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Item 7. Management’s Discussion and Analysis

2023-03-08 compared with 2022-03-09 · 126 added, 120 removed, 242 unchanged (50% of the section changed)

6 unchanged sentences

Allowance for credit losses.

The allowance for credit losses represents management's estimate of expected losses inherent within the existing loan portfolio.

The allowance for credit losses is increased by the provision for credit losses charged to

expense and reduced by loans charged off, net of recoveries.

The allowance for credit losses (ACL) represents management's estimate of expected losses inherent within the existing loan portfolio.

The allowance for credit losses is increased by the provision for credit losses charged to expense and reduced by loans charged off, net of recoveries.

The allowance for credit losses is determined based on management's assessment of several factors:

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Expected credit losses on individually evaluated loans are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate.

We utilize a cohort methodology to determine the allowance for credit losses.

Management utilizes a cohort methodology to determine the allowance for credit losses.

This method identifies and captures the balance of a pool of loans with similar risk characteristics, as of a particular point in time to form a cohort, then tracks the respective losses generated by that cohort of loans over their remaining life.

Our cohorts track loan balances and historical loss experience since 2008.

The cohorts track loan balances and historical loss experience since 2008, and management extends the look back period each quarter to capture all available data points in the historical loss rate calculation.

The quantitative component of the ACL involves assumptions that require a significant level of estimation;

these include historical losses as a predictor of future performance, appropriateness of selected delay periods, and the reasonableness of the portfolio segmentation.

A historical data set is expected to provide the best indication of future credit performance.

Delay periods represent the amount of time it takes a cohort of loans to become seasoned, or incur sufficient attrition through pay downs, renewals, or charge-offs.

Portfolio segmentation relates to the pooling of loans with similar risk characteristics, such as industry types, collateral, and consumer purpose.

On an annual basis, in the first quarter, management performs a recalibration of the delay periods and portfolio segmentation to determine whether they are reasonable and appropriate based on the information available at that time.

Management considers qualitative adjustments to expected credit loss estimates for information not already captured in the loss estimation process.

Where past performance may not be representative of future losses, loss rates are adjusted for qualitative and economic forecast factors.

Qualitative factors include items such as changes in lending policies or procedures, asset specific risks, the impact of COVID-19 on customer's operations, and economic uncertainty in forward-looking forecasts.

Management uses the peak three consecutive quarter net charge off rate to capture maximum potential volatility over the reasonable and supportable forecast period.

Historical losses utilized in setting the qualitative factor ranges are anchored to 2008 and may be supplemented by peer information when needed.

The qualitative factor ranges are recalibrated annually to capture recent behavior that is indicative of the credit profile of the current portfolio.

Qualitative factors include items, such as changes in lending policies or procedures, asset specific risks, and economic uncertainty in forward-looking forecasts.

Economic indicators utilized in forecasting include unemployment rate, gross domestic product, housing starts, and interest rates.

Management uses a two-year reasonable and supportable period across all loan segments to forecast economic conditions.

Management believes the two-year time horizon aligns with available industry guidance and various forecasting sources.

Economic forecast adjustments are overlaid onto historical loss rates.

As such, reversion from forecast rates to historical loss rates is immediate.

The ACL and allowance for unfunded commitments were $39.8 million and $2.1 million, respectively at December 31, 2022, compared to $48.3 million and $3.0 million, respectively at December 31, 2021.

The $8.5 million decrease in the ACL was the result of several factors.

The first was the annual model recalibration.

Each year, in the first quarter, management reviews each model variable to determine if adjustments are necessary to improve the model’s predictability.

In the first quarter 2022 the delay periods were shortened to pick up more recent losses.

Also, the qualitative factor maximum scorecard ranges for certain cohorts were reduced, which reduced

Additionally, the qualitative factors for uncertainty were lowered due to the seasoning of the acquired loans, and as well as lower qualitative factors, due to the sale of non farm non residential commercial loans in the third quarter.

Finally, the reserve was impacted by improved portfolio performance.

The qualitative amount of the reserve decreased $3.3 million to $11.0 million.

The quantitative amount is $28.6 million at December 31, 2022, compared to $33.6 million at December 31, 2021.

There was a $900 thousand decrease in the allowance for unfunded commitments.

See additional discussion of ACL in the Allowance for Credit Losses section below.

Based on management’s analysis of the current portfolio, management believes the allowance is adequate.

Changes in the financial condition of individual borrowers, economic conditions, historical loss experience, or the condition of the various markets in which collateral may be sold may affect the required level of the allowance for credit losses and the associated provision for credit losses.

Should cash flow assumptions or market conditions change, a different amount may be recorded for the allowance for credit losses and the associated provision for credit losses.

As management monitors these changes, as well as those factors discussed above, adjustments may be recorded to the allowance for credit losses and the associated provision for credit losses in the future.

Securities valuation and potential impairment.

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Fair values of the reporting units are determined by an analysis which considers cash flows streams, profitability and estimated market values of the reporting unit.

With the decrease in market value as a result of the pandemic, the Corporation engaged a third party to conduct an in-depth analysis of the Corporation as of October 31, 2021.

The final results determined that there was no impairment of goodwill.

From the effective date of the analysis to December 31, 2021, the Corporation's market value increased.

The majority of the Corporation’s goodwill is recorded at First Financial Bank, N.

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Net income for 2022 was $71.1 million, or $5.82 per share versus $53.0 million, or $4.02 per share for 2021.

The decrease in 2021 net income is due to increased expenses from the Hancock acquisition, as well as declining interest rates.

Return on average assets at December 31, 2021 decreased 12.00% to 1.10% compared to 1.25% at December 31, 2020.

The increase in 2022 net income is primarily due to increased interest rates and growth in earning assets.

Return on average assets at December 31, 2022 increased 28.18% to 1.41% compared to 1.10% at December 31, 2021.

The primary components of income and expense affecting net income are discussed in the following analysis.

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The principal source of the Corporation’s earnings is net interest income, which represents the difference between interest earned on loans and investments and the interest cost associated with deposits and other sources of funding.

Net interest income decreased in 2021 to $143.4 million compared to $146.3 million in 2020.

Net interest income increased in 2022 to $165.0 million compared to $143.4 million in 2021.

Total average interest earning assets increased to $4.80 billion in 2022 from $4.61 billion in 2021.

The tax-equivalent yield on these assets decreased to 3.39% in 2021 from 4.43% in 2020.

Total average interest-bearing liabilities increased to $3.43 billion in 2021 from $2.98 billion in 2020.

The average cost of these interest-bearing liabilities decreased to 0.26% in 2021 from 0.47% in 2020.

The net interest margin decreased from 4.05% in 2020 to 3.20% in 2021.

Earning asset yields decreased 104 basis points while the rate on interest-bearing liabilities decreased by 21 basis points.

The tax-equivalent yield on these assets increased to 3.92% in 2022 from 3.39% in 2021.

Total average interest-

bearing liabilities increased to $3.61 billion in 2022 from $3.43 billion in 2021.

The average cost of these interest-bearing liabilities increased to 0.51% in 2022 from 0.26% in 2021.

The net interest margin increased from 3.20% in 2021 to 3.54% in 2022.

Earning asset yields increased 53 basis points while the rate on interest-bearing liabilities increased by 25 basis points.

CONSOLIDATED BALANCE SHEET - AVERAGE BALANCES AND INTEREST RATES

2021 2020 2019

(Dollar amounts in thousands) Average

Balance Interest Yield/

(Dollar amounts in thousands)

Interest-earning assets:

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Premises and equipment, net

Other assets 183,589 187,415 121,411

Less allowance for loan losses

TOTALS $ 4,814,350 $ 4,312,919 $ 3,439,793

LIABILITIES AND SHAREHOLDERS' EQUITY

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Total interest-bearing liabilities:

3,427,479 8,797 0.26 % 2,981,673 14,139 0.47 % 2,590,589 17,469 0.67 %

Non interest-bearing liabilities:

Demand deposits

Other 71,738 77,444 59,430

4,216,981 3,719,128 2,942,464

Shareholders' equity

TOTALS $ 4,814,350 $ 4,312,919 $ 3,439,793

Net interest earnings

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2022 Compared to 2021 Increase

(Decrease) Due to 2020 Compared to 2019 Increase

2021 Compared to 2020 Increase

(Decrease) Due to

(Dollar amounts in thousands) Volume Rate Volume/

Rate Total Volume Rate Volume/

(Decrease) Due to

(Dollar amounts in thousands)

Interest earned on interest-earning assets:

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The analysis is governed by Accounting Standards Codification (ASC 326), implemented in 2020, which uses an economic forecast that includes the impact of the COVID-19 pandemic.

For the year ended December 31, 2021, the provision for credit losses was $2.5 million, a decrease of $8.1 million, or 77%, compared to 2020.

In 2020, along with the adoption of CECL, $4 million was added to allowance to accommodate anticipated losses from the pandemic.

In 2021 when those losses became unrealized, the additional pandemic allowances were removed, as well as CECL performance requiring lower allowance for credit losses.

Continued loan growth in future periods, an increase in charge-offs, or a decline in our current level of recoveries could result in an increase in provision expense.

Additionally, with the adoption of ASC 326 in 2020, provision expense may become more volatile due to changes in CECL model assumptions of credit quality, economic conditions, and loan composition, which drive allowance for credit losses.

For the year ended December 31, 2022, the negative provision for credit losses was $2.0 million, a decrease of $4.5 million, or 182%, compared to 2021.

The negative provision for the year was the result of several factors.

The first was the annual model recalibration.

Each year, in the first quarter, management reviews each model variable to determine if adjustments are necessary to improve the model’s predictability.

In the first quarter 2022 the delay periods were shortened to pick up more recent losses.

Also, the qualitative factor maximum scorecard ranges for certain cohorts were reduced, which reduced the reserve.

Secondly, management removed two qualitative factors that were deemed no longer applicable.

The first was related to acquisition uncertainty, which management believes to have seasoned adequately that it was no longer warranted.

The second was related to the CECL model and the related uncertainty.

The uncertainty surrounded the newness of the model and potential regulatory scrutiny.

Following two exam cycles, management elected to remove the factor.

Also, during the quarter, historical loss rates continued to decline, which lowers the required reserve.

The historical loss rate declined in most segments.

Based on management’s analysis of the current portfolio, an evaluation that includes consideration of changes in CECL model assumptions of credit quality, economic conditions, and loan composition, management believes the allowance is adequate.

Net charge-offs for 2022 were $6.5 million as compared to $2.6 million for 2021 and $3.5 million for 2020.

Non-accrual loans, excluding TDR’s, decreased to $8.5 million at December 31, 2022 from $9.6 million at December 31, 2021.

Loans past due 90 days and still on accrual decreased to $515 thousand compared to $2.3 million at December 31, 2020.

Loans past due 90 days and still on accrual increased to $1.1 million compared to $515 thousand at December 31, 2021.

On July 12, 2022, the Corporation sold seven classified non-farm nonresidential commercial loans, which were acquired in the two acquisitions in 2019 and 2021, with a total principal balance of $14.9 million.

The net recovery on the sale of $361 thousand includes the charge-off of the seven loans of $2,145 thousand, netted by the $2,072 thousand reserve on those loans, previously charged off in the period, and the $434 thousand unamortized discount

remaining from the acquisitions.

As the related charge offs were previously reserved for and related to acquired loans, the increase in net charge offs for the year does not have a significant impact on the future expected losses.

NON-INTEREST INCOME

Non-interest income of $42.1 million decreased $392 thousand from the $42.5 million earned in 2020.

Non-interest income decreased due to a decrease in gains on sales of mortgage loans.

Non-interest income of $46.7 million increased $4.6 million from the $42.1 million earned in 2021.

The change in non-interest income from 2021 to 2022 was primarily driven by a $4.0 million legal settlement received in February, 2022, and a $2.5 million bank owned life insurance mortality payment.

The Corporation does not expect these items to reoccur.

NON-INTEREST EXPENSES

Non-interest expenses increased to $126.0 million in 2022 from $117.4 million in 2021.

The increase was mainly due to increased expenses from the acquisition of Hancock Bancorp, Inc.

The year-over-year changes are, in part, impacted by the acquisition of Hancock Bancorp in the fourth quarter of 2021.

The Corporation’s federal income tax provision was $16.7 million in 2022 compared to $12.6 million in 2021.

The overall effective tax rate in 2021 of 19.2% increased as compared to a 2020 effective rate of 17.8%.

The increase is primarily due to increase of general business tax credits benefits earned in 2020.

The overall effective tax rate in 2022 of 19.0% decreased as compared to a 2021 effective rate of 19.2%.

COMPARISON OF 2021 TO 2020

Net income for 2020 was $53.8 million or $3.93 per share compared to $48.9 million in 2019 or $3.80 per share.

The increase in 2020 net income is primarily due to an increase in net interest income related to full year impact of acquisition.

2019 net income includes the results from the acquisition of HopFed, Inc.

Net interest income increased $14.6 million in 2020 compared to 2019.

The provision for credit losses increased $5.8 million from $4.7 million in 2019 to $10.5 million in 2020.

Non-interest expenses increased $8.4 million and non-interest income increased $4.0 million.

Net income for 2021 was $53.0 million, or $4.02 per share versus $53.8 million, or $3.93 per share for 2020.

The decrease in

2021 net income is due to increased expenses from the Hancock acquisition, as well as declining interest rates.

Net interest income decreased $2.9 million in 2021 compared to 2020.

The provision for credit losses decreased $8.0 million from $10.5 million in 2020 to $2.5 million in 2021.

Non-interest expenses increased $4.6 million and non-interest income decreased $392 thousand.

The increase in non-interest expenses was largely due to the acquisition of HopFed, Inc.

The provision for income taxes decreased $492 thousand from 2019 to 2020 and the effective tax rate decreased to 17.8% in 2020 from 20.0% in 2019.

The decrease is primarily due to increase of general business tax credits benefits earned in 2020.

The provision for income taxes increased $934 thousand from 2020 to 2021 and the effective tax rate increased to 19.2% in 2021 from 17.8% in 2020.

The increase is primarily due to increase of general business tax credits benefits earned in 2020.

COMPARISON AND DISCUSSION OF 2022 BALANCE SHEET TO 2021

The Corporation's total assets increased 13.5% or $614.6 million at December 31, 2021, from a year earlier.

Available-for-sale securities increased $344.0 million at December 31, 2021, from the previous year.

The Corporation’s total assets decreased 3.6% or $185.8 million at December 31, 2022, from a year earlier.

Available-for-sale securities decreased $29.0 million at December 31, 2022, from the previous year.

Loans, net increased by $260.1 million to $3.03 billion.

Deposits increased $653.6 million while borrowings decreased by $12.6 million.

Deposits decreased $40.7 million while borrowings decreased by $28.8 million.

Total shareholders’ equity decreased $107.3 million to $475.3 million at December 31, 2022.

Accumulated other comprehensive income decreased $137.6 million primarily due to the market value of the securities portfolio, which reflected the large decrease in securities pricing.

In 2022 dividends paid by the Corporation totaled $1.17 per share.

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The Corporation’s investment strategy seeks to maximize income from the investment portfolio while using it as a risk management tool and ensuring safety of principal and capital.

During 2021 the portfolio's balance increased by 33.7%.

The average life of the portfolio increased from 3.8 years in 2020 to 5.0 years in 2021.

During 2022 the portfolio’s balance decreased by 2.1%.

The average life of the portfolio

increased from 5.0 years in 2021 to 6.9 years in 2022.

The portfolio structure will continue to provide cash flows to be reinvested during 2023.

1 year and less 1 to 5 years 5 to 10 years Over 10 Years 2021

(Dollar amounts in thousands) Balance Rate Balance Rate Balance Rate Balance Rate Total

1 year and less

5 to 10 years

Over 10 Years

(Dollar amounts in thousands)

government sponsored entity mortgage-backed securities and agencies and U.S.

Treasury (1) $ 12,784 2.37 % $ 28,466 1.84 % $ 42,881 3.96 % $ 678,295 2.15 % $ 762,426

Collateralized mortgage obligations (1)

States and political subdivisions

Other securities 3,477 1.40 % 1,245 0.01 % 498 0.01 % — — % 5,220

Collateralized debt obligations

TOTAL $ 25,068 2.40 % $ 64,837 2.42 % $ 126,401 3.07 % $ 1,148,428 2.28 % $ 1,364,734

(1) Distribution of maturities is based on the estimated life of the asset.

1 year and less 1 to 5 years 5 to 10 years Over 10 Years 2020

(Dollar amounts in thousands) Balance Rate Balance Rate Balance Rate Balance Rate Total

1 year and less

5 to 10 years

Over 10 Years

(Dollar amounts in thousands)

government sponsored entity mortgage-backed securities and agencies (1)

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Collateralized debt obligations

TOTAL 13,306 2.53 % 75,722 2.64 % 103,162 3.74 % 828,554 2.55 % 1,020,744

(1) Distribution of maturities is based on the estimated life of the asset.

Net unrealized gain/loss on available for sale securities decreased $188.1 million from a net unrealized gain of $19.9 million in 2021 to a net unrealized loss of $168.2 million in 2022.

This decrease was primarily due to the significant decline in the markets in 2022.

The decrease is not related to credit, but due to interest rates.

The Corporation does not expect realized losses, as there is no intent to sell at a loss.

LOAN PORTFOLIO

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Loan Category

Commercial $ 1,674,066 $ 1,521,711 $ 1,584,447 $ 1,166,352 $ 1,139,490

Residential 664,509 604,652 682,077 443,670 436,143

Consumer 474,026 479,750 386,006 341,041 327,976

TOTAL $ 2,812,601 $ 2,606,113 $ 2,652,530 $ 1,951,063 $ 1,903,609

Within After One

But Within After Five

(Dollar amounts in thousands) One Year Five Years Years Total

(Dollar amounts in thousands)

MATURITY DISTRIBUTION

Commercial, financial and agricultural

Residential 664,509

Consumer 474,026

TOTAL $ 2,812,601

Loans maturing after one year with:

1 unchanged sentence

Variable interest rates

TOTAL $ 748,859 $ 389,575

ALLOWANCE FOR CREDIT LOSSES

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Loans charged off:

Commercial 2,158 1,097 2,616 1,122 1,572

Residential 812 944 1,050 841 761

Consumer 5,246 6,355 7,007 6,868 6,429

Total loans charged off

Recoveries of loans previously charged off:

Commercial 1,069 856 1,092 606 1,377

Residential 616 657 1,360 639 842

Consumer 3,884 3,404 3,028 2,345 2,384

Total recoveries

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These components are added together and compared to the balance of our allowance at the evaluation date.

The allowance for credit losses as a percentage of total loans increased to 1.72% at year end 2021 compared to 1.69% at year end 2020.

The increase is primarily due to the adoption of CECL.

A portion of the increase was due to the requirement to include an allowance for credit losses on purchased loans that previously only required an allocation if there was a deterioration since acquisition date.

The calculation of historical losses used in the allowance computation averages the net charge off activity and qualitative factors that supplement historical losses and consider internal and external factors, including reasonable and supportable forecasts, that influence management's expectations of loss in the portfolio.

The allowance for credit losses as a percentage of total loans decreased to 1.30% at year-end 2022 compared to 1.72%

at year-end 2021.

The decrease was the result of several factors.