Stock Yards Bancorp, Inc.: Form 10-Q for the period ended Sep 30, 2023

Stock Yards Bancorp, Inc. (“Bancorp” or “the Company”), is a FHC headquartered in Louisville, Kentucky and is engaged in the business of banking through its wholly owned subsidiaries, Stock Yards Bank & Trust Company (“SYB” or “the Bank”) and SYB Insurance Company, Inc. (“the Captive”). Bancorp, which was incorporated in 1988 in Kentucky, is registered with, and subject to supervision, regulation and examination by, the Board of Governors of the Federal Reserve System. As Bancorp has no significant operations of its own, its business is essentially that of SYB and the Captive. The operations of SYB and the Captive are fully reflected in the consolidated financial statements of Bancorp. Accordingly, references to “Bancorp” in this document may encompass both the holding company and its subsidiaries, however, it should be noted that the business of the Captive is immaterial to the overall results of operations and financial condition of Bancorp. All significant inter-company transactions and accounts have been eliminated in consolidation.

SYB, established in 1904, is a state-chartered non-member financial institution that provides services in Louisville, central, eastern and northern Kentucky, as well as the Indianapolis, Indiana and Cincinnati, Ohio markets through 72 full service banking center locations. The Bank is registered with, and subject to supervision, regulation and examination by the FDIC and the Kentucky Department of Financial Institutions.

The Captive, a wholly owned subsidiary of the Bancorp, is a Nevada-based captive insurance company that provides insurance against certain risks unique to operations of the Company and its subsidiaries for which insurance may not be currently available or economically feasible in today’s insurance marketplace. The Captive pools resources with several other similar insurance company subsidiaries of financial institutions to spread a limited amount of risk among themselves. The Captive is subject to regulations of the State of Nevada and undergoes periodic examinations by the Nevada Division of Insurance. It has elected to be taxed under Section 831(b) of the Internal Revenue Code. Pursuant to Section 831(b), if gross premiums do not exceed $2,650,000, then the Captive is taxable solely on its investment income. The Captive is included in the Company’s consolidated financial statements and its federal income tax return.

On April 10, 2023, the IRS issued a proposed regulation that would potentially classify section 831(b) captive activity as a, “listed transaction,” and disallow the related tax benefits, both prospectively and retroactively, for a period of three years. While the proposed regulation has not been finalized, it is expected to be finalized during the fourth quarter of 2023. As a result, Bancorp elected not to renew the insurance captive effective August 2023 and expects it to be dissolved by the end of the year.

As a result of its acquisition of Commonwealth Bancshares, Inc. on March 7, 2022, Bancorp became the 100% successor owner of three unconsolidated Delaware trust subsidiaries: Commonwealth Statutory Trust III, Commonwealth Statutory Trust IV and Commonwealth Statutory Trust V. The sole assets of the trust subsidiaries represent the proceeds of offerings exchanged for subordinated debentures with similar terms to the TPS.

Also as a result of its acquisition of Commonwealth Bancshares, Inc., Bancorp acquired a 60% interest in Landmark Financial Advisors, LLC (LFA), which is based in Bowling Green, Kentucky and provides wealth management services. Effective December 31, 2022, Bancorp’s partial interest in LFA was sold, resulting in a pre-tax loss of $870,000 recorded in other non-interest expense on the consolidated income statements for the quarter and year ended December 31, 2022. This acquired line of business was not within the Company’s geographic footprint and ultimately did not align with the Company’s long-term strategic model. Net income related to LFA and attributable to Bancorp’s 60% interest, excluding the pre-tax loss on disposition noted above, totaled $483,000 for the year ended December 31, 2022.

Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the consolidated financial statements and accompanying Footnotes presented in Part 1 Item 1 “Financial Statements” and other information appearing in Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2022. To the extent that this discussion describes prior performance, the descriptions relate only to the periods listed, which may not be indicative of Bancorp’s future financial outcomes. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause results to differ materially from management’s expectations.

Cautionary Statement Regarding Forward-Looking Statements

This document contains statements relating to future results of Bancorp that are considered “forward-looking” as defined by Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The forward-looking statements are principally, but not exclusively, contained in Part I Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause actual results, performance, or achievements to be materially different from future results, performance, or achievements expressed or implied by the statement. These statements are often, but not always, made through the use of words or phrases such as “anticipate,” “believe,” “can,” “conclude,” “continue,” “could,” “estimate,” “expect,” “foresee,” “goal,” “intend,” “may,” “might,” “outlook,” “possible,” “plan,” “predict,” “project,” “potential,” “seek,” “should,” “target,” “will,” “will likely,” “would,” or other similar expressions. These forward-looking statements are not historical facts and are based on current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control.

Forward-looking statements detail management’s expectations regarding the future and are based on information known to management only as of the date the statements are made and management undertakes no obligation to update forward-looking statements to reflect events or circumstances that occur after the date forward-looking statements are made, except as required by applicable regulation.

There is no assurance that any list of risks and uncertainties or risk factors is complete. Factors that could cause actual results to differ materially from those expressed or implied in forward-looking statements include, among other things:

• Changes in, or forecasts of, future political and economic conditions, inflation or recession and efforts to control related developments;
• changes in laws and regulations or the interpretation thereof;
• accuracy of assumptions and estimates used in establishing the ACL for loans, ACL for off-balance sheet credit exposures and other estimates;
• impairment of investment securities;
• impairment of goodwill, MSRs, other intangible assets and/or DTAs;
• ability to effectively navigate an economic slowdown or other economic or market disruptions;
• changes in fiscal, monetary, and/or regulatory policies;
• changes in tax polices including but not limited to changes in federal and state statutory rates;
• behavior of securities and capital markets, including changes in interest rates, market volatility and liquidity;
• ability to effectively manage capital and liquidity;
• long-term and short-term interest rate fluctuations, as well as the shape of the U.S. Treasury yield curve;
• the magnitude and frequency of changes to the FFTR implemented by the Federal Open Market Committee of the FRB;
• competitive product and pricing pressures;
• projections of revenue, expenses, capital expenditures, losses, EPS, dividends, capital structure, etc.;
• integration of acquired financial institutions, businesses or future acquisitions;
• changes in the credit quality of Bancorp’s customers and counterparties, deteriorating asset quality and charge-off levels;
• changes in technology instituted by Bancorp, its counterparties or competitors;
• changes to or the effectiveness of Bancorp’s overall internal control environment;
• adequacy of Bancorp’s risk management framework, disclosure controls and procedures and internal control over financial reporting;
• changes in applicable accounting standards, including the introduction of new accounting standards;
• changes in investor sentiment or behavior;
• changes in consumer/business spending or savings behavior;
• ability to appropriately address social, environmental and sustainability concerns that may arise from business activities;
• occurrence of natural or man-made disasters or calamities, including health emergencies, the spread of infectious diseases, pandemics or outbreaks of hostilities, and Bancorp’s ability to deal effectively with disruptions caused by the foregoing;
• ability to maintain the security of its financial, accounting, technology, data processing and other operational systems and facilities;
• ability to withstand disruptions that may be caused by any failure of its operational systems or those of third parties;
• ability to effectively defend itself against cyberattacks or other attempts by unauthorized parties to access information of Bancorp, its vendors or its customers or to disrupt systems; and
• other risks and uncertainties reported from time-to-time in Bancorp’s filings with the SEC, including Part I Item 1A “Risk Factors” of Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2022.

Recent Developments within the Banking Industry

On May 11, 2023, the FDIC approved a notice of proposed rulemaking regarding a special assessment aimed at recovering the cost associated with protecting uninsured depositors following the failures of Silicon Valley Bank and Signature bank earlier this year. At the time of the proposal, the FDIC estimated that these costs totaled approximately $16 billion.

Under the proposal, the base for the special assessment would be equal to an insured depository institution’s estimated uninsured deposits reported as of December 31, 2022, adjusted to exclude the institution’s first $5 billion of uninsured deposits. The special assessment would be collected at an annual rate of approximately 12.5 bps over eight quarterly assessment periods beginning with the first quarterly assessment period of 2024. However, the proposed rate is subject to change prior to any final rule depending on any adjustments to the estimate of losses, mergers or failures, or amendments to reported estimates of uninsured deposits. The proposed rule provides opportunity for public comment for 60 days following publication in the Federal Register. As such, a final ruling on the proposal is expected to be announced during the fourth quarter of 2023.

As proposed, Bancorp would not be subjected to the special assessment. It is estimated that a total of 113 banking organizations would be subject to the special assessment, with 95% of the special assessment expected to be paid by banking organizations with $50 billion or more in total assets. No banking organization with under $5 billion in total assets would be subject to the special assessment.

In response to the potential liquidity issues created by the bank failures noted above, and to restore confidence in the stability of the banking system, the FRB created the Bank Term Funding Program. This program serves as a funding source to any U.S. federally insured depository institution, offering collateral-based fixed-rate advances to eligible borrowers for a term of up to one year. Eligible institutions can request such advances under the program until at least March 11, 2024. As of September 30, 2023, Bancorp has made no request for an advance under this program and currently does not plan to.

Bancorp has not been directly impacted by the early 2023 bank failures. We remain well-capitalized and continue to monitor and manage our liquidity position to satisfy both daily operations and longer-term strategic needs. Bancorp regularly reviews contingency funding strategies and we believe we are well-equipped to handle future liquidity requirements. We will continue to monitor the developments surrounding the recent bank failures noted above, as well as trends within the financial markets generally, to ensure we remain prepared to address potential liquidity issues that may arise.

Issued but Not Yet Effective Accounting Standards Updates

For disclosure regarding the impact to Bancorp’s financial statements of issued-but-not-yet-effective ASUs, see the footnote titled “Summary of Significant Accounting Policies” of Part I Item 1 “Financial Statements.”

Business Segment Overview

Bancorp is divided into two reportable segments: Commercial Banking and WM&T:

Commercial Banking provides a full range of loan and deposit products to individual consumers and businesses in all its markets through retail lending, mortgage banking, deposit services, online banking, mobile banking, private banking, commercial lending, commercial real estate lending, treasury management services, merchant services, international banking, correspondent banking and other banking services. The Bank also offers securities brokerage services via its banking center network through an arrangement with a third party broker-dealer in the Commercial Banking segment.

WM&T provides investment management, financial & retirement planning and trust & estate services, as well as retirement plan management for businesses and corporations in all markets in which Bancorp operates. The magnitude of WM&T revenue distinguishes Bancorp from other community banks of similar asset size.

Overview – Operating Results (FTE)

The following table presents an overview of Bancorp’s financial performance for the three months ended September 30, 2023 and 2022:

(dollars in thousands, except per share data)

Additional discussion follows under the section titled “Results of Operations.”

General highlights for the three months ended September 30, 2023 compared to September 30, 2022:

• Net income totaled $27.1 million for the three months ended September 30, 2023, resulting in diluted EPS of $0.92, compared to net income of $28.5 million for the three months ended September 30, 2022, which resulted in diluted EPS of $0.97.
• Results for the three months ended September 30, 2023 compared to the three months ended September 30, 2022 were driven by strong loan growth, a significantly higher interest rate environment compared to the same period of the prior year and the continued growth of Bancorp’s diversified non-interest revenue streams.
• An increase in the cost of funds stemming from deposit pricing pressure, which has driven deposit contraction and increased borrowing activity, hindered results for the third quarter of 2023 compared to the same period of the prior year.
• Total loans (excluding PPP) increased $559 million, or 11%, compared to September 30, 2022, driven by significant organic growth over the past 12 months. Average loans (excluding PPP) increased $554 million, or 11%, for the three months ended September 30, 2023 compared to the same period of the prior year.
• Bancorp’s ACL on loans increased $8 million, or 11%, compared to September 30, 2022, attributed mainly to the significant organic loan growth experienced over the last 12 months. Provision for credit losses on loans totaled $2.3 million for the three months ended September 30, 2023, compared to provision of $4.1 million for the three months ended September 30, 2022.
• Deposit balances declined $98 million, or 2%, compared to September 30, 2022, as a result of inflationary pressures and rising rates, the latter of which has enticed depositors to seek higher-yielding alternatives. In addition, a portion the deposit decline experienced for the first nine months of 2023 was driven by anticipated public funds runoff. While we have not seen widespread fallout in our overall customer base, deposit competition and a higher interest rate environment has created NIM compression and we expect it will continue to do so through the end of 2023.
• As a result of deposit pricing pressure/competition, Bancorp has experienced a significant shift in the deposit mix, as non-interest bearing deposits and lower-yielding deposits have migrated to higher-yielding options, particularly time deposits. This shift has significantly increased Bancorp’s cost of deposits and overall cost of funds.
• Net interest income (FTE) totaled $61.4 million for the three months ended September 30, 2023, representing a decrease of $1.2 million, or 2%, compared to the three months ended September 30, 2022.
• NIM decreased 12 bps, or 3%, to 3.34% for the three months ended September 30, 2023 compared to the same period of the prior year, driven by rising deposit costs and increased borrowing activity, which has outpaced the benefits of average earning asset expansion and the impact of rising rates on those assets over the past 12 months.
• Non-interest income decreased $2.0 million, or 8%, for the three months ended September 30, 2023, compared to the three months ended September 30, 2022, which was attributed largely to non-recurring activity recorded during the third quarter of 2022, including a $3.1 million gain associated with the sale of acquired property.
• Non-interest expenses increased $1.8 million, or 4%, for the three months ended September 30, 2023, compared to the three months ended September 30, 2022. Non-interest expenses in general remain well-controlled and consistent with expansion, strong performance and continued investment in technology.
• As of September 30, 2023, Bancorp continued to be “well-capitalized,” the highest regulatory capital rating for financial institutions, with all capital ratios experiencing growth compared to both December 31, 2022 and September 30, 2022. Total stockholders’ equity to total assets was 10.21% as of September 30, 2023, compared to 10.14% and 9.63% at December 31, 2022 and September 30, 2022, respectively. Tangible common equity to tangible assets was 7.69% at September 30, 2023, compared to 7.44% and 6.78% at December 31, 2022 and September 30, 2022, respectively.

The following table presents an overview of Bancorp’s financial performance for the nine months ended September 30, 2023 and 2022:

(dollars in thousands, except per share data)

Additional discussion follows under the section titled “Results of Operations.”

General highlights for the nine months ended September 30, 2023 compared to September 30, 2022:

• Net income totaled $83.8 million for the nine months ended September 30, 2023, resulting in diluted EPS of $2.86, compared to net income of $63.2 million for the nine months ended September 30, 2022, which resulted in diluted EPS of $2.20. The nine months ended September 30, 2022 was significantly impacted by the CB acquisition.
• Strong results for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022 were driven by significant organic and acquisition-related growth, higher net interest margin compared to the same period of the prior year and the continued growth of Bancorp’s diversified non-interest revenue streams.
• An increase in the cost of funds stemming from deposit contraction and pricing pressure, as well as increased borrowing activity, had a substantial impact on results for the nine months ended September 30, 2023 compared to the same period of the prior year.
• Bancorp completed its acquisition of CB on March 7, 2022. At the time of acquisition and net of purchase accounting adjustments, CB had approximately $1.34 billion in total assets, $632 million in loans, $247 million in investment securities and $1.12 billion in deposits. The nine months ended September 30, 2022 represented approximately seven months of activity associated with the CB acquisition, including $19.5 million in merger expenses and $4.4 million in credit loss expense attributed to the acquired loan portfolio, which weighed heavily on prior period results.
• Total loans (excluding PPP) increased $559 million, or 11%, compared to September 30, 2022, driven by significant organic growth over the past 12 months. Average loans (excluding PPP) increased $664 million, or 14%, for the nine months ended September 30, 2023 compared to the same period of the prior year as a result of the previously mentioned organic growth coupled with the prior year acquisition.
• Bancorp’s ACL on loans increased $8 million, or 11%, compared to September 30, 2022, attributed mainly to the significant organic loan growth experienced over the last 12 months. Provision for credit losses on loans totaled $6.7 million for the nine months ended September 30, 2023, compared to $6.1 million for the nine months ended September 30, 2022. While organic loan growth drove expense for the current year period, activity for the prior year period was attributed largely to $4.4 million of expense related to the acquired loan portfolio, and to a lesser extent, a deteriorating economic forecast.
• Deposit balances declined $98 million, or 2%, compared to September 30, 2022, as a result of inflationary pressures and rising rates, the latter of which has enticed depositors to seek higher-yielding alternatives. In addition, a portion the deposit decline experienced for the first nine months of 2023 was driven by anticipated public funds runoff. While we have not seen widespread fallout in our overall customer base, deposit competition and a higher interest rate environment has created NIM compression and we anticipate it will continue to do so through the end of 2023 and into early 2024.
• As a result of deposit pricing pressure/competition, Bancorp has experienced a significant shift in the deposit mix, as non-interest bearing deposits and lower-yielding deposits have migrated to higher-yielding options, particularly time deposits. This shift has significantly increased Bancorp’s cost of deposits and overall cost of funds.
• Net interest income (FTE) totaled $185.8 million for the nine months ended September 30, 2023, representing an increase of $17.0 million, or 10%, compared to the nine months ended September 30, 2022.
• NIM increased 19 bps, or 6%, to 3.44% for the nine months ended September 30, 2023 compared to the same period of the prior year, consistent with average balance sheet expansion and significant upward movement in the interest rate environment experienced over the past 12 months. However, rising funding costs, including a substantial increase in the cost of deposits and increased borrowing activity, has placed considerable pressure on NIM through the first nine months of 2023.
• Non-interest income increased $1.8 million, or 3%, for the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022, led by record WM&T and treasury fee income, significant growth in BOLI income associated with the prior year purchase of additional BOLI assets and solid growth in other non-interest income categories, which helped offset non-recurring activity recorded in the prior year period, including a $3.1 million gain on the sale of acquired property. The prior year period did not include a full nine months of activity associated with the acquisition of CB, as the acquisition was completed on March 7, 2022.
• Non-interest expenses declined $8.0 million, or 6%, for the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022. The prior year period included $19.5 million of merger expenses associated with the CB acquisition. Non-interest expenses in general remain well-controlled and consistent with expansion, strong performance and continued investment in technology. As previously noted, the prior year period did not include a full nine months of activity stemming from the acquisition of CB.

Results of Operations

Net Interest Income - Overview

As is the case with most banks, Bancorp’s primary revenue sources are net interest income and fee income from various financial services provided to customers. Net interest income is the difference between interest income earned on loans, investment securities and other interest earning assets less interest expense on deposit accounts and other interest bearing liabilities. Loan volume and interest rates earned on those loans are critical to overall profitability. Similarly, deposit volume is crucial to funding loans and rates paid on deposits directly impact profitability. New business volume is influenced by numerous economic factors including market interest rates, business spending, liquidity, consumer confidence and competitive conditions within the marketplace. The discussion that follows is based on FTE net interest income data.

Comparative information regarding net interest income follows:

(dollars in thousands)

(dollars in thousands)

*See table titled, "Average Balance Sheets and Interest Rates (FTE)" for detail of Net interest income (FTE).

NIM and net interest spread calculations above exclude the sold portion of certain participation loans, which totaled $4 million and $5 million at September 30, 2023 and December 31, 2022, respectively. These sold loans are on Bancorp’s balance sheet as required by GAAP because Bancorp retains some form of effective control; however, Bancorp receives no interest income on the sold portion. These participation loans sold are excluded from NIM and spread analysis, as Bancorp believes it provides a more accurate depiction of loan portfolio performance.

At September 30, 2023, Bancorp’s loan portfolio consisted of approximately 73% fixed and 27% variable rate loans. At inception, most of Bancorp’s fixed rate loans are priced in relation to the five year treasury. Bancorp’s variable rate loans are typically indexed to either Prime or SOFR, generally repricing as those rates change.

Prime rate, the five year Treasury note rate and one month term SOFR are included in the table above to provide a general indication of the interest rate environment in which Bancorp has operated during the past 12 months. The FRB took aggressive interest rate action in 2022, increasing the FFTR a total of 425 bps to a range of 4.25% - 4.50%. These increases ultimately took Prime to 7.50% as of December 31, 2022, marking its highest level since 2007. During the first nine months of 2023, the FRB continued raising rates, albeit at a slower pace, increasing the FFTR a total of 100 bps to a range of 5.25% - 5.50% as of September 30, 2023 via four separate 25 bps rate hikes. As a result, Prime ended at 8.50% as of September 30, 2023.

The current economic outlook remains volatile, regularly changing as new economic data becomes available and the FRB’s efforts to control inflation continue. Recent projections indicate that the FFTR will remain at the current level during the fourth quarter of 2023 and stay there through the first quarter of 2024. As a potential economic slowdown and recession looms, Bancorp expects ongoing pricing pressure/competition for both loans and deposits, changing levels of liquidity within the banking system and a severely inverted yield curve will continue to place pressure on NIM through the end of 2023 and early 2024.

Net Interest Income (FTE) – Three months ended September 30, 2023 compared to September 30, 2022

Net interest spread (FTE) and NIM (FTE) were 2.67% and 3.34%, for the three months ended September 30, 2023, compared to 3.31% and 3.46% for the same period in 2022, respectively. NIM during the three months ended September 30, 2023 was significantly impacted by the following:

• The rising interest rate environment that has evolved from the sustained, pandemic-driven lows experienced beginning in 2020. The FFTR was lowered to a range of 0% - 0.25% in March of 2020, which resulted in Prime dropping to 3.25%, where it remained until the FRB’s hike in mid-March 2022. The FFTR stood at a range of 5.25% - 5.50%, and Prime at 8.50%, as of September 30, 2023, as a result of aggressive interest rate action from the FRB over the past 12 months.
• Intense pricing pressure/competition for deposits has driven a significant increase in the cost of funds and overall deposit contraction, as depositors seek higher yielding deposit alternatives and Bancorp’s borrowing activity has increased, driving NIM compression.

Net interest income (FTE) decreased $1.2 million, or 2%, for the three months ended September 30, 2023 compared to the same period of 2022, as significant organic loan growth and the benefit higher rates had on interest earning assets were outpaced by rising funding costs stemming from intense pricing pressure/competition for deposits and increased borrowing activity.

Total average interest earning assets increased $123 million, or 2%, for the three months ended September 30, 2023, as compared to the same period of 2022, as substantial average loan growth was offset by a decline in average FFS/interest bearing due from bank balances and a decline in average investment securities associated with normal amortization and contractual maturities. However, as a result of a significantly higher interest rate environment, the average rate earned on total interest earning assets climbed 110 bps to 4.84%.

• Average total loan balances increased $537 million, or 11%, for the three months ended September 30, 2023, compared to the same period of 2022. Average non-PPP loan growth of $554 million, or 11%, was driven by strong organic growth, which was partially offset by a $17 million, or 74%, decline in average PPP loan balances resulting from continued pay down and forgiveness activity.
• Average investment securities declined $110 million, or 6%, for the three months ended September 30, 2023 compared to the same period of 2022, the result of normal pay down and maturity activity. Investment in the securities portfolio has slowed considerably over the past 12 months, consistent with funding loan growth and a general industry-wide decline in liquidity.
• Average FFS and interest bearing due from bank balances decreased $318 million, or 72%, for the three months ended September 30, 2023, as loan growth and deposit contraction led to lower levels of liquidity compared to the same period of the prior year.

Total interest income (FTE) increased $21.4 million, or 32%, to $89.0 million for the three months ended September 30, 2023, as compared to the same period of 2022.

• Interest and fee income (FTE) on loans increased $21.4 million, or 38%, to $78.3 million for the three months ended September 30, 2023, compared to the same period of 2022, driven by the rising rate environment and significant organic growth. The yield on the overall loan portfolio increased 110 bps to 5.66% for the three months ended September 30, 2023, compared to 4.56% for the same period of the prior year.
• Despite the decline in average investment securities, there was a $503,000, or 6%, increase in interest income (FTE) on the portfolio for the three months ended September 30, 2023 compared to the same period of 2022, driving a 24 bps increase in the corresponding yield on the portfolio. The increased yield on the investment securities portfolio was driven by the benefit of investments purchased in the prior year once rates began to rise and the continued amortization and maturity of lower-yielding securities.
• Interest income on FFS and interest bearing due from bank balances decreased $810,000 for the three months ended September 30, 2023, as a $318 million decline in corresponding average balances more than offset the dramatic rise in the FFTR experienced over the past twelve months. The yield on these assets increased 303 bps to 5.22% for the three months ended September 30, 2023 compared to the same period of 2022.

Total average interest bearing liabilities increased $457 million, or 10%, to $5.1 billion for the three-month period ended September 30, 2023 compared with the same period in 2022.

• Average interest bearing deposits increased $64 million, or 1%, for the three months ended September 30, 2023 compared to the same period in 2022, as a $296 million increase in average time deposits attributed to Bancorp’s promotional offerings more than offset declines in other interest bearing deposit types.
• Average FHLB advances totaled $402 million for the three months ended September 30, 2023. Bancorp utilized overnight borrowings with the FHLB during the three months ended September 30, 2023 based on evolving liquidity needs. Bancorp also utilized a rolling $200 million term advance in conjunction with three separate interest rate swaps during the quarter in an effort to secure longer-term funding at a more favorable rate. No FHLB borrowings were utilized during the same period of the prior year.
• Average subordinated debentures totaled $27 million for the three months ended September 30, 2023. These subordinated debentures were added as a result of the CB acquisition during the first quarter of 2022.

Total interest expense increased $22.6 million for the three months ended September 30, 2023 compared to the same period of 2022, driven by a significant rise in rates paid on deposits and increased borrowing activity. As a result, the cost of interest bearing liabilities increased 173 bps to 2.16% for the three months ended September 30, 2023 compared to the same period of 2022.

• Total interest bearing deposit expense increased $16.9 million as a result of the aforementioned deposit rate increases, resulting in a 148 bp increase in the cost of interest bearing deposits for the three months ended September 30, 2023 compared to the same period of the prior year. Bancorp expects pricing pressure/competition stemming from the rising rate environment to continue in the coming months.
• Interest expense of $4.9 million was recorded in relation to FHLB borrowings for the three months ended September 30, 2023, driven by the increased borrowing activity previously noted. No FHLB borrowings were utilized for the three months ended September 30, 2022.
• Interest expense totaling $579,000 was recorded for the three months ended September 30, 2023, as a result of the subordinated debentures added through the prior year acquisition, approximately $100,000 of which stems from purchase accounting-related mark-to-market amortization.

Net Interest Income (FTE) – Nine months ended September 30, 2023 compared to September 30, 2022

Net interest spread (FTE) and NIM (FTE) were 2.87% and 3.44%, for the nine months ended September 30, 2023, compared to 3.16% and 3.25% for the same period in 2022, respectively. NIM during the nine months ended September 30, 2023 was significantly impacted by the following:

• The rapidly rising interest rate environment that has evolved from the sustained, pandemic-driven lows experienced beginning in 2020. The FFTR was lowered to a range of 0% - 0.25% in March of 2020, which resulted in Prime dropping to 3.25%, where it remained until the FRB’s first hike in mid-March 2022. The FFTR stood at a range of 5.25% - 5.50%, and Prime at 8.50%, as of September 30, 2023, as a result of aggressive interest rate action from the FRB over the past 12 months.
• Substantial balance sheet expansion stemming from both organic growth and acquisition-related activity for the nine months ended September 30, 2023 compared to the same period of 2022.
• Intense pricing pressure/competition for deposits has driven a significant increase in the cost of funds, deposit mix shift and overall deposit contraction, as depositors seek higher yielding deposit alternatives and Bancorp’s borrowing activity has increased.

Net interest income (FTE) increased $17.0 million, or 10%, for the nine months ended September 30, 2023 compared to the same period of 2022, as a result of significant organic loan growth, investment in the securities portfolio, acquisition-related activity and the benefits of a rising interest rate environment, which more than offset rising funding costs.

Total average interest earning assets increased $274 million, or 4%, to $7.21 billion for the nine months ended September 30, 2023, as compared to the same period of 2022, with the average rate earned on total interest earning assets climbing 126 bps to 4.67%.

• Average total loan balances increased $611 million, or 13%, for the nine months ended September 30, 2023, compared to the same period of 2022. Average non-PPP loan growth of $664 million, or 14%, was driven by strong organic growth and acquisition-related expansion, which was only partially offset by a $53 million, or 84%, decline in average PPP loan balances resulting from continued forgiveness activity.
• Average investment securities grew $80 million, or 5%, for the nine months ended September 30, 2023 compared to the same period of 2022, attributed to a combination of strategically deploying excess liquidity through further investment and acquisition-related activity in 2022 offset by normal amortization and maturity activity through the first nine months of 2023. Investment security purchases during the nine months ended September 30, 2023 were minimal.
• Average FFS and interest bearing due from bank balances decreased $425 million, or 76%, for the nine months ended September 30, 2023, as loan growth and deposit contraction have led to lower levels of liquidity compared to the same period of the prior year.

Total interest income (FTE) increased $74.7 million, or 42%, to $251.9 million for the nine months ended September 30, 2023, as compared to the same period of 2022.

• Interest and fee income (FTE) on loans increased $67.1 million, or 44%, to $219.6 million for the nine months ended September 30, 2023, compared to the same period of 2022, driven by the rising rate environment and both organic and acquisition-related growth, which more than offset a $4.5 million, or 95%, decline in PPP-related income. The yield on the overall loan portfolio increased 119 bps to 5.50% for the nine months ended September 30, 2023, compared to 4.31% for the same period of the prior year.
• Growth in average investment securities led to a $6.0 million, or 30%, increase in interest income (FTE) on the portfolio for the nine months ended September 30, 2023 compared to the same period of 2022, driving a 40 bps, or 24%, increase in the corresponding yield on the portfolio. The increased yield on the investment securities portfolio was driven by the benefit of investments purchased in the prior year once rates began to rise and the continued amortization and maturity of lower-yielding securities.
• Interest income on FFS and interest bearing due from bank balances increased $1.0 million for the nine months ended September 30, 2023, as rising short-term interest rates more than offset a $425 million decline in related average balances. The yield on these assets increased 401 bps to 4.93% for the nine months ended September 30, 2023 compared to the same period of 2022, stemming from the dramatic increase in the FFTR over the past 12 months.

Total average interest bearing liabilities increased $410 million, or 9%, to $4.93 billion for the nine month period ended September 30, 2023 compared with the same period in 2022, with the total average cost increasing 154 bps to 1.79%.

• Average interest bearing deposits increased $97 million, or 2%, for the nine months ended September 30, 2023 compared to the same period in 2022. This increase stems from the addition of $1.12 billion in deposits during the first quarter of 2022 in relation to the CBT acquisition and an increase in time deposits during the first nine months of 2023 attributed to Bancorp’s promotional offerings, which has been partially offset by contraction in other interest bearing deposit categories.
• Average FHLB advances totaled $305 million for the nine months ended September 30, 2023. Bancorp utilized overnight borrowings with the FHLB during the nine months ended September 30, 2023 based on evolving liquidity needs. Bancorp also utilized rolling term advances in conjunction with three separate interest rate swaps during the nine months ended September 30, 2023 in an effort to secure longer-term funding at a more favorable rate. No FHLB borrowings were utilized during the same period of the prior year.
• Average subordinated debentures totaled $27 million for the nine months ended September 30, 2023. These subordinated debentures were added as a result of the CB acquisition during the first quarter of 2022.

Total interest expense increased $57.8 million for the nine months ended September 30, 2023 compared to the same period of 2022, driven largely by deposit rate increases and increased borrowing activity, and to a lesser extent, acquisition-related expansion. As a result, the cost of interest bearing liabilities increased 154 bps to 1.79% for the nine months ended September 30, 2023 compared to the same period of 2022.

• Total interest bearing deposit expense increased $44.6 million mainly as a result aforementioned deposit rate increases, resulting in a 132 bp increase in the cost of interest bearing deposits for the nine months ended September 30, 2023 compared to the same period of the prior year. Bancorp expects pricing pressure/competition stemming from the rising rate environment to continue the coming months.
• Interest expense of $10.6 million was recorded in relation to FHLB borrowings for the nine months ended September 30, 2023, driven by the increased borrowing activity previously noted. No FHLB borrowings were utilized for the nine months ended September 30, 2023.
• Interest expense totaling $1.7 million was recorded for the nine months ended September 30, 2023, as a result of the subordinated debentures added through the prior year acquisition, approximately $300,000 of which stems from purchase accounting-related mark-to-market amortization.

Average Balance Sheets and Interest Rates (FTE) – Three-Month Comparison

(dollars in thousands)

67

Average Balance Sheets and Interest Rates (FTE) – Nine-Month Comparison

(dollars in thousands)

68

Supplemental Information - Average Balance Sheets and Interest Rates (FTE)

• Average loan balances include the principal balance of non-accrual loans, as well as unearned income such as loan premiums, discounts, fees/costs and exclude participation loans accounted for as secured borrowings. Participation loans accounted for as secured borrowings averaged $4 million and $5 million for the three and nine-month periods ended September 30, 2023, respectively. Participation loans accounted for as secured borrowings averaged $5 million for both the three and nine-month periods ended September 30, 2022, respectively.
• Interest income on a FTE basis includes additional amounts of interest income that would have been earned if investments in certain tax-exempt interest earning assets had been made in assets subject to federal taxes yielding the same after-tax income. Interest income on municipal securities and tax-exempt loans has been calculated on a FTE basis using a federal income tax rate of 21%. Approximate tax equivalent adjustments to interest income were $122,000 and $232,000 for the three-month periods ended September 30, 2023 and 2022, respectively, and $441,000 and $677,000 for the nine-month periods ended September 30, 2023 and 2022, respectively.
• Interest income includes loan fees of $1.1 million ($27,000 associated with the PPP) and $2.2 million ($590,000 associated with the PPP) for the three-month periods ended September 30, 2023 and 2022, respectively, and $4.1 million ($217,000 associated with the PPP) and $8.9 million ($4.1 million associated with the PPP) for the nine-month periods ended September 30, 2023 and 2022, respectively. Interest income on loans may be materially impacted by the level of prepayment fees collected and accretion related to acquired loans. Accretion income related to acquired loans totaled $507,000 and $609,000 for the three-month periods ended September 30, 2023 and 2022, respectively, and $2.0 million for nine-month periods ended both September 30, 2023 and 2022, respectively.
• Net interest income, the most significant component of Bancorp's earnings, represents total interest income less total interest expense. The level of net interest income is determined by mix and volume of interest earning assets, interest bearing deposits and borrowed funds, and changes in interest rates.
• NIM represents net interest income on a FTE basis as a percentage of total average interest earning assets.
• Net interest spread (FTE) is the difference between taxable equivalent rates earned on total interest earning assets less the cost of interest bearing liabilities.
• The fair market value adjustment on investment securities resulting from ASC 320, “Investments – Debt and Equity Securities” is included as a component of other assets.

Asset/Liability Management and Interest Rate Risk

Managing interest rate risk is fundamental for the financial services industry. The primary objective of interest rate risk management is to neutralize effects of interest rate changes on net income. By considering both on and off-balance sheet financial instruments, management evaluates interest rate sensitivity with the goal of optimizing net interest income within the constraints of prudent capital adequacy, liquidity needs, market opportunities and customer funding requirements.

Interest Rate Simulation Sensitivity Analysis

Bancorp uses an earnings simulation model to estimate and evaluate the impact of an immediate change in interest rates on earnings in a one-year forecast. The simulation model is designed to reflect dynamics of interest earning assets and interest bearing liabilities. By estimating effects of interest rate fluctuations, the model can approximate interest rate risk exposure. This simulation model is used by management to gauge approximate results given a specific change in interest rates at a given point in time. The model is therefore a tool to indicate earnings trends in given interest rate scenarios and may not indicate actual or expected results.

The results of the interest rate sensitivity analysis performed as of September 30, 2023 were derived from the conservative assumptions Bancorp uses in the model, particularly in relation to deposit betas, which measure how responsive management’s deposit repricing may be to changes in market rates and are based on historical data. Management uses different betas in the rising and falling rate scenarios in an effort to best simulate expected earnings trends. The results presented below reflect an interest rate sensitivity analysis that incorporates a deposit beta of approximately 60% for the rising rate scenarios and 32% for falling rate scenarios, respectively. While the beta’s experienced since rates began to rise in the first quarter of 2022 were significantly below the 60% beta used in the model, the Company anticipates the future rising rate scenario betas to return to the historic averages. The 32% beta used in the falling rate scenario is the result of management’s expectations of deposit rate decreases given the rate changes experienced since the first quarter of 2022.

Bancorp’s interest rate simulation sensitivity analysis details that increases in interest rates of 100, 200 and 300 bps would have a negative effect on net interest income, as would decreases in interest rates of 100 and 200 bps. These results depict a slightly liability sensitive interest rate risk profile in rising rate scenarios and an asset sensitive position in the falling rate scenarios. The decrease in net interest income in the rising rate scenarios is primarily due to variable rate loans and short-term investments repricing slower than deposits and short-term borrowings. The decrease in net interest income in the falling rate scenarios is the result of the lower beta experienced since rates began to rise in the first quarter of 2022, which was the result of a significant percentage of the Company’s deposit cost being less than 100 bps, and therefore cannot decrease the full 100 or 200 bps simulated in the model.

Bancorp’s loan portfolio is currently composed of approximately 73% fixed and 27% variable rate loans, with the fixed rate portion pricing generally based on a spread to the five year treasury curve at the time of origination and the variable portion pricing based on an on-going spread to Prime (approximately 62%) or SOFR (approximately 38%).

In July 2017, the Financial Conduct Authority (the “FCA”), the authority regulating LIBOR, along with various other regulatory bodies, announced that LIBOR would likely be discontinued at the end of 2021. Subsequent to that announcement, in November 2020, the FCA announced that many tenors of LIBOR would continue to be published through June 2023. Subsequent to this, Bank regulators instructed banks to discontinue new originations referencing LIBOR as soon as possible, but no later than December 2021. Effective December 31, 2021, LIBOR is no longer used to issue new loans in the U.S. It has been replaced primarily by SOFR, which is considered to be a more accurate and secure pricing benchmark. Bancorp did not experience any operational issues associated with reference rate reform.

On March 15, 2022, the Adjustable Interest Rate (LIBOR) Act was signed into law as part of the Consolidated Appropriations Act of 2022. This legislation established a uniform benchmark replacement process for financial contracts that matured after the cessation of LIBOR (June 2023) that do not contain clearly defined or practicable fallback provisions. The legislation also established a safe harbor for lenders, providing protection from litigation associated with choosing a replacement rate recommended by the FRB, such as SOFR, and also allows for the continued use of any appropriate benchmark rate for new contracts.

As a result of LIBOR’s cessation in June 2023, the Company did not have any loans or interest rate derivative contracts that referenced LIBOR as of September 30, 2023. The Company now utilizes SOFR as the replacement for LIBOR. The Company had $722 million in loans and interest rate derivative contracts (notional amount) that were indexed to SOFR at September 30, 2023.

Periodically, Bancorp enters into interest rate swap transactions with borrowers who desire to hedge exposure to rising interest rates, while at the same time entering into an offsetting interest rate swap, with substantially matching terms, with another approved independent counterparty. These are undesignated derivative instruments and are recognized on the balance sheet at fair value, with changes in fair value recorded in other non-interest income as interest rates fluctuate. Because of matching terms of offsetting contracts, in addition to collateral provisions which mitigate the impact of non-performance risk, changes in fair value subsequent to initial recognition have a minimal effect on earnings, and are therefore not included in the simulation analysis results above. For additional information see the Footnote titled “Assets and Liabilities Measured and Reported at Fair Value.”

In addition, Bancorp periodically uses derivative financial instruments as part of its interest rate risk management, including interest rate swaps. These interest rate swaps are designated as cash flow hedges as described in the Footnote titled “Derivative Financial Instruments.” For these derivatives, the effective portion of gains or losses is reported as a component of OCI, and is subsequently reclassified into earnings as an adjustment to interest expense in periods in which the hedged forecasted transaction affects earnings.

Provision for Credit Losses

Provision for credit losses on loans at September 30, 2023 represents the amount of expense that, based on Management’s judgment, is required to maintain the ACL for loans at an appropriate level under the CECL model. The determination of the amount of the ACL for loans is complex and involves a high degree of judgment and subjectivity. See the Footnote titled “Basis of Presentation and Summary of Significant Accounting Policies” in Bancorp’s Annual Report on Form 10-K for the year ended December 31, 2022 for detailed discussion regarding Bancorp’s ACL methodology by loan segment.

An analysis of the changes in the ACL for loans, including provision, and selected ratios follow:

(dollars in thousands)

(1) Ratios are not annualized

(2) See the section titled “Non-GAAP Financial Measures” for reconcilement of Non-GAAP to GAAP measures

The ACL for loans totaled $78 million as of September 30, 2023 compared to $70 million at September 30, 2022, representing an ACL to total loans ratio of 1.39% and 1.38% for the respective periods. The ACL to loans (excluding PPP loans) was 1.39% at both September 30, 2023 and September 30, 2022. Based on the 100% SBA guarantee of the PPP loan portfolio, which totaled $5 million at September 30, 2023 and $19 million at September 30, 2022, Bancorp did not reserve for potential losses for these loans within the ACL. See the section titled “Non-GAAP Financial Measures” for reconcilement of non-GAAP to GAAP measures.

Provision of $2.3 million and $6.7 million was recorded to provision for credit losses on loans for the three and nine month periods ended September 30, 2023, respectively. While credit quality remains strong, provision expense for the three and nine months ended September 30, 2023 was driven by strong loan growth, which was partially offset by improvement in unemployment forecast and a reduction in specific reserves due to charge-offs. Net charge off activity for the three and nine months ended September 30, 2023 totaled $1.9 million and $2.2 million, respectively, which was attributed mainly to the charge off of a larger C&I relationship, which was fully reserved for in a prior period.

Provision expense (excluding acquisition-related activity) of $4.1 million and $1.7 million was recorded for the three and nine months ended September 30, 2022, respectively. Expense for the three month period of the prior year was driven by strong third quarter loan growth and to a lesser extent, a negative economic forecast. While these factors also drove expense for the nine month period of the prior year, they were more than offset by the release of approximately $3.0 million in specific reserves relating to acquired individual loans. These loans paid off during the second quarter of 2022 with no loss or charge-off realized by Bancorp.

Further, credit loss expense recorded in the first quarter of 2022 for the loan portfolio acquired from CB, which totaled $4.4 million, added to the expense noted above for the prior year period, resulting in total provision for credit losses on loans of $6.1 million for the nine months ended September 30, 2022.

In addition to the provision activity noted above for the prior year period, the ACL for loans was also increased $10 million during the first quarter of 2022, as a result of the PCD loan portfolio added through the CB acquisition, with the corresponding offset recorded to goodwill (as opposed to provision expense).

While separate from the ACL for loans and recorded in other liabilities on the consolidated balance sheets, the ACL for off balance sheet credit exposures also experienced an increase between December 31, 2022 and September 30, 2023. Provision for credit loss expense for off balance sheet credit exposures of $475,000 and $1.1 million was recorded for the three and nine months ended September 30, 2023, driven by a decline in C&I utilization and increased availability stemming from the addition of new lines of credit. The ACL for off balance sheet credit exposures totaled $5.6 million as of September 30, 2023.

Provision for credit loss expense for off balance sheet credit exposures (excluding acquisition-related activity) of $700,000 and $800,000 was recorded for the three and nine months ended September 30, 2022. The expense recorded for the three and nine months ended September 30, 2022 was driven largely by the addition of new lines of credit, and thus increased availability, within the C&D portfolio. The ACL for off balance sheet credit exposures was also increased $500,000 during the first quarter of 2022 as a result of the CB acquisition, with the offset recorded to goodwill (as opposed to provision expense). The ACL for off balance sheet credit exposures totaled $5 million as of September 30, 2022.

Bancorp’s loan portfolio is well-diversified with no significant concentrations of credit. Geographically, most loans are extended to borrowers in Louisville, central, eastern and northern Kentucky, as well as the Indianapolis, Indiana and Cincinnati, Ohio metropolitan markets. The adequacy of the ACL is monitored on an ongoing basis and it is the opinion of management that the balance of the ACL at September 30, 2023 is adequate to absorb probable losses inherent in the loan portfolio as of the financial statement date.

Non-interest Income

(dollars in thousands)

Total non-interest income decreased $2.0 million or 8%, and increased $1.8 million, or 3%, for the three and nine month periods ended September 30, 2023 compared to the same periods of 2022, respectively. Non-interest income comprised 27.2% and 26.8% of total revenues, defined as net interest income and non-interest income, for the three and nine month periods ended September 30, 2023 compared to 28.5% and 28.2% for the same period of 2022. WM&T services comprised 43.8% of total non-interest income for both the three and nine month periods ended September 30, 2023 compared to 36.8% and 40.7% for the same periods of 2022. While strong organic growth has been experienced across most non-interest income revenue streams over the past 12 months, a large gain recorded in the prior year associated with the sale of acquired property was the primary driver of the decrease for the three month period and the moderate increase for the nine month period. As previously noted, the prior year period only included approximately seven months of activity related to the CB acquisition.

WM&T Services:

The magnitude of WM&T revenue distinguishes Bancorp from other community banks of similar asset size. WM&T revenue increased $878,000, or 10%, and $2.8 million, or 10%, for the three and nine month periods ended September 30, 2023, as compared with the same periods of 2022, consistent with new business development, increased estate fees, positive year-to-date returns from the equity markets and to a lesser extent, acquisition-related activity.

Recurring fees earned for managing accounts are based on a percentage of market value of AUM and are typically assessed on a monthly basis. Recurring fees, which generally comprise the vast majority of WM&T revenue, increased $568,000, or 6%, and $2.3 million, or 9%, for the three and nine month periods ended September 30, 2023, as compared with the same periods of 2022. The increases for the three month and nine month periods were driven largely by new business development, while the nine month period also benefitted from the previously mentioned positive returns from the equity markets. Further, the nine months ended September 30, 2022 included only seven months of activity stemming from the CB acquisition, which added AUM of $2.65 billion as of the acquisition date.

A portion of WM&T revenue, most notably executor and certain employee benefit plan-related fees, are non-recurring in nature and the timing of these revenues corresponds with the related administrative activities. For this reason, such fees are subject to greater period over period fluctuation. Total non-recurring fees increased $310,000 and $468,000 for the three and nine month periods ended September 30, 2023, as compared with the same periods of 2022, which was driven mainly by increased estate fee income.

AUM, stated at market value, totaled $6.67 billion at September 30, 2023 compared with $6.30 billion at September 30, 2022 and $6.59 billion at December 31, 2022. The increase in AUM between September 30, 2022 and September 30, 2023 is attributed to net new business growth and equity market appreciation experienced through the first nine months of 2023.

Contracts between WM&T and their customers do not permit performance-based fees and accordingly, none of the WM&T revenue is performance based. Management believes the WM&T department will continue to factor significantly in Bancorp’s financial results and provide strategic diversity to revenue streams.

Detail of WM&T Service Income by Account Type:

(in thousands)

The preceding table demonstrates that WM&T fee revenue is concentrated within investment advisory and personal trust accounts. WM&T fees are predominantly based on AUM and tailored for individual/company accounts and/or relationships with fee structures customized based on account type and other factors with larger relationships paying a lower percentage of AUM in fees. For example, recurring AUM fee structures are in place for investment management, irrevocable and revocable trusts, personal investment retirement accounts and accounts holding only fixed income securities. WM&T also provides company retirement plan services, which can consist of a one-time conversion fee with recurring AUM fees to follow. While there are also fee structures for estate settlements, income received is typically non-recurring in nature. Fee structures are agreed upon at the time of account opening and any subsequent revisions are communicated in writing to the customer. WM&T fees earned are not performance-based nor are they based on investment strategy or transactions. Bancorp also earns management fees on in-house investments funds acquired from CB.

Assets Under Management by Account Type:

AUM (not included on balance sheet) increased from $6.59 billion at December 31, 2022 to $6.67 billion at September 30, 2023 as follows:

(in thousands)

(1) Non-managed assets represent those for which the WM&T department does not hold investment discretion.

As of September 30, 2023 and December 31, 2022, approximately 81% and 79%, respectively, of AUM were actively managed. Company retirement plan accounts consist primarily of participant-directed assets. The amount of custody and safekeeping accounts are insignificant.

Managed Trust Assets under Management by Class of Investment:

(in thousands)

(1) Includes client directed instruments including rights, warrants, annuities, insurance policies, unit investment trusts, and oil and gas rights.

Managed assets are invested in instruments for which market values can be readily determined, the majority of which are sensitive to market fluctuations and consist of approximately 64% in equities and 36% in fixed income securities as of September 30, 2023, compared to 63% and 37% as of December 31, 2022. This composition has remained relatively consistent from period to period.

Additional Sources of Non-interest income:

Deposit service charges, which consist of non-sufficient funds charges and to a lesser extent, other activity based charges, increased $93,000, or 4%, and $519,000, or 9%, for the three and nine month periods ended September 30, 2023, as compared with the same periods of 2022. While both organic and acquisition-related expansion drove the increases noted above, an industry-wide decline in the volume of fees earned on overdrawn checking accounts has been experienced over the past several years. This trend has been driven by lower check presentment volume, which has in turn led to fewer overdrawn accounts in general. Further, Bancorp anticipates that future growth of this revenue stream could be significantly impacted by changing industry practices. Bancorp could be faced with strategic decisions surrounding deposit-related service charges in the future, which could negatively impact the contributions made by this, or similar, revenue streams.

Debit and credit card income consists of interchange revenue, ancillary fees and incentives received from card processors. Debit and credit card revenue increased $160,000, or 3%, and $487,000, or 4%, for the three and nine month periods ended September 30, 2023, as compared with the same periods of 2022. The increases stem mainly from organic and acquisition-related expansion, which were able to offset continued interchange rate compression. Total debit card income increased $10,000, or less than 1%, and $198,000, or 2%, and total credit card income increased $150,000, or 10%, and $289,000, or 7%, for the three and nine month periods ended September 30, 2023, compared the same periods of the prior year. While Bancorp generally expects this revenue stream to grow with continued expansion of the customer base, interchange rate compression and any potential fluctuation in business and consumer spend levels could serve as challenges to future growth.

Treasury management fees primarily consist of fees earned for cash management services provided to commercial customers. This category continues to stand out as a consistent, growing source of revenue for Bancorp and increased $414,000, or 19%, and $1.2 million, or 19%, for the three and nine month periods ended September 30, 2023, as compared with the same periods of 2022, driven by organic and acquisition-related expansion, increased transaction volume, growing international services and new product sales. Bancorp anticipates this income category will continue to increase based on continued customer base growth and the expanding suite of services offered within Bancorp’s treasury management platform.

Mortgage banking income primarily includes gains on sales of mortgage loans and net loan servicing income offset by MSR amortization. Bancorp’s mortgage banking department predominantly originates residential mortgage loans to be sold in the secondary market, primarily to FNMA and FHLMC. Bancorp offers conventional, VA, FHA and GNMA financing for purchases and refinances, as well as programs for first-time homebuyers. Interest rates on mortgage loans directly influence the volume of business transacted by the mortgage-banking department. Mortgage banking revenue increased $111,000, or 16%, and decreased $119,000, or 4%, for the three and nine month periods ended September 30, 2023, as compared with the same periods of 2022, the variances from the prior year periods being attributed to changing levels of mortgage volume.

Net investment product sales commissions and fees are generated primarily on stock, bond and mutual fund sales, as well as wrap fees earned on brokerage accounts. Wrap fees represent charges for investment programs that bundle together a suite of services, such as brokerage, advisory, research and management and are based on a percentage of account assets. Bancorp deploys its financial advisors primarily through its branch network via an arrangement with a third party broker-dealer, while larger managed accounts are serviced by Bancorp’s WM&T Department. Net investment product sales commissions and fees decreased $101,000, or 11%, and increased $115,000, or 5%, for the three and nine month periods ended September 30, 2023, as compared with the same periods of 2022. The decrease for the three month period is attributed to lower trading volume compared to the third quarter of the prior year, while the increase for the nine month period is attributed to organic and acquisition-related expansion.

BOLI assets represent the cash surrender value of life insurance policies on certain active and non-active employees who have provided consent for Bancorp to be the beneficiary for a portion of such policies. The related change in cash surrender value and any death benefits received under the policies are recorded as non-interest income. This income serves to offset the cost of various employee benefits. During the third quarter of 2022, Bancorp purchased an additional $30 million of BOLI assets in an effort to diversify investment of excess liquidity, bringing total BOLI assets to $86 million as of September 30, 2023. BOLI income increased $53,000 and $625,000 for the three and nine month periods ending September 30, 2023 compared to the same periods of the prior year, which was attributed mainly to the additional prior year investment noted above in addition to general market appreciation within the policy plans during the first nine months of 2023.

Gains and losses on the sale of premises and equipment for the three and nine months ended September 30, 2023 were driven by a gain on the sale of an acquired property during the third quarter and a loss recorded during the second quarter in relation to other merger-related disposal activity. Activity for the three and nine month periods ended September 30, 2022 consisted almost entirely of the sale of certain acquired properties. All sales related to the disposition of acquired branch locations closed subsequent to the prior year merger.

Other non-interest income decreased $804,000, or 57%, and $863,000, or 23%, for the three and nine month periods ended September 30, 2023 compared with the same periods of 2022. The decreases were driven largely by the disposition of Bancorp’s partial interest in LFA effective December 31, 2022, which contributed $566,000 and $1.3 million of other non-interest income for the three and nine month periods ended September 30, 2022. Further, Bancorp recorded a $250,000 write down on an OREO property during the third quarter of 2023. Partially offsetting the declines for the three and nine month periods ended September 30, 2023 were higher interest rate swap fee income and stronger returns from insurance policies outside of Bancorp’s BOLI portfolio compared to the same periods of last year.

Non-interest Expenses

(dollars in thousands)

Total non-interest expenses increased $1.8 million, or 4%, and decreased $8.0 million, or 6%, for the three and nine month periods ended September 30, 2023 compared to the same periods of 2022. The increase for the three month period is consistent with the organic and acquisition-related growth experienced over the past year, while the decrease for the nine month period was driven by one-time merger expenses associated with completion of the CB acquisition during the first quarter of 2022. Compensation and employee benefits comprised 59.7% and 59.5% of Bancorp’s total non-interest expenses for the three and nine month periods ended September 30, 2023, compared to 60.7% and 52.4% for the same periods of 2022. Excluding merger expenses, compensation and employee benefits comprised 60.5% for the nine month period ended September 30, 2022. The nine months ended September 30, 2022 only included approximately seven months of activity associated with the CB acquisition.

Compensation, which includes salaries, incentives, bonuses and stock based compensation, increased $310,000, or 1%, and $4.1 million, or 7%, for the three and nine month periods ended September 30, 2023, as compared with the same periods of 2022. The increases for were attributed to growth in full time equivalent employees and annual merit-based salary increases. Further, the first nine months of 2022 experienced only seven months of acquisition-related activity, as previously noted. Net full time equivalent employees totaled 1,067 at September 30, 2023 compared to 1,040 at December 31, 2022 and 1,028 at September 30, 2022.

Employee benefits consists of all personnel-related expense not included in compensation, with the most significant items being health insurance, payroll taxes and employee retirement plan contributions. Employee benefits increased $329,000, or 8%, and $1.5 million, or 11%, for the three and nine month periods ended September 30, 2023, as compared with the same periods of 2022, driven by an increase in health insurance claims activity and the overall increase in full time equivalent employees noted above.

Net occupancy and equipment expenses primarily include depreciation, rent, property taxes, utilities and maintenance. Costs of capital asset additions flow through the statement of income over the lives of the assets in the form of depreciation expense. Net occupancy expense increased $54,000, or 1%, and $779,000, or 7%, the three and nine month periods ended September 30, 2023, as compared with the same periods of 2022. While the increase for the three month period was marginal, the increase for the nine month period stems mainly from the prior year period experiencing only seven month of acquisition-related activity and the opening of Bancorp’s new operations center in the latter part of 2022. In connection with the CB acquisition, 15 branches were acquired, four of which were closed shortly after acquisition in addition to one existing SYB location, as a result of branch overlap. At September 30, 2023, Bancorp’s branch network consisted of 72 locations throughout Louisville, central, eastern and Northern Kentucky, as well as the MSAs of Indianapolis, Indiana and Cincinnati, Ohio.

Technology and communication expenses include computer software usage and licensing fees, equipment depreciation and expenditures related to investments in technology needed to maintain and improve the quality of customer delivery channels, information security and internal resources. Technology expense increased $489,000, or 13%, and $1.6 million, or 14%, for the three and nine month periods ended September 30, 2023 compared to the same periods of 2022, consistent with acquisition-related activity, customer expansion and continued investment in technology.

Bancorp outsources processing for debit and commercial credit card operations, which generate significant revenue for the Company. These expenses typically fluctuate consistent with transaction volumes. Debit and credit card processing expense increased $200,000, or 14%, and $323,000, or 7%, for the three and nine month periods ending September 30, 2023 compared to the same periods of last year, driven by the increase in transaction volume and customer base expansion resulting from both organic and acquisition-related growth.

Marketing and business development expenses include all costs associated with promoting Bancorp, including community support, retaining customers and acquiring new business. Marketing and business development expenses increased $113,000, or 9%, and $775,000, or 22%, for the three and nine month periods ending September 30, 2023, as compared to the same periods of 2022. The increases were driven largely by strategic decisions to advertise in Bancorp’s new markets, increased advertising expense associated with Bancorp’s time deposit promotions and the general expansion of Bancorp’s existing and prospective customer base.

Postage, printing and supplies expense increased $35,000, or 4%, and $240,000, or 10%, for the three and nine month periods ended September 30, 2023 compared to the same periods of 2022, consistent with Bancorp’s expansion over the past 12 months and promotional mailings.

Legal and professional fees increased $275,000, or 36%, and $214,000, or 9%, for the three and nine month periods ended September 30, 2023 compared to the same periods of last year, attributed mainly to several consulting projects. Legal and professional fees associated with the prior year merger-related activity are captured in merger expenses.

FDIC insurance increased $90,000, or 11%, and $823,000, or 41%, for the three and nine month periods ended September 30, 2023, as compared to the same periods of 2022, driven by Bancorp’s asset growth, the FDIC-mandated increase of the uniform base assessment rate and to a lesser extent, Bancorp’s adjusted CAMEL rating.

Tax credit partnerships generate federal income tax credits, and for each of Bancorp’s investments in tax credit partnerships, the tax benefit, net of related expenses, results in a positive effect on net income. Amounts of credits and corresponding expenses can vary widely depending upon the timing and magnitude of the underlying investments. Amortization expense associated with these investments increased $235,000 and $705,000 for the three and nine month periods ending September 30, 2023 compared to the same periods of last year, driven by investment in several larger tax credit projects during the nine months ended September 30, 2023.

Capital and deposit based taxes, which consist primarily of capital-based local income taxes and franchise taxes, decreased $93,000, or 13%, and increased $53,000, or 3%, for the three and nine month periods ended September 30, 2023 compared to the same periods of 2022. The decrease for the three month period was attributed primarily to lower deposit levels compared to the prior year, while the increase for the nine month period is attributed to the prior year period only experiencing seven months of acquisition-related activity.

Merger expenses represent non-recurring expenses associated with completion of the CB acquisition and consist primarily of investment banker fees, various compensation-related expenses, legal fees, early termination fees relating to various contracts and system conversion expenses. Merger expenses totaling $19.5 million were recorded in relation to the CB acquisition during the nine months ended September 30, 2022.

Intangible amortization expense consists of amortization associated with the CDI of acquired deposit portfolios, as well as an intangible related to customer list of the WM&T business line added through the CB acquisition. The intangibles are generally amortized on an accelerated basis over a period of approximately ten years. Intangible amortization expense decreased $443,000, or 28%, and $415,000, or 11%, for the three and nine months ended September 30, 2023. The decreases were attributed to both the accelerated depreciation method for which intangible assets are amortized, as well as the previously mentioned disposal of Bancorp’s partial interest in LFA at the end of 2022, which included writing off the related CLI effective December 31, 2022. Further, the nine month period ended September 30, 2022 only including seven months of activity associated with the CB acquisition and the related CDI and CLI assets.

Other non-interest expenses increased $235,000, or 9%, and $803,000, or 11%, for the three and nine month periods ended September 30, 2023, as compared to the same periods of 2022. The most notable drivers of the increases were increased card reward expense, higher fraud and theft-related expenses and other ancillary expenses tied to Bancorp’s growth over the past 12 months.

Bancorp’s efficiency ratio (FTE) for the three and nine month periods ended September 30, 2023 was 55.38% and 54.35%, respectively. Bancorp’s efficiency ratio for the three and nine month periods ended September 30, 2022 was 51.30% and 62.11%, the latter period reflecting one-time merger-related expenses attributed to the CB acquisition, all of which were recorded in the first quarter of 2022. Bancorp also considers an adjusted efficiency ratio, which eliminates net gains (losses) on sales, calls, and impairment of investment securities, as well as net gains (losses) on sales of premises and equipment and the disposition of any acquired assets, if applicable, and the fluctuation in non-interest expenses related to amortization of investments in tax credit partnerships and merger-related expenses. Bancorp’s adjusted efficiency ratio was 55.19% and 53.99% for the three and nine month periods ended September 30, 2023 compared to 53.06% and 54.40% for three and nine month periods ended September 30, 2022. See the section titled “Non-GAAP Financial Measures” for reconcilement of non-GAAP to GAAP measures.

Income Tax Expense

A comparison of income tax expense and ETR follows:

(dollars in thousands)

Fluctuations in the ETR are primarily attributed to the following:

• The stock based compensation component of the ETR fluctuates consistent with the level of SAR exercise activity. The ETR was reduced by 0.3% for the nine months ended September 30, 2023 compared to a reduction of 1.3% for the same period of 2022, consistent with exercise and vesting activity.
• The cash surrender value of life insurance policies can vary widely from period to period, driven largely by changes in the markets. The related impact is inversely correlated with the ETR generally, with cash surrender value declines typically serving to increase the ETR and vice versa. Changes in the cash surrender value of life insurance policies decreased the ETR by 0.5% for the nine months ended September 30, 2023, compared to an increase of 0.6% the same period of the prior year.
• Bancorp invests in certain partnerships that yield federal income tax credits. Taken as a whole, the tax benefit of these investments exceeds amortization expense, resulting in a positive impact on net income. The timing and magnitude of these transactions may vary widely from period to period. The ETR for the nine months ended September 30, 2023 and 2022 was reduced by 0.5% and by 0.6%, respectively, by tax credit activity.
• Tax-exempt interest income earned on loans and investment securities reduced the ETR by 0.5% for the nine months ended September 30, 2023 compared to a reduction of 0.7% for the same period of the prior year.
• Non-deductible merger expenses recorded during the nine months ended September 30, 2022 served to increase the ETR 0.2%.
• Bancorp’s insurance captive provides insurance against certain risks for which insurance may not currently be available or economically feasible to Bancorp and SYB, as well as a group of third-party insurance captives. The tax advantages of the Captive, including the tax-deductible nature of premiums paid to the Captive as well as the tax-exemption for premiums received by the Captive, serve to reduce income tax expense. Related activity reduced the ETR by 0.3% for the nine months ended September 30, 2023 and 2022, respectively. However, Bancorp elected not to renew the Captive during the third quarter of 2023 and expects it to be dissolved by the end of the year. As a result, the tax benefits associated with the Captive are not expected to be experienced going forward.

Financial Condition – September 30, 2023 Compared to December 31, 2022

Overview

Total assets increased $407 million, or 5%, to $7.90 billion at September 30, 2023 from $7.50 billion at December 31, 2022. Total loans increased $411 million, or 8%, as the result of two consecutive quarters of near-record loan growth in the second and third quarters of 2023. Additionally, cash and cash equivalents increased $26 million, or 15%, due to increased FHLB borrowing activity and Other assets increased $112 million, or 83%, driven by investment in tax credit partnerships associated with meeting CRA requirements. Partially offsetting this growth was a $152 million, or 9%, decline in total investment securities stemming from scheduled maturity and pay down activity within the total portfolio in addition to a $22 million decline in the market value of the AFS investment portfolio specifically.

Total liabilities increased $361 million, or 5%, to $7.10 billion at September 30, 2023 from $6.74 billion at December 31, 2022. The increase was attributed to a $300 million increase in FHLB borrowings associated with funding loan growth and a $64 million increase in Other liabilities, which related to the accrual of contributions for tax credit partnerships (the offset to the increase in Other assets for tax credit investment noted above). Total deposits were virtually flat at September 30, 2023 compared to December 31, 2022, increasing $12 million, or less than 1%, during the first nine months of 2023.

Stockholders’ equity increased $47 million, or 6%, to $807 million at September 30, 2023 from $760 million at December 31, 2022. Net income of $83.8 million was only partially offset by $25.8 million of dividends declared during the first nine months of 2023 and a $12.4 million decrease in AOCI associated with changes in the interest rate environment and the corresponding impact on the valuation of the AFS debt securities portfolio, serving to grow stockholder’s equity for the period.

Cash and Cash Equivalents

Cash and cash equivalents increased $26 million, or 15%, ending at $193 million at September 30, 2023 compared to $167 million at December 31, 2022, which was driven largely by increased FHLB borrowing activity offsetting loan funding and deposit fluctuations. In addition to utilizing overnight advances with the FHLB based on changing levels of liquidity during the period, Bancorp also entered into a $200 million term advance in conjunction with three separate interest rate swaps during the nine months ended September 30, 2023 as a way of securing longer-term funding at more attractive rates. For more information on these interest rate swaps, see the footnote titled “Derivative Financial Instruments.”

Investment Securities

Investment securities decreased $152 million, or 9%, to $1.47 billion at September 30, 2023 compared to $1.62 billion at December 31, 2022, driven by scheduled maturity and pay down activity within the total portfolio and a decline in the market value of the AFS investment portfolio specifically.

Investment in the securities portfolio was minimal during the nine months ended September 30, 2023, as Bancorp elected to maintain higher levels of liquidity amidst loan growth and deposit fluctuation during the period.

FHLB Stock

FHLB stock holdings increased $15 million to $26 million at September 30, 2023 compared to $11 million at December 31, 2022. The increase was driven by FHLB borrowing activity during the nine months ended September 30, 2023, as FHLB members are required to hold certain levels of FHLB stock in relation to the amount of their borrowings. Bancorp’s FHLB stock holdings will fluctuate consistent with our borrowing activity from period to period.

Loans

Total loans increased $411 million, or 8%, from December 31, 2022 to September 30, 2023. Excluding the PPP portfolio, loans grew $425 million, or 8%, over the same period. Loan growth for the nine months ended September 30, 2023 was concentrated in the CRE and residential real estate segments, while the C&I segment experienced a modest increase of $15 million (excluding PPP), as the second and third quarters of 2023 experienced near-record levels of loan growth.

While total line of credit utilization has improved since hitting pandemic-era lows in early 2021, line of credit usage has remained below pre-pandemic levels, as customers continue to utilize cash in lieu of higher costing lines of credit. Further, the addition of new lines, particularly within the C&D and C&I portfolio segments, has increased availability over the past several quarters, but utilization of the new lines has been relatively slow. Total line of credit utilization was 38.8% as of September 30, 2023, compared to 42.3% at December 31, 2022, with C&I utilization of 26.8% and 33.1% as of the same periods, respectively.

PPP loans of $5 million were outstanding at September 30, 2023. Bancorp has $96,000 in net unrecognized fees related to the PPP as of September 30, 2023, which will be recognized immediately once the loans are paid off or forgiven by the SBA. The timing of forgiveness activity and the related fee recognition has become insignificant, as the balance of the overall PPP portfolio has shrunk.

Bancorp’s credit exposure is diversified between businesses and individuals. No specific industry concentration exceeds 10% of loans outstanding. While Bancorp has a diversified loan portfolio, a customer’s ability to honor contracts is somewhat dependent upon the economic stability and/or industry in which that customer does business. Loans outstanding and related unfunded commitments are primarily concentrated within Bancorp’s current market areas, which encompass the Louisville, Kentucky MSA, central, eastern and northern Kentucky, as well as the Indianapolis, Indiana and Cincinnati, Ohio MSAs.

Bancorp occasionally enters into loan participation agreements with other banks to diversify credit risk. For certain participation loans sold, Bancorp has retained effective control of the loans, typically by restricting the participating institutions from pledging or selling their ownership share of the loan without permission from Bancorp. GAAP requires the participated portion of these loans to be recorded as secured borrowings. These participated loans are included in the C&I and CRE loan portfolio segments with a corresponding liability recorded in other liabilities. At September 30, 2023 and December 31, 2022, the total participated portion of loans of this nature totaled $4 million and $5 million, respectively.

The following table presents the maturity distribution and rate sensitivity of the total loan portfolio as of September 30, 2023:

In the event where Bancorp structures a loan with a maturity exceeding five years (typically CRE loans), an automatic rate adjustment will typically be set in place at five years from origination date to limit interest rate sensitivity.

Non-performing Loans and Assets

Information summarizing non-performing loans and assets follows:

(dollars in thousands)

As of September 30, 2023, non-accrual loans totaled $17 million compared to $14 million at December 31, 2022. The increase in total non-accrual loans between December 31, 2022 and September 30, 2023 stemmed mainly from one large C&I relationship being placed on non-accrual status during the first quarter.

Non-performing assets as of September 30, 2023 consisted of 126 loans, ranging in individual amounts up to $6.1 million, and OREO. At September 30, 2023, OREO included two CRE properties and one residential real estate property.

Delinquent Loans

Delinquent loans (consisting of all loans 30 days or more past due) totaled $16 million and $17 million at September 30, 2023 and December 31, 2022. Delinquent loans to total loans were 0.29% and 0.32% at September 30, 2023 and December 31, 2022, respectively.

Allowance for Credit Losses on Loans

The ACL for loans is a valuation allowance for loans estimated at each balance sheet date in accordance with GAAP. When Bancorp deems all or a portion of a loan to be uncollectible, the appropriate amount is written off and the ACL is reduced by the same amount. Subsequent recoveries, if any, are credited to the ACL when received. See the Footnote titled “Summary of Significant Accounting Policies” for discussion of Bancorp’s ACL methodology on loans. Allocations of the ACL may be made for specific loans, but the entire ACL for loans is available for any loan that, in Bancorp’s judgment, should be charged-off.

Bancorp’s ACL for loans was $78 million as of September 30, 2023 compared to $74 million as of December 31, 2022. Provision expense for credit losses on loans of $6.7 million was recorded for the nine months ended September 30, 2023, driven by strong loan growth, which was partially offset by improvement in unemployment forecast and a reduction in specific reserves due to charge-offs. Net charge-off activity of $1.9 million was recorded for the nine months ended September 30, 2023, which was attributed largely to the charge off of a larger C&I relationship that was fully reserved for earlier in 2023.

The ACL for loans calculation and resulting credit loss expense is significantly impacted by changes in forecasted economic conditions. Should the forecast for economic conditions change, Bancorp could experience further adjustments in its required ACL for loans credit loss expense.

The following table sets forth the ACL by category of loan:

(dollars in thousands)

(1) Excludes the PPP loan portfolio, which was not reserved for based on the underlying 100% SBA guarantee.

The table below details net charge-offs to average loans outstanding by category of loan for the three and nine month periods ended September 30, 2023 and 2022, respectively.

While separate from the ACL for loans and recorded in other liabilities on the consolidated balance sheets, the ACL for off balance sheet credit exposures also experienced an increase between December 31, 2022 and September 30, 2023. Provision for credit loss expense for off balance sheet credit exposures of $1.1 million was recorded for the nine months ended September 30, 2023, driven by a decline in C&I utilization and increased availability stemming from the addition of new lines of credit. The ACL for off balance sheet credit exposures was $5.6 million as of September 30, 2023 compared to $4.5 million as of December 31, 2022.

Premises and Equipment

Premises and equipment are presented on the consolidated balance sheets net of related depreciation on the respective assets, as well as fair value adjustments associated with purchase accounting. Premises and equipment experienced minimal fluctuation between December 31, 2022 and September 30, 2023. Bancorp’s branch network currently consists of 72 locations throughout Louisville, central, eastern and northern, Kentucky, as well as the Indianapolis, Indiana and Cincinnati, Ohio markets.

Premises held for sale totaling $2.4 million was recorded on Bancorp’s consolidated balance sheets as of September 30, 2023, which consists of three vacant parcels of land and a former administrative building, all of which are the result of merger-related activity.

Goodwill

At September 30, 2023, Bancorp had $194 million in goodwill recorded on its balance sheet. Goodwill of $67 million was initially recorded in relation to the March 7, 2022 acquisition of CB, $8.5 million of which was subsequently written off as a result of Bancorp selling its partial interest in LFA effective December 31, 2022.

Events that may trigger goodwill impairment include deterioration in economic conditions, a decline in market-dependent multiples or metrics (i.e. stock price declining below tangible book value), negative trends in overall financial performance and regulatory actions. At September 30, 2023, Bancorp elected to perform a qualitative assessment to determine if it was more-likely-than-not that the fair value of the reporting units exceeded their carrying value, including goodwill. The qualitative assessment indicated that it was not more-likely-than-not that the carrying value of the reporting units exceeded their fair value.

Core Deposit and Customer List Intangibles

CDIs and CLIs arising from business acquisitions are initially measured at fair value and are then amortized on an accelerated method based on their useful lives. As of September 30, 2023 and December 31, 2022, Bancorp’s CDI assets totaled $12.7 million and $15.0 million, respectively. A CDI asset of $13 million was recorded during the first quarter of 2022 as a result of the CB acquisition.

As of September 30, 2023 and December 31, 2022, Bancorp’s CLI assets were $8.8 million and $10.0 million, respectively, and are attributed entirely to the WM&T segment acquired from CB. CLI assets totaling $14 million were recorded in association with the CB acquisition during the first quarter of 2022. However, as a result of Bancorp’s disposition of its partial interest in LFA effective December 31, 2022, the $2 million CLI associated with that business was written off and was included in the loss recorded in relation to the disposition in 2022.

Other Assets and Other Liabilities

Other assets increased $112 million, or 83%, to $247 million between December 31, 2022 and September 30, 2023. Other liabilities increased $64 million, or 51%, to $190 million over the same period.

The increase in Other assets stemmed mainly from Bancorp’s investment in credit partnerships. As of September 30, 2023, Bancorp did not incur any impairment with respect to its intangible assets or other long-lived assets.

The increase in Other liabilities was attributed largely to the accrual of future tax credit investment obligations, which outpaced a reduction in various accrued liabilities, such as employee incentive compensation and benefits.

Deposits

Total deposits increased $12 million, or less than 1%, from December 31, 2022 to September 30, 2023, as the shift from non-interest bearing deposits into interest-bearing deposits has been virtually offsetting. However, average total deposit balances, which experienced a $144 million, or 2%, decline for the nine months ended September 30, 2023, offer a more accurate representation of activity for the year. The decline in average total deposits was driven by a $242 million, or 12% decline in average non-interest bearing deposits, as customers have shifted into higher-yielding alternatives amidst rising rates and economic uncertainty. While we have not seen widespread fallout in our overall customer base, deposit competition and a higher interest rate environment has resulted in rising deposit costs, which we anticipate will continue through the end of 2023 and into early 2024. Further, a portion of the decrease in deposits experienced during the first nine months of 2023 was attributed in large part to public funds runoff. However, deposit pricing pressure/competition has been intense as a result of rising rates and Bancorp expects it will continue to place pressure on NIM through the end of 2023 and heading into 2024.

As a result of this activity, the rates paid by Bancorp on deposits has increased and the deposit base itself has shifted to a more interest-bearing mix over the past several quarters. The cost of interest-bearing deposits rose to 1.55% for the nine months ended September 30, 2023 compared to 0.23% for the same period of the prior year, with the cost of total deposits (including non-interest deposits) rising to 1.11% from 0.15% for the same periods.

Securities Sold Under Agreements to Repurchase

SSUARs decreased $19 million, or 15%, between December 31, 2022 and September 30, 2023, largely as a result of some customers experiencing normal cyclical fluctuation in their SSUAR balances. SSUAR totaling $66 million were assumed in relation to the CB acquisition during the first quarter of 2022.

SSUAR represent a funding source of Bancorp and are used by commercial customers in conjunction with collateralized corporate cash management accounts. Such repurchase agreements are considered financing agreements and mature within one business day from the transaction date. At September 30, 2023 and December 31, 2022, all of these financing arrangements had overnight maturities and were secured by government sponsored enterprise obligations and government agency mortgage-backed securities that were owned and controlled by Bancorp.

SSUARs are collateralized by securities and are treated as financings; accordingly, the securities involved with the agreements are recorded as assets and are held by a safekeeping agent and the obligations to repurchase the securities are reflected as liabilities. All securities underlying the agreements are under the Bancorp’s control.

Federal Funds Purchased

FFP and other short-term borrowing balances increased $3 million, or 31%, between December 31, 2022 and September 30, 2023. At September 30, 2023, FFP related mainly to excess liquidity held by downstream correspondent bank customers of Bancorp.

Subordinated Debentures

As a result of the CB acquisition, Bancorp became the 100% successor owner of the following unconsolidated trust subsidiaries: Commonwealth Statutory Trust III, Commonwealth Statutory Trust IV and Commonwealth Statutory Trust V. The sole assets of the trust subsidiaries represent the proceeds of offerings loaned in exchange for subordinated debentures with similar terms to the TPS. The TPS are treated as part of Tier 1 Capital. The subordinated note and related interest expense are included in Bancorp’s consolidated financial statements. The subordinated notes are currently redeemable at Bancorp’s option on a quarterly basis. As of September 30, 2023, subordinated notes added through the CB acquisition totaled $26 million.

FHLB Advances

FHLB advances outstanding at September 30, 2023 totaled $350 million. These borrowings consisted of a $150 million cash management advance with an overnight maturity utilized for short-term liquidity purposes and a $200 million three-month rolling advance related to three separate interest rate swaps (cash flow hedges) that have been entered into during the nine months ended September 30, 2023 in an effort to secure longer-term funding at more attractive rates. For more information related to the interest rate swaps noted above, see the footnote titled, “Derivative Financial Instruments.”

Liquidity

The role of liquidity management is to ensure funds are available to meet depositors’ withdrawal and borrowers’ credit demands while at the same time maximizing profitability. This is accomplished by balancing changes in demand for funds with changes in supply of those funds. Liquidity is provided by short-term assets that can be converted to cash, AFS debt securities, various lines of credit available to Bancorp, and the ability to attract funds from external sources, principally deposits. Management believes it has the ability to increase deposits at any time by offering rates slightly higher than market rate.

Bancorp’s Asset/Liability Committee is comprised of senior management and has direct oversight responsibility for Bancorp’s liquidity position and profile. A combination of reports provided to management details internal liquidity metrics, composition and level of the liquid asset portfolio, timing differences in short-term cash flow obligations, and exposure to contingent draws on Bancorp’s liquidity.

Bancorp’s most liquid assets are comprised of cash and due from banks, FFS and AFS debt securities. FFS and interest bearing deposits totaled $113 million and $85 million at September 30, 2023 and December 31, 2022, respectively. The increase experienced for the first nine months of 2023 is attributed mainly to the increased in FHLB borrowing activity. FFS normally have overnight maturities while interest-bearing deposits in banks are accessible on demand. These investments are used for general daily liquidity purposes.

The fair value of the AFS debt security portfolio was $1.02 billion and $1.14 billion at September 30, 2023 and December 31, 2022, respectively. The decrease in AFS debt security portfolio for the first nine months of 2023 is attributed to scheduled maturities and normal pay down activity within the portfolio in addition to market value depreciation during the period. The investment portfolio (HTM and AFS) includes total cash flows on amortizing debt securities of approximately $344 million (based on assumed prepayment speeds as of September 30, 2023) expected over the next 12 months, including $163 million of contractual maturities. Combined with FFS and interest bearing deposits from banks, AFS debt securities offer substantial resources to meet either loan growth or reductions in Bancorp’s deposit funding base. Bancorp pledges portions of its investment securities portfolio to secure public funds, cash balances of certain WM&T accounts and SSUAR. At September 30, 2023, the total carrying value of investment securities pledged for these purposes comprised 47% of the debt securities portfolio, leaving approximately $777 million of unpledged debt securities.

Bancorp’s deposit base consists mainly of core deposits, defined as time deposits less than or equal to $250,000, demand, savings, and money market deposit accounts, and excludes public funds and brokered deposits. At September 30, 2023, such deposits totaled $5.71 billion and represented 89% of Bancorp’s total deposits, as compared with $5.60 billion, or 88% of total deposits at December 31, 2022. Because these core deposits are less volatile and are often tied to other products of Bancorp through long lasting relationships, they do not place undue pressure on liquidity. However, given the intense, industry-wide deposit pricing pressure that is currently being experienced, deposits may generally be more sensitive to market rates, with potential decreases possibly straining Bancorp’s liquidity position.

As of September 30, 2023 and December 31, 2022, Bancorp held brokered deposits totaling $591,000 and $599,000, respectively, the majority of which is attributed to deposits added through acquisition-related activity in 2022 and 2021.

Included in total deposit balances at September 30, 2023 are $466 million in public funds generally comprised of accounts with local government agencies and public school districts in the markets in which Bancorp operates. At December 31, 2022, public funds deposits totaled $692 million, the decrease experienced during the first nine months of 2023 was attributed largely to public funds run-off.

Bancorp is a member of the FHLB of Cincinnati. As a member of the FHLB, Bancorp has access to credit products of the FHLB. Bancorp views these borrowings as a potential low cost alternative to brokered deposits. At September 30, 2023 and December 31, 2022, available credit from the FHLB totaled $1.06 billion and $1.36 billion, respectively, the decline during this period being attributed to increased utilization of FHLB borrowings. Bancorp also had unsecured FFP lines with correspondent banks totaling $80 million at both September 30, 2023 and December 31, 2022, respectively.

During the normal course of business, Bancorp enters into certain forms of off-balance sheet transactions, including unfunded loan commitments and letters of credit. These transactions are managed through Bancorp’s various risk management processes. Management considers both on-balance sheet and off-balance sheet transactions in its evaluation of Bancorp’s liquidity.

Bancorp’s principal source of cash is dividends paid to it as the sole shareholder of the Bank. As discussed in the Footnote titled “Commitments and Contingent Liabilities,” as of January 1st of any year, the Bank may pay dividends in an amount equal to the Bank’s net income of the prior two years less any dividends paid for the same two years. At September 30, 2023, the Bank could pay an amount equal to $130 million in dividends to Bancorp without regulatory approval subject to ongoing capital requirements of the Bank.

Sources and Uses of Cash

Cash flow is provided primarily through financing activities of Bancorp, which include raising deposits and borrowing funds from institutional sources such as advances from FHLB and FFP, as well as scheduled loan repayments and cash flows from debt securities. These funds are primarily used to facilitate investment activities of Bancorp, which include making loans and purchasing securities for the investment portfolio. Another important source of cash is net income of the Bank from operating activities. For further detail regarding the sources and uses of cash, see the “Consolidated Statements of Cash Flows” in Bancorp’s consolidated financial statements.

Commitments

In the normal course of business, Bancorp is party to activities that contain credit, market and operational risk that are not reflected in whole or in part in Bancorp’s consolidated financial statements. Such activities include traditional off-balance sheet credit-related financial instruments, commitments under operating leases and long-term debt.

Bancorp provides customers with off-balance sheet credit support through loan commitments and standby letters of credit. Unused loan commitments increased $253 million, or 12%, as of September 30, 2023 compared to December 31, 2022, due to a combination of new line production and lower utilization. Total average line of credit utilization declined to 38.8% as of September 30, 2023 compared to 42.3% at December 31, 2022. C&I line of credit utilization was 26.8% at September 30, 2023 compared to 33.1% at December 31, 2022. While utilization has improved since the pandemic-era lows experienced in early 2021, it remains well below pre-pandemic averages.

Commitments to extend credit are agreements to lend to customers as long as collateral is available as agreed upon and there is no violation of any condition established in the contracts. Commitments generally have fixed expiration dates or other termination clauses. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Bancorp uses the same credit and collateral policies in making commitments and conditional guarantees as for on-balance sheet instruments. Bancorp evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained is based on management’s credit evaluation of the customer. Collateral held varies, but may include accounts receivable, inventory, securities, equipment and real estate. However, should the commitments be drawn upon and should our customers default on their resulting obligation to us, our maximum exposure to credit loss, without consideration of collateral, is represented by the contractual amount of those instruments.

The ACL for off balance sheet credit exposures, which is separate from the ACL for loans and recorded in other liabilities on the consolidated balance sheets, was $5.6 million and $4.5 million as of September 30, 2023 and December 31, 2022, respectively. Provision expense of $1.1 million was recorded for the nine month period ended September 30, 2023, driven by a decline in C&I utilization and increased availability stemming from the addition of new lines of credit.

Standby letters of credit are conditional commitments issued by Bancorp to guarantee the performance of a customer to a third party beneficiary. Those guarantees are primarily issued to support commercial transactions. Standby letters of credit generally have maturities of one to two years.

In addition to owned banking facilities, Bancorp has entered into long-term leasing arrangements for certain facilities. Bancorp also has required future payments for a non-qualified defined benefit retirement plan, TPS and the maturity of time deposits.

See the footnote titled “Commitments and Contingent Liabilities” for additional detail.

Capital

At September 30, 2023, stockholders’ equity totaled $807 million, representing an increase of $47 million, or 6%, compared to December 31, 2022. The increase for the nine months ended September 30, 2023 was attributed to recording net income of $83.8 million, which was only partially offset by $25.8 million of dividends declared and a $12.4 million decrease in AOCI, serving to grow stockholder’s equity for the period. AOCI consists of net unrealized gains or losses on AFS debt securities and a minimum pension liability, each net of income taxes. The changes in AOCI from December 31, 2022 to September 30, 2023 were the result of changes in the interest rate environment and its corresponding impact on the valuation of the AFS debt securities portfolio. See the “Consolidated Statement of Changes in Stockholders’ Equity” for further detail of changes in equity.

Bancorp’s TCE ratio and tangible book value per share, both non-GAAP disclosures, experienced improvement between December 31, 2022 and September 30, 2023, which stemmed largely from recording net income of $83.8 million and to a lesser extent, a $12.4 million negative change in AOCI for the nine months ended September 30, 2023. TCE was 7.69% at September 30, 2023 compared to 7.44% at December 31, 2022, while tangible book value per share was $20.17 at September 30, 2023 compared to $18.50 at December 31, 2022. See the section titled “Non-GAAP Financial Measures” for reconcilement of non-GAAP to GAAP measures.

In May 2023, Bancorp’s Board of Directors extended its share repurchase program authorizing the repurchase of up to 1 million shares, or approximately 4% of Bancorp’s total common shares outstanding at the time. The plan, which will expire in May 2025 unless otherwise extended or completed at an earlier date, does not obligate Bancorp to repurchase any specific dollar amount or number of shares prior to the plan’s expiration. Based on economic developments over the past year and the increased importance of capital preservation, no shares were repurchased in 2022, nor the first nine months of 2023. Approximately 741,000 shares remain eligible for repurchase under the current repurchase plan.

Bank holding companies and their subsidiary banks are required by regulators to meet risk-based capital standards. These standards, or ratios, measure the relationship of capital to a combination of balance sheet and off-balance sheet risks. The value of both balance sheet and off-balance sheet items are adjusted to reflect credit risks. See the Footnote titled “Regulatory Matters” for additional detail regarding regulatory capital requirements, as well as capital ratios of Bancorp and the Bank. The Bank exceeds regulatory capital ratios required to be well-capitalized. Regulatory framework does not define well capitalized for holding companies. Management considers the effects of growth on capital ratios as it contemplates plans for expansion.

Capital ratios as of September 30, 2023 increased compared December 31, 2022, largely as a result of strong operating results, which have helped buoy capital ratios amidst substantial risk-weighted asset growth within the loan portfolio. Bancorp continues to exceed the regulatory requirements for all calculations. Bancorp and the Bank intend to maintain a capital position that meets or exceeds the “well-capitalized” requirements as defined by the FRB and the FDIC, in addition to the capital conservation buffer.

Banking regulators have categorized the Bank as well-capitalized. To meet the definition of well-capitalized for prompt corrective action requirements, a bank must have a minimum 6.5% Common Equity Tier 1 Risk-Based Capital ratio, 8.0% Tier 1 Risk-Based Capital ratio, 10.0% Total Risk-Based Capital ratio and 5.0% Tier 1 Leverage ratio.

Additionally, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, Bancorp and the Bank must hold a 2.5% capital conservation buffer composed of Common Equity Tier 1 Risk-Based Capital above the minimum risk-based capital requirements for the Common Equity Tier 1 Risk-Based Capital ratio, Tier 1 Risk-Based Capital ratio and Total Risk-Based Capital ratio necessary to be considered adequately-capitalized. At September 30, 2023, the adequately-capitalized minimums, including the capital conservation buffer, were a 7.0% Common Equity Tier 1 Risk-Based Capital ratio, 8.5% Tier 1 Risk-Based Capital ratio and 10.5% Total Risk-Based Capital ratio.

As a result of the CB acquisition, Bancorp became the 100% successor owner of the following unconsolidated trust subsidiaries: Commonwealth Statutory Trust III, Commonwealth Statutory Trust IV and Commonwealth Statutory Trust V. The sole assets of the trust subsidiaries represent the proceeds of offerings loaned in exchange for subordinated debentures with similar terms to the TPS. The TPS are treated as part of Tier 1 Capital. The subordinated note and related interest expense are included in Bancorp’s consolidated financial statements. The subordinated notes are currently redeemable at Bancorp’s option on a quarterly basis. As of September 30, 2023, subordinated notes added through the CB acquisition totaled $26 million.

As permitted by the interim final rule issued on March 27, 2020 by the federal banking regulatory agencies, Bancorp elected the option to delay the estimated impact on regulatory capital related to the adoption of ASC 326 “Financial Instruments – Credit Losses,” or CECL, which was effective January 1, 2020. The initial impact of adoption of ASC 326, as well as 25% of the quarterly increases in the ACL subsequent to adoption of ASC 326 (collectively the “transition adjustments”) were delayed for two years. After two years, the cumulative amount of the transition adjustments became fixed and will be phased out of the regulatory capital calculations evenly over a three-year period, with 75% recognized in year three, 50% recognized in year four and 25% recognized in year five. After five years, the temporary regulatory capital benefits will be fully reversed. 2023 represents year four of the transition period for Bancorp. Had Bancorp not elected to defer the regulatory capital impact of CECL, the post ASC 326 adoption capital ratios of Bancorp and the Bank would still have exceeded the well-capitalized level.

Non-GAAP Financial Measures

The following table provides a reconciliation of total stockholders’ equity in accordance with GAAP to tangible stockholders’ equity (TCE), a non-GAAP disclosure. Bancorp provides the TCE per share, a non-GAAP measure, in addition to those defined by banking regulators, based on its widespread use by investors as a means to evaluate capital adequacy:

(dollars in thousands, except per share data)

90

The ACL for loans to total non-PPP loans represents the ACL for loans, divided by total loans less PPP loans. Non-performing loans to total non-PPP loans represents non-performing loans, divided by total loans less PPP loans. Delinquent loans to total non-PPP loans represents delinquent loans (consisting of all loans 30 days or more past due), divided by total loans less PPP loans. Bancorp believes these non-GAAP disclosures are important because they provide comparable ratios after eliminating PPP loans, which are fully guaranteed by the SBA and have not been allocated for within the ACL and are not at risk of non-performance.

(dollars in thousands)

The efficiency ratio, a non-GAAP measure, equals total non-interest expenses divided by the sum of net interest income 1FTE and non-interest income. In addition to the efficiency ratio presented, Bancorp considers an adjusted efficiency ratio. Bancorp believes it is important because it provides a comparable ratio after eliminating net gains (losses) on sales, calls, and impairment of investment securities, as well as net gains (losses) on sales of premises and equipment and disposition of any acquired assets, if applicable, and the fluctuation in non-interest expenses related to amortization of investments in tax credit partnerships and non-recurring merger expenses.

(dollars in thousands)

91

Information required by this item is included in Part I Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

As of the end of the period covered by this report, an evaluation was carried out by Stock Yards Bancorp, Inc.’s management, with the participation of its CEO and CFO, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, the Company’s CEO and CFO concluded that these disclosure controls and procedures were effective as of the end of the period covered by this report. In addition, no change in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred during the fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.