PENNS WOODS BANCORP INC Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)
PROFIT OVERVIEW
Comparison of the ended three and nine months
Summary Results
Net income for the three and nine months endedSeptember 30, 2022 was$5,250,000 and$12,913,000 compared to$4,125,000 and$11,154,000 for the same periods of 2021. Results for the three and nine months endedSeptember 30, 2022 compared to 2021 were impacted by an increase in after-tax securities losses of$199,000 (from a gain of$32,000 to a loss of$167,000 ) for the three month period and an increase in after-tax securities losses of$494,000 (from a gain of$236,000 to a loss of$258,000 ) for the nine month period. Results for the nine months endedSeptember 30, 2022 were impacted by additional compensation expense of$183,000 (after-tax$145,000 ) associated with the voluntary cash settlement of 346,725 outstanding stock options. In addition, an after-tax loss of$201,000 related to a branch closure negatively impacted results for the nine months endedSeptember 30, 2022 . The provision for loan losses increased$780,000 for the three months and$395,000 for the nine months endedSeptember 30, 2022 to$855,000 and$1.3 million , respectively, compared to$75,000 and$940,000 for the 2021 periods. The increases in the provision for loan losses were primarily due to the significant growth in the loan portfolio. Basic and diluted earnings per share for the three and nine months endedSeptember 30, 2022 were$0.74 and$1.83 . Basic and diluted earnings per share for the three and nine months endedSeptember 30, 2021 were$0.58 and$1.58 . Annualized return on average assets was 1.09% for three months endedSeptember 30, 2022 , compared to 0.86% for the corresponding period of 2021. Annualized return on average assets was 0.89% for the nine months endedSeptember 30, 2022 , compared to 0.79% for the corresponding period of 2021.Annualized return on average equity was 12.61% for the three months endedSeptember 30, 2022 , compared to 9.85% for the corresponding period of 2021. Annualized return on average equity was 10.48% for the nine months endedSeptember 30, 2022 , compared to 9.17% for the corresponding period of 2021. Net income from core operations ("core earnings"), which is a non-generally accepted accounting principles (GAAP) measure of net income excluding net securities gains or losses, was$5,417,000 for the three months endedSeptember 30, 2022 compared to$4,093,000 for the same period of 2021. Core earnings were$13.2 million for the nine months endedSeptember 30, 2022 , compared to$10.9 million for the same period of 2021. Core earnings per share for the three months endedSeptember 30, 2022 were$0.77 basic and diluted, compared to$0.58 basic and diluted core earnings per share for the same period of 2021. Core earnings per share for the nine months endedSeptember 30, 2022 were$1.87 basic and diluted, compared to$1.55 basic and diluted for the same period of 2021. Management uses the non-GAAP measure of net income from core operations in its analysis of the Company's performance. This measure, as used by the Company, adjusts net income by excluding significant gains or losses that are unusual in nature. Because certain of these items and their impact on the Company's performance are difficult to predict, management believes the presentation of financial measures excluding the impact of such items provides useful supplemental information in evaluating the operating results of the Company's core businesses. For purposes of this Quarterly Report on Form 10-Q, net income from core operations means net income adjusted to exclude after-tax net securities gains or losses. These disclosures should not be viewed as a substitute for net income determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies. Reconciliation of GAAP and Non-GAAP Financial Measures
Three months ended September Nine months ended September (dollars in thousands except per share data)
30, 30,
2022 2021 2022 2021
GAAP net income
Less: Net securities (losses) gains, after tax
(167) 32 (258) 236 Non-GAAP core earnings$ 5,417 $ 4,093 $ 13,171 $ 10,918 Three
months ended
2022 2021 2022 2021
GAAP Return on average assets (ROA) 1.09 % 0.86 % 0.89 % 0.79 %
Less: net securities (losses) gains, net of tax (0.03) % - % (0.02) % 0.02 %
Non-GAAP core ROA 1.12 % 0.86 % 0.91 % 0.77 %
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Three Months Ended September 30, Nine Months Ended September 30,
2022 2021 2022 2021
GAAP Return on average equity (ROE) 12.61 % 9.85 % 10.48 % 9.17 %
Less: net securities (losses) gains, net of tax (0.41) % 0.07 % (0.21) % 0.19 %
Non-GAAP core ROE . 13.02 % 9.78 % 10.69 % 8.98 %
Three Months Ended Nine Months Ended September
September 30, 30,
2022 2021 2022 2021
GAAP Basic earnings per share (EPS) $ 0.74 $ 0.58 $ 1.83 $ 1.58
Less: net securities (losses) gains, net of tax (0.03) - (0.04) 0.03
Non-GAAP core operating EPS $ 0.77 $ 0.58 $ 1.87 $ 1.55
Three Months Ended Nine Months Ended September
September 30, 30,
2022 2021 2022 2021
GAAP Diluted EPS $ 0.74 $ 0.58 $ 1.83 $ 1.58
Less: net securities (losses) gains, net of tax (0.03) - (0.04) 0.03
Non-GAAP diluted core EPS $ 0.77
Interest and dividend income
Interest and dividend income for the three and nine months endedSeptember 30, 2022 increased$2,150,000 and$2,608,000 compared to the same periods of 2021. The increase in loan portfolio income was due to a increase in the average loan portfolio balance offset partially by a decrease in average rate earned on the portfolio. Investment securities income has been impacted by a decrease in the average rate earned on the portfolio for the nine month period as higher yielding legacy investments matured. The yield on the the investment portfolio increased during the three months endedSeptember 30, 2022 as compared to the same period in 2021 as investment yields began to move upward. The increase in dividend and other interest income is due to the increase in interest earned on federal funds sold and interest-bearing deposits.
Composition of interest and dividend income for the past three and nine months
Three Months Ended
September 30, 2022 September 30, 2021 Change
(In Thousands) Amount % Total Amount % Total Amount %
Loans including fees $ 15,051 89.25 % $ 13,382 90.95 % $ 1,669 12.47 %
Investment securities:
Taxable 949 5.63 834 5.67 115 13.79
Tax-exempt 236 1.40 160 1.09 76 47.50
Dividend and other interest income 628 3.72 338 2.29 290
85.80
Total interest and dividend income$ 16,864 100.00 %$ 14,714 100.00 %$ 2,150 14.61 % Nine Months Ended September 30, 2022 September 30, 2021 Change (In Thousands) Amount % Total Amount % Total Amount % Loans including fees$ 41,709 90.04 %$ 39,826 91.10 %$ 1,883 4.73 % Investment securities: Taxable 2,550 5.50 2,491 5.70 59 2.37 Tax-exempt 594 1.28 495 1.13 99 20.00 Dividend and other interest income 1,470 3.18 903 2.07 567
62.79
Total interest and dividend income$ 46,323 100.00 %$ 43,715 100.00 %$ 2,608 5.97 % 32
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interest expense
Interest expense for the three and nine months endedSeptember 30, 2022 decreased$750,000 and$2,827,000 compared to the same periods of 2021. Interest-bearing deposit rates continued to remain at low levels due to the continued economic impact of supply chain disruption and level of excess balance sheet liquidity. The decrease in deposit rates was offset in part by an increase in average interest-bearing demand deposits for the nine month period. Growth in the deposit portfolio has allowed for a decrease in average long-term borrowings resulting in a decrease in long-term borrowing interest expense.
Composition of interest expense for the past three and nine months
Three Months Ended
September 30, 2022 September 30, 2021 Change
(In Thousands) Amount % Total Amount % Total Amount %
Deposits $ 693 52.03 % $ 1,308 62.83 % $ (615) (47.02) %
Short-term borrowings 26 1.95 3 0.14 23 766.67
Long-term borrowings 613 46.02 771 37.03 (158) (20.49)
Total interest expense $ 1,332 100.00 % $ 2,082 100.00 % $ (750) (36.02) %
Nine Months Ended
September 30, 2022 September 30, 2021 Change
(In Thousands) Amount % Total Amount % Total Amount %
Deposits $ 2,191 53.56 % $ 4,481 64.77 % $ (2,290) (51.10) %
Short-term borrowings 29 0.71 7 0.10 22 314.29
Long-term borrowings 1,871 45.73 2,430 35.13 (559) (23.00)
Total interest expense $ 4,091 100.00 % $ 6,918 100.00 % $ (2,827) (40.86) %
Net Interest Margin
The net interest margin for the three and nine months ended September 30, 2022
was 3.47% and 3.17%, compared to 2.85% and 2.84% for the corresponding periods
of 2021. The increase in the net interest margin for the three and nine month
periods was driven by a decline in the rate paid on interest-bearing deposits of
23 and 29 basis points ("bps") as rates paid decreased throughout 2021 and
remained at historically low levels during 2022. Leading the decline in the rate
paid on interest-bearing deposits were decreases of 84 and 91 bps in the rate
paid on time deposits as time deposits issued prior to the COVID-19 pandemic
matured. The increase in the earning asset yield was driven by an increase in
yield on federal funds sold and interest-bearing deposits due to the rate
increases enacted by the Federal Open Market Committee ("FOMC"). For the three
and nine months ended September 30, 2022 in comparison to the same periods of
2021, there was an increase in rate on federal funds sold of 186 and 70 bps,
respectively, while the rate on interest bearing deposits increased 218 and 48
bps. The three month period ended September 30, 2022 was impacted by an increase
of 18 bps in the yield earned on the securities portfolio as legacy securities
matured with the funds reinvested at higher rates.
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The following is a breakdown of the average balance sheets and associated returns for the trailing three and nine months
AVERAGE BALANCES AND INTEREST RATES
Three Months Ended September 30, 2022 Three Months Ended September 30, 2021
(In Thousands) Average Balance (1) Interest Average Rate Average Balance (1) Interest Average Rate
Assets:
Tax-exempt loans (3) $ 58,735 $ 394 2.66 % $ 46,193 $ 307 2.64 %
All other loans 1,463,330 14,740 4.00 % 1,296,790 13,139 4.02 %
Total loans (2) 1,522,065 15,134 3.94 % 1,342,983 13,446 3.97 %
Federal funds sold 33,641 218 2.57 % 40,000 72 0.71 %
Taxable securities 159,721 1,158 2.94 % 150,308 1,022 2.76 %
Tax-exempt securities (3) 49,177 299 2.47 % 37,069 203 2.22 %
Total securities 208,898 1,457 2.83 % 187,377 1,225 2.65 %
Interest-bearing deposits 34,202 201 2.33 % 205,715 78 0.15 %
Total interest-earning assets 1,798,806 17,010 3.76 % 1,776,075 14,821 3.32 %
Other assets 130,576 132,820
Total assets $ 1,929,382 $ 1,908,895
Liabilities and shareholders' equity:
Savings $ 249,083 26 0.04 % $ 228,255 22 0.04 %
Super Now deposits 405,173 287 0.28 % 308,591 219 0.28 %
Money market deposits 287,660 200 0.28 % 306,177 238 0.31 %
Time deposits 148,968 180 0.48 % 248,649 829 1.32 %
Total interest-bearing deposits 1,090,884 693 0.25 % 1,091,672 1,308 0.48 %
Short-term borrowings 8,062 26 1.23 % 8,696 3 0.14 %
Long-term borrowings 109,269 613 2.23 % 133,536 771 2.29 %
Total borrowings 117,331 639 2.16 % 142,232 774 2.16 %
Total interest-bearing liabilities 1,208,215 1,332 0.44 % 1,233,904 2,082 0.67 %
Demand deposits 533,681 490,500
Other liabilities 21,008 17,027
Shareholders' equity 166,478 167,464
Total liabilities and shareholders'
equity $ 1,929,382 $ 1,908,895
Interest rate spread (3) 3.32 % 2.65 %
Net interest income/margin (3) $ 15,678 3.47 % $ 12,739 2.85 %
1. Information on this table has been calculated using average daily balance
sheets to obtain average balances.
2. Non-accrual loans have been included with loans for the purpose of analyzing
net interest earnings.
3. Income and rates on fully taxable equivalent basis include an adjustment for
the difference between annual income
from tax-exempt obligations and the taxable equivalent of such income at the
standard tax rate of 21% and are reconciled to the equivalent GAAP
measurement below the tables.
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AVERAGE BALANCES AND INTEREST RATES
Nine Months Ended September 30, 2022 Nine Months Ended September 30, 2021
(In Thousands) Average Balance (1) Interest Average Rate Average Balance (1) Interest Average Rate
Assets:
Tax-exempt loans (3) $ 53,269 $ 1,033 2.59 % $ 46,217 $ 991 2.87 %
All other loans 1,403,504 40,893 3.90 % 1,292,028 39,043 4.04 %
Total loans (2) 1,456,773 41,926 3.85 % 1,338,245 40,034 4.00 %
Federal funds sold 43,938 465 1.41 % 21,993 117 0.71 %
Taxable securities 152,937 3,126 2.76 % 147,942 3,105 2.84 %
Tax-exempt securities (3) 45,357 752 2.24 % 36,638 627 2.31 %
Total securities 198,294 3,878 2.64 % 184,580 3,732 2.73 %
Interest-bearing deposits 97,520 429 0.59 % 206,895 172 0.11 %
Total interest-earning assets 1,796,525 46,698 3.48 % 1,751,713 44,055 3.37 %
Other assets 129,048 128,567
Total assets $ 1,925,573 $ 1,880,280
Liabilities and shareholders' equity:
Savings $ 246,063 72 0.04 % $ 222,889 94 0.06 %
Super Now deposits 388,149 721 0.25 % 294,570 694 0.31 %
Money market deposits 296,998 596 0.27 % 307,309 761 0.33 %
Time deposits 167,876 802 0.64 % 253,130 2,932 1.55 %
Total interest-bearing deposits 1,099,086 2,191 0.27 % 1,077,898 4,481 0.56 %
Short-term borrowings 6,308 29 0.59 % 7,152 7 0.13 %
Long-term borrowings 112,457 1,871 2.22 % 138,669 2,430 2.34 %
Total borrowings 118,765 1,900 2.14 % 145,821 2,437 2.23 %
Total interest-bearing liabilities 1,217,851 4,091 0.45 % 1,223,719 6,918 0.76 %
Demand deposits 519,599 473,088
Other liabilities 23,814 21,327
Shareholders' equity 164,309 162,146
Total liabilities and shareholders'
equity $ 1,925,573 $ 1,880,280
Interest rate spread (3) 3.03 % 2.61 %
Net interest income/margin (3) $ 42,607 3.17 % $ 37,137 2.84 %
1. Information on this table has been calculated using average daily balance
sheets to obtain average balances.
2. Non-accrual loans have been included with loans for the purpose of analyzing
net interest earnings.
3. Income and rates on fully taxable equivalent basis include an adjustment for
the difference between annual income
from tax-exempt obligations and the taxable equivalent of such income at the
standard tax rate of 21% and are reconciled to the equivalent GAAP
measure below the tables.
The following table presents the adjustment to convert net interest income to
net interest income on a fully taxable equivalent basis for the three and nine
months ended September 30, 2022 and 2021:
Three Months Ended September 30, Nine Months Ended September 30,
(In Thousands) 2022 2021 2022 2021
Total interest income $ 16,864 $ 14,714 $ 46,323 $ 43,715
Total interest expense 1,332 2,082 4,091 6,918
Net interest income (GAAP) 15,532 12,632 42,232 36,797
Tax equivalent adjustment 146 107 375 340
Net interest income (fully taxable
equivalent) (NON-GAAP) $ 15,678 $ 12,739 $ 42,607 $ 37,137
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The following table sets forth the respective impact that both volume and rate changes have had on net interest income on a fully taxable equivalent basis for the three and nine months endedSeptember 30, 2022 and 2021: Three Months Ended September 30, Three months ended September 30, 2022 vs. 2021 2022 vs. 2021 Increase (Decrease) Due to Increase (Decrease) Due to (In Thousands) Volume Rate Net Volume Rate Net Interest income: Tax-exempt loans $ 85$ 2 $ 87 $ 104 $ (62) $ 42 All other loans 1,666 (65) 1,601 2,600 (750) 1,850 Federal funds sold (13) 159 146 175 173 348 Taxable investment securities 66 70 136 75 (54) 21 Tax-exempt investment securities 71 25 96 134 (9) 125 Interest bearing deposits (114) 237 123 (60) 317 257 Total interest-earning assets 1,761 428 2,189 3,028 (385) 2,643 Interest expense: Savings deposits 4 - 4 5 (27) (22) Super Now deposits 68 - 68 126 (99) 27 Money market deposits (14) (24) (38) (26) (139) (165) Time deposits (251) (398) (649) (776) (1,354) (2,130) Short-term borrowings - 23 23 (1) 0 23 22 Long-term borrowings (138) (20) (158) (439) 0 (120) (559) Total interest-bearing liabilities (331) (419) (750) (1,111) (1,716)
(2,827)
Change in net interest income$ 2,092 $ 847 $ 2,939 $ 4,139 $ 1,331 $ 5,470 Provision for Loan Losses The provision for loan losses is based upon management's quarterly review of the loan portfolio. The purpose of the review is to assess loan quality, identify impaired loans, analyze delinquencies, ascertain loan growth, evaluate potential charge-offs and recoveries, and assess general economic conditions in the markets served. An external independent loan review is also performed annually for the Banks. Management remains committed to an aggressive program of problem loan identification and resolution. The allowance for loan losses is determined by applying loss factors to outstanding loans by type, excluding loans for which a specific allowance has been determined. Loss factors are based on management's consideration of the nature of the portfolio segments, changes in mix and volume of the loan portfolio, and historical loan loss experience. In addition, management considers industry standards and trends with respect to non-performing loans and its knowledge and experience with specific lending segments. Although management believes it uses the best information available to make such determinations and that the allowance for loan losses is adequate atSeptember 30, 2022 , future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making the initial determinations. A downturn in the local economy, increased unemployment, and delays in receiving financial information from borrowers could result in increased levels of nonperforming assets, charge-offs, loan loss provisions, and reductions in income. Additionally, as an integral part of the examination process, bank regulatory agencies periodically review the Banks' loan loss allowance. The banking agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination. When determining the appropriate allowance level, management has attributed the allowance for loan losses to various portfolio segments; however, the allowance is available for the entire portfolio as needed. The allowance for loan losses increased from$14,176,000 atDecember 31, 2021 to$15,211,000 atSeptember 30, 2022 . The increase in allowance was due to growth in the loan portfolio. AtSeptember 30, 2022 andDecember 31, 2021 , the allowance for loan losses to total loans was 0.97% and 1.02%, respectively. 36
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The provision for loan losses totaled$855,000 and$1,335,000 for the three and nine months endedSeptember 30, 2022 and the amounts for the corresponding 2021 periods were$75,000 and$940,000 . The increase in the provision for loan losses for the three months and nine months endedSeptember 30 2022 compared to the corresponding 2021 periods was primarily the result of loan portfolio growth and to a lesser extent the continued economic uncertainty caused by continued supply chain shortages. Nonperforming loans decreased to$5,743,000 atSeptember 30, 2022 from$6,250,000 atDecember 31, 2021 . The majority of nonperforming loans involve loans that are either in a secured position and have sureties with a strong underlying financial position or have a specific allocation for any impairment recorded within the allowance for loan losses. The ratio of non-performing loans to total loans ratio decreased to 0.37% atSeptember 30, 2022 from 0.58% atSeptember 30, 2021 as non-performing loans have decreased to$5.7 million atSeptember 30, 2022 from$7.8 million atSeptember 30, 2021 . Net loan charge-offs of$300,000 for the nine months endedSeptember 30, 2022 impacted the allowance for loan losses, which was 0.97% of total loans atSeptember 30, 2022 compared to 1.08% atSeptember 30, 2021 .
The table below shows the total non-performing loans as of:
Total Nonperforming Loans (In Thousands) 90 Days Past Due Non-accrual Total September 30, 2022$ 1,161 $ 4,582 $ 5,743 June 30, 2022 421 4,679 5,100 March 31, 2022 364 4,917 5,281 December 31, 2021 861 5,389 6,250 September 30, 2021 854 6,909 7,763
Additional allowance for loan losses and net recoveries (charge-offs) are presented in the tables below by loan portfolio segment.
September 30, 2022
Amount of Ratio of Net
Allowance for Allowance for (Charge-Offs)
Loan Losses Loan Losses to Net (Charge-Offs) Recoveries to Average
(In Thousands) Allocated Total loans Total Loans Ratio Recoveries Average Loans Loans
Commercial, financial, and
agricultural $ 2,069 $ 173,365 1.19 % $ 120 $ 169,822 0.07 %
Real estate mortgage:
Residential 5,195 683,242 0.76 % 31 634,031 - %
Commercial 5,536 485,538 1.14 % (152) 458,523 (0.03) %
Construction 210 48,694 0.43 % 28 44,161 0.06 %
Consumer automobiles 1,585 159,681 0.99 % (202) 140,595 (0.14) %
Other consumer installment loans 118 9,811 1.20 % (125) 9,641 (1.30) %
Unallocated 498
$ 15,211 $ 1,560,331 0.97 % $ (300) $ 1,456,773 (0.02) %
Total non-accrual loans outstanding $ 4,582
Non-accrual loans to total loans
outstanding 0.29 %
Allowance for loan losses to
non-accrual loans 331.97 %
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December 31, 2021
Amount of Ratio of Net
Allowance for Allowance for (Charge-Offs)
Loan Losses Loan Losses to Net (Charge-Offs) Recoveries to Average
(In Thousands) Allocated Total loans Total Loans Ratio Recoveries Average Loans Loans
Commercial, financial, and
agricultural $ 1,946 $ 163,285 1.19 % $ (10) $ 175,631 (0.01) %
Real estate mortgage:
Residential 4,701 595,847 0.79 % (107) 584,849 (0.02) %
Commercial 5,336 446,734 1.19 % 95 381,306 0.02 %
Construction 179 37,295 0.48 % 10 41,564 0.02 %
Consumer automobiles 1,411 139,408 1.01 % (143) 152,496 (0.09) %
Other consumer installment loans 111 9,277 1.20 % (112) 9,787 (1.14) %
Unallocated 492
$ 14,176 $ 1,391,846 1.02 % $ (267) $ 1,345,633 (0.02) %
Total outstanding interest-free loans $5,389
0.39 % Allowance for loan losses to non-accrual loans 263.05 % Non-interest Income Total non-interest income for the three and nine months endedSeptember 30, 2022 compared to the same periods in 2021 decreased$868,000 and$1,842,000 . Excluding net securities gains, non-interest income for the three and nine months endedSeptember 30, 2022 decreased$617,000 and$1,217,000 compared to the same periods in 2021. Gain on sale of loans decreased as the volume of loan sales has declined and the product mix has caused the Company to increasingly act in a broker capacity with the fee income from broker activity included in loan broker commissions. Service charges increased for the three and nine month periods primarily due to an increase in overdraft fees. Brokerage commissions have declined due to changes in the product mix and reduced consumer activity. The decrease in debit card fees is a result of an decrease in debit card usage.
Composition of interest-free income for the past three and nine months
Three Months Ended
September 30, 2022 September 30, 2021 Change
(In Thousands) Amount % Total Amount % Total Amount %
Service charges $ 559 26.84 % $ 456 15.45 % $ 103 22.59 %
Net debt securities (losses) gains,
available for sale (156) (7.49) 48 1.63 (204) 425.00
Net equity securities losses (55) (2.64) (8) (0.27) (47) (587.50)
Bank-owned life insurance 170 8.16 279 9.45 (109) (39.07)
Gain on sale of loans 294 14.11 456 15.45 (162) (35.53)
Insurance commissions 109 5.23 129 4.37 (20) (15.50)
Brokerage commissions 142 6.82 237 8.03 (95) (40.08)
Loan broker commissions 438 21.03 772 26.16 (334) (43.26)
Debit card income 344 16.51 388 13.15 (44) (11.34)
Other 238 11.43 194 6.57 44 22.68
Total non-interest income $ 2,083 100.00 % $ 2,951 100.00 % $ (868) (29.41) %
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Nine Months Ended
September 30, 2022 September 30, 2021 Change
(In Thousands) Amount % Total Amount % Total Amount %
Service charges $ 1,563 23.57 % $ 1,218 14.37 % $ 345 28.33 %
Net debt securities (losses) gains,
available for sale (168) (2.53) 323 3.81 (491) 152.01
Net equity securities losses (158) (2.38) (24) (0.28) (134) (558.33)
Bank-owned life insurance 501 7.55 614 7.25 (113) (18.40)
Gain on sale of loans 905 13.65 2,034 24.00 (1,129) (55.51)
Insurance commissions 386 5.82 436 5.15 (50) (11.47)
Brokerage commissions 500 7.54 663 7.82 (163) (24.59)
Loan broker commissions 1,350 20.36 1,449 17.10 (99) (6.83)
Debit card income 1,080 16.28 1,166 13.76 (86) (7.38)
Other 673 10.14 595 7.02 78 13.11
Total non-interest income $ 6,632 100.00 % $ 8,474 100.00 % $ (1,842) (21.74) %
Non-interest Expense
Total non-interest expense decreased $127,000 for the three months ended
September 30, 2022 and increased $1,101,000 for the nine months ended September
30, 2022 compared to the same periods of 2021. The increase in salaries and
employee benefits is attributable to the current employment environment,
employee retention efforts, routine annual wage increases, and the voluntary
cash settlement of 346,725 outstanding stock options resulting in $183,000 of
compensation expense recognized during the second quarter of 2022. Furniture and
equipment expenses in addition to occupancy expenses have decreased as
maintenance costs and the level of depreciation have decreased. Software
amortization fluctuations are due to changes in software licensing costs. Other
expense increased for the nine month period primarily from a write down on
leasehold improvements of $254,000 related to a branch closure during the first
quarter of 2022.
Composition of noninterest expenses for the past three and nine months
Three Months Ended
September 30, 2022 September 30, 2021 Change
(In Thousands) Amount % Total Amount % Total Amount %
Salaries and employee benefits $ 6,016 58.29 % $ 5,837 55.87 % $ 179 3.07 %
Occupancy 730 7.07 745 7.13 (15) (2.01)
Furniture and equipment 816 7.91 883 8.45 (67) (7.59)
Software amortization 188 1.82 226 2.16 (38) (16.81)
Pennsylvania shares tax 334 3.24 373 3.57 (39) (10.46)
Professional fees 626 6.07 615 5.89 11 1.79
Federal Deposit Insurance Corporation
deposit insurance 260 2.52 220 2.11 40 18.18
Marketing 151 1.46 231 2.21 (80) (34.63)
Intangible amortization 34 0.33 44 0.42 (10) (22.73)
Other 1,165 11.29 1,273 12.19 (108) (8.48)
Total non-interest expense $ 10,320 100.00 % $ 10,447 100.00 % $ (127) (1.22) %
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Nine Months Ended
September 30, 2022 September 30, 2021 Change
(In Thousands) Amount % Total Amount % Total Amount %
Salaries and employee benefits $ 18,421 58.02 % $ 17,107 55.82 % $ 1,314 7.68 %
Occupancy 2,380 7.50 2,438 7.96 (58) (2.38)
Furniture and equipment 2,454 7.73 2,663 8.69 (209) (7.85)
Software amortization 660 2.08 632 2.06 28 4.43
Pennsylvania shares tax 1,119 3.52 1,097 3.58 22 2.01
Professional fees 1,746 5.50 1,882 6.14 (136) (7.23)
Federal Deposit Insurance Corporation
deposit insurance 690 2.17 705 2.30 (15) (2.13)
Marketing 435 1.37 434 1.42 1 0.23
Intangible amortization 119 0.37 147 0.48 (28) (19.05)
Other 3,723 11.74 3,541 11.55 182 5.14
Total non-interest expense $ 31,747 100.00 % $ 30,646 100.00 % $ 1,101 3.59 %
Provision for Income Taxes
Income taxes increased $258,000 and $353,000 for the three and nine months ended
September 30, 2022 compared to the same periods of 2021. The effective tax rate
for the three and nine months ended September 30, 2022 was 18.48% and 18.18%
compared to 18.42% and 18.39% for the same periods of 2021. The Company
currently is in a deferred tax asset position. A valuation allowance was
established on the $1,003,000 of capital loss carryforwards for the twelve
months ended December 31, 2021 , which remained unchanged during the third
quarter of 2022.
ASSET/LIABILITY MANAGEMENT
Cash and Cash Equivalents
Cash and cash equivalents decreased
Loans held for sale
Activity regarding loans held for sale resulted in sales proceeds being greater than loan originations, less$905,000 in realized gains, by$1,240,000 for the nine months endedSeptember 30, 2022 .
loan
Gross loans increased$168,553,000 sinceDecember 31, 2021 due primarily to an increase in both residential and commercial real estate mortgage categories in addition to consumer automobile loans increasing as used car inventories rebounded from historically low levels. 40
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The breakdown of the loan portfolio by category as of
September 30, 2022 December 31, 2021 Change (In Thousands) Amount % Total Amount % Total Amount % Commercial, financial, and agricultural $ 173,365 11.11 % $ 163,285 11.73 %$ 10,080 6.17 % Real estate mortgage: Residential 683,242 43.78 595,847 42.80 87,395 14.67 % Commercial 485,538 31.11 446,734 32.09 38,804 8.69 % Construction 48,694 3.12 37,295 2.68 11,399 30.56 % Consumer automobile loans 159,681 10.23 139,408 10.01 20,273 14.54 % Other consumer installment loans 9,811 0.63 9,277 0.67 534 5.76 % Net deferred loan fees and discounts 369 0.02 301 0.02 68 22.59 % Gross loans$ 1,560,700 100.00 %$ 1,392,147 100.00 %$ 168,553 12.11 %
The table below shows the amount of accrued and unaccrued TDRs at
September 30, 2022 December 31, 2021
(In Thousands) Accrual Non-accrual Total Accrual Non-accrual Total
Commercial, financial, and
agricultural $ 271 $ 452 $ 723 $ 314 $ 574 $ 888
Real estate mortgage:
Residential 3,735 174 3,909 3,999 178 4,177
Commercial 1,600 2,237 3,837 1,836 2,509 4,345
$ 5,606 $ 2,863 $ 8,469 $ 6,149 $ 3,261 $ 9,410
Investments
The fair value of the investment debt securities portfolio at September 30, 2022
increased $21,786,000 since December 31, 2021 , while the amortized cost of the
portfolio increased $38,872,000 . The increase in the investment portfolio
amortized value occurred within the state and political segment of the
portfolio. The mortgage-backed segment was reduced as bonds prepaid due to the
low interest rate environment. The other debt segment of the investment
portfolio is primarily corporate bonds and decreased due to maturities. The
municipal segment was increased as primarily bonds with a final maturity of one
to five years have been purchased. The portfolio continues to be actively
managed in order to reduce interest rate and market risk. The unrealized losses
within the debt securities portfolio are the result of market activity, not
credit issues/ratings, as approximately 89.29% of the debt securities portfolio
on an amortized cost basis is currently rated A or higher by either S&P or
Moody's.
The Company considers various factors, which include examples from applicable
accounting guidance, when analyzing the available for sale portfolio for
possible other than temporary impairment. The Company primarily considers the
following factors in its analysis: length of time and severity of the fair value
being less than carrying value; reduction of dividend paid (equities); continued
payment of dividend/interest, credit rating, and financial condition of an
issuer; intent and ability to hold until anticipated recovery (which may be
maturity); and general outlook for the economy, specific industry, and entity in
question.
The bond portion of the portfolio review is conducted with emphases on several
factors. Continued payment of principal and interest is given primary
importance with credit rating and financial condition of the issuer following as
the next most important. Credit ratings were reviewed with the ratings of the
bonds being satisfactory. Bonds that were not currently rated were discussed
with a third party and/or underwent an internal financial review. Each bond is
reviewed to determine whether it is a general obligation bond, which is backed
by the credit and taxing power of the issuing jurisdiction, or a revenue bond,
which is only payable from specified revenues. Based on the review undertaken
by the Company, the Company determined that the decline in value of the various
bond holdings were temporary and were the result of the general market downturns
and interest rate/yield curve changes, not credit issues. The fact that almost
all of such bonds are general obligation bonds further solidified the Company's
determination that the decline in the value of these bond holdings is temporary.
The fair value of the equity portfolio continues to fluctuate as the economic
and political environment continues to impact stock pricing. The amortized cost
of the available for sale equity securities portfolio has remained flat at
$1,350,000 for September 30, 2022 and December 31, 2021 while the fair value
decreased $158,000 over the same time period.
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The distribution of credit ratings by amortized cost and fair value for the debt portfolio
A- toAAA B- to BBB+ C- to CCC+ Not Rated Total Amortized (In Thousands) Amortized Cost Fair Value Amortized Cost Fair Value Amortized Cost Fair Value Cost Fair Value Amortized Cost Fair Value Available for sale (AFS):U.S. Government and agency securities $ 3,003$ 2,902 $ - $ - $ - $ - $ - $ - $ 3,003$ 2,902 Mortgage-backed securities 1,508 7 1,282 - - - - - - 1,508 1,282 State and political securities 151,088 141,138 80 80 - - 495 462 151,663 141,680 Other debt securities 25,007 22,785 5,664 5,130 - - 15,433 14,417 46,104 42,332 Total debt securities AFS$ 180,606 $ 168,107 $ 5,744 $ 5,210 $ - $ -$ 15,928 $ 14,879 $ 202,278 $ 188,196 Financing Activities Deposits Total deposits decreased$30,900,000 fromDecember 31, 2021 toSeptember 30, 2022 . Time deposits decreased$62,559,000 over this period to a total of$142,808,000 as excess on balance sheet liquidity has allowed for a decrease in the reliance on higher rate time deposit funding. An increase in core deposits (deposits less time deposits) of$31,659,000 has provided relationship driven funding for the loan and investment portfolios. Emphasis during 2021 and through 2022 has been on increasing the utilization of electronic (internet and mobile) deposit banking among our customers. Utilization of internet and mobile banking has increased due to these efforts coupled with a change in consumer behavior due to the business and travel restrictions that were temporarily in effect due to the COVID-19 pandemic.
Deposit balances and their changes for the discussed periods follow:
September 30, 2022 December 31, 2021 Change (In Thousands) Amount % Total Amount % Total Amount % Demand deposits $ 537,403 33.79 % $ 494,360 30.49 %$ 43,043 8.71 % NOW accounts 392,140 24.66 366,399 22.60 25,741 7.03 Money market deposits 268,532 16.88 318,877 19.67 (50,345) (15.79) Savings deposits 249,532 15.69 236,312 14.58 13,220 5.59 Time deposits 142,808 8.98 205,367 12.66 (62,559) (30.46) Total deposits$ 1,590,415 100.00 %$ 1,621,315 100.00 %$ (30,900) (1.91) % Borrowed Funds
Total debt increased by 1.53% or
September 30, 2022 December 31, 2021 Change
(In Thousands) Amount % Total Amount % Total Amount %
Short-term borrowings:
FHLB repurchase agreements $ 25,852 19.33 % $ - - % $ 25,852 100.00 %
Securities sold under agreement to
repurchase 5,049 3.78 5,747 4.36 (698) (12.15)
Total short-term borrowings 30,901 23.11 5,747 4.36 25,154 437.69
Long-term borrowings:
Long-term FHLB borrowings 95,000 71.03 118,000 89.59 (23,000) (19.49)
Long-term finance lease 7,829 5.85 7,963 6.05 (134) (1.68)
Total long-term borrowings 102,829 76.89 125,963 95.64 (23,134) (18.37)
Total borrowed funds $ 133,730 100.00 % $ 131,710 100.00 % $ 2,020 1.53 %
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Table of Contents Short-Term Borrowings
The following table provides additional information on secured loans accounted for as repurchase agreements.
Remaining
Contractual maturity overnight and
Continually
(In Thousands) September 30, 2022 December 31, 2021 Investment debt securities pledged, fair value $ 6,941 $ 8,881 Repurchase agreements 5,049 5,747 Capital The adequacy of the Company's capital is reviewed on an ongoing basis with reference to the size, composition, and quality of the Company's resources and regulatory guidelines. Management seeks to maintain a level of capital sufficient to support existing assets and anticipated asset growth, maintain favorable access to capital markets, and preserve high quality credit ratings. Banking institutions are generally required to comply with risk-based capital guidelines set by bank regulatory agencies. The risk-based capital rules are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies and to minimize disincentives for holding liquid assets. Specifically, each is required to maintain certain minimum dollar amounts and ratios of common equity tier I risk-based, tier I risk-based, total risk-based, and tier I leverage capital. In addition to the capital requirements, theFederal Deposit Insurance Corporation Improvements Act ("FDICIA") established five capital categories for banks ranging from "well capitalized" to "critically undercapitalized" for purposes of theFDIC's prompt corrective action rules. To be classified as "well capitalized" under the prompt corrective action rules, common equity tier I risk-based, tier I risked-based, total risk-based, and tier I leverage capital ratios must be at least 6.5%, 8%, 10%, and 5%, respectively. Under existing capital rules, the minimum capital to risk-adjusted assets requirements for banking organizations are a common equity tier 1 capital ratio of 4.5% (6.5% to be considered "well capitalized"), a tier 1 capital ratio of 6.0% (8.0% to be considered "well capitalized"), and total capital ratio of 8.0% (10.0% to be considered "well capitalized"). Under existing capital rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of common equity tier 1 capital above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets. 43
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The Company's capital ratios as ofSeptember 30, 2022 andDecember 31, 2021 were as follows: September 30, 2022 December 31, 2021 (In Thousands) Amount Ratio Amount Ratio
$ 162,230 10.178 %$ 156,439 10.791 % For Capital Adequacy Purposes 71,727 4.500 65,237 4.500
Minimum to maintain the capital conservation buffer at the reporting date
111,575 7.000 101,480 7.000 To Be Well Capitalized 103,605 6.500 94,232 6.500 Total Capital (to Risk-weighted Assets) Actual$ 177,572 11.141 %$ 170,708 11.776 % For Capital Adequacy Purposes 127,509 8.000 115,970 8.000
Minimum to maintain the capital conservation buffer at the reporting date
167,355 10.500 152,211 10.500 To Be Well Capitalized 159,386 10.000 144,963 10.000Tier I Capital (to Risk-weighted Assets) Actual$ 162,230 10.178 %$ 156,439 10.791 % For Capital Adequacy Purposes 95,636 6.000 86,983 6.000
Minimum to maintain the capital conservation buffer at the reporting date
135,484 8.500 123,226 8.500 To Be Well Capitalized 127,514 8.000 115,977 8.000Tier I Capital (to Average Assets) Actual$ 162,230 8.548 %$ 156,439 8.397 % For Capital Adequacy Purposes 75,915 4.000 74,521 4.000 To Be Well Capitalized 94,894 5.000 93,152 5.000
September 30, 2022 December 31, 2021
(In Thousands) Amount Ratio Amount Ratio
$ 116,369 9.887 %$ 110,682 10.337 % For Capital Adequacy Purposes 52,965 4.500 48,183 4.500
Minimum to maintain the capital conservation buffer at the reporting date
82,389 7.000 74,952 7.000 To Be Well Capitalized 76,504 6.500 69,598 6.500 Total Capital (to Risk-weighted Assets) Actual$ 127,706 10.850 %$ 121,094 11.309 % For Capital Adequacy Purposes 94,161 8.000 85,662 8.000
Minimum to maintain the capital conservation buffer at the reporting date
123,586 10.500 112,431 10.500 To Be Well Capitalized 117,701 10.000 107,078 10.000 Tier I Capital (to Risk-weighted Assets) - - Actual$ 116,369 9.887 %$ 110,682 10.337 % For Capital Adequacy Purposes 70,619 6.000 64,244 6.000
Minimum to maintain the capital conservation buffer at the reporting date
100,044 8.500 91,013 8.500 To Be Well Capitalized 94,159 8.000 85,659 8.000Tier I Capital (to Average Assets) Actual$ 116,369 8.355 %$ 110,682 8.326 % For Capital Adequacy Purposes 55,712 4.000 53,174 4.000 To Be Well Capitalized 69,640 5.000 66,468 5.000 44
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Luzerne Bank's capital ratios as ofSeptember 30, 2022 andDecember 31, 2021 were as follows: September 30, 2022 December 31, 2021 (In Thousands) Amount Ratio Amount Ratio
$ 43,380 10.406 %$ 42,291 11.164 % For Capital Adequacy Purposes 18,759 4.500 17,047 4.500
Minimum to maintain the capital conservation buffer at the reporting date
29,181 7.000 26,517 7.000 To Be Well Capitalized 27,097 6.500 24,623 6.500 Total Capital (to Risk-weighted Assets) Actual$ 47,385 11.367 %$ 46,148 12.182 % For Capital Adequacy Purposes 33,349 8.000 30,306 8.000
Minimum to maintain the capital conservation buffer at the reporting date
43,771 10.500 39,776 10.500 To Be Well Capitalized 41,686 10.000 37,882 10.000Tier I Capital (to Risk-weighted Assets) Actual$ 43,380 10.406 %$ 42,291 11.164 % For Capital Adequacy Purposes 25,012 6.000 22,729 6.000
Minimum to maintain the capital conservation buffer at the reporting date
35,434 8.500 32,199 8.500 To Be Well Capitalized 33,350 8.000 30,305 8.000Tier I Capital (to Average Assets) Actual$ 43,380 7.973 %$ 42,291 7.537 % For Capital Adequacy Purposes 21,763 4.000 22,444 4.000 To Be Well Capitalized 27,204 5.000 28,056 5.000
Liquidity; Interest rate sensitivity and market risk
The asset/liability committee addresses the liquidity needs of the Company to ensure that sufficient funds are available to meet credit demands and deposit withdrawals as well as to the placement of available funds in the investment portfolio. In assessing liquidity requirements, equal consideration is given to the current position as well as the future outlook.
The following liquidity ratios are monitored for compliance and were within the limits stated below
1. Net Loans to Total Assets, 85% maximum
2. Net Loans to Total Deposits, 100% maximum
3. Cumulative 90 day Maturity GAP %, +/- 15% maximum
4. Cumulative 1 Year Maturity GAP %, +/- 20% maximum
Fundamental objectives of the Company's asset/liability management process are
to maintain adequate liquidity while minimizing interest rate risk. The
maintenance of adequate liquidity provides the Company with the ability to meet
its financial obligations to depositors, loan customers, and shareholders.
Additionally, it provides funds for normal operating expenditures and business
opportunities as they arise. The objective of interest rate sensitivity
management is to increase net interest income by managing interest sensitive
assets and liabilities in such a way that they can be repriced in response to
changes in market interest rates.
The Banks, like other financial institutions, must have sufficient funds
available to meet liquidity needs for deposit withdrawals, loan commitments and
originations, and expenses. In order to control cash flow, the Banks estimate
future cash flows from deposits, loan payments, and investment security
payments. The primary sources of funds are deposits, principal and interest
payments on loans and investment securities, FHLB borrowings, and brokered
deposits. Management believes the Banks have adequate resources to meet their
normal funding requirements.
Management monitors the Company's liquidity on both a long and short-term basis,
thereby providing management necessary information to react to current balance
sheet trends. Cash flow needs are assessed and sources of funds are determined.
Funding strategies consider both customer needs and economical cost. Both short
and long-term funding needs are addressed by
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maturities and sales of available for sale and trading investment securities, loan repayments and maturities, and liquidating money market investments such as federal funds sold. The use of these resources, in conjunction with access to credit, provides core funding to satisfy depositor, borrower, and creditor needs. Management monitors and determines the desirable level of liquidity. Consideration is given to loan demand, investment opportunities, deposit pricing and growth potential, as well as the current cost of borrowing funds. The Company has a total current maximum borrowing capacity at the FHLB of$720,252,000 . In addition to this credit arrangement, the Company has additional lines of credit with correspondent banks of$100,000,000 . Management believes it has sufficient liquidity to satisfy estimated short-term and long-term funding needs. FHLB borrowings totaled$120,852,000 as ofSeptember 30, 2022 . Interest rate sensitivity, which is closely related to liquidity management, is a function of the repricing characteristics of the Company's portfolio of assets and liabilities. Asset/liability management strives to match maturities and rates between loan and investment security assets with the deposit liabilities and borrowings that fund them. Successful asset/liability management results in a balance sheet structure which can cope effectively with market rate fluctuations. The matching process segments both assets and liabilities into future time periods (usually 12 months, or less) based upon when repricing can be effected. Repriceable assets are subtracted from repriceable liabilities for a specific time period to determine the "gap", or difference. Once known, the gap is managed based on predictions about future market interest rates. Intentional mismatching, or gapping, can enhance net interest income if market rates move as predicted. However, if market rates behave in a manner contrary to predictions, net interest income will suffer. Gaps, therefore, contain an element of risk and must be prudently managed. In addition to gap management, the Company has an asset/liability management policy which incorporates a market value at risk calculation which is used to determine the effects of interest rate movements on shareholders' equity and a simulation analysis to monitor the effects of interest rate changes on the Company's consolidated balance sheet. The Company currently maintains a gap position of being asset sensitive. The Company has strategically taken this position as it has previously decreased the duration of the earning asset portfolio by adding quality short and intermediate term loans such as home equity loans. The Company has added certain longer-term earning assets due to the significant increase in interest rates. Lengthening of the liability portfolio, primarily time deposits, has been undertaken to build protection during the current rising rate environment. A market value at risk calculation is utilized to monitor the effects of interest rate changes on the Company's balance sheet and more specifically shareholders' equity. The Company does not manage the balance sheet structure in order to maintain compliance with this calculation. The calculation serves as a guideline with greater emphasis placed on interest rate sensitivity. Changes to calculation results from period to period are reviewed as changes in results could be a signal of future events. As of the most recent analysis, the results of the market value at risk calculation were within established guidelines due to the strategic direction being taken.
interest rate sensitivity
In this analysis the Company examines the result of a 100, 200, 300, and 400 basis point change in market interest rates and the effect on net interest income. It is assumed that the change is instantaneous and that all rates move in a parallel manner. Assumptions are also made concerning prepayment speeds on mortgage loans and mortgage securities.
The following is an interest rate shock forecast for the end of the 12 month period
Parallel Rate Shock in Basis Points
(In Thousands) -200 -100 Static +100 +200 +300 +400
Net interest income $ 66,551 $ 69,113 $ 71,694 $ 74,346 $ 76,969 $ 79,559 $ 82,072
Change from static (5,143) (2,581) - 2,652 5,275 7,865 10,378
Percent change from static -7.17 % -3.60 % - 3.70 % 7.36 % 10.97 % 14.48 %
The model utilized to create the report presented above makes various estimates
at each level of interest rate change regarding cash flow from principal
repayment on loans and mortgage-backed securities and/or call activity on
investment securities. Actual results could differ significantly from these
estimates which would result in significant differences in the calculated
projected change. In addition, the limits stated above do not necessarily
represent the level of change under which management would undertake specific
measures to realign its portfolio in order to reduce the projected level of
change. Generally, management believes the Company is well positioned to
respond expeditiously when the market interest rate outlook changes.
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inflation
Substantially all of the Company's assets and liabilities relate to banking activities and are monetary. The consolidated financial statements and related financial data are presented following GAAP. GAAP currently requires the Company to measure the financial position and results of operations in terms of historical dollars, except for securities available for sale, impaired loans, and other real estate loans that are measured at fair value. Changes in the value of money due to rising inflation can cause purchasing power loss. Management's opinion is that movements in interest rates affect the financial condition and results of operations to a greater degree than changes in the rate of inflation. It should be noted that interest rates and inflation do affect each other but do not always move in correlation with each other. The Company's ability to match the interest sensitivity of its financial assets to the interest sensitivity of its liabilities in its asset/liability management may tend to minimize the effect of changes in interest rates on the Company's performance.
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