Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) primarily reviews the financial condition and results of operations of Community Bank System, Inc. (the “Company” or “CBSI”) as of and for the three months ended March 31, 2022 and 2021, although in some circumstances the fourth quarter of 2021 is also discussed in order to more fully explain recent trends. The following discussion and analysis should be read in conjunction with the Company’s Consolidated Financial Statements and related notes that appear on pages 3 through 29. All references in the discussion of the financial condition and results of operations refer to the consolidated position and results of the Company and its subsidiaries taken as a whole. Unless otherwise noted, the term “this year” and equivalent terms refers to results in calendar year 2022, “last year” and equivalent terms refer to calendar year 2021, “first quarter” refers to the three months ended March 31, and earnings per share (“EPS”) figures refer to diluted EPS.
This MD&A contains certain forward-looking statements with respect to the financial condition, results of operations, and business of the Company. These forward-looking statements involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements are set herein under the caption “Forward-Looking Statements” on page 45.
Critical Accounting Policies
As a result of the complex and dynamic nature of the Company’s business, management must exercise judgment in selecting and applying the most appropriate accounting policies for its various areas of operations. The policy decision process not only ensures compliance with the current accounting principles generally accepted in the United States of America (“GAAP”), but also reflects management’s discretion with regard to choosing the most suitable methodology for reporting the Company’s financial performance. It is management’s opinion that the accounting estimates covering certain aspects of the business have more significance than others due to the relative importance of those areas to overall performance, or the level of subjectivity in the selection process. These estimates affect the reported amounts of assets and liabilities as well as disclosures of revenues and expenses during the reporting period. Actual results could meaningfully differ from these estimates. Management believes that the critical accounting estimates include the allowance for credit losses, actuarial assumptions associated with the pension, post-retirement and other employee benefit plans, the provision for income taxes, investment valuation, the carrying value of goodwill and other intangible assets, and acquired loan valuations. A summary of the accounting policies used by management is disclosed in Note A, “Summary of Significant Accounting Policies” on pages 76-88 of the most recent Form 10-K (fiscal year ended December 31, 2021) filed with the Securities and Exchange Commission (“SEC”) on March 1, 2022. A summary of new accounting policies used by management is disclosed in Note C, “Accounting Policies” on page 10 of this Form 10-Q.
Supplemental Reporting of Non-GAAP Results of Operations
The Company also provides supplemental reporting of its results on an “operating,” “adjusted” or “tangible” basis, from which it excludes the after-tax effect of amortization of core deposit and other intangible assets (and the related goodwill, core deposit intangible and other intangible asset balances, net of applicable deferred tax amounts), accretion on acquired non-purchased credit deteriorated (“PCD”) loans, acquisition expenses and the unrealized gain (loss) on equity securities. Although these items are non-GAAP measures, the Company’s management believes this information helps investors and analysts measure underlying core performance and improves comparability to other organizations that have not engaged in acquisitions. In addition, the Company provides supplemental reporting for “adjusted pre-tax, pre-provision net revenues,” which excludes the provision for credit losses, acquisition expenses and the unrealized gain (loss) on equity securities from income before income taxes. Although adjusted pre-tax, pre-provision net revenue is a non-GAAP measure, the Company’s management believes this information helps investors and analysts measure and compare the Company’s performance through a credit cycle by excluding the volatility in the provision for credit losses associated with the impact of CECL and the economic uncertainty caused by the COVID-19 pandemic. Diluted adjusted net earnings per share, a non-GAAP measure, were $0.91 in the first quarter of 2022, compared to $1.00 in the first quarter of 2021, a decrease of $0.09, or 9.0%. Adjusted pre-tax, pre-provision net revenue per share, a non-GAAP measure, was $1.12 in the first quarter of 2022, up $0.03, or 2.8%, from the first quarter of 2021. Reconciliations of GAAP amounts with corresponding non-GAAP amounts are presented in Table 10.
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Executive Summary
The Company’s business philosophy is to operate as a diversified financial services enterprise providing a broad array of banking and other financial services to retail, commercial and municipal customers. The Company’s banking subsidiary is Community Bank, N.A. (the “Bank” or “CBNA”). The Company’s Benefit Plans Administrative Services, Inc. (“BPAS”) subsidiary is a leading provider of employee benefits administration, trust services, collective investment fund administration and actuarial consulting services to customers on a national scale. In addition, the Company offers comprehensive financial planning, insurance and wealth management services through its Community Bank Wealth Management Group and OneGroup NY, Inc. (“OneGroup”) operating units.
The Company’s core operating objectives are: (i) optimize the branch network and digital banking delivery systems, primarily through disciplined acquisition strategies and divestitures/consolidations, (ii) build profitable loan and deposit volume using both organic and acquisition strategies, (iii) manage an investment securities portfolio to complement the Company’s loan and deposit strategies and optimize interest rate risk, yield and liquidity, (iv) increase the noninterest component of total revenues through growth in existing financial services business units, and the acquisition of additional financial services and banking businesses, and (v) utilize technology to deliver customer-responsive products and services and improve efficiencies.
Significant factors reviewed by management to evaluate achievement of the Company’s operating objectives and its operating results and financial condition include, but are not limited to: net income and earnings per share; return on assets and equity; components of net interest margin; noninterest revenues; noninterest expenses; asset quality; loan and deposit growth; capital management; performance of individual banking and financial services units; performance of specific product lines and customers; liquidity and interest rate sensitivity; enhancements to customer products and services and their underlying performance characteristics; technology advancements; market share; peer comparisons; and the performance of recently acquired businesses.
First quarter net income decreased $5.8 million as compared to the first quarter of 2021. Earnings per share of $0.86 for the first quarter of 2022 decreased $0.11 from the first quarter of 2021. The decrease in net income and earnings per share for the quarter are primarily the result of increases in the provision for credit losses, operating expenses, income taxes and fully-diluted shares outstanding, partially offset by increases in noninterest revenues and net interest income. First quarter net income adjusted to exclude acquisition expenses and unrealized gains on equity securities (“operating net income”), a non-GAAP measure, decreased $5.6 million as compared to the first quarter of 2021. Earnings per share adjusted to exclude acquisition expenses and unrealized gains on equity securities (“operating earnings per share”), a non-GAAP measure, of $0.87 for the first quarter decreased $0.10 compared to the first quarter of 2021. First quarter 2021 results were complemented by a net benefit recorded in the provision for credit losses and higher Paycheck Protection Program (“PPP”)-related revenues than the first quarter of 2022 which, net of tax, were responsible for a $0.17 decrease in fully-diluted operating earnings per share year-over-year.
Loans and deposits increased on both an average and ending basis as compared to the prior year first quarter, reflective of large net inflows of funds from government stimulus programs and PPP lending, along with improving economic conditions and the Company’s enhanced focus on organic loan generation. The average yield on interest earning assets decreased 34 basis points compared to the prior year first quarter as the average yield on loans declined while the average yield on investments increased. The average yield on loans for the first quarter decreased by 41 basis points compared to the first quarter of 2021, driven by a decrease in market interest rates on new loan originations and a decrease in PPP-related interest income between the periods. During the first quarter of 2022, the Company recorded $1.7 million of PPP-related interest income, including the recognition of $1.5 million of deferred loan fees. This compares to $6.9 million of PPP-related interest income recorded in the prior year’s first quarter, including the recognition of $5.9 million of deferred loan fees. The average yield on investments, including cash equivalents, increased 11 basis points compared to the prior year, as the Company meaningfully shifted the composition of earning assets away from low-yield cash equivalents to higher yielding investment securities between the periods. The Company’s total cost of funds decreased four basis points from the year earlier period, as the rate paid on interest-bearing deposits decreased five basis points, the rate paid on borrowings decreased 38 basis points and noninterest-bearing demand deposit balances increased from the prior year first quarter. The majority of borrowings are customer repurchase agreements, rather than wholesale borrowings obtained through capital markets and correspondent banks. Customer repurchase agreements have deposit-like features and typically bear lower rates of interest than other types of wholesale borrowings.
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The first quarter 2022 provision for credit losses of $0.9 million was $6.6 million higher than the net benefit recognized in the provision for credit losses of $5.7 million during the first quarter of 2021, reflective of a stable economic outlook, low levels of net charge-offs and delinquent loans, an increase in loans outstanding and a decrease in nonperforming loans. Comparatively, in the first quarter of 2021, economic forecasts had improved considerably, resulting in a release of reserves in that quarter. Net charge-offs were $0.5 million for the first quarter of 2022, compared to $0.4 million of net charge-offs for the first quarter of 2021. First quarter 2022 nonperforming loan ratios decreased in comparison to the first quarter of 2021 largely attributable to the upgrade of several large business loans from nonaccrual status to accruing status during the fourth quarter of 2021 and first quarter of 2022.
Net Income and Profitability
As shown in Table 1, net income for the first quarter of $47.1 million decreased $5.8 million, or 11.0%, as compared to the first quarter of 2021. Earnings per share of $0.86 for the first quarter decreased $0.11 compared to the first quarter of 2021. The decrease in net income and earnings per share for the quarter are primarily the result of increases in the provision for credit losses, operating expenses, income taxes and fully-diluted shares outstanding, partially offset by increases in noninterest revenues and net interest income. Operating net income, a non-GAAP measure, of $47.3 million for the first quarter decreased $5.6 million, or 10.5%, as compared to the first quarter of 2021. Operating earnings per share, a non-GAAP measure, of $0.87 for the first quarter was down $0.10 compared to the first quarter of 2021. See Table 10 for Reconciliation of GAAP to Non-GAAP Measures.
As reflected in Table 1, first quarter net interest income of $94.9 million was up $0.9 million, or 1.0%, from the comparable prior year period. The improvement resulted from an increase in interest-earning assets and a decrease in the rate paid on interest-bearing liabilities, partially offset by a decrease in the yield on interest-earning assets and an increase in interest-bearing liabilities.
The provision for credit losses of $0.9 million for the first quarter increased $6.6 million as compared to the $5.7 million net benefit recorded in the provision for credit losses in the first quarter of 2021, reflective of a stable economic outlook, low levels of net charge-offs and delinquent loans, an increase in loans outstanding and a decrease in nonperforming loans.
First quarter noninterest revenues were $65.7 million, up $7.1 million, or 12.2%, from the first quarter of 2021. The increase was a result of increases in employee benefit services revenue, insurance services revenue, deposit services charges and fees, debit interchange and ATM fees and wealth management services revenue, partially offset by decreases in mortgage banking revenue, other banking services revenue and unrealized gains on equity securities.
Noninterest expenses of $99.8 million for the first quarter reflected an increase of $6.6 million, or 7.0%, from the first quarter of 2021. Excluding acquisition-related expenses, first quarter 2022 operating expenses were $6.3 million, or 6.7%, higher as compared to the prior year first quarter. The increase in noninterest expenses for the quarter was due to increases in salaries and benefits, business development and marketing, other expenses, legal and professional fees, amortization of intangible assets, acquisition expenses and data processing and communications, partially offset by a decrease in occupancy and equipment expenses.
Income tax expense increased $0.7 million between comparable quarters due to lower levels of tax benefits related to stock-based compensation activity, an increase in certain state income taxes that were enacted between the periods and a decrease in the proportion of tax-exempt revenues in relation to total revenues, partially offset by a lower amount of pretax income.
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A condensed income statement is as follows:
Table 1: Condensed Income Statements
Three Months Ended
March 31,
(000’s omitted, except per share data)
2022
2021
Net interest income
$
94,872
$
93,954
Provision for credit losses
906
(5,719)
Noninterest revenues
65,673
58,531
Noninterest expenses
99,807
93,246
Income before income taxes
59,832
64,958
Income taxes
12,777
12,108
Net income
$
47,055
$
52,850
Diluted weighted average common shares outstanding
54,515
54,417
Diluted earnings per share
$
0.86
$
0.97
Net Interest Income
Net interest income is the amount by which interest and fees on earning assets (loans, investments, and cash equivalents) exceeds the cost of funds, which consists primarily of interest paid to the Company’s depositors and on borrowings. Net interest margin is the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities as a percentage of earning assets.
As shown in Table 2, net interest income (with nontaxable income converted to a fully tax-equivalent basis) for the first quarter was $95.7 million, a $0.8 million, or 0.9%, increase from the same period last year. The increase resulted from a $1.54 billion increase in average interest-earnings assets and a six basis point decrease in the average rate paid on interest-bearing liabilities, partially offset by a 34 basis point decrease in the average yield on interest-earning assets and a $1.01 billion increase in average interest-bearing liabilities from the first quarter of 2021. As reflected in Table 3, the favorable impacts of the volume increase in interest-earning assets of $11.3 million and the decrease in the average rate paid on interest-bearing liabilities of $1.3 million were partially offset by the unfavorable impacts of the decrease in the average yield on earning assets of $11.4 million and the volume increase in interest-bearing liabilities of $0.4 million. The net interest margin of 2.73% for the first quarter of 2022 was 30 basis points lower than the comparable period of 2021.
The lower average yield on interest earning assets for the quarter was the result of a decrease in the average yield on loans, partially offset by an increase in the average yield on investments, including cash equivalents. The average yield on loans for the first quarter decreased by 41 basis points compared to the first quarter of 2021, reflective of lower market interest rates on new loan originations and a decrease in PPP-related interest income between the periods. During the first quarter of 2022, the Company recorded $1.7 million of PPP-related interest income, including the recognition of $1.5 million of deferred loan fees. This compares to $6.9 million of PPP-related interest income recorded in the prior year’s first quarter, including the recognition of $5.9 million of deferred loan fees. The average yield on investments, including cash equivalents, increased 11 basis points compared to the prior year, as the Company meaningfully shifted the composition of earning assets away from low-yield cash equivalents to higher yield investment securities between the periods. The average yield on cash equivalents increased nine basis points compared to the first quarter of 2021, while the average yield on investments, excluding cash equivalents, decreased 28 basis points.
The average rate on interest-bearing liabilities decreased six basis points compared to the prior year quarter due to a five basis point decrease in the average rate paid on interest-bearing deposits, primarily driven by a decrease in the interest rate paid on time deposits and a 38 basis point decrease in the average rate paid on borrowings. The decrease in the average cost of borrowings was primarily the result of the redemption of certain higher rate subordinated debt instruments in the first quarter of 2021, as well as the decrease in the rates paid on customer repurchase agreements in response to market conditions.
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The first quarter average balance of investments, including cash equivalents, increased $1.51 billion as compared to the corresponding prior year period primarily due to the continued net inflows of deposits. Investment purchases outpaced maturities, calls and principal payments during the first quarter of 2022 as the Company meaningfully shifted the composition of earning assets away from low-yield cash equivalents to higher yielding investment securities. Average loan balances were $30.4 million greater than the prior year’s first quarter balances with growth in the consumer indirect, consumer mortgage, home equity and consumer direct portfolios, partially offset by a decrease in the business lending portfolio due to high levels of PPP loan forgiveness. Excluding PPP loans, average loan balances were $378.1 million greater than the prior year’s first quarter balances with growth in all loan portfolios.
Average interest-bearing deposits increased $1.04 billion between the first quarter of 2021 and the first quarter of 2022 with growth in interest checking, savings and money market deposits due to large inflows of government stimulus-related deposit funding, partially offset by a decrease in time deposits. The average borrowing balance, including borrowings at the Federal Home Loan Bank of New York and the Federal Home Loan Bank of Boston (collectively referred to as “FHLB”), subordinated notes payable, subordinated debt held by unconsolidated subsidiary trusts and securities sold under agreement to repurchase (customer repurchase agreements), decreased $26.6 million compared to the prior year quarter primarily due to decreases in subordinated debt held by unconsolidated subsidiary trusts associated with the redemption of $77.3 million of trust preferred subordinated debt held by Community Capital Trust IV during the first quarter of 2021 and FHLB borrowings, partially offset by an increase in customer repurchase agreements.
Table 2 below sets forth information related to average interest-earning assets and interest-bearing liabilities and their associated yields and rates for the periods indicated. Interest income and yields are on a fully tax-equivalent basis (“FTE”) using marginal income tax rates of 24.3% and 24.1% in 2022 and 2021, respectively. Average balances are computed by totaling the daily ending balances in a period and dividing by the number of days in that period. Loan interest income and yields include amortization of deferred loan income and costs, loan prepayment fees and the accretion of acquired loan marks. Average loan balances include nonaccrual loans and loans held for sale.
Table 2: Quarterly Average Balance Sheet
Three Months Ended
Three Months Ended
March 31, 2022
March 31, 2021
Avg.
Avg.
Average
Yield/Rate
Average
Yield/Rate
(000's omitted except yields and rates)
Balance
Interest
Paid
Balance
Interest
Paid
Interest-earning assets:
Cash equivalents
$
930,882
$
427
0.19
%
$
1,666,715
$
415
0.10
%
Taxable investment securities (1)
5,502,965
22,164
1.63
%
3,239,019
14,760
1.85
%
Nontaxable investment securities (1)
413,268
3,277
3.22
%
427,687
3,511
3.33
%
Loans (net of unearned discount) (2)
7,389,290
72,658
3.99
%
7,358,848
79,882
4.40
%
Total interest-earning assets
14,236,405
98,526
2.81
%
12,692,269
98,568
3.15
%
Noninterest-earning assets
1,359,804
1,465,416
Total assets
$
15,596,209
$
14,157,685
Interest-bearing liabilities:
Interest checking, savings, and money market deposits
$
8,186,821
821
0.04
%
$
7,109,082
754
0.04
%
Time deposits
914,843
1,744
0.77
%
952,407
2,358
1.00
%
Customer repurchase agreements
313,046
211
0.27
%
272,542
237
0.35
%
FHLB borrowings
1,873
10
2.03
%
6,252
31
2.02
%
Subordinated notes payable
3,274
38
4.74
%
3,301
38
4.74
%
Subordinated debt held by unconsolidated subsidiary trusts
0
0
0.00
%
62,715
293
1.89
%
Total interest-bearing liabilities
9,419,857
2,824
0.12
%
8,406,299
3,711
0.18
%
Noninterest-bearing liabilities:
Noninterest checking deposits
3,968,197
3,491,581
Other liabilities
167,312
193,013
Shareholders' equity
2,040,843
2,066,792
Total liabilities and shareholders' equity
$
15,596,209
$
14,157,685
Net interest earnings
$
95,702
$
94,857
Net interest spread
2.69
%
2.97
%
Net interest margin on interest-earning assets
2.73
%
3.03
%
Fully tax-equivalent adjustment
$
830
$
903
(1) Averages for investment securities are based on historical cost basis and the yields do not give effect to changes in fair value that is reflected as a component of noninterest-earning assets, shareholders’ equity, and deferred taxes.
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(2) Includes nonaccrual loans. The impact of interest and fees not recognized on nonaccrual loans was immaterial.
As discussed above and disclosed in Table 3 below, the change in net interest income (fully tax-equivalent basis) may be analyzed by segregating the volume and rate components of the changes in interest income and interest expense for each underlying category.
Table 3: Rate/Volume
Three months ended March 31, 2022
versus March 31, 2021
Increase (Decrease) Due to Change in (1)
(000's omitted)
Volume
Rate
Net Change
Interest earned on:
Cash equivalents
$
(236)
$
248
$
12
Taxable investment securities
9,290
(1,886)
7,404
Nontaxable investment securities
(116)
(118)
(234)
Loans
329
(7,553)
(7,224)
Total interest-earning assets (2)
11,303
(11,345)
(42)
Interest paid on:
Interest checking, savings and money market deposits
110
(43)
67
Time deposits
(90)
(524)
(614)
Customer repurchase agreements
32
(58)
(26)
FHLB borrowings
(21)
0
(21)
Subordinated notes payable
0
0
0
Subordinated debt held by unconsolidated subsidiary trusts
(293)
0
(293)
Total interest-bearing liabilities (2)
409
(1,296)
(887)
Net interest earnings (2)
$
10,905
$
(10,060)
$
845
(1) The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of such change in each component.
(2) Changes due to volume and rate are computed from the respective changes in average balances and rates of the totals; they are not a summation of the changes of the components.
Noninterest Revenues
The Company’s sources of noninterest revenues are of four primary types: 1) general banking services related to loans, including mortgage banking, deposits and other core customer activities typically provided through the branch network and digital banking channels (performed by CBNA); 2) employee benefit trust, collective investment fund, transfer agency, actuarial and benefit plan administration services (performed by BPAS and its subsidiaries); 3) wealth management services, comprised of trust services (performed by the trust unit within CBNA), broker-dealer and investment advisory products and services (performed by Community Investment Services Inc. (“CISI”), OneGroup Wealth Partners, Inc. and The Carta Group, Inc.) and asset management services (performed by Nottingham Advisors, Inc.); and 4) insurance and risk management products and services (performed by OneGroup). Additionally, the Company has other transactions, including unrealized gains or losses on equity securities.
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Table 4: Noninterest Revenues
Three Months Ended
March 31,
(000's omitted)
2022
2021
Employee benefit services
$
29,580
$
26,533
Deposit service charges and fees
9,350
7,781
Mortgage banking
155
688
Debit interchange and ATM fees
6,805
6,299
Insurance services
10,409
8,153
Wealth management services
8,633
8,199
Other banking revenues
739
854
Subtotal
65,671
58,507
Unrealized gain on equity securities
2
24
Total noninterest revenues
$
65,673
$
58,531
Noninterest revenues/operating revenues (FTE basis) (1)
40.9
%
38.4
%
(1) For purposes of this ratio noninterest revenues excludes unrealized gain on equity securities. Operating revenues, a non-GAAP measure, is defined as net interest income on a fully-tax equivalent basis plus noninterest revenues, excluding unrealized gain on equity securities and acquired non-PCD loan accretion. See Table 10 for Reconciliation of GAAP to Non-GAAP Measures.
As displayed in Table 4, noninterest revenues were $65.7 million for the first quarter of 2022. This represents an increase of $7.1 million, or 12.2%, for the quarter in comparison to the same 2021 timeframe. The increase was a result of increases in banking noninterest revenue, employee benefit services revenue, wealth management services revenue and insurance services revenue, partially offset by a decrease in unrealized gain on equity securities.
Banking noninterest revenue of $17.1 million for the first quarter of 2022 increased $1.4 million, or 9.1% as compared to the corresponding prior year period. This year-over-year increase was primarily driven by increases in deposit service charges and fees, including an increase in overdraft fees, and debit interchange and ATM fees, reflective of increased transaction activity, partially offset by decreases in mortgage banking revenue and other banking revenues.
Employee benefit services revenue increased $3.1 million, or 11.5%, as compared to the prior year first quarter primarily related to increases in employee benefit trust and custodial fees, as well as incremental revenues from the acquisition of Fringe Benefits Design of Minnesota, Inc. (“FBD”) during the third quarter of 2021. Wealth management services revenue was up $0.4 million, or 5.3%, as compared to the prior year first quarter primarily driven by increases in investment management and trust services revenues. Insurance services revenue was up $2.3 million, or 27.7%, for the first quarter of 2022 as compared to the first quarter of 2021, driven by organic expansion, as well as the second quarter 2021 acquisition of a Florida-based personal lines insurance agency and third quarter 2021 acquisition of a Boston-based specialty-lines insurance practice.
The ratio of noninterest revenues to operating revenues (FTE basis) was 40.9% for the quarter ended March 31, 2022 versus 38.4% for the equivalent period of 2021. The decrease is due to a 12.2% increase in adjusted noninterest revenues driven by the factors noted above, while adjusted net interest income (FTE basis) increased 0.9% driven by significant earning asset growth partially offset by net interest margin contraction.
The Company is continuing to evaluate its deposit offerings and associated deposit services charges and fees, but is presently uncertain to whether any resulting modifications will have a material impact to banking noninterest revenues. The pending Elmira acquisition is expected to provide incremental deposit service charges and fees revenue and debit interchange and ATM fees revenue once completed.
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Noninterest Expenses
Table 5 below sets forth the quarterly results of the major noninterest expense categories for the current and prior year, as well as efficiency ratios (defined below), a standard measure of expense utilization effectiveness commonly used in the banking industry.
Table 5: Noninterest Expenses
Three Months Ended
March 31,
(000's omitted)
2022
2021
Salaries and employee benefits
$
61,648
$
57,632
Occupancy and equipment
10,952
11,300
Data processing and communications
12,659
12,391
Amortization of intangible assets
3,732
3,351
Legal and professional fees
3,617
3,034
Business development and marketing
2,743
2,030
Acquisition expenses
299
27
Other
4,157
3,481
Total noninterest expenses
$
99,807
$
93,246
Operating expenses (1) /average assets
2.49
%
2.57
%
Efficiency ratio (2)
59.6
%
59.0
%
(1) Operating expenses, a non-GAAP measure, is calculated as total noninterest expenses less acquisition expenses and amortization of intangibles. See Table 10 for Reconciliation of GAAP to Non-GAAP Measures.
(2) Efficiency ratio, a non-GAAP measure, is calculated as operating expenses as defined in (1) above divided by net interest income on a fully tax-equivalent basis excluding acquired non-PCD loan accretion plus noninterest revenues excluding unrealized gain on equity securities. See Table 10 for Reconciliation of GAAP to Non-GAAP Measures.
As shown in Table 5, the Company recorded noninterest expenses of $99.8 million for the first quarter of 2022, representing an increase of $6.6 million, or 7.0%, from the prior year first quarter. The increase in operating expenses was attributable to a $4.0 million, or 7.0%, increase in salaries and employee benefits, a $0.7 million, or 35.1%, increase in business development and marketing, a $0.6 million, or 19.2%, increase in legal and professional fees, a $0.6 million, or 19.4%, increase in other expenses, a $0.4 million, or 11.4%, increase in the amortization of intangible assets, a $0.3 million, or 2.2%, increase in data processing and communications expenses and a $0.3 million increase in acquisition-related expenses. The increases in these expenses were partially offset by a $0.3 million, or 3.1% decrease in occupancy and equipment expense. The increase in salaries and benefits expense was driven by increases in merit and incentive-related employee wages, higher payroll taxes, and higher employee benefit-related expenses, offset, in part, by a decrease in full-time equivalent staff between the periods. Other expenses were up due to the general increase in the level of business activities, including increases in business development and marketing expenses, insurance, professional fees and travel-related expenses. The increase in data processing and communications expenses was due to the Company’s implementation of new customer-facing digital technologies and back office systems between the comparable periods. The decrease in occupancy and equipment expense was largely driven by branch office consolidations undertaken between the periods.
The Company’s efficiency ratio (as defined in the table above) was 59.6% for the first quarter of 2022, 0.6 percentage points unfavorable to the comparable quarter of 2021. This resulted from operating expenses (as described above) increasing 6.6%, while operating revenue (as described above) increased by a lesser 5.5%. Current year operating expenses, excluding intangible amortization and acquisition expenses, as a percentage of average assets decreased eight basis points versus the prior year first quarter. First quarter operating expenses (as defined above) increased 6.6% year-over-year, while average assets increased 10.2% primarily due to large inflows of government stimulus-related deposit funding.
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Income Taxes
The first quarter 2022 effective income tax rate was 21.4%, compared to 18.6% for the first quarter of 2021. The increase in the rate is primarily attributable to a lower level of benefit derived from stock based compensation activity in the first quarter of 2022. The Company recorded a $0.6 million and $1.8 million reduction in income tax expense associated with stock-based compensation tax benefits for the first quarter of 2022 and 2021, respectively. The effective tax rates excluding the stock-based compensation tax benefits were 22.3% for the first quarter of 2022 and 21.4% for the first quarter of 2021, reflective of an increase in certain state income taxes that were enacted between the periods and a decrease in the proportion of tax-exempt revenues in relation to total revenues in the first quarter of 2022 as compared to the prior year’s first quarter.
Investments
The carrying value of investment securities (including unrealized gains and losses on available-for-sale securities) was $5.83 billion at the end of the first quarter, an increase of $852.5 million, or 17.1%, from December 31, 2021 and $2.00 billion, or 52.0%, higher than March 31, 2021. The carrying value of cash equivalents was $840.6 million at the end of the first quarter, a decrease of $877.9 million, or 51.1%, from December 31, 2021 and $1.16 billion, or 57.9%, lower than March 31, 2021, as the Company meaningfully shifted the composition of earning assets away from low-yield cash equivalents to higher yielding investment securities between the periods. The book value (excluding unrealized gains and losses) of investment securities increased $1.21 billion from December 31, 2021 and increased $2.29 billion from March 31, 2021. During the first quarter of 2022, the Company purchased $1.14 billion of U.S. Treasury and agency securities with an average yield of 1.62%, $25.8 million of government agency mortgage-backed securities with an average yield of 2.42%, and $95.7 million of obligations of state and political subdivisions with an average yield of 3.31%. These additions were offset by proceeds of $50.0 million from investment maturities, calls, and principal payments during the first three months of 2022. Additionally, there was $4.7 million of net accretion on investment securities during the first quarter of 2022. The effective duration of the investment securities portfolio was 6.9 years at the end of the first quarter of 2022, as compared to 7.5 years at the end of 2021 and 7.8 years at the end of the first quarter of 2021.
The change in the carrying value of investment securities is also impacted by the amount of net unrealized gains or losses. At March 31, 2022, the portfolio had a $403.7 million net unrealized loss, a decrease of $358.8 million from the $44.9 million net unrealized loss at December 31, 2021 and a $297.4 million decrease from the $106.3 million net unrealized loss at March 31, 2021. These changes in the net unrealized position of the portfolio were principally driven by the movements in medium to long-term interest rates, as well as the volume and rates associated with the securities purchases and maturities that have occurred over the past 12 months.
The following table sets forth the fair value for the Company’s investment securities portfolio:
Table 6: Investment Securities
March 31,
December 31,
March 31,
(000's omitted)
2022
2021
2021
Available-for-Sale Portfolio:
U.S. Treasury and agency securities
$
4,832,087
$
3,998,564
$
2,756,258
Obligations of state and political subdivisions
476,155
430,289
450,171
Government agency mortgage-backed securities
454,247
477,056
544,986
Corporate debt securities
7,497
7,962
3,082
Government agency collateralized mortgage obligations
17,172
20,339
36,894
Total available-for-sale portfolio
5,787,158
4,934,210
3,791,391
Equity and other Securities:
Equity securities, at fair value
465
463
469
Federal Home Loan Bank common stock
7,181
7,188
7,410
Federal Reserve Bank common stock
33,568
33,916
33,916
Other equity securities, at adjusted cost
3,244
3,312
3,311
Total equity and other securities
44,458
44,879
45,106
Total investments
$
5,831,616
$
4,979,089
$
3,836,497
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Loans
Loans ended the first quarter at $7.42 billion, $48.6 million, or 0.7%, higher than the fourth quarter of 2021 ending loans of $7.37 billion and $53.9 million, or 0.7%, higher than March 31, 2021.
The business lending portfolio consists of general-purpose business lending to commercial, industrial, non-profit and municipal customers, mortgages on commercial property and dealer floor plan financing. The business lending portfolio decreased $289.3 million, or 8.5%, from March 31, 2021, primarily driven by a $356.4 million net decrease in PPP loans due to loan forgiveness activities. The portfolio increased $26.6 million, or 0.9%, from December 31, 2021, despite a $42.1 million net decrease in PPP loans between the periods due to loan forgiveness activities. Highly competitive conditions for business lending continue to prevail in both the digital marketplace and geographic regions in which the Company operates. The Company strives to generate growth in its business portfolio in a manner that adheres to its goals of maintaining strong asset quality and producing profitable margins. The Company continues to invest in additional personnel, technology and business development resources to further strengthen its capabilities in this important product category.
The Company participated in both rounds of the PPP, a specialized low-interest loan program funded by the U.S. Treasury Department and administered by the SBA, including lending pursuant to the 2020 Coronavirus Aid, Relief, and Security Act’s (“CARES Act”), now known as first draw loans. In addition, the Company participated in the 2021 Consolidated Appropriations Act’s (“CAA”) PPP loan program, now known as second draw loans. As of March 31, 2022, the Company’s business lending portfolio included 23 first draw PPP loans with a total balance of $1.8 million and 400 second draw PPP loans with a total balance of $42.6 million. This compares to 32 first draw PPP loans with a total balance of $10.7 million and 690 second draw PPP loans with a total balance of $77.2 million at the end of the fourth quarter of 2021, and 874 first draw PPP loans with a total balance of $219.4 million and 1,819 second draw PPP loans with a total balance of $191.5 million at March 31, 2021.
Consumer mortgages increased $183.2 million, or 7.6%, from one year ago, and increased $36.5 million, or 1.4%, from December 31, 2021, driven by continued strong housing demand and the Company’s competitive product offerings and business development efforts. Interest rate levels, secondary market premiums, expected duration and ALCO strategies continue to be the most significant factors in determining whether the Company chooses to retain, versus sell and service, portions of its new mortgage production. The Company is currently holding almost all of its new consumer mortgage production in portfolio. Home equity loans increased $2.9 million, or 0.7%, from one year ago, and increased $0.3 million, or 0.1%, from December 31, 2021.
Consumer installment loans, both those originated directly in the branches and online (referred to as “consumer direct”) and indirectly in automobile, marine, and recreational vehicle dealerships (referred to as “consumer indirect”), increased $157.1 million, or 13.4%, from one year ago, and decreased $14.7 million, or 1.1%, from December 31, 2021. Strained supplies in all categories have had some impact on growth opportunities and continue to cause elevated collateral values in all indirect collateral categories. Although the consumer indirect loan market is highly competitive, the Company is focused on maintaining a profitable, in-market and contiguous market indirect portfolio, while continuing to pursue the expansion of its dealer network. Consumer direct loans provide attractive returns, and the Company is committed to providing competitive market offerings to its customers in this important loan category. Despite the strong competition the Company faces from the financing subsidiaries of vehicle manufacturers and other financial intermediaries, the Company will continue to strive to grow these key portfolios through varying market conditions over the long term.
The ultimate impact the COVID-19 pandemic will have on loan demand and the Company’s loan balances for the rest of 2022 remains uncertain at this time. The Company’s business lending balances will be unfavorably impacted as first draw and second draw PPP loans continue to be forgiven by the SBA. The Company anticipates assisting the majority of its PPP borrowers with forgiveness requests during the remainder of 2022. The longer-term implications that COVID-19 and the repayment of PPP loans will have on business lending loan demand continue to be difficult to predict.
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Asset Quality
The following table sets forth the allocation of the allowance for credit losses by loan category as well as the proportional share of each category’s loan balance to total loans. This allocation is based on management’s assessment, as of a given point in time, of the risk characteristics of each of the component parts of the total loan portfolio and is subject to changes when the risk factors of each component part change. The allocation is not indicative of either the specific amounts of the loan categories in which future charge-offs may be taken, nor should it be taken as an indicator of future loss trends. The allocation of the allowance to each category does not restrict the use of the allowance to absorb losses in any category. As shown in Table 7, total allowance for credit losses at the end of the first quarter was $50.1 million, down $4.9 million, or 8.9%, from one year earlier and up $0.3 million, or 0.6%, from the end of 2021.
Table 7: Allowance for Credit Losses by Loan Type
March 31, 2022
December 31, 2021
March 31, 2021
(000's omitted except for ratios)
Allowance
Loan Mix
Allowance
Loan Mix
Allowance
Loan Mix
Business lending
$
20,008
41.4
%
$
21,021
41.2
%
$
27,042
45.4
%
Consumer mortgage
10,324
34.9
%
10,017
34.7
%
9,686
32.7
%
Consumer indirect
12,866
15.8
%
11,737
16.1
%
11,120
14.0
%
Consumer direct
2,725
2.1
%
2,306
2.1
%
2,682
1.9
%
Home equity
1,468
5.4
%
1,814
5.4
%
1,543
5.4
%
PCD loans
1,756
0.4
%
1,974
0.5
%
1,996
0.6
%
Unallocated
1,000
0.0
%
1,000
0.0
%
1,000
0.0
%
Total
$
50,147
100.0
%
$
49,869
100.0
%
$
55,069
100.0
%
As demonstrated in Table 7 and discussed previously, business lending and consumer installment carry higher credit risk than residential real estate, and as a result, these loans carry allowance for credit losses that cover a higher percentage of their total portfolio balances. The unallocated allowance is maintained for potential inherent losses in the specific portfolios that are not captured due to model imprecision. The unallocated allowance of $1.0 million at March 31, 2022 was consistent with December 31, 2021 and March 31, 2021. The changes in allowance allocations reflect management’s continued refinement of its loss estimation techniques. However, given the inherent imprecision in the many estimates used in the determination of the allocated portion of the allowance, management remained conservative in the approaches used to establish the overall allowance for credit losses. Management considers the allocated and unallocated portions of the allowance for credit losses to be prudent and reasonable. Furthermore, the Company’s allowance for credit losses is general in nature and is available to absorb losses from any loan category.
Allowance for credit losses and loan net charge-off ratios are as follows:
Table 8: Loan Ratios
March 31,
December 31,
March 31,
2022
2021
2021
Allowance for credit losses/total loans
0.68
%
0.68
%
0.75
%
Allowance for credit losses/nonperforming loans
139
%
110
%
73
%
Nonaccrual loans/total loans
0.43
%
0.57
%
0.99
%
Allowance for credit losses/nonaccrual loans
156
%
120
%
75
%
Net charge-offs (annualized) to average loans outstanding (quarterly):
Business lending
(0.03)
%
0.10
%
(0.01)
%
Consumer mortgage
0.00
%
0.00
%
0.02
%
Consumer indirect
0.24
%
0.24
%
0.06
%
Consumer direct
0.32
%
0.53
%
0.22
%
Home equity
(0.08)
%
0.01
%
0.10
%
Total loans
0.03
%
0.09
%
0.02
%
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The net charge-offs during the first quarter of 2022 were $0.5 million, $0.1 million higher than the first quarter of 2021. The business lending, home equity, and consumer mortgage portfolios experienced lower net charge-offs during the first quarter of 2022, as compared to the first quarter of 2021, while the consumer indirect and consumer direct portfolios experienced higher net charge-offs than the equivalent prior year period. The total net charge-off ratio (net charge-offs as a percentage of average loans outstanding) for the first quarter of 2022 was 0.03%, one basis point higher than the first quarter of 2021. Net charge-off ratios for the first quarter of 2022 for the home equity, consumer direct, business lending, and consumer mortgage portfolios were below the Company’s average for the trailing eight quarters, while the net charge-off ratio for the consumer indirect portfolio was above the Company’s average for the trailing eight quarters. The Company believes the continued very low amount of net charge-offs recorded in the first quarter is reflective of general economic conditions, including low levels of unemployment. This is coupled with the residual effect of the extraordinary Federal and State Government financial support provided to consumers throughout the COVID-19 pandemic along with financial support provided to businesses in the form of PPP loans and forbearance programs.
Other real estate owned (“OREO”) at March 31, 2022 was $0.4 million. This compares to $0.7 million at December 31, 2021 and $0.8 million as of March 31, 2021. At March 31, 2022, OREO consisted of five residential properties with a total value of $0.4 million. This compares to two residential properties with a total value of $0.1 million and one commercial property with a total value of $0.6 million at December 31, 2021, and four residential properties with a total value of $0.2 million and one commercial property with a value of $0.6 million at March 31, 2021.
Approximately 38% of the nonperforming loans at March 31, 2022 were related to the business lending portfolio, which is comprised of business loans broadly diversified by industry type. The level of nonperforming loans decreased significantly from the prior year as the economic environment improved and businesses resumed normal operations. The Company upgraded several large business loans that had previously requested extended loan repayment forbearance due to pandemic-related hardship from nonaccrual to accruing status during the first quarter of 2022 and fourth quarter of 2021. These borrowers had successfully restored all past due payments to current status, resumed their pre-forbearance payment obligations for a period of at least six months, and demonstrated sufficient repayment capacity and cash reserves to be reclassified to accruing status during the fourth quarter of 2021 and first quarter of 2022.
Approximately 54% of nonperforming loans at March 31, 2022 were comprised of consumer mortgages. Collateral values of residential properties within the Company’s market area have generally remained stable or have increased over the past several years. Additionally, strong economic conditions prior to COVID-19 and the recent economic recovery, including lower unemployment levels, has positively impacted consumers and had resulted in more favorable nonperforming consumer mortgage ratios. The Company will continue to closely monitor the impact that economic conditions associated with the COVID-19 pandemic could have on its level of delinquent loans, nonperforming assets and ultimately credit-related losses and proactively engage with our customers to strive to limit the potential losses. The remaining 8% of nonperforming loans relate to consumer installment and home equity loans, with home equity nonperforming loan levels being driven by the same factors that were identified for consumer mortgages. The allowance for credit losses to nonperforming loans ratio, a general measure of coverage adequacy, was 139% at the end of the first quarter, as compared to 110% at year-end 2021 and 73% at March 31, 2021. The increase in this ratio between the annual quarterly periods was primarily driven by a continued decrease in nonperforming business loans noted above.
The Company’s senior management, special asset officers and lenders review all delinquent and nonaccrual loans and OREO regularly in order to identify deteriorating situations, monitor known problem credits and discuss any needed changes to collection efforts, if warranted. Based on the group’s consensus, a relationship may be assigned a special assets officer or other senior lending officer to review the loan, meet with the borrowers, assess the collateral and recommend an action plan. This plan could include foreclosure, restructuring loans, issuing demand letters or other actions. The Company’s larger criticized credits are also reviewed on a quarterly basis by senior credit administration management, special assets officers and commercial lending management to monitor their status and discuss relationship management plans. Commercial lending management reviews the criticized business loan portfolio on a monthly basis.
Delinquent loans (30 days past due through nonaccruing) as a percent of total loans was 0.84% at the end of the first quarter, 16 basis points below the 1.00% at year-end 2021 and 45 basis points below the 1.29% at March 31, 2021. The business lending delinquency ratio at the end of the first quarter was 30 basis points below the level at December 31, 2021 and 106 basis points below the level at March 31, 2021, largely attributable to the reclassification of certain business loans’ status from nonaccrual to accruing during the fourth quarter of 2021 and first quarter of 2022. The delinquency rates for the consumer mortgage, consumer indirect, consumer direct and home equity portfolios all increased as compared to the levels at March 31, 2021, however, all decreased as compared to their levels at December 31, 2021. The Company believes that its credit-related losses and delinquent loan levels have recently been below longer-term historical levels in part due to the extraordinary Federal and Statement Government financial assistance provided to consumers throughout the pandemic, as well as the funding support to business customers who participated in PPP lending.
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Prediction of future delinquency and credit loss performance is difficult, because although recent economic growth has been above average and the majority of the restrictions that were put in place during the pandemic have been lifted, there remains uncertainty surrounding the future evolution of the virus, as well as the economic fallout created by supply chain constraints and inflationary pressures. Due to the Company’s continued focus on maintaining strict underwriting standards and the effective utilization of its collection capabilities, the Company expects that its credit performance will eventually return to levels consistent with its average long-term historical results once public health, government intervention and economic conditions return to a more normalized state.
The Company recorded a $0.9 million provision for credit losses in the first quarter, including a $0.1 million credit loss expense related to off-balance sheet credit exposures. The first quarter provision for credit losses was $6.6 million higher than the equivalent prior year period’s net benefit in the provision for credit losses of $5.7 million, which was mostly driven by a significantly more favorable economic condition and outlook and a decline in outstanding balances. The allowance for credit losses of $50.1 million as of March 31, 2022 decreased $4.9 million from the level one year ago. The current quarter provision for credit losses is reflective of a stable economic outlook, low levels of net charge-offs and delinquent loans, an increase in loans outstanding, and a decrease in nonperforming loans. The allowance for credit losses to total loans ratio was 0.68% at March 31, 2022, seven basis points lower than the level at March 31, 2021 and consistent with the level at December 31, 2021.
Refer to Note E: Loans and Allowance for Credit Losses in the notes to the consolidated financial statements for a discussion of management’s methodology used to estimate the allowance for credit losses.
As of March 31, 2022, the net purchase discount related to the $966.0 million of remaining non-PCD loan balances acquired from prior period acquisitions was approximately $7.3 million, or 0.75% of that portfolio.
Deposits
As shown in Table 9, average deposits of $13.07 billion in the first quarter were $1.52 billion, or 13.1%, higher than the first quarter of 2021, primarily due to large inflows of government stimulus-related deposit funding. Total average deposit balances increased $237.7 million, or 1.9%, from the fourth quarter of last year, due to continued net inflows of deposits. The mix of average deposit balances changed as the weighting of non-time deposits (noninterest checking, interest checking, savings and money markets) to total deposits has increased slightly from the prior year levels. The quarterly average cost of deposits was 0.08% for the first quarter of 2022, compared to 0.11% in the first quarter of 2021, reflective of the decrease in the average interest rate on interest bearing deposits primarily due to a decrease in the interest rate paid on time deposits and the impact of aforementioned change in deposit mix. The Company continues to focus on growing its core deposit relationships through its proactive marketing efforts, competitive product offerings and high quality customer service.
Average nonpublic fund deposits for the first quarter of 2022 increased $182.4 million, or 1.6%, versus the fourth quarter of 2021 and increased $1.21 billion, or 11.9%, versus the year-earlier period. Average public fund deposits for the first quarter increased $55.3 million, or 3.3%, from the fourth quarter of 2021 due to the seasonal receipt of taxes and increased $310.4 million, or 22.0%, from the first quarter of 2021, partially attributable to the funding received by local governments and school districts associated with federal COVID and infrastructure programs. Average public fund deposits as a percentage of total average deposits increased from 12.2% in the first quarter of 2021 to 13.2% in the first quarter of 2022.
Table 9: Quarterly Average Deposits
March 31,
December 31,
March 31,
(000’s omitted)
2022
2021
2021
Noninterest checking deposits
$
3,968,197
$
3,935,586
$
3,491,581
Interest checking deposits
3,307,299
3,215,815
2,962,038
Savings deposits
2,299,645
2,227,776
2,018,887
Money market deposits
2,579,877
2,510,766
2,128,157
Time deposits
914,843
942,205
952,407
Total deposits
$
13,069,861
$
12,832,148
$
11,553,070
Nonpublic fund deposits
$
11,348,299
$
11,165,894
$
10,141,931
Public fund deposits
1,721,562
1,666,254
1,411,139
Total deposits
$
13,069,861
$
12,832,148
$
11,553,070
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Borrowings
Borrowings, excluding securities sold under agreement to repurchase, at the end of the first quarter of 2022 totaled $5.1 million. This was $0.1 million, or 0.6%, lower than borrowings at December 31, 2021 and $4.1 million, or 44.5%, below the end of the first quarter of 2021. The decrease from the prior year first quarter was primarily due to decreases in FHLB borrowings. The decrease from the fourth quarter of 2021 was primarily related to the slight decrease in FHLB borrowings and the amortization of premiums on certain acquired subordinated notes payable.
Securities sold under agreement to repurchase, also referred to as customer repurchase agreements, represent collateralized municipal and commercial customer accounts that price and operate similar to a deposit instrument. Customer repurchase agreements were $300.5 million at the end of the first quarter of 2022, $24.2 million lower than December 31, 2021 and $42.8 million higher than March 31, 2021.
Shareholders’ Equity
Total shareholders’ equity of $1.85 billion at the end of the first quarter of 2022 represents a decrease of $248.7 million from the balance at December 31, 2021. The decrease was driven by $271.4 million of other comprehensive loss, net of tax, dividends declared of $23.2 million and common stock repurchased of $3.5 million, partially offset by net income of $47.1 million, net activity under the Company’s employee stock plan of $0.4 million, and $1.9 million recognized from employee stock options earned. The other comprehensive loss, net of tax, was comprised of a $271.6 million decrease in the after-tax market value adjustment on the available-for-sale investment portfolio as market interest rates increased between the periods, partially offset by a positive $0.2 million adjustment to the funded status of the Company’s retirement plans. Over the past 12 months, total shareholders’ equity decreased $119.3 million, as a decrease in the market value adjustment on investments, dividends declared and common stock repurchase activity more than offset net income, the issuance of common stock in association with the employee stock plan and the Company’s benefit plans, and the change in the funded status of the Company’s defined benefit pension and other postretirement plans.
The Company’s Tier 1 leverage ratio, a primary measure of regulatory capital for which 5% is the requirement to be “well-capitalized”, was 9.09% at the end of the first quarter, consistent with the fourth quarter of 2021 and 0.54 percentage points below its level one year earlier. The Tier 1 leverage ratio was consistent with its level at December 31, 2021 as a result of ending shareholders’ equity, excluding intangibles and other comprehensive income or loss items, increasing 1.8%, primarily from net earnings retention, while average assets, excluding intangibles and the market value adjustment on investments, increased 1.9%, primarily due to continued inflows of customer deposits. The Tier 1 leverage ratio decreased compared to the prior year’s first quarter as shareholders’ equity, excluding intangibles and other comprehensive income or loss items, increased 5.7% primarily due to net earnings retention, while average assets excluding intangibles and the market value adjustment, increased 12.0% primarily due to the high levels of customer deposit inflows from government stimulus and PPP programs. The net tangible equity-to-assets ratio (a non-GAAP measure) of 6.98% decreased 1.71 percentage points from December 31, 2021 and decreased 1.50 percentage points versus March 31, 2021 (See Table 10 for Reconciliation of Quarterly GAAP to Non-GAAP Measures). The decrease in the net tangible equity to net tangible assets ratio (non-GAAP) from one year prior was primarily driven by a $139.4 million, or 11.9%, decrease in tangible equity due to the decline in the after-tax market value adjustment on available-for-sale investment securities and a $985.6 million, or 7.1%, increase in tangible assets due to the aforementioned stimulus and PPP-related funding inflows. The decrease in the net tangible equity to net tangible assets ratio (non-GAAP) from the fourth quarter of 2021 was driven by a $247.6 million decrease in tangible equity due to the impact of higher market interest rates on the after-tax market value adjustment on available-for-sale investment securities, while tangible assets increased $74.3 million.
The dividend payout ratio (dividends declared divided by net income) for the first quarter of 2022 was 49.4%, compared to 42.6% for the first quarter of 2021. First quarter dividends declared increased 2.4% versus one year earlier, as the Company’s quarterly dividend per share was raised from $0.42 to $0.43 in the third quarter of 2021, while net income decreased 11.0% over the prior year period, primarily due to the previously noted increase in the provision for credit losses. The 2021 dividend increase marked the Company’s 29 th consecutive year of increased dividend payouts to common shareholders. Additionally, the number of common shares outstanding increased 0.1% over the last twelve months.
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Liquidity
Liquidity risk is a measure of the Company’s ability to raise cash when needed at a reasonable cost and minimize any loss. The Company maintains appropriate liquidity levels in both normal operating conditions as well as stressed environments. The Company must be capable of meeting all obligations to its customers at any time and, therefore, the active management of its liquidity position remains an important management objective. The Bank has appointed the Asset Liability Committee (“ALCO”) to manage liquidity risk using policy guidelines and limits on indicators of potential liquidity risk. The indicators are monitored using a scorecard with three risk level limits. These risk indicators measure core liquidity and funding needs, capital at risk and change in available funding sources. The risk indicators are monitored using such metrics as the core basic surplus ratio, unencumbered securities to average assets, free loan collateral to average assets, loans to deposits, deposits to total funding and borrowings to total funding ratios.
Given the uncertain nature of the Company’s customers’ demands, as well as the Company’s desire to take advantage of earnings enhancement opportunities, the Company must have adequate sources of on and off-balance sheet funds available that can be utilized when needed. Accordingly, in addition to the liquidity provided by balance sheet cash flows, liquidity must be supplemented with additional sources such as credit lines from correspondent banks and borrowings from the FHLB and the Federal Reserve Bank of New York (“Federal Reserve”). Other funding alternatives may also be appropriate from time to time, including wholesale and retail repurchase agreements, large certificates of deposit and the brokered CD market. The primary source of non-deposit funds is FHLB overnight advances, of which there were no outstanding borrowings at March 31, 2022.
The Company’s primary sources of liquidity are its liquid assets, as well as unencumbered loans and securities that can be used to collateralize additional funding. At March 31, 2022, the Bank had $1.02 billion of cash and cash equivalents of which $841 million are interest-earning deposits held at the Federal Reserve, FHLB and other correspondent banks. The Company also had $1.78 billion in unused FHLB borrowing capacity based on the Company’s quarter-end loan collateral levels and maintained $237.1 million of funding availability at the Federal Reserve’s discount window. Additionally, the Company has $3.45 billion of unencumbered securities that could be pledged at the FHLB or Federal Reserve to obtain additional funding. There was $25.0 million available in unsecured lines of credit with other correspondent banks at quarter end.
The Company’s primary approach to measuring short-term liquidity is known as the Basic Surplus/Deficit model. It is used to calculate liquidity over two time periods: first, the amount of cash that could be made available within 30 days (calculated as liquid assets less short-term liabilities as a percentage of average assets); and second, a projection of subsequent cash availability over an additional 60 days. As of March 31, 2022, this ratio was 24.5% for 30-days and 24.7% for 90-days, excluding the Company’s capacity to borrow additional funds from the FHLB and other sources. This is considered to be a sufficient amount of liquidity based on the Company’s internal policy requirement of 7.5%.
A sources and uses statement is used by the Company to measure intermediate liquidity risk over the next twelve months. As of March 31, 2022, there is more than enough liquidity available during the next year to cover projected cash outflows. In addition, stress tests on the cash flows are performed in various scenarios ranging from high probability events with a low impact on the liquidity position to low probability events with a high impact on the liquidity position. The results of the stress tests as of March 31, 2022 indicate the Company has sufficient sources of funds for the next year in all simulated stressed scenarios.
To measure longer-term liquidity, a baseline projection of loan and deposit growth for five years is made to reflect how liquidity levels could change over time. This five-year measure reflects ample liquidity for loan and other asset growth over the next five years.
Though remote, the possibility of a funding crisis exists at all financial institutions. Accordingly, management has addressed this issue by formulating a Liquidity Contingency Plan, which has been reviewed and approved by both the Company’s Board of Directors (the “Board”) and the Company’s ALCO. The plan addresses the actions that the Company would take in response to both a short-term and long-term funding crisis.
A short-term funding crisis would most likely result from a shock to the financial system, either internal or external, which disrupts orderly short-term funding operations. Such a crisis would likely be temporary in nature and would not involve a change in credit ratings. A long-term funding crisis would most likely be the result of drastic credit deterioration at the Company. Management believes that both potential circumstances have been fully addressed through the establishment of trigger points for monitoring such events and detailed action plans that would be initiated if those trigger points are reached.
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Forward-Looking Statements
This report contains comments or information that constitute forward-looking statements (within the meaning of the Private Securities Litigation Reform Act of 1995), which involve significant risks and uncertainties. Forward-looking statements often use words such as “anticipate,” “could,” “target,” “expect,” “estimate,” “intend,” “plan,” “goal,” “forecast,” “believe,” or other words of similar meaning. These statements are based on the current beliefs and expectations of the Company’s management and are subject to significant risks and uncertainties. Actual results may differ materially from the results discussed in the forward-looking statements. Moreover, the Company’s plans, objectives and intentions are subject to change based on various factors (some of which are beyond the Company’s control). Factors that could cause actual results to differ from those discussed in the forward-looking statements include: (1) the macroeconomic and other challenges and uncertainties related to the COVID-19 pandemic, variants of COVID-19, and related vaccine rollout and efficacy, including the negative impacts and disruptions on public health, the Company’s corporate and consumer customers, the communities the Company serves, and the domestic and global economy, which may have an adverse effect on the Company’s business; (2) current and future economic and market conditions, including the effects of changes in housing or vehicle prices, unemployment rates, labor shortages, supply chain disruption, inability to obtain raw materials and supplies, U.S. fiscal debt, budget and tax matters, geopolitical matters, and any slowdown in global economic growth; (3) changes to the U.S. Small Business Administration (“SBA”) Paycheck Protection Program (the “PPP”), including to the rules under which the PPP is administered, with respect to the origination, servicing, or forgiveness of PPP loans, whether now existing or originated in the future, or the terms and conditions of any guaranteed payments due to the Company from the SBA with respect to PPP loans; (4) the effect of, and changes in, monetary and fiscal policies and laws, including future changes in Federal and state statutory income tax rates and interest rate and other policy actions of the Board of Governors of the Federal Reserve System; (5) the effect of changes in the level of checking or savings account deposits on the Company’s funding costs and net interest margin; (6) future provisions for credit losses on loans and debt securities; (7) changes in nonperforming assets; (8) the effect of a fall in stock market or bond prices on the Company’s fee income businesses, including its employee benefit services, wealth management, and insurance businesses; (9) risks related to credit quality; (10) inflation, interest rate, liquidity, market and monetary fluctuations; (11) the strength of the U.S. economy in general and the strength of the local economies where the Company conducts its business; (12) the timely development of new products and services and customer perception of the overall value thereof (including features, pricing and quality) compared to competing products and services; (13) changes in consumer spending, borrowing and savings habits; (14) technological changes and implementation and financial risks associated with transitioning to new technology-based systems involving large multi-year contracts; (15) the ability of the Company to maintain the security of its financial, accounting, technology, data processing and other operating systems and facilities; (16) effectiveness of the Company’s risk management processes and procedures, reliance on models which may be inaccurate or misinterpreted, the Company’s ability to manage its credit or interest rate risk, the sufficiency of its allowance for credit losses and the accuracy of the assumptions or estimates used in preparing the Company’s financial statements and disclosures; (17) failure of third parties to provide various services that are important to the Company’s operations; (18) any acquisitions or mergers that might be considered or consummated by the Company and the costs and factors associated therewith, including differences in the actual financial results of the acquisition or merger compared to expectations and the realization of anticipated cost savings and revenue enhancements; (19) the ability to maintain and increase market share and control expenses; (20) the nature, timing and effect of changes in banking regulations or other regulatory or legislative requirements affecting the respective businesses of the Company and its subsidiaries, including changes in laws and regulations concerning taxes, accounting, banking, service fees, risk management, securities and other aspects of the financial services industry; (21) changes in the Company’s organization, compensation and benefit plans and in the availability of, and compensation levels for, employees in its geographic markets; (22) the outcome of pending or future litigation and government proceedings; (23) the effects of climate change and natural disasters on the Company’s operations or the operations of its customers; (24) other risk factors outlined in the Company’s filings with the SEC from time to time; and (25) the success of the Company at managing the risks of the foregoing.
The foregoing list of important factors is not all-inclusive. For more information about factors that could cause actual results to differ materially from the Company’s expectations, refer to the discussion under the heading “Risk Factors” in the Company’s Annual Report on Form 10-K filed with Securities and Exchange Commission for the year ended December 31, 2021 and this Quarterly Report on Form 10-Q. Any forward-looking statements speak only as of the date on which they are made and the Company does not undertake any obligation to update any forward-looking statement, whether written or oral, to reflect events or circumstances after the date on which such statement is made. If the Company does update or correct one or more forward-looking statements, investors and others should not conclude that the Company will make additional updates or corrections with respect thereto or with respect to other forward-looking statements.
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Reconciliation of GAAP to Non-GAAP Measures
Table 10: GAAP to Non-GAAP Reconciliations
Three Months Ended
March 31,
(000's omitted)
2022
2021
Income statement data
Pre-tax, pre-provision net revenue
Net income (GAAP)
$
47,055
$
52,850
Income taxes
12,777
12,108
Income before income taxes
59,832
64,958
Provision for credit losses
906
(5,719)
Pre-tax, pre-provision net revenue (non-GAAP)
60,738
59,239
Acquisition expenses
299
27
Unrealized gain on equity securities
(2)
(24)
Adjusted pre-tax, pre-provision net revenue (non-GAAP)
$
61,035
$
59,242
Pre-tax, pre-provision net revenue per share
Diluted earnings per share (GAAP)
$
0.86
$
0.97
Income taxes
0.24
0.22
Income before income taxes
1.10
1.19
Provision for credit losses
0.01
(0.10)
Pre-tax, pre-provision net revenue per share (non-GAAP)
1.11
1.09
Acquisition expenses
0.01
0.00
Unrealized gain on equity securities
0.00
0.00
Adjusted pre-tax, pre-provision net revenue per share (non-GAAP)
$
1.12
$
1.09
Net income
Net income (GAAP)
$
47,055
$
52,850
Acquisition expenses
299
27
Tax effect of acquisition expenses
(64)
(5)
Subtotal (non-GAAP)
47,290
52,872
Unrealized gain on equity securities
(2)
(24)
Tax effect of unrealized gain on equity securities
0
4
Operating net income (non-GAAP)
47,288
52,852
Amortization of intangibles
3,732
3,351
Tax effect of amortization of intangibles
(797)
(625)
Subtotal (non-GAAP)
50,223
55,578
Acquired non-PCD loan accretion
(734)
(1,102)
Tax effect of acquired non-PCD loan accretion
157
205
Adjusted net income (non-GAAP)
$
49,646
$
54,681
Return on average assets
Adjusted net income (non-GAAP)
$
49,646
$
54,681
Average total assets
15,596,209
14,157,685
Adjusted return on average assets (non-GAAP)
1.29
%
1.57
%
Return on average equity
Adjusted net income (non-GAAP)
$
49,646
$
54,681
Average total equity
2,040,843
2,066,792
Adjusted return on average equity (non-GAAP)
9.87
%
10.73
%
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Three Months Ended
March 31,
(000's omitted)
2022
2021
Income statement data (continued)
Earnings per common share
Diluted earnings per share (GAAP)
$
0.86
$
0.97
Acquisition expenses
0.01
0.00
Tax effect of acquisition expenses
0.00
0.00
Subtotal (non-GAAP)
0.87
0.97
Unrealized gain on equity securities
0.00
0.00
Tax effect of unrealized gain on equity securities
0.00
0.00
Operating earnings per share (non-GAAP)
0.87
0.97
Amortization of intangibles
0.07
0.06
Tax effect of amortization of intangibles
(0.02)
(0.01)
Subtotal (non-GAAP)
0.92
1.02
Acquired non-PCD loan accretion
(0.01)
(0.02)
Tax effect of acquired non-PCD loan accretion
0.00
0.00
Diluted adjusted net earnings per share (non-GAAP)
$
0.91
$
1.00
Noninterest operating expenses
Noninterest expenses (GAAP)
$
99,807
$
93,246
Amortization of intangibles
(3,732)
(3,351)
Acquisition expenses
(299)
(27)
Total adjusted noninterest expenses (non-GAAP)
$
95,776
$
89,868
Efficiency ratio
Adjusted noninterest expenses (non-GAAP) - numerator
$
95,776
$
89,868
Fully tax-equivalent net interest income
95,702
94,857
Noninterest revenues
65,673
58,531
Acquired non-PCD loan accretion
(734)
(1,102)
Unrealized gain on equity securities
(2)
(24)
Operating revenues (non-GAAP) - denominator
$
160,639
$
152,262
Efficiency ratio (non-GAAP)
59.6
%
59.0
%
March 31,
December 31,
March 31,
(000's omitted)
2022
2021
2021
Balance sheet data – at end of quarter
Total assets
Total assets (GAAP)
$
15,625,883
$
15,552,657
$
14,620,181
Intangible assets
(863,038)
(864,335)
(843,045)
Deferred taxes on intangible assets
43,968
44,160
44,105
Total tangible assets (non-GAAP)
$
14,806,813
$
14,732,482
$
13,821,241
Total common equity
Shareholders' Equity (GAAP)
$
1,852,103
$
2,100,807
$
1,971,397
Intangible assets
(863,038)
(864,335)
(843,045)
Deferred taxes on intangible assets
43,968
44,160
44,105
Total tangible common equity (non-GAAP)
$
1,033,033
$
1,280,632
$
1,172,457
Net tangible equity-to-assets ratio at quarter end
Total tangible common equity (non-GAAP) - numerator
$
1,033,033
$
1,280,632
$
1,172,457
Total tangible assets (non-GAAP) - denominator
$
14,806,813
$
14,732,482
$
13,821,241
Net tangible equity-to-assets ratio at quarter end (non-GAAP)
6.98
%
8.69
%
8.48
%
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.