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 may also 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, which is 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 in a way that constricts net interest spread and NIM, 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 change interest rates
● inflation or deflation
● recession
● changes in unemployment
● changes in the Money Supply
The FRB has taken aggressive interest rate action over the past several years. In March of 2020, the FRB implemented severe, pandemic-driven interest rate decreases that lowered the FFTR to a range of 0% - 0.25% and Prime to 3.25%, sustaining these levels for approximately two years. In an effort to fight resulting inflation that had risen to its highest levels in decades, the FRB increased the FFTR a total of 425 bps in 2022 and an additional 100 bps in 2023, driving the FFTR to a range of 5.25% - 5.50% and Prime to 8.50% as of December 31, 2023.
The dramatic rise in interest rates experienced in 2022 provided significant benefit to NIM, as interest earning assets experienced higher yields and elevated levels of liquidity allowed deposit costs to remain near pandemic-era lows. However, as liquidity dissipated in 2023, intense competition for deposits created significant pricing pressure and drove deposit costs up. The resulting shift in Bancorp’s deposit mix, with a large portion of non-interest bearing and lower-rate deposits migrating to higher-yielding alternatives, created significant NIM compression during the year.
The current economic outlook remains volatile, regularly changing as new economic data becomes available and the FRB’s efforts to control inflation continue. Recent projections indicate that the FFTR will remain at the current level in the first part of 2024, with probabilities suggesting FFTR decreases as we enter the second half of the year. As a potential economic slowdown looms, Bancorp expects ongoing pricing pressure/competition for both loans and deposits, changing levels of liquidity within the banking system and a severely inverted yield curve will continue to place pressure on NIM in the first part of 2024.
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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.
Financial condition and profitability depend significantly on local and national economic conditions.
Our success depends on general economic conditions 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 2024 suggests the potential for slowing growth and even for recession. Higher interest rates, cooling but persistent inflation, and compounding geopolitical risks create a number of uncertainties heading into 2024. 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 ACL 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 potential 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 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 could be negatively impacted by collateral values.
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. 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 43% 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.
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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.
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 global 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, 2023, 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 indicate 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, 2023, Bancorp had intangible assets of $20 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, 2023 all DTAs will be realized. At December 31, 2023, Bancorp had DTAs totaling $47 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.
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The bank failures of early 2023, which included three of the four largest bank failures in U.S. history, created a liquidity crisis within the banking industry and temporarily raised questions amongst depositors regarding the soundness of the banking system generally. While Bancorp was not negatively impacted by these failures, remaining well-capitalized and successfully managing the fluctuations in liquidity created by these events, further bank failures or the failure of financial institutions with whom we have relationships could adversely affect us.
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.
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 or regulations related to consumer deposit relationships could have an adverse impact on our financial condition and results of operations.
Competitive and regulatory 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.
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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.
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, FHLB advances and other borrowings, sales of investment securities, 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. We consider the majority of these deposits to be 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 could negatively impact our financial condition and results of operations.
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We have experienced wide fluctuations in liquidity levels over the past several years. After experiencing record levels of liquidity in 2021 stemming largely from government stimulus, liquidity moderated in 2022, and dissipated in 2023 on the heels of strong loan demand, rising interest rates and a lack of liquidity within the banking system generally. As a result of these fluctuations, we have had to shift from attempting to maximize return by investing excess liquidity to prudently managing deposit and borrowing costs to maintain the liquidity necessary to profitably meet loan demand and operational needs. Any failure to manage the challenges associated with changing levels of liquidity could adversely impact our financial condition and results of operations.
Our investment in tax credit partnerships may not generate expected or anticipated returns, which could have an adverse impact on our results of operations and financial condition.
We periodically invest in tax credit partnerships that generate federal income tax credits. The tax benefit of these investments is expected to exceed the amortization expense associated with them, resulting in a positive impact on net income. Such credits are subject to recapture by taxing authorities based on compliance requirements that must be met at the project level. Further, changes in applicable tax code or the inability of the projects to be completed or properly managed depend on factors that are out of our control. Should we not be able to realize the tax credits and other benefits associated with such investments, our results of operation and financial condition could be negatively impacted.
Operational Risks
Our risk management framework could prove ineffective, which could have an adverse effect on our business, results of operations and financial condition.
We have established a risk management framework to identify, assess and manage our risk exposure. Our enterprise-wide framework is designed to analyze the specific risks we are subject to by evaluating type, likelihood of occurrence and potential severity in an effort to determine levels of inherent risk. We then identify and evaluate the related controls, or lack thereof, around each identified risk to determine the levels of residual risk, subsequently deciding if our controls are sufficient or if any action is warranted.
Any failure or inability of our risk management framework to identify, assess or manage the risks we may be exposed to could have a material adverse effect on our business, results of operations or financial condition.
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.
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.
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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 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, a breach of information could still occur. See the section titled “Cybersecurity” for more information related to our cybersecurity risk management practices.
Incidences of fraud could negatively impact our business, results of operations, and financial condition.
Fraud is a major, and increasing, operational risk for us and the banking industry generally. The sophistication and methods used to perpetuate fraud continue to evolve as technology changes. 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, card transactions and loan originations. While we continually evaluate and update our anti-fraud measures, some level of fraud loss is unavoidable and the risk of loss cannot be eliminated. 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 perform 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.
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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 former insurance subsidiary, the Captive, may be subject to certain IRS responsibilities and penalties.
The Captive, formerly a wholly owned subsidiary of Bancorp, was a Nevada-based captive insurance company that was taxed under Section 831(b) of the Internal Revenue Code. On April 10, 2023, the IRS issued a proposed regulation that would potentially classify section 831(b) captive activity as a, “listed transaction,” and possibly disallow the related tax benefits, both prospectively and retroactively, for a period to be determined. While the regulation has not been finalized, it is expected to be finalized in 2024. Bancorp elected not to renew the Captive in August of 2023 and ultimately dissolved the Captive in December of 2023. The finalization of this proposed regulation and potential disallowance of related tax benefits could negatively impact our financial condition and results of operations.
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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 ESG 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 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 Owning 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.
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Item 1B.Unresolved Staff Comments.
None.
Item 1C. Cybersecurity.
Risk Management and Strategy
Bancorp has established an Information Security (IS) program, which is overseen by the Director of Information Security and the Information Security Officer. Both of these roles report to the Chief Risk Officer. The IS program is structured upon and informed by the Center for Internet Security Risk Assessment Method (CIS RAM), which aligns with the National Institute of Standards and Technology Cybersecurity Framework (NIST CSF). The primary objectives of the IS program are to protect the confidentiality, integrity and availability of our information assets, comply with applicable laws, regulations, contractual obligations and manage significant risks arising from cybersecurity threats. These processes are integrated into the institution’s overall risk management system, ensuring a unified approach to risk mitigation.
The IS program includes several key processes and functions such as access control monitoring, threat detection, vulnerability management, understanding the implications of technological changes, managing third-party relationships, and mandating employee awareness and education among other components. These activities aim to prevent avoidable errors, raise awareness, identify potential vulnerabilities, protect systems, detect security incidents and recover from any incidents that occur. These processes are continually updated and enhanced to keep pace with the evolving cybersecurity landscape.
To ensure effective risk management, Bancorp adopts the three lines of defense model, which consists of the following elements:
When necessary, the institution engages external assessors, consultants, and auditors with expertise in cybersecurity to evaluate and enhance its systems, policies and procedures. These external parties provide valuable insights into emerging threats and best practices, enhancing Bancorp’s ability to adapt and respond effectively. Bancorp also undergoes reoccurring regulatory examinations, and any issues that are identified are actively tracked and monitored for remediation.
In addition to external entities, Bancorp has internal oversight mechanisms to identify cybersecurity risks, including those associated with its use of third-party service providers and related downstream service providers. This includes thorough due diligence during vendor selection, ongoing monitoring, setting clear contractual obligations to uphold cybersecurity standards and other interventions necessary to address risk such as those addressed in Part I Item 1A “Risk Factors.”
In the event of a security incident, Bancorp has developed an Incident Response Plan (IRP) to guide necessary actions. The IRP is a well-established document that is updated at least annually. It provides guidance before, during and after a confirmed or suspected security incident, outlining how to minimize the duration and damage of an incident, identifying a response team and streamlining actions to reduce recovery time.
While Bancorp has not experienced any cybersecurity incidents that have materially affected its operations, it acknowledges the potential impact such risks could have on business strategy, financial condition and operational resilience. The institution remains vigilant, continuously evaluating and enhancing its cybersecurity measures to preemptively address any potential risks that could impact its operations or financial condition in the future. This approach aligns with the institution’s commitment to maintaining the trust and security of its stakeholders in an increasingly digital world.
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Governance
Bancorp’s Credit and Risk Committee, which includes board of director representation, maintains a robust oversight framework for evaluating and managing risks associated with cybersecurity threats. The committee convened six times during the year ended December 31, 2023 in order carry out its oversight responsibilities, engaging directly in discussions about cybersecurity risks to ensure they are comprehensively addressed within the institution’s risk management framework. This included, but was not limited to, vulnerability trends, identified or potential third-party risks, risks precipitated by technological changes, confirmed or potential security incidents, policy and procedure changes, the organization’s risk appetite, the FFIEC’s Cybersecurity Assessment Tool, conclusions from the risk assessment, audit and regulatory reports, routine quarterly and annual reporting, as well as other notable key risk indicators.
The entire board of directors of Bancorp is actively involved in the oversight of the institution’s cybersecurity risks. The Chair of the Credit and Risk Committee regularly reports the committee’s activities to the board of directors. In addition, management reports to the board of directors on an as-needed basis concerning high-priority information security-related topics, such as cybersecurity incidents. This ensures that the board of directors is always informed and can provide strategic direction on significant cybersecurity matters.
A dedicated committee, the Information Security Steering Group (ISSG), is specifically responsible for overseeing cybersecurity threats and informing the decisions of the Credit and Risk Committee. The ISSG, comprising individuals with diverse expertise in technology, risk management and cybersecurity, meets monthly. They discuss a range of strategic topics, including vulnerability trends, identified or potential third-party risks, risks precipitated by technological changes, confirmed or potential security incidents and other items related to the institution’s preparedness measures. The ISSG’s purpose is to provide strategic direction for the IS program and to evaluate known risks based on Bancorp’s existing controls and risk appetite.
Management also plays a crucial role in assessing and managing Bancorp’s cybersecurity risks. Specific roles, such as the Information Security Officer (ISO) and Director of Information Security (DIS), are tasked with monitoring, evaluating, and mitigating these risks in coordination with the ISSG. Both the ISO and DIS possess relevant expertise and experience in cybersecurity, enabling them to effectively navigate and respond to emerging threats. The ISO, who holds a Bachelor’s degree in Computer Science and a Master’s degree in Information Systems Security, along with several relevant industry certifications, has been with Bancorp for three years and has additional experience working in technology outside of the organization. The DIS, who also holds several relevant certifications, has been with Bancorp’s Information Security department for 19 years and brings extensive experience with technology.
To keep the ISSG and Credit and Risk Committee informed, management ensures consistent and structured reporting mechanisms are in place. They regularly update these governing bodies on the prevention, detection and mitigation of cybersecurity incidents. This reporting includes detailed insights into the institution’s cybersecurity posture, ongoing initiatives and any necessary adjustments or enhancements to existing measures.
The communication between management, the ISSG, and the Credit and Risk Committee facilitates a holistic understanding of cybersecurity risks, ensuring proactive measures are in place to safeguard Bancorp's operations, preserve its financial stability, and maintain the trust of its stakeholders.
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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, 2023, in addition to the main office complex and the operations center, Bancorp owned 45 branches, seven of which are located on leased land. At that date, Bancorp also leased 19 branches. Of the 71 total banking locations, 40 are located in our home market of Louisville, while 19, seven and five are located in our Central Kentucky, Cincinnati and Indianapolis metropolitan 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
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PART II
Item 5.Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. ’
Bancorp’s common stock is traded on the NASDAQ under the ticker symbol SYBT. On December 31, 2023, Bancorp had approximately 2,100 shareholders of record, and approximately 13,100 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, 2023.
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 2023 and will expire in May 2025 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 2022, nor in 2023. 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 20, 2024, the Board of Directors declared a quarterly cash dividend of $0.30 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, 2018 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, 2013 and that all dividends were reinvested.
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Period Ending
Period Ending
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Item 6.[RESERVED]
Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations. ’
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 subsidiary, Stock Yards Bank & Trust Company (“SYB” or “the Bank”). 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 and the business of SYB are essentially the same. The operations of SYB are fully reflected in the consolidated financial statements of Bancorp. Accordingly, references to “Bancorp” in this document may encompass both the holding company and the Bank. 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 71 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.
As a result of its acquisition of Kentucky Bancshares, Inc. on May 31, 2021, Bancorp became the 100% successor owner of a Nevada-based insurance captive taxed under Section 831(b) of the Internal Revenue Code. On April 10, 2023, the IRS issued a proposed regulation that would potentially classify section 831(b) captive activity as a, “listed transaction,” and possibly disallow the related tax benefits, both prospectively and retroactively, for a period to be determined. While the regulation has not been finalized, it is expected to be finalized in 2024. Bancorp elected not to renew the Captive in August of 2023 and ultimately dissolved the Captive in December of 2023. The Captive’s activity is included in the Company’s consolidated financial statements and will be included in its 2023 federal income tax return. The Captive’s activity served to reduce Bancorp’s ETR by 0.2%, 0.3% and 0.2% for the years ended December 31, 2023, 2022 and 2021, respectively.
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 LFA, a Bowling Green, Kentucky-based wealth management services company. 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 quarter and 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.”
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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;
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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 AUM 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 initial 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 fourth quarter of 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 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.
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.”
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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, 2023, the significant accounting policy considered the most critical in preparing Bancorp’s consolidated financial statements is the determination of the ACL on loans.
Allowance for Credit Losses on Loans and Provision for Credit Losses
For purposes of establishing the general reserve of the ACL, 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.
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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, 2023, 2022 and 2021:
Years Ended December 31, Variance
Additional discussion follows under the section titled “Results of Operations.”
General highlights for the year ended December 31, 2023 compared to December 31, 2022:
● In 2023, Bancorp set the following financial records:
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Total stockholder’s equity to total assets was 10.50% as of December 31, 2023 compared to 10.14% at December 31, 2022. Total equity increased to $858 million in 2023, driven by net income of $107.7 million and a $23 million positive change in AOCI, offset partially by $35 million of dividends declared. The increase in AOCI from December 31, 2022 to December 31, 2023 was the result of the changing interest rate environment and its corresponding impact on the valuation of the AFS debt securities portfolio.
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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 8.09% as of December 31, 2023, compared to 7.44% at December 31, 2022, the improvement driven by growth in stockholder’s equity associated with the year’s strong operating results and the positive change in AOCI related to the valuation of the AFS debt securities portfolio. See the section titled “Non-GAAP Financial Measures” for reconcilement of non-GAAP to GAAP measures.
General highlights for the year ended December 31, 2022 compared to December 31, 2021:
● In 2022, Bancorp set the following financial records:
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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 to 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.
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Challenges for 2024:
Bancorp has identified the following challenges for fiscal year 2024:
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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)* 2.78 % 3.21 % 3.16 % (43 )bps 5 bps
Five year Treasury note rate at year end 3.84 % 3.99 % 1.26 % (15 )bps 273 bps
NIM and net interest spread calculations above exclude the sold portion of certain participation loans, which totaled $4 million, $5 million and $5 million for the years ended December 31, 2023, 2022 and 2021, 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, 2023, Bancorp’s loan portfolio consisted of approximately 72% fixed and 28% 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 typically indexed to either Prime or SOFR, generally repricing as those rates change. At December 31, 2023, approximately 61% and 39% of Bancorp’s variable rate loan portfolio was indexed to Prime and SOFR, respectively.
Prime rate, the five year Treasury note rate, one month term SOFR are included in the table above to provide a general indication of the interest rate environment Bancorp has operated in during the past three years, a period marked by a dramatic rise in interest rates.
The FRB has taken aggressive interest rate action over this period, holding the FFTR at the pandemic-driven range of 0.00% - 0.25% for the entirety of 2021 until beginning a rate hike strategy in 2022 aimed at taming inflation that had reached its highest levels in decades. The FFTR was increased a total of 425 bps in 2022, and another 100 bps in 2023, ending at a range of 5.25% - 5.50% as of December 31, 2023. As a result, Prime increased from 3.25% at the beginning of 2021 to 8.50% as of December 31, 2023.
Bancorp experienced significant benefit from the rate increases enacted in 2022, as the majority of Bancorp’s variable rate loans rose above their 4.00% floors and deposit rates remained low. However, as interest rates continued to rise in 2023, the positive impact rising rates had on the loan portfolio began to be offset by higher deposit rates stemming from intense pricing pressure and competition, which began to drive NIM compression.
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The current economic outlook remains volatile, regularly changing as new economic data becomes available and the FRB’s efforts to control inflation continue. It is generally anticipated that short-term interest rates will decline at some point in 2024, but there is wide speculation regarding when the FRB will cut the FFTR. Given current economic uncertainty, Bancorp expects ongoing pricing pressure/competition for both loans and deposits, changing levels of liquidity within the banking system generally and an inverted yield curve will continue to place pressure on NIM in the first part of 2024.
Discussion of 2023 vs 2022:
Net interest spread (FTE) and NIM (FTE) were 2.78% and 3.39%, for the year ended December 31, 2023 compared to 3.21% and 3.35% for the year ended December 31, 2022, respectively. NIM during the year ended December 31, 2023 was significantly impacted by the following:
Net interest income (FTE) increased $13.6 million, or 6%, for the year ended December 31, 2023 compared to the same period of 2022, attributed largely to significant organic loan growth, the full year impact of acquisition-related activity and the benefits of a rising interest rate environment, which more than offset rising funding costs.
Total average interest earning assets increased $316.4 million, or 5%, to $7.30 billion for the year ended December 31, 2023, as compared to year ended December 31, 2022, with the average rate earned on total interest earning assets increasing 114 bps to 4.75%.
Total interest income (FTE) increased $94.7 million, or 37%, to $347.2 million for the year ended December 31, 2023, as compared to the year ended December 31, 2022.
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Total average interest bearing liabilities increased $513.2 million, or 11%, to $5.05 billion for the year ended December 31, 2023 compared with the year ended December 31, 2022, with the total average cost increasing 157 bps to 1.97%.
Total interest expense increased $81.1 million for the year ended December 31, 2023 compared to the year ended December 31, 2022, driven by substantial deposit rate increases and increased borrowing activity, and to a lesser extent, acquisition-related expansion. As a result, the cost of interest bearing liabilities increased 157 bps to 1.97% for the year ended December 31, 2023 compared to the prior year.
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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 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%.
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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.
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Average Balance Sheets and Interest Rates (FTE)
Average Average Average Average Average Average
Interest earning assets:
Investment securities:
Non-interest earning assets:
Interest bearing liabilities:
Deposits:
Non-interest bearing liabilities:
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Supplemental Information - Total Company Average Balance Sheets and Interest Rates (FTE)
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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:
Mortgage loans held for sale 21 71 (50 ) (59 ) (9 ) (50 )
Investment securities:
Interest expense:
Deposits:
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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, 2023 were derived from conservative assumptions Bancorp uses in its model, particularly in relation to deposit betas, which measure how responsive management’s deposit repricing may be to changes in market rates based on historical data. Management uses different betas in the rising and falling rate scenarios in an effort to best simulate expected earnings trends. The results presented below reflect an interest rate sensitivity analysis that incorporates a deposit beta of approximately 68% for rising rate scenarios and 37% for falling rate scenarios, respectively. While the betas experienced since rates began to rise in the first quarter of 2022 were significantly below the 68% beta used in the model, the Company anticipates future rising rate scenario betas to return to the historic averages. The 37% beta used in the falling rate scenario is the result of management’s expectations of deposit rate decreases given the current characteristics of the deposit portfolio.
Bancorp’s interest rate simulation sensitivity analysis details that increases in interest rates of 100 and 200 bps would have a negative effect on net interest income, as would decreases in interest rates of 100, 200 and 300 bps. These results depict a slightly liability sensitive interest rate risk profile in rising rate scenarios and an asset sensitive position in the falling rate scenarios. 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. The decrease in net interest income in the falling rate scenarios is the result of the lower beta experienced since rates began to rise in the first quarter of 2022, which was the result of a significant percentage of the Company’s deposit cost being less than 100 bps, and therefore cannot decrease the full 100, 200 or 300 bps simulated in the model.
Basis Points Basis Points Basis Points Basis Points
Bancorp’s loan portfolio is currently composed of approximately 72% fixed and 28% 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 61%) or one month LIBOR/SOFR (approximately 39%).
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 was no longer used to issue new loans in the U.S. It has been replaced primarily by SOFR, which is considered to be a more accurate and secure pricing benchmark. Bancorp did not experience any operational issues associated with reference rate reform.
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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 matured after the cessation of LIBOR (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.
The Company did not have any loans or interest rate derivative contracts that referenced LIBOR as of December 31, 2023. The Company has elected to utilize SOFR as the replacement for LIBOR. The Company had $813 million in loans and interest rate derivative contracts (notional amount) that were indexed to SOFR at December 31, 2023.
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 “Derivative Financial Instruments.” 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.
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Provision for Credit Losses
Provision for credit losses on loans at December 31, 2023 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) 2023 2022 2021
Acquired PCD loans (goodwill adjustment) — 9,950 6,757
Provision for credit losses on loans - acquired loans — 4,429 7,397
Net loan (charge-offs) recoveries (6,628 ) 1 (6,176 )
Provision for credit losses on loans to average total loans 0.23 % 0.20 % 0.04 %
Net loan (charge-offs) recoveries to average total loans -0.12 % 0.00 % -0.16 %
ACL on loans to total loans 1.38 % 1.41 % 1.29 %
ACL on loans to total loans (excluding PPP) (1) 1.38 % 1.42 % 1.34 %
ACL on loans to average total loans 1.46 % 1.53 % 1.36 %
Discussion of 2023 vs 2022:
The ACL for loans totaled $79 million as of December 31, 2023 compared to $74 million at December 31, 2022, representing an ACL to total loans ratio of 1.38% and 1.41% for those periods, respectively. Based on the 100% SBA guarantee of the PPP loan portfolio, which totaled $4 million at December 31, 2023 and $19 million at December 31, 2022, 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 of $12.5 million was recorded for the year ended December 31, 2023. In addition to strong loan growth, a flat unemployment forecast and other factors within the CECL allowance model, provision expense for the year ended December 31, 2023 was driven by net charge offs $6.6 million. Net charge off activity for the year ended December 31, 2023 was attributed mainly to the charge off of two isolated and unrelated C&I relationships, one of which was fully reserved for in a prior period.
Provision expense (excluding acquisition-related activity) of $5.3 million was recorded for the year ended December 31, 2022. Significant 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.
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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).
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, 2022 and December 31, 2023. Provision for credit loss expense for off balance sheet credit exposures of $1.3 million was recorded for the year ended December 31, 2023, driven largely by the addition of new C&D and C&I lines of credit. The ACL for off balance sheet credit exposures totaled $5.9 million as of December 31, 2023.
Provision for credit loss expense for off balance sheet credit exposures (excluding acquisition-related activity) of $575,000 was recorded for the year ended December 31, 2022. The expense recorded for the year ended December 31, 2022 was driven largely by the addition of new lines of credit, and thus increased availability, within the C&D portfolio. The ACL for off balance sheet credit exposures was also increased $500,000 during the first quarter of 2022 as a result of the CB acquisition, with the offset recorded to goodwill (as opposed to provision expense). The ACL for off balance sheet credit exposures totaled $4.5 million as of December 31, 2022.
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, 2023 is adequate to absorb probable losses inherent in the loan portfolio as of the financial statement date.
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 totaled of $9.7 million was recorded for the year ended December 31, 2022, which included $4.4 million of credit loss expense associated with the acquired CB loan portfolio. 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). Net charge off/recovery activity for the year ended December 31, 2022 was minimal.
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 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.
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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.
Non-Interest Income
Variance
Loss on sale of securities AFS (44 ) — — (44 ) NM — —
Discussion of 2023 vs 2022:
Total non-interest income increased $3.1 million, or 3%, for the year ended December 31, 2023 compared to the same period of 2022. Non-interest income comprised 27% and 28% of total revenue, defined as net interest income and non-interest income, for the years ended December 31, 2023 and 2022, respectively. WM&T services comprised 43% of total non-interest income for the year ended December 31, 2023 compared to 41% for the same period of 2022, respectively. While strong organic growth has been experienced across most non-interest income revenue streams over the past 12 months, the prior year period only included approximately 10 months of activity related to the CB acquisition. In addition, a large gain recorded in the prior year associated with the sale of acquired properties benefitted the year ended December 31, 2022.
WM&T Services:
The magnitude of WM&T revenue distinguishes Bancorp from other community banks of similar asset size. WM&T revenue increased $3.7 million, or 10%, for the year ended December 31, 2023 as compared with the same period of 2022, consistent with new business development, increased estate fees and strong returns from the fixed income and equity markets.
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 $3.0 million, or 8%, for the year ended December 31, 2023, as compared with the same period of 2022. The increase was driven largely by new business development and positive returns from the fixed income and equity markets. Further, the year ended December 31, 2022 included only 10 months of activity stemming from the CB acquisition, which added AUM of $2.65 billion as of the acquisition date.
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 increased $705,000 for the year ended December 31, 2023, as compared with the same period of 2022, driven mainly by higher estate fee revenue.
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AUM, stated at market value, totaled $7.16 billion at December 31, 2023 compared to $6.59 billion at December 31, 2022. The increase in AUM over this period was attributed to net new business growth and fixed income/equity market appreciation experienced during the year ended December 31, 2023.
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 Services Income by Account Type:
(in thousands)
Brokerage and insurance services 11 67 78
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. WM&T also provides company retirement plan services, which 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 typically 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.
Assets Under Management by Account Type:
Total AUM (not included on balance sheet) increased from $6.59 billion at December 31, 2022 to $7.16 billion at December 31, 2023 as follows:
(in thousands) Managed Non-managed (1) Total Managed Non-managed (1) Total
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As of December 31, 2023 and 2022, approximately 82% and 79%, 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:
Other mutual funds - fixed, balanced and municipal 551,141 583,713
Common trust funds and collective investment funds 84,996 114,458
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 64% in equities and 36% in fixed income securities as of December 31, 2023, compared to 63% and 37% as of December 31, 2022. This composition has been relatively consistent from period to period.
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 $580,000, or 7%, for the year ended December 31, 2023, as compared with the prior year. While both organic growth and the full year impact of acquisition-related activity drove the increase noted above, an industry-wide decline in the volume of fees earned on overdrawn checking accounts has been experienced over the past several years. Prior to the acquisition-related growth experienced in recent years, this trend had been driven by lower check presentment volume, which has in turn led to fewer overdrawn accounts in general. Further, Bancorp anticipates that future organic 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 $815,000, or 4%, for the year ended December 31, 2023, as compared with the prior year. The increase stemmed mainly from organic growth and the full year impact of acquisition-related activity, which more than offset interchange rate compression. Total debit card income increased $384,000, or 3%, and total credit card income increased $431,000, or 8%, for the year ended December 31, 2023 compared the year ended December 31, 2022. While Bancorp generally expects this revenue stream to grow in conjunction with expansion of the customer base, interchange rate compression and any potential fluctuation in business and consumer spend levels could serve as challenges to future growth.
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 $1.4 million, or 17%, for the year ended December 31, 2023 compared to the prior year, driven by organic growth and the full year impact of acquisition-related activity, increased transaction volume, growing international services and new product sales. 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.
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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 increased $495,000, or 15%, for the year ended December 31, 2023, as compared with the same period of 2022, driven largely by higher servicing fee income tied to the mortgage servicing portfolio added through the prior year acquisition.
As a result of the dissolution of the Captive during the fourth quarter of 2023, a loss totaling $44,000 on the sale of AFS treasury securities held by the Captive was recorded for the year ended December 31, 2023. No such activity was recorded in 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 generally serviced by Bancorp’s WM&T Department. Net investment product sales commissions and fees increased $142,000, or 5%, for the year ended December 31, 2023, as compared with the prior year, attributed to organic growth and the full year impact of acquisition-related activity.
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 $30 million of additional BOLI assets in an effort to diversify investment of excess liquidity. BOLI assets totaled $87 million as of December 31, 2023. BOLI income increased $656,000, or 41%, for the year ended December 31, 2023 compared to the prior year, which was attributed mainly to the additional prior year investment noted above in addition to general market appreciation within the policy plans during the year.
Gains and losses on the sale of premises and equipment for the year ended December 31, 2023 were driven mainly by the sale of an acquired property from CB during the third quarter and other nominal disposal activity. The large gain recorded for the year ended December 31, 2022 stemmed from the sale of certain acquired properties from CB that overlapped with existing locations.
Other non-interest income decreased $336,000, or 6%, for the year ended December 31, 2023 compared with the same period of 2022. The decrease was driven in large part by the disposition of Bancorp’s partial interest in LFA effective December 31, 2022, which contributed $1.3 million of other non-interest income for the year ended December 31, 2022. Further, Bancorp elected not to renew the Captive in August and fully dissolved it during the fourth quarter of 2023, resulting in a $132,000 decrease in Captive income compared to the prior year. Partially offsetting these declines were higher interest rate swap fee income, a $487,000 gain on the sale of VISA Class B stock originally acquired through the CB acquisition and stronger returns from insurance policies held outside of Bancorp’s BOLI portfolio compared to the prior year.
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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 in 2021. Non-interest income comprised 28% of total revenue for both the year ended December 31, 2022 and 2021, respectively. WM&T services comprised 41% of Bancorp’s total non-interest income for the year ended December 31, 2022 compared to 42% for the same period of 2020.
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, more than offsetting significant declines in both fixed income and equity markets experienced during 2022.
Deposit service charges increased $2.4 million, or 42%, for the year ended December 31, 2022, as compared with the same period in 2021, mainly as a result of the contribution associated with acquisition-related activity.
Debit and credit card revenue increased $5.2 million, or 38%, for the year ended December 31, 2022, as compared with the same period in 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%, while total credit card income increased $1.4 million, or 35%.
Treasury management fees increased $1.7 million, or 24%, for the year ended December 31, 2022 compared to 2021, as a result of increased transaction volume, new product sales and customer base expansion. Both organic and acquisition-related sales efforts led to the expansion of online services, ACH origination, remote deposit and fraud mitigation services during 2022.
Mortgage banking revenue decreased $1.5 million, or 32%, for the year ended December 31, 2022 as compared with the same period of 2021, as rising rates and low housing inventory drove lower mortgage volume. Partially offsetting the volume-driven decrease was the benefit the mortgage servicing portfolio added through the CB acquisition.
Net investment product sales commissions and fees increased $510,000, or 20%, for the year December 31, 2022, as compared with the same period of 2021, driven by acquisition-related growth and increased customer trading activity associated with general market volatility during 2022.
BOLI income increased $683,000, or 75% for the year ended December 31, 2022 compared to the same period of 2021, attributed mainly to the additional BOLI investment made during the third quarter of 2022 and contributions from the BOLI portfolio added as a result of the KB acquisition.
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 as 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. Bancorp’s partial interest in LFA contributed was sold effective December 31, 2022.
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Non-interest Expenses
Variance
Federal Home Loan Bank early termination penalty — — 474 — — (474 ) NM
Loss on disposition of LFA — 870 — (870 ) NM 870 NM
Discussion of 2023 vs 2022:
Total non-interest expenses decreased $4.0 million, or 2%, for the year ended December 31, 2023, compared to the same period of 2022. While the year ended December 31, 2022 included one-time merger expenses associated with the completion of the CB acquisition, it only included approximately 10 months of normal, recurring expenses associated with the acquisition. Compensation and employee benefits comprised 59% and 54% of total non-interest expenses for the years ended December 31, 2023 and 2022, respectively. Excluding merger expenses, compensation and employee benefits comprised 60% of total non-interest expenses for the year ended December 31, 2022.
Compensation, which includes salaries, incentives, bonuses and stock based compensation, increased $5.2 million, or 6%, for the year ended December 31, 2023 compared to the prior year. The increase was attributed to growth in full time equivalent employees and annual merit-based salary increases. In addition, compensation expense totaling $630,000 related to an executive retirement agreement was also recorded during the year ended December 31, 2023. Net full time equivalent employees totaled 1,075 at December 31, 2023 compared to 1,033 at December 31, 2022.
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 $1.9 million, or 11%, for the year ended December 31, 2023 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 (recorded on the balance sheet) flow through the statement of income over the lives of the assets in the form of depreciation expense. Net occupancy increased $2.1 million, or 15%, for the year ended December 31, 2023 compared to the prior year. The increase was attributed to relocation of all WM&T employees into a consolidated location as part of finalizing the CB integration plan, the prior year period experiencing only 10 months of acquisition-related activity and the opening of Bancorp’s new operations center in the latter part of 2022. 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. At December 31, 2023, Bancorp’s branch network consisted of 71 locations throughout Louisville, central, eastern and Northern Kentucky, as well as the MSAs of Indianapolis, Indiana and Cincinnati, Ohio.
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Technology and communication expenses include computer software usage and licensing, 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 $2.4 million, or 16%, for the year ended December 31, 2023 compared to the prior year, consistent with the full year impact of acquisition-related activity, customer expansion and continued investment in technology.
Bancorp outsources processing for debit and commercial credit card operations, which generate significant revenue for the Company. These expenses generally fluctuate consistent with transaction volumes. Debit and credit card processing expense increased $572,000, or 10%, for the year ended December 31, 2023 compared to the prior year, consistent with the increase in transaction volume and customer base expansion resulting from both organic growth and the full year impact of acquisition-related activity.
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 $985,000, or 20%, for the year ended December 31, 2023 compared to the prior year. The increase corresponds with strategic decisions to advertise in Bancorp’s new markets, increased advertising expense associated with Bancorp’s deposit promotions and the general expansion of Bancorp’s existing and prospective customer base.
Postage, printing and supplies expense increased $250,000, or 7%, for the year ended December 31, 2023 compared to the prior year, consistent with Bancorp’s expansion and promotional mailings.
Legal and professional fees increased $1.0 million, or 34%, for the year ended December 31, 2023 compared to the prior year. The increase over prior year was driven mainly by various compliance-related consulting engagements associated with preparation for expanded regulatory oversight in conjunction with future growth in total assets. Legal and professional fees associated with merger-related activity are captured in merger expenses.
FDIC insurance increased $1.2 million, or 42%, for the year ended December 31, 2023 compared to the prior year, attributed to Bancorp’s asset growth and the FDIC-mandated increase of the uniform base assessment rate.
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 increased $941,000 for the year ended December 31, 2023 compared to the prior year stemming from Bancorp’s investment in several larger tax credit projects during 2023.
Capital and deposit based taxes, which consist primarily of capital-based local income taxes and franchise taxes, decreased $145,000, or 6%, for the year ended December 31, 2023 compared to the prior year, driven by fluctuation in revenue growth generated within the state of Ohio, which is the only state Bancorp conducts business in that has a capital-based deposit tax.
Merger expenses for the year ended December 31, 2022 represent non-recurring expenses associated with completion of the CB acquisition and consist primarily of investment banker fees, various compensation-related expenses, legal fees, early termination fees relating to various contracts and system conversion expenses. Merger expenses totaling $19.5 million were recorded in relation to the CB acquisition for the year ended December 31, 2022.
Intangible amortization expense consists of amortization associated with the CDI of acquired deposit portfolios, as well as an intangible related to customer list of the WM&T business line added through the CB acquisition. The intangibles are generally amortized on an accelerated basis over a period of approximately ten years. Intangible amortization expense decreased $858,000, or 15%, for the year ended December 31, 2023. The decrease was attributed to both the accelerated depreciation method for which intangible assets are amortized, coupled with the previously mentioned disposal of Bancorp’s partial interest in LFA at the end of 2022, which included writing off the related CLI effective December 31, 2022.
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.
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Other non-interest expenses increased $869,000, or 8%, for the year ended December 31, 2023 compared to the prior year, the most notable drivers being increased card reward expense, higher fraud and theft-related expenses and other ancillary expenses tied to Bancorp’s growth over the past year.
Bancorp’s efficiency ratio (FTE) for the years ended December 31, 2023 and 2022 was 55.23% and 59.30%, respectively, the latter period reflecting one-time merger-related expenses attributed to the CB acquisition, all of which were recorded in the first quarter of 2022. Bancorp also considers an adjusted efficiency ratio, which eliminates net gains (losses) on sales, calls, and impairment of investment securities, as well as net gains (losses) on sales of premises and equipment and the disposition of any acquired assets, if applicable, and the fluctuation in non-interest expenses related to amortization of investments in tax credit partnerships and merger-related expenses. Bancorp’s adjusted efficiency ratio was 54.84% and 53.61% for the years ended December 31, 2023 and 2022, respectively. See the section titled “Non-GAAP Financial Measures” for reconcilement of non-GAAP to GAAP measures.
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 increased $23.6 million, or 37%, for the year ended December 31, 2022 compared to the prior year due to growth in full time equivalent employees, annual merit-based salary increases and higher incentive compensation expense. Net full time equivalent employees totaled 1,033 at December 31, 2022 compared to 820 at December 31, 2021.
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 previously noted.
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.
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.
Debit and credit card processing expense increased $1.4 million, or 31%, for the year ended December 31, 2022 compared to the prior year, consistent with the increase in transaction volume and customer base expansion resulting from both organic and acquisition-related growth.
Marketing and business development expenses increased $855,000, or 21%, for the year ended December 31, 2022 compared to the prior year, corresponding with strategic decisions to advertise and promote in Bancorp’s new markets 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 Bancorp’s overall expansion.
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.
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.
Amortization expense associated with tax credit investments decreased $14,000 for the year ended December 31, 2022 compared to the prior year.
Capital and deposit based 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.
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Merger expenses of $19.5 million were recorded 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.
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. 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.
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’s adjusted efficiency ratio for the year ended December 31, 2022 was 53.61%, compared to 51.76% for the year ended December 31, 2021. 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 2023 vs 2022:
Fluctuations in the ETR are primarily attributed to the following:
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Discussion of 2022 vs 2021:
Fluctuations in the ETR were primarily attributed to the following:
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Financial Condition – December 31, 2023 Compared to December 31, 2022
Overview
Total assets increased $674 million, or 9%, to $8.17 billion at December 31, 2023 from $7.50 billion at December 31, 2022. Total loans increased $565 million, or 11%, as the result of record loan production that drove growth in nearly every loan category. Additionally, cash and cash equivalents increased $99 million, or 59%, due to deposit inflows and increased FHLB borrowing activity, while Other assets increased $152 million driven by investment in tax credit partnerships associated with meeting CRA requirements. Partially offsetting this growth was a $147 million, or 9%, decline in total investment securities stemming from scheduled maturity and pay down activity within the total portfolio, which more than offset a $30 million improvement in the market value of the AFS investment portfolio specifically.
Total liabilities increased $576 million, or 9%, to $7.31 billion at December 31, 2023 from $6.74 billion at December 31, 2022. The increase was attributed to a $279 million, or 4%, increase in total deposits, a $150 million increase in FHLB borrowings associated with funding loan growth and a $121 million increase in Other liabilities, which related to the accrual of contributions for tax credit partnerships (the offset to the increase in Other assets for tax credit investment noted above).
Stockholders’ equity increased $98 million, or 13%, to $858 million at December 31, 2023 from $760 million at December 31, 2022. Net income of $107.7 million and a $23 million increase in AOCI associated with changes in the interest rate environment and the corresponding impact on the valuation of the AFS debt securities portfolio were only partially offset by $35 million of dividends declared during 2023, serving to grow stockholder’s equity for the period.
Cash and Cash Equivalents
Cash and cash equivalents increased $99 million, or 59%, ending at $266 million at December 31, 2023 compared to $167 million at December 31, 2022, attributed largely to deposit growth and increased FHLB borrowing activity, which was partially offset by loan funding activity. Bancorp entered into $200 million of term FHLB advances in conjunction with three separate interest rate swaps during 2023 as a way of securing longer-term funding at more attractive rates. For more information on these interest rate swaps, see the footnote titled “Derivative Financial Instruments.”
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 decreased $147 million, or 9%, to $1.47 billion at December 31, 2023 compared to $1.62 billion at December 31, 2022, driven by scheduled maturity and pay down activity within the total portfolio, more than offsetting a $30 million improvement in the market value of the AFS investment portfolio specifically. Investment in the securities portfolio was minimal during the 2023, as Bancorp elected to maintain higher levels of liquidity amidst substantial loan growth and deposit fluctuations during the year.
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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.
Loans
Total loans increased $565 million, or 11%, from December 31, 2022 to December 31, 2023. Excluding the PPP portfolio, loans grew $579 million, or 11%, over the same period. Loan growth (excluding PPP) for the year ended December 31, 2023 was experienced for nearly all loan categories, with CRE and Residential real estate posting the largest increases over the prior year.
While total line of credit utilization has improved since hitting pandemic-era lows experienced in early 2021, line of credit usage has remained below pre-pandemic levels, as customers continue to utilize cash in lieu of higher costing lines of credit. Further, the addition of new lines, particularly within the C&D and C&I portfolio segments, has increased availability over the past several quarters, but utilization of the new lines has been relatively slow compared to historical usage rates. Total line of credit utilization was 39.2% as of December 31, 2023, compared to 42.3% at December 31, 2022, with C&I utilization of 28.6% and 33.1% as of the same periods, respectively.
Bancorp’s credit exposure is well-diversified between businesses and individuals. 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 concentrated within Bancorp’s current market areas, which encompass the Louisville, Kentucky MSA, central, eastern and northern Kentucky, as well as the Indianapolis, Indiana and Cincinnati, Ohio MSAs.
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CRE represents the largest segment of Bancorp’s loan portfolio, totaling $2.5 billion, or 43%, of total loans as of December 31, 2023. While a combination of higher interest rates and rising central business district vacancies across the country have created credit and collateral concerns within the CRE sector generally, Bancorp believes the quality of its CRE portfolio, and the overall loan portfolio, remains solid. Office building exposure, which is a sub-segment of CRE and perceived to be of particular risk in the current environment, is a smaller component of Bancorp’s loan portfolio, totaling $594 million, or 10%, of total loans as of December 31, 2023. Of this sub-segment total, 55% is owner-occupied and is generally accompanied by a full commercial relationship. Further, approximately $206 million of Bancorp’s office building exposure is medical-related, which presents reduced risk compared other CRE uses. Lastly, this sub-segment is concentrated in Bancorp’s primary markets, with no exposure to large office towers and minimal exposure to central business districts, and continues to perform well with minimal substandard/non-accrual and past due loans as of December 31, 2023.
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 December 31, 2023 and December 31, 2022, the total participated portion of loans of this nature totaled $4 million and $5 million, respectively.
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The following table presents the maturity distribution and rate sensitivity of the loan portfolio at December 31, 2023:
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)
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(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 (1) - - 12 16 34
Non-performing loans to total loans were 0.33% at December 31, 2023 compared to 0.29% at December 31, 2022, the increase being attributed largely to one C&I relationship that was placed on non-accrual status during the first quarter of 2023 and a CRE relationship that was put on non-accrual status during the fourth quarter of 2023.
Non-performing assets totaled $19 million at December 31, 2023 compared to $16 million at December 31, 2022.
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In total, non-performing assets as of December 31, 2023 were comprised of 106 loans ranging in individual amounts up to $6 million and one residential real estate property held as OREO.
The following table presents the major classifications of non-accrual loans by primary portfolio:
Commercial real estate - non-owner occupied $ 8,649 $ 7,707
Commercial real estate - owner occupied 885 2,525
Commercial and industrial - term 4,456 1,182
Commercial and industrial - PPP — 21
Commercial and industrial - lines of credit 215 348
Total commercial and industrial 4,671 1,551
Residential real estate - owner occupied 3,667 1,801
Residential real estate - non-owner occupied 372 219
Total residential real estate 4,039 2,020
Construction and land development — —
Home equity lines of credit 467 205
Leases — —
Credit cards 10 —
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 $342,000, $160,000, and $312,000 for 2023, 2022, and 2021. Interest income that would have been recorded if non-accrual loans were on a current basis in accordance with their original terms was $1.5 million, $1.1 million, and $359,000 for 2023, 2022, and 2021.
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 $43 million and $40 million at December 31, 2023 and 2022, respectively. 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.
Bancorp adopted ASU 2022-02, “Financial Instruments – Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures,”effective January 1, 2023. The amendments in ASU 2022-02 eliminated the recognition and measure of troubled debt restructurings and enhanced disclosures for loan modifications to borrowers experiencing financial difficulty.
During the year ended December 31, 2023, there were no modifications made to loans for borrowers experiencing financial difficulty and there were no payment defaults of existing modified loans within 12 months following modification. Default is determined at 90 days or more past due, charge off, or foreclosure.
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.
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Delinquent Loans
Delinquent loans (consisting of all loans 30 days or more past due) totaled $17 million at both December 31, 2023 and December 31, 2022. Delinquent loans total loans were 0.30% and 0.32% at December 31, 2023 and December 31, 2022.
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.
Bancorp’s ACL for loans was $79 million as of December 31, 2023 compared to $74 million as of December 31, 2022. Provision expense for credit losses on loans of $12.5 million was recorded for the year ended December 31, 2023, driven by strong loan growth and net charge off activity. Net charge-off activity of $6.6 million was recorded for the year ended December 31, 2023, which was attributed mainly to the charge off of two larger, isolated C&I relationships, one of which was fully reserved for in a prior period.
The table below details net charge-offs to average loans outstanding by category of loan for the years ended December 31, 2023, 2022 and 2021:
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The following table sets forth the ACL by category of loan:
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 ACL on loans follow:
Provision for credit losses on loans to average total loans 0.23 % 0.20 % 0.04 %
Net (charge offs)/recoveries to average total loans -0.12 % 0.00 % -0.16 %
ACL for loans to average loans 1.46 % 1.53 % 1.36 %
ACL for loans to total loans 1.38 % 1.41 % 1.29 %
ACL for loans to total loans (excluding PPP) (1) 1.38 % 1.42 % 1.34 %
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, 2022 and December 31, 2023. Provision for credit loss expense for off balance sheet credit exposures of $1.3 million was recorded for the year ended December 31, 2023, driven largely by the addition of new C&D and C&I lines of credit. The ACL for off balance sheet credit exposures totaled $5.9 million as of December 31, 2023, compared to $4.5 million as of December 31, 2022.
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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 experienced minimal fluctuation between December 31, 2022 and December 31, 2023. Bancorp’s branch network consists of 71 locations throughout Louisville, central, eastern and northern, Kentucky, as well as the Indianapolis, Indiana and Cincinnati, Ohio markets as of December 31, 2023.
Premises held for sale totaling $2.5 million was recorded on Bancorp’s consolidated balance sheets as of December 31, 2023, which consists of three vacant parcels of land, an acquired administrative building and two former branch locations.
BOLI
Bank-owned life insurance assets increased $2 million, or 3%, to $87 million at December 31, 2023, compared to $85 million at December 31, 2022, the increase being attributed to appreciation within the plan experienced during the year.
Goodwill
At December 31, 2023, Bancorp had $194 million in goodwill recorded on its balance sheet. Goodwill totaling $67 million was initially 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. Additionally, Goodwill totaling $12 million and $682,000 was recorded in relation to the acquisitions of KSB and Austin State Bank in 2019 and 1996, respectively. The acquisition of TBOC in 2013 resulted in a bargain purchase gain.
Events that may trigger goodwill impairment include deterioration in economic conditions, a decline in market-dependent multiples or metrics (i.e. stock price declining below tangible book value), negative trends in overall financial performance and regulatory actions. At September 30, 2023, 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 of December 31, 2023 and December 31, 2022, Bancorp’s CDI assets totaled $12 million and $15 million, respectively. A CDI asset of $13 million was recorded during the first quarter of 2022 as a result of the CB acquisition.
As of December 31, 2023 and December 31, 2022, Bancorp’s CLI assets were $8 million and $10 million, respectively, and are attributed entirely to the WM&T segment acquired from CB. CLI assets totaling $14 million were initially recorded in association with the CB acquisition during the first quarter of 2022. However, as a result of Bancorp’s disposition of its partial interest in LFA effective December 31, 2022, the $2 million CLI associated with that business was written off and included in the loss recorded in relation to the disposition in 2022.
As of December 31, 2023, Bancorp did not incur any impairment with respect to its intangible assets or other long-lived assets.
Other Assets and Other Liabilities
Other assets increased $152 million to $287 million between December 31, 2022 and December 31, 2023. Other liabilities increased $121 million, or 97%, to $247 million over the same period.
The increase in Other assets stemmed mainly from Bancorp’s investment in tax credit partnerships during 2023, which have served as an economical means of fulfilling CRA requirements. As of December 31, 2023, Bancorp did not incur any impairment with respect to its intangible assets or other long-lived assets.
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The increase in Other liabilities was attributed largely to the accrual of future tax credit investment obligations, which outpaced a reduction in various accrued liabilities, such as employee incentive compensation/benefits and tax liabilities.
Deposits
Total deposits increased $279 million, or 4%, from December 31, 2022 to December 31, 2023, as time deposit growth associated with successful promotional product offerings and other interest-bearing deposit inflows more than offset a decline in non-interest bearing deposits. Average total deposit balances, which offer a more accurate representation of activity for the year, experienced a $67 million, or 1%, decline compared to the prior year, as a $290 million, or 14% decrease in average non-interest bearing deposits was only partially offset by a $223 million, or 5%, increase in average interest-bearing deposit balances.
As a result of intense pricing pressure/competition for deposits, the rates paid by Bancorp on deposits has increased and the deposit base itself has shifted to a heavier interest-bearing mix over the past several quarters. The cost of interest-bearing deposits rose to 1.77% for the year ended December 31, 2023 compared to 0.37% for the same period of the prior year, with the cost of total deposits (including non-interest deposits) rising to 1.28% from 0.25% for the same periods, respectively.
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, 2023 are as follows:
(in thousands)
Three months or less $ 54,203
Over three through six months 91,973
Securities Sold Under Agreement to Repurchase
SSUAR represent a funding source of Bancorp and are used by commercial customers in conjunction with collateralized corporate cash management accounts. Such repurchase agreements are considered financing agreements and mature within one business day from the transaction date. At December 31, 2023 and 2022, all of these financing arrangements had overnight maturities and were secured by government sponsored enterprise obligations and government agency mortgage-backed securities that were owned and controlled by Bancorp.
SSUARs are collateralized by securities and are treated as financings; accordingly, the securities involved with the agreements are recorded as assets and are held by a safekeeping agent and the obligations to repurchase the securities are reflected as liabilities. All securities underlying the agreements are under the Bancorp’s control.
SSUARs increased $20 million, or 15%, between December 31, 2022 and December 31, 2023, largely as a result of some customers experiencing normal cyclical fluctuation in their SSUAR balances.
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Federal Funds Purchased and Other Short-Term Borrowing
FFP and other short-term borrowing balances increased $4 million, or 46%, between December 31, 2022 and December 31, 2023. At December 31, 2023, FFP related mainly to excess liquidity held by downstream correspondent bank customers of Bancorp.
Subordinated debentures
As a result of the CB acquisition, Bancorp became the 100% successor owner of the following unconsolidated 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 loaned in exchange for subordinated debentures with similar terms to the TPS. The TPS are treated as part of Tier 1 Capital. The subordinated note and related interest expense are included in Bancorp’s consolidated financial statements. The subordinated notes are currently redeemable at Bancorp’s option on a quarterly basis. As of December 31, 2023, subordinated notes added through the CB acquisition totaled $27 million.
FHLB advances
FHLB advances outstanding at December 31, 2023 totaled $200 million, consisting entirely of a three-month rolling advance related to three separate interest rate swaps (cash flow hedges) that have been entered into during 2023 in an effort to secure longer-term funding at more attractive rates. For more information related to the interest rate swaps noted above, see the footnote titled, “Derivative Financial Instruments.”
Liquidity
The role of liquidity management is to ensure funds are available to meet depositors’ withdrawal and borrowers’ credit demands, while at the same time maximizing profitability. This is accomplished by balancing changes in demand for funds with changes in supply of funds. Liquidity is provided by short-term assets that can be converted to cash, AFS debt securities, various lines of credit available to Bancorp, and the ability to attract funds from external sources, principally deposits. Management believes it has the ability to increase deposits at any time by offering rates slightly higher than market rate.
Bancorp’s Asset/Liability Committee is comprised of senior management and has direct oversight responsibility for Bancorp’s liquidity position and profile. A combination of reports provided to management details internal liquidity metrics, composition and level of the liquid asset portfolio, timing differences in short-term cash flow obligations, and exposure to contingent draws on Bancorp’s liquidity.