Item 7. Management’s Discussion and Analysis
ITEM 7 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
Certain statements made in this Form 10-K, which are not historical fact, are forward-looking statements within the meaning of Section 27A of the Securities Act, Section 21E of the Exchange Act, and the Private Securities Litigation Reform Act of 1995. Words such as "anticipate," "estimate," "may," "feel," "expect," "believe," "plan," "will," "will likely," "would," "should," "could," "project," "goal," "target," "potential," "seek," "intend," and similar expressions are intended to identify these forward-looking statements but are not the exclusive means of identifying such statements. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially. Factors that might cause such a difference include, but are not limited to:
(1) the ever-changing effects of the COVID-19 pandemic - the duration, extent and severity of which are impossible to predict, including the possibility of further resurgence in the spread of COVID-19 or variants thereof - on economies (local, national and international), supply chains and markets, on the labor market, including the potential for a sustained reduction in labor force participation and on our customers, counterparties, employees and third-party service providers, as well as the effects of various responses of governmental and nongovernmental authorities to the COVID-19 pandemic, including public health actions directed toward the containment of the COVID-19 pandemic (such as quarantines, shut downs and other restrictions on travel and commercial, social and other activities), the availability, effectiveness and acceptance of vaccines, and the implementation of fiscal stimulus packages, which could adversely impact sales volumes, add volatility to the global stock markets, and increase loan delinquencies and defaults;
(2) changes in the interest rate environment due to economic conditions related to the COVID-19 pandemic or other factors and/or the fiscal and monetary policy measures undertaken by the U.S. government and the Federal Reserve Board in response to such economic conditions, which may adversely impact interest rates, the interest rate yield curve, interest margins, loan demand and interest rate sensitivity;
(3) the success, impact, and timing of the implementation of Peoples' business strategies and Peoples' ability to manage strategic initiatives, including the completion and successful integration of planned acquisitions, including the recently-completed merger with Premier and recently-completed acquisitions of NSL and Vantage, and the expansion of commercial and consumer lending activities, in light of the continuing impact of the COVID-19 pandemic on customers' operations and financial condition;
(4) competitive pressures among financial institutions, or from non-financial institutions, which may increase significantly, including product and pricing pressures, which can in turn impact Peoples' credit spreads, changes to third-party relationships and revenues, changes in the manner of providing services, customer acquisition and retention pressures, and Peoples' ability to attract, develop and retain qualified professionals;
(5) uncertainty regarding the nature, timing, cost, and effect of legislative or regulatory changes or actions, or deposit insurance premium levels, promulgated and to be promulgated by governmental and regulatory agencies in the State of Ohio, the Federal Deposit Insurance Corporation, the Federal Reserve Board and the Consumer Financial Protection Bureau, which may subject Peoples, its subsidiaries, or one or more acquired companies to a variety of new and more stringent legal and regulatory requirements which adversely affect their respective businesses, including in particular the rules and regulations promulgated and to be promulgated under the CARES Act, and the follow-up legislation enacted as the Consolidated Appropriations Act, 2021, the American Rescue Plan Act of 2021, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, and the Basel III regulatory capital reform;
(6) the effects of easing restrictions on participants in the financial services industry;
(7) local, regional, national and international economic conditions (including the impact of potential or imposed tariffs, a U.S. withdrawal from or significant renegotiation of trade agreements, trade wars and other changes in trade regulations, closing of border crossings and changes in the relationship of the U.S. and its global trading partners) and the impact these conditions may have on Peoples, its customers and its counterparties, and Peoples' assessment of the impact, which may be different than anticipated;
(8) Peoples may issue equity securities in connection with future acquisitions, which could cause ownership and economic dilution to Peoples' current shareholders;
(9) changes in prepayment speeds, loan originations, levels of nonperforming assets, delinquent loans, charge-offs, and customer and other counterparties' performance and creditworthiness generally, which may be less favorable than expected in light of the COVID-19 pandemic and adversely impact the amount of interest income generated;
38
(10) Peoples may have more credit risk and higher credit losses to the extent there are loan concentrations by location or industry of borrowers or collateral;
(11) future credit quality and performance, including expectations regarding future credit losses and the allowance for credit losses;
(12) changes in accounting standards, policies, estimates or procedures may adversely affect Peoples' reported financial condition or results of operations;
(13) the impact of assumptions, estimates and inputs used within models, which may vary materially from actual outcomes, including under the CECL model;
(14) the discontinuation of LIBOR and other reference rates which may result in increased expenses and litigation, and adversely impact the effectiveness of hedging strategies;
(15) adverse changes in the conditions and trends in the financial markets, including the impacts of the COVID-19 pandemic and the related responses by governmental and nongovernmental authorities to the pandemic, which may adversely affect the fair value of securities within Peoples' investment portfolio, the interest rate sensitivity of Peoples' consolidated balance sheet, and the income generated by Peoples' trust and investment activities;
(16) the volatility from quarter to quarter of mortgage banking income, whether due to interest rates, demand, the fair value of mortgage loans, or other factors;
(17) the effect of the current interest rate environment or changes in interest rates or in the level or composition of our assets or liabilities on our net interest income and our loan originations;
(18) Peoples' ability to receive dividends from its subsidiaries;
(19) Peoples' ability to maintain required capital levels and adequate sources of funding and liquidity;
(20) the impact of larger or similar-sized financial institutions encountering problems, which may adversely affect the banking industry and/or Peoples' business generation and retention, funding and liquidity;
(21) Peoples' ability to secure confidential information and deliver products and services through the use of computer systems and telecommunications networks, including those of Peoples' third-party vendors and other service providers, which may prove inadequate, and could adversely affect customer confidence in Peoples and/or result in Peoples incurring a financial loss;
(22) Peoples' ability to anticipate and respond to technological changes, and Peoples' reliance on, and the potential failure of, a number of third-party vendors to perform as expected, including Peoples' primary core banking system provider, which can impact Peoples' ability to respond to customer needs and meet competitive demands;
(23) operational issues stemming from and/or capital spending necessitated by the potential need to adapt to industry changes in information technology systems on which Peoples and its subsidiaries are highly dependent;
(24) changes in consumer spending, borrowing and saving habits, whether due to changes in retail distribution strategies, consumer preferences and behavior, changes in business and economic conditions (including as a result of the COVID-19 pandemic), legislative or regulatory initiatives (including those in response to the COVID-19 pandemic), or other factors, which may be different than anticipated;
(25) the adequacy of Peoples' internal controls and risk management program in the event of changes in strategic, reputational, market, economic, operational, cybersecurity, compliance, legal, asset/liability repricing, liquidity, credit and interest rate risks associated with Peoples' business;
(26) the impact on Peoples' businesses, personnel, facilities, or systems, of losses related to acts of fraud, theft, misappropriation or violence;
(27) the impact on Peoples' businesses, as well as on the risks described above, of various domestic or international widespread natural or other disasters, pandemics (including COVID-19), cybersecurity attacks, system failures, civil unrest, military or terrorist activities or international conflicts;
(28) the impact on Peoples' businesses and operating results of any costs associated with obtaining rights in intellectual property claimed by others and adequately protecting Peoples' intellectual property;
(29) risks and uncertainties associated with Peoples' entry into new geographic markets and risks resulting from Peoples' inexperience in these new geographic markets;
(30) changes in law or requirements imposed by Peoples' regulators impacting Peoples' capital actions, including dividend payments and share repurchases;
(31) the effect of a fall in stock market prices on the asset and wealth management business;
(32) Peoples' continued ability to grow deposits;
(33) the impact of future governmental and regulatory actions upon Peoples' participation in and execution of government programs related to the COVID-19 pandemic;
(34) uncertainty regarding the impact of the current U.S. presidential administration and Congress on the regulatory landscape, capital markets, elevated government debt, potential changes in tax legislation that may increase tax rates and the response to and management of the COVID-19 pandemic, infrastructure spending and social programs; and,
(35) other risk factors relating to the banking industry or Peoples as detailed from time to time in Peoples' reports filed with the SEC, including those risk factors included in the disclosures under the heading "ITEM 1A RISK FACTORS" of this Form 10-K.
39
All forward-looking statements speak only as of the filing date of this Form 10-K and are expressly qualified in their entirety by the cautionary statements. Although management believes the expectations in these forward-looking statements are based on reasonable assumptions within the bounds of management’s knowledge of Peoples’ business and operations, it is possible that actual results may differ materially from these projections. Additionally, Peoples undertakes no obligation to update these forward-looking statements to reflect events or circumstances after the filing date of this Form 10-K or to reflect the occurrence of unanticipated events except as may be required by applicable legal requirements. Copies of documents filed with the SEC are available free of charge at the SEC’s website at www.sec.gov and/or through Peoples' website – www.peoplesbancorp.com under the "Investor Relations" section.
The following discussion and analysis of Peoples' Consolidated Financial Statements is presented to provide insight into management's assessment of the financial position and results of operations for the periods presented. This discussion and analysis should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto, as well as the ratios and statistics, contained elsewhere in this Form 10-K.
Summary of Significant Transactions and Events
The following is a summary of transactions or events that have impacted or are expected by management to impact Peoples’ results of operations or financial condition:
◦ On March 7, 2022, Peoples wholly-owned subsidiary, Peoples Bank, closed on its acquisition of Vantage, a nationwide provider of equipment financing headquartered in Excelsior, Minnesota. Under the terms of the agreement, Peoples Bank purchased 100% of the equity of Vantage for total cash consideration of $54.0 million. Peoples Bank repaid approximately $28.9 million in recourse debt on behalf of Vantage. Vantage offers mid-ticket equipment leases, primarily for business essential information technology equipment across a wide array of industries. Upon completion of the transaction, Vantage became a subsidiary of Peoples Bank. As a subsidiary, Vantage will continue to operate under the name Vantage Financial, which will leverage Vantage's strong brand recognition within the equipment finance industry.
◦ On September 17, 2021, Peoples completed its merger with Premier Financial Bancorp, Inc. (“Premier”), in which Peoples acquired, in an all-stock merger, Premier, a bank holding company headquartered in Huntington, West Virginia, and the parent company of Premier Bank, Inc. (“Premier Bank”) and Citizens Deposit Bank and Trust, Inc. (“Citizens”). Under the terms and subject to the conditions of the definitive Agreement and Plan of Merger dated March 26, 2021, Premier merged with and into Peoples (the “Merger”), and Premier Bank and Citizens subsequently merged with and into Peoples’ wholly-owned subsidiary, Peoples Bank, in a transaction valued at $261.9 million. At the close of business on September 17, 2021, the financial services offices of each of Premier Bank and Citizens became branches of Peoples Bank. Peoples acquired $1.1 billion in loans and $1.8 billion in deposits. Peoples preliminarily recorded $68.2 million in goodwill and $4.2 million in other intangible assets in connection with the Merger.
◦ On May 4, 2021, Peoples Insurance Agency, LLC ("Peoples Insurance") acquired substantially all of the assets and rights of an insurance agency located in Pikeville, Kentucky and certain rights to related customer accounts, which were previously developed and maintained by Justice & Stamper Insurance Agency, Inc., pursuant to an Asset Purchase Agreement between Peoples Insurance and Justice & Stamper Insurance Agency, Inc. Total consideration for this transaction was $325,000, with $162,500 paid at closing and the second installment in the amount of $162,500 to be paid on the first anniversary of the closing date, less any adjustments pursuant to adverse claims incurred or sustained by or imposed by Peoples Insurance. Peoples recorded customer relationship intangible assets of $230,000 and goodwill of $46,000, related to this transaction.
◦ On March 31, 2021, Peoples completed its acquisition of NS Leasing, LLC ("NSL") pursuant to an Asset Purchase Agreement, dated March 24, 2021, in which Peoples Bank acquired the equipment finance and leasing business of NSL. The transaction closed after the end of business on March 31, 2021 and Peoples Bank began operating the acquired business as North Star Leasing, a division of Peoples Bank on April 1, 2021. Peoples Bank acquired assets comprising NSL's equipment finance business, including $83.3 million in leases and satisfied, on behalf of NSL, certain third-party debt in the amount of $69.1 million. Peoples Bank paid total consideration of $116.6 million, plus a potential earn-out payment to NSL of up to $3.1 million. Based in Burlington, Vermont, the North Star Leasing division underwrites, originates and services equipment leases and equipment financing agreements to businesses throughout the United States. Peoples recorded preliminary goodwill in the amount of $24.7 million and preliminary other intangibles of $14.0 million, which included a customer relationship intangible, trade name intangible and non-compete agreements related to this transaction. Peoples recorded an additional $0.6 million in non-interest expense during the last six months of 2021 related to an update to the estimated earn-out provision of $3.0 million. As of December 31, 2021, equipment leases had grown to $122.5 million.
◦ Peoples began originating loans during the second quarter of 2020 and continued to originate loans during the first five months of 2021 under the loan guarantee program created under the CARES Act, called the Paycheck Protection Program ("PPP"). These loans were targeted to provide small businesses with financial support to cover payroll and certain other specified types of expenses for a specified period of time. Loans made under the PPP are fully guaranteed by the Small Business Administration ("SBA"). Additional information can be found later in this discussion under the caption “FINANCIAL CONDITION - COVID-19 Loan Impacts." As of December 31, 2021, Peoples had $87.1 million aggregate
40
principal amount in PPP loans outstanding (including $23.4 million acquired in the Merger with Premier), which were included in commercial and industrial loan balances, compared to $366.9 million at December 31, 2020. Peoples recognized interest income of $13.0 million for deferred loan fees/cost accretion and $2.3 million of interest income on PPP loans during 2021 compared to $7.5 million for deferred loan fees/cost accretion and $3.2 million of interest income during 2020.
◦ On January 28, 2021, Peoples' Board of Directors approved a share repurchase program authorizing Peoples to purchase up to an aggregate of $30 million of Peoples' outstanding common shares, replacing the share repurchase program which had authorized Peoples to purchase up to an aggregate of $40 million of Peoples' outstanding common shares. During 2021, Peoples did not repurchase any common shares under the share repurchase program authorized on January 28, 2021. On February 27, 2020, Peoples' Board of Directors approved a share repurchase program authorizing Peoples to purchase up to an aggregate of $40.0 million of Peoples' outstanding common shares, replacing the share repurchase program which had authorized Peoples to purchase up to an aggregate of $20.0 million of Peoples' outstanding common shares. During 2020, Peoples repurchased 1,299,577 of Peoples' common shares through Peoples' then-effective common share repurchase program for a total of $29.3 million.
◦ During 2021, Peoples recorded a provision for credit losses of $0.7 million, compared to $26.3 million for 2020 and $2.5 million for 2019. The lower provision for credit losses recognized in 2021 was the result of improvement in loss drivers and Moody's economic outlook published in December 2021.
◦ During 2021, Peoples recorded $1.2 million of expenses related to the COVID-19 pandemic, compared to $1.3 million for 2020. During the fourth quarter of 2021, Peoples awarded common shares to all associates who were at the Assistant Vice President level or below. The remainder of the COVID-19-related expenses were primarily related to providing Peoples' employees meals in support of local businesses, assisting employees with childcare and elder care needs, incentivizing employees to be vaccinated and taking extra precautions in cleaning facilities.
◦ During 2021, Peoples incurred $21.4 million of acquisition-related expenses, compared to $0.5 million for 2020 and $7.3 million for 2019. The acquisition-related expenses in 2021 were primarily related to the NSL acquisition and the Premier acquisition, while the expenses during 2020 and 2019 were due to the Triumph Premium Finance and First Prestonsburg acquisitions, respectively.
◦ Peoples incurred $0.1 million in pension settlement charges in 2021 compared to $1.1 million in 2020, due to the aggregate amount of lump-sum distributions to participants in Peoples' defined benefit pension plan exceeding the threshold for recognizing settlement charges during the period. There were no such settlement charges during 2019.
◦ On April 2, 2020, Peoples entered into a First Amendment to the Loan Agreement with U.S. Bank National Association (the “U.S. Bank Loan Agreement”), entered into on April 3, 2019, to extend the maturity. A Second Amendment to the U.S. Bank Loan Agreement entered into on April 1, 2021 extends the maturity from April 1, 2021 to March 31, 2022. The U.S. Bank Loan Agreement provides Peoples with a revolving line of credit in the maximum aggregate principal amount of $20.0 million that may be used: (i) for working capital purposes; (ii) to finance dividends or other distributions (other than stock dividends and stock splits) on or in respect of Peoples’ capital stock and redemptions, repurchases or other acquisitions of any of Peoples’ capital stock permitted under the U.S. Bank Loan Agreement; and (iii) to finance acquisitions permitted under the U.S. Bank Loan Agreement.
◦ During 2020, Peoples sold restricted Class B Visa stock for a gain of $680,000, which was recorded in other non-interest income. Peoples also sold restricted Class B Visa stock during 2019, resulting in a gain of $787,000.
◦ Effective July 1, 2020, Peoples completed the business combination under which Peoples Bank acquired the operations and assets of Triumph Premium Finance (referred to as the "premium finance acquisition"), a division of TBK Bank, SSB. Based in Kansas City, Missouri, the division operating as Peoples Premium Finance will continue to provide insurance premium financing loans for commercial customers to purchase property and casualty insurance products through its growing network of independent insurance agency partners nationwide. Peoples Bank acquired $84.7 million in loans, at acquisition date, after fair value adjustments. Peoples also recorded $4.3 million of other intangible assets and $5.5 million of goodwill. Total consideration paid for this acquisition was $94.5 million. As of December 31, 2020, Peoples Premium Finance loans had grown to $114.8 million.
◦ During 2020, Peoples recognized credits to its FDIC insurance expense as the FDIC issued credits to member banks to offset against the quarterly assessment as a result of the deposit insurance fund reaching its target threshold for smaller banks. These credits were used by Peoples beginning in 2019 and were fully exhausted during the second quarter of 2020.
◦ During 2020, Peoples recognized $109,000 in bank owned life insurance ("BOLI") income related to tax-free death benefits, compared to $482,000 in 2019. Peoples recognized no BOLI income related to death benefits in 2021.
◦ In an effort to stimulate an economy that was being adversely impacted by the impacts of the COVID-19 pandemic, the Federal Reserve Board first lowered the benchmark Federal Funds Target Rate by 50 basis points on March 3, 2020 and then lowered the target rate another 100 basis points at the next FOMC meeting on March 15, 2020. The Federal Funds Target
41
Rate range was 0% - 0.25% as of March 31, 2020 and maintained this rate as of December 31, 2021. According to the Chair of the Federal Reserve Board, the Federal Funds Target Rate is not likely to drop below this range. However, the Federal Reserve Board does have other tools available that it can employ and has expressed an intention to do so in order to maintain a targeted level of liquidity.
◦ On January 1, 2020, Peoples Insurance acquired a property and casualty-focused independent insurance agency for a purchase price amount equal to $866,000, and recorded $735,000 of customer relationship intangibles, and $27,000 of other assets, resulting in $104,000 of goodwill.
◦ On August 22, 2019, Peoples Risk Management, Inc., a wholly-owned subsidiary of Peoples, was formed. Peoples Risk Management, Inc. is a Nevada-chartered captive insurance company which insures against certain risks unique to the operations of Peoples and for which insurance may not be currently available or economically feasible. Peoples Risk Management, Inc. pools resources with several other similar insurance company subsidiaries of financial institutions to help minimize the risk allocable to each participating insurer.
The impact of these transactions, where material, is discussed in the applicable sections of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Critical Accounting Policies
The accounting and reporting policies of Peoples conform to US GAAP and to general practices within the financial services industry. A summary of significant accounting policies is contained in "Note 1 Summary of Significant Accounting Policies" of the Notes to the Consolidated Financial Statements. While all of these policies are important to understanding the Consolidated Financial Statements, certain accounting policies require management to exercise judgment and make estimates or assumptions that affect the amounts reported in the Consolidated Financial Statements and accompanying Notes. These estimates and assumptions are based on information available as of the date of the Consolidated Financial Statements; accordingly, as this information changes, the Consolidated Financial Statements could reflect different estimates or assumptions.
Management has identified four accounting policies as those that, due to the judgments, estimates and assumptions inherent in the policies, are critical to an understanding of Peoples' Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations. The four accounting policies identified were the allowance for credit losses, business combinations, goodwill, and income taxes. These four accounting policies are described in further detail below.
Allowance for Credit Losses
Peoples adopted ASU 2016-13 "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" on January 1, 2020, and began using the CECL model to estimate its allowance for credit losses. The allowance for credit losses is estimated by management using relevant available information, from both internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. The allowance for credit losses is measured on a pool basis, with loans collectively evaluated when similar risk characteristics exist. Peoples evaluated risk characteristics, including but not limited to: internal or third-party credit scores or credit ratings, risk ratings or classifications, financial asset type, collateral type, size, effective interest rate, term, geographical location, industry of the borrower, vintage, historical or credit loss patterns, and reasonable and supportable forecast periods. Peoples identified 18 segments for which it believes there are similar risk characteristics and utilized a discounted cash flow methodology in determining an allowance for credit losses for each segment.
In estimating credit losses, Peoples uses a loss driver method, which analyzes one or more economic variables to the change in default rate using a regression analysis. Variables that had a strong correlation were selected as economic factors, or variables, for the model. If a single variable was not found to be strongly correlated, additional variables were included. Peoples utilizes U.S. unemployment, Ohio unemployment and Ohio Gross Domestic Product as economic factors in modeling.
In general, Peoples completes a quarterly evaluation based on several qualitative factors to determine if there should be adjustments made to the allowance for credit losses. These factors include economic conditions, collateral, concentrations, troubled assets, Peoples' loss trends, peer loss trends, delinquency trends, portfolio composition and loan growth, underwriting, and certain other risks.
The allowance for credit losses related to specific loans was based on management's estimate of potential losses on impaired loans as determined by (1) the present value of expected future cash flows, (2) the fair value of collateral if the loan is determined to be collateral dependent, or (3) the loan's observable market price.
Peoples also completes a quarterly evaluation for unfunded commitments for loans that are not unconditionally cancellable, which includes construction loans, floor plan lines of credit, home equity lines of credit, other credit lines and letters of credit. Peoples performed a study to determine the historical funding rates of unadvanced portions of loans, and applied these funding rates to the unfunded commitments at period end. The loss rates, including qualitative factors, in
42
determining the allowance for credit losses were applied at the segment level to the unfunded commitment amounts to determine the allowance for credit loss liability for unfunded commitments.
There can be no assurance that the allowance for credit losses will be adequate to cover all losses, but management believes the allowance for credit losses at December 31, 2021 was adequate to provide for expected losses from existing loans based on information available at that time. While management uses available information to estimate losses, the ultimate collectability of a substantial portion of the loan portfolio, and the need for future additions to the allowance, will be based on changes in economic conditions and other relevant factors. As such, adverse changes in economic conditions could reduce currently estimated cash flows for both commercial and consumer borrowers, which would likely cause Peoples to experience increases in problem assets, delinquencies and losses on loans in the future.
To demonstrate the sensitivity to key economic parameters used in the measurement of the allowance for credit losses at December 31, 2021, management calculated the difference between the modeled allowance for credit losses at December 31, 2021, compared to one based on an adverse scenario. The adverse scenario reflected increases of 100 basis points in both U.S. and Ohio unemployment, and a decline in Ohio Gross Domestic Product of 100 basis points. Excluding consideration of general reserve adjustments, this sensitivity analysis would result in a hypothetical increase in the allowance for credit losses of approximately $3.4 million at December 31, 2021.
Prior to January 1, 2020, Peoples utilized the incurred loss model for estimating its allowance for loan losses.
Business Combinations
Peoples utilizes the acquisition method of accounting for business combinations. As of the acquisition date, Peoples records the acquired company's net assets at fair value. The determination of fair value as of the acquisition date requires management to consider various factors that involve judgment and estimation, including the application of discount rates, prepayment rates, attrition rates, future estimates of interest rates, as well as many other assumptions. These assumptions can have a material impact on the estimated fair value, and as a result, the goodwill recorded in a business combination.
Based on recent acquisitions, loans and leases acquired through business combinations have comprised the majority of purchase accounting adjustments in arriving at the fair values of acquired assets and liabilities, with the most significant adjustments relating to the creditworthiness of the acquired portfolios. The assumptions and inputs impacting the allowance for credit losses are discussed in the above paragraphs of this section of Management's Discussion and Analysis. Those same judgments drive the measurement of the credit adjustments of acquired loan and lease portfolios when arriving at fair value. For further information regarding business combination accounting, please refer to “Note 20 Acquisitions” of the Notes to the Consolidated Financial Statements.
Goodwill
Peoples records goodwill as a result of acquisitions accounted for under the acquisition method of accounting. Under the acquisition method, Peoples is required to allocate the consideration paid for an acquired company to the assets acquired, including identified intangible assets, and liabilities assumed based on their estimated fair values at the date of acquisition. Goodwill represents the excess cost over the fair value of net assets acquired and is not amortized but is tested for impairment when indicators of impairment exist, and, in any case, at least annually. For further information regarding the fair values of assets and liabilities recently acquired in business combinations, please refer to “Note 20 Acquisitions” of the Notes to the Consolidated Financial Statements.
The value of recorded goodwill is supported by revenue that is driven by the volume of business transacted and Peoples' ability to provide quality, cost-effective services in a competitive market place. A decline in earnings as a result of a lack of growth or the inability to deliver cost-effective services over sustained periods can lead to impairment of goodwill that could adversely impact earnings in future periods. Goodwill impairment exists when the carrying value of the reporting unit (as defined by US GAAP) exceeds its fair value and an impairment loss is recognized in earnings in an amount equal to that excess, limited to the total amount of goodwill allocated to the reporting unit.
The process of evaluating goodwill for impairment involves highly subjective and complex judgments, estimates and assumptions regarding the fair value of Peoples' reporting unit and, in some cases, goodwill itself. As a result, changes to these judgments, estimates and assumptions in future periods could result in materially different results.
Peoples currently maintains a single reporting unit for goodwill impairment testing. While quoted market prices exist for Peoples' common shares since they are publicly traded, these market prices do not necessarily reflect the value associated with gaining control of an entity. Thus, management takes into account all appropriate fair value measurements in determining the estimated fair value of the reporting unit.
Peoples performs its required annual impairment test as of October 1st each year. Peoples first assesses qualitative factors to determine whether it is more-likely-than-not that the fair value of the reporting unit is less than its carrying amount, including goodwill. In this evaluation, Peoples assesses relevant events and circumstances, which may include macroeconomic conditions, industry and market conditions, cost factors, overall financial performance, events specific to Peoples, significant changes in the reporting unit, or a sustained decrease in stock price. If Peoples determines that it is more-
43
likely-than-not that the fair value of the reporting unit is greater than its carrying amount, then performing the quantitative impairment test is unnecessary.
At October 1, 2021, management completed a qualitative assessment of goodwill. This test resulted in management concluding it was more-likely-than-not that the fair value of the reporting unit exceeded its carrying value.
Peoples is required to perform interim tests for goodwill impairment in subsequent quarters if events occur or circumstances change that indicate potential goodwill impairment exists, such as adverse changes to Peoples' business or a significant decline in Peoples' market capitalization. For further information regarding goodwill, refer to "Note 7 Goodwill and Other Intangible Assets" of the Notes to the Consolidated Financial Statements.
Fair Value Measurements
As a financial services company, the carrying value of certain financial assets and liabilities is impacted by the application of fair value measurements, either directly or indirectly. In certain cases, an asset or liability is measured and reported at fair value on a recurring basis, such as available-for-sale investment securities. In other cases, management must rely on estimates or judgments to determine if an asset or liability not measured at fair value warrants an impairment write-down or whether a valuation reserve should be established. Given the inherent volatility, the use of fair value measurements may have a significant impact on the carrying value of assets or liabilities, or result in material changes to the Consolidated Financial Statements, from period to period.
Detailed information regarding fair value measurements can be found in "Note 2 Fair Value of Financial Instruments" of the Notes to the Consolidated Financial Statements.
EXECUTIVE SUMMARY
Net income for the year ended December 31, 2021 was $47.6 million, compared to $34.8 million for 2020 and $53.7 million for 2019, representing earnings per diluted common share of $2.15, $1.73 and $2.63, respectively. The increase in earnings compared to 2020 was driven by a lower provision for credit losses, which was a result of improved economic factors and updated loss drivers and their impact on assumptions used in the CECL model throughout 2021. Non-core items, and the related tax effect of each, in net income included acquisition-related expenses, contract negotiation expenses, COVID-19-related expenses, a contribution to Peoples Bank Foundation, Inc., pension settlement charges, severance expenses, losses on investment securities, and gains and losses on asset disposals and other transactions. Non-core items negatively impacted earnings per diluted common share by $0.85 for 2021 compared to $0.22 for 2020 and $0.30 for 2019.
Net interest income increased 24% to $172.6 million for 2021, compared to $138.9 million for 2020, and totaled $140.8 million for 2019. Net interest margin was 3.40% in 2021, compared to 3.24% in 2020 and 3.69% in 2019. The increase in net interest income and net interest margin compared to 2020 was largely due to the impact of PPP loan forgiveness and lower funding costs due to customers' maintaining higher cash balances, as well as a higher volume of loans due to the Premier and Premium Finance acquisitions coupled with higher-yielding leases acquired from NSL and organic loan growth. Net interest margin compressed during 2020 as loan yields declined due to the low interest rate environment and investment securities yields decreased as premium amortization increased due to higher refinancing activity. Included in net interest income during 2021 and 2020 was the impact of the PPP loans. Peoples recognized interest income on deferred loan fees/costs of $13.0 million and $7.5 million during the 2021 and 2020, respectively, along with $2.3 million and $3.2 million of interest earned on PPP loans during 2021 and 2020, respectively. Funding costs were controlled during 2021, and declined 20 basis points compared to 2020. Net interest income in 2019 was largely driven by loan growth, which was positively impacted by the First Prestonsburg and ASB acquisitions, and higher loan yields. Accretion income, net of amortization expense, from acquisitions totaled $3.2 million for 2021, $2.8 million for 2020, and $4.9 million for 2019, adding 7 basis points, 7 basis points, and 12 basis points, respectively, to the net interest margin.
The provision for credit losses for 2021 was $0.7 million for 2021, compared to $26.3 million for 2020 and $2.5 million for 2019. Net charge-offs for 2021 were $4.7 million compared to $1.8 million for 2020 and $1.1 million for 2019. Net charge-offs as a percent of average total loans were 0.13% for 2021, 0.05% for 2020 and 0.04% for 2019. The lower provision for credit losses recognized in 2021 was the result of improvement in loss drivers and Moody's economic outlook published in December 2021. The provision for credit losses recognized in 2020 was due to the impact the COVID-19 pandemic had on the economic forecasts and qualitative factors used in the CECL model. The provision for credit losses recognized in 2019 was a result of lower net charge-offs in 2019, which included a $1.8 million recovery on a previously charged-off loan.
Total non-interest income increased 8% compared to 2020. All non-interest income categories were impacted by the Premier acquisition, with the exception of mortgage banking income and commercial loan swap fees. Mortgage banking income decreased due to the volume of refinance activity experienced in 2020 when interest rates declined, which was not repeated in 2021. Swap fee income also decreased as a result of lower customer demand caused by the sustained lower rate environment in 2021. Total non-interest income for 2020 was largely impacted by deposit account service charges, which was driven by the COVID-19 pandemic and the higher balances being maintained by customers throughout 2020. The decline in deposit account service charges during 2020, compared to 2019, was partially offset by higher mortgage banking income, as a result of higher refinancing activity in 2020 due to the low interest rate environment. Increases in trust and investment income and electronic banking income in 2020, compared to 2019,
44
were more than offset by decreases in insurance income, commercial loan swap fee income and bank owned life insurance income. Total non-interest income was positively impacted during 2019 due to the additional deposit accounts and cardholders associated with the acquisitions of First Prestonsburg and ASB.
Total non-interest expense was $183.7 million for 2021, an increase of $50.0 million compared to 2020. The acquisitions of Premier and NSL increased acquisition-related expenses included in other expenses, professional fees, salaries and employee benefit costs, as well as net occupancy and equipment expenses, and amortization of intangible assets. Total non-interest expense for 2020 decreased $3.6 million, or 3%, from 2019 and was driven by a reduction in acquisition-related expenses. Declines in salaries and employee benefit costs, which were mostly due to increased deferred personnel costs associated with the origination of PPP loans, were partially offset by higher data processing and software expense that was largely a result of implementation of new software, coupled with higher core processing costs. Peoples also recorded higher FDIC insurance expense during 2020 compared to 2019, as credits had been received and recognized during 2019, and were fully utilized during the second quarter of 2020. Included in total non-interest expense during 2021 were certain non-core expenses which included acquisition-related expenses of $21.4 million, COVID-19-related expenses of $1.2 million, contract negotiation expenses of $1.2 million and a Peoples Bank Foundation, Inc. contribution of $0.5 million. Non-core expenses for 2020 included COVID-19-related expenses of $1.3 million, severance expenses and pension settlement charges that totaled $1.1 million each, and acquisition-related expenses of $0.5 million. During 2019, non-core expenses included $7.3 million of acquisition-related expenses. Total non-interest expense for 2019 was mostly impacted by increases in salaries and employee benefit costs, net occupancy and equipment expense, electronic banking expense and data processing and software expense, largely attributable to the acquisitions in 2019, which were partially offset by lower FDIC insurance expense and professional fees.
Peoples' efficiency ratio, which is calculated as total non-interest expense less amortization of other intangible assets divided by fully tax-equivalent ("FTE") net interest income, plus total non-interest income, excluding all gains and losses, was 73.6% for 2021, compared to 63.9% for 2020 and 64.7% for 2019. The increase in the efficiency ratio during 2021 was caused by increased non-core expenses discussed above. The improvement in the efficiency ratio during 2020 was mostly due to a reduction in total non-interest expense, which more than offset declines in revenue. The efficiency ratio during 2019 was impacted by higher total revenue, which outpaced increases in total non-interest expense. The efficiency ratio, when adjusted for non-core items, was 63.5% for 2021, 61.9% for 2020 and 61.1% for 2019.
Income tax expense totaled $9.4 million for 2021, compared to $7.9 million for 2020 and $11.7 million for 2019. The effective tax rate for 2021 was 16.5%, 18.5% for 2020 and 17.8% for 2019. The variance in income tax expense for 2021 compared to 2020, was the result of higher pre-tax income in 2021 that resulted from the acquisitions of Premier and NSL.
Total assets increased 48% to $7.06 billion at December 31, 2021, compared to $4.76 billion at year-end 2020. The key contributor to the increase was the assets acquired from the Premier and NSL acquisitions. The allowance for credit losses increased to $64.0 million or 1.43% of total loans, net of deferred fees and costs, compared to $50.4 million and 1.48%, respectively, at December 31, 2020. The increase in the allowance for credit losses compared to December 31, 2020 was due to a $16.9 million increase in the allowance for credit losses related to the purchased credit deteriorated loans acquired from Premier, the establishment of an allowance for credit losses for non-purchased credit deteriorated loans of $11.7 million, and a liability for unfunded commitments of $0.4 million. For the NSL acquisition, Peoples recorded $3.3 million in provision for credit losses during 2021 in order to establish the allowance for credit losses for the acquired leases and $493,000 to establish the allowance for credit losses on purchased credit deteriorated leases.
Total liabilities were $6.22 billion at December 31, 2021, an increase of $2.0 billion since December 31, 2020. Total deposits increased $2.0 billion, to $5.86 billion at December 31, 2021. The significant increase in deposits compared to December 31, 2020 was largely due to deposits acquired from Premier. Total demand deposits comprised 48% of total deposits at December 31, 2021 and were 43% of total deposits at December 31, 2020.
Total stockholders' equity was $845.0 million at December 31, 2021, an increase of 47% from December 31, 2020. The increase compared to 2020 was due to common shares issued for the Premier acquisition and net income for 2021 of $47.6 million, offset partially by dividends paid of $31.2 million and $13.0 million in accumulated other comprehensive losses.
Peoples continued to exceed the capital required by the Federal Reserve Board to be deemed "well capitalized." Peoples' tier 1 capital ratio was 12.81% at December 31, 2021, versus 13.25% at December 31, 2020, while the total capital ratio was 14.06% at December 31, 2021, versus 14.50% at December 31, 2020. The common equity tier 1 risk-based capital ratio was 12.52% at December 31, 2021 compared to 13.01% at December 31, 2020. Compared to December 31, 2020, the change in the capital ratios was due to a lower provision for credit losses recognized during 2021, partially offset by increased acquisition-related expenses and dividends paid to shareholders. Peoples' book value and tangible book value per share were $29.86 and $19.58, respectively, at December 31, 2021, compared to $29.43 and $19.99, respectively, at December 31, 2020. Additional information regarding capital requirements can be found in "Note 17 Regulatory Matters" of the Notes to the Consolidated Financial Statements.
45
RESULTS OF OPERATIONS
Net Interest Income
Peoples earns interest income on investments, loans and leases, and incurs interest expense on interest-bearing deposits and borrowed funds. Net interest income, the amount by which interest income exceeds interest expense, remains Peoples' largest source of revenue and was 71% of total revenue during 2021. The amount of net interest income earned by Peoples is affected by various factors, including changes in market interest rates due to the Federal Reserve Board's monetary policy, the level and degree of pricing competition for both loans and deposits in Peoples' markets, and the amount and composition of Peoples' earning assets and interest-bearing liabilities.
Peoples monitors net interest income performance and manages its balance sheet composition through regular ALCO meetings. The asset-liability management process employed by the ALCO is intended to mitigate the impact of future interest rate changes on Peoples' net interest income and earnings. However, the frequency and/or magnitude of changes in market interest rates are difficult to predict, and may have a greater impact on net interest income than adjustments management is able to make.
As part of the analysis of net interest income, management converts tax-exempt income earned on obligations of states and political subdivisions to the pre-tax equivalent of taxable income using a blended federal and state corporate income tax rate of 22.3% for 2021, and a statutory federal corporate income tax rate of 21% for 2020 and 2019. Management believes the resulting FTE net interest income allows for a more meaningful comparison of tax-exempt income and yields to their taxable equivalents. Net interest margin, which is calculated by dividing FTE net interest income by average interest-earning assets, serves as an important measurement of the net revenue stream generated by the volume, mix and pricing of earning assets and interest-bearing liabilities.
The following table details the calculation of FTE net interest income for the years ended December 31:
(Dollars in thousands) 2021 2020 2019
Net interest income $ 172,553 $ 138,923 $ 140,838
Taxable equivalent adjustments 1,349 1,054 1,068
FTE net interest income $ 173,902 $ 139,977 $ 141,906
46
The following table details Peoples’ average balance sheets, with corresponding income/expense and yield/cost, for the years ended December 31:
2021 2020 2019
( Dollars in thousands)
Average Balance Income/ Expense Yield/Cost Average Balance Income/Expense Yield/Cost Average Balance Income/ Expense Yield/Cost
Short-term investments $ 219,849 $ 313 0.14 % $ 103,767 $ 343 0.33 % $ 43,157 $ 919 2.13 %
Investment securities (a)(b)(c):
Taxable 1,042,419 15,219 1.46 % 868,930 14,370 1.65 % 870,921 23,420 2.69 %
Nontaxable 163,095 4,326 2.65 % 101,965 3,146 3.09 % 106,437 3,331 3.13 %
Total investment securities 1,205,514 19,545 1.62 % 970,895 17,516 1.80 % 977,358 26,751 2.74 %
Loans (b)(c)(d):
Construction 131,834 5,130 3.84 % 107,862 4,883 4.45 % 111,734 6,008 5.30 %
Commercial real estate, other 1,061,323 42,308 3.93 % 854,749 36,499 4.20 % 829,581 44,574 5.30 %
Commercial and industrial 870,682 37,321 4.23 % 925,060 34,458 3.66 % 601,900 31,611 5.18 %
Premium finance 118,242 5,872 4.90 % 50,687 2,855 5.54 % — — — %
Leases 74,442 13,572 17.98 % — — — % — — — %
Residential real estate (e) 700,691 29,686 4.24 % 660,025 31,155 4.72 % 641,053 30,671 4.78 %
Home equity lines of credit 133,340 5,410 4.06 % 127,454 5,799 4.55 % 132,235 7,715 5.83 %
Consumer, indirect 529,994 21,480 4.05 % 453,379 19,364 4.27 % 416,768 17,350 4.16 %
Consumer, direct
88,611 5,501 6.21 % 79,138 5,286 6.68 % 78,838 5,564 7.06 %
Total loans 3,709,159 166,280 4.44 % 3,258,354 140,299 4.26 % 2,812,109 143,493 5.06 %
Allowance for credit losses
(56,038) (47,692) (21,239)
Net loans 3,653,121 166,280 4.51 % 3,210,662 140,299 4.33 % 2,790,870 143,493 5.10 %
Total earning assets 5,078,484 186,138 3.64 % 4,285,324 158,158 3.66 % 3,811,385 171,163 4.46 %
Goodwill and other intangible assets 234,667 181,526 173,529
Other assets 359,443 272,439 237,568
Total assets
$ 5,672,594 $ 4,739,289 $ 4,222,482
Interest-bearing deposits:
Savings accounts $ 772,726 $ 112 0.01 % $ 571,676 $ 175 0.03 % $ 511,112 $ 437 0.09 %
Government deposit accounts
529,955 2,035 0.38 % 375,305 2,226 0.59 % 323,768 3,220 0.99 %
Interest-bearing demand accounts
848,526 303 0.04 % 658,214 455 0.07 % 605,637 1,111 0.18 %
Money market accounts 575,237 390 0.07 % 549,276 1,416 0.26 % 425,207 2,745 0.65 %
Retail certificates of deposit 497,181 3,952 0.79 % 473,244 6,748 1.43 % 465,381 8,002 1.72 %
Brokered deposits (f) 150,716 3,130 2.08 % 223,940 2,480 1.11 % 272,553 6,695 2.46 %
Total interest-bearing deposits
3,374,341 9,922 0.29 % 2,851,655 13,500 0.47 % 2,603,658 22,210 0.85 %
Borrowed funds:
Short-term FHLB advances (f) 30,289 475 1.57 % 129,928 2,489 1.92 % 197,987 4,455 2.25 %
Repurchase agreements and other 70,674 66 0.09 % 46,706 82 0.18 % 46,812 257 0.55 %
Total short-term borrowings 100,963 541 0.54 % 176,634 2,571 1.46 % 244,799 4,712 1.92 %
Long-term FHLB advances 94,050 1,413 1.50 % 107,935 1,740 1.61 % 87,472 1,814 2.07 %
Other borrowings 9,364 360 3.79 % 8,757 370 4.23 % 7,368 521 7.07 %
Total long-term borrowings 103,414 1,773 1.71 % 116,692 2,110 1.81 % 94,840 2,335 2.46 %
Total borrowed funds 204,377 2,314 1.13 % 293,326 4,681 1.59 % 339,639 7,047 2.07 %
Total interest-bearing liabilities
3,578,718 12,236 0.34 % 3,144,981 18,181 0.58 % 2,943,297 29,257 0.99 %
Non-interest-bearing deposits 1,347,702 924,799 653,082
Other liabilities 89,541 94,123 59,980
Total liabilities 5,015,961 4,163,903 3,656,359
Stockholders’ equity 656,633 575,386 566,123
Total liabilities and stockholders’ equity $ 5,672,594 $ 4,739,289 $ 4,222,482
Interest rate spread (b) $ 173,902 3.30 % $ 139,977 3.08 % $ 141,906 3.47 %
Net interest margin (b) 3.40 % 3.24 % 3.69 %
(a) Average balances are based on carrying value.
(b) Interest income and yields are presented on a fully tax-equivalent basis, using a blended federal and state corporate income tax rate of 22.3% for 2021, and a statutory federal corporate income tax rate of 21% for 2020 and 2019.
(c) On January 1, 2020, Peoples adopted ASU 2016-13 and adopted the CECL model, recording an adjustment in cost basis of purchased credit deteriorated assets to reflect the addition of $2.6 million to establish the allowance for credit losses; an increase to the allowance for credit losses (which was the "allowance for loan
47
losses" prior to January 1, 2020) of $5.8 million; the addition of $1.5 million unfunded commitment liability included in accrued expenses and other liabilities; and a cumulative-effect adjustment to reduce retained earnings of $3.7 million, net of statutory corporate federal income tax.
(d) Average balances include nonaccrual, impaired loans, and loans held for sale. Interest income includes interest earned and received on nonaccrual loans prior to the loans being placed on nonaccrual status. Loan fees included in interest income were immaterial for all periods presented.
(e) Loans held for sale are included in the average loan balances listed. Related interest income on loans originated for sale prior to the loan being sold is included in loan interest income.
(f) Interest related to interest rate swap transactions is included, as appropriate to the transaction, in interest expense on short-term FHLB advances and interest expense on brokered deposits for the periods presented in which FHLB advances and brokered deposits were being utilized.
On September 17, 2021, Peoples acquired Premier, which included $1.1 billion in loans and $1.8 billion in deposits. Additionally, Peoples acquired North Star Leasing on April 1, 2021 and an insurance premium finance division on July 1, 2020. During 2021, Peoples had excess cash which increased short-term investments, due to PPP forgiveness and increased deposit balances.
The following table provides an analysis of the changes in FTE net interest income:
(Dollars in thousands) Changes from 2020 to 2021 Changes from 2019 to 2020
Increase (decrease) in: Rate Volume Total (a)
Rate Volume Total (a)
INTEREST INCOME:
Short-term investments $ (258) $ 228 $ (30) $ (1,163) $ 587 $ (576)
Investment Securities (b):
Taxable (4,274) 5,123 849 (8,997) (53) (9,050)
Nontaxable (1,431) 2,611 1,180 (46) (139) (185)
Total investment income (5,705) 7,734 2,029 (9,043) (192) (9,235)
Loans (b) :
Construction (723) 970 247 (925) (200) (1,125)
Commercial real estate, other (2,414) 8,223 5,809 (9,372) 1,297 (8,075)
Commercial and industrial 4,955 (2,092) 2,863 (10,807) 13,654 2,847
Premium finance (358) 3,375 3,017 — 2,855 2,855
Leases — 13,572 13,572 — — —
Residential real estate (3,315) 1,846 (1,469) (416) 900 484
Home equity lines of credit (648) 259 (389) (1,646) (270) (1,916)
Consumer, indirect (1,028) 3,144 2,116 459 1,555 2,014
Consumer, direct (391) 606 215 (298) 20 (278)
Total loan income (3,922) 29,903 25,981 (23,005) 19,811 (3,194)
Total interest income (9,885) 37,865 27,980 (33,211) 20,206 (13,005)
INTEREST EXPENSE:
Deposits:
Savings accounts (112) 49 (63) (309) 47 (262)
Government deposit accounts (934) 743 (191) (1,448) 454 (994)
Interest-bearing demand accounts (260) 108 (152) (745) 89 (656)
Money market accounts (1,090) 64 (1,026) (1,973) 644 (1,329)
Retail certificates of deposit (3,122) 326 (2,796) (1,387) 133 (1,254)
Brokered deposit 1,654 (1,004) 650 (3,182) (1,033) (4,215)
Total deposit cost (3,864) 286 (3,578) (9,044) 334 (8,710)
Borrowed funds:
Short-term borrowings (433) (1,597) (2,030) (1,605) (536) (2,141)
Long-term borrowings (177) (160) (337) (687) 462 (225)
Total borrowed funds cost (610) (1,757) (2,367) (2,292) (74) (2,366)
Total interest expense (4,474) (1,471) (5,945) (11,336) 260 (11,076)
Net interest income $ (5,411) $ 39,336 $ 33,925 $ (21,875) $ 19,946 $ (1,929)
(a) The change in interest due to both rate and volume has been allocated to rate and volume changes in proportion to the relationship of the dollar amounts of the changes in each.
(b) Interest income and yields are presented on a fully tax-equivalent basis, using a blended federal and state corporate income tax rate of 22.3% for 2021 and a statutory federal corporate income tax rate of 21% for 2020 and 2019.
48
During 2021, net interest income grew 24%, and the increase was primarily driven by the acquired Premier and leasing divisions, coupled with growth in Peoples' core business. Net interest margin improved 16 basis points compared to 2020, as loan yields improved and offset declining investment yields, while controlled funding costs benefited net interest margin. Peoples recorded $15.3 million in PPP income during 2021, which was mostly due to the forgiveness of loans, resulting in accretion of net deferred loan fees and costs, and positively impacted net interest margin by 16 basis points. Accretion income, net of amortization expense, from acquisitions, added $3.2 million to net interest income and 7 basis points to net interest margin.
For 2020, net interest income decreased $1.9 million, or 1% compared to 2019, and net interest margin declined to 3.24%, compared to 3.69% for 2019. Net interest income and net interest margin were negatively impacted by the low interest rate environment during 2020, which also led to a $5.0 million increase in premium amortization on Peoples' investment securities portfolio during 2020, compared to 2019. Peoples recorded $10.7 million in interest income on PPP loans during 2020, which included the impact of accretion of net deferred loan fees and costs, which added 2 basis points to net interest margin. Premium finance loans added $2.9 million of interest income during 2020, and 2 basis points to net interest margin. Funding costs declined to 58 basis points compared to 99 basis points for 2019, which was driven by reductions in interest rates on deposits, coupled with controlled borrowing costs. During 2020, Peoples recognized accretion income, net of amortization expense, from acquisitions of $2.8 million, which added 7 basis points to net interest margin, compared to $4.9 million and 12 basis points in 2019.
Additional interest income in 2021 from prepayment fees and interest recovered on nonaccrual loans was $825,000, compared to $738,000 in 2020 and $564,000 in 2019.
Detailed information regarding changes in the Consolidated Balance Sheets can be found under appropriate captions of the "FINANCIAL CONDITION" section of this discussion. Additional information regarding Peoples' interest rate risk and the potential impact of interest rate changes on Peoples' results of operations and financial condition can be found later in this discussion under the caption "Interest Rate Sensitivity and Liquidity."
Provision for Credit Losses
On January 1, 2020, Peoples adopted the provisions of ASU 2016-13 "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments", commonly referred to as the CECL model. Prior to the adoption of the CECL methodology, the provision for credit losses was the "provision for loan losses." The following table details Peoples’ provision for credit losses recognized for the years ended December 31:
(Dollars in thousands) 2021 2020 2019
Provision for other credit losses $ 339 $ 25,798 $ 1,845
Provision for checking account overdrafts 392 456 659
Provision for credit losses $ 731 $ 26,254 $ 2,504
As a percent of average total loans 0.02 % 0.81 % 0.09 %
The provision for credit losses represents the amount needed to maintain the appropriate level of the allowance for credit losses based on management’s formal quarterly analysis of the loan portfolio and procedural methodology that estimates the amount of probable credit losses. The CECL methodology utilized by Peoples relies on economic forecasts, as well as other key assumptions including prepayments, probability of default and loss given default. Under the incurred loss model (the accounting methodology prior to 2020), the process for estimating allowance for loan losses considered various factors that affect losses, such as changes in Peoples’ loan quality and historical loss experience. Given the relatively low recent loss history, the incurred loss model was highly dependent on qualitative factors to arrive at an appropriate allowance for loan losses in periods prior to 2020. These qualitative factors included current economic conditions, and other environmental factors such as changes in real estate market conditions and unemployment.
During 2021, Peoples recorded a lower provision for credit losses compared to a sizable provision for credit losses during 2020. 2020 was impacted by the COVID-19 pandemic, which drove a higher provision for credit losses. During 2021 economic factors and loss drivers improved and resulted in a reduction in the allowance for credit losses, resulting in a lower provision for credit losses. The improvement in economic factors and loss drivers for 2021 were partially offset by the provision for credit losses required to establish the allowance for credit losses for acquired non-purchased credit deteriorated loans and leases during 2021.
During 2020, the COVID-19 pandemic caused the economic outlook and assumptions used in the CECL model to be unfavorable, and as a result, caused the need for additional provision for credit losses to be recorded resulting in a higher allowance for credit losses at the end of the year, compared to 2019.
Additional information regarding changes in the allowance for credit losses and loan credit quality can be found later in this discussion under the caption "Allowance for Credit Losses."
49
Net Gains (Losses) Included in Total Non-Interest Income
Net gains (losses) include gains and losses on investment securities, asset disposals and other transactions, which are recognized in total non-interest income.
The following table details the net gains (losses) for the years ended December 31 recognized by Peoples:
(Dollars in thousands) 2021 2020 2019
Net (loss) gain on investment securities $ (862) $ (368) $ 164
Net gain (loss) on asset disposals and other transactions:
Net loss on other assets $ (460) $ (367) $ (692)
Net gain (loss) on OREO 56 (120) (98)
Net gain on other transactions 897 197 8
Net gain (loss) on asset disposals and other transactions $ 493 $ (290) $ (782)
During 2021, net gains on other transactions were driven by the sale of $59.8 million of predominantly purchased credit deteriorated loans acquired in the Premier Merger ($52.9 million of which were criticized or classified) primarily in the hospitality industry. Peoples recognized a gain of $897,000 related to the discount recorded on those loans when they were acquired from Premier.
The net loss on other assets during 2020 was primarily due to the loss of $145,000 on the sale of a closed branch from the ASB acquisition, and market value write-down of $108,000 related to closed offices that were held for sale. The net gain on other transactions during 2020 was due to receiving $197,000 in funds from a limited partnership investment.
The net loss on other assets during 2019 was driven by net losses on repossessed assets of $320,000, the write-offs of fixed assets acquired from First Prestonsburg of $243,000 and market value write-downs related to closed offices that were held for sale.
Total Non-Interest Income Excluding Net Gains and Losses
Peoples generates total non-interest income excluding net gains and losses from four primary sources: electronic banking income ("e-banking"); trust and investment income; insurance income; and deposit account service charges. Peoples continues to focus on revenue growth from non-interest income sources in order to maintain a diversified revenue stream through greater reliance on total non-interest income excluding net gains and losses. As a result, total non-interest income excluding net gains and losses accounted for 28.6% of Peoples' total revenues (defined as net interest income plus total non-interest income excluding net gains and losses) in 2021, compared to 31.7% in 2020 and 31.5% in 2019.
The decline in Peoples' total non-interest income excluding net gains and losses, as a percent of total revenue during 2021 compared to 2020, was largely due to the Premier Merger and the North Star Leasing acquisition, which caused improved net interest income, resulting in a smaller portion of total revenue being provided by other revenue sources.
E-banking income comprised the largest portion of Peoples' total non-interest income excluding net gains and losses, for 2021. The following table shows Peoples' e-banking income for the years ended December 31:
(Dollars in thousands) 2021 2020 2019
E-banking income $ 18,010 $ 14,246 $ 13,680
Peoples' e-banking services include ATM and debit cards, direct deposit services, Internet and mobile banking, and remote deposit capture, and serve as alternative delivery channels to traditional sales offices for providing services to clients. Revenue is derived largely from ATM and debit cards, as other services are mainly provided at no charge to the customers. The amount of e-banking income is largely dependent on the timing and volume of customer activity. During 2021, e-banking income increased $3.8 million, or 26%, and was driven by the combination of the addition of the Premier acquired accounts, along with increased usage of debit cards. The growth in e-banking income in 2020 of $566,000, or 4%, compared to 2019, was largely due to increased usage of debit cards, coupled with the full year impact of the addition of the First Prestonsburg acquired accounts. In 2021, Peoples' customers used their debit cards to complet e $1.4 billion of transactions, versus $1.0 billion in 2020 and $913.7 million in 2019.
50
Peoples' fiduciary and brokerage revenues continue to be based primarily upon the value of assets under administration and management. The following table details Peoples’ trust and investment income for the years ended December 31:
(Dollars in thousands) 2021 2020 2019
Fiduciary $ 7,930 $ 6,906 $ 6,761
Brokerage 5,966 4,560 4,198
Employee benefit plan fees 2,560 2,196 2,200
Trust and investment income $ 16,456 $ 13,662 $ 13,159
For 2021, trust and investment income grew 20%, as Peoples added new accounts and the underlying market values of assets under administration and management grew, compared to 2020. Peoples also increased its employee benefit plans business during 2021, compared to 2020. During 2020, trust and investment income increased $503,000, or 4%, compared to 2019, while employee benefit plan fees for 2020 were relatively flat compared to 2019.
The following table details Peoples’ assets under administration and management at year-end December 31:
(Dollars in thousands) 2021 2020 2019
Trust $ 2,009,871 $ 1,885,324 $ 1,572,933
Brokerage 1,183,927 1,009,521 944,002
Total $ 3,193,798 $ 2,894,845 $ 2,516,935
Annual average $ 3,053,807 $ 2,510,596 $ 2,382,017
During 2021, Peoples grew assets under administration and management by over 10%, which was partially due to new accounts as well as improved market values, resulting in increased fiduciary and brokerage income compared to 2020. For 2020, Peoples grew assets under management by 15% compared to 2019, as a result of new accounts and higher market values, driving the increase in both fiduciary and brokerage income compared to the prior year. Peoples has had success in recent years in increasing client accounts within its fiduciary and brokerage business, while the market values of existing assets under administration and management have also increased.
The following table details Peoples’ insurance income for the years ended December 31:
(Dollars in thousands) 2021 2020 2019
Property and casualty insurance commissions
$ 11,192 $ 10,240 $ 10,605
Performance-based commissions 2,044 1,457 1,530
Life and health insurance commissions
1,627 1,897 2,065
Other fees and charges 389 448 602
Insurance income $ 15,252 $ 14,042 $ 14,802
Insurance income grew 9% for 2021, compared to 2020. This increase was driven by higher property and casualty insurance commissions, as Peoples added new accounts, and higher performance-based commissions. Insurance income declined 5% during 2020, compared to 2019, and decreased across each category of insurance income. This decline was mostly due to the impact of the COVID-19 pandemic. The majority of performance-based commissions typically is recorded annually in the first quarter and is based on a combination of factors, such as loss experience of insurance policies sold, production volumes and overall financial performance of the individual insurance carriers.
Deposit account service charges are based on the costs associated with services provided by Peoples. The following table details deposit account service charges for the years ended December 31:
(Dollars in thousands) 2021 2020 2019
Overdraft and non-sufficient funds fees $ 5,528 $ 5,073 $ 7,069
Account maintenance fees 3,808 3,573 3,832
Other fees and charges 807 772 799
Deposit account service charges $ 10,143 $ 9,418 $ 11,700
The amount of deposit account service charges, particularly fees for overdrafts and non-sufficient funds, is largely dependent on the timing and volume of customer activity. Management periodically evaluates these fees to ensure they are reasonable based on operational costs and similar to fees charged in Peoples' markets by competitors. Deposit account service charges were positively impacted during 2021 by the Premier Merger and associated additional accounts, while growth was also experienced within fees on existing accounts, which had previously declined since the beginning of the COVID-19 pandemic. During 2020, deposit account service charges declined 20% as customer habits changed as a result of the COVID-19 pandemic, with customers maintaining higher
51
balances, coupled with fiscal stimulus funds provided by the government to individuals and proceeds from PPP loans to businesses compared to 2019.
The following table details the other items included within Peoples' total non-interest income for the years ended December 31:
(Dollars in thousands) 2021 2020 2019
Mortgage banking income $ 3,439 $ 6,499 $ 4,328
Bank owned life insurance income 1,767 1,977 2,430
Commercial loan swap fees 543 1,741 2,228
Other non-interest income $ 3,644 $ 2,745 $ 2,565
Mortgage banking income is comprised mostly of net gains from the origination and sale of long-term, fixed-rate real estate loans in the secondary market, as well as servicing income for sold loans. As a result, the amount of income recognized by Peoples is largely dependent on customer demand and long-term interest rates for residential real estate loans offered in the secondary market. During 2021, mortgage banking declined by 47% and was driven by lower customer demand due to the low rate environment that had been in place since the beginning of 2020. During 2020, mortgage banking income increased by 50% compared to 2019, as the low interest rate environment during the year resulted in heavy refinance activity. In 2021, Peoples sold approximately $57.6 million of loans to the secondary market with servicing retained and sold approximately $37.4 million in loans with servicing released, compared to approximately $111.9 million and $150.9 million, respectively, in 2020. Peoples sold $98.2 million of loans to the secondary market with servicing retained and $55.4 million of loans with servicing released during 2019. The volume of sales has a direct impact on the amount of mortgage banking income.
BOLI income declined 11% during 2021, compared to 2020, and was mostly due to the 2020 recognition of a $109,000 tax-free death benefit that exceeded the cash surrender value of the insurance policies. BOLI income declined $453,000 during 2020, compared to 2019, with the reduction largely driven by the recognition of $482,000 of tax-free death benefits that exceeded the cash surrender value of the insurance policies during 2019. Peoples purchased no additional BOLI policies during 2021, 2020 and 2019.
Commercial loan swap fees are largely dependent on the timing and volume of customer activity. For 2021, commercial loan swap fees declined 69%, as customer demand decreased due to the continued low interest rate environment. The low interest rate environment also resulted in lower commercial loan swap fees during 2020, which were down $487,000 compared to 2019.
Other non-interest income grew during 2021, and was positively impacted by the non-interest income recognized by the leasing division, which contributed $1.3 million of income. Other non-interest income during 2020 and 2019 included additional income related to gains recorded on the sale of restricted Class B Visa stock of $680,000 and $787,000, respectively. There were no similar gains recorded during 2021.
Total Non-Interest Expense
Salaries and employee benefit costs remain Peoples’ largest non-interest expense, accounting for over half of total non-interest expense. The following table details Peoples’ salaries and employee benefit costs for the years ended December 31:
(Dollars in thousands) 2021 2020 2019
Base salaries and wages $ 60,622 $ 52,016 $ 51,835
Sales-based and incentive compensation 16,668 12,200 11,850
Employee benefit costs 11,091 8,510 8,497
Stock-based compensation 3,515 3,607 3,655
Deferred personnel costs (3,695) (4,342) (2,768)
Payroll taxes and other employment costs 6,411 4,370 4,791
Salaries and employee benefit costs $ 94,612 $ 76,361 $ 77,860
Full-time equivalent employees:
Actual at end of the period 1,188 894 900
Average during the period 1,003 894 900
Base salaries and wages increased in 2021 by $8.6 million, or 17%, compared to 2020, and were impacted by the acquisitions of Premier and North Star Leasing. During 2021, Peoples incurred $3.8 million of one-time expenses associated with acquisitions, whereas Peoples incurred $1.1 million in severance expenses in 2020, due primarily to a management restructuring that occurred in the latter half of 2020. Base salaries and wages in 2020 were relatively flat compared to 2019. Base salaries and wages were impacted by merit increases, as well as continued movement towards a $15 per hour minimum wage throughout Peoples' organization. The $15 per hour minimum is being phased in and will largely be implemented by January 1, 2023. Base salaries and wages were also impacted by the addition of employees, primarily as a result of the First Prestonsburg acquisition in 2019.
52
Sales-based and incentive compensation increased in 2021 compared to 2020, largely due to higher incentive compensation related to the overall company performance measures combined with trust and investment income growth. During 2020, sales-based and incentive compensation increased compared to 2019 due to mortgage banking income growth from an increase in real estate loans sold in the secondary market. Peoples' sales-based and incentive compensation plans are designed to grow core earnings while managing risk, and do not encourage unnecessary and excessive risk-taking that could threaten the value of Peoples. The sales-based and incentive compensation plans reward employees for appropriate behaviors and include provisions addressing inappropriate practices with respect to Peoples and its customers, including clawbacks for executives.
Employee benefit costs increased $2.6 million compared to 2020, and were impacted by the Premier and North Star Leasing acquisitions creating an increase in the number of participants in the insurance plan. During 2020, employee benefit costs were relatively flat compared to 2019.
Stock-based compensation is generally recognized over the vesting period, which generally ranges from immediate vesting to vesting at the end of three years, and an adjustment is made at the vesting date to reverse expense for non-vested awards. The majority of Peoples' stock-based compensation is attributable to annual equity-based incentive awards to employees, which are awarded in the first quarter and based upon Peoples achieving certain performance goals during the prior year. During the years presented in the table above, Peoples granted restricted common shares to officers and key employees with performance-based vesting periods and time-based vesting periods, generally with a three-year cliff vesting. Stock-based compensation was relatively flat for 2021, compared to 2020 and 2019.
Deferred personnel costs represent the portion of current period salaries and employee benefit costs considered to be direct loan origination costs. These costs are capitalized and recognized over the life of the loan as a yield adjustment in interest income. As a result, the amount of deferred personnel costs for each period corresponds directly with the volume of loan originations, coupled with the average deferred costs per loan that are updated annually at the beginning of each year. Deferred personnel costs decreased in 2021 compared to 2020. Materially impacting the comparison was the recognition of $921,000 in deferred personnel costs during 2020 related to the origination of PPP loans. Increased production in residential real estate and indirect consumer loans, coupled with PPP loan originations, resulted in higher deferred personnel costs in 2020 compared to 2019. Additional information regarding Peoples' loan activity can be found later in this discussion under the caption "Loans" within "FINANCIAL CONDITION."
Payroll taxes and other employee costs increased during 2021 as a result of the higher base salaries, sales-based and incentive compensation, and employee benefits. During 2020, $454,000 in dividends were received from Ohio Bureau of Workers' Compensation in an effort to ease the impact of COVID-19 on the state's business community and workforce.
Peoples’ net occupancy and equipment expense for the years ended December 31 was comprised of the following:
(Dollars in thousands) 2021 2020 2019
Depreciation expense $ 6,143 $ 5,955 $ 5,702
Repairs and maintenance costs 3,972 2,988 3,016
Net rent expense 1,723 1,293 1,022
Property taxes, utilities and other costs 3,080 2,572 2,691
Net occupancy and equipment expense $ 14,918 $ 12,808 $ 12,431
Net occupancy and equipment expense grew 16% during 2021, compared to 2020, driven by the recent acquisitions and ongoing costs related to the larger footprint. During 2020, net occupancy and equipment expense increased primarily due to increased depreciation expense and net rent expense. The increase in depreciation expense was due to a full year of depreciation related to the First Prestonsburg acquisition in 2019, while net rent expense increased due to the addition of new leases for the recent insurance acquisition and insurance premium finance acquisition, as well as a full year of rent expense for the First Prestonsburg branches.
The following table details the other items included within Peoples' total non-interest expense for the years ended December 31:
(Dollars in thousands) 2021 2020 2019
Professional fees $ 15,783 $ 6,912 $ 7,095
Data processing and software expense 10,542 7,441 6,332
E-banking expense 8,885 7,777 7,186
Amortization of other intangible assets 4,775 3,223 3,359
Marketing expense 3,658 2,101 2,291
Franchise tax expense 3,357 3,506 3,071
Other loan expenses 2,001 1,584 1,956
FDIC insurance expense 1,976 1,302 602
Communication expense 1,657 1,134 1,181
Other non-interest expense $ 21,573 $ 9,546 $ 13,886
53
Total non-interest expense during 2021 increased considerably due to acquisition-related expenses, which totaled $21.4 million, and impacted several lines. Additionally, Peoples had increased ongoing expenses associated with the Premier and North Star Leasing acquisition during 2021, and the full year impact of the Premium Finance acquisition completed during 2020.
Data processing and software expense includes software support, maintenance and depreciation expense. During 2021, data processing and software expense grew due to systems and software upgrades, annual contractual increases and overall growth, which included: the implementation of enhanced functionalities for Peoples' core banking system, including making certain mobile banking tools available to customers; software upgrades; and additional network capacity and security features in the latter part of 2020 and first quarter of 2021. The higher expense during 2021 also reflected increases related to the Premier acquisition. The increase in data processing and software expense for 2020 was driven by systems and software upgrades, annual contractual increases and overall growth, which included: the implementation of enhanced functionalities for Peoples' core banking system, including making certain mobile banking tools available to customers; software upgrades; and additional network capacity and security features.
Peoples' e-banking expense is comprised of costs associated with debit and ATM cards, as well as Internet and mobile banking costs. E-banking expense increased during 2021, as customer usage increased, coupled with the additional accounts acquired from Premier. E-banking expense was up for 2020, compared to 2019, due to an increased usage by customers as a result of the COVID-19 pandemic, which in turn increased the volume of transactions involving debit cards and Peoples' internet and mobile banking service.
Peoples' amortization of other intangible assets is driven by acquisition-related activity. During 2021, amortization of other intangible assets increased as a result of the recent acquisitions of Premier and North Star Leasing and the full year impact of premium finance. Amortization of other intangible assets declined in 2020 due to the reduced amortization from previous acquisitions.
Marketing expense, which includes advertising, donations, marketing campaigns, and other public relations costs, was higher for 2021, compared to 2020, and was mostly due to additional advertising campaigns relating to the addition of the Premier locations. Additionally, Peoples' donations increased during 2021, which included a $500,000 special contribution to the Peoples Bank Foundation, Inc., and donations to each of Marietta College and the Ohio Valley Museum of Discovery. Marketing expense decreased slightly in 2020, compared to 2019, due to declines in electronic and print media, ad agency fees and other public relations expenses.
Peoples is subject to state franchise taxes, which are based largely on Peoples' equity at year-end, in the states where Peoples has a physical presence. Franchise tax expense declined slightly for 2021, and was driven by a change in the calculation for Kentucky, which become income-based instead of an equity-based calculation, and reduced the related tax expense for 2021, compared to 2020. During 2020, franchise tax expense increased compared to 2019, due to higher equity as of December 31, 2019, coupled with additional taxes in Kentucky as a result of the First Prestonsburg acquisition in 2019. Franchise tax expense also includes the Ohio Financial Institution Tax ("FIT"), which is a business privilege tax that is imposed on financial institutions organized for profit and doing business in Ohio. The Ohio FIT is based on the total equity capital in proportion to the taxpayer's gross receipts in Ohio.
During 2021, other loan expenses increased mostly due to the higher volume of indirect consumer loan originations during 2020 and related recognition of deferred costs, which lowered expense during 2020, and was not duplicated during 2021. Other loan expenses declined during 2020, primarily due to the higher deferral of costs associated with an increase in the origination volume of consumer indirect loans.
FDIC insurance expense increased during 2021, and was partially due to credits used by Peoples during the first two quarters of 2020 to offset its FDIC insurance premium, coupled with a lower leverage ratio during early 2020, which negatively impacted insurance expense for 2021. Peoples recorded higher FDIC insurance expense during 2020 compared to the prior year, as credits were received and recognized during 2019, and were fully utilized during the second quarter of 2020. The FDIC quarterly assessment rate is applied to average total assets less average tangible equity, and is based on the leverage ratio, net income before taxes, nonperforming loans as a percent of total assets, OREO, loan mix and asset growth. Additional information regarding Peoples' FDIC insurance assessments may be found in "ITEM 1 BUSINESS" of this Form 10-K in the section captioned "Supervision and Regulation."
Communication expense increased 46% during 2021, compared to 2020, and grew as a result of the upgrading of the network to certain branches (including new branches acquired from Premier coupled with the addition of the NSL location and the full year impact of the location of Premium Finance that was acquired) and increased costs compared to the prior periods among certain vendors that provide communication services. Communication expense was relatively flat for 2020 compared to 2019.
Other non-interest expense increased $12.0 million in 2021 compared to 2020, and decreased $4.3 million in 2020 compared to 2019. Other non-interest expense increased considerably during 2021, and was primarily related to acquisition-related expenses recognized.
Income Tax Expense
A key driver for the amount of income tax expense or benefit recognized by Peoples each year is the amount of pre-tax income. In addition to the expense recognized, Peoples receives tax benefits from tax-exempt investments and loans, BOLI, stock awards that settled or vested during the year, and investments in tax credit funds, which reduce Peoples' effective tax rate. A reconciliation of
54
Peoples' recorded income tax expense/benefit and effective tax rate to the statutory tax rate can be found in "Note 13 Income Taxes" of the Notes to the Consolidated Financial Statements.
For the full year of 2021, income tax expense totaled $9.4 million, compared to $7.9 million in 2020, and $11.7 million in 2019, and the effective tax rate for 2021 was 16.5%, compared to 18.5% for 2020, and 17.8% for 2019. Income tax expense increased during 2021, and was due to higher pre-tax income, which benefited from the recent acquisitions and reduced provision for credit losses. The decrease in income tax expense in 2020 compared to 2019 was the result of lower pre-tax income in 2020 related to the increase in the provision for credit losses recorded during 2020.
For 2021, the effective tax rate was down 2% compared to 2020. Income tax expense for 2021 was impacted by an income tax benefit related to an adjustment from the prior period of $1.1 million. During 2020, income tax expense and the effective tax rate were positively impacted by tax-exempt interest income, non-taxable BOLI income and the full-year impact of the investment in Peoples Risk Management, Inc., which reduced income tax expense by $412,000. Income tax expense for 2020 was also impacted by additional income tax expense related to an adjustment from the prior year of $863,000.
Peoples also recorded a tax expense of $74,000 in 2021, and tax benefits of $5,000 in 2020, and $195,000 in 2019 related to stock awards that settled or vested during the year, with the substantial majority recorded in the first quarter of each year.
Pre-Provision Net Revenue (non-US GAAP)
Pre-provision net revenue ("PPNR") has become a key financial measure used by state and federal bank regulatory agencies when assessing the capital adequacy of financial institutions. PPNR is defined as net interest income plus total non-interest income, excluding all gains and losses, minus total non-interest expense. PPNR excludes income tax expense. As a result, PPNR represents the earnings capacity that can be either retained in order to build capital or used to absorb unexpected losses and preserve existing capital. This ratio represents a non-US GAAP financial measure since it excludes the provision for credit losses and all gains and losses included in earnings.
The following table provides a reconciliation of this non-US GAAP financial measure to the amounts of income before income taxes reported in Peoples' Consolidated Financial Statements for the periods presented:
(Dollars in thousands) 2021 2020 2019
Income before income taxes $ 56,970 $ 42,646 $ 65,358
Add: provision for credit losses (a) 731 26,254 2,504
Add: net loss on OREO — 120 98
Add: net loss on investment securities 862 368 —
Add: net loss on other assets 252 170 692
Less: net gain on OREO 56 — —
Less: net gain on investment securities — — 164
Less: net gain on other assets — — 8
Less: net gain on other transactions 897 — —
Pre-provision net revenue $ 57,862 $ 69,558 $ 68,480
Total average assets $ 5,672,594 $ 4,739,289 $ 4,222,482
Pre-provision net revenue to total average assets 1.02 % 1.47 % 1.62 %
Weighted-average common shares outstanding - diluted 21,959,883 19,843,806 20,273,725
Pre-provision net revenue per common share - diluted $ 2.63 $ 3.49 $ 3.37
(a) On January 1, 2020, Peoples adopted ASU 2016-13 and implemented the CECL model. Prior to the adoption of CECL, the provision for credit losses was the "provision for loan losses." The provision for credit losses includes changes related to the allowance for credit losses on loans, which includes held-to-maturity investment securities and the unfunded commitment liability.
During 2021, PPNR declined, and was heavily impacted by the $21.4 million in acquisition-related expenses, which more than offset the positive impact of higher total revenue compared to 2020. PPNR increased in 2020 mostly due to the reduction in acquisition-related expenses incurred during 2020, compared to 2019, offset by a decrease in net interest income due to the low interest rate environment.
Core Non-Interest Expense (non-US GAAP)
Core non-interest expense is a financial measure used to evaluate Peoples' recurring expense stream. This measure is non-US GAAP financial measure since it excludes the impact of all acquisition-related expenses, contract negotiation expenses, pension settlement charges, severance expenses, COVID-19-related expenses and a Peoples Bank Foundation, Inc. contribution.
55
The following tables provide reconciliations of these non-US GAAP financial measures to the amounts of total non-interest expense reported in Peoples' Consolidated Financial Statements for the periods presented:
(Dollars in thousands) 2021 2020 2019
Core non-interest expense:
Total non-interest expense $ 183,737 $ 133,695 $ 137,250
Less: COVID-19-related expenses 1,248 1,332 —
Less: severance expenses 79 1,055 270
Less: pension settlement charges 143 1,054 —
Less: acquisition-related expenses 21,423 489 7,287
Less: Peoples Bank Foundation, Inc. contribution 500 — —
Less: contract negotiation expenses 1,248 — —
Core non-interest expense $ 159,096 $ 129,765 $ 129,693
The increase in core non-interest expense for 2021, compared to 2020, was driven by higher ongoing costs associated with recent acquisitions. This includes the impact of the Premier acquisition since September 17, 2021, North Star Leasing since April 1, 2021, and the full year impact of the Premium Finance acquisition that was completed on July 1, 2020.
Efficiency Ratio (non-US GAAP)
The efficiency ratio is a key financial measure used to monitor performance. The efficiency ratio is calculated as total non-interest expense (less amortization of other intangible assets) as a percentage of FTE net interest income plus total non-interest income excluding net gains and losses. This financial measure is non-US GAAP since it excludes amortization of other intangible assets and all gains and/or losses included in earnings, and uses FTE net interest income.
The following table provides a reconciliation of this non-US GAAP financial measure to the amounts of total non-interest income and total non-interest expense reported in Peoples' Consolidated Financial Statements for the periods presented:
(Dollars in thousands) 2021 2020 2019
Efficiency ratio:
Total non-interest expense $ 183,737 $ 133,695 $ 137,250
Less: amortization of other intangible assets 4,775 3,223 3,359
Adjusted total non-interest expense 178,962 130,472 133,891
Total non-interest income 68,885 63,672 64,274
Less: net (loss) gain on investment securities (862) (368) 164
Less: net gain (loss) on asset disposals and other transactions 493 (290) (782)
Total non-interest income excluding net gains and losses 69,254 64,330 64,892
Net interest income 172,553 138,923 140,838
Add: fully-tax-equivalent adjustment (a) 1,349 1,054 1,068
Net interest income on a fully-tax equivalent basis 173,902 139,977 141,906
Adjusted revenue $ 243,156 $ 204,307 $ 206,798
Efficiency ratio 73.60 % 63.86 % 64.74 %
Efficiency ratio adjusted for non-core items:
Core non-interest expense $ 159,096 $ 129,765 $ 129,693
Less: amortization of other intangible assets 4,775 3,223 3,359
Adjusted core non-interest expense 154,321 126,542 126,334
Core non-interest income excluding net gains and losses 69,254 64,330 64,892
Net interest income on a fully-tax-equivalent basis 173,902 139,977 141,906
Adjusted core revenue $ 243,156 $ 204,307 $ 206,798
Efficiency ratio adjusted for non-core items 63.47 % 61.94 % 61.09 %
(a) Based on 21% statutory federal corporate income tax rate for 2021, 2020 and 2019.
56
The efficiency ratio increased during 2021, and was largely due to the acquisition-related expenses. The efficiency ratio, when adjusted for non-core items, increased compared to 2020, and was driven by the higher non-interest expense, coupled with the continued low interest rate environment and related impact to net interest income. The efficiency ratio for 2020 improved due to a decrease in non-interest expense. The higher efficiency ratio adjusted for non-core items for 2020, compared to 2019, was driven by lower revenue, while adjusted core non-interest expense was relatively flat.
Managing expenses has been a major focus over recent years; however, during this time Peoples has continued to make meaningful investments in its infrastructure and systems. Peoples was also negatively impacted during 2021 and 2020 by the low interest rate environment and the related reduction to net interest income.
Return on Average Assets Adjusted for Non-Core Items (non-US GAAP)
In addition to return on average assets, management uses return on average assets adjusted for non-core items to monitor performance. The return on average assets ratio adjusted for non-core items represents a non-US GAAP financial measure since it excludes the after-tax impact of all gains and losses, acquisition-related expenses, pension settlement charges, severance expenses, COVID-19-related expenses, Peoples Bank Foundation, Inc. and contract negotiation non-recurring expenses in earnings.
The following table provides a reconciliation of this non-US GAAP financial measure to the amount of net income reported in Peoples' Consolidated Financial Statements for the periods presented:
(Dollars in thousands) 2021 2020 2019
Net income adjusted for non-core items:
Net income $ 47,555 $ 34,767 $ 53,695
Add: net loss on investment securities
862 368 —
Less: tax effect of net loss on investment securities (a)
181 77 —
Less: net gain on investment securities
— — 164
Add: tax effect of net gain on investment securities (a)
— — 34
Add: net loss on asset disposals and other transactions
— 290 782
Less: tax effect of net loss on asset disposals and other transactions (a)
— 61 164
Less: net gain on asset disposals and other transactions (a) 493 — —
Add: tax effect of net loss on asset disposals and other transactions (a) 104 — —
Add: acquisition-related expenses
21,423 1,459 7,530
Less: tax effect of acquisition-related expenses (a)
4,499 306 1,581
Add: severance expenses 79 1,055 270
Less: tax effect of severance expenses (a) 17 222 57
Add: pension settlement charges
143 1,054 —
Less: tax effect of pension settlement charges (a)
30 221 —
Add: COVID-19-related expenses 1,248 1,332 —
Less: tax effect of COVID-19-related expenses (a) 262 280 —
Add: Peoples Bank Foundation, Inc. contribution 500 — —
Less: tax effect of Peoples Bank Foundation, Inc. contribution 105 — —
Add: contract negotiation expenses 1,248 — —
Less: tax effect of contract negotiation expenses 262 — —
Net income adjusted for non-core items (after tax) $ 67,313 $ 39,158 $ 60,345
Return on average assets:
Net income $ 47,555 $ 34,767 $ 53,695
Total average assets 5,672,594 4,739,289 4,222,482
Return on average assets 0.84 % 0.73 % 1.27 %
Return on average assets adjusted for non-core items:
Net income adjusted for non-core items
$ 67,313 $ 39,158 $ 60,345
Total average assets
5,672,594 4,739,289 4,222,482
Return on average assets adjusted for non-core items
1.19 % 0.83 % 1.43 %
(a) Based on a 21% statutory federal corporate income tax rate for 2021, 2020 and 2019.
57
The return on average assets and return on average assets adjusted for non-core items, both increased compared to 2020, as Peoples recorded a lower provision for credit losses during 2021 compared to 2020, while net income improved due to recent acquisitions and core growth. The decreases in return on average assets and return on average assets, adjusted for non-core items for 2020 compared to 2019, were driven by a reduction in income due to the implementation of CECL, which was impacted by the COVID-19 pandemic.
Return on Average Tangible Equity (non-US GAAP)
The return on average tangible equity ratio is a key financial measure used to monitor performance. The return on tangible equity is calculated as net income (less after-tax impact of amortization of other intangible assets) divided by tangible equity. This measure is non-US GAAP since it excludes amortization of other intangible assets from earnings and the impact of goodwill and other intangible assets acquired through acquisitions on total stockholders' equity.
(Dollars in thousands) 2021 2020 2019
Net income excluding amortization of other intangible assets:
Net income $ 47,555 $ 34,767 $ 53,695
Add: amortization of other intangible assets 4,775 3,223 3,359
Less: tax effect of amortization of other intangible assets (a) 1,003 677 705
Net income excluding amortization of other intangible assets 51,327 37,313 56,349
Average tangible equity:
Total average stockholders' equity $ 656,633 $ 575,386 $ 566,123
Less: average goodwill and other intangible assets 234,667 181,526 173,529
Average tangible equity $ 421,966 $ 393,860 $ 392,594
Return on average stockholders' equity ratio:
Net income $ 47,555 $ 34,767 $ 53,695
Average stockholders' equity $ 656,633 $ 575,386 $ 566,123
Return on average stockholders' equity 7.24 % 6.04 % 9.48 %
Return on average tangible equity ratio:
Net income excluding amortization of other intangible assets $ 51,327 $ 37,313 $ 56,349
Average tangible equity $ 421,966 $ 393,860 $ 392,594
Return on average tangible equity 12.16 % 9.47 % 14.35 %
(a) Based on a 21% statutory federal corporate income tax rate for 2021, 2020 and 2019.
Return on average stockholders' equity and return on average tangible equity both improved compared to 2020, and were driven by the recent acquisitions, core growth and reduced provision for credit losses. The decrease in return on average tangible equity for 2020, compared to 2019, was driven by a reduction in net income due to the implementation of CECL, which was negatively impacted by the COVID-19 pandemic.
FINANCIAL CONDITION
Cash and Cash Equivalents
Peoples considers cash and cash equivalents to consist of federal funds sold, cash and balances due from banks, interest-bearing balances in other institutions and other short-term investments that are readily liquid. The amount of cash and cash equivalents fluctuates on a daily basis due to customer activity and Peoples' liquidity needs. At December 31, 2021, excess cash reserves at the FRB of Cleveland were $318.1 million, compared to $25.1 million at December 31, 2020. Peoples also acquired $248.4 million in cash and cash equivalents from Premier. The amount of excess cash reserves maintained is dependent upon Peoples' daily liquidity position, which is driven primarily by changes in deposit and loan balances, coupled with increased liquidity needs due to the COVID-19 pandemic.
In 2021, Peoples' total cash and cash equivalents increased $263.6 million, as cash provided by operating activities and financing activities of $156.4 million and $181.6 million, respectively, were partially offset by cash used in investing activities of $74.4 million. Peoples' investing activities reflected a net decrease of $113.5 million in loans and $852.5 million in purchases of available-for-sale investment securities, which were primarily offset by $849.1 million in net proceeds from sales, principal payments, calls and prepayments on available-for-sale and held-to-maturity investment securities. Financing activities included a $200.8 million net increase in deposits and increase of $14.4 million in short-term borrowings, as well as $31.0 million of cash dividends paid.
In 2020, Peoples' total cash and cash equivalents increased $36.9 million, as cash provided by operating activities and financing activities of $85.5 million and $345.3 million, respectively, were partially offset by cash used in investing activities of $393.9 million.
58
Peoples' investing activities reflected a net increase of $444.1 million in loans and $261.4 million in purchases of available-for-sale investment securities, which were partially offset by $444.6 million in net proceeds from sales, principal payments, calls and prepayments on available-for-sale and held-to-maturity investment securities. Financing activities included a $618.9 million net increase in deposits and $50.0 million of proceeds from long-term borrowings, offset partially by a decrease of $263.7 million in short-term borrowings, as well as the purchase of $29.3 million of treasury stock under the share repurchase program and $27.1 million of cash dividends paid.
Further information regarding the management of Peoples' liquidity position can be found later in this discussion under "Interest Rate Sensitivity and Liquidity."
Investment Securities
The following table provides information regarding Peoples’ investment portfolio at December 31:
(Dollars in thousands) Weighted average yield 2021 2020 2019
Available-for-sale securities, at fair value:
Obligations of:
U.S. Treasury and government agencies 1.05 % $ 35,604 $ — $ —
U.S. government sponsored agencies 0.07 % 81,739 5,363 8,209
States and political subdivisions 2.23 % 259,319 114,919 114,104
Residential mortgage-backed securities 1.58 % 828,517 623,218 791,009
Commercial mortgage-backed securities 1.37 % 63,519 4,783 18,088
Bank-issued trust preferred securities 3.00 % 6,795 4,730 4,691
Total fair value $ 1,275,493 $ 753,013 $ 936,101
Total amortized cost $ 1,283,146 $ 734,544 $ 929,395
Net unrealized (loss) gain $ (7,653) $ 18,469 $ 6,706
Held-to-maturity securities, at amortized cost:
Obligations of:
U.S. government sponsored agencies 2.03 % $ 36,431 $ — $ —
States and political subdivisions (a) 2.23 % $ 151,402 $ 35,139 $ 4,346
Residential mortgage-backed securities 1.90 % 110,708 25,890 21,494
Commercial mortgage-backed securities 1.80 % 75,588 5,429 5,907
Total amortized cost $ 374,129 $ 66,458 $ 31,747
Other investment securities $ 33,987 $ 37,560 $ 42,730
Total investment securities:
Amortized cost $ 1,691,262 $ 838,562 $ 1,003,872
Carrying value $ 1,683,609 $ 857,031 $ 1,010,578
(a) A mortized cost is presented net of the allowance for credit losses of $286 at December 31, 2021 and $60 at December 31, 2020.
At December 31, 2021, Peoples' investment securities represented approximately 23.8% of total assets, compared to 18.0% at December 31, 2020. During 2021, Peoples acquired, in the Premier acquisition, investment securities totaling $552.0 million and subsequently sold $395.2 million of available-for-sale securities. The increase in investment securities compared to 2020 also reflected Peoples' continued reinvestment of proceeds from available-for-sale investment securities and the investment of excess cash in higher-yielding investment securities. During 2021, Peoples acquired from Premier, and made investments into, tax-exempt securities, which are included in obligations of state and political subdivisions. The investments into these securities were made in an effort to reduce exposure to amortizing investment securities, while also maintaining an appropriate level of risk-adjusted yield.
During 2020, Peoples sold $82.6 million of available-for-sale securities and reinvested the majority of the proceeds in held-to-maturity investment securities to minimize the volatility in the securities portfolio, should interest rates begin to rise.
Peoples designates certain securities as "held-to-maturity" at the time of their purchase if management determines Peoples would have the intent and ability to hold the purchased securities until maturity. The unrealized gain or loss related to held-to-maturity investment securities does not directly impact total stockholders' equity, in contrast to the impact from the available-for-sale investment securities portfolio.
Additional information regarding Peoples' investment portfolio can be found in "Note 3 Investment Securities" of the Notes to the Consolidated Financial Statements.
59
Loans
The following table provides information regarding outstanding loan balances at or for the year ended December 31:
(Dollars in thousands) 2021 2020 2019
Originated loans:
Construction $ 137,437 $ 103,169 $ 83,283
Commercial real estate, other 861,610 780,324 671,576
Commercial real estate 999,047 883,493 754,859
Commercial and industrial 779,064 943,024 622,175
Premium finance 136,121 100,571 —
Leases 69,169 — —
Residential real estate 350,595 281,623 314,935
Home equity lines of credit 104,176 93,296 93,013
Consumer, indirect 530,532 503,526 417,127
Consumer, direct 81,330 75,591 70,852
Consumer 611,862 579,117 487,979
Deposit account overdrafts 756 351 878
Total originated loans $ 3,050,790 $ 2,881,475 $ 2,273,839
Acquired loans:
Construction $ 72,795 $ 3,623 $ 5,235
Commercial real estate, other 688,471 149,529 161,662
Commercial real estate 761,266 153,152 166,897
Commercial and industrial 112,328 30,621 40,818
Premium finance 15 14,187 —
Leases 53,339 — —
Residential real estate 421,123 292,384 346,541
Home equity lines of credit 59,417 27,617 39,691
Consumer, indirect — 1 58
Consumer, direct 23,322 3,503 5,681
Consumer 23,322 3,504 5,739
Total acquired loans (a) $ 1,430,810 $ 521,465 $ 599,686
Total loans $ 4,481,600 $ 3,402,940 $ 2,873,525
Average total loans 3,709,159 3,258,354 2,812,109
Average allowance for credit losses (56,038) (47,692) (21,239)
Average loans, net of average allowance for credit losses $ 3,653,121 $ 3,210,662 $ 2,790,870
60
(Dollars in thousands) 2021 2020 2019
Percent of loans to total loans:
Construction 4.7 % 3.1 % 3.1 %
Commercial real estate, other 34.7 % 27.3 % 29.0 %
Commercial real estate 39.4 % 30.4 % 32.1 %
Commercial and industrial 19.9 % 28.6 % 23.1 %
Premium finance 3.0 % 3.4 % — %
Leases 2.7 % — % — %
Residential real estate 17.2 % 16.9 % 23.0 %
Home equity lines of credit 3.7 % 3.6 % 4.6 %
Consumer, indirect 11.8 % 14.8 % 14.5 %
Consumer, direct 2.3 % 2.3 % 2.7 %
Consumer 14.1 % 17.1 % 17.2 %
Deposit account overdrafts (b) NM NM NM
Total percentage 100.0 % 100.0 % 100.0 %
Residential real estate loans being serviced for others $ 430,597 $ 485,972 $ 496,802
(a) Includes all loans acquired, and related loan discount recorded as part of acquisition accounting, in 2012 and thereafter. Loans that were acquired and subsequently re-underwritten are reported as originated upon execution of such credit actions (for example, renewals, and increase in lines of credit).
(b) NM=not meaningful.
As of December 31, 2021, total loans increased 32%, compared to December 31, 2020, which was driven by the Premier and North Star Leasing acquisitions, coupled with core growth. The Premier acquisition added $1.1 billion in loans at December 31, 2021, which were comprised of $96.1 million in construction; $534.9 million in commercial real estate, other; $132.1 million in commercial and industrial; $331.1 million in residential real estate; $45.9 million in home equity lines of credit; and $21.6 million of consumer, direct loan balances. During 2021, the outstanding balance of SBA PPP loans declined $279.8 million, from $366.9 million at December 31, 2020, to $87.1 million at December 31, 2021, which was mainly due to forgiveness proceeds received from the SBA.
During 2020, total loans grew 18%, or $529.4 million. The growth compared to December 31, 2019 was mostly driven by PPP loans added during 2020, which are included in commercial and industrial loan balances, and the new loans being originated through the acquired premium finance sector. At December 31, 2020, PPP loan balances totaled $366.9 million, while the premium finance loans totaled $114.8 million. Consumer indirect loans also contributed to the growth during 2020, and were up $86.3 million, or 21%.
61
The following table details the maturities of Peoples' loan portfolio at December 31, 2021:
(Dollars in thousands) Due in One Year or Less Due in One to Five Years Due in Five to Fifteen Years Due After Fifteen Years Total % of Total
Construction:
Fixed $ 6,503 $ 15,680 $ 9,839 $ 13 $ 32,035 15.2 %
Variable 36,976 90,558 31,254 19,409 178,197 84.8 %
Total 43,479 106,238 41,093 19,422 210,232 100.0 %
Commercial real estate, other:
Fixed 42,107 151,471 215,692 9,183 418,453 27.0 %
Variable 91,549 238,760 485,195 316,124 1,131,628 73.0 %
Total 133,656 390,231 700,887 325,307 1,550,081 100.0 %
Commercial and industrial:
Fixed 104,468 160,955 44,023 214 309,660 34.7 %
Variable 167,851 132,487 266,573 14,821 581,732 65.3 %
Total 272,319 293,442 310,596 15,035 891,392 100.0 %
Premium finance:
Fixed 136,136 — — — 136,136 100.0 %
Leases:
Fixed 122,508 — — — 122,508 100.0 %
Residential real estate:
Fixed 72,874 14,169 174,673 217,831 479,547 62.1 %
Variable 11,655 7,158 93,301 180,057 292,171 37.9 %
Total 84,529 21,327 267,974 397,888 771,718 100.0 %
Home equity lines of credit:
Fixed 5 458 1,019 872 2,354 1.4 %
Variable 1,493 34,292 103,086 22,368 161,239 98.6 %
Total 1,498 34,750 104,105 23,240 163,593 100.0 %
Consumer, indirect:
Fixed 4,070 239,873 286,589 — 530,532 100.0 %
Consumer, direct:
Fixed 3,671 59,469 34,948 291 98,379 94.0 %
Variable 555 2,246 2,945 527 6,273 6.0 %
Total 4,226 61,715 37,893 818 104,652 100.0 %
Loan Concentration
Peoples categorizes its commercial loans according to standard industry classifications and monitors for concentrations in a single industry or multiple industries that could be impacted by changes in economic conditions in a similar manner. Peoples' commercial lending activities continue to be spread over a diverse range of businesses from all sectors of the economy, with no single industry comprising over 10% of Peoples' total loan portfolio.
Loans secured by commercial real estate, including commercial construction loans, continue to comprise the largest portion of Peoples' loan portfolio.
62
The following table provides information regarding the largest concentrations of commercial real estate loans within the loan portfolio at December 31, 2021:
(Dollars in thousands) Outstanding Balance Available Loan Commitments Total Exposure % of Total
Construction:
Apartment complexes $ 69,717 $ 121,583 $ 191,300 44.1 %
Mixed-use facilities 29,419 34,168 63,587 14.7 %
Assisted living facilities and nursing homes 19,183 25,960 45,143 10.4 %
Office buildings and complexes 7,161 14,438 21,599 5.0 %
Residential property 8,545 11,658 20,203 4.7 %
Lodging and lodging related 12,447 1,635 14,082 3.2 %
Retail 9,132 2,747 11,879 2.7 %
Other (a) 54,628 11,554 65,943 15.2 %
Construction $ 210,232 $ 223,743 $ 433,736 100.0 %
Commercial real estate, other:
Retail facilities:
Owner occupied 55,513 1,965 57,478 3.6 %
Non-owner occupied 134,230 1,736 135,966 8.5 %
Total retail 189,743 3,701 193,444 12.1 %
Office buildings and complexes:
Owner occupied 77,603 3,492 81,095 5.1 %
Non-owner occupied 94,634 4,822 99,456 6.2 %
Total office buildings and complexes 172,237 8,314 180,551 11.3 %
Light industrial facilities:
Owner occupied 91,329 1,891 93,220 5.8 %
Non-owner occupied 38,666 633 39,299 2.5 %
Total light industrial facilities 129,995 2,524 132,519 8.3 %
Mixed commercial use facilities:
Owner occupied 53,673 424 54,097 3.4 %
Non-owner occupied 58,716 4,000 62,716 3.9 %
Total mixed commercial use facilities 112,389 4,424 116,813 7.3 %
Lodging and lodging related:
Owner occupied 13,941 — 13,941 0.9 %
Non-owner occupied 85,713 150 85,863 5.4 %
Total lodging and lodging related 99,654 150 99,804 6.3 %
Apartment complexes 93,246 3,508 96,754 6.1 %
Warehouse facilities:
Owner occupied 40,271 2,790 43,061 2.7 %
Non-owner occupied 40,176 74 40,250 2.5 %
Total warehouse facilities 80,447 2,864 83,311 5.2 %
63
(Dollars in thousands) Outstanding Balance Available Loan Commitments Total Exposure % of Total
Assisted living facilities and nursing homes $ 81,349 $ 750 $ 82,099 5.1 %
Education services:
Owner occupied 16,896 98 16,994 1.1 %
Non-owner occupied 22,508 4,000 26,508 1.7 %
Total education services 39,404 4,098 43,502 2.8 %
Restaurant/bar facilities:
Owner occupied 24,482 50 24,532 1.5 %
Non-owner occupied 12,908 253 13,161 0.8 %
Total restaurant/bar facilities 37,390 303 37,693 2.3 %
Healthcare:
Owner occupied 26,085 422 26,507 1.7 %
Non-owner occupied 11,482 — 11,482 0.7 %
Total healthcare facilities 37,567 422 37,989 2.4 %
Agriculture 30,792 1,536 32,328 2.0 %
Other (a) 445,868 15,446 461,314 28.8 %
Commercial real estate, other $ 1,550,081 $ 48,040 $ 1,598,121 100.0 %
(a) All other outstanding balances are less than 2% of the total loan portfolio.
Peoples' commercial lending activities continue to focus on lending opportunities inside its primary and secondary market areas within Ohio, Kentucky, West Virginia, Virginia, Washington, D.C. and Maryland. In all other states, the aggregate outstanding balances of commercial loans in each state were less than 4% of total loans at either December 31, 2021 or December 31, 2020.
Additional information regarding Peoples' loan portfolio can be found in "Note 4 Loans and Leases" of the Notes to the Consolidated Financial Statements.
COVID-19 Loan Impacts
Small Business Administration Paycheck Protection Program
In March 2020, the CARES Act created a new loan guarantee program called the PPP targeted to provide small businesses with support to cover payroll and certain other expenses. Loans made under the PPP are fully guaranteed by the SBA. The PPP loans also afford borrowers forgiveness up to the principal amount of the PPP covered loan, plus accrued interest, if the loan proceeds are used to retain workers and maintain payroll and/or to make certain mortgage interest, lease and utility payments, and certain other criteria are satisfied. The SBA will reimburse PPP lenders for any amount of a PPP covered loan that is forgiven, and PPP lenders are not be held liable for any representations made by PPP borrowers in connection with their requests for loan forgiveness. The PPP expired on May 31, 2021 and no new originations will be made under the program; however, forgiveness proceeds will continue to be received until the loans are paid in full.
Peoples is a PPP participating lender, and the PPP loans originated (including $23.4 million acquired in the merger with Premier) are included in commercial and industrial loans. Peoples also recorded deferred loan origination fees related to the PPP loans, net of deferred loan origination costs, which will be amortized over the life of the respective loans, or until forgiven by the SBA, and will be recognized in net interest income. The following tables detail Peoples' PPP loans and related income at December 31:
(Dollars in millions) 2021 2020
PPP aggregate outstanding principal balances $ 89.3 $ 374.8
PPP net deferred loan origination fees 2.2 7.9
Amortization of net deferred loan origination fees 13.0 7.5
64
Allowance for Credit Losses
On January 1, 2020, Peoples adopted the provisions of ASU 2016-13 "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments", commonly referred to as the CECL model. Prior to the adoption of the CECL model, the allowance for credit losses was the "allowance for loan losses." The amount of the allowance for credit losses at the end of each period represents management's estimate of expected credit losses from existing loans based upon its formal quarterly analysis of the loan portfolio described in the "Critical Accounting Policies" section of this discussion. While this process involves allocations being made to specific loans and pools of loans, the entire allowance is available for all losses incurred within the loan portfolio.
The following details management's allocation of the allowance for credit losses at December 31:
(Dollars in thousands) 2021 2020 2019
Commercial real estate $ 32,146 $ 19,423 $ 7,333
Commercial and industrial 11,063 12,763 8,432
Total commercial 43,209 32,186 15,765
Premium finance 379 1,095 —
Leases 4,797 — —
Residential real estate 7,233 6,044 1,191
Home equity lines of credit 2,005 1,860 546
Consumer, indirect 5,326 8,030 2,937
Consumer, direct 961 1,081 294
Consumer 6,287 9,111 3,231
Deposit account overdrafts 57 63 94
Originated allowance for credit losses 63,967 50,359 20,827
Acquired allowance for credit losses (a) — — 729
Allowance for credit losses (b) $ 63,967 $ 50,359 $ 21,556
As a percent of total loans 1.43 % 1.48 % 0.75 %
(a) Beginning on January 1, 2020, the amounts previously included in "acquired allowance for credit losses" were included in the "originated allowance for credit losses" under the CECL model.
(b) Beginning on January 1, 2020, Peoples calculated the allowance for credit losses using the CECL model, while 2019 used the incurred loss model.
During 2021, the allowance for credit losses grew 27%, which was largely due to the Premier and North Star Leasing acquisitions, and the related need to establish an allowance for credit losses on those portfolios, coupled with organic growth in loan balances during 2021. The North Star Leasing acquisition added $3.3 million to the allowance for credit losses at the acquisition date, of which $493,000 was established for purchased credit deteriorated loans as part of the acquisition accounting, and the remainder was established through the recording of a provision for credit losses. The Premier acquisition added $28.6 million to the allowance for credit losses during the third quarter of 2021, of which $16.9 million was established for purchased credit deteriorated loans as part of the acquisition accounting, and the remainder was established using provision for credit losses. Also during 2021, economic factors and loss drivers improved compared to 2020, and had a positive impact on the CECL model. The allowance for credit losses as a percent of total loans increased slightly during 2021, compared to 2020.
The allowance for credit losses as a percent of total loans was relatively stable at December 31, 2021 compared to December 31, 2020, and was mostly due to the composition of Peoples' loan and lease portfolio. The increase in the allowance for credit losses as a percent of total loans grew at December 31, 2020 compared to December 31, 2019, as a result of the implementation of the CECL model, along with the impact of the COVID-19 pandemic on economic forecasts.
Peoples implemented ASU 2016-13 on January 1, 2020, which resulted in an increase of $5.8 million in the allowance for credit losses. The remaining significant increase in the allowance for credit losses at December 31, 2020 compared to December 31, 2019 was mostly due to the recent COVID-19 pandemic, and the resulting impact on economic forecasts utilized in the CECL model. Peoples calculates its allowance for credit losses using a discounted cash flow model, and incorporates economic forecasts.
Additional information regarding Peoples' allowance for credit losses can be found in "Note 1 Summary of Significant Accounting Policies" and "Note 4 Loans and Leases" of the Notes to the Consolidated Financial Statements.
The following table summarizes the changes in the allowance for credit losses for the years ended December 31:
65
(Dollars in thousands) 2021 2020 2019
Allowance for credit losses, January 1 $ 50,359 $ 25,868 $ 20,195
Gross charge-offs:
Commercial real estate (a) 387 528 156
Commercial and industrial 1,057 1,565 1,062
Premium finance 45 3 —
Leases 1,434 — —
Residential real estate 385 353 312
Home equity lines of credit 197 103 55
Consumer, indirect 1,756 1,923 1,829
Consumer, direct 152 187 211
Consumer 1,908 2,110 2,040
Deposit account overdrafts 575 673 851
Total gross charge-offs 5,988 5,335 4,476
Recoveries:
Commercial real estate 204 200 151
Commercial and industrial 26 2,521 2,415
Premium finance — — —
Leases 339 — —
Residential real estate 143 302 229
Home equity lines of credit 41 12 11
Consumer, indirect 253 302 270
Consumer, direct 112 49 52
Consumer 365 351 322
Deposit account overdrafts 177 186 205
Total recoveries 1,295 3,572 3,333
Net charge-offs (recoveries):
Commercial real estate 183 328 5
Commercial and industrial 1,031 (956) (1,353)
Premium finance 45 3 —
Leases 1,095 — —
Residential real estate 242 51 83
Home equity lines of credit 156 91 44
Consumer, indirect 1,503 1,621 1,559
Consumer, direct 40 138 159
Consumer 1,543 1,759 1,718
Deposit account overdrafts 398 487 646
Total net charge-offs $ 4,693 $ 1,763 $ 1,143
Provision for credit losses, December 31 (b)(c)(d) 731 26,254 2,504
Initial allowance for purchased credit deteriorated assets $ 17,570 $ — $ —
Allowance for credit losses, December 31 (e) $ 63,967 $ 50,359 $ 21,556
Net charge-offs (recoveries) as a percent of average total loans:
Commercial real estate — % 0.01 % — %
Commercial and industrial 0.03 % (0.03) % (0.05) %
Premium finance — % — % — %
Leases 0.03 % — % — %
Residential real estate 0.01 % — % — %
Home equity lines of credit — % — % — %
Consumer, indirect 0.05 % 0.05 % 0.06 %
Consumer, direct — % — % 0.01 %
Consumer 0.05 % 0.05 % 0.07 %
Deposit account overdrafts 0.01 % 0.02 % 0.02 %
Total 0.13 % 0.05 % 0.04 %
(a) Includes nonimpaired loan charge-offs of $2 in 2019.
(b) Includes purchased credit impaired loan provision for credit losses of $19 in 2019.
(c) Includes nonimpaired loan provision for credit losses of $215 in 2019.
66
(d) Amount does not include the provision for unfunded commitment liability.
(e) Beginning on January 1, 2020, the amounts previously included in "acquired allowance for credit losses" were included in the "originated allowance for credit losses" under the CECL model.
During 2021, net charge-offs as a percent of average total loans increased to 0.13%, compared to 0.05% for 2020. This increase was driven by the additional net charge-offs related to lease balances, coupled with the impact of a recovery of $2.5 million on a single commercial loan relationship during 2020, which lowered the ratio for that period. Prior to the acquisition, North Star Leasing was experiencing net charge-off rates of around 3% of average lease balances, and Peoples anticipates that net charge-off levels will increase in future periods as the net charge-offs for the leasing division return to this historical rate.
Net charge-offs for 2020 were $1.8 million, or 0.05% of average total loans, an increase of $0.6 million compared to $1.1 million, or 0.04% of average total loans, for 2019. Net charge-offs in 2020 included a recovery of $2.5 million on a single commercial loan relationship that was previously charged-off; while in 2019, a $2.4 million recovery occurred on the same relationship. The increase in commercial real estate net charge-offs in 2020 compared to 2019 was due to an increase in charge-off activity in 2020. This activity consisted of two larger commercial real estate loans with a total of $200,000 in charge-offs coupled with other smaller commercial real estate charge-offs.
The following table details Peoples’ nonperforming assets at December 31:
(Dollars in thousands) 2021 2020 2019
Loans 90+ days past due and accruing (a):
Construction $ 90 $ — $ —
Commercial real estate, other 689 — 907
Commercial and industrial 1,139 50 155
Premium finance 865 589 —
Leases — — —
Residential real estate 805 1,975 2,677
Home equity lines of credit 50 82 108
Consumer, indirect — 39 —
Consumer, direct 85 17 85
Consumer 85 56 85
Total loans 90+ days past due and accruing 3,723 2,752 3,932
Nonaccrual loans (a):
Construction 6 4 411
Commercial real estate, other 16,849 8,744 6,699
Commercial real estate 16,855 8,748 7,110
Commercial and industrial 2,505 4,017 1,824
Leases 1,581 — —
Residential real estate 8,016 6,080 4,471
Home equity lines of credit 687 708 955
Consumer, indirect 1,302 883 629
Consumer, direct 273 160 48
Consumer 1,575 1,043 677
Total nonaccrual loans 31,219 20,596 15,037
67
(Dollars in thousands) 2021 2020 2019
Nonaccrual troubled debt restructurings (TDRs):
Commercial real estate, other $ 218 $ 367 $ 102
Commercial and industrial 1,067 2,175 331
Leases — — —
Residential real estate 1,631 2,295 1,890
Home equity lines of credit 352 159 210
Consumer, indirect 272 190 211
Consumer, direct 6 11 —
Total nonaccrual TDRs 3,546 5,197 2,744
Total nonperforming loans (NPLs) 38,488 28,545 21,713
OREO:
Commercial 9,105 — 145
Residential 391 134 82
Total OREO 9,496 134 227
Total nonperforming assets (NPAs) $ 47,984 $ 28,679 $ 21,940
Criticized loans (b) $ 194,016 $ 126,619 $ 96,830
Classified loans (c) 106,547 72,518 66,154
Asset Quality Ratios:
Nonaccrual loans as a percent of total loans (d) 0.78 % 0.76 % 0.62 %
NPLs as a percent of total loans (d)(e) 0.86 % 0.82 % 0.75 %
NPAs as a percent of total assets (d)(e) 0.68 % 0.59 % 0.50 %
NPAs as a percent of total loans and OREO (d)(e) 1.07 % 0.84 % 0.76 %
Allowance for credit losses as a percent of nonaccrual loans (d) 184.00 % 195.24 % 121.23 %
Allowance for credit losses as a percent of NPLs (d)(e) 166.20 % 180.14 % 99.28 %
Criticized loans as a percent of total loans (b)(d) 4.33 % 3.72 % 3.37 %
Classified loans as a percent of total loans (c)(d) 2.38 % 2.13 % 2.30 %
(a) On January 1, 2020, Peoples adopted ASU 2016-13 and implemented the CECL model. The accounting for purchased credit deteriorated loans under CECL resulted in the movement of $3.9 million of loans from the 90+ days past due and accruing category to the nonaccrual category as of January 1, 2020. As of December 31, 2019, these loans were presented as 90+ days past due and accruing. Although they were not accruing contractual interest income, they were accreting income from the discount that was recognized due to acquisition accounting.
(b) Includes loans categorized as special mention, substandard or doubtful.
(c) Includes loans categorized as substandard or doubtful.
(d) Data presented as of the end of the year indicated.
(e) Nonperforming loans include loans 90+ days past due and accruing, troubled debt restructured loans and nonaccrual loans. Nonperforming assets include nonperforming loans and OREO.
Nonperforming assets grew 67% during 2021 compared to 2020. These increases were primarily driven by the Premier acquisition. At the same time, criticized loans, which are those categorized as special mention, substandard or doubtful, grew $67.4 million, or 53%, while classified loans, which are those categorized as substandard or doubtful, increased $34.0 million, or 47%, compared to December 31, 2020. These increases were also due to the Premier acquisition.
Nonperforming loans increased in 2020 due to two commercial relationships aggregating $3.2 million and several smaller commercial relationships being placed on nonaccrual. Criticized loans increased $29.8 million, or 31%, at December 31, 2020, compared to December 31, 2019, while classified loans grew $6.4 million, or 10%, at December 31, 2020, compared to December 31, 2019. During 2020, Peoples downgraded several relationships due to the COVID-19 pandemic. The COVID-related downgrades contributed $29.8 million of additional criticized loans and $9.4 million of additional classified loans compared to balances at December 31, 2019.
Based on the provisions provided by the CARES Act, on March 22, 2020, federal and state government banking regulators issued a joint statement, with which the FASB concurred as to the approach, regarding accounting for loan modifications for borrowers affected by COVID-19. In this guidance, short-term modifications, made on a good faith basis in response to COVID-19, to borrowers who were current prior to any relief, are not considered TDRs. This includes short-term modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment which are insignificant. Under the guidance, borrowers that are considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. In addition, modification or deferral programs mandated by the U.S. federal government or any state government related to COVID-19 are not in the scope of ASC 310-40.
68
On August 3, 2020, federal and state banking regulators issued a joint statement, encouraging financial institutions to consider prudent accommodation options to mitigate losses for the borrower and financial institution beyond the initial accommodation period. In this guidance, institutions should also provide consumers with available options for repaying missed payments at the end of their accommodation to avoid delinquencies, as well as options for changes to terms to support sustainable and affordable payments for the long term. These considerations should also include prudent risk management practices at the financial institution based on the credit risk of the borrower. Peoples is actively working with its customers to address any further accommodation needs while carefully evaluating the associated credit risk of the borrowers.
The majority of Peoples' nonaccrual commercial real estate loans consists primarily of owner occupied commercial properties. In general, management believes repayment of these loans is dependent on the sale of the underlying collateral. As such, the carrying values of these loans are ultimately supported by management's estimate of the net proceeds Peoples would receive upon the sale of the collateral. These estimates are based in part on market values provided by independent, licensed or certified appraisers periodically, but no less frequently than annually. Given the volatility in commercial real estate values, management continues to monitor changes in real estate values from quarter-to-quarter and updates its estimates as needed based on observable changes in market prices and/or updated appraisals for similar properties.
Peoples discontinues the accrual of interest on a loan when conditions cause management to believe collection of all or any portion of the loan's contractual interest is doubtful. Such conditions may include the borrower being 90 days or more past due on any contractual payments or the availability of updated information regarding the borrower's financial condition and repayment ability. All unpaid accrued interest deemed uncollectable is reversed, which would reduce Peoples' net interest income. Interest received on nonaccrual loans is included in income only if principal recovery is reasonably assured. Interest income on loans classified as nonaccrual and renegotiated at each year-end that would have been recorded under the original terms of the loans was $1.3 million for 2021, $1.6 million for 2020 and $1.4 million for 2019. No portion of these amounts were recorded during 2021, 2020 or 2019.
Overall, management believes the allowance for credit losses was appropriate at December 31, 2021, based on all significant information currently available. Still, there can be no assurance that the allowance for credit losses will be adequate to cover future losses in Peoples’ loan portfolio.
Additional information regarding Peoples' allowance for credit losses can be found in "Note 4 Loans and Leases" of the Notes to the Consolidated Financial Statements.
Deposits
The following table details Peoples’ deposit balances at December 31:
(Dollars in thousands) 2021 2020 2019
Non-interest-bearing deposits (a) $ 1,641,422 $ 997,323 $ 671,208
Interest-bearing deposits:
Interest-bearing demand accounts (a) 1,167,460 692,113 635,720
Savings accounts 1,036,738 628,190 521,914
Retail CDs 643,759 445,930 490,830
Money market deposit accounts 651,169 591,373 469,893
Governmental deposit accounts 617,259 385,384 293,908
Brokered deposits 104,745 170,146 207,939
Total interest-bearing deposits 4,221,130 2,913,136 2,620,204
Total deposits $ 5,862,552 $ 3,910,459 $ 3,291,412
(a) The sum of amounts presented are considered total demand deposits.
The significant increase in deposits compared to December 31, 2020 was largely due to deposits acquired from Premier. Total demand deposits comprised 48% of total deposits at December 31, 2021 and were 43% of total deposits at December 31, 2020. At December 31, 2021, the period-end deposit increase of $2.0 billion, or 50%, compared to December 31, 2020, was primarily due to deposits acquired from Premier. Also, throughout 2021 and 2020, customers maintained higher balances due to changes in customer habits in light of the COVID-19 pandemic, as well as fiscal stimulus funds and PPP loan proceeds. During 2020, Peoples had reduced its reliance on higher-rate brokered deposits, which included one-way buy Certificate of Deposit Account Registry Services. This was partially offset by the issuance of 90-day brokered demand and savings deposits to fund interest rate swaps. As of December 31, 2021, Peoples had thirteen effective interest rate swaps, with an aggregate notional value of $125.0 million, which were funded by $40.0 million in 90-day FHLB advances and $100.0 million in overnight brokered deposits, which are expected to be extended every 90 days through the maturity dates of the swaps.
The increase in total deposits between December 31, 2020 and December 31, 2019 was largely due to an increase of $326.1 million in non-interest bearing deposits. The growth in non-interest-bearing deposits was related to customers maintaining higher balances due to changes in customer habits in light of the COVID-19 pandemic, as well as fiscal stimulus funds and PPP loan proceeds. During 2020, Peoples had reduced its reliance on higher-rate brokered deposits, which included one-way buy Certificate of
69
Deposit Account Registry Services. This was partially offset by the issuance of 90-day brokered demand and savings deposits to fund interest rate swaps.
Peoples' governmental deposit accounts represent savings and interest-bearing transaction accounts from state and local governmental entities. These funds are subject to periodic fluctuations based on the timing of tax collections and subsequent expenditures or disbursements. Peoples normally experiences an increase in balances annually during the first and third quarter, corresponding with tax collections, with declines normally in the second and fourth quarter of each year, corresponding with expenditures by the governmental entities. Peoples continues to emphasize growth of low-cost deposits that do not require Peoples to pledge assets as collateral, which is required in the case of governmental deposit accounts.
The maturities of retail CDs with total balances of $100,000 or more at December 31 were as follows:
(Dollars in thousands) 2021 2020 2019
3 months or less $ 71,374 $ 55,402 $ 36,623
Over 3 to 6 months 74,529 56,516 48,581
Over 6 to 12 months 83,094 36,448 49,796
Over 12 months 90,864 70,452 104,914
Total $ 319,861 $ 218,818 $ 239,914
Additional information regarding Peoples' deposits can be found in "Note 8 Deposits" of the Notes to the Consolidated Financial Statements.
Borrowed Funds
The following table details Peoples’ short-term and long-term borrowings at December 31:
(Dollars in thousands) 2021 2020 2019
Short-term borrowings:
Overnight borrowings $ — $ — $ 141,000
FHLB 90-day advances 40,000 — 110,000
Current portion of long-term FHLB advances 15,000 20,000 23,009
Repurchase agreements 111,482 53,261 42,968
Total short-term borrowings 166,482 73,261 316,977
Long-term borrowings:
FHLB advances 85,825 102,957 75,672
Junior subordinated debt securities 13,650 7,611 7,451
Total long-term borrowings 99,475 110,568 83,123
Total borrowed funds $ 265,957 $ 183,829 $ 400,100
Total borrowed funds, which include overnight borrowings, are mainly a function of loan growth and changes in total deposit balances. Peoples continually evaluates the overall balance sheet position given the interest rate environment. During 2021, Peoples' repurchase agreements grew mostly due to accounts associated with the Premier acquisition. Peoples also acquired additional junior subordinated debt securities in the Premier acquisition, leading to the increase in long-term borrowings compared to 2020.
During 2020, long-term FHLB advances increased due to borrowing under a $50.0 million long-term FHLB putable, non-amortizing fixed rate advance and the reclassification of $20.0 million to short-term borrowings as the time to maturity of these advances had become less than one year.
In 2019, Peoples' short-term FHLB advances generally consisted of overnight borrowings maintained in connection with the management of Peoples' daily liquidity position.
During 2019, Peoples had seventeen effective interest rate swaps with an aggregate notional value of $160.0 million, of which $110.0 million were funded by FHLB 90-day advances. The remaining $50.0 million were funded by 90-day brokered CDs. Long-term FHLB advances declined by $26.7 million due to the reclassification to short-term borrowings as the time to maturity of these advances had become less than one year.
On April 3, 2019, Peoples entered into a Loan Agreement (the “U.S. Bank Loan Agreement”) with U.S. Bank National Association, the term of which has been extended to March 31, 2022 through an amendment in April 2021. The U.S. Bank Loan Agreement provides Peoples with a revolving line of credit in the maximum aggregate principal amount of $20.0 million.
70
Additional information regarding Peoples' borrowed funds can be found in "Note 9 Short-Term Borrowings" and "Note 10 Long-Term Borrowings" of the Notes to the Consolidated Financial Statements.
Capital/Stockholders’ Equity
During 2021, Peoples' total stockholders' equity grew 47%, mostly due to the issuance of $261.9 million in common shares related to the Premier acquisition. Peoples also recorded net income of $47.6 million, which exceeded dividends paid of $31.2 million.
At December 31, 2021, capital levels for both Peoples and Peoples Bank remained substantially higher than the minimum amounts needed to be considered "well capitalized" under banking regulations. These higher capital levels reflect Peoples' desire to maintain a strong capital position.
During 2020, total stockholders' equity declined mainly due to the repurchase of common shares in the amount of $29.3 million and dividends paid to shareholders of $27.5 million, partially offset by net income of $34.8 million. Also contributing to the decline was the implementation of ASU 2016-13 on January 1, 2020, in which Peoples recorded a one-time transition adjustment to reduce retained earnings by $3.7 million. This adjustment reflected the increase in the allowance for credit losses for loans (excluding the gross up of loan balances related to the establishment of an allowance for credit losses for purchased credit deteriorated loans), the allowance for credit losses for held-to-maturity investment securities and the addition of an unfunded commitment liability, net of statutory federal corporate income taxes. Based on current accounting guidance, Peoples is electing to utilize the five-year phase-in period for the transition adjustment due to the implementation of ASU 2016-13. This phase-in period also includes a 25% deferment of the impact on regulatory capital of the estimated increase in the allowance for credit losses related to the CECL model, which is applied during the first two years of application. For the first two years of the phase-in period, 100% of the transition adjustment due to ASU 2016-13 is excluded for regulatory capital purposes, along with 25% of the increase in the allowance for credit losses compared to the January 1, 2020 allowance for credit losses. In year three of the phase-in, 75% of the transition adjustment, and the cumulative 25% increase in the allowance for credit losses compared to January 1, 2020, are excluded from regulatory capital, while 50% and 25% of these amounts are excluded in years four and five, respectively, under this phase-in period.
Under the risk-based capital rules, in order to avoid limitations on dividends, equity repurchases and compensation, Peoples must exceed the three minimum required ratios by at least the capital conservation buffer. These three minimum required ratios are the common equity tier 1 capital ratio, tier 1 risk-based capital ratio and total risk-based capital ratio. Peoples had a capital conservation buffer of 6.06% at December 31, 2021, 6.50% at December 31, 2020 and 7.58% at December 31, 2019. As such, Peoples exceeded the minimum ratios, including the capital conservation buffer, at December 31, 2021.
The following table details Peoples' actual risk-based capital levels and corresponding ratios at December 31:
(Dollars in thousands) 2021 2020 2019
Capital Amounts:
Common equity tier 1 $ 577,565 $ 409,400 $ 427,415
Tier 1 591,215 417,011 434,866
Total (tier 1 and tier 2) 648,948 456,384 456,422
Net risk-weighted assets $ 4,614,259 $ 3,146,767 $ 2,930,355
Capital Ratios:
Common equity tier 1 12.52 % 13.01 % 14.59 %
Tier 1 12.81 % 13.25 % 14.84 %
Total (tier 1 and tier 2) 14.06 % 14.50 % 15.58 %
Tier 1 leverage ratio 8.67 % 8.97 % 10.41 %
In addition to traditional capital measurements, management uses tangible capital measures to evaluate the adequacy of Peoples' total stockholders' equity. Such financial measures represent non-US GAAP financial information since they exclude the impact of goodwill and other intangible assets acquired through acquisitions on the Consolidated Balance Sheets. Peoples' management believes this information is useful to investors since it facilitates the comparison of Peoples' operating performance, financial condition and trends to peers, especially those without a level of intangible assets similar to that of Peoples. Further, intangible assets generally are difficult to convert into cash, especially during a financial crisis, and could decrease substantially in value should there be deterioration in the overall franchise value. As a result, tangible equity represents a conservative measure of the capacity for Peoples to incur losses but remain solvent.
71
The following table reconciles the calculation of these non-US GAAP financial measures to amounts reported in Peoples' Consolidated Financial Statements at December 31:
(Dollars in thousands) 2021 2020 2019
Tangible equity:
Total stockholders' equity $ 845,025 $ 575,673 $ 594,393
Less: goodwill and other intangible assets 291,009 184,597 177,503
Tangible equity $ 554,016 $ 391,076 $ 416,890
Tangible assets:
Total assets $ 7,063,521 $ 4,760,764 $ 4,354,165
Less: goodwill and other intangible assets 291,009 184,597 177,503
Tangible assets $ 6,772,512 $ 4,576,167 $ 4,176,662
Tangible book value per common share:
Tangible equity $ 554,016 $ 391,076 $ 416,890
Common shares outstanding 28,297,771 19,563,979 20,698,941
Tangible book value per common share $ 19.58 $ 19.99 $ 20.14
Tangible equity to tangible assets ratio:
Tangible equity $ 554,016 $ 391,076 $ 416,890
Tangible assets $ 6,772,512 $ 4,576,167 $ 4,176,662
Tangible equity to tangible assets 8.18 % 8.55 % 9.98 %
The tangible equity to tangible assets ratio declined during 2021, compared to 2020. This reduction was mainly due to the acquisition of North Star Leasing, for which no stockholders' equity was issued and additional goodwill and intangibles were recorded. The decline in tangible equity to tangible assets at December 31, 2020, compared to 2019, was partially due to the origination of PPP loans during 2020, coupled with the repurchase of common shares completed during the year and dividends paid to shareholders, which exceeded net income for the year.
Future Outlook
During 2021, Peoples successfully closed the largest acquisition in its history, along with the acquisition of a specialty financing leasing business that has significant growth potential. During 2022, Peoples will look to expand on the progress made with recent acquisitions, both strengthening the pipeline of referrals between lines of businesses for new clients, as well as growing the specialty finance lending and leasing portfolios.
Net interest income is expected to improve considerably over 2021, as the full year impact of Premier and the acquired leasing business are recognized for 2022. People also anticipates core growth that will contribute to overall higher net interest income than for 2021, while it anticipates that net interest margin will be between 3.50% and 3.60%, excluding any potential increase to the Federal Funds Target Rate. Net interest margin for 2022 will be positively impacted by the full year recognition of the accretion income, net of amortization expense, associated with the Premier acquisition. However, the impact of this improvement will be muted by the lower accretion of net deferred loan fees and costs from the PPP loan forgiveness, which will be much smaller during 2022 than it was during 2021. During 2021, Peoples has significantly improved its deposit costs, which declined 18 basis points to 29 basis points, but will have less opportunity to further decrease deposit costs during 2022. Peoples has also had a negative impact to net interest margin during 2021 as a result of excess liquidity, and anticipates that to continue through portions of 2022.
Total non-interest income, excluding net gains and losses, will benefit from both the acquisitions during 2021, as the Premier acquisition will positively impact electronic banking income and deposit account service charges, while the leasing division will continue to provide a boost from its fee-based income. For 2022, Peoples anticipates growth of 14% to 16% compared to 2021, in total non-interest income, excluding net gains and losses. This increase includes expected growth within trust and investment income, and insurance income, which increased 20% and 9%, respectively, for 2021, compared to 2020.
Excluding acquisition-related expenses, total non-interest expense is anticipated to grow for 2022, which will be mostly due to the additional ongoing costs associated with the recent acquisitions. During 2021, Peoples worked to reduce future data processing and software costs associated with its core processor, and will begin to recognize those savings during 2022. The efficiency ratio for 2022 is expected to improve as Peoples fully recognizes the cost savings associated with the acquisitions, and anticipates an efficiency ratio in the high 50% range.
72
The balance sheet mix of Peoples will be continually evaluated in an effort to mitigate exposure risk, as interest rates are anticipated to increase during 2022. Peoples will work to effectively deploy its excess liquidity into higher yielding opportunities, as they arise.
Peoples will continue to place importance on loan growth. It anticipates that the annual loan growth for 2022, compared to 2021, will be between 6% and 8%. This growth excludes any PPP loan payoffs, and incorporates the expected increases in specialty finance loan and lease balances. At the same time, Peoples will focus on maintaining a high credit quality standard when underwriting new business. While Peoples will focus on asset quality, Peoples anticipates an annual gross charge-off rate, as a percent of average total loans, of between 25 to 40 basis points. This rate includes the expectation of returning to historical charge-off rates for loans, as well as the addition of the leasing portfolio charge-offs, which are traditionally higher than loan charge-off rates.
Peoples does not anticipate a significant amount of deposit growth for 2022, as deposit balances have remained inflated in recent periods. The influx of deposits during the COVID-19 pandemic, which was the result of fiscal stimulus, PPP proceeds and changed consumer spending habits, is not expected to continue into 2022. While Peoples does not anticipate significant runoff of deposits, it does not believe there will be large growth during 2022.
Capital is a key priority for Peoples, and continues to be a source of strength. Peoples' regulatory capital ratios at December 31, 2021 exceeded the minimums needed to be considered well capitalized. Peoples intends to make meaningful investments with capital as opportunities arise, such as acquisitions, and return shareholder value in the form of dividends.
For more information regarding risks and uncertainties that could impact the projections described, please refer to "ITEM 1A RISK FACTORS" of this Form 10-K.
Interest Rate Sensitivity and Liquidity
While Peoples is exposed to various business risks, the risks relating to interest rate sensitivity and liquidity are major risks that can materially impact future results of operations and financial condition due to their complexity and dynamic nature. The objective of Peoples' asset-liability management function is to measure and manage these risks in order to optimize net interest income within the constraints of prudent capital adequacy, liquidity and safety. This objective requires Peoples to focus on interest rate risk exposure and adequate liquidity through its management of the mix of assets and liabilities, their related cash flows and the rates earned and paid on those assets and liabilities. Ultimately, the asset-liability management function is intended to guide management in the acquisition and disposition of earning assets and selection of appropriate funding sources.
Interest Rate Risk
Interest rate risk ("IRR") is one of the most significant risks arising in the normal course of business of financial services companies like Peoples. IRR is the potential for economic loss due to future interest rate changes that can impact the earnings stream, as well as market values, of financial assets and financial liabilities. Peoples' exposure to IRR is due primarily to differences in the maturity or repricing of earning assets and interest-bearing liabilities. In addition, other factors, such as prepayments of loans and investment securities, or early withdrawal of deposits, can affect Peoples' exposure to IRR and increase interest costs or reduce revenue streams.
Peoples has assigned overall management of IRR to the ALCO, which has established an IRR management policy that sets minimum requirements and guidelines for monitoring and managing the level of IRR. The objective of Peoples' IRR management policy is to assist the ALCO in its evaluation of the impact of changing interest rate conditions on earnings and the economic value of equity, as well as assist with the implementation of strategies intended to reduce Peoples' IRR. The management of IRR involves either maintaining or changing the level of risk exposure by changing the repricing and maturity characteristics of the cash flows for specific assets or liabilities. Additional oversight of Peoples' IRR is provided by the Board of Directors of Peoples Bank, which reviews and approves Peoples' IRR management policy at least annually.
The ALCO uses various methods to assess and monitor the current level of Peoples' IRR and the impact of potential strategies or other changes. However, the ALCO predominantly relies on simulation modeling in its overall management of IRR since it is a dynamic measure. Simulation modeling also estimates the impact of potential changes in interest rates and balance sheet structures on future earnings and projected economic value of equity. The methods used by ALCO to assess IRR remain largely unchanged from those disclosed at December 31, 2020.
The modeling process starts with a base case simulation using the current balance sheet and current interest rates held constant for the next twenty-four months. Alternate scenarios are prepared which simulate the impact of increasing and decreasing market interest rates, assuming parallel yield curve shifts. Comparisons produced from the simulation data, showing the changes in net interest income from the base interest rate scenario, illustrate the risks associated with the current balance sheet structure. Additional simulations, when deemed appropriate or necessary, are prepared using different interest rate scenarios from those used with the base case simulation and/or possible changes in balance sheet composition. The additional simulations include non-parallel shifts in interest rates whereby the direction and/or magnitude of changes in short-term interest rates is different from the changes applied to longer-term interest rates. Comparisons showing the net interest income and economic value of equity variances from the base case are provided to the ALCO for review and discussion.
73
The ALCO has established limits on changes in the twelve-month net interest income forecast and the economic value of equity from the base case. The ALCO may establish risk tolerances for other parallel and non-parallel rate movements, as deemed necessary. The following table details the current policy limits used to manage the level of Peoples' IRR:
Immediate and Sustained Shift in Interest Rates Net Interest Income Economic Value of Equity
+ / - 100 basis points -5% -10%
+ / - 200 basis points -10% -15%
+ / - 300 basis points -15% -20%
The following table shows the estimated changes in net interest income and the economic value of equity based upon a standard, parallel shock analysis with balances held constant (dollars in thousands):
Increase (Decrease) in Interest Rates Estimated Increase (Decrease) in
Net Interest Income Estimated (Decrease) Increase in Economic Value of Equity
(in Basis Points) December 31, 2021 December 31, 2020 December 31, 2021 December 31, 2020
300 $ 24,903 11.7 % $ 22,034 17.3 % $ (24,232) (2.0) % $ 117,235 15.7 %
200 16,312 7.7 % 15,899 12.5 % (16,541) (1.3) % 95,189 12.7 %
100 7,899 3.7 % 8,981 7.1 % (5,308) (0.4) % 60,384 8.1 %
(100) (8,615) (4.1) % (7,030) (5.5) % (91,568) (7.4) % (116,205) (15.5) %
This table uses a standard, parallel shock analysis for assessing the IRR to net interest income and the economic value of equity. A parallel shock means all points on the yield curve (one year, two year, three year, etc.) are directionally changed the same amount of basis points. Management regularly assesses the impact of both increasing and decreasing interest rates. The table above shows the impact of upward parallel shocks and a downward parallel shock of 100 basis points. Downward parallel shocks of 300 and 200 basis points are excluded from the table as they are not probable given the current interest rate environment.
Estimated changes in net interest income and economic value of equity are partially driven by assumptions regarding the rate at which non-maturity deposits will reprice given a move in short-term interest rates. These assumptions are monitored closely by Peoples and are reviewed at least semi-annually. As of December 31, 2021, the actual deposit betas experienced by Peoples in the repricing of non-maturity deposits were lower than those used in Peoples’ interest rate risk modeling.
While parallel interest rate shock scenarios are useful in assessing the level of IRR inherent in the balance sheet, interest rates typically move in a nonparallel manner with differences in the timing, direction and magnitude of changes in short-term and long-term interest rates. Thus, any benefit that might occur as a result of the Federal Reserve Board increasing short-term interest rates in the future could be offset by an inverse movement in long-term rates, and vice versa. For this reason, Peoples considers other interest rate scenarios in addition to analyzing the impact of parallel yield curve shifts. These include various flattening and steepening scenarios in which short-term and long-term rates move in different directions with varying magnitude. Peoples believes these scenarios to be more reflective of how interest rates change versus the severe parallel rate shocks described above. Given the shape of market yield curves at December 31, 2021, consideration of the bear steepener and bear flattener scenarios provide insights which were not captured by parallel shifts.
The bear steepener scenario highlights the risk to net interest income and the economic value of equity when short-term rates remain constant while long-term rates rise. In such a scenario, Peoples' variable rate asset yields along with deposit and short-term borrowing costs, which are correlated with short-term rates, remain constant, while long-term asset yields and long-term borrowing costs, which are more correlated with long-term rates, rise. Increased asset yields would not be offset by increases in deposit or funding costs, resulting in an increased amount of net interest income and higher net interest margin. At December 31, 2021, the bear steepener scenario resulted in an increase in both net interest income and the economic value of equity of 0.6% and 4.5%, respectively.
The bear flattener scenario highlights the risk to net interest income and the economic value of equity when short-term rates rise while long-term rates remain constant. In such a scenario, Peoples' variable rate asset yields along with deposit and short-term borrowing costs, which are correlated with short-term rates, increase, while long-term asset yields and long-term borrowing costs, which are more correlated with long-term rates, remain constant. Increased deposit and funding costs would be more than offset by increased variable rate asset yields; resulting in an increased amount of net interest income and higher net interest margin. At December 31, 2021, the bear flattener scenario resulted in an increase in net interest income of 1.0% and a decline in the economic value of equity of 3.7%.
74
During 2021, Peoples' Consolidated Balance Sheet was positioned to benefit from rising interest rates in terms of the potential impact on net interest income. The table illustrates this point as net interest income increases in the rising rate scenarios.
Peoples has entered into interest rate swaps as part of its interest rate risk management strategy. These interest rate swaps are designated as cash flow hedges and involve the receipt of variable rate amounts from a counterparty in exchange for Peoples making fixed payments. As of December 31, 2021, Peoples had thirteen interest rate swap contracts, with an aggregate notional value of $125.0 million. Additional information regarding Peoples' interest rate swaps can be found in "Note 15 Derivative Financial Instruments" of the Notes to the Consolidated Financial Statements.
An asset/liability model used to produce the analysis above requires assumptions to be made such as prepayment rates on interest-earning assets and repricing impact on non-maturity deposits. These business assumptions are based on business plans, economic and market trends, and available industry data. Management believes that its methodology for developing such assumptions is reasonable; however, there can be no assurance that modeled results will be achieved. The asset/liability model along with key modeling assumptions are subjected to a third-party review annually for effectiveness and regulatory compliance.
Liquidity
In addition to IRR management, another major objective of the ALCO is to ensure sufficient levels of liquidity are maintained. The ALCO defines liquidity as the ability to meet anticipated and unanticipated operating cash needs, loan demand and deposit withdrawals without incurring a sustained negative impact on profitability.
A primary source of liquidity for Peoples is deposits. Liquidity is also provided by cash generated from earning assets such as loans and investment securities. Peoples also uses various wholesale funding sources to supplement funding from customer deposits. These external sources provide Peoples with the ability to obtain large quantities of funds in a relatively short time period in the event of sudden unanticipated cash needs. However, an over-utilization of external funding sources can expose Peoples to greater liquidity risk, as these external sources may not be accessible during times of market stress. Additionally, Peoples may be exposed to the risk associated with providing excess collateral to external funding providers, commonly referred to as counterparty risk. As a result, the ALCO's liquidity management policy sets limits on the net liquidity position and the concentration of non-core funding sources, which includes wholesale funding and brokered deposits.
In addition to external sources of funding, Peoples considers certain types of deposits to be less stable or "volatile funding." These deposits include special money market products, large CDs and public funds. Peoples has established volatility factors for these various deposit products, and the liquidity management policy establishes a limit on the total level of volatile funding. Additionally, Peoples measures the maturities of external sources of funding for periods of one month, three months, six months and twelve months, and has established policy limits for the amounts maturing in each of these periods. The purpose of these limits is to minimize exposure to what is commonly termed rollover risk.
An additional strategy used by Peoples in the management of liquidity risk is maintaining a targeted level of liquid assets. Management defines liquid assets as unencumbered cash (including cash on deposit at the FRB of Cleveland), and the market value of unpledged U.S. government and agency securities. Excluded from this definition are pledged securities, non-government securities, non-agency securities, municipal securities and loans. Management has established a minimum level of liquid assets in the liquidity management policy, which is expressed as a percentage of total loans and unfunded loan commitments. At December 31, 2021, Peoples maintained liquid assets of $723.4 million, representing 9.2% of total assets plus unfunded loan commitments. Peoples has also established a policy limit around the level of liquefiable assets expressed as a percentage of total loans and unfunded loan commitments. Liquefiable assets are defined as liquid assets plus the market value of unpledged securities not included in the liquid asset measurement. At December 31, 2021, Peoples maintained liquefiable assets of $991.6 million, representing 12.6% of total assets plus unfunded loan commitments.
An essential element in the management of liquidity risk is a forecast of the sources and uses of anticipated cash flows. On a monthly basis, Peoples forecasts sources and uses of cash for the next twelve months. To assist in the management of liquidity, management has established a liquidity coverage ratio, which is defined as the total sources of cash divided by the total uses of cash. A ratio of greater than 1.0 times indicates that forecasted sources of cash are adequate to fund forecasted uses of cash. The liquidity management policy establishes a minimum limit of 1.0 times. As of December 31, 2021, Peoples had a ratio of 7.53 times, which was within policy limits. Peoples also forecasts secondary or contingent sources of cash, and this includes external sources of funding and liquid assets. These sources of cash would be required if and when the forecasted liquidity coverage ratio dropped below the policy limit of 1.0 times. An additional liquidity measurement used by management includes the total forecasted sources of cash and the contingent sources of cash divided by the forecasted uses of cash. Management has established a minimum ratio of 3.0 times for this liquidity management policy limit. As of December 31, 2021, Peoples had a ratio of 8.28 times, which was within policy limits.
Peoples maintains multiple contingent sources of liquidity including secured wholesale funding lines and unsecured brokered deposit networks. Peoples' primary sources of secured wholesale funding are the FHLB of Cincinnati and the FRB of Cleveland. As of December 31, 2021, Peoples had unused collateral-based borrowing capacities of $427.5 million and $174.4 million, respectively, available with the FHLB of Cincinnati and the FRB of Cleveland. Together, these unused borrowing capacities
75
represent 7.6% of total assets and unfunded loan commitments. Additionally, Peoples had $241.8 million of unpledged loan collateral eligible to secure additional borrowing capacity with the FRB of Cleveland.
Disruptions in the sources and uses of cash can occur which can drastically alter the actual cash flows and negatively impact Peoples' ability to access internal and external sources of cash. Such disruptions might occur due to increased withdrawals of deposits, increases in the funding required for loan commitments, a decrease in the ability to access external funding sources and other factors that would increase the need for funding and limit Peoples' ability to access needed funds. As a result, Peoples maintains a liquidity contingency funding plan ("LCFP") that considers various degrees of disruptions and develops action plans around these scenarios.
Peoples' LCFP identifies scenarios where funding disruptions might occur and creates scenarios of varying degrees of severity. The disruptions considered include an increase in funding of unfunded loan commitments, unanticipated withdrawals of deposits, decreases in the renewal of maturing CDs and reductions in cash earnings. Additionally, the LCFP creates stress scenarios where access to external funding sources, or contingency funding, is suddenly limited, which includes a significant increase in the margin requirements where securities or loans are pledged, limited access to funding from other banks and limited access to funding from the FHLB of Cincinnati and the FRB of Cleveland. Peoples' LCFP scenarios include a base scenario, a mild stress scenario, a moderate stress scenario and a severe stress scenario. Each of these is defined as to the related severity and action plans are developed around each.
Liquidity management also requires the monitoring of risk indicators that may alert the ALCO to a developing liquidity situation or crisis. Early detection of stress scenarios allows Peoples to take actions to help mitigate the impact to Peoples Bank's business operations. The LCFP contains various indicators, termed key risk indicators ("KRIs") that are monitored on a monthly basis, at a minimum. The KRIs include both internal and external indicators and include loan delinquency levels, criticized and classified loan levels, the ratios of non-performing loans to loans and to total assets, the total loan to total deposit ratio, the level of net non-core funding dependence, the level of contingency funding sources, the liquidity coverage ratio, changes in regulatory capital levels, forecasted operating loss and negative media concerning Peoples, irrational competitor pricing that persists, and an increase in rates for external funding sources. The LCFP establishes levels that define each of these KRIs under base, mild, moderate and severe scenarios.
The LCFP is reviewed and updated at least on an annual basis by the ALCO and Peoples Bank's Board of Directors. Additionally, testing of the LCFP is required on an annual basis. Various stress scenarios and the related actions are simulated according to the LCFP. The results are reviewed and discussed and changes or revisions are made to the LCFP accordingly. Additionally, the LCFP is subjected to a third-party review annually for effectiveness and regulatory compliance.
Since March 31, 2020, there has been an increase in deposit balances due to the influx of funds from fiscal stimulus, the PPP and other government actions. Peoples anticipates that these deposit balances will decline over time as the funds are used for intended business purposes; however, this deposit outflow should be partially offset as the associated PPP loans are forgiven and loan reimbursement funds are received. At the same time, we have experienced a decrease in the utilization rate for commercial lines of credit. This decrease is related to the receipt of PPP loan proceeds and other increased cash flows for certain companies. Peoples expects the commercial line of credit utilization percentage to revert back to more historical averages as time progresses.
Overall, management believes the current balance of cash and cash equivalents, anticipated investment portfolio cash flows and the availability of other funding sources will allow Peoples to meet anticipated cash obligations, as well as special needs and off-balance sheet commitments.
Off-Balance Sheet Activities and Contractual Obligations
Peoples routinely engages in activities that involve, to varying degrees, elements of risk that are not reflected in whole or in part in the Consolidated Financial Statements. These activities are part of Peoples' normal course of business and include traditional off-balance sheet credit-related financial instruments, interest rate contracts and commitments to make additional capital contributions in low-income housing tax credit investments.
The following is a summary of Peoples’ significant off-balance sheet activities and contractual obligations. Detailed information regarding these activities and obligations can be found in the Notes to the Consolidated Financial Statements as follows:
Activity or Obligation Note
Off-balance sheet credit-related financial instruments 16
Operating lease obligations 6
Long-term borrowing obligations 10
Traditional off-balance sheet credit-related financial instruments are primarily commitments to extend credit and standby letters of credit. These activities are necessary to meet the financing needs of customers and could require Peoples to make cash payments to third parties in the event certain specified future events occur. The contractual amounts represent the extent of Peoples’ exposure in
76
these off-balance sheet activities. However, since certain off-balance sheet commitments, particularly standby letters of credit, are expected to expire or be only partially used, the total amount of commitments does not necessarily represent future cash requirements.
Peoples continues to lease certain facilities and equipment under noncancellable operating leases with terms providing for fixed monthly payments over periods generally ranging from two to thirty years. Several of Peoples’ leased facilities are inside retail shopping centers or office buildings and, as a result, are not available for purchase. Management believes these leased facilities increase Peoples’ visibility within its markets and afford sales associates additional access to current and potential clients.
For certain acquisitions, often those involving insurance businesses and wealth management books of business, a portion of the consideration is contingent upon revenue metrics being achieved. US GAAP requires that the amounts be recorded upon acquisition based on the best estimate of the future amounts to be paid at the time of acquisition. Any subsequent adjustment to the estimate is recorded in earnings. Based on the acquisitions completed to date, management does not expect contingent consideration to have a material impact on Peoples' future performance.
Management does not anticipate that Peoples’ current off-balance sheet activities will have a material impact on its future results of operations and financial condition based on historical experience and recent trends.
Effects of Inflation on Financial Statements
Substantially all of Peoples’ assets relate to banking and are monetary in nature. As a result, inflation does not impact Peoples to the same degree as companies in capital-intensive industries in a replacement cost environment. During a period of rising prices, a net monetary asset position results in a loss in purchasing power and conversely a net monetary liability position results in an increase in purchasing power. The opposite would be true during a period of decreasing prices. In the banking industry, monetary assets typically exceed monetary liabilities.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Refer to the section captioned "Interest Rate Sensitivity and Liquidity" under "ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" of this Form 10-K, which is incorporated herein by reference.