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The volume variance calculated for 2014 over 2013 was a favorable $7.108 million, due primarily to a $101 million
increase in the average balance of interest-earning assets. The volume variance was enhanced by relatively strong
growth in the average balances of lower-cost non-maturity deposits and higher-yielding real estate loans, although a
disproportionate increase in lower-yielding investments offset that to some extent.
The impact of interest rate changes resulted in an unfavorable rate variance of $3.347 million in net interest income
for 2014 relative to 2013. Our weighted average yield on interest-earning assets fell six basis points, due to a 31
basis point decline in loan yields stemming from continued competition for quality loans that was partially offset by a
higher investment portfolio yield. Investment yields were up due to favorable trends in prepayment rates on
mortgage-backed securities, which impacted the amortization of premiums and accretion of discounts. The weighted
average cost of interest-bearing liabilities was eight basis points lower in 2014, primarily because of a drop in deposit
rates. Even though this was larger than the decline in our yield on earning assets, the year-over-year rate variance
was still unfavorable due to the volume differential between our interest-earning assets and interest-bearing
liabilities. That differential averaged $395 million for 2013, the base period for the rate variance calculation, thus the
decrease in our earning asset yield was applied to a much higher balance than the rate decrease for interest-bearing
liabilities and had a greater impact on net interest income. Partially alleviating the negative pressures on our rate
variance was non-recurring interest income such as interest recovered on non-accrual loans and prepayment
penalties, which, net of interest reversals for loans placed on non-accrual status, totaled $505,000 in 2014 relative to
$330,000 in 2013.
The Company’s net interest margin, which is tax-equivalent net interest income as a percentage of average interest-
earning assets, is affected by the same factors discussed above relative to rate and volume variances. Our net interest
margin was 4.01% in 2014, an increase of one basis point relative to 2013. The principal developments favorably
impacting our net interest margin in 2014 include a higher level of non-recurring interest income, an increase in
investment yields, lower deposit rates, a shift from higher-cost time deposits into lower-cost non-maturity deposits,
and the shift into higher-yielding real estate loans. Competitive pressures on loan yields largely offset those
favorable factors.
Net interest income declined in 2013 relative to 2012 due to a drop of 20 basis points in our net interest margin, with
the margin decline partially offset by growth of $13 million in average interest-earning assets. The principle negative
factors impacting our net interest margin in 2013 were competitive pressures on loan yields and an increase in low-
yielding average balances at the FRB. Partially offsetting the negative developments were a shift in average balances
from non-deposit borrowings and higher-cost time deposits into lower-cost non-maturity deposits, an increase in the
average balance of non-interest bearing demand deposits, and net interest recoveries in 2013 relative to net interest
reversals in 2012.
Provision for Loan and Lease Losses
Credit risk is inherent in the business of making loans. The Company sets aside an allowance for loan and lease
losses, a contra-asset account, through periodic charges to earnings that are reflected in the income statement as the
provision for loan and lease losses. The Company’s loan loss provision has been sufficient to maintain the allowance
for loan and lease losses at a level that, in management’s judgment, is adequate to absorb probable loan losses related
to specifically-identified impaired loans as well as probable incurred losses in the remaining loan portfolio.
Specifically identifiable and quantifiable loan losses are immediately charged off against the allowance, while
principal recoveries on previously charged-off balances are credited back to the allowance.
Our loan loss provision was $350,000 for 2014, representing a reduction of $4.000 million, or 92%, relative to 2013.
The provision was lower in 2014 due in part to a lower level of net charge-offs. Our net charge-offs were $779,000
in 2014 relative to $6.546 million in 2013, for a reduction of $5.767 million, or 88%. Over $3 million in principal
recoveries on previously charged-off balances contributed to the drop in net charge-offs in 2014. Additional factors
which helped reduce our need for building reserves via the loan loss provision in 2014 include the fact that the credit
quality of our performing loan portfolio continues to improve, as newer loans have been underwritten utilizing more
stringent criteria than older vintage loans.
