Bankwell Financial Group, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations This section presents management’s perspective on our financial condition and results of operations. The following discussion and analysis should be read in conjunction with the unaudited interim consolidated financial statements and related notes contained elsewhere in this report on Form 10-Q. To the extent that this discussion describes prior performance, the descriptions relate only to the periods listed, which may not be indicative of future financial outcomes. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause results to differ materially from management’s expectations. Factors that could cause such differences are discussed in the Company’s Form 10-K filed for the year ended December 31, 2022 in the sections titled “Cautionary Note Regarding Forward-Looking Statements” and “Risk Factors.” We assume no obligation to update any of these forward-looking statements. General Bankwell Financial Group, Inc. is a bank holding company headquartered in New Canaan, Connecticut. Through our wholly owned subsidiary, Bankwell Bank, or the Bank, we serve small and medium-sized businesses and retail clients. We have a history of building long-term client relationships and attracting new clients through what we believe is out superior service and our ability to deliver a diverse product offering. The following discussion and analysis presents our results of operations and financial condition on a consolidated basis. However, because we conduct all of our material business operations through the Bank, the discussion and analysis relates to activities primarily conducted at the Bank. We generate most of our revenue from interest on loans and investments and fee-based revenues. Our primary source of funding for our loans is deposits. Our largest expenses are interest on deposits and salaries and related employee benefits. We measure our performance primarily through our net interest margin, efficiency ratio, ratio of ACL-Loans to total loans, return on average assets and return on average equity, among other metrics, while maintaining appropriate regulatory leverage and risk-based capital ratios. Executive Overview We are focused on being the banking provider of choice and to serve as an alternative to our larger competitors. We aim to do this through: • Responsive, client-centric products and services; • Organic growth and strategic acquisitions when market opportunities present themselves; • Utilization of efficient and scalable infrastructure; and • Disciplined focus on risk management. Critical Accounting Policies and Estimates The discussion and analysis of our results of operations and financial condition are based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires us to make significant estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses. Actual results could differ from our current estimates, as a result of changing conditions and future events. We believe that accounting estimates related to the measurement of the ACL-Loans, the valuation of derivative instruments, investment securities and deferred income taxes, and the evaluation of investment securities for other than temporary impairment are particularly critical and susceptible to significant near-term change. 49 Earnings and Performance Overview For the three months ended June 30, 2023, net interest income was $24.0 million, an increase of $0.2 million or 0.7% when compared to the same period in 2022. For the six months ended June 30, 2023, net interest income was $49.5 million, an increase of $6.2 million or 14% when compared to the same period in 2022. The increase in net interest income for the three and six months ended June 30, 2023 was primarily due to an increase in interest and fees on loans due to loan growth and higher overall loan yields. Loan interest income totaled $42.5 million for the three months ended June 30, 2023, compared to $25.1 million for the three months ended June 30, 2022. The increase in interest income for the three and six months ended June 30, 2023 was partially offset by an increase in interest expense on deposits, resulting from an increase in rates necessary to remain competitive in the current economic environment. Noninterest income increased $0.2 million to $1.4 million for the three months ended June 30, 2023 compared to the same period in 2022. Noninterest income increased $0.8 million to $2.9 million for the six months ended June 30, 2023 compared to the same period in 2022.The increase in noninterest income was driven by SBA loan sales for the three and six months ended June 30, 2023 when compared to the same period in 2022. Net income available to common shareholders was $8.0 million, or $1.02 per diluted share, and $12.0 million, or $1.55 per diluted share, for the three months ended June 30, 2023 and 2022, respectively. Net income available to common shareholders was $18.4 million, or $2.34 per diluted share, and $20.2 million, or $2.58 per diluted share, for the six months ended June 30, 2023 and 2022, respectively . The decrease in net income for the three and six months ended 2023 was primarily due to an increase in the provision for credit losses and an increase in noninterest expense, primarily due to increased FDIC insurance expense, and an increase in salary and employee benefits expense, mainly due to severance costs. The decrease was partially offset by a direct result of the aforementioned increases in revenues. Returns on average shareholders' equity and average assets for the three months ended June 30, 2023 were 12.91% and 0.99%, respectively, compared to 22.09% and 1.96%, respectively, for the three months ended June 30, 2022. Returns on average shareholders' equity and average assets for the six months ended June 30, 2023 were 15.15% and 1.14%, respectively, compared to 19.16% and 1.65% , respectively, for the six months ended June 30, 2022. Results of Operations Net Interest Income Net interest income is the difference between interest earned on loans and securities and interest paid on deposits and other borrowings, and is the primary source of our operating income. Net interest income is affected by the level of interest rates, changes in interest rates and changes in the amount and composition of interest earning assets and interest bearing liabilities. Included in interest income are certain loan fees, such as deferred origination fees and late charges. We convert tax-exempt income to a fully taxable equivalent ("FTE") basis using the statutory federal income tax rate adjusted for applicable state income taxes net of the related federal tax benefit. The average balances are principally daily averages. Interest income on loans includes the effect of deferred loan fees and costs accounted for as yield adjustments. Premium amortization and discount accretion are included in the respective interest income and interest expense amounts. FTE net interest income for the three months ended June 30, 2023 and 2022 was $24.1 million and $23.9 million, respectively. FTE net interest income for the six months ended June 30, 2023 and 2022 was $49.6 million and $43.4 million, respectively. FTE interest income for the three months ended June 30, 2023 increased by $20.2 million, or 76.6%, to $46.7 million, compared to FTE interest income for the three months ended June 30, 2022. FTE interest income for the six months ended June 30, 2023 increased by $42.1 million, or 86.6%, to $90.9 million, compared to FTE interest income for the six months ended June 30, 2022. This increase was due to an increase in interest and fees on loans due to loan growth and higher overall loan yields. Interest expense for the three months ended June 30, 2023 increased by $20.0 million compared to interest expense for the three months ended June 30, 2022. Interest expense for the six months ended June 30, 2023 increased by $35.9 million compared to interest expense for the six months ended June 30, 2022. The increase in interest expense for the three and six months ended June 30, 2023 was driven by an increase in interest expense on deposits, resulting from an increase in rates on interest bearing deposits. 50 Distribution of Assets, Liabilities and Shareholders’ Equity; Interest Rates and Interest Differential The following table presents the average balances and yields earned on interest earning assets and average balances and weighted average rates paid on our funding liabilities for the three and six months ended June 30, 2023 and 2022. For the Quarter Ended June 30, 2023 June 30, 2022 Average Balance Interest Yield/ Rate (4) Average Balance Interest Yield/ Rate (4) Assets: Cash and Fed funds sold $ 227,777 $ 3,023 5.32 % $ 247,013 $ 449 0.73 % Securities (1) 128,576 955 2.97 118,534 809 2.73 Loans: Commercial real estate 1,935,058 27,099 5.54 1,443,239 17,278 4.74 Residential real estate 56,981 643 4.51 66,460 553 3.33 Construction 206,844 3,691 7.06 106,285 1,938 7.21 Commercial business 557,482 10,646 7.55 393,318 5,327 5.36 Consumer 29,326 500 6.84 5,298 45 3.43 Total loans 2,785,691 42,579 6.05 2,014,600 25,141 4.94 Federal Home Loan Bank stock 5,610 98 7.00 3,263 15 1.79 Total earning assets 3,147,654 $ 46,655 5.86 % 2,383,410 $ 26,414 4.38 % Other assets 96,603 79,380 Total assets $ 3,244,257 $ 2,462,790 Liabilities and shareholders' equity: Interest bearing liabilities: NOW $ 98,048 $ 42 0.18 % $ 136,414 $ 59 0.17 % Money market 902,225 8,083 3.59 931,101 1,146 0.49 Savings 112,585 860 3.06 198,304 103 0.21 Time 1,298,170 11,792 3.64 451,508 675 0.60 Total interest bearing deposits 2,411,028 20,777 3.46 1,717,327 1,983 0.46 Borrowed Money 163,138 1,738 4.21 85,092 558 2.59 Total interest bearing liabilities 2,574,166 $ 22,515 3.51 % 1,802,419 $ 2,541 0.57 % Noninterest bearing deposits 375,514 407,890 Other liabilities 46,565 34,231 Total liabilities 2,996,245 2,244,540 Shareholders' equity 248,012 218,250 Total liabilities and shareholders' equity $ 3,244,257 $ 2,462,790 Net interest income (2) $ 24,140 $ 23,873 Interest rate spread 2.36 % 3.81 % Net interest margin (3) 3.07 % 4.01 % (1) Average balances and yields for securities are based on amortized cost. (2) The adjustment for securities and loans taxable equivalency amounted to $51 thousand and $50 thousand for the three months ended June 30, 2023 and 2022, respectively. (3) Annualized net interest income as a percentage of earning assets. (4) Yields are calculated using the contractual day count convention for each respective product type. 51 For the Six Months Ended June 30, 2023 June 30, 2022 Average Balance Interest Yield/ Rate (4) Average Balance Interest Yield/ Rate (4) Assets: Cash and Fed funds sold $ 271,328 $ 6,590 4.90 % $ 296,239 $ 603 0.41 % Securities (1) 129,225 1,912 2.96 115,452 1,563 2.71 Loans: Commercial real estate 1,926,852 52,125 5.38 1,393,836 32,273 4.61 Residential real estate 58,207 1,286 4.42 70,125 1,224 3.49 Construction 186,684 6,651 7.09 104,176 2,971 5.67 Commercial business 549,963 21,394 7.74 388,249 9,954 5.10 Consumer 23,971 749 6.30 5,666 147 5.25 Total loans 2,745,677 82,205 5.95 1,962,052 46,569 4.72 Federal Home Loan Bank stock 5,442 193 7.14 3,051 29 1.94 Total earning assets 3,151,672 $ 90,900 5.74 % 2,376,794 $ 48,764 4.08 % Other assets 90,427 89,866 Total assets 3,242,099 $ 2,466,660 Liabilities and shareholders' equity: Interest bearing liabilities: NOW $ 95,494 $ 81 0.17 % $ 124,361 $ 106 0.17 % Money market 905,021 14,468 3.22 950,131 2,326 0.49 Savings 124,387 1,586 2.57 196,400 204 0.21 Time 1,275,417 21,675 3.43 452,676 1,553 0.69 Total interest bearing deposits 2,400,319 37,810 3.18 1,723,568 4,189 0.49 Borrowed Money 162,215 3,454 4.24 84,770 1,144 2.68 Total interest bearing liabilities 2,562,534 $ 41,264 3.25 % 1,808,338 $ 5,333 0.59 % Noninterest bearing deposits 389,608 406,707 Other liabilities 45,494 38,683 Total liabilities 2,997,636 2,253,728 Shareholders' equity 244,463 212,932 Total liabilities and shareholders' equity $ 3,242,099 $ 2,466,660 Net interest income (2) $ 49,636 $ 43,431 Interest rate spread 2.49 % 3.49 % Net interest margin (3) 3.15 % 3.65 % (1) Average balances and yields for securities are based on amortized cost. (2) The adjustment for securities and loans taxable equivalency amounted to $102 thousand and $98 thousand for the six months ended June 30, 2023 and 2022 , respectively. (3) Annualized net interest income as a percentage of earning assets. (4) Yields are calculated using the contractual day count convention for each respective product type. 52 Effect of changes in interest rates and volume of average earning assets and average interest bearing liabilities The following table shows the extent to which changes in interest rates and changes in the volume of average earning assets and average interest bearing liabilities have affected net interest income. For each category of earning assets and interest bearing liabilities, information is provided relating to: changes in volume (changes in average balances multiplied by the prior year’s average interest rates); changes in rates (changes in average interest rates multiplied by the prior year’s average balances); and the total change. Changes attributable to both volume and rate have been allocated proportionately based on the relationship of the absolute dollar amount of change in each. Three Months Ended June 30, 2023 vs 2022 Increase (Decrease) Six Months Ended June 30, 2023 vs 2022 Increase (Decrease) (In thousands) Volume Rate Total Volume Rate Total Interest and dividend income: Cash and Fed funds sold $ (37) $ 2,611 $ 2,574 $ (55) $ 6,043 $ 5,988 Securities 71 75 146 196 152 348 Loans: Commercial real estate 6,558 3,263 9,821 13,784 6,067 19,851 Residential real estate (87) 177 90 (230) 291 61 Construction 1,795 (43) 1,752 2,793 887 3,680 Commercial business 2,678 2,641 5,319 5,089 6,351 11,440 Consumer 373 82 455 567 36 603 Total loans 11,317 6,120 17,437 22,003 13,632 35,635 Federal Home Loan Bank stock 17 67 84 37 126 163 Total change in interest and dividend income 11,368 8,873 20,241 22,181 19,953 42,134 Interest expense: Deposits: NOW (17) 1 (16) (24) (1) (25) Money market (36) 6,973 6,937 (116) 12,258 12,142 Savings (63) 820 757 (101) 1,484 1,383 Time 3,000 8,116 11,116 6,336 13,785 20,121 Total deposits 2,884 15,910 18,794 6,095 27,526 33,621 Borrowed money 698 481 1,179 1,410 901 2,311 Total change in interest expense 3,582 16,391 19,973 7,505 28,427 35,932 Change in net interest income $ 7,786 $ (7,518) $ 268 $ 14,676 $ (8,474) $ 6,202 Provision for Credit Losses The provision for credit losses is based on management’s periodic assessment of the adequacy of our ACL-Loans and ACL-Unfunded Commitments which, in turn, is based on interrelated factors such as the composition of our loan portfolio and its inherent risk characteristics, the level of nonperforming loans and net charge-offs, both current and historic, local economic and credit conditions, the direction of real estate values, and regulatory guidelines. The provision for credit losses is charged against earnings in order to maintain our ACL-Loans and ACL-Unfunded Commitments and reflects management’s best estimate of probable losses inherent in our loan portfolio as of the balance sheet date. The provision for credit losses for the three months ended June 30, 2023 was $2.6 million compared to a credit for credit losses of $1.4 million for the three months ended June 30, 2022 . The provision for credit losses for the six months ended June 30, 2023 was $3.4 million compared to a credit for credit losses of $1.2 million for the six months ended June 30, 2022. On January 1, 2023, the Company adopted ASC 326 Financial Instruments - Credit Losses ("CECL"). Upon adoption of CECL, the Company recorded a one-time cumulative effect, pre-tax adjustment $5.1 million to the ACL-Loans and a corresponding net of tax adjustment to beginning retained earnings. The Company also recorded a one-time cumulative effect, pre-tax adjustment of $1.3 million to the ACL-Unfunded commitments (which is reflected in Accrued expenses and other liabilities on the 53 Consolidated Balance Sheets) and a corresponding net of tax adjustment to beginning retained earnings. The provision for the three and six months ended 2023 are mainly attributable to macroeconomic factors. Noninterest Income Noninterest income is a component of our revenue and is comprised primarily of fees generated from deposit relationships with our clients, fees generated from sales and referrals of loans, and income earned on bank-owned life insurance. The following tables compare noninterest income for the three and six months ended June 30, 2023 and 2022: Three Months Ended June 30, Change (Dollars in thousands) 2023 2022 $ % Gains and fees from sales of loans $ 725 $ 608 $ 117 19.2 % Bank-owned life insurance 292 265 27 10.2 Service charges and fees 361 249 112 45.0 Other 23 30 (7) (23.3) Total noninterest income $ 1,401 $ 1,152 $ 249 21.6 % Six Months Ended June 30, Change (Dollars in thousands) 2023 2022 $ % Gains and fees from sales of loans $ 1,656 $ 1,239 $ 417 33.7 % Bank-owned life insurance 573 525 48 9.1 Service charges and fees 647 489 158 32.3 Other 51 (143) 194 Favorable Total noninterest income $ 2,927 $ 2,110 $ 817 38.7 % Noninterest income increased by $0.2 million to $1.4 million for the three months ended June 30, 2023 compared to the three months ended June 30, 2022. Noninterest income increased by $0.8 million to $2.9 million for the six months ended June 30, 2023 compared to the six months ended June 30, 2022. The increase in noninterest income was driven by an increase in SBA loan sales and increases in service charges and fees for the three and six months ended 2023. 54 Noninterest Expense The following table compares noninterest expense for the three and six months ended June 30, 2023 and 2022: Three Months Ended June 30, Change (Dollars in thousands) 2023 2022 $ % Salaries and employee benefits $ 6,390 $ 5,433 $ 957 17.6 % Occupancy and equipment 2,204 2,193 11 0.5 Professional services 692 1,000 (308) (30.8) Data processing 729 689 40 5.8 Director fees 453 339 114 33.6 FDIC insurance 1,050 262 788 300.8 Marketing 177 107 70 65.4 Other 946 913 33 3.6 Total noninterest expense $ 12,641 $ 10,936 $ 1,705 15.6 % Six Months Ended June 30, Change (Dollars in thousands) 2023 2022 $ % Salaries and employee benefits $ 12,471 $ 10,373 $ 2,098 20.2 % Occupancy and equipment 4,288 4,343 (55) (1.3) Professional services 2,014 1,981 33 1.7 Data processing 1,400 1,343 57 4.2 Director fees 845 691 154 22.3 FDIC insurance 2,112 485 1,627 335.5 Marketing 328 152 176 115.8 Other 1,874 1,493 381 25.5 Total noninterest expense $ 25,332 $ 20,861 $ 4,471 21.4 % Noninterest expense increased by $1.7 million to $12.6 million for the three months ended June 30, 2023 compared to the three months ended June 30, 2022. Noninterest expense increased by $4.5 million to $25.3 million for the six months ended June 30, 2023 compared to the six months ended June 30, 2022. The increase in noninterest expense was primarily driven by an increase in salaries and employee benefits expense and FDIC insurance expense. Salaries and employee benefits expense totaled $6.4 million for the three months ended June 30, 2023, an increase of $1.0 million when compared to the same period in 2022. Salaries and employee benefits expense totaled $12.5 million for the six months ended June 30, 2023, an increase of $2.1 million when compared to the same period in 2022. The increase in salaries and employee benefits expense was driven by an increase in full time equivalent employees, with full time equivalent employees totaling 141 at June 30, 2023 compared to 132 for the same period in 2022. The increase in salaries and employee benefits expense was also due to one-time severance costs and lower loan originations, which reduces the Bank's ability to defer expenses. FDIC insurance expense totaled $1.1 million for the three months ended June 30, 2023, an increase of $0.8 million when compared to the same period in 2022. FDIC insurance expense totaled $2.1 million for the six months ended June 30, 2023, an increase of $1.6 million when compared to the same period in 2022. The increase in FDIC insurance expense is attributed to the overall balance sheet growth, increased use of brokered deposits, and an increase in FDIC insurance rates. Income Taxes Income tax expense for the three months ended June 30, 2023 and 2022 totaled $2.2 million and $3.5 million, respectively. The effective tax rates for the three months ended June 30, 2023 and 2022 were 21.5% and 22.4%, respectively. Income tax expense for the six months ended June 30, 2023 and 2022 totaled $5.4 million and $5.6 million, respectively. The effective tax rates for the six months ended June 30, 2023 and 2022 were 22.6% and 21.6%, respectively. 55 Financial Condition Summary Assets totaled $3.3 billion at June 30, 2023 and remained flat compared to December 31, 2022. Gross loans totaled $2.8 billion at June 30, 2023, an increase of $98.2 million or 3.7% compared to December 31, 2022. Deposits totaled $2.8 billion at June 30, 2023, and decreased $12.0 million or $0.4% compared to December 31, 2022. Shar eholders’ equity totaled $248.8 million as of June 30, 2023, an increase of $10.3 million compared to December 31, 2022, primarily a result of net income of $18.4 million for the six months ended June 30, 2023. The increase was partially offset by the Day 1 CECL adoption of $4.9 million, dividends paid of $3.1 million, and a $1.5 million unfavorable impact to accumulated other comprehensive income. The unfavorable impact to accumulated other comprehensive income was driven by fair value marks on the Company's Available for sale investment securities portfolio of $0.9 million and fair value marks related to hedge positions involving interest rate swaps of $0.7 million. The Company's interest rate swaps are used to hedge interest rate risk. Loan Portfolio We originate commercial real estate loans, construction loans, commercial business loans and consumer loans in our market. We also pursue certain types of commercial lending opportunities outside our market, particularly where we have strong business relationships. Our loan portfolio is the largest category of our earning assets. Total loans before deferred loan fees and the ACL-Loans were $2.8 billion at June 30, 2023 and $2.7 billion at December 31, 2022. Total gross loans increased $98.2 million as of June 30, 2023 compared to the year ended December 31, 2022. The following table compares the composition of our loan portfolio for the dates indicated: (In thousands) At June 30, 2023 At December 31, 2022 Change Real estate loans: Residential $ 54,631 $ 60,588 $ (5,957) Commercial 1,930,972 1,921,252 9,720 Construction 219,615 155,198 64,417 2,205,218 2,137,038 68,180 Commercial business 530,913 520,447 10,466 Consumer 37,474 17,963 19,511 Total loans $ 2,773,605 $ 2,675,448 $ 98,157 Asset Quality We actively manage asset quality through our underwriting practices and collection operations. Our Board of Directors monitors credit risk management. The Directors Loan Committee ("DLC") has primary oversight responsibility for the credit-granting function including approval authority for credit-granting policies, review of management’s credit-granting activities and approval of large exposure credit requests, as well as loan review and problem loan management and resolution. The committee reports the results of its respective oversight functions to our Board of Directors. In addition, our Board of Directors receives information concerning asset quality measurements and trends on a monthly basis. While we continue to adhere to prudent underwriting standards, our loan portfolio is not immune to potential negative consequences as a result of general economic weakness, such as a prolonged downturn in the housing market or commercial real estate market on a national scale. Decreases in real estate values could adversely affect the value of property used as collateral for loans. In addition, adverse changes in the economy could have a negative effect on the ability of borrowers to make scheduled loan payments, which would likely have an adverse impact on earnings. 56 The Company has established credit policies applicable to each type of lending activity in which it engages. The Company evaluates the creditworthiness of each client and extends credit of up to 80% of the market value of the collateral, (85% maximum for owner occupied commercial real estate), depending on the client's creditworthiness and the type of collateral. The client’s ability to service the debt is monitored on an ongoing basis. Real estate is the primary form of collateral. Other important forms of collateral are business assets, time deposits and marketable securities. While collateral provides assurance as a secondary source of repayment, the Company ordinarily requires the primary source of repayment for commercial loans to be based on the client’s ability to generate continuing cash flows. The Company does not provide first or second consumer mortgage loans secured by residential properties but has a small legacy portfolio which continues to amortize, pay off due to the sale of the collateral, or refinance away from the Company. Credit risk management involves a partnership between our relationship managers and our credit approval, portfolio management, credit administration and collections departments. Disciplined underwriting, portfolio monitoring and early problem recognition are important aspects of maintaining our high credit quality standards and low levels of nonperforming assets since our inception in 2002. Nonperforming assets . Nonperforming assets include nonaccrual loans and property acquired through foreclosures or repossession. The following table presents nonperforming assets and additional asset quality data for the dates indicated: (In thousands) At June 30, 2023 At December 31, 2022 Nonaccrual loans: Real estate loans: Residential $ 1,429 $ 2,152 Commercial 1,905 2,781 Commercial business 2,815 2,126 Construction 9,382 9,382 Total nonaccrual loans 15,531 16,441 Other real estate owned — — Total nonperforming assets $ 15,531 $ 16,441 Nonperforming assets to total assets 0.48 % 0.51 % Nonaccrual loans to total gross loans 0.56 % 0.61 % ACL-loans as a % of total loans 1.11 % 0.84 % ACL-loans as a % of nonperforming loans 197.63 % 136.43 % Total past due loans to total gross loans 1.30 % 0.60 % Nonperforming assets totaled $15.5 million and represented 0.48% of total assets at June 30, 2023, compared to $16.4 million and 0.51% of total assets at December 31, 2022. Nonaccrual loans totaled $15.5 million at June 30, 2023 and $16.4 million at December 31, 2022. There was no other real estate owned at June 30, 2023 or December 31, 2022. Past due loans increased to $36.0 million, or 1.30% of total loans, as of June 30, 2023, compared to $16.1 million, or 0.60% of total loans, as of December 31, 2022. Of the June 30, 2023 past due loans, $9.3 million of loans were between 31 - 33 days past due and have subsequently become current. ACL-Loans We evaluate the adequacy of the ACL-Loans based on "forward looking" expected losses. Management believes that the current ACL-Loans will be adequate to absorb credit losses on existing loans that may become uncollectible based on the evaluation of known and inherent risks in the loan portfolio. The evaluation takes into consideration such factors as changes in the nature and size of the portfolio, overall portfolio quality and specific problem loans, and current economic conditions which may affect the borrowers’ ability to pay. The evaluation also details historical losses by loan segment and the resulting credit loss rates which are projected for current loan total amounts. Loss estimates for specified problem loans are also detailed. All of the factors considered in the analysis of the adequacy of the ACL-Loans may be subject to change. 57 We estimate losses on specific loans, or groups of loans, where the probable loss can be identified and reasonably determined. The balance of our ACL-Loans is based on internally assigned risk classifications of loans, the Bank’s and peer banks’ historical loss experience, changes in the nature of the loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, current economic factors and the estimated impact of current economic conditions on certain historical loan loss rates. Our general practice is to identify problem credits early and recognize full or partial charge-offs as promptly as practicable when it is determined that it is probable that the loan will not be repaid according to its original contractual terms, including principal and interest. Full or partial charge-offs on collateral dependent individually evaluated loans are recognized when the collateral is deemed to be insufficient to support the carrying value of the loan. We do not recognize a recovery when an updated appraisal indicates a subsequent increase in value of the collateral. Our charge-off policies, which comply with standards established by our banking regulators, are consistently applied from period to period. Charge-offs are recorded on a monthly basis, as incurred. Partially charged-off loans continue to be evaluated on a monthly basis and additional charge-offs or provisions (credit) for credit losses may be recorded on the remaining loan balance based on the same criteria. The following table presents the activity in our ACL-Loans and related ratios for the dates indicated: Three Months Ended June 30, Six Months Ended June 30, (Dollars in thousands) 2023 2022 2023 2022 Balance at beginning of period $ 27,998 $ 17,141 $ 22,431 $ 16,902 CECL Day 1 Adjustment 5,079 — Balance at beginning of period-Adjusted 27,998 17,141 27,510 16,902 Charge-offs: Commercial real estate — — — — Commercial business — — (439) — Consumer (25) — (37) (4) Total charge-offs (25) — (476) (4) Recoveries: Commercial real estate — 77 — 77 Commercial business 32 — 33 13 Consumer 11 — 15 1 Total recoveries 43 77 48 91 Net (charge-offs) recoveries 18 77 (428) 87 Provision for credit losses - loans 2,678 (1,445) 3,612 (1,216) Balance at end of period $ 30,694 $ 15,773 $ 30,694 $ 15,773 Net charge-offs to average loans — % — % 0.02 % — % ACL-Loans to total gross loans 1.11 % 0.77 % 1.11 % 0.77 % At June 30, 2023, our ACL-Loans was $30.7 million and represented 1.11% of total gross loans, compared to $22.4 million, or 0.84% of total gross loans, at December 31, 2022. 58 The following table presents the allocation of the ACL-Loans balance and the related allocation percentage of these loans across the total loan portfolio: At June 30, 2023 At December 31, 2022 (Dollars in thousands) ACL-Loans Loans as Percent of Total Loan Portfolio ACL-Loans Loans as Percent of Total Loan Portfolio Residential real estate $ 190 0.62 % $ 163 2.27 % Commercial real estate 19,948 64.99 15,597 71.81 Construction 1,798 5.86 311 5.80 Commercial business 6,788 22.12 6,214 19.45 Consumer 1,970 6.41 146 0.67 Total ACL-Loans $ 30,694 100.00 % $ 22,431 100.00 % The allocation of the ACL-Loans at June 30, 2023 reflects our assessment of credit risk and probable loss within each portfolio. We believe that the level of the ACL-Loans at June 30, 2023 is appropriate to cover probable losses. ACL- Unfunded Commitments The ACL-Unfunded Commitments provision is based on "forward looking" losses inherent with funding the unused portion of legal commitments to lend. The reserve for unfunded credit commitments is included within other liabilities in the accompanying Consolidated Balance Sheets. Changes in the ACL-Unfunded Commitments are reported as a component of the Provision for credit losses in the accompanying Consolidated Statements of Income. Investment Securities At June 30, 2023, the carrying value of our investment securities portfolio totaled $117.8 million and represented 3.6% of total assets, compared to $121.6 million, or 3.7% of total assets, at December 31, 2022. The net unrealized loss position on our investment portfolio at June 30, 2023 was $10.3 million and included gross unrealized gains of $0.4 million. The net unrealized loss position on our investment portfolio at December 31, 2022 was $9.2 million and included gross unrealized gains of $0.3 million. Deposit Activities and Other Sources of Funds June 30, 2023 December 31, 2022 (Dollars in thousands) Amount Percent Amount Percent Noninterest bearing demand $ 367,635 13.18 % $ 404,559 14.44 % NOW 106,189 3.81 104,057 3.72 Money market 879,017 31.52 913,868 32.63 Savings 108,625 3.89 151,944 5.42 Time 1,327,397 47.60 1,226,390 43.79 Total deposits $ 2,788,863 100.00 % $ 2,800,818 100.00 % Total deposits were $2.8 billion at June 30, 2023, a decrease of $12.0 million, from the balance at December 31, 2022. Brokered certificates of deposits totaled $918.1 million at June 30, 2023 and $976.5 million at December 31, 2022. There were no certificates of deposits from national listing services at June 30, 2023 or December 31, 2022. Brokered money market accounts totaled $50.6 million at June 30, 2023 and $50.1 million at December 31, 2022. Brokered deposits represent brokered certificates of deposit, brokered money market accounts, one way buy Certificate of Deposit Account Registry Service (CDARS), and one way buy Insured Cash Sweep (ICS). 59 As of June 30, 2023, our insured deposits were 2,105.1, or 75% of total deposits. Insured deposits are comprised of $1,984.7 million of FDIC-insured deposits, or 71% of total deposits, and $120.4 million of deposits insured by standby letters of credit with the Federal Home Loan Bank of Boston, or 4% of total deposits. At June 30, 2023 and December 31, 2022, time deposits with a denomination of $100 thousand or more, including CDARS and brokered deposits, totaled $1,222.6 million and $1,157.2 million, respectively, maturing during the periods indicated in the table below: (Dollars in thousands) June 30, 2023 December 31, 2022 Maturing: Within 3 months $ 325,183 $ 251,036 After 3 but within 6 months 285,829 252,673 After 6 months but within 1 year 307,767 530,400 After 1 year 303,783 123,130 Total $ 1,222,562 $ 1,157,239 We utilize advances from the Federal Home Loan Bank of Boston, or FHLB, as part of our overall funding strategy and to meet short-term liquidity needs, and to a lesser degree, manage interest rate risk arising from the difference in asset and liability maturities. Total FHLB advances were $90.0 million at June 30, 2023 and December 31, 2022, respectively. The Bank has additional borrowing capacity at the FHLB up to a certain percentage of the value of qualified collateral. In accordance with agreements with the FHLB, the qualified collateral must be free and clear of liens, pledges and encumbrances. At June 30, 2023, the Bank had pledged $998.8 million of eligible loans as collateral to support borrowing capacity at the FHLB of Boston. As of June 30, 2023, the Bank had immediate availability to borrow an additional $385.4 million based on qualified collateral. At June 30, 2023 , the Bank had a secured borrowing line with the FRB, a letter of credit with the FHLB, and unsecured lines of credit with Zions Bank, Pacific Coast Bankers Bank ("PCBB"), Atlantic Community Bankers Bank ("ACBB"), and Texas Capital Bank. The total borrowing line, letter, or line of credit and the amount outstanding at June 30, 2023 is summarized below: June 30, 2023 Total Letter or Line of Credit Total Outstanding (Dollars in thousands) FRB $ 839,276 $ — FHLB 614,307 228,901 Zions Bank 45,000 — PCBB 38,000 — ACBB 12,000 — Texas Capital Bank 10,000 — Total $ 1,558,583 $ 228,901 Liquidity and Capital Resources Liquidity Management Liquidity is defined as the ability to generate sufficient cash flows to meet all present and future funding requirements at reasonable costs. Our primary source of liquidity is deposits. While our generally preferred funding strategy is to attract and retain low cost deposits, our ability to do so is affected by competitive interest rates and terms in the marketplace. Other sources of funding include discretionary use of purchased liabilities (e.g., FHLB term advances and other borrowings), cash flows from our investment securities portfolios, loan sales, loan repayments and earnings. Investment securities designated as available for sale may also be sold in response to short-term or long-term liquidity needs. 60 The Bank’s liquidity positions are monitored daily by management. The Asset Liability Committee ("ALCO") establishes guidelines to ensure maintenance of prudent levels of liquidity. ALCO reports to the Company’s Board of Directors. The Bank has a detailed liquidity funding policy and a contingency funding plan that provide for the prompt and comprehensive response to unexpected demands for liquidity. We employ a stress testing methodology to estimate needs for contingent funding that could result from unexpected outflows of funds in excess of “business as usual” cash flows. The Bank has established unsecured borrowing capacity with Zions Bank, PCBB, ACBB (formerly Bankers’ Bank Northeast), and Texas Capital Bank. The Bank also maintains additional collateralized borrowing capacity with the FRB and the FHLB in excess of levels used in the ordinary course of business. Our sources of liquidity include cash, unpledged investment securities, borrowings from the FRB, FHLB, lines of credit from Zions Bank, PCBB, ACBB, Texas Capital Bank, the brokered deposit market and national CD listing services. Capital Resources Shar eholders’ equity totaled $248.8 million as of June 30, 2023, an increase of $10.3 million compared to December 31, 2022, primarily a result of net income of $18.4 million for the six months ended June 30, 2023. The increase was partially offset by the Day 1 CECL adoption of $4.9 million, dividends paid of $3.1 million, and a $1.5 million unfavorable impact to accumulated other comprehensive income. The unfavorable impact to accumulated other comprehensive income was driven by fair value marks on the Company's Available for sale investment securities portfolio of $0.9 million and fair value marks related to hedge positions involving interest rate swaps of $0.7 million. The Company's interest rate swaps are used to hedge interest rate risk. The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. At June 30, 2023, the Bank met all capital adequacy requirements to which it was subject and exceeded the regulatory minimum capital levels to be considered well-capitalized under the regulatory framework for prompt corrective action. At June 30, 2023, the Bank’s ratio of Common Equity Tier 1 capital to risk-weighted assets was 10.34%, total capital to risk-weighted assets was 11.41%, Tier 1 capital to risk-weighted assets was 10.34% and Tier 1 capital to average assets was 9.41%. Under the current guidelines, banking organizations must have a minimum total risk-based capital ratio of 8.0%, a minimum Tier 1 risk-based capital ratio of 6.0%, a minimum common equity Tier 1 risk-based capital ratio of 4.5%, and a minimum leverage ratio of 4.0% in order to be "adequately capitalized." In addition to these requirements, banking organizations must maintain a capital conservation buffer consisting of common Tier 1 equity in an amount above the minimum risk-based capital requirements for “adequately capitalized” institutions equal to 2.5% of total risk-weighted assets, resulting in a requirement for the Company and the Bank to effectively maintain common equity Tier 1, Tier 1 and total capital ratios of 7.0%, 8.5% and 10.5%, respectively. The Company and the Bank must maintain the capital conservation buffer to avoid restrictions on the ability to pay dividends, pay discretionary bonuses, or to engage in share repurchases. Asset/Liability Management and Interest Rate Risk We measure interest rate risk using simulation analysis to calculate earnings and equity at risk. These risk measures are quantified using simulation software from one of the leading firms in the field of asset/liability modeling. Key assumptions relate to the behavior of interest rates and spreads, prepayment speeds and the run-off of deposits. From such simulations, interest rate risk, or IRR, is quantified and appropriate strategies are formulated and implemented. We model IRR by using two primary risk measurement techniques: simulation of net interest income and simulation of economic value of equity. These two measurements are complementary and provide both short-term and long-term risk profiles for the Company. Because both baseline simulations assume that our balance sheet will remain static over the simulation horizon, the results do not reflect adjustments in strategy that ALCO could implement in response to rate shifts. The simulation analyses are updated quarterly. We use a net interest income at risk simulation to measure the sensitivity of net interest income to changes in market rates. This simulation captures underlying product behaviors, such as asset and liability repricing dates, balloon dates, interest rate indices and spreads, rate caps and floors, as well as other behavioral attributes. The simulation of net interest income also requires a number of key assumptions such as: (i) prepayment projections for loans and securities that are projected under each interest rate scenario using internal and external mortgage analytics; (ii) new business loan rates that are based on recent new business origination experience; and (iii) deposit pricing assumptions for non-maturity deposits reflecting the Bank’s history, management judgment and core deposit studies. Combined, these assumptions can be inherently uncertain, and as a result, actual results may differ from simulation forecasts due to the timing, magnitude and frequency of interest rate changes, future business conditions, as well as unanticipated changes in management strategies. 61 We use two sets of standard scenarios to measure net interest income at risk. For the Parallel Ramp Scenarios, rate changes are ramped over a twelve-month horizon based upon a parallel yield curve shift and then maintained at those levels over the remainder of the simulation horizon. Parallel Shock Scenarios assume instantaneous parallel movements in the yield curve compared to a flat yield curve scenario. Simulation analysis involves projecting a future balance sheet structure and interest income and expense under the various rate scenarios. Internal policy regarding internal rate risk simulations currently specifies that for instantaneous parallel shifts of the yield curve, estimated net interest income at risk for the subsequent one-year period should not decline by more than: 6% for a 100 basis point shift; 12% for a 200 basis point shift; and 18% for a 300 basis point shift. Per Company policy, the Bank should not be outside these limits for twelve consecutive months unless the Bank's forecasted capital ratios are considered to be "well capitalized". As of June 30, 2023, the Bank has met all minimum regulatory capital requirements to be considered "well capitalized". The following tables set forth the estimated percentage change in our net interest income at risk over one-year simulation periods beginning June 30, 2023 and December 31, 2022: Parallel Ramp Estimated Percent Change in Net Interest Income Rate Changes (basis points) June 30, 2023 December 31, 2022 -100 1.20 % 2.20 % +200 (3.20) (4.80) Parallel Shock Estimated Percent Change in Net Interest Income Rate Changes (basis points) June 30, 2023 December 31, 2022 -100 2.50 % 2.20 % +100 (2.70) (2.70) +200 (6.00) (6.00) +300 (8.60) (8.90) The net interest income at risk simulation results indicate that, as of June 30, 2023, we remain liability sensitive. The liability sensitivity is due to the fact that there are more liabilities than assets subject to repricing as market rates change. We conduct an economic value of equity at risk simulation in tandem with net interest income simulations, to ascertain a longer term view of our interest rate risk position by capturing longer-term repricing risk and options risk embedded in the balance sheet. It measures the sensitivity of economic value of equity to changes in interest rates. The economic value of equity at risk simulation values only the current balance sheet and does not incorporate the growth assumptions used in one of the income simulations. As with the net interest income simulation, this simulation captures product characteristics such as loan resets, repricing terms, maturity dates, rate caps and floors. Key assumptions include loan prepayment speeds, deposit pricing elasticity and non-maturity deposit attrition rates. These assumptions can have significant impacts on valuation results as the assumptions remain in effect for the entire life of each asset and liability. All key assumptions are subject to a periodic review. Base case economic value of equity at risk is calculated by estimating the net present value of all future cash flows from existing assets and liabilities using current interest rates. The base case scenario assumes that future interest rates remain unchanged. 62 The following table sets forth the estimated percentage change in our economic value of equity at risk, assuming various shifts in interest rates: Estimated Percent Change in Economic Value of Equity ("EVE") Rate Changes (basis points) June 30, 2023 December 31, 2022 -100 2.90 % 2.30 % +100 (4.30) (3.90) +200 (10.50) (9.30) +300 (14.90) (14.00) While ALCO reviews and updates simulation assumptions and also periodically back-tests the simulation results to ensure that the assumptions are reasonable and current, income simulation may not always prove to be an accurate indicator of interest rate risk or future net interest margin. Over time, the repricing, maturity and prepayment characteristics of financial instruments and the composition of our balance sheet may change to a different degree than estimated. ALCO recognizes that deposit balances could shift into higher yielding alternatives as market rates change. ALCO has modeled increased costs of deposits in the rising rate simulation scenarios presented above. It should be noted that the static balance sheet assumption does not necessarily reflect our expectation for future balance sheet growth, which is a function of the business environment and client behavior. Another significant simulation assumption is the sensitivity of core deposits to fluctuations in interest rates. Income simulation results assume that changes in both core savings deposit rates and balances are related to changes in short-term interest rates. Lastly, mortgage-backed securities and mortgage loans involve a level of risk that unforeseen changes in prepayment speeds may cause related cash flows to vary significantly in differing rate environments. Such changes could affect the level of reinvestment risk associated with cash flow from these instruments, as well as their market value. Changes in prepayment speeds could also increase or decrease the amortization of premium or accretion of discounts related to such instruments, thereby affecting interest income.