General
Unless otherwise indicated or unless the context requires otherwise, all
references in this Report to the “Corporation,” “we,” “us,” “our,” or similar
references mean
subsidiary. “FBB” or the “Bank” refers to our subsidiary,
Forward-Looking Statements This report may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995, which reflect our current views with respect to future events and financial performance. Forward-looking statements are not based on historical information, but rather are related to future operations, strategies, financial results, or other developments. Forward-looking statements are based on management's expectations as well as certain assumptions and estimates made by, and information available to, management at the time the statements are made. Such statements are subject to risks and uncertainties, including among other things: •Adverse changes in the economy or business conditions, either nationally or in our markets, including, without limitation, inflation, supply chain issues, labor shortages, wage pressures, and the adverse effects of the COVID-19 pandemic on the global, national, and local economy. •Competitive pressures among depository and other financial institutions nationally and in our markets. •Increases in defaults by borrowers and other delinquencies. •Our ability to manage growth effectively, including the successful expansion of our client support, administrative infrastructure, and internal management systems. •Fluctuations in interest rates and market prices. •Changes in legislative or regulatory requirements applicable to us and our subsidiaries. •Changes in tax requirements, including tax rate changes, new tax laws, and revised tax law interpretations. •Fraud, including client and system failure or breaches of our network security, including our internet banking activities. •Failure to comply with the applicable SBA regulations in order to maintain the eligibility of the guaranteed portions of SBA loans. These risks could cause actual results to differ materially from what we have anticipated or projected. These risk factors and uncertainties should be carefully considered by our stockholders and potential investors. See Part I, Item 1A - Risk Factors in our Annual Report on Form 10-K for the year endedDecember 31, 2022 and Part II, Item 1A - Risk Factors below for discussion relating to risk factors impacting us. Investors should not place undue reliance on any such forward-looking statements, which speak only as of the date made. The factors described within this Form 10-Q could affect our financial performance and could cause actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods. Where any such forward-looking statement includes a statement of the assumptions or bases underlying such forward-looking statement, we caution that, while our management believes such assumptions or bases are reasonable and are made in good faith, assumed facts or bases can vary from actual results, and the differences between assumed facts or bases and actual results can be material, depending on the circumstances. Where, in any forward-looking statement, an expectation or belief is expressed as to future results, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the statement of expectation or belief will be achieved or accomplished.
We do not intend to, and specifically disclaim any obligation to, update any
forward-looking statements.
The following discussion and analysis is intended as a review of significant
events and factors affecting our financial condition and results of operations
for the periods indicated. The discussion should be read in conjunction with the
unaudited Consolidated Financial Statements and the Notes thereto presented in
this Form 10-Q.
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Overview
We are a registered bank holding company incorporated under the laws of the
State of Wisconsin and are engaged in the commercial banking business through
our wholly-owned banking subsidiary, FBB. All of our operations are conducted
through FBB and First Business Specialty Finance, LLC ("FBSF"), a wholly-owned
subsidiary of FBB. We operate as a business bank focusing on delivering a full
line of commercial banking products and services tailored to meet the specific
needs of small and medium-sized businesses, business owners, executives,
professionals, and high net worth individuals. Our products and services include
those for business banking, private wealth, and bank consulting. Within business
banking, we offer commercial lending, asset-based lending, accounts receivable
financing, equipment financing, floorplan financing, vendor financing, SBA
lending and servicing, treasury management services, and company retirement
plans. Our private wealth management services include trust and estate
administration, financial planning, investment management, and private banking
for executives and owners of our business banking clients and others. Our bank
consulting experts provide investment portfolio administrative services, asset
liability management services, and asset liability management process validation
for other financial institutions. We do not utilize a branch network to attract
retail clients. Our operating model is predicated on deep client relationships,
financial expertise, and an efficient, centralized administration function
delivering best in class client satisfaction. Our focused model allows
experienced staff to provide the level of financial expertise needed to develop
and maintain long-term relationships with our clients.
Financial Performance Summary
Results as of and for the three months ended
•Net income available to common shareholders totaled$8.8 million , or diluted earnings per share of$1.05 , for the three months endedMarch 31, 2023 , compared to$8.7 million , or diluted earnings per share of$1.02 , for the same period in 2022. •Annualized return on average assets ("ROA") for the three months endedMarch 31, 2023 measured 1.17% compared to 1.30% for the same period in 2022. •Return on average common equity ("ROACE") is defined as net income available to common shareholders divided by average equity less average preferred stock, if any. ROACE was 13.96% for the three months endedMarch 31, 2023 , compared to 14.70% for the same period in 2022. •Pre-tax, pre-provision ("PTPP") adjusted earnings, which excludes certain one-time and discrete items, and PTPP ROA were$13.3 million and 1.79%, respectively, for the three months endedMarch 31, 2023 , increasing$3.4 million and 30 basis points from the same period in 2022. •Fees in lieu of interest, defined as prepayment fees, asset-based loan fees, non-accrual interest, and loan fee amortization, totaled$651,000 for the three months endedMarch 31, 2023 , compared to$1.3 million for the same period in 2022. •Net interest margin was 3.86% for the three months endedMarch 31, 2023 compared to 3.39% for the same period in 2022. Adjusted net interest margin, which excludes certain one-time and volatile items, was 3.74% for the three months endedMarch 31, 2023 , up from 3.22% for the same period in 2022. •Top line revenue, defined as net interest income plus non-interest income, totaled$35.1 million for the three months endedMarch 31, 2023 , up$6.3 million , or 21.9% from the same period in 2022. •Effective tax rate was 23.82% for the three months endedMarch 31, 2023 compared to 20.03% for the same period in 2022. •Provision for credit losses was an expense of$1.6 million for the three months endedMarch 31, 2023 compared to a benefit of$855,000 for the same period in 2022. •Total assets atMarch 31, 2023 increased$187.8 million , or 25.2% annualized, to$3.164 billion from$2.977 billion atDecember 31, 2022 . •Period-end gross loans and leases receivable increased$96.1 million , or 15.7% annualized, to$2.539 billion as ofMarch 31, 2023 compared to$2.443 billion as ofDecember 31, 2022 . Average gross loans and leases of$2.481 billion increased$236.6 million , or 10.5%, for the three months endedMarch 31, 2023 , compared to$2.245 billion for the same period in 2022. •Non-performing assets were$3.5 million and 0.11% of total assets as ofMarch 31, 2023 , compared to$3.8 million and 0.13% of total assets as ofDecember 31, 2022 . •The allowance for credit losses, including reserve for unfunded credit commitments, increased$3.3 million compared toDecember 31, 2022 . The allowance for credit losses increased to 1.08% of total loans, compared to 0.99% atDecember 31, 2022 . •Period-end in-market deposits atMarch 31, 2023 increased$88.8 million , or 18.1% annualized, to$2.055 billion from$1.966 billion as ofDecember 31, 2022 . Average in-market deposits of$2.001 billion increased$68.0 million , or 3.5%, for the three months endedMarch 31, 2023 , compared to$1.933 billion for the same period in 2022. 43 -------------------------------------------------------------------------------- Table of Contents •Private wealth and trust assets under management and administration increased by$144.1 million , or 22.6% annualized, to$2.804 billion atMarch 31, 2023 , compared to$2.660 billion atDecember 31, 2022 . Assets under management and administration decreased$29.9 million compared to the same period in 2022. Private wealth management service fees decreased$187,000 , or 6.6%, for the three months endedMarch 31, 2023 , compared to the three months endedMarch 31, 2022 . Response to Banking Liquidity Events Two bank failures occurring inMarch 2023 prompted industry concern regarding bank deposit funding, liquidity sources, and capital adequacy. In addition to an increased focus on client relationships, management has reviewed deposit composition, sources of liquidity, and securities and capital. As the Bank focuses on commercial banking clientele, the client deposit balances are naturally larger in size than those of peer banks with retail banking operations. Thus, the Bank has long offered extended deposit insurance products to protect clients' operating business assets, beyond theFDIC limit. As ofMarch 31, 2023 , the Corporation had the following deposit composition and depositor insurance status: Deposit composition As of March 31, December 31, September 30, June 30, March 31, (in thousands) 2023 2022 2022 2022 2022
Non-interest-bearing transaction accounts
Interest-bearing transaction accounts
612,500 576,601 461,883 466,785 539,492 Money market accounts 662,157 698,505 742,545 731,718 806,917 Certificates of deposit 308,191 153,757 160,655 114,000 63,977 Wholesale deposits 422,088 202,236 158,321 12,321 12,321 Total deposits$ 2,476,840 $ 2,168,206 $ 2,087,545 $ 1,869,331 $ 2,023,694 Uninsured deposits 941,375 951,739 1,007,935 935,101 1,099,505 Uninsured deposits as a percent of total deposits 38.0 % 43.9 % 48.3 % 50.0 % 54.3 % Extended deposit insurance(1) 567,390 495,621 439,092 461,372 470,140
(1)Included in interest-bearing transaction accounts and certificates of deposit
balances above.
Management regularly reviews all primary and secondary sources of liquidity in preparation for any unforeseen funding needs, such as potential fallout from recent market events. These are prioritized based on available capacity, term flexibility, and cost. AtMarch 31, 2023 , the Company's liquidity position included record in-market deposits of$2.055 billion , up$88.8 million over prior quarter, and total deposits of$2.477 billion . As detailed below, readily available liquidity of$656.6 million atMarch 31, 2023 is also up compared to$449.6 million atDecember 31, 2022 . Management has not accessed theFederal Reserve's Bank Term Funding Program as ofMarch 31, 2023 . Sources of liquidity As of March 31, December 31, September 30, June 30, March 31, (in thousands) 2023 2022 2022 2022 2022 Short-term investments$ 159,859 $ 76,871 $ 86,707 $ 56,233 $ 75,514 Collateral value of unencumbered pledged loans 296,393 184,415 289,513 174,315 361,487 Market value of unencumbered securities 200,332 188,353 173,013 182,429 201,896 Readily available liquidity 656,584 449,639 549,233 412,977 638,897 Fed fund lines 45,000 45,000 45,000 45,000 45,000 Excess brokered CD capacity1 1,027,869 1,162,241 1,100,369 1,112,386 1,275,931 Total liquidity$ 1,729,453 $ 1,656,880 $ 1,694,602 $ 1,570,363 $ 1,959,828 Uninsured deposits 941,375 951,739 1,007,935 935,101 1,099,505
(1)Bank internal policy limits brokered CDs to 50% of total bank funding when
combined with FHLB advances.
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The Bank is required by federal regulation to maintain sufficient liquidity to
ensure safe and sound operations. We believe that the Bank has sufficient
liquidity to match the balance of net withdrawable deposits and short-term
borrowings in light of present economic conditions and deposit flows.
Securities and Capital
The Bank holds$248.5 million in its investment securities portfolio which is 7.9% of our total assets, with a total portfolio mark-to-market ("MTM") adjustment of 9% as ofMarch 31, 2023 . Further, the Corporation has grown tangible book value by 12.2% over the past twelve months. Modeling in the full MTM adjustments on our balance sheet produced a similarly strong capital result as ofMarch 31, 2023 ; fully-marked tangible common equity to tangible assets ("TCE") totaled 7.56%, compared to our reported ratio of 7.69%, both of which fall within management's target TCE range of 7.5%-8.5%. The Company's capital ratios continued to exceed the highest required regulatory benchmark levels. Capital ratios remain strong with the voluntary inclusion of mark-to-market adjustments on the full balance sheet.
Capital Ratios
As of and for the Three Months Ended
March 31, December 31, September 30, June 30, March 31,
2023 2022 2022 2022 2022
Total capital to risk-weighted assets 11.04 % 11.26 % 11.66 % 11.56 % 11.87 %
Tier I capital to risk-weighted assets 9.01 % 9.20 % 9.48 % 9.34 % 9.27 %
Common equity tier I capital to
risk-weighted assets 8.61 % 8.79 % 9.04 % 8.90 % 8.81 %
Tier I capital to adjusted assets 9.00 % 9.17 % 9.34 % 9.19 % 9.09 %
Tangible common equity to tangible
assets (TCE ratio) 7.69 % 7.98 % 8.06 % 8.16 % 8.14 %
Adjusted TCE ratio 7.56 % 7.86 % 8.18 % 8.25 % 8.09 %
Results of Operations
Top Line Revenue
Top line revenue, comprised of net interest income and non-interest income,
increased $6.3 million , or 21.9%, for the three months ended March 31, 2023 ,
compared to the same period in 2022, due to a 24.6% and 13.9% increase in net
interest income and non-interest income, respectively. The increase in net
interest income was driven by an increase in net interest margin and average
loans and leases outstanding. The increase in non-interest income was due to an
increase in commercial loan swap fee income, loan fee income, and income from
investments in mezzanine funds, partially offset by a reduction in gains on the
sale of SBA loans, service charges on deposits, and trust fee income.
The components of top line revenue were as follows:
For the Three Months Ended March 31,
2023 2022 $ Change % Change
(Dollars in Thousands)
Net interest income $ 26,705 $ 21,426 $ 5,279 24.6%
Non-interest income 8,410 7,386 1,024 13.9
Top line revenue $ 35,115 $ 28,812 $ 6,303 21.9
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Annualized Return on Average Assets and Annualized Return on Average Common
Equity
ROA for the three months endedMarch 31, 2023 decreased to 1.17%, compared to 1.30% for the three months endedMarch 31, 2022 . The decrease in ROA was due to an increase in credit loss provision and operating expenses, partially offset by an increase in top line revenue. We consider ROA a critical metric to measure the profitability of our organization and how efficiently our assets are deployed. ROA also allows us to better benchmark our profitability to our peers without the need to consider different degrees of leverage which can ultimately influence return on equity measures. ROACE for the three months endedMarch 31, 2023 was 13.96%, compared to 14.47% for the three months endedMarch 31, 2022 . The primary reason for the change in ROACE is consistent with the net income variance explanation as discussed under Return on Average Assets above. We view ROACE as an important measurement for monitoring profitability and continue to focus on improving our return to our shareholders by enhancing the overall profitability of our client relationships, controlling our expenses, and minimizing our costs of credit.
Efficiency Ratio and Pre-Tax, Pre-Provision Adjusted Earnings
Efficiency ratio measured 62.02% for the three months endedMarch 31, 2023 , compared to 65.55% for the three endedMarch 31, 2022 . Efficiency ratio is a non-GAAP measure representing operating expense, which is non-interest expense excluding the effects of the SBA recourse benefit or provision, impairment of tax credit investments, net gains or losses on repossessed assets, amortization of other intangible assets, and other discrete items, if any, divided by operating revenue, which is equal to net interest income plus non-interest income less realized net gains or losses on securities, if any. PTPP adjusted earnings for three months endedMarch 31, 2023 was$13.3 million , compared to$9.9 million for the three months endedMarch 31, 2022 . PTPP adjusted earnings is defined as operating revenue less operating expense. In the judgment of the Corporation's management, the adjustments made to non-interest expense and non-interest income allow investors and analysts to better assess the Corporation's operating expenses in relation to its core operating revenue by removing the volatility associated with certain one-time items and other discrete items. PTPP adjusted earnings allows management to benchmark performance of our model to our peers without the influence of the credit loss provision and tax considerations, which will ultimately influence other traditional financial measurements, including ROA and ROACE. The information provided below reconciles the efficiency ratio to its most comparable GAAP measure.
Please refer to the Non-Interest Income and Non-Interest Expense sections
below for discussion on additional drivers of the year-over-year change in the
efficiency ratio and PTPP adjusted earnings.
For the Three Months Ended
2023 2022 $ Change % Change
(Dollars in Thousands)
Total non-interest expense $ 21,767 $ 18,823 $ 2,944 15.6%
Less:
Net loss on repossessed assets 6 12 (6) (50.0) SBA recourse provision (18) (76) 58 (76.3) Total operating expense (a)$ 21,779 $ 18,887 $ 2,892 15.3 Net interest income$ 26,705 $ 21,426 $ 5,279 24.6 Total non-interest income 8,410 7,386 1,024 13.9 Operating revenue (b)$ 35,115 $ 28,812 $ 6,303 21.9 Efficiency ratio 62.02 % 65.55 %
Pre-tax, pre-provision adjusted earnings (b-a)
$ 9,925 $ 3,411 34.4 Average total assets$ 2,984,600 $ 2,666,241 $ 318,359 11.9 Pre-tax, pre-provision adjusted return on average assets 1.79 %
1.49 %
We believe the Corporation will generate positive operating leverage on an
annual basis and progress towards enhancing the long-term efficiency ratio at a
measured pace as we focus on strategic initiatives directed toward revenue
growth, process improvement, and automation. The Corporation's recent
improvement during the period of comparison is principally due to the rising
interest rate environment and related expansion of net interest margin.
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Net Interest Income
Net interest income levels depend on the amount of and yield on
interest-earning assets as compared to the amount of and rate paid on
interest-bearing liabilities. Net interest income is sensitive to changes in
market rates of interest and the asset/liability management processes to prepare
for and respond to such changes.
The following table provides information with respect to (1) the change in net
interest income attributable to changes in rate (changes in rate multiplied by
prior volume) and (2) the change in net interest income attributable to changes
in volume (changes in volume multiplied by prior rate) for the three months
ended March 31, 2023 compared to the same period in 2022. The change in net
interest income attributable to changes in rate and volume (changes in rate
multiplied by changes in volume) has been allocated to the rate and volume
changes in proportion to the relationship of the absolute dollar amounts of the
change in each.
Increase (Decrease) for the Three Months
Ended March 31,
2023 Compared to 2022
Rate Volume Net
(In Thousands)
Interest-earning assets
Commercial real estate and other mortgage loans(1) $ 7,819 $ 552 $ 8,371
Commercial and industrial loans(1) 5,589 2,678 8,267
Consumer and other loans(1) 133 (29) 104
Total loans and leases receivable 13,541 3,201 16,742
Mortgage-related securities 520 (10) 510
Other investment securities 81 24 105
FHLB and FRB Stock 111 44 155
Short-term investments 318 (1) 317
Total net change in income on interest-earning assets 14,571 3,258 17,829
Interest-bearing liabilities
Transaction accounts 3,568 17 3,585
Money market accounts 4,200 (41) 4,159
Certificates of deposit 1,411 651 2,062
Wholesale deposits 76 1,782 1,858
Total deposits 9,255 2,409 11,664
FHLB advances 1,388 37 1,425
Other borrowings 10 (45) (35)
Junior subordinated notes(2) - (504) (504)
Total net change in expense on interest-bearing liabilities 10,653 1,897 12,550
Net change in net interest income $ 3,918 $ 1,361 $ 5,279
(1)The average balances of loans and leases include non-performing loans and
leases and loans held for sale.
(2)The rate column for the three months ended March 31, 2022 included $236,000
in accelerated amortization of debt issuance costs.
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The tables below show our average balances, interest, average yields/rates, net interest margin, and the spread between the combined average yields earned on interest-earning assets and average rates on interest-bearing liabilities for the three months endedMarch 31, 2023 and 2022. The average balances are derived from average daily balances. For the Three Months Ended March 31, 2023 2022 Average Average Average Average Balance Interest Yield/Rate(4) Balance Interest Yield/Rate(4) (Dollars in Thousands) Interest-earning assets Commercial real estate and other mortgage loans(1)$ 1,518,053 $ 21,717 5.72 %$ 1,459,891 $ 13,346 3.66 % Commercial and industrial loans(1) 916,457 17,557 7.66 734,904 9,290 5.06 Consumer and other loans(1) 46,690 540 4.63 49,847 436 3.50 Total loans and leases receivable(1) 2,481,200 39,814 6.42 2,244,642 23,072 4.11 Mortgage-related securities(2) 182,494 1,270 2.78 184,962 760 1.64 Other investment securities(3) 55,722 320 2.30 50,555 215 1.70 FHLB and FRB stock 17,125 327 7.64 14,002 172 4.91 Short-term investments 28,546 333 4.67 31,111 16 0.21 Total interest-earning assets 2,765,087 42,064 6.09 2,525,272 24,235 3.84 Non-interest-earning assets 219,513 140,969 Total assets$ 2,984,600 $ 2,666,241 Interest-bearing liabilities Transaction accounts$ 567,435 3,840 2.71$ 533,251 255 0.19 Money market accounts 699,314 4,497 2.57 784,276 338 0.17 Certificates of deposit 236,083 2,117 3.59 52,519 55 0.42 Wholesale deposits 187,784 1,976 4.21 16,236 118 2.91 Total interest-bearing deposits 1,690,616 12,430 2.94 1,386,282 766 0.22 FHLB advances 398,109 2,461 2.47 385,080 1,036 1.08 Other borrowings 36,794 468 5.09 40,311 503 4.99 Junior subordinated notes(5) - - - 9,850 504 20.47 Total interest-bearing liabilities 2,125,519 15,359 2.89 1,821,523 2,809 0.62 Non-interest-bearing demand deposit accounts 497,770 562,530 Other non-interest-bearing liabilities 98,347 42,537 Total liabilities 2,721,636 2,426,590 Stockholders' equity 262,964 239,651 Total liabilities and stockholders' equity$ 2,984,600 $ 2,666,241 Net interest income$ 26,705 $ 21,426 Interest rate spread 3.19 % 3.22 % Net interest-earning assets$ 639,568 $ 703,749 Net interest margin 3.86 % 3.39 % Average interest-earning assets to average interest-bearing liabilities 130.09 % 138.64 % Return on average assets(4) 1.17 1.30 Return on average equity(4) 13.96 14.47 Average equity to average assets 8.81 8.99 Non-interest expense to average assets(4) 2.92 2.82 (1)The average balances of loans and leases include non-performing loans and leases and loans held for sale. Interest income related to non-performing loans and leases is recognized when collected. Interest income includes net loan fees in lieu of interest. (2)Includes amortized cost basis of assets available-for-sale and held-to-maturity. (3)Yields on tax-exempt municipal securities are not presented on a tax-equivalent basis in this table. (4)Represents annualized yields/rates. (5)The rate column for the three months endedMarch 31, 2022 included$236,000 in accelerated amortization of debt issuance costs. 48
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The change in yield of the respective interest-earning asset or the rate paid on interest-bearing liability compared to the change in short-term market rates is commonly referred to as a beta. The table below displays the beta calculations for loans and leases, total interest earning assets, in-market deposits, interest-bearing deposits and total interest-bearing liabilities for the three months endedMarch 31, 2023 and 2022. Additionally, adjusted total loans and leases and total interest-earning assets excludes the volatile impact of fees in lieu of interest. For
the Three Months Ended
2023
2022
Asset and Liability Beta Analysis Average Yield/Rate (4) Increase (Decrease) Total loans and leases receivable (a) 6.42 % 4.11 % 2.31 % Total interest-earning assets(b) 6.09 % 3.84 % 2.25 % Adjusted total loans and leases receivable (1)(c) 6.31 % 3.88 % 2.43 % Adjusted total interest-earning assets (1)(d) 5.99 % 3.63 % 2.36 % Total in-market deposits(e) 2.09 % 0.13 % 1.96 % Total bank funding(f) 2.30 % 0.31 % 1.99 % Net interest margin(g) 3.86 % 3.39 % 0.47 % Adjusted net interest margin(h) 3.74 % 3.22 % 0.52 % Effective fed funds rate (3)(i) 4.51 % 0.09 % 4.42 % Beta Calculations: Total loans and leases receivable(a)/(i) 52.20 % Total interest-earning assets(b)/(i) 50.82 % Adjusted total loans and leases receivable (1)(c)/(i) 55.03 % Adjusted total interest-earning assets (1)(d)/(i) 53.32 % Total in-market deposits(e)/(i) 44.34 % Total bank funding(2)(f)/(i) 45.02 % Net interest margin(g)/(i) 10.63 % Adjusted net interest margin(h)/(i) 11.76 %
(1)Excluding fees in lieu of interest.
(2)Total bank funding represents total deposits plus FHLB advances.
(3)
Funds Rates [DFF]. retrieved from FRED,
(4)Represents annualized yields/rates.
Comparison of Net Interest Income for the Three Months Ended
2022 Net interest income increased$5.3 million , or 24.6%, during the three months endedMarch 31, 2023 , compared to the three months endedMarch 31, 2022 . The increase in net interest income reflected an increase in net interest margin and increase in average gross loans and leases, partially offset by a reduction in fees in lieu of interest. Fees in lieu of interest, which can vary from quarter to quarter, totaled$651,000 for the three months endedMarch 31, 2023 , compared to$1.3 million for the same period in 2022. Excluding fees in lieu of interest, net interest income for the three months endedMarch 31, 2023 increased$5.7 million , or 27.9%. Average gross loans and leases for the three months endedMarch 31, 2023 increased$236.6 million , or 10.5%, compared to the three months endedMarch 31, 2022 . 49 -------------------------------------------------------------------------------- Table of Contents The yield on average loans and leases for the three months endedMarch 31, 2023 was 6.42%, compared to 4.11% for the three months endedMarch 31, 2022 . Excluding the impact of loan fees in lieu of interest, the yield on average loans and leases for the three months endedMarch 31, 2023 was 6.31%, compared to 3.88% for the three months endedMarch 31, 2022 . The yield on average interest-earning assets for the three months endedMarch 31, 2023 measured 6.09%, compared to 3.84% for the three months endedMarch 31, 2022 . Excluding loan fees in lieu of interest, the yield on average interest-earning assets for the three months endedMarch 31, 2023 was 5.99%, compared to 3.63% for the three months endedMarch 31, 2022 . The increase in yields was primarily due to rising rates on variable-rate loans, following theFederal Open Market Committee's ("FOMC") decision to raise the target Fed Funds rate 425 basis points over the period of comparison, as well as the reinvestment of cash flows from the securities and fixed-rate loan portfolios in a rising rate environment. The daily average effective federal funds rate for the three months endedMarch 31, 2023 increased 442 basis points, compared to the same period in 2022. This equates to an interest-earning asset beta of 53.3% for the three months endedMarch 31, 2023 . The rate paid on average interest-bearing in-market deposits for the three months endedMarch 31, 2023 increased to 2.78%, from 0.19% for the three months endedMarch 31, 2022 . The average rate paid on total interest-bearing liabilities for the three months endedMarch 31, 2023 increased to 2.89%, from 0.62% for the three months endedMarch 31, 2022 . Total interest-bearing liabilities include interest-bearing deposits, federal funds purchased, FHLB advances, subordinated and junior subordinated notes payable, and other borrowings. The average rates paid increased due to the increase in short-term market rates and the replacement of maturing wholesale funds at higher fixed rates. This equates to an interest-bearing liability beta of 51.4% for the three months endedMarch 31, 2023 . Net interest margin increased to 3.86% for the three months endedMarch 31, 2023 , compared to 3.39% for the three months endedMarch 31, 2022 . The primary driver of improved net interest margin was the aforementioned increase in earning asset yields, partially offset by corresponding increase in funding costs. Adjusted net interest margin measured 3.74% for the three months endedMarch 31, 2023 , compared to 3.22% for the three months endedMarch 31, 2022 . Adjusted net interest margin is a non-GAAP measure representing net interest income excluding the impact of fees in lieu of interest, and other recurring, but volatile, components of net interest margin divided by average interest-earning assets less other recurring, but volatile, components of average interest-earning assets. Management believes its success in growing in-market deposits, disciplined loan pricing, and increased production in existing higher-yielding commercial lending products will allow the Corporation to achieve a net interest margin that supports our long-term profitability goals. However, the collection of loan fees in lieu of interest is an expected source of volatility to quarterly net interest income and net interest margin. In addition, net interest margin may also experience volatility due to events such as the collection of interest on loans previously in non-accrual status or the accumulation of significant short-term deposit inflows.
Provision for Credit Losses
We determine our provision for credit losses pursuant to our allowance for credit loss methodology, which was updated onJanuary 1, 2023 , for the adoption of ASC 326. It is based on a reasonable and supportable forecast as well as considerations for composition, risk, and performance indicators in our credit portfolio. Refer to Allowance for Credit Losses, below, for further information regarding our allowance for credit loss methodology. The Corporation recognized a$1.6 million provision expense for the three months endedMarch 31, 2023 , compared to a benefit of$855,000 for the three months endedMarch 31, 2022 . The provision expense for the three months endedMarch 31, 2023 was primarily due to an increase of$979,000 related to loan growth and a$474,000 increase in the reserve due to modest deterioration in forecasted economic conditions over the four quarter forecast period. 50
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The following table shows the components of the provision for credit losses for
the three months ended
For the Three Months Ended March 31,
2023 2022
(In Thousands)
Change in qualitative factor changes $ 9 $ (416)
Change in quantitative factor changes 474 (206)
Charge-offs 166 22
Recoveries (107) (210)
Change in reserves on individually evaluated loans, net (36) (280)
Change due to loan growth, net 979 235
Change in unfunded credit commitment reserves $ 76 $ -
Total provision for credit losses $
1,561
The addition of specific reserves on individually evaluated loans represents new specific reserves established when collateral shortfalls or government guaranty deficiencies are present, while the release of specific reserves represents the reduction of previously established reserves that are no longer required. Changes in the allowance for credit losses due to qualitative factor changes reflect management's evaluation of the level of risk within the portfolio based upon several factors for each portfolio segment. Charge-offs in excess of previously established specific reserves require an additional provision for credit losses to maintain the allowance for credit losses at a level deemed appropriate by management. This amount is net of the release of any specific reserve that may have already been provided. Refer to Asset Quality, below, for further information regarding the overall credit quality of our loan and lease portfolio.
Comparison of Non-Interest Income for the Three Months Ended
2022
Non-Interest Income
Non-interest income increased $1.0 million , or 13.9%, to $8.4 million for the
three months ended March 31, 2023 compared to $7.4 million for the same period
in 2022. The increase in total non-interest income for the three months ended
March 31, 2023 was due to increases in other non-interest income, driven by
mezzanine fund investment income, loan fee income, and commercial loan swap fee
income. These favorable variances were partially offset by a decrease in private
wealth management services fee income, services charges on deposits, and gains
on sale of SBA loans.
Management continues to focus on revenue growth from multiple non-interest
income sources in order to maintain a diversified revenue stream through greater
contributions from fee-based revenues. Total non-interest income accounted for
23.9% of total revenues for the three months ended March 31, 2023 , compared to
25.6% for the three months ended March 31, 2022 .
The components of non-interest income were as follows:
For
the Three Months Ended
2023 2022 $ Change % Change
(Dollars in Thousands)
Private wealth management services fee
income $ 2,654 $ 2,841 $ (187) (6.6)%
Gain on sale of SBA loans 476 585 (109) (18.6)
Service charges on deposits 682 999 (317) (31.7)
Loan fees 803 652 151 23.2
Increase in cash surrender value of
bank-owned life insurance 366 349 17 4.9
Swap fees 557 225 332 147.6
Other non-interest income 2,872 1,735 1,137 65.5
Total non-interest income $ 8,410 $ 7,386 $ 1,024 13.9
Fee income ratio(1) 23.9 % 25.6 %
(1) Fee income ratio is fee income, per the above table, divided by top line
revenue (defined as net interest income plus non-interest income).
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Private wealth management service fees decreased$187,000 , or 6.6%, for the three months endedMarch 31, 2023 , compared to the same period in 2022. Private wealth management fee income is primarily driven by the amount of assets under management and administration, as well as the mix of business at different fee structures, and can be positively or negatively influenced by the timing and magnitude of volatility within the capital markets. As ofMarch 31, 2023 , private wealth and trust assets under management and administration totaled$2.804 billion , decreasing$29.9 million , or 1.1%, compared to$2.834 billion as ofMarch 31, 2022 , as new client relationships and new money from existing clients was more than offset by the decline in market values. Other non-interest income increased$1.1 million , or 65.5%, for the three months endedMarch 31, 2023 , respectively, compared to the same period in 2022. The increase for the three months endedMarch 31, 2023 was primarily due to strong returns from the Corporation's investments in mezzanine funds. Commercial loan interest rate swap fee income increased$332,000 , or 147.6%, for the three months endedMarch 31, 2023 , compared to the same period in 2022. We originate commercial real estate loans in which we offer clients a floating rate and an interest rate swap. The client's swap is then offset with a counter-party dealer. The execution of these transactions generates swap fee income. The aggregate amortizing notional value of interest rate swaps with various borrowers was$787.8 million as ofMarch 31, 2023 , compared to$744.2 million and$626.8 million as ofDecember 31, 2022 andMarch 31, 2022 , respectively. Interest rate swaps can be an attractive product for our commercial borrowers, although associated fee income can be variable from period to period based on loan activity and the interest rate environment in any given quarter. Service charges on deposits decreased$317,000 , or 31.7%, for the three months endedMarch 31, 2023 , compared to the same period in 2022. The decrease was driven by an increase in the earnings credit rate which was adjusted with the rising rate environment.Treasury management business development efforts remain robust as gross analyzed service charges, net of waived fees, increased 17.6%, or$211,000 , to$1.4 million for the three months endedMarch 31, 2023 , compared to the same period in 2022. Management believes growth in gross analyzed service charges is a strong indicator of success for the Corporation given the direct correlation to adding and expanding core business relationships. Loan fees increased$151,000 , or 23.2%, for the three months endedMarch 31, 2023 , compared to the same period in 2022. The increase was due to an increase in equipment financing and floorplan financing activity generating additional service fee income. Gain on sale of SBA loans decreased$109,000 , or 18.6%, for the three months endedMarch 31, 2023 , compared to the same period in 2022. Premiums on the sale and notional value of SBA loans sold decreased compared to prior year quarter, as the Corporation elected to hold a higher number of SBA loans on its balance sheet in the current interest rate environment. 52
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Comparison of Non-Interest Expense for the Three Months Ended March 31,
2023 and 2022
Non-Interest Expense
Non-interest expense for the three months endedMarch 31, 2023 increased by$2.9 million , or 15.6%, compared to the same period in 2022. Operating expense, which excludes certain one-time and discrete items as defined in the Efficiency Ratio table above, increased$2.9 million , or 15.3%, for the three months endedMarch 31, 2023 , compared to the same period in 2022. The increase in operating expense was primarily due to an increase in compensation, professional fees, marketing, and computer software.
The components of non-interest expense were as follows:
For the Three Months Ended March 31,
2023 2022 $ Change % Change
(Dollars in Thousands)
Compensation $ 15,908 $ 13,638 $ 2,270 16.6 %
Occupancy 631 555 76 13.7
Professional fees 1,343 1,170 173 14.8
Data processing 875 780 95 12.2
Marketing 628 500 128 25.6
Equipment 295 244 51 20.9
Computer software 1,183 1,082 101 9.3
FDIC insurance 394 313 81 25.9
Other non-interest expense 510 541 (31) (5.7)
Total non-interest expense $ 21,767 $ 18,823 $ 2,944 15.6
Total operating expense(1) $ 21,779 $ 18,887
Full-time equivalent employees 341 313
(1)Total operating expense represents total non-interest expense, adjusted to
exclude the impact of discrete items as previously defined in the non-GAAP
efficiency ratio calculation, above.
Compensation expense for the three months endedMarch 31, 2023 increased$2.3 million , or 16.6%, compared to the three months endedMarch 31, 2022 . The increase reflects above historical annual merit and market increases, reflecting wage inflation, payroll taxes paid in the quarter on a record annual cash bonus earned in 2022, and an expanded workforce. Successful hiring efforts to secure talent resulted in average full-time equivalent employees for the three months endedMarch 31, 2023 increasing to 340, up 9.7%, compared to 310 for the three months endedMarch 31, 2022 . Professional fees increased$173,000 , or 14.8%, for the three months endedMarch 31, 2023 , compared to the three months endedMarch 31, 2022 . The increase was primarily due to an increase in the use of professional staffing services and costs associated with an office relocation. Marketing expense increased$128,000 , or 25.6%, for the three months endedMarch 31, 2023 , compared to the three months endedMarch 31, 2022 . The increase during the three months endedMarch 31, 2023 was primarily due to an increase in business development efforts and advertising projects related to our expanded sales force and national footprint.
Computer software expense increased
ended
increase during the three months ended
continued investments in existing technologies commensurate with the
Corporation’s expanded headcount and overall balance sheet growth.
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Income Taxes
Income tax expense totaled$2.8 million for the three months endedMarch 31, 2023 compared to$2.2 million for the three months endedMarch 31, 2022 . Income tax expense included a$149,000 net benefit from a tax credit investment, no tax credits were recognized in the prior year quarter. The effective tax rate for the three months endedMarch 31, 2023 was 23.82% compared to 20.03% for the same period in 2022. For 2023, the Corporation expects to report an effective tax rate between 21%-22%, as the Bank continues to receive the benefit from its tax credit investments. Generally, the provision for income taxes is determined by applying an estimated annual effective income tax rate to income before taxes and adjusting for discrete items. The rate is based on the most recent annualized forecast of pre-tax income, book versus tax differences and tax credits, if any. If we conclude that a reliable estimated annual effective tax rate cannot be determined, the actual effective tax rate for the year-to-date period may be used. We re-evaluate the income tax rates each quarter. Therefore, the current projected effective tax rate for the entire year may change. Financial Condition General Total assets increased by$187.8 million , or 6.3%, to$3.164 billion as ofMarch 31, 2023 compared to$2.977 billion atDecember 31, 2022 . The increase in total assets was primarily driven by an increase in cash, loans and leases receivable, and available-for-sale securities. Total liabilities increased by$181.9 million , or 6.7%, to$2.898 billion atMarch 31, 2023 compared to$2.716 billion atDecember 31, 2022 . The increase in total liabilities was principally due to an increase in deposits. Total stockholders' equity increased by$5.9 million , or 2.3%, to$266.6 million atMarch 31, 2023 compared to$260.6 million atDecember 31, 2022 . The increase in total stockholders' equity was due to retention of earnings and unrealized gains on available-for-sale securities, partially offset by dividends paid to common stockholders, stock repurchased, and cumulative change in accounting principal for ASC 326.
Cash and Cash Equivalents
Cash and cash equivalents include short-term investments and cash and due from banks. Cash and due from banks increased$303,000 to$26.1 million atMarch 31, 2023 . Short-term investments increased by$83.0 million to$159.9 million atMarch 31, 2023 from$76.9 million atDecember 31, 2022 as management held excess cash at the FRB in response to the banking industry liquidity events during the quarter. Please see the section entitled Response to Banking Liquidity Events above for additional information. Our short-term investments primarily consist of interest-bearing deposits held at the FRB. We value the safety and soundness provided by the FRB, and therefore, we incorporate short-term investments in our readily accessible liquidity program. As ofMarch 31, 2023 andDecember 31, 2022 , interest-bearing deposits held at the FRB were$158.9 million and$76.5 million , respectively. The increase in cash held at the FRB is primarily due to management's response to the banking industry liquidity events during first quarter 2023. Please refer to the section entitled Liquidity and Capital Resources for further discussion.
Securities
Total securities, including available-for-sale and held-to-maturity, increased by$23.8 million , or 10.6%, to$248.5 million , or 7.9% of total assets atMarch 31, 2023 compared to$224.7 million , or 7.5% of total assets atDecember 31, 2022 . During the three months endedMarch 31, 2023 the Corporation recognized unrealized gains of$3.8 million before income taxes through other comprehensive income, compared to unrealized losses of$12.5 million for the same period in 2022. The unrealized losses in the prior year period were solely driven by the increase in interest rates. As ofMarch 31, 2023 andDecember 31, 2022 , our overall securities portfolio, including available-for-sale securities and held-to-maturity securities, had an estimated weighted-average expected maturity of 5.9 years and 6.3 years, respectively. Our investment philosophy remains as stated in our most recent Annual Report on Form 10-K. We use a third-party pricing service as our primary source of market prices for our securities portfolio. On a quarterly basis, we validate the reasonableness of prices received from this source through independent verification, data integrity validation primarily through comparison of current price to an expectation-based analysis of movement in prices based upon the changes in the related yield curves, and other market factors. We did not recognize any credit losses in the securities portfolio as ofMarch 31, 2023 . 54
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Loans and Leases Receivable
Period-end loans and leases receivable, net of allowance for credit losses, increased by$94.4 million , or 15.6% annualized to$2.513 billion atMarch 31, 2023 from$2.419 billion atDecember 31, 2022 driven by commercial loan growth, partially offset by a decrease in commercial real estate loans. Due to the adoption of ASC 326, the current quarter included a change to our portfolio segmentation. The balances as ofMarch 31, 2023 reflect reclassifications of$43 million to commercial and industrial from commercial real estate and$7 million from consumer and other to commercial real estate. Including the reclassification impact of adopting ASC 326 in the prior period of comparison, C&I loans increased$66.2 million , or 29.5% annualized, to$963.3 million . The increase was due to growth across the majority of the Bank's C&I products and geographies. Management does not believe this level of C&I loan growth is sustainable and expects growth to moderate to lower double-digit levels in subsequent quarters. Including the reclassification impact of adopting ASC 326 in the prior period of comparison, total commercial real estate ("CRE") loans increased$22.5 million , or 6.0% annualized, to$1.529 billion . The increase was due to growth across the majority of the Bank's C&I products and geographies. Management does not believe this level of C&I loan growth is sustainable and expects growth to moderate to lower double-digit levels in subsequent quarters. Including the reclassification impact of adopting ASC 326 in the prior period of comparison, CRE loans represented 60.2% and 61.7% of our total loans as ofMarch 31, 2023 andDecember 31, 2022 , respectively. The decline in CRE concentration in the period of comparison is the result of management's success in expanding the Bank's various C&I products across both its local and national footprints. As ofMarch 31, 2023 , 15.3% of the CRE loans were owner-occupied CRE, compared to 15.2% as ofDecember 31, 2022 . We consider owner-occupied CRE more characteristic of the Corporation's C&I portfolio as, in general, the client's primary source of repayment is the cash flow from the operating entity occupying the commercial real estate property. We continue to actively pursue C&I loans across the Corporation as this segment of our loan and lease portfolio provides an attractive yield commensurate with an appropriate level of credit risk and creates opportunities for in-market deposit, treasury management, and private wealth management relationships which generate additional fee revenue. Underwriting of new credit is primarily through approval from a serial sign-off or committee process and is a key component of our operating philosophy. Business development officers have no individual lending authority. To monitor the ongoing credit quality of our loans and leases, each credit is evaluated for proper risk rating using a nine grade risk rating system at the time of origination, subsequent renewal, evaluation of updated financial information from our borrowers, or as other circumstances dictate. While we continue to experience significant competition from banks operating in our primary geographic areas, we remain committed to our underwriting standards and will not deviate from those standards for the sole purpose of growing our loan and lease portfolio. We continue to expect our new loan and lease activity to be adequate to replace normal amortization, allowing us to continue growing in future years. The types of loans and leases we originate and the various risks associated with these originations remain consistent with information previously outlined in our most recent Annual Report on Form 10-K.
Deposits
As ofMarch 31, 2023 , total period-end deposits increased by$308.6 million to$2.477 billion from$2.168 billion atDecember 31, 2022 , primarily due to a$219.9 million and$154.4 million increase in wholesale deposits and certificate of deposit accounts, partially offset by a decrease in non-interest-bearing transaction accounts of$65.2 million . The large increase in wholesale deposits is primarily driven by a shift from FHLB advances to wholesale deposits to manage interest rate risk and increase excess liquidity. Please see the section entitled Response to Banking Liquidity Events above for additional information on the increase in liquidity as ofMarch 31, 2023 . Total period-end in-market deposits increased$88.8 million , or 18.1% annualized, to$2.055 billion , compared to$1.966 billion . Growth in interest-bearing transaction accounts and certificates of deposits, driven by client movement into extended insurance products, was partially offset by a seasonal decrease in non-interest-bearing transaction accounts and money market accounts. Management believes the Bank's deposit-centric sales strategy, led by treasury management sales, will contribute to a net increase in deposits annually; however, period-end deposit balances associated with in-market relationships will fluctuate based upon maturity of time deposits, client demands for the use of their cash, and our ability to maintain existing and new client relationships. Our strategic efforts remain focused on adding in-market deposit relationships. We measure the success of in-market deposit gathering efforts based on the number and average balances of our deposit accounts as compared to ending balances due 55
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to the variability of some of our larger relationships. The Bank’s average
in-market deposits, consisting of all transaction accounts, money market
accounts, and certificates of deposit, were
ended
FHLB Advances and Other Borrowings
As ofMarch 31, 2023 , FHLB advances and other borrowings decreased by$114.9 million , or 25.2%, to$341.9 million from$456.8 million atDecember 31, 2022 . As deposit balances have increased, we have been able to reduce our usage of FHLB advances. We have strategically reduced our usage of FHLB advances in favor of wholesale deposits to increase the Bank's readily available liquidity. We will continue to utilize FHLB advances and wholesale deposits to manage interest rate risk, liquidity, and contingency funding. As ofMarch 31, 2023 , the Corporation had no other borrowings. As ofDecember 31, 2022 , the Corporation had other borrowings of$6.1 million which consisted of sold loans which were accounted for as a secured borrowing because they did not qualify for true sale accounting. Consistent with our funding philosophy to manage interest rate risk, we will use the most efficient and cost effective source of wholesale funds. We will utilize FHLB advances to the extent we maintain an adequate level of excess borrowing capacity for liquidity and contingency funding purposes and pricing remains favorable in comparison to the wholesale deposit alternative. We will use FHLB advances and/or brokered certificates of deposit in specific maturity periods needed, typically three to five years, to match-fund fixed rate loans and effectively mitigate the interest rate risk measured through our asset/liability management process and to support asset growth initiatives while taking into consideration our operating goals and desired level of usage of wholesale funds. Please refer to the section entitled Liquidity and Capital Resources, below, for further information regarding our use and monitoring of wholesale funds. Preferred Stock The Corporation has 12,500 shares, or$12.5 million in aggregate liquidation preference, of 7.0% Fixed-to-Floating Rate Non-Cumulative Perpetual Preferred Stock, Series A, par value$0.01 per share, with a liquidation preference of$1,000 per share (the "Series A Preferred Stock") outstanding as ofMarch 31, 2023 andDecember 31, 2022 . The Corporation expects to pay dividends on the Series A Preferred Stock when and if declared by its Board, at a fixed rate of 7.0% per annum, payable quarterly, in arrears, onMarch 15 ,June 15 ,September 15 andDecember 15 of each year up to, but excluding,March 15, 2027 . For each dividend period from and includingMarch 15, 2027 , dividends will be paid at a floating rate of Three-Month Term SOFR plus a spread of 539 basis points per annum. During the three months endedMarch 31, 2023 , the Corporation paid$219,000 in preferred cash dividends with respect to the Series A Preferred Stock. The Series A Preferred Stock is perpetual and has no stated maturity. The Corporation may redeem the Series A Preferred Stock at its option at a redemption price equal to$1,000 per share, plus any declared and unpaid dividends (without regard to any undeclared dividends), subject to regulatory approval, on or afterMarch 15, 2027 or within 90 days following a regulatory capital treatment event, in accordance with the terms of the Series A Preferred Stock. 56
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Derivatives
The Board approved Bank policies allow the Bank to participate in hedging strategies or to use financial futures, options, forward commitments, or interest rate swaps. The Bank utilizes, from time to time, derivative instruments in the course of its asset/liability management. The Corporation's derivative financial instruments, under which the Corporation is required to either receive cash from or pay cash to counterparties depending on changes in interest rates applied to notional amounts, are carried at fair value on the consolidated balance sheets. As ofMarch 31, 2023 , the aggregate amortizing notional value of interest rate swaps with various commercial borrowers was approximately$787.8 million , compared to$744.2 million as ofDecember 31, 2022 . We receive fixed rates and pay floating rates based upon designated benchmark interest rates on the swaps with commercial borrowers. These swaps mature betweenMay 2024 andJune 2039 . Commercial borrower swaps are completed independently with each borrower and are not subject to master netting arrangements. As ofMarch 31, 2023 , the commercial borrower swaps were reported on the Consolidated Balance Sheet as a derivative liability of$49.0 million compared to a derivative asset and liability of$1.0 million and$61.4 million , respectively, as ofDecember 31, 2022 . On the offsetting swap contracts with dealer counterparties, we pay fixed rates and receive floating rates based upon designated benchmark interest rates. These interest rate swaps also have maturity dates betweenMay 2024 andJune 2039 . Dealer counterparty swaps are subject to master netting agreements among the contracts within our Bank and were reported on the Consolidated Balance Sheet as a net derivative asset of$45.8 million as ofMarch 31, 2023 , compared to a net derivative liability of$60.4 million as ofDecember 31, 2022 . The gross amount of dealer counterparty swaps as ofMarch 31, 2023 , without regard to the enforceable master netting agreement, was a gross derivative asset of$49.0 million , compared to a gross derivative liability of$1.0 million and gross derivative asset of$61.4 million as ofDecember 31, 2022 . The Corporation also enters into interest rate swaps to manage interest rate risk and reduce the cost of match-funding certain long-term fixed rate loans. These derivative contracts involve the receipt of floating rate interest from a counterparty in exchange for the Corporation making fixed-rate payments over the life of the agreement, without the exchange of the underlying notional value. The instruments are designated as cash flow hedges as the receipt of floating rate interest from the counterparty is used to manage interest rate risk associated with forecasted issuances of short-term FHLB advances. The change in the fair value of these hedging instruments is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged transactions affects earnings. As ofMarch 31, 2023 , the aggregate notional value of interest rate swaps designated as cash flow hedges was$106.4 million . These interest rate swaps mature betweenDecember 2022 andMarch 2034 . A pre-tax unrealized loss of$1.4 million was recognized in other comprehensive income for the three months endedMarch 31, 2023 , and there was no ineffective portion of these hedges. The Corporation also enters into interest rate swaps to mitigate market value volatility on certain long-term fixed securities. The objective of the hedge is to protect the Corporation against changes in fair value due to changes in benchmark interest rates. The instruments are designated as fair value hedges as the changes in the fair value of the interest rate swap are expected to offset changes in the fair value of the hedged item attributable to changes in the SOFR swap rate, the designated benchmark interest rate. These derivative contracts involve the receipt of floating rate interest from a counterparty in exchange for the Corporation making fixed-rate payments over the life of the agreement, without the exchange of the underlying notional value. The change in the fair value of these hedging instruments is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged transactions affects earnings. As ofMarch 31, 2023 , the aggregate notional value of interest rate swaps designated as fair value hedges was$12.5 million . These interest rate swaps mature betweenFebruary 2031 andOctober 2034 . A pre-tax unrealized loss of$175,000 was recognized in other comprehensive income for the three months endedMarch 31, 2023 , and there was no ineffective portion of these hedges.
For further information and discussion of our derivatives, see Note 13 –
Derivative Financial Instruments of the Consolidated Financial Statements.
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Asset Quality
Non-performing Assets
Total non-performing assets consisted of the following at
March 31, December 31,
2023 2022
(Dollars in Thousands)
Non-performing loans and leases
Commercial real estate:
Commercial real estate - owner occupied $ - $ -
Commercial real estate - non-owner occupied - -
Construction - -
Multi-family - -
1-4 family 28 30
Total non-performing commercial real estate 28 30
Commercial and industrial 3,384 3,629
Consumer and other - -
Total non-performing loans and leases 3,412 3,659
Repossessed assets, net 89 95
Total non-performing assets 3,501 3,754
Total non-performing loans and leases to gross loans and leases 0.13 % 0.15 %
Total non-performing assets to gross loans and leases plus
repossessed assets, net
0.14 0.15 Total non-performing assets to total assets 0.11 0.13 Allowance for credit losses to gross loans and leases 1.08 0.99 Allowance for credit losses to non-performing loans and leases 807.44 662.20 Non-performing loans decreased$247,000 , or 6.8%, to$3.4 million atMarch 31, 2023 , compared to$3.7 million atDecember 31, 2022 . The decrease in non-performing loans was principally due to loan payoffs, loans returning to accrual status, and$166,000 of charge-offs. The Corporation's non-performing loans as a percentage of total gross loans and leases measured 0.13% and 0.15% atMarch 31, 2023 andDecember 31, 2022 , respectively. We use a wide variety of available metrics to assess the overall asset quality of the portfolio and no one metric is used independently to make a final conclusion as to the asset quality of the portfolio. Non-performing assets as a percentage of total assets was 0.11% and 0.13% atMarch 31, 2023 andDecember 31, 2022 , respectively. As ofMarch 31, 2023 andDecember 31, 2022 , the payment performance of our loans and leases did not point to any new areas of concern, as approximately 99.87% and 99.85%, respectively, of the total portfolio at the end of each period was in a current payment status. We also monitor asset quality through our established categories as defined in Note 5 - Loans and Allowance for Credit Losses of the Consolidated Financial Statements. As we continue to actively monitor the credit quality of our loan and lease portfolios, we may identify additional loans and leases for which the borrowers or lessees are having difficulties making the required principal and interest payments based upon factors including, but not limited to, the inability to sell the underlying collateral, inadequate cash flow from the operations of the underlying businesses, liquidation events, or bankruptcy filings. We are proactively working with our loan borrowers experiencing financial difficulty to find meaningful solutions to difficult situations that are in the best interests of the Bank. As ofMarch 31, 2023 , as well as in all previous reporting periods, there were no loans over 90 days past due and still accruing interest. Loans and leases greater than 90 days past due are placed on non-accrual status and individually evaluated for reserve requirement. Cash received while a loan or a lease is on non-accrual status is generally applied solely against the outstanding principal. If collectability of the contractual principal and interest is not in doubt, payments received may be applied to both interest due on a cash basis and principal. 58
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The following represents additional information regarding our non-performing
loans and leases:
As of and for
the
As of and for the Three Months Ended Year Ended
March 31, December 31,
2023 2022 2022
(In Thousands)
Individually evaluated loans and leases with no
specific reserves required $ 1,037 $ 4,082 $ 1,067
Individually evaluated loans and leases with
specific reserves required 2,375 1,536 2,592
Total individually evaluated loans and leases 3,412 5,618 3,659
Less: Specific reserves (included in allowance for
credit losses)
1,622 1,225 1,650 Net non-performing loans and leases$ 1,790 $ 4,393 $ 2,009 Average non-performing loans and leases$ 3,536 $ 6,195 $ 4,899 Foregone interest income attributable to non-performing loans and leases $ 78
Less: Interest income recognized on non-performing
loans and leases
40 28 1,436 Net foregone interest income on non-performing loans and leases $ 38$ 77 $ (1,036) Allowance for Credit Losses The allowance for credit losses, including unfunded commitment reserves, increased$3.3 million , or 13.70%, to$27.6 million as ofMarch 31, 2023 from$24.2 million as ofDecember 31, 2022 . The allowance for credit losses as a percentage of gross loans and leases improved to 1.08% as ofMarch 31, 2023 from 0.99% as ofDecember 31, 2022 . The increase in allowance for credit losses as a percent of gross loans and leases was principally due to recognition of reserves on unfunded credit commitments under a new accounting principal (ASC 326) and forecasted deterioration of economic conditions used in the estimate. Subjective factors were updated for the changes to portfolio segment under the new standard. See Note 1 - Nature of Operations and Summary of Significant Accounting Policies for additional details on the adoption of ASC 326 and management's estimation model. During the three months endedMarch 31, 2023 , we recorded net charge-offs on individually evaluated loans and leases of$59,000 , comprised of$166,000 of charge-offs and$107,000 of recoveries. While we likely will continue to experience some level of periodic charge-offs in the future as exit strategies are considered and executed. Loans and leases with previously established specific reserves, may ultimately result in a charge-off under a variety of scenarios. As ofMarch 31, 2023 andDecember 31, 2022 , our ratio of allowance for credit losses to total non-performing loans and leases was 807.44% and 662.20%, respectively. This ratio increased primarily due to increase in reserve estimate for collectively evaluated loans and the continuation of a low level of non-performing loans and leases. As discussed above, the adoption of ASC 326 includes the use of a reasonable and supportable forecast. The model utilized captures the increased likelihood of a recession which adds to reserves in advance of the observance of specific negative credit indicators in the loan portfolio. Non-performing loans and leases exhibit weaknesses that inhibit repayment in compliance with the original terms of the note or lease; however, the evaluation of non-performing loans and leases may not always result in a specific reserve included in the allowance for credit losses. As part of the underwriting process, as well as our ongoing monitoring efforts, we try to ensure that we have sufficient collateral to protect our interest in the related loan or lease. As a result of this practice, a significant portion of our outstanding balance of non-performing loans or leases may not require additional specific reserves or require only a minimal amount of required specific reserve. Management is proactive in recording charge-offs to bring loans to their net realizable value in situations where it is determined with certainty that we will not recover the entire amount of our principal. This practice may lead to a lower allowance for credit loss to non-performing loans and leases ratio as compared to our peers or industry expectations. As asset quality strengthens, our allowance for credit losses is measured more through collective characteristics of our portfolio rather than through specific identification and we would therefore expect this ratio to rise. Conversely, if we identify further impaired loans, this ratio could fall if the impaired loans are adequately collateralized and therefore require no specific or general reserve. Given our business practices and evaluation of our existing loan and lease portfolio, we believe this coverage ratio is appropriate for the probable losses inherent in our loan and lease portfolio as ofMarch 31, 2023 . 59
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To determine the level and composition of the allowance for credit losses, we break out the portfolio by segments with similar risk characteristics. First, we evaluate loans and leases for non-performing classification. We analyze each loan and lease identified as non-performing on an individual basis to determine a specific reserve based upon the estimated value of the underlying collateral for collateral-dependent loans, or alternatively, the present value of expected cash flows. All loans not evaluated individually are evaluated collectively as part of a portfolio segment or portfolio segment and class. These collective evaluations utilized a reasonable and supportable forecast which includes projections of credit losses based on one of two established methods: discounted cash flow or weighted average remaining maturity. Each model includes a set of assumptions which are evaluated not less than annually by management. Further, the methodology also focuses on evaluation of several qualitative factors for each portfolio segment or portfolio segment and class, including but not limited to: product growth rates, management's ongoing review and grading of the loan and lease portfolios, consideration of delinquency experience, changes in the size of the loan and lease portfolios, level of loans and leases subject to more frequent review by management, changes in underlying collateral, concentrations in specific industries, and other qualitative factors that could affect credit losses. When it is determined that we will not receive our entire contractual principal or the loss is confirmed, we record a charge against the allowance for credit loss reserve to bring the loan or lease to its net realizable value. Many of the impaired loans as ofMarch 31, 2023 are collateral dependent. It is typically part of our process to obtain appraisals on impaired loans and leases that are primarily secured by real estate or equipment at least annually, or more frequently as circumstances warrant. As we have completed new appraisals and/or market evaluations, in specific situations current fair values collateralizing certain impaired loans were inadequate to support the entire amount of the outstanding debt. Foreclosure actions may have been initiated on certain of these commercial real estate and other mortgage loans. As a result of our review process, we have concluded an appropriate allowance for credit losses for the existing loan and lease portfolio was$27.6 million , or 1.08% of gross loans and leases, atMarch 31, 2023 . However, given ongoing complexities with current workout situations and the uncertainty surrounding future economic conditions, further charge-offs, and increased provisions for credit losses may be recorded if additional facts and circumstances lead us to a different conclusion. In addition, various federal and state regulatory agencies review the allowance for credit losses. These agencies could require certain loan and lease balances to be classified differently or charged off when their credit evaluations differ from those of management, based on their judgments about information available to them at the time of their examination. 60
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A summary of the activity in the allowance for credit losses follows:
As of
and for the Three Months Ended March
31,
2023 2022
(Dollars in Thousands)
Allowance at beginning of period $ 24,230 $ 24,336
Impact of adoption of ASC 326 1,818 -
Charge-offs:
Commercial real estate: Commercial real estate - owner occupied - - Commercial real estate - non-owner occupied - - Construction - - Multi-family - - 1-4 family - - Commercial and industrial (166) (22) Consumer and other loans - - Total charge-offs (166) (22) Recoveries: Commercial real estate: Commercial real estate - owner occupied - 115 Commercial real estate - non-owner occupied 1 1 Construction - - Multi-family - - 1-4 family - - Commercial and industrial 95 84 Consumer and other loans 11 10 Total recoveries 107 210 Net recoveries (59) 188 Provision for credit losses 1,561 (855) Allowance at end of period$ 27,550 $ 23,669
Components:
Allowance for loan losses$ 26,140 $ 23,669 Allowance for unfunded credit commitments 1,410 - Total ACL$ 27,550 $ 23,669 Annualized net recoveries as a percent of average gross loans and leases 0.01 % (0.03) % 61
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Liquidity and Capital Resources
The Corporation expects to meet its liquidity needs through existing cash on
hand, established cash flow sources, its third party senior line of credit, and
dividends received from the Bank. While the Bank is subject to certain generally
applicable regulatory limitations regarding its ability to pay dividends to the
Corporation, we do not believe that the Corporation will be adversely affected
by these dividend limitations. The Corporation's principal liquidity
requirements at March 31, 2023 were the interest payments due on subordinated
notes and cash dividends payable to both common and preferred stockholders. The
capital ratios of the Bank met all applicable regulatory capital adequacy
requirements in effect on March 31, 2023 , and continue to meet the heightened
requirements imposed by Basel III, including the capital conservation buffer.
The Corporation's Board and management teams adhere to the appropriate
regulatory guidelines on decisions which affect their capital positions,
including but not limited to, decisions relating to the payment of dividends and
increasing indebtedness.
The Bank maintains liquidity by obtaining funds from several sources. The
Bank's primary sources of funds are principal and interest payments on loans
receivable and mortgage-related securities, deposits, and other borrowings, such
as federal funds, and FHLB advances. The scheduled payments of loans and
mortgage-related securities are generally a predictable source of funds. Deposit
flows and loan prepayments, however, are greatly influenced by general interest
rates, economic and industry conditions, and competition.
We view readily accessible liquidity as a critical element to meet our cash and
collateral obligations. We define our readily accessible liquidity as the total
of our short-term investments, our unencumbered securities available-for-sale,
and our unencumbered pledged loans. As described in the Response to Banking
Liquidity Events section above, our readily accessible liquidity increased
quarter over quarter. At March 31, 2023 and December 31, 2022 , the Bank had
$158.9 million and $76.5 million on deposit with the FRB recorded in short-term
investments, respectively. Any excess funds not used for loan funding or
satisfying other cash obligations were maintained as part of our readily
accessible liquidity in our interest-bearing accounts with the FRB, as we value
the safety and soundness provided by the FRB. We plan to utilize excess
liquidity to fund loan and lease portfolio growth, pay down maturing debt, allow
run off of maturing wholesale certificates of deposit or invest in securities to
maintain adequate liquidity at an improved margin.
We had $729.6 million of outstanding wholesale funds at March 31, 2023 ,
compared to $618.6 million of wholesale funds as of December 31, 2022 , which
represented 26.2% and 23.9%, respectively, of ending balance total bank funding.
Wholesale funds include FHLB advances, brokered certificates of deposit, and
deposits gathered from internet listing services. Total bank funding is defined
as total deposits plus FHLB advances. We are committed to raising in-market
deposits while utilizing wholesale funds to mitigate interest rate risk.
Wholesale funds continue to be an efficient and cost effective source of funding
for the Bank and allows it to gather funds across a larger geographic base at
price levels and maturities that are more attractive than local time deposits
when required to raise a similar level of in-market deposits within a short time
period. Access to such deposits and borrowings allows us the flexibility to
refrain from pursuing single service deposit relationships in markets that have
experienced unfavorable pricing levels. In addition, the administrative costs
associated with wholesale funds are considerably lower than those that would be
incurred to administer a similar level of local deposits with a similar maturity
structure. Wholesale funds are also stable as each issuance has a structured
maturity date and may only be redeemed in certain limited circumstances. During
the time frames necessary to accumulate wholesale funds in an orderly manner, we
will use short-term FHLB advances to meet our temporary funding needs. The
short-term FHLB advances will typically have terms of one week to one month to
cover the overall expected funding demands.
As described in the Response to Banking Liquidity Events section above,
period-end in-market deposits increased as of March 31, 2023 , compared to
December 31, 2022 . There was a shift of in-market deposit mix to term deposits
at higher interest rates, which was partially offset by deposit movement from
transaction accounts to alternative investment options and clients funding their
normal course of business activities. The decline in transaction and money
market accounts was not the result of the loss of any significant client
relationships, and we expect to continue to establish new client relationships
and increase transaction account balances with existing clients' accounts.
Nonetheless, we will continue to use wholesale funds in specific maturity
periods, typically three to five years, needed to effectively mitigate the
interest rate risk measured through our asset/liability management process or in
shorter time periods if in-market deposit balances decline. In order to provide
for ongoing liquidity and funding, none of our wholesale certificates of deposit
allow for withdrawal at the option of the depositor before the stated maturity
(with the exception of deposits accumulated through the internet listing service
which have the same early withdrawal privileges and fees as do our other
in-market deposits) and FHLB advances with contractual maturity terms. The Bank
limits the percentage of wholesale funds to total bank funds in accordance with
liquidity policies approved by its Board. The Bank was in compliance with its
policy limits as of March 31, 2023 .
The Bank was able to access the wholesale funding market as needed at rates
and terms comparable to market standards during the quarter ended March 31,
2023 . In the event that there is a disruption in the availability of wholesale
funds at maturity, the Bank has managed the maturity structure, in compliance
with our approved liquidity policy, so at least one year
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of maturities could be funded through readily accessible liquidity. These potential funding sources include deposits maintained at the FRB or Federal Reserve Discount Window utilizing currently unencumbered securities and acceptable loans as collateral. As ofMarch 31, 2023 , the available liquidity was in excess of the stated policy minimum. We believe the Bank will also have access to the unused federal funds lines, cash flows from borrower repayments, and cash flows from security maturities. The Bank also has the ability to raise local market deposits by offering attractive rates to generate the level required to fulfill its liquidity needs. The Corporation has filed a shelf registration with theSecurities and Exchange Commission that would allow the Corporation to offer and sell, from time to time and in one or more offerings, up to$75.0 million in aggregate initial offering price of common and preferred stock, debt securities, warrants, subscription rights, units, or depository shares, or any combination thereof. During the three months endedMarch 31, 2023 , operating activities resulted in a net cash inflow of$9.9 million , which included net income of$9.0 million . Net cash used by investing activities for the three months endedMarch 31, 2023 was$116.3 million primarily due to net loan disbursements, investments made in securities available for sale, and additional investments in federal home loan bank stock and federal reserve bank stock. Net cash provided by financing activities was$189.7 million for the three months endedMarch 31, 2023 primarily due to a net increase in deposits, partially offset by the repayment of FHLB advances. Please refer to the Consolidated Statements of Cash Flows included in PART I., Item 1 for further details regarding significant sources of cash flow for the Corporation. Contractual Obligations and Off-Balance Sheet Arrangements As ofMarch 31, 2023 , there were no material changes to our contractual obligations and off-balance sheet arrangements disclosed in our Annual Report on Form 10-K for the year endedDecember 31, 2022 . We continue to believe that we have adequate capital and liquidity available from various sources to fund projected contractual obligations and commitments.
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