NORWOOD FINANCIAL CORP. Introduction
This Management's Discussion and Analysis and related financial data are
presented to assist in the understanding and evaluation of the financial
condition and results of operations for the Company and the Bank, as of
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for the years ended
Critical Accounting Policies
Note 2 to the Company's consolidated financial statements (incorporated by reference in Item 8 of the Form 10-K) lists significant accounting policies used in the development and presentation of its financial statements. This discussion and analysis, the significant accounting policies, and other financial statement disclosures identify and address key variables and other qualitative and quantitative factors that are necessary for an understanding and evaluation of the Company and its results of operations. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of deferred tax assets, the determination of other-than-temporary impairment on securities, the determination of goodwill impairment and the fair value of financial instruments. Please refer to the discussion of the allowance for loan losses calculation under "Allowance for Loan Losses and Non-performing Assets" in the "Financial Condition" section. The deferred income taxes reflect temporary differences in the recognition of the revenue and expenses for tax reporting and financial statement purposes, principally because certain items are recognized in different periods for financial reporting and tax return purposes. Although realization is not assured, the Company believes it is more likely than not that all deferred tax assets will be realized. In estimating other-than-temporary impairment losses on securities, the Company considers 1) the length of time and extent to which the fair value has been less than cost and 2) the financial condition of the issuer. The Company does not have the intent to sell these securities and it is more likely than not that it will not sell the securities before recovery of their cost basis. The Company believes that any unrealized losses atDecember 31, 2021 and 2020 represent temporary impairment of the securities.
The fair value of financial instruments is based upon quoted market prices, when available. For those instances where a quoted price is not available, fair values are based upon observable market based parameters, as well as unobservable parameters. Any such valuation is applied consistently over time.
In connection with the acquisition ofDelaware in 2016, we recorded goodwill in the amount of$1.6 million , representing the excess of amounts paid over the fair value of the net assets of the institution acquired at the date of acquisition. In connection with the acquisition of UpState.inJuly 2020 , we recorded goodwill in the amount of$17.9 million , representing the excess of amounts paid over the fair value of the net assets of the institution acquired at the date of acquisition.Goodwill is tested annually and deemed impaired when the carrying value of goodwill exceeds its implied fair value.
FINANCIAL CONDITION
Total Assets
Total assets as ofDecember 31, 2021 were$2.069 billion compared to$1.852 billion as of year-end 2020, an increase of$216.6 million . The increase in assets was primarily attributable to the$221.4 million increase in total deposits. Loans Receivable As ofDecember 31, 2021 , loans receivable totaled$1.355 billion compared to$1.411 billion as of year-end 2020, a decrease of$55.8 million due primarily to a$78.8 million decrease in PPP loans resulting from loan forgiveness. Commercial real estate loans grew$49.6 million , while residential mortgage loans increased$9.9 million during the year. The Bank's loan products include loans for personal and business use. Personal lending includes mortgage lending to finance principal residences and, to a lesser extent, second home dwellings. The Bank's loan products include fixed-rate mortgage products with terms up to 30 years which may be sold in the secondary market through the Federal National Mortgage Association ("Fannie Mae") or the FHLB, or held in the Bank's portfolio to the extent consistent with our asset/liability management strategies. Fixed-rate home equity loans are originated on terms up to 180 months. Home equity lines of credit tied to the prime rate are also offered. The Bank also offers indirect dealer financing of automobiles (new and used), boats, and recreational vehicles through a limited network of dealers inNortheast Pennsylvania and the Southern Tier ofNew York . AtDecember 31, 2021 , there were$141.7 million of indirect loans in the portfolio. In connection with the acquisition of UpState in 2020, the Company acquired approximately$413.5 million in loans, including$37.3 million in residential real estate loans,$289.0 million in commercial real estate loans,$92.0 million in commercial, financial and agricultural loans, and$2.3 million in consumer loans. As ofDecember 31, 2021 , the approximate outstanding balance of these acquired loans was$287.1 million . In connection with the acquisition ofDelaware , the Company acquired approximately$116.7 million in loans, including$68.7 million in residential real estate loans,$22.5 million in commercial real estate loans,$13.6 million in commercial, 11
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financial and agricultural loans,$6.5 million in consumer loans and$5.4 in construction loans. As ofDecember 31, 2021 , the approximate outstanding balance of these acquired loans was$37.6 million . Commercial loans and commercial mortgages are provided to local small and mid-sized businesses at a variety of terms and rate structures. Commercial lending activities include lines of credit, revolving credit, term loans, mortgages, various forms of secured lending and a limited amount of letter of credit facilities. The rate structure may be fixed, immediately repricing tied to the prime rate or adjustable at set intervals. Also included in commercial loans are municipal finance lending in which the Bank has been active in recent years. Municipal lending includes both general obligations of local taxing authorities and revenue obligations of specific revenue producing projects such as sewer authorities and educational units. AtDecember 31, 2021 , the Bank had approximately$135.7 million in loans on commercial rentals, as well as$116.3 million of loans outstanding on residential rentals, which are its largest lending concentrations. As a qualifiedSmall Business Administration ("SBA") lender, the Bank originated$156.3 million of PPP loans in total, including loans originated byUSNY Bank prior to the acquisition date. The Bank's construction lending has primarily involved lending for commercial construction projects and for single-family residences. All loans for the construction of speculative sale homes have a loan-to-value ratio of not more than 80%. For both commercial and single-family projects, loan proceeds are disbursed during the construction phase according to a draw schedule based on the stage of completion. Construction projects are inspected by contracted inspectors or bank personnel. Construction loans are underwritten on the basis of the estimated value of the property as completed. For commercial projects, the Bank typically also provides the permanent financing after the construction period, as a commercial mortgage. The Bank also, from time to time, originates loans secured by undeveloped land. Land loans granted to individuals have a term of up to five years. Land loans granted to developers may have an interest only period during development. The substantial majority of land loans have a loan-to-value ratio not exceeding 75%. The Bank has limited its exposure to land loans but may expand its lending on raw land, as market conditions allow, to qualified borrowers experienced in the development and sale of raw land. Loans involving construction financing and loans on raw land have a higher level of risk than loans for the purchase of existing homes since collateral values, land values, development costs and construction costs can only be estimated at the time the loan is approved. The Bank has sought to minimize its risk in construction lending and in lending for the purchase of raw land by offering such financing primarily to builders and developers to whom the Bank has loaned funds in the past and to persons who have previous experience in such projects. The Bank also limits construction lending and loans on raw land to its market area, with which management is familiar. Adjustable-rate loans decrease the risks associated with changes in interest rates by periodically repricing, but involve other risks because as interest rates increase, the underlying payments by the borrower increase, thus increasing the potential for payment default. At the same time, the marketability of the underlying collateral may be adversely affected by higher interest rates. Upward adjustment of the contractual interest rate may also be limited by the maximum periodic interest rate adjustment permitted in certain adjustable-rate mortgage loan documents, and, therefore is potentially limited in effectiveness during periods of rapidly rising interest rates. These risks have not had an adverse effect on the Bank. The Bank's adjustable-rate loan portfolio includes approximately$14.8 million in loan participations indexed to the London Interbank Offered Rate ("LIBOR") which is expected to be phased out byJune 30, 2023 . The Bank anticipates that the terms of LIBOR-based loans, which have not matured prior to the phase-out of LIBOR will be negotiated to incorporate a to-be-determined substitute reference rate. The Bank must rely on the lead bank to renegotiate the terms of loans in which the Bank has a participation. There can be no assurance that the lead bank will be able to successfully renegotiate the loans in which the Bank has participations or that the substitute reference rate will perform as satisfactorily as LIBOR. Consumer lending, including indirect financing, provides benefits to the Bank's asset/liability management program by reducing the Bank's exposure to interest rate changes, due to their generally shorter terms. Such loans may entail additional credit risks compared to owner-occupied residential mortgage lending especially when unsecured or secured by collateral such as automobiles that depreciate rapidly. Commercial lending including real-estate related loans entail significant additional risks when compared with residential real estate and consumer lending. For example, commercial loans typically involve larger loan balances to single borrowers or groups of related borrowers. The payment experience on such loans typically is dependent on the successful operation of the project and these risks can be significantly impacted by the cash flow of the borrowers and market conditions for commercial office, retail, and warehouse space. In periods of decreasing cash flows, the commercial borrower may permit a lapse in general maintenance of the property causing the value of the underlying collateral to deteriorate. The liquidation of commercial property is often more costly and may involve more time to sell than residential real estate. The Bank offsets such factors with requiring more owner equity, a lower loan to value ratio and 12
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by obtaining the personal guaranties of the principals. In addition, a majority of the Bank's commercial real estate portfolio is owner-occupied property.
Commercial loans and leases are considered to have a higher degree of credit risk than secured real estate lending. The repayment of unsecured commercial business loans is wholly dependent on the success of the borrower's business, while secured commercial business loans may be secured by collateral that may not be readily marketable in the event of default. Municipal financing includes lending to local taxing authorities and revenue-producing projects. Such loans may constitute the general obligation of the taxing authority or may rely on a specific revenue source which is responsible for the repayment of the debt. General obligations are considered to carry a lower level of risk than other loan types since they are backed by the full faith and credit of the taxing authority. Revenue obligations are backed solely by revenues generated by the project financed and repayment may be affected by the success of the project. Due to the type and nature of the collateral, consumer lending generally involves more credit risk when compared with residential real estate lending. Consumer lending collections are typically dependent on the borrower's continuing financial stability, and thus, are more likely to be adversely affected by job loss, divorce, illness and personal bankruptcy. In most cases, any repossessed collateral for a defaulted consumer loan will not provide an adequate source of repayment of the outstanding loan balance. The remaining deficiency is usually turned over to a collection agency. There are additional risks associated with indirect lending since we must rely on the dealer to provide accurate information to us and accurate disclosures to the borrowers. These loans are principally done on a non-recourse basis. We seek to mitigate these risks by only dealing with dealers with whom we have a long-standing relationship. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") prohibits lenders from making residential mortgages unless the lender makes a reasonable and good faith determination that the borrower has a reasonable ability to repay the mortgage loan according to its terms. A borrower may recover statutory damages equal to all finance charges and fees paid within three years of a violation of the ability-to-repay rule and may raise a violation as a defense to foreclosure at any time. As authorized by the Dodd-Frank Act, theConsumer Financial Protection Bureau ("CFPB") has adopted regulations defining "qualified mortgages" that are presumed to comply with the Dodd-Frank Act's ability-to-repay rules. Under theCFPB regulations, qualified mortgages must satisfy the following criteria: (i) no negative amortization, interest-only payments, balloon payments, or term greater than 30 years; (ii) no points or fees in excess of 3% of the loan amount for loans over$100,000 ; (iii) borrower's income and assets are verified and documented; and (iv) the borrower's debt-to-income ratio generally may not exceed 43%. Qualified mortgages are conclusively presumed to comply with the ability-to-pay rule unless the mortgage is a "higher cost" mortgage, in which case the presumption is rebuttable. Under the EGRRCPA, enacted in 2018, residential mortgages originated for portfolio by insured depository institutions, like the Bank, with less than$10 billion in total consolidated assets will be treated as qualified mortgages; provided that the mortgage terms do not include interest-only payments or negative amortization, total points and fees do not exceed 3% of the loan amount, prepayment penalties are not in excess of those permitted for qualified mortgages under Regulation Z and the lender has considered and documented the debt, income and financial resources of the borrower. The Bank has established various lending limits for its officers and also maintains an Officer Loan Committee to approve higher loan amounts. The Officer Loan Committee is comprised of the President and Chief Executive Officer,Chief Lending Officer and other Bank officers. The Officer Loan Committee has the authority to approve all loans up to set limits based on the type of loan and the collateral. Requests in excess of these limits must be submitted to the Directors' Loan Committee or Board of Directors for approval. Additionally, the President and Chief Executive Officer, and the Chief Lending Officer and other officers have the authority to approve secured and unsecured loans up to amounts approved by the Board of Directors and maintained in the Bank's Loan Policy. Notwithstanding individual lending authority, certain loan policy exceptions must be submitted to the Officer Loan Committee for approval.
Hazard insurance coverage is required on all properties securing loans made by the Bank. Flood insurance is also required, when applicable.
Loan applicants are notified of the credit decision by letter. If the loan is
approved, the loan commitment specifies the terms and conditions of the proposed
loan including the amount, interest rate, amortization term, a brief description
of the required collateral, and the required insurance coverage. The borrower
must provide proof of fire, flood (if applicable) and casualty insurance on the
property serving as collateral and title insurance, and these applicable
insurances must be maintained during the full term of the loan.
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The following table sets forth maturities and interest rate sensitivity for selected categories of loans as ofDecember 31, 2021 . Scheduled repayments are reported in the maturity category in which payment is due. Demand loans, loans having no stated schedule of repayments and no stated maturity and overdrafts are reported as due in one year or less. After Five One Year After One to Years After Through 15 or Less Five Years years 15 years Total (dollars in thousands) Real Estate: Residential$ 49,550 $ 119,830 $ 75,898 $ 27,762 $ 273,040 Commercial 55,376 192,647 327,434 53,267 628,724 Agricultural 1,003 1,420 16,475 43,027 61,925 Construction 2,483 807 8,036 10,664 21,990 Commercial loans 81,996 77,427 25,943 665 186,031 Other agricultural loans 10,390 10,700 13,848 2,992 37,930 Consumer loans 59,202 79,960 7,183 55 146,400 Total$ 260,000 $ 482,791 $ 474,817 $ 138,432 $ 1,356,040 Loans with fixed rates$ 46,765 $ 192,717 $ 345,033 $ 199,759 $ 784,274 Loans with floating rates 136,262 362,582 69,722 3,200 571,766 Total$ 183,027 $ 555,299 $ 414,755 $ 202,959 $ 1,356,040
allowance for Loan Losses
The allowance for loan losses totaled$16,442,000 as ofDecember 31, 2021 and represented 1.21% of total loans receivable compared to$13,150,000 and 0.93% of total loans as of year-end 2020. Net charge-offs for 2021 totaled$908,000 and represented 0.07% of average loans compared to$809,000 and 0.07% of average loans in 2020. Management assesses the adequacy of the allowance for loan losses on a quarterly basis. The process includes a review of the risks inherent in the loan portfolio. It also includes an analysis of impaired loans and a historical review of losses. Other factors considered in the analysis include: concentrations of credit in specific industries in the commercial portfolio, the local and regional economic conditions, trends in delinquencies, internal risk rating classifications, total loan growth in the portfolio and fluctuations in large balance credits. During 2020, the Company added qualitative factors for COVID-19 related industries and for loans which have received deferral of payment due to COVID-19 factors. For loans acquired, including those that are not deemed impaired at acquisition, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value. Subsequent to the purchase date, the methods utilized to estimate the required allowance for credit losses for these loans is similar to originated loans; however, the Company records a provision for loan losses only when the required allowance exceeds any remaining credit discounts. The Company has limited exposure to higher-risk loans. The Company does not originate option ARM products, interest only loans, sub-prime loans or loans with initial teaser rates in its residential real estate portfolio. The Company has$10.8 million of junior lien home equity loans. For 2021, there were$13,000 of charge-offs for this portfolio, with recoveries of$13,000 in 2021. As ofDecember 31, 2021 , the Company considered its concentration of credit risk profile to be acceptable. The highest concentrations are in commercial rentals and the residential rentals categories. During 2020, the Company recognized an increase in its adversely classified loans due primarily to loan balances acquired from UpState. The loans were accounted for in accordance with ASC 310-30, and were appropriately recorded at fair value after recording a specific loan fair value adjustment of$6,937,000 . The Company assesses a loss factor against the classified loans, which is based on prior experience. Classified loans that are considered impaired are measured on a loan-by-loan basis. The Company values such loans by either the present value of expected cash flows, the loan's obtainable market price or the fair value of collateral if the loan is collateral dependent. AtDecember 31, 2021 , the recorded investment in impaired loans, not requiring an allowance for loan losses, was$157,000 (net of charge-offs against the allowance for loan losses of$0 ). The recorded investment in impaired loans, requiring an allowance for loan losses, was$1,517,000 , (net of charge-offs against the allowance for loan losses of$0 ) . AtDecember 31, 2020 , the recorded 14
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investment in impaired loans not requiring an allowance for loan losses, was$2,662,000 (net of charge-offs of$652,000 ). The recorded investment in impaired loans, requiring an allowance for loan losses, was$0 .
As a result of its analysis, after applying these factors, management considers
the allowance as of
The following table sets forth information with respect to the Bank's allowance
for loan losses as of
As of December 31,
2021 2020
(dollars in thousands)
Total loans receivable, net of deferred fees
Allowance balance at beginning of period$ 13,150 $
8,509
Net (charge-offs) recoveries: Real Estate-Residential 57 (35) Real Estate-Commercial (433) (413) Real Estate-Agricultural - - Real Estate-Construction - - Commercial loans (124) 37 Other agricultural loans (27) (11) Consumer (381) (387) Total (908) (809) Provision Expense 4,200 5,450 Allowance balance at end of period$ 16,442 $ 13,150 Average loans receivable: Real Estate-Residential$ 264,305 $ 241,961 Real Estate-Commercial 595,854 511,592 Real Estate-Agricultural 64,295 26,935 Real Estate-Construction 21,793 18,268 Commercial loans 247,953 206,164 Other agricultural loans 40,215 16,645 Consumer 152,478 156,208 Total average loans outstanding$ 1,386,893 $
1,177,773
Net (charge-offs) recoveries as a percent of average loans outstanding Real Estate-Residential 0.02 % (0.01) % Real Estate-Commercial (0.07) (0.08) Real Estate-Agricultural - - Real Estate-Construction - - Commercial loans (0.05) 0.02 Other agricultural loans (0.07) (0.07) Consumer (0.25) (0.25) Total net charge-offs (0.07) % (0.07) % Credit Quality Ratios: As a percent of year-end loans, net of unearned income: Allowance for loan losses 1.21% 0.93% Nonaccrual loans 0.05% 0.24% Nonperforming loans 0.05% 0.24% Allowance for loan losses to nonaccrual loans 2557.08%
387.79%
Allowance for loan losses to nonperforming loans 2240.05% 387.79%
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The following table sets forth the allocation of the Bank's allowance for loan
losses by loan category and the percent of loans in each category to total loans
at the date indicated. The allocation is made for analytical purposes and is not
necessarily indicative of the categories in which credit losses may occur. The
total allowance is available to absorb losses from any type of loan.
As of December 31,
2021 2020
% of % of
Loans Loans
to Total to Total
Amount Loans Amount Loans
(dollars in thousands)
Real estate - residential $ 2,175 20.1 % $ 1,960 18.6 %
Real estate - commercial 10,878 46.4 8,004 41.0
Real estate - agricultural - 4.6 - 4.7
Real estate - construction 133 1.6 150 1.5
Commercial 1,490 13.7 1,360 20.1
Other agricultural loans - 2.8 - 2.9
Consumer 1,766 10.8 1,676 11.2
Total $ 16,442 100 % $ 13,150 100 %
As a result of the acquisition of UpState, the Company added $107.3 million of
agricultural loans to the loan portfolio. These loans are included in the
outstanding balance information, but do not require an allocation of the
allowance for loan losses since they were recorded at fair value in accordance
with ASC 310-20 and ASC 310-30.
Additional information about the allowance for loan losses at December 31, 2021
is presented under "Item 1. Business" of this Annual Report on Form 10-K, as
well as in Note 2 and Note 4 to the audited consolidated financial statements.
Non-Performing Assets
Non-performing assets consist of non-performing loans and real estate owned as a result of foreclosure, which is held for sale. Loans are placed on non-accrual status when management believes that a borrower's financial condition is such that collection of interest is doubtful. Commercial and real estate related loans are generally placed on non-accrual when interest is 90 days delinquent. When loans are placed on non-accrual, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against the allowance for loan losses. As ofDecember 31, 2021 , non-performing loans totaled$734,000 and represented 0.05% of total loans compared to$3,391,000 or 0.24% as ofDecember 31, 2020 . The decrease in the level of non-performing loans reflects upgrades to accrual status on several loans acquired from UpState, as well as payments received on other non-performing credits. Additionally, one loan with a carrying value of$1,487,000 as ofDecember 31, 2020 was transferred toForeclosed Real Estate Owned during 2021. Foreclosed real estate owned totaled$1,742,000 as ofDecember 31, 2021 and$965,000 as ofDecember 31, 2020 . During 2021, property with a carrying value of$255,000 was disposed of through a sale. The Company did not recorded a gain from the sale of the property. Additionally, one loan with a carrying value of$1,032,000 was transferred to Foreclosed Real Estate Owned during 2021.
Securities
The securities portfolio consists ofU.S. Treasury securities,U.S. Government agencies, mortgage-backed securities issued by government sponsored entities and municipal obligations. The Company classifies its investments into two categories: held to maturity (HTM) and available for sale (AFS). The Company does not have trading securities. Securities classified as HTM are those in which the Company has the ability and the intent to hold the security until contractual maturity. As ofDecember 31, 2021 , there were no securities carried in the HTM portfolio. Securities classified as AFS are eligible to be sold due to liquidity needs or interest rate risk management. These securities are adjusted to and carried at their fair value with any unrealized gains or losses recorded net of deferred income taxes, as an adjustment to capital and reported in the equity section of the Consolidated Balance Sheet as other comprehensive income. As ofDecember 31, 2021 ,$406.8 million of securities were so classified and carried at their fair value, with unrealized losses, net of tax, of$1,453,000 included in accumulated other comprehensive income as a component of stockholders' equity. The Company considers its investment portfolio a source of earnings and liquidity. Investment securities may also be pledged to secure public deposits and customer repurchase agreements. 16
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As ofDecember 31, 2021 , the average life of the portfolio was 5.6 years. The Company has maintained a relatively short average life in the portfolio in order to generate cash flow to support loan growth and maintain liquidity levels. Purchases for the year totaled$268.2 million , while maturities and principal reductions totaled$68.2 million and proceeds from sales were$11.4 million . The purchases were funded principally by cash flow generated from the portfolio and excess overnight liquidity. The following table sets forth certain information regarding securities not carried at fair value through earnings, weighted average yields, and maturities of the Company's securities portfolio as ofDecember 31, 2021 and 2020. Yields on tax-exempt securities are stated on a fully taxable equivalent basis using a Federal tax rate of 21%. Actual maturities may differ from contractual maturities as certain instruments have call features which allow prepayment of obligations. Maturity on the mortgage-backed securities is based upon contractual terms, the average life may differ as a result of changes in cash flow. After One After Five Total Investment One Year or Less Through Five Years Through Ten Years After Ten Years Securities Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average Value Yield Value Yield Value Yield Value Yield Value Yield (dollars in thousands)U.S. Treasury securities $ - - %$ 1,060 1.01 %$ 18,291 1.19 % $ - - %$ 19,351 1.18 % U.S. Government agencies - - - - 16,011 1.51 16,011 1.51 State and political subdivision 583 1.93 10,427 3.14 20,601 2.25 114,256 2.33 145,867 2.38 Corporate obligations - - - - - - - - - - Mortgage-backed securities-government sponsored entities - - 2,665 2.40 4,110 1.96 218,778 1.39 225,553 1.41 Total Investment Securities$ 583 1.93 %$ 14,152 2.84 %$ 59,013 1.70 %$ 333,034 1.71 %$ 406,782 1.75 % The portfolio had no adjustable-rate instruments as ofDecember 31, 2021 and 2020. The portfolio contained no private label mortgage-backed securities, collateralized debt obligations (CDOs), or trust preferred securities, and no off-balance sheet derivatives were in use. As ofDecember 31, 2021 , the portfolio did not contain any step-up bonds. The mortgage-backed securities portfolio includes pass-through bonds and collateralized mortgage obligations (CMO's) issued by Fannie Mae, Freddie Mac and theGovernment National Mortgage Association (GNMA). The Company evaluates the securities in its portfolio for other-than-temporary-impairment (OTTI) as fair value declines below cost. In estimating OTTI, management considers (1) the length of time and the extent of the decline in fair value and (2) the financial condition and near-term prospects of the issuer. As ofDecember 31, 2021 , the Company held 140 investment securities in a loss position, which had a combined unrealized loss of$4.8 million . Management believes that these losses are principally due to changes in interest rates and represent temporary impairment as the Company does not have the intent to sell these securities and it is more likely than not that it will not have to sell the securities before recovery of their cost basis. No impairment charges were recognized in 2021 or 2020.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company uses fair value measurements to record fair value adjustments to certain financial instruments and determine fair value disclosures (see Note 16 of Notes to the Consolidated Financial Statements). Approximately$406.8 million , which represents 19.7% of total assets atDecember 31, 2021 , consisted of financial instruments recorded at fair value on a recurring basis. This amount consists entirely of the Company's available for sale securities portfolio and interest rate derivatives. The Company uses valuation methodologies involving market-based or market-derived information, collectively Level 1 and 2 measurements, to measure fair value. There were no transfers into or out of Level 3 for any instruments for the years endedDecember 31, 2021 and 2020. The Company utilizes a third party provider to perform valuations of the investments. Methods used to perform the valuations include: pricing models that vary based on asset class, available trade and bid information, actual transacted prices, and proprietary models for valuations of state and municipal obligations. In addition, the Company has a sample of fixed-income securities valued by another independent source. The Company does not adjust values received from its providers, unless it is evident that fair value measurement is not consistent with the Company's policies. 17
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The Company also utilizes a third party provider to provide the fair value of certain loan servicing rights. Fair value for the purpose of this measurement is defined as the amount at which the asset could be exchanged in a current transaction between willing parties, other than in a forced liquidation. The fair value of mortgage servicing rights as ofDecember 31, 2021 and 2020 was$500,000 and$476,000 , respectively.
DEPOSITS
The Bank provides a full range of deposit products to its retail and business customers. These include interest-bearing and noninterest bearing transaction accounts, statement savings and money market accounts. Certificate of deposit terms range up to five years for retail instruments. As ofDecember 31, 2021 , the Bank has$992,000 of brokered deposits obtained through internet listing services, and no broker deposits which were secured throughCede & Co. All of these brokered deposits were acquired from UpState. The Bank has no current brokered deposits through its participation in the Certificate of Deposit Account Registry Service ("CDARS"). The Bank participates in the Jumbo CD ($100,000 and over) markets with local municipalities and school districts which are typically priced on a competitive bid basis. Other services the Bank offers its customers include cash management, direct deposit, Remote Deposit Capture, mobile deposit capture, PopMoney® mobile payments and Automated Clearing House (ACH) activity. The Bank operates thirty-one automated teller machines and is affiliated with the MoneyPass® ATM network. Internet banking including bill-pay is offered through the website at www.waynebank.com. Other services, such as eStatements and mobile banking are available online. The following table sets forth information regarding deposit categories of the Company. Years Ended December 31, 2021 2020 Average Average Balance Rate Paid Balance Rate Paid (dollars in thousands) Noninterest-bearing demand$ 423,404 - %$ 297,175 - % Interest-bearing demand 180,080 0.11 123,172 0.13 Money Market 295,626 0.23 185,214 0.28 Savings 265,981 0.06 200,042 0.06 Time 517,087 0.71 457,844 1.27 Total$ 1,682,178 $ 1,263,447 As ofDecember 31, 2021 and 2020, the total of uninsured deposits of the Company was$235,515,000 and$177,596,000 , respectively. Total uninsured deposits is calculated based on regulatory reporting requirements and reflects the portion of any deposit of a customer at an insured depository institution that exceeds the applicableFDIC insurance coverage for that depositor at that institution and amounts in any other uninsured investment or deposit accounts that are classified as deposits and not subject to any federal or state deposit insurance regime.
As of
The following table indicates the amount of time deposits that are uninsured by
time remaining until maturity as of
Amount
(in thousands)
Three months or less $ 65,401
Over 3 through 6 months 55,639
Over 6 months through 12 months 109,607
Over 12 months 26,591
$ 257,238
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Total deposits as ofDecember 31, 2021 , were$1.757 billion , an increase of$221.4 million fromDecember 31, 2020 . Deposit growth included$145.4 million in non-maturity interest-bearing deposits, and$81.1 million in non-interest bearing demand deposits. The large increases recorded in 2021 reflect the cash inflow from economic stimulus related to the Covid-19 pandemic. Time deposits decreased$5.1 million . Time deposits over$250,000 , which consist principally of school district funds, other public funds and short-term deposits from large commercial customers with maturities generally less than one year, totaled$257.2 million as ofDecember 31, 2021 , compared to$205.4 million at year-end 2020. These deposits are subject to competitive bid and the Company bases its bid on current interest rates, loan demand, investment portfolio structure and the relative cost of other funding sources. As ofDecember 31, 2021 , non-interest bearing demand deposits totaled$440.7 million compared to$359.6 million at year-end 2020. Cash management accounts in the form of securities sold under agreements to repurchase included in short-term borrowings, totaled$60.8 million at year end 2021 compared to$63.3 million as ofDecember 31, 2020 . These balances represent commercial and municipal customers' funds invested in overnight securities. The Company considers these accounts as a source of core funding.
RESULTS OF OPERATIONS
Summary
Net income for the Company for the year endedDecember 31, 2021 was$24,915,000 , which was$9,835,000 higher than the$15,080,000 earned in 2020. Earnings per share on a fully diluted basis were$3.04 for 2021 compared to$2.09 in 2020. The return on average assets for the year was 1.24% with a return on average equity of 12.35%, compared to 0.97% and 9.06%, respectively, in 2020. Net interest income increased$14,837,000 , which offset a$4,138,000 increase in other expenses. The variances reflect the full-year effect of the results of the acquisition of UpState. Net interest income (fully taxable equivalent, or fte) totaled$66,100,000 , which was an increase of$14,741,000 from the 2020 total. Average loans outstanding increased$209.1 million in 2021, which resulted in an increase in interest income (fte) of$11.1 million . Total average securities increased$120.0 million in 2021 as proceeds from deposit growth and overnight liquidity were used to fund new purchases, resulting in a$1.2 million increase in interest income (fte) on securities. Average interest-bearing deposits increased$292.5 million , but decreasing interest rates on certificates of deposit resulted in a$1.9 reduction in interest expense. The cost of borrowed funds decreased$369,000 compared to the prior year due primarily to a lower cost of borrowings. The resulting net interest spread (fte) increased three basis points to 3.39% in 2021 as a 29 basis point reduction in the yield earned was offset by a 32 basis point decrease in the cost of funds. All variances include the full-year impact from the acquisition of UpState. Loans receivable decreased$55.8 million from the prior year-end, due primarily to a$78.8 million decrease in PPP loans resulting from loan forgiveness. Loan growth included a$49.6 million increase in commercial real estate loans. Retail loans decreased$5.2 million in 2021 due to a$4.4 million decrease in real estate loans secured by farmland and a$4.7 million decrease in indirect auto and marine financing. Residential mortgage loans and construction loans increased$10.9 million , net. Total non-performing loans decreased from$3,391,000 , or 0.24% of total loans at the end of 2020, to$734,000 , or 0.05% of total loans onDecember 31, 2021 . Net charge-offs totaled$908,000 in 2021, which was an increase from the$809,000 recorded in 2020. Based on management's analysis, the Company determined that it would be appropriate to allocate$4,200,000 to the allowance for loan losses in 2021, which resulted in an increase in the ratio of the allowance for loan losses to total loans outstanding of 1.21% atDecember 31, 2021 compared to 0.93% atDecember 31, 2020 . The allowance for loan losses represented 2,240% of total non-performing loans onDecember 31, 2021 compared to 388% as ofDecember 31, 2020 . Total other income for the year endedDecember 31, 2021 totaled$8,325,000 compared to$7,780,000 in the prior year, an increase of$545,000 . Gains on the sale of loans and investment securities decreased$329,000 in the aggregate, while service charges and fees increased$578,000 . All other items of other income increased$296,000 , net. The increase reflects the full-year of benefits derived from the acquisition of UpState. Other expenses were$38,578,000 in 2021 compared to$34,440,000 for the similar period in 2020, an increase of$4,138,000 . Salaries and benefits costs increased$3,487,000 in 2021, while occupancy and equipment costs rose$674,000 . All other operating expenses decreased$23,000 , net. The increases reflect the full-year cost of operating four new community offices acquired from UpState. Income tax expense for the year totaled$5,945,000 , which was an increase of$2,659,000 from the prior year. The effective tax rate in 2021 was 19.3% compared to 17.9% in 2020. 19
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The following table sets forth changes in net income (in thousands):
Net income 2020$ 15,080 Net interest income 14,837 Provision for loan losses 1,250
Net gains on sales of loans and securities (329) Other income
874
Salaries and employee benefits (3,487)
Occupancy, furniture and equipment (674)
Professional fees (520)
Merger related expenses 2,049
Other expenses (1,506)
Income tax expense (2,659)
Net income 2021 $ 24,915
NET INTEREST INCOME
Net interest income is the most significant source of revenue for the Company
and represented 88.7% of total revenue for the year ended December 31, 2021 . Net
interest income (fte) totaled $66,100,000 for the year ended December 31, 2021
compared to $51,359,000 for 2020, an increase of $14,741,000 . The resulting fte
net interest spread and net interest margin were 3.39% and 3.50%, respectively,
in 2021 compared to 3.36% and 3.55%, respectively, in 2020.
Interest income (fte) for the year ended December 31, 2021 totaled $71,857,000
compared to $59,338,000 in 2020. The fte yield on average earning assets was
3.81%, decreasing 29 basis points from the 4.10% reported last year. The
tax-equivalent yield on total loans increased 10 basis points to 4.73% in 2021,
while average loans outstanding increased $209.1 million , resulting in an
increase in interest income (fte) from loans of $11.1 million . The yield on
securities decreased 48 basis points in 2021 due primarily to lower yields on
new purchases. Average securities outstanding increased $120.0 million as cash
flow from deposit growth was utilized to fund new purchases, and interest income
(fte) from the portfolio increased $1.2 million .
Interest expense was $5,757,000 in 2021 which resulted in an average cost of
interest-bearing liabilities of 0.42% compared to total interest expense of
$7,979,000 in 2020 with an average cost of 0.74%. Total interest-bearing
deposits cost was 0.38% in 2021, which was a decrease of 30 basis points over
the prior year. The decrease in cost was due primarily to time certificates of
deposit that repriced to current market rates upon maturity, resulting in a
decrease in the interest rate paid from 1.27% in 2020 to 0.71% in 2021.
Borrowing costs also decreased in 2021, reflecting the lower interest rate
environment.
PROVISION FOR LOAN LOSSES
The provision for loan losses was$4,200,000 in 2021 compared to$5,450,000 in 2020. The decreased provision for loan losses recorded in 2021 reflects the improvement in the economic factor and other qualitative factors that are utilized to establish a subjective assessment of the adequacy of the allowance for loan losses. Qualitative factors specific to the pandemic that were developed in 2020 required a$2.3 million allocation to the required allowance for loan losses atDecember 31, 2021 . Additionally, the qualitative factor related to large balance loans added$1.4 million to the allowance in 2021 due to growth in this category of loans and an increase in the factor. Management assesses the adequacy of the allowance for loan losses on a quarterly basis. The process includes a review of the risks inherent in the loan portfolio. It also includes an analysis of impaired loans and a historical review of losses. Other factors considered in the analysis include: concentrations of credit in specific industries in the commercial portfolio, the local and regional economic conditions, trends in delinquencies, internal risk rating classifications, total loan growth in the portfolio and fluctuations in large balance credits. For loans acquired, including those that are not deemed impaired at acquisition, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value. Subsequent to the purchase date, the methods utilized to estimate the required allowance for credit losses for these loans is similar to originated loans; however, the Company records a provision for loan losses only when the required allowance exceeds any remaining credit discounts.
OTHER INCOME
Total other income was$8,325,000 for the year endedDecember 31, 2021 compared to$7,780,000 in 2020, an increase of$545,000 . Service charges and fees increased$572,000 in 2021, while gains on the sale of loans and investment securities decreased$329,000 in the aggregate. All other items of other income increased$302,000 , net. 20
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Other Income (dollars in thousands)
For the year ended
2021 2020
Service charges on deposit accounts $ 398 $ 377
ATM Fees 443 457
Overdraft Fees 1,029 985
Safe deposit box rental 100 102
Loan related service fees 1,368 1,416
Debit card 2,228 1,656
Fiduciary activities 748 682
Commissions on mutual funds & annuities 127 122
Earnings on and proceeds from bank-owned life insurance 941 845 Other income
674 540
8,056 7,182
Net realized gains on sales of securities 92 71
Gains on sales of loans 177 527
Total $ 8,325 $ 7,780
OTHER EXPENSES
Other expenses totaled $38,578,000 for the year ended December 31, 2021 compared
to $34,440,000 in the prior year. The $4,138,000 increase in other expenses
reflects the additional costs related to the operations of the four new
community offices acquired from UpState. Salaries and employee benefits costs
increased $3,487,000 in 2021, while occupancy and equipment costs increased
$674,000 . All other operating expenses decreased $23,000 , net. The Company's
efficiency ratio, which measures total other expenses as a percentage of net
interest income (fte) plus other income, was 51.8% in 2021 compared to 58.2% in
2020.
Other Expenses (dollars in thousands)
For the year ended
2021 2020
Salaries $ 12,944 $ 10,903
Employee benefits 7,664 6,218
Occupancy 3,533 3,128
Furniture and equipment 1,289 1,020
Data processing and related operations 2,415 2,457
Federal Deposit Insurance Corporation insurance assessment 681 399 Advertising 473 385 Professional fees 1,582 1,062 Postage and telephone 993 983 Office supplies 443 555 Taxes, other than income 1,122 997 Foreclosed real estate 115 53 Amortization of intangible assets 123 114 Merger related - 2,049 Other 5,201 4,117 Total$ 38,578 $ 34,440 INCOME TAXES Income tax expense for the year endedDecember 31, 2021 totaled$5,945,000 , which resulted in an effective tax rate of 19.3%, compared to$3,286,000 and 17.9% for 2020. The higher effective tax rate reflects the increase in taxable income. CAPITAL AND DIVIDENDS Total stockholders' equity as ofDecember 31, 2021 , was$205.3 million , compared to$194.8 million as ofDecember 31, 2020 . Earnings retention net of an$8.7 million reduction resulting from cash dividends declared, contributed to the increase. Fluctuations in interest rates impacted the fair value of the Company's Available-for Sale securities, and contributed to$5.4 million decrease in capital as a reduction in accumulated other comprehensive income. As ofDecember 31, 2021 the Company had a leverage capital ratio of 21
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8.51%, a Tier 1 risk-based capital ratio and a common equity Tier 1 risk-based
capital ratio of 12.49%, and a total risk-based capital ratio of 13.66%,
compared to 8.71%, 11.65% and 12.62%, respectively, at
NON-GAAP FINANCIAL MEASURES
This Annual Report contains or references tax-equivalent interest income and net
interest income, which are non-GAAP financial measures. Tax-equivalent interest
income and net interest income are derived from GAAP interest income and net
interest income using a marginal tax rate of 21%. We believe the presentation of
interest income and net interest income on a tax-equivalent basis ensures
comparability of interest income and net interest income arising from both
taxable and tax-exempt sources and is consistent with industry practice.
The following table reconciles net interest income to net interest income on a
tax-equivalent basis:
(dollars in thousands) Years ended December 31,
2021 2020
Net interest income $ 65,313 $ 50,476
Tax-equivalent basis adjustment
using a 21% marginal tax rate 787 883
Net interest income on a fully
taxable equivalent basis $ 66,100 51,359
22
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CONSOLIDATED AVERAGE BALANCE SHEETS WITH RESULTANT INTEREST AND RATES
(Tax-Equivalent Basis, dollars in thousands)
Year Ended December
31 2021 2020
Average Average Average Average
Balance Interest Rate Balance Interest Rate
(2) (1) (2) (1)
ASSETS
Interest-earning
assets:
Interest-bearing
deposits with banks $ 175,854 $ 266 0.15 % $ 65,812 $ 72 0.11 %
Securities available
for sale:
Taxable 261,912 4,055 1.55 150,019 2,915 1.94
Tax-exempt 61,610 1,889 3.06 53,502 1,800 3.37
Total securities
available for sale 323,522 5,944 1.84 203,521 4,715 2.32
Loans receivable
(3)(4) 1,386,893 65,647 4.73 1,177,773 54,551 4.63
Total
interest-earning
assets 1,886,269 71,857 3.81 1,447,106 59,338 4.10
Noninterest earning
assets:
Cash and due from
banks 23,828 18,693
Allowance for loan
losses (15,263) (10,388)
Other assets 114,210 100,144
Total noninterest
earning assets 122,775 108,449
TOTAL ASSETS $ 2,009,044 $ 1,555,555
LIABILITIES AND
STOCKHOLDERS' EQUITY
Interest-bearing
liabilities:
Interest-bearing
demand and money
market $ 475,706 894 0.19 $ 308,386 683 0.22
Savings 265,981 169 0.06 200,042 112 0.06
Time 517,087 3,694 0.71 457,844 5,815 1.27
Total
interest-bearing
deposits 1,258,774 4,757 0.38 966,272 6,610 0.68
Short-term
borrowings 73,810 284 0.38 57,014 325 0.57
Other borrowings 36,196 716 1.98 50,286 1,044 2.08
Total
interest-bearing
liabilities 1,368,780 5,757 0.42 1,073,572 7,979 0.74
Noninterest-bearing
liabilities:
Noninterest-bearing
demand deposits 423,404 297,175
Other liabilities 15,179 18,381
Total
noninterest-bearing
liabilities 438,583 315,556
Stockholders' equity 201,681 166,427
TOTAL LIABILITIES
AND STOCKHOLDERS'
EQUITY $ 2,009,044 $ 1,555,555
Net Interest
Income/spread
(tax equivalent
basis) 66,100 3.39 % 51,359 3.36 %
Tax-equivalent basis
adjustment (787) (883)
Net Interest Income $ 65,313 $ 50,476
Net interest margin
(tax equivalent
basis) 3.50 % 3.55 %
(1)Interest and yields are presented on a tax-equivalent basis using a marginal tax rate of 21%.
(2)Average balances have been calculated based on daily balances.
(3)Loan balances include non-accrual loans and are net of unearned income.
(4)Loan yields include the effect of amortization of purchased credit marks and deferred fees net of costs.
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RATE/VOLUME ANALYSIS
The following table shows the fully taxable equivalent effect of changes in volumes and rates on interest income and interest expense.
Increase/(Decrease)
(dollars in thousands) 2021 compared to 2020
Variance due to
Volume Rate Net
INTEREST-EARNING ASSETS:
Interest-bearing deposits $ 135 $ 59 $ 194
Securities available for sale:
Taxable 2,002 (862) 1,140
Tax-exempt securities 267 (178) 89
Total securities available for sale 2,269 (1,040) 1,229
Loans receivable 9,731 1,365 11,096
Total interest-earning assets 12,135 384 12,519
INTEREST-BEARING LIABILITIES Interest-bearing demand and money market 344 (133) 211 Savings
57 - 57
Time 468 (2,589) (2,121)
Total interest-bearing deposits 869 (2,722) (1,853)
Short-term borrowings 76 (117) (41)
Other borrowings (291) (37) (328)
Total interest-bearing liabilities 654 (2,876) (2,222)
Net interest income (tax-equivalent basis)
Changes in net interest income that could not be specifically identified as either a rate or volume change were allocated proportionately to changes in volume and changes in rate.
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