This discussion and analysis provides an overview of the financial condition and
results of operations of Embassy Bancorp, Inc. (the "Company") as of September
30, 2022 and for the three and nine months ended September 30, 2022 and 2021,
respectively. This discussion should be read in conjunction with the preceding
consolidated financial statements and related footnotes, as well as with the
audited consolidated financial statements and the accompanying notes for the
year ended December 31, 2021 included in the Company's Form 10-K filed with the
Securities and Exchange Commission. Current performance does not guarantee and
may not be indicative of similar performance in the future.
Critical Accounting Policies
Disclosure of the Company's significant accounting policies is included in Note
1 to the consolidated financial statements included in the Company's Form 10-K
for the year ended December 31, 2021. Some of these policies are particularly
sensitive, requiring significant judgments, estimates and assumptions to be made
by management, most particularly in connection with determining the provision
for loan losses and the appropriate level of the allowance for loan losses and
the valuation of deferred tax assets. Additional information is contained in
this Form 10-Q under the paragraphs titled "Provision for Loan Losses," "Credit
Risk and Loan Quality," and "Income Taxes" contained on the following pages.
Caution About Forward-looking Statements
This report contains forward-looking statements, including statements of goals,
intentions, and expectations as to future trends, plans, events or results of
Company operations and policies and regarding general economic conditions. These
forward-looking statements are intended to be covered by the safe harbor for
forward-looking statements provided by the Private Securities Litigation Reform
Act of 1995. These statements are based upon current and anticipated economic
conditions, nationally and in the Company's market, interest rates and interest
rate policy, competitive factors and other conditions that, by their nature, are
not susceptible to accurate forecast, and are subject to significant
uncertainty.
Such forward-looking statements can be identified by the use of forward-looking
terminology such as "believes", "expects", "may", "intends", "will", "should",
"anticipates", or the negative of any of the foregoing or other variations
thereon or comparable terminology, or by discussion of strategy.
No assurance can be given that the future results covered by forward-looking
statements will be achieved. Such statements are subject to risks,
uncertainties, and other factors that could cause actual results to differ
materially from future results expressed or implied by such forward-looking
statements. Important factors that could impact the Company's operating results
include, but are not limited to, (i) the effects of changing economic conditions
in the Company's market areas and nationally, (ii) credit risks of commercial,
real estate, consumer and other lending activities, (iii) significant changes in
interest rates, (iv) changes in federal and state banking laws and regulations
which could impact the Company's operations, (v) changes in accounting policies
or procedures as may be required by FASB or regulatory agencies, (vi) risks and
uncertainties related to the COVID-19 pandemic and its variants and resulting
governmental and societal responses, (vii) geopolitical events in the Ukraine,
Russia, and North Korea, and (viii) other external developments which could
materially affect the Company's business and operations, as well as the risks
described in the Company's Form 10-K for the year ended December 31, 2021 and
subsequent filings with the SEC.
OVERVIEW
The Company is a Pennsylvania corporation organized in 2008 and registered as a
bank holding company pursuant to the Bank Holding Company Act of 1956, as
amended (the "BHC Act"). The Company was formed for purposes of acquiring
Embassy Bank For The Lehigh Valley (the "Bank") in connection with the
reorganization of the Bank into a bank holding company structure, which was
consummated on November 11, 2008. Accordingly, the Company owns all of the
capital stock of the Bank, giving the organization more flexibility in meeting
its capital needs as the Company continues to grow. Embassy Holdings, LLC (the
"LLC") is a wholly-owned subsidiary of the Bank organized to engage in the
holding of property acquired by the Bank in satisfaction of debts previously
contracted. As such, the consolidated financial statements contained herein
include the accounts of the Company, the Bank and the LLC.
The Bank, which is the Company's primary operating subsidiary, was originally
incorporated as a Pennsylvania bank on May 11, 2001 and opened its doors on
November 6, 2001. It was formed by a group of local business persons and
professionals with significant prior experience in community banking in the
Lehigh Valley area of Pennsylvania, the Bank's primary market area, for the
purpose of providing a local community bank to serve Lehigh and Northampton
Counties in Pennsylvania.
Since its inception, the Board's philosophy has been that, by running the Bank
with a view toward the long term, only good things will happen for the Bank's
customers, team members, shareholders and the Lehigh Valley community.
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At September 30, 2022, the Company continued to be in a strong financial and
operational condition. The Bank's September 30, 2022 capital ratios exceeded the
amounts required to be considered "well capitalized" as defined in applicable
banking regulations. The Company's ratio of non-performing loans to total loans
and the ratio of non-performing loans to total loans excluding PPP loans at
September 30, 2022 were both 0.19% and the ratio of non-performing assets to
total assets was 0.14%. The Company had its last Community Reinvestment Act
("CRA") examination in 2022 and received a "satisfactory" rating.
The Company's assets decreased by $17.2 million from $1.63 billion at December
31, 2021 to $1.62 billion at September 30, 2022. The decrease was due to a $97.5
million decrease in cash and cash equivalents and a decrease of $8.3 million in
net PPP loans receivable due to net loan forgiveness, offset by an increase of
$1.6 million in securities available for sale, an increase of $73.3 million in
net loans receivable (excluding PPP loans), and an increase in other assets of
$14.3 million. The growth in securities available for sale and net loans
receivable was primarily funded by deposits. The decrease in cash and cash
equivalents was primarily due to repayments of FHLB long term borrowings of
$14.7 million maturing during the first quarter of 2022, purchases of available
for sale securities, net loan growth (excluding PPP), offset, in part, by the
forgiveness of PPP loans, an increase in deposits, and an increase in securities
sold under agreement to repurchase. The $1.6 million growth in securities was
net of an increase in unrealized losses of $72.3 million. The increase of $14.3
million in other assets was primarily due to the growth of $15.2 million in the
deferred tax asset in relation to unrealized losses on securities. The current
unrealized loss position of the securities portfolio is due to increasing market
interest rates in response to economic conditions since purchase and not due to
credit quality of the investment portfolio. The Company's deposits grew
$40.0 million from $1.47 billion at December 31, 2021 to $1.51 billion at
September 30, 2022. The overall deposit growth was due to a highly effective
relationship building, sales and marketing effort, which served to further
increase the Company's overall presence in the market it serves, along with
deposit relationships developed as a result of cross-marketing efforts to its
loan and other non-depository banking service customers. Also contributing to
the growth is the increased usage of the Company's online banking platform,
competitively offered rates, and the continued convenience and efficiency of our
branch network and branch personnel. The Company also continues to gain new
deposit opportunities created by recent merger announcements, name changes, and
competitive branch hour adjustments and/or closures in the Company's market
area, attracting new customers looking to relocate to a local, reputable
community bank.
Net loans receivable (excluding PPP loans) increased by $73.3 million to $1.17
billion at September 30, 2022 from $1.10 billion at December 31, 2021. The
market continues to be very competitive and the Company is committed to
maintaining a high-quality portfolio that returns a reasonable market rate.
While the past and current economic and competitive conditions in the
marketplace have created more competition for loans to credit-worthy customers,
the Company continues to expand its market presence, its pipeline, and continues
to focus on developing a reputation as being a market leader in both commercial
and consumer/mortgage lending. Management believes that this combination of
relationship building, cross marketing and responsible underwriting will
translate into continued long-term growth of a portfolio of quality loans and
core deposit relationships, although there can be no assurance of this. The
Company continues to monitor interest rate exposure of its interest-bearing
assets and liabilities and believes that it is well positioned for any
anticipated future market rate adjustments. See expanded discussion under the
Financial Condition: Loans section below.
Net income for the three months ended September 30, 2022 was $4.7 million
compared to net income for the three months ended September 30, 2021 of $4.4
million, an increase of $309 thousand, or 7.0%. Basic and diluted earnings per
share increased to $0.63 for the three months ended September 30, 2022, as
compared to $0.59 for the three months ended September 30, 2021. The difference
in net income for the three months ended September 30, 2022 and September 30,
2021 resulted from an increase in net interest income driven by a $786 thousand,
or 72.0%, increase in investment securities interest income. The Company's
pre-tax net income for the three months ended September 30, 2021 included $867
thousand of PPP loan interest and fees, as compared to $2 thousand for the three
months ended September 30, 2022. There was also an increase in non-interest
income, offset by an increase in the provision for loan losses and an increase
in non-interest expenses.
Net income for the nine months ended September 30, 2022 was $12.7 million
compared to net income for the nine months ended September 30, 2021 of $12.6
million, an increase of $130 thousand, or 1.0%. Basic and diluted earnings per
share increased to $1.68 for the nine months ended September 30, 2022, as
compared to $1.67 for the nine months ended September 30, 2021. The difference
in net income for the nine months ended September 30, 2022 and September 30,
2021 resulted from an increase in net interest income driven by a $2.8 million,
or 111.0%, increase in investment securities interest income. The Company's
pre-tax net income for the nine months ended September 30, 2021 included $2.4
million of PPP loan interest and fees, as compared to $183 thousand for the nine
months ended September 30, 2022. In the nine months ended September 30, 2022
there was also an increase in non-interest income and a decrease in the
provision for loan losses, offset by an increase in non-interest expenses,
compared to the same nine month period in 2021.
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RESULTS OF OPERATIONS
Net Interest Income
The Company determines interest rate spread and margin on both a US GAAP and tax
equivalent basis. The use of tax equivalent basis in determining interest rate
spread and margin is considered a non-US GAAP measure. The Company believes use
of this measure provides meaningful information to the reader of the
consolidated financial statements when comparing taxable and nontaxable assets.
However, it is supplemental to US GAAP which is used to prepare the Company's
consolidated financial statements and should not be read in isolation or relied
upon as a substitute for US GAAP measures. In addition, the non-US GAAP measure
may not be comparable to non-US GAAP measures reported by other companies. The
tax rate used to calculate the tax equivalent adjustments was 21% for 2022 and
2021.
Total interest income for the three months ended September 30, 2022 increased
$737 thousand to $13.0 million, as compared to $12.3 million for the three
months ended September 30, 2021. Average earning assets were $1.58 billion for
the three months ended September 30, 2022 as compared to $1.50 billion for the
three months ended September 30, 2021. The increase was driven by a $53.8
million increase in average taxable loans and a $92.3 million increase in
average investment securities. The tax equivalent yield on average earning
assets was 3.29% for the third quarter of 2022 compared to 3.27% for the third
quarter of 2021.
Total interest expense for the three months ended September 30, 2022 decreased
$28 thousand to $910 thousand, as compared to $938 thousand for the three months
ended September 30, 2021. Average interest bearing liabilities were $1.16
billion for the three months ended September 30, 2022 as compared to $1.10
billion for the three months ended September 30, 2021. The yield on average
interest bearing liabilities was 0.31% and 0.34% for the third quarter of 2022
and 2021, respectively.
Net interest income for the three months ended September 30, 2022 was $12.1
million, compared to $11.3 million for the three months ended September 30,
2021. The improvement in net interest income is, in part, the result of an
increase in the balances of taxable loans and an increase in taxable and
non-taxable investments, along with an increase in the rate of taxable
investments, non-taxable investments, federal funds sold, and interest bearing
deposits with banks. Also contributing to the improvement in net interest income
for the three months ended September 30, 2022 was a decrease in the balance of
certificates of deposits and a decrease in interest expense on long term FHLB
borrowings due to being paid off in the first quarter of 2022. The improvements
were offset, in part, by a decrease in the interest and fee income from PPP
loans, a decrease in the rates of taxable and non-taxable loans, a decrease in
the balance of interest bearing deposits with banks, and an increase in the
balance of interest bearing demand deposits, NOW, money market, and savings. The
Company's net interest margin is 3.04% on a US GAAP basis and 3.06% on a tax
equivalent (non-US GAAP) basis for the three months ended September 30, 2022, as
compared to 3.00% on a US GAAP basis and 3.02% on a tax equivalent (non-US GAAP)
basis for the three months ended September 30, 2021.
Total interest income for the nine months ended September 30, 2022 increased
$1.2 million to $36.8 million, as compared to $35.6 million for the nine months
ended September 30, 2021. Average earning assets were $1.58 billion for the nine
months ended September 30, 2022 as compared to $1.44 billion for the nine months
ended September 30, 2021. The tax equivalent yield on average earning assets was
3.13% for the nine months ended September 30, 2022 compared to 3.33% for the
nine months ended September 30, 2021.
Total interest expense for the nine months ended September 30, 2022 decreased
$404 thousand to $2.7 million, as compared to $3.1 million for the nine months
ended September 30, 2021. Average interest bearing liabilities were $1.17
billion for the nine months ended September 30, 2022 as compared to $1.06
billion for the nine months ended September 30, 2021. The yield on average
interest bearing liabilities was 0.31% and 0.39% for the nine months ended
September 30, 2022 and September 30, 2021, respectively.
Net interest income for the nine months ended September 30, 2022 was $34.1
million compared to $32.5 million for the nine months ended September 30, 2021.
The slight improvement in net interest income is, in part, the result of an
increase in the balances of taxable loans, an increase in taxable and
non-taxable investments due to purchases of $93.3 million and an increase in
interest bearing deposits with banks, along with an increase in the rates of
taxable and non-taxable investments, federal funds sold, and interest bearing
deposits with banks. Also contributing to the improvement in net interest income
for the nine months ended September 30, 2022 was a decrease in the balance and
rates of certificates of deposit, a decrease in interest expense on long term
FHLB borrowings due to repayment in the first quarter of 2022, and no interest
expense from PPPLF borrowings due to repayment in the first quarter of 2021. The
improvements were offset, in part, by a decrease in the interest and fee income
from PPP loans, a decrease in the rates of taxable loans and non-taxable loans,
and an increase in the balance of interest bearing demand deposits, NOW, money
market, and savings. The Company's net interest margin is 2.88% on a US GAAP
basis and 2.90% on a tax equivalent (non-US GAAP) basis for the nine months
ended September 30, 2022, as compared to 3.02% on a US GAAP basis and 3.04% on a
tax equivalent (non-US GAAP) basis for the nine months ended September 30, 2021.
The Company's net interest margin was also affected by the balance of PPP loans,
which bear interest at a rate of 1.0%, and PPPLF borrowings, which bore an
interest rate of 0.35% and were paid off in early February 2021. The net
interest margin on a tax
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equivalent (non-US GAAP) basis excluding PPP loans and PPP interest income and
PPPLF borrowings interest expense for the three and nine months ended September
30, 2022 was 3.08% and 2.90%, respectively, compared to 2.85% and 2.90% for the
three and nine months ended September 30, 2021, respectively.
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The tables below sets forth average balances and corresponding yields for the
corresponding periods ended September 30, 2022 and 2021, respectively:
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EMBASSY BANCORP, INC. 