GERMAN AMERICAN BANCORP, INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
German American Bancorp, Inc. is a Nasdaq-traded (symbol: GABC) financial
holding company based in Jasper, Indiana . German American, through its banking
subsidiary German American Bank , operates 78 banking offices in 20 contiguous
southern Indiana counties and 14 Kentucky counties. The Company also owns an
investment brokerage subsidiary (German American Investment Services, Inc. ) and
a full line property and casualty insurance agency (German American Insurance,
Inc. ).
Throughout this Management's Discussion and Analysis, as elsewhere in this
Report, when we use the term "Company," we will usually be referring to the
business and affairs (financial and otherwise) of German American Bancorp, Inc.
and its subsidiaries and affiliates as a whole. Occasionally, we will refer to
the term "parent company" or "holding company" when we mean to refer to only
German American Bancorp, Inc.
This section presents an analysis of the consolidated financial condition of the
Company as of September 30, 2022 and December 31, 2021 and the consolidated
results of operations for the three and nine months ended September 30, 2022 and
2021. This discussion should be read in conjunction with the consolidated
financial statements and other financial data presented elsewhere herein and
with the financial statements and other financial data, as well as the
Management's Discussion and Analysis of Financial Condition and Results of
Operations, included in the Company's Annual Report on Form 10-K for the year
ended December 31, 2021 .
MANAGEMENT OVERVIEW
This updated discussion should be read in conjunction with management’s overview that was included in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the fiscal year ended
OnJanuary 1, 2022 , the Company completed its acquisition ofCitizens Union Bancorp of Shelbyville, Inc. ("CUB"). CUB, headquartered inShelbyville, Kentucky , operated 15 retail banking offices located inShelby ,Jefferson ,Spencer ,Bullitt ,Oldham ,Owen ,Gallatin andHardin counties inKentucky through its banking subsidiary,Citizens Union Bank of Shelbyville, Inc. As of the closing of the transaction, CUB had total assets of approximately$1.109 billion , total loans of approximately$683.8 million , and total deposits of approximately$930.5 million . The Company issued approximately 2.9 million shares of its common stock, and paid approximately$50.8 million in cash, in exchange for all of the issued and outstanding shares of common stock of CUB.
For more information regarding this acquisition, see Note 15 (Business combinations) in the Notes to the consolidated financial statements included in Item 1 of this Report.
Net profit for the quarter ended
Net income for the nine months endedSeptember 30, 2022 totaled$57,410,000 , or$1.95 per share, a decline of 20% on a per share basis compared with the first nine months of 2021 net income of$64,865,000 , or$2.44 per share. The change in net income during the first nine months of 2022, compared with the same period of 2021, was largely impacted by acquisition-related expenses for the CUB transaction that closed onJanuary 1, 2022 . The first nine months of 2022 results of operations included acquisition-related expenses of$12,276,000 ($9,336,000 or$0.32 per share, on an after tax basis) and also included Day 1 provision for credit losses under the CECL model of$6,300,000 ($4,725,000 or$0.16 per share, on an after tax basis). The decline in per share net income for the nine months endedSeptember 30, 2022 , as compared to the same period of 2021, was also impacted by the Company'sJanuary 1, 2022 issuance of approximately 2.9 million shares of common stock as part of the merger consideration in the CUB transaction.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The financial condition and results of operations for the Company presented in
the Consolidated Financial Statements, accompanying Notes to the Consolidated
Financial Statements, and selected financial data appearing elsewhere within
this Report, are, to a large degree, dependent upon the Company's accounting
policies. The selection of and application of these policies involve estimates,
judgments, and uncertainties that are subject to change. The critical accounting
policies and
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estimates that the Company has determined to be the most susceptible to change
in the near term relate to the determination of the allowance for credit losses,
the valuation of securities available for sale, income tax expense, and the
valuation of goodwill and other intangible assets.
Provision for credit losses
The Company maintains an allowance for credit losses to cover the estimated expected credit losses over the expected contractual life of the loan portfolio. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged-off. A provision for credit losses is charged to operations based on management's periodic evaluation of the necessary allowance balance. Evaluations are conducted at least quarterly and more often if deemed necessary. The ultimate recovery of all loans is susceptible to future market factors beyond the Company's control. The Company has an established process to determine the adequacy of the allowance for credit losses. The determination of the allowance is inherently subjective, as it requires significant estimates, including the amounts and timing of expected future cash flows on individually analyzed loans, estimated losses on other classified loans and pools of homogeneous loans, and consideration of past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, reasonable and supportable forecasts and other factors, all of which may be susceptible to significant change. The allowance consists of two components of allocations, specific and general. These two components represent the total allowance for credit losses deemed adequate to cover expected credit losses over the expected life of the loan portfolio. Commercial and agricultural loans are subject to a standardized grading process administered by an internal loan review function. The need for specific reserves is considered for credits when: (a) the customer's cash flow or net worth appears insufficient to repay the loan; (b) the loan has been criticized in a regulatory examination; (c) the loan is on non-accrual; or (d) other reasons where the ultimate collectability of the loan is in question, or the loan characteristics require special monitoring. Specific reserves on individually analyzed loans are determined by comparing the loan balance to the present value of expected cash flows or expected collateral proceeds. Allocations are also applied to categories of loans not individually analyzed but for which the rate of loss is expected to be greater than other similar type loans, including non-performing consumer or residential real estate loans. Such allocations are based on past loss experience, reasonable and supportable forecasts and information about specific borrower situations and estimated collateral values. General allocations are made for commercial and agricultural loans that are graded as substandard and special mention, but are not individually analyzed for specific reserves as well as other pools of loans, including non-classified loans, homogeneous portfolios of consumer and residential real estate loans, and loans within certain industry categories believed to present unique risk of loss. General allocations of the allowance are primarily made based on historical averages for loan losses for these portfolios along with reasonable and supportable forecasts, judgmentally adjusted for economic, external and internal quantitative and qualitative factors and portfolio trends. Economic factors include evaluating changes in international, national, regional and local economic and business conditions that affect the collectability of the loan portfolio. Internal factors include evaluating changes in lending policies and procedures; changes in the nature and volume of the loan portfolio; and changes in experience, ability and depth of lending management and staff. The allowance for credit losses for loans represents management's estimate of all expected credit losses over the expected contractual life of the loan portfolio. Determining the appropriateness and adequacy of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the loan portfolio may result in significant changes in the allowance for credit losses in future periods.
Valuation of securities
Available-for-sale debt securities in unrealized loss positions are evaluated
for impairment related to credit losses at least quarterly. For
available-for-sale debt securities in an unrealized loss position, the Company
assesses whether we intend to sell, or it is more likely than not that we will
be required to sell the security before recovery of its amortized cost basis. If
either of the criteria regarding intent or requirement to sell is met, the
security's amortized cost basis is written down to fair value through income.
For available-for sale debt securities that do not meet the criteria, the
Company evaluates whether the decline in fair value has resulted from credit
losses or other factors. In making this assessment, management considers the
extent to which fair value is less than amortized cost, any changes to the
rating of the security by a rating agency, and adverse conditions specifically
related to the security and the issuer, among other factors. If this assessment
indicates that a credit loss exists, the Company compares the present value of
cash flows expected to be collected from the security with the amortized cost
basis of
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the security. If the present value of cash flows expected to be collected is
less than the amortized cost basis for the security, a credit loss exists and an
allowance for credit losses is recorded, limited to the amount that the fair
value of the security is less than its amortized cost basis. Any impairment that
has not been recorded through an allowance for credit losses is recognized in
other comprehensive income, net of applicable taxes. No allowance for credit
losses for available-for-sale debt securities was needed at September 30, 2022 .
Accrued interest receivable on available-for-sale debt securities is excluded
from the estimate of credit losses. As of September 30, 2022 , gross unrealized
gains on the securities available-for-sale portfolio totaled approximately
$117,000 and gross unrealized losses totaled approximately $391,011,000 . The net
amount of these two items, net of applicable taxes, is included in other
comprehensive income.
Equity investments whose fair value is not easily determinable are recognized at cost, less depreciation, observable price changes being recognized in profit or loss.
income tax expense
Income tax expense includes estimates related to valuation allowance on deferred tax assets and potential losses related to exposure to tax audits deemed to occur.
A valuation allowance reduces deferred tax assets to the amount management believes is more likely than not to be realized. In evaluating the realization of deferred tax assets, management considers the likelihood that sufficient taxable income of appropriate character will be generated within carry-back and carry-forward periods, including consideration of available tax planning strategies. Tax-related loss contingencies, including assessments arising from tax examinations and tax strategies, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. In considering the likelihood of loss, management considers the nature of the contingency, the progress of any examination or related protest or appeal, the views of legal counsel and other advisors, experience of the Company or other enterprises in similar matters, if any, and management's intended response to any assessment.
Goodwill resulting from business combinations represents the excess of the purchase price over the fair value of the net assets of businesses acquired.Goodwill resulting from business combinations is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date.Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually. The Company has selectedDecember 31 as the date to perform the annual impairment test.Goodwill is the only intangible asset with an indefinite life on the Company's balance sheet. No impairment toGoodwill was indicated based on year-end testing and no triggering events occurred in 2022 causing reassessment. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Other intangible assets consist of core deposit and acquired customer relationship intangible assets. They are initially measured at fair value and then are amortized over their estimated useful lives, which range from 6 to 10 years.
RESULTS OF OPERATIONS
Net revenue:
Net profit for the quarter ended
Net income for the nine months endedSeptember 30, 2022 totaled$57,410,000 , or$1.95 per share, a decline of 20% on a per share basis compared with the first nine months of 2021 net income of$64,865,000 , or$2.44 per share. The change in net income during the first nine months of 2022, compared with the same period of 2021, was largely impacted by acquisition-related expenses for the CUB transaction that closed onJanuary 1, 2022 . The first nine months of 2022 results of operations included acquisition-related expenses of$12,276,000 ($9,336,000 or$0.32 per share, on an after tax basis) and also included Day 1 provision for credit losses under the CECL model of$6,300,000 ($4,725,000 or$0.16 per share, on an after tax basis). The decline in per share net income for the nine months endedSeptember 30, 2022 , as compared to the same period of 2021, was also impacted by the Company'sJanuary 1, 2022 issuance of approximately 2.9 million shares of common stock as part of the merger consideration in the CUB transaction. 48 --------------------------------------------------------------------------------
Net interest income:
Net interest income is the Company's single largest source of earnings, and represents the difference between interest and fees realized on earning assets, less interest paid on deposits and borrowed funds. Several factors contribute to the determination of net interest income and net interest margin, including the volume and mix of earning assets, interest rates, and income taxes. Many factors affecting net interest income are subject to control by management policies and actions. Factors beyond the control of management include the general level of credit and deposit demand,Federal Reserve Board monetary policy, and changes in tax laws.
The following table summarizes net interest income (on a tax equivalent basis) for the three months ended
Average Balance Sheet
(Tax-equivalent basis / dollars in thousands)
Three Months Ended Three Months Ended
September 30, 2022 September 30, 2021
Income / Principal Income /
Principal Balance Expense Yield / Rate Balance Expense Yield / Rate
ASSETS
Federal Funds Sold and Other
Short-term Investments $ 402,006 $ 2,053 2.03 % $ 391,814 $ 141 0.14 %
Securities:
Taxable 1,009,395 5,276 2.09 % 857,394 3,261 1.52 %
Non-taxable 838,770 7,679 3.66 % 788,128 5,937 3.01 %
Total Loans and Leases?²? 3,676,862 43,251 4.67 % 3,055,926 35,538 4.62 %
TOTAL INTEREST EARNING ASSETS 5,927,033 58,259 3.91 % 5,093,262 44,877 3.51 %
Other Assets 558,823 384,892
Less: Allowance for Credit Losses (45,276) (40,687)
TOTAL ASSETS $ 6,440,580 $ 5,437,467
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing Demand, Savings
and Money Market Deposits $ 3,477,902 $ 3,131 0.36 % $ 2,737,358 $ 663 0.10 %
Time Deposits 451,390 466 0.41 % 395,114 476 0.48 %
FHLB Advances and Other Borrowings 143,548 1,229 3.39 % 190,252 1,149 2.40 %
TOTAL INTEREST-BEARING LIABILITIES 4,072,840 4,826 0.47 % 3,322,724 2,288 0.27 %
Demand Deposit Accounts 1,738,237 1,409,841
Other Liabilities 42,759 46,268
TOTAL LIABILITIES 5,853,836 4,778,833
Shareholders' Equity 586,744 658,634
TOTAL LIBABILITIES AND
SHAREHOLDERS' EQUITY $ 6,440,580 $ 5,437,467
COST OF FUNDS 0.32 % 0.18 %
NET INTEREST INCOME $ 53,433 $ 42,589
NET INTEREST MARGIN 3.59 % 3.33 %
(1) Effective tax rates have been determined as if interest earned on the Company’s investments in municipal bonds and loans were fully taxable. (2) Loans held for sale and outstanding loans have been included in average loans.
During the third quarter of 2022, net interest income, on a non tax-equivalent basis, totaled$51,698,000 , an increase of$10,411,000 , or 25%, compared to the third quarter of 2021 net interest income of$41,287,000 . The increase in net interest income during the third quarter of 2022 compared with the third quarter of 2021 was primarily attributable to an improved net interest margin and a higher level of earning assets driven largely by the CUB acquisition and deposit growth, which led to a higher level of securities investment. These increases were partially mitigated by a lower level of PPP loan fee recognition. The tax equivalent net interest margin for the quarter endedSeptember 30, 2022 was 3.59% compared with 3.33% in the third quarter of 2021. The improvement in the net interest margin during the third quarter of 2022 was largely attributable to increased market interest rates resulting in improved yields on earning assets. The Company's net interest margin in both periods presented was impacted by fees recognized as a part of the PPP and accretion of loan discounts on acquired loans. The 49 --------------------------------------------------------------------------------
the impact of PPP fees and increased loan forgiveness was significantly lower in the third quarter of 2022 compared to the third quarter of 2021.
Fees recognized on PPP loans through net interest income totaled$46,000 during the third quarter of 2022 and$4,111,000 during the third quarter of 2021. The fees recognized related to the PPP were immaterial to the net interest margin on an annualized basis in the third quarter of 2022 and 32 basis points in the third quarter of 2021. Accretion of loan discounts on acquired loans contributed approximately 7 basis points to the net interest margin in the third quarter of 2022 and 4 basis points in the third quarter of 2021. Accretion of discounts on acquired loans totaled$1,099,000 during the third quarter of 2022 and$516,000 during the third quarter of 2021.
The following table summarizes net interest income (on a tax equivalent basis) for the nine months ended
Average Balance Sheet
(Tax-equivalent basis / dollars in thousands)
Nine Months Ended Nine Months Ended
September 30, 2022 September 30, 2021
Income / Principal Income /
Principal Balance Expense Yield / Rate Balance Expense Yield / Rate
ASSETS
Federal Funds Sold and Other
Short-term Investments $ 533,758 $ 3,565 0.89 % $ 372,177 $ 329 0.12 %
Securities:
Taxable 1,033,881 14,909 1.92 % 794,023 9,391 1.58 %
Non-taxable 869,039 22,204 3.41 % 681,153 15,928 3.12 %
Total Loans and Leases?²? 3,664,506 122,331 4.46 % 3,094,214 105,263 4.55 %
TOTAL INTEREST EARNING ASSETS 6,101,184 163,009 3.57 % 4,941,567 130,911 3.54 %
Other Assets 549,657 400,058
Less: Allowance for Credit Losses (45,765) (44,612)
TOTAL ASSETS $ 6,605,076 $ 5,297,013
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing Demand, Savings
and Money Market Deposits $ 3,531,100 $ 5,115 0.19 % $ 2,645,261 $ 1,972 0.10 %
Time Deposits 490,483 1,360 0.37 % 429,201 1,878 0.59 %
FHLB Advances and Other Borrowings 157,761 3,387 2.87 % 184,467 3,445 2.50 %
TOTAL INTEREST-BEARING LIABILITIES 4,179,344 9,862 0.32 % 3,258,929 7,295 0.30 %
Demand Deposit Accounts 1,739,389 1,352,519
Other Liabilities 44,017 46,282
TOTAL LIABILITIES 5,962,750 4,657,730
Shareholders' Equity 642,326 639,283
TOTAL LIBABILITIES AND
SHAREHOLDERS' EQUITY $ 6,605,076 $ 5,297,013
COST OF FUNDS 0.22 % 0.20 %
NET INTEREST INCOME $ 153,147 $ 123,616
NET INTEREST MARGIN 3.35 % 3.34 %
(1) Effective tax rates have been determined as if interest earned on the Company’s investments in municipal bonds and loans were fully taxable. (2) Loans held for sale and outstanding loans have been included in average loans.
During the first nine months of 2022, net interest income, on a non tax-equivalent basis, totaled$148,203,000 , an increase of$28,104,000 , or 23%, compared to the same period of 2021 net interest income of$120,099,000 . The increase in net interest income during the first nine months of 2022 compared with same period of 2021 was primarily attributable to a higher level of earning assets driven by both the CUB acquisition and deposit growth, which led to a higher level of securities and short-term investments. Such increase was partially mitigated by a lower level of PPP loan fee recognition. The tax equivalent net interest margin for the nine months endedSeptember 30, 2022 was 3.35% compared with 3.34% for the same period of 2021. Excluding the impact of the PPP fees as well as accretion on loan discounts, there was improvement in the Company's net interest margin for the first nine months of 2022 largely attributable to improved yields on earning assets driven by increased market interest rates. 50 -------------------------------------------------------------------------------- Fees recognized on PPP loans through net interest income totaled$873,000 during the first nine months of 2022 and$9,894,000 during the same period of 2021. The fees recognized related to the PPP contributed approximately 3 basis points to the net interest margin on an annualized basis in the first nine months of 2022 and 27 basis points in the same period of 2021. Accretion of loan discounts on acquired loans contributed approximately 12 basis points to the net interest margin in the first nine months of 2022 and 6 basis points in the first nine months of 2021. Accretion of discounts on acquired loans totaled$3,739,000 during the first nine months of 2022 and$2,054,000 during the first nine months of 2021. Provision for Credit Losses: The Company provides for credit losses through regular provisions to the allowance for credit losses. The provision is affected by net charge-offs on loans and changes in specific and general allocations of the allowance. During the quarter endedSeptember 30, 2022 , the Company recorded a provision for credit losses of$350,000 compared with a negative provision for credit losses of$2,000,000 during the third quarter of 2021. During the nine months endedSeptember 30, 2022 , the Company recorded a provision for credit losses of$5,850,000 compared with the first nine months of 2021 negative provision for credit losses of$8,500,000 . During the first quarter of 2022, the provision for credit losses included$6,300,000 for the Day 1 CECL addition to the allowance for credit loss related to the CUB acquisition for the non-PCD loans. The negative provision for credit losses in the third quarter of 2021 as well as the first nine months of 2021 was largely due to a decline in certain adversely criticized assets and improvement in certain pandemic-related stressed sectors for which the Company had provided significant levels of allowance for credit losses during 2020. Net charge-offs totaled$682,000 , or 7 basis points on an annualized basis, of average loans outstanding during the third quarter of 2022 compared with$197,000 , or 3 basis points, of average loans during the third quarter of 2021. Net charge-offs totaled$1,285,000 or 5 basis points on an annualized basis of average loans outstanding during the nine months endedSeptember 30, 2022 , compared with$561,000 or 2 basis points on an annualized basis of average loans outstanding during the same period of 2021. The provision for credit losses made during the three and nine months endedSeptember 30, 2022 was made at a level deemed necessary by management to absorb expected losses in the loan portfolio. A detailed evaluation of the adequacy of the allowance for credit losses is completed quarterly by management, the results of which are used to determine provision for credit losses. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions and reasonable and supportable forecasts along with other qualitative and quantitative factors.
Non-interest income:
During the quarter endedSeptember 30, 2022 , non-interest income totaled$14,097,000 , a decrease of$1,459,000 , or 9%, compared with the third quarter of 2021. The decrease in non-interest income during the third quarter of 2022 compared with the third quarter of 2021 was in large part attributable to the sale of two branch office locations during the third quarter of 2021 and lower volumes and lower pricing levels of loans sold in the secondary market. Non-interest Income Three Months Ended Change From (dollars in thousands) September 30, Prior Period Amount Percent 2022 2021 Change Change Wealth Management Fees$ 2,376 $ 2,690 $ (314) (12) % Service Charges on Deposit Accounts 3,014 2,017 997 49 Insurance Revenues 1,995 2,007 (12) (1) Company Owned Life Insurance 416 493 (77) (16) Interchange Fee Income 4,054 3,339 715 21 Other Operating Income 1,365 2,595 (1,230) (47) Subtotal 13,220 13,141 79 1 Net Gains on Sales of Loans 854 2,197 (1,343) (61) Net Gains on Securities 23 218 (195) (89) Total Non-interest Income$ 14,097 $ 15,556 $ (1,459) (9) 51
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Wealth management fees have fallen
Service charges on deposit accounts increased$997,000 , or 49%, during the third quarter of 2022 compared with the third quarter of 2021. The increase during the third quarter of 2022 was the result of the CUB acquisition as well as increased deposit customer activity. Interchange fee income increased$715,000 , or 21%, during the quarter endedSeptember 30, 2022 compared with the third quarter of 2021. The increase in the level of fees during the third quarter of 2022 compared with the third quarter of 2021 was related to the CUB acquisition as well as increased card utilization by customers. Other operating income declined$1,230,000 , or 47%, during the third quarter of 2022 compared with the same quarter of 2021. The decline during the third quarter of 2022 compared with the third quarter of 2021 was primarily attributable to the net gain of$1,378,000 related to the sale of the two branch office locations during the third quarter of 2021.
Net gains on loan sales declined
During the nine months endedSeptember 30, 2022 , non-interest income totaled$45,465,000 , an increase of$970,000 , or 2%, compared with the first half of 2021. Non-interest Income Nine Months Ended Change From (dollars in thousands) September 30, Prior Period Amount Percent 2022 2021 Change Change Wealth Management Fees$ 7,656 $ 7,668 $ (12) - % Service Charges on Deposit Accounts 8,568 5,430 3,138 58 Insurance Revenues 7,970 7,319 651 9 Company Owned Life Insurance 1,768 1,230 538 44 Interchange Fee Income 11,848 9,651 2,197 23 Other Operating Income 3,858 5,287 (1,429) (27) Subtotal 41,668 36,585 5,083 14 Net Gains on Sales of Loans 3,324 6,417 (3,093) (48) Net Gains on Securities 473 1,493 (1,020) (68) Total Non-interest Income$ 45,465 $ 44,495 $ 970 2 Service charges on deposit accounts increased$3,138,000 , or 58%, during the first nine months of 2022 compared with the same period of 2021. The increase during 2022 compared with 2021 was the result of the CUB acquisition as well as increased deposit customer activity. Company owned life insurance revenue increased$538,000 , or 44%, during the nine months endedSeptember 30, 2022 compared with the first nine months of 2021. The increase was largely related to death benefits received from life insurance policies during 2022 and to the CUB acquisition. Interchange fee income increased$2,197,000 , or 23%, during the first nine months of 2022 compared with the same period of 2021. The increase in the level of fees during the first nine months of 2022 compared with the same period of 2021 was related to the CUB acquisition as well as increased card utilization by customers. Other operating income declined$1,429,000 , or 27%, during the nine months endedSeptember 30, 2022 compared with the same period of 2021. This decline was primarily attributable to the net gain of$1,378,000 related to the sale of the two branch office locations during the third quarter of 2021. Net gains on sales of loans declined$3,093,000 , or 48%, during the first three quarters of 2022 compared with the same period of 2021. The decline in 2022 compared with 2021 was generally attributable to a lower volume of loans sold and lower pricing levels. Loan sales totaled$142.6 million during 2022 compared with$200.0 million during 2021. 52 -------------------------------------------------------------------------------- The Company realized$473,000 in gains on sales of securities during the first nine months of 2022 compared with$1,493,000 during the same period of 2021. The sales of securities in both periods was done as part of modest shifts in the allocations within the securities portfolio.
Non-interest charges:
During the quarter endedSeptember 30, 2022 , non-interest expense totaled$34,716,000 , an increase of$2,272,000 , or 7%, compared with the third quarter of 2021. The increase in non-interest expense in the third quarter of 2022 compared with the third quarter of 2021 was primarily related to the operating costs for CUB. Non-interest Expense Three Months Ended Change From (dollars in thousands) September 30, Prior Period Amount Percent 2022 2021 Change Change Salaries and Employee Benefits$ 19,751 $ 17,274 $ 2,477 14 % Occupancy, Furniture and Equipment Expense 3,685 3,453 232 7 FDIC Premiums 477 383 94 25 Data Processing Fees 2,712 2,006 706 35 Professional Fees 1,188 1,357 (169) (12) Advertising and Promotion 1,215 897 318 35 Intangible Amortization 897 661 236 36 Other Operating Expenses 4,791 6,413 (1,622) (25) Total Non-interest Expense$ 34,716 $ 32,444 $ 2,272 7 Salaries and benefits increased$2,477,000 , or 14%, during the quarter endedSeptember 30, 2022 compared with the third quarter of 2021. The increase in salaries and benefits during the third quarter of 2022 compared with the third quarter of 2021 was largely related to the salaries and benefit costs for the CUB employee base and a higher number of full time equivalent employees. Data processing fees increased$706,000 , or 35%, during the third quarter of 2022 compared with the third quarter of 2021. The increase in data processing fees during the third quarter of 2022 compared with the same period of the prior year was in part attributable to the CUB acquisition and costs related to continued data system enhancements.
Advertising and promotion costs have increased
Other operating expenses declined$1,622,000 , or 25%, during the third quarter of 2022 compared with the third quarter of 2021. The decline in the third quarter of 2022 compared with the same period of 2021 was primarily attributable to the establishment of a$3,050,000 settlement reserve for a lawsuit challenging the Company's assessment of overdraft fees for certain debit card transactions during the third quarter of 2021. Partially offsetting this decline were increased operating costs related to the acquisition of CUB. As previously reported, settlement and dismissal of the above lawsuit was approved by the court inAugust 2022 . During the nine months endedSeptember 30, 2022 , non-interest expense totaled$118,577,000 , an increase of$25,837,000 , or 28%, compared with the first nine months of 2021. The first nine months of 2022 non-interest expenses included approximately$12,276,000 of non-recurring acquisition-related expenses for the acquisition of CUB. The primary drivers of the remaining increases in the first nine months of 2022 compared with the first three quarters of 2021 were the operating costs for CUB. 53 --------------------------------------------------------------------------------
Non-interest Expense Nine Months Ended Change From
(dollars in thousands) September 30, Prior Period
Amount Percent
2022 2021 Change Change
Salaries and Employee Benefits $ 63,223 $ 51,454 $ 11,769 23 %
Occupancy, Furniture and Equipment Expense 11,266 11,631 (365) (3)
FDIC Premiums 1,418 1,046 372 36
Data Processing Fees 12,896 5,528 7,368 133
Professional Fees 5,124 4,030 1,094 27
Advertising and Promotion 3,380 2,384 996 42
Intangible Amortization 2,871 2,132 739 35
Other Operating Expenses 18,399 14,535 3,864 27
Total Non-interest Expense $ 118,577 $ 92,740 $ 25,837 28
Salaries and benefits increased $11,769,000 , or 23%, during the first nine
months of 2022 compared with the same period of 2021. The increase in salaries
and benefits during the first nine months of 2022 compared with the first nine
months of 2021 was largely attributable to the CUB acquisition completed on
January 1, 2022 . The first three quarters of 2022 included approximately
$1,480,000 of acquisition-related salary and benefit costs of a non-recurring
nature with the remainder of the increase due primarily to the salaries and
benefits costs for the CUB employee base.
Occupancy, furniture and equipment expense declined $365,000 , or 3%, during the
first nine months of 2022 compared with the same period of 2021. The decline
during the first nine months of 2022 compared to the first nine months of 2021
was largely related to operating fewer branch offices from the Company's
existing branch network (excluding the CUB acquisition), which was the result of
the Company's 2021 operating optimization plan, and non-recurring costs
associated with the optimization plan in the first nine months of 2021,
partially mitigated by the operating costs of the CUB branch network in the
first nine months of 2022.
Data processing fees increased $7,368,000 , or 133%, during the first three
quarters of 2022 compared with the same period of 2021. The increase during 2022
compared with 2021 was largely driven by acquisition-related costs which totaled
approximately $4,982,000 during the first three quarters of 2022, along with the
CUB operating costs and costs related to continued data system enhancements.
Professional fees increased $1,094,000 , or 27%, in the first nine months of 2022
compared with the first nine months of 2021. The increase during 2022 was
primarily due to professional fees associated with the CUB acquisition. Merger
and acquisition related professional fees totaled approximately $1,755,000
during the first nine months of 2022.
Advertising and promotion expense increased $996,000 , or 42%, in the first three
quarters of 2022 compared with the first three quarters of 2021. The increase
during 2022 was due in large part to expenses related to the CUB acquisition.
Other operating expenses increased $3,864,000 , or 27%, during the first nine
months of 2022 compared with the first nine months of 2021. The increase in 2022
compared to 2021 was largely attributable to acquisition-related costs that
totaled approximately $3,862,000 in the first nine months of 2022 and operating
costs associated with CUB. The acquisition-related costs were primarily vendor
contract termination costs. These increases were partially offset by the
aforementioned establishment of a $3,050,000 settlement reserve during the first
nine months of 2021.
Income Taxes:
The Company's effective income tax rate was 20.0% and 18.6%, respectively,
during the three months ended September 30, 2022 and 2021. The Company's
effective income tax rate was 17.1% and 19.3%, respectively, during the nine
months ended September 30, 2022 and 2021. The effective tax rate in all periods
presented was lower than the blended statutory rate resulting primarily from the
Company's tax-exempt investment income on securities, loans and company-owned
life insurance, income tax credits generated from affordable housing projects,
and income generated by subsidiaries domiciled in a state with no state or local
income tax.
FINANCIAL CONDITION
The total assets of the Company amount to
54 -------------------------------------------------------------------------------- Securities available for sale declined$188.0 million as ofSeptember 30, 2022 compared with year-end 2021. The decline in the securities portfolio in the first three quarters of 2022 was largely the result of fair value adjustments on the available-for-sale portfolio caused by the rapid rise in market interest rates throughout 2022.September 30, 2022 total loans increased$678.4 million compared withDecember 31, 2021 . The increase in total loans atSeptember 30, 2022 , compared with year-end 2021, was largely due to the acquisition of CUB, which was partially offset by a decline in PPP loans. The Company had no PPP loans atSeptember 30, 2022 compared with$19.5 million atDecember 31, 2021 . End of Period Loan Balances: September 30, December 31, Current Period (dollars in thousands) 2022 2021 Change Commercial and Industrial Loans and Leases$ 644,284 $ 548,350 $ 95,934 Commercial Real Estate Loans 1,923,794 1,530,677 393,117 Agricultural Loans 401,608 358,150 43,458 Home Equity and Consumer Loans 370,335 307,184 63,151 Residential Mortgage Loans 346,347 263,565 82,782 Total Loans$ 3,686,368 $ 3,007,926 $ 678,442
The following table shows the breakdown of the allowance for credit losses for the periods indicated (in thousands of dollars):
September 30 ,
2022 2021
Commercial and Industrial Loans and Leases $ 13,673 $ 9,754
Commercial Real Estate Loans 22,143 19,245
Agricultural Loans 4,529 4,505
Home Equity and Consumer Loans 2,143 1,808
Residential Mortgage Loans 2,211 1,705
Unallocated - -
Total Allowance for Credit Losses $ 44,699 $ 37,017
The Company's allowance for credit losses totaled $44.7 million at September 30,
2022 compared to $37.0 million at year-end 2021. The allowance for credit losses
represented 1.21% of period-end loans at September 30, 2022 compared with 1.23%
at year-end 2021.
The Company adopted ASU No. 2016-13, Financial Instruments - Credit Losses
(Topic 326) ("CECL") on January 1, 2020 . The Company added $9.4 million to the
allowance for credit losses in conjunction with the closing of the CUB
acquisition on January 1, 2022 , related to the CUB loan portfolio. Of the
increase in the allowance for credit losses for the CUB portfolio, $6.3 million
was recorded through the provision for credit losses on "Day 1" under the CECL
model for non-PCD loans. The Company also acquired $29.9 million in PCD loans
for which the Company recorded a credit adjustment of $3.1 million which was
included in the allowance for credit losses.
Under the CECL model, certain acquired loans continue to carry a fair value
discount as well as an allowance for credit losses. As of September 30, 2022 ,
the Company held net discounts on acquired loans of $6.6 million which included
$2.8 million related to the CUB loan portfolio.
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The following is an analysis of the Company’s non-performing assets at
Non-performing Assets: September 30, December 31, (dollars in thousands) 2022 2021 Non-accrual Loans$ 13,054 $ 14,602 Past Due Loans (90 days or more) 726 156 Total Non-performing Loans 13,780 14,758 Other Real Estate - - Total Non-performing Assets$ 13,780 $ 14,758 Restructured Loans $ -$ 104 Non-performing Loans to Total Loans 0.37 % 0.49 % Allowance for Credit Loss to Non-performing Loans 324.38 %
250.83%
The following table shows outstanding loans and loans 90 days or more past due by loan category:
Loans Past Due 90 Days
Non-Accrual Loans or More & Still Accruing
September 30, December 31, December 31,
2022 2021 September 30, 2022 2021
Commercial and Industrial Loans and Leases $ 8,695 $ 10,530 $ 28 $ -
Commercial Real Estate Loans 2,059 2,243 - 156
Agricultural Loans 899 1,136 698 -
Home Equity Loans 262 24 - -
Consumer Loans 89 82 - -
Residential Mortgage Loans 1,050 587 - -
Total $ 13,054 $ 14,602 $ 726 $ 156
Non-performing assets totaled $13.8 million at September 30, 2022 compared to
$14.8 million at year-end 2021. Non-performing assets represented 0.22% of total
assets at September 30, 2022 compared to 0.26% at December 31, 2021 .
Non-performing loans totaled $13.8 million at September 30, 2022 compared to
$14.8 million at year-end 2021. Non-performing loans represented 0.37% of total
loans at September 30, 2022 compared to 0.49% at December 31, 2021 .
End of Period Deposit Balances: September 30, December 31, Current Period (dollars in thousands) 2022 2021 Change Non-interest-bearing Demand Deposits $
1,755,065
Interest-bearing current, savings and money market accounts
3,381,082 2,867,994 513,088 Time Deposits <$100,000 248,455 201,683 46,772 Time Deposits of$100,000 or more 189,739 145,416 44,323 Total Deposits$ 5,574,341 $ 4,744,316 $ 830,025 Capital Resources: As ofSeptember 30, 2022 , shareholders' equity declined by$173.8 million to$494.7 million compared with$668.5 million at year-end 2021. The decline in shareholders' equity was primarily attributable to a decline in accumulated other comprehensive income of$324.5 million related to the decrease in value of the Company's available-for-sale securities portfolio driven by a rapid increase in market interest rates during the first nine months of 2022. Partially mitigating the decline was the issuance of the Company's common shares in the acquisition of CUB. Approximately 2.9 million shares were issued to CUB shareholders resulting in an increase to shareholders' equity of$111.9 million . Also mitigating the decline was increased retained earnings of$37.1 million due to net income of$57.4 million , which was partially offset by the payment of$20.3 million in shareholder dividends. Shareholders' equity represented 7.9% of total assets atSeptember 30, 2022 and 11.9% of total assets atDecember 31, 2021 . Shareholders' equity included$190.8 million of goodwill and other intangible assets atSeptember 30, 2022 compared to$127.6 million of goodwill and other intangible assets atDecember 31, 2021 . The increase in goodwill and other intangible assets was attributable to the CUB acquisition. 56 -------------------------------------------------------------------------------- OnJanuary 31, 2022 , the Company's Board of Directors approved a plan to repurchase up to 1.0 million shares of the Company's outstanding common stock. On a share basis, the amount of common stock subject to the new repurchase plan represented approximately 3% of the Company's outstanding shares on the date it was approved. The Company is not obligated to purchase any shares under the plan, and the plan may be discontinued at any time. The actual timing, number and share price of shares purchased under the repurchase plan will be determined by the Company at its discretion and will depend upon such factors as the market price of the stock, general market and economic conditions and applicable legal requirements. At the time it approved the new plan, the Board also terminated a similar plan that had been adopted inJanuary 2021 . The Company has not repurchased any shares of common stock under the 2022 repurchase plan. Federal banking regulations provide guidelines for determining the capital adequacy of bank holding companies and banks. These guidelines provide for a more narrow definition of core capital and assign a measure of risk to the various categories of assets. The Company is required to maintain minimum levels of capital in proportion to total risk-weighted assets and off-balance sheet exposures. The current risk-based capital rules, as adopted by federal banking regulators, are based upon guidelines developed by theBasel Committee on Banking Supervision and reflect various requirements of the Dodd-Frank Act (the "Basel III Rules"). The Basel III Rules require banking organizations to, among other things, maintain a minimum ratio of Total Capital to risk-weighted assets, a minimum ratio of Tier 1 Capital to risk-weighted assets, a minimum ratio of "Common Equity Tier 1 Capital" to risk-weighted assets, and a minimum leverage ratio (calculated as the ratio of Tier 1 Capital to adjusted average consolidated assets). In addition, under the Basel III Rules, in order to avoid limitations on capital distributions, including dividend payments, the Company is required to maintain a 2.5% capital conservation buffer above the adequately capitalized regulatory capital ratios. AtSeptember 30, 2022 , the capital levels for the Company and its subsidiary bank remained well in excess of the minimum amounts needed for capital adequacy purposes and the Bank's capital levels met the necessary requirements to be considered well-capitalized.
The table below presents the consolidated capital ratios of the Company and the banking subsidiary according to regulatory guidelines:
Minimum for Capital
9/30/2022 12/31/2021 Adequacy Purposes
Ratio Ratio ?¹? Well-Capitalized Guidelines
Total Capital (to Risk Weighted Assets)
Consolidated 15.21 % 16.20 % 8.00 % N/A
Bank 13.88 % 13.36 % 8.00 % 10.00 %
Tier 1 (Core) Capital (to Risk Weighted
Assets)
Consolidated 13.76 % 14.61 % 6.00 % N/A
Bank 13.26 % 12.83 % 6.00 % 8.00 %
Common Tier 1, (CET 1) Capital Ratio
(to Risk Weighted Assets)
Consolidated 13.04 % 14.18 % 4.50 % N/A
Bank 13.26 % 12.83 % 4.50 % 6.50 %
Tier 1 Capital (to Average Assets)
Consolidated 10.10 % 10.10 % 4.00 % N/A
Bank 9.75 % 8.88 % 4.00 % 5.00 %
(1) Excluding capital conservation buffer.
InDecember 2018 , the federal banking regulators approved a final rule to address changes to credit loss accounting under GAAP, including banking organizations' implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of the new accounting standard. OnMarch 27, 2020 , in an action related to the CARES Act, the federal banking regulators announced an interim final rule to delay the estimated impact on regulatory capital stemming from the implementation of CECL. The interim final rule, which was finalized effectiveSeptember 30, 2020 , maintains the three-year transition option in the previous rule and provides banks the option to delay for two years an estimate of CECL's effect on regulatory capital, relative to the incurred loss methodology's effect on regulatory capital, followed by a three-year transition period (five-year transition option). The Company elected to adopt the five-year transition option and, as a result, began the required three-year phase-in by reflecting 25% of the previously deferred estimated capital impact of CECL in its regulatory capital effectiveJanuary 1, 2022 . An additional 25% is to be phased in at the beginning of each subsequent year until fully phased in byJanuary 1, 2025 . Under the 57 -------------------------------------------------------------------------------- five-year transition option, the amount of adjustments to regulatory capital that could be deferred until the phase-in period began included both the initial impact of our adoption of CECL atJanuary 1, 2020 and 25% of subsequent changes in our allowance for credit losses during each quarter of the two-year period endedDecember 31, 2021 . OnApril 9, 2020 , federal banking regulators issued an interim final rule to modify the Basel III regulatory capital rules applicable to banking organizations to allow those organizations participating in the PPP to neutralize the regulatory capital effects of participating in the program. Specifically, the agencies have clarified that banking organizations, including the Company and the Bank, are permitted to assign a zero percent risk weight to PPP loans for purposes of determining risk-weighted assets and risk-based capital ratios.
Liquidity:
The Consolidated Statement of Cash Flows details the elements of changes in the Company's consolidated cash and cash equivalents. Total cash and cash equivalents decreased$23.8 million during the nine months endedSeptember 30, 2022 ending at$373.0 million . During the nine months endedSeptember 30, 2022 , operating activities resulted in net cash inflows of$82.5 million . Investing activities resulted in net cash inflows of$84.1 million during the nine months endedSeptember 30, 2022 . Financing activities resulted in net cash outflows for the nine months endedSeptember 30, 2022 of$190.4 million . The parent company is a corporation separate and distinct from its bank and other subsidiaries. The Company uses funds at the parent-company level to pay dividends to its shareholders, to acquire or make other investments in other businesses or their securities or assets, to repurchase its stock from time to time, and for other general corporate purposes including debt service. The parent company does not have access at the parent-company level to the deposits and certain other sources of funds that are available to its bank subsidiary to support its operations. Instead, the parent company has historically derived most of its revenues from dividends paid to the parent company by its bank subsidiary. The Company's banking subsidiary is subject to statutory restrictions on its ability to pay dividends to the parent company. The parent company has in recent years supplemented the dividends received from its subsidiaries with borrowings. As ofSeptember 30, 2022 , the parent company had approximately$41.6 million of cash and cash equivalents available to meet its cash flow needs.
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
The Company from time to time in its oral and written communications makes statements relating to its expectations regarding the future. These types of statements are considered "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The Company may include forward-looking statements in filings with theSecurities and Exchange Commission ("SEC"), such as this Form 10-Q, in other written materials, and in oral statements made by senior management to analysts, investors, representatives of the media, and others. Such forward looking statements can include statements about the Company's net interest income or net interest margin; its adequacy of allowance for credit losses, levels of provisions for credit losses, and the quality of the Company's loans, investment securities and other assets; simulations of changes in interest rates; expected results from mergers with or acquisitions of other businesses; litigation results; tax estimates and recognition; dividend policy; parent company cash resources and cash requirements, and parent company capital resources; estimated cost savings, plans and objectives for future operations; and expectations about the Company's financial and business performance and other business matters as well as economic and market conditions and trends. They often can be identified by the use of words like "plan," "expect," "can," "might," "may," "will," "would," "could," "should," "intend," "project," "estimate," "believe" or "anticipate," or similar expressions.
Forward-looking statements speak only as of the date on which they are made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the forward-looking statement is made.
Readers are cautioned that, by their nature, all forward-looking statements are based on assumptions and are subject to risks, uncertainties, and other factors. Actual results may differ materially and adversely from the expectations of the Company that are expressed or implied by any forward-looking statement. The discussions in this Item 2 list some of the factors that could cause the Company's actual results to vary materially from those expressed or implied by any forward-looking statements. Other risks, uncertainties, and factors that could cause the Company's actual results to vary materially from those expressed or implied by any forward-looking statement include:
•the unknown future direction of interest rates and the timing and magnitude of any changes in interest rates;
•changes in competitive conditions;
•the introduction, withdrawal, success and timing of asset/liability management
strategies or of mergers and acquisitions and other business initiatives and
strategies;
58
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•changes in customer borrowing, repayment, investment and deposit practices;
•changes in budgetary, monetary and fiscal policies;
•changes in financial and capital markets;
•the potential deterioration in general economic conditions, nationally or locally, resulting in, among other things, a deterioration in the quality of credit;
•the severity and duration of the COVID-19 pandemic and its impact on general economic and financial market conditions and on our business, results of operations and financial condition;
•our participation as a PPP lender;
•capital management activities, including any future sales of new securities, or any repurchases or redemptions by the Company of outstanding debt or equity securities;
•the factors determining investment impairment charges;
•the impact, extent and timing of technological changes;
• potential cyberattacks, information security breaches and other criminal activities;
•litigation liabilities, including related costs, expenses, settlements and judgments, or the outcome of matters before regulatory agencies, whether pending or commencing in the future;
• shares of the
•the possible effects of the replacement of the London interbank offer rate (LIBOR);
•the impact of the current standard on expected credit losses (CECL);
•changes in accounting principles and interpretations;
•potential increases of federal deposit insurance premium expense, and possible future special assessments ofFDIC premiums, either industry wide or specific to the Company's banking subsidiary;
•actions by regulators under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and the Federal Deposit Insurance Act and other possible legislative and regulatory actions and reforms;
•impacts resulting from possible amendments or revisions to the Dodd-Frank Act and the regulations promulgated thereunder, or toConsumer Financial Protection Bureau rules and regulations;
•the continued availability of sufficient excess earnings and capital for the legal and prudent declaration and payment of cash dividends; and
•with respect to the merger with CUB, the possibility that the anticipated benefits of the transaction, including anticipated cost savings and strategic gains, are not realized when expected or at all, including as a result of the impact of, or problems arising from, the integration of the two companies, unexpected credit quality problems of the acquired loans or other assets, or unexpected attrition of the customer base of the acquired institution or branches. Such statements reflect our views with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to the operations, results of operations, growth strategy and liquidity of the Company. Readers are cautioned not to place undue reliance on these forward-looking statements. Investors should consider these risks, uncertainties, and other factors, in addition to those mentioned by the Company in its Annual Report on Form 10-K for its fiscal year endedDecember 31, 2021 , this Quarterly Report on Form 10-Q, and otherSEC filings from time to time, when considering any forward-looking statement. 59
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