STOCK YARDS BANCORP, INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations. ‘ (form 10-K)
Written by ABC AUDIO on February 25, 2022
The consolidated financial statements include the accounts of
Bancorp, Inc.
collectively referred to as “Bancorp” or the “Company.” All significant
inter-company transactions and accounts have been eliminated in consolidation.
Bancorp is a FHC headquartered inLouisville, Kentucky . Established in 1904, SYB is a state-chartered non-member financial institution that provides services inLouisville , central, eastern and northernKentucky , as well as theIndianapolis, Indiana andCincinnati, Ohio metropolitan markets through 63 full-service banking center locations. The Captive is aNevada -based, wholly-owned insurance subsidiary of the Company, which was retained in conjunction with the KB acquisition and provides insurance coverage not currently provided by Bancorp's commercial policies to Bancorp and SYB, as well as a group of third-party insurance captives.
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.”
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 "aim," "anticipate," "believe," "can," "conclude," "continue," "could," "estimate," "expect," "foresee," "goal," "intend," "likely," "may," "might," "outlook," "possible," "plan," "predict," "project," "potential," "seek," "should," "target," "will," "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 law. 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:
? impact of the COVID-19 pandemic on Bancorp’s business, including the impact of
the actions taken by governmental authorities to try and contain the pandemic
or address the impact of the pandemic on the
limitation, various relief efforts), and the resulting effect of all such
items on our operations, liquidity and capital position, and on the financial
condition of Bancorp's borrowers and other customers;
? changes in, or forecasts of, future political and economic conditions,
inflation and efforts to control it;
? accuracy of assumptions and estimates used in establishing the ACL on loans,
ACL for off-balance sheet credit exposures and other estimates;
? impairment of investment securities, goodwill, MSRs, other intangible assets
or DTAs;
? ability to effectively navigate an economic slowdown or other economic or
market disruptions; ? changes in laws and regulations or the interpretation thereof; ? changes in fiscal, monetary, and/or regulatory policies;
? changes in tax polices including but not limited to changes in federal and
state statutory rates;
? behavior of securities and capital markets, including changes in interest
rates, market volatility and liquidity; ? ability to effectively manage capital and liquidity;
? long-term and short-term interest rate fluctuations, as well as the shape of
theU.S. Treasury yield curve; 22
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? the magnitude and frequency of changes to the FFTR implemented by the Federal
Open Market Committee of the FRB ; ? competitive product and pricing pressures; ? projections of revenue, expenses, capital expenditures, losses, EPS, dividends, capital structure, etc.; ? descriptions of plans or objectives for future operations, products, or services; ? integration of acquired financial institutions, businesses or future acquisitions;
? changes in the credit quality of Bancorp’s customers and counterparties,
deteriorating asset quality and charge-off levels;
? changes in technology instituted by Bancorp, its counterparties or
competitors;
? changes to or the effectiveness of Bancorp's overall internal control
environment;
? adequacy of Bancorp’s risk management framework, disclosure controls and
procedures and internal control over financial reporting;
? changes in applicable accounting standards, including the introduction of new
accounting standards; ? changes in investor sentiment or behavior; ? changes in consumer/business spending or savings behavior;
? ability to appropriately address social, environmental and sustainability
concerns that may arise from business activities;
? occurrence of natural or man-made disasters or calamities, including health
emergencies, the spread of infectious diseases, pandemics or outbreaks of
hostilities, and Bancorp’s ability to deal effectively with disruptions caused
by the foregoing;
? ability to maintain the security of its financial, accounting, technology,
data processing and other operational systems and facilities;
? ability to withstand disruptions that may be caused by any failure of its
operational systems or those of third parties;
? ability to effectively defend itself against cyberattacks or other attempts by
unauthorized parties to access information of Bancorp, its vendors or its
customers or to disrupt systems; and
? other risks and uncertainties reported from time-to-time in Bancorp’s filings
with theSEC , including Part I Item 1A "Risk Factors.". Bancorp executed a definitive Agreement and Plan of Merger ("agreement"), dated as ofAugust 3, 2021 , to acquireCommonwealth Bancshares, Inc. and its subsidiaryCommonwealth Bank & Trust Company (collectively referred to as "Commonwealth"). This document contains statements regarding the proposed acquisition transaction that are not statements of historical fact and are considered forward-looking statements within the criteria described above. These statements are likewise subject to various risks and uncertainties that may cause actual results and outcomes of the proposed transaction to differ, possibly materially, from the anticipated results or outcomes expressed or implied in these forward-looking statements. In addition to factors disclosed in reports filed by Bancorp with theSEC , risks and uncertainties for Bancorp, Commonwealth and the combined company include, but are not limited to: the possibility that some or all of the anticipated benefits of the proposed merger will not be realized or will not be realized within the expected time period; the risk that integration of Commonwealth's operations with those of Bancorp will be materially delayed or will be more costly or difficult than expected; the parties' inability to meet expectations regarding the timing, completion and accounting and tax treatments of the merger; the failure to satisfy the conditions to completion of the merger; the failure of the proposed transaction to close for any other reason, including, without limitation, the occurrence of any event, change or other circumstance that could give rise to the right of either party or both parties to the definitive agreement to terminate the agreement; diversion of management's attention from ongoing business operations and opportunities due to the merger; the challenges of integrating and retaining key employees; the effect of the announcement of the merger on Bancorp's, Commonwealth's or the combined company's respective customer and employee relationships and operating results; the possibility that the merger may be more expensive to complete than anticipated, including as a result of unexpected factors or events; dilution caused by Bancorp's issuance of additional shares of common stock in connection with the merger; the magnitude and duration of the COVID-19 pandemic and its impact on the global economy and financial market conditions and the business, results of operations and financial condition of Bancorp, Commonwealth and the combined company; and general competitive, economic, political and market conditions and fluctuations. 23
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Pending Acquisition of
Commonwealth Bank & Trust Company
EffectiveAugust 3, 2021 , Bancorp executed a definitive agreement, pursuant to which Bancorp will acquire all of the outstanding common stock of privately-ownedCommonwealth Bancshares, Inc. , which operates 15 retail branches, including nine inJefferson County , four inShelby county and two inNorthern Kentucky . Under the terms of the Agreement, the Company will acquire all outstanding common stock in a combined stock and cash transaction, resulting in total consideration to Commonwealth's shareholders of approximately$171 million based on estimates as ofFebruary 17, 2022 . Bancorp will fund the cash payment portion of the acquisition through existing resources on-hand. Bancorp has received all required regulatory approvals to complete the acquisition and the acquisition is expected to close on or aroundMarch 7, 2022 , subject to satisfaction or waiver of remaining closing conditions. As ofDecember 31, 2021 , Commonwealth reported approximately$1.31 billion in assets,$680 million in loans,$1.16 billion in deposits and$88 million in tangible common equity. Commonwealth also maintains aWealth Management and Trust Department with total assets under management of$2.73 billion atDecember 31, 2021 . The combined franchise will have 78 branches at acquisition date and anticipates serving customers through a branch network of 73 locations, as Bancorp has notified regulators of its intent to close five locations as part of the merger. The combined franchise will have total assets of approximately$8.0 billion ,$4.85 billion in gross loans,$6.95 billion in deposits and$7.53 billion in trust assets under management.
Completed
OnMay 31, 2021 , Bancorp completed its acquisition ofKentucky Bancshares, Inc. and its wholly owned subsidiary,Kentucky Bank , collectively defined as "KB," a commercial bank and trust company operating 19 branches throughout central and easternKentucky with$1.27 billion in assets,$755 million in loans (including PPP),$396 million in AFS debt securities and$1.04 billion in deposits at the time of acquisition.Kentucky Bancshares, Inc. was also the holding company for an insurance captive, which Bancorp acquired and retained. Bancorp acquired all outstanding common stock ofKentucky Bancshares, Inc. in a combined stock and cash transaction that resulted in total consideration paid toKentucky Bancshares, Inc. shareholders of$233 million . Bancorp recorded goodwill of$123 million and incurred pre-tax merger related expenses totaling$18.1 million for the year endedDecember 31, 2021 as a result of the KB acquisition. The acquisition of KB had a significant impact on the ACL and credit loss provisioning for the year endedDecember 31, 2021 . In total, acquisition-related activity served to increase the ACL by$14.2 million for the year endedDecember 31, 2021 . This increase consisted of$6.8 million attributed to the acquired PCD loan portfolio, with the corresponding offset recorded to goodwill (as opposed to provision for credit loss expense), and$7.4 million attributed to the acquired non-PCD portfolio, which represented the acquisition-related provision expense for the year endedDecember 31, 2021 .
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. EffectiveJanuary 1, 2021 throughDecember 31, 2021 , the significant accounting policies considered the most critical in preparing Bancorp's consolidated financial statements are the determination of the ACL on loans andGoodwill .
Allowance for Credit Losses on Loans and Provision for Credit Losses
On
Losses,” which created material changes to Bancorp’s critical accounting policy
that existed at
For purposes of establishing the general reserve, Bancorp stratifies the loan portfolio into homogeneous groups of loans that possess similar loss potential characteristics and calculates the net amount expected to be collected over the life of the loans to estimate the credit losses in the loan portfolio. Bancorp's methodologies for estimating the ACL on loans consider available relevant information about the collectability of cash flows, including information about past events, current conditions, and reasonable and supportable forecasts. The ACL on loans is established through credit loss expense charged to current earnings. The amount maintained in the ACL reflects management's estimate of the net amount not expected to be collected on the loan portfolio at the balance sheet date over the life of the loan. The ACL is comprised of specific reserves assigned to certain loans that do not share general risk characteristics and general reserves on pools of loans that do share general risk characteristics. Factors contributing to the determination of specific reserves include the creditworthiness of the borrower and more specifically, changes in the expected future receipt of principal and interest payments and/or in the value of pledged collateral. A reserve is recorded when the carrying amount of the loan exceeds the discounted estimated cash flows using the loan's initial effective interest rate, an expected loss ratio based on historical losses adjusted as appropriate for qualitative factors, or the fair value of the collateral for certain collateral-dependent loans. With the adoption of CECL, provision expense may be more volatile due to changes in the CECL model assumptions of credit quality, macroeconomic factors and conditions, and loan composition. The pandemic has had a material impact on Bancorp's quarterly ACL calculations. While Bancorp has not yet experienced credit quality issues resulting in charge-offs related to the pandemic, ACL calculations and resulting credit loss expense is significantly impacted by changes in forecasted economic conditions, which were generally volatile for the years endedDecember 31, 2020 and 2021, respectively. Should the forecast for economic conditions worsen, Bancorp could experience further increases in its required ACL and record additional credit loss expense. 25
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Table of ContentsGoodwill Goodwill resulting from business combinations represents the excess of the purchase price over the fair value of the net assets of businesses acquired.Goodwill resulting from business combinations is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any non-controlling interests in the acquire, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date.Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually. Events that may trigger goodwill impairment include deterioration in economic conditions, a decline in market-dependent multiples or metrics (i.e. stock price falling below tangible book value), negative trends in overall financial performance and regulatory action. Bancorp has selectedSeptember 30 as the date to perform the annual impairment test.Goodwill is the only intangible asset with an indefinite life on Bancorp's consolidated balance sheets. No impairment toGoodwill was indicated based on Bancorp's annual testing for 2021. AtDecember 31, 2021 , Bancorp had$136 million in goodwill recorded on its balance sheet, consisting primarily of$123 million recorded in association with the acquisition of KB. As permitted under GAAP, management has up to 12 months following the date of acquisition to finalize the fair values of the acquired assets and assumed liabilities related to the KB acquisition. During this measurement period, Bancorp may record subsequent adjustments to goodwill for provisional amounts recorded at the acquisition date. Further, additional goodwill is expected to be recorded in association with the pending Commonwealth acquisition in 2022, which will increase the amount of goodwill on Bancorp's balance sheet significantly. 26
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Table of Contents Business Segment Overview
Bancorp is divided into two reportable segments: Commercial Banking and WM&T:
Commercial Banking provides a full range of loan and deposit products to individual consumers and businesses in all its markets through retail lending, mortgage banking, deposit services, online banking, mobile banking, private banking, commercial lending, commercial real estate lending, leasing, treasury management services, merchant services, international banking, correspondent banking and other banking services. The Bank also offers securities brokerage services via its banking center network through an arrangement with a third party broker-dealer in the Commercial Banking segment. WM&T provides investment management, financial & retirement planning and trust & estate services, as well as retirement plan management for businesses and corporations in all markets in which Bancorp operates. The magnitude of WM&T revenue distinguishes Bancorp from other community banks of similar asset size.
Overview – Impact of the COVID-19 Pandemic on Financial Condition and Results of
Operations
The COVID-19 pandemic in theU.S. and efforts to contain both the virus and the related economic fallout have had a complex and significant impact on the economy, the banking industry and Bancorp. While the distribution of vaccinations, easing of restrictions on public commerce and business activities, and stabilizing unemployment levels have been positive developments over the past several months, the pandemic's effects on local, national and global economic activity may continue to weigh on Bancorp's financial condition and results of operations in 2022.
Bancorp’s financial condition and results of operations for the year ended
factors, among others:
? Overall excess balance sheet liquidity ? The sustained low interest rate environment and related NIM compression
? Significant participation in the SBA’s PPP, which concluded on
? The FRB’s Seasonally Adjusted National Civilian Unemployment Rate forecast and
the resulting impact to the ACL on loans and off balance sheet credit
exposures
The FRB's decision to lower the FFTR 150 bps in March of 2020 in response to the
then-developing pandemic decreased the FFTR to a range of 0%-0.25% and Prime to
3.25%, where both remained as of December 31, 2020 and 2021. Consistent with the
rate drops, key benchmark rates, such as the five-year treasury rate and
one-month LIBOR, declined dramatically. While the interest rate environment has
improved in recent quarters, key rates remain well below pre-pandemic levels.
Bancorp's participation in the PPP resulted in approximately 5,500 PPP loan
originations totaling $918 million ($887 million net of unearned deferred fees
and costs) since the program's inception as part of the CARES Act, which was
signed into law in March 2020 . While the first round of PPP expired in August
2020 , legislative action created a second round of funding for the program and
subsequently extended the program to May 31, 2021 .
As part of the first round of the PPP, Bancorp originated over 3,400 PPP loans
totaling $657 million ($637 million net of unearned deferred fees and costs). As
of December, 2021, 98% of the dollars originated in the first round have been
forgiven. Further, approximately 99% of the $19.6 million in net fees received
for this round have been recognized life to date. As these borrowers were
required to begin making payments in July, accelerated forgiveness activity was
experienced during the third and fourth quarters of 2021. Remaining round one
originations are expected to be forgiven in the coming months.
As part of the second round of the PPP, Bancorp originated over 2,100 PPP loans
totaling $261 million ($250 million net of unearned deferred fees and costs). As
of December 31, 2021 , 49% of the dollars originated in the second round have
been forgiven and 61% of the $11.4 million in net fees received for this round
were recognized in 2021. As these borrowers are not required to make payments
for 16 months, Bancorp expects a significant portion of these borrowers will
seek forgiveness in early to mid-2022 in connection with their tax return
preparation.
As of
Bancorp totaled
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Interest and fee income earned on the PPP portfolio totaled$22.0 million and$13.6 million for the years endedDecember 31, 2021 and 2020, respectively. As ofDecember 31, 2021 , Bancorp had$4.6 million of net unearned deferred fees related to the PPP that have yet to be recognized and as a result, PPP loan forgiveness will continue to have an impact on operating results for the first part of 2022. As a result of the PPP originations, forgiveness activity, record deposit levels and historically low interest rates, excess liquidity has created NIM compression, as well as challenges associated with deploying idle cash. Bancorp made substantial investments in the AFS debt securities portfolio during the year in an effort to deploy excess liquidity, purchasing$505 million in AFS debt securities (excluding those added through the KB acquisition) in 2021. The ACL on loans (excluding acquisition related activity) decreased$5 million betweenDecember 31, 2020 andDecember 31, 2021 , a stark contrast from the large reserve build recorded betweenDecember 31, 2019 andDecember 31, 2020 , which included a$15 million increase that was separate and subsequent to the increases recorded effectiveJanuary 1, 2020 in relation to the initial adoption of CECL. The pandemic had a material impact on ACL calculations in 2020 and 2021, as provisioning surged amidst changes in forecasted economic conditions, especially the FRB's Seasonally Adjusted National Civilian Unemployment Rate. After peaking towards the middle of 2020, unemployment forecasts have steadily improved, as have other underlying CECL model factors, resulting in a reduction of the provision for credit losses recorded in each quarter of 2021. While separate from the ACL on loans and recorded in other liabilities on the consolidated balance sheets, the ACL for off balance sheet credit exposures also experienced a decrease betweenDecember 31, 2020 andDecember 31, 2021 . A net benefit of$2.2 million was recorded to provision for credit losses for off balance sheet exposures in 2021, as loss factors associated within the calculation improved and line of credit utilization continued to increase, while remaining below pre-pandemic levels. Partially offsetting this decrease was a$250,000 increase to the ACL for off balance sheet credit exposures recorded during the second quarter, in relation to the KB acquisition, which had no impact on earnings. The ACL for off balance sheet credit exposures stood at$3.5 million as ofDecember 31, 2021 compared to$5.4 million as ofDecember 31, 2020 . Bancorp has not incurred any significant challenges to its ability to maintain its systems and controls in light of the measures taken to prevent the spread of COVID-19 and has not incurred significant resource constraints through the implementation of its business continuity plans and does not anticipate incurring such issues in the future. Bancorp has not made, and at this time does not expect to make, any material staffing or compensation changes as a result of the pandemic. 28
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Overview – Operating Results (FTE)
The following table presents an overview Bancorp’s financial performance for the
years ended
Years Ended December 31, Variance (dollars in thousands, except per share data) 2021 2020 2019 2021 / 2020 2020 / 2019 Net income$ 74,645 $ 58,869 $ 66,067 27 % (11 )%
Diluted earnings per share
15 % (10 )% ROA 1.33 % 1.40 % 1.90 % (7 )bps (50 )bps ROE 13.02 % 14.01 % 17.09 % (99 )bps (308 )bps
Additional discussion follows under the section titled “Results of Operations.”
General highlights for the year ended
2020
? Bancorp completed its acquisition of KB during the second quarter of 2021. At
the time of acquisition, KB had
(including PPP),$396 million in AFS debt securities and$1.04 billion in deposits.
o The year ended
with the KB acquisition, which contributed approximately
interest income,
non-interest expense (excluding one-time merger related expenses). In
addition, one-time merger related expenses totaling
loss expense on the acquired loan portfolio of
the year ended
? In 2021, Bancorp set the following financial records:
o Total revenue, comprising net interest income FTE and non-interest income, of
o Record loan production (excluding PPP), which drove
portfolio growth and, combined with expansion into theCentral Kentucky market, led to record total loans of$4.12 billion atDecember 31, 2021
o Total deposit growth of
million in 2020,
o WM&T AUM totaled
growth during the year, approximately
the KB acquisition
o WM&T services income of
generation and strong market performance atDecember 31, 2021 o Debit and credit card income of$13.5 million , supported by organic and acquisition-related growth in transaction volume and customer base
o Higher transaction volume, new product sales and customer base expansion
boosted Treasury Management fees to a record
? Net income totaled
resulting in diluted EPS of
diluted EPS of
o Operating results from the year ended
impacted by the acquisition of KB, PPP forgiveness activity, reduction in both
the ACL on loans and ACL for off-balance sheet exposures, substantial organic
loan and deposit growth (excluding acquisition and PPP) and historic levels of
excess liquidity.
o Operating results for the year ended
2021, primarily due to increased credit loss provisioning and reserves for
off-balance sheet credit exposures associated with the developing pandemic and
unprecedented government stimulus actions had a significant impact on
Bancorp’s operating results in 2020.
? NIM decreased 17 bps to 3.22% for the year ended
3.39% for the prior year consistent with the sustained low interest rate
environment and record levels of excess liquidity, which created significant
NIM compression. Despite the decrease in NIM, organic loan growth, the KB
acquisition, fee income associated with PPP loans and deposit rate cuts
resulted in a
to the prior year.
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? Total loans (excluding PPP loans) increased
ended
(entered into as a result of the KB acquisition), the remaining
was attributed to strong organic growth highlighted by each of the
? Total provision for credit losses was a net benefit of
ended
for the year ended
o While provision of
added through the KB acquisition, a cumulative net benefit of
recorded for credit losses on loans and credit losses on off balance sheet
exposures in 2021, as a result of stabilized unemployment forecasts, generally
improving CECL model factors and stronger line of credit utilization.
o The adoption of CECL effective
developments, such as elevated unemployment and historic declines in line of
credit utilization amidst the evolving pandemic drove elevated provisioning in
2020.
? C&I line of credit utilization improved to 31.8% at
26.1% at
gradually declining levels of utilization that bottomed out in March of 2021,
improving thereafter in each of the final three quarters of 2021. While this
was a positive development for loan growth during the year, utilization still
remains well below pre-pandemic levels.
? Bancorp’s ACL on loans to total loans was 1.29% at
to 1.47% at
? Total deposits increased
to
to the central
while significant organic growth was also experienced during the year, as
customers generally maintained elevated levels of liquidity stemming from
economic uncertainty, PPP funding and continued federal stimulus. Deposits have
remained elevated for several quarters and finished at record levels (including
and excluding acquisition-related activity) as of
? Non-interest income increased
resulted in a substantial contribution to non-interest income, significant
organic growth was also experienced across all non-interest revenue streams,
with the exception of mortgage banking, led by WM&T, card income and
management fees.
? Non-interest expenses increased
related to one-time merger related expenses (including expenses relating to the
pending Commonwealth acquisition). While recurring expenses attributed to the
KB acquisition comprise the majority of the remaining increase, non-interest
expenses in general remained well-controlled and consistent with expansion,
strong performance and continued investment in technology.
? Bancorp’s efficiency ratio (FTE) for the year ended
to 59.94% from 54.06% for the prior year, consistent with recording one-time
merger related costs of
Excluding one-time merger related costs and expenses related to the
amortization of tax credit partnerships, Bancorp’s non-GAAP efficiency ratio at
section titled “Non-GAAP Financial Measures” for reconcilement of non-GAAP to
GAAP measures.
? The ETR increased to 21.75% for the year ended
for the same period in 2020. The increase was significantly impacted by the
prior year benefit of a large historic tax credit project coupled with Bancorp's transition from a capital-based franchise tax to theKentucky corporate income tax, which beganJanuary 1, 2021 . Total stockholder's equity to total assets was 10.17% as ofDecember 31, 2021 compared to 9.56% atDecember 31, 2020 . Total equity increased$235 million in 2021, as$205 million of stock issued for the acquisition of KB and net income of$74.6 million were offset by$28.2 million of dividends declared, changes in AOCI and stock based compensation activity. 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 8.22% as ofDecember 31, 2021 , compared with 9.28% atDecember 31, 2020 , the decline driven by goodwill of$123 million recorded in relation to the KB acquisition. See the section titled "Non-GAAP Financial Measures" for reconcilement of non-GAAP to GAAP measures. 30
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General highlights for the year ended
2019
? Net income totaled
resulting in diluted EPS of
ended
related to two
in addition to one-time merger related expenses, which equated to
diluted share for 2019. Operating results for the year ended
were lower compared to the prior year, primarily due to increased credit loss
provisioning and reserves for off-balance sheet credit exposures associated
with the uncertain pandemic-related economic conditions, a substantially lower
interest rate environment and unprecedented government stimulus actions.
? NIM decreased 43 bps to 3.39% for the year ended
3.82% for the prior year, consistent with the decline in the interest rate
environment, the addition of the low-yielding PPP portfolio and excess balance
sheet liquidity; offset by strong average year over prior year loan growth
(excluding PPP loans) and the strategic lowering of stated deposit interest
rates and CD offering rates in tandem with FRB interest rate actions. Despite
the decrease in NIM, Bancorp’s deposit rate cuts and fee income associated with
PPP loans resulted in a
compared to the prior year.
? Effective
326, or CECL. The adoption of this standard increased the opening balance of
the ACL on loans and the reserve for off-balance sheet credit exposures as of
corresponding income statement impact.
? Total loans (excluding PPP loans) increased
ended
book-ended the largest quarterly loan balance contraction in the Company’s
history during the second quarter and flat net loan activity in the third
quarter.
? Line of credit utilization declined significantly in 2020, falling to 38.0% at
by C&I line usage, which dropped from 40.9% at
? Deposit balances ended at record levels at
result of PPP funding and higher levels of liquidity held by customers
attributable to current economic uncertainty.
? Despite overall strong credit metrics, significant credit loss provisioning
occurred based on the on-going economic crisis, its corresponding impact on
unemployment forecast adjustments within the CECL model, the addition of a
large specific reserve, qualitative factor adjustments and loan growth.
Significant provisioning related to off-balance sheet credit exposures was also
recorded for the year ended
utilization (mainly C&I).
? Bancorp’s ACL on loans to total loans was 1.47% at
to 0.94% at
PPP loans) rose to 1.74% at
? Non-interest income increased 5% for the year ended
to the prior year on the heels of record mortgage banking income despite
substantially lower deposit service charge income and the prior year period
benefitting from
which included a large estate fee in the first quarter of 2020 and continued
growth in treasury management fees and card income also contributed to the
increase.
? Non-interest expenses increased 4% for the year ended
compared to the same period of 2019. Elevated tax credit amortization stemming
from a large tax credit investment and continued investment in technology drove
the increase despite declines associated with one-time acquisition-related
charges and non-recurring activity in the prior year and pandemic-driven
decreases in marketing and business development activity.
? Bancorp’s efficiency ratio (FTE) for the year ended
to 54.06% from 56.07% for the prior year, the latter of which included
million in one-time merger-related expenses associated with the 2019 KSB
acquisition.
? The ETR increased to 13.1% for the year ended
the same period in 2019, the latter of which benefitted from
non-recurring tax adjustments related to twoKentucky tax law changes. Total stockholder's equity to total assets was 9.56% as ofDecember 31, 2020 compared to 10.91% atDecember 31, 2019 , the decline driven by the outsized balance sheet growth attributed to PPP participation. Total equity increased$34.4 million in 2020, as net income of$58.9 million and changes in AOCI were offset by dividends declared of$24.5 million and various stock based compensation. Bancorp's ratio of TCE to total tangible assets was 9.28% as ofDecember 31, 2020 , compared with 10.55% atDecember 31, 2019 , the decline driven by the significant balance sheet growth associated with PPP participation as noted above. See the section titled "Non-GAAP Financial Measures" for reconcilement of non-GAAP to GAAP measures. 31
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Table of Contents Challenges for 2022:
Bancorp has identified the following challenges for fiscal year 2022:
? Bancorp expects to complete the merger of
first quarter of 2022. Bancorp has received all required regulatory approvals
to complete the acquisition and the acquisition is expected to close on or
around
cultures, loan and deposit products, pricing strategies, data processing
systems and other technologies, accounting, internal audit and financial
reporting systems, operating systems and internal controls, and marketing
programs and personnel. Bancorp will need to manage the transition effectively
to maximize retention of Commonwealth’s customers and employees, integrate
personnel and systems efficiently, and maximize anticipated economic benefits.
? The prospects of a rising interest rate environment for 2022 and beyond present
interest rate risk management challenges. Bancorp has benefitted significantly
from the low cost of funds provided by its deposit base over the past year, as
stated deposit rates have remained at very low levels since early 2020. Bancorp
has also made significant investment in its AFS debt securities portfolio at
low fixed rates, the market values of which will be impacted by rising rates.
Given the record levels of liquidity held by Bancorp and in the banking system
generally, the interest rate risk profile of Bancorp is expected to be slightly
asset sensitive with interest rates expected to rise.
? NIM compression remains a challenge for 2022. While the FRB is projecting
multiple rate hikes in 2022 based on its
record levels of liquidity, existing and anticipated pricing
pressure/competition and other economic factors, such as inflation, provide
reasons for caution. Further, the timing of forgiveness associated with the
remaining outstanding PPP portfolio will continue to affect loan yields and
NIM, particularly in the first part of 2022.
? Net loan growth, excluding the PPP portfolio, is a major focus for Bancorp in
2022. This will be impacted by developments surrounding the on-going pandemic,
competition, prevailing interest rates, economic conditions, line of credit
utilization and loan prepayments. Bancorp believes there is continued
opportunity for loan growth in all of its markets, including the recently
entered
deliver attractive loan growth over the long-term is linked to Bancorp’s
overall success. ? The continued integration and development of the centralKentucky market
remains a top priority for 2022 as well. The acquisition of KB in 2021 expanded
Bancorp’s presence in central and eastern
provide broader product offerings, increased lending capabilities and an
expanded branch delivery system to existing and prospective customers alike,
creating solid growth opportunities and a larger platform for future expansion.
Prioritizing the development of the central
of the WM&T business in this market, will play a major role in delivering
strong operating results in the coming year.
? Bancorp derives significant non-interest income from WM&T services. Most of
these fees are based upon the market value of AUM at respective period ends. To
continue growth of this income source, Bancorp must attract new customers and
retain existing customers. Bancorp believes there is opportunity for growth in
all of its markets, particularly through the newly entered
market and the pending acquisition of
of which will serve to grow our WM&T customer base significantly. Growth in
market values of AUM and fees is dependent upon positive returns in the overall
capital markets, which ended 2021 near record highs. Bancorp has no control
over market volatility.
? Competitive factors surrounding the developing trend of financial institutions
reducing or eliminating certain deposit account fees, particularly
overdraft-related fees, presents a significant challenge to growing
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, as consumer use of these bank deposit services continues
to evolve. Continuous monitoring of these trends and evaluation of any
potential changes to our deposit service fee structure will play a key role in
the growth of Bancorp’s non-interest income.
? Technological advances are consistently providing opportunities for Bancorp to
consider potential new products and delivery channels. Bancorp’s
customers’ demand for innovative and relevant products and services is expected
to trend along with changing technology. Bancorp will need to continue to make
prudent investments in technology while managing associated risks so as to
remain competitive with other financial service providers, especially as
Bancorp’s continued expansion raises the level of expectation from customers.
? Over the past several years, Bancorp’s asset quality metrics have trended
within a narrow range, exceeding benchmarks and reaching historically strong
levels. Bancorp realizes that present asset quality metrics are positive and,
recognizing the cyclical nature of the lending business, Bancorp anticipates
this trend will likely normalize over time.
? Operating results for 2020 and 2021 were significantly impacted by the pandemic
and efforts to contain both the virus and its economic impact will continue to
weigh on the economy, the banking industry and Bancorp. As such, any future
regulatory and legislative actions taken in response to related developments
could have a significant impact on future operating results.
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Table of Contents Results of Operations
Net Interest Income – Overview
As is the case with most banks, Bancorp's primary revenue sources are net interest income and fee income from various financial services provided to customers. Net interest income is the difference between interest income earned on loans, investment securities and other interest earning assets less interest expense on deposit accounts and other interest bearing liabilities. Loan volume and interest rates earned on those loans are critical to overall profitability. Similarly, deposit volume is crucial to funding loans and rates paid on deposits directly impact profitability. New business volume is influenced by numerous economic factors including market interest rates, business spending, liquidity, consumer confidence and various competitive conditions within the marketplace. The discussion that follows is based on fully tax-equivalent interest data.
Comparative information regarding net interest income follows:
As of and for the Years Variance EndedDecember 31 , (dollars in thousands) 2021 2020 2019 2021 / 2020 2020 / 2019 Net interest income$ 171,074 $ 135,921 $ 125,348 26 % 8 % Net interest income (FTE)* 171,508 136,133 125,571 26 % 8 % Net interest spread 3.16% 3.22% 3.50% (6) bps (28) bps Net interest margin 3.22% 3.39% 3.82% (17) bps (43) bps Average earning assets$ 5,318,968 $ 4,019,336 $ 3,290,345 32 % 22 % Five year Treasury note rate 1.26% 0.36% 1.69% 90 bps (133) bps at year end Average five year Treasury 0.86% 0.53% 1.95% 33 bps (142) bps note rate Prime rate at year end 3.25% 3.25% 4.75% - bps (150) bps Average Prime 3.25% 3.53% 5.29% (28) bps (176) bps One month LIBOR at year end 0.10% 0.14% 1.76% (4) bps (162) bps Average one month LIBOR 0.10% 0.52% 2.22% (42) bps (170) bps
*See table titled, “Average Balance Sheets and Interest Rates (FTE)” for detail
of Net interest income (FTE).
NIM and net interest spread calculations above exclude the sold portion of certain participation loans, which totaled$5 million ,$10 million and$8 million for the years endedDecember 31, 2021 , 2020 and 2019, 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. Prime rate, the five yearTreasury note rate and the one month LIBOR are included in the table above to provide a general indication of the interest rate environment in which Bancorp has operated during the past three years. Approximately$1.2 billion , or 30%, of Bancorp's loans are variable rate and are indexed to either Prime or LIBOR, generally repricing as those rates change. At inception, most of Bancorp's fixed rate loans are priced in relation to the five yearTreasury rate. The interest rate environment has experienced a significant decline over the three year period referenced above. The FFTR began 2019 at a range of 2.25-2.50%, and in turn, Prime began that same year at 5.50%, representing the highest interest rates experienced post-Great Recession. Subsequent to hitting those peak marks, the FRB lowered the FFTR five times for a total of 225 bps, the most recent of which came in March of 2020 and took the FFTR to a range of 0-0.25% and Prime to 3.25%, where both remained as ofDecember 31, 2020 andDecember 31, 2021 . 33
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Table of Contents Discussion of 2021 vs 2020: Net interest spread and NIM were 3.16% and 3.22% for the year endedDecember 31, 2021 compared to 3.22% and 3.39% for the year endedDecember 31, 2020 . NIM was significantly impacted in 2021 by the following:
? A sustained low interest rate environment, driven by the lowering of the FFTR
in
3.25%, where it has remained since the first quarter of 2020.
? PPP originations, which began in the second quarter of 2020 and continued
through expiration of the program on
forgiveness activity, which accelerates the recognition of fee income on these
loans and continues to have a significant effect on NIM. The PPP portfolio
contributed an 18 bps benefit to NIM for the year ended
result of forgiveness activity, which drove the recognition of
in PPP-related fee income. In comparison, the PPP portfolio had a negative
impact of 3 bps on NIM for the year end
amount of originations that occurred in 2020 and the affect that the
low-yielding, 1% stated rate of these notes had on NIM for the period.
? Overall, excess balance sheet liquidity contributed approximately 25 bps of
NIM compression for the year ended
balance sheet liquidity contributed approximately 13 bps of NIM compression
for the same period of 2020. In general, excess liquidity within the banking
system has led to a highly competitive loan rate environment over the past two
years.
? Substantial balance sheet growth, both organic and acquisition-related, which
resulted in total average earning asset growth of
average interest-bearing liability growth of
year endedDecember 31, 2021 compared to the same period of 2020.
? The lowering of deposit rates in tandem with FRB interest rate actions and the
benefit of paying off all FHLB advances during 2021. Net interest income (FTE) increased$35.4 million , or 26%, for the year endedDecember 31, 2021 compared to the same period of 2020, due to interest and fee income associated with the PPP portfolio, substantial growth in the non-PPP loan portfolio and AFS debt securities portfolio, and the aforementioned lowering of deposit rates. Total average interest earning assets increased$1.30 billion , or 32%, to$5.32 billion for the year endedDecember 31, 2021 , as compared to the same period of 2020, with the average rate earned on total interest earning assets contracting 34 bps to 3.34%.
? Average total loans increased
balances grew
compared to the same period of 2020, attributed to both the acquisition and
strong organic growth. Average PPP loan balances decreased
10%, for the year ended
consistent with forgiveness activity throughout 2021.
? Average AFS debt securities grew
a combination of strategically deploying excess liquidity through further
investment and the KB acquisition.
? Average FFS and interest bearing due from balances increased
94%, for the year ended
of deposits.
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Total interest income (FTE) increased
for the year ended
? Interest and fee income on loans (FTE) increased
period of 2020, driven by accelerated recognition of PPP fee income consistent
with forgiveness activity, organic loan growth and the contribution attributed
to the KB acquisition.
? Significant growth in average AFS debt securities drove an increase of
million, or 37%, for interest income (FTE) on the portfolio for the year ended
interest rate environment experienced over the past twelve months weighed
heavily on fixed income security yields, which decreased 59 bps, or 31%.
? Despite the substantial increase experienced for average FFS and interest
bearing due from balances, corresponding interest income decreased
13%, for the year ended
as a result of the FRB lowering the FFTR 150 bps in
0-0.25%, where it remained for the final three quarters of 2020 and the
entirety of 2021.
Total average interest bearing liabilities increased $773 million , or 30%, to
$3.39 billion for the year ended December 31, 2021 compared with the same period
in 2020, with the total average cost declining 28 bps to 0.18%.
? Average interest bearing deposits increased
ended
interest-bearing demand deposits accounting for
Interest bearing deposits added as a result of the KB acquisition along with
significant federal stimulus action, such as PPP funding, propelled deposit
balances to record levels at
uncertainty surrounding the on-going pandemic has resulted in the customer
base maintaining higher levels of liquidity, similar to customer behavior seen
during the Great Recession.
? Consistent with the higher interest bearing deposit balances noted above, as
well as the KB acquisition, average SSUAR balances increased
55%, for the year ended
? Average FHLB advances decreased$45 million , or 73%, for the year ended
to mature without renewal or replacement over the past year, including
million of three month advances relating to cash flow hedge interest rate
swaps. In addition, Bancorp elected to pay down certain advances prior to
their maturity during the first and second quarters of 2021, the latter of
which resulted in an early-termination fee of $474,000 , recorded as a
component non-interest expense during the second quarter of 2021. Bancorp made
this decision due to its excess liquidity driven by the substantial deposit
growth it achieved over the past year, combined with the near-term outlook for
low interest rates at the time of pay off. As of
had no outstanding FHLB advances. Total interest expense decreased$5.9 million , or 50%, for the year endedDecember 31, 2021 compared to the same period of 2020, a direct result of deposit rate reductions implemented in response to the falling interest rate environment and to a lesser extent, the reduction in interest expense on FHLB advances.
? Total interest bearing deposit expense decreased
a 25 bps decline in the cost of average total interest bearing deposits.
? Interest expense on FHLB advances declined
of the substantial reduction in average FHLB advances outstanding. As noted
above, Bancorp had no outstanding FHLB advances as of
Discussion of 2020 vs 2019: Net interest spread and NIM were 3.22% and 3.39% for the year endedDecember 31, 2020 compared to 3.50% and 3.82% for the year endedDecember 31, 2019 . NIM was significantly impacted in 2020 by the following:
? The FFTR was lowered 225 bps between
in Prime dropping to 3.25%. Average Prime declined significantly to 3.53% for
2020 compared to 5.29% for 2019.
?
NIM and loan yields.
? PPP loan originations, which boosted net interest income, had a negative
impact on NIM and loan yields.
? The strategic lowering of stated deposit interest rates and CD offering rates
over the past twelve months in tandem with FRB interest rate actions. ? Strong average non-PPP loan growth. ? Excess balance sheet liquidity and elevated deposit balances. Bancorp originated approximately 3,400 PPP loans, equating to$637 million (net of origination fees and costs) during 2020. Bancorp recognized$9.1 million in net origination fee income associated with the PPP portfolio in 2020. While this had a positive impact on interest and fee income, as well as net interest income, the 1% stated yield on the PPP portfolio negatively impacted the overall loan portfolio yield by 17 bps and NIM by 3 bps for the year endedDecember 31, 2020 . 35
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Average FFS and interest bearing due from bank balances increased significantly for the year endedDecember 31, 2020 compared with the same period in 2019. Excess liquidity contributed to approximately 15 bps of NIM compression for the year endedDecember 31, 2020 compared to 9 bps for the year endedDecember 31, 2019 . Net interest income (FTE) increased$10.6 million , or 8%, for the year endedDecember 31, 2020 compared to the same period of 2019, primarily attributed to the lowering of stated deposit rates in response to the changing interest rate environment and the additional fee income associated with the PPP portfolio in 2020. Total average interest earning assets increased$729 million , or 22%, to$4.02 billion for the year endedDecember 31, 2020 , with the average rate earned on total interest earning assets contracting 82 bps to 3.68%.
? Average loans increased
2020 compared to the same period of 2019 with
growth attributed to the PPP portfolio. In addition to the 2019 KSB
acquisition, Bancorp experienced strong organic growth across all three
markets in 2020, which led to a
portfolio balances.
? Average FFS and interest bearing due from bank balances increased
for the year ended
consistent with the elevated level of deposits. Total interest income (FTE) was flat, down$32,000 to$148.1 million for the year endedDecember 31, 2020 , as compared with the same period of 2019 despite the drastic decline in the interest rate environment.
? Interest and fee income on loans (FTE) increased approximately
or 2%, to
interest rate contraction in 2020 led to a
income on the non-PPP loan portfolio.
? With the exception of mortgage loans held for sale, interest income on the
remaining interest earning asset portfolio was negatively impacted by the
changes in the interest rate environment in addition to substantial average
balance growth. Total average interest bearing liabilities increased$353 million , or 16%, to$2.62 billion for the year endedDecember 31, 2020 , as compared with the same period of 2019, with the average cost decreasing 54 bps to 0.46%.
? Average interest bearing deposits increased
ended
interest-bearing demand deposits representing
? Average FHLB advances declined
31, 2020 compared to the same period of 2019, as matured advances were not
replaced or renewed in 2020.
Total interest expense decreased
stated deposit rate reductions implemented in response to the changing interest
rate environment.
? Total interest bearing deposit expense decreased$10.1 million , or 49%, driving a 54 bps decrease in the cost of average total interest bearing
liabilities to 0.42% as deposit rates were cut in tandem with FRB interest
rate actions.
? FHLB advance expense decreased
replaced or renewed in 2020, resulting in lower interest expense.
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Table of Contents
Average Balance Sheets and Interest Rates (FTE)
2021 2020 2019
Years ended December
31, (dollars in Average Average Average Average Average Average
thousands) Balance Interest Rate Balance Interest Rate Balance Interest Rate
Interest earning
assets:
Federal funds sold and
interest bearing due
from banks $ 446,783 $ 645 0.14 % $ 229,905 $ 738 0.32 % $ 136,514 $ 2,933 2.15 %
Mortgage loans held for
sale 11,170 249 2.23 20,156 533 2.64 3,836 182 4.74
Available for sale debt
securities:
Taxable 879,298 11,575 1.32 443,035 8,432 1.90 413,801 9,291 2.25
Tax-exempt 19,636 340 1.73 10,047 265 2.64 22,710 570 2.51
Total securities 898,934 11,915 1.33 453,082 8,697 1.92 436,511 9,861 2.26
Federal Home Loan Bank
stock 10,824 262 2.42 11,284 253 2.24 10,858 548 5.05
SBA Paycheck Protection
Program (PPP) loans 397,282 22,044 5.55 442,510 13,636 3.08 - - -
Non-PPP loans 3,553,975 142,395 4.01 2,862,399 124,226 4.34 2,702,626 134,591 4.98
Total loans 3,951,257 164,439 4.16 3,304,909 137,862 4.17 2,702,626 134,591 4.98
Total interest earning
assets 5,318,968 177,510 3.34 4,019,336 148,083 3.68 3,290,345 148,115 4.50
Less allowance for
credit losses on loans 57,696 45,008 27,057
Non-interest earning
assets:
Cash and due from banks 63,477 46,277 44,884
Premises and equipment,
net 69,483 57,474 63,197
Bank owned life
insurance 44,720 32,899 32,631
Accrued interest
receivable and other 187,934 106,615 76,998
Total assets $ 5,626,886 $ 4,217,593 $ 3,480,998
Interest bearing
liabilities:
Deposits:
Interest bearing demand $ 1,633,606 $ 1,771 0.11 % $ 1,133,308 $ 1,776 0.16 % $ 875,897 $ 4,951 0.57 %
Savings 328,570 93 0.03 190,368 36 0.02 166,509 291 0.17
Money market 919,778 589 0.06 771,363 1,482 0.19 695,411 7,105 1.02
Time 420,308 3,174 0.76 412,506 7,184 1.74 406,176 8,213 2.02
Total interest bearing
deposits 3,302,262 5,627 0.17 2,507,545 10,478 0.42 2,143,993 20,560 0.96
Securities sold under
agreements to
repurchase 62,534 24 0.04 40,363 37 0.09 38,555 101 0.26
Federal funds purchased 10,596 14 0.13 9,457 35 0.37 11,182 217 1.94
Federal Home Loan Bank
advances 16,317 337 2.07 61,483 1,400 2.28 70,755 1,640 2.32
Subordinated debt - - - - - - 922 26 2.82
Total interest bearing
liabilities 3,391,709 6,002 0.18 2,618,848 11,950 0.46 2,265,407 22,544 1.00
Non-interest bearing
liabilities:
Non-interest bearing
demand deposits 1,578,795 1,100,942 765,103
Accrued interest
payable and other 83,121 77,684 63,925
Total liabilities 5,053,625 3,797,474 3,094,435
Stockholders' equity 573,261 420,119 386,563
Total liabilities and
stockholder's equity $ 5,626,886 $ 4,217,593 $ 3,480,998
Net interest income $ 171,508 $ 136,133 $ 125,571
Net interest spread 3.16 % 3.22 % 3.50 %
Net interest margin 3.22 % 3.39 % 3.82 %
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Table of Contents
Supplemental Information – Total Company Average Balance Sheets and Interest
Rates (FTE)
? Average loan balances include the principal balance of non-accrual loans, as
well as unearned income such as loan premiums, discounts, fees/costs and
exclude participation loans accounted for as secured borrowings. Participation
loans averaged
December 31, 2021 , 2020 and 2019, respectively.
? Interest income on a FTE basis includes additional amounts of interest income
that would have been earned if investments in certain tax-exempt interest
earning assets had been made in assets subject to federal taxes yielding the
same after-tax income. Interest income on municipal securities and tax-exempt
loans has been calculated on a FTE basis using a federal income tax rate of
21%. Approximate tax equivalent adjustments to interest income were
respectively.
? Interest income includes loan fees of
with the PPP),
million for the years ended
Interest income on loans may be impacted by the level of prepayment fees
collected and accretion related to loans purchased.
? Net interest income, the most significant component of Bancorp’s earnings,
represents total interest income less total interest expense. The level of net
interest income is determined by mix and volume of interest earning assets,
interest bearing deposits and borrowed funds, and changes in interest rates.
? NIM represents net interest income on a FTE basis as a percentage of average
interest earning assets.
? Net interest spread (FTE) is the difference between taxable equivalent rates
earned on interest earning assets less the cost of interest bearing
liabilities.
? The fair market value adjustment on investment securities resulting from ASC
320, Investments – Debt and Equity Securities is included as a component of
other assets.
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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)
Year ended December 31, 2021 Year ended December 31, 2020
Compared to Compared to
Year ended December 31, 2020 Year ended December 31, 2019
Total Net Increase (Decrease) Due to Total Net Increase (Decrease) Due to
(in thousands) Change Rate Volume Change Rate Volume
Interest income:
Federal funds sold and
interest bearing due
from banks $ (93 ) $ (547 ) $ 454 $ (2,195 ) $ (3,441 ) $ 1,246
Mortgage loans held for
sale (284 ) (74 ) (210 ) 351 (113 ) 464
Securities available
for sale:
Taxable 3,143 (3,210 ) 6,353 (859 ) (1,484 ) 625
Tax-exempt 75 (114 ) 189 (305 ) 28 (333 )
Federal Home Loan Bank
stock 9 20 (11 ) (295 ) (316 ) 21
SBA Paycheck Protection
Program (PPP) loans 8,408 9,928 (1,520 ) 13,636 - 13,636
Non-PPP Loans 18,169 (10,096 ) 28,265 (10,365 ) (18,000 ) 7,635
Total interest income 29,427 (4,093 ) 33,520 (32 ) (23,326 ) 23,294
Interest expense:
Deposits:
Interest bearing demand (5 ) (647 ) 642 (3,175 ) (4,326 ) 1,151
Savings 57 23 34 (255 ) (292 ) 37
Money market (893 ) (1,136 ) 243 (5,623 ) (6,324 ) 701
Time (4,010 ) (4,143 ) 133 (1,029 ) (1,155 ) 126
Total interest bearing
deposits (4,851 ) (5,903 ) 1,052 (10,082 ) (12,097 ) 2,015
Securities sold under
agreements to
repurchase (13 ) (28 ) 15 (64 ) (69 ) 5
Federal funds purchased (21 ) (25 ) 4 (182 ) (153 ) (29 )
Federal Home Loan Bank
advances (1,063 ) (119 ) (944 ) (240 ) (28 ) (212 )
Subordinated debt - - - (26 ) - (26 )
Total interest expense (5,948 ) (6,075 ) 127 (10,594 ) (12,347 ) 1,753
Net interest income $ 35,375 $ 1,982 $ 33,393 $ 10,562 $ (10,979 ) $ 21,541
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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. 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, respectively. These results are attributed to over half of the variable rate loan portfolio being currently at or near floor rates, as these yields will not increase until short-term rates exceed these floor rates. For example, a significant portion of the variable rate loan portfolio is tied to Prime, with floor rates of 4.00%. Given Prime is at 3.25% as ofDecember 31, 2021 , short-term rates would have to increase over 75 bps for these loans to move above their floor rates. 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. Asset balances subject to immediate repricing cause an estimated decline in net interest income in the down 100 bps scenario, as rates on non-maturity deposits cannot be lowered sufficiently to offset declining interest income. These estimates of the summarized below. Change in Rates -200 -100 +100 +200 Basis Points Basis Points Basis Points Basis Points % Change from base net interest income at December 31, 2021 NA -2.18 % -2.84 % 4.50 % Bancorp's interest rate risk profile is generally neutral. The results of the interest rate sensitivity analysis performed as ofDecember 31, 2021 suggest a slightly liability sensitive profile as a result of the long-term, conservative assumptions Bancorp uses in the model, particularly in relation to deposit betas, which measure how responsive management's deposit repricing may be to changes in market rates. However, given the historic levels of liquidity currently held by Bancorp and in the banking system generally, the Company anticipates actual deposit betas will remain well below long-term averages through 2022 despite forecasted interest rate hikes from the FRB. In a scenario where deposit betas are well below long-term averages, Bancorp's interest rate risk profile shifts to a slightly asset sensitive position, but remains generally neutral. Bancorp's loan portfolio is currently composed of approximately 70% fixed and 30% variable rate loans, with the fixed rate portion pricing (excluding PPP loans) 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 66%) or one month LIBOR (approximately 34%). Bancorp's loan portfolio (excluding PPP loans) atDecember 31, 2020 was composed of approximately 69% fixed and 31% variable rate loans. InJuly 2017 , theFinancial 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, inNovember 2020 , theFCA announced that many tenors of LIBOR would continue to be published throughJune 2023 . Subsequent to this, Bank regulators instructed banks to discontinue new originations referencing LIBOR as soon as possible, but no later thanDecember 2021 . EffectiveDecember 31, 2021 , Libor will no longer be used to issue new loans in theU.S. It is expected to be replaced primarily by the Secured Overnight Financing Rate (SOFR), which many experts consider a more accurate and more secure pricing benchmark. To facilitate the transition process, management has instituted an enterprise-wide program to identify, assess, and monitor risks associated with the expected discontinuance or unavailability of LIBOR. 40
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Management has focused on operational readiness, as well as instituting processes and systems to validate that contract risk is clearly identified and understood. New originations and any modifications or renewals of LIBOR-based contracts contained fallback language to assist in an orderly transition to an alternative reference rate. For Bank contracts that have a duration beyondDecember 31, 2021 , and that reference LIBOR, all fallback provisions and variations are currently being identified and sorted into classifications based upon those provisions. Upon classification, the contracts are monitored and possibly remediated if fallback provisions are not deemed sufficiently robust. The Bank realizes that remediating certain contracts indexed to LIBOR may require consent from the counterparties, which could be difficult and costly to obtain in certain limited circumstances. As ofDecember 31, 2021 , the Company had approximately$425 million in loans and interest rate derivative contracts of$123 million (notional amount) that reference LIBOR. Each of the LIBOR-referenced amounts discussed above will vary in future periods as current contracts expire with potential replacement contracts using either LIBOR or an alternative reference rate. The Company, and other industry participants, continue to review alternative reference rates that could be utilized as a replacement for LIBOR. The Company had 7 loans totaling$24 million that were indexed to SOFR atDecember 31, 2021 . 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. As ofDecember 31, 2021 , Bancorp had no outstanding interest rate swaps designated as cash flow hedges. 41
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Table of Contents Provision for Credit Losses Provision for credit losses for the years endedDecember 31, 2021 and 2020 represents the amount of expense that, based on Management's judgment, is required to maintain the ACL on loans at an appropriate level under the CECL model. Years prior to 2020 were historically calculated under the incurred loss model. The determination of the amount of the ACL on 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 on loans methodology by loan portfolio segment.
An analysis of the changes in the ACL on loans, including provision, and
selected ratios follow:
Years endedDecember 31 , (dollars in thousands) 2021 2020 2019 Beginning balance$ 51,920 $ 26,791 $ 25,534 KB acquisition - PCD loans (goodwill adjustment) 6,757 - - CECL - cumulative adjustment - 9,856 - Adjusted beginning balance 58,677 36,647 25,534 Provision for credit losses on loans (6,000 ) 16,918
1,000
Provision for credit losses on loans - KB acquisition 7,397 - - Total provision for credit losses on loans 1,397 16,918 1,000 Total charge-offs (7,681 ) (2,101 ) (684 ) Total recoveries 1,505 456 941 Net loan (charge-offs) recoveries (6,176 ) (1,645 ) 257 Ending balance$ 53,898 $ 51,920 $ 26,791 Average total loans$ 3,951,257 $ 3,304,909 $ 2,702,626 Provision for credit losses on loans to average loans 0.04 % 0.51 % 0.04 % Net loan (charge-offs) recoveries to average loans -0.16 % -0.05 % 0.01 % ACL on loans to total loans 1.29 % 1.47 % 0.94 % ACL on loans to total loans (excluding PPP) (1) 1.34 % 1.74 % - ACL on loans to average loans 1.36 % 1.57 % 0.99 %
(1) See the section titled “Non-GAAP Financial Measures” for reconcilement of
non-GAAP to GAAP measures.
Discussion of 2021 vs 2020: The ACL on loans totaled$54 million as ofDecember 31, 2021 compared to$52 million atDecember 31, 2020 , representing an ACL to total loans ratio of 1.29% and 1.47% for those periods, respectively. The ACL to total loans (excluding PPP loans) was 1.34% atDecember 31, 2021 compared to 1.74% atDecember 31, 2020 , the decrease stemming from loan growth that was offset by forgiveness activity within the PPP portfolio and a lower ACL. Based on the 100% SBA guarantee of the PPP loan portfolio, which totaled$141 million (net of unamortized deferred fees) atDecember 31, 2021 and$550 million atDecember 31, 2020 , Bancorp did not record a general reserve for potential losses for these loans within the ACL. See the section titled "Non-GAAP Financial Measures" for reconcilement of non-GAAP to GAAP measures. Upon adoption of ASC 326 effectiveJanuary 1, 2020 , Bancorp recorded an increase of$8.2 million to the ACL on loans and a corresponding decrease to retained earnings, net of the DTA impact. In addition, non-accretable yield marks of$1.6 million related to formerly classified PCI loans were reclassed between the amortized cost basis of loans and corresponding ACL on loans, which were subsequently charged-off in the third quarter of 2020 with no resulting impact to provision expense. The adjustment upon adoption of ASC 326 raised the beginning balance of the ACL on loans to$37 million onJanuary 1, 2020 . Additionally, with the adoption of CECL, provision expense may be more volatile due to changes in the CECL model assumptions of credit quality, macroeconomic factors and conditions, and loan composition. 42
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Due to continued improvement in the unemployment forecast, updates to Bancorp's CECL modeling and strong historic credit metrics, a net benefit (excluding acquisition-related activity) of$6.0 million was recorded for the year endedDecember 31, 2021 . Offsetting this benefit was credit loss expense on loans associated with the non-PCD loan portfolio added as a result of the KB acquisition, which was recorded during the second quarter of 2021 and totaled$7.4 million . In total, provision for credit losses on loans decreased$15.5 million for the year endedDecember 31, 2021 compared to the same period of 2020. The significantly higher expense recorded for the year endedDecember 31, 2020 was the result of adopting of CECL effectiveJanuary 1, 2020 and the subsequent pandemic-related developments experienced shortly thereafter, particularly elevated unemployment forecasts. In addition to the non-PCD provision activity previously discussed for the year endedDecember 31, 2021 , the ACL on loans was also increased$6.8 million as a result of the PCD loan portfolio added through the KB acquisition during the second quarter, with the corresponding offset recorded to goodwill. Partially offsetting this increase was net charge off activity of$6.2 million for the year endedDecember 31, 2021 , respectively, serving to reduce the ACL on loans. Net charge off activity for 2021 was driven by the charge off of two CRE relationships totaling$4.4 million . These charged off amounts were fully reserved and had no income statement impact for the year endedDecember 31, 2021 . In addition, there was a$555,000 recovery of a note that was fully charged off in 2020. While separate from the ACL on loans and recorded in other liabilities on the consolidated balance sheets, the ACL for off balance sheet credit exposures also experienced a decrease betweenDecember 31, 2020 andDecember 31, 2021 . A net benefit of$2.2 million was recorded for the year endedDecember 31, 2021 , as nearly all applicable loan segments experienced declines in their reserve loss percentages consistent with generally improving model factors and improvement in line of credit utilization, most notably within the C&I portfolio. In addition, the ACL for off balance sheet credit exposures was increased$250,000 as a result of available credit added through the KB acquisition during the second quarter, with the corresponding offset recorded to goodwill. The ACL for off balance sheet credit exposures stood at$3.5 million as ofDecember 31, 2021 compared to$5.4 million as ofDecember 31, 2020 . Bancorp's loan portfolio is diversified with no significant concentrations of credit. Geographically, most loans are extended to borrowers inLouisville , central, eastern and northernKentucky , as well as theIndianapolis, Indiana andCincinnati, Ohio metropolitan markets. The adequacy of the allowance is monitored on an ongoing basis and it is the opinion of management that the balance of the allowance atDecember 31, 2021 is adequate to absorb probable losses inherent in the loan portfolio as of the financial statement date. Discussion of 2020 vs 2019: Upon adoption of ASC 326 effectiveJanuary 1, 2020 , Bancorp recorded an increase of$8.2 million to the ACL on loans and a corresponding decrease to retained earnings, net of the DTA impact. In addition, non-accretable yield marks of$1.6 million related to formerly classified PCI loans were reclassed between the amortized cost basis of loans and corresponding ACL. The adjustment upon adoption of ASC 326 increased the ACL on loans balance to$37 million effective ofJanuary 1, 2020 . The ACL on loans totaled$52 million atDecember 31, 2020 compared to$27 million atDecember 31, 2019 , representing an ACL to total loans ratio of 1.47% and 0.94% for those periods, respectively. The ACL to total loans (excluding PPP loans) was 1.74% atDecember 31, 2020 . Based on the 100% SBA guarantee of the PPP loan portfolio, which totaled$550 million (net of unamortized deferred fees) atDecember 31, 2020 , Bancorp did not record a general reserve for potential losses for this portfolio. See the section titled "Non-GAAP Financial Measures" for reconcilement of non-GAAP to GAAP measures. Despite overall strong credit metrics, Bancorp recorded provision for credit losses$16.9 million for the year endedDecember 31, 2020 , as compared with$1.0 million for the same period of 2019, the latter of which was determined under the incurred loan loss model. Credit loss provisioning for 2020 was significantly impacted by the economic crisis due to the pandemic, its corresponding impact on unemployment forecast adjustments within the CECL model, loan growth, specific reserve additions and qualitative factor adjustments. The forecasted change in the unemployment rate coupled with the qualitative factor adjustments resulted in approximately$12.4 million of the total provision for credit loss expense recorded for the year endedDecember 31, 2020 . In addition, Bancorp recorded$2.8 million in provision for credit losses in 2020 related to net loan growth which was heavily concentrated in the fourth quarter. During the second quarter of 2020, a large CRE relationship was placed on non-accrual status and allocated a$2 million specific reserve within the ACL on loans. An additional$1 million specific reserve was added to this relationship during the fourth quarter. During the third quarter of 2020, the Company recorded charge-offs totaling$1.6 million related to loans that were acquired in the prior year acquisition and fully allocated for through purchase accounting adjustments at the time of acquisition. While these are reflected as charge-offs, there was no impact to the provision for credit losses, nor to the income statement, associated with these loans and charge-off activity for the year endedDecember 31, 2020 was otherwise minimal. 43
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Non-Interest Income
Variance
(dollars in thousands) 2021 / 2020 2020 / 2019
Years Ended
% $ % Wealth management and trust services$ 27,613 $ 23,406 $ 22,643 $ 4,207 18 %$ 763 3 %
Deposit service charges 5,852 4,161 5,193 1,691
41 (1,032 ) (20 ) Debit and credit card income 13,456 8,480 8,123 4,976 59 357 4
28 415 8 Mortgage banking income 4,724 6,155 2,934 (1,431 ) (23 ) 3,221 110 Net investment products sales commissions and fees 2,553 1,775 1,498 778 44 277 18 Bank owned life insurance 914 693 1,031 221 32 (338 ) (33 ) Other 3,826 1,822 3,014 2,004 110 (1,192 ) (40 ) Total non-interest income$ 65,850 $ 51,899 $ 49,428 $ 13,951 27 %$ 2,471 5 % Discussion of 2021 vs 2020: Total non-interest income increased$14.0 million , or 27%, for the year endedDecember 31, 2021 compared to the same period of 2020. Non-interest income comprised 27.8% of total revenue, defined as net interest income and non-interest income, for the year endedDecember 31, 2021 compared to 27.6% for the same period of 2020, respectively. WM&T services comprised 41.9% of total non-interest income for the year endedDecember 31, 2021 compared to 45.1% for the same period of 2020, respectively. The KB acquisition accounted for a meaningful increase in total non-interest income for the year endedDecember 31, 2021 , concentrated most notably in deposit service charges, debit and credit card income, and mortgage banking income. WM&T Services: The magnitude of WM&T revenue distinguishes Bancorp from other community banks of similar asset size. WM&T revenue increased$4.2 million , or 18%, for the year endedDecember 31, 2021 as compared with the same period of 2020. Stock market appreciation, coupled with record net new business development and to a lesser extent, the KB acquisition, drove the substantial revenue increase for 2021. 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$4.4 million , or 20%, for the year endedDecember 31, 2021 , as compared with the same period of 2020, as a result of significant stock market appreciation experienced in addition to both organic and acquisition-related growth in net new business. A portion of WM&T revenue, most notably executor and certain employee benefit plan-related fees, are non-recurring in nature and the timing of these revenues typically correspond with the related administrative activities. For this reason, such fees are subject to greater period over period fluctuation. Total non-recurring fees decreased$211,000 , or 26%, for the year endedDecember 31, 2021 , as compared with the same period of 2020. The decrease from prior year was driven mainly by a large estate fee recorded in the first quarter of 2020. AUM, stated at market value, totaled$4.80 billion atDecember 31, 2021 compared to$3.85 billion atDecember 31, 2020 . The large increase in AUM is attributed to significant stock market appreciation experienced in addition to record net new business growth and AUM of approximately$250 million added through the KB acquisition. 44
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Contracts between WM&T and their customers do not permit performance-based fees and accordingly, none of the WM&T revenue is performance based. Management believes the WM&T department will continue to factor significantly in Bancorp's financial results and provide strategic diversity to revenue streams.
Detail of WM&T Service Income by Account Type:
(in thousands) Years Ended December 31, 2021 2020 2019 Investment advisory$ 12,003 $ 9,747 $ 9,072 Personal trust 7,569 7,027 7,164
Personal investment retirement 5,168 4,319 3,821
Company retirement
1,798 1,457 1,503 Foundation and endowment 797 589 559 Custody and safekeeping 146 129 130 Brokerage and insurance services 78 45 52 Other 54 93 342 Total WM&T services income$ 27,613 $ 23,406 $ 22,643 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, revocable trusts, personal investment retirement accounts and accounts holding only fixed income securities. Company retirement plan services can consist of a one-time conversion fee with recurring AUM fees to follow. While there are also fee structures for estate settlements, income received is often non-recurring in nature. Fee structures are agreed upon at the time of account opening and any subsequent revisions are communicated in writing to the customer. WM&T fees earned are not performance-based nor are they based on investment strategy or transactions.
Assets Under Management by Account Type:
Total AUM (not included on balance sheet) increased from
December 31, 2021 December 31, 2020
(in thousands) Managed Non-managed (1) Total Managed Non-managed (1) Total
Investment advisory $ 1,919,593 $ 34,879 $ 1,954,472 $ 1,547,742 $ 72,696 $ 1,620,438
Personal trust 939,703 150,221 1,089,924 721,150 112,053 833,203
Personal investment
retirement 620,312 3,478 623,790 506,005 3,241 509,246
Company retirement 35,234 599,129 634,363 40,006 481,222 521,228
Foundation and endowment 368,572 1,532 370,104 281,986 2,532 284,518
Subtotal $ 3,883,414 $ 789,239 $ 4,672,653 $ 3,096,889 $ 671,744 $ 3,768,633
Custody and safekeeping - 128,178 128,178 - 83,004 83,004
Total $ 3,883,414 $ 917,417 $ 4,800,831 $ 3,096,889 $ 754,748 $ 3,851,637
(1) Non-managed assets represent those for which the WM&T department does not
hold investment discretion.
As ofDecember 31, 2021 and 2020, approximately 81% and 80%, 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. 45
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Managed Trust AUM by Class of Investment:
December 31, December 31,
(in thousands) 2021 2020
Interest bearing deposits $ 173,603 $ 168,344
Treasury and government agency obligations 39,736
31,719
State, county and municipal obligations 110,795 119,344 Money market mutual funds 7,299 58,493 Equity mutual funds 944,500 752,476 Other mutual funds - fixed, balanced and municipal 612,913 441,275 Other notes and bonds 171,087 165,828 Common and preferred stocks 1,681,006 1,238,973 Real estate mortgages - 190 Real estate 58,344 51,682 Other miscellaneous assets (1) 84,131 68,565 Total managed assets$ 3,883,414 $ 3,096,889
(1) Includes client directed instruments including rights, warrants, annuities,
insurance policies, unit investment trusts, and oil and gas rights.
Managed assets are invested in instruments for which market values can be readily determined, the majority of which are sensitive to market fluctuations and consist of approximately 68% in equities and 32% in fixed income securities as ofDecember 31, 2021 compared to 64% and 36% as ofDecember 31, 2020 . This composition has been relatively consistent from period to period and theWM&T Department holds no proprietary mutual funds.
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$1.7 million , or 41%, for the year endedDecember 31, 2021 , as compared with the prior year, as a result of a meaningful contribution from the KB acquisition and a recovery from the subdued pandemic-induced activity experienced in the prior year. Consistent with the industry, customer behavior and transaction volume in 2020 was significantly impacted by the pandemic and continued government efforts to minimize its impact on the economy, such as stimulus payments, PPP funding and more lucrative unemployment compensation, which led to greatly reduced overdraft activity. Bancorp anticipates that future growth of this revenue stream will be significantly impacted by changing industry practices, as many larger financial institutions have opted to greatly reduce, or completely eliminate, certain deposit service charges, particularly overdraft-related fees. Bancorp will be faced with strategic decisions surrounding deposit-related charges in the future, which may negatively impact the contributions made by this revenue stream to total non-interest income. Debit and credit card income consists of interchange revenue, ancillary fees and incentives received from card processors. Debit and credit card revenue increased$5.0 million , or 59%, for the year endedDecember 31, 2021 , as compared with the same period of 2020, as a result of increased transaction volume and continued expansion of the customer bases, both organically and through acquisition-related activity. Total debit card income increased$3.6 million , or 61%, and total credit card income increased$1.4 million , or 54%, for the year endedDecember 31, 2021 compared the year endedDecember 31, 2020 . Bancorp expects this revenue stream will continue to increase with expansion of the customer base and further development of the debit and credit card businesses.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$1.5 million , or 28%, for the year endedDecember 31, 2021 compared to the prior year, complemented by strong new product sales and customer base expansion. Demand for Bancorp's treasury products increased throughout the pandemic, as these products allow customers to operate more efficiently in a decentralized environment. In addition, sales efforts involving existing customers has led to increases in online services, reporting, ACH origination, remote deposit and fraud mitigation services during 2021. 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. 46
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Mortgage banking income primarily includes gains on sales of mortgage loans and 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 toFNMA and FHLMC. Interest rates on the mortgage loans sold are locked with the borrower and investor prior to loan closing, thus Bancorp bears no interest rate risk related to loans held for sale. Bancorp offers conventional,VA and FHA financing for purchases and refinances, as well as programs for first-time homebuyers. Interest rates on mortgage loans directly influence the volume of business transacted by the mortgage-banking department. Mortgage banking revenue decreased$1.4 million , or 23%, for the year endedDecember 31, 2021 , as compared with the prior year. The sustained low long-term rate environment that began in 2020 incentivized refinancing and purchasing activity, which resulted in elevated mortgage banking income over the course of 2020 and the first part of 2021. However, as expected, volume started normalizing during 2021 as the pool of potential customers who have yet to refinance shrank, general housing inventory remained limited and interest rates began to rise above the absolute low levels experienced during 2020. Mortgage rates are generally correlated with the 10 year treasury rate, which has fluctuated widely in recent years, averaging 2.14% in 2019, plummeting to 0.89% in 2020 and sparking the increase in activity described above and subsequently rising to an average of 1.45% during 2021. Beginning in the fourth quarter of 2020, the Bank elected to retain a select portion of qualified secondary market single family residential real estate loan production from the mortgage banking department on balance sheet in an effort to deploy a portion of excess liquidity in lieu of buying mortgage-backed securities within the AFS debt securities portfolio. Approximately$72 million and$31 million in 15/30 year fixed rate loans were retained for the years endedDecember 31, 2021 and 2020, respectively, as part of this strategy, forgoing gain on sale that would typically have been recognized in mortgage banking income for those years. Net investment product sales commissions and fees are generated primarily on stock, bond and mutual fund sales, as well as wrap fees on brokerage accounts. Wrap fees represent 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 assets. Bancorp deploys its financial advisors primarily through its branch network via an arrangement with a third party broker-dealer, while larger managed accounts are serviced by Bancorp'sWM&T Department . Net investment product sales commissions and fees increased$778,000 , or 44%, for the year endedDecember 31, 2021 , as compared with the prior year due to the KB acquisition and increased trading 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 of policies 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. BOLI income increased$221,000 , or 32%, for the year endedDecember 31, 2021 compared to the prior year attributed almost entirely to the contribution of the KB acquisition. Other non-interest income increased$2.0 million for the year endedDecember 31, 2021 as compared with the prior year. The increase was driven by a plethora of activity, most notably a death benefit of$523,000 on an insurance policy outside of traditional BOLI, stronger market returns on such insurance policies, the addition of the Captive and gains on OREO sold. Discussion of 2020 vs 2019: Total non-interest income increased$2.5 million , or 5%, for the year endedDecember 31, 2020 compared to the same period in 2019. Non-interest income comprised 28% of total revenue for both the year endedDecember 31, 2020 and 2019. WM&T services comprised 45% of Bancorp's total non-interest income for the year endedDecember 31, 2020 compared to 46% for the same period in 2019. WM&T revenue increased$763,000 , or 3%, to$23.4 million for the year endedDecember 31, 2020 , as compared with the same period of 2019. While stock market volatility associated with the COVID-19 pandemic had a significant impact on the WM&T department, particularly in the second quarter of 2020, strong market performance in the latter half of the year, record new business growth and a large non-recurring estate fee from the first quarter of 2020 led to WM&T income of$23.4 million . 47
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Deposit service charges decreased$1.0 million , or 20%, for the year endedDecember 31, 2020 , as compared with the same period in 2019. The steady decline in the volume of fees earned on overdrawn checking accounts experienced over the years prior to 2019 was significantly exacerbated by the pandemic with declines in transaction volume and paper check presentments beginning inApril 2020 . Stimulus checks, extensions of tax payment due dates, more lucrative unemployment compensation, diminished pandemic spend and PPP funding all impacted consumer behavior in 2020. Debit and credit card revenue increased$357,000 or 4%, for the year endedDecember 31, 2020 , as compared with the same period in 2019 despite pandemic-related hurdles, as a result of growth in the customer bases. Total debit card income increased$85,000 , or 1%, while total credit card income increased$272,000 , or 11%. Similar to deposit service charges above, Bancorp saw significant improvement in transaction volume in the latter of half of 2020 as statewide activity restrictions due to the pandemic in Bancorp's markets implemented earlier in year were eased and/or lifted.Treasury management fees increased$415,000 , or 8%, for the year endedDecember 31, 2020 compared to 2019, as Bancorp's was able to overcome the significant decline in pandemic related transaction volume with new product sales and expansion of its customer base (partially attributable to the PPP). The demand for Bancorp's treasury products increased during the pandemic, as these products allowed customers to operate more efficiently in a decentralized environment. Mortgage banking revenue increased$3.2 million , or 110%, for the year endedDecember 31, 2020 as compared with the same period of 2019, as sustained low long-term rates incentivized refinancing activity and resulted in record mortgage banking income. InSeptember 2020 , the Bank elected to start retaining a portion of qualified secondary market single family residential real estate loan production from the mortgage banking department on balance sheet in an effort to deploy excess liquidity. Approximately$31 million in 15/30 year fixed rate loans were retained throughDecember 31, 2020 , forgoing approximately$845,000 in gain on sales of loans that would typically have been recognized in mortgage banking income. Net investment product sales commissions and fees increased$277,000 , or 18%, for the yearDecember 31, 2020 , as compared with the same period of 2019, as market volatility during 2020 led to increased customer trading activity. Primarily as a result of a$296,000 death benefit received in the third quarter of 2019, BOLI income decreased$338,000 , for the year endedDecember 31, 2020 compared to the prior year. Other non-interest income decreased$1.2 million , or 40%, for the year endedDecember 31, 2020 as compared with the same period of 2019. This decrease was driven by a plethora of non-recurring activity that occurred in 2019 including swap fee income of$374,000 , a$212,000 gain on the sale of VISA Class B stock originally acquired in a 2013 acquisition, proceeds of$142,000 associated with life insurance policies outside of the traditional BOLI program and a$126,000 banking center relocation incentive. 48
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Non-interest expenses
Variance
2021 / 2020 2020 / 2019
Years Ended December 31 ,
(dollars in thousands) 2021 2020 2019 $ % $ %
Compensation $ 63,034 $ 51,368 $ 49,882 $ 11,666 23 % $ 1,486 3 %
Employee benefits 13,479 11,064 10,691 2,415 22 373 3
Net occupancy and
equipment 9,688 8,182 8,159 1,506 18 23 -
Technology and
communication 11,145 8,732 7,318 2,413 28 1,414 19
Debit and credit card
processing 4,494 2,606 2,493 1,888 72 113 5
Marketing and business
development 4,150 2,383 3,627 1,767 74 (1,244 ) (34 )
Postage, printing and
supplies 2,213 1,778 1,652 435 24 126 8
Legal and professional 2,583 2,392 2,138 191 8 254 12
FDIC insurance 1,847 1,217 245 630 52 972 397
Amortization of
investments in tax
credit partnerships 367 3,096 1,078 (2,729 ) (88 ) 2,018 187
Capital and deposit
based taxes 2,090 4,386 3,870 (2,296 ) (52 ) 516 13
Merger expenses 19,025 - 1,313 19,025 100 (1,313 ) (100 )
Federal Home Loan Bank early termination penalty 474 - - 474 100 - - Other 7,691 4,455 5,650 3,236 73 (1,195 ) (21 ) Total non-interest expenses$ 142,280 $ 101,659 $ 98,116 $ 40,621 40 %$ 3,543 4 % Discussion of 2021 vs 2020: Total non-interest expenses increased$40.6 million , or 40%, for the year endedDecember 31, 2021 compared to the prior year. Compensation and employee benefits comprised 54% of total non-interest expenses for the year endedDecember 31, 2021 , compared to 61% for the year endedDecember 31, 2020 . Excluding merger expenses, compensation and employee benefits comprised 62% of total non-interest expenses for the year endedDecember 31, 2021 . Compensation, which includes salaries, incentives, bonuses and stock based compensation, increased$11.7 million , or 23%, for the year endedDecember 31, 2021 compared to the prior year. The increases were attributed to growth in full time equivalent employees, annual merit-based salary increases and higher incentive compensation expense. Net full time equivalent employees totaled 820 atDecember 31, 2021 compared to 641 atDecember 31, 2020 . The large increase compared to prior periods was attributed to the addition of 184 FTEs as a result of expansion into theCentral Kentucky market (through the acquisition of KB). 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$2.4 million , or 22%, for the year endedDecember 31, 2021 compared to the prior year, consistent with the overall increase in full time equivalent employees noted above. Net occupancy and equipment expenses primarily include depreciation, rent, property taxes, utilities and maintenance. Costs of capital asset additions flow through the statement of income over the lives of the assets in the form of depreciation expense. Net occupancy increased$1.5 million , or 18%, for the year endedDecember 31, 2021 compared to the prior year. The KB acquisition resulted in the addition of 19 locations and was the primary driver of the increase over the prior year. Technology and communication expenses include computer software amortization, equipment depreciation and expenditures related to investments in technology needed to maintain and improve the quality of customer delivery channels, information security and internal resources. Technology expense increased$2.4 million , or 28%, for the year endedDecember 31, 2021 compared to the prior year, attributed mainly to the acquisition, as the core system conversion did not occur until late August. 49
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Bancorp outsources processing for debit and commercial credit card operations, which generate significant revenue for the Company. These expenses fluctuate consistent with transaction volumes. Debit and credit card processing expense increased$1.9 million , or 72%, for the year endedDecember 31, 2021 , correlating in part with the increase in transaction volume and customer base expansion resulting from both organic and acquisition-related growth that served to increase debit and credit card non-interest income. Marketing and business development expenses include all costs associated with promoting Bancorp including community support, retaining customers and acquiring new business. Marketing and business development expenses increased$1.8 million , or 74%, for the year endedDecember 31, 2021 compared to the prior year. Consistent with the Company's strategic plan, a significant investment was made to advertise and promote the Bank in theCentral Kentucky market post-acquisition close. The Company also increased its contribution to the Bank's foundation established to support various community initiatives, due to strong 2021 operational results. Further, pandemic-related restrictions during 2020 significantly muted travel and entertainment spending, resulting in lower expense last year.
Postage, printing and supplies expense increased
ended
attributed almost entirely to the KB acquisition and increased customer
communication.
Legal and professional fees increased
driven largely by increased collection activity in 2021.
FDIC insurance increased$630,000 , or 52%, for the year endedDecember 31, 2021 compared to the prior year. The increase was related to the acquisition and PPP-driven larger balance sheet in addition to the first quarter of 2020 benefitting from the last portion of small institution credits first issued by theFDIC in 2019. Tax credit partnerships generate federal income tax credits, and for each of Bancorp's investments in tax credit partnerships, the tax benefit, net of related expenses, results in a positive effect upon net income. Amounts of credits and corresponding expenses can vary widely depending upon the timing and magnitude of the underlying investments. Amortization expense associated with these investments decreased$2.7 million for the year endedDecember 31, 2021 compared to the prior year due to a large tax credit deal completed in the fourth quarter of 2020. Capital and deposit based taxes decreased$2.3 million , or 52%, for the year endedDecember 31, 2021 , consistent with the state ofKentucky transitioning financial institutions from a capital-based franchise tax to theKentucky corporate income tax effectiveJanuary 1, 2021 . Merger expenses represent non-recurring expenses associated with completion of the KB acquisition and consist primarily of investment banker fees, legal fees, various compensation-related expenses, early termination fees relating to various contracts and system conversion expenses. Merger expenses totaling$525,000 were recorded for the year endedDecember 31, 2021 related to the pending Commonwealth acquisition. An early termination fee of$474,000 was incurred during the second quarter of 2021 in relation to the pre-payment of FHLB advances totaling$14 million prior to their respective contractual maturities. Bancorp chose to payoff these term advances, with a weighted average cost of 2.03%, due to its excess liquidity driven by the substantial deposit growth it achieved over the past year, combined with the near-term outlook for low interest rates at the time of pay off. Bancorp had no FHLB advances outstanding as ofDecember 31, 2021 . Other non-interest expenses increased$3.2 million , or 73%, for the year endedDecember 31, 2021 . These increases were driven by a number of factors, including$1.1 million of expense attributed to the KB acquisition, including amortization of the CDI related to KB's deposit portfolio, expenses associated with the addition of the Captive and other miscellaneous expenses, such as debit and credit card rewards and card losses. Further, large credits to expense were recorded in the prior year associated with a gain on a bank-owned property sold and the reversal of an accrual related to a potentialIRS penalty that was dismissed. Bancorp's efficiency ratio (FTE) for 2021 of 59.94% increased from 54.06% in 2020 due to the one-time merger-related expenses. Excluding these non-recurring expenses and amortization of investments in tax credit partnerships, the adjusted efficiency ratio, a non-GAAP measure, would have been 51.77% and 52.42% for 2021 and 2020. See the section titled "Non-GAAP Financial Measures" for reconcilement of non-GAAP to GAAP measures. 50
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Total non-interest expenses increased
2019. Compensation and employee benefits comprised 61% and 62% of Bancorp’s
total non-interest expenses for 2020 and 2019, respectively.
Compensation increased
increase was attributed to annual merit-based salary increases, higher
incentive-related compensation and an increase in full time equivalent
employees, which grew from 591 at the beginning of 2019 to 641 at
2020
professionals.
Employee benefits increased
attributed to growth in FTEs.
Net occupancy increased$23,000 for 2020 compared with 2019. Three new locations were added in the second quarter of 2019 as part of the KSB acquisition and an additional branch location was added in theLouisville market during the third quarter of 2019. In 2020, Bancorp opened an additional branch in theCincinnati MSA, as well as another location inLouisville . As ofDecember 31, 2020 , Bancorp had 44 full service banking center locations. Technology expense increased$1.4 million , or 19%, in 2020 compared to 2019 consistent with expanding customer-facing software and system functionality, as well as increased licensing/maintenance expense, higher mortgage loan processing expenses, treasury management customer expansion and the migration to a hosted core environment during the third quarter of 2020.
Debit and credit card processing expense increased
compared with 2019, consistent with the correlated increase experienced for
debit and credit card income.
Marketing and business development expenses decreased$1.2 million , or 34%, for the year endedDecember 31, 2020 , as compared to the same period of 2019. The onset of the pandemic resulted in less physical customer interaction in addition to lower advertising expense. Bancorp committed to pay$116,000 to the Bank's foundation, established to support various community initiatives, as ofDecember 31, 2020 compared to$600,000 as ofDecember 31, 2019 . Postage, printing and supply expenses increased$126,000 , or 8%, in 2020 compared to 2019, as a result of banking center/customer expansion coupled with replacing transaction-based forms throughout the Bank in relation to the migration to a hosted core environment, which occurred in the third quarter of 2020. Legal and professional fees increased$254,000 , or 12%, for 2020 compared to 2019, as a result of various consulting engagements and litigation costs arising through the normal course of business.FDIC insurance increased$972,000 for the year endedDecember 31, 2020 , as compared to the same period of 2019. As a result of the national FDIC Reserve Ratio reaching 1.38% in 2019, theFDIC released credits to small institutions in the prior year. For this reason, Bancorp recorded noFDIC insurance expense for the third and fourth quarters of 2019, and incurred only a portion of the assessed expense in the first quarter of 2020, as these credits were depleted.FDIC insurance expense normalized in the second quarter of 2020 and ultimately increased in the third and fourth quarters as a result of a higher leverage ratio attributed to a PPP-driven larger balance sheet. Amortization of investments in tax credit partnership increased$2.0 million from 2020 to 2019 as a result of a large tax credit deal completed in the fourth quarter of 2020.
Capital and deposit based taxes increased
2019 consistent with overall balance sheet growth.
Merger expenses recorded for the year endedDecember 31, 2019 represent non-recurring expenses associated with completion of the KSB acquisition and consisted primarily of consulting fees, legal fees, various compensation-related expenses and system conversion expenses. No such expense was recorded for the year endedDecember 31, 2020 . Other non-interest expenses decreased$1.2 million , or 21%, for 2020 compared to 2019 driven by the sale of a bank-owned property recorded as an off-set to non-interest expense in the second quarter of 2020 along with elevated 2019 expense that included the write off of assets totaling$347,000 in connection with signing the contract to migrate to the hosted core processing solution and elevated fraud and robbery-related losses. 51
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Bancorp's efficiency ratio (FTE) of 54.06% for 2020 improved from 56.07% in 2019. Excluding amortization of investments in tax credit partnerships and non-recurring merger related expenses, the adjusted efficiency ratio, a non-GAAP measure, would have been 52.42% and 54.70% for 2020 and 2019. See the section titled "Non-GAAP Financial Measures" for reconcilement of non-GAAP to GAAP measures. Income Taxes
A comparison of income tax expense and ETR follows:
Years Ended
2019
Income before income tax expense$ 95,397 $ 67,743 $ 75,660 Income tax expense 20,752 8,874 9,593 Effective tax rate 21.75 % 13.10 % 12.68 % Discussion of 2021 vs 2020:
Fluctuations in the ETR are primarily attributed to the following:
? Bancorp invests in certain partnerships that yield federal income tax credits.
Taken as a whole, the tax benefit of these investments exceeds amortization
expense, resulting in a positive impact on net income. The timing and
magnitude of these transactions may vary widely from period to period. The ETR
for 2020 included the full year benefit of a large historic tax credit project
that was completed in the fourth quarter of last year, serving to reduce the
ETR by 5.5% for the year.
? The state of
institutions to transition from a capital based franchise tax to the
corporate income tax effective
combined
net operating loss carryforwards. These changes served to increase the ETR
3.5% for the year endedDecember 31, 2021 .
? An insurance captive was acquired as a result of the KB acquisition. The
Captive provides insurance against certain risks for which insurance may not
currently be available or economically feasible to Bancorp and SYB, as well as
a group of third-party insurance captives. The tax advantages of the Captive,
including the tax-deductible nature of premiums paid to the Captive as well as
the tax-exemption for premiums received by the Captive, serve to reduce income
tax expense. For the year ended
reduced the ETR 0.2%.
? The stock-based compensation component of the ETR fluctuates consistent with
the level of SAR exercise activity. The ETR was reduced by 1.1% and 0.7% for
the years endedDecember 31, 2021 and 2020, respectively. The CARES Act includes several significant provisions for corporations including increasing the amount of deductible interest under section 163(j), allowing companies to carryback certain net operating losses, and increasing the amount of net operating loss that corporations can use to offset income. These changes did not have a significant impact on Bancorp's income taxes for the years endedDecember 31, 2021 and 2020. Discussion of 2020 vs 2019:
Fluctuations in the ETR are primarily attributed to the following:
? The ETR for 2020 benefitted from the impact of a large historic tax credit
project that was completed during the fourth quarter of 2020.
? In
institutions to transition from a capital based franchise tax to the
corporate income tax beginning in 2021. Historically, the franchise tax, a
component of non-interest expenses, was assessed at 1.1% of net capital and
has averaged
income and will be included as a component of current and deferred state
income tax expense. Associated with this change, predominantly during the
first quarter of 2019, Bancorp established a
existing temporary differences estimated to reverse after the effective date
of the law change. Bancorp recorded a corresponding state tax benefit, net of
federal tax impact of
for 2019.
? In
a combined
net operating loss carryforwards. The combined filing, beginning in 2021, will
allow Bancorp’s Holding Company net operating loss carryforwards to offset
against net revenue generated by the Bank up to 50% of the Bank’s
taxable income and reduce Bancorp’s tax liability. Bancorp recorded a state
tax benefit, net of federal tax impact of
second quarter of 2019, or approximately
52
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Financial Condition –
Overview Total assets increased$2.04 billion , or 44%, to$6.65 billion atDecember 31, 2021 from$4.61 billion atDecember 31, 2020 . Total assets of$1.27 billion were added onMay 31, 2021 as a result of the KB acquisition, including loans of$755 million (including PPP) and total AFS debt securities of$396 million . In addition, goodwill of$123 million was recorded in relation to the transaction. Total loans (excluding loans added through the acquisition and the PPP portfolio) grew$291 million , or 10%, betweenDecember 31, 2020 andDecember 31, 2021 . Total liabilities increased$1.80 billion , or 43%, to$5.97 billion atDecember 31, 2021 from$4.17 billion atDecember 31, 2020 . Total liabilities of$1.16 billion were assumed onMay 31, 2021 as a result of the KB acquisition, including total deposits of$1.04 billion . Excluding deposits assumed through the acquisition, deposit balances ended at record levels as ofDecember 31, 2021 , growing$760 million , or 19%, sinceDecember 31, 2020 , as federal stimulus efforts have bolstered deposits and uncertainty surrounding the pandemic has resulted in Bancorp's customer base maintaining higher balances in general over the past year. Cash and Cash Equivalents Cash and cash equivalents increased$643 million to$961 million as ofDecember 31, 2021 . Bancorp maintained higher levels of liquidity in 2021 attributable to the PPP, record levels of deposits and acquisition-related growth.AFS Debt Securities AFS debt securities include securities that may be sold in response to changes in interest rates, resultant prepayment risk and other factors related to interest rate and prepayment risk changes and are carried at fair value with unrealized gains or losses, net of tax effect, included in stockholders' equity. The primary purpose of the AFS debt 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 and credit and liquidity considerations. All of Bancorp's debt securities are classified as AFS. Carrying value is summarized as follows: Variance December 31, (in thousands) 2021 2020 $ Change % ChangeU.S. Treasury and otherU.S. Government obligations$ 122,501 $ -$ 122,501 100 % Government sponsored enterprise obligations 135,021 138,078 (3,057 ) -2 % Mortgage-backed securities - government agencies 846,624 437,585 409,039 93 % Obligations of states and political subdivisions 75,075 11,315 63,760 563 % Other 1,077 - 1,077 100 %
Total available for sale debt securities
101 % AFS debt securities increased$593 million to$1.18 billion atDecember 31, 2021 compared to$587 million atDecember 31, 2020 . AFS debt securities totaling$396 million were added as a result of the KB acquisition, approximately$91 million of which were sold shortly after acquisition. In addition, Bancorp continued to actively invest in the securities portfolio during 2021 in an effort to deploy a portion of excess liquidity, a strategy enacted in the latter half of 2020, by purchasing$505 million of AFS debt securities for the year endedDecember 31, 2021 . Partially offsetting growth associated with purchasing activity was scheduled amortization and elevated prepayment activity, largely within the MBS portfolio, as well as market depreciation stemming from an upward move in the interest rate environment experienced through most of 2021. As a result of the activity above, average AFS debt securities grew$446 million , or 98%, over the past twelve months. 53
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Maturity distribution and weighted average yields of the AFS debt securities
portfolio follows:
December 31, Due after one but Due after five but
2021 Due within one year within five years within ten years Due after ten years
(dollars in
thousands) Amount Yield Amount Yield Amount Yield Amount Yield
U.S. Treasury
and other U.S.
Government
obligations 4,011 0.06 % 118,490 0.50 % $ - - % $ - - %
Government
sponsored
enterprise
obligations 972 1.68 12,007 0.52 13,817 1.47 108,225 2.04
MBS - government
agencies 916 -0.17 20,995 1.07 67,263 1.59 757,450 1.29
Obligations of
states and
political
subdivisions 415 3.88 9,044 1.38 13,866 1.46 51,750 1.80
Other 120 - - 957 2.19 -
$ 6,434 0.52 % $ 160,536 0.63 % $ 95,903 1.56 % $ 917,425 1.41 %
Actual maturities for mortgage-backed securities may differ from contractual
maturities due to prepayments on underlying collateral.
Loans
Composition of loans by primary loan portfolio class follows:
Variance
December 31, (dollars in thousands) 2021 2020 $
Change % Change
Commercial real estate - non-owner occupied$ 1,128,244 $ 833,470 $ 294,774 35 % Commercial real estate - owner occupied 678,405 508,672 169,733 33 % Total commercial real estate 1,806,649 1,342,142 464,507 35 %
Commercial and industrial – term 596,710 525,776 70,934
13 % Commercial and industrial - term - PPP 140,734 550,186 (409,452 ) -74 % Commercial and industrial - lines of credit 370,312 249,378 120,934 48 %
Total commercial and industrial 1,107,756 1,325,340 (217,584 )
-16 % Residential real estate - owner occupied 400,695 239,191 161,504 68 % Residential real estate - non-owner occupied 281,018 140,930 140,088 99 % Total residential real estate 681,713 380,121 301,592 79 % Construction and land development 299,206 291,764 7,442 3 % Home equity lines of credit 138,976 95,366 43,610 46 % Consumer 104,294 71,874 32,420 45 % Leases 13,622 14,786 (1,164 ) -8 % Credit cards 17,087 10,203 6,884 67 % Total Loans (1)$ 4,169,303 $ 3,531,596 $ 637,707 18 %
(1) Total loans are presented inclusive of premiums, discounts and net loan
origination fees and costs.
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The composition of loans is presented below by primary loan portfolio class and
bifurcated between Bancorp’s legacy loan portfolio and the loan portfolio
attributed to the
acquisition. This composition is presented to provide detail of the
Kentucky
composition of Bancorp at
As of December 31, 2021
(dollars in thousands) Legacy Central Kentucky Total
Commercial real estate – non-owner occupied
Commercial real estate – owner occupied
579,599 98,806 678,405 Total commercial real estate 1,489,664
316,985 1,806,649
Commercial and industrial - term 535,923 60,787 596,710 Commercial and industrial - term - PPP 135,004 5,730 140,734 Commercial and industrial - lines of credit 327,269 43,043 370,312 Total commercial and industrial 998,196
109,560 1,107,756
Residential real estate - owner occupied 312,817 87,878 400,695 Residential real estate - non-owner occupied 120,981 160,037 281,018 Total residential real estate 433,798
247,915 681,713
Construction and land development 281,054 18,152 299,206 Home equity lines of credit 91,882 47,094 138,976 Consumer 89,352 14,942 104,294 Leases 13,622 - 13,622 Credits cards 15,475 1,612 17,087 Total loans (1)$ 3,413,043 $ 756,260$ 4,169,303
(1) Total loans are presented inclusive of premiums, discounts, and net loan
origination fees and costs.
Total loans increased$638 million , or 18%, fromDecember 31, 2020 toDecember 31, 2021 , driven by the addition of$756 million in loans associated with expansion into theCentral Kentucky market. While organic growth was substantial, significant forgiveness-related contraction was experienced within the PPP portfolio betweenDecember 31, 2020 andDecember 31, 2021 . Excluding the loan portfolio attributed to theCentral Kentucky market, loan contraction of$119 million , or 3%, was experienced betweenDecember 31, 2020 andDecember 31, 2021 , as the aforementioned forgiveness activity resulted in PPP portfolio balances declining$409 million during 2021. Partially offsetting the large decline in PPP balances was organic growth of$291 million , or 10%, nearly half of which, or$146 million , was attributed to strong loan production within the CRE portfolio. Further, gradually improving line of credit utilization and the strategic retention of a portion of qualified secondary market single family residential real estate loan production from the mortgage banking department helped drive growth of$78 million and$54 million in the C&I line of credit and residential real estate portfolios, respectively. After hitting a pandemic-era low atMarch 31, 2021 , total line of credit utilization improved in each subsequent quarter of 2021, led by C&I line utilization improving to 31.8% atDecember 31, 2021 from 26.1% atDecember 31, 2020 . However, line of credit usage remained well below pre-pandemic levels throughout the year, as the availability of the more favorable PPP lending facility generally disparaged utilization until the program expired onMay 31, 2021 . Bancorp originated$637 million PPP loans ($657 million gross of unamortized fees and costs) as part of round one of the program, which expired in August of 2020. As ofDecember 31, 2021 , 98% of the dollars originated in round one had been forgiven. All but$52,000 of the$19.6 million in fee income received for round one originations has been recognized life to date. 55
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Bancorp originated$250 million ($261 million gross of unamortized deferred fees and costs) as part of round two of the PPP program, which expiredMay 31, 2021 . As ofDecember 31, 2021 , 49% of the dollars originated had been forgiven and 61% of the fees received for the second round of the program had been recognized life to date. As second round borrowers are not required to make payments for 16 months, it is probable that a significant portion of the borrowing base will seek forgiveness in early to mid-2022 in connection with their tax return preparation. PPP loans of$141 million ($146 million gross of unamortized deferred fees and costs) were outstanding atDecember 31, 2021 , including$6 million outstanding related to the KB acquisition, compared to$550 million atDecember 31, 2020 . Bancorp has$4.6 million in net unrecognized fees related to the PPP as ofDecember 31, 2021 , which are recognized over the life of the respective loans and accelerated when the loans are paid off or forgiven. In accordance with Section 4013 of the CARES Act and in response to requests from borrowers who experienced business interruptions related to the pandemic, Bancorp extended payment deferrals for those affected borrowers. Depending on the demonstrated need of the customer, Bancorp deferred either the full loan payment or the principal-only portion of respective loan payments for 90 or 180 days for some borrowers directly impacted by the pandemic. As ofDecember 31, 2021 outstanding full payment loan deferrals totaled just$169,000 , down from$37 million , or 1.24% of total loans (excluding PPP loans), atDecember 31, 2020 . Bancorp's credit exposure is diversified with secured and unsecured loans to individuals and businesses. No specific industry concentration exceeds 10% of loans outstanding. While Bancorp has a diversified loan portfolio, a customer's ability to honor contracts is somewhat dependent upon the economic stability and/or industry in which that customer does business. Loans outstanding and related unfunded commitments are primarily concentrated within Bancorp's current market areas, which encompassLouisville, Kentucky , central and easternKentucky ,Indianapolis, Indiana andCincinnati, Ohio . Bancorp occasionally enters into loan participation agreements with other banks to diversify credit risk. For certain participation loans sold, Bancorp has retained effective control of the loans, typically by restricting the participating institutions from pledging or selling their ownership share of the loan without permission from Bancorp. GAAP requires the participated portion of these loans to be recorded as secured borrowings. These participated loans are included in the C&I and CRE loan portfolio segments with a corresponding liability recorded in other liabilities. AtDecember 31, 2021 andDecember 31, 2020 , the total participated portion of loans of this nature totaled$5 million and$10 million , respectively. 56
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The following table presents the maturity distribution and rate sensitivity of
the loan portfolio at
Maturity
December 31, After one After five Ater
2021 (in Within one but within but within fifteen
thousands) year five years fifteen years years Total % of Total
Commercial
real estate -
non-owner
occupied
Fixed rate $ 40,076 $ 453,597 $ 232,958 $ 147,088 $ 873,719 77 %
Variable rate 44,499 116,374 92,146 1,506 254,525 23 %
Total $ 84,575 $ 569,971 $ 325,104 $ 148,594 $ 1,128,244 100 %
Commercial
real estate -
owner-occupied
Fixed rate $ 29,328 $ 281,473 $ 239,829 $ 56,115 $ 606,745 89 %
Variable rate 12,017 23,278 34,715 1,650 71,660 11 %
Total $ 41,345 $ 304,751 $ 274,544 $ 57,765 $ 678,405 100 %
Commercial and
industrial -
term
Fixed rate $ 11,414 $ 247,254 $ 133,499 $ 16,356 $ 408,523 68 %
Variable rate 31,081 120,111 36,995 - 188,187 32 %
Total $ 42,495 $ 367,365 $ 170,494 $ 16,356 $ 596,710 100 %
Commercial and
industrial -
term - PPP
Fixed rate $ 8,018 $ 132,716 $ - $ - $ 140,734 100 %
Variable rate - - - - - 0 %
Total $ 8,018 $ 132,716 $ - $ - $ 140,734 100 %
Commercial and
industrial -
lines of
credit
Fixed rate $ 6,514 $ 16,262 $ 25,377 $ - $ 48,153 13 %
Variable rate 242,891 76,931 2,337 - 322,159 87 %
Total $ 249,405 $ 93,193 $ 27,714 $ - $ 370,312 100 %
Residential
real estate -
owner occupied
Fixed rate $ 5,062 $ 13,255 $ 72,247 $ 303,978 $ 394,542 98 %
Variable rate 1,836 2,272 1,181 864 6,153 2 %
Total $ 6,898 $ 15,527 $ 73,428 $ 304,842 $ 400,695 100 %
Residential
real estate -
non-owner
occupied
Fixed rate $ 9,684 $ 70,844 $ 70,852 $ 120,262 $ 271,642 97 %
Variable rate 4,522 2,037 2,817 - 9,376 3 %
Total $ 14,206 $ 72,881 $ 73,669 $ 120,262 $ 281,018 100 %
Construction
and land
development
Fixed rate $ 20,107 $ 31,636 $ 54,827 $ 9,392 $ 115,962 39 %
Variable rate 65,523 76,028 40,890 803 183,244 61 %
Total $ 85,630 $ 107,664 $ 95,717 $ 10,195 $ 299,206 100 %
Home equity
lines of
credit
Fixed rate $ - $ - $ - $ - $ - 0 %
Variable rate 6,276 33,645 69,939 29,116 138,976 100 %
Total $ 6,276 $ 33,645 $ 69,939 $ 29,116 $ 138,976 100 %
(continued)
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(continued) Maturity
After one but After five but Ater
December 31, 2021 (in Within one within five within fifteen fifteen
thousands) year years years years Total % of Total
Consumer
Fixed rate $ 5,437 $ 25,582 $ 8,847 $ 934 $ 40,800 39 %
Variable rate 51,855 11,259 380 - 63,494 61 %
Total $ 57,292 $ 36,841 $ 9,227 $ 934 $ 104,294 100 %
Leases
Fixed rate $ 605 $ 9,701 $ 3,316 $ - $ 13,622 100 %
Variable rate - - - - - 0 %
Total $ 605 $ 9,701 $ 3,316 $ - $ 13,622 100 %
Credit Cards
Fixed rate $ - $ - $ - $ - $ - 0 %
Variable rate 17,087 - - - 17,087 100 %
Total $ 17,087 $ - $ - $ - $ 17,087 100 %
Total Loans
Fixed rate $ 136,245 $ 1,282,320 $ 841,752 $ 654,125 $ 2,914,442 70 %
Variable rate 477,587 461,935 281,400 33,939 1,254,861 30 %
Total $ 613,832 $ 1,744,255 $ 1,123,152 $ 688,064 $ 4,169,303 100 %
In the event where 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 interest rate sensitivity.
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Non-performing Loans and Assets
Information summarizing non-performing loans and assets follows:
December 31 , (dollars in thousands) 2021 2020 2019 2018 2017 Non-accrual loans$ 6,712 $ 12,514 $ 11,494 $ 2,611 $ 6,511 Troubled debt restructurings 12 16 34 42 869 Loans past due 90 days or more and still accruing 684 649 535 745 2 Total non-performing loans 7,408 13,179 12,063 3,398 7,382 Other real estate owned 7,212 281 493 1,018 2,640 Total non-performing assets$ 14,620 $ 13,460 $ 12,556 $ 4,416 $ 10,022 Non-performing loans to total loans 0.18 % 0.37 % 0.42 % 0.13 % 0.31 % Non-peforming loans to total loans (excluding PPP) (1) 0.18 % 0.44 % - - - Non-performing assets as to total assets 0.22 % 0.29 % 0.34 % 0.13 % 0.31 % Allowance to non-performing loans 728 % 394 % 222 % 751 % 337 %
(1) See the section titled “Non-GAAP Financial Measures” for reconcilement of
non-GAAP to GAAP measures.
Non-performing loans to total loans were 0.18% atDecember 31, 2021 compared to 0.37% atDecember 31, 2020 . Non-performing loans to total loans (excluding PPP loans) were 0.18% atDecember 31, 2021 compared to 0.44% atDecember 31, 2020 . Non-performing assets increased$1 million to$15 million atDecember 31, 2021 compared toDecember 31, 2020 , mainly due to foreclosure on a large CRE relationship that was in non-accrual status atDecember 31, 2020 and shifted to OREO atDecember 31, 2021 . In total, non-performing assets as ofDecember 31, 2021 were comprised of 103 loans ranging in individual amounts up to$950,000 , one nominal accruing TDR loan and foreclosed real estate held for sale. Foreclosed real estate held atDecember 31, 2021 included two CRE properties and two residential real estate properties. 59
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The following table presents the major classifications of non-accrual loans by
portfolio:
December 31, (in thousands) 2021 2020
Commercial real estate – non-owner occupied
Commercial real estate – owner occupied 1,748 1,403
Total commercial real estate
2,468 11,681 Commercial and industrial - term 670 6 Commercial and industrial - lines of credit 228 88 Total commercial and industrial 898 94
Residential real estate – owner occupied 1,997 413
Residential real estate – non-owner occupied 293 101
Total residential real estate
2,290 514 Construction and land development - - Home equity lines of credit 646 221 Consumer 410 4 Leases - - Credit cards - - Total non-accrual loans$ 6,712 $ 12,514 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$312,000 ,$350,000 , and$552,000 for 2021, 2020, and 2019. Interest income that would have been recorded if non-accrual loans were on a current basis in accordance with their original terms was$359,000 ,$457,000 , and$491,000 for 2021, 2020, and 2019. 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 potential problem loans totaled approximately$40 million and$26 million atDecember 31, 2021 and 2020. These relationships are monitored closely for possible future inclusion in non-performing loans. Management believes it has adequately reflected credit exposure in these loans in its determination of the allowance. Loans accounted for as TDRs include modifications from original terms such as those due to bankruptcy proceedings, certain changes to amortization periods or extended suspension of principal payments due to customer financial difficulties. To the extent that Bancorp chooses to work with borrowers by providing reasonable concessions rather than initiating collection, this would result in an increase in loans accounted for as TDRs. TDRs that are in non-accrual status are reported as non-accrual loans. Loans accounted for as TDRs are individually evaluated for impairment and are reported as non-performing loans. OnMarch 2020 , the CARES Act was signed into law. Section 4013 of the CARES Act, "Temporary Relief from Troubled Debt Restructurings," provides banks the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time to account for the effects of COVID-19. To qualify for Section 4013 of the CARES Act, borrowers must have been current atDecember 31, 2019 . All modifications are eligible as long as they are executed betweenMarch 1, 2020 and the earlier of (i)December 31, 2020 , or (ii) the 60th day after the end of the COVID-19 national emergency declared by the President ofthe United States . Multiple modifications of the same credits are allowed and there is no cap on the duration of the modification. OnDecember 21, 2020 , certain provisions of the CARES Act, including the temporary suspension of certain requirements related to TDRs, were extended throughDecember 31, 2021 . 60
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Also inMarch 2020 , various regulatory agencies, including theBoard of Governors of theFederal Reserve System and theFederal Deposit Insurance Corporation , issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by the pandemic. The interagency statement was effective immediately and impacted accounting for loan modifications. Under Accounting Standards Codification 310-40, "Receivables - Troubled Debt Restructurings by Creditors," ("ASC 310-40"), a restructuring of debt constitutes a TDR if the creditor, for economic or legal reasons related to the debtor's financial difficulties, grants a concession to the debtor that it would not otherwise consider. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs. This includes short-term modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented.
At both
as a TDR, the balance of which was
those dates.
Delinquent Loans Delinquent loans (consisting of all loans 30 days or more past due) totaled$11 million atDecember 31, 2021 compared to$17 million atDecember 31, 2020 . Delinquent loans total loans were 0.26% and 0.48% atDecember 31, 2021 andDecember 31, 2020 . Delinquent loans to total loans (excluding PPP loans) were 0.27% and 0.57% atDecember 31, 2021 andDecember 31, 2020 . See the section titled "Non-GAAP Financial Measures" for reconcilement of non-GAAP to GAAP measures.
Allowance for Credit Losses on Loans
The ACL is a valuation allowance for loans estimated at each balance sheet date in accordance with GAAP. When Bancorp deems all or a portion of a loan to be uncollectible, the appropriate amount is written off and the ACL is reduced by the same amount. Subsequent recoveries, if any, are credited to the ACL when received. See the footnote titled "Summary of Significant Accounting Policies" for discussion of Bancorp's ACL methodology on loans. Allocations of the ACL may be made for specific loans, but the entire ACL on loans is available for any loan that, in Bancorp's judgment, should be charged-off.
The following table sets forth the ACL by category of loan:
December 31, 2021 December 31, 2020
ACL on
loans to
(dollars in Allocated % of Total ACL Total Allocated % of Total ACL ACL on loans
thousands) Allowance on loans Loans (1) Allowance on loans to Total Loans
Commercial real estate - non-owner occupied$ 15,960 30 % 1.41 %$ 19,396 37 % 2.33 % Commercial real estate - owner occupied 9,595 18 % 1.41 % 6,983 13 % 1.37 % Total commercial real estate 25,555 48 % 1.41 % 26,379 50 % 1.97 % Commercial and industrial - term (1) 8,577 16 % 1.44 % 8,970 17 % 1.71 % Commercial and industrial - lines of credit 4,802 9 % 1.30 % 3,614 7 % 1.45 % Total commercial and industrial 13,379 25 % 1.38 % 12,584 24 % 1.62 % Residential real estate - owner occupied 4,316 8 % 1.08 % 3,389 7 % 1.42 % Residential real estate - non-owner occupied 3,677 7 % 1.31 % 1,818 3 % 1.29 % Total residential real estate 7,993 15 % 1.17 % 5,207 10 % 1.37 % Construction and land development 4,789 9 % 1.60 % 6,119 12 % 2.10 % Home equity lines of credit 1,044 2 % 0.75 % 895 2 % 0.94 % Consumer 772 1 % 0.74 % 340 1 % 0.47 % Leases 204 0 % 1.50 % 261 1 % 1.77 % Credit cards 162 0 % 0.95 % 135 0 % 1.32 % Total$ 53,898 100 % 1.34 %$ 51,920 100 % 1.74 %
(1) Excludes the PPP loan portfolio at
which was not reserved for based on the 100% SBA guarantee.
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The adoption of CECL and the subsequent beginning of the pandemic had a material impact on Bancorp's quarterly ACL on loans calculations for 2020. Upon adoption of ASC 326 onJanuary 1, 2020 , Bancorp recorded an increase of$8.2 million to the ACL on loans and a corresponding decrease to retained earnings, net of the DTA impact. The adjustment upon adoption of ASC 326 raised the ACL on loans balance to$37 million effectiveJanuary 1, 2020 . Bancorp's ACL on loans was$54 million as ofDecember 31, 2021 compared to$52 million as ofDecember 31, 2020 . The change in the ACL on loans was driven by a number of competing factors, which resulted in the$2.0 million , or 4%, increase experienced for the year endedDecember 31, 2021 . Acquisition-related activity was responsible for a total increase to the ACL on loans of$14.2 million , comprised of a$6.8 million day one adjustment for specific reserves placed on acquired PCD loans (offset to goodwill) and$7.4 million of provision expense related to the remaining acquired non-PCD loan portfolio. Partially offsetting the acquisition-related increases was a net reduction of the ACL on loans of$6.0 million for the year endedDecember 31, 2021 stemming from an improved unemployment forecast, general improvement in other underlying CECL model factors compared to recent periods and updates to Bancorp's CECL model. Further reducing the ACL on loans were net charge offs of$6.2 million for the year, which were driven by the charge off of two large CRE relationships totaling$4.4 million . Both relationships were fully reserved and the charge off had no income statement impact for the year endedDecember 31, 2021 . Partially offsetting these charge offs was a$555,000 recovery of a note that was fully charged off in 2020. Outstanding loan balances (excluding PPP) grew$1.05 billion , or 35%, betweenDecember 31, 2020 andDecember 31, 2021 , as a result of the loan portfolio added through the KB acquisition and strong organic loan growth. This growth and related changes in the overall loan mix contributed$16.8 million of provision expense for the year endedDecember 31, 2021 . However, a net benefit of$15.4 million stemming from the improvement in the unemployment forecast and underlying CECL model factors mentioned above significantly offset the growth-related expense. The FRB's forecast of the Seasonally Adjusted National Civilian Unemployment Rate is the primary loss driver within Bancorp's CECL model. The actual rate steadily improved over the past year after spiking to 14.8% in April of 2020, standing at 3.9% as ofDecember 31, 2021 , which caused the forecast to improve substantially throughout the year. Changes in the unemployment forecast contributed a net benefit to provision for credit losses on loans of approximately$6 million for the year endedDecember 31, 2021 compared to a net reserve build of approximately$11 million for the year endedDecember 31, 2020 . The pandemic has had a material impact on Bancorp's quarterly ACL on loans calculations. While Bancorp has not yet experienced credit quality issues resulting in charge-offs related to the pandemic, the ACL on loans calculation and resulting credit loss expense is significantly impacted by changes in forecasted economic conditions. Should the forecast for economic conditions worsen, Bancorp could experience further increases in its required ACL on loans and record additional credit loss expense. While the execution of payment deferrals under the CARES ACT has assisted credit quality ratios, it is possible that asset quality could worsen at future measurement periods if the effects of the pandemic are prolonged. While separate from the ACL on loans and recorded in Other Liabilities on Bancorp's consolidated balance sheets, the ACL for off balance sheet credit exposures decreased$1.9 million , or 35%, to$3.5 million atDecember 31, 2021 . Reductions of the ACL for off balance sheet credit exposures totaling$2.2 million were recorded for the year endedDecember 31, 2021 , as a result of continued improvement in line of credit utilization, attributed largely to the C&I portfolio, and improved CECL model factors. C&I line of credit utilization improved to 31.8% atDecember 31, 2021 compared to 26.1% atDecember 31, 2020 . While utilization improved significantly during 2021, it still remains well below pre-pandemic levels. Partially offsetting these reductions was the loan portfolio added through the KB acquisition, which resulted in a$250,000 increase in the ACL for off balance sheet credit exposures at acquisition date with no corresponding impact on earnings. 62
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Summary of Activity in the ACL on Loans
The table below reflects activity in the ACL related to loans for the years
ended
(in thousands) Initial Provision for Year ended December 31, Beginning Allowance on Credit Losses 2021 Balance PCD Loans on Loans
Charge-offs Recoveries Ending Balance
Commercial real estate - non-owner occupied$ 19,396 $ 1,491 $ (2,031 ) $ (3,065 ) $ 169 $ 15,960 Commercial real estate - owner occupied 6,983 2,112 1,826 (1,909 ) 583 9,595 Total commercial real estate 26,379 3,603 (205 ) (4,974 ) 752 25,555 Commercial and industrial - term 8,970 1,022 (112 ) (1,337 ) 34 8,577 Commercial and industrial - lines of credit 3,614 1,755 (567 ) - - 4,802 Total commercial and industrial 12,584 2,777 (679 ) (1,337 ) 34 13,379 Residential real estate - owner occupied 3,389 142 1,134 (383 ) 34 4,316 Residential real estate - non-owner occupied 1,818 88 1,766 - 5 3,677 Total residential real estate 5,207 230 2,900 (383 ) 39 7,993 Construction and land development 6,119 - (1,333 ) - 3 4,789 Home equity lines of credit 895 147 1 - 1 1,044 Consumer 340 - 743 (987 ) 676 772 Leases 261 - (57 ) - - 204 Credit cards 135 - 27 - - 162 Total$ 51,920 $ 6,757 $ 1,397$ (7,681 ) $ 1,505 $ 53,898 Initial ACL on Impact of Loans Purchased
Year ended
Ending (in thousands) Balance ASC 326 Deterioration Credit Losses Charge-offs Recoveries Balance Commercial real estate - non-owner occupied$ 5,235 $ 2,946 $ 152$ 11,194 $ (143 ) $ 12$ 19,396 Commercial real estate - owner occupied 3,327 1,542 1,350 2,115 (1,351 ) - 6,983 Total commercial real estate 8,562 4,488 1,502 13,309 (1,494 ) 12 26,379 Commercial and industrial - term 6,782 365 - 1,832 (18 ) 9 8,970 Commercial and industrial - lines of credit 5,657 (1,528 ) - (515 ) - - 3,614 Total commercial and industrial 12,439 (1,163 ) - 1,317 (18 ) 9 12,584 Residential real estate - owner occupied 1,527 1,087 99 737 (79 ) 18 3,389 Residential real estate - non-owner occupied 947 429 - 442 (2 ) 2 1,818 Total residential real estate 2,474 1,516 99 1,179 (81 ) 20 5,207 Construction and land development 2,105 3,056 - 902 - 56 6,119 Home equity lines of credit 728 114 - 53 - - 895 Consumer 100 264 34 91 (508 ) 359 340 Leases 237 (4 ) - 28 - - 261 Credit cards - commercial 146 (50 ) - 39 - - 135 Total net loan (charge-offs) recoveries$ 26,791 $ 8,221 $ 1,635$ 16,918 $ (2,101 ) $ 456 $ 51,920 63
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The table below reflects activity in the ACL related to loans for the year endedDecember 31, 2019 , presented in accordance with ASC 310 prior to the adoption of ASC 326:
Year ended
(in thousands)
Balance Credit Losses
Charge-offs Recoveries Ending Balance
Real estate mortgage$ 10,681 $ 1,021 $ (38 )$ 100 $ 11,764 Commercial and industrial 11,965 684 (94 ) 267 12,822 Construction and development 1,760 (644 ) - 203 1,319 Undeveloped land 752 34 - - 786 Consumer 376 (95 ) (552 ) 371 100 Total$ 25,534 $ 1,000 $ (684 ) $ 941 $ 26,791
The table below details net charge-offs to average loans outstanding by category
of loan for the years ended
2021 2020
Net (charge Net (charge
offs)/ offs)/
Net (charge recoveries Net (charge recoveries
Year ended December 31, offs)/ to average offs)/ to average
(dollars in thousands) recoveries Average Loans loans
recoveries Average Loans loans
Commercial real estate - non-owner occupied$ (2,896 ) $ 1,027,405 -0.28 % $ (131 )$ 798,085 -0.02 % Commercial real estate - owner occupied (1,326 ) 592,577 -0.22 % (1,351 ) 481,057 -0.28 % Total commercial real estate (4,222 ) 1,619,982 -0.26 % (1,482 ) 1,279,142 -0.12 % Commercial and industrial - term (1,303 ) 550,101 -0.24 % (9 ) 500,571 0.00 % Commercial and industrial - term - PPP - 397,282 0.00 % - 442,510 0.00 % Commercial and industrial - lines of credit - 290,231 0.00 % - 264,777 0.00 % Total commercial and industrial (1,303 ) 1,237,614 -0.11 % (9 ) 1,207,858 0.00 % Residential real estate - owner occupied (349 ) 334,718 -0.10 % (61 ) 218,998 -0.03 % Residential real estate - non-owner occupied 5 221,214 0.00 % - 137,470 0.00 % Total residential real estate (344 ) 555,932 -0.06 % (61 ) 356,468 -0.02 % Construction and land development 3 290,705 0.00 % 56 259,283 0.02 % Home equity lines of credit 1 121,276 0.00 % - 100,616 0.00 % Consumer (311 ) 98,093 -0.32 % (149 ) 77,082 -0.19 % Leases - 13,770 0.00 % - 14,897 0.00 % Credit cards - 13,885 0.00 % - 9,563 0.00 % Total$ (6,176 ) $ 3,951,257 -0.16 %$ (1,645 ) $ 3,304,909 -0.05 % 64
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Selected ratios relating to the allowance follow:
Years Ended December 31, 2021 2020 2019 Provision for credit losses to average loans 0.04 % 0.51 % 0.04 % Net (charge-offs)/recoveries to average loans -0.16 % -0.05 % 0.01 % Allowance for credit losses to average loans 1.36 % 1.57 % 0.99 % Allowance for credit losses to total loans 1.29 % 1.47 % 0.94 % Allowance for credit losses to total loans (excluding PPP) (1) 1.34 % 1.74 % -
(1) See the section titled “Non-GAAP Financial Measures” for reconcilement of
non-GAAP to GAAP measures.
Premises and Equipment Premises and equipment are presented on the consolidated balance sheets net of related depreciation on the respective assets as well as fair value adjustments associated with purchase accounting. Premises and equipment increased$19 million , or 33%, betweenDecember 31, 2020 andDecember 31, 2021 as a result of the KB acquisition, which added 19 locations. As ofDecember 31, 2021 , Bancorp has 63 full service banking center locations; 33 in the Louisville MSA, 19 in central and easternKentucky , 6 in the Cincinnati MSA and 5 in theIndianapolis MSA. BOLI Bank-owned life insurance assets increased$20 million , or 60%, to$53 million atDecember 31, 2021 , compared to$33 million atDecember 31, 2020 , the increase stemming directly from life insurance assets added as a result of the KB acquisition.Goodwill AtDecember 31, 2021 , Bancorp had$136 million in goodwill recorded on its balance sheet, including$123 million recorded in association with the acquisition of KB. As permitted under GAAP, management has up to 12 months following the date of acquisition to finalize the fair values of the acquired assets and assumed liabilities related to the KB acquisition. During this measurement period, Bancorp may record subsequent adjustments to goodwill for provisional amounts recorded at the acquisition date. Events that may trigger goodwill impairment include deterioration in economic conditions, a decline in market-dependent multiples or metrics (i.e. stock price falling below tangible book value), negative trends in overall financial performance and regulatory action. AtSeptember 30, 2021 , Bancorp elected to perform a qualitative assessment to determine if it was more-likely-than-not that the fair value of the Commercial Banking reporting unit exceeded its carrying value, including goodwill. The qualitative assessment indicated that it was not more-likely-than-not that the carrying value of the reporting unit exceeded its fair value.
Core Deposit Intangibles (CDI)
CDI assets arising from business acquisitions are initially measured at fair value and are then amortized on an accelerated method of their useful lives. CDI assets increased$4 million as ofDecember 31, 2021 compared toDecember 31, 2020 , entirely as a result of assets added through the KB acquisition.
Other Assets and Other Liabilities
Other assets increased$15 million , or 21%, as ofDecember 31, 2021 compared toDecember 31, 2020 while other liabilities increased$9 million , or 10%, for the same respective periods. The increase in Other Assets betweenDecember 31, 2020 andDecember 31, 2021 was attributed mainly to the addition of a large CRE OREO property, growth in MSR assets stemming from the KB acquisition, increased values of insurance policies outside of traditional BOLI, additional investment in tax credit partnerships and general increases in other assets related to the KB acquisition. Partially offsetting the overall increase was a reduction in interest rate swap assets. 65
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The increase for Other Liabilities betweenDecember 31, 2020 andDecember 31, 2021 was driven by the accrual of an AFS debt security purchase that will settle in early 2022 and higher accrued employee incentive compensation associated with record operating results. These increases were offset by the reduction of various accrued liabilities, including tax credit partnership obligations, the ACL for off balance sheet credit exposures and interest rate swap liabilities. Market value changes on interest rate swap transactions maintained for certain loan customers played a role in the fluctuations of both Other Asset and Other Liabilities, as noted above. Bancorp enters into these interest rate swap transactions with borrowers who desire to hedge exposure to rising interest rates, while at the same time entering into an offsetting interest rate swap, with substantially matching terms, with another approved independent counterparty. These are undesignated derivative instruments and are recognized on the balance sheet at fair value via both an asset and a related liability as Bancorp has an agreement with the borrower (the asset) and the counterparty (the liability). Because of matching terms of offsetting contracts and collateral provisions mitigating any non-performance risk, changes in fair value have an offsetting effect on the related asset and liability. For this reason, the market value changes over the past 12 months stemming from the declining interest rate environment have resulted in increases to both the asset and liability associated with these transactions. For additional information, see the footnote titled "Derivative Financial Instruments." Deposits Total deposits increased$1.80 billion , or 45%, fromDecember 31, 2020 toDecember 31, 2021 . Deposits totaling$1.04 billion were assumed as a result of the KB acquisition. Deposit balances attributed to the acquired portfolio and related market increased slightly to$1.08 billion as ofDecember 31, 2021 . Excluding the deposits attributed to theCentral Kentucky market, deposits grew$718 million , or 18%. Average deposit balances have increased$1.27 billion , or 35%, over the past 12 months, as federal programs such as the PPP, stimulus checks and enhanced unemployment benefits drove both ending and average deposit balances to record levels as ofDecember 31, 2021 in addition to deposits added as a result of the acquisition. (dollars in thousands) Variance December 31, 2021 2020 $ Change % Change Non-interest bearing demand deposits$ 1,755,754 $ 1,187,057 $ 568,697 48 % Interest bearing deposits: Interest bearing demand 2,131,928 1,355,985 775,943 57 % Savings 415,258 208,774 206,484 99 % Money market 1,050,352 844,414 205,938 24 %
Time deposit accounts of
16,680 23 % Other time deposits 344,477 319,339 25,138 8 % Total time deposits 434,222 392,404 41,818 11 % Total interest bearing deposits 4,031,760 2,801,577 1,230,183 44 % Total deposits (1)$ 5,787,514 $ 3,988,634 $ 1,798,880 45 %
(1) Includes
2021
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The composition of deposits, bifurcated between Bancorp's legacy deposit portfolio and the deposit portfolio acquired through expansion into theCentral Kentucky market through the KB acquisition, is presented below. This composition is presented to provide detail of theCentral Kentucky market's deposit portfolio and its contribution to the total deposit composition of Bancorp atDecember 31, 2021 . As of December 31, 2021 (dollars in thousands) Legacy Central Kentucky Total Non-interest bearing demand deposits$ 1,533,188 $ 222,566$ 1,755,754 Interest bearing deposits: Interest bearing demand 1,628,598 503,330 2,131,928 Savings 258,032 157,226 415,258 Money market 961,579 88,773 1,050,352 Time deposit accounts of$250,000 or more 66,045 23,700 89,745 Other time deposits(1) 259,636 84,841 344,477 Total time deposits 325,681 108,541 434,222 Total interest bearing deposits 3,173,890 857,870 4,031,760 Total deposits$ 4,707,078 $ 1,080,436 $ 5,787,514 Despite the sharp average balance increase experienced over the past twelve months, Bancorp has experienced significant benefit from lower deposit rates. The average cost of interest bearing deposits declined 25 bps to 0.17% betweenDecember 31, 2020 andDecember 31, 2021 , while the overall cost of deposits (including non-interest bearing deposits) declined 14 bps to 0.15% over the same period.
Average deposit balances and average rates paid on such deposits for the years
indicated are summarized as follows:
2021 2020 2019
Years Ended
(dollars in thousands) Average balance Average rate Average balance Average rate Average balance Average rate
Non-interest bearing demand deposits$ 1,578,795 - %$ 1,100,942 - % $ 765,103 - % Interest bearing demand deposits 1,633,606 0.11 1,133,308 0.16 875,897 0.57 Savings deposits 328,570 0.03 190,368 0.02 166,509 0.17 Money market deposits 919,778 0.06 771,363 0.19 695,411 1.02 Time deposits 420,308 0.76 412,506 1.74 406,176 2.02 Total Average Deposits$ 4,881,057 $ 3,608,487 $ 2,909,096 Maturities of time deposits of$250,000 or more atDecember 31, 2021 are summarized as follows: (in thousands) 3 months or less$ 16,561 Over 3 through 6 months 13,215 Over 6 through 12 months 35,753 Over 12 months 24,216 Total$ 89,745 67
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Securities Sold Under Agreement to Repurchase
Information regarding SSUAR follows:
December 31, (dollars in thousands) 2021 2020 Outstanding balance at end of period$ 75,466 $ 47,979
Weighted average interest rate at end of period 0.04 % 0.05 %
Years EndedDecember 31 , (dollars in thousands) 2021 2020
2019
Average outstanding balance during the period$ 62,534 $ 40,363 $ 38,555 Average interest rate during the period 0.04 % 0.09 % 0.26 % Maximum outstanding at any month end during the period$ 81,964 $ 47,979 $ 52,599 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 Bank's control. The majority of SSUARs are indexed to immediately repricing indices such as the FFTR. SSUARs totaled$75 million and$48 million atDecember 31, 2021 andDecember 31, 2020 , respectively, as SSUARs totaling$11 million were assumed as part of the KB acquisition. The remaining increase in SSUAR is consistent with the general trend of customers maintaining elevated deposit balances.
Federal Funds Purchased and Other Short-Term Borrowing
FFP and other short-term borrowing balances decreased
between
relate entirely to excess liquidity held by downstream correspondent bank
customers of Bancorp.
FHLB Advances FHLB advances decreased$32 million betweenDecember 31, 2020 andDecember 31, 2021 due to maturing advances not being renewed or replaced in addition to elective pay offs, resulting in Bancorp having no outstanding FHLB advances atDecember 31, 2021 . During the first quarter of 2021, Bancorp elected to pay down certain advances prior to maturity without incurring pre-payment penalties. During the second quarter of 2021, Bancorp paid off$14 million of term advances, with a weighted average cost of 2.03%, prior to their maturity incurring an early-termination fee of$474,000 . Bancorp based this decision on its excess liquidity position driven by the substantial deposit growth it achieved over the past year, combined with consideration for the cost of the advances and a break-even analysis. As a result of the KB acquisition, FHLB advances totaling$91 million were assumed and paid off immediately upon acquisition based on current levels of excess liquidity. Early termination penalties totaling$2.5 million were incurred as a result of the payoffs, but had no income statement impact for the year endedDecember 31, 2021 due to the fair value adjustment recorded through goodwill at acquisition. 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 those 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. 68
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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. For the years endedDecember 31, 2020 and 2021, Bancorp did not experience any significant funding issues related to the PPP or the pandemic in general. A significant portion of the PPP borrowings have remained in the form of commercial deposits and have generally been slow to outflow, as customers have utilized the funds to strengthen their balance sheets. In addition, federal stimulus checks and more lucrative unemployment benefits have also contributed to higher than normal deposit balances, resulting in record levels of liquidity. If a liquidity issue arose, Bancorp would utilize overnight funds from the FHLB (the lowest costing source), in which Bancorp has available credit of$1.00 billion as ofDecember 31, 2021 . Bancorp's most liquid assets are comprised of cash and due from banks, FFS and AFS debt securities. FFS and interest bearing deposits totaled$899 million and$275 million atDecember 31, 2021 andDecember 31, 2020 , respectively. FFS normally have overnight maturities while interest-bearing deposits in banks are accessible on demand. These investments are used for general daily liquidity purposes. The fair value of the AFS debt security portfolio was$1.18 billion and$587 million atDecember 31, 2021 andDecember 31, 2020 , respectively. The investment portfolio includes scheduled maturities of$6 million and expected cash flows on amortizing AFS debt securities of approximately$185 million (based on scheduled payments and assumed pre-payment speeds as ofDecember 31, 2021 ) over the next 12 months. Combined with FFS and interest bearing deposits from banks, AFS debt securities offer substantial resources to meet either loan growth or reductions in Bancorp's deposit funding base. Bancorp pledges portions of its investment securities portfolio to secure public funds, cash balances of certain WM&T accounts and SSUAR. AtDecember 31, 2021 , total investment securities pledged for these purposes comprised 75% of the AFS debt securities portfolio, leaving approximately$301 million of unpledged AFS debt securities. Bancorp's deposit base consists mainly of core deposits, defined as time deposits less than or equal to$250,000 , demand, savings, money market deposit accounts and excludes public funds and brokered deposits. AtDecember 31, 2021 , such deposits totaled$5.05 billion and represented 87% of Bancorp's total deposits, as compared with$3.54 billion , or 89% of total deposits atDecember 31, 2020 . Because these core deposits are less volatile and are often tied to other products of Bancorp through long lasting relationships, they do not place undue pressure on liquidity. However, many of Bancorp's individual depositors are currently maintaining historically high balances. These excess balances may be more sensitive to market rates, with potential decreases possibly straining Bancorp's liquidity position. As ofDecember 31, 2021 andDecember 31, 2020 , Bancorp held brokered deposits totaling$5 million and$25 million , respectively. The$5 million of brokered deposits outstanding atDecember 31, 2021 was entirely attributed to deposits added through the KB acquisition.
Included in total deposit balances at
million
accounts from local government agencies and public school districts in the
markets in which Bancorp operates. The large increase stems from deposit
relationships added through expansion into the
Bancorp is a member of the FHLB ofCincinnati . As a member of the FHLB, Bancorp has access to credit products of the FHLB. Bancorp views these borrowings as a potential low cost alternative to brokered deposits. AtDecember 31, 2021 andDecember 31, 2020 , available credit from the FHLB totaled$1.00 billion and$804 million , respectively. The increase in available credit during 2021 resulted from an increase in eligible loans (those pledged for collateral-based borrowing capacity) and the maturity or elective payoff of all FHLB borrowings. See the footnote titled "FHLB Advances" for additional detail. Additionally, Bancorp had unsecured available FFP lines with correspondent banks totaling$80 million at bothDecember 31, 2021 andDecember 31, 2020 . During the normal course of business, Bancorp enters into certain forms of off-balance sheet transactions, including unfunded loan commitments and letters of credit. These transactions are managed through Bancorp's various risk management processes. Management considers both on-balance sheet and off-balance sheet transactions in its evaluation of Bancorp's liquidity. 69
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Bancorp's principal source of cash revenue is dividends paid to it as the sole shareholder of the Bank. As discussed in the footnote titled "Commitments and Contingent Liabilities," as ofJanuary 1st of any year, the Bank may pay dividends in an amount equal to the Bank's net income of the prior two years less any dividends paid for the same two years. AtDecember 31, 2021 , the Bank may pay an amount equal to$53 million in dividends to Bancorp without regulatory approval subject to ongoing capital requirements of the Bank. Sources and Uses of Cash Cash flow is provided primarily through financing activities of Bancorp, which include raising deposits and borrowing funds from institutional sources such as advances from the FHLB and FFP, as well as scheduled loan repayments and cash flows from AFS debt securities. These funds are primarily used to facilitate investment activities of Bancorp, which include making loans and purchasing securities for the investment portfolio. Another important source of cash is net income of the Bank from operating activities. For further detail regarding the sources and uses of cash, see the "Consolidated Statements of Cash Flows" in Bancorp's consolidated financial statements. Commitments In the normal course of business, Bancorp is party to activities that contain credit, market and operational risk that are not reflected in whole or in part in Bancorp's consolidated financial statements. Such activities include traditional off-balance sheet credit-related financial instruments, commitments under operating leases and long-term debt. Bancorp provides customers with off-balance sheet credit support through loan commitments and standby letters of credit. Unused loan commitments increased$300 million as ofDecember 31, 2021 compared toDecember 31, 2020 consistent with the KB acquisition. Commitments to extend credit are an agreement to lend to a customer as long as collateral is available as agreed upon and there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Bancorp uses the same credit and collateral policies in making commitments and conditional guarantees as for on-balance sheet instruments. Bancorp evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained is based on management's credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, securities, equipment and real estate. However, should the commitments be drawn upon and should our customers default on their resulting obligation to us, our maximum exposure to credit loss, without consideration of collateral, is represented by the contractual amount of those instruments. Additional detail regarding credit-related financial instruments, including both commitments to extend credit and letters of credit atDecember 31, 2021 are as follows: Amount of commitment expiration per period Less than 1-3 3-5 Over 5 (in thousands) 1 year years years years Total Unused loan commitments$ 929,296 $ 365,662 $ 113,717 $ 251,698 $ 1,660,373 Standby letters of credit 30,265 480 34 - 30,779
See the footnote titled “Commitments and Contingent Liabilities” for additional
detail.
AtDecember 31, 2021 andDecember 31, 2020 , Bancorp had accrued$3.5 million and$5.4 million , respectively, in other liabilities for its estimate of inherent risks related to unfunded credit commitments. The decrease is consistent with improvement in both line of credit utilization and the underlying CECL model factors.
Standby letters of credit are conditional commitments issued by Bancorp to
guarantee the performance of a customer to a third party beneficiary. Those
guarantees are primarily issued to support commercial transactions. Standby
letters of credit generally have maturities of one to two years.
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In addition to owned banking facilities, Bancorp has entered into long-term
leasing arrangements for certain branch facilities. Bancorp also has required
future payments for a non-qualified defined benefit retirement plan, time
deposit maturities and other obligations.
Required payments under such commitments atDecember 31, 2021 are as follows: Payments due by period Less than 1-3 3-5 Over 5 (in thousands) 1 year years years years Total Time deposit maturities$ 320,741 $ 96,422 $ 16,977 $ 82 $ 434,222 Operating leases (1) 2,634 5,081 3,532 7,699 18,946 Defined benefit retirement plan - 137 356 2,785 3,278 Other (2) 1,616 1,865 1,588 2,673 7,742
(1) Includes assumed renewals.
(2) Consists primarily of contractual requirements relating to tax credit
investments and community sponsorships.
Capital
Information pertaining to Bancorp’s capital balances and ratios follows:
Years endedDecember 31 , (dollars in thousands, except per share data) 2021 2020 2019 Stockholders' equity$ 675,869 $ 440,701 $ 406,297 Dividends per share$ 1.10 $ 1.08 $ 1.04 Dividend payout ratio, based on basic EPS 36.67 % 41.38 % 35.62 % Bancorp increased its cash dividends declared to stockholders during 2021 to an annual dividend of$1.10 , from$1.08 per share in 2020 and$1.04 in 2019. This represents a payout ratio of 36.67% based on basic EPS and an annual dividend yield of 1.72% based upon the year-end closing stock price. AtDecember 31, 2021 , stockholders' equity totaled$676 million , representing an increase of$235 million , or 53%, compared toDecember 31, 2020 . The large increase during 2021 was attributed mainly to stock issued in relation to the KB acquisition, which totaled$205 million . Further, net income of$74.6 million was partially offset by a larger negative change in AOCI and dividends declared for the year endedDecember 31, 2021 . AOCI consists of net unrealized gains or losses on AFS debt securities and a minimum pension liability, each net of income taxes. AOCI declined$17 million fromDecember 31, 2020 toDecember 31, 2021 , with the fluctuation stemming from the changing interest rate environment and corresponding valuation of the AFS debt securities portfolio. See the "Consolidated Statement of Changes in Stockholders' Equity" for further detail of changes in equity. InMay 2021 , Bancorp's Board of Directors extended its share repurchase program authorizing the repurchase of up to 1 million shares, or approximately 4% of Bancorp's total common shares outstanding at inception. The plan, which will expire inMay 2023 unless otherwise extended or completed at an earlier date, does not obligate Bancorp to repurchase any specific dollar amount or number of shares prior to the plan's expiration. Based on economic developments over the past year, the increased importance of capital preservation and the announcement of two acquisitions, no shares were repurchased in 2020 nor 2021. Approximately 741,000 shares remain eligible for repurchase under the current repurchase plan. 71
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Bank holding companies and their subsidiary banks are required by regulators to meet risk-based capital standards. These standards, or ratios, measure the relationship of capital to a combination of balance sheet and off-balance sheet risks. The value of both balance sheet and off-balance sheet items are adjusted to reflect credit risks. See the footnote titled "Regulatory Matters" for additional detail regarding regulatory capital requirements, as well as capital ratios of Bancorp and the Bank. The Bank exceeds regulatory capital ratios required to be well-capitalized. Regulatory framework does not define well capitalized for holding companies. Management considers the effects of growth on capital ratios as it contemplates plans for expansion. The following table sets forth consolidated Bancorp's and the Bank's risk based capital ratios: December 31, 2021 2020 Total risk-based capital (1) Consolidated 12.79 % 13.36 % Bank 12.42 12.99 Common equity tier 1 risk-based capital (1) Consolidated 11.94 12.23 Bank 11.56 11.85 Tier 1 risk-based capital (1) Consolidated 11.94 12.23 Bank 11.56 11.85 Leverage (2) Consolidated 8.86 9.57 Bank 8.57 9.26 (1) Under banking agencies' risk-based capital guidelines, assets and credit-equivalent amounts of derivatives and off-balance sheet credit exposures are assigned to broad risk categories. The aggregate dollar amount in each risk category is multiplied by the associated risk weight of the category. Weighted values are added together, resulting in Bancorp's total risk-weighted assets. These ratios are computed in relation to average assets.
(2) Ratio is computed in relation to average assets.
Capital ratios for the year endedDecember 31, 2021 decreased compared to the prior year as a result of substantial average asset and risk-weighted asset growth, driven by both organic and acquisition-related activity. While pressure was placed on risk-based capital and leverage ratios due to this growth, Bancorp continues to exceed the regulatory requirements for all calculations. Bancorp and the Bank intend to maintain a capital position that meets or exceeds the "well-capitalized" requirements as defined by the FRB and theFDIC , in addition to the capital conservation buffer. Banking regulators have categorized the Bank as well-capitalized. To meet the definition of well-capitalized for prompt corrective action requirements, a bank must have a minimum 6.5% Common Equity Tier 1Risk-Based Capital ratio, 8.0% Tier 1Risk-Based Capital ratio, 10.0%Total Risk-Based Capital ratio and 5.0% Tier 1 Leverage ratio. Additionally, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, Bancorp and the Bank must hold a 2.5% capital conservation buffer composed of Common Equity Tier 1Risk-Based Capital above the minimum risk-based capital requirements for the Common Equity Tier 1Risk-Based Capital ratio, Tier 1Risk-Based Capital ratio andTotal Risk-Based Capital ratio necessary to be considered adequately-capitalized. AtDecember 31, 2021 , the adequately-capitalized minimums, including the capital conservation buffer, were a 6.0% Common Equity Tier 1Risk-Based Capital ratio, 8.5% Tier 1Risk-Based Capital ratio and 10.5%Total Risk-Based Capital ratio. 72
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As permitted by the interim final rule issued onMarch 27, 2020 by the federal banking regulatory agencies, Bancorp elected the option to delay the estimated impact on regulatory capital related to the adoption of ASC 326 "Financial Instruments - Credit Losses," or CECL, which was effectiveJanuary 1, 2020 . The initial impact of adoption of ASC 326, as well as 25% of the quarterly increases in the ACL subsequent to adoption of ASC 326 (collectively the "transition adjustments") were declared to be delayed for two years. After two years, the cumulative amount of the transition adjustments will become fixed and will be phased out of the regulatory capital calculations evenly over a three-year period, with 75% recognized in year three, 50% recognized in year four and 25% recognized in year five. After five years, the temporary regulatory capital benefits will be fully reversed.Had Bancorp not elected to defer the regulatory capital impact of CECL, the post ASC 326 adoption capital ratios of Bancorp and the Bank would have exceeded the well-capitalized level. Fair Value Measurements Bancorp follows the provisions of authoritative guidance for fair value measurements. This guidance is definitional and disclosure oriented and addresses how companies should approach measuring fair value when required by GAAP. It prescribes various disclosures about financial statement categories and amounts which are measured at fair value, if such disclosures are not already specified elsewhere in GAAP. Authoritative guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between participants at the measurement date. The guidance requires fair value measurements to be classified as Level 1 (quoted prices), Level 2 (based on observable inputs) or Level 3 (based on significant unobservable, internally-derived inputs). Bancorp's AFS debt securities and interest rate swaps are recorded at fair value on a recurring basis. Other accounts including mortgage loans held for sale, MSRs, impaired loans and OREO may be recorded at fair value on a non-recurring basis, generally in the application of lower of cost or market adjustments or write-downs of specific assets. The AFS debt securities portfolio is comprised ofU.S. Treasury and otherU.S. government obligations, debt securities ofU.S. government-sponsored corporations (including mortgage-backed securities), and obligations of state and political subdivisions.U.S. Treasury securities are priced using quoted prices of identical securities in an active market. These measurements are classified as Level 1 in the hierarchy above. All other securities are priced using standard industry models or matrices with various assumptions such as yield curves, volatility, prepayment speeds, default rates, time value, credit rating and market prices for similar instruments. These assumptions are generally observable in the market place and can be derived from or supported by observable data. These measurements are classified as Level 2 in the hierarchy above. Interest rate swaps are valued using primarily Level 2 inputs. Fair value measurements generally based on benchmark forward yield curves and other relevant observable market data. For purposes of potential valuation adjustments to derivative positions, Bancorp evaluates the credit risk of its counterparties as well as its own credit risk. To date, Bancorp has not realized any losses due to a counterparty's inability to perform and the change in value of derivative assets and liabilities attributable to credit risk was not significant during 2019, 2020 and 2021. MSRs, carried in other assets and recorded at fair value upon capitalization, are amortized to correspond with estimated servicing income and are periodically assessed for impairment based on fair value at the reporting date. Fair value is based on a valuation model that calculates the present value of estimated net servicing income. The model incorporates assumptions that market participants would use in estimating future net servicing income. These measurements are classified as Level 3. AtDecember 31, 2021 and 2020, there was no valuation allowance for MSRs, as fair value exceeded carrying value. Loans considered to be collateral dependent are measured for impairment and, if indicated, a specific allocation is established based on the value of underlying collateral. Collateral dependent loans include non-accrual loans and loans accounted for as TDRs. For collateral dependent loans, fair value amounts represent only those loans with specific valuation allowances and loans charged down to their carrying value. AtDecember 31, 2021 andDecember 31, 2020 , the carrying value of collateral dependent loans measured at fair value on a non-recurring basis was$7 million and$8 million . These measurements are classified as Level 3. 73
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OREO, which is carried in other assets at the lower of cost or fair value, is periodically assessed for impairment based on fair value at the reporting date. Fair value is commonly based on recent real estate appraisals or valuations performed by internal or external parties which use judgments and assumptions that are property-specific and sensitive to changes in the overall economic environment. Appraisals may be further discounted based on management's historical knowledge and/or changes in market conditions from the date of the most recent appraisal. Many of these inputs are not observable and, accordingly, these measurements are classified as Level 3. OREO is equal to the carrying value of only parcels of OREO for which carrying value equals appraised value. If a parcel of OREO has a carrying value below its appraised value, it is not considered to be carried at fair value. The losses represent write-downs which occurred during the period indicated. AtDecember 31, 2021 and 2020, the carrying value of OREO was$7 million and$281,000 .
See the Footnote titled “Assets and Liabilities Measured and Reported at Fair
Value,” for additional detail regarding fair value measurements.
Non-GAAP Financial Measures
The following table provides a reconciliation of total stockholders' equity in accordance with GAAP to tangible stockholders' equity (TCE), a non-GAAP disclosure. Bancorp provides the TCE per share, a non-GAAP measure, in addition to those defined by banking regulators, based on its widespread use by investors as a means to evaluate capital adequacy:
data)
2021
2020
Total stockholders' equity - GAAP (a)$ 675,869 $ 440,701 Less: Goodwill (135,830 ) (12,513 ) Less: Core deposit intangible (5,596 ) (1,962 ) Tangible common equity - Non-GAAP (c)$ 534,443 $ 426,226 Total assets - GAAP (b)$ 6,646,025 $ 4,608,629 Less: Goodwill (135,830 ) (12,513 ) Less: Core deposit intangible (5,596 ) (1,962 ) Tangible assets - Non-GAAP (d)$ 6,504,599 $
4,594,154
Total stockholders' equity to total assets - GAAP (a/b) 10.17 % 9.56 % Tangible common equity to tangible assets - Non-GAAP (c/d) 8.22 % 9.28 % Total shares outstanding (e) 26,596 22,692 Book value per share - GAAP (a/e)$ 25.41 $
19.42
Tangible common equity per share - Non-GAAP (c/e) 20.09 18.78
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ACL on loans to total non-PPP loans represents the ACL on loans, divided by total loans less PPP loans. Non-performing loans to total non-PPP loans represents non-performing loans, divided by total loans less PPP loans. Delinquent loans to total non-PPP loans represents delinquent loans (consisting of all loans 30 days or more past due), divided by total loans less PPP loans. Bancorp believes these non-GAAP disclosures are important because they provide comparable ratios after eliminating PPP loans, which are fully guaranteed by the SBA and have not been allocated for within the ACL and are not at risk of non-performance. December 31, (dollars in thousands) 2021 2020 Total loans - GAAP (a)$ 4,169,303 $ 3,531,596 Less: PPP loans (140,734 ) (550,186 ) Total non-PPP loans - Non-GAAP (b)$ 4,028,569
Allowance for credit losses on loans (c) $ 53,898$ 51,920 Non-performing loans (d) 7,408 13,179 Delinquent loans (e) 11,036 16,939
Allowance for credit losses on loans to total loans –
GAAP (c/a)
1.29 %
1.47 %
Allowance for credit losses on loans to total loans –
Non-GAAP (c/b)
1.34 %
1.74 %
Non-performing loans to total loans - GAAP (d/a) 0.18 % 0.37 % Non-performing loans to total loans - Non-GAAP (d/b) 0.18 %
0.44 %
Delinquent loans to total loans - GAAP (e/a) 0.26 % 0.48 % Delinquent loans to total loans - Non-GAAP (e/b) 0.27 % 0.57 % The efficiency ratio, a non-GAAP measure, equals total non-interest expenses divided by the sum of net interest income FTE and non-interest income. The ratio excludes net gains (losses) on sales, calls, and impairment of investment securities, if applicable. In addition to the efficiency ratio, Bancorp considers an adjusted efficiency ratio. Bancorp believes it is important because it provides a comparable ratio after eliminating the fluctuation in non-interest expenses related to amortization of investments in tax credit partnerships. Net interest income on a FTE basis includes the additional amount of interest income that would have been earned if investments in certain tax-exempt interest earning assets had been made in assets subject to federal, state and local taxes yielding the same after-tax income. Years endedDecember 31 , (dollars in thousands) 2021 2020
2019
Total non-interest expenses – GAAP (a)
$ 98,116 Less: Non-recurring merger expenses (19,025 ) - (1,313 ) Less: Amortization of investments in tax credit partnerships (367 ) (3,096 ) (1,078 ) Total non-interest expenses - Non-GAAP (c )$ 122,888 $ 98,563
Total net interest income, FTE$ 171,508 $ 136,133 $ 125,571 Total non-interest income 65,850 51,899
49,428
Less: Gain/loss on sale of securities - - - Total revenue - GAAP (b)$ 237,358 $ 188,032 $ 174,999 Efficiency ratio - GAAP (a/b) 59.94 % 54.06 % 56.07 % Efficiency ratio - Non-GAAP (c/b) 51.77 % 52.42 % 54.70 % 75
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