Community Financial System, Inc.: Form 10-Q for the period ended Sep 30, 2023

This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) primarily reviews the financial condition and results of operations of Community Bank System, Inc. (the “Company” or “CBSI”) as of and for the three and nine months ended September 30, 2023 and 2022, although in some circumstances the second and first quarters of 2023 are also discussed in order to more fully explain recent trends. The following discussion and analysis should be read in conjunction with the Company's Consolidated Financial Statements and related notes that appear on pages 3 through 34. All references in the discussion of the financial condition and results of operations refer to the consolidated position and results of the Company and its subsidiaries taken as a whole. Unless otherwise noted, the term “this year” and equivalent terms refers to results in calendar year 2023, “last year” and equivalent terms refer to calendar year 2022, “third quarter” refers to the three months ended September 30, 2023, “YTD” refers to the nine months ended September 30, 2023, and earnings per share (“EPS”) figures refer to diluted EPS.

This MD&A contains certain forward-looking statements with respect to the financial condition, results of operations, and business of the Company. These forward-looking statements involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements are set herein under the caption “Forward-Looking Statements” on page 57.

Critical Accounting Policies and Estimates

As a result of the complex and dynamic nature of the Company’s business, management must exercise judgment in selecting and applying the most appropriate accounting policies for its various areas of operations. The policy decision process not only ensures compliance with the current accounting principles generally accepted in the United States of America (“GAAP”), but also reflects management’s discretion with regard to choosing the most suitable methodology for reporting the Company’s financial performance. It is management’s opinion that the accounting estimates covering certain aspects of the business have more significance than others due to the relative importance of those areas to overall performance, or the level of subjectivity in the selection process. These estimates affect the reported amounts of assets and liabilities as well as disclosures of revenues and expenses during the reporting period. Actual results could meaningfully differ from these estimates. Management believes that the critical accounting estimates include the allowance for credit losses, actuarial assumptions associated with the pension, post-retirement and other employee benefit plans, the provision for income taxes, investment valuation, the carrying value of goodwill and other intangible assets and acquired loan valuations. A summary of the accounting policies used by management is disclosed in the MD&A on pages 31-33 and Note A, “Summary of Significant Accounting Policies” on pages 76-87 of the most recent Form 10-K (fiscal year ended December 31, 2022) filed with the Securities and Exchange Commission (“SEC”) on March 1, 2023, and there have been no material changes. A summary of new accounting policies used by management is disclosed in Note C, “Significant Accounting Policies” beginning on page 12 of this Form 10-Q.

Supplemental Reporting of Non-GAAP Results of Operations

The Company also provides supplemental reporting of its results on an “operating,” “adjusted” or “tangible” basis, from which it excludes the after-tax effect of amortization of core deposit and other intangible assets (and the related goodwill, core deposit intangible and other intangible asset balances, net of applicable deferred tax amounts), accretion on acquired non-purchased credit deteriorated (“PCD”) loans, acquisition expenses, acquisition-related contingent consideration adjustment, acquisition-related provision for credit losses, unrealized loss (gain) on equity securities, realized loss on investment securities and gain on debt extinguishment. Although these items are non-GAAP measures, the Company’s management believes this information helps investors and analysts measure underlying core performance and improves comparability to other organizations that have not engaged in acquisitions. In addition, the Company provides supplemental reporting for “adjusted pre-tax, pre-provision net revenues,” which excludes the provision for credit losses, acquisition expenses, acquisition-related contingent consideration adjustment, unrealized loss (gain) on equity securities, realized loss on investment securities and gain on debt extinguishment from income before income taxes. Although adjusted pre-tax, pre-provision net revenue is a non-GAAP measure, the Company’s management believes this information helps investors and analysts measure and compare the Company’s performance through a credit cycle by excluding the volatility in the provision for credit losses associated with the impact of CECL, helps investors and analysts measure underlying core performance and improves comparability to other organizations that have not engaged in acquisitions. The Company also provides supplemental reporting of its net interest margin on a “fully tax-equivalent” basis, which includes an adjustment to net interest income that represents taxes that would have been paid had nontaxable investment securities and loans been taxable. Although fully tax-equivalent net interest margin is a non-GAAP measure, the Company’s management believes this information helps enhance comparability of the performance of assets that have different tax liabilities. Diluted earnings per share were $0.82 in the third quarter of 2023, down $0.08, or 8.9%, from the third quarter of 2022. Diluted adjusted net earnings per share, a non-GAAP measure, were $0.86 in the third quarter of 2023, compared to $0.94 in the third quarter of 2022, an $0.08 per share, or 8.5%, decrease. Adjusted pre-tax, pre-provision net revenue, a non-GAAP measure, was $1.10 per share in the third quarter of 2023, down $0.15, or 12.0%, from the third quarter of 2022. Reconciliations of GAAP amounts with corresponding non-GAAP amounts are presented in Table 11.

Executive Summary

The Company’s business philosophy is to operate as a diversified financial services enterprise providing a broad array of banking and other financial services, including benefits administration, insurance services and wealth management services, to retail, commercial, institutional and municipal customers. The Company’s banking subsidiary is Community Bank, N.A. (the “Bank” or “CBNA”). The Company’s Benefit Plans Administrative Services, Inc. (“BPAS”) subsidiary is a leading provider of employee benefits administration, trust services, collective investment fund administration, and actuarial consulting services to customers on a national scale. In addition, the Company offers comprehensive financial planning, trust administration and wealth management services through its Community Bank Wealth Management Group operating unit and insurance services through its OneGroup NY, Inc. (“OneGroup”) operating unit.

The Company’s core operating objectives are: (i) optimize the branch network and digital banking delivery systems, primarily through disciplined acquisition strategies, certain selective de novo expansions and divestitures/consolidations, (ii) build profitable loan and deposit volume using both organic and acquisition strategies, (iii) manage an investment securities portfolio to complement the Company’s loan and deposit strategies and mitigate interest rate and liquidity risk and optimize net interest income generation, (iv) increase the noninterest component of total revenues through growth in existing banking, employee benefit, insurance and wealth management services business units, and the acquisition of additional financial services and banking businesses, and (v) utilize technology to deliver customer-responsive products and services and improve efficiencies.

Significant factors reviewed by management to evaluate achievement of the Company’s operating objectives and its operating results and financial condition include, but are not limited to: net income and earnings per share; return on assets and equity; components of net interest margin; noninterest revenues; noninterest expenses; credit metrics; loan and deposit growth; capital management; performance of individual banking and financial services units; performance of specific product lines and customers; liquidity and interest rate sensitivity; enhancements to customer products and services and their underlying performance characteristics; technology advancements; market share; peer comparisons; and the performance of recently acquired businesses.

Third quarter 2023 net income decreased $4.6 million, or 9.4%, compared to the third quarter of 2022, while YTD net income decreased $37.3 million, or 27.5% compared to the equivalent 2022 timeframe. Earnings per share of $0.82 for the third quarter of 2023 was $0.08 less than the third quarter of 2022, while 2023 YTD earnings per share of $1.82 was $0.67 lower than 2022 YTD earnings per share. The decrease in net income and earnings per share between the quarterly periods was due to an increase in operating expenses and a decrease in net interest income, partially offset by an increase in noninterest revenues and decreases in the provision for credit losses, income taxes and fully-diluted shares outstanding. The YTD decrease in net income and earnings per share was primarily the result of a $52.3 million pre-tax realized loss on the sale of certain available-for-sale investment securities during the first quarter of 2023 in connection with a balance sheet repositioning executed in order to reduce overnight borrowings and improve net interest income and margin. The sales were completed in January and February 2023 and preceded the negative developments in the banking industry that occurred in March 2023. The YTD decrease in net income and earnings per share was also reflective of increases in operating expenses, net interest income and noninterest revenues and decreases in income taxes, the provision for credit losses and fully-diluted shares outstanding.

Third quarter and YTD net income adjusted to exclude acquisition expenses, acquisition-related contingent consideration adjustments, acquisition-related provision for credit losses, gain on debt extinguishment, realized loss on sales of investment securities and the unrealized loss on equity securities (“operating net income”), a non-GAAP measure, decreased $4.8 million, or 9.8%, as compared to the third quarter of 2022 and decreased $2.5 million, or 1.7%, compared to September YTD 2022. Earnings per share adjusted to exclude acquisition expenses, acquisition-related contingent consideration adjustment, acquisition-related provision for credit losses, gain on debt extinguishment, realized loss on sales of investment securities and the unrealized loss on equity securities (“operating earnings per share”), a non-GAAP measure, of $0.82 for the third quarter decreased $0.08 compared to the third quarter of 2022. Operating earnings per share of $2.60 for the first nine months of 2023 decreased $0.02 compared to the prior year period. Reconciliations of GAAP amounts with corresponding non-GAAP amounts are presented in Table 11.

The Company’s deposit base and liquidity position continues to be strong, as the Company maintained total immediately available liquidity sources of $4.81 billion at the end of the third quarter of 2023, more than double its estimated uninsured deposits, net of collateralized and intercompany deposits. Estimated insured deposits, net of collateralized and intercompany deposits, represent greater than 80% of third quarter ending total deposits. The Company’s deposit base is well diversified across customer segments, which as of September 30, 2023 is comprised of approximately 61% consumer, 26% business and 13% municipal, and broadly dispersed with an average deposit balance per account under $20,000. Since the Federal Reserve began raising the federal funds rate on March 17, 2022 in an effort to combat inflation, the cycle-to-date deposit beta for the Company was 13% and the cycle-to-date total funding beta was 15%, reflective of a high proportion of non-interest bearing deposits, representing approximately 29% of total deposits, and the composition and stability of the customer base. In addition, more than 70% of the Company’s total deposits were in noninterest checking, interest checking and savings accounts at the end of the third quarter, and the Company does not currently utilize brokered or wholesale deposits.

Net interest margin increased seven basis points between the third quarter of 2022 and the third quarter of 2023 and increased 27 basis points on a YTD basis. Fully tax-equivalent net interest margin, a non-GAAP measure, also increased seven basis points between the third quarter of 2022 and the third quarter of 2023 and increased 28 basis points on a YTD basis. Loan balances increased on both an average and ending basis as compared to the prior year third quarter and YTD period, primarily reflective of continued strong organic loan growth along with the second quarter 2022 acquisition of Elmira Savings Bank (“Elmira”) which favorably impacted the average YTD balance growth. Deposit balances decreased on both an average and ending basis as compared to the third quarter of 2022 and YTD due in part to outflows driven by higher customer expenditure levels in the inflationary environment, as well as increased rate competition from other banks and non-depository financial institutions. However, deposit balances were up on an ending basis from the end of the prior quarter and the end of the prior year. The yield on average interest earning assets increased 76 basis points compared to the prior year third quarter and 81 basis points compared to the prior YTD period, as the yields on average loans, investments and interest-earning cash equivalents all improved. The yield on average loans for the third quarter increased 70 basis points compared to the third quarter of 2022 and 67 basis points between comparable YTD periods, driven by market-related increases in interest rates on new loans, a significant increase in variable and adjustable rate loan yields driven by rising market interest rates, including the prime rate, and a high level of new loan originations. The yield on average investments, including cash equivalents, increased 19 basis points compared to the prior year’s third quarter and 35 basis points on a YTD basis, which also benefitted from rising market interest rates and reflected the impact of the sale of certain available-for-sale investment securities during the first quarter of 2023 and the maturity of certain investment securities between the periods. The Company’s total cost of funds increased 72 basis points from last year’s third quarter and 55 basis points YTD, as the rate paid on interest-bearing deposits and the rate paid on borrowings both increased.

The provision for credit losses of $2.9 million for the third quarter and $7.1 million for YTD 2023 were $2.2 million and $4.9 million lower than the provision for credit losses for the comparable prior year periods, respectively. The third quarter and YTD 2023 provision for credit losses were reflective of a stabilizing economic outlook combined with an increase in loans outstanding while the third quarter and YTD 2022 provision for credit losses was reflective of a moderate deterioration in the economic outlook, an increase in loans outstanding and $3.9 million of acquisition-related provision for credit losses due to the Elmira acquisition. Asset quality remained strong during the third quarter of 2023. The nonperforming loan ratio of 0.39% at September 30, 2023 was only one basis point higher than the ratio at September 30, 2022 and three basis points above the ratio one quarter prior. The total delinquent loan ratio remained below historical averages at 0.90%, but increased slightly from 0.71% at the end of the third quarter of 2022 and 0.83% at the end of the prior quarter. Net charge-offs continued to be well below long-term average levels at $1.2 million, or an annualized 0.05% of average loans, for the third quarter and $3.5 million, or an annualized 0.05% of average loans, for the first nine months of 2023, compared to net charge-offs of $0.4 million, or an annualized 0.02% of average loans, for the prior year third quarter and $1.3 million, or an annualized 0.02% of average loans, for the first nine months of 2022.

Banking noninterest revenues, comprised of deposit service fees, mortgage banking and other banking services revenues, were down $0.9 million, or 5.1%, as compared to the prior year’s third quarter and were down $1.1 million, or 2.1%, between the comparable YTD periods. The Company implemented certain deposit fee changes, including the elimination of nonsufficient and unavailable funds fees on personal accounts late in the fourth quarter of 2022. Financial services business revenues, comprised of employee benefit services, insurance services and wealth management services revenues, were up $3.3 million, or 7.1%, as compared to the prior year’s third quarter and up $5.3 million, or 3.7%, compared to the prior YTD period. The increase in quarterly financial services business revenues reflected growth in all of the three business units while the YTD increase reflected increases in insurance services and employee benefit services revenues that were partially offset by a slight decline in wealth management services revenues.

Noninterest expenses increased $8.3 million, or 7.7%, between the third quarter of 2022 and the third quarter of 2023 and increased $25.2 million, or 7.9%, between September YTD 2022 and September YTD 2023. The YTD increase was primarily due to a $17.0 million, or 8.8%, increase in salaries and employee benefits driven by increases in merit and market-related employee wages, higher employee benefit-related expenses including higher medical expenses, and certain executive retirement-related expenses. The remaining net increase in other expense categories was due to various factors including general inflationary pressures, larger FDIC insurance expenses due in part to an increase in the base assessment rate effective on January 1, 2023, higher legal and professional fees associated with various matters, an increase in data processing and communications expenses due to the Company’s continued investment in customer-facing and back office digital technologies and higher business development and marketing expenses due to the Company’s investment in digital marketing initiatives and higher levels of targeted advertisements intended to generate deposits. The Company has initiated a plan to optimize the retail customer service workforce which will temporarily reduce branch-related operating expenses, and reinvest in the retail network through de novo branch expansion in new, more densely populated markets throughout the Company’s geographic footprint.

On July 26, 2023, the SEC finalized rules requiring registrants to disclose material cybersecurity incidents that they experience on Form 8-K and to disclose on an annual basis material information regarding their cybersecurity risk management, strategy, and governance. Annual disclosures will be required in CBSI’s Annual Report on Form 10-K for the year ended 2023. The Form 8-K disclosure requirements will become effective beginning on December 18, 2023.

Net Income and Profitability

As shown in Table 1, net income for the third quarter and September YTD of $44.1 million and $98.2 million, respectively, decreased $4.6 million, or 9.4%, as compared to the third quarter of 2022 and decreased $37.3 million, or 27.5%, compared to September YTD 2022. Earnings per share of $0.82 for the third quarter was $0.08 lower than the third quarter of 2022, while earnings per share for the first nine months of 2023 of $1.82 was $0.67 lower than the first nine months of 2022. The decrease in net income and earnings per share for the quarter was reflective of an increase in operating expenses and a decrease in net interest income, partially offset by an increase in noninterest revenues and decreases in the provision for credit losses, income taxes and fully-diluted shares outstanding. The decrease in net income and earnings per share for the YTD period as compared to the prior year was the result of a decrease in noninterest revenues, primarily due to the impact of a $52.3 million pre-tax realized loss on sales of investment securities in the first quarter of 2023 as part of a balance sheet repositioning, as well as an increase in operating expenses, partially offset by an increase in net interest income and decreases in the provision for credit losses, income taxes and fully-diluted shares outstanding. Operating net income, a non-GAAP measure, of $44.2 million and $140.2 million for the third quarter and September YTD, respectively, decreased $4.8 million, or 9.8%, as compared to the third quarter of 2022 and decreased $2.5 million, or 1.7%, compared to September YTD 2022. Operating earnings per share, a non-GAAP measure, of $0.82 for the third quarter was down $0.08 compared to the third quarter of 2022, while operating earnings per share of $2.60 for the first nine months of 2023 was down $0.02 compared to the first nine months of 2022. See Table 11 for Reconciliation of GAAP to Non-GAAP Measures.

As reflected in Table 1, third quarter net interest income of $107.8 million was down $2.6 million, or 2.4%, from the comparable prior year period. The quarterly decrease resulted from a decrease in interest-earning asset balances and an increase in the rate paid on interest-bearing liabilities, partially offset by an increase in the yield on interest-earning assets and a decrease in interest-bearing liability balances. Net interest income for the first nine months of 2023 increased $19.7 million, or 6.4%, versus the first nine months of 2022. The year-over-year improvement resulted from an increase in the yield on average interest-earning asset balances, partially offset by a decrease in average interest-earning asset balances and increases in the cost and average balance of interest-bearing liabilities.

The provision for credit losses for the third quarter of $2.9 million and September YTD of $7.1 million decreased $2.2 million and $4.9 million as compared to the third quarter and first nine months of 2022, respectively. The third quarter and YTD 2023 provision for credit losses was reflective of a stable economic outlook, continued low levels of net charge-offs, delinquent loans and nonperforming loans and an increase in loans outstanding. The YTD 2022 provision for credit losses included $3.9 million of acquisition-related provision for credit losses due to the Elmira acquisition.

Third quarter and year-to-date noninterest revenues were $67.6 million and $147.1 million, respectively, up $2.3 million, or 3.6%, from the third quarter of 2022 and down $48.0 million, or 24.6%, from the first nine months of 2022. The increase compared to the prior year’s third quarter was a result of increases in employee benefit services revenue, insurance services revenue, other banking revenues, wealth management services revenues and debit interchange and ATM fees, partially offset by decreases in deposit service charges and fees, mortgage banking revenues and a larger unrealized loss on equity securities. The YTD decrease was primarily due to the incurrence of the previously mentioned $52.3 million pre-tax realized loss on the sale of certain available-for-sale securities associated with the Company’s first quarter 2023 balance sheet repositioning, as well as decreases in deposit service charges and fees, debit interchange and ATM fees, wealth management services revenues, mortgage banking revenues and unrealized loss on equity securities, partially offset by increases in insurance services revenues, employee benefit services revenues and other banking revenues and a realization of a gain on debt extinguishment.

Noninterest expenses of $116.5 million and $343.6 million for the third quarter and September YTD periods, respectively, reflected an increase of $8.3 million, or 7.7%, from the third quarter of 2022 and an increase of $25.2 million, or 7.9%, from the first nine months of 2022. The increase in noninterest expenses for the quarterly and YTD periods were due to increases in salaries and benefits, other expenses, data processing and communications expenses, business development and marketing expenses and legal and professional fees, partially offset by decreases in acquisition-related expenses and amortization of intangible assets. Excluding acquisition-related expenses comprised of contingent consideration adjustments and integration-related expenses, 2023 operating expenses were $8.6 million, or 8.0%, higher for the third quarter and $29.1 million, or 9.3%, higher for the year-to-date timeframe.

The effective income tax rates were 21.2% and 21.1% for third quarter and YTD 2023, respectively, as compared to 22.0% and 21.6% for the comparable prior year periods. The decline in the quarterly and YTD effective income tax rates were primarily attributable to a decrease in the full-year 2023 pre-tax income projection as a result of the loss on investment security sales recognized in the first quarter of 2023.

A condensed income statement is as follows:

Table 1: Condensed Income Statements

(000’s omitted, except per share data)

Net Interest Income

Net interest income is the amount by which interest, dividends and fees on interest-earning assets (loans, investments and cash equivalents) exceeds the cost of funds, which consists primarily of interest paid to the Company’s depositors and interest paid on borrowings. Net interest margin is the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities as a percentage of interest-earning assets.

As shown in Table 2a, net interest income (with nontaxable income converted to a fully tax-equivalent basis, a non-GAAP measure) for the third quarter was $108.8 million, a decrease of $2.7 million, or 2.4%, compared to the same period last year. This was driven by a 100 basis point increase in the rate paid on average interest-bearing liabilities and a $666.2 million decrease in average interest-earning assets, partially offset by a 76 basis point increase in the yield on average interest-earnings assets and a $42.6 million decrease in average interest-bearing liabilities in comparison to the third quarter of 2022. As reflected in Table 3 for the quarter, net interest income was unfavorably impacted by $24.3 million due to the increase in the rate paid on average interest-bearing liabilities and $5.5 million due to the volume decrease in interest-earning assets, partially offset by the favorable impact on net interest income of $27.1 million due to the increase in the yield on average interest-earning assets. September YTD net interest income (with nontaxable income converted to a fully tax-equivalent basis), as reflected in Table 2b, of $331.3 million, increased $19.9 million, or 6.4%, from the year-earlier period. The September YTD increase resulted from an 81 basis point increase in the yield on average interest-earning assets, partially offset by a $58.4 million increase in average interest-bearing liabilities, a $412.0 million decrease in average interest-earning assets and a 77 basis point increase in the average rate paid on interest-bearing liabilities. As reflected in Table 3 for September YTD, the increase in the yield on average interest-earning assets had a favorable impact on net interest income of $85.0 million, partially offset by the unfavorable impacts on net interest income of $9.4 million due to the volume decrease in average interest-earning assets, $55.6 million due to the increase in the rate paid on average interest-bearing liabilities and $0.1 million due to the increase in average interest-bearing liabilities.

Net interest margin of 3.07% and fully tax-equivalent net interest margin (non-GAAP) of 3.10% for the third quarter of 2023 were both seven basis points higher as compared to the third quarter of 2022. The increase was the result of a 76 basis point increase in the interest-earning asset yield and the decreases in average interest-earning asset balances and overnight borrowings driven by the sales and maturities of certain available-for-sale investment securities between the periods, partially offset by a 100 basis point increase in the rate paid on average interest-bearing liabilities. Net interest margin of 3.13% for the first nine months of 2023 was 27 basis points higher than the comparable period of 2022 while the fully tax-equivalent net interest margin (non-GAAP) of 3.16% for the first nine months of 2023 was 28 basis points higher than the comparable period of 2022. The yield on interest-earning assets increased 81 basis points, while the rate on interest-bearing liabilities increased by 77 basis points for the first nine months of 2023 as compared to the prior year period. The decline in noninterest and low-rate checking deposit balances also had an adverse impact on the net interest margin and fully tax-equivalent net interest margin (non-GAAP) for both periods.

The 76 basis point increase in the yield on average interest-earning assets for the quarter was the result of increases in both the yield on average loans and the yield on average investments, including cash equivalents. The yield on average loans for the third quarter increased by 70 basis points compared to the third quarter of 2022. The third quarter of 2023 yield on average investments, including cash equivalents, increased 19 basis points compared to the prior year. The 81 basis point increase in the yield on interest-earning assets for the first nine months of 2023 was the result of a 67 basis point increase in the yield on average loans and a 35 basis point increase in the yield on average investments, including cash equivalents, compared to the prior YTD period. The increase in loan yields were reflective of market-related increases in interest rates on new loans, a significant increase in variable and adjustable rate loan yields driven by rising market interest rates, including the prime rate and a high level of new loan originations. The increase in investment yields were driven by market interest rate increases and the sales and maturities of certain available-for-sale investment securities during the first nine months of 2023.

The rate paid on average interest-bearing liabilities increased by 100 basis points compared to the prior year quarter as the average rate paid on interest-bearing deposits increased 92 basis points and the average rate paid on external borrowings increased 200 basis points from the comparable prior period. For the first nine months of 2023, the rate paid on average interest-bearing liabilities increased by 77 basis points from the comparable prior year period as the rate paid on average interest-bearing deposits increased 67 basis points and the rate paid on average external borrowings increased 212 basis points. The rate paid on average interest-bearing deposits increased as interest rates on certain interest-bearing deposits were raised in response to market conditions. The increase in the cost of average borrowings was primarily the result of the greater utilization of comparatively higher rate overnight and term borrowings to fund loan growth, as well as the increase in the rates paid on customer repurchase agreements in response to market conditions.

The Company expects deposit costs to continue to increase to reflect the rapid changes in market interest rates that have occurred over the past year and that the cycle-to-date deposit beta will increase over current levels. The expected increase in deposit beta is reflective of the Company’s strategy to maintain a strong core deposit base and continue to provide competitive offerings to customers, as well as heightened competition for deposit funding in the higher rate environment. The Company has been and will be proactive in managing customer relationships with depositors, particularly large balance consumer, commercial and municipal customers, as a key component of this strategy. In addition, the Company expects funding costs to increase due to higher deposit costs, in part due to the continued migration from noninterest and low rate products to higher rate products, and potentially a greater reliance on comparatively high cost wholesale borrowings.

The third quarter and YTD average balance of investments, including cash equivalents, decreased $1.64 billion and $1.68 billion, respectively, as compared to the corresponding prior year periods, primarily due to declines in the investment securities portfolio driven by scheduled maturities and the sales of certain available-for-sale investment securities in connection with the Company’s first quarter balance sheet repositioning. Investment security sales, maturities, calls and principal payments outpaced purchases during the third quarter and YTD periods. The cash equivalents component of average earning assets increased $27.5 million and decreased $436.5 million for the third quarter and YTD periods, respectively, compared to the prior year periods. The YTD decline in average cash equivalents was due in part to the funding of strong organic loan growth. Average loan balances increased $970.3 million for the quarter and $1.27 billion YTD as compared to the prior year, due to high levels of organic growth and the impact of the Elmira acquisition.

Average interest-bearing deposits decreased $180.4 million compared to the prior year quarter and $190.8 million compared to the prior YTD period. The quarterly and YTD decreases in average interest-bearing deposits were due to decreases in interest checking, money market and savings deposits, partially offset by an increase in time deposits. The decrease in deposit balances were due in part to outflows driven by higher customer expenditure levels in the inflationary environment. The average borrowing balance, including borrowings at the Federal Home Loan Bank of New York and the Federal Home Loan Bank of Boston (collectively referred to as “FHLB”), subordinated notes payable and securities sold under agreement to repurchase (customer repurchase agreements), increased $137.9 million and $249.2 million for the quarter and YTD periods respectively. The increase in average borrowings from the prior year quarter and YTD periods was primarily due to an increase in overnight and term borrowings to meet the Company’s funding needs, including $300.0 million of term FHLB borrowings secured during the third quarter of 2023 at a weighted average rate of 4.69%.

Tables 2a and 2b below sets forth information related to average interest-earning assets and interest-bearing liabilities and their associated yields and rates for the periods indicated. Interest income and yields are on a fully tax-equivalent basis (“FTE”) using a marginal income tax rate of 24.2% in 2023 and 24.1% in 2022. Average balances are computed by totaling the daily ending balances in a period and dividing by the number of days in that period. Loan interest income and yields include amortization of deferred loan income and costs, loan prepayment, late and other fees and the accretion of acquired loan marks. Average loan balances include acquired loan purchase discounts and premiums, nonaccrual loans and loans held for sale.

Table 2a: Quarterly Average Balance Sheet

(1) Averages for investment securities are based on amortized cost basis and the yields do not give effect to changes in fair value that is reflected as a component of noninterest-earning assets, shareholders’ equity, and deferred taxes.

(2) Includes nonaccrual loans. The impact of interest and fees not recognized on nonaccrual loans was immaterial.

(3) The FTE adjustment represents taxes that would have been paid had nontaxable investment securities and loans been taxable. The adjustment attempts to enhance the comparability of the performance of assets that have different tax liabilities.

Table 2b: Year-to-Date Average Balance Sheet

(1) Averages for investment securities are based on amortized cost basis and the yields do not give effect to changes in fair value that is reflected as a component of noninterest-earning assets, shareholders’ equity, and deferred taxes.

(2) Includes nonaccrual loans. The impact of interest and fees not recognized on nonaccrual loans was immaterial.

(3) The FTE adjustment represents taxes that would have been paid had nontaxable investment securities and loans been taxable. The adjustment attempts to enhance the comparability of the performance of assets that have different tax liabilities.

As discussed above and disclosed in Table 3 below, the change in net interest income (FTE basis) may be analyzed by segregating the volume and rate components of the changes in interest income and interest expense for each underlying category.

Table 3: Rate/Volume

(1) The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of such change in each component.

(2) Changes due to volume and rate are computed from the respective changes in average balances and rates of the totals; they are not a summation of the changes of the components.

Noninterest Revenues

The Company’s sources of noninterest revenues are of four primary types: 1) general banking services related to loans, including mortgage banking, deposits and other core customer activities typically provided through the branch network and digital banking channels (performed by CBNA); 2) employee benefit trust, collective investment fund, transfer agency, actuarial, benefit plan administration and recordkeeping services (performed by BPAS and its subsidiaries); 3) wealth management services, comprised of trust services (performed by the trust unit within CBNA), broker-dealer and investment advisory products and services (performed by Community Investment Services Inc. (“CISI”), OneGroup Wealth Partners, Inc. and The Carta Group, Inc.) and asset management services (performed by Nottingham Advisors, Inc.); and 4) insurance and risk management products and services (performed by OneGroup). Additionally, the Company has other transactions that impact noninterest revenues, including realized and unrealized gains or losses on investment securities and gain on debt extinguishment.

Table 4: Noninterest Revenues

(1) For purposes of this ratio noninterest revenues excludes loss on sales of investment securities, gain on debt extinguishment and unrealized loss on equity securities. Operating revenues, a non-GAAP measure, is defined as net interest income on a FTE basis excluding acquired non-PCD loan accretion plus noninterest revenues, excluding loss on sales of investment securities, gain on debt extinguishment and unrealized loss on equity securities. See Table 11 for Reconciliation of GAAP to Non-GAAP Measures.

As displayed in Table 4, noninterest revenues were $67.6 million for the third quarter of 2023 and $147.1 million for the first nine months of 2023. This represents an increase of $2.3 million, or 3.6%, for the quarter and a decrease of $48.0 million, or 24.6%, for the YTD period in comparison to the equivalent 2022 periods. The increase for the quarterly period was driven by increases in employee benefit services revenue, insurance services revenue and wealth management services revenue, partially offset by a decrease in banking noninterest revenue. The YTD decrease was primarily a result of a $52.3 million pre-tax realized loss on the sale of certain available-for-sale securities in connection with a strategic balance sheet repositioning executed during the first quarter of 2023 to provide the Company with greater flexibility in managing balance sheet growth and deposit funding. Excluding the realized loss on sale of investment securities, unrealized loss on equity securities and gain on debt extinguishment recognized in the first quarter of 2023, noninterest revenues were up $4.2 million, or 2.2%, between September YTD 2023 and September YTD 2022 which was driven by increases in insurance services revenue and employee benefit services revenue, partially offset by decreases in banking noninterest revenue and wealth management services revenue.

Banking noninterest revenue of $17.6 million for the third quarter and $51.8 million for the first nine months of 2023 decreased $0.9 million, or 5.1%, and decreased $1.1 million, or 2.1%, respectively, as compared to the corresponding prior year periods. The quarterly decrease was driven by decreases in deposit service charges and fees and mortgage banking revenues, partially offset by increases in other banking revenues and debit interchange and ATM fees. The YTD decrease was driven by decreases in deposit service charges and fees, debit interchange and ATM fees and mortgage banking revenues, partially offset by an increase in other banking revenues. The decreases in deposit service charges and fees were reflective of the Company’s implementation of certain deposit fee changes, including the elimination of nonsufficient and unavailable funds fees on personal accounts late in the fourth quarter of 2022. The Company expects to continue to evaluate its deposit service charges and other fees for further modifications during the last quarter of 2023 and early 2024 in order to better serve the Company’s customers by offering an array of products and services designed to meet their particular type of banking needs.

Employee benefit services revenue increased $2.1 million, or 7.6%, and $1.6 million, or 1.8%, for the three and nine months ended September 30, 2023, respectively, as compared to the equivalent prior year periods primarily related to new business and a significant year-over-year increase in the total participants under administration, along with a modest increase from market appreciation. Insurance services revenue was up $0.8 million, or 6.9%, and $4.0 million, or 12.6%, for the third quarter and YTD periods, respectively, driven primarily by a strong premium market and organic expansion, along with growth resulting from acquisitions between the periods. Wealth management services revenue was up $0.4 million, or 5.8%, for the third quarter of 2023, but down $0.2 million, or 1.0%, for September 2023 YTD as compared to the same time periods of 2022.

The ratio of noninterest revenues to total revenues was 38.5% for the third quarter of 2023 and 31.0% for September YTD 2023, compared to 37.1% for the prior year’s third quarter and 38.7% for September YTD 2022. The quarterly increase was due to noninterest revenues increasing 3.6% while net interest income decreased 2.4% driven by higher funding costs. The YTD decrease was primarily the result of the $48.0 million, or 24.6%, decrease in total noninterest revenues due to the aforementioned $52.3 million realized loss on sales of investment securities, while net interest income increased 6.4%, driven by net interest margin expansion.

The ratio of noninterest revenues to operating revenues (FTE basis, non-GAAP), as defined in footnote 1 of Table 4 above, was 38.5% for the quarter and 37.8% for the nine months ended September 30, 2023, respectively, versus 37.2% and 38.8% for the comparable periods of 2022. The increase between the quarterly periods was due to a 3.7% increase in adjusted noninterest revenues, while adjusted net interest income (FTE basis) decreased 2.4%. The year-to-date decrease was a function of a 6.4% increase in adjusted net interest income (FTE basis) while adjusted noninterest revenues increased 2.2%.

Noninterest Expenses

Table 5 below sets forth the quarterly and YTD results of the major noninterest expense categories for the current and prior year, as well as efficiency ratios (defined below), a standard measure of expense utilization effectiveness commonly used in the banking industry.

Table 5: Noninterest Expenses

(1) Operating expenses, a non-GAAP measure, is calculated as total noninterest expenses less acquisition expenses, acquisition-related contingent consideration adjustment and amortization of intangible assets. See Table 11 for Reconciliation of GAAP to Non-GAAP Measures.

(2) Operating efficiency ratio a non-GAAP measure, is calculated as operating expenses as defined in footnote (1) above divided by net interest income on a FTE basis excluding acquired non-PCD loan accretion plus noninterest revenues excluding loss on sales of investment securities, gain on debt extinguishment and unrealized loss on equity securities. See Table 11 for Reconciliation of GAAP to Non-GAAP Measures.

As shown in Table 5, the Company recorded noninterest expenses of $116.5 million and $343.6 million for the third quarter and YTD periods of 2023, respectively, representing an increase of $8.3 million, or 7.7%, for the quarter and an increase of $25.2 million, or 7.9%, for the YTD period. Third quarter and YTD 2023 noninterest expenses included $0.1 million and $1.1 million of acquisition expenses and acquisition-related contingent consideration adjustment, respectively, compared to $0.4 million and $5.1 million in third quarter and YTD 2022, respectively. Salaries and employee benefits increased $4.5 million, or 6.8%, and $17.0 million, or 8.8%, for the third quarter and YTD periods of 2023, respectively, as compared to the corresponding periods of 2022. The remaining change to noninterest expenses are attributed to data processing and communications (up $1.3 million for the quarter and $2.4 million YTD), occupancy and equipment (consistent between the quarters and up $0.1 million YTD), legal and professional fees (up $0.6 million for the quarter and $1.9 million YTD), business development and marketing (up $1.0 million for the quarter and $2.1 million YTD), amortization of intangible assets (down $0.3 million for the quarter and $0.5 million YTD) and other expenses (up $1.5 million for the quarter and $6.0 million YTD).

The increase in salaries and benefits was driven by merit and market-related increases in employee wages, higher employee medical expenses and certain executive retirement expenses. Other expenses were up primarily due to increases in insurance expenses, travel-related expenses and non-service related components of the net periodic pension benefit credit. The higher insurance costs included in other expenses reflected larger FDIC insurance expenses due in part to an increase in the base assessment rate effective January 1, 2023. Legal and professional fees were up on a YTD basis primarily due to fees associated with various matters. The increase in data processing and communications expenses was due to the Company’s continued investment in customer-interfacing and digital technologies and the upgrading of operational support systems between the comparable periods. Business development and marketing expenses increased due to the Company’s investment in digital marketing initiatives and higher levels of targeted advertisements intended to generate deposit inflows.

The Company’s GAAP efficiency ratio was 66.4% for the third quarter of 2023, 4.8 percentage points unfavorable to the comparable quarter of 2022. This resulted from total noninterest expenses increasing 7.7% due to the factors noted above, while total revenues decreased 0.2%, primarily due to lower net interest income driven by higher funding costs. The GAAP efficiency ratio of 72.3% for September YTD 2023 was 9.1 percentage points unfavorable to the 63.2% GAAP efficiency ratio for September YTD 2022. The increase in the GAAP efficiency ratio between the comparable YTD periods was the result of total revenues decreasing 5.6% primarily due to the $52.3 million pre-tax realized loss on the sale of certain available-for-sale securities during the first quarter of 2023, while total noninterest expenses increased 7.9% due to the factors noted above. Annualized current quarter noninterest expenses as a percentage of average assets increased 0.30 percentage points versus the third quarter of the prior year as noninterest expenses increased 7.7% while average assets decreased 2.8%. On a YTD basis, annualized noninterest expenses as a percentage of average assets increased 0.28 percentage points as noninterest expenses increased 7.9% while average assets decreased 2.1%. Noninterest expenses increased between both periods due to the factors noted above and average assets decreased between both periods primarily due to the aforementioned sale of certain available-for-sale investment securities during the first quarter of 2023.

The Company’s operating efficiency ratio (a non-GAAP measure, as defined in the table above) was 64.3% for the third quarter, 5.0 percentage points unfavorable to the comparable quarter of 2022. This resulted from operating expenses (as defined above) increasing 8.6%, while operating revenues (as defined above) increased 0.1%. The operating efficiency ratio (non-GAAP) of 62.8% for the first nine months of 2023 was 2.8 percentage points unfavorable compared to the first nine months of 2022 due to 9.8% higher operating expenses (as defined above), while operating revenues (as defined above) increased by 4.8%. Current year operating expenses (as defined above) as a percentage of average assets (non-GAAP) increased 0.31 percentage points versus the prior year quarter and the prior year-to-date period as operating expenses (as defined above) increased while average assets decreased on both a quarterly and YTD basis. Operating expenses (as defined above) increased 8.6% for the quarter and 9.8% for the year-to-date period, while average assets decreased 2.8% for the quarter and 2.1% for the year-to-date period.

Income Taxes

The third quarter and YTD 2023 effective income tax rates were 21.2% and 21.1%, respectively, as compared to 22.0% and 21.6% for the comparable periods of 2022. The decrease in the third quarter and YTD 2023 effective income tax rates are primarily attributable to a decrease in the full-year 2023 pre-tax income projection as a result of the loss on investment security sales recognized in the first quarter of 2023. The Company recorded a $0.3 million and $0.6 million reduction in income tax expense associated with stock-based compensation tax benefits for YTD 2023 and YTD 2022, respectively. The effective tax rates adjusted to exclude stock-based compensation tax benefits for the third quarter and YTD 2023 were 21.2% and 21.3%, respectively, as compared to 22.0% for both of the comparable periods of 2022.

Investment Securities

The carrying value of investment securities (including unrealized gains and losses) was $3.96 billion at the end of the third quarter, a decrease of $1.35 billion, or 25.5%, from December 31, 2022 and $1.27 billion, or 24.2%, lower than September 30, 2022. The balance of cash equivalents was $260.0 million at the end of the third quarter, an increase of $241.6 million from December 31, 2022 and $230.0 million from September 30, 2022. The book value of investment securities (excluding unrealized gains and losses) of $4.51 billion at the end of the third quarter decreased $1.33 billion from December 31, 2022 and $1.69 billion from September 30, 2022. During the first nine months of 2023, the Company purchased $23.9 million of government agency mortgage-backed securities with an average yield of 5.49%, which the Company classified as held-to-maturity. These additions were offset by proceeds of $733.8 million from the sale of certain available-for-sale U.S. Treasury securities associated with the first quarter 2023 balance sheet repositioning and $582.6 million of investment maturities, calls and principal payments during the first nine months of 2023. Additionally, there was $30.1 million of net accretion on investment securities during the first nine months of 2023. The effective duration of the investment securities portfolio was 7.2 years at the end of the third quarter of 2023, as compared to 6.3 years at the end of 2022 and 6.5 years at the end of the third quarter of 2022.

The change in the carrying value of investment securities is also impacted by the amount of net unrealized gains or losses in the available-for-sale and equity securities portfolio. At September 30, 2023, the investment portfolio excluding held-to-maturity investment securities had a $546.4 million net unrealized loss, as compared to a $522.7 million net unrealized loss at December 31, 2022 and a $964.9 million net unrealized loss at September 30, 2022. These changes in the net unrealized position of the portfolio were principally driven by the movements in medium to long-term interest rates, as well as the volume and rates associated with the securities purchases, maturities and reclassifications that have occurred over the past 12 months and the recognition of the loss on sales of available-for-sale investment securities related to aforementioned balance sheet repositioning.

The following table sets forth the carrying value of the Company’s investment securities portfolio:

Table 6: Investment Securities

Loans

Loans ended the third quarter at $9.45 billion, $640.7 million, or 7.3%, higher than at December 31, 2022 and $906.5 million, or 10.6%, higher than at September 30, 2022.

The business lending portfolio consists of general-purpose business lending to commercial, industrial, non-profit and municipal customers, mortgages on commercial property and vehicle dealer floor plan financing. The business lending portfolio increased $420.5 million, or 12.0%, from September 30, 2022 and increased $269.3 million, or 7.4%, from December 31, 2022, driven by net organic growth. Growth in commercial mortgages drove the majority of the increase between both periods, in particular commercial real estate multi-family and commercial real estate non-owner occupied, followed by commercial real estate owner occupied, and to a lesser extent increases in commercial and industrial lines of credit, partially offset by decreases in commercial and industrial term loans. While certain macroeconomic concerns are emerging related to non-owner occupied commercial real estate, the Company’s exposure to this portfolio remains diverse and relatively low at 186% of total bank-level regulatory capital, 24% of total loans and 15% of total assets. The balance increases are reflective of continued high demand for multi-family housing, expansion of internal resources and proactive business development and pricing in the Company’s market areas. Competitive conditions for business lending continue to prevail in both the digital marketplace and geographic regions in which the Company operates. The Company strives to generate growth in its business portfolio in a manner that adheres to its goals of maintaining strong asset quality and producing profitable margins. The Company continues to invest in additional personnel, technology and business development resources to further strengthen its capabilities in this important product category.

Consumer mortgages increased $221.2 million, or 7.4%, from one year ago and increased $184.3 million, or 6.1%, from December 31, 2022, reflective of organic growth. Over the past year, the Company produced net organic growth in the consumer mortgage segment due to the Company’s competitive product offerings, recruitment of additional mortgage loan originators and proactive business development efforts. Home equity loans increased $11.7 million, or 2.7%, from one year ago, and increased $10.8 million, or 2.5%, from December 31, 2022, in part aided by lower levels of consumer mortgage refinancing-related payoffs and paydowns in the higher interest rate environment.

Consumer installment loans, both those originated directly in the branches and online (referred to as “consumer direct”) and indirectly in automobile, marine, and recreational vehicle dealerships (referred to as “consumer indirect”), increased $253.0 million, or 15.4%, from one year ago and increased $176.3 million, or 10.3%, from December 31, 2022. The increase was primarily due to the Company offering competitive pricing, benefitting from reduced participation by certain competitors and capturing an increased share of the solid sales volumes that existed in its market area and dealer network which, combined with higher vehicle sales prices, resulted in significant growth in the Company’s consumer indirect portfolio, despite national vehicle shortages. Although the consumer indirect loan market is highly competitive, the Company is focused on maintaining a profitable in-market and contiguous market indirect portfolio, while continuing to pursue the expansion of its dealer network. Consumer direct loans have historically provided attractive returns, and the Company is committed to providing competitive market offerings to its customers in this important loan category. Despite the strong competition the Company faces from the financing subsidiaries of vehicle manufacturers and other financial intermediaries, the Company will continue to strive to grow these key portfolios through varying market conditions over the long term.

Asset Quality

The following table sets forth the allocation of the allowance for credit losses by loan category as well as the proportional share of each category’s loan balance to total loans. This allocation is based on management’s assessment, as of a given point in time, of the risk characteristics of each of the component parts of the total loan portfolio and is subject to change when the risk factors of each component part change. The allocation is not indicative of the specific amount of future net charge-offs that will be incurred in each of the loan categories, nor should it be taken as an indicator of future loss trends. The allocation of the allowance to each category does not restrict the use of the allowance to absorb losses in any category. As shown in Table 7, total allowance for credit losses at the end of the third quarter was $64.9 million, an increase of $4.6 million, or 7.6%, from one year earlier and an increase of $3.9 million, or 6.4%, from the end of 2022.

Table 7: Allowance for Credit Losses by Loan Type

As demonstrated in Table 7, the consumer direct and indirect installment loan portfolios carry higher credit risk than the business lending, consumer mortgage and home equity portfolios and therefore the Company allocates a higher proportional allowance to these portfolios. The unallocated allowance is maintained for potential inherent losses in the specific portfolios that are not captured due to model imprecision. The unallocated allowance of $1.0 million at September 30, 2023 was consistent with December 31, 2022 and September 30, 2022. The changes in allowance allocations reflect management’s continued refinement of its loss estimation techniques. However, given the inherent imprecision in the many estimates used in the determination of the allocated portion of the allowance, management remained conservative in the approaches used to establish the overall allowance for credit losses. Management considers the allocated and unallocated portions of the allowance for credit losses to be prudent and reasonable.

Allowance for credit losses and loan net charge-off ratios are as follows:

Table 8: Loan Ratios

Net charge-offs during the third quarter of 2023 were $1.2 million, an increase of $0.9 million compared to the third quarter of 2022. All portfolios except the home equity portfolio experienced higher net charge-off levels in the third quarter of 2023 compared to the third quarter of 2022. The total net charge-off ratio (net charge-offs annualized as a percentage of average loans outstanding for the quarter) for the third quarter was 0.05%, four basis points lower than the ratio at December 31, 2022 and three basis points higher than the ratio at September 30, 2022. Despite the increase in net charge-offs in the third quarter of 2023, the net charge-off ratio remains well below the Company’s average for the past ten years of 0.12%. Net charge-off ratios for the third quarter of 2023 for the consumer mortgage, consumer direct and home equity portfolios were above the Company’s average for the trailing eight quarters, while the net charge-off ratio for the business lending and consumer indirect portfolios were below the Company’s average for the trailing eight quarters. Economic conditions have been relatively stable with the unemployment rate in particular remaining low and supporting the continued historically low levels of net charge-offs experienced by the Company.

Other real estate owned (“OREO”) at September 30, 2023 was $0.6 million. This compares to $0.5 million at both December 31, 2022 and September 30, 2022. At September 30, 2023, OREO consisted of 10 residential properties with a total value of $0.6 million. This compares to seven residential properties with a total value of $0.5 million at December 31, 2022, and eight residential properties with a total value of $0.5 million at September 30, 2022.

Approximately 15% of the nonperforming loans at September 30, 2023 were related to the business lending portfolio, which is comprised of business loans broadly diversified by industry type. While the level of nonperforming business loans was $0.8 million higher than the prior year, the business lending nonperforming loans ratio was consistent as business conditions in the Company’s market area remain stable.

Approximately 76% of nonperforming loans at September 30, 2023 were comprised of consumer mortgages. Collateral values of residential properties within most of the Company’s market areas have generally remained stable or increased over the past several years. Although high inflation has had some adverse impact on consumers, the unemployment rate remains low and this has contributed to the credit performance in the consumer mortgage loan segment remaining favorable. The remaining 9% of nonperforming loans relate to consumer installment and home equity loans, with home equity nonperforming loan levels being driven by the same factors that were identified for consumer mortgages. The allowance for credit losses to nonperforming loans ratio, a general measure of coverage adequacy, was 176% at the end of the third quarter, as compared to 183% at year-end 2022 and 186% at September 30, 2022. The decrease in this ratio between the annual quarterly periods was primarily driven by the increases in nonperforming business loan and consumer mortgage levels rising proportionally more than the allowance for credit losses.

The Company’s senior management, special asset officers and lenders review all delinquent and nonaccrual loans and OREO regularly in order to identify deteriorating situations, monitor known problem credits and discuss any needed changes to collection efforts, if warranted. Based on this analysis, a relationship may be assigned a special assets officer or other senior lending officer to review the loan, meet with the borrowers, assess the collateral and recommend an action plan. This plan could include foreclosure, restructuring loans, issuing demand letters or other actions. The Company’s larger criticized credits are also reviewed on a quarterly basis by senior credit administration management, special assets officers and business lending management to monitor their status and discuss credit management plans. Business lending management reviews the criticized business loan portfolio on a monthly basis.

Delinquent loans (defined as loans 30 days or more past due or in nonaccrual status) as a percent of total loans was 0.90% at the end of the third quarter, one basis point above the 0.89% at year-end 2022 and 19 basis points above the 0.71% at September 30, 2022. The business lending delinquency ratio at the end of the third quarter of 0.49% was nine basis points above the level of 0.40% at December 31, 2022 and 32 basis points above the level of 0.17% at September 30, 2022. The delinquency rates for the consumer indirect and consumer direct portfolios decreased as compared to the levels at December 31, 2022, while delinquency rates in the consumer mortgage and home equity portfolios increased. The delinquency rates for all loan portfolios increased compared to the levels at September 30, 2022. Despite the increase in delinquent loans in the third quarter of 2023, the current quarter delinquency rates remained below the Company’s average for the past ten years of 1.04%.

The Company recorded a $2.9 million provision for credit losses in the third quarter of 2023. The third quarter provision for credit losses was $2.2 million lower than the equivalent prior year period’s provision for credit losses of $5.1 million. The third quarter of 2023 provision for credit losses reflects stable economic forecasts and asset quality metrics as well as net loan growth between the periods. The allowance for credit losses of $64.9 million as of September 30, 2023 increased $3.9 million compared to December 31, 2022 and increased $4.6 million compared to September 30, 2022. The allowance for credit losses to total loans ratio was 0.69% at September 30, 2023, consistent with the level at December 31, 2022 and two basis points lower than the level at September 30, 2022. Refer to Note E: Loans and Allowance for Credit Losses in the notes to the consolidated financial statements for a discussion of management’s methodology used to estimate the allowance for credit losses.

As of September 30, 2023, the net purchase discount related to the $1.09 billion of remaining non-PCD loan balances acquired in prior period acquisitions was approximately $21.6 million, or 2.0% of that portfolio.

Deposits

As shown in Table 9, average deposits of $12.77 billion in the third quarter were $562.5 million, or 4.2%, lower than the third quarter of 2022. Total average deposit balances decreased $408.1 million, or 3.1%, from the fourth quarter of last year, while on an ending basis total deposits increased $18.5 million, or 0.1%, from December 31, 2022. The mix of average deposit balances changed as the weighting of non-maturity deposits (noninterest checking, interest checking, savings and money market) to total deposits has decreased from the prior year levels. Average noninterest checking deposits as a percentage of average total deposits was 29.8% in the third quarter compared to 31.4% in the third quarter of 2022 and 31.9% in the fourth quarter of last year. Average non-maturity deposits represented 89.2% of the Company’s deposit funding base and time deposits represented 10.8% of total average deposits in the third quarter of 2023 compared to 92.8% and 7.2%, respectively, in the equivalent period year period. The quarterly average cost of deposits was 0.76% for the third quarter of 2023, compared to 0.18% for the fourth quarter of 2022 and 0.11% in the third quarter of 2022, reflective of the increase in the average interest rate paid on interest-bearing deposits as interest rates on certain interest-bearing deposits were raised in response to market conditions, as well as a decline in the proportion of noninterest and low-rate deposit balances. The Company continues to focus on expanding its deposit relationship base through its competitive product offerings and high quality customer service.

The Company’s deposit base is well diversified across customer segments, which as of September 30, 2023 is comprised of approximately 61% consumer, 26% business and 13% municipal, and broadly dispersed with an average personal deposit account balance of approximately $12,000 and average business deposit relationship of approximately $62,000, while the Company’s total average deposit account balance is under $20,000. In addition, at the end of the quarter, 70% of the Company’s total deposits were in checking and savings accounts and the weighted-average age of the Company’s non-maturity deposit accounts was approximately 15 years. As of September 30, 2023, the Company’s total uninsured deposits, net of collateralized and intercompany deposits, is estimated at approximately $2.11 billion. This amount is determined by adjusting the amounts reported in the Bank Call Report by intercompany deposits, which are not external customers and are therefore eliminated in consolidation, and municipal deposits which are collateralized by certain pledged investment securities. The Bank Call Report estimated uninsured deposit balances at September 30, 2023 are reported gross at $3.92 billion, which includes intercompany account balances of $334.2 million and collateralized deposits of $1.47 billion. Estimated insured deposits, net of collateralized and intercompany deposits, represent greater than 80% of third quarter ending total deposits.

Average nonpublic fund deposits for the third quarter of 2023 decreased $422.2 million, or 3.6%, versus the fourth quarter of 2022 and decreased $589.4 million, or 4.9%, versus the year-earlier period as competition intensified in the rising interest rate environment. Average public fund deposits for the third quarter increased $14.1 million, or 1.1%, from the fourth quarter of 2022 and increased $26.9 million, or 2.0%, from the third quarter of 2022, primarily due to the Company’s competitive pricing and business development efforts. Average public fund deposits as a percentage of total average deposits increased from 10.0% in the third quarter of 2022 to 10.6% in the third quarter of 2023.

Table 9: Quarterly Average Deposits

Borrowings

Borrowings, excluding securities sold under agreement to repurchase, at the end of the third quarter of 2023 totaled $316.8 million. This was $474.3 million lower than borrowings at December 31, 2022 and $174.3 million above the level at the end of the third quarter of 2022. The increase from the prior year third quarter was primarily due to an increase in other FHLB borrowings of $297.4 million as the Company secured $300.0 million of fixed rate FHLB term borrowings in the third quarter of 2023 to support the funding of continued loan growth. The decrease from the fourth quarter of 2022 was primarily related to a decrease in overnight borrowings of $768.4 million as the Company utilized proceeds from its first quarter securities sales and subsequent investment security maturities to pay down these borrowings.

Securities sold under agreement to repurchase, also referred to as customer repurchase agreements, represent collateralized municipal and commercial customer accounts that price and operate similar to a deposit instrument. Customer repurchase agreements were $330.3 million at the end of the third quarter of 2023, a decrease of $16.4 million and $22.5 million from December 31, 2022 and September 30, 2022, respectively.

Shareholders’ Equity and Regulatory Capital

Total shareholders’ equity was $1.55 billion at the end of the third quarter, up $3.2 million from the balance at December 31, 2022. The increase was driven by net income of $98.2 million, $6.7 million recognized from employee stock options earned and net activity under the Company’s employee stock plans of $0.7 million, partially offset by $5.3 million of other comprehensive loss, net of tax, dividends declared of $71.5 million and common stock repurchased of $25.7 million. The other comprehensive loss, net of tax, was comprised of a $4.4 million decrease in the after-tax market value adjustment on the available-for-sale investment portfolio due to movements in medium to long-term interest rates, as well as the volume and rates associated with the securities purchases, sales, maturities and reclassifications that have occurred over the past nine months and the recognition of the loss on sales of available-for-sale investment securities related to aforementioned balance sheet repositioning, and a negative $0.9 million adjustment to the funded status of the Company’s retirement plans. Over the past 12 months, total shareholders’ equity increased $93.8 million, driven primarily by an increase in the market value adjustment on investments, net income, the accretion of the market value adjustment associated with the transfer of securities from the available-for-sale portfolio to the held-to-maturity portfolio and the issuance of stock in association with the employee stock plan, partially offset by dividends declared, common stock repurchase activity and the change in the funded status of the Company’s defined benefit pension and other postretirement plans.

The dividend payout ratio (dividends declared divided by net income) for the first nine months of 2023 was 72.8%, compared to 51.8% for the nine months ended September 30, 2022. Excluding the after-tax impact of the loss on sales of investment securities, the YTD 2023 dividend payout ratio was 51.3%. Dividends declared for the first nine months of 2023 increased 1.8% compared to the first nine months of 2022, as the Company’s quarterly dividend per share was raised from $0.43 to $0.44 in the third quarter of 2022 and from $0.44 to $0.45 in the third quarter of 2023, while net income decreased 27.5% versus the equivalent year-to-date period due to increases in operating expenses and realized loss on investment securities, partially offset by increases in net interest income and noninterest revenues and a decrease in the provision for credit losses. Excluding the after-tax impact of the securities sales in the first quarter of 2023, net income increased 2.8% between the first nine months of 2023 and the equivalent prior year period. Additionally, the number of common shares outstanding decreased 0.6% over the last twelve months, as common stock repurchases outweighed new issuance activity in the Company’s employee stock plans. During the third quarter of 2023, the Company announced a one-cent, or 2.3%, increase in the quarterly dividend to $0.45 per share on its common stock, which marked the 31st consecutive year of dividend increases for the Company.

The Company and the Bank are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements and ability to pay dividends. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and the Bank’s on and off-balance sheet items as calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

The Company and the Bank are required to maintain a “capital conservation buffer” for risk-weighted capital parameters, composed entirely of common equity Tier 1 capital, in addition to minimum risk-based capital ratios. The required capital conservation buffer is 2.5% as of September 30, 2023 and December 31, 2022. Therefore, to satisfy both the minimum risk-based capital ratios and the capital conservation buffer as of September 30, 2023 and December 31, 2022, the Company and the Bank must maintain:

(i) Common equity Tier 1 capital to total risk-weighted assets (“Common equity tier 1 capital ratio”) of at least 7.0%,

(ii) Tier 1 capital to total risk-weighted assets (“Tier 1 risk-based capital ratio”) of at least 8.5%, and

(iii) Total capital (Tier 1 capital plus Tier 2 capital) to total risk-weighted assets (“Total risk-based capital ratio”) of at least 10.5%.

In addition, the Company and Bank must maintain a ratio of ending Tier 1 capital to adjusted quarterly average assets (“Tier 1 leverage ratio”) of at least 5.0% to be considered “well capitalized” under the regulatory framework for prompt corrective action.

As of September 30, 2023 and December 31, 2022, the Company and Bank meet all applicable capital adequacy requirements to be considered “well capitalized”. As of September 30, 2023 and December 31, 2022, the regulatory capital ratios for the Company and Bank are presented below.

Table 10: Regulatory Ratios

The Company’s Tier 1 leverage ratio, a primary measure of regulatory capital as defined above, was 9.44% at the end of the third quarter, up 0.65 percentage points from December 31, 2022 and 0.66 percentage points above its level one year earlier. The increase in the Tier 1 leverage ratio in comparison to December 31, 2022 was the result of ending shareholders’ equity, excluding intangibles (net of associated deferred tax liabilities or “net intangibles”) and other comprehensive income or loss items, increasing 0.6%, while average assets, excluding intangibles and the market value adjustment on investments, decreased 6.3%. The Tier 1 leverage ratio increased compared to the prior year’s third quarter as shareholders’ equity, excluding net intangibles and other comprehensive income or loss items, increased 3.2% as net earnings retention outweighed share repurchases, while average assets, excluding intangibles and the market value adjustment on investments, decreased 4.1%. The increase in shareholders’ equity, excluding net intangibles and other comprehensive income or loss items, between both periods was primarily due to net earnings retention, that despite the negative impact of the realized loss on investment security sales in connection with the first quarter 2023 balance sheet repositioning, outweighed share repurchases. The decrease in average assets, excluding intangibles and the market value adjustment on investments, between both periods was primarily due to the impact from the Company’s first quarter 2023 balance sheet repositioning.

The shareholders’ equity-to-assets ratio was 10.11% at the end of the third quarter of 2023 compared to 9.80% at December 31, 2022 and 9.37% at September 30, 2022. The tangible equity-to-assets ratio (a non-GAAP measure) of 4.81% increased 0.17 percentage points from December 31, 2022 and increased 0.73 percentage points versus September 30, 2022 (see Table 11 for Reconciliation of GAAP to Non-GAAP Measures). The increase in the tangible equity-to-assets ratio (non-GAAP) from one year prior was primarily driven by a $97.4 million, or 16.2%, increase in tangible equity due to the decline in accumulated other comprehensive loss related to the Company’s investment securities portfolio due in part to the timing of the reclassification of certain investment securities from the available-for-sale portfolio to the held-to-maturity portfolio in the fourth quarter of 2022 and a $204.6 million, or 1.4%, decrease in tangible assets due primarily to the aforementioned sales and maturities of certain available-for-sale investment securities. The increase in the net tangible equity-to-assets ratio (non-GAAP) from December 31, 2022 was driven by a $3.2 million, or 0.5%, increase in tangible equity, while tangible assets decreased $449.4 million, or 3.0%, primarily due to the reduction in investment securities and borrowings resulting from the Company’s first quarter balance sheet repositioning and investment maturities.

Liquidity

Liquidity risk is a measure of the Company’s ability to raise cash when needed at a reasonable cost and minimize any loss. The Company maintains appropriate liquidity levels in both normal operating conditions as well as stressed environments. The Company must be capable of meeting all obligations to its customers at any time and, therefore, the active management of its liquidity position remains an important management objective. The Bank has appointed the Asset Liability Committee (“ALCO”) to manage liquidity risk using policy guidelines and limits on indicators of potential liquidity risk. The indicators are monitored using a scorecard with three risk level limits. These risk indicators measure core liquidity and funding needs, capital at risk and change in available funding sources. The risk indicators are monitored using such metrics as the core basic surplus ratio, unencumbered securities to average assets, free loan collateral to average assets, loans to deposits, deposits to total funding and borrowings to total funding ratios.

Given the uncertain nature of the Company’s customers' demands, as well as the Company's desire to take advantage of earnings enhancement opportunities, the Company must have adequate sources of on and off-balance sheet funds available that can be utilized when needed. Accordingly, in addition to the liquidity provided by balance sheet cash flows, liquidity must be supplemented with additional sources such as credit lines from correspondent banks and borrowings from the FHLB and the Federal Reserve. Other funding alternatives may also be appropriate from time to time, including wholesale and retail repurchase agreements, large certificates of deposit and the brokered CD market. The primary sources of non-deposit funds are FHLB or Federal Reserve overnight advances and other FHLB term borrowings. At September 30, 2023, there were $316.8 million of other FHLB term borrowings and no overnight borrowings outstanding.

The Company’s primary sources of liquidity are its liquid assets, as well as unencumbered loans and securities that can be used to collateralize additional funding. At September 30, 2023, the Bank had $455.8 million of cash and cash equivalents of which $260.0 million are interest-earning deposits held at the Federal Reserve, FHLB and other correspondent banks. The Company also had $2.61 billion in unused FHLB & FRB borrowing capacity based on the Company’s quarter-end loan collateral levels. Additionally, the Company had approximately $1.75 billion of securities that could be sold or pledged at the FHLB or Federal Reserve to obtain additional funding. There was $25.0 million available in an unsecured line of credit with a correspondent bank at quarter end. The Company’s sources of immediately available liquidity of $4.81 billion at the end of the third quarter of 2023 represent over 200% of the Company’s estimated uninsured deposits, net of collateralized and intercompany deposits, estimated at approximately $2.11 billion.

The Company’s primary approach to measuring short-term liquidity is known as the Basic Surplus/Deficit model. It is used to calculate liquidity over two time periods: first, the amount of cash that could be made available within 30 days (calculated as liquid assets less short-term liabilities as a percentage of average assets); and second, a projection of subsequent cash availability over an additional 60 days. As of September 30, 2023, this ratio was 10.5% for 30-days and 9.3% for 90-days, excluding the Company’s capacity to borrow additional funds from the FHLB and other sources. This is considered to be a sufficient amount of liquidity based on the Company’s internal policy requirement of 7.5%.

A sources and uses statement is used by the Company to measure intermediate liquidity risk over the next twelve months. As of September 30, 2023, there is more than enough liquidity available during the next year to cover projected cash outflows. In addition, stress tests on the cash flows are performed in various scenarios ranging from high probability events with a low impact on the liquidity position to low probability events with a high impact on the liquidity position. The results of the stress tests as of September 30, 2023 indicate the Company has sufficient sources of funds for the next year in all simulated stressed scenarios.

To measure longer-term liquidity, a baseline projection of loan and deposit growth for five years is made to reflect how liquidity levels could change over time. This five-year measure reflects ample liquidity for loan and other asset growth over the next five years.

The possibility of a funding crisis exists at all financial institutions. A funding crisis would most likely result from a shock to the financial system which disrupts orderly short-term funding operations or from a significant tightening of monetary policy that limits the national money supply. Accordingly, management has addressed this issue by formulating a Liquidity Contingency Plan, which has been reviewed and approved by both the Company’s Board of Directors (the “Board”) and the Company’s ALCO. The plan addresses the actions that the Company would take in response to both a short-term and long-term funding crisis. Management believes that both potential circumstances have been fully addressed through the establishment of trigger points for monitoring such events and detailed action plans that would be initiated if those trigger points are reached. These trigger points are not by themselves definitive indicators of insufficient liquidity, but rather a mechanism for management to monitor conditions and possibly provide advance warning which could avert or reduce the impact of a crisis. Liquidity triggers are based on a variety of factors, including Company history, trends, and current operating performance, industry observations, and changes in internal and external economic factors. Indicators include: core liquidity and funding needs such as the core basic surplus, unencumbered securities to average assets, and free FHLB and FRB loan collateral to average assets; heightened funding needs indicators such as average loans to average deposits, average public and nonpublic deposits to total funding, and average borrowings to total funding; capital at risk indicators consisting mainly of regulatory ratios; asset quality indicators; and decrease in funds availability indicators which is a combination of internal and external factors such as increased restrictions on borrowing or downturns in the credit market. The Company has established three risk levels for these liquidity triggers that define the response based on the severity of the circumstances. Responses vary from an assessment of possible funding deficiencies with no impact on normal business operations to immediate action required due to impending funding problems. For more information regarding the risk factor associated with the possibility of a funding crisis, refer to the discussion under the heading “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2022 as filed with the SEC on March 1, 2023 and the Quarterly Report on Form 10-Q for the quarter ended March 31, 2023 as filed with the SEC on May 10, 2023.

Forward-Looking Statements

This report contains comments or information that constitute forward-looking statements (within the meaning of the Private Securities Litigation Reform Act of 1995), which involve significant risks and uncertainties. Forward-looking statements often use words such as “anticipate,” “could,” “target,” “expect,” “estimate,” “intend,” “plan,” “goal,” “forecast,” “believe,” or other words of similar meaning. These statements are based on the current beliefs and expectations of the Company’s management and are subject to significant risks and uncertainties. Actual results may differ materially from the results discussed in the forward-looking statements. Moreover, the Company’s plans, objectives and intentions are subject to change based on various factors (some of which are beyond the Company’s control). Factors that could cause actual results to differ from those discussed in the forward-looking statements include: (1) adverse developments in the banking industry related to recent bank failures and the potential impact of such developments on customer confidence and regulatory responses to these developments; (2) current and future economic and market conditions, including the effects of changes in commercial real estate and residential housing or vehicle prices, higher unemployment rates, labor shortages, supply chain disruption, inability to obtain raw materials and supplies, U.S. fiscal debt, budget and tax matters, geopolitical matters and conflicts, and any slowdown in global economic growth; (3) the effect of, and changes in, monetary and fiscal policies and laws, including future changes in Federal and state statutory income tax rates and interest rate and other policy actions of the Board of Governors of the Federal Reserve System; (4) the effect of changes in the level of checking or savings account deposits on the Company’s funding costs and net interest margin; (5) future provisions for credit losses on loans and debt securities; (6) changes in nonperforming assets; (7) the effect of a fall in stock market or bond prices on the Company’s fee income businesses, including its employee benefit services, wealth management, and insurance businesses; (8) risks related to credit quality; (9) inflation, interest rate, liquidity, market and monetary fluctuations; (10) the strength of the U.S. economy in general and the strength of the local economies where the Company conducts its business; (11) the timely development of new products and services and customer perception of the overall value thereof (including features, pricing and quality) compared to competing products and services; (12) changes in consumer spending, borrowing and savings habits; (13) technological changes and implementation and financial risks associated with transitioning to new technology-based systems involving large multi-year contracts; (14) the ability of the Company to maintain the security, including cybersecurity, of its financial, accounting, technology, data processing and other operating systems, facilities and data; (15) effectiveness of the Company’s risk management processes and procedures, reliance on models which may be inaccurate or misinterpreted, the Company’s ability to manage its credit or interest rate risk, the sufficiency of its allowance for credit losses and the accuracy of the assumptions or estimates used in preparing the Company’s financial statements and disclosures; (16) failure of third parties to provide various services that are important to the Company’s operations; (17) any acquisitions or mergers that might be considered or consummated by the Company and the costs and factors associated therewith, including differences in the actual financial results of the acquisition or merger compared to expectations and the realization of anticipated cost savings and revenue enhancements; (18) the ability to maintain and increase market share and control expenses; (19) the nature, timing and effect of changes in banking regulations or other regulatory or legislative requirements affecting the respective businesses of the Company and its subsidiaries, including changes in laws and regulations concerning taxes, accounting, banking, service fees, risk management, securities, capital requirements, and other aspects of the financial services industry; (20) changes in the Company’s organization, compensation and benefit plans and in the availability of, and compensation levels for, employees in its geographic markets; (21) the outcome of pending or future litigation and government proceedings; (22) other risk factors outlined in the Company’s filings with the SEC from time to time; and (23) the success of the Company at managing the risks of the foregoing.

The foregoing list of important factors is not all-inclusive. For more information about factors that could cause actual results to differ materially from the Company’s expectations, refer to the discussion under the heading “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2022 as filed with the SEC on March 1, 2023 and the Form 10-Q for the quarter ended March 31, 2023, as filed with the SEC on May 10, 2023. Any forward-looking statements speak only as of the date on which they are made and the Company does not undertake any obligation to update any forward-looking statement, whether written or oral, to reflect events or circumstances after the date on which such statement is made. If the Company does update or correct one or more forward-looking statements, investors and others should not conclude that the Company will make additional updates or corrections with respect thereto or with respect to other forward-looking statements.

Reconciliation of GAAP to Non-GAAP Measures

Table 11: GAAP to Non-GAAP Reconciliations

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates, prices or credit risk. Credit risk associated with the Company’s loan portfolio has been previously discussed in the asset quality section of the MD&A. Management believes that the tax risk of the Company’s municipal investments associated with potential future changes in statutory, judicial and regulatory actions is minimal. Treasury, agency, mortgage-backed and collateralized mortgage obligation securities issued by government agencies comprise 88.4% of the total portfolio and are currently rated AAA by Moody’s Investor Services and AA+ by Standard & Poor’s. Obligations of state and political subdivisions account for 11.4% of the total portfolio, of which, 96.2% carry a minimum rating of A-. The remaining 0.2% of the portfolio is comprised of other investment grade securities. The Company does not have material foreign currency exchange rate risk exposure. Therefore, almost all the market risk in the investment portfolio is related to interest rates.

The ongoing monitoring and management of both interest rate risk and liquidity over the short and long term time horizons is an important component of the Company’s asset/liability management process, which is governed by guidelines established in the policies reviewed and approved annually by the Company’s Board. The Board delegates responsibility for carrying out the policies to the ALCO, which meets each month. The committee is made up of the Company’s senior management as well as regional and line-of-business managers who oversee specific earning asset classes and various funding sources. As the Company does not believe it is possible to reliably predict future interest rate movements, it has maintained an appropriate process and set of measurement tools, which enables it to identify and quantify sources of interest rate risk in varying rate environments. The primary tool used by the Company in managing interest rate risk is income simulation. This begins with the development of a base case scenario, which projects net interest income (“NII”) over the next twelve month period. The base case scenario NII may increase or decrease significantly from quarter to quarter reflective of changes during the most recent quarter in the Company’s: (i) earning assets and liabilities balances, (ii) composition of earning assets and liabilities, (iii) earning asset yields, (iv) cost of funds and (v) model projections, as well as current market interest rates, including the slope of the yield curve and projected changes in the slope of the yield curve over the twelve month period. The direction of interest rates, the slope of the yield curve, the modeled changes in deposit balances and the cost of funds, including, the Company’s deposit and funding betas are not easily predicted in the current market environment, and therefore, a wide variety of strategic balance sheet and treasury yield curve scenarios are modeled on an ongoing basis.

The following reflects the Company’s estimated NII sensitivity as compared to the base case scenario over the subsequent twelve months based on:

• Balance sheet levels using September 30, 2023 as a starting point.
• The model assumes the Company’s average deposit balances will increase approximately 1.6% over the next twelve months.
• The model assumes the Company’s average earning asset balances will increase approximately 6.6% over the next twelve months, largely due to forecasted loan growth.
• Cash flows on earning assets are based on contractual maturity, optionality, and amortization schedules along with applicable prepayments derived from internal historical data and external sources.
• The model assumes no additional investment security purchases over the next twelve months. Investment cash flows will be used to pay down overnight borrowings and fund loan growth.
• In the rising rates scenarios, the prime rate, federal funds, and treasury curve rates are assumed to move up/down in a parallel manner by the amounts listed below over a 12-month period. Deposit balance and mix changes and the resultant deposit and funding betas are assumed to move in a manner that reflects the Company’s (i) long-term historical relationship between the Company’s deposit rate movement and changes in the federal funds rate, (ii) recent interest rate cycle experience, (iii) significant management judgment and (iv) other factors, including recent market behaviors of customers and competitors.

Net Interest Income Sensitivity Model

Projected NII over the 12-month forecast period decreases in the up 100 and up 200 rate environments largely due to deposits and overnight borrowings repricing higher in year 1, which are only partially offset by loans repricing higher.

Projected NII increases in the down 100 and down 200 rate environments due to lower funding costs which are partially offset by lower income on loans.

The analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions: the nature and timing of interest rate levels (including yield curve shape), prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows, and other factors. While the assumptions are developed based upon a reasonable outlook for national and local economic and market conditions, the Company cannot make any assurances as to the predictive efficacy of these assumptions, including how customer preferences or competitor influences might change. Furthermore, the sensitivity analysis does not reflect actions that the ALCO might take in responding to or anticipating changes in interest rates and other developments.

Evaluation of Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures, as defined in Rule 13a -15(e) and 15d – 15(e) under the Securities Exchange Act of 1934 as amended (the “Exchange Act”), designed to ensure information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is: (i) recorded, processed, summarized, and reported within the time periods specified in the SEC rules and forms, and (ii) accumulated and communicated to management, including the principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure. Based on management’s evaluation of the effectiveness of the Company’s disclosure controls and procedures, with the participation of the Chief Executive Officer and the Chief Financial Officer, it has concluded that, as of the end of the period covered by this Quarterly Report on Form 10-Q, these disclosure controls and procedures were effective as of September 30, 2023.

Changes in Internal Control over Financial Reporting

The Company regularly assesses the adequacy of its internal controls over financial reporting. There have been no changes in the Company’s internal controls over financial reporting in connection with the evaluation referenced in the paragraph above that occurred during the Company’s quarter ended September 30, 2023 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

There has not been any material change in the risk factors disclosure from that contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2022, as filed with the SEC on March 1, 2023, and the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2023, as filed with the SEC on May 10, 2023.