Western New England Bancorp, Inc. (WNEB) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion should be read
in conjunction with the Company’s Consolidated Financial Statements and notes thereto, each appearing elsewhere in this Annual
Report on Form 10-K. Management’s discussion focuses on 2023 results compared to 2022. For a discussion of 2022 results compared
to 2021, refer to Part II, Item 7 of our Annual Report filed on Form 10-K, which was filed with the SEC on March 10, 2023.
Overview.
We strive to remain a leader in meeting
the financial service needs of the local community and to provide quality service to the individuals and businesses in the market
areas that we have served since 1853. Historically, we have been a community-oriented provider of traditional banking products
and services to business organizations and individuals, including products such as residential and commercial real estate loans,
consumer loans and a variety of deposit products. We meet the needs of our local community through a community-based and service-oriented
approach to banking.
We have adopted a growth-oriented strategy
that continues to focus on increasing commercial lending and residential lending. Our strategy also calls for increasing deposit
relationships, specifically core deposits, and broadening our product lines and services. We believe that this business strategy
is best for our long-term success and viability, and complements our existing commitment to high quality customer service.
In connection with our overall growth strategy,
we seek to:
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Increase market share and achieve scale to improve the Company’s profitability and efficiency and return value to shareholders; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Grow the Company’s commercial loan portfolio and related commercial deposits by targeting businesses in our primary market area of Hampden County and Hampshire County in western Massachusetts and Hartford and Tolland Counties in northern Connecticut to increase the net interest margin and loan income; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Supplement the commercial portfolio by growing the residential real estate portfolio to diversify the loan portfolio and deepen customer relationships; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Focus on expanding our retail banking deposit franchise and increase the number of households served within our designated market area; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Invest in people, systems and technology to grow revenue, improve efficiency and enhance the overall customer experience; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Grow revenues, increase book value per share and tangible book value, pay competitive dividends to shareholders and utilize the Company’s stock repurchase plan to leverage our capital and enhance franchise value; and |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Consider growth through acquisitions. We may pursue expansion opportunities in existing or adjacent strategic locations with companies that add complementary products to our existing business and at terms that add value to our existing shareholders. |
You should read the following financial
results for the year ended December 31, 2023 in the context of this strategy.
57
For the twelve months ended December 31,
2023, net income was $15.1 million, or $0.70 diluted earnings per share, compared to net income of $25.9 million, or $1.18 diluted
earnings per share, for the twelve months ended December 31, 2022. The results for the twelve months ended December 31, 2023 showed
decreases in net interest income and non-interest income, as well as increases in non-interest expense and the provision for credit
losses.
During the twelve months ended December
31, 2023, net interest income decreased $11.3 million, or 14.3%, to $67.9 million, compared to $79.2 million for the twelve months
ended December 31, 2022. The decrease in net interest income was due to an increase in interest expense of $26.5 million, partially
offset by an increase in interest and dividend income of $15.2 million, or 17.7%.
During the twelve months ended December
31, 2023, the Company recorded a provision for credit losses of $872,000 under the CECL model, compared to a provision for credit
losses of $700,000 during the twelve months ended December 31, 2022 under the incurred loss model. The increase in reserves was
primarily due to changes in the economic environment and related adjustments to the quantitative components of the CECL methodology.
General.
Our consolidated results
of operations depend primarily on net interest and dividend income. Net interest and dividend income is the difference between
the interest income earned on interest-earning assets and the interest paid on interest-bearing liabilities. Interest-earning assets
consist primarily of commercial real estate loans, commercial and industrial loans, residential real estate loans and securities.
Interest-bearing liabilities consist primarily of time deposits and money market accounts, demand deposits, savings accounts and
borrowings from the FHLB. The consolidated results of operations also depend on the provision for loan losses, non-interest income,
and non-interest expense. Non-interest income includes service fees and charges, income on bank-owned life insurance, gains on
sales of mortgages, gains on non-marketable equity investments and gains (losses) on securities. Non-interest expense includes
salaries and employee benefits, occupancy expenses, data processing, advertising expense, FDIC insurance assessment, professional
fees and other general and administrative expenses.
Critical Accounting
Policies.
Our accounting policies
are disclosed in Note 1 to our consolidated financial statements. Given our current business strategy and asset/liability structure,
the more critical policy is the allowance for credit losses and provision for credit losses. In addition to the informational disclosure
in the notes to the consolidated financial statements, our policy on this accounting policy is described in detail in the applicable
sections of “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Senior
management has discussed the development and selection of this accounting policy and the related disclosures with the Audit Committee
of our Board of Directors.
The process of evaluating the loan portfolio,
classifying loans and determining the allowance and provision is described in detail in Part I under “Business –
Lending Activities - Allowance for Credit Losses.” On January 1, 2023, the Company adopted ASU 2016-13 Financial Instruments
– Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, as amended, which replaces the incurred
loss methodology with an expected loss methodology that is referred to as CECL methodology. The measurement of expected credit
losses under the CECL methodology is applicable to financial assets measured at amortized cost, including loan receivables and
HTM debt securities. In addition, ASC 326 made changes to the accounting for AFS debt securities.
The Company adopted ASC 326 using the modified
retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting
periods beginning January 1, 2023 are presented under ASC 326 while prior period amounts continue to be reported in accordance
with previously applicable GAAP. The Company recorded a net increase to retained earnings of $9,000 as of January 1, 2023 for the
cumulative effect of adopting ASC 326, which includes a net deferred tax liability of $4,000. The transition adjustment includes
a $1.2 million increase to the allowance for credit losses and the recording of a $918,000 allowance for credit losses on off-balance
sheet credit exposures.
The allowance for credit losses is an estimate
of expected losses inherent within the Company's existing loans held for investment portfolio. The allowance for credit losses
for loans held for investment, as reported in our consolidated balance sheet, is adjusted by a credit loss expense, which is reported
in earnings, and reduced by the charge-off of loan amounts, net of recoveries. Accrued interest receivable on loans held for investment
was $7.5 million at December 31, 2023 and is excluded from the estimate of credit losses.
58
This evaluation is inherently subjective
as it requires material estimates that may be susceptible to significant change. The credit loss estimation process involves procedures
to appropriately consider the unique characteristics of loan portfolio segments, which consist of commercial real estate loans,
residential real estate loans, commercial and industrial loans, and consumer loans. These segments are further disaggregated into
loan classes, the level at which credit risk is monitored. For each of these pools, the Company generates cash flow projections
at the instrument level wherein payment expectations are adjusted for estimated prepayment speed, curtailments, time to recovery,
probability of default, and loss given default. The modeling of expected prepayment speeds, curtailment rates, and time to recovery
are based on historical internal data. The quantitative component of the ACL on loans is model-based and utilizes a forward-looking
macroeconomic forecast. The Company uses a discounted cash flow method, incorporating probability of default and loss given default
forecasted based on statistically derived economic variable loss drivers, to estimate expected credit losses. This process includes
estimates which involve modeling loss projections attributable to existing loan balances, and considering historical experience,
current conditions, and future expectations for pools of loans over a reasonable and supportable forecast period. The historical
information either experienced by the Company or by a selection of peer banks, when appropriate, is derived from a combination
of recessionary and non-recessionary performance periods for which data is available.
Although management believes
it has established and maintained the allowance for credit losses at adequate levels for the current economic environment and supportable
forecast period, if management’s assumptions and judgments prove to be incorrect due to changes in the economic environment
and related adjustments to the quantitative components of the CECL methodology, and the allowance for credit losses is not adequate
to absorb forecasted losses, our earnings and capital could be significantly and adversely affected.
Analysis of Net Interest Income.
The Company’s earnings are largely
dependent on its net interest income, which is the difference between interest earned on loans and investments and the cost of
funding (primarily deposits and borrowings). Net interest income expressed as a percentage of average interest-earning assets is
referred to as net interest margin. For more information regarding the Company’s use of Non-GAAP financial measures see “Explanation
of Use of Non-GAAP Financial Measurements.”
Average Balance Sheet.
The following table sets forth information
relating to the Company for the years ended December 31, 2023, 2022 and 2021. The average yields and costs are derived by dividing
interest income or interest expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively,
for the periods shown. Average balances are derived from average daily balances. The yields include fees which are considered adjustments
to yields. Loan interest and yield data does not include any accrued interest from non-accruing loans.
59
| For the Years Ended December 31, | ||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2023 | 2022 | 2021 | ||||||||||||||||||||||||||||||||||
| Average | Average Yield/ | Average | Average Yield/ | Average | Average Yield/ | |||||||||||||||||||||||||||||||
| Balance | Interest | Cost | Balance | Interest | Cost | Balance | Interest | Cost | ||||||||||||||||||||||||||||
| (Dollars in thousands) | ||||||||||||||||||||||||||||||||||||
| ASSETS: | ||||||||||||||||||||||||||||||||||||
| Interest-earning assets | ||||||||||||||||||||||||||||||||||||
| Loans(1)(2) | $ | 2,006,166 | $ | 91,640 | 4.57 | % | $ | 1,953,527 | $ | 77,758 | 3.98 | % | $ | 1,887,926 | $ | 74,620 | 3.95 | % | ||||||||||||||||||
| Securities(2) | 368,201 | 8,371 | 2.27 | 407,444 | 8,299 | 2.04 | 319,778 | 5,398 | 1.69 | |||||||||||||||||||||||||||
| Other investments - at cost | 12,425 | 558 | 4.49 | 10,289 | 177 | 1.72 | 10,242 | 115 | 1.12 | |||||||||||||||||||||||||||
| Short-term investments(3) | 20,459 | 1,021 | 4.99 | 25,712 | 191 | 0.74 | 111,931 | 139 | 0.12 | |||||||||||||||||||||||||||
| Total interest-earning assets | 2,407,251 | 101,590 | 4.22 | 2,396,972 | 86,425 | 3.61 | 2,329,877 | 80,272 | 3.45 | |||||||||||||||||||||||||||
| Total non-interest-earning assets | 155,511 | 152,941 | 147,980 | |||||||||||||||||||||||||||||||||
| Total assets | $ | 2,562,762 | $ | 2,549,913 | $ | 2,477,857 | ||||||||||||||||||||||||||||||
| LIABILITIES AND EQUITY: | ||||||||||||||||||||||||||||||||||||
| Interest-bearing liabilities | ||||||||||||||||||||||||||||||||||||
| Interest-bearing checking accounts | $ | 142,005 | 1,041 | 0.73 | $ | 139,993 | 530 | 0.38 | $ | 109,648 | 399 | 0.36 | ||||||||||||||||||||||||
| Savings accounts | 202,354 | 181 | 0.09 | 222,267 | 161 | 0.07 | 205,394 | 154 | 0.07 | |||||||||||||||||||||||||||
| Money market accounts | 697,621 | 9,529 | 1.37 | 890,763 | 3,187 | 0.36 | 776,725 | 2,412 | 0.31 | |||||||||||||||||||||||||||
| Time deposits | 524,827 | 15,898 | 3.03 | 363,258 | 1,474 | 0.41 | 477,067 | 2,543 | 0.53 | |||||||||||||||||||||||||||
| Total interest-bearing deposits | 1,566,807 | 26,649 | 1.70 | 1,616,281 | 5,352 | 0.33 | 1,568,834 | 5,508 | 0.35 | |||||||||||||||||||||||||||
| Short-term borrowings and long-term debt | 135,532 | 6,560 | 4.84 | 31,556 | 1,344 | 4.26 | 38,294 | 1,164 | 3.04 | |||||||||||||||||||||||||||
| Interest-bearing liabilities | 1,702,339 | 33,209 | 1.95 | 1,647,837 | 6,696 | 0.41 | 1,607,128 | 6,672 | 0.42 | |||||||||||||||||||||||||||
| Non-interest-bearing deposits | 602,652 | 647,971 | 608,936 | |||||||||||||||||||||||||||||||||
| Other non-interest-bearing liabilities | 24,885 | 35,615 | 39,108 | |||||||||||||||||||||||||||||||||
| Total non-interest-bearing liabilities | 627,537 | 683,586 | 648,044 | |||||||||||||||||||||||||||||||||
| Total liabilities | 2,329,876 | 2,331,423 | 2,255,172 | |||||||||||||||||||||||||||||||||
| Total equity | 232,886 | 218,490 | 222,685 | |||||||||||||||||||||||||||||||||
| Total liabilities and equity | $ | 2,562,762 | $ | 2,549,913 | $ | 2,477,857 | ||||||||||||||||||||||||||||||
| Less: Tax-equivalent adjustment(2) | (472 | ) | (497 | ) | (424 | ) | ||||||||||||||||||||||||||||||
| Net interest and dividend income | $ | 67,909 | $ | 79,232 | $ | 73,177 | ||||||||||||||||||||||||||||||
| Net interest rate spread(4) | 2.25 | % | 3.18 | % | 3.01 | % | ||||||||||||||||||||||||||||||
| Net interest rate spread, on a tax-equivalent basis(5) | 2.27 | % | 3.20 | % | 3.03 | % | ||||||||||||||||||||||||||||||
| Net interest margin(6) | 2.82 | % | 3.31 | % | 3.14 | % | ||||||||||||||||||||||||||||||
| Net interest margin, on a tax-equivalent basis(7) | 2.84 | % | 3.33 | % | 3.16 | % | ||||||||||||||||||||||||||||||
| Ratio of average interest-earning assets to average interest-bearing liabilities | 141.41 | % | 145.46 | % | 144.97 | % |
60
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| (1) | Loans, including nonaccrual loans, are net of deferred loan origination costs and unadvanced funds. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| (2) | Loan and securities income are presented on a tax-equivalent basis using a tax rate of 21% for 2023, 2022 and 2021. The tax-equivalent adjustment is deducted from tax-equivalent net interest and dividend income to agree to the amount reported on the consolidated statements of net income. See “Explanation of Use of Non-GAAP Financial Measurements”. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| (3) | Short-term investments include federal funds sold. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| (4) | Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| (5) | Net interest rate spread, on a tax-equivalent basis, represents the difference between the tax-equivalent weighted average yield on interest-earning assets and the tax-equivalent weighted average cost of interest-bearing liabilities. See “Explanation of Use of Non-GAAP Financial Measurements”. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| (6) | Net interest margin represents net interest and dividend income as a percentage of average interest-earning assets. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| (7) | Net interest margin, on a tax-equivalent basis, represents tax-equivalent net interest and dividend income as a percentage of average interest-earning assets. See “Explanation of Use of Non-GAAP Financial Measurements”. |
61
Rate/Volume Analysis.
The following table shows
how changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected
our interest and dividend income and interest expense during the periods indicated. Information is provided in each category with
respect to: (1) interest income changes attributable to changes in volume (changes in volume multiplied by prior rate); (2) interest
income changes attributable to changes in rate (changes in rate multiplied by prior volume); and (3) the net change.
The changes attributable
to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due
to rate.
| Year Ended December 31, 2023 Compared to Year Ended December 31, 2022 | Year Ended December 31, 2022 Compared to Year Ended December 31, 2021 | |||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Increase (Decrease) Due to | Increase (Decrease) Due to | |||||||||||||||||||||||
| Volume | Rate | Net | Volume | Rate | Net | |||||||||||||||||||
| Interest-earning assets | (In thousands) | (In thousands) | ||||||||||||||||||||||
| Loans (1) | $ | 2,095 | $ | 11,787 | $ | 13,882 | $ | 2,593 | $ | 545 | $ | 3,138 | ||||||||||||
| Investment securities (1) | (799 | ) | 871 | 72 | 1,480 | 1,421 | 2,901 | |||||||||||||||||
| Other investments - at cost | 37 | 344 | 381 | 1 | 60 | 61 | ||||||||||||||||||
| Short-term investments | (39 | ) | 869 | 830 | (107 | ) | 159 | 52 | ||||||||||||||||
| Total interest-earning assets | 1,294 | 13,871 | 15,165 | 3,967 | 2,185 | 6,152 | ||||||||||||||||||
| Interest-bearing liabilities | ||||||||||||||||||||||||
| Interest-bearing checking accounts | 8 | 503 | 511 | 110 | 21 | 131 | ||||||||||||||||||
| Savings accounts | (14 | ) | 34 | 20 | 13 | (6 | ) | 7 | ||||||||||||||||
| Money market accounts | (691 | ) | 7,033 | 6,342 | 354 | 421 | 775 | |||||||||||||||||
| Time deposits | 656 | 13,768 | 14,424 | (607 | ) | (462 | ) | (1,069 | ) | |||||||||||||||
| Short-term borrowing and long-term debt | 4,428 | 788 | 5,216 | (205 | ) | 385 | 180 | |||||||||||||||||
| Total interest-bearing liabilities | 4,387 | 22,126 | 26,513 | (335 | ) | 359 | 24 | |||||||||||||||||
| Change in net interest and dividend income | $ | (3,093 | ) | $ | (8,255 | ) | $ | (11,348 | ) | $ | 4,302 | $ | 1,826 | $ | 6,128 |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| (1) | Securities and loan income and net interest income are presented on a tax-equivalent basis using a tax rate of 21% for 2023, 2022 and 2021. The tax-equivalent adjustment is deducted from tax-equivalent net interest income to agree to the amount reported in the consolidated statements of net income. See “Explanation of Use of Non-GAAP Financial Measurements.” |
62
Explanation of Use of Non-GAAP Financial
Measurements.
We believe that it is common practice in
the banking industry to present interest income and related yield information on tax-exempt loans and securities on a tax-equivalent
basis and that such information is useful to investors because it facilitates comparisons among financial institutions. However,
the adjustment of interest income and yields on tax-exempt loans and securities to a tax-equivalent amount is considered a non-GAAP
financial measure. A reconciliation from GAAP to non-GAAP is provided below.
| For the twelve months ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 12/31/2023 | 12/31/2022 | 12/31/2021 | ||||||||||
| (In thousands) | ||||||||||||
| Loans (no tax adjustment) | $ | 91,169 | $ | 77,264 | $ | 74,200 | ||||||
| Tax-equivalent adjustment (1) | 471 | 494 | 420 | |||||||||
| Loans (tax-equivalent basis) | $ | 91,640 | $ | 77,758 | $ | 74,620 | ||||||
| Securities (no tax adjustment) | $ | 8,370 | $ | 8,296 | $ | 5,394 | ||||||
| Tax-equivalent adjustment (1) | 1 | 3 | 4 | |||||||||
| Securities (tax-equivalent basis) | $ | 8,371 | $ | 8,299 | $ | 5,398 | ||||||
| Net interest income (no tax adjustment) | $ | 67,909 | $ | 79,232 | $ | 73,177 | ||||||
| Tax equivalent adjustment (1) | 472 | 497 | 424 | |||||||||
| Net interest income (tax-equivalent basis) | $ | 68,381 | $ | 79,729 | $ | 73,601 | ||||||
| Net interest income (no tax adjustment) | $ | 67,909 | $ | 79,232 | $ | 73,177 | ||||||
| Less: | ||||||||||||
| Purchase accounting adjustments | (50 | ) | 175 | (55 | ) | |||||||
| Prepayment penalties and fees | 64 | 281 | 181 | |||||||||
| PPP fee income | 99 | 728 | 6,769 | |||||||||
| Adjusted net interest income (non-GAAP) | $ | 67,796 | $ | 78,048 | $ | 66,282 | ||||||
| Average interest-earning assets | $ | 2,407,251 | $ | 2,396,972 | $ | 2,329,877 | ||||||
| Average interest-earnings asset, excluding average PPP loans | $ | 2,405,525 | $ | 2,391,252 | $ | 2,219,286 | ||||||
| Net interest margin (no tax adjustment) | 2.82 | % | 3.31 | % | 3.14 | % | ||||||
| Net interest margin, tax-equivalent | 2.84 | % | 3.33 | % | 3.16 | % | ||||||
| Adjusted net interest margin, excluding purchase accounting adjustments, PPP fee income and prepayment penalties (non-GAAP) | 2.82 | % | 3.26 | % | 2.99 | % |
63
| At or for the twelve months ended | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 12/31/2023 | 12/31/2022 | 12/31/2021 | ||||||||||
| (In thousands) | ||||||||||||
| Book Value per Share (GAAP) | $ | 10.96 | $ | 10.27 | $ | 9.87 | ||||||
| Non-GAAP adjustments: | ||||||||||||
| Goodwill | (0.58 | ) | (0.56 | ) | (0.55 | ) | ||||||
| Core deposit intangible | (0.08 | ) | (0.10 | ) | (0.11 | ) | ||||||
| Tangible Book Value per Share (non-GAAP) | $ | 10.30 | $ | 9.61 | $ | 9.21 | ||||||
| Income Before Income Taxes (GAAP) | $ | 19,584 | $ | 34,629 | $ | 31,724 | ||||||
| Non-GAAP adjustments: | ||||||||||||
| Provision for (reversal of) credit losses | 872 | 700 | (925 | ) | ||||||||
| PPP Income | (99 | ) | (728 | ) | (6,769 | ) | ||||||
| Gain on bank-owned life insurance death benefit | (778 | ) | - | — | ||||||||
| Loss (gain) on defined benefit plan termination | 1,143 | (2,807 | ) | — | ||||||||
| Income Before Taxes, Provision, PPP Income, Bank-Owned Life Insurance Death Benefit and Defined Benefit Termination (non-GAAP) | $ | 20,722 | $ | 31,794 | $ | 24,030 | ||||||
| Adjusted Efficiency Ratio: | ||||||||||||
| Non-interest Expense (GAAP) | $ | 58,350 | $ | 57,235 | $ | 54,942 | ||||||
| Non-GAAP adjustments: | ||||||||||||
| Loss on prepayment of borrowings | — | — | (45 | ) | ||||||||
| Non-interest Expense for Adjusted Efficiency Ratio (non-GAAP) | $ | 58,350 | $ | 57,235 | $ | 54,897 | ||||||
| Net Interest Income (GAAP) | $ | 67,909 | $ | 79,232 | $ | 73,177 | ||||||
| Non-interest Income (GAAP) | $ | 10,897 | $ | 13,332 | $ | 12,564 | ||||||
| Non-GAAP adjustments: | ||||||||||||
| Loss on disposal of premises and equipment | 3 | — | — | |||||||||
| Loss on securities, net | — | 4 | 72 | |||||||||
| Unrealized losses on marketable equity securities | 1 | 717 | 168 | |||||||||
| Loss on interest rate swap termination | — | — | 402 | |||||||||
| Gain on bank-owned life insurance death benefit | (778 | ) | — | — | ||||||||
| Gain on non-marketable equity investments | (590 | ) | (422 | ) | (898 | ) | ||||||
| Loss (gain) on defined benefit plan termination | 1,143 | (2,807 | ) | — | ||||||||
| Non-interest Income for Adjusted Efficiency Ratio (non-GAAP) | $ | 10,676 | $ | 10,824 | $ | 12,308 | ||||||
| Total Revenue for Adjusted Efficiency Ratio (non-GAAP) | $ | 78,585 | $ | 90,056 | $ | 85,485 | ||||||
| Efficiency Ratio (GAAP) | 74.04 | % | 61.83 | % | 64.08 | % | ||||||
| Adjusted Efficiency Ratio (Non-interest Expense for Adjusted Efficiency Ratio (non-GAAP)/Total Revenue for Adjusted Efficiency Ratio (non-GAAP)) | 74.25 | % | 63.55 | % | 64.64 | % |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| (1) | The tax equivalent adjustment is based upon a 21% tax rate for 2023, 2022 and 2021. |
64
Comparison of Financial Condition at
December 31, 2023 and December 31, 2022.
At December 31, 2023, total assets were
$2.6 billion, an increase of $11.4 million, or 0.4%, from December 31, 2022. The balance sheet composition and changes since December
31, 2022 are discussed below.
Cash and Cash Equivalents.
Cash and cash equivalents is comprised
of cash on hand and amounts due from banks, interest-earning deposits in other financial institutions and federal funds sold. Cash
and cash equivalents totaled $28.8 million, or 1.1% of total assets, at December 31, 2023 and $30.3 million, or 1.2% of total assets,
at December 31, 2022. Balances in cash and cash equivalents will fluctuate due primarily to the timing of net deposit flows, borrowing
and loan inflows and outflows, investment purchases and maturities, calls and sales proceeds, and the immediate liquidity needs
of the Company.
Investments.
At December 31, 2023, the AFS and HTM securities
portfolio represented 14.1% of total assets compared to 14.8% at December 31, 2022. At December 31, 2023, the Company’s AFS
securities portfolio, recorded at fair market value, decreased $9.9 million, or 6.7%, from $147.0 million at December 31, 2022
to $137.1 million. The HTM securities portfolio, recorded at amortized cost, decreased $6.8 million, or 3.0%, from $230.2 million
at December 31, 2022 to $223.4 million at December 31, 2023. The marketable equity securities portfolio decreased $6.0 million,
or 96.9%, from $6.2 million at December 31, 2022 to $196,000 at December 31, 2023. The decrease in the AFS and HTM securities portfolios
was primarily due to amortization and payoffs recorded during the twelve months ended December 31, 2023.
At December 31, 2023, the Company reported
unrealized losses on the AFS securities portfolio of $29.2 million, or 17.5% of the amortized cost basis of the AFS securities
portfolio, compared to unrealized losses of $32.2 million, or 18.0% of the amortized cost basis of the AFS securities at December
31, 2022. At December 31, 2023, the Company reported unrealized losses on the HTM securities portfolio of $35.7 million, or 16.0%,
of the amortized cost basis of the HTM securities portfolio, compared to $39.2 million, or 17.0% of the amortized cost basis of
the HTM securities portfolio at December 31, 2022.
The Bank is required to purchase FHLB stock
at par value in association with advances from the FHLB. The stock is classified as a restricted investment and carried at cost
which management believes approximates fair value. The Company’s investment in FHLB capital stock amounted to $3.2 million
and $2.9 million at December 31, 2023 and December 31, 2022, respectively.
At December 31, 2023 and 2022, the Company
held $423,000 of Atlantic Community Bankers Bank stock. The stock is restricted and carried in other assets at cost. The stock
is evaluated for impairment based on an estimate of the ultimate recovery to the par value.
Loans.
At December 31, 2023, total loans increased
$35.9 million, or 1.8%, to $2.0 billion from December 31, 2022. Residential real estate loans, including home equity loans, increased
$27.1 million, or 3.9%, commercial real estate loans increased $10.4 million, or 1.0%, and commercial and industrial loans decreased
$2.4 million, or 1.1%.
Bank-Owned Life Insurance ("BOLI").
The Company indirectly utilizes the earnings
on BOLI to offset the cost of the Company’s benefit plans. The cash surrender value of BOLI was $75.1 million and $74.6 million
at December 31, 2023 and 2022, respectively.
Deposits.
At December 31, 2023, total deposits decreased
$85.7 million, or 3.8%, from December 31, 2022, to $2.1 billion at December 31, 2023, due to industry-wide pressures and a competitive
market for deposits. Core deposits, which the Company defines as all deposits except time deposits, decreased $285.4 million, or
15.7%, from $1.8 billion, or 81.5% of total deposits, at December 31, 2022, to $1.5 billion, or 71.5% of total deposits, at December
31, 2023. Money market accounts decreased $166.7 million, or 20.8%, to $634.4 million, non-interest-bearing deposits decreased
$65.9 million, or 10.2%, to $579.6 million, savings accounts decreased $35.0 million, or 15.7%, to $187.4 million and interest-bearing
checking accounts decreased $17.7 million, or 11.9%, to $131.0 million. Time deposits increased $199.7 million, or 48.5%, from
$411.7 million at December 31, 2022 to $611.4 million at December 31, 2023. Brokered time deposits, which are included in time
deposits, totaled $1.7 million at December 31, 2023. The Company did not have any brokered deposits at December 31, 2022. At December
31, 2023, the Bank’s uninsured deposits represented 26.8% of total deposits, compared to 30.8% at December 31, 2022.
65
Borrowed Funds.
At December 31, 2023, total borrowings
increased $94.3 million, or 151.5%, from $62.2 million at December 31, 2022 to $156.5 million. Short-term borrowings decreased
$25.3 million, or 61.1%, to $16.1 million, compared to $41.4 million at December 31, 2022. Long-term borrowings increased $119.5
million, from $1.2 million at December 31, 2022, to $120.6 million at December 31, 2023, to replace deposit attrition. Long-term
borrowings consisted of $30.6 million outstanding with the FHLB and $90.0 million outstanding under the FRB’s BTFP. At December
31, 2023, borrowings also consisted of $19.7 million in fixed-to-floating rate subordinated notes.
Shareholders’ Equity.
At December 31, 2023, shareholders’
equity was $237.4 million, or 9.3% of total assets, compared to $228.1 million, or 8.9% of total assets, at December 31, 2022.
The increase was primarily attributable to net income of $15.1 million, partially offset by a decrease in accumulated other comprehensive
loss of $3.3 million, $5.0 million for the repurchase of common stock and cash dividends paid of $6.1 million. At December 31,
2023, total shares outstanding were 21,666,807.
The Company’s book value per share
was $10.96 at December 31, 2023 compared to $10.27 at December 31, 2022, while tangible book value per share, a non-GAAP financial
measure, increased $0.69, or 7.2%, from $9.61 at December 31, 2022 to $10.30 at December 31, 2023. The Company had no incurred
credit losses in its investment portfolio in 2023 or 2022. Tangible book value is a Non-GAAP measure. For more information regarding
the Company’s use of Non-GAAP financial measures see “Explanation of Use of Non-GAAP Financial Measurements.”
As of December 31, 2023, the Company’s and the Bank’s regulatory capital ratios continued to exceed the levels required
to be considered “well-capitalized” under federal banking regulations.
Pension Plan.
The Board of Directors previously announced
the termination of the Westfield Bank Defined Benefit Plan (the “DB Plan”) on October 31, 2022, subject to required
regulatory approval. At December 31, 2022, the Company reversed $7.3 million in net unrealized losses recorded in accumulated other
comprehensive income attributed to both the DB Plan curtailment resulting from the termination of the DB Plan as well as changes
in discount rates. In addition, during the three months ended December 31, 2022, the Company recorded a gain on curtailment of
$2.8 million through non-interest income. During the twelve months ended December 31, 2023, the Company made an additional cash
contribution of $1.3 million in order to fully fund the DB Plan on a plan termination basis. In addition, for those participants
who did not opt for a one-time lump sum payment, the Company funded $6.3 million to purchase a group annuity contract to transfer
its remaining liabilities under the DB Plan. During the twelve months ended December 31, 2023, the Company recognized the final
termination expense of $1.1 million related to the DB Plan termination, which was recorded through non-interest income.
Assets under Management.
Total assets under management include loans
serviced for others and investment assets under management. Loans serviced for others and investment assets under management are
not carried as assets on the Company's consolidated balance sheet, and as such, total assets under management is not a financial
measurement recognized under GAAP, however, management believes its disclosure provides information useful in understanding the
trends in total assets under management.
The Company provides a wide range of investment
advisory and wealth management services through Westfield Investment Services through LPL Financial, a third-party broker-dealer.
Investment assets under management increased $19.6 million, or 12.9%, to $172.1 million as of December 31, 2023, from $152.5 million
as of December 31, 2022.
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Comparison of Operating Results for
Years Ended December 31, 2023 and 2022.
General.
For the twelve months ended December 31,
2023, the Company reported net income of $15.1 million, or $0.70 per diluted share, compared to $25.9 million, or $1.18 per diluted
share, for the twelve months ended December 31, 2022. Return on average assets and return on average equity were 0.59% and 6.47%
for the twelve months ended December 31, 2023, respectively, compared to 1.02% and 11.85% for the twelve months ended December
31, 2022, respectively.
Net Interest
Income and Net Interest Margin.
During the twelve months ended December
31, 2023, net interest income decreased $11.3 million, or 14.3%, to $67.9 million, compared to $79.2 million for the twelve months
ended December 31, 2022. The decrease in net interest income was due to an increase in interest expense of $26.5 million, partially
offset by an increase in interest and dividend income of $15.2 million, or 17.7%.
The net interest margin for the twelve
months ended December 31, 2023 was 2.82%, compared to 3.31% during the twelve months ended December 31, 2022. The net interest
margin, on a tax-equivalent basis, was 2.84% for the twelve months ended December 31, 2023, compared to 3.33% for the twelve months
ended December 31, 2022.
The average yield on interest-earning assets,
without the impact of tax-equivalent adjustments, increased 62 basis points from 3.58% for the twelve months ended December 31,
2022 to 4.20% for the twelve months ended December 31, 2023. During the twelve months ended December 31, 2023, average interest-earning
assets increased $10.3 million, or 0.4%, to $2.4 billion compared to the twelve months ended December 31, 2022, primarily due to
an increase in average loans of $52.6 million, or 2.7%, and an increase in average other investments of $2.1 million, or 20.8%,
partially offset by a decrease in average securities of $39.2 million, or 9.6%, and a decrease in average short-term investments,
consisting of cash and cash equivalents, of $5.3 million, or 20.4%.
During the twelve months ended December
31, 2023, the average cost of funds, including non-interest-bearing demand accounts and borrowings, increased 115 basis points
from 0.29% for the twelve months ended December 31, 2022 to 1.44%. For the twelve months ended December 31, 2023, the average cost
of core deposits, including non-interest-bearing demand deposits, increased 45 basis points from 0.20% for the twelve months ended
December 31, 2022 to 0.65% for the twelve months ended December 31, 2023. The average cost of time deposits increased 262 basis
points from 0.41% for the twelve months ended December 31, 2022 to 3.03% during the same period in 2023. The average cost of borrowings,
which include FHLB advances and subordinated debt, increased 58 basis points from 4.26% for the twelve months ended December 31,
2022 to 4.84% for the twelve months ended December 31, 2023.
For the twelve months ended December 31,
2023, average demand deposits, an interest-free source of funds, decreased $45.3 million, or 7.0%, from $648.0 million, or 28.6%
of total average deposits, for the twelve months ended December 31, 2022, to $602.7 million, or 27.8% of total average deposits.
Provision for Credit Losses.
The credit loss estimation process involves
procedures to appropriately consider the unique characteristics of loan portfolio segments, which consist of commercial real estate
loans, residential real estate loans, commercial and industrial loans, and consumer loans. These segments are further disaggregated
into loan classes, the level at which credit risk is monitored. For each of these pools, the Company generates cash flow projections
at the instrument level wherein payment expectations are adjusted for estimated prepayment speed, curtailments, time to recovery,
probability of default, and loss given default. The modeling of expected prepayment speeds, curtailment rates, and time to recovery
are based on historical internal data. The quantitative component of the ACL on loans is model-based and utilizes a forward-looking
macroeconomic forecast. The Company uses a discounted cash flow method, incorporating probability of default and loss given default
forecasted based on statistically derived economic variable loss drivers, to estimate expected credit losses. This process includes
estimates which involve modeling loss projections attributable to existing loan balances, and considering historical experience,
current conditions, and future expectations for pools of loans over a reasonable and supportable forecast period. The historical
information either experienced by the Company or by a selection of peer banks, when appropriate, is derived from a combination
of recessionary and non-recessionary performance periods for which data is available.
67
During the twelve months ended December
31, 2023, the Company recorded a provision for credit losses of $872,000 under the CECL model, compared to a provision for credit
losses of $700,000 during the twelve months ended December 31, 2022 under the incurred loss model. The increase in reserves was
primarily due to changes in the economic environment and related adjustments to the quantitative components of the CECL methodology.
The Company recorded net charge-offs of
$2.0 million for the twelve months ended December 31, 2023, as compared to net charge-offs of $556,000 for the twelve months ended
December 31, 2022. The charge-offs for the twelve months ended December 31, 2023 were related to one commercial relationship acquired
on October 21, 2016 from Chicopee Bancorp, Inc., which was placed on nonaccrual status during the first quarter of 2023. The Company
recorded a $1.9 million charge-off on the relationship, which represented the non-accretable credit mark that was required to be
grossed-up to the loan’s amortized cost basis with a corresponding increase to the allowance for credit losses under CECL
implementation. At December 31, 2023, the Company had charged-off 61% of the total relationship and the remaining exposure of $940,000
is collateralized at this time.
Although management believes it has established
and maintained the allowance for credit losses at appropriate levels for the current economic environment and supportable forecast
period, future adjustments may be necessary if economic, real estate and other conditions differ substantially from the current
operating environment.
Non-Interest
Income.
For the twelve months ended December 31,
2023, non-interest income decreased $2.4 million, or 18.3%, from $13.3 million for the twelve months ended December 31, 2022 to
$10.9 million for the twelve months ended December 31, 2023. During the twelve months ended December 31, 2023, the Company recorded
a $1.1 million final termination expense related to the DB Plan termination, compared to a curtailment gain related to the DB Plan
termination of $2.8 million, during the twelve months ended December 31, 2022. The Company also recorded a non-taxable gain of
$778,000 on BOLI death benefits during the twelve months ended December 31, 2023. The Company did not have comparable income during
the twelve months ended December 31, 2022. Excluding the termination expense and the curtailment gain related to the DB Plan termination
and the BOLI death benefit, non-interest income increased $737,000, or 7.0%.
During the twelve months ended December
31, 2023, service charges and fees decreased $216,000, or 2.4%, primarily due to changes in the Company’s overdraft program
that were implemented in 2023. Income from BOLI increased $95,000, or 5.5%, from $1.7 million for the twelve months ended December
31, 2022 to $1.8 million for the twelve months ended December 31, 2023. Other income from loan-level swap fees on commercial loans
decreased $25,000 for the twelve months ended December 31, 2023. During the twelve months ended December 31, 2023, the Company
reported a gain of $590,000 on non-marketable equity investments compared to a gain of $422,000 during the twelve months ended
December 31, 2022. During the twelve months ended December 31, 2023, the Company reported a loss on the disposal of premises and
equipment of $3,000. The Company did not have comparable activity during the same period in 2022. During the twelve months ended
December 31, 2022, the Company also reported unrealized losses on marketable equity securities of $717,000, compared to unrealized
losses on marketable equity securities of $1,000 during the twelve months ended December 31, 2023. During the twelve months ended
December 31, 2022, the Company reported realized losses on the sale of securities of $4,000. The Company did not have a comparable
gain or loss during the same period in 2023.
Non-Interest
Expense.
For the twelve months ended December 31,
2023, non-interest expense increased $1.1 million, or 1.9%, to $58.4 million, compared to $57.2 million for the twelve months ended
December 31, 2022. The increase in non-interest expense was primarily due to an increase in other expense of $953,000, or 10.1%,
as a result of a $510,000 legal settlement accrual. During the three months ended December 31, 2023, the Company reached an agreement-in-principle
to settle purported class action lawsuits concerning the Company’s deposit products and related disclosures, specifically
involving overdraft fees and insufficient funds fees. This agreement-in-principle reflects our business decision to avoid the costs,
uncertainties and distractions of further litigation. Excluding the legal settlement accrual, non-interest expense increased $605,000,
or 1.1%, from $57.2 million, for the twelve months ended December 31, 2022 to $57.8 million for the twelve months ended December
31, 2023.
During the same period, FDIC insurance
expense increased $273,000, or 26.0%, data processing increased $272,000, or 9.4%, professional fees, which is comprised of legal
fees, audit and professional fees, increased $161,000, or 5.9%, due to the recent settlement of litigation, and advertising expense
increased $87,000, or 6.2%. These increases were partially offset by a decrease in salaries and employee benefits of $483,000,
or 1.5%, due to lower incentive compensation costs, occupancy expense decreased $76,000, or 1.5%, and furniture and equipment expense
decreased $72,000, or 3.6%.
68
For the twelve months ended December 31,
2023, the efficiency ratio was 74.0%, compared to 61.8% for the twelve months ended December 31, 2022. For the twelve months ended
December 31, 2023, the adjusted efficiency ratio, a non-GAAP financial measure, was 74.3%, compared to 63.6% for the twelve months
ended December 31, 2022. For more information regarding the Company’s use of Non-GAAP financial measures see “Explanation
of Use of Non-GAAP Financial Measurements.”
Income Taxes.
Income tax expense for the twelve months
ended December 31, 2023 was $4.5 million, with an effective tax rate of 23.1%, compared to $8.7 million, with an effective tax
rate of 25.2%, for twelve months ended December 31, 2022. The decrease in income tax expense for the twelve months ended December
31, 2023 compared to the twelve months December 31, 2022 was due to lower income before income taxes in 2023.
Liquidity and Capital
Resources.
The term “liquidity”
refers to our ability to generate adequate amounts of cash to fund loan originations, loan purchases, deposit withdrawals and operating
expenses. Our primary sources of liquidity are deposits, scheduled amortization and prepayments of loan principal and mortgage-backed
securities, maturities and calls of investment securities and funds provided by our operations. We also can borrow funds from the
FHLB based on eligible collateral of loans and securities. Our material cash commitments include funding loan originations, fulfilling
contractual obligations with third-party service providers, maintaining operating leases for certain of our Bank properties and
satisfying repayment of our long-term debt obligations.
Primary Sources
of Liquidity
The Company, on an ongoing
basis, closely monitors the Company’s liquidity position for compliance with internal policies, and believes that available
sources of liquidity are adequate to meet funding needs in the normal course of business. As part of that monitoring process,
the Company stresses the potential liabilities calculation to ensure a strong liquidity position. Included in the calculation
are assumptions of some significant deposit run-off as well as funds needed for loan closing and investment purchases. The
Company does not anticipate engaging in any activities, either currently or over the long-term, for which adequate funding would
not be available and which would therefore result in significant pressure on liquidity. However, an economic recession could
negatively impact the Company’s liquidity. The Bank relies heavily on FHLB as a source of funds, particularly with
its overnight line of credit. In past economic recessions, some FHLB branches have suspended dividends, cut dividend payments,
and not bought back excess FHLB stock that members hold in an effort to conserve capital. FHLB has stated that it expects
to be able to continue to pay dividends, redeem excess capital stock, and provide competitively priced advances in the future.
At December 31, 2023
and December 31, 2022, outstanding borrowings from the FHLB were $40.6 million and $36.2 million, respectively. At December 31,
2023, we had $535.6 million in available borrowing capacity with the FHLB. We have the ability to increase our borrowing capacity
with the FHLB by pledging investment securities or additional loans.
The Company has an available line of credit
of $48.6 million with the FRB Discount Window at an interest rate determined and reset on a daily basis. Borrowings from the FRB
Discount Window are secured by certain securities from the Company’s investment portfolio not otherwise pledged. As of December
31, 2023 and December 31, 2022, there were no advances outstanding under either of these lines.
On March 12, 2023, the FRB made available
the BTFP, which enhances the ability of banks to borrow greater amounts against certain high-quality, unencumbered investments
at par value. During the year ended December 31, 2023, the Company participated in the BTFP, which enabled the Company to pay off
higher rate FHLB advances. With the BTFP, the Company has the ability to pay off the BTFP advance prior to maturity without incurring
a penalty or termination fee.
69
At December 31, 2023, long-term debt included
$90.0 million in outstanding advances under the BTFP with a weighted average fixed rate of 4.71%. There were no advances outstanding
with the FRB under the BTFP at December 31, 2022. At December 31, 2023, the Company had $23.6 million in available borrowing capacity
under the BTFP.
In addition, we have available lines of
credit of $15.0 million and $10.0 million with other correspondent banks. Interest rates on these lines are determined and reset
on a daily basis by each respective bank. At December 31, 2023 and 2022, we did not have an outstanding balance under either of
these lines of credit. In addition, we may enter into reverse repurchase agreements with approved broker-dealers. Reverse repurchase
agreements are agreements that allow us to borrow money using our securities as collateral.
We also have outstanding at any time, a
significant number of commitments to extend credit and provide financial guarantees to third parties. These arrangements are subject
to strict credit control assessments. Guarantees specify limits to our obligations. Because many commitments and almost all guarantees
expire without being funded in whole or in part, the contract amounts are not estimates of future cash flows. We are also obligated
under agreements with the FHLB to repay borrowed funds and are obligated under leases for certain of our branches and equipment.
Maturing investment securities
are a relatively predictable source of funds. However, deposit flows, calls of securities and prepayments of loans and mortgage-backed
securities are strongly influenced by interest rates, general and local economic conditions and competition in the marketplace.
These factors reduce the predictability of the timing of these sources of funds.
The Company’s primary
activities are the origination of commercial real estate loans, commercial and industrial loans and residential real estate loans,
as well as and the purchase of mortgage-backed and other investment securities. During the year ended December 31, 2023, we originated
$225.6 million in loans, compared to $447.4 million in 2022. During the year ended December 31, 2023, total loans increased $35.9
million, or 1.8%, compared to an increase of $126.7 million, or 6.8%, for the year ended December 31, 2022. At December 31, 2023,
the Company had approximately $92.0 million in loan commitments and letters of credit to borrowers and approximately $352.5 million
in available home equity and other unadvanced lines of credit.
Deposit inflows and outflows
are affected by the level of interest rates, the products and interest rates offered by competitors and by other factors. At December
31, 2023, time deposit accounts scheduled to mature within one year totaled $596.3 million. Based on the Company’s deposit
retention experience and current pricing strategy, we anticipate that a significant portion of these time deposits will remain
on deposit. We monitor our liquidity position frequently and anticipate that it will have sufficient funds to meet our current
funding commitments for the next 12 months and beyond.
At December 31, 2023,
the Company and the Bank exceeded each of the applicable regulatory capital requirements (See Note 13, Regulatory Capital,
to our consolidated financial statements for further information on our regulatory requirements).
Material Cash Commitments
The Company entered into
a long-term contractual obligation with a vendor for use of its core provider and ancillary services beginning in 2016. Total remaining
contractual obligations outstanding with this vendor as of December 31, 2023 were estimated to be $11.6 million, with $5.4 million
expected to be paid within one year and the remaining $6.2 million to be paid within the next three years. Further, the Company
has operating leases for certain of its banking offices and ATMs. Our leases have remaining lease terms of less than one year to
fifteen years, some of which include options to extend the leases for additional five-year terms up to ten years. Undiscounted
lease liabilities totaled $9.9 million as of December 31, 2023. Principal payments expected to be made on our lease liabilities
during the twelve months ended December 31, 2024 were $1.5 million. The remaining lease liability payments totaled $8.4 million
and are expected to be made after December 31, 2024 (See Note 12, Leases, to our consolidated financial statements for further
information on our lease obligations).
In addition, the Company
completed an offering of $20 million in aggregate principal amount of its 4.875% fixed-to-floating rate subordinated notes (the
“Notes”) to certain qualified institutional buyers in a private placement transaction on April 20, 2021. Unless earlier
redeemed, the Notes mature on May 1, 2031. At December 31, 2022, $19.7 million aggregate principle amount of the Notes was outstanding.
The Notes will bear interest from the initial issue date to, but excluding, May 1, 2026, or the earlier redemption date, at a fixed
rate of 4.875% per annum, payable quarterly in arrears on May 1, August 1, November 1 and February 1 of each year, beginning August
1, 2021, and from and including May 1, 2026, but excluding the maturity date or earlier redemption date, equal to the benchmark
rate, which is the 90-day average secured overnight financing rate, plus 412 basis points, determined on the determination date
of the applicable interest period, payable quarterly in arrears on May 1, August 1, November 1 and February 1 of each year. The
Company may also redeem the Notes, in whole or in part, on or after May 1, 2026, and at any time upon the occurrence of certain
events, subject in each case to the approval of the Board of Governors of the Federal Reserve (See Note 8, Long-Term Debt,
to our consolidated financial statements for further information on our long-term debt).
70
We do not anticipate
any material capital expenditures during the calendar year 2024, except in pursuance of the Company’s strategic initiatives.
The Company does not have any balloon or other payments due on any long-term obligations or any off-balance sheet items other than
the commitments and unused lines of credit noted above.
Off-Balance Sheet
Arrangements.
The Company does not
have any off-balance sheet arrangements, other than noted above and in Note 16, Commitments and Contingencies, to our consolidated
financial statements, that have or are reasonably likely to have a current or future effect on our financial condition, changes
in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that
is material to investors.
Management of Market Risk.
As a
financial institution, our primary market risk is interest rate risk since substantially all transactions are denominated in U.S.
dollars with no direct foreign exchange or changes in commodity price exposure. Fluctuations in interest rates will affect both
our level of income and expense on a large portion of our assets and liabilities. Fluctuations in interest rates will also affect
the market value of all interest-earning assets and interest-bearing liabilities.
The Company’s interest rate management
strategy is to limit fluctuations in net interest income as interest rates vary up or down and control variations in the market
value of assets, liabilities and net worth as interest rates vary. We seek to coordinate asset and liability decisions so that,
under changing interest rate scenarios, net interest income will remain within an acceptable range.
In order to achieve the Company’s
objectives of managing interest rate risk, the Asset and Liability Management Committee (“ALCO”) meets periodically
to discuss and monitor the market interest rate environment relative to interest rates that are offered on our products. ALCO presents
quarterly reports to the Board of Directors which includes the Company’s interest rate risk position and liquidity position.
The Company’s primary
source of funds are deposits, consisting primarily of time deposits, money market accounts, savings accounts, demand accounts and
interest-bearing checking accounts, which have shorter terms to maturity than the loan portfolio. Several strategies have been
employed to manage the interest rate risk inherent in the asset/liability mix, including but not limited to:
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | maintaining the diversity of our existing loan portfolio through residential real estate loans, commercial and industrial loans and commercial real estate loans; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | emphasizing investments with an expected average duration of five years or less; and |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | when appropriate, using interest rate swaps to manage the interest rate position of the balance sheet. |
In 2022, cash flows from
deposit inflows were used to fund loan growth and purchase HTM and AFS securities. The Company continues its emphasis on growing
commercial loans, which typically have variable interest rates and shorter maturities than residential loans.
The actual amount of
time before loans are repaid can be significantly affected by changes in market interest rates. Prepayment rates will also vary
due to a number of other factors, including the regional economy in the area where the loans were originated, seasonal factors,
demographic variables and the assumability of the loans. However, the major factors affecting prepayment rates are prevailing interest
rates, related financing opportunities and competition. We monitor interest rate sensitivity so that we can adjust our asset and
liability mix in a timely manner and minimize the negative effects of changing rates.
71
The Company’s liquidity
sources are vulnerable to various uncertainties beyond our control. Loan amortization and investment cash flows are a relatively
stable source of funds, while loan and investment prepayments and calls, as well as deposit flows vary widely in reaction to market
conditions, primarily prevailing interest rates. Asset sales are influenced by pledging activities, general market interest rates
and unforeseen market conditions. Our financial condition is affected by our ability to borrow at attractive rates, retain deposits
at market rates and other market conditions. We consider our sources of liquidity to be adequate to meet expected funding needs
and also to be responsive to changing interest rate markets.
Interest Rate Risk.
Interest rate risk represents
the sensitivity of earnings to changes in market interest rates. As interest rates change, the interest income and expense streams
associated with our financial instruments also change, thereby impacting net interest income, the primary component of our earnings.
ALCO utilizes the results of a detailed and dynamic simulation model to quantify the estimated exposure of net interest income
to sustained interest rate changes. While ALCO routinely monitors simulated net interest income sensitivity over a rolling two-year
horizon, they also utilize additional tools to monitor potential longer-term interest rate risk.
The simulation model
captures the impact of changing interest rates on the interest income received and interest expense paid on all interest-earning
assets and interest-bearing liabilities reflected on our consolidated balance sheet, as well as for derivative financial instruments.
This sensitivity analysis is compared to ALCO policy limits, which specify a maximum tolerance level for net interest income exposure
over a one and two-year horizon, assuming no balance sheet growth.
The repricing and/or new rates of assets
and liabilities moved in tandem with market rates. However, in certain deposit products, the use of data from a historical analysis
indicated that the rates on these products would move only a fraction of the rate change amount. Pertinent data from each loan
account, deposit account and investment security was used to calculate future cash flows. The data included such items as maturity
date, payment amount, next repricing date, repricing frequency, repricing index, repricing spread, caps and floors. Prepayment
speed assumptions were based upon the difference between the account rate and the current market rate. We also evaluate changes
in interest rate sensitivity under various scenarios including but not limited to nonparallel shifts in the yield curve, variances
in prepayment speeds and variances to correlations of instrument rates to market indexes.
The table below shows
our net interest income sensitivity analysis reflecting the following changes to net interest income for the first and second years
of the simulation model. The analysis assumes no balance sheet growth, a parallel shift in interest rates, and all rate changes
were “ramped” over the first 12-month period and then maintained at those levels over the remainder of the simulation
horizon.
| Estimated Changes in Net Interest Income | ||||||||
|---|---|---|---|---|---|---|---|---|
| Changes in Interest Rates | At December 31, 2023 | At December 31, 2022 | ||||||
| 1 – 12 Months | ||||||||
| +200 basis points | -4.1 | % | -3.9 | % | ||||
| -200 basis points | 3.4 | % | 2.2 | % | ||||
| 13 – 24 Months | ||||||||
| +200 basis points | -0.4 | % | 0.2 | % | ||||
| -200 basis points | 23.3 | % | 11.4 | % |
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The preceding sensitivity analysis does
not represent a forecast of net interest income, nor do the calculations represent any actions that management may undertake in
response to changes in interest rates. They should not be relied upon as being indicative of expected operating results. These
hypothetical estimates are based upon numerous assumptions including, among others, the nature and timing of interest rate levels,
yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits and reinvestment/replacement
of asset and liability cash flows. While assumptions are developed based upon current economic and local market conditions, we
cannot make any assurances as to the predictive nature of these assumptions, including how customer preferences or competitor influences
might change.
Periodically, if deemed appropriate, we
may use interest rate swaps, floors and caps, which are common derivative financial instruments, to hedge our interest rate exposure
to interest rate movements. The Board of Directors has approved hedging policy statements governing the use of these instruments.
These interest rate swaps are designated as cash flow hedges and involve the receipt of variable rate amounts from a counterparty
in exchange for our making fixed payments.
Recent Accounting Pronouncements.
Refer to Note 1 to our consolidated financial
statements for a summary of the recent accounting pronouncements.
Impact of Inflation
and Changing Prices.
The Company’s consolidated
financial statements and accompanying notes have been prepared in accordance with GAAP. GAAP generally requires the measurement
of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing
power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike
industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates
have a greater impact on performance than do the effects of inflation.