Peoples Financial Services Corp.: Form 10-Q for the period ended Sep 30, 2024

The following discussion and analysis should be read in conjunction with the unaudited consolidated interim financial statements contained in Part I, Item 1 of this report, and with our audited consolidated financial statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” presented in our Annual Report on Form 10-K for the year ended December 31, 2023.

Cautionary Note Regarding Forward-Looking Statements:

This quarterly report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to risks and uncertainties. These statements are based on assumptions and may describe future plans, strategies and expectations of Peoples Financial Services Corp. and its subsidiaries that are subject to significant risks and uncertainties, and are subject to change based on various factors (some of which are beyond our control). These forward-looking statements are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions. All statements in this report, other than statements of historical facts, are forward-looking statements.

Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Important factors that could cause our actual results to differ materially from those in the forward-looking statements include, but are not limited to: macroeconomic trends; the effects of any recession in the United States; the impact on financial markets from geopolitical conflicts such as the military conflict between Russia and Ukraine and the conflict in Israel; risks associated with business combinations, including, the possibility that we may be unable to achieve expected synergies and operating efficiencies of the FNCB merger within the expected timeframes or at all; the possibility that we may be unable to successfully integrate operations of FNCB , or that the integration may be more difficult, time consuming or costly than expected; the FNCB merger may divert management's attention from ongoing business operations and opportunities; effects of the FNCB merger on our ability to retain customers and retain and hire key personnel and maintain relationships with our vendors, and on our operating results and business generally; changes in interest rates; economic conditions, particularly in our market area; legislative and regulatory changes and the ability to comply with the significant laws and regulations governing the banking and financial services business; monetary and fiscal policies of the U.S. government, including policies of the U.S. Department of Treasury and the Federal Reserve System; adverse developments in the financial industry generally, responsive measures to mitigate and manage such developments, related supervisory and regulatory actions and costs, and related impacts on customer and client behavior; credit risk associated with lending activities and changes in the quality and composition of our loan and investment portfolios; demand for loan and other products; deposit flows; competition; changes in the values of real estate and other collateral securing the loan portfolio, particularly in our market area; changes in relevant accounting principles and guidelines; inability of third party service providers to perform; and our ability to prevent, detect and respond to cyberattacks. Additional factors that may affect our results are discussed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2023, in Part II, Item 1A of this report and in reports we file with the Securities and Exchange Commission from time to time.

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, we do not undertake, and specifically disclaim any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.

Business Overview:

On the Acquisition Date, the Company completed the acquisition of FNCB in accordance with the Merger Agreement, by and among the Company and FNCB. Pursuant to the Merger Agreement, on the Acquisition Date, FNCB merged with and into Peoples, with Peoples continuing as the surviving corporation, and immediately following the merger, FNCB Bank merged with and into Peoples Bank, with Peoples Bank as the surviving bank. The primary reasons for the merger included: expansion of the branch network and commanding market share positions in northeastern Pennsylvania; attractive low-cost funding base; strong cultural alignment and a deep commitment to shareholders, customers, employees, and communities served by Peoples and FNCB; meaningful value creation to shareholders; increased trading liquidity; and increased dividends for People’s shareholders.

In connection with the completion of the merger, former FNCB shareholders received 0.1460 shares of the Company’s common stock per share of FNCB common stock. The value of the total transaction consideration was approximately $133.7 million. The consideration included the issuance of 2,935,456 shares of the Company’s common stock, valued at $45.54 per share, which was the closing price of the Company’s common stock on June 28, 2024, the last trading day prior to the consummation of the merger. Also included in the total consideration was cash in lieu of any fractional shares, which was effectively settled upon closing.

The acquisition of FNCB was accounted for as a business combination using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed, and consideration paid are recorded at estimated fair values on the Acquisition Date. The excess consideration paid over the fair value of the net assets acquired has been reported as goodwill in the Company’s consolidated statements of financial condition. The $13.6 million of goodwill created from the merger is not amortizable or deductible for tax purposes. The amount of goodwill represents an asset attributed to the future benefits arising from other assets acquired in a business combination. Future benefits consist largely of the synergies and economies of scale expected from combining the operations of FNCB and Peoples. Peoples does not currently provide segment reporting for GAAP, therefore the goodwill will be assigned to the whole operating company. The Company will continue to keep the measurement of goodwill open for any additional adjustments to the fair value of certain accounts, for example loans, that may arise during the Company’s final review procedures of any updated information. If considered necessary, any subsequent adjustments to the fair value of assets acquired and liabilities assumed, identifiable intangible assets, or other purchase accounting adjustments will result in adjustments to goodwill within the first twelve months following the Acquisition Date.

Critical Accounting Policies:

Disclosure of our significant accounting policies is included in Note 1 to the consolidated financial statements of the Annual Report on Form 10-K for the year ended December 31, 2023, which is incorporated herein by reference. Some of these policies are particularly sensitive requiring significant judgments, estimates and assumptions.

Business Combinations:

Assets acquired and liabilities assumed in business combinations are measured at fair value as of the Acquisition Date. In many cases, determining the fair value of the assets acquired and liabilities assumed requires the Company to estimate the timing and amount of cash flows expected to result from these assets and liabilities and to discount these cash flows at appropriate rates of interest, which require the utilization of significant estimates and judgment in accounting for the acquisition.

Goodwill and Other Intangible Assets:

The Company has goodwill with a net carrying value of $77.0 million and $63.4 million at September 30, 2024 and December 31, 2023, respectively. The Company's policy is to test goodwill for impairment annually on December 31 or on an interim basis if an event triggering impairment may have occurred. If a reporting unit’s carrying amount exceeds its fair value, an entity will record an impairment charge based on that difference. At September 30, 2024, we performed a qualitative evaluation, which involves determining whether any events occurred or circumstances changed that would more likely than not reduce the Company's fair value below its carrying value. We noted no such matters. There is no assurance that changes in events or circumstances in the future will not result in impairment.

Core deposit intangibles are amortized on an accelerated basis using an estimated life of ten years. The core deposit intangibles are evaluated annually for impairment in accordance with GAAP. An impairment loss will be recognized if the carrying amount of the intangible asset is not fully recoverable and exceeds fair value. The carrying amount of the intangible asset is not considered fully recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use of the asset.

We believe that the fair values of our intangible assets were in excess of their carrying amounts and therefore there was no impairment of intangible assets at September 30, 2024.

Review of Financial Position:

Total assets increased $1.6 billion or 57.8% annualized from December 31, 2023, to $5.4 billion at September 30, 2024. The increase in assets during the nine months was primarily due to the merger with FNCB. FNCB contributed, after fair value purchase accounting adjustments, approximately $1.8 billion in total assets, $1.2 billion in loans, and $1.4 billion in deposits at July 1, 2024. Total loans increased $1.2 billion since December 31, 2023 and totaled $4.1 billion at September 30, 2024. Investments increased $162.4 million. Federal funds sold balances increased $33.4 million to $178.1 million at September 30, 2024 compared to a balance of $144.7 million at December 31, 2023.

Deposits increased $1.4 billion to $4.6 billion at September 30, 2024 from $3.3 billion at December 31, 2023. Interest-bearing deposits increased $1.3 billion to $3.9 billion compared to $2.6 billion at December 31, 2023. Noninterest-bearing deposits increased $72.9 million to $717.6 million from $644.7 million as of December 31, 2023.

Total short-term borrowings at September 30, 2024 were $37.3 million, an increase of $19.8 million from $17.6 million at December 31, 2023. Long term debt increased $86.5 million to $111.5 million from $25.0 million at December 31, 2023 and subordinated debentures increased $8.0 million to $41.0 million from $33.0 million at December 31, 2023. Total stockholders’ equity increased $134.6 million from $340.4 million at year-end 2023 to $475.1 million at September 30, 2024 due to the merger with FNCB as well as a decrease to accumulated other comprehensive loss resulting from a reduction in the unrealized loss on available for sale investment securities, partially offset by dividends.

The unrealized losses on the held to maturity portfolio totaled $10.8 million and $13.2 million at September 30, 2024 and December 31, 2023, respectively. For the nine months ended September 30, 2024, total assets averaged $4.2 billion, and increased $539.2 million from the same period of 2023.

Investment Portfolio:

The majority of the investment portfolio is classified as available for sale, which allows for greater flexibility in using the investment portfolio for liquidity purposes by allowing securities to be sold when market opportunities occur. Investment securities available for sale totaled $562.5 million at September 30, 2024, an increase of $163.6 million, or 41.0% from $398.9 million at December 31, 2023. The increase was primarily due to the addition of $177.9 million to the portfolio as a result of the merger with FNCB, as well as an increase in fair value due to market value adjustments, partially offset by maturities and principal payments.

Investment securities held to maturity, which consisted of 86.0% of mortgage-backed securities issued or guaranteed by U.S. Government agency and U.S. Government-sponsored entities, totaled $79.9 million at September 30, 2024, a decrease of $5.0 million, or 5.0% from $84.9 million at December 31, 2023. The decrease was primarily due to principal payments. Held to maturity securities had a market value of $69.0 million at September 30, 2024 compared to $71.7 million at December 31, 2023.

As a result of the merger with FNCB, the Company added $3.8 million in equity investments, consisting primarily of publicly traded bank holding companies, which are carried at fair value. Equity investments totaled $3.9 million at September 30,2024 compared to $98 thousand at December 31,2023.

For the nine months ended September 30, 2024, the investment portfolio averaged $588.7 million, an increase of $22.2 million or 3.9% compared to $566.5 million for the same period last year. Average tax-exempt municipal bonds have decreased $4.5 million or 4.9% to $87.6 million for the nine months ended September 30, 2024 from $92.1 million during the comparable period of 2023, and taxable investments have increased $26.7 million, or 5.6% to $501.1 million from an average of $474.4 million for the nine months ended September 30, 2023. The fully tax equivalent (“FTE”) yield on the investment portfolio, a non-GAAP measure, increased 56 basis points to 2.33% for the nine months ended September 30, 2024, from 1.77% for the comparable period of 2023 due to the additional investments from the FNCB merger which were accounted for at fair value based on current market rates.

Securities available for sale are carried at fair value, with unrealized gains or losses net of deferred income taxes reported in the Accumulated Other Comprehensive Loss component of stockholders’ equity. We reported net unrealized losses, included as a separate component of stockholders’ equity of $30.3 million net of a deferred income tax benefit of $8.5 million at September 30, 2024, and net unrealized losses of $40.3 million, net of deferred income tax benefit of $11.3 million, at December 31, 2023.

Our Asset/Liability Committee (“ALCO”) reviews the performance and risk elements of the investment portfolio quarterly. Through active balance sheet management and analysis of the securities portfolio, we endeavor to maintain sufficient liquidity to satisfy depositor requirements and meet the credit needs of our customers.

Loan Portfolio:

Total loans increased $1.2 billion or 57.2% annualized since December 31, 2023 and totaled $4.1 billion at September 30, 2024. The loan growth in each of our loan categories was due primarily to increases in our overall portfolio resulting from the merger with FNCB, along with organic increases in our commercial and industrial loan portfolio.

Commercial and industrial loans increased $346.4 million to $890.1 million at September 30, 2024 compared to $543.7 million at December 31, 2023.

Commercial real estate loans increased $446.5 million to $2.3 billion at September 30, 2024 compared to $1.9 billion at December 31, 2023.

Consumer loans increased $63.7 million to $146.0 million at September 30, 2024 compared to $82.3 million at December 31, 2023.

Residential real estate loans increased $189.8 million to $550.6 million at September 30, 2024 compared to $360.8 million at December 31, 2023.

The Company also added an equipment financing portfolio as a result of the FNCB merger. The portfolio totaled $173.5 million at September 30, 2024.

For the nine months ended September 30, 2024, total loans averaged $3.3 billion, an increase of $443.3 million or 15.7% compared to $2.8 billion for the same period of 2023. The FTE yield on the entire loan portfolio was 5.50% for the nine months ended September 30, 2024, a 73 basis point increase from the comparable period last year. The increase in yield was primarily due to the effective interest rates on the loans acquired in the FNCB merger.

In addition to the risks inherent in our loan portfolio, in the normal course of business, we are also a party to financial instruments with off-balance sheet risk to meet the financing needs of our customers. These instruments include legally binding commitments to extend credit, unused portions of lines of credit and commercial letters of credit made under the same underwriting standards as on-balance sheet instruments, and may involve, to varying degrees, elements of credit risk and interest rate risk (“IRR”) in excess of the amount recognized in the consolidated financial statements.

Unused commitments at September 30, 2024, totaled $791.5 million, consisting of $729.6 million in unfunded commitments of existing loan facilities and $61.9 million in standby letters of credit. Due to fixed maturity dates, specified conditions within these instruments, and the ultimate needs of our customers, many will expire without being drawn upon. We believe that amounts actually drawn upon can be funded in the normal course of operations and, therefore, do not represent a significant liquidity risk to us. In comparison, unused commitments at December 31, 2023 totaled $587.6 million, consisting of $525.4 million in unfunded commitments of existing loans and $62.2 million in standby letters of credit.

Asset Quality:

Distribution of nonperforming assets

(Dollars in thousands, except percents)

Nonperforming assets increased by $16.6 million during the first nine months of 2024 and included $7.6 million of loans acquired from the FNCB merger. Nonperforming assets totaled $21.5 million or 0.40% of total assets at September 30, 2024, an increase from $4.9 million or 0.13% of total assets at December 31, 2023.

Loans on nonaccrual status increased $17.0 million to $20.9 million at September 30, 2024 from $4.0 million at December 31, 2023. Nonaccrual loans acquired in the FNCB merger equaled $7.6 million at September 30, 2024 and included a $4.1 million relationship with a non-profit that has ceased operations. Nonaccrual loans increased due to placing a $2.6 million collateral dependent real estate loan on nonaccrual as the primary source of repayment is in doubt and there are limited secondary sources of repayment. Potential loss is mitigated as the loan carries a 70 percent guarantee of a government agency for a significant amount of the outstanding balance. In addition, a $1.7 million commercial relationship was placed on non-accrual in the current period due to the business closing, and a $3.6 million real estate relationship was also placed on nonaccrual due to ownership concerns. There was one foreclosed property at September 30, 2024 in the amount of $27 thousand. There were no foreclosed properties at December 31, 2023.

Generally we pursue a goal of maintaining a high loan-to-deposit ratio in order to drive profitability. However, this objective is superseded by our goal of maintaining strong asset quality. We continued our efforts to maintain sound underwriting standards for both commercial and consumer credit.

The allowance for credit losses equaled $39.3 million or 0.97% of loans, net at September 30, 2024 compared to $21.9 million or 0.77% of loans, net, at December 31, 2023. The increase was due primarily to the establishment of an allowance for non-PCD loans of $14.3 million subsequent to the FNCB merger. Loans charged-off, net of recoveries, for the nine months ended September 30, 2024, equaled $158 thousand and less than 0.01% of average loans, compared to $76 thousand and less than 0.01% of average loans for the comparable period last year.

Deposits:

We attract the majority of our deposits from within our market area through the offering of various deposit instruments including demand deposit accounts, NOW accounts, money market deposit accounts, savings accounts, and time deposits, including certificates of deposit and IRAs.

For the nine months ended September 30, 2024, total deposits increased $1.3 billion or 55.4% annualized to $4.6 billion from $3.3 billion at December 31, 2023. Noninterest-bearing deposits increased $72.9 million, or 15.1% annualized and interest-bearing deposits increased $1.3 billion, or 65.2% annualized during the nine months ended September 30, 2024. The increase in deposits was primarily due to the deposits assumed in the FNCB merger.

Interest-bearing checking, NOW, and money market accounts increased $879.3 million to $2.5 billion at September 30, 2024 from $1.6 billion at December 31, 2023. Savings accounts increased $80.4 million to $509.4 million as of September 30, 2024 from $429.0 million at December 31, 2023. Time deposits less than $250 thousand increased $319.4 million to $824.8 million at September 30, 2024, from $505.4 million at December 31, 2023. Time deposits $250 thousand or more increased $6.9 million to $128.1 million at September 30, 2024 from $121.3 million at year end 2023. The increases were primarily the result of the merger with FNCB, together with seasonal inflows.

The deposit base consisted of 38.6% retail accounts, 33.3% commercial accounts, 19.7% municipal relationships and 8.4% brokered deposits at September 30, 2024. At September 30, 2024, total estimated uninsured deposits were approximately $1.6 billion, or 33.8% of total deposits; as compared to approximately $883.5 million, or 26.9% of total deposits at December 31, 2023. Included in the uninsured total at September 30, 2024 is $372.5 million of municipal deposits collateralized by letters of credit issued by the FHLB and pledged investment securities, and $2.6 million of affiliate company deposits. We also offer customers access to IntraFi's CDARS and ICS programs through which their deposits may be allocated separate FDIC-insured institutions, while they are able to maintain their relationship with our bank.

For the nine months ended September 30, interest-bearing deposits averaged $3.0 billion in 2024 compared to $2.5 billion in 2023, an increase of $495.2 million or 20.0%. The cost of interest-bearing deposits was 2.85% in 2024 compared to 2.15% for the same period last year. The overall cost of interest bearing liabilities, including the cost of borrowed funds was 2.94% for the nine months ended September 30, 2024 and 2.26% for the same period in 2023. The higher costs are due primarily to increases in interest rates paid in order to attract and retain current balances.

Borrowings:

Peoples Bank utilizes borrowings as a secondary source of liquidity for its asset/liability management. Advances are available from the FHLB provided certain standards related to credit worthiness have been met. Repurchase and term agreements are also available from the FHLB. In addition, Peoples Bank may borrow from the Federal Reserve utilizing the Discount Window.

Overall, total borrowings were $189.9 million at September 30, 2024, which included short-term borrowings, long-term debt, other borrowings and subordinated debt, compared to $75.6 million at December 31, 2023, an increase of $114.3 million. At September 30, 2024, other borrowings, which include cash collateral pledged by derivative counterparties to offset interest rate exposure, totaled $12.4 million compared to $17.6 million at December 31, 2023. Lower market interest rates resulted in reduced exposure, and in a decrease to pledged cash collateral. Short term, long term and subordinated debt all include increases primarily due to the FNCB merger. Long-term debt was $111.5 million at September 30, 2024 compared with $25.0 million at year end 2023. Long term debt is comprised of $25.0 million from the Federal Reserve’s BTFP program, and the remaining with the Federal Home Loan Bank of Pittsburgh. Junior subordinated debt, which was acquired as part of the FNCB merger, totaled $8.0 million at September 30, 2024. Subordinated debt outstanding was unchanged at $33.0 million at September 30, 2024 and December 31, 2023.

Market Risk Sensitivity:

Market risk is the risk to our earnings or financial position resulting from adverse changes in market rates or prices, such as interest rates, foreign exchange rates or equity prices. Our exposure to market risk is primarily IRR associated with our lending, investing and deposit-gathering activities. During the normal course of business, we are not exposed to foreign exchange risk or commodity price risk. Our exposure to IRR can be explained as the potential for change in our reported earnings and/or the market value of our net worth. Variations in interest rates affect earnings by changing net interest income and the level of other interest-sensitive income and operating expenses. Interest rate changes also affect the underlying economic value of our assets, liabilities and off-balance sheet items. These changes arise because the present value of future cash flows, and often the cash flows themselves, change with interest rates. The effects of the changes in these present values reflect the change in our underlying economic value and provide a basis for the expected change in future earnings related to interest rates. IRR is inherent in the role of banks as financial intermediaries. However, a bank with a high degree of IRR may experience lower earnings, impaired liquidity and capital positions, and most likely, a greater risk of insolvency. Therefore, banks must carefully evaluate IRR to promote safety and soundness in their activities.

The FOMC has begun decreasing the federal funds rate in part due to lower inflation. Since September 2024, the FOMC has decreased the federal funds target rate by 75 basis points. Due to these factors, IRR and effectively managing it are very important to both bank management and regulators. Bank regulations require us to develop and maintain an IRR management program, overseen by our board of directors and senior management, that involves a comprehensive risk management process in order to effectively identify, measure, monitor and control risk. Should bank regulatory agencies identify a material weakness in our risk management process or high exposure relative to our capital, bank regulatory agencies may take action to remedy these shortcomings. Moreover, the level of IRR exposure and the quality of our risk management process is a determining factor when evaluating capital adequacy.

The ALCO, comprised of members of our board of directors, senior management and other appropriate officers, oversees our IRR management program. Specifically, ALCO analyzes economic data and market interest rate trends, as well as competitive pressures, and utilizes computerized modeling techniques to reveal potential exposure to IRR. This allows us to monitor and attempt to control the influence these factors may have on our rate-sensitive assets (“RSA”) and rate-sensitive liabilities (“RSL”), and overall operating results and financial position. One such technique utilizes a static gap model that considers repricing frequencies of RSA and RSL in order to monitor IRR. Gap analysis attempts to measure our interest rate exposure by calculating the net amount of RSA and RSL that reprice within specific time intervals. A positive gap occurs when the amount of RSA repricing in a specific period is greater than the amount of RSL repricing within that same time frame and is indicated by an RSA/RSL ratio greater than 1.0. A negative gap occurs when the amount of RSL repricing is greater than the amount of RSA and is indicated by an RSA/RSL ratio of less than 1.0. A positive gap implies that earnings will be impacted favorably if interest rates rise and adversely if interest rates fall during the period. A negative gap tends to indicate that earnings will be affected inversely to interest rate changes.

Our cumulative one-year RSA/RSL ratio equaled 1.14% at September 30, 2024, an increase from 0.73% at December 31, 2023. As previously mentioned, a positive gap indicates that if interest rates increase, our earnings would likely be favorably impacted. The overall focus of ALCO is to maintain a well-balanced interest rate risk position in order to safeguard future earnings. The current position at September 30, 2024, indicates that the amount of RSA repricing within one year would exceed that of RSL, thereby causing net interest income to increase as market rates increase. However, these forward-looking statements are qualified in the aforementioned section entitled “Cautionary Note Regarding Forward-Looking Statements” in this Management’s Discussion and Analysis.

Static gap analysis, although a standard measuring tool, does not fully illustrate the impact of interest rate changes on future earnings. First, market rate changes normally do not equally or simultaneously affect all categories of assets and liabilities. Second, assets and liabilities that can contractually reprice within the same period may not do so at the same time or to the same magnitude. Third, the interest rate sensitivity analysis presents a one-day position. Variations occur daily as we adjust our rate sensitivity throughout the year. Finally, assumptions must be made in constructing such an analysis.

As the static gap report fails to address the dynamic changes in the balance sheet composition or prevailing interest rates, we utilize a simulation model to enhance our asset/liability management. This model is used to create pro forma net interest income scenarios under various interest rate shocks. Simulation model results at September 30, 2024, produced results similar to those indicated by the one-year static gap position. In addition, parallel and instantaneous shifts in interest rates under various interest rate shocks resulted in changes in net interest income that were well within ALCO policy limits during the first year of simulation. We will continue to monitor our IRR throughout 2024 and endeavor to employ deposit and loan pricing strategies and direct the reinvestment of loan and investment repayments in order to manage our IRR position.

Financial institutions are affected differently by inflation than commercial and industrial companies that have significant investments in fixed assets and inventories. Most of our assets are monetary in nature and change correspondingly with variations in the inflation rate. It is difficult to precisely measure the impact inflation has on us, however we believe that our exposure to inflation can be mitigated through asset/liability management.

Liquidity:

Liquidity management is essential to our continuing operations and enables us to meet financial obligations as they come due, as well as to take advantage of new business opportunities as they arise. Financial obligations include, but are not limited to, the following:

• Funding new and existing loan commitments;
• Payment of deposits on demand or at their contractual maturity;
• Repayment of borrowings as they mature;
• Payment of lease obligations; and
• Payment of operating expenses.

These obligations are managed daily, thus enabling us to effectively monitor fluctuations in our liquidity position and to adapt that position according to market influences and balance sheet trends. Future liquidity needs are forecasted and strategies are developed to ensure adequate liquidity at all times.

Historically, core deposits have been the primary source of liquidity because of their stability and lower cost, in general, than other types of funding. Providing additional sources of funds are loan and investment payments and prepayments and the ability to sell both available for sale securities and mortgage loans held for sale.

Our ALCO generally meets quarterly, and most recently met in September to review our IRR profile, capital adequacy and liquidity. At September 30, 2024, the Company’s cash and due from banks balances were $97.1 million. Our maximum borrowing capacity with the FHLB as of September 30, 2024 was $1.4 billion, of which $477.6 million was outstanding in the form of borrowings and irrevocable standby letters of credit, and the remaining $968.7 is available. Additionally, the Company maintains $569.8 million of availability at the Federal Reserve Bank’s Discount Window, through the pledging of securities and through a borrower-in-custody of collateral arrangement, which enables us to pledge certain loans not being used as collateral elsewhere. Of this amount, $25.0 million was outstanding in borrowings associated with the Bank Term Funding Program. Additional sources of credit with corresponding banks total $18.0 million, none of which is currently utilized. The Company also maintains an available for sale investment securities portfolio, comprised primarily of highly liquid U.S. Treasury securities, highly-rated municipal securities and U.S. agency-backed mortgage backed securities. This portfolio serves as an additional source of liquidity and capital. At September 30, 2024, the Company’s available for sale investment securities portfolio totaled $562.5 million, $298.5 million of which were unencumbered. We believe our liquidity is adequate to meet both present and future financial obligations and commitments on a timely basis.

We employ a number of analytical techniques in assessing the adequacy of our liquidity position. One such technique is the use of ratio analysis to determine the extent of our reliance on noncore funds to fund our investments and loans maturing after September 30, 2024. Our noncore funds at September 30, 2024, were comprised of time deposits in denominations of $100 thousand or more, brokered deposits and other borrowings. These funds are not considered to be a strong source of liquidity because they are very interest rate sensitive and are considered to be highly volatile. At September 30, 2024, our net noncore funding dependence ratio, the difference between noncore funds and short-term investments to long-term assets, was 11.8%, while our net short-term noncore funding dependence ratio, noncore funds maturing within one-year, less short-term investments to long-term assets equaled 1.9%. Comparatively, our overall noncore dependence ratio at year-end 2023 was 12.1% and our net short-term noncore funding dependence ratio was 4.7%, indicating that our reliance on noncore funds has decreased overall as a result of increases to our longer term assets such as loans and investments and an increase in our federal funds balances, primarily due to in part to the FNCB merger.

The Consolidated Statements of Cash Flows present the changes in cash and cash equivalents from operating, investing and financing activities. Cash and cash equivalents, consisting of cash on hand, cash items in the process of collection, deposit balances with other banks and federal funds sold, increased $98.1 million during the nine months ended September 30, 2024. Cash and cash equivalents increased $216.7 million for the same period last year. For the nine months ended September 30, 2024, net cash outflows of $200.1 million, from financing activities, were offset by $267.6 million received in investing activities and $30.6 million received in operating activities. For the same period of 2023, net cash inflows of $24.3 million from operating activities and $240.4 million from financing activities were partially offset by net cash outflows of $48.1 million from investing activities.

Operating activities received net cash of $30.6 million for the nine months ended September 30, 2024, and provided $24.3 million for the corresponding nine months of 2023. Net income, adjusted for the effects of gains and losses along with noncash transactions such as depreciation and the provision for credit losses, is the primary source of funds from operations.

Investing activities primarily include transactions related to the FNCB merger, lending activities, and investment portfolio. Investing activities provided net cash of $267.6 million for the nine months ended September 30, 2024, compared to using net cash of $48.1 million for the same period of 2023. Proceeds from the sale of a portion of the investments acquired in the FNCB merger was the primary factor causing the net inflow, as well as $28.8 million in cash received in the FNCB merger.

Financing activities used net cash of $200.1 million for the nine months ended September 30, 2024, and provided net cash of $240.4 million for the corresponding nine months of 2023. In 2024, deposit outflows, and payments of borrowings were the largest source of the net cash outflow. The year ago period included new long-term borrowings and the addition of brokered deposits to build our cash position. While a portion of the outflow is seasonal, we continue to seek deposits from new markets and customers as well as existing customers, including municipalities and school districts.

We believe that our future liquidity needs will be satisfied through maintaining an adequate level of cash and cash equivalents, by maintaining readily available access to traditional funding sources, and through proceeds received from the investment and loan portfolios. We believe that our current sources of funds will enable us to meet all cash obligations as they come due.

Capital:

Stockholders’ equity totaled $475.1 million or $47.53 per share at September 30, 2024, compared to $340.4 million or $48.35 per share at December 31, 2023. Stockholders’ equity increased during the nine month period ended September 30, 2024 primarily due to the FNCB merger, earnings, and a decrease in other comprehensive loss due to changes in market values of available for sale securities, offset by a dividend payout of $11.9 million.

Dividends declared equaled $1.44 per share for the nine months ended September 30, 2024 and $1.23 per share for the same period of 2023. The Company has paid cash dividends since its formation as a bank holding company in 1986. The Company’s board of directors declared on October 25, 2024 a fourth quarter dividend of $0.6175 per share payable on December 13, 2024 to shareholders of record as of November 29, 2024. The increase to the quarterly cash dividend, which began in the third quarter of 2024, was contemplated as part of the Merger Agreement between the Company and FNCB. It is the present intention of the Company’s board of directors to continue this dividend payment policy. Further dividends, however, must necessarily depend upon earnings, financial condition, appropriate legal restrictions and other factors relevant at the time the board of directors considers payment of dividends.

Current rules, which implemented the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act, call for the following capital requirements: (i) a minimum ratio of common equity tier 1 capital to risk-weighted assets of 4.5%; (ii) a minimum ratio of tier 1 capital to risk-weighted assets of 6%; (iii) a minimum ratio of total capital to risk-weighted assets of 8%; and (iv) a minimum leverage ratio of 4%. In addition, the final rules establish a common equity tier 1 capital conservation buffer of 2.5% of risk-weighted assets applicable to all banking organizations. If a banking organization fails to hold capital above the minimum capital ratios and the capital conservation buffer, it will be subject to certain restrictions on capital distributions and discretionary bonus payments.

The adequacy of capital is reviewed on an ongoing basis with reference to the size, composition and quality of resources and regulatory guidelines. We seek to maintain a level of capital sufficient to support existing assets and anticipated asset growth, maintain favorable access to capital markets, and preserve high quality credit ratings. At September 30, 2024, Peoples Bank’s Tier 1 capital to total average assets was 8.23% as compared to 9.34% at December 31, 2023. Peoples Bank’s Tier 1 capital to risk weighted asset ratio was 10.68% and the total capital to risk weighted asset ratio was 11.68% at September 30, 2024. These ratios were 13.30% and 14.12% at December 31, 2023. Peoples Bank’s common equity Tier 1 to risk weighted asset ratio was 10.68% at September 30, 2024 compared to 13.30% at December

31, 2023. Peoples Bank met all capital adequacy requirements and was deemed to be well-capitalized under regulatory standards at September 30, 2024.

Review of Financial Performance:

The Company’s financial results for any periods ended prior to July 1, 2024 reflect Peoples results only on a

stand alone basis, prior to the merger with FNCB. As a result of this factor and the below listed adjustments related to the FNCB merger, the Company’s financial results for the third quarter of 2024 may not be directly comparable to prior reported periods. The following schedule highlights specific merger related activity for the three and nine months ended September 30, 2024:

Peoples reported a net loss of $4.3 million or ($0.43) per diluted share for the three months ended September 30, 2024, a decline of $11.1 million when compared to net income of $6.7 million or $0.95 per share for the comparable period of 2023. Quarterly net income included higher net interest income of $18.0 million due primarily to increases in the volume of earning assets due to the FNCB merger and the $3.7 million net accretion impact of purchase accounting marks on loans, deposits and borrowings acquired and assumed in the FNCB merger. The higher net interest income increased the net interest margin to 3.26% in the current period. Noninterest income was $5.7 million, up from $3.6 million in the year ago period. Noninterest expenses increased by $18.4 million, which included merger related expenses of $9.7 million, and higher overall expenses due to the FNCB merger. Provision for income tax decreased by $2.0 million on lower earnings.

Peoples reported net income of $2.4 million, or $0.30 per diluted share for the nine months ended September 30, 2024, a decrease of 89.9% when compared to $23.8 million, or $3.31 per diluted share for the comparable period of 2023. The decrease in earnings in the nine months ended September 30, 2024 is a result of a higher provision for credit loss of $16.9 million which included a $14.3 million provision for non-PCD loans acquired in the FNCB merger, higher merger related expenses of $10.2 million and higher overall expenses due to the FNCB merger, partially offset by higher net interest income of $11.0 million and higher noninterest income of $1.7 million primarily due to the FNCB merger.

Return on average assets (“ROA”) measures our net income in relation to total assets. Our annualized ROA was (0.33)% for the third quarter of 2024 compared to 0.72% for the same period of 2023. Return on average equity (“ROE”) indicates how effectively we can generate net income on the capital invested by stockholders. Our annualized ROE was (3.58)% for the third quarter of 2024 compared to 8.05% for the comparable period in 2023. The declines in our annualized ROA and ROE were due primarily to a lower level of net income resulting from non-recurring charges related to the FNCB merger.

Non-GAAP Financial Measures:

The following are non-GAAP financial measures which provide useful insight to the reader of the consolidated financial statements but should be supplemental to GAAP used to prepare Peoples’ consolidated financial statements and should not be read in isolation or relied upon as a substitute for GAAP measures. In addition, Peoples’ non-GAAP measures may not be comparable to non-GAAP measures of other companies. The tax rate used to calculate the fully-taxable equivalent (FTE) adjustment was 21% for 2024 and 2023.

The following table reconciles the non-GAAP financial measures of FTE net interest income for the three and nine months ended September 30, 2024 and 2023:

(Dollars in thousands)

(Dollars in thousands)

The efficiency ratio is noninterest expenses, less amortization of intangible assets and acquisition related expenses, as a percentage of FTE net interest income plus noninterest income less gains on equity securities and gains on sale of assets. Management monitors the efficiency ratio to determine how well it is managing its operating expenses; a lower efficiency ratio is generally preferable as it indicates the Company is spending less to generate income. The Company is continuing to pursue opportunities to reduce expenses as a percentage of operating revenues.

The following table reconciles the non-GAAP financial measures of the efficiency ratio to GAAP for the three and nine months ended September 30, 2024 and 2023:

(Dollars in thousands, except percents)

(Dollars in thousands, except percents)

Net Interest Income:

Net interest income is the fundamental source of earnings for commercial banks. Fluctuations in the level of net interest income can have the greatest impact on net profits. Net interest income is defined as the difference between interest revenue, interest and fees earned on interest-earning assets, and interest expense, the cost of interest-bearing liabilities supporting those assets. The primary sources of earning assets are loans and investment securities, while interest-bearing deposits, short-term and long-term borrowings, and subordinated debt comprise interest-bearing liabilities. Net interest income is impacted by:

• Variations in the volume, rate and composition of earning assets and interest-bearing liabilities;
• Changes in general market rates; and
• The level of nonperforming assets.

Changes in net interest income are measured by the net interest spread and net interest margin. Net interest spread, the difference between the average yield earned on earning assets and the average rate incurred on interest-bearing liabilities, illustrates the effects changing interest rates have on profitability. Net interest margin, net interest income as a percentage of earning assets, is a more comprehensive ratio, as it reflects not only the spread, but also the change in the composition of interest-earning assets and interest-bearing liabilities. Tax-exempt loans and investments carry pre-tax yields lower than their taxable counterparts. Therefore, in order to make the analysis of net interest income more comparable, tax-exempt income and yields are reported herein on a FTE basis, as FTE net interest income using the prevailing federal statutory tax rate of 21.0% in 2024 and 2023.

For the three and nine months ended September 30, 2024, the average balances include $1.2 billion in loans, $177.0 million of investments, $1.4 billion in deposits, $226.3 million in borrowings, and $8.0 million in junior subordinated debt acquired in the FNCB merger. For the three months ended September 30, FTE net interest income, a non-GAAP measure, increased $18.2 million to $40.0 million in 2024 from $21.8 million in 2023. The net interest spread increased to 2.74% for the three months ended September 30, 2024 from 1.79% for the three months ended September 30, 2023 as the earning asset yield increased 123 basis points while the average rate paid on interest-bearing liabilities increased 28 basis points. The FTE net interest margin increased to 3.26% for the third quarter of 2024 from 2.44% for the comparable period of 2023. The increase in tax-equivalent net interest margin from the year ago period was primarily from a higher volume of earning assets and the net accretion impact of purchase accounting marks on loans, deposits and borrowings acquired and assumed in the FNCB merger, which totaled $3.7 million of net interest income, and represented 30 basis points of tax-equivalent net interest margin.

For the three months ended September 30, FTE interest income on earning assets, a non-GAAP measure, increased $29.8 million to $69.0 million in 2024 as compared to $39.2 million in 2023. The overall yield on earning assets, on a FTE basis, increased 123 basis points for the three months ended September 30, 2024 to 5.63% as compared to 4.40% for the three months ended September 30, 2023. The increase to FTE interest income is due to the increase in rates for newly acquired assets, and an increase in our earning asset base, including those acquired from the FNCB merger and rising rate indices. The overall yield earned on investments increased 127 basis points in the third quarter of 2024 to 3.02% from 1.75% for the third quarter of 2023 primarily as a result of a restructured portfolio mix and acquiring the investment portfolio at fair value based on current market rates. Average investment balances were $158.1 million higher when comparing the current and year ago quarter. The yield on loans increased 124 basis points in the third quarter of 2024 to 6.09% from 4.85% for the third quarter of 2023 as a result of loans acquired in the FNCB merger, new loans originated at higher portfolio rates, floating and adjustable loans repricing higher, and the net accretion of the loan marks from the impact of purchase accounting which benefited the yield by 46 basis points. Average loan balances were $1.2 billion higher when compared to the same quarter in 2023. Average federal funds sold decreased $42.4 million to $92.1 million for the three months ended September 30, 2024 and yielded 5.26%, as compared to $134.6 million and a yield of 5.52% in the year ago period. We expect asset yields to stabilize as floating rate assets repricing downward from the FOMC action to cut rates 50 basis points in September will be offset by new loan originations booked at higher portfolio rates and lower yielding adjustable rate assets repricing higher than current stated rates.

Total interest expense increased $11.5 million to $29.0 million for the three months ended September 30, 2024 from $17.5 million for the three months ended September 30, 2023. The total cost of funds increased 28 basis points for the three months ended September 30, 2024 to 2.89% as compared to 2.61% in the year ago period. The increase in costs was due to an increase to the average balance of higher priced brokered certificate of deposits, higher rates paid on both interest-bearing deposits and short term borrowings, combined with higher average balances in the current period. The impact of amortizing the marks due to purchase accounting on the time deposits, borrowings and junior subordinated debt added 10 basis points to the funding costs. Average rates paid on deposits increased as the result of higher market rates and local competition for deposits. We expect increased competition for funding to continue to impact costs during the remaining months of 2024.

Net interest income changes due to rate and volume for the nine months ended September 30

(Dollars in thousands)

FTE net interest income, a non-GAAP measure, was $79.1 million in the nine months ended September 30, 2024 and $67.9 million in the comparable period last year. There was both a positive volume and rate variance. The growth in average interest-bearing assets exceeded that of the growth in earning liabilities, and resulted in higher FTE net interest income, a non-GAAP measure, of $4.1 million. A rate variance resulted in an increase in net interest income of $7.1 million.

Average earning assets increased $459.5 million to $3.9 billion for the nine months ended September 30, 2024 and accounted for a $17.6 million increase in interest income. Average taxable loans increased $426.1 million, which caused interest income to increase $17.1 million. Average tax-exempt loans increased $17.1 million which caused interest income to increase $0.4 million. Average taxable investments increased $26.7 million comparing 2024 and 2023, which resulted in increased interest income of $0.4 million while average tax-exempt investments decreased $4.5 million, which resulted in a decrease to interest income of $70 thousand. Average interest bearing deposits with banks increased $4.5 million which resulted in an increase of $0.2 million to interest income. Average federal funds sold decreased $10.5 million for the nine months ended September 30, 2024 which resulted in a decrease of $0.4 million to interest income.

Average interest-bearing liabilities rose $527.7 million to $3.1 billion for the nine months ended September 30, 2024 from $2.6 billion for the nine months ended September 30, 2023 resulting in a net increase in interest expense of $13.5 million. Interest-bearing deposit accounts, including money market, NOW and savings accounts increased $271.5 million which resulted in a total increase in interest expense of $5.6 million. In addition, large denomination time deposits averaged $76.3 million more in the current period and caused interest expense to increase $1.8 million. An increase of $147.4 million in average time deposits less than $100 thousand which included higher priced callable brokered CDs, resulted in an increase to interest expense of $4.9 million. Short-term borrowings averaged $6.8 million lower and decreased interest expense $0.3 million while long-term borrowing increased $36.6 million and resulted in an increase to interest expense of $1.3 million.

For the nine months ended September 30, 2024, a favorable rate variance occurred, as the FTE yield on earning assets increased 72 basis points while there was a 68 basis point increase in the cost of funds. As a result, FTE net interest income increased $7.1 million comparing the nine months ended September 30, 2024 and 2023. The FTE yield on earning assets was 5.01% in the 2024 period compared to 4.29% in 2023 resulting in an increase in interest income of $18.5 million. The yield on the taxable investment portfolio increased 62 basis points to 2.30% during the nine months ended September 30, 2024 from 1.68% in the year ago period, resulting in an increase of $2.3 million in interest income. The yield on the tax exempt investment portfolio remained flat at 2.22% during the nine months ended September 30, 2024 and in the year ago period. The FTE yield on the loan portfolio increased 73 basis points to 5.50% in 2024 from 4.77% in 2023 and resulted in an increase to interest income of $16.2 million.

The yield on interest bearing deposits increased 70 basis points to 2.85% from 2.15% in the year ago period resulting in an increase in interest expense of $11.2 million. The yield on long term borrowings increased 43 basis points to 4.67% from 4.33% in the year ago period but had a negligible effect to interest expense. The yield on short term borrowings increased 38 basis points to 5.31% from 4.93% in the year ago period and resulted in an increase to interest expense of $0.2 million.

The average balances of assets and liabilities, corresponding interest income and expense and resulting average yields or rates paid are summarized as follows. Averages for earning assets include nonaccrual loans. Investment averages include available for sale securities at amortized cost. Income on investment securities and loans is adjusted to a FTE basis using the prevailing federal statutory tax rate of 21%.

(Dollars in thousands, except percents)

Provision for Credit Losses:

Effective January 1, 2023 the Company transitioned to ASU 2016-13 Financial Instruments - Credit Losses (Topic 326), commonly referred to as CECL. Based on our most current evaluation, we believe that the allowance is adequate to absorb any known and inherent losses in the portfolio as of September 30, 2024.

For the three months ended September 30, 2024, $14.5 million was recorded to the provision for credit losses compared to a credit of $0.2 million in the year ago period. The current period provision included a non-recurring provision of $14.3 million for FNCB non-PCD loans. Excluding the impact of the FNCB merger, the provision for credit losses for the three months ended September 30, 2024 was $0.2 million.

For the nine months ended September 30, 2024, a provision for credit losses of $15.8 million was recorded and included a $14.3 million initial provision for non-PCD loans acquired in the FNCB merger. The provision in the prior nine month period included a credit of $0.9 million which was attributed to various factors, including updated economic assumptions as well as changes in qualitative factors, portfolio composition and asset quality.

Noninterest Income:

Noninterest income for the three months ended September 30, 2024 and 2023 was $5.7 million and $3.7 million, respectively. The increase was primarily due to the FNCB merger and consisted of higher levels of service charges, fees, commissions and other income, wealth management fees and increased cash surrender value of life insurance. These increases were partially offset by lower interest rate swap revenue due to reduced origination volume.

Noninterest income was $12.7 million for the nine months ended September 30, 2024 and $10.9 million for the comparable period ended September 30, 2023. Services charges and fees increased $1.5 million, wealth management income increased $0.3 million and gains on equity securities increased $0.2 million while interest rate swap revenue decreased $0.5 million on lower loan origination volume and market value adjustments.

Noninterest Expenses:

In general, noninterest expense is categorized into three main groups: employee-related expenses, occupancy and equipment expenses, and other expenses. However, included in the current period are acquisition related expenses incurred in connection with our merger with FNCB. Employee-related expenses are costs associated with providing salaries, including payroll taxes and benefits, to our employees. Occupancy and equipment expenses, the costs related to the maintenance of facilities and equipment, include depreciation, general maintenance and repairs, real estate taxes, rental expense offset by any rental income, and utility costs. Other expenses include general operating expenses such as advertising, contractual services, insurance, including FDIC assessment, provision for unfunded commitments, other taxes and supplies. Several of these costs and expenses are variable while the remainder are fixed. We utilize budgets and other related strategies in an effort to control the variable expenses.

Noninterest expense increased $18.4 million to $35.5 million for the three months ended September 30, 2024, from $17.1 million for the same period a year ago. Acquisition related expenses, such as legal and consulting, and core system de-conversion fees and advisory fees totaled $9.7 million. Salaries and employee benefits were $4.4 million higher due to the addition of 195 full time equivalent employees. Occupancy and equipment expenses increased $2.1 million in the three months ended September 30, 2024 due to higher information technology (IT) expense and higher facilities costs from inflationary price pressure and the additional branches acquired in the FNCB merger.

Noninterest expense for the nine months ended September 30, 2024 was $71.7 million, an increase of $21.5 million or 42.8% from $50.2 million for the nine months ended September 30, 2023. The increase was due primarily to higher acquisition related expenses, and higher expenses due to additional full time equivalent employees and facilities due to the FNCB merger. Salaries and employee benefits expenses increased $4.1 million compared to the year ago period due to additional employees related to the merger. Occupancy and equipment expenses were higher by $3.1 million in the nine months ended September 30, 2024 due to increased technology costs related to system integration and increased account and transaction volumes, and higher facilities costs. Acquisition related expenses totaled $11.2 million compared to $1.0 million a year ago.

Income Taxes:

We recorded an income tax benefit of $0.7 million or 13.2% of pre-tax loss, and a $1.3 million provision, or 16.5% of pre-tax income for the three ended September 30, 2024 and September 30, 2023 respectively. For the nine months ended September 30, 2024 we recorded a provision of $0.2 million, or 9.1% of pretax income compared to $4.5 million, or 16.1% of pretax income for the nine month period ended September 30, 2023. Lower income tax expense was due to lower pre-tax income for the three and nine months ended September 30, 2024.

Market risk is the risk to our earnings and/or financial position resulting from adverse changes in market rates or prices, such as interest rates, foreign exchange rates or equity prices. Our exposure to market risk is primarily interest rate risk (“IRR”), which arises from our lending, investing and deposit gathering activities. Our market risk sensitive instruments consist of derivative and non-derivative financial instruments, none of which are entered into for trading purposes. During the normal course of business, we are not exposed to foreign exchange risk or commodity price risk. Our exposure to IRR can be explained as the potential for change in reported earnings and/or the market value of net worth. Variations in interest rates affect the underlying economic value of assets, liabilities and off-balance sheet items. These changes arise because the present value of future cash flows, and often the cash flows themselves, change with interest rates. The effects of the changes in these present values reflect the change in our underlying economic value, and provide a basis for the expected change in future earnings related to interest rates. Interest rate changes affect earnings by changing net interest income and the level of other interest-sensitive income and operating expenses. IRR is inherent in the role of banks as financial intermediaries.

A bank with a high degree of IRR may experience lower earnings, impaired liquidity and capital positions, and most likely, a greater risk of insolvency. Therefore, banks must carefully evaluate IRR to promote safety and soundness in their activities. Interest rate risk is the risk of loss to future earnings due to changes in interest rates. The Asset Liability Management Committee (“ALCO”) is responsible for establishing policy guidelines on liquidity and acceptable exposure to interest rate risk. Generally quarterly, ALCO reports on the status of liquidity and interest rate risk matters to the Company’s board of directors. The objective of the ALCO is to manage assets and funding sources to produce results that are consistent with the Company’s liquidity, capital adequacy, growth, risk and profitability goals and are within policy limits.

The Company utilizes the pricing and structure of loans and deposits, the size and duration of the investment securities portfolio, the size and duration of the wholesale funding portfolio, and off-balance sheet interest rate contracts to manage interest rate risk. The off-balance sheet interest rate contracts may include interest rate swaps, caps and floors. These interest rate contracts involve, to varying degrees, credit risk and interest rate risk. Credit risk is the possibility that a loss may occur if a counterparty to a transaction fails to perform according to terms of the contract. The notional amount of the interest rate contracts is the amount upon which interest and other payments are based. The notional amount is not exchanged, and therefore, should not be taken as a measure of credit risk. See Note 13 to the Audited Consolidated Financial Statements contained in Part II, Item 8 of our Annual Report on Form 10-K for the period ended December 31, 2023 and Note 11 to the unaudited consolidated interim financial statements contained in Part I, Item 1 of this report for additional information.

The ALCO uses income simulation to measure interest rate risk inherent in the Company’s on-balance sheet and off-balance sheet financial instruments at a given point in time by showing the effect of interest rate shifts on net interest income over a 24-month horizon and a 60-month horizon. The simulations assume that the size and general composition of the Company’s balance sheet remain static over the simulation horizons, with the exception of certain deposit mix shifts from low-cost time deposits to higher cost time deposits in selected interest rate scenarios. Additionally, the simulations take into account the specific repricing, maturity, call options, and prepayment characteristics of differing financial instruments that may vary under different interest rate scenarios. The characteristics of financial instrument classes are reviewed typically quarterly by the ALCO to ensure their accuracy and consistency.

The ALCO reviews simulation results to determine whether the Company’s exposure to a decline in net interest income remains within established tolerance levels over the simulation horizons and to develop appropriate strategies to manage this exposure. As of September 30, 2024 and December 31, 2023, net interest income simulations indicated that exposure to changing interest rates over the simulation horizons remained within tolerance levels established by the Company. All changes are measured in comparison to the projected net interest income that would result from an “unchanged” rate scenario where both interest rates and the composition of the Company’s balance sheet remain stable for a 24-month and 60-month period. In addition to measuring the change in net interest income as compared to an unchanged interest rate scenario, the ALCO also measures the trend of both net interest income and net interest margin over a 24-month and 60-month horizon to ensure the stability and adequacy of this source of earnings in different interest rate scenarios.

Model results at September 30, 2024 indicated a higher starting level of net interest income (“NII”) compared to the July 31, 2024 model which included the larger earning asset base from the FNCB merger. The current model results include the positive impact of purchase accounting resulting from the net accretion of the fair value marks.

Our interest rate risk position exhibits a relatively well-matched position to both rising and falling interest rate environments in the first twelve months of the simulation while a sustained falling rate and parallel downward shifting yield curve presents the greatest potential risk to NII over the long-term horizon. A steeper yield curve mitigates a portion of the exposure to falling rates. After the first eighteen months of the model simulation, the benefit to NII increases in a rising rate environment as a result of the higher assumed replacement rates on assets repricing while funding costs stabilize. This position at September 30, 2024 is similar to our July, 31, 2024 model results.

The ALCO regularly reviews a wide variety of interest rate shift scenario results to evaluate interest rate risk exposure, including scenarios showing the effect of steepening or flattening changes in the yield curve as well as parallel changes in interest rates of up to 400 basis points. Because income simulations assume that the Company’s balance sheet will remain static over the simulation horizon, the results do not reflect adjustments in strategy that the ALCO could implement in response to rate shifts.

The FOMC has begun decreasing the federal funds rate in part due to lower inflation. Since September 2024, the FOMC has decreased the federal funds target rate by 75 basis points which has resulted in our floating rate loans repricing lower and negatively impacting NII. Management commenced reducing deposit rates prior to the FOMC actions and expects to continue to reduce rates to mitigate the impact on interest income from the asset side of the balance sheet. Management expects cash flow from the investment portfolio to reprice higher than current portfolio rates, adjustable rate loans to reprice higher than current portfolio rates and new loan originations be added at higher than current portfolio rates to mitigate the lower interest from the floating rate loans. If we are unable to reduce our deposit costs as expected or we experience an outflow of deposits due to lower rates which could result in a shift to higher costing funding sources, expected levels of NII will be reduced.

The projected impacts of instantaneous changes in interest rates on our net interest income and economic value of equity at September 30, 2024, based on our simulation model, as compared to our ALCO policy limits are summarized as follows:

Our simulation model creates pro forma net interest income scenarios under various interest rate shocks. Given instantaneous and parallel shifts in general market rates of plus 100 basis points, our projected net interest income for the 12 months ending September 30, 2024, would decrease 0.1% from model results using current interest rates. Additional disclosures about market risk are included in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2023, and in Part I, Item 2 of this quarterly report, in each case under the heading “Market Risk Sensitivity,” and are incorporated into this Item 3 by reference.

(a) Evaluation of disclosure controls and procedures.

At September 30, 2024, the end of the period covered by this Quarterly Report on Form 10-Q, the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) evaluated the effectiveness of the Company’s disclosure controls and procedures as defined in Rule 13a-15(e) under the Exchange Act. Based upon that evaluation, the CEO and CFO concluded that the disclosure controls and procedures, at September 30, 2024, were effective to provide reasonable assurance that information required to be disclosed in the Company’s reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and to provide reasonable assurance that information required to be disclosed in such reports is accumulated and communicated to the CEO and CFO to allow timely decisions regarding required disclosure.

(b) Changes in internal control.

Effective on July 1, 2024, Peoples completed its merger with FNCB. During the third quarter of 2024, management commenced an evaluation of the design and operating effectiveness of internal controls over financial reporting related to the FNCB acquired business. The evaluation of changes to processes, technology systems, and other components of internal control over financial reporting related to the FNCB acquired business is ongoing. Except for the changes made in connection with the merger, there were no changes in the Company’s internal control over financial reporting in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 under the Exchange Act that occurred during the fiscal quarter ended September 30, 2024 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Our Annual Report on Form 10-K for the year ended December 31, 2023 (2023 Form 10-K) describes market, credit, and business operations risk factors that could affect our business, results of operations or financial condition. There have been no material changes from the risk factors as previously disclosed in our 2023 Form 10-K.