financial performance, and concentrations.

We participate in various lending programs in which guarantees are supplied by U.S. government agencies, such as the SBA, U.S. Department of Agriculture, Rural Economic and Community Development and Farm Service Agency, among others. As of December 31, 2024, the principal balance of such loans (included in commercial loans) was $21.8 million, and the guaranteed portion amounted to $13.4 million.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

We determine our current lending standards for commercial real estate and real estate construction lending by property type and specifically address many criteria, including: maximum loan amounts, maximum loan-to-value (“LTV”), requirements for pre-leasing or pre-sales, minimum debt-service coverage ratios, minimum borrower equity, and maximum loan to cost. Currently, the maximum standard for LTV is 85%, with lower limits established for certain higher risk types, such as raw land which has a 65% LTV maximum.

Consumer loans totaled $1.61 billion at December 31, 2024, down $106.8 million compared to 2023, and represented 36% of the 2024 year-end loan portfolio versus 39% at December 31, 2023. Loans in this classification include residential real estate loans, residential real estate lines, indirect consumer and other consumer installment loans. Credit risk for these types of loans is generally influenced by general economic conditions, including inflation, the characteristics of individual borrowers, and the nature of the loan collateral. Risks of loss are generally on smaller average balances per loan spread over many borrowers. Once charged off, there is usually less opportunity for recovery on these smaller retail loans. Credit risk is primarily controlled by reviewing the creditworthiness of the borrowers, monitoring payment histories, and taking appropriate collateral and guaranty positions.

Residential real estate portfolios include conventional first lien mortgages and home equity loans and lines of credit. For conventional first lien mortgages, we generally limit the maximum loan to 85% of collateral value without credit enhancement (e.g., personal mortgage insurance). A portion of our fixed-rate conventional mortgage loans are sold in the secondary market with servicing rights retained. Our conventional mortgage products continue to be underwritten using FHLMC secondary marketing guidelines. Our underwriting guidelines for home equity products include a combination of borrower FICO (credit score), the LTV of the property securing the loan and evidence of the borrower having sufficient income to repay the loan. Currently, for home equity products, the maximum acceptable LTV is 90%. The average FICO score for new home equity production was 742 and 750 during the years ended December 31, 2024 and 2023, respectively.

Residential real estate loans totaled $650.2 million at the end of 2024, up $384 thousand, from the end of the prior year and comprised 15% of total loans outstanding at both December 31, 2024 and December 31, 2023. The residential real estate line portfolio amounted to $75.6 million at December 31, 2024 down $1.8 million, compared to 2023 and represented 2% of total loans at both December 31, 2024 and December 31, 2023. The residential real estate loans and lines portfolios had a weighted average LTV at origination of approximately 70% at December 31, 2024 and 2023. Approximately 92% of the loans and lines were first lien positions at December 31, 2024 and 2023.

Consumer indirect loans amounted to $845.8 million at December 31, 2024 down $103.1 million, or 11%, compared to 2023 and represented 19% of the 2024 year-end loan portfolio versus 21% at year-end 2023. The loans are primarily for the purchase of automobiles (both new and used) and light duty trucks primarily by individuals, but also by corporations and other organizations. The loans are originated through dealerships and assigned to us with terms that typically range from 36 to 84 months. During the year ended December 31, 2024, we originated $292.1 million in indirect loans with a mix of approximately 27% new vehicles and 73% used vehicles. This compares with $489.0 million in indirect loans with a mix of approximately 29% new vehicles and 71% used vehicles for 2023. The average FICO score for indirect loan production was approximately 724 and 713 during the years ended December 31, 2024 and 2023, respectively. Effective January 1, 2024, we exited the Pennsylvania automobile market in order to align our focus more fully around our core Upstate New York market, which includes a strong network of approximately 370 new automobile dealers.

Other consumer loans totaled $42.8 million at December 31, 2024, down $2.3 million, compared to 2023, and represented approximately 1% of the 2024 and 2023 year-end loan portfolio. Other consumer loans consist of BaaS loans, personal loans (collateralized and uncollateralized) and deposit account collateralized loans. The decline in our other consumer loans primarily related to the intentional wind-down of our BaaS loans.

Our loan portfolio is widely diversified by types of borrowers, industry groups, and market areas within our operating footprint. Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to numerous borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At December 31, 2024, no significant concentrations, as defined above, existed in our portfolio. Our largest loan portfolios are CRE and indirect automobile lending. Our CRE loan portfolio is geographically diversified through multiple property types, as well as cities and markets in New York State, and the Mid-Atlantic region (Maryland, Virginia, Washington, DC) with various sources of borrower repayment. The indirect automobile loan portfolio consists of geographically diverse small loans with an average loan size of approximately $30,000. Approximately, 78% of the portfolio is to Tier 1 and Tier 2 borrowers with a FICO score greater than 670. Credit concentration limits are defined and established in our policies, and compliance with limits is monitored and reported to management and board-level committees, with defined actions to be taken in instances of a limit breach.

Loans Held for Sale and Loan Servicing Portfolio

Loans held for sale (not included in the loan portfolio composition table) were entirely comprised of residential real estate loans and totaled $2.3 million and $1.4 million as of December 31, 2024 and 2023, respectively.

We sell certain qualifying newly originated or refinanced residential real estate loans on the secondary market. Residential real estate loans serviced for others, which are not included in the consolidated statements of financial condition, amounted to $280.8 million and $269.4 million as of December 31, 2024 and 2023, respectively.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Allowance for Credit Losses

The following table summarizes the activity in the allowance for credit losses–loans (in thousands) for the periods indicated.

Net charge-offs of $8.7 million in 2024 represented 0.20% of average loans compared to $8.5 million, or 0.20%, in 2023. The allowance for credit losses–loans decreased to $48.0 million at December 31, 2024, compared with $51.1 million at December 31, 2023, due to a decrease in the current year provision for loan losses, primarily driven by a shift in mix of loan balances (consumer indirect category decreased and represented a smaller percentage of the portfolio), combined with positive trends in qualitative factors and a slight decrease in loan specific reserves. Non-performing loans increased $14.7 million to $41.4 million at December 31, 2024 from prior year end, primarily due to one $15.5 million commercial loan relationship that was placed on nonaccrual status during the third quarter of 2024. The ratio of the allowance for credit losses–loans to total loans was 1.07% and 1.14% at December 31, 2024 and 2023, respectively. The ratio of allowance for credit losses–loans to non-performing loans was 116% at December 31, 2024, compared with 192% at December 31, 2023, reflective of the lower allowance for credit losses–loans.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

The following table sets forth the allocation of the allowance for credit losses–loans by loan category as of the dates indicated. The allocation is made for analytical purposes and is not necessarily indicative of the categories in which actual losses may occur. The total allowance is available to absorb losses from any segment of the loan portfolio (in thousands).

Loans not analyzed for a specific reserve are segmented into “pools” of loans based upon similar risk characteristics. This is referred to as the “pooled loan” component of the allowance for credit losses estimate. The allowance for credit losses for pooled loans estimate is based upon periodic review of the collectability of the loans quantitatively correlating historical loan experience with reasonable and supportable forecasts using forward looking information. Adjustments to the quantitative evaluation may be made for differences in current or expected qualitative risk characteristics such as changes in: underwriting standards, delinquency level, regulatory environment, economic condition, Company management and the status of portfolio administration including the Company’s credit risk review function. The Company establishes a specific reserve for individually evaluated loans which do not share similar risk characteristics with the loans included in the forecasted allowance for credit losses. These individually evaluated loans are removed from the pooling approach discussed above for the forecasted allowance for credit losses, and include nonaccrual loans, and other loans deemed appropriate by management. The process we use to determine the overall allowance for credit losses is based on this analysis. Based on this analysis, we believe the allowance for credit losses is adequate as of December 31, 2024.

Assessing the adequacy of the allowance for credit losses involves substantial uncertainties and is based upon management’s evaluation of the amounts required to meet estimated charge-offs in the loan portfolio after weighing a variety of factors, including the risk profile of our loan products and customers.

Factors beyond our control, however, such as general national and local economic conditions, can adversely impact the adequacy of the allowance for credit losses. As a result, no assurance can be given that adverse economic conditions or other circumstances will not result in increased losses in the portfolio or that the allowance for credit losses will be sufficient to meet actual loan losses. See Part I, Item 1A “Risk Factors” for the risks impacting this estimate. Management presents a quarterly review of the adequacy of the allowance for credit losses to the Audit Committee of our Board of Directors based on the methodology that is described in further detail in Part I, Item I “Business” under the section titled “Lending Activities.” See also “Critical Accounting Estimates” for additional information on the allowance for credit losses.

The adequacy of the allowance for credit losses is subject to ongoing management review. While management evaluates currently available information in establishing the allowance for credit losses–loans, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for credit losses–loans. Such agencies may require us to increase the allowance based on their judgments about information available to them at the time of their examination.

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Non-performing Assets and Potential Problem Loans

The following table summarizes our non-performing assets (in thousands) as of the dates indicated:

Non-performing assets include non-performing loans and foreclosed assets. Non-performing assets at December 31, 2024 were $41.5 million, an increase of $14.7 million from $26.8 million at December 31, 2023. The primary component of non-performing assets is non-performing loans, which were $41.4 million or 0.92% of total loans at December 31, 2024, compared with $26.7 million or 0.60% of total loans at December 31, 2023. The increase in nonperforming loans related primarily to one $15.5 million commercial loan relationship that was placed on nonaccrual status during the third quarter of 2024.

Approximately $1.1 million, or 3%, of the $41.4 million of nonaccrual loans, a component of non-performing loans, as of December 31, 2024 were current with respect to payment of principal and interest but were classified as non-accruing because repayment in full of principal and/or interest was uncertain.

Foreclosed assets consist of real property formerly pledged as collateral for loans, which we have acquired through foreclosure proceedings or acceptance of a deed in lieu of foreclosure. We had $60 thousand and $142 thousand of properties representing foreclosed asset holdings at December 31, 2024 and 2023, respectively.

Potential problem loans are loans that are currently performing, but information known about possible credit problems of the borrowers causes us to have concern as to the ability of such borrowers to comply with the present loan payment terms and may result in disclosure of such loans as nonperforming at some time in the future. These loans remain in a performing status due to a variety of factors, including payment history, the value of collateral supporting the credits, and/or personal or government guarantees. We consider loans classified as substandard, which continue to accrue interest, to be potential problem loans. We identified $33.7 million and $29.9 million in loans that continued to accrue interest which were classified as substandard as of December 31, 2024 and 2023, respectively.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

FUNDING ACTIVITIES

Deposits

The following table summarizes the composition of our deposits (in thousands) as of the dates indicated.

As of December 31, 2024 and 2023, the aggregate amount of uninsured deposits (deposits in amounts greater than $250 thousand, which is the maximum amount for federal deposit insurance) was $1.93 billion, or 38% of total deposits, and $1.82 billion, or 35% of total deposits, respectively. The portion of our time deposits by account that were in excess of the FDIC insurance limit was $328.4 million and $302.6 million at December 31, 2024 and 2023, respectively. The maturities of our uninsured time deposits at December 31, 2024 were as follows: $102.7 million in three months or less; $94.6 million between three months and six months; $88.3 million between six months and one year; and $42.8 million over one year. Approximately $1.00 billion and $956.3 million of reciprocal and public deposits, characterized as preferred deposits for FDIC call report purposes, were collateralized by government-backed securities as of December 31, 2024 and 2023, respectively. As of December 31, 2024, estimated uninsured nonpublic deposits were approximately 18% of total deposits.

We offer a variety of deposit products designed to attract and retain customers, with the primary focus on building and expanding long-term relationships. At December 31, 2024, total deposits were $5.10 billion, representing a decrease of $108.2 million, or 2%, which was primarily the result of a decrease in brokered and reciprocal deposits, partially offset by increases in non-public and public deposits. Time deposits were approximately 30% and 27% of total deposits at December 31, 2024 and 2023, respectively.

Non-public deposits, the largest component of our funding sources, totaled $3.21 billion and $3.12 billion at December 31, 2024 and 2023, respectively, and represented 63% and 60% of total deposits as of the end of each year, respectively. We have managed this segment of funding through a strategy of competitive pricing that minimizes the number of customer relationships that have only a single service high-cost deposit account.

As an additional source of funding, we offer a variety of public (municipal) deposit products to the towns, villages, counties and school districts within our market. Public deposits generally range from 20% to 30% of our total deposits. There is a high degree of seasonality in this component of funding, because the level of deposits varies with the seasonal cash flows for these public customers. We maintain the necessary levels of short-term liquid assets to accommodate the seasonality associated with public deposits. Total public deposits were $1.07 billion and $1.02 billion at December 31, 2024 and December 31, 2023, respectively, and represented 21% and 20% of total deposits as of the end of each year, respectively.

We participate in reciprocal deposit programs, which enable depositors to receive FDIC insurance coverage for deposits otherwise exceeding the maximum insurable amount. Through these programs, deposits in excess of the maximum insurable amount are placed with multiple participating financial institutions. Reciprocal deposits totaled $746.7 million at December 31, 2024, compared to $817.6 million at December 31, 2023, and represented 15% and 16% of total deposits as of the end of each year, respectively.

Brokered deposits totaled $80.9 million, or 2% of total deposits, and $256.8 million, or 5% of total deposits, at December 31, 2024 and 2023, respectively. As of December 31, 2024 and December 31, 2023, respectively, $28.1 million and $206.8 million of interest-bearing demand deposits and $52.8 million and $50.0 million of time deposits were brokered deposit accounts. We reduced the outstanding balance of the brokered sweep deposit portfolio by $180.0 million in March 2024 through the utilization of more cost effective funding sources.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Borrowings

The Company classifies borrowings as short-term or long-term in accordance with the original terms of the agreement. Outstanding borrowings are summarized as follows as of December 31 (in thousands):

Short-term Borrowings

Short-term borrowings at December 31, 2024 and 2023 were $99.0 million and $185.0 million, respectively, which included $99.0 million and $107.0 million in short-term FHLB borrowings, respectively. The FHLB borrowings are collateralized by securities from the Company’s investment portfolio and certain qualifying loans. Borrowings at December 31, 2023 also included $78.0 million of funds borrowed under the Federal Reserve Bank (“FRB”) Bank Term funding program. In May 2023, we borrowed $15.0 million under the FRB Bank Term Funding Program at an interest rate of 4.8%, which matured on May 8, 2024. In December 2023, we borrowed $50.0 million under the program at 4.89%, which matured on December 13, 2024 and $13.0 million at 4.88%, which matured on December 20, 2024. Short-term FHLB borrowings have original maturities of less than one year and include overnight borrowings which we typically utilize to address short-term funding needs as they arise. Short-term borrowings and brokered deposits have historically been utilized to manage the seasonality of public deposits. We continue to be proactive in managing funding costs and reduced short-term borrowings in 2024.

As of December 31, 2024, $50.0 million of the short-term borrowings balance was designated as a cash-flow hedge, which became effective in April 2022, at a fixed rate of 0.787%, $30.0 million was designated as a cash-flow hedge, which became effective in January 2023, at a fixed rate of 3.669%, and $25.0 million was designated as a cash-flow hedge, which became effective in May 2023, at a fixed rate of 3.4615%. At December 31, 2024 and 2023, the Company’s borrowings had a weighted average rate of 4.68% and 5.30%, respectively.

We have credit capacity with the FHLB and can borrow through facilities that include amortizing and term advances or repurchase agreements. We had approximately $251.4 million of immediate credit capacity with the FHLB and $848.4 million in secured borrowing capacity at the FRB discount window, none of which was outstanding at December 31, 2024. The FHLB and FRB credit capacity are collateralized by securities from our investment portfolio and certain qualifying loans. We had $155.0 million of credit available under unsecured federal funds purchased lines with various banks, with no amounts outstanding at December 31, 2024. Additionally, we had approximately $183.3 million of unencumbered liquid securities available for pledging.

The Parent has a revolving line of credit with a commercial bank allowing borrowings up to $20.0 million in total as an additional source of working capital. No amounts have been drawn on the line of credit at December 31, 2024 and 2023.

Long-term Borrowings

As of December 31, 2024 and 2023 and we had a long-term advance payable to FHLB of $50.0 million. The advance matures on January 20, 2026 and bears interest at a fixed rate of 4.05%. FHLB advances are collateralized by securities from our investment portfolio and certain qualifying loans.

On October 7, 2020, we completed a private placement of $35.0 million in aggregate principal amount of fixed-to-floating rate subordinated notes due 2030 to qualified institutional buyers and accredited institutional investors that were subsequently exchanged for subordinated notes with substantially the same terms (the “2020 Notes”) registered under the Securities Act of 1933, as amended. The 2020 Notes have a maturity date of October 15, 2030 and bear interest, payable semi-annually, at the rate of 4.375% per annum, until October 15, 2025. Commencing on that date, the interest rate will reset quarterly to an interest rate per annum equal to the then current three-month SOFR plus 4.265%, payable quarterly until maturity. The 2020 Notes are redeemable by us, in whole or in part, on any interest payment date on or after October 15, 2025, and we may redeem the Notes in whole at any time upon certain other specified events. We used the net proceeds for general corporate purposes, organic growth and to support regulatory capital ratios at Five Star Bank. The 2020 Notes qualify as Tier 2 capital for regulatory purposes.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

On April 15, 2015, we issued $40.0 million of subordinated notes (the “2015 Notes”) in a registered public offering. The 2015 Notes bear interest at a fixed rate of 6.0% per year, payable semi-annually, for the first 10 years. From April 15, 2025 to the April 15, 2030 maturity date, the interest rate will reset quarterly to an annual interest rate equal to the then current three-month CME Term SOFR plus 0.26262%. The 2015 Notes are redeemable by us at any quarterly interest payment date beginning on April 15, 2025 to maturity at par, plus accrued and unpaid interest. The 2015 Notes qualify as Tier 2 capital for regulatory purposes.

Shareholders’ Equity

Total shareholders’ equity was $569.0 million at December 31, 2024, an increase of $114.2 million from $454.8 million at December 31, 2023. The increase in shareholders’ equity was reflective of the $108.6 million in net proceeds from the common stock offering. Accumulated other comprehensive loss included in shareholders’ equity decreased $67.3 million during the year due primarily to lower net unrealized losses on securities available for sale. Net loss for the year decreased shareholders’ equity by $41.6 million, while common and preferred stock dividends declared decreased equity by $19.9 million. Treasury stock decreased $2.3 million primarily due to the issuance of shares for the vesting of restricted stock units. For detailed information on shareholders’ equity, see Note 14, Shareholders’ Equity, of the notes to consolidated financial statements. FII and the Bank are subject to various regulatory capital requirements. At December 31, 2024, both FII and the Bank exceeded all regulatory requirements. For detailed information on regulatory capital requirements, see Note 13, Regulatory Matters, of the notes to consolidated financial statements.

LIQUIDITY AND CAPITAL MANAGEMENT

The objective of maintaining adequate liquidity is to assure that we meet our financial obligations. These obligations include the withdrawal of deposits on demand or at their contractual maturity, the repayment of matured borrowings, the ability to fund new and existing loan commitments and the ability to take advantage of new business opportunities. We achieve liquidity by maintaining a strong base of both core customer funds and maturing short-term assets; we also rely on our ability to sell or pledge securities and lines-of-credit and our overall ability to access to the financial and capital markets.

Liquidity for the Bank is managed through the monitoring of anticipated changes in loans, the investment portfolio, core deposits and wholesale funds. The strength of the Bank’s liquidity position is a result of its base of core customer deposits. These core deposits are supplemented by wholesale funding sources that include credit lines with the other banking institutions such as the FHLB and the FRB.

The primary sources of liquidity for FII are dividends from the Bank and access to financial and capital markets. Dividends from the Bank are limited by various regulatory requirements related to capital adequacy and earnings trends. The Bank relies on cash flows from operations, core deposits, borrowings and short-term liquid assets.

On December 13, 2024, we completed an underwritten public offering of 4,600,000 shares of common stock, including 600,000 shares as result of the underwriters exercising their overallotment option, at $25.00 per share. We received net proceeds of $108.6 million after deducting underwriting discounts and commissions, and offering expenses from the sale of our common stock. As intended, a portion of the net proceeds was used to fund losses associated with a strategic investment securities restructuring, which was completed in late December 2024. The proceeds may also be used for general corporate purposes which may include the repayment of indebtedness.

Cash and cash equivalents were $87.3 million as of December 31, 2024, a decrease of approximately $37.1 million from $124.4 million as of December 31, 2023. During 2024, net cash provided by operating activities totaled $77.1 million and the principal source of operating activity cash flow was net income adjusted for noncash income and expense items, including a $100.1 million net loss on the sale of investment securities. Net cash used in investing activities totaled $8.2 million, which included outflows of $25.8 million for net loan originations, $5.0 million for purchases of premises and equipment, and $4.5 million net cash used for the purchase of investment securities, partially offset by $27.0 million of proceeds from the sale of the assets of our insurance subsidiary. Net cash used in financing activities of $106.0 million was primarily attributed to a $108.2 million net decrease in deposits, an $86.0 million net decrease in short-term borrowings and $20.0 million in dividend payments, partially offset by $108.6 million of net proceeds from our common stock offering.

Planned Uses of Capital Resources

The Company has various long-term contractual obligations as of December 31, 2024, which include:

•
Time deposits for $1.55 billion;

•
Supplemental executive retirement plans for $181 thousand;

•
Subordinated notes for $75.0 million

•
FHLB long-term advances for $50.0 million; and

•
Operating leases for $48.2 million.

For additional information on the Company’s long-term contractual obligations above, see Note 9, Deposits, Note 19, Employee Benefit Plans, Note 10, Borrowings, and Note 7, Leases, in the accompanying consolidated financial statements.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

We have financial instruments with off-balance sheet risk established in the normal course of business to meet the financing needs of customers. These financial instruments include commitments to extend credit for $1.27 billion and standby letters of credit for $14.6 million as of December 31, 2024. We do not expect all of the commitments to extend credit and standby letters of credit to be funded. Thus, the total commitment amounts do not necessarily represent our future cash requirements.

We have committed to investments in limited partnerships, primarily related to small business investment companies, tax credit investments and FinTech and ESG-related investment funds. As of December 31, 2024, the off-balance sheet commitments related to these investments totaled $8.6 million. We have also recorded a $16.4 million liability primarily related to committed contributions for tax credit investments in property placed in service on or before December 31, 2024.

With the exception of obligations in connection with our irrevocable loan commitments, limited partnership investments and tax credit investments as of December 31, 2024, we had no other off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. For additional information on off-balance sheet arrangements, see Note 1, Summary of Significant Accounting Policies and Note 12, Commitments and Contingencies, in the notes to the accompanying consolidated financial statements.

Shelf Registration

We have an effective shelf registration statement on file with the SEC for an indeterminate number of securities that is effective for three years (expires December 4, 2027), around which time we expect to file a replacement shelf registration statement. Under this universal shelf registration statement, we have the capacity to offer and sell from time to time securities, including common stock, debt securities, preferred stock, warrants and units. Under this shelf registration, we completed an underwritten public offering of 4,600,000 shares of common stock at $25.00 per share on December 13, 2024.

Security Yields and Maturities Schedule

The following table sets forth certain information regarding the amortized cost (“Cost”), cost-weighted average yields (“Yield”), which is defined as the book yield weighted against the ending book value, and contractual maturities of our debt securities portfolio as of December 31, 2024 (dollars in thousands). Mortgage-backed securities are included in maturity categories based on their stated maturity date. Actual maturities may differ from the contractual maturities presented because borrowers may have the right to call or prepay certain investments. No tax-equivalent adjustments were made to the weighted average yields.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Contractual Loan Maturity Schedule

The following table summarizes the contractual maturities of our loan portfolio at December 31, 2024. Loans, net of deferred loan origination costs, include principal amortization and non-accruing loans. Demand loans having no stated schedule of repayment or maturity and overdrafts are reported as due in one year or less (in thousands).

(1) Amounts include prepayment assumptions based on actual historical experience.

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Capital Resources

The FRB has adopted a system using risk-based capital guidelines to evaluate the capital adequacy of bank holding companies on a consolidated basis. The final rules implementing the Basel Committee on Banking Supervision’s (“BCBS”) capital guidelines for U.S. banks were fully phased-in on January 1, 2019. As of December 31, 2024, the Company’s capital levels remained characterized as “well-capitalized” under the BCBS rules. See Note 13, Regulatory Matters of the notes to consolidated financial statements and the “Basel III Capital Rules” section below for further discussion. The following table reflects the Company’s ratios and their components as of December 31 (in thousands):

(1)
Includes unrealized gains and losses related to the Company’s reclassification of available for sale investment securities to the held to maturity category.

We have elected to apply the 2020 Current Expected Credit Losses methodology (“CECL”) transition provision related to the impact of the CECL accounting standard on regulatory capital, as provided by the US banking agencies’ March 2020 interim final rule. Under the 2020 CECL transition provision, the regulatory capital impact of the Day 1 adjustment to the allowance for credit losses (after-tax) upon the January 1, 2020 CECL adoption date has been deferred and will phase in to regulatory capital at 25% per year commencing January 1, 2022. For the ongoing impact of CECL, we were allowed to defer the regulatory capital impact of the allowance for credit losses in an amount equal to 25% of the change in the allowance for credit losses (pre-tax) recognized through earnings for each period between January 1, 2020, and December 31, 2021. The cumulative adjustment to the allowance for credit losses between January 1, 2020, and December 31, 2021, was also phased in to regulatory capital at 25% per year commencing January 1, 2022.

Basel III Capital Rules

Under the Basel III Rules, the current minimum capital ratios, including an additional capital conservation buffer (2.5%) applicable to the Company and the Bank, are:

•
7.0% CET1 to risk-weighted assets;

•
8.5% Tier 1 capital (that is, CET1 plus Additional Tier 1 capital) to risk-weighted assets; and

•
10.5% Total capital (that is, Tier 1 capital plus Tier 2 capital) to risk-weighted assets.

As of December 31, 2024, the Company’s capital levels remained characterized as “well-capitalized” under the Basel III rules, including the additional capital conservation buffer.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

CRITICAL ACCOUNTING ESTIMATES

Our consolidated financial statements are prepared in accordance with GAAP and are consistent with predominant practices in the financial services industry. Application of critical accounting policies, which are those policies that management believes are the most important to our financial position and results, requires management to make estimates, assumptions, and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes and are based on information available as of the date of the financial statements. Future changes in information may affect these estimates, assumptions and judgments, which, in turn, may affect amounts reported in the financial statements.

We have numerous accounting policies, of which the most significant are presented in Note 1, Summary of Significant Accounting Policies, of the notes to consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes and, in this discussion, provide information on how significant assets, liabilities, revenues and expenses are reported in the consolidated financial statements and how those reported amounts are determined. Based on the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has determined that the accounting policy with respect to the allowance for credit losses requires particularly subjective or complex judgments important to our financial position and results of operations, and, as such, is considered to be a critical accounting estimate as discussed below.

Adequacy of the Allowance for Credit Losses

The allowance for credit losses represents management’s estimate of probable credit losses inherent in the loan portfolio, and consists of an allowance for credit losses for pooled loans and a specific reserve for individually evaluated loans. Management estimates the allowance for credit losses for pooled loans utilizing a Discounted Cash Flow (“DCF”) method. The DCF method implements a probability of default with loss given default and exposure at default estimation. The probability of default and loss given default are applied to future cash flows that are adjusted to present value and these discounted expected losses become the allowance for credit losses. In the analysis at the portfolio level, we found that the best model for predicting defaults considers the national unemployment rate. With the large number of observations afforded by using peer data, the default curve is less sensitive to unusual loss events and has a much smoother shape. The national unemployment rate is an extremely strong predictor of defaults and explains almost all variation in the default rate. Excluded from the pooled analysis are loans to be individually evaluated due to the assets not maintaining similar risk characteristics to those included in pooled loans. These loans are generally considered to be collateral dependent and, therefore, an analysis of the collateral position versus the pooled loan discounted cash flow approach better reflects the potential loss. Individually evaluated accounts include: loans over 90 days past due, loans placed on non-accrual status and classified assets with exposure greater than $2.0 million.

Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and the use of subjective measurements including, but not limited to, management’s assessment of the internal risk classifications of loans, estimating future losses utilizing current forecasts, forward-looking estimates of qualitative factors including national and local economic trends and conditions (excluding national unemployment), levels and trends in delinquencies, non-accrual loans and classified assets, trends in volume, terms and concentrations of loans, changes in lending policies and procedures, quality of credit review function and administration and changes in the regulatory environment, management, markets and product offerings. Because current economic conditions and borrower strength can change, and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the appropriateness of the allowance for credit losses, could change significantly. Management will periodically assess what adjustments are necessary to qualitatively adjust the allowance for credit losses based on their assessment of current expected credit losses. Various regulatory agencies also review the allowance for credit losses as an integral part of their examination process. Such agencies may require additions to the allowance for credit losses or may require that certain loan balances be charged off or downgraded into criticized loan categories when their credit evaluations differ from those of management, based on their judgments about information available to them at the time of their examination. We believe the level of the allowance for credit losses is appropriate as recorded in the consolidated financial statements. As future events cannot be determined with precision, actual results could differ significantly from our estimates.

For additional discussion related to our accounting policies for the allowance for credit losses, see the sections titled “Allowance for Credit Losses” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 1, Summary of Significant Accounting Policies, of the notes to consolidated financial statements.

RECENT ACCOUNTING PRONOUNCEMENTS

See Note 1, Summary of Significant Accounting Policies – Recent Accounting Pronouncements, in the notes to consolidated financial statements for a discussion of recent accounting pronouncements.

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