FARMERS NATIONAL BANC CORP. The following presents a discussion and analysis of Farmers' financial condition and results of operations by its management. The review highlights the principal factors affecting earnings and the significant changes in balance sheet items for the years 2022, 2021 and 2020. Financial information for prior years is presented when appropriate. The objective of this financial review is to enhance the reader's understanding of the accompanying tables and charts, the consolidated financial statements, notes to financial statements and financial statistics appearing elsewhere in this Annual Report on Form 10-K. Where applicable, this discussion also reflects management's insights of known events and trends that have or may reasonably be expected to have a material effect on Farmers' business, financial condition or results of operations.
Cautionary Note Regarding Forward Looking Statements
This Annual Report on Form 10-K contains "forward-looking statements" within the meaning of the safe harbor provisions of theU.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are not statements of historical fact, but rather statements based on Farmers' current expectations, beliefs and assumptions regarding the future of Farmers' business, future plans and strategies, projections, anticipated events and trends, its intended results and future performance, the economy and other future conditions. Forward-looking statements are preceded by terms such as "will," "would," "should," "could," "may," "expect," "estimate," "believe," "anticipate," "intend," "plan" "project," or variations of these words, or similar expressions. Forward-looking statements are not a guarantee of future performance, and actual future results could differ materially from those contained in forward-looking information. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict and many of which are outside of our control. Numerous uncertainties, risks, and changes could cause or contribute to Farmers' actual results, performance, and achievements to be materially different from those expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, without limitation, risks and uncertainties detailed from time to time in Farmers' filings with theSecurities and Exchange Commission , including without limitation the risk factors disclosed in Item 1A, "Risk Factors" of this Annual Report on Form 10-K. Many of these factors are beyond the Company's ability to control or predict, and readers are cautioned not to put undue reliance on those forward-looking statements. The following, which is not intended to be an all-encompassing list, summarizes several factors that could cause the Company's actual results to differ materially from those anticipated or expected in any forward-looking statement:
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general economic conditions in markets where the Company conducts business, which could materially impact credit quality trends;
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the length and extent of the economic impacts of the COVID-19 pandemic;
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the length and extent of the economic impacts of the ongoing conflict in
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actions by the
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disruptions in the mortgage and lending markets and significant or unexpected fluctuations in interest rates related to governmental responses to inflation, including financial stimulus packages and interest rate changes;
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general business conditions in the banking industry;
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the regulatory environment;
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general fluctuations in interest rates;
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demand for loans in the market areas where the Company conducts business;
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rapidly changing technology and evolving banking industry standards;
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competitive factors, including increased competition with regional and national financial institutions;
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Farmers' ability to attract, recruit and retain skilled employees; and
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new service and product offerings by competitors and price pressures.
Other factors not currently anticipated may also materially and adversely affect the Company's results of operations, cash flows and financial position. There can be no assurance that future results will meet expectations. While the Company believes that the forward-looking statements in the presentation are reasonable, you should not place undue reliance on any forward-looking statement. In addition, these statements speak only as of the date made. The Company does not undertake, and expressly disclaims, any obligation to update or alter any statements whether as a result of new information, future events or otherwise, expect as may be required by applicable law.
Results of Operations
Comparison of Operating Results for the Years Ended
The Company reported net income of$60.6 million for the year endedDecember 31, 2022 , compared to$51.8 million for the year endedDecember 31, 2021 . The Company reported$1.79 per diluted common share in 2022 compared$1.77 per diluted common share in 2021. The results for 2022 include a full year of income and expense from Cortland compared to ten months in 2021.
Net Interest Income
The Company's net interest income represents the difference between the interest income earned on interest-earning assets and the interest expense paid on interest-bearing liabilities. The Company recognized net interest income of$124.2 million for the year endedDecember 31, 2022 , compared to$108.0 million for the year endedDecember 31, 2021 . The tax-equivalent net interest margin declined to 3.18% for 2022 compared to 3.45% for the year endedDecember 31, 2021 . The margin declined due to a lower level of PPP interest income and fees in 2022 compared to 2021 and increased funding costs associated with theFederal Reserve's aggressive rate increases in 2022. In addition, the balance of securities available for sale as a percentage of interest earning assets is higher in 2022 than in 2021. These balances generally have a lower yield than loans, which, in turn, negatively impacts the net interest margin. Total interest income increased from$116.5 million in 2021 to$142.1 million for the year endedDecember 31, 2022 . The increase was primarily due to an increase in the average balance of loans and securities offset by a decline in the yields received on loans and tax exempt securities. Interest income on loans increased to$107.8 million for the year endedDecember 31, 2022 compared to$94.8 million for the year endedDecember 31, 2021 . This increase was due to the average loan balances increasing$317.4 million from the year endedDecember 31, 2021 toDecember 31, 2022 . The increase was mainly a result of twelve months of acquired Cortland loans in 2022, compared to two months in 2021. The yield on loans declined to 4.58% in 2022 from 4.66% in 2021. Income on taxable securities increased by$9.4 million in 2022 due to greater average balances of$464.5 million in 2022 and higher yields on the securities. The increased balance was due to the Cortland acquisition and purchases of securities. Income on tax exempt securities increased$2.4 million in 2022. The increase in income on tax-exempt securities was due to an increase in the average balance of$117.2 million offset by a decline in the yield on these securities of 24 basis points ("bp"). Interest expense increased$9.4 million to$17.9 million in 2022 from$8.5 million in 2021. The increase was due to a larger volume of interest-bearing liabilities and higher rates on deposits and borrowings. The average balance of interest-bearing deposits increased$442.2 million to$2.7 billion atDecember 31, 2022 primarily due to the Cortland acquisition while the cost of interest-bearing deposits increased by 19 bp year over year. Interest expense related to interest-bearing deposits was$13.1 million in 2022 compared to$6.8 million in 2021. 31 -------------------------------------------------------------------------------- Interest expense on short-term borrowings increased from$11 thousand in 2021 to$1.4 million in 2022. This increase was due to the increased usage of short term borrowings and an increase in the cost of those borrowings due to theFederal Reserve increasing the fed funds rate 425 bp in 2022. Interest on long-term borrowings increased to$3.4 million in 2022 from$1.7 million in 2021. This increase was primarily due to the increased cost of some of the long term borrowings that are tied to variable rates and which increased in 2022. Average Balance Sheets and Related Yields and Rates (Table Dollar Amounts in Thousands except Per Share Data) 32
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Years ended
December 31, 2022 2021 2020
AVERAGE AVERAGE AVERAGE
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
EARNING ASSETS
Loans (1) (3) $ 2,358,724 $ 108,100 4.58 % $ 2,041,347
1,081,966 20,843 1.93 617,475 11,399 1.85 209,817 5,423 2.58
Tax-exempt
securities (2) (3) 465,855 14,952 3.21 348,627 12,027 3.45 250,394 9,675 3.86
Other investments 33,153 871 2.63 21,912 498 2.27 16,073 543 3.38
Federal funds sold
and other cash 76,253 684 0.90 180,718 200 0.11 124,447 298 0.24
Total earning
assets 4,015,951 145,450 3.62 3,210,079 119,304 3.72 2,663,667 114,718 4.31
NONEARNING ASSETS
Cash and due from
banks 27,360 23,204 35,647
Premises and
equipment 38,278 28,227 25,563
Allowance for Loan
Losses (27,739 ) (25,187 ) (17,454 )
Unrealized gains on
securities (170,617 ) 19,589 20,067
Other assets 261,475 149,972 141,904
Total Assets $ 4,144,708 $ 3,405,884 $ 2,869,394
INTEREST-BEARING
LIABILITIES
Time deposits $ 360,687 $ 3,044 0.84 % $ 393,039 $ 3,652 0.93 % $ 480,302 $ 8,083 1.68 %
Brokered time
deposits 56,965 1,240 2.18 11,737 75 0.64 72,472 1,057 1.46
Savings deposits 846,418 1,352 0.16 569,179 712 0.13 462,021 1,080 0.23
Demand deposits -
interest bearing 1,392,058 7,449 0.54 1,240,014 2,336 0.19 856,462 4,161 0.49
Short term
borrowings 55,668 1,408 2.53 3,957 11 0.28 20,764 359 1.73
Long term
borrowings 87,972 3,427 3.90 70,057 1,683 2.40 82,451 1,396 1.69
Total
Interest-Bearing
Liabilities 2,799,768 17,920 0.64 2,287,983 8,469 0.37 1,974,472 16,136 0.82
NONINTEREST-BEARING LIABILITIES AND STOCKHOLDERS' EQUITY Demand deposits - noninterest bearing 959,294 714,978 546,177 Other Liabilities 34,180 23,498 21,570 Stockholders' equity 351,466 379,425 327,175 Total Liabilities and Stockholders' Equity$ 4,144,708 $ 3,405,884 $ 2,869,394 Net interest income and interest rate spread$ 127,530 2.98 %$ 110,835 3.35 %$ 98,582 3.49 % Net interest margin 3.18 % 3.45 % 3.70 %
(1)
Interest on loans includes fee income of$4.5 million ,$10.3 million and$8.3 million for 2022, 2021 and 2020, respectively, and is reduced by amortization of$3.0 million ,$2.6 million and$2.7 million for 2022, 2021 and 2020, respectively.
(2)
Includes unamortized discounts and premiums. Average balance and yield are computed using the average historical amortized cost.
(3)
For 2022, adjustments of$310 thousand and$3.1 million were made to tax equate income on tax exempt loans and tax exempt securities. For 2021, adjustments of$360 thousand and$2.5 million were made to tax equate income on tax exempt loans and tax 33 -------------------------------------------------------------------------------- exempt securities. For 2020, adjustments of$400 thousand and$2.0 million were made to tax equate income on tax exempt loans and tax exempt securities. These adjustments are based on a marginal federal income tax rate of 21%, less disallowances. RATE AND VOLUME ANALYSIS
(Table Dollar Amounts in Thousands except Per Share Data)
The following table analyzes by rate and volume the dollar amount of changes in the components of the interest differential:
2022 change from 2021 2021 change from 2020
Net Change Due Change Due Net Change Due Change Due
Change To Volume To Rate Change To Volume To Rate
Tax Equivalent Interest
Income
Loans $ 12,920 $ 14,798 $ (1,878 ) $ (3,599 ) $ (1,034 ) $ (2,565 )
Taxable securities 9,444 8,575 869 5,976 10,536 (4,560 )
Tax-exempt securities 2,925 4,044 (1,119 ) 2,352 3,796 (1,444 )
Other investments 373 255 118 (45 ) 197 (242 )
Funds sold and other cash 484 (116 ) 600 (97 ) 135 (232 )
Total interest income $ 26,146 $ 27,556 $ (1,410 ) $ 4,587 $ 13,630 $ (9,043 )
Interest Expense
Time deposits $ (608 ) $ (301 ) $ (307 ) $ (4,431 ) $ (1,469 ) $ (2,962 )
Brokered time deposits 1,165 289 876 (982 ) (886 ) (96 )
Savings deposits 640 347 293 (368 ) 250 (618 )
Demand deposits 5,113 286 4,827 (1,825 ) 1,863 (3,688 )
Short term borrowings 1,397 144 1,253 (348 ) (291 ) (57 )
Long term borrowings 1,744 430 1,314 287 (210 ) 497
Total interest expense $ 9,451 $ 1,195 $ 8,256 $ (7,667 ) $ (743 ) $ (6,924 )
Increase (decrease) in tax
equivalent net interest
income $ 16,695 $ 26,361 $ (9,666 ) $ 12,254 $ 14,373 $ (2,119 ) The amount of change not solely due to rate or volume changes was allocated between the change due to rate and the change due to volume based on the relative size of the rate and volume changes.
Noninterest Income
The Company's total noninterest income increased to$44.2 million for the year endedDecember 31, 2022 compared to$38.2 million for the year endedDecember 31, 2021 . Major categories of noninterest income are discussed below.
Service charges on deposit accounts increased to
Bank owned life insurance income increased to$1.8 million for the year endedDecember 31, 2022 from$1.3 million for the year endedDecember 31, 2021 . This increase was due to the addition of Cortland as well as proceeds from death benefits of$184,000 received from the policies. Trust fees increased to$9.6 million in 2022 from$9.4 million in 2021 while investment commissions decreased from$2.3 million in 2021 to$2.2 million in 2022. The trust business continued to grow in 2022 even with the uncertain economic environment and volatile markets. The investment commissions declined primarily due to volatile equity markets.
Insurance agency commissions increased from
Security gains, including fair value changes on equity securities, decreased by$1.5 million in 2022. The Company recorded a loss on the sale of securities of$454,000 in 2022 compared to a gain of$1.0 million in 2021. The Company elected to restructure a portion of its investment portfolio in 2022 that resulted in the loss. 34 -------------------------------------------------------------------------------- The net gains on the sale of loans declined by$6.2 million in 2022 to$2.1 million from$8.3 million in 2021. The decline was due to a decline in margins as well as the volume of loans sold. In addition, the Company recognized a gain of$239 thousand in 2021 for the sale of the Company's credit card portfolio.
Debit card fees increased to
The Company recorded an
Other operating income increased to$4.0 million for the year endedDecember 31, 2022 from$2.3 million for the year endedDecember 31, 2021 . This increase was due to the addition of Cortland and higher SBIC/SBA fund income in 2022 compared to 2021. Noninterest Expenses Noninterest expense was$94.4 million for the year endedDecember 31, 2022 , compared to$79.2 million in 2021, which was an increase of$15.2 million , or 19.2%. The increase is primarily due to the merger with Cortland with the added employees and operating costs associated with a larger bank. Salaries and employee benefits increased by$5.6 million to$45.0 million in 2022 compared to$39.4 million in 2021. This increase was primarily due to the Company having a higher level of employees due to the addition of Cortland.
Occupancy and equipment expense increased
Professional fees increased to$6.1 million in 2022 from$4.2 million in 2021. The increase was due to Cortland and a higher level of consulting expense in 2022. Merger related costs decreased to$4.1 million in 2022 compared to$7.1 million in 2021. This increase was due to the acquisition of Cortland in 2021, while 2022 costs were from the Emclaire acquisition that was completed onJanuary 1, 2023 . An additional special charitable donation of$6.0 million was made during 2022 compared to no additional donation in 2021. The donation was made possible by the$8.4 million legal settlement income discussed above.
Income Taxes
Income tax expense increased from$10.3 million for the year endedDecember 31, 2021 to$12.2 million for the year endedDecember 31, 2022 . The increase was due to a$10.7 million increase in income before income taxes. Income taxes are computed using the appropriate effective tax rates for each period. The effective tax rates are less than the statutory tax rate primarily due to nontaxable interest and dividend income. The effective income tax rate was 16.8% for 2022 and 16.5% in 2021. Refer to Note 18 to the consolidated financial statements for additional information regarding the effective tax rate.
Comparison of Operating Results for the Years Ended
The Company reported net income of$51.8 million for the year endedDecember 31, 2021 , compared to$41.9 million for the year endedDecember 31, 2020 . On a diluted per common share basis, the Company reported$1.77 in 2021 and$1.47 in 2020. The results for 2021 include two months of income and expenses from Cortland compared to none in 2020 along with acquisition-related expense and additional provision for credit losses as a result of the merger and the adoption of CECL. 35 -------------------------------------------------------------------------------- OnNovember 1, 2021 , the Company completed its acquisition ofCortland Bancorp ("Cortland") for consideration consisting of a combination of cash and stock. Under the terms of the merger agreement, shareholders of Cortland were able to receive either$28 per share in cash or 1.75 shares of the Company's common stock, subject to an overall limitation of 75% of the shares being exchanged for Company shares and 25% for cash. The Company issued 5.6 million shares of its common stock along with cash of$29.6 million , which represented a transaction value of approximately$128.5 million based on its closing stock price of$17.82 onOctober 31, 2021 , the closing of the merger.Goodwill of$48.5 million arising from the acquisition consisted largely of synergies and the cost savings resulting from the combining of the entities.
Net Interest Income
The Company's net interest income represents the difference between the interest income earned on interest-earning assets and the interest expense paid on interest-bearing liabilities. Net interest income was$108.0 million for the year endedDecember 31, 2021 , compared to$96.2 million for the year endedDecember 31, 2020 . The tax-equivalent net interest margin was 3.45% for the year endedDecember 31, 2021 , compared to 3.70% for the year endedDecember 31, 2020 . The margin declined due to the continued low level of treasury rates and the federal funds rate, both of which has impacted asset yields more negatively than deposit costs. In addition, the balance of securities available for sale as a percentage of interest earning assets is higher in 2021 than in 2020. These balances generally have a lower yield than loans, which, in turn, negatively impacts the net interest margin. Total interest income increased to$116.5 million for the year endedDecember 31, 2021 compared to$112.3 million for the year endedDecember 31, 2020 . The increase of$4.2 million was primarily due to an increase in the income on taxable and tax-exempt securities offset by a decline in the interest earned on loans. The average balance of loans decreased$21.6 million for the year endedDecember 31, 2021 while the yield on loans declined to 4.66% in 2021 from 4.79% in 2020, which caused interest income on loans to decline$3.6 million in 2021 to$94.8 million . The decline in average loan balances was primarily due to the payoff of PPP loans along with declines in other loan categories due to high levels of customer liquidity and refinance opportunities offset by the addition of Cortland's loan balances. The increase in income on taxable and tax-exempt securities to$20.9 million in 2021 compared to 2020 was primarily due to an increase in the average balance on these securities of$505.9 million offset by a decline in their yield. During 2021, the Company continued to invest excess cash balances into securities. Interest expense declined$7.7 million to$8.5 million in 2021 compared to$16.1 million in 2020. The decrease was due to a 45 basis point decline in the cost of interest-bearing liabilities offset by an increase in average interest-bearing liabilities of$313.5 million . The average balance of interest-bearing deposits increased$342.7 million to$2.2 billion atDecember 31, 2021 . Interest expense related to interest-bearing deposits was$6.8 million in 2021 compared to$14.4 million in 2020. Interest on short-term borrowings declined to$7 thousand in 2021 compared to$359 thousand in 2020 as the Company paid off these borrowings in 2021. Interest on long-term borrowings increased to$1.7 million in 2021 from$1.4 million in 2020. Noninterest Income Total noninterest income increased to$38.2 million for the year endedDecember 31, 2021 compared to$36.2 million for the year endedDecember 31, 2020 . The increase in noninterest income is mainly due to increases across many categories of noninterest income offset by declines in the gain on sale of loans. Bank owned life insurance income increased by$543 thousand in 2021 from 2020 due to the purchase of more insurance at the end of 2020 and the addition of Cortland. 36 -------------------------------------------------------------------------------- Trust fees increased to$9.4 million in 2021 from$7.6 million in 2020 while investment commissions increased by$746 thousand in 2021 compared to 2020. Both of these categories benefitted from growth as well as the strong performance of the equity markets in 2021.
Insurance agency commissions increased to
Security gains, including fair value changes on equity securities, increased by$624 thousand in 2021 to$1.0 million compared to gains of$380 thousand in 2020. The Company elected to restructure a portion of its investment portfolio in 2021 that resulted in higher gains. The net gains on the sale of loans declined by$3.1 million in 2021 to$8.3 million from$11.4 million in 2020. The decline was due to a decline in margins as well as the volume of loans sold. The decline was offset somewhat by the recognition of a$239 thousand gain on the sale of the Company's credit card portfolio in 2021.
Debit card fees increased by
Noninterest Expenses
Noninterest expense was
Salaries and employee benefits declined by$433 thousand to$39.4 million in 2021 compared to$39.8 million in 2020. This decline was primarily due to the Company having a higher level of unfilled positions in 2021 compared to 2020 due to the continuing labor shortage offset by the addition of Cortland. In addition, the benefit of deferred salary costs was greater in 2021 than in 2020. Occupancy and equipment expense increased$1.2 million to$8.5 million in 2021 from$7.3 million in 2020. The increase was due to Cortland and a higher level of facilities maintenance in 2021 compared to 2020. Professional fees increased to$4.2 million in 2021 from$2.7 million in 2020. The increase was due to Cortland and a higher level of consulting expense in 2021. Merger related costs increased to$7.1 million in 2021 compared to$3.2 million in 2020. This increase was due to the acquisition of Cortland in 2021, which was a larger acquisition than the acquisition of Maple Leaf in 2020.
State and local taxes increased
37
--------------------------------------------------------------------------------Income Taxes
Income tax expense increased to$10.3 million for 2021 compared to$8.4 million in 2020. The increase was due to an$11.8 million increase in income before income taxes. Income taxes are computed using the appropriate effective tax rates for each period. The effective tax rates are less than the statutory tax rate primarily due to nontaxable interest and dividend income. The effective income tax rate was 16.5% for 2021 and 16.7% for 2020. The decreased effective tax rate is due to additions to the non-taxable municipal securities portfolio. Refer to Note 18 to the consolidated financial statements for additional information regarding the effective tax rate.
Loan Portfolio
Maturities and Sensitivities of Loans to Interest Rates
The following schedule shows the composition of loans and the percentage of loans in each category at the dates indicated. Balances include unamortized loan origination fees and costs.
Years Ended December 31, 2022 2021 2020 2019 2018 Commercial Real Estate$ 1,026,822 42.6 %$ 1,010,674 43.3 %$ 712,818 34.3 %$ 615,521 34.0 %$ 578,181 33.3 % Commercial 294,406 12.2 312,532 13.4 401,003 19.3 255,458 14.1 244,742 14.1 Residential Real Estate 607,557 25.3 580,242 24.9 523,340 25.2 499,301 27.6 492,133 28.4 Consumer 228,794 9.5 195,343 8.4 208,842 10.0 214,998 11.9 221,795 12.8 Agricultural 247,171 10.3 232,291 10.0 232,041 11.2 226,261 12.4 198,989 11.4 Total Loans$ 2,404,750 100.0 %$ 2,331,082 100.0 %$ 2,078,044 100.0 %$ 1,811,539 100.0 %$ 1,735,840 100.0 %
The following schedule sets forth maturities based on remaining scheduled
repayments of principal for loans listed above as of
Types of Loans 1 Year or less 1 to 5 Years 5 to 15 Years Over 15 Years Commercial$ 22,755 $ 147,091 $ 81,616 $ 42,944 Commercial Real Estate$ 57,131 $ 286,471 $ 604,796 $ 78,424 Residential Real Estate $ 6,732$ 35,409 $ 143,217 $ 422,199 Consumer $ 3,107$ 89,741 $ 124,831 $ 11,115 Agricultural $ 2,297$ 32,576 $ 49,370 $ 162,928
The amounts of loans as of
Loan Sensitivities 1 Year or less Over 1 Year
Total
Floating or Adjustable Rates of Interest$ 44,200 $ 1,207,563 $ 1,251,763 Fixed Rates of Interest 47,822 1,105,165 1,152,987 Total Loans$ 92,022 $ 2,312,728 $ 2,404,750 Total loans were$2.4 billion at year-end 2022, compared to$2.3 billion at year-end 2021 representing an increase of 3.2%. Loans comprised 58.7% of the Bank's average earning assets in 2022, compared to 64.0% in 2021. The product mix in the loan portfolio includes commercial real estate loans 42.6%, commercial loans comprising 12.2%, residential real estate loans 25.3%, consumer loans 9.5% and agricultural loans 10.3% atDecember 31, 2022 , compared with 43.3%, 13.4%, 24.9%, 8.4% and 10.0%, respectively, atDecember 31, 2021 . Loans contributed 74.3% of total taxable equivalent interest income in 2022 and 80.0% in 2021. Loan yields were 4.58% in 2022, 96 basis points greater than the average rate for total earning assets. Management recognizes that while the loan portfolio holds some of the Bank's' highest yielding assets, it is inherently the most risky portfolio. Accordingly, management attempts to balance credit risk versus return with conservative credit standards. Management has developed and maintains comprehensive underwriting guidelines and a loan review function that monitors credits during and after the approval process. To minimize risks associated with changes in the borrower's future repayment capacity, the Bank generally requires scheduled periodic principal and interest payments on all types 38 -------------------------------------------------------------------------------- of loans and normally requires collateral. Commercial real estate loans increased from$1.01 billion atDecember 31, 2021 to$1.03 billion atDecember 31, 2022 , an increase of$16.1 million or 1.6%. The Company's commercial real estate loan portfolio includes loans for owner occupied and non-owner occupied real estate. These loans are made to finance properties such as office and industrial buildings, hotels and retail shopping centers. Residential real estate mortgage loans increased 4.7% to$607.6 million atDecember 31, 2022 , compared to$580.2 million in 2021. Farmers originated both fixed rate and adjustable rate mortgages during 2022. Fixed rate terms are offered with terms between to fifteen and 30 years while adjustable rate products are offered with maturities up to thirty years. The Company sells all fixed rate loans that are secondary market eligible. Commercial loans atDecember 31, 2022 decreased 5.8% from year-end 2021 with outstanding balances of$294.4 million . The Bank's commercial loans are granted to customers within the immediate trade area of the Bank. The mix is diverse, covering a wide range of borrowers, business types and local municipalities. The Bank monitors and controls concentrations within a particular industry or segment of the economy. These loans are made for purposes such as equipment purchases, capital and leasehold improvements, the purchase of inventory, general working capital and small business lines of credit. Agricultural loans increased from$232.3 million in 2021 to$247.2 million in 2022, an increase of$14.9 million . The Company's agricultural loan portfolio contains a diverse mix of dairy, crops, land, poultry and cattle loans.
Consumer loans increased from
Summary of Credit Loss Experience
The following is an analysis of the allowance for credit losses for 2022. During 2022 and 2021 the Company used the CECL methodology while the incurred loss methodology was used in prior years:
Years Ended December 31, 2022 2021 2020 2019 2018 Balance at Beginning of Year$ 29,386 $ 22,144 $ 14,487 $ 13,592 $ 12,315 Charge-Offs: Commercial Real Estate (300 ) (70 ) (122 ) (45 ) 0 Commercial (2,042 ) (388 ) (412 ) (200 ) (220 ) Residential Real Estate (92 ) (297 ) (172 ) (400 ) (318 ) Consumer (870 ) (912 ) (1,347 ) (1,702 ) (2,318 ) Total Charge-Offs (3,304 ) (1,667 ) (2,053 ) (2,347 ) (2,856 ) Recoveries on Previous Charge-Offs: Commercial Real Estate 3 33 31 4 126 Commercial 75 199 11 13 190 Residential Real Estate 89 162 85 58 148 Consumer 479 411 483 717 669 Total Recoveries 646 805 610 792 1,133 Net Charge-Offs (2,658 ) (862 ) (1,443 ) (1,555 ) (1,723 ) Impact of CECL adoption 0 2,160 0 0 0 Provision For Credit Losses and Day One Purchase entry 250 5,944 9,100 2,450 3,000 Balance at End of Year$ 26,978 $ 29,386 $ 22,144 $ 14,487 $ 13,592 Ratio of Net Charge-offs to Average Loans Outstanding 0.11 % 0.04 % 0.07 % 0.09 % 0.10 % Allowance for Credit Losses/Total Loans 1.12 1.26 1.07 0.80 0.78 Provisions charged to operations, which includes the provision for unfunded commitments, amounted to$1.1 million in 2022, compared to$4.9 million in 2021, a decrease of$3.8 million . The reduced provision for the current year was mainly a result of current economic conditions resulting from the improvement in the COVID-19 pandemic. 39 -------------------------------------------------------------------------------- The Company adopted ASU 2016-13 in 2021, to calculate the allowance for credit losses ("ACL") which requires projecting credit losses over the lifetime of the credits. The ACL is adjusted through the provision for credit losses and reduced by net charge offs of loans. Although the Company has a diversified loan portfolio, the credit risk in the loan portfolio is largely influenced by general economic conditions and trends of the counties and markets in which the debtors operate, and the resulting impact on the operations of borrowers or on the value of any underlying collateral. The credit loss estimation process involves procedures that consider the unique characteristics of the Company's loan portfolio segments. These segments are disaggregated into the loan pools for monitoring. A model of risk characteristics, such as loss history and delinquency experience, trends in past due and non-performing loans, as well as existing economic conditions and supportable forecasts used to determine credit loss assumptions. The Company uses two methodologies to analyze loan pools. The cohort method ("cohort") and the probability of default/loss given default ("PD/LGD"). Cohort relies on the creation of cohorts to capture loans that qualify for a particular segment, as of a point in time. Those loans are then tracked over their remaining lives to determine their loss experience. The Company aggregates financial assets on the basis of similar risk characteristics when evaluating loans on a collective basis. Those characteristics include, but aren't limited to, internal or external credit score, risk ratings, financial asset, loan type, collateral type, size, effective interest rate, term, or geographical location. The Company uses cohort primarily for consumer loan portfolios. The probability of default ("PD") portion of PD/LGD is defined by the Company as 90 days past due, placed on non-accrual, becomes a troubled debt restructuring or is partially, or wholly, charged-off. Typically, a one-year time period is used to asses PD. PD can be measured and applied using various risk criteria. Risk rating is one common way to apply PDs. Loss given default ("LGD") is to determine the percentage of loss by facility or collateral type. LGD estimates can sometimes be driven, or influenced, by product type, industry or geography. The Company uses PD/LGD primarily for commercial loan portfolios. Net charge-offs for the year endedDecember 31, 2022 were$2.7 million ,$1.8 million , or 208.3% more than net charge-offs for the year endedDecember 31, 2021 . The allowance for credit losses to total loans decreased to 1.12% atDecember 31, 2022 compared to 1.26% atDecember 31, 2021 . Nonperforming loans to total loans decreased from 0.69% atDecember 31, 2021 to 0.62% atDecember 31, 2022 . In accordance with the accounting relief provisions of CARES and subsequent provisions of the Health and Economic Recovery Omnibus Emergency Solutions (HEROES) Acts, the Bank postponed the adoption of the current expected credit losses ("CECL") accounting standard, in 2020, primarily due to the impact that the COVID-19 pandemic was having on the economy and the lack of reasonable and supportable economic forecasts. The Company adopted ASU 2016-13 onJanuary 1, 2021 . The Company recorded the one-time adjustment to equity, to comply with the ASU adoption, which increased the allowance for credit losses by$1.9 million , net of tax. The provision for credit losses charged to operating expense is based on management's judgment after taking into consideration all factors connected with the collectability of the existing loan portfolio. Management evaluates the loan portfolio in light of economic conditions, changes in the nature and volume of the loan portfolio, industry standards and other relevant reasonable and supportable forecasts. Specific factors considered by management in determining the amounts charged to operating expenses include previous charge-off experience, the status of past due interest and principal payments, the quality of financial information supplied by loan customers and the general condition of the industries in the community to which loans have been made.
The allowance for credit losses decreased
Typically, commercial and commercial real estate loans are identified as
collateral dependent when they become ninety days past due, or earlier if
management believes it is probable that the Company will not collect all amounts
due under the terms of the loan agreement. When Farmers identifies a loan and
concludes that the loan is collateral dependent, Farmers performs an internal
collateral valuation as an interim measure. Farmers typically obtains an
external appraisal to validate its internal collateral valuation as soon as is
practical and adjusts the associated specific loss reserve, if necessary.
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The ratio of the allowance for credit losses to non-performing loans at December
31, 2022 was 182.3%, compared to 181.5% at December 31, 2021 . The percentage of
non-performing loans to total loans decreased slightly from 0.69% in 2021 to
0.62% in 2022. The balance in the allowance for credit losses decreased in 2022
to $27.0 million from $29.4 million in 2021. Last year's allowance was impacted
by the adoption of CECL on January 1, 2021 .
Nonperforming Assets
December 31, 2022 2021 2020 2019 2018
Nonaccrual loans:
Commercial Real Estate $ 4,057 $ 3,004 $ 389 $ 108 $ 422
Commercial 3,840 7,190 3,789 1,169 946
Residential Real Estate 3,438 4,280 5,783 2,801 4,166
Consumer 494 682 864 858 495
Agricultural 2,482 314 680 542 736
Total Nonaccrual Loans $ 14,311 $ 15,470 $ 11,505 $ 5,478 $ 6,765
Loans Past Due 90 Days or More 492 725 2,330 867 966
Total Nonperforming Loans $ 14,803 $ 16,195 $ 13,835 $ 6,345 $ 7,731
Total Nonperforming Assets $ 14,876 $ 16,195 $ 13,835 $ 6,364 $ 7,731
Loans modified in troubled
debt restructurings $ 5,559 $ 3,862 $ 4,105 $ 4,597 $ 5,520
TDRs included in Nonaccrual
Loans $ 3,455 $ 1,962 $ 2,366 $ 2,673 $ 2,997
Percentage of Nonperforming
Loans to Total Loans 0.62 % 0.69 % 0.67 % 0.35 % 0.45 %
Percentage of Nonperforming
Assets to Total Assets 0.36 % 0.39 % 0.45 % 0.26 % 0.33 %
Loans Delinquent 30-89 days $ 9,605 $ 8,891 $ 9,297 $ 11,893 $ 8,877
Percentage of Loans Delinquent
30-89 days
to Total Loans 0.40 % 0.38 % 0.45 % 0.66 % 0.51 %
The Company has forgone interest income of approximately $548 thousand from
nonaccrual loans as of December 31, 2022 that would have been earned, over the
life of the loans, if all loans had performed in accordance with their original
terms.
Net charge-offs as a percentage of average loans outstanding increased from
0.04% for 2021 to 0.11% for 2022 as net charge-offs increased from $862 thousand
in 2021 to $2.7 million in 2022. An increase in gross charge-offs was
experienced in the commercial loan portfolio of $2.0 million combined with a
$230 thousand increase in gross charge-offs in the commercial real estate loan
portfolio. These were off set slightly with a decrease in charge-offs of $205
thousand in the residential real estate portfolio.
The following table summarizes the Company's allocation of the allowance for
credit losses for under CECL for 2022 and 2021 and the allowance for loan losses
for prior years:
December 31, 2022 2021 2020 2019 2018
Loans to Loans to Loans to Loans to Loans to
Total Total Total Total Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
Commercial
Real Estate $ 14,840 50.5 % $ 15,879 51.0 % $ 10,775 43.1 % $ 6,127 43.6 % $ 5,294 42.1 %
Commercial 4,186 14.6 4,949 15.7 5,022 21.6 2,443 16.9 2,200 16.8
Residential
Real Estate 4,374 25.3 4,870 24.9 3,684 25.2 3,032 27.6 2,982 28.3
Consumer 3,578 9.6 3,688 8.4 2,663 10.0 2,885 11.9 3,116 12.8
$ 26,978 100.0 % $ 29,386 100.0 % $ 22,144 100.0 % $ 14,487 100.0 % $ 13,592 100.0 %
. The allowance allocated to each of the four loan categories should not be
interpreted as an indication that charge-offs in 2022 occurred in the same
proportions or that the allocation indicates future charge-off trends. The
allowance allocated to the one-to-four family real estate loan category and the
consumer loan category is based upon the Company's allowance methodology for
homogeneous loans, and increases and decreases in the balances of those
41
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portfolios. The commercial loan category, which represents 14.6% of the total
loan portfolio, management relies on the Bank's internal loan review procedures
and allocates accordingly based on loan classifications. The gross charge-offs
in the commercial loan portfolio, was $2.0 million for 2022. For the consumer
loan category, which represents approximately 9.6% of total loans and in 2022,
the gross charge-offs accounted for 26.3% of the losses of the entire loan
portfolio.
There were no loans other than those identified above, that management has known
information about possible credit problems of borrowers and their ability to
comply with the loan repayment terms. Management is actively monitoring certain
borrowers' financial condition and loans which management wants to more closely
monitor due to special circumstances. These loans and their potential loss
exposure have been considered in management's analysis of the adequacy of the
allowance for credit losses.
Loan Commitments and Lines of Credit
In the normal course of business, the Bank has extended various commitments for credit. Commitments for mortgages, revolving lines of credit and letters of credit generally are extended for a period of one month up to one year. Normally, no fees are charged on any unused portion, but an annual fee of two percent is charged for the issuance of a letter of credit. As ofDecember 31, 2022 , there were no concentrations of loans exceeding 10% of total loans that are not disclosed as a category of loans. As of that date, there were also no other interest-earning assets that are either nonaccrual, past due, restructured or non-performing.
The investment securities portfolio decreased$159.7 million in 2022 to$1.3 billion atDecember 31, 2022 from$1.4 billion atDecember 31, 2021 . This decrease is primarily the result of the changes in fair value. The portfolio had an unrealized loss of$266.5 million in 2022 compared to an unrealized gain of$11.7 million in 2021. For additional information regarding Farmers' investment securities see Note 3 to the Consolidated Financial Statements.
The following table shows the carrying value of investment securities by type of obligation at the dates indicated:
December 31, 2022
2021
U.S. Treasury securities$ 52,280 $
61,662
29,169
Mortgage-backed securities - residential and collateralized mortgage obligations 602,496 668,571 Small Business Administration 3,474 5,430 Obligations of states and political subdivisions 530,080 658,815 Corporate bonds 3,879 4,030 Equity securities 196 228 Other investments measured at net asset value 15,048 14,721 Total securities$ 1,283,269 $ 1,442,626 42
-------------------------------------------------------------------------------- A summary of debt securities held atDecember 31, 2022 classified according to maturity and including weighted average yield for each range of maturities is set forth below: Type and Maturity Grouping December 31, 2022 Weighted Average Fair Value Yield (1)U.S. Treasury securities Maturing within one year $ 222 1.71 % Maturing after one year but within five years 287 2.12 % Maturing after five years but within ten years 51,771 1.10 % Total U.S. Treasury securities$ 52,280 1.10 %
$ 0 0.00 %
Maturing after one year but within five years 22,623 1.98 %
Maturing after five years but within ten years 48,747 2.47 %
Maturing after ten years 4,446 3.45 %
Total U.S. government sponsored enterprise debt
securities $ 75,816 2.39 %
Mortgage-backed securities - residential and
collateralized mortgage
obligations (2)
Maturing within one year $ 3 4.65 %
Maturing after one year but within five years 602 2.48 %
Maturing after five years but within ten years 35,858 2.35 %
Maturing after ten years 566,033 1.63 %
Total mortgage-backed securities $ 602,496 1.86 %
Small Business Administration
Maturing within one year $ 0 0.00 %
Maturing after one year but within five years 0 0.00 %
Maturing after five years but within ten years 2,643 2.14 %
Maturing after ten years 831 1.98 %
Total small business administration $ 3,474 2.10 %
Obligations of states and political subdivisions
Maturing within one year $ 0 0.00 %
Maturing after one year but within five years 1,294 2.66 %
Maturing after five years but within ten years 32,568 2.50 %
Maturing after ten years 496,218 2.55 %
Total obligations of states and political
subdivisions $ 530,080 2.55 %
Corporate bonds
Maturing within one year $ 99 2.97 %
Maturing after one year but within five years 1,142 2.02 %
Maturing after five years but within ten years 2,539 4.71 %
99 2.16 %
Total other securities $ 3,879 3.80 %
(1)
The weighted average yield has been computed by dividing the total contractual
interest income adjusted for amortization of premium or accretion of discount
over the life of the security by the par value of the securities outstanding.
The weighted average yield of tax-exempt obligations of states and political
subdivisions has been calculated on a fully taxable equivalent basis. The
amounts of adjustments to interest which are based on the statutory tax rate of
21% were $9 thousand , $93 thousand , $303 thousand and $3.7 million for the four
ranges of maturities.
(2)
Payments based on contractual maturity.
Premises and Equipment
Premises and equipment increased to$39.2 million atDecember 31, 2022 compared to$37.5 million atDecember 31, 2021 . This increase was primarily due to normal additions to furniture and fixtures and right if use assets, related to leases, throughout the year. 43 --------------------------------------------------------------------------------
Bank Owned Life Insurance
Farmers owns bank owned life insurance policies on the lives of certain members of management. The purpose of this investment is to help fund the costs of employee benefit plans. The cash surrender value of these policies was$75.0 million atDecember 31, 2022 , compared to$73.9 million atDecember 31, 2021 . The increase was primarily due to positive changes in the fair value of the policies.
Deposits
Total deposits atDecember 31, 2022 , were$3.6 billion compared to$3.5 billion atDecember 31, 2021 , an increase of$14.5 million . Non-interest bearing deposits decreased$19.3 million during 2022 to$897.0 million and interest-bearing deposits decreased$104.2 million to$2.5 billion . These decreases were offset by$138.1 million in brokered certificates of deposit atDecember 31, 2022 compared to none atDecember 31, 2021 .
Average balances and average rates paid on deposits are as follows:
Years Ended December 31
2022 2021 2020
Amount Rate Amount Rate Amount Rate
Noninterest-bearing demand $ 959,294 0.00 % $ 714,978 0.00 % $ 546,177 0.00 %
Interest-bearing demand 1,392,058 0.54 % 1,240,014 0.19 % 856,462 0.49 %
Money market 389,036 0.14 % 246,900 0.24 % 213,455 0.46 %
Savings 457,382 0.02 % 322,279 0.04 % 248,566 0.04 %
Brokered time deposits 56,965 2.18 % 11,737 0.64 % 72,472 1.46 %
Certificates of deposit 360,687 0.84 % 393,039 0.93 % 480,302 1.68 %
Total $ 3,615,422 0.64 % $ 2,928,947 0.34 % $ 2,417,434 0.69 %
The following table sets forth the maturities of retail certificates of deposit
having principal amounts
Retail certificates of deposit maturing in quarter ending: March 31, 2023$ 37,942 June 30, 2023 32,287 September 30, 2023 7,227 December 31, 2023 36,243 After December 31, 2023 21,967 Total retail certificates of deposit with balances$250,000 or greater$ 135,666 Uninsured deposits for bank and savings and loan registrants areU.S. federally insured depository institutions as the portion of deposit accounts inU.S. offices that exceed theFDIC insurance limit or similar state deposit insurance regimes and amounts in any other uninsured investment or deposit account that are classified as deposits and not subject to any federal or state deposit insurance regimes. Deposits in amounts in excess of theFDIC insurance limit were$1.31 billion atDecember 31, 2022 . 44 --------------------------------------------------------------------------------
Short-Term Borrowings
Total short-term borrowings increased from zero atDecember 31, 2021 to$95.0 million atDecember 31, 2022 . The borrowings helped to offset the runoff in noninterest bearing and interest bearing demand deposits, excluding brokered time deposits. The Company uses short term FHLB advances to manage the ongoing fluctuations with loans and deposits when necessary.
Long-Term Borrowings
Total long-term borrowings increased$453 thousand to$88.2 million atDecember 31, 2022 , from$87.8 million atDecember 31, 2021 . During 2021, the Company assumed$4.3 million of junior subordinated debt securities in the merger with Cortland. In addition, inNovember 2021 , the Company completed the issuance of$75.0 million aggregate principal amount, fixed-to-floating rate subordinated notes dueDecember 15, 2031 , in a private offering exempt from the registration requirements under the Securities Act of 1933, as amended. The notes carry a fixed rate of 3.125% for five years at which time they will convert to a floating rate based on the three-month term secured overnight funding rate, plus a spread of 220 basis points. The Company may, at its option, beginningDecember 15, 2026 , redeem the notes, in whole or in part, from time to time, subject to certain conditions. The net proceeds from the sale were approximately$73.8 million , after deducting the offering expenses. See Note 13 within Item 8 of this Annual report on Form 10-K for additional detail.
Stockholders' Equity
Total stockholders' equity decreased to$292.3 million atDecember 31, 2022 from$472.4 million atDecember 31, 2021 . The decrease is mainly due to the decline in accumulated other comprehensive income of$219.8 million betweenDecember 31, 2021 andDecember 31, 2022 , due to unrealized losses associated with the investment securities portfolio. Net income contributed$60.6 million and was offset by the dividends paid on common stock during 2022.
Contractual Obligations, Commitments, Contingent Liabilities and Off-Balance Sheet Arrangements
The following table presents, as ofDecember 31, 2022 , the Company's significant fixed and determinable contractual obligations by payment date. The payment amounts represent those amounts contractually due to the recipient and do not include any unamortized premiums or discounts or other similar carrying value adjustments. Further discussion of the nature of each obligation is included in the referenced note to the consolidated financial statements. Commitments12/31/2022 Note Ref. 2023 2024 2025 2026 2027 Thereafter Deposits without maturity$ 2,999,188 Certificates of deposit and brokered time deposits 11 475,826$ 32,412 $ 25,686 $ 17,214 $ 7,240 $ 4,202 Long-term borrowings 13 0 0 0 0 0 93,000 Leases 9 1,074 905 865 831 821 5,992 There are also$13.1 million of commitments to various partnership investment funds. The Company invests in these funds, consisting of low-income housing tax credit investments and SBIC funds, in efforts to comply with Community Reinvestment Act regulations. The commitments have no predetermined due dates but are expected to be funded sporadically over the next ten years. Note 14 to the consolidated financial statements discusses in greater detail other commitments and contingencies and the various obligations that exist under those agreements. Examples of these commitments and contingencies include commitments to extend credit and standby letters of credit. 45 -------------------------------------------------------------------------------- AtDecember 31, 2022 , the Company did not engage in derivatives or hedging contracts that may expose the Company to liabilities greater than the amounts recorded on the consolidated balance sheet. Management's policy is to not engage in derivatives contracts for speculative trading purposes. The Company does utilize interest-rate swaps as a way of helping manage interest rate risk and not as derivatives for trading purposes. See Note 22 within Item 8 of this Annual report on Form 10-K for additional detail.
Liquidity
The principal sources of funds for the Bank are deposits, loan and security repayments, borrowings from financial institutions, repurchase agreements and other funds provided by operations. The Bank also has the ability to borrow from the FHLB. While scheduled loan repayments and maturing investments are relatively predictable, deposit flows and early loan prepayments are more influenced by interest rates, general economic conditions and competition. Investments in liquid assets maintained by the Company and the Bank are based upon management's assessment of (1) the need for funds, (2) expected deposit flows, (3) yields available on short-term liquid assets, and (4) objectives of the asset and liability management program. The Bank's Asset/Liability Committee (ALCO) is responsible for monitoring liquidity guidelines, policies and procedures. ALCO uses a variety of methods to monitor the liquidity position of the Bank including a liquidity analysis that measures potential sources and uses of funds over future time periods. ALCO also performs contingency funding analyses to determine the Bank's ability to meet potential liquidity needs under stress scenarios that cover varying time horizons ranging from immediate to long-term. AtDecember 31, 2022 , the Company had total on-hand liquidity, defined as total cash and cash equivalents, unencumbered securities and additional FHLB borrowing capacity, of$1.5 billion . Capital Resources The Bank, as a national chartered bank, is subject to the dividend restrictions set forth by the OCC. The OCC must approve declaration of any dividends in excess of the sum of profits for the current year and retained net profits for the preceding two years (as defined).Farmers and Farmers Bank are required to maintain minimum amounts of capital to total "risk weighted" assets, as defined by the banking regulators. AtDecember 31, 2022 , under the minimum capital requirements associated with the Basel Committee on capital and liquidity regulation (Basel III),Farmers Bank and Farmers are required to have actual and minimum capital ratios, which are detailed in Note 16 of the Consolidated Financial Statements.Farmers Bank and Farmers had capital ratios above the minimum levels atDecember 31, 2022 and 2021. At year-end 2022 and 2021, the most recent regulatory notifications categorizedFarmers Bank as well capitalized under the regulatory framework for prompt corrective action. During 2013, the Federal banking regulators approved a final rule to implement revised capital adequacy standards of theBasel Committee on Banking Supervision , commonly called Basel III, and to address relevant provisions of the Dodd-Frank Act. The final rule strengthens the definition of regulatory capital, increases risk-based capital requirements, makes selected changes to the calculation of risk-weighted assets, and adjusts the prompt corrective action thresholds. The Bank has retained, through a one-time election, the prior treatment for most accumulated other comprehensive income, such that unrealized gains and losses on securities available for sale that did not affect regulatory capital amounts and ratios. As mentioned in the prior paragraph, the Bank falls within the new regulatory capital ratio guidelines.
Critical Accounting Policies
The Company follows financial accounting and reporting policies that are in accordance with generally accepted accounting principles inthe United States of America and conform to general practices within the banking industry. Some of these accounting policies are considered to be critical accounting policies. Critical accounting policies are those policies that require management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The Company has identified three accounting policies that are critical accounting policies and an understanding of these policies is necessary to understand the financial statements. These policies relate to determining the adequacy of the allowance for credit 46 -------------------------------------------------------------------------------- losses, if there is any impairment of goodwill and other intangibles, and estimating the fair value of assets acquired and liabilities assumed in connection with any merger activity. Additional information regarding these policies is included in the notes to the consolidated financial statements, including Note 1 (Summary of Significant Accounting Policies), Note 4 (Loans) and Note 2 (Business Combinations), and the section above captioned "Loan Portfolio." Management believes that the judgments, estimates and assumptions used in the preparation of the consolidated financial statements are appropriate given the factual circumstances at the time. Farmers maintains an allowance for credit losses. The allowance for credit losses is presented as a reserve against loans on the balance sheets. Credit losses are charged off against the allowance for credit losses, while recoveries of amounts previously charged off are credited to the allowance for credit losses. A provision for credit losses is charged to operations based on management's periodic evaluation of adequacy of the allowance. The provision for credit losses provides for probable losses on loans. The credit loss estimation process involves procedures that consider the unique characteristics of the Company's loan portfolio segments. These segments are disaggregated into the loan pools for monitoring. A model of risk characteristics, such as loss history and delinquency experience, trends in past due and non-performing loans, as well as existing economic conditions and supportable forecasts used to determine credit loss assumptions. The Company uses two methodologies to analyze loan pools. The cohort method and the PD/LGD. Cohort relies on the creation of cohorts to capture loans that qualify for a particular segment, as of a point in time. Those loans are then tracked over their remaining lives to determine their loss experience. The Company aggregates financial assets on the basis of similar risk characteristics when evaluating loans on a collective basis. Those characteristics include, but are not limited to, internal or external credit score, risk ratings, financial asset, loan type, collateral type, size, effective interest rate, term, or geographical location. The Company uses cohort primarily for consumer loan portfolios. The probability of default ("PD") portion of PD/LGD is defined by the Company as 90 days past due, placed on non-accrual, becomes a troubled debt restructuring or is partially, or wholly, charged-off. Typically, a one-year time period is used to asses PD. PD can be measured and applied using various risk criteria. Risk rating is one common way to apply PDs. Loss given default ("LGD") is to determine the percentage of loss by facility or collateral type. LGD estimates can sometimes be driven, or influenced, by product type, industry or geography. The Company uses PD/LGD primarily for commercial loan portfolios. Management believes that the accounting for goodwill and other intangible assets also involves a higher degree of judgment than most other significant accounting policies. GAAP establishes standards for the amortization of acquired intangible assets and the impairment assessment of goodwill.Goodwill arising from business combinations represents the value attributable to unidentifiable intangible assets in the business acquired. The Company's goodwill relates to the value inherent in the banking industry and that value is dependent upon the ability of the Company's subsidiaries to provide quality, cost-effective services in a competitive marketplace. The goodwill value is supported by revenue that is in part driven by the volume of business transacted. A decrease in earnings resulting from a decline in the customer base or the inability to deliver cost-effective services over sustained periods can lead to impairment of goodwill that could adversely impact earnings in future periods. GAAP requires an annual evaluation of goodwill for impairment, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The fair value of the goodwill is estimated by reviewing the past and projected operating results for the subsidiaries and comparable industry information. AtDecember 31, 2022 , on a consolidated basis, Farmers had intangibles of$7.0 million subject to amortization and$94.6 million in goodwill, which was not subject to periodic amortization. The Company accounts for acquisitions underFinancial Accounting Standards Board ("FASB") ASC Topic 805, Business Combinations, which requires the use of the acquisition method of accounting. Assets acquired and liabilities assumed in a business combination are recorded at the estimated fair value on their purchase date. As provided for under GAAP, management has up to 12 months following the date of the acquisition to finalize the fair values of acquired assets and assumed liabilities, where it was not possible to estimate the acquisition date fair value upon consummation. Management finalized the fair values of acquired assets and assumed liabilities within this 12-month period and management currently considers such values to be the Day 1 Fair Values for the acquisition transactions. In particular, the valuation of acquired loans involves significant estimates, assumptions and judgment 47 -------------------------------------------------------------------------------- based on information available as of the acquisition date. Loans acquired in a business combination transaction are evaluated either individually or in pools of loans with similar characteristics; including consideration of a credit component. A number of factors are considered in determining the estimated fair value of purchased loans including, among other things, the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, estimated holding periods, contractual interest rates compared to market interest rates, and net present value of cash flows expected to be received.
Recent Accounting Pronouncements and Developments
Note 1 to the consolidated financial statements discusses new accounting
policies adopted by Farmers during 2022 and 2021 and the expected impact of
accounting policies recently issued or proposed but not yet required to be
adopted. To the extent the adoption of new accounting standards materially
affects financial condition, results of operations or liquidity, the impacts are
discussed in the applicable sections of this financial review and notes to the
consolidated financial statements.
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