SIERRA BANCORP This discussion presents Management's analysis of the Company's financial condition as ofDecember 31, 2022 and 2021, and the results of operations for each year in the three-year period endedDecember 31, 2022 . The discussion is best read in conjunction with the Company's consolidated financial statements and the notes related thereto presented elsewhere in this Form 10-K Annual Report (see Item 8 below). CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATMENTS Statements contained in this report or incorporated by reference that are not purely historical are forward looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 as amended, including the Company's expectations, intentions, beliefs, or strategies regarding the future. These forward-looking statements include, but are not limited to, statements about the Company's plans, objectives, expectations and intentions that are not historical facts, and other statements identified by words such as "expects", "anticipates", "intends", "plans", "believes", "should", "projects", "seeks", "estimates", or the negative version of those words or other comparable words or phrases of a future or forward-looking nature. All forward-looking statements concerning economic conditions, growth rates, income, expenses, or other values which are included in this document are based on information available to the Company on the date noted, and the Company assumes no obligation to correct, revise, or update any such forward-looking statements. It is important to note that the Company's actual results could materially differ from those in such forward-looking statements and you should not place undue reliance on these forward-looking statements. Risk factors and the Company's ability to manage that risk could cause actual results to differ materially from those in forward-looking statements include but are not limited to those outlined previously in Item 1A.
Critical Accounting Estimates
The Company's financial statements are prepared in accordance with accounting principles generally accepted inthe United States . The financial information and disclosures contained within those statements are significantly impacted by Management's estimates and judgments, which are based on historical experience and incorporate various assumptions that are believed to be reasonable under current circumstances. Actual results may differ from those estimates under divergent conditions. Critical accounting estimates are those that involve the most complex and subjective decisions and assessments and have the greatest potential impact on the Company's stated results of operations. In Management's opinion, the Company's critical accounting estimates deal primarily with the following areas: the establishment of an allowance for credit losses on loans and leases, as explained in detail in Note 2 to the consolidated financial statements and in the "Provision for Credit Losses on Loans and Leases" and "Allowance for Credit Losses on Loans and Leases" sections of this discussion and analysis; the valuation of impaired loans and foreclosed assets, as discussed in Note 2 to the consolidated financial statements; income taxes and deferred tax assets and liabilities, especially with regard to the ability of the Company to recover deferred tax assets as discussed in the "Provision for Income Taxes" and "Other Assets" sections of this discussion and analysis; and goodwill and other intangible assets, which are evaluated annually for impairment and for which we have determined that no impairment exists, as discussed in Note 2 to the consolidated financial statements and in the "Other Assets" section of this discussion and analysis. Critical accounting areas are evaluated on an ongoing basis to ensure that the Company's financial statements incorporate the most recent expectations with regard to those areas. 32
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The following table presents selected historical financial information concerning the Company, which should be read in conjunction with our audited consolidated financial statements, including the related notes, and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere herein.
Selected Financial Data
(dollars in thousands, except per share data)
As of and for the years ended December 31,
Operating Data 2022 2021 2020
Provision for income taxes 11,256 14,187 11,079
Net income 33,659 43,012 35,444
Selected Balance Sheet Summary
Total loans and leases, net 2,029,757 1,973,605 2,442,226
Total assets 3,608,590 3,371,014 3,220,742
Total deposits 2,846,164 2,781,572 2,624,606
Total liabilities 3,305,008 3,008,520 2,876,846
Total shareholders' equity 303,582 362,494 343,896
Net loans to total deposits 71.32% 70.95% 93.05%
Per Share Data
Net income per basic share 2.25 2.82 2.33
Net income per diluted share 2.24 2.80 2.32
Book value 20.01 23.74 22.35
Cash dividends 0.93 0.87 0.80
Weighted average common shares outstanding basic 14,955,756 15,241,957 15,216,749
Weighted average common shares outstanding diluted 15,022,755 15,353,445 15,280,325
Key Operating Ratios:
Performance Ratios: (1)
Return on average equity 10.66% 12.05% 10.80%
Return on average assets 0.97% 1.29% 1.22%Average equity to average assets ratio 9.06% 10.72% 11.28% Net interest margin (tax-equivalent) 3.47% 3.56% 3.95% Efficiency ratio (tax-equivalent) (4) 60.16% 59.92% 57.18% Asset Quality Ratios: (1) Non-performing loans to total loans (2) 0.95% 0.23% 0.31% Non-performing assets to total loans and other real estate owned (2) 0.95% 0.23% 0.35% Net (recoveries) charge-offs to average loans 0.58% (0.01%) 0.04%
Allowance for credit losses on loans and leases to total loans at period end
1.12% 0.72% 0.72%
Allowance for credit losses on loans and leases to
nonaccrual loans 117.78% 315.26% 233.46%
Regulatory Capital Ratios: (3)
Tier 1 capital to adjusted average assets (leverage
ratio) 10.30% 10.43% 10.50%
(1) Asset quality ratios are end of period ratios. Performance ratios are based
on average daily balances during the periods indicated.
(2) Performing TDR's are not included in nonperforming loans and are therefore
not included in the numerators used to calculate these ratios.
For definitions and further information relating to regulatory capital (3) requirements, see "Item 1, Business - Supervision and Regulation - Capital
Adequacy Requirements" herein.
The efficiency ratio is a non-GAAP measure and is a calculation of (4) noninterest expense as a percentage of the sum of net interest income and
noninterest income excluding net gains (losses) from securities and bank
owned life insurance income.
Overview of the Results of Operations and Financial Condition
Results of Operations Summary
The Company recognized net income of$33.7 million in 2022 relative to$43.0 million in 2021 and$35.4 million in 2020. Net income per diluted share was$2.24 in 2022, as compared to$2.80 in 2021 and$2.32 for 2020. The Company's return on average assets and return on average equity were 0.97% and 10.66%, respectively, in 2022, as compared to 1.29% and 12.05%, respectively, in 2021 and 1.22% and 10.80%, respectively, for 2020. Our financial results for 2022 were negatively impacted by a higher level of provisioning for credit losses on loans and leases, as discussed in greater detail in the applicable sections below. The following is a summary of the major factors that impacted the Company's results of operations for the years presented in the consolidated financial statements.
Net interest income improved by 1% in 2022 over 2021 due to both growth and mix
? of earning assets partially offset by an increase in the cost of
interest-bearing liabilities, and 4% in 2021 over 2020, due
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primarily to a lower cost of interest-bearing liabilities and growth in earning
assets, partially offset by lower yields on earning assets. The increase in
average earning assets in 2022 over 2021 was due primarily to purchases of
investment securities, partially offset by decreases in the average balance of
loans. We experienced an increase of
primarily driven by the purchase of
residential real estate loans, while all other loan categories declined due to
pay-downs, maturities, charge-offs and reduced credit line utilization. The
positive impact of average asset growth in 2022 along with a 15 bps increase in
yield was negatively impacted by a 39 bps increase in yield on interest bearing
liabilities due to certificates of deposits and shifting from a net sold
position to a net purchased position. The net interest margin in 2022 was 9 bps
lower than 2021.
The increase in average earning assets in 2021 over 2020 was due primarily to a
offset by decreases in all of the other loan categories. We experienced a
million decline in average mortgage warehouse line utilization, and a
million decline in commercial loans mostly due to the forgiveness of SBA PPP
loans. The increase in real estate loans was primarily driven by the purchase
of
? half of 2021. These loan purchases were made due to turnover of lending staff
while the Company recruited new lending teams across the footprint. The
positive impact of average asset growth in 2021 was augmented by a 10 bps
decrease in yield on interest bearing liabilities. These two favorable impacts
on margin were partially offset by a 46 basis point decline in yield on
interest earning assets. The net interest margin in 2021 was 39 bps lower than
2020. Net interest income has also been impacted by nonrecurring interest
items, which added
million in 2021 and
We recorded a provision for credit losses on loans and leases of
in 2022, as compared to a
provision in 2020. The 2022 provision for credit losses on loans and leases
loss benefit arose from the impact of
the year ending 2022. The elevated net charge-offs were mostly due to two loan
relationships; one dairy loan relationship with total charge-offs of
million and a single office building loan relationship that was sold at a
million discount due to an increased risk of default that would have likely led
to a prolonged collection period. Refer to the discussion on loan services
? expense below, for more detailed information regarding the dairy loan
relationship and events subsequent to year end 2022 regarding disposition of
those assets. The 2021 loan and lease loss benefit arose from our determination
of the appropriate level for our allowance for loan and lease losses and was
driven by declines in loan balances coupled with improved credit quality of
existing loan balances and the influence of lower historical loan and lease
losses. We considered the continued uncertainty surrounding the estimated
impact that COVID-19 has had on the economy and our loan customers overall,
making appropriate changes to the qualitative loss factors governing these
areas.
Noninterest income increased by
million or 7%, in 2021 over 2020. The increase in 2022 was primarily due to a
sale of investment securities, a
business partnership expenses, and
assets. These favorable variances were partially offset by a
unfavorable fluctuation in income on Bank-Owned Life Insurance (BOLI)
associated with deferred compensation plans. The increase in 2021 was primarily
? due to a
increase in life insurance proceeds, a decrease of
housing tax credit fund amortization, an increase of
valuation gain of restricted equity investments owned by the Company, partially
offset by a
securities and a
real estate assets in our low income housing tax credit funds that have reached
their life expectancy. Fluctuations in BOLI associated with deferred compensation plans contributed$0.2 million of the increase.
Noninterest expense increased by
2021, and increased by
? noninterest expense in 2022 was due mostly to a
and benefits expense primarily for new loan production teams and a
restitution payment to customers charged nonsufficient fund fees on
representments in the past five
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years, partially offset by lower legal costs, telecommunications, and a positive
variance in director's deferred compensation expense which is linked to the
unfavorable changes in bank-owned life insurance income. The increase in
noninterest expense in 2021 was due mostly to a
salaries and benefits expense, a
and a
premises expense also contributed to the difference.
The Company recorded income tax provisions of
income in 2022;
million, or 24% of pre-tax income in 2020. The increase in tax rate in 2022
? was due to the impact of the equity markets on our deferred compensation plan
creating non-deductible losses on BOLI used to offset deferred compensation.
This negative impact on tax rate was partially offset by an increase in
municipal bond income and lower overall pre-tax income in 2022.
Financial Condition Summary
The Company's assets totaled$3.6 billion atDecember 31, 2022 as compared to$3.4 billion atDecember 31, 2021 . Total liabilities were$3.3 billion atDecember 31, 2022 as compared to$3.0 billion at the end of 2021, and shareholders' equity totaled$325.7 million atDecember 31, 2022 compared to$362.5 million atDecember 31, 2021 . The following is a summary of key balance sheet changes during 2022.
Total assets increased by
? growth and the purchase of investment securities, primarily funded through an
increase in deposits and borrowed funds in 2022. Gross loans and leases increased$63.2 million , or 3%. This increase was
predominantly due to the purchase of
single family mortgage loan pools during the year. Organic loan production for
the year ending 2022 was
comparative period in 2021. These loan increases were offset by
? in loan maturities, charge-offs and payoffs, which occurred mostly during the
first nine months of the year. As interest rates began to rise, property values
increased and as a result some of our borrowers sold their real estate. We also
had a
and a decline in credit line utilization of
utilization includes a
utilization due to higher interest rates reducing the demand for mortgages.
Deposit balances reflect net growth of
? 2022 was primarily from an increase in time deposits of
by a decrease in other deposit balances of$101.1 million . Total capital decreased by$58.9 million , or 16%, ending the year with a
balance of
million unfavorable swing in accumulated other comprehensive income (loss), a
? one-time adjustment from the implementation of CECL on
repurchases. The declines were partially offset by
The remaining difference is related to stock options exercised and restricted
stock granted during the year.
Results of Operations
The Company earns income from two primary sources. The first is net interest
income, which is interest income generated by earning assets less interest
expense on deposits and other borrowed money. The second is noninterest income,
which primarily consists of customer service charges and fees but also comes
from non-customer sources such as BOLI and investment gains. The majority of the
Company's noninterest expense is comprised of operating costs that facilitate
offering a full range of banking services to our customers.
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Net Interest Income and Net Interest Margin
Net interest income was$109.6 million in 2022 as compared to$109.0 million in 2021 and$104.8 million in 2020. This equates to increases of 1% in 2022 and 4% in 2021. The level of net interest income we recognize in any given period depends on a combination of factors including the average volume and yield for interest-earning assets, the average volume and cost of interest-bearing liabilities, and the mix of products which comprise the Company's earning assets, deposits, and other interest-bearing liabilities. Net interest income is also impacted by the acceleration of net deferred loan fees and costs for loans paid off early (including SBA PPP loans forgiven), reversal of interest for loans placed on non-accrual status, and the recovery of interest on loans that had been on non-accrual and were paid off, sold, or returned to accrual status. The following table shows average balances for significant balance sheet categories and the amount of interest income or interest expense associated with each category for each of the past three years. The table also displays calculated yields on each major component of the Company's investment and loan portfolios, average rates paid on each key segment of the Company's interest-bearing liabilities, and our net interest margin for the noted periods. AVERAGE BALANCES AND RATES (Dollars in Thousands, Unaudited) Year Ended December 31, 2022 2021 2020 Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Assets Balance(1) Expense Rate(2) Balance(1) Expense Rate(2) Balance(1) Expense Rate(2) Investments: Interest-earning due from banks$ 91,420 $ 519 0.57%$ 269,932 $ 370 0.14%$ 25,228 $ 156 0.62% Taxable 808,750 25,789 3.19% 406,790 7,239 1.78% 379,024 8,199 2.16% Non-taxable 319,682 8,805 3.49% 258,472 6,218 3.05% 216,387 5,707 3.34% Total investments 1,219,852 35,113 3.07% 935,194 13,827 1.66% 620,639 14,062 2.51% Loans and Leases: (3) Real estate 1,831,874 77,708 4.24% 1,818,362 84,074 4.62% 1,610,686 79,175 4.92% Agricultural 31,565 1,176 3.73% 42,866 1,598 3.73% 47,299 1,887 3.99% Commercial 81,798 4,383 5.36% 153,880 7,828 5.09% 179,924 6,738 3.74% Consumer 4,301 638 14.83% 4,993 831 16.64% 6,584 1,069 16.24% Mortgage warehouse 54,606 2,695 4.94% 147,996 4,807 3.25% 221,319 7,135 3.22% Other 2,139 106 4.96% 1,485 111 7.47% 2,878 177 6.15% Total loans and leases 2,006,283 86,706 4.32% 2,169,582 99,249 4.57% 2,068,690 96,181 4.65% Total interest earning assets (4) 3,226,135 121,819 3.85% 3,104,776 113,076 3.70% 2,689,329 110,243 4.16% Other earning assets 15,685 15,043 13,103 Non-earning assets 243,340 208,665 207,590 Total assets$ 3,485,160 $ 3,328,484 $ 2,910,022
Liabilities and shareholders'
equity
Interest bearing deposits:
Demand deposits $ 195,192 $ 485 0.25% $ 143,171 $ 331 0.23% $ 121,867 $ 278 0.23%
NOW 532,692 322 0.06% 597,992 444 0.07% 497,984 388 0.08%
Savings accounts 476,128 278 0.06% 427,803 240 0.06% 336,620 221 0.07%
Money market 150,378 95 0.06% 140,365 111 0.08% 124,755 128 0.10%
Time deposits 317,806 4,914 1.55% 333,204 1,039 0.31% 436,806 2,687 0.62%
Brokered deposits 74,917 725 0.97% 81,041 225 0.28% 36,071 246 0.68%
Total interest bearing deposits 1,747,113 6,819 0.39% 1,723,576 2,390 0.14% 1,554,103 3,948 0.25%
Borrowed funds:
Federal funds purchased 16,980 693 4.08% 1,561 1 0.06% 1,918 4 0.21%
Repurchase agreements 110,387 319 0.29% 70,443 210 0.30% 34,614 137 0.40%
Short term borrowings 30,728 1,057 3.44% 3,625 2 0.06% 54,244 102 0.19%
Long term debt 49,172 1,713 3.48% 13,351 468 3.51% - - -
Subordinated debentures 35,387 1,603 4.53% 35,208 979 2.78% 35,031 1,217 3.47%
Total borrowed funds 242,654 5,385 2.22% 124,188 1,660 1.34% 125,807 1,460 1.16%
Total interest bearing
liabilities 1,989,767 12,204 0.61% 1,847,764 4,050 0.22% 1,679,910 5,408 0.32%
Noninterest bearing demand
deposits 1,121,060 1,064,119 862,274
Other liabilities 58,538 59,723 39,510
Shareholders' equity 315,795 356,878 328,328
Total liabilities and
shareholders' equity $ 3,485,160 $ 3,328,484 $ 2,910,022
Interest income/interest earning
assets 3.85% 3.70% 4.15%
Interest expense/interest earning
assets 0.38% 0.14% 0.20%
Net interest income and margin(5) $ 109,615 3.47% $ 109,026 3.56% $ 104,835 3.95%(1) Average balances are obtained from the best available daily or monthly data
and are net of deferred fees and related direct costs.
(2) Yields and net interest margin have been computed on a tax equivalent basis.
(3) Loans are gross of the allowance for possible loan and lease losses. Net loan
fees have been included in the calculation of interest income. Net loan fees
(costs) and loan acquisition FMV amortization were
million, and
2020 respectively.
(4) Non-accrual loans are slotted by loan type and have been included in total
loans for purposes of total interest earning assets.
(5) Net interest margin represents net interest income as a percentage of average
interest-earning assets (tax-equivalent).
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The Volume and Rate Variances table below sets forth the dollar difference for
the comparative periods in interest earned or paid for each major category of
interest-earning assets and interest-bearing liabilities, and the amount of such
change attributable to fluctuations in average balances (volume) or differences
in average interest rates. Volume variances are equal to the increase or
decrease in average balances multiplied by prior period rates, and rate
variances are equal to the change in rates multiplied by prior period average
balances. Variances attributable to both rate and volume changes, calculated by
multiplying the change in rates by the change in average balances, have been
allocated to the mix variance.
Volume & Rate Variances
(dollars in thousands)
Years Ended December 31,
2022 over 2021 2021 over 2020
Increase(decrease) due to Increase(decrease) due to
Assets: Volume Rate Mix Net Volume Rate Mix Net
Investments:
Federal funds sold/due
from time $ (245) $ 1,162 $ (768) $
149
7,153 5,733 5,664 18,550 602 (1,455) (107) (960) Non-taxable
1,473 901 213 2,587 1,110 (500) (99) 511 Total investments
8,381 7,796 5,109 21,286 3,229 (2,080) (1,384) (235)
Loans and leases: Real estate 625 (6,939) (52)
(6,366) 10,209 (4,704) (606) 4,899 Agricultural
(421) (1) - (422) (177) (124) 12 (289)
Commercial (3,666) 417 (196) (3,445) (975) 2,415 (350) 1,090
Consumer (115) (91) 13 (193) (259) 27 (6) (238)Mortgage warehouse (3,033) 2,497 (1,576) (2,112) (2,365) 54 (17) (2,328) Other 49 (38) (16) (5) (86) 38 (18) (66)
Total loans and leases (6,561) (4,155) (1,827) (12,543) 6,347 (2,294) (985) 3,068 Total interest earning assets
$ 1,820 $ 3,641 $ 3,282 $ 8,743 $ 9,576 $ (4,374) $ (2,369) $ 2,833 Liabilities: Interest bearing deposits: Demand$ 120 $ 25 $ 9 $ 154 $ 49 $ 3 $ 1 $ 53 NOW (48) (83) 9 (122) 78 (18) (4) 56 Savings accounts 27 10 1 38 60 (32) (9) 19 Money market 8 (22) (2) (16) 16 (29) (4) (17) Time deposits (48) 4,113 (190) 3,875 (637) (1,325) 314 (1,648) Brokered deposits (17) 559 (42)
500 307 (146) (182) (21) Total interest bearing deposits
42 4,602 (215) 4,429 (127) (1,547) 116 (1,558)
Borrowed funds:
Borrowed funds:
Federal funds purchased 10 63 619 692 (1) (3) 1 (3)
Repurchase agreements 119 (6) (4) 109 142 (34) (35) 73
Short term borrowings 15 123 917 1,055 (95) (72) 67 (100) Long term debt 1,256 (3) (8) 1,245 - - 468 468 TRUPS 5 616 3 624 6 (243) (1) (238) Total borrowed funds 1,405 793 1,527 3,725 52 (352) 500 200 Total interest bearing liabilities 1,447 5,395 1,312
8,154 (75) (1,899) 616 (1,358) Net interest income
$ 373 $ (1,754) $ 1,970 $
589
Net interest income in 2022 as compared to 2021 was impacted by a favorable volume variance of$0.4 million and a favorable mix variance of$2.0 million , partially offset by an unfavorable rate variance of$1.8 million . For 2021 relative to 2020, net interest income reflects a favorable volume variance of$9.6 million partially offset by an unfavorable rate 37
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variance of$2.5 million and an unfavorable mix variance of$3.0 million . The 2022 versus 2021 volume variance is due mostly to increases in average balances, resulting from growth in investment portfolio balances, mostly in floating rate commercial loan obligations, partially offset by a decline in average loan balances. The 2021 versus 2020 volume variance is due mostly to increases in average balances, resulting from the organic growth in commercial real estate loans, as well as increased investment portfolio balances. The 2021 versus 2020 volume variance is due mostly to increases in average balances, resulting from the organic growth in commercial real estate loans, growth in commercial loans due to our participation in the SBA PPP program and higher utilization of mortgage warehouse lines. Given the low rate environment, loan demand for our mortgage warehouse lines had increased, as demonstrated by the$3.7 million favorable volume variance. The Company's net interest margin, which is tax-equivalent net interest income as a percentage of average interest-earning assets declined by 9 basis points to 3.47% in 2022, and declined by 39 basis points to 3.56% in 2021 as compared to 2020. Thenet interest margin compression was caused by an unfavorable rate variance of$1.8 million since the weighted average yield on interest-earning assets increased by only 15 basis points and the weighted average cost of interest-bearing liabilities increased by 39 basis points in 2022 compared to 2021. There was also a favorable mix variance of$2.0 million primarily from the purchase of CLOs at floating higher interest rates, which was partially offset by a decrease in loan and lease balances and an increase in higher cost interest bearing liabilities in 2022 compared to 2021. The decrease in 2021 was due to the lower rate environment and its impact on all debt securities. Rates paid on non-maturity deposits were approximately the same in 2022 but declined for 2021 over 2020. Interest bearing demand accounts increased 2 basis points in 2022 but were the same in 2021 over 2020. There was a 2 basis point decrease on money market accounts in 2022 over 2021 and in 2021 over 2020. Since theFederal Open Markets Committee of theFederal Reserve System raised the federal funds target rate 425 basis points throughout 2022, both customer time and brokered deposits along with other borrowed funds were negatively impacted. The weighted average cost of interest-bearing liabilities increased 39 basis points in 2022 and declined 10 basis points in 2021. Customer time deposit rates in 2022 increased 124 basis points due to a floating rate time deposit product offered by the Bank along with a 69 basis point increase in the rate paid on brokered deposits. The Bank offers a time deposit product with a rate set to a spread to prime. The current spreads range from prime minus 400 bps to prime minus 325 bps. Given the significant increase in the prime rate during 2022, the interest on such deposits increased during 2022 coupled with additional balances added to such accounts. The 2021 decrease of 31 basis points was due to the relatively short duration of our time deposit portfolio in a historically low-rate environment in 2021. Overnight borrowings and adjustable-rate trust-preferred securities ("TRUPS") are also tied to short-term rates which increased during 2022, resulting in an unfavorable increase of 88 basis points. During 2021 the cost of these same overnight borrowings and TRUPS were relatively low. During the year, adjustments to interest income occur due to the following adjustments: interest income recovered upon the resolution of nonperforming loans, the reversal of interest income when a loan is placed on non-accrual status, and accelerated fees or prepayment penalties recognized for early payoffs of loans. Such adjustments totaled$1.6 million in 2022,$3.5 million in 2021, and$1.2 million in 2020. Further, discount accretion on loans from whole-bank acquisitions enhanced our net interest margin by approximately one basis point in 2022, two basis points in 2021, and two basis points in 2020.
Provision for Loan and Lease Losses and Provision for Credit Losses
Credit risk is inherent in the business of making loans. The Company sets aside an allowance for credit losses on loans and leases, a contra-asset account, through periodic charges to earnings which are reflected in the income statement as the provision for loan and lease losses. The Company recorded a provision for credit losses on loans and leases of$10.9 million in 2022; a benefit for loan and lease losses of$3.7 million in 2021, and a provision for loan and lease losses of$8.6 million in 2020. The Company was subject to the adoption of the Current Expected Credit Loss ("CECL") accounting method under FASB Accounting Standards Update 2016-03 and related amendments, Financial Instruments - Credit Losses (Topic 326) and implemented the update onJanuary 1, 2022 . Upon implementation the Company recorded a$10.4 million increase in the allowance for credit losses, which included a$0.9 million reserve for unfunded commitments as an adjustment to equity, net of deferred taxes. The Company's$14.5 million unfavorable increase for the year ending 2022 compared to the same period in 2021 is primarily due to the impact of$11.5 million in net charge-offs during the year ending 2022. The elevated net charge-offs were mostly due to two loan relationships; one dairy loan relationship with total charge-offs of$8.7 million and a single office building loan relationship that was sold at a$1.9 million discount due to an increased risk of default that would have likely led to a prolonged collection period. 38
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The Company's$12.2 million , favorable decline in provision for loan and lease losses for the year ending 2021 compared to the same period in 2020 is due mostly to lower historical loan loss rates, a decline in outstanding balances on loans, a change in the mix of loans, and net year-to-date 2021 recoveries of previously charged-off loan balances. During 2021, management adjusted its qualitative risk factors under our current incurred loss model for improved economic conditions, improvements in the severity and volume of past due loans, and a reduction in the level of concentrations of credit in non-owner occupied real estate loans. The growth in the provision for loan and lease losses in 2020, was due to the strong organic non-owner occupied commercial real estate loan growth generated in the second half of 2020 and the continued uncertainty surrounding the estimated impact that COVID-19 has had on the economy. The provision was also impacted by downgrades of certain loans deferred under section 4013 of the CARES Act, including 10 loans for$1.4 million placed on non-accrual at the end of the deferral period. Management evaluated its qualitative risk factors under the current incurred loss model and adjusted these factors for economic conditions, changes in the mix of the portfolio due to loans subject to a payment deferral, potential changes in collateral values due to reduced cash flows, and external factors such as government actions and the impact that COVID-19 may have on our customers. With the provision for credit losses on loans and leases recorded in 2022 we were able to maintain our allowance for credit losses on loans and leases at a level that, in Management's judgment, is adequate to absorb probable credit losses on loans and leases related to individually identified loans as well as probable credit losses in the remaining loan portfolio. Specifically identifiable and quantifiable loan and lease losses are immediately charged off against the allowance. The Company recorded net loan and lease charge offs of$11.5 million in 2022. The Company experienced net loan and lease recoveries of$0.2 million in 2021 and net loan and lease charge-offs of$0.7 million in 2020. The provision for credit losses on loans and leases for 2022 was elevated due to the impact of two loan relationships as previously discussed above. The loan and lease loss (benefit) provision for 2021 and 2020 were favorably impacted by the following factors: most charge-offs were recorded against pre-established reserves, which alleviated what otherwise might have been a need for reserve replenishment; loss rates for most loan types have been declining, thus having a positive impact on general reserves required for performing loans; and, new loans booked have been underwritten using continued tighter credit standards. The Company's policies for monitoring the adequacy of the allowance and determining loan amounts that should be charged off, and other detailed information with regard to changes in the credit allowance, are discussed in Note 2 to the consolidated financial statements and below under "Allowance for Credit Losses on Loans and Leases." The process utilized to establish an appropriate allowance for credit losses on loans and leases can result in a high degree of variability in the Company's provision for credit losses on loans and leases, and consequently in our net earnings. 39
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Noninterest Revenue and Operating Expense
The table below sets forth the major components of the Company's noninterest
revenue and operating expense for the years indicated, along with relevant
ratios:
Non-Interest Income/Expense
(dollars in thousands)
Year Ended December 31,
2022 2021 2020
NONINTEREST INCOME:Service charges on deposit accounts$ 12,535 $ 11,846 $ 11,765 Debit card fees 8,533 8,485
7,023
Other service charges and fees 2,872 2,939
2,964
Bank owned life insurance (loss) income (996) 2,648
2,412
Gain on sale of securities 1,487 11
390
Gain (loss) on tax credit investment 253 (524)
(1,189) Other 6,086 2,674 2,785 Total noninterest income 30,770 28,079 26,150
As a % of average interest-earning assets 0.95% 0.90%
0.97%
OTHER OPERATING EXPENSES: Salaries and employee benefits 47,053 42,431
40,178
Occupancy costs
Furniture and equipment 1,847 1,720 2,028
Premises 7,871 8,117 7,814Advertising and promotion costs 1,729 1,521
1,889
Data processing costs 6,202 5,890 4,661
Deposit services costs 9,492 9,049 8,483
Loan services costs
Loan processing 550 501 879
Foreclosed assets 84 72 253
Other operating costsTelephone and data communications 1,563 2,013
1,775
Postage and mail 373 308 321
Other 2,725 2,176 1,647
Professional services costs
Legal and accounting 2,133 4,794 1,990Other professional services costs 2,005 4,015
2,990
Stationery and supply costs 486 345 446
Sundry & tellers 690 604 558
Total other operating expense $ 84,803 $ 83,556 $ 75,912 As a % of average interest-earning assets 2.63% 2.69%
2.82%
Net noninterest income as a % of average interest-earning assets (1.67%) (1.79%)
(1.85%)
Efficiency ratio (1) (2) 60.16% 59.92%
57.18%
(1) Tax Equivalent
(2) The efficiency ratio is a non-GAAP measure and is a calculation of
noninterest expense as a percentage of the sum of net interest income and
noninterest income excluding net gains (losses) from securities and bank
owned life insurance income.
Noninterest income in 2022 increased$2.7 million , or 10% as compared to an increase of$1.9 million , or 7%, in 2021. Total noninterest income was 0.95% of average interest-earning assets in 2022 as compared to a ratio of 0.90% in 2021 and 0.97% in 2020. The ratio increased in 2022 due to a 10% increase in noninterest income. 40 Table of Contents The principal component of the Company's noninterest revenue, service charges on deposit accounts, increased by$0.7 million , or 6%, in 2022 as compared to 2021 and by$0.1 million , or 1%, in 2021 over 2020. This line item is primarily driven by the volume of transaction accounts. As a percent of average transaction account balances, service charge income was 1.0% in 2022, 1.0% in 2021 and 1.9% in 2020. This line item consists of a variety of fees including service charges on corporate accounts, treasury management fees, charges on corporate and consumer accounts including treasury management fees, ATM fees, overdraft income, and monthly service charges on certain accounts. Overdraft income on both consumer and corporate accounts totaled$4.6 million (net of restitution) in 2022;$4.9 million in 2021 and$5.1 million in 2020. Debit card fees consists of interchange fees from our customers' use of debit cards for electronic funds transactions. This category was relatively flat in 2022 and 2021 but increased by$1.5 million , or 21%, in 2021 as compared to 2020. The increases in 2021 were primarily a result of increased usage of debit cards by our customers as 2020 was impacted by the pandemic. Other service charges and fees decreased by$0.1 million , or 2% in 2022 over 2021 and was mostly unchanged in 2021 over 2020.. This account includes certain transaction related fees including merchant income, currency orders, safe deposit box fees, and wire fees. BOLI income generally fluctuates based on the market due to the Company's "separate account" BOLI being invested in assets that closely mirror investments choices of deferred compensation participants. There is also a part of BOLI that is "general account" and receives a standard crediting rate from the carrier which remains relatively stable year over year. However, the separate-account BOLI used to offset deferred compensation fluctuates significantly from year-to-year as many of our deferred compensation participants are invested in equity-index style funds. In the comparative years ending 2022 over 2021, BOLI income decreased$3.6 million , however in 2021 over 2020, BOLI income increased by$0.2 million or 10%. The Company had$9.0 million invested in separate account BOLI atDecember 31, 2022 . This separate account BOLI closely matched participant-directed investment allocations that can include equity, bond, or real estate indices, and are thus subject to gains or losses which often contribute to significant fluctuations in income (and associated expense accruals). Net losses on separate account BOLI totaled$2.0 million in 2022 as compared to gains of$1.7 million in 2021, and$1.4 million in 2020. This resulted in unfavorable variances of$3.7 million for the comparative years ending 2022 as compared to 2021 and favorable variances of$0.2 million for the comparative years ending 2021 as compared to 2020. As noted, gains and losses on separate account BOLI are related to expense accruals or reversals associated with participant gains and losses on deferred compensation balances, thus the overall net impact on taxable income tends to be minimal. The Company's books also reflect a net cash surrender value for general account BOLI of$43.2 million atDecember 31, 2022 and 2021. General account BOLI produces income that is used to help offset expenses associated with executive salary continuation plans, director retirement plans and other employee benefits. Interest credit rates on general account BOLI do not change frequently so the income has typically been fairly consistent with$1.0 million , of general account BOLI income recorded for all three years endingDecember 31, 2022 , 2021, and 2020. The Company recognized a$1.5 million gain on the sale of investment securities in 2022, as compared to a nominal gain in 2021 and a$0.4 million gain in 2020. In 2022 the Company restructured the securities portfolio to decrease effective duration, taking advantage of slight rallies in theTreasury market in early and late 2022. In 2020 of the Company sold debt securities, in an effort to restructure the portfolio primarily to eliminate small residual balances and reduce potential credit risk on certain municipal holdings. The Gain(Loss) on tax credit investment reflects pass-through expenses associated with our investments in low-income housing tax credit funds and other limited partnerships. Those expenses, which are netted out of revenue, decreased by$0.8 million , or 148%, in 2022 as compared to 2021, and increased by$0.7 million , or 56%, in 2021 as compared to 2020. The variance in 2022 is due to a favorable adjustment of expenses, while in 2021 we had funds that had expired and had reached the end of their useful tax benefit life. The other category, increased$3.4 million to$6.1 million in 2022 and decreased to$0.8 million from$1.7 million in 2021. In 2022 we had non-recurring gains from the sale of other assets including$2.6 million from the sale of Visa B shares. The primary reason for the decrease in 2021 was from a 2020 non- recurring gain as discussed in the prior year comparison, but was partially offset by a gain from life insurance proceeds and the sale of fixed assets. 41
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Total operating expense, or noninterest expense, increased by$1.2 million , or 1%, in 2022 as compared to 2021, and by$7.6 million , or 10%, in 2021 as compared to 2020. The increase in 2022 is due mostly to a$4.6 million increase in salary and benefits expense and a$0.7 million restitution payment to customers charged nonsufficient fund fees on representments in the past five years, partially offset by lower legal costs, telecommunications, and a positive variance in director's deferred compensation expense which is linked to the unfavorable changes in bank-owned life insurance income The primary increase in 2021 was in legal and accounting costs as discussed in further detail below.
Noninterest expense as a percent of average interest-earning assets trended down each year. This ratio was 2.6% in 2022, 2.7% in 2021 and 2.8% in 2020.
The largest component of noninterest expense, salaries, and employee benefits increased$4.6 million or 11% in 2022 as compared to 2021, and increased$2.3 million , or 6% in 2021 as compared to 2020. The increase in 2022 was due mostly to the strategic hiring of new loan production teams, increases to the Company's minimum wage, and standard annual increases to our employee's base compensation. The increase in 2021, was mostly due to the$2.3 million decrease in deferred loan origination salaries associated with successful loan originations which are accounted for in accordance with FASB guidelines on the recognition and measurement of non-refundable fees and origination costs for lending activities, and accruals associated with employee deferred compensation plans. Loan origination salaries that were deferred from current expense for recognition over the life of related loans totaled$2.3 million in 2022,$1.1 million in 2021, and$3.3 million for 2020. Employee deferred compensation expense accruals totaled$0.1 million in 2022, and$0.2 million in 2021, and 2020. As noted above in our discussion of BOLI income, employee deferred compensation plan accruals are related to separate account BOLI income and losses, as are directors deferred compensation accruals that are included in "other professional services," and the net income impact of all income/expense accruals related to deferred compensation is usually minimal. Salaries and benefits were 55% of total operating expense in 2022, relative to 51% in 2021 and 53% in 2020. The number of full-time equivalent staff employed by the Company totaled 491 at the end of 2022, as compared to 480 atDecember 31, 2021 and 501 atDecember 31, 2020 . The increase in FTE during 2022 was due to the strategic hiring of lending and management staff. Staff attrition throughout 2021, without the need for immediate replacements due to temporary branch lobby closures or limited branch lobby hours attributed to the COVID-19 pandemic, was the primary reason for the FTE decline. As branch lobbies resumed normal operating hours and public access, during the summer of 2021, full-time equivalent staff were expected to increase, however finding talent was extremely challenging not only for the Company but for the entire industry. 2021 was the year of the "Great Resignation" with over 4.4 million people leaving their jobs according to theBureau of Labor Statistics . Total rent and occupancy expense, including furniture and equipment costs, decreased$0.1 million in 2022 as compared to 2021 due to the consolidation of five branch facilities in 2021. For 2021 and 2022 rent and occupancy expense was approximately the same. Advertising and promotion costs increased$0.2 million or 14%, in 2022 over 2021 and decreased by 19% to$1.5 million in 2021 as compared to 2020. The increase in 2022 was due to the resumption of special events as COVID-19 restrictions were lifted. The decrease in 2021 came from the cessation of special events and in-branch marketing campaigns necessitated by the COVID-19 pandemic. Data processing costs increased by$0.3 million or 5% in 2022 as compared to 2021 and increased by$1.2 million , or 26%, in 2021 as compared to 2020. The increase in 2022 was primarily from an increase in core processing costs. In late 2022, the Company renegotiated its core processing contract and expects annual savings from this renegotiation of approximately$1.0 million . The increase in 2021 was due to higher disaster recovery and data back-up costs as a result of outsourcing this work in late 2020 rather than performing it in-house, higher core processing costs as we expand our data warehousing capabilities, and higher loan management software costs for the expansion of digital loan Platform. Deposit services costs increased by$0.4 million or 5% in 2022 as compared to 2021 and increased by$0.6 million , or 7%, in 2021 over 2020. Deposit costs have been impacted in both 2022 and 2021, by increases in debit card processing due to higher customer activity levels and increased utilization of armored car services. These increases in both years were partially offset by decreases in ATM servicing costs as we replaced most of our ATMs throughout 2021 with newer models 42 Table of Contents
that require less maintenance. Additionally, in the second quarter of 2023, the Company is expecting to convert its debit card processing to a new provider which should result in lower processing costs.
Loan services costs are comprised of loan processing costs, and net costs associated with foreclosed assets. Loan processing costs, which include expenses for property appraisals and inspections, loan collections, demand and foreclosure activities, loan servicing, loan sales, and other miscellaneous lending costs, increased by$0.1 million or 10% in 2022 as compared to 2021 and decreased by$0.6 million , or 49%, in 2021 as compared to 2020. The increase in 2022 was primarily due to an increase of$0.1 million in the provision for unfunded commitments. The decrease in 2021 was due to smaller amounts in nearly every category of loan servicing and precipitated by the reduction in the volume of loans made by the Company. Foreclosed assets costs are comprised of write-downs taken subsequent to reappraisals, OREO operating expense (including property taxes), and losses on the sale of foreclosed assets, net of rental income on OREO properties and gains on the sale of foreclosed assets. There were$0.1 million in expenses in both 2022 and 2021 as compared to$0.03 million in 2020. These costs fluctuate based on market conditions of OREO relative to our holding value, the nature of the underlying properties and the volume of OREO properties in inventory. At the end of 2022, the Company had no OREO properties remaining in inventory. Subsequent to year end,$18.1 million of nonaccrual loans within the aforementioned dairy relationship were foreclosed upon and were moved to other real estate owned or other foreclosed assets at net realizable value. The Company sold a portion of such assets in the first quarter of 2023 for$7.7 million , which constituted book value. The Company continues to actively work with interested buyers to sell the remaining assets of the dairy. The "other operating costs" category includes telecommunications expense, postage, and other miscellaneous costs. Telecommunications expense decreased by 22% to$1.6 million in 2022 as compared to 2021, and increased by 13% to$2.0 million in 2021 over 2020. The telecommunications decrease in 2022 was due to the reduction of redundancy in lines during 2021, while the increase in 2021 was due to the improvement of our data infrastructure and a certain amount of redundancy during the transition. Postage expense increased by$0.1 million or 21% in 2022 as compared to 2021 and was slightly lower in 2021 as compared to 2020. The increase in 2022 was due to deposit account disclosure mailings from the change in our overdraft and NSF fee practices. The decrease in 2021 and 2020 was due to concentrated efforts to decrease our utilization of overnight mail services and increase usage of digital technologies. The "Other" category under other operating costs increased by$0.5 million or 25% in 2022 as compared to 2021 and increased by$0.5 million , or 32% in 2021 as compared to 2020. The increase in 2022 were primarily due to restitution payments to customers charged nonsufficient fund fees on representments in the past five years. The increase in 2021 were mostly due to higher consulting costs and expenses on discontinued branch leases. Total Professional Services costs, which includes directors fees, decreased by$4.7 million or 53% in 2022 as compared to 2021 and increased by$3.8 million , or 77%, in 2021 as compared to 2020. Professional Services costs consists of legal and accounting, acquisition, and other professional services costs. Legal and Accounting costs decreased by$2.7 million or 56% in 2022 as compared to 2021 and increased by$2.8 million , or 141% in 2021 as compared to 2020. The decrease in 2022 was mostly due to a decrease in legal costs and related legal reserves, along with lower costs related to certain audit functions that were previously outsourced. The increase in 2021 was mostly due to an increase in legal costs, related legal reserves, and additional costs related to the outsourcing of certain audit functions. Other professional services costs includeFDIC assessments and other regulatory expenses, directors' costs, and certain insurance costs among other things. This category decreased by$2.0 million or 50% in 2022 as compared to 2021 and increased by$1.0 million or 34%, in 2021 as compared to 2020. The decrease in 2022 was mostly from the change in director's deferred compensation expense which is linked to the fluctuation in BOLI income. The increase in 2021 was due to an increase inFDIC assessment expenses, increased director's equity compensation expense, and professional services costs. There was also a favorable swing in the director's deferred compensation expense for both 2022 and 2021, which is mostly offset by higher BOLI income, as described above under the separate account BOLI. Stationery and supply costs increased by$0.1 million or 41% in 2022 as compared to 2021 and decreased by$0.1 million , or 23%, in 2021 as compared to 2020. The increase in 2022 was primarily from startup costs of new loan production offices while the decrease in 2021 over 2020, is mostly due to efficiencies gained as a result of movement towards a digital working environment and less reliance
on
paper.
43
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Sundry and teller costs were $0.7 million in 2022, $0.6 million in 2021 and
2020. In 2022, as well as 2021 and 2020, debit card losses are elevated and
trending upwards consistent with the higher volume of debit card transactions.
These costs are expected to decline in 2023 with the change to a new debit card
processor during the second quarter, although no assurance can be given that
this will be the case.
The Company's tax-equivalent overhead efficiency ratio was 60.2% in 2022, 59.9%
in 2021, and 57.2% in 2020. The overhead efficiency ratio represents total
noninterest expense divided by the sum of fully tax-equivalent net interest and
noninterest income, with the provision for loan and lease losses and investment
gains/losses excluded from the equation. The Company is continually working on
efforts to control costs, as well as higher income which is the denominator of
the equation. Several strategic projects in 2023 are expected to have a positive
impact on this ratio.
Income Taxes
Our income tax provision was $11.3 million , or 25.1% of pre-tax income in 2022,
$14.2 million , or 24.8% of pre-tax income in 2021 and $11.1 million , or 23.8% of
pre-tax income in 2020. The tax accrual rate was higher in 2022 and 2021 due to
a lower proportion of non-taxable income primarily due to losses on
separate-account BOLI described above.
The Company sets aside a provision for income taxes on a monthly basis. The
amount of that provision is determined by first applying the Company's statutory
income tax rates to estimated taxable income, which is pre-tax book income
adjusted for permanent differences, and then subtracting available tax credits.
Permanent differences include but are not limited to tax-exempt interest income,
BOLI income or loss, and certain book expenses that are not allowed as tax
deductions. The Company's investments in state, county and municipal bonds
provided $8.8 million of federal tax-exempt income in 2022, $6.2 million in
2021, and $5.7 million in 2020. Moreover, in addition to life insurance proceeds
of $0.4 million in both 2022 and 2021 and $0.07 million in 2020, net increases
in the cash surrender value of bank-owned life insurance added $2.6 million to
tax-exempt income in 2021; and $2.4 million in 2020, but reduced tax-exempt
income by $1.0 million in 2022.
Our tax credits consist primarily of those generated by investments in
low-income housing tax credit funds. We had a total of $10.1 million invested in
low-income housing tax credit funds as of December 31, 2022 and $2.9 million as
of December 31, 2021 , which are included in other assets rather than in our
investment portfolio. Those investments have generated substantial tax credits
over the past few years, with about $0.5 million in credits available for each
of the three tax years: 2022, 2021, and 2020. The credits are dependent upon the
occupancy level of the housing projects and income of the tenants and cannot be
projected with certainty. Furthermore, our capacity to utilize them will
continue to depend on our ability to generate sufficient pre-tax income. We plan
to invest in additional tax credit funds in the future, but if the economics of
such transactions do not justify continued investments, then the level of
low-income housing tax credits will taper off in future years until they are
substantially utilized by the end of 2037. That means that even if taxable
income stayed at the same level through 2037, our tax accrual rate would
gradually increase.
Financial Condition
Assets totaled$3.6 billion atDecember 31, 2022 , an increase of$237.6 million , or 7%, for the year. Assets increased in 2022 primarily a result of a$298.5 million increase in investment securities, a$63.2 million increase in gross loans and leases, a$67.6 million increase in other assets, net of a$180.4 million decrease in cash and due from banks. Deposits were up$64.6 million , or 2%. Total capital decreased by$58.9 million , or 16%. The major components of the Company's balance sheet are individually analyzed below, along with information on off-balance sheet activities and exposure.
Loan and Lease Portfolio
The Company's loan and lease portfolio represents the single largest portion of
invested assets, substantially greater than the investment portfolio or any
other asset category, and the quality and diversification of the loan and lease
portfolio are important considerations when reviewing the Company's financial
condition.
44
Table of Contents
The Loan and Lease Distribution table that follows sets forth by loan type the
Company's gross loans and leases outstanding, and the percentage distribution in
each category at the dates indicated. The balances for each loan type include
nonperforming loans, if any, but do not reflect any deferred or unamortized loan
origination, extension, or commitment fees, or deferred loan origination costs.
Although not reflected in the loan totals below and not currently comprising a
material part of our lending activities, the Company also occasionally
originates and sells, or participates out portions of, loans to non-affiliated
investors.
Loan and Lease Distribution
(dollars in thousands)
As of December 31,
2022 2021 2020 2019 2018
Real estate:
1-4 family residential
construction $ - $ 21,368 $ 48,490 $ 105,715 $ 105,187
Other construction/land 18,357 25,188 71,443 91,010 108,268
1-4 family - closed-end 417,092 290,236 140,280 200,742 237,530
Equity lines 21,638 26,915 38,472 50,091 56,932
Multi-family residential 91,485 53,385 61,834 54,432 54,893
Commercial real estate - owner
occupied 323,895 334,581 343,607 344,412 302,052
Commercial real estate -
non-owner occupied 891,197 880,279 1,059,685 412,454 438,349
Farmland 113,594 106,765 129,968 144,063 151,513
Total real estate 1,877,258 1,738,717 1,893,779 1,402,919 1,454,724
Agricultural 28,193 34,098 45,001 48,231 49,162
Commercial and industrial 77,695 109,213 207,784 117,230 129,712
Mortgage warehouse lines 65,439 101,184 307,679 189,103 91,813
Consumer loans 4,232 4,649 5,721 7,978 9,119
Total loans and leases 2,052,817 1,987,861 2,459,964 1,765,461 1,734,530
Allowance for credit losses on
loans (23,060) (14,256) (17,738) (9,923) (9,750)
Total loans and leases, net $ 2,029,757 $ 1,973,605 $ 2,442,226 $ 1,755,538 $ 1,724,780
Percentage of Total Loans and
Leases
Real estate:
1-4 family residential
construction 0.00% 1.07% 1.97% 5.99% 6.06%
Other construction/land 0.89% 1.27% 2.90% 5.16% 6.24%
1-4 family - closed-end 20.32% 14.60% 5.70% 11.37% 13.69%
Equity lines 1.05% 1.35% 1.56% 2.84% 3.28%
Multi-family residential 4.46% 2.69% 2.51% 3.08% 3.16%
Commercial real estate - owner
occupied 15.78% 16.83% 13.97% 19.51% 17.41%
Commercial real estate -
non-owner occupied 43.42% 44.28% 43.08% 23.36% 25.28%
Farmland 5.53% 5.37% 5.28% 8.16% 8.74%
Total real estate 91.45% 87.47% 76.98% 79.45% 83.88%
Agricultural 1.37% 1.72% 1.83% 2.73% 2.83%
Commercial and industrial 3.78% 5.48% 8.45% 6.64% 7.48%
Mortgage warehouse lines 3.19% 5.09% 12.51% 10.71% 5.29%
Consumer loans 0.21% 0.23% 0.23% 0.45% 0.53%
100.01% 100.00% 100.00% 100.00% 100.00%
The Company's loan and lease balances increased in 2022, mostly from the
purchase of high quality jumbo mortgage pools early in the year. The decline in
2021 was due to management actions to reduce non-owner occupied commercial real
estate concentrations after a period of strong growth in 2020, a decline in
utilization of mortgage warehouse lines, and SBA PPP loan forgiveness.
Conversely, the Company experienced net growth in each of the three years from
2018 through 2020, despite fluctuations caused by variability in outstanding
balances on mortgage warehouse lines, reductions associated with the resolution
of impaired loans, weak loan demand in some years, tightened underwriting
standards, and
45
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intense competition. This growth over these three years was due in part to acquisitions, as well as whole loan purchases and participations, and participation in the SBA PPP loan program in 2020.
For 2022, the Company had$173.1 million in loan purchases which were designed as a bridge to organic loan growth with the recent hiring of new ag loan production teams. These new ag loan production teams were hired to develop relationships within our footprint for both loans and deposits. These new loans should provide additional diversification of the loan portfolio and provide floating rate loan products which complement the fixed rate real estate loans. As demonstrated by the expansion of the lending teams both in 2022 and 2021, management remains focused on organic loan growth which totaled$292.2 million during 2022. No assurance can be provided with regard to future net growth in aggregate loan balances given occasional surges in prepayments, fluctuations in mortgage warehouse lending; and maintaining concentrations in certain sectors within our risk management parameters.
The overall decline in real estate secured loans during 2021 was partially
offset by an increase of
For 2020, gross loans were up by$700.5 million , or 40%, due largely to$649.9 million of organic growth in commercial real estate non-owner occupied loans. This growth was a deliberate effort of our Northern and Southern market loan production teams and was facilitated by the opening of a loan production office inNorthern California (Roseville, California ) and an expansion of the loan team inSouthern California . This growth was complimented by an increase of$118.6 million , or 63% in mortgage warehouse lines and an increase of$93.5 million , or 82% in commercial and industrial loans due to our participation in the SBA PPP loan program. Multi-family residential loans increased$7.4 million or 14%. These increases were partially offset by declines in all other loan categories. As a part of their regulatory oversight, the federal regulators have issued guidelines on sound risk management practices with respect to a financial institution's concentrations in commercial real estate ("CRE") lending activities. These guidelines were issued in response to the agencies' concerns that rising CRE concentrations might expose institutions to unanticipated earnings and capital volatility in the event of adverse changes in the commercial real estate market. The guidelines identify certain concentration levels that, if exceeded, will expose the institution to additional supervisory analysis with regard to the institution's CRE concentration risk. The guidelines, as amended, are designed to promote appropriate levels of capital and sound loan and risk management practices for institutions with a concentration of CRE loans. In general, the guidelines, as amended, establish the following supervisory criteria as preliminary indications of possible CRE concentration risk: (1) the institution's total construction, land development and other land loans represent 100% or more of Tier 1 risk-based capital plus allowance for credit losses loans and leases; or (2) total CRE loans as defined in the regulatory guidelines represent 300% or more of Tier 1 risk-based capital plus allowance for credit losses on loans and leases, and the institution's CRE loan portfolio has increased by 50% or more during the prior 36 month period. This ratio was 249% atDecember 31, 2021 and declined to 246% atDecember 31, 2022 . AtDecember 31, 2022 , the Bank's total construction, land development and other land loans represented 5% of Tier 1 risk-based capital plus allowance for credit losses on loans and leases. The Bank believes as indicated by the guidelines that it does not have a concentration in CRE loans atDecember 31, 2022 . The Bank and its board of directors have discussed the guidelines and believe that the Bank's underwriting policies, management information systems, independent credit administration process, and monitoring of real estate loan concentrations are sufficient to address the risk management of CRE under the guidelines. 46 Table of Contents Loan and Lease Maturities The following table shows the maturity distribution for total loans and leases outstanding as ofDecember 31, 2022 , including non-accruing loans, grouped by remaining scheduled principal payments: Loans and Lease Maturity (dollars in thousands) As of December 31, 2022 Due in One Due after One Due after Five Fixed rate: Year or Year through Years through Due after Floating rate: due after one Less Five Years Fifteen Years Fifteen Years Total due after one year year Real estate$ 23,405 $ 114,841 $ 331,561 $ 1,408,855 $ 1,878,662 $ 680,279$ 1,174,978 Agricultural 18,366 7,151 2,418 1 27,936 5,019 4,551
Commercial and industrial 23,759 29,642 22,767 610 76,778 23,098 29,921 Mortgage warehouse lines 65,439 - -
- 65,439 - -
Consumer loans 1,026 1,386 284 1,429 4,125 478 2,621
Total $ 131,995 $ 153,020 $ 357,030 $ 1,410,895 $ 2,052,940 $ 708,874 $ 1,212,071
Generally, the Company's contractual life of loans matches the loan's
amortization period, which is generally 25 years. Rates on loans longer than
five years typically adjust starting before ten years and each five years
thereafter. For a comprehensive discussion of the Company's liquidity position,
balance sheet repricing characteristics, and sensitivity to interest rates
changes, refer to the "Liquidity and Market Risk" section of this discussion and
analysis.
Off-Balance Sheet Arrangements
The Company maintains commitments to extend credit in the normal course of business, as long as there are no violations of conditions established in the outstanding contractual arrangements.
Unused commitments, excluding mortgage warehouse and overdraft lines, were$219.7 million atDecember 31, 2022 , compared to$219.6 million atDecember 31, 2021 . Total line utilization, excluding mortgage warehouse and overdraft lines, was 59% atDecember 31, 2022 and 61% atDecember 31, 2021 and was 32% atDecember 31, 2022 and 48% atDecember 31, 2021 , including mortgage warehouse lines. Mortgage warehouse utilization declined to 10% atDecember 31, 2022 , as compared to 27% atDecember 31, 2021 . Total mortgage warehouse availability increased to$594.6 million atDecember 31, 2022 as compared to$276.8 million atDecember 31, 2021 due to adding new customers. It is not likely that all of those commitments will ultimately be drawn down. Unused commitments represented approximately 40% of gross loans outstanding atDecember 31, 2022 and 25% atDecember 31, 2021 . The Company also had undrawn letters of credit issued to customers totaling$6.0 million and$6.7 million atDecember 31, 2022 and 2021, respectively. Off-balance sheet obligations pose potential credit risk to the Company, and a$0.8 million reserve for unfunded commitments is reflected as a liability in our consolidated balance sheet atDecember 31, 2022 , up$0.6 million from the previous year. The unused commitments related to mortgage warehouse are unconditionally cancellable at any time. The effect on the Company's revenues, expenses, cash flows and liquidity from the unused portion of the commitments to provide credit cannot be reasonably predicted because there is no guarantee that the lines of credit will ever be used. However, the "Liquidity" section in this Form 10-K outlines resources available to draw upon should we be required to fund a significant portion of unused commitments. In addition to unused commitments to provide credit, the Company holds two letters of credit with theFederal Home Loan Bank of San Francisco totaling$127.9 million as security for certain deposits and to facilitate certain credit arrangements with the Company's customers. That letter of credit is backed by loans which are pledged to the FHLB by the Company. For more information regarding the Company's off-balance sheet arrangements, see Note 14 to the consolidated financial statements in Item 8 herein. 47 Table of Contents Contractual Obligations
At the end of 2022, the Company had contractual obligations for the following payments, by type and period due:
Contractual Obligations
(dollars in thousands)
Payments Due by Period
Less Than More Than
Total 1 Year 2-3 Years 4-5 Years 5 Years
Subordinated debentures $ 35,481 $ - $ - $ - $ 35,481
Long term debt 49,214 - - - 49,214
Operating leases 8,369 2,061 3,019 1,797 1,492Other long-term obligations 9,688 526
1,814 44 7,304
Total $ 102,752 $ 2,587 $ 4,833 $ 1,841 $ 93,491
Nonperforming Assets
Nonperforming assets ("NPAs") are comprised of loans for which the Company is no
longer accruing interest, and foreclosed assets which primarily consists of
OREO. If the Company grants a concession to a borrower in financial difficulty,
the loan falls into the category of a troubled debt restructuring ("TDR"), which
may be designated as either nonperforming or performing depending on the loan's
accrual status.
The following table presents comparative data for the Company's NPAs and performing TDRs as of the dates noted:
Nonperforming Assets and Performing TDRs
(dollars in thousands)
As of December 31,
2022 2021 2020 2019 2018
Real estate:
Other construction/land $ - $ - $ - $ 31 $ 82
1-4 family - closed-end 629 1,023 1,193 741 799
Equity lines 59 892 2,403 480 408
Commercial real estate - owner occupied - 1,234 1,678 1,440 605
Commercial real estate - non-owner occupied - - 582 2,105 49
Farmland 15,812 - 442 258 1,642
TOTAL REAL ESTATE 16,500 3,149 6,298 5,055 3,585
Agricultural 2,855 378 250 - -
Commercial and industrial 217 973 1,026 651 1,425
Consumer loans 7 22 24 31 146
TOTAL NONPERFORMING LOANS (1) (2)
Foreclosed assets - 93 971 800 1,082 Total nonperforming assets$ 19,579 $ 4,615 $ 8,569 $ 6,537 $ 6,238 Performing TDRs (1)$ 4,522 $ 4,910 $ 11,382 $ 8,415 $ 10,920 Loans deferred under CARES Act (2) $ -$ 10,411 $ 29,500 $ - $ - Nonperforming loans as a % of total gross loans and leases 0.95% 0.23% 0.31% 0.32% 0.30% Nonperforming assets as a % of total gross loans and leases and foreclosed assets 0.95% 0.23%
0.35% 0.37% 0.36%
(1) Performing TDRs are not included in nonperforming loans above, nor are they
included in the numerators used to calculate the ratios disclosed in this
table.
(2) Loans deferred under the CARES act are not included in nonperforming loans
above, nor are they included in the numerators used to calculate the ratios
disclosed in the table.
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NPAs totaled $19.6 million , or 1.0% of gross loans and leases plus foreclosed
assets at the end of 2022, up from $4.6 million , or 0.2% of gross loans and
leases plus foreclosed assets at the end of 2021. NPAs decreased $3.1 million or
50% in 2021.
Nonperforming loans secured by real estate comprised $16.5 million of total
nonperforming loans at December 31, 2022 , an increase of $13.4 million , since
December 31, 2021 . There was also an increase of $2.5 million in agricultural
production loans but a decrease of $0.8 million in commercial and industrial
loans. Consumer nonperforming loans were nominal at December 31, 2022 .
Nonperforming loan balances at December 31, 2022 include $0.6 million in TDRs
and other loans that were paying as agreed, but which met the technical
definition of nonperforming and were classified as such. We also had $4.5
million in loans classified as performing TDRs for which we were still accruing
interest at December 31, 2022 , an decrease of $0.4 million , or 8%, relative to
December 31, 2021 . Notes 2 and 4 to the consolidated financial statements
provide a more comprehensive disclosure of TDR balances and activity within
recent periods.
The Company had no foreclosed assets at December 31, 2022 . At the end of 2021
foreclosed assets totaled $0.1 million , which was comprised of one property that
was subsequently sold in 2022. All foreclosed assets are periodically evaluated
and written down to their fair value less expected disposition costs, if lower
than the then-current carrying value.
Allowance for Credit Losses/Allowance for Loan and Lease Losses
The allowance for credit losses on loans and leases, a contra-asset, is established through a provision for credit losses on loans and leases. The allowance for credit losses on loans and leases is at a level that, in Management's judgment, is adequate to absorb probable credit losses on loans related to individually identified loans as well as probable credit losses in the remaining loan portfolio. Specifically identifiable and quantifiable losses are immediately charged off against the allowance; recoveries are generally recorded only when sufficient cash payments are received subsequent to the charge off. Note 2 to the consolidated financial statements provides a more comprehensive discussion of the accounting guidance we conform to and the methodology we use to determine an appropriate allowance for credit losses on loans and leases. The Company's allowance for credit losses on loans and leases was$23.1 million , or 1.12% of gross loans atDecember 31, 2022 , relative to$14.3 million , or 0.7% of gross loans atDecember 31, 2021 . The increase in the allowance resulted from an increase in non-accrual loan balances, primarily as a result of a downgrade in the first quarter of 2022 of one loan relationship in the dairy industry consisting of four separate loans. AtDecember 31, 2022 , nonaccrual loans totaled$19.6 million compared to$4.5 million atDecember 31, 2021 . All of the Company's impaired assets are periodically reviewed and are either well-reserved based on current loss expectations or are carried at the fair value of the underlying collateral, net of expected disposition costs. The ratio of the allowance to nonperforming loans was 118% atDecember 31, 2022 , relative to 315% atDecember 31, 2021 , and 233% atDecember 31, 2020 . As described above, a separate allowance of$0.8 million for potential losses inherent in unused commitments is included in other liabilities atDecember 31, 2022 . The Company recorded a provision for loan and lease losses of$10.9 million in 2022 as compared to a loan and lease loss benefit of$3.7 million in 2021, and a loan and lease loss provision of$8.6 million in 2020. Our allowance for probable losses on individually identified loans decreased$0.4 million , or 46%, during 2022, and$0.2 million , or 20%, during 2021. The allowance for probable losses inherent in the remaining portfolio increased by$9.2 million , or 68%. The primary reason for this increase is the$9.4 million CECL transition amount from the adoption of FASB Accounting Standards Update 2016-03 and related amendments, Financial Instruments - Credit Losses (Topic 326). 49
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The following table sets forth the Company's net charge-offs as a percentage to
the average loan balances in each loan category, as well as other credit related
ratios at or for the periods indicated:
Credit Ratios
(dollars in thousands, unaudited)
As of and for the years ended December 31,
2022 2021 2020
Net Charge-offs Average Loan Net Charge-offs Average Loan Net Charge-offs Average Loan
(Recoveries) Balance Percentage (Recoveries) Balance Percentage (Recoveries) Balance Percentage
Real estate:
1-4 family residential
construction $ - $ 5,927 - $ - $ 36,245 - $ - $ 85,934 -
Other construction/land (260) 21,806 (1.19)% (328) 35,906 (0.91)% (40) 86,363 (0.05)%
1-4 family - closed-end (87) 399,435 (0.02)% 67 160,522 0.04% (13) 175,776 (0.01)%
Equity lines (12) 23,189 (0.05)% (13) 33,484 (0.04)% (34) 44,306 (0.08)%
Multi-family residential - 65,785 - - 57,318 - - 58,666 -
Commercial real estate - owner
occupied - 325,354 - - 350,197 - - 322,460 -
Commercial real estate - non-owner
occupied 1,911 884,522 0.22% (82) 1,021,759 (0.01)% - 701,422 -
Farmland 4,418 105,856 4.17% - 122,931 - - 135,759 -
Total real estate 5,970 1,831,874 0.33% (356) 1,818,362 (0.02)% (87) 1,610,686 (0.01)%
Agricultural 4,788 31,565 15.17% 50 42,866 0.12% - 47,299 -Commercial and industrial 159 83,937 0.19% (64) 155,365 (0.04)% 307 182,802 0.17% Mortgage warehouse lines - 54,606
- - 147,996 - - 221,319 -
Consumer loans 632 4,301 14.69% 202 4,993 4.05% 515 6,584 7.82%
Total $ 11,549 $ 2,006,283 0.58% $ (168) $ 2,169,582 (0.01)% $ 735 $ 2,068,690 0.04%
Allowance for credit losses on
loans and leases to gross loans
and leases at end of period 1.12% 0.72% 0.72%
Nonaccrual loans to gross loans
and leases at end of period 0.95% 0.23% 0.31%
Allowance for credit losses on
loans and leases to nonaccrual
loans 117.78% 315.26% 233.46%
Provided below is a summary of the allocation of the allowance for loan and
lease losses for specific loan categories at the dates indicated. The allocation
presented should not be viewed as an indication that charges to the allowance
will be incurred in these amounts or proportions, or that the portion of the
allowance allocated to a particular loan category represents the total amount
available for charge-offs that may occur within that category.
Allocation of Allowance for Credit Losses on Loans and Leases
(dollars in thousands)
As of December 31,
2022 2021 2020 2019 2018
%Total (1) %Total (1) %Total (1) %Total (1) %Total (1)
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
Real Estate $ 21,274 91.45% $ 11,586 87.46% $ 11,766 87.46% $ 5,635 76.97% $ 5,831 79.55%
Agricultural 194 1.37% 464 1.71% 482 1.71% 193 1.82% 256 2.73% Commercial and industrial (2) 1,274
6.97% 1,559 10.60% 4,721 10.60% 2,685 20.98% 2,394 17.28%
Consumer loans 314 0.21% 510 0.23% 720 0.23% 1,278 0.23% 1,239 0.44%
Unallocated 4 - 137 - 49 - 132 - 30 -
Total $ 23,060 100.00% $ 14,256 100.00% $ 17,738 100.00% $ 9,923 100.00% $ 9,750 100.00%
(1) Represents percentage of loans in category to total loans
(2) Includes mortgage warehouse lines
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The Company's allowance for credit losses on loans and leases at December 31,
2022 represents Management's best estimate of probable losses in the loan
portfolio as of that date, but no assurance can be given that the Company will
not experience substantial losses relative to the size of the allowance.
Furthermore, fluctuations in credit quality, changes in economic conditions,
updated accounting, or regulatory requirements, and/or other factors could
induce us to augment or reduce the allowance. The Company adopted the current
expected credit losses methodology on January 1, 2020 , under FASB Accounting
Standards Update 2016-03 and related amendments, Financial Instruments - Credit
Losses (Topic 326) to January 1, 2022 . However, as previously noted under the
Allowance for Loan and Lease Losses section above in March 2020 , the Company
elected under Section 4014 of the Coronavirus Aid, Relief, and Economic Security
(CARES) Act to defer the implementation of CECL. At the time the decision was
made, there was a significant change in economic uncertainty on the local,
regional, and national levels as a result of local and state stay-at-home
orders, as well as relief measures provided at a national, state, and local
level. Further, the Company has taken actions to serve our communities during
the pandemic, including permitting short-term payment deferrals to current
customers, as well as originating bridge loans and SBA PPP loans. Upon adoption
of CECL, the Company was required to make an adjustment to equity, net of taxes,
equal to the difference between the allowance for credit losses calculated under
the CECL method and the allowance for loan and lease losses as calculated under
the incurred loss method as of December 31, 2021 . Therefore, on January 1, 2022 ,
the Company recorded a $10.4 million increase in the allowance for credit
losses, which includes a $0.9 million reserve for unfunded commitments as an
adjustment to equity, net of deferred taxes.
Investments
The Company's investments may at any given time consist of debt securities and marketable equity securities (together, the "investment portfolio"), investments in the time deposits of other banks, surplus interest-earning balances in ourFederal Reserve Bank ("FRB") account, and overnight fed funds sold. Surplus FRB balances and fed funds sold to correspondent banks typically represent the temporary investment of excess liquidity. The Company's investments serve several purposes: 1) they provide liquidity to even out cash flows from the loan and deposit activities of customers; 2) they provide a source of pledged assets for securing public deposits, bankruptcy deposits and certain borrowed funds which require collateral; 3) they constitute a large base of assets with maturity and interest rate characteristics that can be changed more readily than the loan portfolio, to better match changes in the deposit base and other funding sources of the Company; 4) they are another interest-earning option for surplus funds when loan demand is light; and 5) they can provide partially tax exempt income. Aggregate investments totaled$1.3 billion , or 35% of total assets atDecember 31, 2022 , as compared to$1.2 billion , or 35% of total assets atDecember 31, 2021 . We had no fed funds sold at the end of the reporting periods, and interest-bearing balances held primarily in ourFederal Reserve Bank account totaled$3.2 million atDecember 31, 2022 , as compared to$193.3 million atDecember 31, 2021 . The average rate on the interest-bearing balances was 0.57% for 2022. In an effort to change the mix of lower rate earning assets, the Company worked diligently to identify higher yielding earning assets, within the Company's risk profile for purchase. With respect to the investment portfolio, the Company purchased$181.5 million ofAAA and AA-rated Collateralized Loan Obligations ("CLOs") bringing the total CLOs to$498.4 million atDecember 31, 2022 . These structured investments complement our fixed-rate earning assets, including fixed rate loans, as CLOs have rates that adjust quarterly. The Company's investment securities portfolio had a book balance of$1.3 billion atDecember 31, 2022 , compared to$973.3 million atDecember 31, 2021 , reflecting a net increase of$298.5 million , or 31%. The Company carries "available for sale" investments at their fair market values and "held to maturity" investments at amortized cost. We currently have the intent and ability to hold our investment securities to maturity, but the securities are all marketable. The expected effective duration was 1.83 years for available-for-sale investments and 6.4 years for held-to-maturity investments atDecember 31, 2022 , as compared to 3.2 years for available-for-sale investments atDecember 31, 2021 . The expected effective duration was 1.83 years for available-for-sale investments and 6.4 years for held-to-maturity investments atDecember 31, 2022 , as compared to 3.2 years for available-for-sale investments atDecember 31 , 2021.In the second and fourth quarters of 2022 the Company transferred$162.1 million and$198.3 million , respectively of "available for sale" investments to "held to maturity". Those securities were transferred at fair market value on the date of the transfer. The transfer was initiated to reduce the effect of potential future rate increases on accumulated other comprehensive income due to changes in estimated fair value.. See Note 3,Investment Securities for additional information. 51
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The following Investment Portfolio table reflects the carrying amount for each primary category of investment securities for the past three years:
Investment Portfolio-Available for Sale
(dollars in thousands)
As of December 31,
2022 2021 2020
Carrying Carrying
Carrying Amount Percent Amount Percent Amount Percent
Available for sale
U.S. government agencies $ 50,599 3.98% $ 1,574 0.16% $ 1,800 0.33%
Mortgage-backed securities 122,532 9.63% 306,727 31.52% 314,435 57.80% State and political subdivisions
205,980 16.20% 304,268 31.25% 227,739 41.87%
Corporate bonds 57,435 4.52% 28,529 2.93% - -
Collateralized loan obligations 498,377 39.19%
332,216 34.13% - -
Total available for sale 934,923 73.51% 973,314 100.00% 543,974 100.00%
Held to maturity
U.S. government agencies 6,047 0.48% - - - -
Mortgage-backed securities 157,473 12.38% - - - -State and political subdivisions 173,361 13.63%
- - - -
Total held to maturity 336,881 26.49% - - - -
Total securities $ 1,271,804 100.00% $ 973,314 100.00% $ 543,974 100.00%
Based on an analysis of its available for sale securities with unrealized losses
as of December 31, 2022 , The Company determined their decline in value was
unrelated to credit loss and was primarily the result of interest rate changes
and market spreads subsequent to acquisition. The fair value of debt securities
is expected to recover as payments are received and the debt securities approach
maturity. In addition, the Company determined there was a $0.1 million credit
loss expected on the held-to-maturity debt securities portfolio which was
recorded as an allowance for credit losses on held-to-maturity securities.
Investment securities that were pledged as collateral for Federal Home Loan Bank
borrowings, repurchase agreements, public deposits and other purposes as
required or permitted by law totaled $183.5 million at December 31, 2022 and
$167.2 million at December 31, 2021 , leaving $1.1 billion in unpledged debt
securities at December 31, 2022 and $806.1 million at December 31, 2021 .
Securities that were pledged in excess of actual pledging needs and were thus
available for liquidity purposes, if needed, totaled $43.1 million at
December 31, 2022 and $47.0 million at December 31, 2021 .
The table below groups the Company's investment securities by their remaining
time to maturity as of December 31, 2022 , and provides weighted average yields
for each segment.
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Maturity and Yield of Held-to-Maturity Investment Portfolio
(dollars in thousands)
December 31, 2022
After One After Five Years
Within But Within But Within After Mortgage-Backed
One Year Five Years Ten Years Ten Years Securities Total
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
Held to maturity
U.S. government
agencies $ - - $ 400 2.81% $ 5,647 2.05% $ - - $ - - $ 6,047 2.10%
Mortgage-backed
securities - - - - - - - - 157,473 2.07% 157,473 2.07%
State and political
subdivisions 672 3.58% 1,659 4.00% 13,401 3.15% 157,692 3.64% - - 173,424 3.61%
Total securities $ 672 $ 2,059 $ 19,048 $ 157,692 $ 157,473 $ 336,944
Cash and Due from Banks
Interest-earning cash balances were discussed above in the "Investments"
section, but the Company also maintains a certain level of cash on hand in the
normal course of business as well as non-earning deposits at other financial
institutions. Our balance of cash and due from banks depends on the timing of
collection of outstanding cash items (checks), the amount of cash held at our
branches and our reserve requirement, among other things, and is subject to
significant fluctuations in the normal course of business. While cash flows are
normally predictable within limits, those limits are fairly broad and the
Company manages its short-term cash position through the utilization of
overnight loans to, and borrowings from, correspondent banks, including the
Federal Reserve Bank and the Federal Home Loan Bank . Should a large "short"
overnight position persist for any length of time, the Company typically raises
money through focused retail deposit gathering efforts or by adding brokered
time deposits. If a "long" position is prevalent, we will let brokered deposits
or other wholesale borrowings roll off as they mature, or we might invest excess
liquidity into longer-term, higher-yielding bonds. The Company's balance of
noninterest earning cash and balances due from correspondent banks totaled $72.8
million , or 2% of total assets at December 31, 2022 , and $63.1 million , or 2% of
total assets at December 31, 2021 . The average balance of non-earning cash and
due from banks, which can be used to determine trends, was $79.3 million for
2022, $75.7 million for 2021 and $72.0 million for 2020.
Premises and Equipment
Premises and equipment are stated on our books at cost, less accumulated depreciation, and amortization. The cost of furniture and equipment is expensed as depreciation over the estimated useful life of the related assets, and leasehold improvements are amortized over the term of the related lease or the estimated useful life of the improvements, whichever is shorter.
The following premises and equipment table reflects the original cost, accumulated depreciation and amortization, and net book value of fixed assets by major category, for the years noted:
Premises and Equipment
(dollars in thousands)
As of December 31,
2022 2021 2020
Accumulated Accumulated Accumulated
Depreciation Depreciation Depreciation
and Net Book and Net Book and Net Book
Cost Amortization Value Cost Amortization Value Cost Amortization Value
Land $ 4,823 $ - $ 4,823 $ 4,823 $ - $ 4,823 $ 5,751 $ - $ 5,751
Buildings 21,170 11,864 9,306 21,006 11,284 9,722 21,580 11,005 10,575 Furniture and equipment 18,948 14,711 4,237 19,242
14,925 4,317 20,705 15,474 5,231 Leasehold improvements 14,732 10,620 4,112 14,682
9,973 4,709 15,226 9,278 5,948
Total $ 59,673 $ 37,195 $ 22,478 $ 59,753 $ 36,182 $ 23,571 $ 63,262 $ 35,757 $ 27,505
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The net book value of the Company's premises and equipment was 1% of total
assets at both
Other Assets
Goodwill totaled$27.4 million atDecember 31, 2022 , unchanged for the year and other intangible assets were$2.3 million , a decrease of$1.0 million , or 30%, as a result of amortization expense recorded on core deposit intangibles. The Company's goodwill and other intangible assets are evaluated annually for potential impairment following FASB guidelines and based on those analytics Management has determined that no impairment exists as ofDecember 31, 2022 . The net cash surrender value of bank-owned life insurance policies decreased to$52.2 million atDecember 31, 2022 from$54.2 million atDecember 31, 2021 , due to the decline of BOLI income from net cash surrender values. Refer to the "Noninterest Revenue and Operating Expense" section above for a more detailed discussion of BOLI and the income/expense it generates. The remainder of other assets consists primarily of right-of-use assets tied to operating leases, accrued interest receivable, deferred taxes, investments in bank stocks, other real estate owned, prepaid assets, investments in low-income housing credits, investments in SBA loan funds, and other miscellaneous assets. The total operating lease right-of-use asset recorded on the books is$11.4 million less accumulated amortization of$4.5 million . The bank stocks includePacific Coast Bankers Bank stock and restricted stock related to theFederal Home Loan Bank of San Francisco stock held in conjunction with our FHLB borrowings and is not deemed to be marketable or liquid. Our net deferred tax asset is evaluated as of every reporting date pursuant to FASB guidance, and we have determined that no impairment exists.
Deposits
Deposits represent another key balance sheet category impacting the Company's
net interest margin and profitability metrics. Deposits provide liquidity to
fund growth in earning assets, and the Company's net interest margin is improved
to the extent that growth in deposits is concentrated in less volatile and
typically less costly non-maturity deposits such as demand deposit accounts, NOW
accounts, savings accounts, and money market demand accounts. Information
concerning average balances and rates paid by deposit type for the past three
fiscal years is contained in the Distribution, Rate, and Yield table located in
the previous section under "Results of Operations-Net Interest Income and Net
Interest Margin." A
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distribution of the Company's deposits showing the period-end balance
and percentage of total deposits by type is presented as of the dates noted in
the following table:
Deposit Distribution
(dollars in thousands)
Year Ended December 31,
2022 2021 2020 2019 2018
Interest bearing demand deposits $ 150,875 $ 129,783 $ 109,938 $ 91,212 $ 101,243
Noninterest bearing demand deposits 1,088,199 1,084,544 943,664 690,950 662,527
NOW 490,707 614,770 558,407 458,600 434,483
Savings 456,980 450,785 368,420 294,317 283,953
Money market 139,795 147,793 131,232 118,933 123,807
Customer time deposits 399,608 293,897 412,945 464,362 460,327
Brokered deposits 120,000 60,000 100,000 50,000 50,000
Total deposits $ 2,846,164 $ 2,781,572 $ 2,624,606 $ 2,168,374 $ 2,116,340
Percentage of Total Deposits
Interest bearing demand deposits 5.30% 4.67% 4.19% 4.21% 4.78%
Noninterest bearing demand deposits 38.23% 38.99% 35.95% 31.86% 31.31%
NOW 17.24% 22.10% 21.28% 21.15% 20.53%
Savings 16.06% 16.21% 14.04% 13.57% 13.42%
Money market 4.91% 5.31% 5.00% 5.48% 5.85%
Customer time deposits 14.04% 10.57% 15.73% 21.42% 21.75%
Brokered deposits 4.22% 2.16% 3.81% 2.31% 2.36%
Total 100.00% 100.00% 100.00% 100.00% 100.00%
Deposit balances reflect net growth of $64.6 million , or 2%, in 2022 and $157.0
million , or 6%, during 2021. The increase in 2022 was primarily from brokered
deposits while the increase in 2021 was primarily due to organic growth as both
consumer and commercial existing customers increased their deposit account
balances.
Noninterest bearing demand deposit balances were up $3.7 million ; NOW and
interest-bearing demand accounts decreased by $103.0 million , or 14% in 2022.
Overall non-maturity deposits decreased by $0.1 million , or 4%, to $2.3 billion
at December 31, 2022 .
Management is of the opinion that a relatively high level of core customer deposits is one of the Company's key strengths, and we continue to strive for core deposit retention and growth.
The following table presents the estimated deposits exceeding theFDIC insurance limit: Uninsured Deposits (dollars in thousands) Year Ended December 31, 2022 2021 Uninsured deposits$ 919,467 $ 929,583 55 Table of Contents The estimated aggregate amount of time deposits in excess of theFDIC insurance limit is$97.8 million . The following table presents the maturity distribution of the estimated uninsured time deposits: Uninsured Time Deposit Maturity Distribution (dollars in thousands)
As of
Three Over three Over six months Over
months or months through through twelve twelve
less six months months months Total
Uninsured time deposits $ 88,851 $ 3,491 $ 4,820 $ 591 $ 97,753
Other Borrowings
The Company's non-deposit borrowings may, at any given time, include fed funds
purchased from correspondent banks, borrowings from the Federal Home Loan Bank ,
advances from the FRB, securities sold under agreements to repurchase, and/or
junior subordinated debentures. The Company uses short-term FHLB advances and
fed funds purchased on uncommitted lines to support liquidity needs created by
seasonal deposit flows, to temporarily satisfy funding needs from increased loan
demand, and for other short-term purposes. The FHLB line is committed, but the
amount of available credit depends on the level of pledged collateral.
Total non-deposit interest-bearing liabilities increased $221.5 million , or
116%, in 2022, due primarily to increases in overnight fed funds purchased,
customer repurchase agreements, and FHLB advances. Non-deposit interest-bearing
liabilities decreased $25.8 million , or 12%, in 2021, due primarily to decreases
in overnight fed funds purchased, and FHLB advances. The decreases were
partially offset by increases in customer repurchase agreements and long-term
debt. The Company had $125.0 million in overnight fed funds purchased and $94.0
million in overnight FHLB advances at December 31, 2022 as compared to, no
overnight fed funds purchased, overnight FHLB advances or short-term borrowings
from the FHLB at December 31, 2021 . Repurchase agreements totaled $109.2 million
at year-end 2022 relative to a balance of $106.9 million at year-end 2021.
Repurchase agreements represent "sweep accounts", where commercial deposit
balances above a specified threshold are transferred at the close of each
business day into non-deposit accounts secured by investment securities. The
Company had junior subordinated debentures totaling $35.5 million at
December 31, 2022 and $35.3 million December 31, 2021 , in the form of long-term
borrowings from trust subsidiaries formed specifically to issue trust preferred
securities. The small increase resulted from the amortization of discount on
junior subordinated debentures that were part of our acquisition of Coast
Bancorp in 2016. Long term debt was $49.2 million at December 31, 2022 as
compared to $49.1 million for the year ended December 31, 2021 . The small
increase resulted from the amortization of debt issuance costs.
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The details of the Company's short-term borrowings are presented in the table below, for the years noted:
Short-term Borrowings
(dollars in thousands)
Year Ended December 31,
2022 2021 2020
Repurchase Agreements
Balance at December 31 $ 109,169 $ 106,937 $ 39,138
Average amount outstanding 110,387 70,443 34,614
Maximum amount outstanding at any month end 118,014 106,937 41,449 Average interest rate for the year
0.29% 0.30% 0.40%
Fed funds purchased
Balance at December 31 $ 125,000 $ - $ 100,000
Average amount outstanding 16,980 1,561 1,918Maximum amount outstanding at any month end 125,000 - 100,000 Average interest rate for the year
4.08% 0.06% 0.21%
FHLB advances
Balance at December 31 $ 94,000 $ - $ 42,900
Average amount outstanding 30,728 3,625 54,244Maximum amount outstanding at any month end 103,100 5,000 195,100 Average interest rate for the year
3.44% 0.06% 0.19%
Other Noninterest Bearing Liabilities
Other liabilities are principally comprised of accrued interest payable, other accrued but unpaid expenses, and certain clearing amounts. The Company's balance of other liabilities increased by$9.8 million , or 28%, during 2022. The primary reason for this increase was a commitment in low income housing tax credit funds and an increase in accrued interest payable due to the increase in interest rates during 2022.
Capital Resources
The Company had total shareholders' equity of$303.6 million atDecember 31, 2022 as compared to$362.5 million atDecember 31, 2021 . The decrease of$58.9 million , or 16%, is due to$33.7 million in net income and approximately$1.3 million in additional capital related to equity compensation, net of a$67.7 million decrease in our accumulated other comprehensive income,$13.9 million in dividends paid and$7.3 million from the cumulative effect of a change in accounting principal from the implementation of CECL, topic 326. One of our strategies for managing the potential for future unrealized losses in our securities portfolio to limit impacts to accumulated other comprehensive income and tangible capital was the movement of certain securities from available for sale to the held to maturity category, more fully discussed above under "Investments" and further below. The federal banking agencies published a final rule onNovember 13, 2019 , that provided a simplified measure of capital adequacy for qualifying community banking organizations. A qualifying community banking organization that opts into the community bank leverage ratio framework and maintains a leverage ratio greater than 9 percent will be considered to have met the minimum capital requirements, the capital ratio requirements for the well capitalized category under the Prompt Corrective Action framework, and any other capital or leverage requirements to which the qualifying banking organization is subject. A qualifying community banking organization with a leverage ratio of greater than 9 percent may opt into the community bank leverage ratio framework if it has average consolidated total assets of less than$10 billion , has off-balance-sheet exposures of 25% or less of total consolidated assets, and has total trading assets and trading liabilities of 5 percent or less of total consolidated assets. Further, the bank must not be an advance approaches banking organization. 57 Table of Contents The final rule became effectiveJanuary 1, 2020 and banks that met the qualifying criteria were able to elect to use the community bank leverage framework starting with the quarter endedMarch 31, 2020 . The CARES Act reduced the required community bank leverage ratio to 8% until the earlier ofDecember 31, 2020 , or the national emergency is declared over. The federal bank regulatory agencies adopted an interim final rule to implement this change from the CARES Act. The Company and the Bank meet the criteria outlined in the final rule and the interim final rule and adopted the community bank leverage ratio framework in the first quarter 2020.The Company uses a variety of measures to evaluate its capital adequacy, including the community bank leverage ratio, which the Company adopted in 2020, and risk-based capital and leverage ratios in preceding years, that are calculated separately for the Company and the Bank. Management reviews these capital measurements on a quarterly basis and takes appropriate action to help ensure that they meet or surpass established internal and external guidelines. As permitted by the regulators for financial institutions that are not deemed to be "advanced approaches" institutions, the Company has elected to opt out of the Basel III requirement to include accumulated other comprehensive income in risk-based capital.
The following table sets forth the Company's and the Bank's regulatory capital ratios at the dates indicated:
To Be Well
Capitalized
Under
Prompt
Corrective
Action
Regulations
(CBLR
Framework)
December 31, (1)
2022
Tier 1 (Core) Capital to average total assets
Sierra Bancorp and subsidiary 10.30% 9.00%
Bank of the Sierra 10.99% 9.00%
2021
Tier 1 (Core) Capital to average total assets
Sierra Bancorp and subsidiary 10.43% 8.50%
Bank of the Sierra 11.31% 8.50%
(1) Under interim transition final guidance, the community bank leverage ratio
minimum requirement was reduced to 8.5% for calendar year 2021.
At the end of 2022, as our Community Bank Leverage Ratio exceeded 9.0%, the Company and the Bank were both classified as "well capitalized," the highest rating of the categories defined under the Bank Holding Company Act and the Federal Deposit Insurance Corporation Improvement Act of 1991, and our regulatory capital ratios remained above the median for peer financial institutions. We do not foresee any circumstances that would cause the Company or the Bank to be less than "well capitalized", although no assurance can be given that this will not occur. A more detailed table of regulatory capital ratios, which includes the capital amounts and ratios required to qualify as "well capitalized" as well as minimum capital ratios, appears in Note 16 to the Consolidated Financial Statements in Item 8 herein. For additional details on risk-based and leverage capital guidelines, requirements, and calculations and for a summary of changes to risk-based capital calculations which were recently approved by federal banking regulators, see "Item 1, Business - Supervision and Regulation - Capital Adequacy Requirements" and "Item 1, Business - Supervision and Regulation - Prompt Corrective Action Provisions" herein. In addition to monitoring regulatory capital ratios, the Company monitors its tangible common equity ratio (TCE Ratio). The TCE Ratio declined from 9.93% atDecember 31, 2021 to 7.65% atDecember 31, 2022 . This decline was primarily
a
result in a decrease in Accumulated Other Comprehensive Income due to the impact of higher interest rates on the value of investments available for sale. As the change in estimated fair value of securities available for sale are included in Other Comprehensive Income, if values decline due to changes in interest rates, liquidity, or spreads, equity is also reduced. Similarly, if values increase for the same reasons, equity is also increased. Although the Company elected to exclude changes in Accumulated Other Comprehensive Income for regulatory capital purposes, such changes do impact the stated book equity and tangible common equity. One of the reasons the Company purchases floating rate investments is to minimize the impact of changes in rates on tangible equity. Similarly, as described above, the Company moved$360.4 58
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million in securities from available for sale to held to maturity. At
The Company also looks at the double leverage ratio, which is a measure of the reliance on the holding company's borrowings that are injected into the subsidiary Bank as capital. As holding company borrowings are primarily serviced by the receipt of dividends from the subsidiary Bank, this ratio is monitored as well as cash at the holding company for purposes of servicing the cash needs at the holding company level. This ratio is calculated by dividing subsidiary Bank capital by the holding company/consolidated capital. The Company generally maintains a double leverage ratio of under 125%. The double leverage ratio was 119.9% atDecember 31, 2022 as compared to 118.1% atDecember 31, 2021 .
Liquidity and Market Risk Management
Liquidity
Liquidity management refers to the Company's ability to maintain cash flows that are adequate to fund operations and meet other obligations and commitments in a timely and cost-effective manner. Detailed cash flow projections are reviewed by Management on a monthly basis, with various stress scenarios applied to assess our ability to meet liquidity needs under unusual or adverse conditions. Liquidity ratios are also calculated and reviewed on a regular basis. While those ratios are merely indicators and are not measures of actual liquidity, they are closely monitored, and we are committed to maintaining adequate liquidity resources to draw upon should unexpected needs arise. The Company, on occasion, experiences cash needs as the result of loan growth, deposit outflows, asset purchases or liability repayments. To meet short-term needs, we can borrow overnight funds from other financial institutions, draw advances viaFederal Home Loan Bank lines of credit, or solicit brokered deposits if customer deposits are not immediately obtainable from local sources. Availability on lines of credit from correspondent banks and the FHLB totaled$955.9 million atDecember 31, 2022 . The Company was also eligible to borrow approximately$42.3 million at the Federal Reserve Discount Window based on pledged assets atDecember 31, 2022 . Furthermore, funds can be obtained by drawing down excess cash that might be available in the Company's correspondent bank deposit accounts, or by liquidating unpledged investments or other readily saleable assets. In addition, the Company can raise immediate cash for temporary needs by selling under agreement to repurchase those investments in its portfolio which are not pledged as collateral. As ofDecember 31, 2022 , unpledged debt securities plus pledged securities in excess of current pledging requirements comprised$1.1 billion of the Company's investment balances, as compared to$853.2 million atDecember 31, 2021 . Other sources of potential liquidity include but are not necessarily limited to any outstanding fed funds sold and vault cash. The Company has a higher level of actual balance sheet liquidity than might otherwise be the case since we utilize a letter of credit from the FHLB rather than investment securities for certain pledging requirements. That letter of credit, which is backed by loans pledged to the FHLB by the Company, totaled$127.9 million atDecember 31, 2022 . Management is of the opinion that available investments and other potentially liquid assets, along with standby funding sources it has arranged, are more than sufficient to meet the Company's current and anticipated short-term liquidity needs.
At
Primary and Secondary Liquidity Sources
$ 77,131 $ 257,528
Unpledged investment securities 1,097,164
806,132 Excess pledged securities 43,096 47,024 FHLB borrowing availability 718,842 787,519 Unsecured lines of credit 237,000 305,000
Funds available through fed discount window 42,278
50,608 Totals $ 2,215,511 $ 2,253,811 The Company's primary liquidity ratio and net loans to deposits ratio was 40% and 72%, respectively, atDecember 31, 2022 , as compared to internal policy guidelines of "greater than 15%" and "less than 95%." Other liquidity ratios reviewed 59 Table of Contents periodically by Management and the Board include theCommunity Bank leverage ratio, net change in overnight position and wholesale funding to total assets (including ratios and sub-limits for the various components comprising wholesale funding). All ratios were within policy guidelines atDecember 31, 2022 . The holding company's primary uses of funds include operating expenses incurred in the normal course of business, debt servicing, shareholder dividends, and stock repurchases. Its primary source of funds is dividends from the Bank since the holding company does not conduct regular banking operations. AtDecember 31, 2022 , the holding company maintained a cash balance of$26.1 million . Management anticipates that the Bank will have sufficient earnings to provide dividends to the holding company to meet its funding requirements for the foreseeable future and the Bank is not subject to any regulatory restrictions for paying dividends to the holding company, other than the legal and regulatory limitations on dividend payments, as outlined in Item 5(c) Dividends in this Form 10-K.
Interest Rate Risk Management
Market risk arises from changes in interest rates, exchange rates, commodity
prices and equity prices. The Company does not engage in the trading of
financial instruments, nor does it have exposure to currency exchange rates. Our
market risk exposure is primarily that of interest rate risk, and we have
established policies and procedures to monitor and limit our earnings and
balance sheet exposure to changes in interest rates. The principal objective of
interest rate risk management is to manage the financial components of the
Company's balance sheet in a manner that will optimize the risk/reward equation
for earnings and capital under a variety of interest rate scenarios.
To identify areas of potential exposure to interest rate changes, we utilize
commercially available modeling software to perform monthly earnings simulations
and calculate the Company's market value of portfolio equity under varying
interest rate scenarios. The model imports relevant information for the
Company's financial instruments and incorporates Management's assumptions on
pricing, duration, and optionality for anticipated new volumes. Various rate
scenarios consisting of key rate and yield curve projections are then applied in
order to calculate the expected effect of a given interest rate change on
interest income, interest expense, and the value of the Company's financial
instruments. The rate projections can be shocked (an immediate and parallel
change in all base rates, up or down), ramped (an incremental increase or
decrease in rates over a specified time period), economic (based on current
trends and econometric models) or stable (unchanged from current actual levels).
In addition to a stable rate scenario, which presumes that there are no changes
in interest rates, we typically use at least eight other interest rate scenarios
in conducting our rolling 12-month net interest income simulations: upward
shocks of 100, 200, 300, and 400 basis points, and downward shocks of 100, 200,
300, and 400 basis points. Those scenarios may be supplemented, reduced in
number, or otherwise adjusted as determined by Management to provide the most
meaningful simulations in light of economic conditions and expectations at the
time. Pursuant to policy guidelines, we generally attempt to limit the projected
decline in net interest income relative to the stable rate scenario to no more
than 5% for a 100 basis point (bp) interest rate shock, 10% for a 200 bp shock,
15% for a 300 bp shock, and 20% for a 400 bp shock.
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The Company had the following estimated net interest income sensitivity profiles
over one-year, without factoring in any potential negative impact on spreads
resulting from competitive pressures or credit quality deterioration (dollars in
thousands):
December 31, 2022 December 31, 2021
% Change % Change
in Net $ Change in in Net $ Change in
Interest Net Interest Interest Net Interest
Immediate change in Interest Rates (basis points) Income Income Income Income
+400 (4.02%) $ (4,829) 16.59% $ 16,974
+300 (2.74%) $ (3,291) 13.69% $ 14,009
+200 (1.43%) $ (1,717) 9.98% $ 10,214
+100 (0.16%) $ (195) 5.64% $ 5,772
Base
-100 (2.76%) $ (3,312) (10.29%) $ (10,529)
-200 (6.49%) $ (7,796) NR NR
-300 (9.96%) $ (11,977) NR NR
-400 (12.83%) $ (15,422) NR NR
The simulation for the period endingDecember 31, 2022 , indicates that the Company is slightly liability sensitive, with net interest income decreasing in rising and declining rate scenarios, with a continued drop in interest rates having the most substantial negative impact. The change in the magnitude of the Company's asset sensitivity based on its interest rate risk model atDecember 31, 2022 , as compared toDecember 31, 2021 , is due mostly to the level of overnight borrowings both in Fed Funds purchased and overnight FHLB borrowings and in customer time deposits tied to the prime interest rate. In addition, based on the magnitude of rate changes, interest rates on new loans did not increase at the rates modeled in 2021 and therefore, the beta on loan yields was lowered in modeling interest rate risk in 2022. Any change in interest rate in the model would expect to decrease net interest income. AtDecember 31, 2022 , the Company had$219.0 million in overnight borrowings as compared to none atDecember 31, 2021 . AtDecember 31, 2021 , the Company had$193.2 million in overnight cash held with theFederal Reserve bank as compared to$3.2 million atDecember 31, 2022 . The Company has approximately$594.6 million of unfunded mortgage warehouse lines atDecember 31, 2022 . If rates decrease, it would be expected that a significant portion of the unfunded mortgage warehouse lines would become funded and thereby, mitigate the impact of lower rates on the balance sheet through higher utilization. For the period endingDecember 31, 2021 , the simulation indicated that the Company is asset sensitive, with sizeable increases in net interest income in rising rate scenarios, however a continued drop in interest rates could have a substantial negative impact. The change in the magnitude of the Company's asset sensitivity based on its interest rate risk model atDecember 31, 2021 , as compared toDecember 31, 2020 , is due mostly to the level of overnight cash held as an interest bearing deposit at theFederal Reserve Bank . AtDecember 31, 2021 , the Company had$193.2 million in overnight cash with theFederal Reserve Bank compared to$2.4 million atDecember 31, 2020 . As this cash is held overnight, any change in interest rate in the model would increase the yield on such overnight cash immediately, therefore, increasing the Company's asset sensitivity. In addition to the net interest income simulations shown above, we run stress scenarios for the unconsolidated Bank modeling the possibility of no balance sheet growth, the potential runoff of "surge" core deposits which flowed into the Bank in the most recent economic cycle, and unfavorable movement in deposit rates relative to yields on earning assets (i.e., higher deposit betas). When no balance sheet growth is incorporated and a stable interest rate environment is assumed, projected annual net interest income is about$2.6 million lower, or 2% than in our standard simulation. However, the stressed simulations reveal that the Company's greatest potential pressure on net interest income would result from excessive non-maturity deposit runoff and/or unfavorable deposit rate changes in rising rate scenarios, which could reduce our net interest income by 14% in the event of a 30% decay/shift in such balances.
The economic value (or "fair value") of financial instruments on the Company's balance sheet will also vary under the interest rate scenarios previously discussed. The difference between the projected fair value of the Company's financial
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assets and the fair value of its financial liabilities is referred to as the
economic value of equity ("EVE"), and changes in EVE under different interest
rate scenarios are effectively a gauge of the Company's longer-term exposure to
interest rate fluctuations. Fair values for financial instruments are estimated
by discounting projected cash flows (principal and interest) at anticipated
replacement interest rates for each account type, while the fair value of
non-financial accounts is assumed to equal their book value for all rate
scenarios. An economic value simulation is a static measure utilizing balance
sheet accounts at a given point in time, and the measurement can change
substantially over time as the Company's balance sheet evolves and interest rate
and yield curve assumptions are updated.
The change in economic value under different interest rate scenarios depends on
the characteristics of each class of financial instrument, including stated
interest rates or spreads relative to current or projected market-level interest
rates or spreads, the likelihood of principal prepayments, whether contractual
interest rates are fixed or floating, and the average remaining time to
maturity. As a general rule, fixed-rate financial assets become more valuable in
declining rate scenarios and less valuable in rising rate scenarios, while
fixed-rate financial liabilities gain in value as interest rates rise and lose
value as interest rates decline. The longer the duration of the financial
instrument, the greater the impact a rate change will have on its value. In our
economic value simulations, estimated prepayments are factored in for financial
instruments with stated maturity dates, and decay rates for non-maturity
deposits are projected based on historical patterns and Management's best
estimates. The table below shows estimated changes in the Company's EVE as of
December 31, 2022 , and 2021, under different interest rate scenarios relative to
a base case of current interest rates (dollars in thousands):
December 31, 2022 December 31, 2021
% Change % Change
in Fair $ Change in in Fair $ Change in
Value of Fair Value of Value of Fair Value of
Immediate change in Interest Rates (basis points) Equity Equity Equity Equity
+400 6.90% $ 41,453 36.40% $ 210,185
+300 6.01% $ 36,093 32.66% $ 188,603
+200 4.55% $ 27,340 26.21% $ 151,341
+100 3.11% $ 18,680 15.54% $ 89,711
Base
-100 (13.32%) $ (80,005) (22.25%) $ (128,469)
-200 (32.90%) $ (197,558) NR NR
-300 (30.32%) $ (182,083) NR NR
-400 (20.11%) $ (120,782) NR NR
The table shows that our EVE will generally deteriorate in declining rate
scenarios but should benefit from a parallel shift upward in the yield curve.
The increase in value of the Company's large volume of stable DDA balances is
expected to outweigh the decrease in value of the fixed rate assets, causing the
overall net increase in EVE in the up-shock scenarios. Our EVE sensitivity is
decreasing in the current interest rate environment and fell considerably over
the last twelve months ending December 31, 2022 given the higher rate
environment at December 31, 2022 as compared to December 31, 2021 . Sensitively
decreased from 16% to 3% in the Up 100 shock and decreased from 36% to 7% in the
Up 400 shock. All up-shock scenarios fall within Policy guidelines. All the down
shock scenarios have exceeded the Policy guidelines and will continue to exceed
them until deposit rates move back up to more normalized higher levels.
We also run stress scenarios for the unconsolidated Bank's EVE to simulate the
possibility of slower loan prepayment speeds in the up-shock scenarios and
faster prepayment speeds in the down-shock scenarios as well as unfavorable
changes in deposit rates, and higher deposit decay rates. Model results are
highly sensitive to changes in assumed decay rates for non-maturity deposits, in
particular, with material unfavorable variances occurring relative to the
standard simulations shown above as decay rates are increased. Furthermore,
while not as extreme as the variances produced by increasing non-maturity
deposit decay rates, EVE also displays a relatively high level of sensitivity to
unfavorable changes in deposit rate betas in rising interest rate scenarios.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information concerning quantitative and qualitative disclosures of market risk called for by Item 305 of Regulation S-K is included as part of Item 7 above. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Market Risk Management".
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