ENTERPRISE FINANCIAL SERVICES CORP 10-K

ITEM 7: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction The objective of this section is to provide an overview of the results of operations and financial condition of the Company by focusing on changes in certain key measures from year to year. It should be read in conjunction with the Consolidated Financial Statements and related Notes contained in “Item 8. Financial Statements and Supplementary Data,” and other financial data presented elsewhere in this report, particularly the information regarding the Company’s business operations described in Item 1. A detailed discussion comparing 2021 and 2020 results is incorporated herein by reference to Item 7 of the Company’s 2021 Annual Report on Form 10-K filed on February 25, 2022. Executive Summary Our Company offers a broad range of business and personal banking services including wealth management services. Lending services include commercial and industrial, commercial real estate, real estate construction and development, residential real estate, specialty, and other loans. A wide variety of deposit products and a complete suite of treasury management and international trade services complement our lending capabilities. Tax-credit brokerage activities consist of the acquisition of Federal and State tax credits and the sale of these tax credits. The Company’s results of operations are also affected by prevailing economic conditions, competition, government policies and other actions of regulatory agencies. The Company’s financial condition, operating results and liquidity in 2022 were impacted by the monetary policy actions enacted to address rising inflation. In 2022, the Federal Reserve increased interest rates seven times for a total increase of 425 basis points to the Federal Funds Target Interest Rate during the year, while also changing its accommodative monetary policy through a reduction of Treasuries and agency mortgage-backed securities held on its balance sheet. This follows a period of highly expansionary fiscal support from the federal government during the start of the COVID-19 pandemic in 2020-2021. 29 Financial Performance Highlights Below are highlights of our financial performance for the years ended December 31, 2022, 2021 and 2020. ($ in thousands, except per share data) Year ended December 31, 2022 2021 2020 EARNINGS Total interest income $ 515,082 $ 383,230 $ 304,779 Total interest expense 41,179 23,036 34,778 Net interest income 473,903 360,194 270,001 Provision (benefit) for credit losses (611) 13,385 65,398 Net interest income after provision (benefit) for credit losses 474,514 346,809 204,603 Total noninterest income 59,162 67,743 54,503 Total noninterest expense 274,216 245,919 167,159 Income before income tax expense 259,460 168,633 91,947 Income tax expense 56,417 35,578 17,563 Net income $ 203,043 $ 133,055 $ 74,384 Preferred dividends 4,041 — — Net income available to common shareholders $ 199,002 $ 133,055 $ 74,384 Basic earnings per share $ 5.32 $ 3.86 $ 2.76 Diluted earnings per share $ 5.31 $ 3.86 $ 2.76 Return on average assets 1.52 % 1.16 % 0.90 % Return on average common equity 13.95 % 10.49 % 8.24 % Return on average tangible common equity 1 19.10 % 14.18 % 11.23 % Net interest margin (fully tax equivalent) 3.89 % 3.41 % 3.56 % Efficiency ratio 51.44 % 57.47 % 51.51 % Core efficiency ratio 1 49.77 % 49.68 % 48.70 % Dividend payout ratio 16.89 % 19.66 % 26.61 % Book value per common share $ 38.93 $ 38.53 $ 34.57 Tangible book value per common share 1 $ 28.67 $ 28.28 $ 25.48 Average common equity to average assets 11.25 % 11.14 % 10.94 % Tangible common equity to tangible assets 1 8.43 % 8.13 % 8.40 % At or for the year ended December 31, 2022 2021 2020 ASSET QUALITY Net charge-offs $ 3,899 $ 11,629 $ 1,907 Nonperforming loans 9,981 28,024 38,507 Classified assets 99,122 100,797 123,808 Classified assets to total assets 0.76 % 0.74 % 1.27 % Nonperforming loans to total loans 0.10 % 0.31 % 0.53 % Nonperforming assets to total assets 0.08 % 0.23 % 0.45 % Allowance for credit losses to total loans 1.41 % 1.61 % 1.89 % Net charge-offs to average loans 0.04 % 0.14 % 0.03 % 1 Non-GAAP measures. A reconciliation has been included in this MD&A section under the caption “Use of Non-GAAP Financial Measures.” 30 The Company noted the following trends during 2022: • The Company reported net income of $203.0 million, or $5.31 per diluted share for 2022, compared to $133.1 million, or $3.86 per diluted share for 2021. In addition to organic growth, contributing to the increase in net income was a full year of First Choice operations and an increase in market interest rates. Net income in 2022 also benefited from a reduction in the provision for credit losses of $14.0 million and a $25.5 million reduction in merger-related and branch-closure expenses, compared to 2021. Acquisition related provision for credit losses of $25.4 million were included in the provision for credit losses in 2021. This expense, commonly referred to as the “CECL double-count”, is recognized when a loan portfolio is acquired. Excluding the CECL double-count, the benefit for credit losses decreased in 2022 primarily due to loan growth and the forward-looking CECL methodology and the worsening outlook for forecasted economic factors compared to 2021. • Preferred stock dividends of $4.0 million were declared and paid on the Series A Preferred Stock. • Net interest income for 2022 totaled $473.9 million , an increase of $113.7 million, or 32%, compared to $360.2 million for 2021. Organic loan growth, higher average loan balances from the First Choice acquisition, and an increase in market interest rates increased net interest income. These increases were partially offset by a decline in PPP interest and fee income as the program wound down. PPP income totaled $5.0 million and $27.3 million in 2022 and 2021, respectively. • The net interest margin increased 48 basis points to 3.89% during 2022, compared to 3.41% in 2021. The increase was primarily due to the 4.97% loan yield in 2022, which increased 64 basis points, from 4.33% in 2021. • Noninterest income decreased $8.5 million, or 13%, to $59.2 million in 2022 compared to $67.7 million in 2021. While the increase in interest rates benefited net interest income, higher interest rates resulted in lower mortgage banking and tax credit income. The Company also became subject to the Durbin Amendment limitation on interchange income in 2022, which reduced card services revenue by approximately $2.0 million. • Noninterest expenses totaled $274.2 million for 2022, an increase of $28.3 million, or 12%, compared to 2021. A full year of First Choice expenses, higher compensation from merit increases and an expanded associate base, and higher deposit servicing costs were the primary drivers of the increase in noninterest expense. Offsetting these increases were declines in nonrecurring expenses of $22.1 million in merger expenses and $3.4 million in branch-closure expenses recognized in 2021. The Company’s core efficiency ratio 1 was stable at 49.8% in 2022, compared to 49.7% for the prior year. • The Company’s effective tax rate was 21.7% in 2022 compared to 21.1% in 2021. 1 Non-GAAP measures. A reconciliation has been included in this MD&A section under the caption “Use of Non-GAAP Financial Measures.” 2022 Significant Transactions During 2022, we announced the following significant transactions: • The Company repurchased 700,473 of its common shares at a weighted-average share price of $47.00. • Dividends paid in 2022 of $0.90 per share increased $0.15 per share, or 20%, compared to $0.75 per share in 2021. • Retired 1,980,093 shares of treasury stock. 31 2021 Significant Transactions During 2021, we announced the following significant transactions: • On July 21, 2021, the Company announced the completion of its acquisition of First Choice, a commercial bank based in Los Angeles, CA, with $2.3 billion in assets. The overall transaction had a value of $346 million. • Continued supporting customers through PPP, lending an additional $341 million of PPP loans. • The Company announced the closing of five branch locations in California and St. Louis. A lease and fixed asset impairment charge of $3.8 million was recognized, including $0.4 million reported in merger-related expenses. • The Company redeemed $50.0 million of 4.75% fixed-to-floating rate subordinated notes. • The Company issued and sold 3,000,000 depositary shares, each representing 1/40th interest in a share of 5% noncumulative, perpetual preferred stock totaling $72.0 million, net of issuance costs. • The Company repurchased 1,299,527 of its common shares at a weighted-average share price of $46.62. • Dividends paid in 2021 of $0.75 per share increased $0.03 per share, or 4%, compared to $0.72 per share in 2020. 32 RESULTS OF OPERATIONS Net Interest Income Average Balance Sheet The following table presents, for the periods indicated, certain information related to our average interest-earning assets and interest-bearing liabilities, as well as, the corresponding interest rates earned and paid, all on a tax equivalent basis. Average balances are presented on a daily average basis. Year ended December 31, 2022 2021 2020 ($ in thousands) Average Balance Interest Income/Expense Average Yield/ Rate Average Balance Interest Income/Expense Average Yield/ Rate Average Balance Interest Income/Expense Average Yield/ Rate Assets Interest-earning assets: Loans 1, 2 $ 9,193,682 $ 456,703 4.97 % $ 8,055,873 $ 349,112 4.33 % $ 6,071,496 $ 270,673 4.46 % Taxable securities 1,228,514 29,638 2.41 908,189 19,305 2.13 1,016,100 25,524 2.51 Non-taxable securities 2 872,173 25,184 2.89 659,804 18,468 2.80 350,501 11,151 3.18 Total securities 2,100,687 54,822 2.61 1,567,993 37,773 2.41 1,366,601 36,675 2.68 Interest-earning deposits 1,074,165 10,599 0.99 1,084,853 1,496 0.14 228,760 620 0.27 Total interest-earning assets 12,368,534 522,124 4.22 10,708,719 388,381 3.63 7,666,857 307,968 4.02 Noninterest-earning assets 951,090 758,591 587,057 Total assets $ 13,319,624 $ 11,467,310 $ 8,253,914 Liabilities and Shareholders' Equity Interest-bearing liabilities: Interest-bearing demand accounts $ 2,318,363 $ 7,038 0.30 % $ 2,122,752 $ 1,614 0.08 % $ 1,494,364 $ 2,101 0.14 % Money market accounts 2,781,579 19,306 0.69 2,557,836 4,669 0.18 1,977,826 7,754 0.39 Savings accounts 819,043 305 0.04 724,768 225 0.03 589,832 279 0.05 Certificates of deposit 569,272 3,509 0.62 570,496 4,160 0.73 676,889 10,915 1.61 Total interest-bearing deposits 6,488,257 30,158 0.46 5,975,852 10,668 0.18 4,738,911 21,049 0.44 Subordinated debentures and notes 155,160 9,166 5.91 195,686 10,960 5.60 179,534 9,885 5.51 FHLB advances 33,467 599 1.79 59,945 803 1.34 241,635 2,673 1.11 Securities sold under agreements to repurchase 211,039 506 0.24 225,894 235 0.10 206,338 542 0.26 Other borrowings 22,812 750 3.29 26,428 370 1.40 32,147 629 1.96 Total interest-bearing liabilities 6,910,735 41,179 0.60 6,483,805 23,036 0.36 5,398,565 34,778 0.64 Noninterest bearing liabilities: Demand deposits 4,805,549 3,597,204 1,854,982 Other liabilities 104,581 109,148 97,492 Total liabilities 11,820,865 10,190,157 7,351,039 Shareholders' equity 1,498,759 1,277,153 902,875 Total liabilities & shareholders' equity $ 13,319,624 $ 11,467,310 $ 8,253,914 Net interest income $ 480,945 $ 365,345 $ 273,190 Net interest spread 3.62 % 3.27 % 3.38 % Net interest margin (tax equivalent) 3.89 % 3.41 % 3.56 % 1 Average balances include non-accrual loans. Interest income includes net loan fees of $16.7 million, $28.4 million, and $18.4 million for the years ended December 31, 2022, 2021, and 2020 respectively. Loan fees in 2022 and 2021 included PPP fees of $4.1 million and $21.7 million, respectively. 2 Non-taxable income is presented on a fully tax-equivalent basis using a 25.2% tax rate in each of 2022 and 2021 and a 24.7% tax rate in 2020. The tax-equivalent adjustments were $7.0 million for the year ended December 31, 2022, $5.1 million for the year ended December 31, 2021, and $3.2 million for the year ended December 31, 2020. 33 Rate/Volume The following table sets forth, on a tax-equivalent basis for the periods indicated, a summary of the changes in interest income and interest expense resulting from changes in yield/rates and volume. 2022 compared to 2021 2021 compared to 2020 Increase (decrease) due to Increase (decrease) due to ($ in thousands) Volume 1 Rate 2 Net Volume 1 Rate 2 Net Interest earned on: Loans $ 52,238 $ 55,353 $ 107,591 $ 86,183 $ (7,744) $ 78,439 Taxable securities 7,474 2,859 10,333 (2,541) (3,678) (6,219) Non-taxable securities 3 6,115 601 6,716 8,799 (1,482) 7,317 Interest-earning deposits (15) 9,118 9,103 1,313 (437) 876 Total interest-earning assets 65,812 67,931 133,743 93,754 (13,341) 80,413 Interest paid on: Interest-bearing demand accounts $ 162 $ 5,262 $ 5,424 $ 689 $ (1,176) $ (487) Money market accounts 443 14,194 14,637 1,844 (4,929) (3,085) Savings 31 49 80 55 (109) (54) Certificates of deposit (9) (642) (651) (1,506) (5,249) (6,755) Subordinated debentures and notes (2,368) 574 (1,794) 902 173 1,075 FHLB advances (423) 219 (204) (2,341) 471 (1,870) Securities sold under agreements to repurchase (16) 287 271 47 (354) (307) Other borrowed funds (57) 437 380 (100) (159) (259) Total interest-bearing liabilities (2,237) 20,380 18,143 (410) (11,332) (11,742) Net interest income $ 68,049 $ 47,551 $ 115,600 $ 94,164 $ (2,009) $ 92,155 1 Change in volume multiplied by yield/rate of prior period. 2 Change in yield/rate multiplied by volume of prior period. 3 Nontaxable income is presented on a fully tax equivalent basis using a tax rate of 25.2% and 24.7% for 2021 and 2020, respectively. NOTE: The change in interest due to both rate and volume has been allocated to rate and volume changes in proportion to the relationship of the absolute dollar amounts of the change in each. Net interest income (on a tax equivalent basis) was $480.9 million for 2022, compared to $365.3 million for 2021, an increase of $115.6 million, or 32%. Total interest income increased $133.7 million and total interest expense increased $18.1 million. The increase in net interest income in 2022 was primarily due to a higher average yield on interest earning assets and higher loan volumes that benefited from the First Choice acquisition. These increases were offset by a decline in PPP loan income and an increase in the average cost paid on interest bearing liabilities. Loans issued through the PPP bear interest at 1% and have either a two or five year maturity. The Company also received fees for the issuance of PPP loans that varied based on the size of the loan. Interest income and loan fees included in net interest income from the PPP program totaled $5.0 million and $27.3 million in 2022 and 2021, respectively. At December 31, 2022, the Company had $7.3 million in PPP loans and $0.1 million in deferred fees, compared to $272.0 million in loans and $4.2 million in fees at the end of 2021. The tax-equivalent net interest margin was 3.89% for 2022, compared to 3.41% for 2021. The primary driver of the increase in net interest margin from 2021 to 2022 was an increase market interest rates. In 2022, the Federal Reserve significantly increased interest rates for the first time since 2018. The federal funds target rate increased 425 basis points in 2022. The increase in short-term rates increased the yield on the Company’s variable-rate loan portfolio, as well as the yield earned on new loan production. As of December 31, 2022, variable-rate loans comprised approximately 63% of total loans. The increase in market interest rates also increased the cost on interest bearing liabilities, although at a slower rate than the increase on the earning asset yield. The earning asset yield 34 increased 59 basis points to 4.22% in 2022, compared to 3.63% in 2021. Comparatively, the cost of interest bearing liabilities increased 24 basis points to 0.60%, from 0.36% in 2021. Average interest-earning assets increased $1.7 billion, or 15%, to $12.4 billion for the year ended December 31, 2022. The increase was due to growth in average earning assets due to the inclusion of a full year of First Choice operations, organic growth in the loan portfolio and a deployment of excess liquidity into the investment portfolio. Average securities represented 17% of earnings assets in 2022 and 15% in 2021. Average interest-earning deposits decreased from 10% to 9% of earning assets, due to the increase in securities. Volume growth of the balance sheet drove an increase in interest income on earning assets of $65.8 million, while the increase in interest rates drove interest income on interest-earnings assets up by $67.9 million in 2022 compared to 2021. Average interest-bearing liabilities increased $426.9 million, or 7% for the year ended December 31, 2022. The increase resulted from $512.4 million of growth in interest-bearing deposits, primarily in money market and interest bearing demand deposit accounts due to organic growth and the First Choice acquisition. Average debt and wholesale borrowings declined $85.5 million in 2022 from 2021, due to the redemption of $50.0 million in subordinated debentures at 4.75% in the fourth quarter 2021 and a decreased need for wholesale borrowings due to the growth in average deposits. The total cost of interest-bearing liabilities increased 24 basis points, from 0.36% in 2021 to 0.60% in 2022. The shift in the mix of interest-bearing liabilities reduced interest expense in 2022 by $2.2 million, while the increase in the average cost of interest bearing liabilities increased interest expense $20.4 million in 2022. Noninterest Income The following table presents a comparative summary of the major components of noninterest income for each of the years in the three-year period ended December 31, 2022: Year ended December 31, Change from ($ in thousands) 2022 2021 2020 2022 vs. 2021 2021 vs. 2020 Service charges on deposit accounts $ 18,326 $ 15,428 $ 11,717 $ 2,898 $ 3,711 Wealth management revenue 10,010 10,259 9,732 (249) 527 Card services revenue 11,551 11,880 9,481 (329) 2,399 Tax credit income 2,558 8,028 6,611 (5,470) 1,417 Miscellaneous income 16,717 22,148 16,962 (5,431) 5,186 Total noninterest income $ 59,162 $ 67,743 $ 54,503 $ (8,581) $ 13,240 Noninterest income decreased $8.6 million, or 13%, in 2022 compared to 2021. This decrease was primarily due to a $5.5 million decrease in tax credit income and a $5.4 million decrease in miscellaneous income. Rising interest rates reduced tax credit income due to the impact on tax credit projects carried at fair value. The rise in interest rates increased the discount rate used in the fair value of these projects, resulting in a lower fair value. The $5.4 million decline in miscellaneous income was primarily due to a $2.6 million decrease in mortgage banking income and a $2.6 million decrease in private equity distributions. The rise in market interest rates in 2022 reduced demand for 1-4 family mortgages, which led to the decline in mortgage banking income. Private equity distributions are not a consistent source of income and fluctuates based on distributions from the underlying funds. Included within miscellaneous income was a $1.0 million increase in swap fee income in 2022 from customer hedging transactions, that was offset by a $1.0 million decrease in gains on the sale of other real estate. Card services revenue declined $0.3 million in 2022. Included in this decrease was a decline of $2.1 million in debit card interchange income, partially offset by a $1.8 million increase in credit card fees. The Durbin Amendment limits the amount of interchange income banks can earn on debit card transactions after total assets exceed $10 billion. This limitation went into effect for the Company at the beginning of the third quarter of 2022 and was the primary driver of the reduction in debit card revenue. The decreases in noninterest income described above were partially offset by a $2.9 million increase in service charges on deposit accounts. This increase was due to deposit growth and the number of accounts using the Company’s treasury management products and was also partially attributed to a full year of First Choice deposit service revenue. 35 Noninterest Expense The following table presents a comparative summary of the components of noninterest expense: Year ended December 31, Change from ($ in thousands) 2022 2021 2020 2022 vs. 2021 2021 vs. 2020 Employee compensation and benefits $ 147,029 $ 124,904 $ 92,288 $ 22,125 $ 32,616 Occupancy 17,640 16,286 13,457 1,354 2,829 Data processing 13,513 12,242 9,050 1,271 3,192 Professional fees 7,079 4,289 3,940 2,790 349 Branch-closure expenses — 3,441 — (3,441) 3,441 Merger-related expenses — 22,082 4,174 (22,082) 17,908 Deposit costs 31,082 14,211 1,246 16,871 12,965 Other expenses 57,873 48,464 43,004 9,409 5,460 Total noninterest expense $ 274,216 $ 245,919 $ 167,159 $ 28,297 $ 78,760 Efficiency ratio 51.44 % 57.47 % 51.51 % (6.03) % 5.96 % Core efficiency ratio 1 49.77 % 49.68 % 48.70 % 0.09 % 0.98 % 1 A non-GAAP measure. A reconciliation has been included in this MD&A section under the caption “Use of Non-GAAP Financial Measures.” Noninterest expense increased $28.3 million, or 12%, in 2022 compared to 2021. The increase was attributed primarily to a $22.1 million increase in compensation and benefits, a $16.9 million increase in deposit costs and a $9.4 million increase in other expenses. The increase in compensation and benefits was due to annual merit increases and an increase in full time equivalent employees, higher share-based compensation from higher award levels and higher performance based vesting due to the Company’s financial performance, and a full year of First Choice operations. First Choice operations added $11.2 million in additional noninterest expense in 2022 over 2021. For certain deposit accounts in the Company’s specialized deposit portfolio, clients receive an earnings credit rate on average collected balances that may be used to offset expenses associated with the client’s activities for managing the accounts. These expenses are reflected in noninterest expense. The increase in deposit costs in 2022 is due to organic growth in specialized deposits and an increase in market interest rates that impacts competitive conditions that those clients can garner in the market. The increase in other expense of $9.4 million was attributed primarily to a $3.1 million increase in business development, a $2.0 million increase in the amortization of tax credit investments, a $1.4 million increase in SBA repair and denial reserves, a $1.0 million increase in credit/debit card transaction processing expenses, and a $1.0 million increase in FDIC assessment insurance. The increase in business development is primarily due to increased activity as the economy has reopened since the start of the COVID-19 pandemic. The increase in amortization of tax credit investments is primarily due to new investments in new market tax credits that are amortized in noninterest expense, while the tax benefit is recognized in tax expense. The increase in credit/debit card transaction processing is due to higher volumes of activity and the increase in FDIC assessment insurance is due to the increase in the overall balance sheet of the Company. Partially offsetting the increases described above were decreases of $22.1 million in merger related expenses on the First Choice acquisition and a $3.4 million decrease in branch-closure expenses from a branch rationalization project that was finalized in 2021. The Company expects to continue to invest in its associates and other infrastructure that supports growth. In addition, low unemployment, inflationary pressures and a shift in employee work arrangements to a virtual/hybrid model are expected to continue to have an impact on future operating expenses. 36 Income Taxes The Company’s blended federal and state tax rate was approximately 25.2% at the end of both 2022 and 2021. The effective tax rate, which is adjusted for permanent differences, such as tax exempt income, was 21.7% in 2022 compared to 21.1% in 2021. The increase was primarily due to higher pretax income in 2022 and an increase in state taxable income due to the Company’s expanded geographic footprint. See “Item 8. Note 16 – Income Taxes” for additional information. FINANCIAL CONDITION Summary Balance Sheet ($ in thousands) December 31, % Increase (Decrease) 2022 2021 2020 2022 vs. 2021 2021 vs. 2020 Total cash and cash equivalents $ 291,359 $ 2,021,689 $ 537,703 (85.59) % 275.99 % Securities 2,245,722 1,795,687 1,400,039 25.06 % 28.26 % Total loans 9,737,138 9,017,642 7,224,935 7.98 % 24.81 % Total assets 13,054,172 13,537,358 9,751,571 (3.57) % 38.82 % Deposits 10,829,150 11,343,799 7,985,389 (4.54) % 42.06 % Total liabilities 11,531,909 12,008,242 8,672,596 (3.97) % 38.46 % Total shareholders’ equity 1,522,263 1,529,116 1,078,975 (0.45) % 41.72 % Assets Loans by Type The Company has a diversified loan portfolio, with no particular concentration of credit in any one economic sector; however, a substantial portion of the portfolio, including the C&I category, is secured by real estate. The ability of the Company’s borrowers to honor their contractual obligations is partially dependent upon the local economy and its effect on the real estate market. The following table sets forth the composition of the loan portfolio by type of loans: December 31, ($ in thousands) 2022 2021 Commercial and industrial $ 3,859,882 $ 3,392,375 Commercial real estate - investor owned 2,357,820 2,141,143 Commercial real estate - owner occupied 2,270,551 2,035,785 Construction and land development 611,565 734,073 Residential real estate 395,537 454,052 Other 241,783 260,214 Total loans $ 9,737,138 $ 9,017,642 December 31, 2022 2021 Commercial and industrial 39.6 % 37.6 % Commercial real estate - investor owned 24.2 % 23.8 % Commercial real estate - owner occupied 23.3 % 22.6 % Construction and land development 6.3 % 8.1 % Residential real estate 4.1 % 5.0 % Other 2.5 % 2.9 % Total loans 100.0 % 100.0 % 37 C&I loans are made based on the borrower’s ability to generate cash flows for repayment from income sources, general credit strength, experience, and character, even though such loans may also be secured by real estate or other assets. The credit risk related to commercial loans is largely influenced by general economic conditions and the resulting impact on a borrower’s operations. PPP loans of $7.3 million and $272.0 million were included in C&I loans in the tables above at the end of 2022 and 2021, respectively. The Company continues to focus on originating high-quality C&I relationships as they typically have variable interest rates and allow for cross selling opportunities involving other banking products. C&I loan growth also supports our efforts to maintain the Company’s asset-sensitive interest rate risk position. Additionally, our specialized products, especially sponsor finance, life insurance premium financing, and tax credit lending, consist of primarily C&I loans, and have contributed significantly to the Company’s C&I loan growth. These loans are sourced through relationships developed with wealth and estate planning firms, private equity funds and tax credit specialists and are not bound geographically by our markets. As a result, these specialized loan products offer opportunities to expand and diversify our overall geographic concentration by entering into new markets. Real estate loans place an emphasis on the estimated cash flows from the operation of the property and/or the underlying collateral value. • Our commercial real estate loans, including investor-owned and owner-occupied categories, primarily represent commercial property loans on which the primary source of repayment is income from the property. These loans are principally underwritten based on the cash flow coverage of the property, the Company’s loan to value guidelines, and generally require either the limited or full guaranty of principal sponsors of the credit. Commercial real estate loans also represent owner-occupied C&I loans for which the primary source of repayment is dependent on sources other than the underlying collateral. • Construction and land development loans relating primarily to residential and commercial properties, represent financing secured by real estate under development for eventual sale or undeveloped ground. At December 31, 2022, $351.9 million of these loans include the use of interest reserves and follow standard underwriting guidelines. Construction projects are monitored by the loan officer and a centralized independent loan disbursement function. • Residential real estate loans include residential mortgages, which are loans that, due to size or other attributes, do not qualify for conventional home mortgages available-for-sale in the secondary market, second mortgages, home equity lines and conventional mortgages that are part of a broad banking relationship with the Company. Residential mortgage loans are usually limited to a maximum of 80% of collateral value at origination. Other loans represent loans to individuals, loans to state and political subdivisions, loans to nondepository financial institutions, and loans to purchase or are fully secured by investment securities. Credit risk is managed by thoroughly reviewing the creditworthiness of the borrowers prior to origination and thereafter. 38 The following table presents a breakdown of loans by NAICS code at the periods indicated: December 31, 2022 2021 ($ in thousands) Outstanding Balance % Outstanding Balance % Accommodation and Food Services $ 880,870 9 % $ 785,485 9 % Administrative and Support and Waste Management and Remediation Services 200,586 2 % 176,601 2 % Agriculture, Forestry, Fishing and Hunting 1 200,144 2 % 195,342 2 % Arts, Entertainment, and Recreation 105,851 1 % 120,805 1 % Construction 555,343 6 % 580,731 6 % Educational Services 51,083 — % 52,034 1 % Finance and Insurance 1,622,712 17 % 1,344,389 15 % Health Care and Social Assistance 455,839 5 % 372,109 4 % Information 100,004 1 % 64,686 1 % Management of Companies and Enterprises 78,548 1 % 84,110 1 % Manufacturing 694,483 7 % 613,725 7 % Mining, Quarrying, and Oil and Gas Extraction 8,106 — % 9,771 — % Other Services (except Public Administration) 536,112 6 % 593,149 7 % Professional, Scientific, and Technical Services 304,027 3 % 329,009 4 % Public Administration 9,111 — % 11,358 — % Real Estate and Rental and Leasing 2,534,275 26 % 2,462,088 27 % Retail Trade 517,659 5 % 460,763 5 % Transportation and Warehousing 257,384 3 % 214,132 2 % Utilities 34,079 — % 25,393 — % Wholesale Trade 491,218 5 % 445,771 5 % Other 99,704 1 % 76,191 1 % Total Loans $ 9,737,138 100 % $ 9,017,642 100 % 1 Includes $94.0 million and $95.5 million in animal production at December 31, 2022, and 2021, respectively and $95.6 million and $92.1 million in crop production at December 31, 2022, and 2021, respectively. The following table presents a breakdown of commercial & industrial loans by size at the periods indicated: December 31, 2022 2021 ($ in thousands) Number of Loans Outstanding Balance Average Balance Number of Loans Outstanding Balance Average Balance <$2 million 2,116 $ 771,717 $ 365 3,326 $ 921,537 $ 277 $2-5 million 314 991,748 3,158 289 915,656 3,168 $5-10 million 124 862,427 6,955 92 627,728 6,823 >$10 million 76 1,233,990 16,237 60 927,454 15,458 Total 2,630 $ 3,859,882 $ 1,468 3,767 $ 3,392,375 $ 901 39 The following table presents a breakdown of commercial real estate loans by size at the periods indicated: December 31, 2022 2021 ($ in thousands) Number of Loans Outstanding Balance Average Balance Number of Loans Outstanding Balance Average Balance <$2 million 3,170 $ 1,872,671 $ 591 3,300 $ 1,840,760 $ 558 $2-5 million 416 1,272,977 3,060 383 1,184,292 3,092 $5-10 million 105 727,681 6,930 90 626,733 6,964 >$10 million 50 755,042 15,101 34 525,143 15,445 Total 3,741 $ 4,628,371 $ 1,237 3,807 $ 4,176,928 $ 1,097 The following table presents a breakdown of construction loans by size at the periods indicated: December 31, 2022 2021 ($ in thousands) Number of Loans Outstanding Balance Average Balance Number of Loans Outstanding Balance Average Balance <$2 million 408 $ 181,813 $ 446 539 $ 212,129 $ 394 $2-5 million 52 154,563 2,972 63 200,775 3,187 $5-10 million 14 96,194 6,871 30 206,262 6,875 >$10 million 13 178,995 13,769 8 114,907 14,363 Total 487 $ 611,565 $ 1,256 640 $ 734,073 $ 1,147 The following table presents a breakdown of residential loans by size at the periods indicated: December 31, 2022 2021 ($ in thousands) Number of Loans Outstanding Balance Average Balance Number of Loans Outstanding Balance Average Balance <$2 million 2,252 $ 293,691 $ 130 2,457 $ 304,224 $ 124 $2-5 million 21 70,658 3,365 27 83,666 3,099 $5-10 million 4 31,188 7,797 8 54,019 6,752 >$10 million — — — 1 12,143 12,143 Total 2,277 $ 395,537 $ 174 2,493 $ 454,052 $ 182 The following table presents a breakdown of other loans by size at the periods indicated: December 31, 2022 2021 ($ in thousands) Number of Loans Outstanding Balance Average Balance Number of Loans Outstanding Balance Average Balance <$2 million 1,265 $ 125,136 $ 99 1,415 $ 154,663 $ 109 $2-5 million 18 59,099 3,283 16 43,306 2,707 $5-10 million 3 18,255 6,085 7 41,262 5,895 >$10 million 3 39,293 13,098 2 20,983 10,491 Total 1,289 $ 241,783 $ 188 1,440 $ 260,214 $ 181 40 The following table presents a breakdown of total loans by geographic region at the periods indicated: December 31, (in thousands) 2022 2021 Midwest $ 3,214,305 $ 2,939,092 Southwest 1,242,125 1,084,343 West 1,654,899 1,656,511 Specialty, PPP and Other loans 3,625,809 3,337,696 Total $ 9,737,138 $ 9,017,642 Loan guarantees, primarily on SBA 7(a) loans, totaled $960.3 million and $1.2 billion at December 31, 2022 and 2021, respectively. The following table provides additional information on select specialty lending detail, at the periods indicated: December 31, ($ in thousands) 2022 2021 Change % Change C&I $ 1,904,654 $ 1,478,689 $ 425,965 28.8 % CRE investor owned 2,176,424 1,955,087 221,337 11.3 % CRE owner occupied 1,174,094 1,112,463 61,631 5.5 % SBA loans 1,312,378 1,241,449 70,929 5.7 % Sponsor finance 635,061 508,469 126,592 24.9 % Life insurance premium finance 817,115 653,028 164,087 25.1 % Tax credits 559,605 486,881 72,724 14.9 % SBA PPP loans 7,272 271,958 (264,686) (97.3) % Residential real estate 379,924 430,985 (51,061) (11.8) % Construction and land development 534,753 625,526 (90,773) (14.5) % Other 235,858 253,107 (17,249) (6.8) % Total Loans $ 9,737,138 $ 9,017,642 $ 719,496 8.0 % The sponsor finance portfolio is primarily comprised of loans in the manufacturing and wholesale trade sectors. It includes mid-market company mergers and acquisitions, targeted private equity firms, principally SBICs, and senior debt financing to portfolio companies. The life insurance premium finance category specializes in financing whole life insurance premiums utilized in high net worth estate planning, through relationships with boutique estate planners throughout the United States. The tax credit portfolio includes tax credit-related lending on affordable housing projects funded through the use of federal and state low income housing tax credits. In addition, we provide leveraged and other loans on projects funded through the CDFI New Markets Tax Credit Program. This portfolio also includes tax credit brokerage through 10-year streams of state tax credits from affordable housing development funds. The tax credits are sold to clients and other individuals for tax planning purposes. SBA loans are originated under the SBA 7(a) program and are primarily owner-occupied, commercial real estate loans secured by a 1st lien. These loans predominantly have a 75% portion guaranteed by the SBA. SBA PPP loans originated in response to the COVID-19 pandemic and are guaranteed by the SBA. The loans may be forgivable by the SBA if certain requirements are met. 41 Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to numerous borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. At December 31, 2022, no significant concentrations exceeding 10% of total loans existed in the Company’s loan portfolio, except as described above. The following table presents the maturity distribution of loans at December 31, 2022 categorized by fixed or variable interest rates, net of unearned loan fees: ($ in thousands) Due in One Year or Less (1) After One Through Five Years After Five Through Fifteen Years After Fifteen Years Total Percent of Total Loans Fixed Rate Loans Commercial and industrial $ 60,863 $ 449,944 $ 464,988 $ 11,593 $ 987,388 10 % Real estate: Commercial 193,033 1,416,693 554,376 19,952 2,184,054 22 % Construction and land development 41,884 73,081 4,703 3,064 122,732 1 % Residential 8,901 87,614 17,159 29,740 143,414 2 % Other 6,946 2,431 98,291 81,769 189,437 2 % Total $ 311,627 $ 2,029,763 $ 1,139,517 $ 146,118 $ 3,627,025 37 % Variable Rate Loans Commercial and industrial $ 1,093,647 $ 1,584,018 $ 165,260 $ 29,569 $ 2,872,494 30 % Real estate: Commercial 155,516 487,648 412,447 1,388,706 2,444,317 25 % Construction and land development 159,160 202,875 53,165 73,633 488,833 5 % Residential 45,670 30,635 71,506 104,312 252,123 2 % Other 7,914 16,089 28,219 124 52,346 1 % Total $ 1,461,907 $ 2,321,265 $ 730,597 $ 1,596,344 $ 6,110,113 63 % Total Loans Commercial and industrial $ 1,154,510 $ 2,033,962 $ 630,248 $ 41,162 $ 3,859,882 40 % Real estate: Commercial 348,549 1,904,341 966,823 1,408,658 4,628,371 47 % Construction and land development 201,044 275,956 57,868 76,697 611,565 6 % Residential 54,571 118,249 88,665 134,052 395,537 4 % Other 14,860 18,520 126,510 81,893 241,783 3 % Total $ 1,773,534 $ 4,351,028 $ 1,870,114 $ 1,742,462 $ 9,737,138 100 % (1) Includes loans with no stated maturity and overdraft lines of credit. The majority of variable loans are based on the prime rate, LIBOR, or SOFR. At December 31, 2022, $3.7 billion or 60% of variable rate loans were subject to an interest rate floor. Most loan originations have one-to three-year maturities. Management monitors this mix as part of its interest rate risk management. See “Interest Rate Risk” of this MD&A section. 42 Provision and Allowance for Credit Losses The following table presents the components of the provision for credit losses for the periods indicated: December 31, (in thousands) 2022 2021 Benefit for loan losses $ (4,210) $ (10,911) Provision on acquired loans — 23,904 Provision for off-balance sheet commitments 1 4,462 1,911 Provision for held-to-maturity securities 121 165 Recovery of accrued interest (984) (1,684) Provision (benefit) for credit losses $ (611) $ 13,385 1 2021 includes $1.5 million as part of the First Choice acquired commitments. The provision for credit losses, which includes a provision for losses on unfunded commitments, is a charge to earnings to maintain the ACL at a level consistent with management’s assessment of expected losses in the loan portfolio at the balance sheet date. The Company also records reversals of interest on nonaccrual loans and interest recoveries directly through the provision of credit losses. CECL requires economic forecasts to be factored into determining estimated losses. As a result, CECL is designed to typically require a higher level of provision at the start of an economic downturn. The decrease in the provision for credit losses in 2022 was primarily due to the provision on acquired loans from the First Choice acquisition recognized in 2021, partially offset by a change in economic forecasts that worsened in 2022 and an increase in unfunded commitments. Two of the primary economic loss drivers used in estimating the ACL include the percentage change in GDP and unemployment. At December 31, 2022, the Company’s forecast of the percentage change in GDP included a range of (2.3)% to 3.5% and unemployment included a range of 3.5% to 7.7%. This compares to a range of (2.2)% to 6.7% for the percentage change in GDP and a range of 3.0% to 8.7% for unemployment in 2021. The Company utilizes a one-year reasonable and supportable forecast and a one-year reversion period. In the acquisition of First Choice in 2021, we recognized an allowance of $7.6 million on PCD loans and an allowance of $23.9 million on non-PCD loans. Pursuant to the CECL accounting methodology, the allowance on PCD loans is recorded as part of the acquired loan portfolio. The allowance on non-PCD loans was established through a charge to the provision for credit losses in the post-combination financial statements. The Company did not recognize an acquisition related provision for credit losses in 2022. 43 To the extent the Company does not recognize charge-offs and economic forecasts improve in future periods, the Company could recognize a reversal of provision for credit losses. Conversely, if economic conditions and the Company’s forecast worsens, the Company could recognize elevated levels of provision for credit losses. The provision is also reflective of charge-offs in the period. The following table is a summary of the allocation of the allowance for credit losses for the periods indicated: December 31, ($ in thousands) 2022 2021 Balance at End of Period Applicable to: Amount Percent of loans in each category to total loans Amount Percent of loans in each category to total loans Commercial and industrial $ 53,835 39.6 % $ 63,825 37.6 % Real estate: Commercial 58,943 47.5 % 53,437 46.3 % Construction and land development 11,444 6.3 % 14,536 8.1 % Residential 7,928 4.1 % 7,927 5.1 % Other 4,782 2.5 % 5,316 2.9 % Total allowance $ 136,932 100.0 % $ 145,041 100.0 % The allowance for credit losses was 1.41% of total loans at December 31, 2022, compared to 1.61%, and 1.89%, at December 31, 2021 and 2020, respectively. The decline in the allowance to total loans ratio in 2022 compared to 2021 was primarily due to an improvement in credit quality, a shift in the mix of the loan portfolio to categories with lower reserve requirements, and net loan charge-offs of $3.9 million. The following table is a summary of net charge-offs (recoveries) to average loans for the periods indicated: December 31, 2022 2021 ($ in thousands) Net Charge-offs (Recoveries) Average Loans (1) Net Charge-offs (Recoveries)/Average Loans Net Charge-offs (Recoveries) Average Loans (1) Net Charge-offs (Recoveries)/Average Loans Commercial and industrial $ 3,869 $ 3,555,483 0.11 % $ 10,425 $ 3,195,017 0.33 % Real estate: Commercial (593) 4,323,757 (0.01) % 810 3,586,773 0.02 % Construction and land development (53) 689,048 (0.01) % (451) 673,646 (0.07) % Residential 539 382,485 0.14 % 558 396,777 0.14 % Other 137 240,816 0.06 % 287 197,172 0.15 % Total $ 3,899 $ 9,191,589 0.04 % $ 11,629 $ 8,049,385 0.14 % (1) Excludes loans held for sale. See “Critical Accounting Policies and Estimates” of this MD&A section for more information on the allowance for credit losses methodology. Nonperforming loans and assets See “Item 8. Note 1 – Summary of Significant Accounting Policies” for more information on nonaccrual loans and other real estate. 44 The following table presents the categories of nonperforming assets, excluding government guaranteed portions: December 31, ($ in thousands) 2022 2021 Non-accrual loans $ 9,766 $ 23,449 Loans past due 90 days or more and still accruing interest 142 1,716 Restructured loans 73 2,859 Total nonperforming loans 9,981 28,024 Other real estate 269 3,493 Total nonperforming assets $ 10,250 $ 31,517 Total assets $ 13,054,172 $ 13,537,358 Total loans 9,737,138 9,017,642 Total allowance for credit losses 136,932 145,041 Allowance for credit losses to nonaccrual loans 1,402 % 619 % Allowance for credit losses to nonperforming loans 1,372 % 518 % Allowance for credit losses to total loans 1.41 % 1.61 % Nonaccrual loans to total loans 0.10 % 0.26 % Nonperforming loans to total loans 0.10 % 0.31 % Nonperforming assets to total assets 0.08 % 0.23 % Nonperforming loans based on loan type were as follows: ($ in thousands) December 31, 2022 Number of loans December 31, 2021 Number of loans Commercial and industrial $ 4,443 44 % 14 $ 21,538 77 % 34 Commercial real estate 4,200 42 % 10 4,414 16 % 14 Construction and land development 1,192 12 % 2 — — % — Residential real estate 73 1 % 1 2,048 7 % 12 Other 73 1 % 2 24 — % 4 Total $ 9,981 100 % 29 $ 28,024 100 % 64 The following table summarizes the changes in nonperforming loans: Year ended December 31, ($ in thousands) 2022 2021 Nonperforming loans, beginning of period $ 28,024 $ 38,507 Additions to nonaccrual loans 8,904 43,350 Charge-offs (9,393) (17,185) Principal payments (17,554) (36,648) Nonperforming loans, end of period $ 9,981 $ 28,024 Nonperforming loans at December 31, 2022 decreased $18.0 million, or 64%, when compared to December 31, 2021. The decrease in nonperforming loans during 2022 was primarily from principal payments of $17.6 million and charge-offs of $9.4 million. The charge-offs off nonperforming loans were primarily in C&I and residential real estate, representing 65% and and 22% of gross charge-offs in 2022, respectively. 45 Other real estate The following table summarizes the changes in other real estate: Year ended December 31, ($ in thousands) 2022 2021 Other real estate, beginning of period $ 3,493 $ 5,330 Additions — 3,175 Writedowns in value (268) (29) Sales (2,956) (4,983) Other real estate, end of period $ 269 $ 3,493 Investments At December 31, 2022, our portfolio of investment securities was $2.2 billion, or 17%, of total assets, compared to $1.8 billion, or 13%, of total assets as of December 31, 2021. The increase in 2022 was due to a reallocation of excess liquidity into the investment portfolio. The portfolio is comprised of both available-for-sale and held-to-maturity securities. The table below sets forth the carrying value of investment securities, excluding the allowance for credit losses: December 31, 2022 2021 ($ in thousands) Amount % Amount % Obligations of U.S. Government sponsored enterprises $ 237,785 10.6 % $ 173,511 9.6 % Obligations of states and political subdivisions 946,456 42.1 % 811,463 45.2 % Agency mortgage-backed securities 716,422 31.9 % 581,964 32.4 % U.S. Treasury Bills 208,534 9.3 % 91,170 5.1 % Corporate debt securities 137,260 6.1 % 138,193 7.7 % Total $ 2,246,457 100.0 % $ 1,796,301 100.0 % The allowance for credit losses on held-to-maturity debt securities was $0.7 million and $0.6 million at December 31, 2022 and 2021, respectively. The Company had no debt securities classified as trading at December 31, 2022, or 2021. The following table summarizes contractual maturity and tax-equivalent yields on the investment portfolio at December 31, 2022: Within 1 year 1 to 5 years 5 to 10 years Over 10 years Total ($ in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Obligations of U.S. Government-sponsored enterprises $ — — % $ 204,217 1.32 % $ 18,721 2.79 % $ 14,847 2.10 % $ 237,785 1.48 % Obligations of states and political subdivisions 2,019 3.71 % 22,340 2.29 % 111,165 3.57 % 810,932 3.11 % 946,456 3.15 % Agency mortgage-backed securities 6,141 2.80 % 64,629 3.00 % 55,614 2.82 % 590,038 2.64 % 716,422 2.69 % U.S. Treasury Bills 102,931 3.16 % 100,825 2.68 % 4,778 3.07 % — — % 208,534 2.93 % Corporate debt securities — — % 32,486 3.11 % 104,774 3.46 % — — % 137,260 3.38 % Total $ 111,091 3.15 % $ 424,497 2.09 % $ 295,052 3.33 % $ 1,415,817 2.90 % $ 2,246,457 2.82 % Yields on tax-exempt securities are computed on a taxable equivalent basis using a tax rate of 25.2%. Actual maturities can differ from contractual maturities, as borrowers may have the right to call or repay obligations with or without prepayment penalties. 46 Other investments primarily consist of the FHLB capital stock, common stock investments related to our trust preferred securities, community development funds, and other investments in private equity funds, primarily SBICs. These investments do not have a stated maturity. December 31, 2022 2021 ($ in thousands) Amount % Amount % FHLB capital stock $ 14,015 22.0 % $ 12,075 20.2 % Other investments 49,775 78.0 % 47,821 79.8 % Total $ 63,790 100.0 % $ 59,896 100.0 % Deposits The following table shows the breakdown of deposits by type: Years ended December 31, % Increase (decrease) ($ in thousands) 2022 2021 2022 vs. 2021 Noninterest-bearing demand accounts $ 4,642,732 $ 4,578,436 1.4 % Interest-bearing demand accounts 2,256,295 2,465,884 (8.5) % Money market accounts 2,655,159 2,890,976 (8.2) % Savings accounts 744,256 800,210 (7.0) % Certificates of deposit: Brokered 118,968 128,970 (7.8) % Other 411,740 479,323 (14.1) % Total deposits $ 10,829,150 $ 11,343,799 (4.5) % Noninterest-bearing deposits / Total deposits 43 % 40 % The following table shows the average balance and average rate of deposits by type: Years ended December 31, 2022 2021 2020 ($ in thousands) Average Balance Average Rate Paid Average Balance Average Rate Paid Average Balance Average Rate Paid Noninterest-bearing deposit accounts $ 4,805,549 — % $ 3,597,204 — % $ 1,854,982 — % Interest-bearing demand accounts 2,318,363 0.30 % 2,122,752 0.08 % 1,494,364 0.14 % Money market accounts 2,781,579 0.69 % 2,557,836 0.18 % 1,977,826 0.39 % Savings accounts 819,043 0.04 % 724,768 0.03 % 589,832 0.05 % Certificates of deposit 569,272 0.62 % 570,496 0.73 % 676,889 1.61 % Total interest-bearing deposits $ 6,488,257 0.46 % $ 5,975,852 0.18 % $ 4,738,911 0.44 % Total average deposits $ 11,293,806 0.27 % $ 9,573,056 0.11 % $ 6,593,893 0.32 % Average total deposits were $11.3 billion for the year ended December 31, 2022, an increase of $1.7 billion, or 18%, from December 31, 2021. The increase in 2022 was primarily due to a full year of balances from the First Choice acquisition and organic growth. The increase in 2021 was primarily due to the First Choice and Seacoast acquisitions and the high level of liquidity in the economy. 47 The following table sets forth the maturities of estimated uninsured certificates of deposit as of December 31, 2022. Uninsured deposits are amounts estimated to exceed the FDIC deposit insurance limit and are not subject to any federal or state insurance program. ($ in thousands) Total Three months or less $ 27,656 Over three through six months 22,492 Over six through twelve months 48,721 Over twelve months 25,702 Total $ 124,571 As of December 31, 2022, estimated uninsured deposits totaled $5.9 billion, including $124.6 million of certificates of deposit. Also, at December 31, 2021 estimated uninsured deposits totaled $5.9 billion. Shareholders’ equity Shareholders’ equity totaled $1.5 billion at December 31, 2022, a decrease of $6.9 million, or 0.4%, from December 31, 2021. Significant activity during the year ended December 31, 2022 included the following: • Increase from net income of $203.0 million; • Net decrease in fair value of available-for-sale securities and cash flow hedges of $149.1 million; • Decrease from dividends paid on common stock of $33.6 million and preferred stock of $4.0 million, respectively; • Decrease from share repurchases of $32.9 million, pursuant to the Company’s publicly-announced stock repurchase program; and • Retirement of 1,980,093 of treasury stock shares. Liquidity and Capital Resources Liquidity The objective of liquidity management is to ensure we have the ability to generate sufficient cash or cash equivalents in a timely and cost-effective manner to meet our commitments as they become due. Typical demands on liquidity are changes in deposit levels, maturing time deposits which are not renewed, and fundings under credit commitments to customers. Funds are available from a number of sources, such as the core deposit base and loan and security repayments and maturities. Additionally, liquidity is provided from lines of credit with the FHLB, the Federal Reserve, and correspondent banks; the ability to acquire large and brokered deposits; sales of the securities portfolio; and the ability to sell loan participations to other banks. These alternatives are an important part of our liquidity plan and provide flexibility and efficient execution of the asset-liability management strategy. The Company’s Asset-Liability Management Committee oversees our liquidity position, the parameters of which are approved by the Bank’s Board of Directors. Our liquidity position is monitored daily. Our liquidity management framework includes measurement of several key elements, such as a loan to deposit ratio, a liquidity ratio, and a dependency ratio. The Company’s liquidity framework also incorporates contingency planning to assess the nature and volatility of funding sources and to determine alternatives to these sources. While core deposits and loan and investment repayments are principal sources of liquidity, funding diversification is another key element of liquidity management and is achieved by strategically varying depositor types, terms, funding markets, and instruments. Liquidity from assets is available primarily from cash balances and the investment portfolio. Cash and interest-bearing deposits with other banks totaled $291.4 million at December 31, 2022, compared to $2.0 billion at 48 December 31, 2021. The decline in cash balances during 2022 is due to loan growth and a deployment of liquidity into the investment portfolio, coupled with a decline in total deposits. The increase in market interest rates in 2022 increased the competitive environment for deposits, as depositors have more alternatives to bank deposit accounts. This reverses the trend from 2020-2021, when the low interest rate environment, coupled with an uncertain outlook and government stimulus, increased liquidity within the banking industry. Investment securities are another important tool to the Company’s liquidity objectives. Securities totaled $2.2 billion at December 31, 2022, and included $734 million pledged as collateral for deposits of public institutions, treasury, loan notes, and other requirements. The remaining $1.4 billion could be pledged or sold to enhance liquidity, if necessary. Liability liquidity funding sources are available to increase financial flexibility. In addition to amounts borrowed at December 31, 2022, the Company could borrow an additional $752 million from the FHLB of Des Moines under blanket loan pledges and has additional real estate loans that could be pledged. The Company also has $1.4 billion available from the Federal Reserve Bank under a pledged loan agreement. The Company also has unsecured federal funds lines with six correspondent banks totaling $90 million. In the normal course of business, the Company enters into certain forms of off-balance sheet transactions, including unfunded loan commitments and letters of credit. These transactions are managed through the Company’s various risk management processes. Management considers both on-balance sheet and off-balance sheet transactions in its evaluation of the Company’s liquidity. The Company has $3.2 billion in unused commitments to extend credit as of December 31, 2022. While this commitment level would exhaust the majority the Company’s current liquidity resources, the nature of these commitments is such that the likelihood of funding them in the aggregate at any one time is low. At the holding company level, our primary funding sources are dividends and payments from the Bank and proceeds from the issuance of equity (i.e. stock option exercises, stock offerings) and debt instruments. The main use of this liquidity is to provide the funds necessary to pay dividends to shareholders, service debt, invest in subsidiaries as necessary, and satisfy other operating requirements. In 2022, the holding company maintained a revolving line of credit for an aggregate amount up to $25 million, all of which was available at December 31, 2022. The line of credit has a one-year term that was renewed in February 2023. The proceeds can be used for general corporate purposes. The Company has an effective automatic shelf registration statement on Form S-3 allowing for the issuance of various forms of equity and debt securities. The Company’s ability to offer securities pursuant to the registration statement depends on market conditions and the Company’s continuing eligibility to use the Form S-3 under rules of the SEC. Strong capital ratios, credit quality and core earnings are essential to retaining cost-effective access to the wholesale funding markets. Deterioration in any of these factors could have a negative impact on the Company’s ability to access these funding sources and, as a result, these factors are monitored on an ongoing basis as part of the liquidity management process. The Bank is subject to regulations and, among other things, may be limited in its ability to pay dividends or transfer funds to the parent company. Accordingly, consolidated cash flows as presented in the consolidated statements of cash flows may not represent cash immediately available for the payment of cash dividends to the Company’s shareholders or for other cash needs. Through the normal course of operations, the Company has entered into certain contractual obligations and other commitments. Such obligations relate to funding of operations through deposits or debt issuances, as well as leases for premises and equipment. As a financial services provider, the Company routinely enters into commitments to extend credit. While contractual obligations represent future cash requirements of the Company, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans made by the Company. The Company also enters into derivative contracts under which the Company either receives cash from or pays cash to counterparties depending on changes in interest rates. Derivative contracts are carried at fair value on the consolidated balance sheet with the fair value representing the net present value of expected future cash receipts or payments based on 49 market interest rates as of the balance sheet date. The fair value of these contracts changes daily as market interest rates change. For additional information on the Company’s contractual obligations and commitments see the following footnotes in Item 8: “Note 5 – Leases,” “Note 6 – Derivative Financial Instruments,” “Note 10 – Subordinated Debentures and Notes,” “Note 11 – Federal Home Loan Bank Advances,” “Note 12 – Other Borrowings,” and “Note 17 – Commitments.” Capital Resources The Company and the Bank are subject to various regulatory capital requirements administered by the state and federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the financial statements and results of operations of the Company. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and its bank affiliate must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The banking affiliate’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and tier 1 capital to risk-weighted assets, and of tier 1 capital to average assets. To be categorized as “well-capitalized”, banks must maintain minimum total risk-based (10%), tier 1 risk-based (8%), common equity tier 1 risk-based (6.5%), and tier 1 leverage ratios (5%). As of December 31, 2022, and December 31, 2021, the Company and the Bank met all capital adequacy requirements to which they are subject. The Bank met the definition of “well-capitalized” at each of December 31, 2022 and 2021. Refer to “Item 8. Note 14 – Regulatory Capital” for a summary of our risk-based capital and leverage ratios. The following table summarizes the Company’s capital ratios: December 31, 2022 December 31, 2021 ($ in thousands) EFSC Bank EFSC Bank To Be Well-Capitalized Minimum Ratio with CCB Common Equity Tier 1 Capital to Risk Weighted Assets 11.1 % 12.1 % 11.3 % 12.5 % 6.5 % 7.0 % Tier 1 Capital to Risk Weighted Assets 12.6 % 12.1 % 13.0 % 12.5 % 8.0 % 8.5 % Total Capital to Risk Weighted Assets 14.2 % 13.1 % 14.7 % 13.5 % 10.0 % 10.5 % Leverage Ratio (Tier 1 Capital to Average Assets) 10.9 % 10.5 % 9.7 % 9.3 % 5.0 % 4.0 % Tangible common equity to tangible assets 1 8.4 % 8.1 % Common equity tier 1 capital $ 1,228,786 $ 1,333,978 $ 1,091,823 $ 1,201,340 Tier 1 capital 1,394,426 1,334,030 1,257,462 1,201,391 Total risk-based capital 1,568,332 1,444,685 1,423,036 1,303,715 1 Not a required regulatory capital ratio The Company believes the tangible common equity and regulatory capital ratios are important measures of capital strength. The tangible common equity to tangible assets ratio is considered a non-GAAP measure. The tables included in this MD&A section under the caption “Use of Non-GAAP Financial Measures” reconcile these ratios to U.S. GAAP. 50 Risk Management Market risk arises from exposure to changes in interest rates and other relevant market rate or price risk. The Company faces market risk in the form of interest rate risk through transactions other than trading activities. Market risk from these activities, in the form of interest rate risk, is measured and managed through a number of methods. The Company uses financial modeling techniques to measure interest rate risk. These techniques measure the sensitivity of future earnings due to changing interest rate environments. Guidelines established by the Bank’s Asset/Liability Management Committee and approved by the Bank’s Board of Directors are used to monitor exposure of earnings at risk. General interest rate movements are used to develop sensitivity as management believes it has no primary exposure to a specific point on the yield curve. These limits are based on the Company’s exposure to immediate and sustained parallel rate movements, either upward or downward. The Company does not have any direct market risk from commodity exposures. Interest Rate Risk Our interest rate risk management practices are aimed at optimizing net interest income, while guarding against deterioration that could be caused by certain interest rate scenarios. Interest rate sensitivity varies with different types of interest-earning assets and interest-bearing liabilities. We attempt to maintain interest-earning assets, comprised primarily of both loans and investments, and interest-bearing liabilities, comprised primarily of deposits, maturing or repricing in similar time horizons in order to manage any impact from market interest rate changes according to our risk tolerance. The Company uses an earnings simulation model to measure earnings sensitivity to changing rates. The Company determines the sensitivity of its short-term future earnings to a hypothetical plus or minus 100 to 300 basis point parallel rate shock through the use of simulation modeling. The simulation of earnings includes the modeling of the balance sheet as an ongoing entity. Future business assumptions involving administered rate products, prepayments for future rate-sensitive balances, and the reinvestment of maturing assets and liabilities are included. These items are then modeled to project net interest income based on a hypothetical change in interest rates. The resulting net interest income for the next 12-month period is compared to the net interest income amount calculated using flat rates. This difference represents the Company’s earnings sensitivity to a positive or negative parallel rate shock. The following table summarizes the projected impact of interest rate shocks on net interest income: Rate Shock 1 Annual % change in net interest income At December 31, 2022 2021 + 300 bp 11.1% 22.9% + 200 bp 7.5% 14.1% + 100 bp 3.8% 5.6% - 100 bp (4.1)% NA - 200 bp (9.0)% NA - 300 bp (15.1)% NA 1 Due to the levels of interest rates in 2021, the downward shock scenarios are not shown. In addition to the rate shocks shown in the table above, the Company models net interest income under various dynamic interest rate scenarios. In general, changes in interest rates are positively correlated with changes in net interest income. The Company occasionally uses interest rate derivative instruments as an asset/liability management tool to hedge mismatches in interest rate exposure indicated by the net interest income simulation described above. They are used to modify the Company’s exposures to interest rate fluctuations and provide more stable spreads between loan yields and the rate on their funding sources. At December 31, 2022, the Company had derivative contracts to manage interest rate risk, including $200.0 million in notional value on derivatives to hedge the cash flows on 51 floating rate loans and $62.0 million in notional value on derivatives on floating rate debt. Derivative financial instruments are discussed in “Item 8. Note 6 – Derivative Financial Instruments.” The FCA has announced that the most common USD LIBOR settings (overnight, 1-month. 3-month, 6-month and 12-month) will cease publication after September 30, 2024. LIBOR was the most liquid and common interest rate index in the world and was commonly referenced in financial instruments. With the cessation of LIBOR, the Company has selected term SOFR as the replacement index for the majority of its variable rate loans and has begun providing customer notifications in early 2023. The Company ceased using LIBOR and ICE swap rates in new contracts and began issuing SOFR based loans in December 2021. We have exposure to LIBOR in various financial contracts. Instruments that may be impacted include loans, debt instruments and derivatives, among other financial contracts indexed to LIBOR and that mature after December 31, 2022. We also have loans that are indirectly linked to LIBOR through reference to the ICE swap rate. We have an internal working group composed of members from legal, credit, finance, operations, risk and audit to monitor developments, develop policies and procedures, assess the impact to the Company from the replacement index for affected contracts that expire after the expected discontinuation of representative LIBOR on June 30, 2023. Amending certain contracts indexed to LIBOR may require consent from the counterparties which could be difficult and costly to obtain in certain circumstances. As of December 31, 2022, the Company’s financial contracts indexed to LIBOR included $1.4 billion in loans (including $497.5 million indirectly linked to LIBOR through reference to an ICE swap rate), $74.8 million in borrowings, and $466.9 million (notional) in derivatives. The Company had $6.1 billion in variable rate loans as of December 31, 2022. Of these loans, $3.7 billion have an interest rate floor and nearly all of those loans were at or above the floor. $1.4 billion in variable rate loans are indexed to LIBOR, $2.9 billion are indexed to the prime rate, $1.4 billion are indexed to SOFR, and $413.4 million are indexed to other rates. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The following accounting policies are considered most critical to the understanding of the Company’s financial condition and results of operations. These critical accounting policies require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. Because these estimates and judgments are based on current circumstances, they may change over time or prove to be inaccurate based on experience. In the event different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of a materially different financial condition and/or results of operations could reasonably be expected. The impact and any associated risks related to our critical accounting policies on our business operations are described throughout “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” where such policies affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see “Item 8. Note 1 – Summary of Significant Accounting Policies.” The Company has prepared all of the consolidated financial information in this report in accordance with GAAP. The Company makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using loss experience and other factors, including the current economic environment, which management believes to be reasonable under the circumstances. We adjust such estimates and assumptions when facts and circumstances dictate. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods. There can be no assurances that actual results will not differ from those estimates. Allowance for Credit Losses The Company maintains separate allowances for funded loans, unfunded loans, and held-to-maturity securities, collectively referred to the ACL. The ACL is a valuation account to adjust the cost basis to the amount expected to 52 be collected, based on management’s experience, current conditions, and reasonable and supportable forecasts. For purposes of determining the allowance for funded and unfunded loans, the portfolios are segregated into pools that share similar risk characteristics that are then further segregated by credit grades. Loans that do not share similar risk characteristics are evaluated on an individual basis and are not included in the collective evaluation. The Company estimates the amount of the allowance based on loan loss experience, adjusted for current and forecasted economic conditions, including unemployment, changes in GDP, and commercial and residential real estate prices. The Company’s forecast of economic conditions uses internal and external information and considers a weighted average of a baseline, upside, and downside scenarios. Because economic conditions can change and are difficult to predict, the anticipated amount of estimated loan defaults and losses, and therefore the adequacy of the allowance, could change significantly and have a direct impact on the Company’s credit costs. The Company’s allowance for credit losses on loans was $136.9 million at December 31, 2022 based on the weighting of the different economic scenarios. As a hypothetical example, if the Company had only used the upside scenario, the allowance would have decreased $24.1 million. Conversely, the allowance would have increased $40.5 million using only the downside scenario. Acquisitions Acquisitions and Business Combinations are accounted for using the acquisition method of accounting. The assets and liabilities of the acquired entities have been recorded at their estimated fair values at the date of acquisition. Goodwill represents the excess of the purchase price over the fair value of net assets acquired, including the amount assigned to identifiable intangible assets. The purchase price allocation process requires an estimation of the fair values of the assets acquired and the liabilities assumed. When a business combination agreement provides for an adjustment to the cost of the combination contingent on future events, the Company includes an estimate of the acquisition-date fair value as part of the cost of the combination. To determine the fair values, the Company relies on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques. The results of operations of the acquired business are included in the Company’s consolidated financial statements from the respective date of acquisition. Merger-related costs are costs the Company incurs to effect a business combination. Merger-related expenses include costs directly related to merger or acquisition activity and include legal and professional fees, system consolidation and conversion costs, and compensation costs such as severance and retention incentives for employees impacted by acquisition activity. The Company accounts for merger-related costs as expenses in the periods in which the costs are incurred and the services are received. Income Taxes Management uses certain assumptions and estimates in determining income taxes payable or refundable for the current year, deferred income tax assets and liabilities and income tax expense. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance may be established. We consider the determination of this valuation allowance to be a critical accounting policy because of the need to exercise significant judgment in evaluating the amount and timing of recognition of deferred tax liabilities and assets, including projections of future taxable income. These judgments and estimates are reviewed on a continual basis as regulatory and business factors change. A valuation allowance for deferred tax assets may be required in the future if the amounts of taxes recoverable through loss carry backs decline, if we project lower levels of future taxable income, or we project lower levels of tax planning strategies. Such valuation allowance would be established through a charge to income tax expense that would adversely affect our operating results. Effects of New Accounting Pronouncements See “Item 8. Note 1 – Summary of Significant Accounting Policies – Recent Accounting Pronouncements” for information on recent accounting pronouncements and their impact, if any, on our consolidated financial statements. 53 Use of Non-GAAP Financial Measures The Company’s accounting and reporting policies conform to U.S. GAAP and the prevailing practices in the banking industry. However, the Company provides other financial measures, such as core efficiency ratio, tangible common equity ratio, return on average tangible common equity, and tangible book value per common share, in this report that are considered “non-GAAP financial measures.” Generally, a non-GAAP financial measure is a numerical measure of a company’s financial performance, financial position, or cash flows that exclude (or include) amounts that are included in (or excluded from) the most directly comparable measure calculated and presented in accordance with GAAP. The Company considers its core efficiency ratio, tangible common equity ratio, return on average tangible common equity, and tangible book value per common share, collectively “core performance measures,” presented in this report, as relevant measures of financial performance, even though they are non-GAAP measures, as they provide supplemental information by which to evaluate the impact of certain non-comparable items, and the Company’s operating performance on an ongoing basis. Core performance measures exclude certain other income and expense items such as merger-related expenses, facilities charges, and the gain or loss on sale of investment securities, which the Company believes to be not indicative of or useful to measure the Company’s operating performance on an ongoing basis. The attached tables contain a reconciliation of these core performance measures to the GAAP measures. The Company believes the tangible common equity ratio provides useful information to investors about the Company’s capital strength even though it is considered to be a non-GAAP financial measure and is not part of the regulatory capital requirements to which the Company is subject. The Company believes these non-GAAP measures and ratios, when taken together with the corresponding GAAP measures and ratios, provide meaningful supplemental information regarding the Company’s performance and capital strength. The Company’s management uses, and believes investors benefit from referring to, these non-GAAP measures and ratios in assessing the Company’s operating results and related trends and when forecasting future periods. However, these non-GAAP measures and ratios should be considered in addition to, and not as a substitute for or preferable to, ratios prepared in accordance with GAAP. The Company has provided a reconciliation of, where applicable, the most comparable GAAP financial measures and ratios to the non-GAAP financial measures and ratios, or a reconciliation of the non-GAAP calculation of the financial measure for the periods indicated. Reconciliations of Non-GAAP Financial Measures Core Efficiency Ratio 54 For the Years ended December 31, ($ in thousands) 2022 2021 2020 Net interest income (GAAP) $ 473,903 $ 360,194 $ 270,001 Tax-equivalent adjustment 7,042 5,151 3,190 Less incremental accretion income — — 4,083 Noninterest income (GAAP) 59,162 67,743 54,503 Less gain (loss) on sale of other real estate (93) 884 — Less gain on sale of investment securities — — 421 Less other non-core income — — 265 Core revenue (non-GAAP) $ 540,200 $ 432,204 $ 322,925 Noninterest expense (GAAP) $ 274,216 $ 245,919 $ 167,159 Less amortization on intangibles 5,367 5,691 5,673 Less merger-related expenses — 22,082 4,174 Less branch-closure expenses — 3,441 — Less other non-core expenses — — 57 Core noninterest expense (non-GAAP) $ 268,849 $ 214,705 $ 157,255 Core efficiency ratio (non-GAAP) 49.77 % 49.68 % 48.70 % Tangible Common Equity, Tangible Book Value per Share, and Tangible Common Equity Ratio Period ended December 31, ($ in thousands, except per share data) 2022 2021 2020 Total shareholders' equity $ 1,522,263 $ 1,529,116 $ 1,078,975 Less preferred stock 71,988 71,988 — Less goodwill 365,164 365,164 260,567 Less intangible assets 16,919 22,286 23,084 Tangible common equity $ 1,068,192 $ 1,069,678 $ 795,324 Common shares outstanding 37,253 37,820 31,210 Tangible book value per share $ 28.67 $ 28.28 $ 25.48 Total assets $ 13,054,172 $ 13,537,358 $ 9,751,571 Less goodwill 365,164 365,164 260,567 Less intangible assets 16,919 22,286 23,084 Tangible assets $ 12,672,089 $ 13,149,908 $ 9,467,920 Tangible common equity to tangible assets 8.43 % 8.13 % 8.40 % 55 Return on Average Tangible Common Equity (ROATCE) For the Years ended December 31, ($ in thousands) 2022 2021 2020 Average shareholder’s equity $ 1,498,759 $ 1,277,153 $ 902,875 Less average preferred stock 71,988 8,903 — Less average goodwill 365,164 307,614 217,205 Less average intangible assets 19,516 22,460 23,551 Average tangible common equity $ 1,042,091 $ 938,176 $ 662,119 Net income available to common shareholders (GAAP) $ 199,002 $ 133,055 $ 74,384 Return on average tangible common equity 19.10 % 14.18 % 11.23 % ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Please refer to “Risk Factors” included in Item 1A and “Risk Management” and “Interest Rate Risk” included in Management’s Discussion and Analysis under Item 7. 56