Item 1A. Risk Factors.
FACTORS THAT MAY AFFECT FUTURE RESULTS
An investment in Bancorp’s common stock is subject to risks inherent in its business. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included in this filing. In addition to the risks and uncertainties described below, other risks and uncertainties not currently known to Bancorp or that Bancorp currently deems to be immaterial also may materially and adversely affect its business, financial condition and results of operations in the future. The value or market price of Bancorp’s common stock could decline due to any of these identified or other risks, and an investor could lose all or part of their investment.
There are factors, many beyond Bancorp’s control, which may significantly change the results or expectations of Bancorp. Some of these factors are described below, however, many are described in the other sections of this Annual Report on Form 10-K.
Economic, Market and Credit Risks
Fluctuations in interest rates could reduce profitability.
Our primary source of income is from net interest spread, the difference between interest earned on loans and investments and interest paid on deposits and borrowings. We expect to periodically experience gaps in interest rate sensitivities of assets and liabilities, meaning that either interest-bearing liabilities may be more sensitive to changes in market interest rates than interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to our position, earnings could be negatively affected.
Many factors affect fluctuation of market interest rates, including, but not limited to the following:
● the FRB’s actions to control interest rates
● inflation or deflation
● recession
● changes in unemployment
● changes in the money supply
The FRB has taken aggressive interest rate actions over the past year, implementing multiple rate hikes in an effort to tame inflation that has reached its highest levels in decades. Beginning 2022 at a range of 0.00% - 0.25%, the FFTR was subsequently increased a cumulative 425 bps during the year, bringing it a range of 4.25% - 4.50%, and Prime to 7.50%, as of December 31, 2022.
The current economic outlook suggests continued interest rate action from the FRB through at least the first quarter of 2023 and prospects of a continuing rising rate environment. While Bancorp expects continued rising rates to have a positive effect on NIM, pricing pressure/competition for both loans and deposits, changing levels of liquidity within the banking system and the possibility of a more severely inverted yield curve could continue to place pressure on NIM.
Deposit rates tend to be tied to the short end of the rate curve, while fixed-rate loans are largely priced based upon longer term rates, typically five-year offerings. A flattened, or inverted, yield curve may increase our funding costs while limiting rates that can be earned on loans and investments, thereby decreasing our net interest income and earnings. Further, migration of deposits out of Bancorp, as customers pursue higher rates, could impact liquidity and earnings, as we compete for deposits. Changes in the mix of deposits could result in increased average rates paid on deposits, and lower earnings. Our asset-liability management strategy, which is designed to mitigate risk from changes in market interest rates, may not be able to prevent changes in interest rates from having a material adverse effect on our results of operations and financial condition.
12
Table of Contents
Financial condition and profitability depend significantly on local and national economic conditions.
Our success depends on general economic conditions both locally, regionally and nationally. A portion of our customers’ ability to repay their obligations is directly tied to local, regional, national or global economic activity. Deterioration in the quality of the credit portfolio could have a material adverse effect on our financial condition, results of operations, and ultimately capital.
The economic outlook for 2023 suggests sluggish growth, continued monetary tightening to subdue inflation, and the potential of a recession. While consumer and business balance sheets remain strong by historical standards, excess liquidity built up during the pandemic, largely through government stimulus, has gradually dissipated over the course of 2022, leaving borrowers with less cushion to withstand economic downturns than may have been available in recent years. As such, the severity of any potential recession or economic downturn could have a significant impact on borrowers’ ability to perform.
Our allowance for credit losses may not be adequate to cover actual losses, which could negatively impact earnings.
The allowance for credit losses on loans and the liability for unfunded lending commitments reflect management’s estimate of credit losses expected in the loan portfolio, including unfunded lending commitments, as of the balance sheet date. These estimates are the result of our continuing evaluation of specific credit risks and loss experience, current loan portfolio quality, present economic, political and regulatory conditions, industry concentrations, reasonable and supportable forecasts of future economic conditions, and other factors that may provide an indication of credit losses. The determination of our allowance for credit losses inherently involves a high degree of subjectivity and requires assumptions to be made by management. If our assumptions prove to be incorrect or economic problems are worse than projected, adjustments may be necessary to allow for changing economic conditions or adverse developments in the loan portfolio. Any material increase to the required level of ACL, or insufficiency of the ACL to cover actual loan losses, could adversely affect our business, financial condition, and results of operations.
Federal and state regulators annually review our allowance and may require an adjustment in the ACL on loans. If regulatory agencies require any increase in the allowance for which we had not allocated, it would have a negative effect on our financial results.
Our credit metrics are currently at historically strong levels and this trend could normalize over time.
Over the past several years, our asset quality metrics have trended within a narrow range, exceeding benchmarks and reaching historically strong levels. We realize that present asset quality metrics are positive and, recognizing the cyclical nature of the lending business, we anticipate this trend will likely normalize over time.
Financial condition and profitability depend on real estate values in our market areas.
We offer a variety of secured loans, including C&I lines of credit, C&I term loans, real estate, C&D, HELOCs, consumer and other loans. Many of our loans are often secured by real estate primarily in our market areas. In instances where borrowers are unable to repay their loans and there has been deterioration in the value of loan collateral, we could experience higher loan losses which could have a material adverse effect on financial condition, and results of operations.
Significant stock market volatility could negatively affect our financial results.
Income from WM&T constitutes approximately 41% of non-interest income. Trust AUM are expressed in terms of market value, and a significant portion of fee income is based upon those values, which generally fluctuate consistent with overall capital markets.
Capital and credit markets experience volatility and disruption from time to time. These conditions may place downward pressure on credit availability, credit worthiness and customers’ inclinations to borrow. Prolonged volatility or a significant disruption could negatively impact customers’ ability to seek new loans or to repay existing loans. Personal wealth of many borrowers and guarantors has historically added a source of financial strength to certain loans and would be negatively impacted by severe market declines. Sustained reliance on personal assets to make loan payments would result in deterioration of their liquidity, and could result in loan defaults.
13
Table of Contents
The value of our investment securities may be negatively affected by factors outside of our control and impairment of these securities could have an adverse impact on our financial condition and results of operations.
Factors beyond our control can significantly influence the fair value of our investment securities. These factors include, but are not limited to, changes in market interest rates, rating agency actions, defaults by issuers or with respect to underlying securities, volatility and liquidity within capital markets and changes in local, regional, national or international economic conditions. Impairment to the fair value of these securities can result in realized and/or unrealized losses in future periods and declines in other comprehensive income, which could have an adverse effect on our business, financial condition and results of operations.
Impairment of goodwill, other intangible assets or deferred tax assets could have an adverse impact on our financial condition and results of operations.
In accordance with GAAP, goodwill is not amortized but, instead, is subject to impairment on at least an annual basis or more frequently if an event occurs or circumstances change that reduce the fair value of a reporting unit below its carrying amount. In the event that we conclude that all or a portion of our goodwill may be impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital. At December 31, 2022, Bancorp had goodwill of $194 million.
Bancorp’s intangible assets primarily relate to core deposits and customer relationships. Intangible assets with definite lives are amortized on an accelerated basis over their estimated life. Intangible assets, premises and equipment and other long-lived assets are tested for impairment whenever events or changes in circumstances indicated the carrying amount of the assets may not be recoverable from future undiscounted cash flows. In the event that we conclude that all or a portion of our intangible assets may be impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital. At December 31, 2022, Bancorp had intangible assets of $25 million.
In assessing the potential for realization of DTAs, management considers whether it is more likely than not that some portion or all of the DTAs will not be realized. Assessing the need for, or the sufficiency of, a valuation allowance requires management to evaluate all available evidence, both negative and positive, including whether future taxable income in sufficient amounts and character within the carryback and carryforward periods is available under tax law, including the use of tax planning strategies. We have concluded that, based on the level of positive evidence, it is more likely than not that at December 31, 2022 all DTAs will be realized. At December 31, 2022, Bancorp had DTAs totaling $54 million.
The impact of each of these impairment matters could have a material adverse effect on our business, results of operations and financial condition.
The soundness of other financial institutions could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services companies are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to different industries and counterparties and through transactions with counterparties in the bank and non-bank financial services industries, including broker-dealers, commercial banks, investment banks and other institutional customers. As a result, defaults by, or even rumors or questions about, one or more bank or non-bank financial services companies, or bank or non-bank financial services industries in general, could lead to market-wide liquidity problems and could result in losses or defaults by us or other institutions. These losses or defaults could have an adverse effect on our business, financial condition and results of operations.
Our mortgage banking line of business is highly dependent upon programs administered by the FNMA and FHLMC. Changes in existing U.S. government-sponsored mortgage programs or servicing eligibility standards could materially and adversely affect our business, financial position, results of operations and cash flows.
Our ability to generate revenue through mortgage loan sales to institutional investors depends to a significant degree on programs administered by the FNMA and FHLMC. These entities play powerful roles in the residential mortgage industry and as a result, we have significant business relationships with them. Our status as an approved seller and servicer with both entities is subject to compliance with their selling and servicing guidelines.
14
Table of Contents
Any discontinuation of, or significant reduction or material change in, the operation of the FNMA and FHLMC, or any significant adverse change in the level of activity in the secondary mortgage market or the underwriting criteria of the FNMA or FHLMC would likely prevent us from originating and selling most, if not all, of our mortgage loan originations.
Derivatives associated with our mortgage banking line of business subject us to interest rate and counter-party risks, which could adversely affect our business, financial condition and results of operations.
Mortgage banking derivatives used in the ordinary course of business consist primarily of mandatory forward sales contracts and interest rate lock loan commitments. Mandatory forward contracts represent future loan commitments to deliver loans at a specified price and date and are used to manage interest rate risk on loan commitments and mortgage loans held for sale. Interest rate lock loan commitments represent commitments to fund loans at a specific rate.
We are exposed to interest rate risk on loans held for sale and rate lock loan commitments. As market interest rates fluctuate, the fair value of mortgage loans held for sale and rate lock commitments will decline or increase. To offset this interest rate risk, we enter into derivatives, such as mandatory forward contracts to sell loans. The fair value of these mandatory forward contracts will fluctuate as market interest rates fluctuate, and the change in the value of these instruments is expected to largely, though not entirely, offset the change in fair value of loans held for sale and rate lock commitments. While the objective of this activity is to minimize the exposure to losses on rate lock loan commitments and loans held for sale due to market interest rate fluctuations, the net effect of derivatives on earnings depends on risk management activities and a variety of other factors, including: market interest rate volatility; the amount of rate lock commitments that close; the ability to fill the forward contracts before expiration; and the time period required to close and sell loans. The extent to which these derivatives do not offset each other could adversely affect our financial condition and results of operations.
Mandatory forward contracts also contain an element of risk in that the counterparties may be unable to meet the terms of such agreements. In the event the counterparties fail to deliver commitments or are unable to fulfill their obligations, we could potentially incur significant additional costs by replacing the positions at then-current market rates, adversely impacting our financial condition and results of operations.
Changing industry trends related to consumer deposit relationships could have an adverse impact on our financial condition and results of operations.
Competitive factors surrounding the developing trend of financial institutions reducing or eliminating certain deposit account fees, particularly overdraft-related fees, presents a significant challenge to maintaining deposit-related non-interest income in the future and potentially threatens a revenue stream that has been in an industry-wide, regulation-driven decline for several years. Strategic decisions surrounding this trend may impact not only deposit-related income, but also deposit relationships in general, particularly for retail customers.
Any elimination of, or reduction or material change to, the fees we charge for certain deposit-related services could result in a significant decline of non-interest income. Failure to closely monitor, and appropriately adapt to, changes in industry practices and consumer behavior could have an adverse impact on our performance.
Strategic Risks
Acquisitions could adversely affect our business, financial condition and results of operations.
An institution that we acquire may have asset quality issues or contingent liabilities that we did not discover or fully recognize in the due diligence process, thereby resulting in unanticipated losses. Acquisitions of other institutions also typically require integration of different corporate cultures, loan and deposit products, pricing strategies, data processing systems and other technologies, accounting, compliance, internal audit and financial reporting systems, operating systems and internal controls, marketing programs and personnel of the acquired institution. The integration process is complicated and time consuming and could divert our attention from other business concerns and may be disruptive to our customers and customers of the acquired institution. Our failure to successfully integrate an acquired institution could result in loss of key customers and employees, and prevent us from achieving expected synergies and cost savings. We may finance acquisitions with borrowed funds, thereby increasing our leverage and reducing liquidity, or with potentially dilutive issuances of equity securities.
15
Table of Contents
Competition with other financial institutions could adversely affect profitability.
We operate in a highly competitive industry that could become even more so as a result of earnings pressure from peer organizations, legislative, regulatory and technological changes and continued consolidation. We face vigorous competition in price and structure of financial products from banks and other financial institutions. In recent years, credit unions have expanded their lending mix and now compete heavily with banks in the CRE lending market. Non-traditional providers’ high risk tolerance for fixed rate, long-term loans has adversely affected our net loan growth and results of operations. We also compete with other non-traditional providers of financial services, such as brokerage firms and insurance companies. As internet-based financial services continue to grow in acceptance, we must remain relevant as an institution where consumers and businesses value personal service while other institutions offer these services without human interaction. The variety of sources of competition may reduce or limit our margins on banking services, increase operational costs through expanded product offerings, reduce market share and adversely affect our financial condition and results of operations.
We may not be able to attract and retain skilled people.
Our performance is dependent on our ability to attract and retain qualified employees. Competition for qualified employees in the industry and markets in which we engage can be intense, and we may not be able to retain or hire the individuals wanted or needed for certain positions. Changes in the labor market and general employment trends, including elevated employee attrition, labor availability and wage inflation, also present challenges to our ability to attract and retain qualified employees.
If we are unable to continue to attract and retain qualified employees, or do so at rates necessary to maintain the Company’s competitive position, our performance, including the Company’s competitive position, could suffer, and, in turn, adversely affect our business, financial condition or results of operations.
We are subject to liquidity risks.
Liquidity is essential to our business. We rely on our ability to generate deposits and effectively manage the repayment and maturity schedules of our loans and investment securities, respectively, to ensure we have adequate liquidity to fund our operations. An inability to raise funds through deposits, borrowings, sales of investment securities, FHLB advances, sales of loans and other sources could have a significant negative effect on our liquidity.
We are dependent on large commercial deposit relationships as a primary funding source. Approximately 47% of our total deposits are centralized in accounts with balances $500,000 or greater. We categorize these deposits as core funds, as they represent long-standing, full-service relationships and are a testament to our commitment to partner with business customers by providing exemplary service and competitive products. A sudden shift in customer behavior within these deposits resulting in balances being reduced or exiting Bancorp altogether could impact our ability to capitalize on growth opportunities and meet current obligations. We have secondary funding sources to draw upon as needed, but the cost of those funds would be higher than typical deposit accounts, which would negatively impact our financial condition and results of operations.
After experiencing record levels of excess liquidity in 2021, liquidity began normalizing in the latter half of 2022, and we expect continued normalization as we enter 2023. Should loan demand not meet desired levels, excess liquidity must be invested in an effort to maximize return. The risks associated with such investment include the inability to find alternative options suitable to our risk profile, investing in alternatives that adversely impact our financial condition and results of operations, and liquidity risk associated with any specific investment. Further, holding elevated levels of liquidity can have a significant impact on our NIM and result in additional margin compression.
Operational Risks
Our accounting policies and methods are critical to how we report our financial condition and results of operations. They require management to make estimates about matters that are uncertain.
Accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Management must exercise judgment in selecting and applying these accounting policies and methods so they comply with GAAP.
16
Table of Contents
We have identified certain accounting policies as being critical because they require management’s judgment to ascertain the valuations of assets, liabilities, commitments and contingencies. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset, or reducing a liability. We have established detailed policies and control procedures intended to ensure these critical accounting estimates and judgments are well-controlled and applied consistently.
Policies and procedures are intended to ensure that the process for changing methodologies occurs in an appropriate manner. Because of the uncertainty surrounding judgments and estimates pertaining to these matters, there can be no assurances that actual our results will not differ from those estimates. See the section titled “Critical Accounting Policies and Estimates” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for more information.
An extended disruption of vital infrastructure could negatively impact our business, results of operations, and financial condition.
Our operations depend upon, among other things, infrastructure, including equipment and facilities. Extended disruption of vital infrastructure by fire, power loss, natural disaster, telecommunications failure, information systems breaches, corporate account take-over, terrorist activity or the domestic and foreign response to such activity, or other events outside of our control could have a material adverse impact on the financial services industry, the economy as a whole or on our financial condition and results of operations. Our business continuity plan may not work as intended or may not prevent significant interruption of operations. Occurrence of any failures or interruptions of information systems could damage our reputation, result in loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have an adverse effect on our financial condition and results of operations.
Security breaches or incidences of fraud could negatively impact our business, results of operations, and financial condition.
Our assets, which are at risk for cyber-attacks, include financial assets and non-public information belonging to customers. Cyber security risks include cyber espionage, blackmail, ransom, theft, and corporate account takeovers. We employ many preventive and detective controls to protect our assets, and provide mandatory recurring information security training for all employees. We have invested in multiple preventative tools in an attempt to protect customers from cyber threats and corporate account takeover and regularly provide educational information regarding cyber threats to customers. We utilize multiple third-party vendors who have access to ours assets via electronic media. While we require third parties, many of whom are small companies, to have similar or superior controls in place, there is no guarantee that a breach of information could not occur. Activities of the Bank that subject Bancorp to risk of fraud by customers, employees, vendors, or members of the general public include ACH transactions, wire transactions, ATM/ITM transactions, checking transactions, credit card transactions and loan originations. Repeated incidences of fraud or a single large occurrence could adversely impact our reputation, financial condition and results of operations.
We are dependent upon outside third parties for processing and handling of the Company’s records and data.
We rely on software developed by third-party vendors to process various transactions. In some cases, we have contracted with third parties to run their proprietary software on our behalf. While we perform a review of controls instituted by applicable vendors over these programs in accordance with industry standards and performs testing of user controls, we rely on continued maintenance of controls by these third-party vendors, including safeguards over security of client data. We may incur a temporary disruption in our ability to conduct business or process transactions, or incur reputational damage, if a third-party vendor fails to adequately maintain internal controls or institute necessary changes to systems. Such a disruption or breach of security could have a material adverse effect on our business. Further, if these third-party service providers experience difficulties, or should terminate their services, and we are unable to replace them on a timely basis, our business operations could be interrupted. If an interruption were to continue for a significant period of time, or if we incurred excessive costs involved with replacing third-party service provider, our business, financial condition and results of operations could be adversely affected.
17
Table of Contents
Our ability to stay current on technological changes in order to compete and meet customer demands is constantly being challenged.
The financial services industry is constantly undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. Future success of Bancorp will depend, in part, upon our ability to address the needs of our customers by utilizing technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional operational efficiencies and greater privacy and security protection for customers and their personal information. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services as quickly as competitors or be successful in marketing these products and services to our customers. We rely on third party providers for many of our technology-driven banking products and services. Some of these companies may be slow to respond with upgrades or enhancements to their products to keep pace with improvements in technology or the introduction of competing products. Failure to successfully keep pace with technological change affecting the financial services industry could impair our ability to effectively compete to retain or acquire new business and could have an adverse impact on our business, financial position and results of operations.
Changes in customer use of banks could adversely affect our financial condition and results of operations.
The rapid evolution of non-bank alternatives for initiation and completion of financial transactions puts us at risk of losing sources of revenue and funding. The ability of customers to pay bills, deposit and transfer funds, and purchase assets without utilizing the banking system could result in loss of fee income, deposits, and loans. If we are unable to continue timely development of competitive new products and services, our financial condition and results of operations could be adversely affected.
Regulatory and Legal Risks
We operate in a highly regulated environment and may be adversely affected by changes to or lack of compliance with federal, state and local laws and regulations.
We are subject to extensive regulation, supervision and examination by federal and state banking authorities. Any change to, or addition of, applicable regulations or federal or state legislation could have a substantial impact on our financial condition and results of operations. If our policies, procedures and systems are deemed deficient, we would be subject to liability, including fines and regulatory actions, which may include restrictions on the ability to pay dividends and the requirement to obtain regulatory approvals to proceed with certain aspects of our business plan, including branching and acquisitions.
Changes in tax laws and regulations may have an adverse impact on our financial condition and results of operations.
Any change or potential enactment of tax legislation, or changes in the interpretation of existing tax law, including provisions impacting tax rates, apportionment, consolidation or combination, income, expense, credits and exemptions may have a material adverse effect on our business, financial condition and results of operations.
Transactions between Bancorp and its insurance subsidiary, the Captive, may be subject to certain IRS responsibilities and penalties.
The Captive, a wholly owned subsidiary of the Company, is a Nevada-based captive insurance company that provides insurance against certain risks unique to operations of the Company and its subsidiaries for which insurance may not be currently available or economically feasible in today’s insurance marketplace. The Treasury Department of the United States and the IRS by way of Notice 2016-66 have stated that transactions believed to be similar in nature to transactions between Bancorp and the Captive may be deemed “transactions of interest” because such transactions may have potential for tax avoidance or evasion. If the IRS ultimately concludes such transactions do create violations of the tax code, the Company could be subject to the payment of penalties and interest.
18
Table of Contents
We are subject to litigation risk and reputational risk pertaining to fiduciary responsibility.
From time to time, customers may make claims and take legal action pertaining to our fiduciary responsibilities. Whether customer claims and legal action related to our fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to us they may result in significant financial liability and/or adversely affect the market perception of us and our products and services, as well as impact customer demand for those products and services. Any financial liability or reputational damage could have a material adverse effect on our financial condition and results of operations.
Increasing scrutiny and evolving expectations from regulators, investors and other stakeholders with respect to our environmental, social and governance practices may impose additional costs on us or expose us to new or additional risks.
Companies are facing increasing scrutiny from regulators, investors and other stakeholders related to their environmental, social and governance (ESG) practices and disclosure. Investor advocacy groups, investment funds and influential investors are also increasingly focused on these practices, especially as they relate to the environment, health and safety, diversity, labor conditions and human rights. Increased ESG-related compliance costs could result in increases to our overall operational costs. New government regulations could also result in new or more stringent forms of ESG oversight and expanding mandatory and voluntary reporting, diligence and disclosure. Additionally, concerns over the long-term impacts of climate change have led and will continue to lead to governmental efforts to mitigate those impacts. Failure to adapt or comply with related legislation, regulatory requirements or investor or stakeholder expectations and standards could negatively impact our reputation, financial condition and results of operations.
Risks Related to Our Common Stock
Our common stock price may fluctuate significantly, which could make it difficult for you to resell our common stock at times and/or prices acceptable to an investor.
The price of our common stock can fluctuate widely in response to various factors, some of which are beyond our control, and we expect our stock price will continue to fluctuate in the future. Factors impacting the price of our common stock include, but are not limited to:
● actual or anticipated variations in our quarterly results of operations;
● our past and future dividend practices;
● departure of our management team or other key personnel;
● new technology used, or services offered, by competitors;
● litigation and governmental investigations.
General market fluctuations, industry factors, economic and political conditions and events, inflation and economic slowdowns or recessions, interest rate changes and credit loss trends or fluctuations could also cause our stock price to decrease, regardless of operating results.
19
Table of Contents
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
The corporate headquarters of Bancorp are located at 1040 East Main Street, Louisville, Kentucky, a complex that also serves as the Bank’s main branch. Bancorp’s operations center is located at a separate location in Louisville. At December 31, 2022, in addition to the main office complex and the operations center, Bancorp owned 52 branches, seven of which are located on leased land. At that date, Bancorp also leased 21 branches. Of the 73 banking locations, 42 are located in our home market of Louisville, while 19, seven and five are located in our Central Kentucky, Cincinnati and Indianapolis markets, respectively.
Item 3. Legal Proceedings.
In the ordinary course of operations, Bancorp and the Bank are defendants in various legal proceedings. There is no proceeding pending or, to the knowledge of management, threatened in which an adverse decision could result in a material adverse change in the business or consolidated financial position of Bancorp or the Bank.
Item 4. Mine Safety Disclosures.
NA
20
Table of Contents
PART II
Bancorp’s common stock is traded on the NASDAQ under the ticker symbol SYBT. On December 31, 2022, Bancorp had approximately 2,200 shareholders of record, and approximately 12,300 beneficial owners holding shares in nominee or “street” name.
The following table shows information relating to the repurchase of shares of common stock by Bancorp during the three months ended December 31, 2022.
Effective May 22, 2019, Bancorp’s Board of Directors approved a share repurchase program authorizing the repurchase of 1 million shares, or approximately 4% of Bancorp’s total common shares outstanding at the time. Stock repurchases are expected to be made from time to time on the open market or in privately negotiated transactions, subject to applicable securities laws. The plan, which was extended in May 2021 and will expire in May 2023 unless otherwise extended or completed at an earlier date, does not obligate the Company to repurchase any specific dollar amount or number of shares prior to the plan’s expiration. No shares were repurchased in 2021, nor in 2022. Approximately 741,000 shares remain eligible for repurchase.
There were no equity securities of the registrant sold without registration during the quarter covered by this report.
On February 22, 2023, the Board of Directors declared a quarterly cash dividend of $0.29 per common share.
The following performance graphs and data shall not be deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that section, nor shall it be deemed soliciting material or subject to Regulation 14A of the Exchange Act or incorporated by reference in any filing under the Exchange Act or the Securities Act of 1933, except as shall be expressly set forth by specific reference in such filing.
The first graph compares performance of Bancorp’s Common Stock to the Russell 2000 Index, the S&P U.S BMI Banks - Midwest Region Index and the KBW NASDAQ Bank Index for the last five fiscal years. The graph assumes the value of the investment in Bancorp’s Common Stock and in each index was $100 at December 31, 2017 and that all dividends were reinvested.
In addition to the five-year period presented, the ten-year period is presented because it provides additional perspective, and Bancorp management believes that longer-term performance is of interest. The ten-year graph assumes the value of the investment in Bancorp’s Common Stock and in each respective index was $100 at December 31, 2012 and that all dividends were reinvested.
21
Table of Contents
Period Ending
Period Ending
22
Table of Contents
Item 6. [RESERVED]
Stock Yards Bancorp, Inc. (“Bancorp” or “the Company”), is a FHC headquartered in Louisville, Kentucky and is engaged in the business of banking through its wholly owned subsidiaries, Stock Yards Bank & Trust Company (“SYB” or “the Bank”) and SYB Insurance Company, Inc. (“the Captive”). Bancorp, which was incorporated in 1988 in Kentucky, is registered with, and subject to supervision, regulation and examination by, the Board of Governors of the Federal Reserve System. As Bancorp has no significant operations of its own, its business is essentially that of SYB and the Captive. The operations of SYB and the Captive are fully reflected in the consolidated financial statements of Bancorp. Accordingly, references to “Bancorp” in this document may encompass both the holding company and its subsidiaries, however, it should be noted that the business of the Captive is immaterial to the overall results of operations and financial condition of Bancorp. All significant inter-company transactions and accounts have been eliminated in consolidation.
SYB, established in 1904, is a state-chartered non-member financial institution that provides services in Louisville, central, eastern and northern Kentucky, as well as the Indianapolis, Indiana and Cincinnati, Ohio markets through 73 full service banking center locations. The Bank is registered with, and subject to supervision, regulation and examination by the FDIC and the Kentucky Department of Financial Institutions.
The Captive, a wholly owned subsidiary of the Bancorp, is a Nevada-based captive insurance company that provides insurance against certain risks unique to operations of the Company and its subsidiaries for which insurance may not be currently available or economically feasible in today’s insurance marketplace. The Captive pools resources with several other similar insurance company subsidiaries of financial institutions to spread a limited amount of risk among themselves. The Captive is subject to regulations of the State of Nevada and undergoes periodic examinations by the Nevada Division of Insurance. It has elected to be taxed under Section 831(b) of the Internal Revenue Code. Pursuant to Section 831(b), if gross premiums do not exceed $2,450,000, then the Captive is taxable solely on its investment income. The Captive is included in the Company’s consolidated financial statements and its federal income tax return.
As a result of its acquisition of Commonwealth Bancshares, Inc. on March 7, 2022, Bancorp became the 100% successor owner of three unconsolidated Delaware trust subsidiaries: Commonwealth Statutory Trust III, Commonwealth Statutory Trust IV and Commonwealth Statutory Trust V. The sole assets of the trust subsidiaries represent the proceeds of offerings exchanged for subordinated debentures with similar terms to the TPS.
Also as a result of its acquisition of Commonwealth Bancshares, Inc., Bancorp acquired a 60% interest in Landmark Financial Advisors, LLC (LFA), which is based in Bowling Green, Kentucky and provides wealth management services. LFA is consolidated into the Company. The 40% non-controlling interest is presented within the consolidated financial statements and represents the interest in LFA not owned by Bancorp. Effective December 31, 2022, Bancorp’s partial interest in LFA was sold, resulting in a pre-tax loss of $870,000 recorded in other non-interest expense on the consolidated income statements for the year ended December 31, 2022. This acquired line of business was not within the Company’s geographic footprint and ultimately did not align with the Company’s long-term strategic model. Net income related to LFA and attributable to Bancorp’s 60% interest, excluding the pre-tax loss on disposition noted above, totaled $483,000 for the year ended December 31, 2022.
Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the consolidated financial statements and accompanying Footnotes presented in Part II Item 8 “Financial Statements and Supplementary Data.”
23
Table of Contents
Cautionary Statement Regarding Forward-Looking Statements
This document contains statements relating to future results of Bancorp that are considered “forward-looking” as defined by Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The forward-looking statements are principally, but not exclusively, contained in Part II Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Part I Item 1A “Risk Factors.”
Forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause actual results, performance, or achievements to be materially different from future results, performance, or achievements expressed or implied by the statement. These statements are often, but not always, made through the use of words or phrases such as “anticipate,” “believe,” “can,” “conclude,” “continue,” “could,” “estimate,” “expect,” “foresee,” “goal,” “intend,” “may,” “might,” “outlook,” “possible,” “plan,” “predict,” “project,” “potential,” “seek,” “should,” “target,” “will,” “will likely,” “would,” or other similar expressions. These forward-looking statements are not historical facts and are based on current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control.
Forward-looking statements detail management’s expectations regarding the future and are based on information known to management only as of the date the statements are made and management undertakes no obligation to update forward-looking statements to reflect events or circumstances that occur after the date forward-looking statements are made, except as required by applicable regulation.
There is no assurance that any list of risks and uncertainties or risk factors is complete. Factors that could cause actual results to differ materially from those expressed or implied in forward-looking statements include, among other things:
● changes in laws and regulations or the interpretation thereof;
● impairment of investment securities;
● impairment of goodwill, MSRs, other intangible assets and/or DTAs;
● changes in fiscal, monetary, and/or regulatory policies;
● ability to effectively manage capital and liquidity;
● competitive product and pricing pressures;
● changes in investor sentiment or behavior;
● changes in consumer/business spending or savings behavior;
24
Table of Contents
On March 7, 2022, Bancorp completed its acquisition of Commonwealth Bancshares, Inc. and its wholly owned subsidiary, Commonwealth Bank & Trust Company, collectively defined as “CB,” a Louisville, Kentucky-based commercial bank and trust company, which operated 15 retail branches, including nine in Jefferson County, four in Shelby County, and two in Northern Kentucky. At the time of acquisition and net of purchase accounting adjustments, CB had $1.34 billion in assets, $632 million in loans, $247 million in investment securities and $1.12 billion in deposits in addition to maintaining a WM&T Department with total assets under management of approximately $2.65 billion. CB was also the holding company for three unconsolidated Delaware trust subsidiaries and held a 60% interest in LFA. Bancorp became the 100% successor owner of all three trust subsidiaries and also retained the 60% interest in LFA upon acquisition, the latter of which was disposed of effective December 31, 2022. Bancorp acquired all outstanding common stock of CB, Inc. in a combined stock and cash transaction that resulted in total consideration paid to CB shareholders of $168 million.
Bancorp recorded goodwill of approximately $67 million and incurred merger related expenses totaling $19.5 million during the first quarter of 2022 as a result of the CB acquisition. As a result of Bancorp’s disposition of its partial interest in LFA, which resulted in a pre-tax loss of $870,000 recorded in other non-interest expense on the consolidated income statements for the year ended December 31, 2022, goodwill totaling $8.5 million was written off, bringing total goodwill related to the CB acquisition to $58 million as of December 31, 2022.
The acquisition of CB has had a significant impact on the ACL and credit loss provisioning in 2022. In total, the CB acquisition served to increase the ACL on loans by $14 million at acquisition date. This increase consisted of $10 million attributed to the acquired PCD loan portfolio, with the corresponding offset recorded to goodwill (as opposed to provision for credit loss expense), and $4.4 million of provision for credit loss expense attributed to the acquired non-PCD portfolio, which represented the acquisition-related credit loss expense at the time of acquisition.
Acquisition of Kentucky Bancshares, Inc. and its Subsidiary Kentucky Bank
On May 31, 2021, Bancorp completed its acquisition of Kentucky Bancshares, Inc. and its wholly owned subsidiary, Kentucky Bank, collectively defined as “KB,” a Paris, Kentucky-based commercial bank and trust company, which operated 19 retail branches throughout central and eastern Kentucky. At the time of acquisition and net of purchase accounting adjustments, KB had $1.27 billion in assets, $755 million in loans, $396 million in investment securities and $1.04 billion in deposits. KB was also the holding company for an insurance captive, which Bancorp retained and renamed SYB Insurance Company, Inc. Bancorp acquired all outstanding common stock of KB in a combined stock and cash transaction that resulted in total consideration paid to KB shareholders of $233 million.
Bancorp recorded goodwill of approximately $123 million and incurred merger related expenses totaling $18.1 million for the year ended December 31, 2021 as a result of the KB acquisition.
The acquisition of KB had a significant impact on the ACL and credit loss provisioning for the year ended December 31, 2021. In total, the KB acquisition served to increase the ACL by $14 million at acquisition date. This increase consisted of $7 million attributed to the acquired PCD loan portfolio, with the corresponding offset recorded to goodwill (as opposed to provision for credit loss expense), and $7.4 million of provision for credit loss expense attributed to the acquired non-PCD portfolio, which represented the acquisition-related credit loss expense at the time of acquisition.
25
Table of Contents
Issued but Not Yet Effective Accounting Standards Updates
For disclosure regarding the impact to Bancorp’s financial statements of issued-but-not-yet-effective ASUs, see the Footnote titled “Summary of Significant Accounting Policies” of Part II Item 8 “Financial Statements and Supplementary Data.”
Critical Accounting Policies and Estimates
Bancorp’s consolidated financial statements and accompanying footnotes have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported periods.
Management continually evaluates its accounting policies and estimates that it uses to prepare the consolidated financial statements. In general, management’s estimates and assumptions are based on historical experience, accounting and regulatory guidance, and information obtained from independent third-party professionals. Actual results may differ from those estimates made by management.
Critical accounting policies are those that management believes are the most important to the portrayal of Bancorp’s financial condition and operating results and require management to make estimates that are difficult, subjective and complex. Most accounting policies are not considered by management to be critical accounting policies. Several factors are considered in determining whether or not a policy is critical in the preparation of the financial statements. These factors include, among other things, whether the estimates have a significant impact on the financial statements, the nature of the estimates, the ability to readily validate the estimates with other information including independent third parties or available pricing, sensitivity of the estimates to changes in economic conditions and whether alternative methods of accounting may be utilized under GAAP. Management has discussed each critical accounting policy and the methodology for the identification and determination of critical accounting policies with Bancorp’s Audit Committee. As of December 31, 2022, the significant accounting policies considered the most critical in preparing Bancorp’s consolidated financial statements are the determination of the ACL on loans and Goodwill.
Allowance for Credit Losses on Loans and Provision for Credit Losses
On January 1, 2020, Bancorp adopted ASC 326 “Financial Instruments – Credit Losses,” which created material changes to Bancorp’s critical accounting policy that existed at December 31, 2019.
For purposes of establishing the general reserve, Bancorp stratifies the loan portfolio into homogeneous groups of loans that possess similar loss potential characteristics and calculates the net amount expected to be collected over the life of the loans to estimate the credit losses in the loan portfolio. Bancorp’s methodologies for estimating the ACL on loans consider available relevant information about the collectability of cash flows, including information about past events, current conditions, and reasonable and supportable forecasts.
The ACL on loans is established through credit loss expense charged to current earnings. The amount maintained in the ACL reflects management’s estimate of the net amount not expected to be collected on the loan portfolio at the balance sheet date over the life of the loan. The ACL is comprised of specific reserves assigned to certain loans that do not share general risk characteristics and general reserves on pools of loans that do share general risk characteristics. Factors contributing to the determination of specific reserves include the creditworthiness of the borrower and more specifically, changes in the expected future receipt of principal and interest payments and/or in the value of pledged collateral. A reserve is recorded when the carrying amount of the loan exceeds the discounted estimated cash flows using the loan’s initial effective interest rate, an expected loss ratio based on historical losses adjusted as appropriate for qualitative factors, or the fair value of the collateral for certain collateral-dependent loans.
Provision for credit losses can be subject to volatility as ACL calculations and the resulting expense are significantly impacted by changes in CECL model assumptions such as macroeconomic factors and conditions, credit quality and loan composition. Forecasted economic conditions have been generally volatile since Bancorp’s adoption of CECL, as the pandemic, related government stimulus efforts, the Federal Reserve’s efforts to combat inflation, and recession-based fears have driven constantly changing estimates of the economy over the past several years.
26
Table of Contents
Goodwill
Goodwill resulting from business combinations represents the excess of the purchase price over the fair value of the net assets of businesses acquired. Goodwill resulting from business combinations is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any non-controlling interests in the acquire, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually. Events that may trigger goodwill impairment include deterioration in economic conditions, a decline in market-dependent multiples or metrics (i.e. stock price falling below tangible book value), negative trends in overall financial performance and regulatory action.
Bancorp has selected September 30 as the date to perform the annual impairment test. Goodwill is the only intangible asset with an indefinite life on Bancorp’s consolidated balance sheets. No impairment to Goodwill was indicated based on Bancorp’s annual testing for 2022.
At December 31, 2022, Bancorp had $194 million in goodwill recorded on its balance sheet. Goodwill totaling $67 million was recorded in association with the acquisition of CB in 2022, $8.5 million of which was subsequently written off as a result of the disposition of Bancorp’s partial interest in LFA. Goodwill totaling $123 million was recorded in association with the acquisition of KB in 2021. Effective December 31, 2022, management finalized the fair values of the acquired assets and assumed liabilities associated with the CB acquisition in advance of the 12 month post-acquisition date, as allowed by GAAP.
27
Table of Contents
Business Segment Overview
Bancorp is divided into two reportable segments: Commercial Banking and WM&T:
Commercial Banking provides a full range of loan and deposit products to individual consumers and businesses in all its markets through retail lending, mortgage banking, deposit services, online banking, mobile banking, private banking, commercial lending, commercial real estate lending, leasing, treasury management services, merchant services, international banking, correspondent banking and other banking services. The Bank also offers securities brokerage services via its banking center network through an arrangement with a third party broker-dealer in the Commercial Banking segment.
WM&T provides investment management, financial & retirement planning and trust & estate services, as well as retirement plan management for businesses and corporations in all markets in which Bancorp operates. The magnitude of WM&T revenue distinguishes Bancorp from other community banks of similar asset size.
Overview – Operating Results (FTE)
The following table presents an overview Bancorp’s financial performance for the years ended December 31, 2022, 2021 and 2020:
Years Ended December 31, Variance
Additional discussion follows under the section titled “Results of Operations.”
General highlights for the year ended December 31, 2022 compared to December 31, 2021:
● In 2022, Bancorp set the following financial records:
28
Table of Contents
29
Table of Contents
Total stockholder’s equity to total assets was 10.14% as of December 31, 2022 compared to 10.17% at December 31, 2021. Total equity increased to $760 million in 2022, driven by the issuance of $134 million in stock for the acquisition of CB and net income of $93.0 million, which were partially offset by a $108 million negative change in AOCI and $33 million of dividends declared. The large decline in AOCI from December 31, 2021 to December 31, 2022 was the result of the rising interest rate environment and its corresponding impact on the valuation of the AFS debt securities portfolio.
TCE is a measure of a company’s capital, which is useful in evaluating the quality and adequacy of capital. Bancorp’s ratio of TCE to total tangible assets was 7.44% as of December 31, 2022, compared with 8.22% at December 31, 2021, the decline driven by both the large interest-rate driven changes in AOCI noted above and acquisition-related growth. See the section titled “Non-GAAP Financial Measures” for reconcilement of non-GAAP to GAAP measures.
General highlights for the year ended December 31, 2021 compared to December 31, 2020:
30
Table of Contents
Total stockholder’s equity to total assets was 10.17% as of December 31, 2021 compared to 9.56% at December 31, 2020. Total equity increased $235 million in 2021, driven by the issuance of $205 million in stock for the acquisition of KB and net income of $74.6 million, which were partially offset by $28 million of dividends declared, changes in AOCI and stock-based compensation activity.
Bancorp’s ratio of TCE to total tangible assets was 8.22% as of December 31, 2021, compared with 9.28% at December 31, 2020, the decline driven by acquisition-related growth. See the section titled “Non-GAAP Financial Measures” for reconcilement of non-GAAP to GAAP measures.
31
Table of Contents
Challenges for 2023:
Bancorp has identified the following challenges for fiscal year 2023:
32
Table of Contents
Results of Operations
Net Interest Income - Overview
As is the case with most banks, Bancorp’s primary revenue sources are net interest income and fee income from various financial services provided to customers. Net interest income is the difference between interest income earned on loans, investment securities and other interest earning assets less interest expense on deposit accounts and other interest bearing liabilities. Loan volume and interest rates earned on those loans are critical to overall profitability. Similarly, deposit volume is crucial to funding loans and rates paid on deposits directly impact profitability. New business volume is influenced by numerous economic factors including market interest rates, business spending, liquidity, consumer confidence and various competitive conditions within the marketplace. The discussion that follows is based on FTE net interest income data.
Comparative information regarding net interest income follows:
As of and for the Years Ended December 31, Variance
Net interest spread (FTE)* 3.21 % 3.16 % 3.22 % 5 bps (6) bps
Five year Treasury note rate at year end 3.99 % 1.26 % 0.36 % 273 bps 90 bps
Average five year Treasury note rate 3.00 % 0.86 % 0.53 % 214 bps 33 bps
One month term SOFR at year end 4.36 % 0.06 % 0.07 % 430 bps (1) bps
One month term LIBOR at year end 4.39 % 0.10 % 0.14 % 429 bps (4) bps
*See table titled, "Average Balance Sheets and Interest Rates (FTE)" for detail of Net interest income (FTE).
NIM and net interest spread calculations above exclude the sold portion of certain participation loans, which totaled $5 million, $5 million and $8 million for the years ended December 31, 2022, 2021 and 2020, respectively. These sold loans are on Bancorp’s balance sheet as required by GAAP because Bancorp retains some form of effective control; however, Bancorp receives no interest income on the sold portion. These participation loans sold are excluded from NIM and spread analysis, because Bancorp believes it provides a more accurate depiction of loan portfolio performance.
At December 31, 2022, Bancorp’s loan portfolio consisted of approximately 71% fixed and 29% variable rate loans. At inception, most of Bancorp’s fixed rate loans are priced in relation to the five year treasury. Bancorp’s variable rate loans are indexed to either Prime, LIBOR or SOFR, generally repricing as those rates change.
Prime rate, the five year Treasury note rate, one month term LIBOR and one month term SOFR are included in the table above to provide a general indication of the interest rate environment in which Bancorp has operated during the past three years, a period that experienced significant interest rate volatility, denoted by the FRB’s dramatic pandemic-driven rate cuts of March 2020 that were sustained until the inflation-driven rate increases of 2022.
The FRB has taken aggressive interest rate action over the past year, implementing multiple rate hikes in an effort to tame inflation that has reached its highest levels in decades. The FFTR was increased a total of 425 bps in 2022, beginning the year at a range of 0.00% - 0.25% and ending the year at a range of 4.25% - 4.50%. As a result, Prime increased from 3.25% at the beginning of 2022 to 7.50% as of December 31, 2022, ending the year at its highest level since 2007. Bancorp has experienced significant benefit from the rate increases enacted in 2022, particularly since the mid-June rate hike that lifted Prime to 4.75% and in effect, took the majority of Bancorp’s variable rate loans off of their 4.00% floors. Subsequent rate increases have continued to provide meaningful benefit, offset partially by Bancorp’s election to raise deposit rates.
33
Table of Contents
The current economic outlook suggests continued interest rate increases from the FRB through the first half of 2023, albeit at a reduced pace compared to 2022. Pricing pressure/competition for both loans and deposits, changing levels of liquidity within the banking system and an inverted yield curve could continue to place pressure on NIM.
Discussion of 2022 vs 2021:
Net interest spread (FTE) and NIM (FTE) were 3.21% and 3.35%, for the year ended December 31, 2022 compared to 3.16% and 3.22% for the same period in 2021, respectively. NIM during the year ended December 31, 2022 was significantly impacted by the following:
Net interest income (FTE) increased $62.8 million, or 37%, for the year ended December 31, 2022 compared to the same period of 2021, largely as a result of acquisition-related activity, but also driven in part by strong organic loan growth, substantial deployment of excess liquidity into the investment securities portfolio and the continued benefit of a rising interest rate environment. Partially offsetting this increase was the rising cost of interest bearing deposits and the addition of subordinated debt through the CB acquisition.
Total average interest earning assets increased $1.67 billion, or 31%, to $6.99 billion for the year ended December 31, 2022, as compared to the same period of 2021, with the average rate earned on total interest earning assets increasing from 3.34% to 3.61%.
34
Table of Contents
Total interest income (FTE) increased $75.0 million, or 42%, to $252.5 million for the year ended December 31, 2022, as compared to the same period of 2021.
Total average interest bearing liabilities increased $1.15 billion, or 34%, to $4.54 billion for the year ended December 31, 2022 compared with the same period in 2021, with the total average cost increasing 22 bps to 0.40%.
Total interest expense increased $12.3 million for the year ended December 31, 2022 compared to the same period of 2021, driven by acquisition-related average balance growth, Bancorp’s first deposit rate increases in almost two years and debt assumed through the CB acquisition. As a result, the cost of interest bearing liabilities increased 22 bps to 0.40% for the year ended December 31, 2022 compared to the same period of 2021.
35
Table of Contents
Discussion of 2021 vs 2020:
Net interest spread and NIM were 3.16% and 3.22% for the year ended December 31, 2021 compared to 3.22% and 3.39% for the year ended December 31, 2020. NIM was significantly impacted in 2021 by the following:
Net interest income (FTE) increased $35.4 million, or 26%, for the year ended December 31, 2021 compared to the same period of 2020, due to interest and fee income associated with the PPP portfolio, substantial growth in the non-PPP loan portfolio and investment securities portfolio, and the aforementioned lowering of deposit rates.
Total average interest earning assets increased $1.30 billion, or 32%, to $5.32 billion for the year ended December 31, 2021, as compared to the same period of 2020, with the average rate earned on total interest earning assets contracting 34 bps to 3.34%.
36
Table of Contents
Total interest income (FTE) increased $29.4 million, or 20%, to $177.5 million for the year ended December 31, 2021 as compared to the same period of 2020.
Total average interest bearing liabilities increased $773 million, or 30%, to $3.39 billion for the year ended December 31, 2021 compared with the same period in 2020, with the total average cost declining 28 bps to 0.18%.
Total interest expense decreased $5.9 million, or 50%, for the year ended December 31, 2021 compared to the same period of 2020, a direct result of deposit rate reductions implemented in response to the falling interest rate environment and to a lesser extent, the reduction in interest expense on FHLB advances.
37
Table of Contents
Average Balance Sheets and Interest Rates (FTE)
Interest earning assets:
Investment securities:
Non-interest earning assets:
Interest bearing liabilities:
Deposits:
Non-interest bearing liabilities:
38
Table of Contents
Supplemental Information - Total Company Average Balance Sheets and Interest Rates (FTE)
39
Table of Contents
The following table illustrates the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities impacted Bancorp’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to (i) changes attributable to changes in volume (changes in volume multiplied by prior rate), (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume) and (iii) net change. The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate. Tax-equivalent adjustments are based on a federal income tax rate of 21%. The change in interest due to both rate and volume has been allocated to the change due to rate and the change due to volume in proportion to the relationship of the absolute dollar amounts of the change in each.
Rate/Volume Analysis (FTE)
Compared to Compared to
Total Net Increase (Decrease) Due to Total Net Increase (Decrease) Due to
(in thousands) Change Rate Volume Change Rate Volume
Interest income:
Investment securities:
Interest expense:
Deposits:
Securities sold under agreements to repurchase 543 500 43 (13 ) (28 ) 15
40
Table of Contents
Asset/Liability Management and Interest Rate Risk
Managing interest rate risk is fundamental for the financial services industry. The primary objective of interest rate risk management is to neutralize effects of interest rate changes on net income. By considering both on and off-balance sheet financial instruments, management evaluates interest rate sensitivity with the goal of optimizing net interest income within the constraints of prudent capital adequacy, liquidity needs, market opportunities and customer requirements.
Interest Rate Simulation Sensitivity Analysis
Bancorp uses an earnings simulation model to estimate and evaluate the impact of an immediate change in interest rates on earnings in a one-year forecast. The simulation model is designed to reflect dynamics of interest earning assets and interest bearing liabilities. By estimating effects of interest rate fluctuations, the model can approximate interest rate risk exposure. This simulation model is used by management to gauge approximate results given a specific change in interest rates at a given point in time. The model is therefore a tool to indicate earnings trends in given interest rate scenarios and may not indicate actual or expected results.
The results of the interest rate sensitivity analysis performed as of December 31, 2022 were derived from the long-term, conservative assumptions Bancorp uses in the model, particularly in relation to deposit betas, which measure how responsive management’s deposit repricing may be to changes in market rates and are based on historical data. The results presented below reflect an interest rate sensitivity analysis that incorporates a deposit beta of approximately 60%, which approximates Bancorp’s long-term average. While the beta’s experienced in 2022 were significantly below this level, the Company anticipates the future betas will be closer to, or even exceed, historic averages.
Bancorp’s interest rate simulation sensitivity analysis details that increases in interest rates of 100, 200 and 300 bps would have a negative effect on net interest income, respectively, while decreases of 100 and 200 bps in interest rates would have a positive effect on net interest income. These results depict a slightly liability sensitive interest rate risk profile. The decrease in net interest income in the rising rate scenarios is primarily due to variable rate loans and short-term investments repricing slower than deposits and short-term borrowings.
Change in Rates
Basis Points Basis Points Basis Points Basis Points Basis Points
Bancorp’s loan portfolio is currently composed of approximately 71% fixed and 29% variable rate loans, with the fixed rate portion pricing generally based on a spread to the five year treasury curve at the time of origination and the variable portion pricing based on an on-going spread to Prime (approximately 65%) or one month LIBOR/SOFR (approximately 35%).
In July 2017, the Financial Conduct Authority (the “FCA”), the authority regulating LIBOR, along with various other regulatory bodies, announced that LIBOR would likely be discontinued at the end of 2021. Subsequent to that announcement, in November 2020, the FCA announced that many tenors of LIBOR would continue to be published through June 2023. Subsequent to this, Bank regulators instructed banks to discontinue new originations referencing LIBOR as soon as possible, but no later than December 2021. Effective December 31, 2021, LIBOR is no longer used to issue new loans in the U.S. It is expected to be replaced primarily by the SOFR, which many experts consider a more accurate and more secure pricing benchmark. To facilitate the transition process, management has instituted an enterprise-wide program to identify, assess, and monitor risks associated with the expected discontinuance or unavailability of LIBOR.
On March 15, 2022, the Adjustable Interest Rate (LIBOR) Act was signed into law as part of the Consolidated Appropriations Act of 2022. This legislation established a uniform benchmark replacement process for financial contracts that mature after the cessation of LIBOR (scheduled for June 2023) that do not contain clearly defined or practicable fallback provisions. The legislation also established a safe harbor for lenders, providing protection from litigation associated with choosing a replacement rate recommended by the FRB, such as SOFR, and also allows for the continued use of any appropriate benchmark rate for new contracts.
41
Table of Contents
As of December 31, 2022, the Company had approximately $477 million in loans and interest rate derivative contracts of $120 million (notional amount) that reference LIBOR. Each of the LIBOR-referenced amounts discussed above will vary in future periods as current contracts expire with potential replacement contracts using either LIBOR or an alternative reference rate. The Company, and other industry participants, continue to review alternative reference rates that could be utilized as a replacement for LIBOR. The Company had $206 million in loans that were indexed to SOFR at December 31, 2022.
Periodically, Bancorp enters into interest rate swap transactions with borrowers who desire to hedge exposure to rising interest rates, while at the same time entering into an offsetting interest rate swap, with substantially matching terms, with another approved independent counterparty. These are undesignated derivative instruments and are recognized on the balance sheet at fair value, with changes in fair value recorded in other non-interest income as interest rates fluctuate. Because of matching terms of offsetting contracts, in addition to collateral provisions which mitigate the impact of non-performance risk, changes in fair value subsequent to initial recognition have a minimal effect on earnings, and are therefore not included in the simulation analysis results above. For additional information see the Footnote titled “Assets and Liabilities Measured and Reported at Fair Value.”
In addition, Bancorp periodically uses derivative financial instruments as part of its interest rate risk management, including interest rate swaps. These interest rate swaps are designated as cash flow hedges as described in the Footnote titled “Interest Rate Swaps.” For these derivatives, the effective portion of gains or losses is reported as a component of OCI, and is subsequently reclassified into earnings as an adjustment to interest expense in periods in which the hedged forecasted transaction affects earnings. As of December 31, 2022, Bancorp had no outstanding interest rate swaps designated as cash flow hedges.
42
Table of Contents
Provision for Credit Losses
Provision for credit losses on loans at December 31, 2022 represents the amount of expense that, based on Management’s judgment, is required to maintain the ACL for loans at an appropriate level under the CECL model. The determination of the amount of the ACL for loans is complex and involves a high degree of judgment and subjectivity. See the footnote titled “Summary of Significant Accounting Policies” for detailed discussion regarding Bancorp’s ACL methodology by loan segment.
An analysis of the changes in the ACL on loans, including provision, and selected ratios follow:
As of and for the years ended December 31, (dollars in thousands) 2022 2021 2020
Acquired PCD loans (goodwill adjustment) 9,950 6,757 —
CECL - cumulative adjustment — — 9,856
Provision for credit losses on loans - acquired loans 4,429 7,397 —
Net loan (charge-offs) recoveries 1 (6,176 ) (1,645 )
Provision for credit losses on loans to average total loans 0.20 % 0.04 % 0.51 %
Net loan (charge-offs) recoveries to average total loans 0.00 % -0.16 % -0.05 %
ACL for loans to total loans 1.41 % 1.29 % 1.47 %
ACL for loans to total loans (excluding PPP) (1) 1.42 % 1.34 % 1.74 %
ACL for loans to average total loans 1.53 % 1.36 % 1.57 %
(1) See the section titled “Non-GAAP Financial Measures” for reconcilement of non-GAAP to GAAP measures.
Discussion of 2022 vs 2021:
The ACL for loans totaled $74 million as of December 31, 2022 compared to $54 million at December 31, 2021, representing an ACL to total loans ratio of 1.41% and 1.29% for those periods, respectively. The ACL to loans (excluding PPP loans) was 1.42% at December 31, 2022 compared to 1.34% at December 31, 2021. Based on the 100% SBA guarantee of the PPP loan portfolio, which totaled $19 million at December 31, 2022 and $141 million at December 31, 2021, Bancorp did not reserve for potential losses for these loans within the ACL. See the section titled “Non-GAAP Financial Measures” for reconcilement of non-GAAP to GAAP measures.
Provision expense for credit losses on loans (excluding acquisition-related activity) of $5.3 million was recorded for the year ended December 31, 2022. Significant organic loan growth, inflation and recession-based increases in the projected unemployment rate forecast, along with qualitative factor updates related to the potential impact of rising rates on the C&I portfolio, were the main drivers of expense within the CECL model for 2022. Further, net charge off/recovery activity for the year ended December 31, 2022 was minimal.
Credit loss expense recorded for the acquired CB loan portfolio totaled $4.4 million and was recorded in the first quarter of 2022, bringing total provision for credit losses on loans to $9.7 million for the year ended December 31, 2022. Further, the ACL for loans was also increased $10 million as a result of the PCD loan portfolio added through the CB acquisition during the first quarter, with the corresponding offset recorded to goodwill (as opposed to provision for credit loss expense).
43
Table of Contents
Total provision expense for credit losses on loans of $1.4 million was recorded for the year ended December 31, 2021, as acquisition-related expense competed with a number of improving factors within the CECL model. Expense totaling $7.4 million was recorded in association with the non-PCD loan portfolio added through the KB acquisition during the second quarter of 2021, which was partially offset by a net benefit of $6.0 million recorded for the year ended December 31, 2021, and was driven by a then-improving unemployment forecast, updates to Bancorp’s CECL modeling and strong historic credit metrics. Further, the ACL for loans was also increased $6.8 million as a result of the PCD loan portfolio added through the KB acquisition during the second quarter of 2021, with the corresponding offset recorded to goodwill (as opposed to provision for credit loss expense).
The ACL for off balance sheet credit exposures, while separate from the ACL for loans and recorded in other liabilities on the consolidated balance sheets, also experienced an increase between December 31, 2021 and December 31, 2022. The CB acquisition resulted in a $500,000 increase to the ACL for off balance sheet credit exposures during the first quarter of 2022, with the corresponding offset recorded to goodwill (as opposed to provision for credit loss expense). Provision for credit loss expense for off balance sheet credit exposures of $575,000 was also recorded for the year ended December 31, 2022, driven mainly by the addition of new lines of credit, and thus increased availability, largely within the C&D portfolio. ACL for off balance sheet credit exposures stood at $4.5 million as of December 31, 2022 compared to $3.5 million as of December 31, 2021.
While the year ended December 31, 2021 experienced a similar $250,000 increase to the ACL for off balance sheet credit exposures as a result of the KB acquisition, negative provision for credit loss expense for off balance sheet credit exposures totaling $2.2 million was recorded for the year ended December 31, 2021. This large benefit was the result of general declines in reserve loss percentages consistent with then-improving CECL model factors and improvement in line of credit utilization.
Bancorp’s loan portfolio is well-diversified with no significant concentrations of credit. Geographically, most loans are extended to borrowers in Louisville, central, eastern and northern Kentucky, as well as the Indianapolis, Indiana and Cincinnati, Ohio metropolitan markets. The adequacy of the ACL is monitored on an ongoing basis and it is the opinion of management that the balance of the ACL at December 31, 2022 is adequate to absorb probable losses inherent in the loan portfolio as of the financial statement date.
Discussion of 2021 vs 2020:
The ACL on loans totaled $54 million as of December 31, 2021 compared to $52 million at December 31, 2020, representing an ACL to total loans ratio of 1.29% and 1.47% for those periods, respectively. The ACL to total loans (excluding PPP loans) was 1.34% at December 31, 2021 compared to 1.74% at December 31, 2020, the decrease stemming from loan growth and a lower ACL. Based on the 100% SBA guarantee of the PPP loan portfolio, which totaled $141 million (net of unamortized deferred fees) at December 31, 2021 and $550 million at December 31, 2020, Bancorp did not record a general reserve for potential losses for these loans within the ACL. See the section titled “Non-GAAP Financial Measures” for reconcilement of non-GAAP to GAAP measures.
Upon adoption of ASC 326 effective January 1, 2020, Bancorp recorded an increase of $8.2 million to the ACL on loans and a corresponding decrease to retained earnings, net of the DTA impact. In addition, non-accretable yield marks of $1.6 million related to formerly classified PCI loans were reclassed between the amortized cost basis of loans and corresponding ACL on loans, which were subsequently charged-off in the third quarter of 2020 with no resulting impact to provision for credit loss expense. The adjustment upon adoption of ASC 326 raised the beginning balance of the ACL on loans to $37 million on January 1, 2020.
In total, provision for credit losses on loans decreased $15.5 million, or 92%, for the year ended December 31, 2021 compared to the same period of 2020. The significantly higher expense recorded for the year ended December 31, 2020 was the result of CECL adoption and the subsequent pandemic-related developments experienced shortly thereafter, particularly elevated future unemployment forecasts.
Due to continued improvement in the unemployment forecast, updates to Bancorp’s CECL modeling and strong historic credit metrics, a net benefit (excluding acquisition-related activity) of $6.0 million was recorded for the year ended December 31, 2021, which was offset by credit loss expense on loans associated with the non-PCD loan portfolio added as a result of the KB acquisition, which was recorded during the second quarter of 2021 and totaled $7.4 million.
44
Table of Contents
Further, the ACL on loans was also increased $6.8 million as a result of the PCD loan portfolio added through the KB acquisition during the second quarter, with the corresponding offset recorded to goodwill. Partially offsetting this increase was net charge off activity of $6.2 million for the year ended December 31, 2021, serving to reduce the ACL on loans. Net charge off activity for 2021 was driven by the charge off of two CRE relationships totaling $4.4 million. These charged off amounts were fully reserved and had no income statement impact for the year ended December 31, 2021. In addition, there was a $555,000 recovery of a note that was fully charged off in 2020.
While separate from the ACL on loans and recorded in other liabilities on the consolidated balance sheets, the ACL for off balance sheet credit exposures also experienced a decrease between December 31, 2020 and December 31, 2021. A net benefit of $2.2 million was recorded for the year ended December 31, 2021, as nearly all applicable loan segments experienced declines in their reserve loss percentages consistent with generally improving model factors and improvement in line of credit utilization, most notably within the C&I portfolio. In addition, the ACL for off balance sheet credit exposures was increased $250,000 as a result of available credit added through the KB acquisition during the second quarter, with the corresponding offset recorded to goodwill. The ACL for off balance sheet credit exposures stood at $3.5 million as of December 31, 2021 compared to $5.4 million as of December 31, 2020.
Non-Interest Income
Variance
NM - Not Meaningful
Discussion of 2022 vs 2021:
Total non-interest income increased $23.3 million, or 35%, for the year ended December 31, 2022 compared to the same period of 2021. Non-interest income comprised 28% of total revenue, defined as net interest income and non-interest income, for the years ended December 31, 2022 and 2021, respectively. WM&T services comprised 41% of total non-interest income for the year ended December 31, 2022 compared to 42% for the same period of 2021, respectively. Acquisition-related activity drove a significant portion of the non-interest income increase for the year ended December 31, 2022 compared to the same period of 2021.
45
Table of Contents
WM&T Services:
The magnitude of WM&T revenue distinguishes Bancorp from other community banks of similar asset size. WM&T revenue increased $8.5 million, or 31%, for the year ended December 31, 2022 as compared with the same period of 2021. Significant growth in AUM drove the increase over prior year, consistent with acquisition-related activity and organic new business development. However, significant declines in both fixed income and equity markets weighed heavily on WM&T revenue in 2022, as inflation and recession-based fears, coupled with geopolitical tensions, have resulted in continued volatility.
Recurring fees earned for managing accounts are based on a percentage of market value of AUM and are typically assessed on a monthly basis. Recurring fees, which generally comprise the vast majority of WM&T revenue, increased $8.7 million, or 32%, for the year ended December 31, 2022, as compared with the same period of 2021, as a result of the aforementioned acquisition-related and organic business development.
A portion of WM&T revenue, most notably executor and certain employee benefit plan-related fees, are non-recurring in nature and the timing of these revenues typically correspond with the related administrative activities. For this reason, such fees are subject to greater period over period fluctuation. Total non-recurring fees decreased $194,000, or 32%, for the year ended December 31, 2022, as compared with the same period of 2021, consistent with lower estate fee revenue.
AUM, stated at market value, totaled $6.59 billion at December 31, 2022 compared to $4.80 billion at December 31, 2021. The large increase is attributed mainly to AUM of $2.65 billion added through the first quarter CB acquisition, as well as organic net new business growth over the past year, which were partially offset by significant declines in both fixed income and equity markets during 2022, as previously noted.
Contracts between WM&T and their customers do not permit performance-based fees and accordingly, none of the WM&T revenue is performance based. Management believes the WM&T department will continue to factor significantly in Bancorp’s financial results and provide strategic diversity to revenue streams.
Detail of WM&T Service Income by Account Type:
(in thousands)
Brokerage and insurance services 67 78 45
The preceding table demonstrates that WM&T fee revenue is concentrated within investment advisory and personal trust accounts. WM&T fees are predominantly based on AUM and tailored for individual/company accounts and/or relationships with fee structures customized based on account type and other factors with larger relationships paying a lower percentage of AUM in fees. For example, recurring AUM fee structures are in place for investment management, irrevocable and revocable trusts, personal investment retirement accounts and accounts holding only fixed income securities. Company retirement plan services can consist of a one-time conversion fee with recurring AUM fees to follow. While there are also fee structures for estate settlements, income received is often non-recurring in nature. Fee structures are agreed upon at the time of account opening and any subsequent revisions are communicated in writing to the customer. WM&T fees earned are not performance-based nor are they based on investment strategy or transactions. Bancorp also earns management fees on in-house investments funds acquired from CB.
46
Table of Contents
Assets Under Management by Account Type:
Total AUM (not included on balance sheet) increased from $4.80 billion at December 31, 2021 to $6.59 billion at December 31, 2022 as follows:
(in thousands) Managed Non-managed (1) Total Managed Non-managed (1) Total
(1) Non-managed assets represent those for which the WM&T department does not hold investment discretion.
As of December 31, 2022 and 2021, approximately 79% and 81%, respectively, of total AUM were actively managed. Company retirement plan accounts primarily consist of participant-directed assets. The amount of custody and safekeeping accounts are insignificant.
Managed Trust AUM by Class of Investment:
Treasury and government agency obligations 176,917 39,736
Other mutual funds - fixed, balanced and municipal 583,713 612,913
Common trust funds and collective investment funds 114,458 -
Real estate mortgages 774 -
(1) Includes client directed instruments including rights, warrants, annuities, insurance policies, unit investment trusts, and oil and gas rights.
Managed assets are invested in instruments for which market values can be readily determined, the majority of which are sensitive to market fluctuations and consist of approximately 63% in equities and 37% in fixed income securities as of December 31, 2022 compared to 68% and 32% as of December 31, 2021. This composition has been relatively consistent from period to period. Common trust funds and collective investment funds were added as a result of the CB acquisition in 2022. However, these investments are immaterial to WM&T revenue, AUM and the overall strategy of our WM&T business.
47
Table of Contents
Additional Sources of Non-interest income:
Deposit service charges, which consist of non-sufficient funds charges and to a lesser extent, other activity based charges, increased $2.4 million, or 42%, for the year ended December 31, 2022, as compared with the prior year, mainly as a result of the contribution associated with acquisition-related activity over the past 12 months. Outside of acquisition-related growth, an industry-wide decline in the volume of fees earned on overdrawn checking accounts has been experienced over the past several years. This trend has been driven by lower check presentment volume, which has in turn led to fewer overdrawn accounts in general. Further, Bancorp anticipates that future growth of this revenue stream could be significantly impacted by changing industry practices. Bancorp could be faced with strategic decisions surrounding deposit-related service charges in the future, which could negatively impact the contributions made by this, or similar, revenue streams.
Debit and credit card income consists of interchange revenue, ancillary fees and incentives received from card processors. Debit and credit card revenue increased $5.2 million, or 38%, for the year ended December 31, 2022, as compared with the same period of 2021, as a result of increased transaction volume and continued expansion of the customer bases, both organically and through acquisition-related activity. Total debit card income increased $3.8 million, or 40%, and total credit card income increased $1.4 million, or 35%, for the year ended December 31, 2022 compared the year ended December 31, 2021. Bancorp expects this revenue stream will continue to increase with expansion of the customer base and further expansion of the debit and credit card programs.
Treasury management fees primarily consist of fees earned for cash management services provided to commercial customers. This category continues to stand out as a consistent, growing source of revenue for Bancorp and increased $1.7 million, or 24%, for the year ended December 31, 2022 compared to the prior year, driven by increased transaction volume, new product sales and customer base expansion. Both organic and acquisition-related sales efforts have led to the expansion of online services, ACH origination, remote deposit and fraud mitigation services over the past year. Bancorp anticipates this income category will continue to increase based on continued customer base growth and the expanding suite of services offered within Bancorp’s treasury management platform.
Mortgage banking income primarily includes gains on sales of mortgage loans and net loan servicing income offset by MSR amortization. Bancorp’s mortgage banking department predominantly originates residential mortgage loans to be sold in the secondary market, primarily to FNMA and FHLMC. Bancorp offers conventional, VA, FHA and GNMA financing for purchases and refinances, as well as programs for first-time homebuyers. Interest rates on mortgage loans directly influence the volume of business transacted by the mortgage-banking department. Mortgage banking revenue decreased $1.5 million, or 32%, for the year ended December 31, 2022, as compared with the same period of 2021. Overall volume declined in 2022 compared to the prior year as a result of rising interest rates and low housing inventory. While this has in turn led to the year-over-year decline noted above, mortgage banking income has benefitted from the addition of the mortgage loan servicing portfolio added through the CB acquisition, comprising approximately $1.43 billion in mortgage loans at December 31, 2022.
Net investment product sales commissions and fees are generated primarily on stock, bond and mutual fund sales, as well as wrap fees earned on brokerage accounts. Wrap fees represent quarterly charges for investment programs that bundle together a suite of services, such as brokerage, advisory, research and management and are based on a percentage of account assets. Bancorp deploys its financial advisors primarily through its branch network via an arrangement with a third party broker-dealer, while larger managed accounts are serviced by Bancorp’s WM&T Department. Net investment product sales commissions and fees increased $510,000, or 20%, for the year ended December 31, 2022, as compared with the same period of 2021, driven by acquisition-related growth, which included the addition of financial advisors, and increased trading activity associated with general market volatility.
BOLI assets represent the cash surrender value of life insurance policies on certain active and non-active employees who have provided consent for Bancorp to be the beneficiary for a portion of such policies. The related change in cash surrender value and any death benefits received under the policies are recorded as non-interest income. This income serves to offset the cost of various employee benefits. During the third quarter of 2022, Bancorp purchased an additional $30 million of BOLI assets in an effort to diversify investment of excess liquidity, bringing total BOLI assets to $85 million as of December 31, 2022. BOLI income increased $683,000, or 75%, for the year ended December 31, 2022 compared to the same period of the prior year, which was attributed mainly to the additional investment noted above and contributions from the BOLI portfolio added as a result of the KB acquisition in May of 2021.
48
Table of Contents
During the third and fourth quarters of 2022, Bancorp completed the sale of certain acquired properties that overlapped with existing locations, recording a pre-tax gain of $4.4 million as a result.
Other non-interest income increased $1.4 million, or 36%, for the year ended December 31, 2022 compared with the same period of 2021. The increase was driven largely by the contribution from LFA, a financial advising firm added through the CB acquisition, and an increase in other miscellaneous fee income. As previously noted, Bancorp’s partial interest in LFA was sold effective December 31, 2022. Other non-interest income attributed to Bancorp’s partial interest in LFA totaled $1.3 million for the year ended December 31, 2022.
Discussion of 2021 vs 2020:
Total non-interest income increased $14.0 million, or 27%, for the year ended December 31, 2021 compared to the same period in 2020. Non-interest income comprised 28% of total revenue for both the year ended December 31, 2021 and 2020, respectively. WM&T services comprised 42% of Bancorp’s total non-interest income for the year ended December 31, 2021 compared to 45% for the same period of 2020.
WM&T revenue increased $4.2 million, or 18%, for the year ended December 31, 2021, as compared with the same period of 2020. Stock market appreciation, coupled with then-record net new business development and to a lesser extent, the KB acquisition, drove the substantial increase for 2021 as compared to 2020.
Deposit service charges increased $1.7 million, or 41%, for the year ended December 31, 2021, as compared with the same period in 2020. The increase resulted from the combination of a meaningful contribution associated with the KB acquisition and a recovery from the subdued activity experienced in 2020, as customer behavior and transaction volume was significantly impacted by pandemic-related developments.
Debit and credit card revenue increased $5.0 million, or 59%, for the year ended December 31, 2021, as compared with the same period in 2020, as a result of increased transaction volume and continued expansion of the customer bases, both organically and through acquisition-related activity. Total debit card income increased $3.6 million, or 61%, while total credit card income increased $1.4 million, or 54%.Similar to deposit service charges above, debit and credit card revenue volume benefitted from both acquisition-related activity and a recovery from the pandemic-related slowdowns of 2020.
Treasury management fees increased $1.5 million, or 28%, for the year ended December 31, 2021 compared to 2020, as a result of strong new product sales and customer base expansion. The demand for Bancorp’s treasury products increased during the pandemic, as these products allowed customers to operate more efficiently in a decentralized environment.
Mortgage banking revenue decreased $1.4 million, or 23%, for the year ended December 31, 2021 as compared with the same period of 2020. The sustained low long-term interest rate environment that incentivized refinancing and purchasing activity resulted in elevated mortgage banking income in 2020. Over the course of 2021, volume began normalizing as the pool of potential customers who had yet to refinance shrank, general housing inventory remained limited and interest rates began to rise above the absolute low levels experienced in 2020, resulting in lower mortgage banking income.
Net investment product sales commissions and fees increased $778,000, or 44%, for the year December 31, 2021, as compared with the same period of 2020, due to the KB acquisition and increased trading activity.
BOLI income increased $221,000, or 32% for the year ended December 31, 2021 compared to the same period of 2020, attributed in large part to BOLI assets added through the KB acquisition.
Other non-interest income increased $2.2 million, for the year ended December 31, 2021 as compared with the same period of 2020. This increase was driven by a plethora of activity, most notably a death benefit of $523,000 on an insurance policy outside of traditional BOLI, stronger market returns on such insurance policies, the addition of the Captive through the KB acquisition and gains on OREO sold.
49
Table of Contents
Non-interest expenses
Variance
Federal Home Loan Bank early termination penalty — 474 — (474 ) (100 ) 474 100
Loss on sale of interest in LFA 870 — — 870 100 — —
Discussion of 2022 vs 2021:
Total non-interest expenses increased $49.5 million, or 35%, for the year ended December 31, 2022 compared to the prior year. Compensation and employee benefits comprised 54% of total non-interest expenses for the years ended December 31, 2022 and 2021, respectively. Excluding merger expenses, compensation and employee benefits comprised 60% of total non-interest expenses for the year ended December 31, 2022, compared to 62% for the year ended December 31, 2021.
Compensation, which includes salaries, incentives, bonuses and stock based compensation, increased $23.6 million, or 37%, for the year ended December 31, 2022 compared to the prior year. The increase was attributed to growth in full time equivalent employees, annual merit-based salary increases and higher incentive compensation expense. Net full time equivalent employees totaled 1,040 at December 31, 2022 compared to 820 at December 31, 2021. The acquisitions of CB in March of 2022 and KB in May of 2021 resulted in the combined addition of 372 full time equivalent employees over the past two years.
Employee benefits consists of all personnel-related expense not included in compensation, with the most significant items being health insurance, payroll taxes and employee retirement plan contributions. Employee benefits increased $3.1 million, or 23%, for the year ended December 31, 2022 compared to the prior year, consistent with the overall increase in full time equivalent employees noted previously.
Net occupancy and equipment expenses primarily include depreciation, rent, property taxes, utilities and maintenance. Costs of capital asset additions flow through the statement of income over the lives of the assets in the form of depreciation expense. Net occupancy increased $4.6 million, or 48%, for the year ended December 31, 2022 compared to the prior year. In connection with the CB acquisition, 15 branches were acquired, four of which were closed shortly after acquisition in addition to one existing SYB location, as a result of branch overlap. The KB acquisition in May of 2021 resulted in the addition of 19 branch locations in addition to operational buildings. At December 31, 2022, Bancorp’s branch network consisted of 73 locations throughout Louisville, central, eastern and Northern Kentucky, as well as the markets of Indianapolis, Indiana and Cincinnati, Ohio.
50
Table of Contents
Technology and communication expenses include computer software amortization, equipment depreciation and expenditures related to investments in technology needed to maintain and improve the quality of customer delivery channels, information security and internal resources. Technology expense increased $3.8 million, or 34%, for the year ended December 31, 2022 compared to the prior year, consistent with acquisition-related activity, customer expansion and core system upgrades.
Bancorp outsources processing for debit and commercial credit card operations, which generate significant revenue for the Company. These expenses fluctuate consistent with transaction volumes. Debit and credit card processing expense increased $1.4 million, or 31%, for the year ended December 31, 2022, correlating in part with the increase in transaction volume and customer base expansion resulting from both organic and acquisition-related growth that served to increase corresponding debit and credit card non-interest income.
Marketing and business development expenses include all costs associated with promoting Bancorp including community support, retaining customers and acquiring new business. Marketing and business development expenses increased $855,000, or 21%, for the year ended December 31, 2022 compared to the prior year. The increase corresponds with strategic decisions to advertise and promote in Bancorp’s new markets, as well as general expansion of Bancorp’s existing and prospective customer base and a post-pandemic return to in-person client meeting/entertainment.
Postage, printing and supplies expense increased $1.1 million, or 52%, for the year ended December 31, 2022 compared to the prior year, consistent with increased customer communication and Bancorp’s expansion tied to acquisition-related activity.
Legal and professional fees increased $360,000, or 14%, for the year ended December 31, 2022 compared to the prior year. The increase over prior year was driven by various consulting engagements, collection-related expenses and litigation costs arising through the normal course of business. Legal and professional fees associated with merger-related activity are captured in merger expenses.
FDIC insurance increased $911,000, or 49%, for the year ended December 31, 2022 compared to the prior year, consistent with organic and acquisition-related balance sheet growth for which the insurance is assessed on.
Tax credit partnerships generate federal income tax credits, and for each of Bancorp’s investments in tax credit partnerships, the tax benefit, net of related expenses, results in a positive effect upon net income. Amounts of credits and corresponding expenses can vary widely depending upon the timing and magnitude of the underlying investments. Amortization expense associated with these investments decreased $14,000 for the year ended December 31, 2022 compared to the prior year.
Capital and deposit based taxes, which consist primarily of deposit-based taxes and state of Ohio franchise taxes, increased $531,000, or 25%, for the year ended December 31, 2022 compared to the prior year, as a result of both organic and acquisition-related growth.
Merger expenses represent non-recurring expenses associated with completion of acquisitions and consist primarily of investment banker fees, legal fees, various compensation-related expenses, early termination fees relating to various contracts and system conversion expenses. Merger expenses totaled $19.5 million for the year ended December 31, 2022 and were attributed to the completion of the CB acquisition. By comparison, merger expensed for the year ended December 31, 2021 totaled $19.0 million, of which all but $525,000 was associated with the completion of the KB acquisition.
An early termination fee of $474,000 was recorded for the year ended December 31, 2021 in relation to the pre-payment of $14 million in FHLB advances prior to contractual maturities. Bancorp chose to payoff these term advances during the second quarter of 2021 due to excess liquidity held on the balance sheet and the near-term outlook for low interest rates at the time of payoff. No such activity was recorded for the year ended December 31, 2022.
Intangible amortization expense consists of amortization associated with the CDI of acquired deposit portfolios, as well as other intangibles related to customer lists of the WM&T and LFA business lines added through the CB acquisition. The intangibles are generally amortized on an accelerated basis over a period of approximately ten years. Intangible amortization for the year ended December 31, 2022 totaled $5.5 million compared to $770,000 for the same period of the prior year, the significant increase stemming from the CB acquisition. As previously noted, Bancorp’s partial interest in LFA was sold effective December 31, 2022. Amortization expense associated with the CLI of the LFA business totaled $357,000 for the year ended December 31, 2022.
51
Table of Contents
As noted previously, Bancorp’s partial interest in LFA was sold effective December 31, 2022. The sale resulted in a pre-tax loss of $870,000, which was recorded as non-interest expense for the year ended December 31, 2022.
Other non-interest expenses increased $3.6 million, or 52%, for the year ended December 31, 2022. The most notable drivers of the increase were expenses associated with the addition of the insurance captive as a result of the KB acquisition in May of 2021, increased card reward expense, higher fraud-related expenses and other ancillary expenses tied to Bancorp’s significant growth over the last 12 months.
Bancorp’s efficiency ratio (FTE) for the year ended December 31, 2022 was 59.30%, as compared to 59.94% for the same period of 2021. The efficiency ratio (FTE) for both years was significantly impacted by the acquisitions of CB and KB in 2022 and 2021, respectively. Bancorp also considers an adjusted efficiency ratio, which eliminates net gains (losses) on sales and calls of investment securities, as well as net gains (losses) on sales of acquired premises and equipment and disposition of any acquired assets, if applicable, and the fluctuation in non-interest expenses related to amortization of investments in tax credit partnerships and non-recurring merger expenses. Bancorp’s adjusted efficiency ratio for the year ended December 31, 2022 was 53.62%, compared to 51.77% for the year ended December 31, 2021. See the section titled “Non-GAAP Financial Measures” for reconcilement of non-GAAP to GAAP measures.
Discussion of 2021 vs 2020:
Total non-interest expenses increased $40.6 million, or 40%, for the year ended December 31, 2021 compared to 2020. Compensation and employee benefits comprised 54% and 61% of Bancorp’s total non-interest expenses for the years ended December 31, 2021 and 2020, respectively. Excluding merger expenses, compensation and employee benefits comprised 62% of total non-interest expenses for the year ended December 31, 2021.
Compensation increased $11.7 million, or 23%, for 2021 compared to 2020. The increase was attributed to growth in full time equivalent employees driven by the KB acquisition, annual merit-based salary increases and higher incentive compensation expense. Net full time equivalent employees totaled 820 at December 31, 2021 compared to 641 at December 31, 2020.
Employee benefits increased $2.4 million, or 22%, in 2021 compared with 2020, attributed to acquisition-related growth in FTEs.
Net occupancy increased $1.5 million, or 18% for 2021 compared with 2020. The KB acquisition resulted in the addition of 19 branches and was the primary driver of the increase over 2020.
Technology expense increased $2.4 million, or 28%, in 2021 compared to 2020, consistent with acquisition-related growth and continued investment in technology needed to maintain and improve the quality of customer delivery channels, information security and internal resources.
Debit and credit card processing expense increased $1.9 million, or 72%, for 2021 as compared with 2020, consistent with the correlated increase experienced for card income that was driven by both organic and acquisition-related growth.
Marketing and business development expenses increased $1.8 million, or 74%, for the year ended December 31, 2021, as compared to the same period of 2020. The increase was the result of strategic plans to invest in the advertisement and promotion of the Bank in the newly entered central and eastern Kentucky markets and contributions to the Bank’s foundation that supports various community initiatives. Further, marketing and business development activities, particularly travel and entertainment, were significantly muted during 2020 as a result of pandemic.
Postage, printing and supply expenses increased $435,000, or 24%, in 2021 compared to 2020, driven by the KB acquisition and increased customer communication.
Legal and professional fees increased $191,000, or 8%, for 2021 compared to 2020. The increase over 2020 was largely attributed to increased loan collection-related activity.
FDIC insurance increased $630,000, or 52%, for the year ended December 31, 2021 compared to 2020. The increase was related to the acquisition and PPP-driven growth of the balance sheet. Further, the first quarter of 2020 benefitted from the last portion of small institution credits first issued by the FDIC in 2019.
52
Table of Contents
Amortization of investments in tax credit partnership decreased $2.7 million from 2021 to 2020 as a result of a large tax credit deal completed in the fourth quarter of 2020.
Capital and deposit based taxes decreased $2.3 million, or 52%, in 2021 compared to 2020, consistent with the state of Kentucky transitioning financial institutions from a capital-based franchise tax to the Kentucky corporate income tax effective January 1, 2021.
Merger expenses recorded for the year ended December 31, 2021 primarily represent non-recurring expenses associated with completion of the KB acquisition. No such expense was recorded for the year ended December 31, 2020.
An early termination fee of $474,000 was incurred during the second quarter of 2021 in relation to the pre-payment of $14 million in FHLB advances prior to contractual maturities. Bancorp chose to pay off these advances due to excess liquidity and the near-term outlook for low interest rates at the time of pay off.
Intangible amortization expense for the years ended December 31, 2021 and 2020 consisted of amortization associated with the CDI of acquired deposit portfolios. Such expense totaled $770,000 for 2021, representing a $447,000 increase over 2020, which was driven by CDI added as a result of the KB acquisition.
Other non-interest expenses increased $2.8 million, or 67%, for 2021 compared to 2020, stemming largely from the addition of the insurance captive through the KB acquisition, increased card reward expense, and higher debit and credit card losses. Further, 2020 benefitted from larger credits to expense associated with a gain on a bank-owned property sold and the reversal of an accrual related to a potential IRS penalty that was dismissed.
Bancorp’s efficiency ratio (FTE) of 59.94% for 2021 increased from 54.06% in 2020 due to one-time merger-related expenses associated with the KB acquisition. Bancorp’s adjusted efficiency ratio was 51.77% and 52.42% for 2021 and 2020. See the section titled “Non-GAAP Financial Measures” for reconcilement of non-GAAP to GAAP measures.
Income Taxes
A comparison of income tax expense and ETR follows:
Discussion of 2022 vs 2021:
Fluctuations in the ETR were primarily attributed to the following:
53
Table of Contents
Discussion of 2021 vs 2020:
Fluctuations in the ETR were primarily attributed to the following:
The CARES Act included several significant provisions for corporations including increasing the amount of deductible interest under section 163(j), allowing companies to carryback certain net operating losses, and increasing the amount of net operating loss that corporations can use to offset income. These changes did not have a significant impact on Bancorp’s income taxes for the years ended December 31, 2022, 2021 and 2020.
54
Table of Contents
Financial Condition – December 31, 2022 Compared to December 31, 2021
Overview
Total assets increased $850 million, or 13%, to $7.50 billion at December 31, 2022 from $6.65 billion at December 31, 2021. Total assets of $1.34 billion were added on March 7, 2022 as a result of the CB acquisition, including loans of $632 million and total investment securities of $247 million. Goodwill of $67 million was initially recorded in relation to the transaction, $8.5 million of which was subsequently written off as a result of the previously noted sale of Bancorp’s partial interest in LFA. Total loans (excluding loans added through the CB acquisition and the PPP portfolio) grew $529 million, or 13%, between December 31, 2021 and December 31, 2022. However, the acquisition-related and organic growth experienced in 2022 was partially offset by a $794 million reduction in cash and cash equivalents stemming largely from a decline in deposits experienced in the latter part of the year.
Total liabilities increased $766 million, or 13%, to $6.74 billion at December 31, 2022 from $5.97 billion at December 31, 2021. Total liabilities of $1.24 billion were assumed on March 7, 2022 as a result of the CB acquisition, including total deposits of $1.12 billion. Further, SSUAR totaling $66 million and subordinated debentures of $26 million were also assumed in the acquisition. However, the aforementioned decline in deposits experienced in the latter part of the year served to partially offset the acquisition-related growth noted above.
Stockholders’ equity increased $85 million, or 13%, to $760 million at December 31, 2022 from $676 million at December 31, 2021. Stock issued in relation to the CB acquisition, which totaled $134 million, and net income of $93.0 million were offset by a $108 million negative fluctuation in AOCI and dividends declared during 2022. The large decline in AOCI from December 31, 2021 to December 31, 2022 was the result of the rising interest rate environment and its corresponding impact on the valuation of the AFS debt securities portfolio.
Cash and Cash Equivalents
Cash and cash equivalents declined $794 million, or 83%, ending at $167 million at December 31, 2022 compared to $961 million at December 31, 2021. The decline stemmed from loan growth and investment in the securities portfolio in addition to deposit run-off, as the elevated deposit balances generally maintained by the customer base over the past several quarters have gradually dissipated. While the average balance of cash and cash equivalents increased $58 million, or 7%, over the past 12 months on the heels of PPP activity and deposit growth stemming from both acquisition-related activity and the aforementioned higher deposit levels maintained by the customer base in general, Bancorp has seen liquidity retreat from the record levels experienced at the end of 2021.
Investment Securities
The primary purpose of the investment securities portfolio is to provide another source of interest income, as well as a tool for liquidity management. In managing the composition of the balance sheet, Bancorp seeks a balance between earnings sources, credit and liquidity considerations.
Investment securities increased $438 million, or 37%, to $1.62 billion at December 31, 2022 compared to $1.18 billion at December 31, 2021. In addition to $247 million of securities added as a result of the CB acquisition, Bancorp continued to actively invest in the securities portfolio in an effort to deploy excess liquidity by purchasing $653 million of debt securities during the year ended December 31, 2022. Partially offsetting growth associated with purchasing and acquisition-related activity was scheduled maturity/amortization and prepayment activity, as well as market depreciation of approximately $143 million stemming from an upward move in the interest rate environment experienced during the year ended December 31, 2022.
55
Table of Contents
A portion of the securities added during the first quarter of 2022, through both acquisition and normal investment activity, were classified as HTM. This election was made in an effort to lessen the impact that the rising interest rate environment has on the valuation of the AFS debt securities portfolio, and ultimately its impact on capital through AOCI. No debt securities were classified as HTM at December 31, 2021. As of December 31, 2022 and 2021, Bancorp’s investment securities portfolio consisted of AFS and HTM securities as detailed below:
AFS HTM Total
(in thousands) Carrying Investment
December 31, 2022 Fair Value Value Securities
Obligations of states and political subdivisions 127,599 - 127,599
U.S. Treasury and other U.S. Government obligations $ 122,501 $ - $ 122,501
Government sponsored enterprise obligations 135,021 - 135,021
Obligations of states and political subdivisions 75,075 - 75,075
The maturity distribution (based on contractual maturity) and weighted average yields of the AFS and HTM investment security portfolios follow:
AFS
Due after one but Due after five but
(dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield
HTM
Due after one but Due after five but
(dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield
Actual maturities for mortgage-backed securities may differ from contractual maturities due to prepayments on underlying collateral.
56
Table of Contents
Loans
Composition of loans by primary loan portfolio class follows:
Variance
December 31, (dollars in thousands) 2022 2021 $ Change % Change
(1) Total loans are presented inclusive of premiums, discounts and net loan origination fees and costs.
Total loans increased $1.04 billion, or 25%, from December 31, 2021 to December 31, 2022, driven by the addition of $632 million in loans related to the CB acquisition and strong organic loan growth, which more than offset a $122 million decline in the PPP loan portfolio.
Excluding the loans acquired through the CB acquisition and the PPP portfolio, loan growth of $529 million, or 13%, was experienced between December 31, 2021 and December 31, 2022, driven by solid organic growth across virtually every loan portfolio segment.
After hitting a pandemic-era low of 36.5% at March 31, 2021, total line of credit utilization has improved significantly, reaching 42.3% at December 31, 2022, led by C&I utilization, which increased from 23.9% to 33.1% over the same period, respectively. However, line of credit usage has remained below pre-pandemic levels, with customers continuing to utilize excess cash for financing needs as opposed to drawing on available lines. Further, the addition of new lines, particularly within the C&D and C&I portfolio segments, increased availability for the year ended December 31, 2022, but utilization of the new lines has remained relatively slow.
PPP loans of $19 million were outstanding at December 31, 2022, including approximately $312,000 in related net unrecognized fees, which will be recognized immediately once the loans are paid off or forgiven by the SBA. The timing of forgiveness activity and the related fee recognition on the remaining outstanding PPP portfolio has become less significant, as over 98% of the original portfolio has been forgiven.
57
Table of Contents
Bancorp’s credit exposure is diversified with secured and unsecured loans to individuals and businesses. No specific industry concentration exceeds 10% of loans outstanding. While Bancorp has a diversified loan portfolio, a customer’s ability to honor contracts is somewhat dependent upon the economic stability and/or industry in which that customer does business. Loans outstanding and related unfunded commitments are primarily concentrated within Bancorp’s current market areas, which encompass Louisville, Kentucky, central and eastern Kentucky, Indianapolis, Indiana and Cincinnati, Ohio.
Bancorp occasionally enters into loan participation agreements with other banks to diversify credit risk. For certain participation loans sold, Bancorp has retained effective control of the loans, typically by restricting the participating institutions from pledging or selling their ownership share of the loan without permission from Bancorp. GAAP requires the participated portion of these loans to be recorded as secured borrowings. These participated loans are included in the C&I and CRE loan portfolio segments with a corresponding liability recorded in other liabilities. At both December 31, 2022 and December 31, 2021, the total participated portion of loans of this nature totaled approximately $5 million, respectively.
58
Table of Contents
The following table presents the maturity distribution and rate sensitivity of the loan portfolio at December 31, 2022:
Maturity
Commercial real estate - non-owner occupied
Commercial real estate - owner-occupied
Commercial and industrial - term
Commercial and industrial - term - PPP
Variable rate - - - - - 0 %
Commercial and industrial - lines of credit
Residential real estate - owner occupied
Residential real estate - non-owner occupied
Construction and land development
Home equity lines of credit
Fixed rate $ - $ - $ - $ - $ - 0 %
(continued)
59
Table of Contents
(continued) Maturity
Consumer
Leases
Variable rate - - - - - 0 %
Credit Cards
Fixed rate $ - $ - $ - $ - $ - 0 %
Total Loans
In the event Bancorp structures a loan with a maturity exceeding five years (typically CRE loans), an automatic rate adjustment will typically be set in place at five years from origination date to limit overall interest rate sensitivity.
Non-performing Loans and Assets
Information summarizing non-performing loans and assets follows:
Troubled debt restructurings - 12 16 34 42
(1) See the section titled “Non-GAAP Financial Measures” for reconcilement of non-GAAP to GAAP measures.
Non-performing loans to total loans were 0.29% at December 31, 2022 compared to 0.18% at December 31, 2021, the increase being attributed largely to one CRE relationship that was put on non-accrual status.
Non-performing assets totaled $16 million at December 31, 2022 compared to $15 million at December 31, 2021.
60
Table of Contents
In total, non-performing assets as of December 31, 2022 were comprised of 111 loans ranging in individual amounts up to $7 million and OREO. At December 31, 2022, OREO included two CRE properties and one residential real estate property.
The following table presents the major classifications of non-accrual loans by primary portfolio:
Commercial real estate - non-owner occupied $ 7,707 $ 720
Commercial real estate - owner occupied 2,525 1,748
Commercial and industrial - term 1,182 670
Commercial and industrial - PPP 21 —
Commercial and industrial - lines of credit 348 228
Total commercial and industrial 1,551 898
Residential real estate - owner occupied 1,801 1,997
Residential real estate - non-owner occupied 219 293
Total residential real estate 2,020 2,290
Construction and land development — —
Home equity lines of credit 205 646
Leases — —
Credit cards — —
Loans are placed in a non-accrual income status when prospects for recovering both principal and accrued interest are considered doubtful or when a default of principal or interest has existed for 90 days or more, unless such a loan is well- secured and in the process of collection or renewal. Interest income recorded on non-accrual loans as principal payments was $160,000, $312,000, and $350,000 for 2022, 2021, and 2020. Interest income that would have been recorded if non-accrual loans were on a current basis in accordance with their original terms was $1.1 million, $359,000, and $457,000 for 2022, 2021, and 2020.
In addition to non-performing loans discussed above, there were loans, which are accruing interest, for which payments were current or less than 90 days past due where borrowers are experiencing elevated financial difficulties. These substandard loans totaled approximately $40 million at both December 31, 2022 and 2021. These relationships are monitored closely for possible future inclusion in non-performing loans. Management believes it has adequately reflected credit exposure in these loans in its determination of the allowance.
Loans accounted for as TDRs include modifications from original terms such as those due to bankruptcy proceedings, certain changes to amortization periods or extended suspension of principal payments due to customer financial difficulties. To the extent that Bancorp chooses to work with borrowers by providing reasonable concessions rather than initiating collection, this would result in an increase in loans accounted for as TDRs. TDRs that are in non-accrual status are reported as non-accrual loans. Loans accounted for as TDRs are individually evaluated for impairment and are reported as non-performing loans.
During the year ended December 31, 2022, there were no loans modified as TDRs and there were no payment defaults of existing TDRs within 12 months following modification. At December 31, 2022, Bancorp had one loan classified as a TDR, the balance of which was $850,000. Bancorp had two loans classified as TDR at December 31, 2021, the balances of which were $950,000 and $12,000, respectively, the latter of which was paid off during the year ended December 31, 2022.
61
Table of Contents
Delinquent Loans
Delinquent loans (consisting of all loans 30 days or more past due) totaled $17 million at December 31, 2022 compared to $11 million at December 31, 2021. Delinquent loans total loans were 0.32% and 0.26% at December 31, 2022 and December 31, 2021. The increase in delinquent loans between December 31, 2022 and 2021 stems mainly from loans added through acquisitions over the past two years.
Allowance for Credit Losses on Loans
The ACL for loans is a valuation allowance for loans estimated at each balance sheet date in accordance with GAAP. When Bancorp deems all or a portion of a loan to be uncollectible, the appropriate amount is written off and the ACL is reduced by the same amount. Subsequent recoveries, if any, are credited to the ACL when received. See the Footnote titled “Summary of Significant Accounting Policies”for discussion of Bancorp’s ACL methodology on loans. Allocations of the ACL may be made for specific loans, but the entire ACL for loans is available for any loan that, in Bancorp’s judgment, should be charged-off.
The following table reflects activity in the ACL for loans for the years ended December 31, 2022, 2021 and 2020:
Residential real estate - non-owner occupied 3,677 - (75 ) (27 ) 22 3,597
62
Table of Contents
Commercial and industrial - lines of credit 5,657 (1,528 ) - (515 ) - - 3,614
Bancorp’s ACL for loans was $74 million as of December 31, 2022 compared to $54 million as of December 31, 2021. The change in the ACL for loans was driven by a number of factors, which resulted in the $20 million, or 36%, increase for the year ended December 31, 2022. Activity associated with the CB acquisition was responsible for a total increase to the ACL for loans of $14 million in 2022, comprised of a $10 million day one adjustment for specific reserves placed on acquired PCD loans (offset to goodwill) and $4.4 million of provision for credit loss expense on loans related to the remaining acquired non-PCD loan portfolio.
63
Table of Contents
Provision expense for credit losses on loans (excluding acquisition-related activity) of $5.3 million was recorded for the year ended December 31, 2022. Significant organic loan growth, inflation and recession-based fears that drove increases in the projected unemployment rate forecast, along with qualitative factor updates related to the potential impact of rising rates on the C&I portfolio were the main drivers of expense within the CECL model for 2022. Further, net charge off/recovery activity for the year ended December 31, 2022 was minimal.
The table below details net charge-offs to average loans outstanding by category of loan for the years ended December 31, 2022, 2021 and 2020:
64
Table of Contents
The following table sets forth the ACL by category of loan:
(1) Excludes the PPP loan portfolio, which was not reserved for based on the underlying 100% SBA guarantee.
The ACL for loans calculation and resulting credit loss expense is significantly impacted by changes in forecasted economic conditions. Should the forecast for economic conditions change, Bancorp could experience further adjustments in its required ACL for loans credit loss expense.
Selected ratios relating to the allowance follow:
Provision for credit losses on loans to average total loans 0.20 % 0.04 % 0.51 %
Net (charge-offs)/recoveries to average total loans 0.00 % -0.16 % -0.05 %
ACL for loans to average loans 1.53 % 1.36 % 1.57 %
ACL for loans to total loans 1.41 % 1.29 % 1.47 %
ACL for loans to total loans (excluding PPP) (1) 1.42 % 1.34 % 1.74 %
(1) See the section titled “Non-GAAP Financial Measures” for reconcilement of non-GAAP to GAAP measures.
While separate from the ACL for loans and recorded in other liabilities on the consolidated balance sheets, the ACL for off balance sheet credit exposures also experienced an increase between December 31, 2021 and December 31, 2022. The CB acquisition resulted in a $500,000 increase to the ACL for off balance sheet credit exposures during the first quarter, with the corresponding offset recorded to goodwill (as opposed to provision for credit loss expense). Provision for credit loss expense of $575,000 was also recorded for the year ended December 31, 2022, driven largely by the addition of new construction loans, partially offset by increased C&I utilization. ACL for off balance sheet credit exposures stood at $4.5 million as of December 31, 2022 compared to $3.5 million as of December 31, 2021.
65
Table of Contents
Premises and Equipment
Premises and equipment are presented on the consolidated balance sheets net of related depreciation on the respective assets, as well as fair value adjustments associated with purchase accounting. Premises and equipment increased $25 million, or 32%, between December 31, 2021 and December 31, 2022, driven by the CB acquisition. As a result of the acquisition, 15 branches were acquired, four of which were closed shortly acquisition as a result of overlapping with existing locations of the Bank. Bancorp’s branch network currently consists of 73 locations throughout Louisville, central, eastern and northern, Kentucky, as well as the Indianapolis, Indiana and Cincinnati, Ohio markets.
Premises held for sale totaling $3 million was recorded on Bancorp’s consolidated balance sheets as of December 31, 2022, which consists of three vacant parcels of land, one branch acquired from CB and one legacy SYB branch.
BOLI
Bank-owned life insurance assets increased $32 million, or 60%, to $85 million at December 31, 2022, compared to $53 million at December 31, 2021. During the third quarter of 2022, Bancorp purchased an additional $30 million of BOLI assets in an effort to deploy excess liquidity.
Goodwill
At December 31, 2022, Bancorp had $194 million in goodwill recorded on its balance sheet. Goodwill of $67 million was initially recorded in relation to the March 7, 2022 acquisition of CB, $8.5 million of which was subsequently written off as a result of Bancorp selling its partial interest in LFA. Effective December 31, 2022, management finalized the fair values of the acquired assets and assumed liabilities associated with the CB acquisition in advance of the 12 month post-acquisition date, as allowed by GAAP.
Events that may trigger goodwill impairment include deterioration in economic conditions, a decline in market-dependent multiples or metrics (i.e. stock price falling below tangible book value), negative trends in overall financial performance and regulatory action. At September 30, 2022, Bancorp elected to perform a qualitative assessment to determine if it was more-likely-than-not that the fair value of the reporting units exceeded their carrying value, including goodwill. The qualitative assessment indicated that it was not more-likely-than-not that the carrying value of the reporting units exceeded their fair value.
Core Deposit and Customer List Intangibles
CDIs and CLIs arising from business acquisitions are initially measured at fair value and are then amortized on an accelerated method based on their useful lives. As a result of the 2022 CB acquisition, a CDI asset of $13 million was recorded. As a result of the 2021 KB acquisition, a CDI asset of $4 million was recorded. As of December 31, 2022 and December 31, 2021, Bancorp’s CDI assets were $15 million and $6 million, respectively.
CLI assets totaling $14 million were also recorded in association with the CB acquisition. Of this total, $12 million was attributed to CB’s WM&T segment and $2 million attributed to LFA. No similar assets were recorded in relation to the KB acquisition. As of December 31, 2022, Bancorp’s CLI assets totaled $10 million. As previously noted, Bancorp’s interest in LFA was sold effective December 31, 2022. As a result, the CLI associated with LFA noted above was written off and is included in the loss recorded in relation to the sale for the year ended December 31, 2022.
Other Assets and Other Liabilities
Other assets increased $49 million, or 57%, as of December 31, 2022 compared to December 31, 2021, while other liabilities increased $29 million, or 30%, for the same respective periods.
The increase in other assets stems largely from a $30 million increase in DTAs driven by the significant market depreciation experienced within the AFS debt securities portfolio for the year ended December 31, 2022 associated with rising interest rates. The rising interest rate environment also drove an $8 million increase in Bancorp’s interest rate swap assets. Further, $13 million in MSR assets were added during the first quarter in relation to the CB acquisition.
As of December 31, 2022, Bancorp did not incur any impairment with respect to its intangible assets or other long-lived assets.
66
Table of Contents
The increase for Other liabilities between December 31, 2021 and December 31, 2022 was driven largely by acquisition-related activity resulting in higher accrued employee incentive compensation, employee benefits and various other liabilities. Further, the rising interest rate environment also drove an $8 million increase in Bancorp’s interest rate swap liabilities, corresponding with the increase noted above for Other assets.
Market value changes on interest rate swap transactions maintained for certain loan customers played a role in the fluctuations of both Other Asset and Other Liabilities, as noted above. Bancorp enters into these interest rate swap transactions with borrowers who desire to hedge exposure to rising interest rates, while at the same time entering into an offsetting interest rate swap, with substantially matching terms, with another approved independent counterparty. These are undesignated derivative instruments and are recognized on the balance sheet at fair value via both an asset and a related liability as Bancorp has an agreement with the borrower (the asset) and the counterparty (the liability). Because of matching terms of offsetting contracts and collateral provisions mitigating any non-performance risk, changes in fair value have an offsetting effect on the related asset and liability. For this reason, the market value changes over the past 12 months stemming from the rising interest rate environment have resulted in increases to both the asset and liability associated with these transactions. For additional information, see the footnote titled “Interest Rate Swaps.”
Deposits
Total deposits increased $604 million, or 10%, from December 31, 2021 to December 31, 2022. Deposits totaling $1.12 billion were assumed as a result of the CB acquisition on March 7, 2022. Excluding the deposits added through the CB acquisition, deposits declined $517 million, or 9%, as the elevated deposit levels that had generally been maintained by the customer base for several quarters following the PPP moderated during 2022. While Bancorp has not experienced fallout within the customer base, we anticipate deposit pricing will be a challenge to future NIM expansion.
(dollars in thousands) Variance
Interest bearing deposits:
Bancorp experienced both significant average deposit growth and sharp increases in the rates paid on deposits for the year ended December 31, 2022 as compared to 2021. While average deposit growth was attributed entirely to the CB acquisition, the FRB’s aggressive interest rate moves drove up deposit rates. Bancorp increased rates on transaction and time deposit accounts alike during 2022, due to both proactive strategic measures and competitive pricing pressure. The average cost of interest bearing deposits increased 20 bps to 0.37% between December 31, 2021 and December 31, 2022, while the overall cost of deposits (including non-interest bearing deposits) increased 10 bps to 0.25% over the same period. Bancorp anticipates increasing deposit costs could continue to place pressure on NIM in 2023.
67
Table of Contents
Average deposit balances and average rates paid on such deposits for the years indicated are summarized as follows:
Maturities of time deposits of $250,000 or more at December 31, 2022 are as follows:
(in thousands)