FINWARD BANCORP General
The Bancorp's earnings are dependent upon the earnings of the Bank. The Bank's earnings are primarily dependent upon net interest margin. The net interest margin is the difference between interest income earned on loans and investments and interest expense paid on deposits and borrowings stated as a percentage of average interest earning assets. The net interest margin is perhaps the clearest indicator of a financial institution's ability to generate core earnings. Fees and service charges, wealth management operations income, gains and losses from the sale of assets, provisions for loan losses, income taxes and operating expenses also affect the Bancorp's profitability. A summary of the Bancorp's significant accounting policies are detailed in Note 1 to the Bancorp's consolidated financial statements included in this report. Preparing financial statements in conformity with accounting principles generally accepted inthe United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period, as well as the disclosures provided. Actual results could differ from those estimates. Estimates associated with the allowance for loan losses are particularly susceptible to material change in the near term. AtDecember 31, 2022 , the Bancorp had total assets of$2.1 billion and total deposits of$1.8 billion . The Bancorp's deposit accounts are insured up to applicable limits by theDeposit Insurance Fund (DIF) that is administered by theFederal Deposit Insurance Corporation (FDIC), an agency of the federal government. AtDecember 31, 2022 , stockholders' equity totaled$136.4 million , with book value per share at$31.73 . Net income for 2022 was$15.1 million , or$3.60 diluted earnings per common share. The return on average assets was 0.74%, while the return on average stockholders' equity was 10.47%. OnJanuary 31, 2022 , the Bancorp completed its acquisition ofRoyal Financial, Inc. ("RYFL") pursuant to an Agreement and Plan of Merger datedJuly 28, 2021 (the "Merger Agreement") between the Bancorp and RYFL. Pursuant to the terms of the Merger Agreement, RYFL merged with and into the Bancorp, with the Bancorp as the surviving corporation (the "RYFL Merger"). Simultaneous with the RYFL Merger,Royal Savings Bank , anIllinois state-chartered savings bank and wholly-owned subsidiary of RYFL, merged with and into the Bank, with the Bank as the surviving institution. Under the terms of the Merger Agreement, RYFL stockholders who owned 101 or more shares of RYFL common stock were permitted to elect to receive either 0.4609 shares of Finward common stock or$20.14 in cash, or a combination of both, for each share of RYFL common stock owned, subject to proration and allocation provisions, such that 65% of the shares of RYFL common stock outstanding immediately prior to the closing of the merger were converted into the right to receive shares of Finward common stock and the remaining 35% of the outstanding RYFL shares were converted into the right to receive cash. Stockholders holding less than 101 shares of RYFL common stock received fixed consideration of$20.14 in cash and no stock consideration for each share of RYFL common stock. As a result of RYFL stockholder stock and cash elections and the related allocation and proration provisions of the Merger Agreement, Finward issued 795,423 shares of its common stock and paid cash consideration of approximately$18.7 million in the RYFL Merger. Based on the closing price of Finward's common stock onJanuary 28, 2022 , the transaction had an implied valuation of approximately$56.7 million . The acquisition further expanded the Bank's banking center network inCook County andDuPage County, Illinois , expanding the Bank's full-service retail banking network. 47 of 113 --------------------------------------------------------------------------------
Financial Condition During the year endedDecember 31, 2022 , total assets increased by$449.6 million (27.7%), to$2.1 billion , with interest-earning assets increasing by$382.4 million (25.1%). AtDecember 31, 2022 , interestearning assets totaled$1.9 billion and represented 92.1% of total assets. Loans totaled$1.5 billion and represented 79.4% of interest-earning assets, 73.1% of total assets and 85.3% of total deposits. The loan portfolio, which is the Bancorp's largest asset, is a significant source of both interest and fee income. December 31, December 31, (Dollars in thousands) 2022 2021 Balance % Loans Balance % Loans Residential real estate$ 484,595 32.1 % 260,134 27.1 % Home equity 38,978 2.6 % 34,612 3.6 % Commercial real estate 486,431 32.2 % 317,145 33.0 % Construction and land development 108,926 7.2 % 123,822 12.9 % Multifamily 251,014 16.6 % 61,194 6.4 % Consumer 918 0.1 % 582 0.1 % Manufactured Homes 34,882 2.3 % 37,887 3.9 % Commercial business 93,278 6.2 % 115,772 12.1 % Government 9,549 0.7 % 8,991 0.9 % Loans receivable 1,508,571 100.0 % 960,139 100.0 % Plus: Net deferred loans origination costs 5,083
6,810
Undisbursed loan funds (23 ) (229 ) Loans receivable, net of deferred fees and costs$ 1,513,631 $ 966,720 Adjustable rate loans / loans receivable$ 698,842 46.3 %$ 542,975 56.6 % December 31, December 31, 2022 2021 Loans receivable to total assets 73.1 % 59.6 % Loans receivable to earning assets 79.4 % 63.4 % Loans receivable to total deposits 85.3 % 67.4 % The Bancorp is primarily a portfolio lender. Mortgage banking activities historically have been limited to the sale of fixed rate mortgage loans with contractual maturities greater than 15 years. These loans are identified as held for sale when originated and sold, on a loan-by-loan basis, in the secondary market. The Bancorp will also retain fixed rate mortgage loans with a contractual maturity greater than 15 years on a limited basis. During the twelve months endedDecember 31, 2022 , the Bancorp originated$44.9 million in new fixed rate mortgage loans for sale, compared to$153.1 million during the twelve months endedDecember 31, 2021 . During the twelve months endedDecember 31, 2022 , the Bancorp originated$105.4 million in new mortgage loans retained in its portfolio, compared to$45.1 million during the twelve months endedDecember 31, 2021 . These retained loans are primarily construction loans and adjustable-rate loans with a fixed-rate period of 7 years or less, and the Bank continues to sell longer-duration fixed rate mortgages into the secondary market. Net gains realized from the mortgage loan sales totaled$1.4 million for the twelve months endedDecember 31, 2022 , compared to$5.3 million for the twelve months endedDecember 31, 2021 . AtDecember 31, 2022 , the Bancorp had$1.5 million in loans that were classified as held for sale, compared to$5.0 million atDecember 31, 2021 . Non-performing loans include those loans that are 90 days or more past due and accruing and those loans that have been placed on non-accrual status. AtDecember 31, 2022 , all non-performing loans are also accounted for on a non-accrual basis, except for two residential real estate loans totaling$166 thousand , and one consumer manufactured loan totaling$82 thousand that remained accruing and more than 90 days past due. 48 of 113 --------------------------------------------------------------------------------
The Bancorp's nonperforming loans are summarized below:
(Dollars in thousands) Loan Segment December 31, 2022 December 31, 2021 Residential real estate $ 5,513 $ 4,682 Home equity 594 657 Commercial real estate 3,242 1,031 Construction and land development - - Multifamily 7,064 455 Commercial business 1,881 436 Consumer - - Manufactured homes 82 - Government - - Total $ 18,376 $ 7,261 Nonperforming loans to total loans 1.21 % 0.75 % Nonperforming loans to total assets 0.89 % 0.45 %
Substandard loans include non-performing loans and potential problem loans,
where information about possible credit issues or other conditions causes
management to question the ability of such borrowers to comply with loan
covenants or repayment terms. No loans were internally classified as doubtful or
loss at
The Bancorp's substandard loans are summarized below:
(Dollars in thousands)
Loan Segment December 31, 2022 December 31, 2021
Residential real estate $ 6,035 $ 3,722
Home equity 612 632
Commercial real estate 7,421 3,562
Construction and land development - -
Multifamily 7,064 384
Commercial business 1,881 387
Consumer - -
Manufactured homes - -
Government - -
Total $ 23,013 $ 8,687
In addition to identifying and monitoring non-performing and other classified
loans, management maintains a list of special mention loans. Special mention
loans represent loans management is closely monitoring due to one or more
factors that may cause the loan to become classified as substandard.
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--------------------------------------------------------------------------------The Bancorp's special mention loans are summarized below:
(Dollars in thousands)
Loan Segment December 31, 2022 December 31, 2021
Residential real estate $ 1,338 $ 2,940
Home equity 385 415
Commercial real estate 4,955 12,011
Construction and land development 2,346 3,630
Multifamily 1,859 153
Commercial business 703 1,915
Consumer - -
Manufactured homes - 59
Government - -
Total $ 11,586 $ 21,123
A loan is considered impaired when, based on current information and events, it
is probable that a borrower will be unable to pay all amounts due according to
the contractual terms of the loan agreement. Typically, management does not
individually classify smaller-balance homogeneous loans, such as residential
mortgages or consumer loans, as impaired, unless they are troubled debt
restructurings.
Purchased loans acquired in a business combination are recorded at estimated
fair value on their purchase date. Purchased loans with evidence of credit
quality deterioration since origination are considered purchased credit impaired
loans. Expected future cash flows at the purchase date in excess of the fair
value of loans are recorded as interest income over the life of the loans if the
timing and amount of the future cash flows is reasonably estimable ("accretable
yield"). The difference between contractually required payments and the cash
flows expected to be collected at acquisition is referred to as the
non-accretable difference and represents probable losses in the portfolio. In
determining the acquisition date fair value of purchased credit impaired loans,
and in subsequent accounting, the Bancorp aggregates these purchased loans into
pools of loans by common risk characteristics, such as credit risk rating and
loan type. Subsequent to the purchase date, increases in cash flows over those
expected at the purchase date are recognized as interest income prospectively.
Subsequent decreases to the expected cash flows will generally result in a
provision for loan losses.
The Bancorp's impaired loans, including purchased credit impaired loans, are
summarized below:
(Dollars in thousands)
Loan Segment December 31, 2022 December 31, 2021
Residential real estate $ 2,506 $ 1,771
Home equity 419 284
Commercial real estate 5,327 1,600
Construction and land development - -
Multifamily 7,121 556
Commercial business 2,711 1,597
Consumer 17 -
Manufactured homes - -
Government - -
Total $ 18,101 $ 5,808
At times, the Bancorp will modify the terms of a loan to forego a portion of
interest or principal or reduce the interest rate on the loan to a rate
materially less than market rates, or materially extend the maturity date of a
loan as part of a troubled debt restructuring. The valuation basis for the
Bancorp's troubled debt restructurings is based on the present value of expected
future cash flows; unless consistent cash flows are not present, then the fair
value of the collateral securing the loan is the basis for valuation.
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--------------------------------------------------------------------------------The Bancorp's troubled debt restructured loans are summarized below:
(Dollars in thousands) Loan Segment December 31, 2022 December 31, 2021 Residential real estate $ 1,190 $ 342 Home equity 261 83 Commercial real estate 1,984 747 Construction and land development - - Multifamily - - Commercial business 476 694 Consumer - - Manufactured homes - - Government - - Total $ 3,911 $ 1,866 AtDecember 31, 2022 , management is of the opinion that there are no loans, except certain of those discussed above, where known information about possible credit problems of borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms and which will imminently result in such loans being classified as past due, non-accrual or a troubled debt restructure. Management does not presently anticipate that any of the non-performing loans or classified loans would materially affect future operations, liquidity or capital resources. The allowance for loan losses (ALL) is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses, and decreased by charge-offs net of recoveries. A loan is charged off against the allowance by management as a loss when deemed uncollectible, although collection efforts continue and future recoveries may occur. The determination of the amounts of the ALL and provisions for loan losses is based on management's current judgments about the credit quality of the loan portfolio with consideration given to all known relevant internal and external factors that affect loan collectability as of the reporting date. The appropriateness of the current period provision and the overall adequacy of the ALL are determined through a disciplined and consistently applied quarterly process that reviews the Bancorp's current credit risk within the loan portfolio and identifies the required allowance for loan losses given the current risk estimates. The Bancorp's provision for loan losses for the twelve months ended are summarized below: (Dollars in thousands) Loan Segment December 31, 2022 December 31, 2021 Residential real estate $ 517 $ 220 Home equity 53 81 Commercial real estate 700 639 Construction and land development (866 ) 714 Multifamily 159 222 Commercial business (676 ) (377 ) Consumer 113 10 Manufactured homes - - Government - - Total $ - $ 1,509 51 of 113
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The Bancorp's charge-off and recovery information is summarized below:
(Dollars in thousands)
As of the twelve months ended December 31, 2022
Loan Segment Charge-off Recoveries Net Charge-offs
Residential real estate $ (29 ) $ 53 $ 24
Home equity - - -
Commercial real estate (431 ) - (431 )
Construction and land development - - -
Multifamily - - -
Commercial business (57 ) 89 32
Consumer (91 ) 20 (71 )
Manufactured homes - -
Government - - -
Total $ (608 ) $ 162 $ (446 )
The ALL provisions take into consideration management's current judgments about
the credit quality of the loan portfolio, loan portfolio balances, changes in
the portfolio mix and local economic conditions. In determining the provision
for loan losses for the current period, management has considered risks
associated with the local economy, changes in loan balances and mix, and asset
quality.
In addition, management considers reserves that are not part of the ALL that
have been established from acquisition activity. The Bancorp acquired loans for
which there was evidence of credit quality deterioration since origination and
it was determined that it was probable that the Bancorp would be unable to
collect all contractually required principal and interest payments. At December
31, 2022 , total purchased credit impaired loans nonaccretable and accretable
discount totaled $1.5 million compared to $1.4 million at December 31, 2021 .
Additionally, the Bancorp has acquired loans where there was no evidence of
credit quality deterioration since origination and has marked these loans to
their fair values. As part of the fair value of loans receivable, a net fair
value discount was established for loans acquired and has a balance of $5.5
million at December 31, 2022 , compared to $1.1 million at December 31, 2021 .
Details on these fair value marks and the additional reserves created can be
found in Note 4, Loans Receivable.
A deferred cost reserve is maintained for the portfolio of manufactured home
loans that have been purchased. This reserve is available for use for
manufactured home loan nonperformance and costs associated with nonperformance.
If the segment performs in line with expectation, the deferred cost reserve is
paid as an origination cost to the third party originator of the loan.
The Bancorp's allowance to total loans and non-performing loans are
summarized below:
(Dollars in thousands)
December 31, 2022 December 31, 2021
Allowance for loan losses $ 12,897 $ 13,343
Total loans $ 1,513,631 $ 966,720
Non-performing loans $ 18,376 $ 7,261
ALL-to-total loans 0.85 % 1.38 %
ALL-to-non-performing loans (coverage ratio) 70.2 % 183.8 %
The December 31, 2022 , balance in the ALL account is considered adequate by
management after evaluation of the loan portfolio, past experience and current
economic and market conditions. While management may periodically allocate
portions of the allowance for specific problem loans, the whole allowance is
available for any loan charge offs that occur. The allocation of the ALL
reflects performance and growth trends within the various loan categories, as
well as consideration of the facts and circumstances that affect the repayment
of individual loans, and loans which have been pooled as of the evaluation date,
with particular attention given to non-performing loans and loans which have
been classified as substandard, doubtful or loss. Management has allocated
reserves to both performing and non-performing loans based on current
information available.
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During 2022, net sales of foreclosed real estate totaled
The primary objective of the Bancorp's investment portfolio is to provide for the liquidity needs of the Bancorp and to contribute to profitability by providing a stable flow of dependable earnings. Funds are generally invested in federal funds, interest bearing balances in other financial institutions,U.S. government securities,U.S. treasury securities, federal agency obligations, obligations of state and local municipalities and corporate securities. The securities portfolio totaled$370.9 million atDecember 31, 2022 , compared to$526.9 million atDecember 31, 2021 , a decrease of$156.0 million or 29.6%. The decrease is attributable to increased unrealized losses within the portfolio and the use of cashflows from the securities portfolio to fund loan growth. AtDecember 31, 2022 , the securities portfolio represented 19.5% of interest-earning assets and 17.9% of total assets compared to 34.6% of interest-earning assets and 32.5% of total assets atDecember 31, 2021 .
As of
The Bancorp's end-of-period investment portfolio and other short-term investments and stock balances were as follows:
December 31, December 31,
(Dollars in thousands) 2022 2021
Balance % Securities Balance % Securities
U.S. government
sponsored entities $ 7,625 2.1 % $ 8,669 1.6 %
U.S. treasury
securities 389 0.1 % 400 0.1 %
Collateralized
mortgage obligations
and residential
mortgage-backed
securities 134,116 36.2 % 184,701 35.1 %
Municipal securities 227,718 61.3 % 332,127 63.0 %
Collateralized debt
obligations 1,048 0.3 % 992 0.2 %
Total securities
available-for-sale $ 370,896 100.0 % $ 526,889 100.0 %
December 31, December 31, YTD
(Dollars in thousands) 2022 2021 Change
Balance Balance $ %
Interest bearing deposits in other
financial institutions $ 11,210 $ 19,987 $ (8,777 ) -43.9 %
Fed funds sold 107 464 (357 ) -76.9 %
Certificates of deposit in other
financial institutions 2,456 1,709 747 43.7 %
Federal Home Loan Bank stock 6,547 3,247 3,300 101.6 %
The net decrease in interest bearing deposits in other financial institutions is
primarily the result of the timing of investments in interest earning assets
relative to the inflow and outflow of deposits and repurchase agreements.
Deposits are a fundamental and cost-effective source of funds for lending and
other investment purposes. The Bancorp offers a variety of products designed to
attract and retain customers, with the primary focus on building and expanding
relationships.
53 of 113--------------------------------------------------------------------------------
The Bancorp's end-of-period deposit portfolio balances were as follows:
December 31, December 31, YTD
(Dollars in thousands) 2022 2021 Change
Balance Balance $ %
Checking $ 755,377 $ 629,038 $ 126,339 20.1 %
Savings 402,365 293,976 108,389 36.9 %
Money market 254,157 271,970 (17,813 ) -6.5 %
Certificates of deposit 363,118 239,217 123,901 51.8 %
Total deposits $ 1,775,017 $ 1,434,201 $ 340,816 23.8 %
The overall increase in total deposits was primarily a result of the Royal acquisition, the Bancorp's efforts to maintain and grow core deposits, and customer preferences for the security and liquidity of the Bancorp's deposit product offerings.
The Bancorp's borrowed funds are primarily used to fund asset growth not
supported by deposit generation. The Bancorp's end-of-period borrowing balances
were as follows:
December 31, December 31, YTD
(Dollars in thousands) 2022 2021 Change
Balance Balance $ %
Repurchase agreements $ 15,503 $ 14,581 $ 922 6.3 %
Borrowed funds 120,000 - 120,000 100.0 %
Total borrowed funds $ 135,503 $ 14,581 $ 120,922 829.3 %
Repurchase agreements increased as part of normal account fluctuations within
that product line. Borrowed funds increased as short-term FHLB advances were
taken during the year, due to cyclical inflows and outflows of interest-earnings
assets and interest-bearing liabilities.
Liquidity and Capital Resources
For the Bancorp, liquidity management refers to the ability to generate sufficient cash to fund current loan demand, meet deposit withdrawals, and pay dividends and operating expenses. Because profit and liquidity are often conflicting objectives, management attempts to maximize the Bank's net interest margin by making adequate, but not excessive, liquidity provisions. Furthermore, funds are managed so that future profits will not be significantly impacted as funding costs increase. Changes in the liquidity position result from operating, investing and financing activities. Cash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income. The primary investing activities include loan originations, loan repayments, investments in interest bearing balances in financial institutions, and the purchase, sale, and maturity of investment securities. Financing activities focus almost entirely on the generation of customer deposits. In addition, the Bancorp utilizes borrowings (i.e., repurchase agreements, FHLB advances and federal funds purchased) as a source of funds. During 2022, cash and cash equivalents decreased$1.9 million compared to an increase of$13.3 million for 2021. The primary sources of cash and cash equivalents were cash and cash equivalents from acquisition activity, the sale of loans originated for sale, proceeds from the sale of securities, proceeds from the maturity and paydown of securities, and proceeds from FHLB advances. The primary uses of cash and cash equivalents were the purchase of securities, change in deposits, and loan originations. During 2022, net cash from operating activities totaled$17.8 million , compared to$18.8 million for 2021. Cash provided from operating activities was primarily a result of net income and sale of loans originated for sale, offset by loans originated for sale and net change in other assets, accrued expenses, and other liabilities. Net cash outflows from investing activities totaled$1.1 million during 2022, compared to outflows of$127.7 million during 2021. Cash outflows from investing activities were primarily related to the net change in loans receivable and purchase of securities, offset against the cash and cash equivalents from acquisition activity, net, and proceeds from the sales and maturities of securities. Net cash outflows from financing activities totaled$18.5 million in 2022, compared to net cash inflows of$122.1 million in 2021. The net cash outflows from financing activities were primarily a result of net change in deposits and repayment of FHLB advances, offset against the change in proceeds from FHLB advances. During 2022, the Bancorp's Board of Directors maintained dividends as earnings and capital continued to be sufficient to warrant the current dividend. 54 of 113
-------------------------------------------------------------------------------- Management strongly believes that safety and soundness is enhanced by maintaining a high level of capital. Stockholders' equity totaled$136.4 million atDecember 31, 2022 , compared to$156.6 million atDecember 31, 2021 , a decrease of$20.2 million (3.2%). The decrease was primarily the result of an increase in net unrealized losses of available for sale securities of$68.6 million and dividends of$5.3 million , offset against issuance of shares for the acquisition of Royal of$38.0 million and net income of$15.1 million . AtDecember 31, 2022 , book value per share was$31.73 compared to$45.00 for 2021.
The following table shows that, at
(Dollars in millions) Minimum Required To Be
Minimum Required For Well Capitalized Under Prompt
Actual Capital Adequacy Purposes Corrective Action Regulations
December 31, 2022 Amount Ratio Amount Ratio Amount Ratio
Common equity tier 1
capital to
risk-weighted assets $ 161.3 10.1 % $ 71.6 4.5 % $ 103.4 6.5 %
Tier 1 capital to
risk-weighted assets $ 161.3 10.1 % $ 95.5 6.0 % $ 127.3 8.0 %
Total capital to
risk-weighted assets $ 174.2 10.9 % $ 127.3 8.0 % $ 159.1 10.0 %
Tier 1 capital to
adjusted average
assets $ 161.3 7.7 % $ 84.3 4.0 % $ 105.4 5.0 %
The Bancorp's ability to pay dividends to its shareholders is entirely dependent
upon the Bank's ability to pay dividends to the Bancorp. Under Indiana law, the
Bank may pay dividends from its undivided profits (generally, earnings less
losses, bad debts, taxes and other operating expenses) as is considered
expedient by the Bank's Board of Directors. However, the Bank must obtain the
approval of the Indiana Department of Financial Institutions (DFI) if the total
of all dividends declared by the Bank during the current year, including the
proposed dividend, would exceed the sum of retained net income for the year to
date plus its retained net income for the previous two years. For this purpose,
"retained net income," means net income as calculated for call report purposes,
less all dividends declared for the applicable period. An exemption from DFI
approval would require that the Bank have been assigned a composite uniform
financial institutions rating of 1 or 2 as a result of the most recent federal
or state examination; the proposed dividend would not result in a Tier 1
leverage ratio below 7.5%; and that the Bank not be subject to any corrective
action, supervisory order, supervisory agreement, or board approved operating
agreement. The aggregate amount of dividends that may be declared by the Bank in
2022, without the need for qualifying for an exemption or prior DFI approval, is
its 2023 net profits. Moreover, the FDIC and the Federal Reserve Board may
prohibit the payment of dividends if it determines that the payment of dividends
would constitute an unsafe or unsound practice in light of the financial
condition of the Bank. On November 29, 2022 , the Board of Directors of the
Bancorp declared a fourth quarter dividend of $0.31 per share. The Bancorp's
fourth quarter dividend was paid to shareholders on January 6, 2023 .
Results of Operations -
Comparison of 2022 to 2021
Net income for 2022 was$15.1 million , compared to$15.0 million for 2021, an increase of$117 thousand (0.8%). The twelve-month earnings increase is primarily related to higher net interest income, offset again higher noninterest expense and lower noninterest income. The earnings represent a return on average assets of 0.74% for 2022, compared to 0.95% for 2021. The return on average equity was 10.47% for 2022, compared to 9.61% for 2021. 55 of 113 -------------------------------------------------------------------------------- Net interest income for 2022, was$67.1 million , an increase of$18.6 million (38.2%) from$48.6 million for 2021. The increased net interest margin is primarily related to increased loan balances from the acquisition of Royal, organic loan growth, and the ability to manage deposit and borrowing costs to support earning asset growth. The weighted-average yield on interest-earning assets was 3.81% for 2022, compared to 3.44% for 2021. The weighted-average cost of funds was 0.26% for 2022, compared to 0.15% for 2021. The impact of the 3.81% return on interest earning assets and the 0.26% cost of funds resulted in a net interest spread of 3.55% for 2022, compared to a net interest spread of 3.29% for 2021. During 2022, total interest income increased by$21.4 million (42.2%) while total interest expense increased by$2.8 million (134.9%). The net interest margin was 3.56% for 2022, compared to 3.29% for 2021. The Bancorp's tax equivalent net interest margin for 2022, was 3.74% compared to 3.51% for 2021. Comparing the net interest margin on a tax equivalent basis more accurately compares the returns on tax-exempt loans and securities to those on taxable interest-earning assets. The increase in interest earning asset income for the year endedDecember 31, 2022 , compared to the year endedDecember 31, 2021 , is primarily related to increased reinvestment rates in 2022 for loans, securities, and excess cash balances, as a result of theFederal Reserve rate increases occurring though out 2022. The increase in interest bearing liability expense is primarily the result of the Bancorp adjusting deposit and repurchase agreement pricing to align with the current interest rate cycle, along with increased borrowing costs as a result of theFederal Reserve rate increases.
The following table shows the change in noninterest income for the year ending
(Dollars in thousands, except per share data) Twelve Months EndedDecember 31 ,
2022 2021 $ Change % Change
Noninterest income:
Fees and service charges 6,257 5,388 869 16.1 %
Wealth management operations 2,113 2,375 (262 ) -11.0 %
Gain on sale of loans
held-for-sale, net 1,368 5,296 (3,928 ) -74.2 %
Gain on sale of securities, net 662 1,987 (1,325 ) -66.7 %
Increase in cash value of bank
owned life insurance 810 715 95 13.3 %
Gain on sale of foreclosed real
estate 16 47 (31 ) -66.0 %
Other 283 139 144 103.6 %
Total noninterest income 11,509 15,947 (4,438 ) -27.8 %
The increase in fees and service charges is primarily the result of the
acquisition of Royal and the resulting increase in our customer base. The
decrease in wealth management operations is the result of lower fee income year
over year due to market conditions. The decrease in gain on sale of loans is the
result of significant refinance activity in 2021 due to the economic and
low-rate environment, which resulted in more loans originated and sold in 2021
compared to 2022. We expect demand for fixed rate mortgage loans held-for-sale
in the secondary market to be lower as borrowing rates on loans increase. The
decrease in gains on the sale of securities is a result of current market
conditions and actively repositioning the portfolio.
The following table shows the change in noninterest expense for the year ending
(Dollars in thousands, except per share data) Twelve Months EndedDecember 31 ,
2022 2021 $ Change % Change
Noninterest expense:
Compensation and benefits 28,990 24,241 4,749 19.6 %
Occupancy and equipment 6,785 5,537 1,248 22.5 %
Data processing 6,750 3,648 3,102 85.0 %
Marketing 1,907 1,085 822 75.8 %
Impairment charge on assets held
for sale 1,232 - 1,232 0.0 %
Federal deposit insurance premiums 1,228 861 367 42.6 %
Professional services 1,211 1,205 6 0.5 %
Net loss recognized on sale of
premises and equipment 303 - 303 0.0 %
Other 13,694 10,059 3,635 36.1 %
Total noninterest expense 62,100 46,636 15,464 33.2 %
56 of 113-------------------------------------------------------------------------------- The increase in compensation and benefits is primarily the result of the Royal acquisition, management's continued focus on talent management, and wage inflation. The increase in data processing expense is primarily the result of data conversion expenses related to the acquisition of Royal, increased system utilization due to growth of the Bank, and continued investment in technological advancements such as Salesforce and nCino. The increase in occupancy and equipment expense is primarily related to the Royal acquisition and higher operating costs. Marketing expenses have increased to enhance brand recognition in new markets and gain more wallet share. The increase in impairment charge on assets held for sale is the result of impairment on the carrying value of branches held for sale. The increase in federal deposit insurance premiums is primarily the result of growth of the bank's average assets. The increase in net loss recognized on sale of premises and equipment is the result of the sale of a branch to reduce future fixed costs, allowing for redeployment of a portion of occupancy expenses into building a digital-forward foundation so that Finward can better serve its customers. The increase in other operating expenses is primarily the result of one-time expenses related to the acquisition of Royal, continued investments in strategic initiatives focusing on growth of the organization, and inflationary pressures. Income tax expenses for the year endedDecember 31, 2022 , totaled$1.5 million , compared to income tax expense of$1.4 for the year endedDecember 31, 2021 , an increase of$64 thousand (4.5%). The combined effective federal and state tax rates for the Bancorp was 8.9% for the year endedDecember 31, 2022 , compared to 8.6% for the year endedDecember 31, 2021 . The Bancorp's higher current effective tax rate is a result of higher earnings relative to tax preferred income.
Critical Accounting Policies
Critical accounting policies are those accounting policies that management believes are most important to the portrayal of the Bancorp's financial condition and that require management's most difficult, subjective or complex judgments. The Bancorp's most critical accounting policies are summarized below. Other accounting policies, including those related to the fair values of financial instruments and the status of contingencies, are summarized in Note 1 to the Bancorp's consolidated financial statements. Valuation ofInvestment Securities - The fair values of securities available for sale are determined on a recurring basis by obtaining quoted prices on nationally recognized securities exchanges or pricing models utilizing significant observable inputs such as matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities. Different judgments and assumptions used in pricing could result in different estimates of value. In certain cases where market data is not readily available because of lack of market activity or little public disclosure, values may be based on unobservable inputs and classified in Level 3 of the fair value hierarchy. At the end of each reporting period securities held in the investment portfolio are evaluated on an individual security level for other-than-temporary impairment in accordance with the Investments - Debt and Equity Securities Topic of the Accounting Standards Codification. Significant judgments are required in determining impairment, which include making assumptions regarding the estimated prepayments, loss assumptions and the change in interest rates. We consider the following factors when determining an other-than-temporary impairment for a security: The length of time and the extent to which the market value has been less than amortized cost; the financial condition and near-term prospects of the issuer; the underlying fundamentals of the relevant market and the outlook for such market for the near future; and an assessment of whether the Bancorp has (1) the intent to sell the debt securities or (2) more likely than not will be required to sell the debt securities before its anticipated market recovery. If either of these conditions is met, management will recognize other-than-temporary impairment. If, in management's judgment, an other-than-temporary impairment exists, the cost basis of the security will be written down for the credit loss, and the unrealized loss will be transferred from accumulated other comprehensive loss as an immediate reduction of current earnings. Management will utilize an independent valuation specialist to value securities semi-annually for other-than-temporary impairment. Allowance for Loan Losses - The Bancorp maintains an Allowance for Loan Losses ("ALL") to absorb probable incurred credit losses that arise from the loan portfolio. The ALL is increased by the provision for loan losses, and decreased by charge-offs net of recoveries. The determination of the amounts of the ALL and provisions for loan losses is based upon management's current judgments about the credit quality of the loan portfolio with consideration given to all known relevant internal and external factors that affect loan collectability. The methodology used to determine the current year provision and the overall adequacy of the ALL includes a disciplined and consistently applied quarterly process that combines a review of the current position with a risk assessment worksheet. Factors that are taken into consideration in the analysis include an assessment of national and local economic trends, a review of current year loan portfolio growth and changes in portfolio mix, and an assessment of trends for loan delinquencies and loan charge-off activity. Particular attention is given to non-accruing loans and accruing loans past due 90 days or more, and loans that have been classified as substandard, doubtful, or loss. Changes in the provision are directionally consistent with changes in observable data. 57 of 113 -------------------------------------------------------------------------------- Commercial and industrial, and commercial real estate loans that exhibit credit weaknesses and loans that have been classified as impaired are subject to an individual review. Where appropriate, ALL allocations are made to these loans based on management's assessment of financial position, current cash flows, collateral values, financial strength of guarantors, industry trends, and economic conditions. ALL allocations for homogeneous loans, such as residential mortgage loans and consumer loans, are based on historical charge-off activity and current delinquency trends. Management has allocated general reserves to both performing and non-performing loans based on historical data and current information available. Risk factors for non-performing and internally classified loans are based on an analysis of either the projected discounted cash flows or the estimated collateral liquidation value for individual loans defined as substandard or doubtful. Estimated collateral liquidation values are based on established loan underwriting standards and adjusted for current mitigating factors on a loan-by-loan basis. Aggregate substandard loan collateral deficiencies are determined for residential, commercial real estate, commercial business, and consumer loan portfolios. These deficiencies are then stated as a percentage of the total substandard balances to determine the appropriate risk factors. Risk factors for performing and non-classified loans are based on a weighted average of net charge-offs for the most recent three years, which are then stated as a percentage of average loans for the same period. Historical risk factors are calculated for residential, commercial real estate, commercial business, and consumer loans. The three year weighted average historical factors are then adjusted for current subjective risks attributable to: regional and national economic factors; loan growth and changes in loan composition; organizational structure; composition of loan staff; loan concentrations; policy changes and out of market lending activity. The risk factors are applied to these types of loans to determine the appropriate level for the ALL. Adjustments may be made to these allocations that reflect management's judgment on current conditions, delinquency trends, and charge-off activity. Based on the above discussion, management believes that the ALL is currently adequate, but not excessive, given the risk inherent in the loan portfolio.
Impact of Inflation and Changing Prices
The financial statements and related data presented herein have been prepared in accordance with accounting principles generally accepted inthe United States of America , which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. The primary assets and liabilities of the Bancorp are monetary in nature. As a result, interest rates have a more significant impact on the Bancorp's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or magnitude as the prices of goods and services.
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